21st Century Insurace 10K 12-31-2004
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For the
fiscal year ended December 31, 2004
Commission
File Number 0-6964
21ST
CENTURY INSURANCE GROUP
(Exact
name of registrant as specified in its charter)
Delaware |
95-1935264 |
(State
or other jurisdiction of |
(I.R.S.
Employer |
incorporation
or organization) |
Identification
No.) |
|
|
6301
Owensmouth Avenue |
|
Woodland
Hills, California |
91367 |
(Address
of principal executive offices) |
(Zip
Code) |
|
|
(818)
704-3700 |
www.21st.com |
(Registrant's
telephone number, including area code) |
(Registrant's
Web site) |
Securities
registered pursuant to Section 12 (b) of the Act:
|
Name
of each exchange on |
Title
of each class |
which
registered |
Common
Stock, Par Value $0.001 |
New
York Stock Exchange |
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
o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o
Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes x No
o
The
aggregate market value of the voting stock held by non-affiliates of 21st
Century Insurance Group, based on the average high and low prices for shares of
the registrant's Common Stock on June 30, 2004, as reported by the New York
Stock Exchange, was approximately $401,000,000.
There
were 85,489,061 shares of common stock outstanding on January 31,
2005.
Document
Incorporated By Reference:
Part III
of this Form 10-K incorporates by reference certain information from the
registrant's definitive proxy statement for the Annual Meeting of Stockholders
to be filed with the Securities and Exchange Commission within 120 days after
the close of the year ended December 31, 2004.
TABLE
OF CONTENTS
Description |
|
Page
Number |
Part
I |
|
|
Item
1. |
Business |
4 |
Item
2. |
Properties |
19 |
Item
3. |
Legal
Proceedings |
19 |
Item
4. |
Submission
of Matters to a Vote of Security Holders |
20 |
Part
II |
|
20 |
Item
5. |
Market
for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities |
20 |
Item
6. |
Selected
Financial Data |
21 |
Item
7. |
Management's
Discussion and Analysis of Financial Condition and Results of
Operations |
22 |
Item
7A. |
Quantitative
and Qualitative Disclosures about Market Risk |
38 |
Item
8. |
Financial
Statements and Supplementary Data |
40 |
Item
9. |
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure |
76 |
Item
9A. |
Controls
and Procedures |
76 |
Item
9B. |
Other
Information |
77 |
Part
III |
|
77 |
Item
10. |
Directors
and Executive Officers of the Registrant |
77 |
Item
11. |
Executive
Compensation |
77 |
Item
12. |
Security
Ownership of Certain Beneficial Owners and Management |
77 |
Item
13. |
Certain
Relationships and Related Transactions |
77 |
Item
14. |
Principal
Accountant Fees and Services |
77 |
Part
IV |
|
78 |
Item
15. |
Exhibits
and Financial Statement Schedules |
78 |
Schedule
II - Condensed Financial Information of Registrant |
81 |
Signatures
of Officers and Board of Directors |
85 |
Exhibits |
|
86 |
10(i) |
Short
Term Incentive Plan. |
|
10(r) |
Summary
of Director Compensation. |
|
10(v) |
Amendments
to Lease Agreements for Registrant's Principal Offices. |
|
10(w) |
Registrant's
Supplemental Pension Plan. |
|
10(x) |
Registrant's
Supplemental 401(k) Plan. |
|
10(y) |
Settlement
and Release Agreement between Registrant and G. Edward
Combs. |
|
10(z) |
Registrant's
Executive Medical Reimbursement Plan. |
|
14
|
Code
of Ethics. |
|
21 |
Subsidiaries
of Registrant. |
|
23
|
Consent
of Independent Registered Public Accounting Firm. |
|
31.1 |
Certification
of President and Chief Executive Officer Pursuant to Exchange Act Rule
13a-14(a). |
|
31.2
|
Certification
of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a). |
|
32.1 |
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. |
|
PART
I
ITEM
1. BUSINESS
General
21st
Century Insurance Group (together with its subsidiaries, referred to hereinafter
as the "Company", "we", "us" or "our") is an insurance holding company
registered on the New York Stock Exchange (NYSE: TW).
We are a
direct-to-consumer provider of personal auto insurance covering over 1.5 million
vehicles in California and eight other Western, Southwestern and Midwestern
states.1 We also
provide motorcycle and personal umbrella insurance in
California. Twenty-four hours per day, 365 days a year, customers have the
option to purchase insurance, service their policy or report a claim over the
phone directly through our licensed insurance professionals at 1-800-211-SAVE
(English) or 1-888-920-2121 (Spanish) or through our full service bilingual Web
site at www.21st.com. We believe that we deliver
superior policy features and customer service at a competitive
price.
21st
Century Insurance Group was founded in 1958 and, effective December 4, 2003, was
incorporated under the laws of the State of Delaware. Previously, the Company
was incorporated in California. Several subsidiaries of American International
Group, Inc. (hereinafter referred to as "AIG") together own approximately 63% of
our outstanding common stock.
Copies of
our filings with the Securities and Exchange Commission on Form 10-K, Form 10-Q,
Form 8-K and proxy statements are available along with copies of earnings
releases on the Company's Web site at www.21st.com. Copies
may also be obtained free of charge directly from the Company's Investor
Relations Department (6301 Owensmouth Avenue, Woodland Hills, California 91367,
phone 818-673-3996).
Geographic
Concentration of Business
We write
private passenger automobile insurance primarily in California (96% of
policyholders). We also currently write auto insurance in Arizona, Nevada,
Oregon, Washington, Illinois, Indiana, Ohio, and Texas1.
_________________________
1We began
offering insurance in Texas on January 3, 2005. Results from Texas are not
expected to be material in 2005.
The
following table presents a geographical summary of our direct premiums written
for the past five years (in millions):
|
|
Direct
Premiums Written |
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
Personal
auto lines1 |
|
|
|
|
|
|
|
|
|
|
|
California |
|
$ |
1,285.6 |
|
$ |
1,189.5 |
|
$ |
967.3 |
|
$ |
879.4 |
|
$ |
861.6 |
|
Arizona2 |
|
|
33.0 |
|
|
21.2 |
|
|
13.0 |
|
|
— |
|
|
— |
|
Nevada |
|
|
6.3 |
|
|
6.7 |
|
|
8.1 |
|
|
8.9 |
|
|
7.7 |
|
Oregon |
|
|
1.2 |
|
|
1.4 |
|
|
1.6 |
|
|
2.0 |
|
|
2.2 |
|
Washington |
|
|
3.7 |
|
|
4.6 |
|
|
5.8 |
|
|
8.5 |
|
|
9.7 |
|
Ohio |
|
|
1.6 |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
Indiana |
|
|
1.3 |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
Illinois |
|
|
4.4 |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
Total
personal auto lines |
|
|
1,337.1 |
|
|
1,223.4 |
|
|
995.8 |
|
|
898.8 |
|
|
881.2 |
|
Lines
in runoff |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Homeowner3
and
Earthquake4 |
|
|
0.1 |
|
|
0.1 |
|
|
2.4 |
|
|
30.5 |
|
|
29.5 |
|
Total |
|
$ |
1,337.2 |
|
$ |
1,223.5 |
|
$ |
998.2 |
|
$ |
929.3 |
|
$ |
910.7 |
|
The table
below summarizes the concentrations of our California vehicles in force for the
personal auto lines excluding the Assigned Risk program and personal umbrella
and motorcycle coverages as of the end of each of the past five years. Our
California market share reflects a weighted distribution that tracks the
concentration of households and population. At the end of 2004, 30.3% of the
vehicles insured by us were registered in Los Angeles County. In comparison,
December 31, 2003 data from the California Department of Motor Vehicles (the
most recent available) indicates that 24% of its registrations were for vehicles
in Los Angeles County.
Voluntary
Personal Auto Lines |
|
Concentration
of California Vehicles in Force |
|
December
31, |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
Los
Angeles County |
|
|
30.3 |
% |
|
32.3 |
% |
|
37.2 |
% |
|
42.0 |
% |
|
43.6 |
% |
San
Diego County |
|
|
13.6 |
|
|
13.5 |
|
|
13.4 |
|
|
13.4 |
|
|
12.6 |
|
Southern
California excluding Los Angeles and San Diego
Counties5 |
|
|
20.3 |
|
|
21.4 |
|
|
23.5 |
|
|
25.9 |
|
|
26.5 |
|
Central
and Northern California6 |
|
|
35.8 |
|
|
32.8 |
|
|
25.9 |
|
|
18.7 |
|
|
17.3 |
|
|
|
|
100.0 |
% |
|
100.0 |
% |
|
100.0 |
% |
|
100.0 |
% |
|
100.0 |
% |
Types
and Limits of Insurance Coverage
Our
private passenger auto insurance contract generally covers: bodily injury
liability; property damage; medical payments; uninsured and underinsured
motorist; rental reimbursement; uninsured motorist property damage and collision
deductible waiver; towing; comprehensive; and collision. All of these policies
are written for a six-month term except for policies sold under the Assigned
Risk Program, which are for twelve months.
_________________
1 |
Includes
motorcycle and personal umbrella coverages, which are immaterial for all
periods presented. |
2 |
Excludes
amounts not consolidated prior to our acquisition of a majority of the
voting interests in 21st Century Insurance Company of the Southwest
(previously named 21st Century Insurance Company of Arizona): $12.8
million in 2001 and $14.7 million in 2000. |
3 |
We
no longer have any California homeowner policies in force. See further
discussion in Item 7 under the caption Underwriting
Results - Homeowner and Earthquake Lines in Runoff. |
4 |
We
ceased writing earthquake coverage in 1994, but we have remaining loss
reserves from the 1994 Northridge Earthquake that are subject to possible
adverse development. See further discussion in Item 7 under the captions
Underwriting
Results - Homeowner and Earthquake Lines in Runoff, Critical
Accounting Estimates,
and in Note 16 to the Notes to Consolidated Financial
Statements. |
5 |
Includes
the following counties: Imperial, Kern, Orange, Riverside, Santa Barbara,
San Bernardino and Ventura. |
6 |
Includes
all California counties other than Los Angeles County, San Diego County,
and those specified in Footnote 5. |
Minimum
levels of bodily injury and property damage are required by state law and
typically cover the other party's claims when our policyholder causes an
accident. Uninsured and underinsured motorist are optional coverages and cover
our policyholder when the other party is at fault and has no or insufficient
liability insurance to cover the insured's injuries and loss of income.
Comprehensive and collision coverages are also optional and cover damage to the
policyholder's automobile whether or not the insured is at fault. In some
states, we are required to offer personal injury protection coverage in lieu of
the medical payments coverage required in California.
Various
limits of liability are underwritten with maximum limits of $500,000 per person
and $500,000 per accident. Our most popular bodily injury liability limits in
force are $100,000 per person and $300,000 per accident.
Our
personal umbrella policy ("PUP") provides a choice of liability coverage limits
of $1.0 million, $2.0 million or $3.0 million in excess of underlying automobile
liability coverage that we write. Since May 2002, we have required minimum
underlying automobile limits, written by us, of $250,000 per person and $500,000
per accident for PUP policies sold. We reinsure 90% of any PUP loss with
unrelated reinsurers.
Personal
Auto Product Innovations
Starting
in May 2002, we began offering motorcycle coverage primarily to our auto
policyholders in California. In August 2002, we introduced a new private
passenger auto policy in California that does not have certain standard features
found in our primary policy. This limited-feature product is similar in most
respects to the product offered by many of our competitors, and is positioned as
a lower-cost alternative for customers who believe they need less coverage than
provided by our standard product. In October 2002, we enhanced our underwriting
guidelines allowing us to provide quotes to more customers who do not meet
California's statutory "good driver" definition, but who are considered to be
insurable risks within our class plan.
The
foregoing product innovations account for approximately 14% of new auto policies
written in California in 2004. Each innovation was designed to earn an
underwriting profit equivalent to the rest of the California auto product (with
the exception of the Assigned Risk program). Initial results for each product
innovation are in line with expected profit levels.
Marketing
While we
offer personal auto policies in nine states, most of our marketing efforts are
focused on the larger urban markets in California. Beginning in late 2001, we
resumed active marketing in Arizona. We began offering personal auto insurance
in Illinois, Indiana and Ohio on January 28, 2004, and in Texas on January 3,
2005.
Our
marketing and underwriting strategy is to appeal to careful and responsible
drivers who desire a feature-rich product at a competitive price. We use direct
mail, broadcast and print media, outdoor, community events and the Internet to
generate inbound telephone calls, which are served by centralized licensed
insurance agents. Because our sales agents are centralized, we can deliver a
highly efficient and professional experience for our customers 24 hours per day,
365 days per year through a convenient, toll-free 800-211-SAVE telephone number.
Customers may also obtain an auto rate quotation and purchase a policy on our
Web site
at www.21st.com.
Approximately
60% of all Spanish speaking residents in the United States live in the states of
California, Arizona, Illinois, and Texas. We are the only significant auto
insurer to provide full service in Spanish via our Web site and bilingual
professionals 24 hours per day, 365 days per year through a dedicated toll-free
telephone number at 888-920-2121. Additionally we utilize Spanish speaking
advertising and materials to attract the Spanish speaking
community.
The
following table summarizes advertising expenditures (in millions) and total new
auto policies written for the past five years:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
Total
advertising expenditures |
|
$ |
66.7 |
|
$ |
53.9 |
|
$ |
43.3 |
|
$ |
16.9 |
|
$ |
9.8 |
|
New
auto policies written 1 |
|
|
225,349 |
|
|
265,589 |
|
|
189,652 |
|
|
63,264 |
|
|
89,429 |
|
Consumer
Advocacy
We have
introduced several publications and community events designed to assist
customers and potential customers in making choices about their auto insurance
and automobile safety. Crash
Course in Auto Insurance,
available in both English and Spanish, compares coverage and service features of
products offered by the Company and its major competitors for California,
Arizona, Illinois, Indiana and Ohio. The comparisons are explained in
understandable language to help "demystify" the choices consumers must make in
selecting their personal auto insurance carrier.
We also
publish the Child
Safety Seat Guide,
Crash
Test Ratings Guide, and
The
Golden Road - Today's Senior Drivers, which we
distribute through county fairs, direct mail promotions and other
venues.
For the
past three years, 21st Century Insurance and the California Highway Patrol
("CHP") have conducted safety fairs in communities throughout California. In the
last three years, the CHP has conducted nearly 3,900 inspections, removed and
destroyed over 1,900 hazardous child safety seats, and we donated over 2,900 new
seats to California families. Based on the success of this program in
California, we entered into a partnership in 2004 with the state of Illinois to
conduct safety fairs in communities throughout Illinois. In 2004, the state
conducted nearly 500 inspections, removed and destroyed over 160 hazardous
seats, and we donated 800 new seats to Illinois families. In January 2005, the
Company also formed a partnership with the governor of Texas and the Texas
Department of Public Safety to conduct safety fairs throughout the
state.
21st
Century Insurance has also partnered with the CHP and the Arizona Department of
Public Safety to post billboards around the states encouraging drivers to be
safe. Ads in English and Spanish feature lighthearted messages discussing a
serious topic - Sober Driving. All of the materials are co-branded by the
Company, the CHP and the Arizona Department of Public Safety, as
applicable.
Customer
Retention and Vehicles in Force
Customer
retention in California, measured based on the number of vehicles in force, were
as follows as of the end of each of the past five years:
December
31, |
2004 |
2003 |
2002 |
2001 |
2000 |
Average
customer retention - California
personal auto2 |
93% |
92% |
93% |
92% |
96% |
California
vehicles in force3 |
1,477,625 |
|
1,383,175 |
|
1,178,459 |
|
1,051,982 |
|
1,150,643 |
|
All
other states vehicles in force |
62,922 |
|
33,332 |
|
27,174 |
|
23,489 |
|
31,337 |
|
Total
vehicles in force |
1,540,547 |
|
1,416,507 |
|
1,205,633 |
|
1,075,471 |
|
1,181,980 |
|
|
|
|
|
|
|
California
auto
base rate changes |
None |
+3.9%
April |
+5.7%
May |
+4.0%
July |
+6.4%
November |
From
March 1996 to February 1999, we implemented six rate decreases which resulted in
a cumulative reduction in rates of nearly 23% in our California Personal Auto
Program. As a result of this series of rate decreases, retention rates rose to
record levels for us through 2000. Growth in vehicles in force during this
period was modest as our major competitors also lowered their rates. In the year
2000 we recognized that loss costs had stopped declining and were again rising.
While our competitors took no action or, in some cases, continued to take rate
decreases, we took decisive action to improve our results and resume profitable
growth when the marketplace ultimately did react to these adverse trends. In
2000 we curtailed our advertising, adopted stricter underwriting measures,
modified our class plan rating system, and increased our California auto program
base rate by 6.4%, followed by a further rate increase of 4% in 2001. These
actions contributed to a decline in retention and vehicles in force in 2001.
Beginning in the latter half of 2001, our major California competitors began
implementing rate increases and we restarted active marketing and advertising,
both of which contributed to the increases in our retention and vehicles in
force in 2002. In January 2003, the Company received approval for a 3.9% rate
increase, which we implemented for new and renewal policies effective March 31,
2003. This increase did not significantly impact retention. We took no
California rate increases or decreases in 2004.
____________________
1 |
Includes
new PUP and motorcycle policies, which are insignificant for all periods
presented. |
2 |
Represents
an overall measure of customer retention, including new customers as well
as long-time customers. Retention rates for new customers typically are
lower than for long-time customers. |
3 |
Includes
PUP and motorcycle. |
Underwriting
and Pricing
The
regulatory system in California requires the prior approval of insurance rates.
Within the regulatory framework, we establish our premium rates based primarily
on actuarial analyses of our own historical loss and expense data. This data is
compiled and analyzed to establish overall rate levels as well as classification
differentials.
Our rates
are established at levels intended to generate underwriting profits and vary for
individual policies based on a number of rating characteristics. These rates are
a blend of base rates and class plan filings made with the California Department
of Insurance ("CDI"). Base rates are the primary amount projected to generate an
adequate underwriting profit. Class plan changes are filings that serve to
modify the factors that impact the base rates so that each individual receives a
rate that reflects their respective losses and expenses. Class plan changes are
generally meant to be revenue neutral to us, but ultimately are done in
conjunction with a base rate filing.
California
law requires that the primary rating characteristics that must be used for
automobile policies are driving record (e.g., history of accidents and moving
violations), annual mileage and number of years the driver has been licensed. A
number of other "optional" rating factors are also permitted and used in
California, which include characteristics such as automobile garaging location,
make and model of car, policy limits and deductibles, and gender and marital
status.
The
following table summarizes increases in our premium rates for each of the past
five years:
|
|
Increases
in Our Premium Rates |
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
Personal
auto lines excluding PUP |
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
— |
% |
|
3.9 |
% |
|
5.7 |
% |
|
4.0 |
% |
|
6.4 |
% |
Arizona |
|
|
4.8 |
|
|
3.0 |
|
|
3.7 |
|
|
16.5 |
|
|
20.0 |
|
Nevada |
|
|
6.4 |
|
|
— |
|
|
22.0 |
|
|
12.6 |
|
|
— |
|
Oregon |
|
|
— |
|
|
— |
|
|
3.1 |
|
|
14.0 |
|
|
21.0 |
|
Washington |
|
|
7.4 |
|
|
— |
|
|
10.7 |
|
|
44.9 |
|
|
— |
|
Lines
in runoff |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Homeowner |
|
|
N/A |
|
|
N/A |
|
|
13.2 |
|
|
4.0 |
|
|
— |
|
Earthquake |
|
|
N/A |
|
|
N/A |
|
|
N/A |
|
|
N/A |
|
|
N/A |
|
We are
required to offer insurance to any California applicant who meets the statutory
definition of a "good driver." This definition includes, but is not limited to,
all drivers licensed the previous three years with no more than one violation
point count under criteria contained in the California Vehicle Code. These
criteria include a variety of moving violations and certain at-fault
accidents.
We review
many of our policies prior to the time of renewal and as changes occur during
the policy period. Some mid-term changes may result in premium adjustments,
cancellations or non-renewals because of a substantial increase in
risk.
Competition
The
personal automobile insurance market is highly competitive and is comprised of a
large number of well-capitalized companies, many of which operate in more states
and offer a wider variety of products than we do. Several of these competitors
are larger and have greater financial resources than we do on a stand-alone
basis. According to A.M. Best, we were the seventh largest writer of private
passenger automobile insurance in California based on direct premiums written
for 2003 (latest year for which information is available). Our main competition
comes from other major writers who concentrate on the "good driver"
market.
Market
shares in California of the top ten writers of personal automobile insurance,
based on direct premiums written, according to A.M. Best, for the past five
years were as follows:
|
|
Market
Share in California
Based
on Direct Premiums Written |
|
Years
Ended December 31, |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
1999 |
|
21st
Century Insurance Group |
|
|
6 |
% |
|
6 |
% |
|
6 |
% |
|
6 |
% |
|
6 |
% |
State
Farm Group |
|
|
14 |
|
|
14 |
|
|
13 |
|
|
13 |
|
|
14 |
|
Zurich/Farmers
Group |
|
|
10 |
|
|
11 |
|
|
12 |
|
|
13 |
|
|
14 |
|
Mercury
General Group |
|
|
9 |
|
|
9 |
|
|
8 |
|
|
8 |
|
|
8 |
|
Automobile
Club of Southern California Group |
|
|
9 |
|
|
9 |
|
|
9 |
|
|
9 |
|
|
9 |
|
California
State Auto Group |
|
|
9 |
|
|
9 |
|
|
10 |
|
|
10 |
|
|
10 |
|
Allstate
Insurance Group |
|
|
8 |
|
|
9 |
|
|
11 |
|
|
10 |
|
|
9 |
|
USAA
Group |
|
|
3 |
|
|
3 |
|
|
3 |
|
|
3 |
|
|
3 |
|
Progressive
Insurance Group |
|
|
3 |
|
|
2 |
|
|
2 |
|
|
2 |
|
|
3 |
|
Government
Employees Group (GEICO) |
|
|
3 |
|
|
3 |
|
|
3 |
|
|
3 |
|
|
2 |
|
Servicing
of Business
Computerized
systems provide the information resources, telecommunications and data
processing capabilities necessary to manage our business. These systems support
the activities of our marketing, sales, service and claims people who are
dedicated to serving the needs of customers. New technology investments have
been focused on making it faster and easier for customers to transact business
while ultimately lowering our per-transaction costs.
Using our
bilingual Web site, most customers are now able to receive and accept
quotations, bind policies, pay their bills, inquire about the status of their
policies and billing information, make most common policy changes, submit first
notice of loss on a claim and access a wealth of consumer information. New
technology provides our sales and service agents with integrated knowledge about
customer contacts and enables speedier and even more convenient customer
service.
Claims
Claims
operations include the receipt and analysis of initial loss reports, assignment
of legal counsel when necessary, and management of the settlement process.
Whenever possible, physical damage claims are handled by our drive-in claims
facilities, vehicle inspection centers and Direct Repair Program ("DRP")
providers. The claims management staff administers the claims settlement process
and oversees the work of the legal and adjuster personnel involved in that
process. Each claim is carefully analyzed to provide for fair loss payments,
compliance with our contractual and regulatory obligations and management of
loss adjustment expenses. Liability and property damage claims are handled by
specialists in each area.
We make
extensive use of our DRP to expedite the repair process. Our program involves
agreements with more than 200 independent repair facilities. We agree to accept
the repair facility's damage estimate without requiring each vehicle to be
reinspected by our adjusters. All DRP facilities undergo a screening process
before being accepted, and we maintain an aggressive inspection audit program to
assure quality results. Our inspection teams visit all repair facilities each
month and perform a quality control inspection on approximately 45% of all
repairable vehicles in this program. The customer benefits by getting the repair
process started faster and by having the repairs guaranteed for as long as the
customer owns the vehicle. We benefit by not incurring the overhead expense of a
larger staff of adjusters and by negotiating repair prices we believe are
beneficial. Currently, more than 30% of all damage repairs are handled using the
DRP method.
Our
policy is to use original equipment manufacturer ("OEM") parts for body repairs.
As a result, we believe we do not have exposure to the types of class action
suits some competitors have drawn over their use of after-market
parts.
We have
established 12 claims division service offices in areas of major customer
concentrations. Our four vehicle inspection centers, located in Southern and
Northern California, as well as Arizona, handle total losses, thefts and
vehicles that are not drivable.
The
claims services division is responsible for subrogation and medical payment
claims. We also maintain a Special Investigations Unit as required by the
California State Insurance Code, which investigates suspected fraudulent claims.
We believe our efforts in this area have been responsible for saving several
million dollars annually.
We
utilize internal legal staff to handle most aspects of claims litigation. These
attorneys handle approximately 80% of all lawsuits against our policyholders.
Suits directly against the Company, and those which may involve a conflict of
interest, are assigned to outside counsel.
Growth
and Profitability Objectives
We have
stated that our long-term goal is to build an organization that consistently
produces a 96% combined ratio or better, using accounting principles generally
accepted in the United States of America ("GAAP"), and at least 15% annual
growth in direct written premiums. To achieve these goals, we have undertaken
many steps since 1999 including:
· |
Continued
our multi-state expansion with the addition of Illinois, Indiana and Ohio
in 2004, and Texas in 2005; |
· |
Restored
pricing and underwriting discipline; |
· |
Successfully
restarted active advertising for new
customers; |
· |
Introduced
product innovations to spur growth and profitability;
and |
· |
Launched
numerous initiatives to lower per-transaction
costs. |
Underwriting
Expense Ratio - Personal Auto Lines
Under
GAAP, the underwriting expense ratio is defined as underwriting expenses divided
by net premiums earned as underwriting expenses are recognized over the period
that net premiums are earned. The statutory underwriting expense ratio is
stated as a percentage of premiums written rather then premiums earned because
most underwriting expenses are recognized when policies are written. Information
extracted from statutory filings by A.M. Best for the top ten California
personal automobile insurance companies for 2003, the most recent year
available, indicates that our direct statutory underwriting expense ratio for
private passenger auto (defined as direct underwriting expenses on a statutory
basis divided by direct premiums written) was lower then seven of our nine
largest competitors in the markets in which we served for 2003. Our GAAP
underwriting results and ratios are discussed in Item 6. Selected Financial
Data and Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Results of Operations.
Losses
and Loss Adjustment Expense Reserves
The cost
to settle a customer's claim is comprised of two major components: losses and
loss adjustment expenses ("LAE").
Losses in
connection with third party coverages represent damages as a result of an
insured's acts that result in property damage or bodily injury. First party
losses involve damage or injury to the insured's property or person. In either
case, the ultimate cost of the loss is not always immediately known and, over
time, may be higher or lower than initially estimated. When establishing initial
and subsequent estimates, the amount of loss is reduced for salvage (e.g.,
proceeds from the disposal of the wrecked automobile) and subrogation (e.g.,
proceeds from another party who is fully or partially liable, such as the
insurer of the driver who caused the accident involving one of our
customers).
Loss
adjustment expenses represent the costs of adjusting, investigating and settling
claims, and are primarily comprised of the cost of our claims department,
external inspection services, and internal and external legal counsel. Corporate
support areas such as human resources, finance, and information technology
provide services to our overall operations, and, accordingly, a portion of their
operational costs are also allocated to LAE. The LAE allocable portion of such
corporate support costs is reviewed periodically as changes occur in our
organization, and we modify the allocation percentages as appropriate. During
2004, such changes effectively decreased our ratio of overhead LAE to earned
premium by 2.7 percentage points from 4.4% in 2003 to 1.7% in 2004.
Accounting
for losses and LAE is highly subjective because these costs must be estimated,
often weeks, months or even years in advance of when the payments are actually
made to claimants, attorneys, claims personnel and others involved in the claims
settlement process.
Accounting
principles require insurers to record estimates for losses and LAE in the
periods in which the insured events, such as automobile accidents, occur. This
estimation process requires us to estimate both the number of accidents that
have occurred (called "frequency") and the ultimate amount of loss and LAE
(called "severity") related to each accident. We employ actuaries who are
professionally trained and certified in the process of establishing estimates
for frequency and severity. Historically, our actuaries have not projected a
range around the carried loss reserves. Rather, they have used several methods
and different underlying assumptions to produce a number of point estimates for
the required reserves. Management reviews the assumptions underlying the loss
ratios and selects the carried reserves after carefully reviewing the
appropriateness of the underlying assumptions.
Estimating
the Frequency of Auto Accidents. By
studying the historical lag between the actual date of loss and the date the
accident is reported by the customer to the claims department, our actuaries can
make a reasonable, yet never perfect, estimate for the number of claims that
ultimately will be reported for a given period. This measurement is referred to
as frequency. The difference between the estimated ultimate number of claims
that will be made and the number that have actually been reported in any given
period is referred to as incurred but not reported ("IBNR") claims.
Estimating
the Severity of Auto Claims. For both
property damage and injury claims our adjusters determine what exposures exist
in open reserves. All property damage reserves and any injury reserves estimated
to be less than $15,000 are set at "average amounts" determined by our
actuaries. For both bodily injury and uninsured motorist claims estimated to
have value in excess of $15,000, adjusters in our claims department establish
loss estimates based upon various factors such as the extent of the injuries,
property damage sustained, and the age of the claim. Our actuaries review these
estimates, giving consideration to the adjusters' historical ability to
accurately estimate the ultimate claim and length of time it will take to settle
the claim, and provide for development in the adjusters' estimates as
applicable. Generally, the longer it takes to settle a claim, the higher the
ultimate claim cost. The ultimate amount of the loss is considered the
"severity" of the claim. In addition, the actuaries estimate the severity of the
IBNR claims.
The
severities are estimated by our actuaries each month based on historical studies
of average claim payments and the patterns of how the claims were paid. Again,
the fundamental assumption used in making these estimates is that past events
are reliable indicators of future outcomes.
Estimating
Losses and LAE for Lines in Runoff. While the
personal auto lines represent our core business, we also have losses and LAE
relating to development on remaining loss reserves for homeowners and earthquake
lines. These lines are said to be "in runoff" because we no longer have policies
in force. As discussed in the Notes to Consolidated Financial Statements, we
have not written any earthquake policies since 1994 and we exited the homeowners
insurance business at the beginning of 2002. Developing reserve estimates for
the earthquake line is particularly subjective because most of the remaining
earthquake claims are in litigation. Our actuaries evaluate the homeowners
reserve requirement on a quarterly basis, while personnel in our legal and
claims areas prepare monthly evaluations of the earthquake
reserves.
Loss
and LAE Reserve Development
Management
believes that our reserves are adequate and represent our best estimate based on
the information currently available. However, because reserve estimates are
necessarily subject to the outcome of future events, changes in estimates are
unavoidable in the property and casualty insurance business. These changes
sometimes are referred to as "loss development" or "reserve
development."
For the
personal auto lines, our actuaries prepare a monthly evaluation of loss and LAE
indications by accident year, and we assess whether there is a need to adjust
reserve estimates. As claims are reported and settled and as other new
information becomes available, changes in estimates are made and are included in
earnings of the period of the change.
The
changes in prior accident year estimates of losses and LAE incurred recorded in
each of the past five calendar years, net of reinsurance, are summarized below
(in thousands):
|
|
Changes
in the Calendar Year of Prior
Accident
Year Estimates, Net of Reinsurance |
|
Years
ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
Personal
auto |
|
$ |
(2,936 |
) |
$ |
11,159 |
|
$ |
16,200 |
|
$ |
45,742 |
|
$ |
42,178 |
|
Homeowner
and Earthquake1 |
|
|
2,831 |
|
|
40,048 |
|
|
56,158 |
|
|
72,265 |
|
|
2,845 |
|
Total |
|
$ |
(105 |
) |
$ |
51,207 |
|
$ |
72,358 |
|
$ |
118,007 |
|
$ |
45,023 |
|
Positive
amounts represent deficiencies in loss and LAE reserves, while negative amounts
represent redundancies.
To
understand these changes, it is useful to put them in the context of the
cumulative reserve development experienced by the Company over a longer time
frame. The tables on the following pages present the development of loss and LAE
reserves for the personal auto lines (Table 1) and for the homeowner and
earthquake lines in runoff (Table 2), for the years 1994 through 2004. The
figures in both tables are shown gross of reinsurance.
_____________________
1 |
We
no longer have any California homeowner policies in force. We ceased
writing earthquake coverage in 1994, but we have remaining loss reserves
from the 1994 Northridge Earthquake that are subject to possible adverse
development. See further discussion in Item 7 under the captions
Underwriting
Results - Homeowner and Earthquake Lines in Runoff, Critical
Accounting Estimates,
and the Notes to Consolidated Financial
Statements. |
In Tables 1 and 2 on the following pages, a redundancy
(deficiency) exists when the original reserve estimate is greater (less) than
the re-estimated reserves. Each amount in the tables includes the effects of all
changes in amounts for prior periods. The tables do not present accident year or
policy year development data. Conditions and trends that have affected the
development of liabilities in the past may not necessarily occur in the future.
Therefore, it would not be appropriate to extrapolate future deficiencies or
redundancies based on the table. A detailed discussion of loss and LAE reserve
development follows the tables.
The top
line of each table shows the reserves at the balance sheet date for each of the
years indicated. The upper portion of the table indicates the cumulative amounts
paid as of subsequent year ends with respect to that reserve liability. The
lower portion of the table indicates the re-estimated amount of the previously
recorded reserves based on experience as of the end of each succeeding year,
including cumulative payments made since the end of the respective year. The
estimates change as more information becomes known about the frequency and
severity of claims for individual years.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TABLE
1 - Auto Lines as of December 31, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Amounts
in thousands, except claims) |
|
1994 |
|
1995 |
|
1996 |
|
1997 |
|
1998 |
|
1999 |
|
2000 |
|
2001 |
|
2002 |
|
2003 |
|
2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
for losses and LAE, direct |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
552,872 |
|
$ |
506,747 |
|
$ |
468,257 |
|
$ |
403,263 |
|
$ |
329,021 |
|
$ |
261,990 |
|
$ |
286,057 |
|
$ |
301,985 |
|
$ |
333,113 |
|
$ |
419,913 |
|
$ |
489,411 |
|
Paid
(cumulative) as of: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later |
|
|
329,305
|
|
|
318,273
|
|
|
260,287
|
|
|
253,528
|
|
|
247,317
|
|
|
242,579
|
|
|
268,515
|
|
|
239,099 |
|
|
249,815 |
|
|
280,534 |
|
|
|
|
Two
years later |
|
|
403,462
|
|
|
392,420
|
|
|
336,538
|
|
|
319,064
|
|
|
307,797
|
|
|
311,659
|
|
|
332,979 |
|
|
312,909 |
|
|
328,951 |
|
|
|
|
|
|
|
Three
years later |
|
|
429,595
|
|
|
416,541
|
|
|
354,854
|
|
|
333,349
|
|
|
324,778
|
|
|
324,740 |
|
|
352,592 |
|
|
333,955 |
|
|
|
|
|
|
|
|
|
|
Four
years later |
|
|
435,795
|
|
|
422,393
|
|
|
357,913
|
|
|
340,907
|
|
|
326,932 |
|
|
327,745 |
|
|
358,806 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later |
|
|
437,041
|
|
|
423,429
|
|
|
363,068
|
|
|
341,446 |
|
|
327,418 |
|
|
328,557 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later |
|
|
437,052
|
|
|
427,723
|
|
|
362,824 |
|
|
341,374 |
|
|
327,162 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later |
|
|
437,015 |
|
|
427,355 |
|
|
362,508 |
|
|
341,076 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later |
|
|
436,737 |
|
|
427,059 |
|
|
362,216 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later |
|
|
436,518 |
|
|
426,844 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later |
|
|
436,307 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
re-estimated as of: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later |
|
|
465,934
|
|
|
440,158
|
|
|
365,566
|
|
|
359,262
|
|
|
313,192
|
|
|
309,953
|
|
|
352,709 |
|
|
323,791
|
|
|
348,865 |
|
|
417,225 |
|
|
|
|
Two
years later |
|
|
438,672
|
|
|
424,091
|
|
|
366,858
|
|
|
337,258
|
|
|
321,711
|
|
|
340,914
|
|
|
354,720
|
|
|
338,338 |
|
|
354,784 |
|
|
|
|
|
|
|
Three
years later |
|
|
439,125
|
|
|
425,404
|
|
|
359,925
|
|
|
335,246
|
|
|
341,695
|
|
|
328,190
|
|
|
361,264 |
|
|
339,965 |
|
|
|
|
|
|
|
|
|
|
Four
years later |
|
|
438,895
|
|
|
424,643
|
|
|
357,607
|
|
|
355,605
|
|
|
326,506
|
|
|
329,182 |
|
|
361,068 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later |
|
|
436,397
|
|
|
422,389
|
|
|
377,414
|
|
|
340,537
|
|
|
326,565 |
|
|
329,318 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later |
|
|
435,878
|
|
|
442,024
|
|
|
361,980
|
|
|
340,552 |
|
|
327,626 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later |
|
|
451,478
|
|
|
426,719
|
|
|
361,865 |
|
|
341,396 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later |
|
|
448,972
|
|
|
426,636 |
|
|
362,541 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later |
|
|
436,237 |
|
|
427,093 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later |
|
|
436,540 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redundancy
(Deficiency) |
|
$ |
116,332 |
|
$ |
79,654 |
|
$ |
105,716 |
|
$ |
61,867 |
|
$ |
1,395 |
|
$ |
(67,328 |
) |
$ |
(75,011 |
) |
$ |
(37,980 |
) |
$ |
(21,671 |
) |
$ |
2,688 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Auto Claims Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Claims
reported during the year for CA only |
|
|
352,182 |
|
|
324,143 |
|
|
294,615 |
|
|
279,211 |
|
|
295,905 |
|
|
307,403 |
|
|
323,395 |
|
|
298,417 |
|
|
293,955 |
|
|
331,734 |
|
|
354,156 |
|
Claims
pending at year end for CA only |
|
|
70,717 |
|
|
63,142 |
|
|
58,172 |
|
|
55,738 |
|
|
56,739 |
|
|
57,134 |
|
|
54,760 |
|
|
50,365 |
|
|
51,488 |
|
|
58,577 |
|
|
59,676 |
|
See
Note 8 of the Notes to Consolidated Financial Statements.
TABLE
2 - Homeowner and Earthquake Lines in Runoff as of December
31, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Amounts
in thousands) |
|
1994 |
|
1995 |
|
1996 |
|
1997 |
|
1998 |
|
1999 |
|
2000 |
|
2001 |
|
2002 |
|
2003 |
|
2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
for losses and LAE, direct |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
203,371 |
|
$ |
78,087 |
|
$ |
75,272 |
|
$ |
34,624 |
|
$ |
52,982 |
|
$ |
14,258 |
|
$ |
12,379 |
|
$ |
47,305 |
|
$ |
50,896 |
|
$ |
18,410 |
|
$ |
6,131 |
|
Paid
(cumulative) as of: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later |
|
|
193,887
|
|
|
55,738
|
|
|
75,100
|
|
|
30,232
|
|
|
48,848
|
|
|
13,103
|
|
|
30,706
|
|
|
58,274 |
|
|
71,147 |
|
|
16,277 |
|
|
|
|
Two
years later |
|
|
236,406
|
|
|
119,211
|
|
|
100,296
|
|
|
74,127
|
|
|
58,281
|
|
|
37,404
|
|
|
78,647 |
|
|
125,447 |
|
|
87,343 |
|
|
|
|
|
|
|
Three
years later |
|
|
295,768
|
|
|
139,792
|
|
|
142,850
|
|
|
82,974
|
|
|
81,887
|
|
|
83,985 |
|
|
143,564 |
|
|
140,742 |
|
|
|
|
|
|
|
|
|
|
Four
years later |
|
|
314,225
|
|
|
180,799
|
|
|
151,342
|
|
|
106,274
|
|
|
128,266 |
|
|
147,856 |
|
|
157,792 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later |
|
|
354,324
|
|
|
188,987
|
|
|
174,513
|
|
|
152,592 |
|
|
192,121 |
|
|
161,560 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later |
|
|
362,379
|
|
|
211,771
|
|
|
220,805 |
|
|
216,383 |
|
|
205,591 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later |
|
|
385,161
|
|
|
257,839 |
|
|
284,455 |
|
|
229,808 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later |
|
|
431,154 |
|
|
321,169 |
|
|
297,754 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later |
|
|
494,260 |
|
|
334,053 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later |
|
|
507,110 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
re-estimated as of: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later |
|
|
253,775
|
|
|
116,741
|
|
|
101,903
|
|
|
77,445
|
|
|
58,582
|
|
|
18,024
|
|
|
68,245 |
|
|
103,470 |
|
|
89,281 |
|
|
22,406 |
|
|
|
|
Two
years later |
|
|
290,526
|
|
|
142,071
|
|
|
145,635
|
|
|
82,716
|
|
|
61,393
|
|
|
72,546 |
|
|
121,176 |
|
|
142,211 |
|
|
93,388 |
|
|
|
|
|
|
|
Three
years later |
|
|
316,256
|
|
|
182,616
|
|
|
150,434
|
|
|
85,519
|
|
|
116,429
|
|
|
125,089 |
|
|
159,331 |
|
|
146,152 |
|
|
|
|
|
|
|
|
|
|
Four
years later |
|
|
355,690
|
|
|
186,631
|
|
|
153,521
|
|
|
140,532 |
|
|
169,157 |
|
|
163,045 |
|
|
162,998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later |
|
|
359,084
|
|
|
190,334
|
|
|
208,533 |
|
|
193,375 |
|
|
207,064 |
|
|
166,548 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later |
|
|
363,260
|
|
|
245,267
|
|
|
261,389 |
|
|
231,217 |
|
|
210,486 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later |
|
|
418,407
|
|
|
298,161 |
|
|
299,109 |
|
|
234,661 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later |
|
|
471,330 |
|
|
335,657 |
|
|
302,550 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later |
|
|
508,639 |
|
|
338,735 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later |
|
|
511,724 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redundancy
(Deficiency) |
|
$ |
(308,353 |
) |
$ |
(260,648 |
) |
$ |
(227,278 |
) |
$ |
(200,037 |
) |
$ |
(157,504 |
) |
$ |
(152,290 |
) |
$ |
(150,619 |
) |
$ |
(98,847 |
) |
$ |
(42,492 |
) |
$ |
(3,996 |
) |
|
|
|
NOTE:
Costs associated with claims that were re-opened as a result of SB 1899 are
displayed in the table as a 1994 event (since they all related to the Northridge
Earthquake) even though the legislation allowing the re-opening of these claims
was not passed until almost seven years later.
See
Notes 8 and 16 of the Notes to Consolidated Financial
Statements.
Auto
Lines Reserve Development. As shown
in the ten-year development table, our auto lines historically developed
redundancies prior to 1999 and have exhibited adverse development for 1999
through 2002. For 2003, there was favorable development of $2.7 million. The
period from 1993 to 1999 was quite unusual in that, during that time, we
experienced declining frequencies and declining severities in our auto line. As
Table 1 shows, we did not immediately have confidence in these declining trends
and did not immediately lower our reserve estimates.
Much of
the decline in trend occurred between 1996 and 1998 because of moderation in
health care costs due to greater use of HMO's and laws that were enacted in
California that limited the ability of uninsured motorists and drunk drivers to
collect non-economic damages. During 1999, we assumed that the past trend of
declining frequencies and severities would continue. However, in retrospect, it
can now be seen that the favorable decline in trends ended and loss costs began
to increase. In 2000, we continued to assume lower loss severity primarily
because of what then seemed to be an acceleration in the pattern of claims
payments and the uncertainty inherent in identifying a change in multi-year
patterns. In 2001, we experienced significant, unexpected development in our
uninsured motorist coverage while the actuarial indications for most prior
accident years were adjusted upward as more data became available. The changes
in injury trends affected the entire California market and occurred, to a
greater or lesser degree, in virtually every state in the country.
Starting
in 2001, we improved the quality and timeliness of the data available to make
initial estimates and periodic changes in estimates. We have dedicated more
resources to better understand the underlying drivers of the changes in
frequency and severity trends as they begin emerging. For example, in the second
quarter of 2003 we began making accident month actuarial analyses of our
reserves for the auto lines. Our improved methodology is reflected in the small
favorable development of $2.7 million recorded in 2004 with respect to 2003 and
prior accident years.
Homeowner
and Earthquake Lines in Runoff. In
Table 2, substantially all of the development relates to the earthquake line. A
major earthquake occurred on January 17, 1994, centered in the San Fernando
Valley community of Northridge (the "Northridge Earthquake"). Through December
31, 2004, we have settled over 46,000 Northridge Earthquake claims (including
auto claims) at a total cost (i.e., loss plus LAE) of over $1.2
billion.
In
September 2000, the State of California enacted Senate Bill 1899 ("SB 1899"),
which allowed Northridge Earthquake claims barred by contract and the statute of
limitations to be reopened during calendar year 2001. Please see Note 16 of the
Notes to Consolidated Financial Statements for additional background on the
Northridge Earthquake and SB 1899, including a discussion of factors that have
contributed to the difficulty of obtaining accurate loss and LAE estimates in
the wake of that legislation.
The loss
development in Table 2 is easiest to understand by dividing it into "pre-SB
1899" and "post-SB 1899" segments. This is because the costs relating to the
reopened claims are displayed in the table as a 1994 event (since they all
related to the Northridge Earthquake), even though the legislation allowing the
re-opening of certain claims was not passed until almost seven years later.
Before SB 1899 was passed in late 2000, we had only approximately 50 earthquake
claims remaining to be resolved out of an initial 35,000 homeowner earthquake
claims. Although we settled 98% of the claims within a year of the quake, many
upward changes in estimates were required in 1994 and beyond as new information
emerged on the severity of the damages and as settlements of litigated claims
occurred. As a result, we recorded the following upward changes in loss
estimates after 1994, but before SB 1899 came into play: 1995 - $57 million;
1996 - $40 million; 1997 - $24.8 million; 1998 - $40 million; 1999 - $2.5
million; and 2000 - $3.5 million.
Calendar
year 2001 was the one-year window SB 1899 permitted for claimants to bring
additional insurance claims and legal actions allegedly arising out of the
Northridge Earthquake. Prior to the enactment of this law, such claims were
considered by previously applicable law to be fully barred, or settled and
closed. Any additional legal actions with respect to such claims were barred
under the policy contracts, settlement agreements, and/or applicable statutes of
limitation. As a result of the enactment of this unprecedented legislation,
claimants asserted additional claims against the Company allegedly related to
damages that occurred in the 1994 earthquake but which were now being reported
seven years later in 2001. Plaintiff attorneys and public adjusters conducted
extensive advertising campaigns to solicit claimants. Hundreds of claims were
filed in the final days and hours before the December 31, 2001
deadline.
During
2001, the Company recorded an additional $70.0 million of pre-tax losses related
to the 1994 earthquake, including $50 million in the fourth quarter to cover the
indemnity and inspection portion of the claims. In the first two quarters of
2002, we expensed an additional $11.9 million of legal defense costs as they
were paid. The Company lacked sufficient information to record a reasonable
estimate of the related legal defense costs until the third quarter of 2002, at
which time an additional provision of $46.9 million was recorded. Based on
subsequent developments, we recorded an additional provision of $37.0 million in
the first quarter of 2003 and $2.2 million in 2004 (see additional discussion in
Note 16 of the Notes to Consolidated Financial Statements).
At the
end of each month, legal and claims personnel within the Company review the
adequacy of the remaining SB 1899 reserves based on the most current information
available. Based on that review, we believe our remaining earthquake reserves
are adequate as of December 31, 2004. More than ninety-eight percent of the
claims submitted and litigation brought against the Company as a result of SB
1899 have been resolved. Substantially all of the Company's remaining 1994
Earthquake claims are in litigation. No class actions have been certified and
the trial court has denied class action status for the two remaining cases
seeking class action status. While the reserves established are the Company's
current best estimate of the cost of resolving its 1994 Earthquake claims,
including claims arising as a result of SB 1899, these reserves continue to be
highly uncertain because of the difficulty in predicting how the remaining
litigated cases will be resolved.
Reinsurance
A
reinsurance transaction occurs when an insurer transfers or cedes a portion of
its exposure to a reinsurer for a premium. The reinsurance cession does not
legally discharge the insurer from its liability for a covered loss, but
provides for reimbursement from the reinsurer for the ceded portion of the risk.
We periodically monitor the continuing appropriateness of our reinsurance
arrangements to determine that our retention levels are reasonable and that our
reinsurers are financially sound, able to meet their obligations under the
agreements and that the contracts are competitively priced.
The
majority of our cessions are with AIG subsidiaries, which have earned A.M.
Best's highest financial rating of A++. The A.M. Best financial ratings of our
other reinsurers range from A- to A+. Our reinsurance arrangements are discussed
in more detail in Note 10 of the Notes to Consolidated Financial
Statements.
Our net
retention of insurance risk after reinsurance for 2005 and the preceding five
years is summarized below:
|
|
Contracts
Incepting During |
|
Net
Retention |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
Auto
and motorcycle lines |
|
|
100 |
% |
|
100 |
% |
|
100 |
% |
|
97 |
%1 |
|
94 |
% |
|
92 |
% |
Personal
umbrella policies2 |
|
|
10 |
|
|
10 |
|
|
10 |
|
|
10 |
|
|
16 |
|
|
37 |
|
Homeowner
line in runoff |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
94 |
|
|
92 |
|
We also
have catastrophe reinsurance agreements relating to the auto line with Endurance
Specialty Insurance Company, National Union Insurance Company of Pittsburg, PA
and Transatlantic Reinsurance Company, which reinsure any covered events up to
$45.0 million in excess of $20.0 million ($30.0 million in excess of $15.0
million prior to January 1, 2004).
_________________________
1 |
Effective
September 1, 2002, we entered into an agreement to cancel future cessions
under our quota share with AIG subsidiaries. The treaty would have ceded
4% of premiums for the auto and motorcycle lines to AIG subsidiaries in
the remainder of 2002 and would have declined to 2% in 2003. After
September 1, 2002, 100% of auto and motorcycle premiums are retained by
us. |
2 |
Personal
umbrella coverage is only available to our auto customers. Approximately
1% of auto customers have umbrella coverage. |
State
Regulation of Insurance Companies
Insurance
companies are subject to regulation and supervision by the insurance departments
of the various states. The insurance departments have broad regulatory,
supervisory and administrative powers, such as:
· |
Licensing
of insurance companies, agents and customer service employees;
|
· |
Prior
approval, in California and some other jurisdictions, of premium
rates; |
· |
Establishment
of capital and surplus requirements and standards of
solvency; |
· |
Nature
of, and limitations on, investments insurers are allowed to
hold; |
· |
Periodic
examinations of the affairs of insurers; |
· |
Annual
and other periodic reports of the financial condition and results of
operations of insurers; |
· |
Establishment
of statutory accounting rules; |
· |
Issuance
of securities by insurers; |
· |
Restrictions
on payment of dividends; and |
· |
Restrictions
on transactions with affiliates. |
Currently,
the California Department of Insurance ("CDI") has primary regulatory
jurisdiction over our subsidiaries, 21st Century Insurance Company and 21st
Century Casualty Company, including prior approval of premium rates. The CDI
typically conducts a financial examination of our affairs every three years. The
most recently completed triennial examination, for the three years ended
December 31, 2002, contained no findings or adjustments. In general, the current
regulatory requirements in the other states in which our subsidiaries are
licensed insurers are less restrictive than in California. 21st Century
Insurance Company of the Southwest (formerly 21st Century Insurance Company of
Arizona) changed its state of domicile from Arizona to Texas effective December
31, 2004.
In
addition to regulation by the CDI, the Company and the personal lines insurance
business in general are also subject to legislative, judicial and political
action in addition to the normal business forces of competition between
companies and the choices consumers make based on their
preferences.
To our
knowledge, no new laws were enacted in 2004 by any state in which we do business
that are expected to have a material impact on the auto insurance industry.
However, during 2004, hearings were conducted by the CDI, which could ultimately
result in regulations that would restrict the use of territory in automobile
insurance rating. Such regulations, if implemented, could negatively affect our
book of business.
Holding
Company Regulation
Our
subsidiaries are also subject to regulation by the CDI pursuant to the
provisions of the California Insurance Holding Company System Regulatory Act
(the "Holding Company Act"). Many transactions defined to be of an
"extraordinary" nature may not be effected without the prior approval of the
CDI. In addition, the Holding Company Act limits the amount of dividends our
insurance subsidiaries may pay. An extraordinary transaction includes a dividend
which, together with other dividends or distributions made within the preceding
twelve months, exceeds the greater of (i) 10% of the insurance company's
policyholders' surplus as of the preceding December 31 or (ii) the insurance
company's statutory net income for the preceding calendar year.
The
insurance subsidiaries currently have $199.6 million of statutory unassigned
surplus. Up to $109.8 million of this amount could be paid as dividends to the
parent company without prior written approval from insurance regulatory
authorities in 2005. Our insurance subsidiaries have not paid any dividends to
our holding company since 2001 due to the previous uncertainty surrounding the
taxability of dividends received by holding companies from their insurance
subsidiaries (see further discussion in Note 5 of the Notes to Consolidated
Financial Statements).
Non-Voluntary
Business
Automobile
liability insurers in California are required to participate in the California
Automobile Assigned Risk Plan ("CAARP"). Drivers whose driving records or other
relevant characteristics make them difficult to insure in the voluntary market
may be eligible to apply to CAARP for placement as "assigned risks." The number
of assignments for each insurer is based on the total applications received by
the plan and the insurer's market share. As of December 31, 2004, the number of
assigned risk insured vehicles was 2,254 compared to 3,678 at the end of 2003.
The CAARP assignments have historically produced underwriting losses. As of
December 31, 2004, this business represented less than 1% of our total direct
premiums written, and the underwriting losses were $0.9 million in 2004, $0.5
million in 2003 and $0.5 million in 2002.
Insurers
offering homeowner insurance in California are required to participate in the
California FAIR Plan ("FAIR Plan"). FAIR Plan is a state administered pool of
difficult-to-insure homeowners. Each participating insurer is allocated a
percentage of the total premiums written and losses incurred by the pool
according to its share of total homeowner direct premiums written in the state.
Participation in the current year FAIR Plan operations is based on the pool from
two years prior. Since we ceased writing direct homeowners business in 2002, the
Company will continue to receive assignments in the 2005 calendar year. Our FAIR
Plan underwriting results for 2003, 2002 and 2001 were immaterial.
Employees
We had
approximately 2,800 full and part-time employees at December 31, 2004. We
provide medical, pension and 401(k) savings plan benefits to eligible employees,
according to the provisions of each plan.
Debt
Offering
In
December 2003, the Company completed a private offering of $100 million
principal amount of 5.9 percent Senior Notes due in December 2013 at a discount
of $0.8 million. The effective interest rate on the Senior Notes, when all
offering costs are taken into account and amortized over the term of the Senior
Notes, is approximately 6 percent per annum. Of the $99.2 million in net
proceeds from the offering, $85.0 million was used to increase the statutory
surplus of 21st Century Insurance Company, a wholly-owned subsidiary of the
Company, and the balance was retained by the holding company.
On April
6, 2004, pursuant to a registration rights agreement executed in connection with
the offering, the Company filed a registration statement with the SEC enabling
holders to exchange the private offering notes for publicly registered notes. On
July 8, 2004, the Company completed an exchange offer in which all of the
private offering notes were exchanged for publicly registered notes having the
same terms.
We lease
approximately 406,000 square feet of office space for our headquarters
facilities, which are located in Woodland Hills, California. The lease term
expires in February 2015, and the lease may be renewed for two consecutive
five-year periods.
We also
lease office space in 15 other locations, of which 12 locations are in
California primarily for claims-related employees. We anticipate no difficulty
in extending these leases or obtaining comparable office facilities in suitable
locations.
Our
newest location is a customer service, sales and claims center in Lewisville,
Texas. The facility opened in mid-2004 and represents a strategic expansion of
our service and sales resources.
On
December 31, 2002, the Company entered into a sale-leaseback transaction for
$15.8 million of equipment and leasehold improvements and $44.2 million of
software. The leaseback transaction has been accounted for as a capital lease.
For a summary of the Company's lease obligations, see discussion under Item 7 of
this report and Notes 9 and 12 of the Notes to Consolidated Financial
Statements.
ITEM
3. |
LEGAL
PROCEEDINGS |
In the
normal course of business, the Company is named as a defendant in lawsuits
related to claims and insurance policy issues, both on individual policy files
and by class actions seeking to attack the Company's business practices. A
description of the legal proceedings to which the Company and its subsidiaries
are a party is contained in Note 12 of the Notes to Consolidated Financial
Statements.
ITEM
4. |
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS |
No
matters submitted during the fourth quarter of 2004.
PART
II
ITEM
5. |
MARKET
FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES |
Price
Range of Common Stock
The
Company's common stock is listed on the New York Stock Exchange ("NYSE") under
the ticker symbol "TW". The following table sets forth the high and low bid
prices on the NYSE for the common stock for the indicated periods.
|
|
2004 |
|
2003 |
|
|
|
High |
|
Low |
|
High |
|
Low |
|
Fourth
Quarter |
|
$ |
13.82 |
|
$ |
12.39 |
|
$ |
14.50 |
|
$ |
13.00 |
|
Third
Quarter |
|
|
14.15 |
|
|
12.50 |
|
|
16.05 |
|
|
13.03 |
|
Second
Quarter |
|
|
15.35 |
|
|
12.50 |
|
|
17.25 |
|
|
12.00 |
|
First
Quarter |
|
|
14.90 |
|
|
13.19 |
|
|
13.50 |
|
|
11.20 |
|
(b) |
Holders
of Common Stock |
The
approximate number of holders of our common stock on December 31, 2004 was
600.
Quarterly
dividends of $0.02 per share were declared from the first quarter of 2003
through the fourth quarter of 2004. The Company's Board of Directors considers a
variety of factors in determining the timing and amount of dividends.
Accordingly, the Company's past history of dividend payments does not assure
that future dividends will be paid. In addition, there are limits on the
insurance subsidiaries' dividend paying capacity. In 2005, the Company estimates
that one of its insurance subsidiaries has capacity to pay approximately $109.8
million in dividends to its parent, before the effect of California state income
taxes, without prior approval of the CDI.
(d) |
Securities
Authorized for Issuance under Equity Compensation
Plans |
Securities
authorized for issuance under equity compensation plans at December 31, 2004 are
as follows:
|
COLUMN
A |
COLUMN
B |
COLUMN
C |
|
|
|
|
Plan
Category |
Number
of Securities to be Issued Upon Exercise of Outstanding Options, Warrants
and Rights
(in
thousands) |
Weighted-Average
Exercise Price of Outstanding Options, Warrants and
Rights |
Number
of Securities Remaining Available for Future Issuance Under Equity
Compensation Plans (Excluding Securities Reflected in Column (A))
(in
thousands) |
Equity
compensation plans approved by stockholders |
8,109 |
$16.49 |
5,367 |
Equity
compensation plans not approved by stockholders |
None |
N/A |
N/A |
Total |
8,109 |
$16.49 |
5,367 |
See Note
14 of the Notes to Consolidated Financial Statements for additional
information.
ITEM
6. |
SELECTED
FINANCIAL DATA |
The
following selected financial data for each of the years in the five-year period
ended December 31, 2004 should be read in conjunction with the Company's
consolidated financial statements and the accompanying notes included in Item 8
of this report. All amounts set forth in the following tables are in thousands,
except for ratios and per share data.
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
Personal
Auto Lines Data |
|
|
|
|
|
|
|
|
|
|
|
Direct
premiums written |
|
$ |
1,337,190 |
|
$ |
1,223,377 |
|
$ |
995,794 |
|
$ |
898,862 |
|
$ |
881,212 |
|
Ceded
premiums written1
|
|
|
(4,815 |
) |
|
(4,858 |
) |
|
(18,902 |
) |
|
(56,205 |
) |
|
(72,675 |
) |
Net
premiums written |
|
|
1,332,375 |
|
|
1,218,519 |
|
|
976,892 |
|
|
842,657 |
|
|
808,537 |
|
Net
premiums earned |
|
|
1,313,551 |
|
|
1,172,679 |
|
|
924,559 |
|
|
838,489 |
|
|
803,770 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio2 |
|
|
75.4 |
% |
|
78.6 |
% |
|
82.9 |
% |
|
88.1 |
% |
|
90.8 |
% |
Underwriting
expense ratio3
|
|
|
19.7 |
|
|
17.9 |
|
|
15.6 |
|
|
14.9 |
|
|
14.2 |
|
Combined
ratio4 |
|
|
95.1 |
% |
|
96.5 |
% |
|
98.5 |
% |
|
103.0 |
% |
|
105.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All
Lines Data |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
premiums written |
|
$ |
1,337,198 |
|
$ |
1,223,484 |
|
$ |
998,248 |
|
$ |
929,315 |
|
$ |
910,720 |
|
Ceded
premiums written5 |
|
|
(4,814 |
) |
|
(4,854 |
) |
|
(32,949 |
) |
|
(60,359 |
) |
|
(78,592 |
) |
Net
premiums written |
|
|
1,332,384 |
|
|
1,218,630 |
|
|
965,299 |
|
|
868,956 |
|
|
832,128 |
|
Net
premiums earned |
|
|
1,313,670 |
|
|
1,172,677 |
|
|
924,559 |
|
|
864,145 |
|
|
825,486 |
|
Total
revenues |
|
|
1,383,332 |
|
|
1,246,464 |
|
|
981,295 |
|
|
914,078 |
|
|
869,762 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio |
|
|
75.6 |
% |
|
82.0 |
% |
|
89.4 |
% |
|
96.7 |
% |
|
90.8 |
% |
Expense
ratio3 |
|
|
19.7 |
|
|
17.9 |
|
|
15.5 |
|
|
15.0 |
|
|
14.4 |
|
Combined
ratio6 |
|
|
95.3 |
% |
|
99.9 |
% |
|
104.9 |
% |
|
111.7 |
% |
|
105.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income (Loss) |
|
$ |
88,225 |
|
$ |
53,575 |
|
$ |
(12,256 |
) |
$ |
(27,568 |
) |
$ |
12,945 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
(Loss) per Share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
1.03 |
|
$ |
0.63 |
|
$ |
(0.14 |
) |
$ |
(0.32 |
) |
$ |
0.15 |
|
Diluted |
|
|
1.03 |
|
|
0.63 |
|
|
(0.14 |
) |
|
(0.32 |
) |
|
0.15 |
|
Dividends
declared per Share |
|
|
0.08 |
|
|
0.08 |
|
|
0.26 |
|
|
0.32 |
|
|
0.48 |
|
__________________________
1 |
The
decrease in premiums ceded from 2000 through 2004 was caused primarily by
scheduled decreases in the AIG subsidiaries quota share program, which was
terminated effective September 1, 2002. |
2 |
The
loss and LAE ratios have decreased since 2000 primarily due to increases
in net premiums earned and the favorable impact on claim frequency of
drought conditions that have largely prevailed in southern
California. |
3 |
The
increase in the 2002 to 2004 expense ratios is primarily due to increased
advertising expenditures, increased costs for improving customer service
and opening a call center in Texas. The increase in the expense ratio from
2000 to 2001 reflects higher depreciation charges due to investments in
new technology. |
4 |
The
combined ratio for the personal auto lines was impacted by the following
items: $13.6 million of costs associated with workforce reductions and the
settlement of litigation matters in 2001; Year 2000 remediation costs of
$2.4 million in 1999; and (favorable) unfavorable prior accident year loss
and LAE development of $(2.9) million, $11.2 million, $16.2 million, $45.7
million, and $42.2 million in 2004, 2003, 2002, 2001, and 2000,
respectively. |
5 |
In
addition to the AIG subsidiaries cession discussed in footnote 1 above,
our homeowners line was 100% reinsured in 2002. |
6 |
In
addition to the effect of the items described in footnote 4 above, the
combined ratio for all lines was impacted by adverse development on
remaining loss reserves from the homeowner and earthquake lines, which are
in runoff, of $2.8 million in 2004, $40.2 million in 2003, $58.8 million
in 2002, $77.6 million in 2001, and $2.7 million in
2000. |
December
31, |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
Balance
Sheet Data: |
|
|
|
|
|
|
|
|
|
|
|
Total
investments and cash |
|
$ |
1,418,912 |
|
$ |
1,284,686 |
|
$ |
1,030,478 |
|
$ |
884,633 |
|
$ |
920,328 |
|
Total
assets |
|
|
1,864,314 |
|
|
1,738,132 |
|
|
1,470,037 |
|
|
1,354,398 |
|
|
1,340,916 |
|
Unpaid
losses and loss adjustment expenses |
|
|
495,542 |
|
|
438,323 |
|
|
384,009 |
|
|
349,290 |
|
|
298,436 |
|
Unearned
premiums |
|
|
331,036 |
|
|
312,254 |
|
|
266,477 |
|
|
236,473 |
|
|
236,519 |
|
Debt1 |
|
|
138,290 |
|
|
149,686 |
|
|
60,000 |
|
|
—
|
|
|
—
|
|
Total
liabilities |
|
|
1,089,913 |
|
|
1,037,442 |
|
|
814,429 |
|
|
695,092 |
|
|
620,355 |
|
Stockholders'
equity |
|
|
774,401 |
|
|
700,690 |
|
|
655,608 |
|
|
659,306 |
|
|
720,561 |
|
Book
value per common share |
|
|
9.06 |
|
|
8.20 |
|
|
7.67 |
|
|
7.72 |
|
|
8.46 |
|
Statutory
surplus2 |
|
|
614,893 |
|
|
535,026 |
|
|
397,381 |
|
|
393,119 |
|
|
475,640 |
|
Net
premiums written to surplus ratio3 |
|
|
2.2:1 |
|
|
2.3:1 |
|
|
2.4:1 |
|
|
2.2:1 |
|
|
1.7:1 |
|
ITEM
7. |
MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS |
Overview
We are a
direct-to-consumer provider of personal auto insurance in California and eight
other Western, Southwestern and Midwestern states. We also provide motorcycle
and personal umbrella insurance in California. We believe that we deliver
superior policy features and customer service at a competitive price. We began
offering personal auto insurance in Illinois, Indiana and Ohio on January 28,
2004, and in Texas on January 3, 2005.4
Our
primary goals include achieving and sustaining 15% annual growth in premiums
written and a 96% (or better) combined ratio in our personal auto lines. For
2004, our net premiums earned for personal auto grew 12% ($140.9 million) to
$1,313.6 million from $1,172.7 million in 2003. The combined ratio for personal
auto improved 1.4% to 95.1% in 2004 compared to 96.5% in 2003.
Net
income for 2004 was $88.2 million, compared to net income of $53.6 million in
2003 and a net loss in 2002 of $12.3 million. The 2003 full year results include
a first quarter after-tax charge of $24.1 million to strengthen earthquake
reserves and certain nonrecurring, nonoperational items that increased second
quarter net income by $9.6 million after-tax.
Cash flow
from operations for the fourth quarter of 2004 was $34.1 million compared to
$43.2 million from the fourth quarter of 2003. For the
year ended December 31, 2004, cash flow from operations was $203.4 million
compared to $188.5 million for 2003. Total assets also increased to $1.86
billion at December 31, 2004, from $1.74 billion at December 31, 2003. In
December 2003, the Company completed a $100 million senior debt offering and
used $85 million of the proceeds to increase the statutory surplus of its
principal insurance subsidiary.
See
"Results of Operations" for more details as to our overall and personal auto
lines results.
___________________________
1 |
Amount
shown for 2002 is a capital lease obligation (see Note 9 of the Notes to
Consolidated Financial Statements). |
2 |
Amount
shown for 2002 would be $343,661 were it not for the sale-leaseback
transaction described in Note 9 of the Notes to Consolidated
Financial Statements. |
3 |
Amount
shown for 2002 would be 2.8:1 were it not for the sale-leaseback
transaction referred to above. |
4 |
Results
from the Texas market are not expected to be material in
2005. |
The
remainder of our Management's Discussion and Analysis provides a narrative on
the Company's financial condition and performance that should be read in
conjunction with the accompanying financial statements. It includes the
following sections:
· |
Liquidity
and Capital Resources |
· |
Contractual
Obligations and Commitments |
· |
Off
Balance Sheet Arrangements |
· |
Losses
and LAE Incurred |
· |
Critical
Accounting Estimates |
· |
Recent
Accounting Standards |
· |
Forward-Looking
Statements |
Financial
Condition
Investments
and cash increased $134.2 million (10.4%) since the prior year primarily due to
the $203.4 million of operating cash flow offset by cash outflows of $40.4
million for fixed assets, $20.0 million for debt servicing, $8.5 million in
shareholder dividends, and $0.3 million net change in various
accounts.
The
Company's investment portfolio of $1,384.2 million contained $42.0 million of
equity securities, which are a new investment vehicle for the
Company.
At
December 31, 2004, investment-grade bonds comprised substantially all of the
fair value of the fixed maturity portfolio. As of December 31, 2004, eleven
fixed maturity securities were rated below BBB. These securities represent less
than 1% of our total investments. Of our total investments at December 31, 2004,
approximately 22.3% were invested in tax-exempt, fixed-income securities,
compared to 61.7% at December 31, 2003.
Increased
advertising, compensation and other operating costs through December 31, 2004,
associated with increased customer volume, contributed to an increase in
deferred policy acquisitions costs ("DPAC") of $5.7 million to $58.8 million,
compared to $53.1 million at December 31, 2003. The Company's DPAC is estimated
to be fully recoverable (see Critical
Accounting Estimates - Deferred Policy Acquisition Costs).
Our loss
and LAE reserves, gross and net of reinsurance, are summarized in the following
table:
AMOUNTS
IN THOUSANDS |
|
2004 |
|
2003 |
|
December
31, |
|
Gross |
|
Net |
|
Gross |
|
Net |
|
Unpaid
Losses and LAE: |
|
|
|
|
|
|
|
|
|
Personal
auto lines |
|
$ |
489,411 |
|
$ |
485,759 |
|
$ |
419,913 |
|
$ |
413,348 |
|
Homeowner
and earthquake lines in runoff |
|
|
6,131 |
|
|
5,138 |
|
|
18,410 |
|
|
16,011 |
|
Total
|
|
$ |
495,542 |
|
$ |
490,897 |
|
$ |
438,323 |
|
$ |
429,359 |
|
Gross
unpaid losses and LAE increased by $57.2 million in 2004 primarily due to a
reserve increase of $69.5 million in the personal auto lines as a result of
growth in our customer base. The increase in the personal auto lines was offset
by the $12.3 million net decrease in the homeowner and earthquake lines, which
are in runoff (see Results
of Operations - Loss and LAE Incurred for a
description of the Company's reserving process).
Unearned
premiums increased 6.0% to $331.0 million at the end of 2004 compared to $312.3
million at the end of 2003 due to higher volume in our personal auto
lines.
Debt
consists of a $38.4 million capital lease obligation with GE Capital Corporation
and the $99.9 million senior note offering issued in December 2003, aggregating
$138.3 million (see Note 9 of the Notes to Consolidated Financial Statements).
The primary purpose of both borrowings was to increase the statutory surplus of
21st Century Insurance Company, our wholly-owned subsidiary, which had
significant adverse earthquake and auto reserve development in 2000, 2001, and
2002. The decrease in debt of $11.4 million from the prior year is attributable
to principal payments on the capital lease.
Stockholders'
equity and book value per share increased to $774.4 million and $9.06,
respectively, at December 31, 2004, compared to $700.7 million and $8.20 at
December 31, 2003. The increase for the year ended December 31, 2004, was
primarily due to net income of $88.2 million, offset by a decrease in
accumulated other comprehensive income of $8.9 million and dividends to
stockholders of $6.8 million.
Effective
December 4, 2003, we changed our state of incorporation from California to
Delaware. In connection with the change, our common stock was assigned a par
value of $0.001 per share, resulting in a reclassification of $419.2 million
from common stock to additional paid-in capital. There was no change in the
location of company operations, location of employees, or the way we do business
as a result of the reincorporation.
Liquidity
and Capital Resources
21st
Century Insurance Group. Our
holding company's main sources of liquidity historically have been dividends
received from our insurance subsidiaries and proceeds from issuance of debt or
equity securities. Apart from the exercise of stock options and restricted stock
grants to employees, the effects of which have not been significant, we have not
issued any equity securities since 1998 when AIG exercised its warrants to
purchase common stock for cash of $145.6 million. Our insurance subsidiaries
have not paid any dividends to our holding company since 2001 due to the
previous uncertainty surrounding the taxability of dividends received by holding
companies from their insurance subsidiaries (see further discussion in Note 5 of
the Notes to Consolidated Financial Statements).
In
December 2003, we completed a private offering of $100 million principal amount
of 5.9 percent Senior Notes due in December 2013. The effective interest rate on
the Senior Notes when all offering costs are taken into account and amortized
over the term of the Senior Notes is approximately 6 percent per annum. Of the
$99.2 million net proceeds from the offering, $85.0 million was used to increase
the statutory surplus of our wholly-owned insurance subsidiary, 21st Century
Insurance Company, and the balance was retained by our holding company. On July
8, 2004, the Company completed an exchange offer in which all of the private
offering notes were exchanged for publicly registered notes having the same
terms.
Effective
December 31, 2003, the California Department of Insurance approved an
intercompany lease whereby 21st Century Insurance Company leases certain
computer software from our holding company. The monthly lease payment, currently
$0.6 million, started in January 2004 and is subject to upward adjustment based
on the cost incurred by the holding company to complete certain enhancements to
the software.
Our
holding company's significant cash obligations over the next several years
consist of interest payments on the Senior Notes ($5.9 million annually) and the
estimated cost of $22.0 million to implement our California policy servicing
system in 2005, exclusive of any dividends to stockholders that the holding
company may declare, and the repayment of the $100 million principal on the
Senior Notes due in 2013. The holding company expects to be able to meet those
obligations from sources of cash currently available (i.e., payments received
from the intercompany lease and cash and investments at the holding company.
Total cash and investments at the holding company were $16.2 million at December
31, 2004.), additional funds obtainable from the capital markets or from
dividends received from its insurance subsidiaries. California currently levies
state income taxes of approximately 1.8% on the amount of any such dividends
received.
Our
insurance subsidiaries could pay $109.8 million in 2005 as dividends to the
holding company without prior written approval from insurance regulatory
authorities.
Insurance
Subsidiaries. We have
achieved underwriting profits in our core auto insurance operations for the last
twelve quarters and have thereby enhanced our liquidity. Our cash flow from
operations and short-term cash position generally are more than sufficient to
meet obligations for claim payments, which by the nature of the personal
automobile insurance business tend to have an average duration of less than a
year. In California, where approximately 96.5% of our premium is written,
underwriting profit improved in 2004 without additional rate increases. We
implemented a 3.9% auto premium rate increase effective March 31, 2003 and a
5.7% rate increase in May of 2002, both of which continued a series of actions
we began taking in 2000 to restore underwriting profitability.
Although
in the past years we have been successful in gaining regulatory approval for
rate increase, there can be no assurance that insurance regulators will grant
future rate increases that may be necessary to offset possible future increases
in claims cost trends. Also, we remain exposed to possible upward development in
previously recorded reserves for claims pursuant to SB 1899. As a result of such
uncertainties, underwriting losses could occur in the future. Further, we could
be required to liquidate investments to pay claims, possibly during unfavorable
market conditions, which could lead to the realization of losses on sales of
investments. Adverse outcomes to any of the foregoing uncertainties would create
some degree of downward pressure on the insurance subsidiaries' earnings or cash
flows, which in turn could negatively impact our liquidity.
As of
December 31, 2004, our insurance subsidiaries had a combined statutory surplus
of $614.9 million compared to $535.0 million at December 31, 2003. The change in
statutory surplus was primarily due to statutory net income of $110.3 million.
This was partially offset by a decrease in net deferred tax assets of $20.9
million and an increase in nonadmitted assets of $10.0 million. Our ratio of net
premiums written to statutory surplus improved to 2.2 at December 31, 2004,
compared to 2.3 at December 31, 2003.
On June
15, 2004, the CDI finalized its examination reports on the statutory financial
statements for the Company's California-domiciled insurance subsidiaries for the
three-year period ended December 31, 2002. The reports did not contain any
findings or adjustments.
Transactions
with Related Parties. Since
1995, we have entered into several transactions with AIG subsidiaries, including
various reinsurance agreements, which are discussed under Item 1.
Business. At December 31, 2004, reinsurance recoverables, net of payables,
from AIG subsidiaries were $1.4 million, compared to $5.8 million at December
31, 2003. Other transactions with AIG subsidiaries, which are immaterial, have
resulted from competitive bidding processes for certain corporate insurance
coverages and certain software and data processing services. In October 2003, as
a result of a competitive bidding process, we entered into an agreement with an
AIG subsidiary to provide investment management services to us; the agreement
was approved by the California Department of Insurance.
Contractual
Obligations and Commitments
We have
various contractual obligations that are recorded as liabilities in our
consolidated financial statements. Certain contractual obligations, such as
operating lease obligations, are not recognized as liabilities in our
consolidated financial statements, but are required to be disclosed.
The
following table summarizes our significant contractual obligations and
commitments at December 31, 2004 and the future periods in which such
obligations are expected to be settled in cash. In addition, the table reflects
the timing of principal payments on outstanding senior notes.
|
|
|
|
Payments
Due by Period |
|
AMOUNTS
IN MILLIONS |
|
Total |
|
2005 |
|
2006
through
2007 |
|
2008
through
2009 |
|
Remaining
years
after
2009 |
|
Senior
notes |
|
$ |
153.1 |
|
$ |
5.9 |
|
$ |
11.8 |
|
$ |
11.8 |
|
$ |
123.6 |
|
Capital
lease obligation |
|
|
41.9 |
|
|
14.0 |
|
|
27.9 |
|
|
– |
|
|
–
|
|
Debt |
|
|
195.0 |
|
|
19.9 |
|
|
39.7 |
|
|
11.8 |
|
|
123.6 |
|
Operating
Leases1 |
|
|
194.3 |
|
|
27.2 |
|
|
42.8 |
|
|
34.1 |
|
|
90.2 |
|
Total |
|
$ |
389.3 |
|
$ |
41.1 |
|
$ |
82.5 |
|
$ |
45.9 |
|
$ |
213.8 |
|
The table
above excludes periodic contributions to pension plans and payments to settle
claims, which are discussed below. The capital lease obligation above resulted
from the sale-leaseback transaction discussed earlier (see further discussion of
these items in Notes 9 and 12 of the Notes to Consolidated Financial
Statements). We have no material purchase obligations or other on or off balance
sheet long-term liabilities or obligations at December 31, 2004 (see discussion
about variable interest entities in Note 2 of the Notes to Consolidated
Financial Statements).
Our
largest insurance subsidiary is responsible for making payments on both the
capital lease obligation and most of the operating lease obligations. The
holding company is the obligor on the home office subsidiary leases in Woodland
Hills, California.
We
sponsor defined benefit pension plans that may obligate us to make contributions
to the plans from time to time. Total contributions to the plans were $2.7
million in 2004, $7.0 million in 2003 and $21.5 million in 2002. For the past
several years we have followed the practice of contributing sufficient amounts
to the qualified defined benefit pension plan to meet or exceed statutory
funding requirements, without exceeding the maximum amount that would be
deductible for corporate income tax purposes, and while maintaining plan assets
at a level at least equal to the actuarial present value of accumulated plan
benefits. The amount and timing of future contributions to our qualified defined
benefit pension plan depends on a number of unpredictable factors including
statutory funding requirements, the market performance of the plan's assets,
cash requirements for benefit payments to retirees, and future changes in
interest rates that affect the actuarial measurement of the plan's obligations.
Contributions to our non-qualified defined benefit pension plan generally are
limited to amounts needed to make benefit payments to retirees, which are
expected to total approximately $1.1 million in 2005.
We had
estimated liabilities for losses and LAE of $495.5 million at December 31, 2004,
the majority of which will be required to be paid in 2005 as the related claims
are settled. We expect operating cash flow to be sufficient to meet our
obligations to pay claims and we have readily marketable investments available
for sale should operating cash flows prove to be inadequate.
Off
Balance Sheet Arrangements
We
currently have no letters of credit, have issued no guarantees on behalf of
others (other than the guarantee by 21st Century Insurance Group of the capital
lease obligation described above), have no trading activities involving
non-exchange-traded contracts accounted for at fair value, and have no
obligations under any derivative financial instruments. In addition, the Company
has no material retained interests in assets transferred to any unconsolidated
entity (see further discussion in Note 2 of the Notes to Consolidated Financial
Statements).
_________________________
1 |
Includes
amounts due under long-term software license agreements of approximately
$15.1 million. |
Results
of Operations
Overall
Results. We
reported an increase of 64.7% in net income to $88.2 million, or $1.03 earnings
per share, on direct premiums written of $1,337.2 million for the year ended
December 31, 2004, compared to a net income of $53.6 million,
or $0.63 earnings
per share, on direct premiums written of $1,223.5 million for the year ended
December 31, 2003. For the year ended December 31, 2002, we reported a net loss
of $12.3 million, or $0.14 loss per share, on direct premiums written of $998.2
million. The results for 2003 and 2002 include: (i) after-tax charges of $24.1
million in the first quarter of 2003 and $34.2 million in the third quarter of
2002 to
strengthen earthquake reserves; (ii) after-tax net income of $9.6 million for
the year ended December 31, 2003, resulting from nonrecurring, nonoperational
items and a favorable tax settlement with the IRS; and (iii) an after-tax charge
of $24.2 million, for the year ended December 31, 2002, relating to a write-off
of software.
Personal
Auto Lines Results. The
following table presents the components of our personal auto lines underwriting
profit or loss and the components of the combined ratio for the past three
years:
AMOUNTS
IN THOUSANDS |
|
Personal
Auto Lines |
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Direct
premiums written |
|
$ |
1,337,190 |
|
$ |
1,223,377 |
|
$ |
995,794 |
|
Net
premiums written |
|
|
1,332,375 |
|
|
1,218,519 |
|
|
976,892 |
|
Net
premiums earned |
|
|
1,313,551 |
|
|
1,172,679 |
|
|
924,559 |
|
Net
losses and loss adjustment expenses |
|
|
991,008 |
|
|
922,122 |
|
|
768,277 |
|
Underwriting
expenses incurred |
|
|
258,571 |
|
|
209,551 |
|
|
142,899 |
|
Personal
auto lines underwriting profit |
|
$ |
63,972 |
|
$ |
41,006 |
|
$ |
13,383 |
|
Ratios: |
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio |
|
|
75.4 |
% |
|
78.6 |
% |
|
82.9 |
% |
Underwriting
expense ratio |
|
|
19.7 |
% |
|
17.9 |
% |
|
15.6 |
% |
Combined
ratio |
|
|
95.1 |
% |
|
96.5 |
% |
|
98.5 |
% |
The
following table reconciles our personal auto lines underwriting profit to our
consolidated net income (loss):
AMOUNTS
IN THOUSANDS |
|
|
|
|
|
|
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Personal
auto lines underwriting profit |
|
$ |
63,972 |
|
$ |
41,006 |
|
$ |
13,383 |
|
Homeowner
and earthquake lines in runoff, underwriting loss |
|
|
(2,714 |
) |
|
(40,175 |
) |
|
(58,768 |
) |
Net
investment income |
|
|
58,831 |
|
|
45,833 |
|
|
46,345 |
|
Realized
investment gains |
|
|
10,831 |
|
|
13,177 |
|
|
10,391 |
|
Write-off
of software |
|
|
– |
|
|
– |
|
|
(37,177 |
) |
Other
income |
|
|
– |
|
|
14,777 |
|
|
– |
|
Interest
and fees expense |
|
|
(8,627 |
) |
|
(3,471 |
) |
|
– |
|
Federal
income tax (expense) benefit |
|
|
(34,068 |
) |
|
(17,572 |
) |
|
13,570 |
|
Net
income (loss) |
|
$ |
88,225 |
|
$ |
53,575 |
|
$ |
(12,256 |
) |
Comments
relating to the underwriting results of the personal auto and the homeowner and
earthquake lines in runoff are presented below.
Underwriting
Results
The
tables presented in the Notes to Consolidated Financial Statements summarize the
Company's unaudited quarterly results of operations for each of the two years in
the period ended December 31, 2004. The following discussion of underwriting
results by line of business should be read in conjunction with the information
presented in those tables and elsewhere herein.
Personal
Auto. Personal
automobile insurance is our primary line of business. Vehicles insured outside
of California accounted for less than 4% of our direct premiums written in 2004,
2003 and 2002.
Our
management remains focused on achieving sustainable 15% direct premium written
growth and a combined ratio of 96%. In 2004, we met our profitability goals,
posting our best combined ratio since 1999, and our direct premiums written grew
9.3% despite an increasingly competitive California marketing climate.
Direct
premiums written grew 9.3% in 2004, 22.8% in 2003 and 10.8% in 2002, for a
three-year compound average growth rate of 14.1%, or slightly less than our
long-term goal of 15%. Market conditions in California were somewhat less
favorable for growth in 2004 than in the preceding two years; for example, some
major competitors sought rate decreases in 2004 in contrast with the market-wide
rate increases, which helped to spur consumers' shopping activity in 2003 and
2002. As we proceed with our multi-state expansion, we believe that achieving
our long-term growth goal will steadily depend less on the California
marketplace.
California
auto retention was 93% for the year ended December 31, 2004, compared to 92% and
93% for the years ended December 31, 2003 and 2002, respectively. The increase
in 2004 is primarily due to a decline in the growth rate of new customers who
typically have a lower retention rate than long-time customers.
Net
premiums earned increased $140.9 million (12.0%) to $1,313.6 million in 2004,
compared to $1,172.7 million in 2003 and $924.6 million in 2002. The combined
ratio was 95.1% for the year ended December 31, 2004, compared to 96.5% and
98.5% for 2003 and 2002, respectively.
Net
losses and LAE incurred increased $68.9 million (7.5%) to $991.0 million in 2004
compared to $922.1 million and $768.3 million in 2003 and 2002, respectively.
The loss and LAE ratios were 75.4%, 78.6% and 82.9% for the years ended December
31, 2004, 2003 and 2002, respectively. The effects on the loss and LAE ratios of
changes in estimates relating to insured events of prior years were as follows:
0.2% favorable in 2004; 1.0% unfavorable in 2003; and 1.8% unfavorable in 2002.
For additional discussion of the factors that led to these changes in estimates,
please see Item 1 of this report under the heading Loss
and Loss Adjustment Expense Reserves. In
general, changes in estimates are recorded in the period in which new
information becomes available indicating that a change is warranted, usually in
conjunction with our monthly actuarial review.
The
ratios of underwriting expenses to net premiums earned were 19.7%, 17.9% and
15.6% for the years ended December 31, 2004, 2003 and 2002, respectively. The
increase from 2002 to 2003 was primarily due to growth in advertising
expenditures and costs associated with increasing the number of new sales agents
to handle record volume of new business during the latter half of 2002 and all
of 2003. The increase from 2003 to 2004 consists primarily of increased
advertising costs, additional sales workforce costs, and facility and support
costs to improve service and support the Texas call center. Several productivity
enhancement initiatives are underway aimed at reducing per unit process costs
and lowering fixed costs in corporate support areas.
Homeowner
and Earthquake Lines in Runoff. We have
not written any earthquake policies since 1994 and we exited the homeowners
insurance business at the beginning of 2002. The homeowner and earthquake lines,
which are in runoff, experienced adverse development on the remaining loss
reserves of $2.8 million, compared to adverse development of $40.1 million in
2003 and $56.2 million in 2002. Of these amounts, $2.2 million, $36.9 million,
and $52.6 million, respectively, related to SB 1899 earthquake claims. We
caution that the recorded loss and LAE estimates for our earthquake lines are
subject to a greater than normal degree of uncertainty for a variety of reasons
(see Note 16 of the Notes to Consolidated Financial Statements).
We have
executed various transactions to exit from our homeowner line. Under a January
1, 2002 agreement with Balboa Insurance Company ("Balboa"), a subsidiary of
Countrywide Financial Corporation ("Countrywide"), 100% of homeowner unearned
premium reserves and losses on or after that date were ceded to Balboa. Under
the terms of this agreement, we retain certain loss adjustment expenses. We
began non-renewing homeowner policies expiring on February 21, 2002, and
thereafter. Substantially all of these customers were offered homeowner coverage
through an affiliate of Countrywide. We have completed this process and no
longer have any homeowner policies in force.
Losses
and LAE Incurred
The
following table summarizes losses and LAE incurred, net of reinsurance, for the
periods indicated:
AMOUNTS
IN THOUSANDS |
|
|
|
|
|
|
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Net
Losses and LAE incurred related to insured events of: |
|
|
|
|
|
|
|
Current
year: |
|
|
|
|
|
|
|
Personal
auto lines |
|
$ |
993,944 |
|
$ |
910,963 |
|
$ |
752,077 |
|
Homeowner
and earthquake lines in runoff |
|
|
2 |
|
|
141 |
|
|
2,222 |
|
Total
current year |
|
$ |
993,946 |
|
|
911,104 |
|
|
754,299 |
|
|
|
|
|
|
|
|
|
|
|
|
Prior
years: |
|
|
|
|
|
|
|
|
|
|
Personal
auto lines |
|
|
(2,936 |
) |
|
11,159 |
|
|
16,200 |
|
Homeowner
and earthquake lines in runoff |
|
|
2,831 |
|
|
40,048 |
|
|
56,158 |
|
Total
prior years' reserve (redundancy) deficiency recorded
in current year |
|
|
(105 |
) |
|
51,207 |
|
|
72,358 |
|
Total |
|
$ |
993,841 |
|
$ |
962,311 |
|
$ |
826,657 |
|
Net
favorable reported loss development for the prior accident years was $0.1
million, which resulted from favorable development on the personal auto lines
that was offset by adverse development on the homeowner and earthquake lines in
runoff. The methods used to determine such estimates and to establish the
resulting reserves are continually reviewed and updated. Any adjustments
resulting therefrom are reflected in current operating income. It is
management's belief that the unpaid losses and LAE are adequate to cover unpaid
losses and LAE as of December 31, 2004. While we perform quarterly reviews of
the adequacy of established unpaid losses and LAE, there can be no assurance
that our ultimate unpaid losses and LAE will not develop redundancies or
deficiencies and possibly differ materially from our unpaid losses and LAE as of
December 31, 2004. In the future, if the unpaid losses and LAE develop
redundancies or deficiencies, such redundancy or deficiency would have a
positive or adverse impact, respectively, on future results of
operations.
The
process of making changes to unpaid losses and LAE begins with the preparation
of several point estimates of unpaid losses and LAE, a review of the actual
claims experience in the quarter, actual rate changes achieved, actual changes
in coverage, mix of business, and changes in certain other factors such as
weather and recent tort activity that may affect the loss ratio. Our actuaries
prepare several point estimates of unpaid losses and LAE for each of the
coverages, and they use their experience and judgment to arrive at an overall
actuarial point estimate of the unpaid losses and LAE for that coverage.
Meetings are held with appropriate departments to discuss significant issues as
a result of the review. This process culminates in a reserve meeting to review
the unpaid losses and LAE. Other relevant internal and external factors
considered include a qualitative assessment of inflation and other economic
conditions, changes in the legal, regulatory, judicial and social environments,
underlying policy pricing, exposure and policy forms, claims handling, and
geographic distribution shifts. As a result of the meeting, unpaid losses and
LAE are finalized and we record quarterly changes in unpaid losses and LAE for
each of our coverages. The change in unpaid losses and LAE for the quarter for
each coverage is the difference between net ultimate losses and LAE and the net
paid losses and LAE recorded through the end of the quarter. The overall change
in our unpaid losses and LAE is based on the sum of these coverage level
changes.
The point
estimate methods include the use of paid loss triangles, incurred loss
triangles, claim count triangles, and severity triangles, as well as expected
loss ratio methods. Quantitative techniques frequently have to be supplemented
by subjective consideration, including managerial judgment, to assure that the
overall unpaid losses and LAE are adequate to meet projected losses. For
example, in property damage coverages, repair cost trends by geographic region
vary significantly. These factors are periodically reviewed and subsequently
adjusted, as appropriate, to reflect emerging trends which are based upon past
loss experience. Thus, many factors are implicitly considered in estimating the
loss costs recognized.
Judgment
is required in analyzing the appropriateness of the various methods and factors
to avoid overreacting to data anomalies that may distort such prior trends. For
example, changes in limits distributions or development in the most recent
accident quarters would require more actuarial judgment. We do not believe
disclosure of specific point estimates calculated by the actuaries would be
meaningful. Any one actuarial point estimate is based on a particular series of
judgments and assumptions of the actuary. Another actuary may make different
assumptions, and therefore reach a different point estimate.
There is
a potential for significant variation in developing unpaid losses and LAE. Most
automobile claims are reported within two to three months whereas the estimate
of ultimate severities exhibits greater variability at the same maturity.
Generally, actual historical loss development factors are used to project future
loss development, and there can be no assurance that future loss development
patterns will be the same as in the past. However, we believe that our reserving
methodologies are in line with other personal lines insurers and would normally
expect ultimate unpaid losses and LAE development to vary by as much as 5% of
the carried unpaid losses and LAE.
As a
result of the significant growth in the non-Los Angeles County regions, the
Company has experienced changes in the mix of business relative to geography and
policy limits. We believe that the assumption with the highest likelihood of
change that could materially affect carried unpaid losses and LAE is property
damage and collision severity in the San Francisco and Bay Area regions, which
have significantly different repair costs and have exhibited significant policy
growth. A 5% change in the severity assumption for these regions would result in
an increase or decrease in total unpaid losses and LAE of 0.14%, or $1.8
million.
While we
have settled over 98% of Northridge Earthquake claims and related litigation,
estimates of both the litigation costs and ultimate settlement or judgment
amounts related to these claims are subject to a high degree of uncertainty.
Please see Note 16 of the Notes to Consolidated Financial Statements for
additional background on the Northridge Earthquake and SB 1899.
Investment
Income
We
utilize a conservative investment philosophy. No derivatives or nontraditional
securities are held in our investment portfolio and only 3% of the portfolio
consists of equity securities. Substantially all of the fixed maturity portfolio
is investment grade. Net investment income was $58.8 million in 2004, compared
to $45.8 million in 2003 and $46.3 million in 2002. Average invested assets
increased 23.2% in 2004, 17.9% in 2003 and 1.3% in 2002. The average annual
pre-tax yields on invested assets were 4.4% in 2004, 4.2% in 2003, and 5.1% in
2002. The average annual after-tax yields on invested assets were 3.3% in 2004,
3.6% in 2003, and 4.3% in 2002.
Net
realized gains on the sale of investments1
were
$10.8 million in 2004 (gross realized gains were $14.1 million and gross
realized losses were $3.3 million), compared to net realized gains of $13.2
million in 2003 (gross realized gains were $13.7 million and gross realized
losses were $0.5 million), and net realized gains of $10.4 million in 2002
(gross realized gains were $13.1 million and gross realized losses were $2.7
million). At December 31, 2004, $308.0 million (22.3%) of our total fixed
maturity investments at fair value were invested in tax-exempt bonds, compared
to 64.9% at December 31, 2003 and 60.7% at December 31, 2002, with the
remainder, representing 77.7% of the portfolio, invested in taxable securities,
compared to 35.1% at December 31, 2003 and 39.3% at December 31, 2002. The shift
to taxable securities in 2004 was made to reduce the average duration of the
portfolio and to accelerate the realization of the Company's NOL
carryforward.
_______________________________
1 |
Includes
loss on disposal of fixed assets of $849, $156 and $479 in 2004, 2003, and
2002, respectively. |
We
recognized no other-than-temporary impairments in 2004, 2003, or 2002 (see
discussion under Critical
Accounting Estimates).
Other
Income
Other
income of $14.8 million in the year ended December 31, 2003, included $9.3
million resulting from a nonrecurring, nonoperational item from the settlement
of litigation, interest income of $4.8 million relating to a favorable
settlement with the Internal Revenue Service ("IRS"), and miscellaneous items of
$0.7 million. No other income was reported in 2004 and 2002.
Critical
Accounting Estimates
Our
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America. The financial information
contained within those statements is, to a significant extent, financial
information that is based on approximate measures of the financial effects of
transactions and events that have already occurred. Our significant accounting
policies are described in Note 2 of the Notes to Consolidated Financial
Statements and are essential to understanding Management's Discussion and
Analysis of Financial Condition and Results of Operations. Some of our
accounting policies require significant judgment to estimate values of either
assets or liabilities. In addition, significant judgment may be needed to apply
what often are complex accounting principles to individual transactions to
determine the most appropriate treatment. We have established procedures and
processes to facilitate making the judgments necessary to prepare the financial
statements.
The
following is a summary of the more judgmental and complex accounting estimates
and principles. In each area, we have discussed the assumptions most important
in the estimation process. We have used the best information available to
estimate the related items involved. Actual performance that differs from our
estimates and future changes in the key assumptions could change future
valuations and materially impact our financial condition and results of
operations.
Management
has discussed our critical accounting policies and estimates, together with any
changes therein, with the Audit Committee of our Board of Directors.
Losses
and Loss Adjustment Expenses. The
estimated liabilities for losses and loss adjustment expenses ("LAE") include
the accumulation of estimates of losses for claims reported on or prior to the
balance sheet dates, estimates (based upon actuarial analysis of historical
data) of losses for claims incurred but not reported, the development of case
reserves to ultimate values and estimates of expenses for investigating,
adjusting and settling all incurred claims. Amounts reported are estimates of
the ultimate costs of settlement, net of estimated salvage and subrogation. The
estimated liabilities are necessarily subject to the outcome of future events,
such as changes in medical and repair costs, as well as economic and social
conditions that impact the settlement of claims. In addition, time can be a
critical part of reserving determinations since the longer the span between the
incidence of a loss and the payment or settlement of the claim, the more
variable the ultimate settlement amount can be. Accordingly, short-tail claims,
such as property damage claims, tend to be more reasonably predictable than
relatively longer-tail liability claims. For our current mix of auto exposures,
which include both property and liability exposures, an average of approximately
80% of the ultimate losses are settled within twelve months of the date of loss.
Given the inherent variability in the estimates, management believes the
aggregate reserves are adequate, although we continue to caution that the
reserve estimates relating to SB 1899 are subject to a greater than normal
degree of variability and possible future material adjustment as new facts
become known. The methods of making such estimates and establishing the
resulting reserves are reviewed and updated monthly and any resulting
adjustments are reflected in current operations. Changes in these recorded
liabilities flow directly to the income statement on a dollar-for-dollar basis.
For example, an upward revision of $1 million in the estimated recorded
liability for unpaid losses and LAE would decrease underwriting profit, and
pre-tax income, by the same $1 million amount. Conversely, a downward revision
of $1 million would increase pre-tax income by the same $1 million
amount.
Property
and Equipment.
Accounting standards require a write-off to be recognized when an asset is
abandoned or an asset group's carrying value exceeds its fair value. For
purposes of recognition and measurement of an impairment loss, a long-lived
asset or assets are grouped with other assets and liabilities at the lowest
level for which identifiable cash flows are largely independent of the cash
flows of other assets and liabilities. Accounting standards require asset groups
to be tested for possible impairment under certain conditions. In the third
quarter of 2002, we recorded a pre-tax charge to write off $37.2 million of
previously capitalized software costs for abandoned portions of an advanced
personal lines processing system. As such, in 2002, we assessed the asset group
that included the advanced personal lines processing system for impairment.
However, an impairment was not triggered by the abandonment as we determined
that the impairment recognition criterion had not been met. Future cash flows
expected to be generated by the asset group exceeded its carrying amount. There
have been no events or circumstances in 2004 that would require a reassessment
of the asset group for impairment.
Income
Taxes.
Determining the consolidated provision for income tax expense, deferred tax
assets and liabilities and any related valuation allowance involves judgment.
Generally accepted accounting principles require deferred tax assets and
liabilities ("DTAs" and "DTLs," respectively) to be recognized for the estimated
future tax effects attributed to temporary differences and carryforwards based
on provisions of the enacted tax law. The effects of future changes in tax laws
or rates are not anticipated. Temporary differences are differences between the
tax basis of an asset or liability and its reported amount in the financial
statements. For example, we have a DTA because the tax bases of our loss and LAE
reserves are smaller than their book bases. Similarly, we have a DTL because the
book basis of our capitalized software exceeds its tax basis. Carryforwards
include such items as alternative minimum tax credits, which may be carried
forward indefinitely, and net operating losses ("NOLs"), which can be carried
forward 15 years for losses incurred before 1998 and 20 years thereafter. A
summary of the significant DTAs and DTLs relating to the Company's temporary
differences and carryforwards is included in Note 5 of the Notes to Consolidated
Financial Statements.
At
December 31, 2004, our DTAs total $136.7 million, and our DTLs total $80.6
million. The net of those amounts, $56.1 million, represents the net deferred
tax asset reported in the consolidated balance sheet.
We are
required to reduce DTAs (but not DTLs) by a valuation allowance to the extent
that, based on the weight of available evidence, it is "more likely than not"
(i.e., a likelihood of more than 50%) that any DTAs will not be realized.
Recognition of a valuation allowance would decrease reported earnings on a
dollar-for- dollar basis in the year in which any such recognition were to
occur. The
determination of whether a valuation allowance is appropriate requires the
exercise of management judgment. In making this judgment, management is required
to weigh the positive and negative evidence as to the likelihood that the DTAs
will be realized.
Portions
of our NOL carryforward are scheduled to expire beginning in 2017, as shown in
the table below (amounts in millions):
Year
of Expiration |
|
NOL
Excluding 21st of Southwest |
|
SRLY1
NOL
of 21st of Southwest |
|
Consolidated
NOL |
|
2017 |
|
$ |
– |
|
$ |
1,794 |
|
$ |
1,794 |
|
2018 |
|
|
– |
|
|
1,068 |
|
|
1,068 |
|
2019 |
|
|
|
|
|
1,466 |
|
|
1,466 |
|
2020 |
|
|
35,061 |
|
|
3,172 |
|
|
38,233 |
|
2021 |
|
|
134,647 |
|
|
2,180 |
|
|
136,827 |
|
2022 |
|
|
37,316 |
|
|
|
|
|
37,316 |
|
Totals |
|
$ |
207,024 |
|
$ |
9,680 |
|
$ |
216,704 |
|
Our core
business has generated an underwriting profit for the past three years.
Management believes it is reasonable to expect future underwriting profits and
to conclude it is at least more likely than not that we will be able to realize
the benefits of our DTAs. If necessary, we believe we could implement
tax-planning strategies, such as investing a higher proportion of our investment
portfolio in taxable securities, in order to generate sufficient future taxable
income to utilize the NOL carryforwards prior to their expiration. Accordingly,
no valuation allowance has been recognized as of December 31, 2004 and
2003. However, generating future taxable income is dependent on a number of
factors, including regulatory and competitive influences that may be beyond our
ability to control. Future underwriting losses could possibly jeopardize our
ability to utilize our NOLs. In the event adverse development or underwriting
losses due to either SB 1899 matters or other causes were to occur, management
might be required to reach a different conclusion about the realization of the
DTAs and, if so, recognize a valuation allowance at that time.
___________________________
1 |
“SRLY”
stands for Separate Return Limitation Year. Under the Federal tax code,
only future income generated by 21st of Southwest (formerly 21st of
Arizona) may be utilized against this portion of our
NOL. |
Deferred
Policy Acquisition Costs.
Deferred policy acquisition costs ("DPAC") include premium taxes and other
variable costs incurred with writing business. These costs are deferred and
amortized over the 6-month policy period in which the related premiums are
earned.
Management
assesses the recoverability of deferred policy acquisition costs on a quarterly
basis. The assessment calculates the relationship of actuarially estimated costs
incurred to premiums from contracts issued or renewed for the period. We do not
consider anticipated investment income in determining the recoverability of
these costs. Based on current indications, no reduction in DPAC is required.
The loss
and LAE ratio used in the recoverability estimate is based primarily on expected
ultimate ratios provided by our actuaries. While management believes that is a
reasonable assumption, actual results could differ materially from such
estimates.
Investments.
Temporary unrealized investment gains and losses, net of applicable tax effects,
are included as an element of accumulated other comprehensive income (loss),
which is classified as a separate component of stockholders' equity. For
investments with unrealized losses due to market conditions or industry-related
events, where the Company has the positive intent and ability to hold the
investment for a period of time sufficient to allow a market recovery or to
maturity, declines in value below cost are not assumed to be
other-than-temporary.
Where
declines in values of securities below cost or amortized cost are considered to
be other-than-temporary, a charge is required to be reflected in income for the
difference between cost or amortized cost and the fair value. The determination
of whether a decline in market value is "other-than-temporary" is necessarily a
matter of subjective judgment. No such charges were recorded in 2004, 2003 or
2002. The timing and amount of realized losses and gains reported in income
could vary if conclusions other than those made by management were to determine
whether an other-than-temporary impairment exists. However, there would be no
impact on equity because any unrealized losses are already included in
accumulated other comprehensive income.
The
following is a summary by issuer of non-investment grade securities and unrated
securities held (at fair value):
AMOUNTS
IN THOUSANDS |
|
|
|
|
|
December
31, |
|
2004 |
|
2003 |
|
Non-investment
grade securities (i.e., rated below BBB): |
|
|
|
|
|
Cox
Communications, Inc. |
|
$ |
2,240 |
|
$ |
|
|
Ford
Motor Credit Company |
|
|
4,615 |
|
|
— |
|
General
Motors Acceptance Corp |
|
|
5,643 |
|
|
— |
|
Unrated
securities: |
|
|
|
|
|
|
|
Impact
Community Capital LLC1 |
|
|
2,023 |
|
|
2,023 |
|
Impact
C.I.L. Parent |
|
|
5,111 |
|
|
2,444 |
|
Total
non-investment grade and unrated securities2 |
|
$ |
19,632 |
|
$ |
4,467 |
|
_______________________________
1 |
Impact
Community Capital LLC, is a limited partnership that was established under
California’s COIN program (California Organized Investment Network), a
voluntary association of California insurers providing funding for low
cost housing projects. |
2 |
The
total net unrealized gain (loss) for these securities as of December 31,
2004 and 2003 was $0.4 million and $0,
respectively. |
The
following table summarizes realized gains and losses for the past three years.
Additional information has been provided with respect to how long investments
that were sold at a loss in each year were in an unrealized loss
position.
AMOUNTS
IN THOUSANDS |
|
|
|
|
|
|
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Realized
(losses) on sales of investments: |
|
|
|
|
|
|
|
Held
for less than one year |
|
$ |
(1,062 |
) |
$ |
(229 |
) |
$ |
(322 |
) |
Held
one year or more |
|
|
|
|
|
|
|
|
|
|
In
an unrealized loss position at December 31, 2003 |
|
|
(1,251 |
) |
|
– |
|
|
– |
|
In
an unrealized loss position at December 31, 2002 |
|
|
(19 |
) |
|
(148 |
) |
|
– |
|
In
an unrealized loss position at December 31, 2001 |
|
|
– |
|
|
– |
|
|
(83 |
) |
In
an unrealized loss position at December 31, 2000 |
|
|
– |
|
|
– |
|
|
– |
|
In
an unrealized loss position at December 31, 1999 |
|
|
– |
|
|
–
|
|
|
(196 |
) |
In
an unrealized loss position at December 31, 1998 |
|
|
– |
|
|
– |
|
|
(1,567 |
) |
In
an unrealized gain position at December 31, 2003 |
|
|
(133 |
) |
|
– |
|
|
– |
|
In
an unrealized gain position at December 31, 2002 |
|
|
– |
|
|
(5 |
) |
|
– |
|
In
an unrealized gain position at December 31, 2001 |
|
|
– |
|
|
– |
|
|
(15 |
) |
Total
realized losses on sales of investments held one year or
more1 |
|
|
(1,403 |
) |
|
(153 |
) |
|
(1,861 |
) |
Total
realized losses on sales of investments |
|
|
(2,465 |
) |
|
(382 |
) |
|
(2,183 |
) |
Total
realized gains on sales of investments |
|
|
14,145 |
|
|
13,715 |
|
|
13,053 |
|
Realized
gain (loss) on disposal of property and equipment |
|
|
(849 |
) |
|
(156 |
) |
|
(479 |
) |
Total
realized investment gains |
|
$ |
10,831 |
|
$ |
13,177 |
|
$ |
10,391 |
|
The
following table summarizes the fair values of investments sold at a loss or at a
gain on the date of sale:
AMOUNTS
IN THOUSANDS |
|
Fair
Value of
Investments
Sold |
|
December
31, |
|
2004 |
|
2003 |
|
2002 |
|
Fair
value of investments sold at a loss on date of sale |
|
$ |
142,222 |
|
$ |
21,002 |
|
$ |
111,144 |
|
Fair
value of investments sold at a gain on date of sale |
|
|
585,252 |
|
|
297,230 |
|
|
470,043 |
|
The
following table summarizes investments held by us, having an unrealized loss of
$0.1 million or more, and aggregate information relating to all other
investments in unrealized loss positions:
|
|
2004 |
|
2003 |
|
AMOUNTS
IN THOUSANDS,
EXCEPT
NUMBER OF ISSUES
December
31, |
|
#
issues |
Fair
Value |
|
Unrealized
Loss |
#
issues |
Fair
Value |
|
Unrealized
Loss |
Investments
with unrealized losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding
$0.1 million and for: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
than 6 months |
|
|
7 |
|
$ |
88,258 |
|
$ |
1,045 |
|
|
4 |
|
$ |
50,512 |
|
$ |
680 |
|
6-12
months |
|
|
15 |
|
|
154,284 |
|
|
3,415 |
|
|
2 |
|
|
8,509 |
|
|
662 |
|
More
than 1 year |
|
|
2 |
|
|
4,765 |
|
|
326 |
|
|
– |
|
|
– |
|
|
– |
|
Less
than $0.1 million |
|
|
91 |
|
|
306,984 |
|
|
2,387 |
|
|
83 |
|
|
179,166 |
|
|
2,074 |
|
Total
fixed maturity securities2 |
|
|
115 |
|
|
554,291 |
|
|
7,173 |
|
|
89 |
|
|
238,187
|
|
|
3,416
|
|
Equity
securities less than $0.1 million |
|
|
64 |
|
|
15,479 |
|
|
293 |
|
|
– |
|
|
– |
|
|
– |
|
Total
investments |
|
|
179 |
|
$ |
569,770 |
|
$ |
7,466 |
|
|
89 |
|
$ |
238,187 |
|
$ |
3,416 |
|
_______________________________
1 |
Amount
represents less than 0.001% of total carrying value of
investments. |
2 |
Unrealized
losses represent less than 0.5% of the total carrying value of
investments. |
A summary
by contractual maturity of bonds in an unrealized loss position by year of
maturity follows:
|
|
2004 |
|
2003 |
|
AMOUNTS
IN THOUSANDS
December
31, |
|
Amortized
Cost |
|
Carrying
Value |
|
Unrealized
Loss |
|
Amortized
Cost |
|
Carrying
Value |
|
Unrealized
Loss |
|
Bond
Maturities |
|
|
|
|
|
|
|
|
|
|
|
|
|
Due
in one year or less |
|
$ |
9,778 |
|
$ |
9,738 |
|
$ |
40 |
|
$ |
2,519 |
|
$ |
2,515 |
|
$ |
4 |
|
Due
after one year through five years |
|
|
26,537 |
|
|
26,073 |
|
|
464 |
|
|
78,687 |
|
|
77,590 |
|
|
1,097 |
|
Due
after five years through ten years |
|
|
318,644 |
|
|
314,898 |
|
|
3,746 |
|
|
47,026 |
|
|
45,975 |
|
|
1,051 |
|
Due
after ten years |
|
|
206,505 |
|
|
203,582 |
|
|
2,923 |
|
|
113,371 |
|
|
112,107 |
|
|
1,264 |
|
|
|
$ |
561,464 |
|
$ |
554,291 |
|
$ |
7,173 |
|
$ |
241,603 |
|
$ |
238,187 |
|
$ |
3,416 |
|
Stock-based
compensation. Under
the provisions of Statement of Financial Accounting Standard ("SFAS") No. 123,
Accounting
for Stock-Based Compensation, we have
elected to continue using the intrinsic-value method of accounting for
stock-based awards granted to employees in accordance with Accounting Principles
Board Opinion No. 25, Accounting
for Stock Issued to Employees.
Accordingly, we have not recognized in income any compensation expense for the
fair value of stock options awarded to employees. Companies electing to continue
to follow the intrinsic-value method must make pro forma disclosures, as if the
fair value based method of accounting had been applied. A summary of the expense
that would have been recorded, together with the underlying assumptions, had we
recognized for the fair value of stock-based awards, is included in Notes 2 and
14 of the Notes to Consolidated Financial Statements.
Recent
Accounting Standards
In
December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 123 (revised 2004)
("SFAS No. 123R"), Share-based
Payment, which
replaces SFAS No. 123, Accounting
for Stock-Based Compensation, and
supersedes APB No. 25, Accounting
for Stock Issued to Employees. As a
result of SFAS No. 123R, the Company will be required to recognize the cost of
its stock options as an expense in the consolidated statement of operations
beginning in the third quarter 2005. The Company is currently assessing the
impact that the adoption of SFAS No. 123R will have on its consolidated results
of operations. Although this assessment is ongoing, management believes the
effect of adopting SFAS No. 123R will be material to the Company's consolidated
results of operations.
On
September 30, 2004, the FASB issued FASB Staff Position EITF No. 03-1-1,
Effective
Date of Paragraphs 10-20 of EITF No. 03-1,
The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments,
delaying the effective date of this guidance until the FASB has resolved certain
implementation issues with respect to this guidance. The disclosure requirements
of EITF No. 03-1 were previously adopted by the Company as of December 31, 2003
and reflected in the Annual Report on Form 10-K for that year for the Company's
investments.
In
January 2003, the FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities, an interpretation of Accounting Research
Bulleting No. 51, and
amended it in December 2003 ("FIN 46R"). An entity is subject to the
consolidation rules of FIN 46R and is referred to as a variable interest entity
("VIE") if it lacks sufficient equity to finance its activities without
additional financial support from other parties or if its equity holders lack
adequate decision making ability based on criteria set forth in the
interpretation. FIN 46R requires an investor with a majority of the variable
interests in a VIE to consolidate the entity.
FIN 46R
also requires disclosures about VIEs that companies are not required to
consolidate, but in which a company has a significant variable interest. On
August 29, 2003, the Company funded a revolving loan agreement with Impact
C.I.L., LLC ("Impact C.I.L."), a VIE. At present, the Company has contributed
$5.1 million to be used to purchase mortgage loans in economically disadvantaged
areas. The Company is not the primary beneficiary of the VIE and participates at
an 11.11% level in the entity's funding activities. Potential losses are limited
to the amount invested as well as associated operating fees.
The
Company's maximum commitment is for up to 11.1% ($24 million) of $216 million of
participation. The mortgages purchased with these funds may be securitized.
Impact
C.I.L. is a subsidiary of Impact Community Capital, LLC ("Impact"), whose
charter is to provide real estate loans in economically disadvantaged areas. At
present, the Company has a $2.0 million note receivable from Impact in addition
to the $5.1 million investment noted above. If the mortgages purchased with
these funds are not securitized, the note receivable will be liquidated in ten
years from the initial date of the agreement. The Company has voting rights and
ownership of Impact in proportion to its investment (approximately
10%).
The
Company does not have any other material VIEs that it needs, or will need, to
consolidate or disclose.
Forward-Looking
Statements
This
report contains statements that constitute forward-looking information.
Investors are cautioned that these forward-looking statements are not guarantees
of future performance or results and involve risks and uncertainties, and that
actual results or developments may differ materially from the forward-looking
statements as a result of various factors. The reader should not rely on
forward-looking statements in this annual report on Form 10-K. Forward-looking
statements are statements not based on historical information and which relate
to future operations, strategies, financial results or other developments. You
can usually identify forward-looking statements by terminology such as "may,"
"will," "should," "expect," "plan," "anticipate," "believe," "estimate,"
"predict," "intend," "potential," or "continue" or with the negative of these
terms or other comparable terminology.
Although
we believe that the expectations reflected in these forward-looking statements
are reasonable, we cannot guarantee our future results, level of activity,
performance or achievements. Forward-looking statements include, among other
things, discussions concerning our potential expectations, beliefs, estimates,
forecasts, projections and assumptions. Forward-looking statements may address,
among other things:
· |
Our
strategy for growth; |
· |
Our
expected combined ratio and growth of written
premiums; |
It is
possible that our actual results, actions and financial condition may differ,
possibly materially, from the anticipated results, actions and financial
condition indicated in these forward-looking statements. Important factors that
could cause our actual results and actions to differ, possibly materially, from
those in the specific forward-looking statements include those discussed in this
report under the heading "Management's Discussion and Analysis of Financial
Condition and Results of Operations" as well as:
· |
The
effects of competition and competitors' pricing
actions; |
· |
Adverse
underwriting and claims experience, including as a result of revived
earthquake claims under SB 1899; |
· |
Customer
service problems; |
· |
The
impact on our operations of natural disasters, principally earthquake, or
civil disturbance, due to the concentration of our facilities and
employees in Woodland Hills,
California; |
· |
Information
system problems, including failures to implement information technology
projects on time and within budget; |
· |
Internal
control failures; |
· |
Adverse
developments in financial markets or interest rates;
|
· |
Results
of legislative, regulatory or legal actions, including the inability to
obtain approval for rate increases and product changes and adverse actions
taken by state regulators in market conduct examinations;
and |
· |
Our
ability to service the senior notes, including our ability to receive
dividends and/or sufficient payments from our subsidiaries to service our
obligations. |
We do not
undertake any obligation to update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
ITEM
7A. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market
risk is the risk of loss from adverse changes in market prices and interest
rates. In addition to market risk we are exposed to other risks, including the
credit risk related to the issuers of our financial instruments, the underlying
insurance risk related to our core business and the exposure of the personal
lines insurance business, as a regulated industry, to legal, legislative,
judicial, political and regulatory action. Financial instruments are not used
for trading purposes. The following disclosure reflects estimated changes in
value that may result from selected hypothetical changes in market rates and
prices. Actual results may differ.
Our cash
flow from operations and short-term cash position generally are more than
sufficient to meet our projected obligations for claim payments, which by the
nature of the personal automobile insurance business tend to have an average
duration of less than one year. As a result, it has been unnecessary for us to
employ elaborate market risk management techniques involving complicated asset
and liability duration matching or hedging strategies. Accordingly, the Company
primarily invests in fixed maturity investments, which at December 31, 2004,
comprised almost 97% of the fair value of the Company's total investments. The
remainder of the Company's investments, representing approximately 3% of total
investments at market value, is held in equity securities.
For all
of our fixed maturity investments, we seek to provide for liquidity and
diversification while maximizing income without sacrificing investment quality.
The value of the fixed maturity portfolio is subject to interest rate risk where
the value of the fixed maturity portfolio decreases as market interest rates
increase, and conversely, when market interest rates decrease, the value of the
fixed maturity portfolio increases. Duration is a common measure of the
sensitivity of a fixed maturity security's value to changes in interest rates.
The higher the duration, the more sensitive a fixed maturity security is to
market interest rate fluctuations. Effective duration also measures this
sensitivity, but it takes into account call terms, as well as changes in
remaining term, coupon rate, and cash flow.
Since
fixed maturity investments with longer remaining terms to maturity tend to
realize higher yields, the Company's investment philosophy typically resulted in
a portfolio with an effective duration of over 6 years (almost 7 years as of
December 31, 2001). Due to the current interest rate environment, management, in
consultation with the Investment Committee, targeted a lower duration for the
Company's fixed maturity investment portfolio to reduce the negative impact of
potential increases in interest rates. As a result, the effective duration of
the fixed maturity portfolio declined from approximately 6 years as of December
31, 2003 to 5.4 years at December 31, 2004.
The
Company has also obtained long-term fixed rate financing as a means of
increasing the statutory surplus of the Company's largest insurance
subsidiary.
The
following table shows the financial statement carrying values of our fixed
maturity investments, which are reported at fair value, and our debt, which is
reported at historical value. The table also presents estimated carrying values
at adjusted market rates assuming a 100 basis point increase in market interest
rates, given the effective duration noted above, for the fixed maturity
investment portfolio and a 100 basis point decrease in market interest rates for
the debt determined from a present value calculation. The following sensitivity
analysis summarizes only the exposure to market interest rate risk:
AMOUNTS
IN MILLIONS
December
31, 2004 |
|
Carrying
Value |
Estimated
Carrying Value at Adjusted Market Rates/Prices Indicated
Above |
Change
in Value
as a Percentage
of Carrying Value |
Fixed
maturity investments available for sale |
|
$ |
1,342.1 |
|
$ |
1,268.1 |
|
|
(5.51 |
%) |
Debt |
|
|
138.3 |
|
|
146.4 |
|
|
5.86 |
% |
The
common equity portfolio, which represents approximately 3% of total investments
at market value, consists primarily of public utility common stocks. Beta is a
measure of a security's systematic (non-diversifiable) risk, which is the
percentage change in an individual security's return for a 1% change in the
return of the market. The average Beta for the Company's common stock holdings
was 0.50.
The
following table presents the financial statement carrying value of our equity
portfolio and the effect of a hypothetical 20% reduction in the overall value of
the stock market using the Beta noted above and accordingly summarizes only the
exposure to equity price risk for the Company's equity securities:
AMOUNTS
IN MILLIONS
December
31, 2004 |
|
Carrying
Value |
Estimated
Carrying Value at Hypothetical 20%
Reduction in Overall
Value of Stock Stock Market |
Change
in Value
as a Percentage
of Carrying Value |
Equity
securities available for sale |
|
$ |
42.1 |
|
$ |
37.8 |
|
|
(10.1 |
%) |
The
discussion above provides only a limited, point-in-time view of the market risk
sensitivity of our financial instruments. The actual impact of market interest
rate and price changes on the financial instruments may differ significantly
from those shown.
ITEM
8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA:
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
STOCKHOLDERS
AND BOARD OF DIRECTORS
21ST
CENTURY INSURANCE GROUP
We have
completed an integrated audit of 21st Century Insurance Group's 2004
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2004, and audits of its 2003 and 2002 consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
Consolidated
financial
statements and
financial statement schedule
In our
opinion, the consolidated financial statements listed in the index appearing
under Item 15(a)(1) present fairly, in all material respects, the financial
position of 21st Century Insurance Group and its subsidiaries (the "Company") at
December 31, 2004 and 2003, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2004, in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 15(a)(2) presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
Internal
control over financial reporting
Also, in
our opinion, management's assessment, included in Management's Report on
Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal
Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission
("COSO"), is fairly stated, in all material respects, based on those criteria.
Furthermore, in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal
Control - Integrated Framework issued
by the COSO. The Company's management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express opinions on management's assessment and on the effectiveness of
the Company's internal control over financial reporting based on our audit. We
conducted our audit of internal control over financial reporting in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. An audit of internal control
over financial reporting includes obtaining an understanding of internal control
over financial reporting, evaluating management's assessment, testing and
evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we consider necessary in the circumstances.
We believe that our audit provides a reasonable basis for our opinions.
A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/
PricewaterhouseCoopers LLP
Los
Angeles, California
February
16, 2005
21ST
CENTURY INSURANCE GROUP |
|
|
|
|
|
CONSOLIDATED
BALANCE SHEETS |
|
|
|
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA |
|
|
|
|
|
December
31, |
|
2004 |
|
2003 |
|
Assets |
|
|
|
|
|
Fixed
maturity investments available-for-sale, at fair value (amortized cost:
$1,320,592 and $1,183,526) |
|
$ |
1,342,130 |
|
$ |
1,219,676 |
|
Equity
securities available-for-sale, at fair value (cost:
$41,450) |
|
|
42,085 |
|
|
– |
|
Total
investments |
|
|
1,384,215 |
|
|
1,219,676 |
|
Cash
and cash equivalents |
|
|
34,697 |
|
|
65,010 |
|
Accrued
investment income |
|
|
16,161 |
|
|
14,746 |
|
Premiums
receivable |
|
|
105,814 |
|
|
104,638 |
|
Reinsurance
receivables and recoverables |
|
|
7,160 |
|
|
12,135 |
|
Prepaid
reinsurance premiums |
|
|
1,787 |
|
|
1,719 |
|
Deferred
income taxes |
|
|
56,135 |
|
|
76,611 |
|
Deferred
policy acquisition costs |
|
|
58,759 |
|
|
53,079 |
|
Leased
property under capital lease, net of deferred gain of $3,116 and $4,698
and net of accumulated amortization of $24,794 and $12,397 |
|
|
31,719 |
|
|
42,534 |
|
Property
and equipment, at cost less accumulated depreciation of $68,529 and
$60,070 |
|
|
129,372 |
|
|
101,237 |
|
Other
assets |
|
|
38,495 |
|
|
46,747 |
|
Total
assets |
|
$ |
1,864,314 |
|
$ |
1,738,132 |
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders' equity |
|
|
|
|
|
|
|
Unpaid
losses and loss adjustment expenses |
|
$ |
495,542 |
|
$ |
438,323 |
|
Unearned
premiums |
|
|
331,036 |
|
|
312,254 |
|
Debt |
|
|
138,290 |
|
|
149,686 |
|
Claims
checks payable |
|
|
38,737 |
|
|
45,702 |
|
Reinsurance
payable |
|
|
633 |
|
|
1,761 |
|
Other
liabilities |
|
|
85,675 |
|
|
89,716 |
|
Total
liabilities |
|
|
1,089,913 |
|
|
1,037,442 |
|
|
|
|
|
|
|
|
|
Commitments
and contingencies |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity: |
|
|
|
|
|
|
|
Common
stock, par value $0.001 per share; 110,000,000 shares authorized; shares
issued & outstanding 85,489,061 and 85,435,505 |
|
|
85 |
|
|
85 |
|
Additional
paid-in capital |
|
|
420,425 |
|
|
419,245 |
|
Retained
earnings |
|
|
341,196 |
|
|
259,808 |
|
Accumulated
other comprehensive income (loss): |
|
|
|
|
|
|
|
Net
unrealized gains on available-for-sale investments, net of deferred income
taxes of $7,760 and of $12,653 |
|
|
14,412 |
|
|
23,497 |
|
Minimum
pension liability in excess of unamortized prior service cost, net of
deferred income taxes of $925 and of $1,047 |
|
|
(1,717 |
) |
|
(1,945 |
) |
Total
stockholders' equity |
|
|
774,401 |
|
|
700,690 |
|
Total
liabilities and stockholders' equity |
|
$ |
1,864,314 |
|
$ |
1,738,132 |
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP |
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA |
|
|
|
|
|
|
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Revenues |
|
|
|
|
|
|
|
Net
premiums earned |
|
$ |
1,313,670 |
|
$ |
1,172,677 |
|
$ |
924,559 |
|
Net
investment income |
|
|
58,831 |
|
|
45,833 |
|
|
46,345 |
|
Other
|
|
|
— |
|
|
14,777 |
|
|
— |
|
Net
realized investment gains |
|
|
10,831 |
|
|
13,177 |
|
|
10,391 |
|
Total
revenues |
|
|
1,383,332 |
|
|
1,246,464 |
|
|
981,295 |
|
Losses
and expenses |
|
|
|
|
|
|
|
|
|
|
Net
losses and loss adjustment expenses |
|
|
993,841 |
|
|
962,311 |
|
|
826,657 |
|
Policy
acquisition costs |
|
|
222,479 |
|
|
202,189 |
|
|
123,642 |
|
Other
operating expenses |
|
|
36,092 |
|
|
7,346 |
|
|
19,645 |
|
Write-off
of software |
|
|
— |
|
|
— |
|
|
37,177 |
|
Interest
and fees expense |
|
|
8,627 |
|
|
3,471 |
|
|
—
|
|
Total
losses and expenses |
|
|
1,261,039 |
|
|
1,175,317 |
|
|
1,007,121 |
|
Income
(loss) before provision for income taxes |
|
|
122,293 |
|
|
71,147 |
|
|
(25,826 |
) |
Provision
for income taxes |
|
|
34,068 |
|
|
17,572 |
|
|
(13,570 |
) |
Net
income (loss) |
|
$ |
88,225 |
|
$ |
53,575 |
|
$ |
(12,256 |
) |
|
|
|
|
|
|
|
|
|
|
|
Earnings
(loss) per common share |
|
|
|
|
|
|
|
|
|
|
Basic
and diluted |
|
$ |
1.03 |
|
$ |
0.63 |
|
$ |
(0.14 |
) |
Weighted
average shares outstanding - basic |
|
|
85,466,127 |
|
|
85,432,838 |
|
|
85,414,076 |
|
Weighted
average shares outstanding - diluted |
|
|
85,602,567 |
|
|
85,637,672 |
|
|
85,414,076 |
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP |
|
|
|
|
|
|
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock |
|
|
|
|
|
Accumulated
|
|
|
|
AMOUNTS
IN THOUSANDS, |
|
|
|
No
par value |
|
$0.001
par value |
|
Additional
Paid-
in |
|
Retained
|
|
Other
Comprehensive |
|
|
|
EXCEPT
SHARE DATA |
|
Shares |
|
Amount |
|
Amount |
|
Capital |
|
Earnings |
|
Income
(Loss) |
|
Total |
|
Balance
- January 1, 2002 |
|
|
85,361,848 |
|
$ |
416,991 |
|
$ |
— |
|
$ |
— |
|
$ |
248,635 |
|
$ |
(6,320 |
) |
$ |
659,306 |
|
Comprehensive
(loss) income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(12,256 |
)(1) |
|
29,877 |
(2) |
|
17,621 |
|
Cash
dividends declared on common stock ($0.26 per
share) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(22,210 |
) |
|
|
|
|
(22,210 |
) |
Other |
|
|
69,657 |
|
|
1,993 |
|
|
|
|
|
|
|
|
(1,102 |
) |
|
|
|
|
891 |
|
Balance
- December 31, 2002 |
|
|
85,431,505 |
|
|
418,984 |
|
|
— |
|
|
— |
|
|
213,067 |
|
|
23,557 |
|
|
655,608 |
|
Comprehensive
income (loss) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
53,575 |
(1) |
|
(2,005 |
)(2) |
|
51,570 |
|
Cash
dividends declared on common stock ($0.08 per
share) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,834 |
) |
|
|
|
|
(6,834 |
) |
Other |
|
|
4,000 |
|
|
346 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
346 |
|
Effects
of reincorporation |
|
|
|
|
|
(419,330 |
) |
|
85 |
|
|
419,245 |
|
|
|
|
|
|
|
|
— |
|
Balance
- December 31, 2003 |
|
|
85,435,505 |
|
|
—
|
|
|
85 |
|
|
419,245 |
|
|
259,808 |
|
|
21,552 |
|
|
700,690 |
|
Comprehensive
income (loss) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88,225 |
(1) |
|
(8,857 |
)(2) |
|
79,368 |
|
Cash
dividends declared on common stock ($0.08 per
share) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,837 |
) |
|
|
|
|
(6,837 |
) |
Other |
|
|
53,556 |
|
|
|
|
|
|
|
|
1,180 |
|
|
|
|
|
|
|
|
1,180 |
|
Balance
- December 31, 2004 |
|
|
85,489,061 |
|
$
|
— |
|
$ |
85 |
|
$ |
420,425 |
|
$ |
341,196 |
|
$ |
12,695 |
|
$ |
774,401 |
|
(1) Net
(loss) income for the year.
(2) Net
change in accumulated other comprehensive income (loss) for 2004, 2003 and 2002
is as follows:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Unrealized
holding (losses) gains arising during the period, net of tax (benefit)
expense of $(804), $3,833, and $17,811, respectively |
|
$ |
(1,493 |
) |
$ |
7,116 |
|
$ |
33,078 |
|
Reclassification
adjustment for investment gains included in net income (loss), net of tax
expense of $4,089, $4,667, and $3,805, respectively |
|
|
(7,592 |
) |
|
(8,666 |
) |
|
(7,065 |
) |
Change
in minimum pension liability in excess of unamortized prior service cost,
net of deferred income tax expense (benefit) of $123, $(245), and $2,081,
respectively |
|
|
228 |
|
|
(455 |
) |
|
3,864 |
|
Total |
|
$ |
(8,857 |
) |
$ |
(2,005 |
) |
$ |
29,877 |
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP |
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA |
|
|
|
|
|
|
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Operating
activities |
|
|
|
|
|
|
|
Net
income (loss) |
|
$ |
88,225 |
|
$ |
53,575 |
|
$ |
(12,256 |
) |
Adjustments
to reconcile net income (loss) to net cash |
|
|
|
|
|
|
|
|
|
|
provided
by operating activities: |
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization |
|
|
22,260 |
|
|
20,206 |
|
|
19,341 |
|
Net
amortization of investment premiums |
|
|
7,011 |
|
|
3,756 |
|
|
1,000 |
|
Write-off
of software |
|
|
— |
|
|
— |
|
|
37,177 |
|
Amortization
of restricted stock grants |
|
|
604 |
|
|
346 |
|
|
506 |
|
Provision
(benefit) for deferred income taxes |
|
|
25,246 |
|
|
13,406 |
|
|
(5,370 |
) |
Realized
gains on sale of investments |
|
|
(10,831 |
) |
|
(13,177 |
) |
|
(10,391 |
) |
Changes
in assets and liabilities: |
|
|
|
|
|
|
|
|
|
|
Reinsurance
balances |
|
|
3,779 |
|
|
12,953 |
|
|
17,542 |
|
Federal
income taxes |
|
|
3,801 |
|
|
(2,825 |
) |
|
4,670 |
|
Other
assets |
|
|
(9,835 |
) |
|
(25,562 |
) |
|
(38,068 |
) |
Unpaid
losses and loss adjustment expenses |
|
|
57,219 |
|
|
54,314 |
|
|
34,720 |
|
Unearned
premiums |
|
|
18,782 |
|
|
45,777 |
|
|
30,004 |
|
Claims
checks payable |
|
|
(6,965 |
) |
|
6,398 |
|
|
3,198 |
|
Other
liabilities |
|
|
4,060 |
|
|
19,293 |
|
|
(7,490 |
) |
Net
cash provided by operating activities |
|
|
203,356 |
|
|
188,460 |
|
|
74,583 |
|
Investing
activities |
|
|
|
|
|
|
|
|
|
|
Investments
available-for-sale |
|
|
|
|
|
|
|
|
|
|
Purchases |
|
|
(937,010 |
) |
|
(641,433 |
) |
|
(625,690 |
) |
Calls
or maturities |
|
|
52,579 |
|
|
38,592 |
|
|
41,850 |
|
Sales |
|
|
710,586 |
|
|
314,648 |
|
|
564,398 |
|
Purchases
of property and equipment |
|
|
(40,445 |
) |
|
(23,355 |
) |
|
(19,140 |
) |
Net
cash used in investing activities |
|
|
(214,290 |
) |
|
(311,548 |
) |
|
(38,582 |
) |
Financing
activities |
|
|
|
|
|
|
|
|
|
|
Proceeds
from issuance of debt |
|
|
— |
|
|
99,871 |
|
|
60,000 |
|
Repayment
of debt |
|
|
(11,409 |
) |
|
(10,185 |
) |
|
— |
|
Payment
of debt issuance costs |
|
|
— |
|
|
(650 |
) |
|
— |
|
Dividends
paid (per share: $0.10; $0.08; and $0.24) |
|
|
(8,546 |
) |
|
(6,835 |
) |
|
(20,501 |
) |
Proceeds
from the exercise of stock options |
|
|
576 |
|
|
—
|
|
|
1,488 |
|
Net
cash (used in) provided by financing activities |
|
|
(19,379 |
) |
|
82,201 |
|
|
40,987 |
|
|
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash and cash equivalents |
|
|
(30,313 |
) |
|
(40,887 |
) |
|
76,988 |
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of year |
|
|
65,010 |
|
|
105,897 |
|
|
28,909 |
|
Cash
and cash equivalents, end of year |
|
$ |
34,697 |
|
$ |
65,010 |
|
$ |
105,897 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
information |
|
|
|
|
|
|
|
|
|
|
Net
income taxes paid (refunded) |
|
$ |
3,912 |
|
$ |
— |
|
$ |
(12,920 |
) |
Interest
paid |
|
|
8,612 |
|
|
2,975 |
|
|
—
|
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
1. DESCRIPTION OF BUSINESS
21st
Century Insurance Group is an insurance holding company founded in 1958 and,
effective December 4, 2003, was incorporated under the laws of the State of
Delaware. Previously, the Company was incorporated in California. The term
"Company," unless the context requires otherwise, refers to 21st Century
Insurance Group and its consolidated subsidiaries, all of which are
wholly-owned: 21st Century Insurance Company, 21st Century Casualty Company,
21st Century Insurance Company of the Southwest, 20th Century Insurance
Services, Inc., and i21 Insurance Services. The latter two companies are not
property and casualty insurance subsidiaries, and their results are
immaterial.
The
common stock of the Company is traded on the New York Stock Exchange under the
trading symbol "TW." Through several of its subsidiaries, American International
Group, Inc. ("AIG") currently owns approximately 63% of the Company's
outstanding common stock.
NOTE
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Consolidation and Presentation
The
accompanying consolidated financial statements include the accounts and
operations of the Company. All material intercompany accounts and transactions
have been eliminated. The consolidated financial statements have been prepared
in conformity with accounting principles generally accepted in the United States
of America ("GAAP"). The preparation of the financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
amounts reported in the financial statements. Actual results could differ from
these estimates.
On
October 16, 2003, the board of directors voted to change 21st Century Insurance
Group's state of incorporation from California to Delaware. There was no change
in the location of Company operations, location of employees, or the way the
Company does business. Shareholders holding a majority of the voting power
approved the reincorporation by written consent on October 17, 2003. The
reincorporation became effective December 4, 2003.
21st
Century Insurance Company of the Southwest
21st
Century Insurance Company of Arizona ("21st of Arizona") changed its name to
21st Century Insurance Company of the Southwest on September 30, 2004, and
re-domesticated from Arizona to Texas on December 31, 2004. 21st of Arizona was
a joint venture between the Company and AIG from 1995 to 2001. On January 1,
2002, the Company acquired AIG's 51% interest in 21st of Arizona for $4.4
million.
Transactions
with Related Parties
Since
1995, the Company has entered into several transactions with AIG subsidiaries,
including various reinsurance agreements, which are discussed in Note 10 of the
Notes to Consolidated Financial Statements. At December 31, 2004, reinsurance
recoverables, net of payables, from AIG subsidiaries were $1.4 million, compared
to $5.8 million at December 31, 2003. Other transactions with AIG subsidiaries
have resulted from competitive bidding processes for certain corporate insurance
coverages and certain software and data processing services. In October 2003, as
a result of a competitive bidding process, the Company entered into an agreement
with an AIG subsidiary whereby AIG provides the Company with investment
management services; the agreement was approved by the California Department of
Insurance.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Investments
The
Company classifies its investment portfolio as available-for-sale and carries it
at fair value. Investments available-for-sale include securities that management
intends to hold for indefinite periods, but which may be sold in response to
changes in interest rates, tax planning considerations, or other aspects of
asset/liability management. Fair values for fixed maturity and equity securities
are based on quoted market prices, broker quotes and other valuation techniques.
Realized gains and losses are included in the consolidated statements of
operations based on the specific identification method.
Temporary
unrealized investment gains and losses, net of applicable tax effects, are
included as an element of accumulated other comprehensive income (loss), which
is classified as a separate component of stockholders' equity. For investments
with unrealized losses due to market conditions or industry-related events,
where the Company has the positive intent and ability to hold the investment for
a period of time sufficient to allow a market recovery or to maturity, declines
in value below cost are not assumed to be other-than-temporary.
Where
declines in values of securities below cost or amortized cost are considered to
be other-than-temporary, a charge is required to be reflected in income for the
difference between cost or amortized cost and the fair value. The determination
of whether a decline in market value is other-than-temporary is necessarily a
matter of subjective judgment. No such charges were recorded in 2004, 2003 or
2002. Realized losses and gains reported in income could vary if conclusions
other than those made by management were used to determine whether an
other-than-temporary impairment exists. However, there would be no impact on
equity because any unrealized losses are already included in accumulated other
comprehensive income.
Cash
and Cash Equivalents
Cash and
cash equivalents include cash, demand deposits and short-term investments in
money market mutual funds having a maturity of three months or less at the date
of purchase.
Recognition
of Revenues
Insurance
premiums and reinsurance ceding commissions are recognized pro rata over the
terms of the policies. The unearned portion of premiums is included in the
consolidated balance sheets as a liability for unearned premiums. Installment
and other fees for services are recognized in the periods the services are
rendered.
Deferred
Policy Acquisition Costs
Deferred
policy acquisition costs ("DPAC") include premium taxes and other variable costs
incurred in connection with writing business. These costs are deferred and
amortized over the 6-month policy period in which the related premiums are
earned.
Management
assesses the recoverability of deferred policy acquisition costs on a quarterly
basis. The
assessment calculates the relationship of actuarially estimated costs incurred
to premiums from contracts issued or renewed for the period. We do not consider
anticipated investment income in determining the recoverability of these costs.
Based on current indications, no reduction in DPAC is required. The loss and
loss adjustment expense ratio used in the recoverability estimate is the
expected ultimate ratio provided by our actuaries. While management believes
that is a reasonable assumption, actual results could differ materially from
such estimate.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Leased
Property under Capital Lease
Leased
property under capital lease is recorded as a capital asset and amortized on a
straight-line basis over the estimated useful lives of the property, which range
from 3 to 10 years. The related lease obligation is included in debt on the
balance sheet.
Property
and Equipment
Property
and equipment is recorded at cost and depreciated on a straight-line basis. We
capitalize certain consulting costs, payroll and payroll-related costs for
employees related to computer software developed for internal use. The estimated
useful lives used for depreciation purposes are: furniture and leasehold
improvements - 7 years; equipment - 3 to 5 years; automobiles - 5 years;
software currently in service - 3 to 15 years.
Management
assesses the Company's property and equipment, including software development
projects in progress, for impairment. The assessment of impairment involves a
two-step process, whereby an initial assessment for potential impairment is
performed, by comparing the carrying value and cost to complete, if any, to
estimates of future undiscounted cash flows from operations at the lowest level
for which identifiable cash flows are largely independent of the cash flows of
other assets and liabilities. If future undiscounted cash flows are
insufficient, an impairment write down is recorded for the difference between
the carrying value and estimated fair value of the asset group. There have been
no events or circumstances in 2004 that would require a reassessment of any
asset group for impairment.
Intangible
Asset
On June
24, 2004, the Company paid $1.5 million to acquire the business name "21st
Century Insurance and Financial Services," which will be used as a fictitious
business name for 20th Century Insurance Services. The payment has been
capitalized as an intangible asset, in accordance with SFAS No. 142,
Goodwill
and Other Intangible Assets, and is
included in "Other Assets" on the accompanying balance sheet as of December 31,
2004.
The
business name has an indefinite useful life, and in accordance with SFAS No. 142
will not be amortized until its useful life is determined to no longer be
indefinite. Under SFAS No. 142, an intangible asset is to be carried at fair
value and has to be tested for impairment on an annual basis. The impairment
test as of December 31, 2004 indicated that the asset was not
impaired.
Losses
and Loss Adjustment Expenses
The
estimated liabilities for losses and loss adjustment expenses ("LAE") include
the accumulation of estimates of losses for claims reported prior to the balance
sheet dates, estimates (based upon actuarial analysis of historical data) of
losses for claims incurred but not reported, the development of case reserves to
ultimate values, and estimates of expenses for investigating, adjusting and
settling all incurred claims. Amounts reported are estimates of the ultimate
costs of settlement, net of estimated salvage and subrogation. These estimated
liabilities are necessarily subject to the outcome of future events, such as
changes in medical and repair costs as well as economic and social conditions
that impact the settlement of claims. Management believes that the aggregate
reserves are adequate and represent our best estimate based on the information
currently available. The methods of making such estimates and for establishing
the resulting reserves are reviewed and updated as applicable, and any
adjustments resulting therefrom are reflected in current
operations.
A
necessarily more subjective process is used to estimate earthquake losses
arising out of California Senate Bill 1899 ("SB 1899") because most of the
remaining earthquake claims are in litigation. See Note 16 of the Notes to
Consolidated Financial Statements for a discussion of the factors considered by
management in establishing those liabilities.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Reinsurance
In the
normal course of business, the Company seeks to reduce its exposure to losses
that may arise from catastrophes and to reduce its overall risk levels by
obtaining reinsurance from other insurance enterprises or reinsurers.
Reinsurance premiums and reserves on reinsured business are accounted for on a
basis consistent with those used in accounting for the original policies issued
and the terms of the reinsurance contracts.
Reinsurance
contracts do not relieve the Company from its obligations to policyholders. The
Company periodically reviews the financial condition of its reinsurers to
minimize its exposure to losses from reinsurer insolvencies.
Reinsurance
receivables and recoverables include balances due from other insurance companies
for paid losses and LAE as well as ceded unpaid losses and LAE under the terms
of reinsurance agreements. Amounts applicable to ceded unearned premiums are
reported as prepaid reinsurance premiums in the accompanying balance sheets. The
Company believes the fair value of its reinsurance recoverables approximates
their carrying amounts.
Income
Taxes
Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years the differences are expected to be recovered or
settled. Quarterly, the Company reviews its deferred tax assets for
recoverability.
Fair
Value of Financial Instruments
The
carrying value of financial assets and liabilities reported in the accompanying
balance sheets for cash and cash equivalents, accrued investment income and
trade accounts receivable and payable at December 31, 2004 and 2003, approximate
fair value because of the short maturity of these instruments. Investments
available-for-sale are carried at fair value in the accompanying balance sheets.
The fair value of notes payable is estimated based on the quoted market prices
for the same or similar issues, or on the current rates offered to us for debt
with the same remaining maturities. The carrying values of our debt were $138.3
million and $149.7 million and the estimated fair values were $140.9 million and
$150.9 million
as of December 31, 2004 and 2003, respectively. Considerable judgment is
required to develop estimates of fair value. Accordingly, the estimates are not
necessarily indicative of the amounts we could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value
amounts.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Stock-Based
Compensation
SFAS No.
148, Accounting
for Stock-Based Compensation-Transition and Disclosure, amends
the disclosure requirements of SFAS No. 123, Accounting
for Stock-Based Compensation, to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. As permitted by SFAS No. 148, the
Company accounts for its fixed stock options using the intrinsic-value method,
prescribed in Accounting Principles Board ("APB") Opinion No. 25, Accounting
for Stock Issued to Employees, which
generally does not result in compensation expense recognition for stock options.
Under the intrinsic-value method, compensation cost for stock options is
measured at the date of grant as the excess, if any, of the quoted market price
of the Company's stock over the exercise price of the options.
In
addition to stock options, we also grant restricted stock awards to certain
officers and employees. Upon issuance of grants under the plan, unearned
compensation equivalent to the market value on the date of grant is charged to
paid-in capital and subsequently amortized over the vesting period of the grant.
The Company becomes entitled to an income tax deduction in an amount equal to
the taxable income reported by the holders of the restricted shares when the
restrictions are released. Restricted shares are forfeited if officers and
employees terminate prior to the lapsing of restrictions. We record forfeitures
of restricted stock as treasury share repurchases and any compensation cost
previously recognized with respect to unvested stock awards is reversed in the
period of forfeiture. This accounting treatment results in compensation expense
being recorded in a manner consistent with that required under SFAS No. 123,
and, therefore, pro forma net income and earnings per share amounts for the
Restricted Share Plan would be unchanged from those reported in the financial
statements.
Had
compensation cost for the Company's stock-based compensation plans been
determined based on the estimated fair value at the grant dates of stock-based
compensation, net income and earnings per share would have been reduced to the
pro forma amounts indicated below:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Net
income (loss), as reported |
|
$ |
88,225 |
|
$ |
53,575 |
|
$ |
(12,256 |
) |
|
|
|
|
|
|
|
|
|
|
|
Add:
Stock-based employee compensation expense included in reported net income
(loss), net of related tax effects |
|
|
381 |
|
|
215 |
|
|
329 |
|
|
|
|
|
|
|
|
|
|
|
|
Deduct:
Total stock-based employee compensation expense determined under fair
value based method for all awards, net of related tax
effects |
|
|
(5,904 |
) |
|
(4,908 |
) |
|
(5,637 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss), pro forma |
|
$ |
82,702 |
|
$ |
48,882 |
|
$ |
(17,564 |
) |
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted earnings (loss) per share |
|
|
|
|
|
|
|
|
|
|
As
reported |
|
$ |
1.03 |
|
$ |
0.63 |
|
$ |
(0.14 |
) |
Pro
forma |
|
$ |
0.97 |
|
$ |
0.55 |
|
$ |
(0.21 |
) |
Earnings
Per Share
Basic
earnings per share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if options or other contracts to issue common stock were exercised or
converted into common stock.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Recent
Accounting Standards
In
December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 123 (revised 2004)
("SFAS No. 123R"), Share-based
Payment, which
replaces SFAS No. 123, Accounting
for Stock-Based Compensation, and
supersedes APB No. 25, Accounting
for Stock Issued to Employees. As a
result of SFAS No. 123R, the Company will be required to recognize the cost of
its stock options as an expense in the consolidated statement of operations
beginning in the third quarter 2005. The Company is currently assessing the
impact that the adoption of SFAS No. 123R will have on its consolidated results
of operations. Although this assessment is ongoing, management believes the
effect of adopting SFAS No. 123R will be material to the Company's consolidated
results of operations.
On
September 30, 2004, the FASB issued FASB Staff Position EITF No. 03-1-1,
Effective
Date of Paragraphs 10-20 of EITF No. 03-1,
The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments,
delaying the effective date of this guidance until the FASB has resolved certain
implementation issues with respect to this guidance. The disclosure requirements
of EITF No. 03-1 were previously adopted by the Company as of December 31, 2003
and reflected in the Annual Report on Form 10-K for that year for the Company's
investments.
In
January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, Consolidation
of Variable Interest Entities, an interpretation of Accounting Research
Bulleting No. 51, and
amended it in December 2003 ("FIN 46R). An entity is subject to the
consolidation rules of FIN 46R and is referred to as a variable interest entity
("VIE") if it lacks sufficient equity to finance its activities without
additional financial support from other parties or if its equity holders lack
adequate decision making ability based on criteria set forth in the
interpretation. FIN 46R requires an investor with a majority of the variable
interests in a VIE to consolidate the entity.
FIN 46R
also requires disclosures about VIEs that companies are not required to
consolidate, but in which a company has a significant variable interest. On
August 29, 2003, the Company funded a revolving loan agreement with Impact
C.I.L., LLC ("Impact C.I.L."), a VIE. At present the Company has contributed
$5.1 million to be used to purchase mortgage loans in economically disadvantaged
areas. The Company is not the primary beneficiary of the VIE and participates at
an 11.11% level in the entity's funding activities. Potential losses are limited
to the amount invested as well as associated operating fees.
The
Company's maximum commitment is for up to 11.1% ($24 million) of $216 million of
participation. The mortgages purchased with these funds may be securitized.
Impact
C.I.L. is a subsidiary of Impact Community Capital, LLC ("Impact"), whose
charter is to provide real estate loans in economically disadvantaged areas. At
present, the Company has a $2.0 million note receivable from Impact in addition
to the $5.1 million investment noted above. If the mortgages purchased with
these funds are not securitized, the note receivable will be liquidated in 10
years from the initial date of the agreement. The Company has voting rights and
ownership of Impact in proportion to its investment (approximately
10%).
The
Company does not have any other material VIEs that it needs, or will need, to
consolidate or disclose.
Reclassifications
Certain
prior year amounts have been reclassified to conform to the current year
presentation.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
3. EARNINGS (LOSS) PER SHARE ("EPS")
For each
of the three years ended December 31, 2004, 2003, and 2002, the numerator for
the calculation of both basic and diluted EPS is equal to net income (loss)
reported for that year. The difference between basic and diluted EPS
denominators is due to dilutive stock options. The denominator for the
computation of basic EPS was 85,466,127 shares, 85,432,838 shares, and
85,414,076 shares for 2004, 2003 and 2002, respectively. The denominator for
diluted EPS was 85,602,567 shares, 85,637,672 shares, and 85,414,076 shares for
2004, 2003 and 2002, respectively.
Options
to purchase an aggregate of 6,156,772 shares, 5,121,446 shares, and 5,010,411
shares of common stock were considered anti-dilutive during 2004, 2003 and 2002,
respectively, and were not included in the computation of diluted EPS because
the options' exercise prices were greater than the average market price of the
common stock for each respective period. These options expire at various points
in time through December 2014 (see Note 14 of the Notes to Consolidated
Financial Statements).
NOTE
4. INVESTMENTS
A summary
of net investment income follows:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Interest
on fixed maturities |
|
$ |
57,188 |
|
$ |
45,668 |
|
$ |
45,777 |
|
Interest
on cash equivalents |
|
|
1,484 |
|
|
857 |
|
|
922 |
|
Dividends
on equity securities |
|
|
1,126 |
|
|
— |
|
|
— |
|
Investment
expense |
|
|
(967 |
) |
|
(692 |
) |
|
(354 |
) |
Net
investment income |
|
$ |
58,831 |
|
$ |
45,833 |
|
$ |
46,345 |
|
A summary
of net realized investment gains (losses) follows:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Realized
gains on sales of fixed maturity securities |
|
$ |
11,419 |
|
$ |
13,715 |
|
$ |
13,053 |
|
Realized
gains on equity securities |
|
|
2,726 |
|
|
— |
|
|
— |
|
Total
realized gains on sales of investments |
|
|
14,145 |
|
|
13,715 |
|
|
13,053 |
|
Realized
losses on sales of fixed maturity securities |
|
|
(1,708 |
) |
|
(382 |
) |
|
(2,183 |
) |
Realized
losses on equity securities |
|
|
(757 |
) |
|
— |
|
|
— |
|
Total
realized losses on sales of investments |
|
|
(2,465 |
) |
|
(382 |
) |
|
(2,183 |
) |
Realized
losses on disposal of property and equipment |
|
|
(849 |
) |
|
(156 |
) |
|
(479 |
) |
Total
net realized investment gains |
|
$ |
10,831 |
|
$ |
13,177 |
|
$ |
10,391 |
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
A summary
of investments follows:
|
|
|
|
Gross |
|
Gross |
|
|
|
|
|
Amortized |
|
Unrealized |
|
Unrealized |
|
Fair |
|
|
|
Cost |
|
Gains |
|
Losses |
|
Value |
|
December
31, 2004 |
|
|
|
|
|
|
|
|
|
U.S.
Treasury securities and obligations of U.S. |
|
|
|
|
|
|
|
|
|
Government
corporations and agencies |
|
$ |
204,990 |
|
$ |
1,420 |
|
$ |
(1,345 |
) |
$ |
205,065 |
|
Obligations
of states and political subdivisions |
|
|
292,149 |
|
|
20,057 |
|
|
(51 |
) |
|
312,155 |
|
Corporate
securities |
|
|
823,453 |
|
|
7,234 |
|
|
(5,777 |
) |
|
824,910 |
|
Total
fixed maturity investments |
|
|
1,320,592 |
|
|
28,711 |
|
|
(7,173 |
) |
|
1,342,130 |
|
Equity
securities |
|
|
41,450 |
|
|
928 |
|
|
(293 |
) |
|
42,085 |
|
Total
investments |
|
$ |
1,362,042 |
|
$ |
29,639 |
|
$ |
(7,466 |
) |
$ |
1,384,215 |
|
December
31, 2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury securities and obligations of U.S. |
|
|
|
|
|
|
|
|
|
|
|
|
|
Government
corporations and agencies |
|
$ |
192,936 |
|
$ |
2,312 |
|
$ |
(970 |
) |
$ |
194,278 |
|
Obligations
of states and political subdivisions |
|
|
834,058 |
|
|
32,679 |
|
|
(1,392 |
) |
|
865,345 |
|
Corporate
securities |
|
|
156,532 |
|
|
4,575 |
|
|
(1,054 |
) |
|
160,053 |
|
Total
fixed maturity investments |
|
|
1,183,526 |
|
|
39,566 |
|
|
(3,416 |
) |
|
1,219,676 |
|
Equity
securities |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
Total
investments |
|
$ |
1,183,526 |
|
$ |
39,566 |
|
$ |
(3,416 |
) |
$ |
1,219,676 |
|
The
Company has no non-interest bearing fixed maturity investments, investments
accounted for on a non-accrual basis or any individual securities in excess of
10% of stockholders' equity. Fixed maturities available-for-sale, at December
31, 2004, are summarized by contractual maturity year as follows:
|
|
Amortized |
|
Fair |
|
|
|
Cost |
|
Value |
|
Fixed
maturities due: |
|
|
|
|
|
2005 |
|
$ |
11,300 |
|
$ |
11,279 |
|
2006-2009 |
|
|
53,869 |
|
|
54,681 |
|
2010-2014 |
|
|
696,477 |
|
|
703,705 |
|
2015
and thereafter |
|
|
233,322 |
|
|
248,593 |
|
Asset-backed
securities |
|
|
325,624 |
|
|
323,872 |
|
Total |
|
$ |
1,320,592 |
|
$ |
1,342,130 |
|
Expected
maturities of the Company's investments may differ from contractual maturities
because certain borrowers have the right to call or prepay obligations with or
without call or prepayment penalties.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
following table summarizes the Company's gross unrealized losses and estimated
fair values on investments, aggregated by investment category and length of time
that individual securities have been in a continuous unrealized loss
position.
|
|
Less than 12 Months |
|
12 Months or More |
|
Total |
|
December
31, 2004 |
|
Fair
Value |
|
Unrealized
Losses |
|
Fair
Value |
|
Unrealized
Losses |
|
Fair
Value |
|
Unrealized
Losses |
|
U.S.
Treasury securities and obligations of U.S. |
|
|
|
|
|
|
|
|
|
|
|
|
|
Governmentcorporations and agencies |
|
$ |
128,491 |
|
$ |
1,277 |
|
$ |
1,927 |
|
$ |
68 |
|
$ |
130,418 |
|
$ |
1,345 |
|
Obligations of
states and political |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
subdivisions |
|
|
— |
|
|
— |
|
|
1,030 |
|
|
51 |
|
|
1,030 |
|
|
51 |
|
Corporate
securities |
|
|
412,119 |
|
|
5,249 |
|
|
10,724 |
|
|
528 |
|
|
422,843 |
|
|
5,777 |
|
Total
fixed maturity investments |
|
|
540,610 |
|
|
6,526 |
|
|
13,681 |
|
|
647 |
|
|
554,291 |
|
|
7,173 |
|
Equity
securities |
|
|
15,479 |
|
|
293 |
|
|
— |
|
|
— |
|
|
15,479 |
|
|
293 |
|
Total
Investments |
|
$ |
556,089 |
|
$ |
6,819 |
|
$ |
13,681 |
|
$ |
647 |
|
$ |
569,770 |
|
$ |
7,466 |
|
The
Company held 179 investment positions with unrealized losses as of December 31,
2004. Of the 179 investment positions, 64 positions were in equity securities,
which have been held for less than one year, as the Company typically holds
equity securities for 90 days or less. The remaining 115 investment positions
were fixed maturity securities and are all investment grade; none of the
unrealized losses are considered credit related and given the length of time in
an unrealized loss position do not appear to represent other-than-temporary
impairment. Of the 115 fixed maturity securities in an unrealized loss position,
the Company had 8 investments that were in an unrealized loss position for 12
months or more, however, the unrealized loss for such investments, which are all
investment grade, comprised less than 5% of amortized cost.
Cash and
securities with carrying values of $7.1 million and $6.7 million as of December
31, 2004 and 2003 were on deposit with state regulatory authorities in
accordance with the related statutory insurance requirements.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
5. INCOME TAXES
Income
tax expense (benefit) consists of:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Current
tax expense (benefit) |
|
$ |
8,822 |
|
$ |
4,166 |
|
$ |
(8,200 |
) |
Deferred
tax expense (benefit) |
|
|
25,246 |
|
|
13,406 |
|
|
(5,370 |
) |
Total
tax expense (benefit) |
|
$ |
34,068 |
|
$ |
17,572 |
|
$ |
(13,570 |
) |
A
reconciliation of income tax computed at the federal statutory tax rate of 35%
to total income tax expense (benefit) follows:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Federal
income tax expense (benefit) at statutory rate |
|
$ |
42,803 |
|
$ |
24,902 |
|
$ |
(9,039 |
) |
Tax-exempt
income, net |
|
|
(4,888 |
) |
|
(8,581 |
) |
|
(9,377 |
) |
State
and local taxes, net of federal benefit |
|
|
(4,477 |
) |
|
560 |
|
|
5,151 |
|
Dividends
received deduction |
|
|
(294 |
) |
|
— |
|
|
— |
|
Research
and experimentation tax credit |
|
|
— |
|
|
(374 |
) |
|
(1,040 |
) |
Nondeductible
political contributions |
|
|
497 |
|
|
135 |
|
|
766 |
|
Effect
on prior years of settlement of tax dispute |
|
|
— |
|
|
949 |
|
|
— |
|
Effect
of nondeductible executive compensation |
|
|
435 |
|
|
— |
|
|
— |
|
Other
- net |
|
|
(8 |
) |
|
(19 |
) |
|
(31 |
) |
Income
tax expense (benefit) |
|
$ |
34,068 |
|
$ |
17,572 |
|
$ |
(13,570 |
) |
In a
December 21, 2000, court ruling, Ceridian
Corporation v. Franchise Tax Board, a
California statute that allowed a tax deduction for the dividends received from
wholly-owned insurance subsidiaries was held unconstitutional on the grounds
that it discriminated against out-of-state insurance holding companies.
Subsequent to the court ruling, the staff of the California Franchise Tax Board
("FTB") took the position that the discriminatory sections of the statute are
not severable and the entire statute is invalid. As a result, the FTB began
disallowing dividend-received deductions for all insurance holding companies,
regardless of domicile, for open tax years ending on or after December 1, 1997.
Although the FTB made no formal assessment, the Company anticipated a
retroactive disallowance that would result in additional tax assessments and
recorded a provision for this contingency in a prior year. In the third quarter
of 2004, California enacted AB 263, which will allow the Company to file certain
amended California tax returns and claim a dividends received deduction. As a
result, the Company re-estimated its liability and reduced its tax provision by
approximately $4.9 million in the third quarter 2004, which reduced the
effective tax rate for 2004.
Income
tax payments for the year ended December 31, 2004 totaled $16.4 million. No
income tax payments were required in the years ended December 31, 2003 and 2002.
During 2004, we received $12.5 million from the IRS to settle the majority of
the prior year receivable. As of December 31, 2004, the Company's federal income
tax refund receivable was $2.8 million.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
Company's net deferred tax asset is comprised of:
December
31, |
|
2004 |
|
2003 |
|
Deferred
tax assets ("DTAs"): |
|
|
|
|
|
Net
operating loss carryforward |
|
$ |
75,847 |
|
$ |
105,317 |
|
Alternative
minimum tax credit |
|
|
24,142 |
|
|
10,717 |
|
Unearned
premiums |
|
|
23,825 |
|
|
22,377 |
|
Unpaid
losses and LAE |
|
|
7,828 |
|
|
8,107 |
|
Research
credit |
|
|
2,423 |
|
|
2,607 |
|
Minimum
pension liability |
|
|
925 |
|
|
1,047 |
|
Other
DTAs - net |
|
|
1,778 |
|
|
14 |
|
Total
DTAs |
|
|
136,768 |
|
|
150,186 |
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities ("DTLs"): |
|
|
|
|
|
|
|
EDP
software development costs |
|
|
48,871 |
|
|
40,729 |
|
Deferred
policy acquisition costs |
|
|
20,566 |
|
|
18,578 |
|
Unrealized
investment gains |
|
|
7,760 |
|
|
12,653 |
|
Other
DTLs - net |
|
|
3,436 |
|
|
1,615 |
|
Total
DTLs |
|
|
80,633 |
|
|
73,575 |
|
Net
deferred tax asset |
|
$ |
56,135 |
|
$ |
76,611 |
|
As of
December 31, 2004, the Company had a tax net operating loss ("NOL") carryforward
of $216.7 million for regular tax purposes, all of which expires on or after
2017, and an alternative minimum tax credit carryforward of $24.1 million.
Alternative minimum tax credits may be carried forward indefinitely to offset
future regular tax liabilities.
We are
required to reduce DTAs (but not DTLs) by a valuation allowance to the extent
that, based on the weight of available evidence, it is "more likely than not"
(i.e., a likelihood of more than 50%) that any DTAs will not be realized.
Recognition of a valuation allowance would decrease reported earnings on a
dollar-for- dollar basis in the year in which any such recognition were to
occur. The
determination of whether a valuation allowance is appropriate requires the
exercise of management judgment. In making this judgment, management is required
to weigh the positive and negative evidence as to the likelihood that the DTAs
will be realized.
Our core
business has generated an underwriting profit for the past three years.
Management believes it is reasonable to expect future underwriting profits and
to conclude it is at least more likely than not that we will be able to realize
the benefits of our DTAs. If necessary, we believe we could implement
tax-planning strategies to generate sufficient future taxable income to utilize
the NOL carryforwards prior to their expiration. Accordingly, no valuation
allowance has been recognized as of December 31, 2004. However, generating
future taxable income is dependent on a number of factors, including regulatory
and competitive influences that may be beyond our ability to control. Future
underwriting losses could possibly jeopardize our ability to utilize our NOLs.
If so, management might be required to reach a different conclusion about the
realization of the DTAs and recognize a valuation allowance at that
time.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
6. DEFERRED POLICY ACQUISITION COSTS
Following
is a summary of policy acquisition costs deferred for amortization against
future income and the related amortization charged to income from operations
(policy acquisition costs are amortized over the 6-month policy
period):
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Deferred
policy acquisition costs, beginning of year |
|
$ |
53,079 |
|
$ |
46,190 |
|
$ |
30,631 |
|
Acquisition
costs deferred |
|
|
228,159 |
|
|
209,078 |
|
|
139,201 |
|
Acquisition
costs amortized and charged to income |
|
|
|
|
|
|
|
|
|
|
during
the year |
|
|
(222,479 |
) |
|
(202,189 |
) |
|
(123,642 |
) |
Deferred
policy acquisition costs, end of year |
|
$ |
58,759 |
|
$ |
53,079 |
|
$ |
46,190 |
|
Total
advertising costs included in acquisition costs deferred during 2004, 2003 and
2002 were $66.7 million, $53.9 million, and $43.3 million, respectively.
NOTE
7. PROPERTY AND EQUIPMENT
A summary
of property and equipment follows:
December
31, |
|
2004 |
|
2003 |
|
Furniture
and equipment |
|
$ |
38,676 |
|
$ |
37,666 |
|
Automobiles |
|
|
881 |
|
|
1,505 |
|
Leasehold
improvements |
|
|
14,245 |
|
|
11,890 |
|
Software
currently in service |
|
|
87,283 |
|
|
34,136 |
|
Software
development projects in progress |
|
|
56,816 |
|
|
76,110 |
|
Subtotal |
|
|
197,901 |
|
|
161,307 |
|
Less
accumulated depreciation, including $25,506 and $19,057 for software
currently in service |
|
|
(68,529 |
) |
|
(60,070 |
) |
Total |
|
$ |
129,372 |
|
$ |
101,237 |
|
Depreciation
expense on software currently in service was $7.0 million, $4.2 million, and
$9.6 million in 2004, 2003 and 2002, respectively. In the third quarter of 2002,
we recorded a pre-tax charge to write off $37.2 million of previously
capitalized software costs for abandoned portions of an advanced personal lines
processing system. Substantially all software development projects in progress,
which primarily relate to the advanced personal lines processing system, are
expected to be implemented during 2005.
NOTE
8. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Accounting
for losses and LAE is highly subjective because these costs must be estimated,
often weeks, months or even years in advance of when the payments are actually
made to claimants, attorneys, claims personnel and others involved in the claims
settlement process.
Accounting
principles require insurers to record estimates for loss and LAE in the periods
in which the insured events, such as automobile accidents, occur. This
estimation process requires the Company to estimate both the number of accidents
that have occurred (called "frequency") and the ultimate amount of loss and LAE
(called "severity") related to each accident. The Company employs actuaries who
are professionally trained and certified in the process of establishing
estimates for frequency and severity.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
methods used to determine such estimates and to establish the resulting reserves
are continually reviewed and updated. Any adjustments resulting therefrom are
reflected in current operating income. It is management's belief that the unpaid
losses and LAE are adequate to cover unpaid losses and LAE as of December 31,
2004. While the Company performs quarterly reviews of the adequacy of
established unpaid losses and LAE, there can be no assurance that ultimate
amounts will not differ materially, higher or lower, from the recorded liability
for unpaid losses and LAE as of December 31, 2004. In the future, if the unpaid
losses and LAE develop redundancies or deficiencies, such redundancy or
deficiency would have a positive or adverse impact, respectively, on future
results of operations.
The
following analysis provides a reconciliation of the activity in the reserve for
unpaid losses and loss adjustment expenses:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
At
beginning of year: |
|
|
|
|
|
|
|
Reserve
for losses and LAE, gross of reinsurance |
|
$ |
438,323 |
|
$ |
384,009 |
|
$ |
349,290 |
|
Reinsurance
recoverable |
|
|
(8,964 |
) |
|
(20,351 |
) |
|
(23,512 |
) |
Acquisition
of 21st of Arizona |
|
|
— |
|
|
— |
|
|
6,749 |
|
Reserve
for losses and LAE, net of reinsurance |
|
$ |
429,359 |
|
|
363,658 |
|
|
332,527 |
|
Losses
and LAE incurred, net of reinsurance: |
|
|
|
|
|
|
|
|
|
|
Current
year |
|
|
993,946 |
|
|
911,104 |
|
|
754,299 |
|
Prior
years |
|
|
(105 |
) |
|
51,207 |
|
|
72,358 |
|
Total |
|
|
993,841 |
|
|
962,311 |
|
|
826,657 |
|
Losses
and LAE paid, net of reinsurance: |
|
|
|
|
|
|
|
|
|
|
Current
year |
|
|
642,664 |
|
|
590,678 |
|
|
513,738 |
|
Prior
years |
|
|
289,639 |
|
|
305,932 |
|
|
281,788 |
|
Total |
|
|
932,303 |
|
|
896,610 |
|
|
795,526 |
|
At
end of year: |
|
|
|
|
|
|
|
|
|
|
Reserve
for losses and LAE, net of reinsurance |
|
|
490,897 |
|
|
429,359 |
|
|
363,658 |
|
Reinsurance
recoverable |
|
|
4,645 |
|
|
8,964 |
|
|
20,351 |
|
Reserve
for losses and LAE, gross of reinsurance |
|
$ |
495,542 |
|
$ |
438,323 |
|
$ |
384,009 |
|
The
change in prior accident year estimates recorded in each of the past three
years, net of applicable reinsurance, are summarized below:
Years
ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Personal
auto |
|
$ |
(2,936 |
) |
$ |
11,159 |
|
$ |
16,200 |
|
Homeowner
and earthquake 1
|
|
|
2,831 |
|
|
40,048 |
|
|
56,158 |
|
Total |
|
$ |
(105 |
) |
$ |
51,207 |
|
$ |
72,358 |
|
Positive
amounts represent deficiencies in loss and LAE reserves, while negative amounts
represent redundancies.
The
provision for losses and LAE recorded in 2003 and 2002 for insured events of
prior years primarily resulted from the Company's recognition of earthquake
losses under SB 1899, as discussed in Note 16 of the Notes to Consolidated
Financial Statements, and from adverse development in personal auto loss
severity.
_____________________
1 |
The
Company no longer has any California homeowners policies in force. The
Company ceased writing earthquake coverage in 1994, but has remaining loss
reserves from the 1994 Northridge Earthquake that are subject to adverse
development. |
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
process of making periodic changes to unpaid losses and LAE begins with the
preparation of several point estimates of unpaid losses and LAE, a review of the
actual claims experience in the period, actual rate changes achieved, actual
changes in coverage, mix of business, and changes in certain other factors such
as weather and recent tort activity that may affect the loss ratio. Other
relevant internal and external factors considered include a qualitative
assessment of inflation and other economic conditions, changes in the legal,
regulatory, judicial and social environments, underlying policy pricing,
exposure and policy forms, claims handling, and geographic distribution shifts.
The Company's actuaries prepare several point estimates of unpaid losses and LAE
for each of the coverages, and use experience and judgment to arrive at an
overall actuarial point estimate of the unpaid losses and LAE for that coverage.
Meetings are held with appropriate departments to discuss significant issues as
a result of the review. This process culminates in a reserve meeting to review
the unpaid losses and LAE. The basis for carried unpaid losses and LAE is the
overall actuarial point estimate.
As a
result of this process, unpaid losses and LAE are finalized and periodic changes
are recorded for each of our coverages. The change in unpaid losses and LAE for
the period for each coverage is the difference between net ultimate losses and
LAE and the net paid losses and LAE recorded through the end of the period. The
overall change in our unpaid losses and LAE is based on the sum of these
coverage level changes.
The
following table shows unpaid losses and LAE gross and net of
reinsurance:
|
|
2004 |
|
2003 |
|
December
31, |
|
Gross |
|
Net |
|
Gross |
|
Net |
|
Unpaid
Losses and LAE |
|
|
|
|
|
|
|
|
|
Personal
auto lines |
|
$ |
489,411 |
|
$ |
485,759 |
|
$ |
419,913 |
|
$ |
413,348 |
|
Homeowner
and earthquake |
|
|
6,131 |
|
|
5,138 |
|
|
18,410 |
|
|
16,011 |
|
Total
|
|
$ |
495,542 |
|
$ |
490,897 |
|
$ |
438,323 |
|
$ |
429,359 |
|
The $69.5
million increase in the gross auto reserves for the year ended December 31,
2004, is comprised of growth in reserves attributable to the higher number of
insured automobiles of approximately $36.8 million, the effects of higher
average loss costs of approximately $35.6 million and the favorable development
in prior accident year reserves of approximately $2.9 million.
NOTE
9. DEBT
Debt at
December 31 consisted of:
|
|
2004 |
|
2003 |
|
Senior
Notes (5.9%; maturing in 2013) |
|
$ |
99,884 |
|
$ |
99,871 |
|
Obligation
under capital lease (5.7%; maturing through 2007) |
|
|
38,406 |
|
|
49,815 |
|
Total
debt |
|
$ |
138,290 |
|
$ |
149,686 |
|
The
primary purpose of both of the borrowings enumerated above was to increase the
statutory surplus of the Company's largest insurance subsidiary.
In
December 2003, the Company completed a private offering of $100 million
principal amount of 5.9 percent Senior Notes due in December 2013 at a discount
of $0.8 million. The effective interest rate on the Senior Notes, when all
offering costs are taken into account and amortized over the term of the Senior
Notes, is approximately 6 percent per annum. Of the $99.2 million in net
proceeds from the Senior Notes, $85.0 million was used to increase the statutory
surplus of 21st Century Insurance Company, a wholly-owned subsidiary of the
Company, and the balance was retained by the holding company.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
Senior Notes are redeemable at the Company's option, at any time in whole, or
from time to time in part, prior to maturity at a redemption price equal to the
greater of (A) 100% of the principal amount of the notes or (B) the sum of the
present values of the remaining scheduled payments of principal and interest
thereon (exclusive of interest accrued through the date of redemption)
discounted to the redemption date on a semi-annual basis (assuming a 360-day
year consisting of twelve 30-day months) at the Treasury Rate, plus 25 basis
points (plus in each case, accrued interest thereon to the date of
redemption).
On April
6, 2004, pursuant to a registration rights agreement executed in connection with
the offering, the Company filed a registration statement with the SEC enabling
holders to exchange the private offering notes for publicly registered notes. On
July 8, 2004, the Company completed an exchange offer in which all of the
private offering notes were exchanged for publicly registered notes having the
same terms.
On
December 31, 2002, the Company entered into a sale-leaseback transaction for
$15.8 million of equipment and leasehold improvements and $44.2 million of
software. The transaction is accounted for as a capital lease under SFAS No. 13,
Accounting
for Leases, as
amended by SFAS No. 28, Accounting
for Sales with Leasebacks. The
lease includes a covenant that if AIG ceases to have a majority interest in the
Company, or if statutory surplus falls below $300.0 million, or if the net
premiums written to surplus ratio is greater than 3.8:1, or if claims paying
ratings fall below BBB+ (as rated by Standard & Poor's), Baa1 (as rated by
Moody's) or B++ (as rated by A.M. Best), the Company will either deliver a
letter of credit to the lessor or pay the lessor the then outstanding balance,
including a prepayment penalty of up to 3%. The lessor has been granted a
security interest in the property and equipment, subject to the sale-leaseback,
and also certain software in process of development. See Note 12 of the Notes to
Consolidated Financial Statements for the related contractual commitment
schedule.
Depreciation
expense for leased property under capital lease was $12.4 million for the years
2004 and 2003. There was no depreciation expense on leased property under
capital lease for 2002.
NOTE
10. REINSURANCE
Effective
September 1, 2002, the Company entered into an agreement to cancel future
cessions under its quota share reinsurance treaty with AIG subsidiaries
resulting in a pre-tax charge of $0.9 million. The treaty would have ceded 4% of
premiums and losses and LAE to AIG subsidiaries in the remainder of 2002 and 2%
in 2003.
The
Company has a catastrophe reinsurance agreement for its auto lines with
Endurance Specialty Insurance Ltd. (20%) and AIG subsidiaries Transatlantic
Reinsurance Company (20%) and National Union Insurance Company of Pittsburg, PA
(60%), which reinsures any covered events up to $45.0 million in excess of $20.0
million effective January 1, 2004. In 2003 and 2002, covered events were up to
$30.0 million in excess of $15.0 million and the reinsurers were Folksamerica
Reinsurance Company (6.7%), Endurance Specialty Insurance Ltd. (16.7%),
Transatlantic Reinsurance Company (16.7%) and National Union Insurance Company
of Pittsburg, PA (60%).
Effective
January 1, 2004, the 90% quota share reinsurance treaty covering the Company's
Personal Umbrella Policies ("PUP") was amended so that the reinsurers are as
follows: Swiss RE Underwriters - 55%, Hannover Ruckversicherungs - 35%.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
following summarizes the approximate percentage of business retained and ceded
under various reinsurance programs with AIG subsidiaries and unrelated insurers.
Most programs provide for ceding commissions that approximate the Company's
direct policy acquisition costs and other operating expenses.
|
|
Contracts
Incepting During |
|
|
|
2004 |
|
2003 |
|
2002 |
|
Auto
Policies |
|
|
|
|
|
|
|
Retained |
|
|
100 |
% |
|
100 |
% |
|
97 |
% |
Ceded |
|
|
— |
|
|
— |
|
|
3 |
% |
Catastrophe
cover in excess of $20 million in 2004 and $15 million in 2003 and
2002 |
|
$ |
45,000 |
|
$ |
30,000 |
|
$ |
30,000 |
|
Homeowner
Policies1
|
|
|
|
|
|
|
|
|
|
|
Retained |
|
|
— |
|
|
— |
|
|
— |
|
Ceded |
|
|
|
|
|
|
|
|
100 |
% |
PUP
Policies |
|
|
|
|
|
|
|
|
|
|
Retained |
|
|
10 |
% |
|
10 |
% |
|
10 |
% |
Ceded |
|
|
90 |
% |
|
90 |
% |
|
90 |
% |
The
effect of reinsurance on premiums written and earned is as follows:
|
|
2004 |
|
2003 |
|
2002 |
|
Years
Ended December 31, |
|
Written |
Earned |
Written |
Earned |
Written |
Earned |
Gross |
|
$ |
1,337,198 |
|
$ |
1,318,417 |
|
$ |
1,223,484 |
|
$ |
1,177,705 |
|
$ |
998,248 |
|
$ |
971,059 |
|
Ceded |
|
|
(4,814 |
) |
|
(4,747 |
) |
|
(4,854 |
) |
|
(5,028 |
) |
|
(32,949 |
) |
|
(46,500 |
) |
Net |
|
$ |
1,332,384 |
|
$ |
1,313,670 |
|
$ |
1,218,630 |
|
$ |
1,172,677 |
|
$ |
965,299 |
|
$ |
924,559 |
|
Gross
losses and loss adjustment expenses have been reduced by reinsurance ceded as
follows:
Years
Ended December 31, |
|
2004 |
2003 |
2002 |
Gross
losses and LAE incurred |
|
$ |
997,612 |
|
$ |
966,512 |
|
$ |
870,402 |
|
Ceded
losses and LAE incurred |
|
|
(3,771 |
) |
|
(4,201 |
) |
|
(43,745 |
) |
Net
losses and LAE incurred |
|
$ |
993,841 |
|
$ |
962,311 |
|
$ |
826,657 |
|
At
December 31, 2004 and 2003, the Company's reinsurance recoverables, net of
payables, from AIG subsidiaries were $1.5 million and $5.8 million,
respectively. The Company ceded $1.1 million, $0.9 million, and $29.1 million in
net premiums earned to AIG subsidiaries in 2004, 2003 and 2002, respectively.
Losses and LAE incurred of $0.1 million, $1.6 million, and $28.4 million were
ceded to AIG subsidiaries in 2004, 2003 and 2002, respectively.
NOTE
11. EMPLOYEE BENEFIT PLANS
The
Company has both funded and unfunded non-contributory defined benefit pension
plans, which together cover essentially all employees who have completed at
least one year of service. For certain key employees designated by the Board of
Directors, the Company sponsors an unfunded non-qualified supplemental executive
retirement plan. The supplemental plan benefits are based on years of service
and compensation during the three highest of the last ten years of employment
prior to retirement and are reduced by the benefit payable from the pension plan
and 50% of the social security benefit. For other eligible employees, the
pension benefits are based on employees' compensation during all years of
service. The Company's funding policy is to make annual contributions as
required by applicable regulations. In 2004, 2003, and 2002, the Company made
additional contributions to fully fund the accumulated benefit obligation of its
qualified plan.
____________________
1 The
Company’s homeowner policies did not include any earthquake
coverage.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Other
information regarding the Company's defined benefit pension plans
follows:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
Change
in projected benefit obligation: |
|
|
|
|
|
Benefit
obligation at beginning of year |
|
$ |
100,933 |
|
$ |
78,684 |
|
Service
cost |
|
|
6,493 |
|
|
4,607 |
|
Interest
cost |
|
|
6,639 |
|
|
5,627 |
|
Plan
amendments |
|
|
— |
|
|
85 |
|
Actuarial
loss |
|
|
4,873 |
|
|
14,161 |
|
Benefits
paid |
|
|
(2,463 |
) |
|
(2,230 |
) |
Projected
benefit obligation at end of year |
|
$ |
116,475 |
|
$ |
100,934 |
|
Change
in plan assets: |
|
|
|
|
|
|
|
Fair
value of plan assets at beginning of year |
|
$ |
77,099 |
|
$ |
58,276 |
|
Actual
return on plan assets net of expenses |
|
|
9,290 |
|
|
14,053 |
|
Employer
contributions |
|
|
2,659 |
|
|
7,000 |
|
Benefits
paid |
|
|
(2,463 |
) |
|
(2,230 |
) |
Fair
value of plan assets at end of year |
|
$ |
86,585 |
|
$ |
77,099 |
|
Reconciliation
of funded status: |
|
|
|
|
|
|
|
Funded
status |
|
$ |
(29,890 |
) |
$ |
(23,835 |
) |
Unrecognized
net loss |
|
|
36,267 |
|
|
36,026 |
|
Unrecognized
prior service cost |
|
|
678 |
|
|
788 |
|
Net
pension asset recognized at year end |
|
$ |
7,055 |
|
$ |
12,979 |
|
Amounts
recognized in the balance sheet consist of: |
|
|
|
|
|
|
|
Prepaid
pension cost - qualified plan |
|
$ |
16,610 |
|
$ |
19,849 |
|
Accrued
benefit liability - non-qualified plan |
|
|
(9,555 |
) |
|
(6,870 |
) |
Additional
minimum liability - non-qualified plan |
|
|
(3,285 |
) |
|
(3,742 |
) |
Intangible
asset |
|
|
643 |
|
|
750 |
|
Accumulated
other comprehensive income, pre-tax |
|
|
2,642 |
|
|
2,992 |
|
Net
pension asset recognized at year end |
|
$ |
7,055 |
|
$ |
12,979 |
|
The
accumulated benefit obligation for all defined benefit pension plans was $95.3
million and $83.4 million at December 31, 2004 and 2003, respectively, of which
90.7% and 92.0%, respectively, were vested.
Information
for the unfunded supplemental executive retirement plan, which has an
accumulated benefit obligation in excess of plan assets, is as follows:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
Projected
benefit obligation |
|
$ |
19,232 |
|
$ |
16,552 |
|
Accumulated
benefit obligation |
|
|
12,840 |
|
|
11,586 |
|
Fair
value of plan assets |
|
|
— |
|
|
974 |
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Net
periodic benefit costs for all plans were comprised of the
following:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Service
cost |
|
$ |
6,493 |
|
$ |
4,607 |
|
$ |
3,788 |
|
Interest
cost |
|
|
6,638 |
|
|
5,627 |
|
|
5,008 |
|
Expected
return on plan assets |
|
|
(6,441 |
) |
|
(4,857 |
) |
|
(4,193 |
) |
Amortization
of unrecognized transition obligation |
|
|
— |
|
|
— |
|
|
181 |
|
Amortization
of prior service cost |
|
|
111 |
|
|
105 |
|
|
105 |
|
Amortization
of net loss |
|
|
2,163 |
|
|
2,012 |
|
|
1,012 |
|
Net
periodic benefit cost |
|
$ |
8,964 |
|
$ |
7,494 |
|
$ |
5,901 |
|
Additional
information
The
(decrease) increase in minimum liability included in accumulated other
comprehensive income, net of deferred income taxes, for the years ended December
31, 2004 and 2003 was $(0.2) and $0.5 million, respectively.
Assumptions
December
31, |
|
2004 |
|
2003 |
|
Weighted-average
assumptions used to determine the benefit obligations: |
|
|
|
|
|
Discount
rate |
|
|
6.00 |
% |
|
6.10 |
% |
Rate
of compensation increase |
|
|
4.60 |
% |
|
4.60 |
% |
Years
Ended December 31, |
|
2004 |
|
2003 |
|
Weighted-average
assumptions used to determine the net cost: |
|
|
|
|
|
Discount
rate |
|
|
6.10 |
% |
|
6.75 |
% |
Expected
return on plan assets |
|
|
8.50 |
% |
|
8.50 |
% |
Rate
of compensation increase |
|
|
4.60 |
% |
|
5.60 |
% |
December
31 is the measurement date for the plans. The discount rate can vary from year
to year and is determined by developing a hypothetical bond portfolio matched to
our projected benefit costs.
The
overall expected long-term rate of return on assets is a weighted-average
expectation for the return on plan assets. The Company considers historical
performance and current benchmarks to arrive at expected long-term rates of
return in each asset category. The Company assumed that 75% of its portfolio
would be invested in equity securities, with the remainder invested in debt
securities.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Plan
Assets
The
Company's pension plan weighted-average asset allocations for 2004 and 2003, and
target allocation for 2005, by asset category are as follows:
|
|
Target Allocation |
|
Percentage
of Plan Assets at December 31, |
|
Asset
Category |
|
2005 |
|
2004 |
2003 |
Equity
Securities |
|
|
66-84 |
% |
|
|
76 |
% |
|
72 |
% |
Debt
Securities |
|
|
22-28 |
|
|
|
21 |
|
|
19 |
|
Other |
|
|
0-12 |
|
|
|
3 |
|
|
9 |
|
Total |
|
|
|
|
|
|
100 |
% |
|
100 |
% |
The
Company's pension plan assets are managed by outside investment managers. The
Company's investment strategy is to maximize return on investments while
minimizing risk. The Company believes the best way to accomplish this goal is to
take a conservative approach to its investment strategy by investing in
high-grade equity and debt securities.
Pension
Plan Contributions
During
2004, the Company contributed $2.7 million to its pension plans. Based on
current assumptions, the Company does not expect to be required to contribute to
its qualified plan in 2005. However, the amount and timing of future
contributions to our qualified defined benefit pension plan depends on a number
of unpredictable factors including statutory funding requirements, the market
performance of the plan's assets, cash requirements for benefit payments to
retirees, and future changes in interest rates that affect the actuarial
measurement of the plan's obligations. Contributions to our non-qualified
defined benefit pension plan generally are limited to amounts needed to make
benefit payments to retirees, which are expected to total approximately $1.1
million in 2005.
Estimated
Future Benefit Payments
Benefit
payments for the Company's defined benefit pension plans, which reflect expected
future service, are expected to be paid as follows:
Years
ended December 31, |
|
Pension
Plans |
|
2005 |
|
$ |
2,666 |
|
2006 |
|
|
2,882 |
|
2007 |
|
|
3,174 |
|
2008 |
|
|
3,435 |
|
2009 |
|
|
3,795 |
|
2010-2014 |
|
|
29,876 |
|
Total |
|
$ |
45,828 |
|
Defined
Contribution Plans
The
Company sponsors a contributory savings and security plan for eligible employees
and officers. The Company provides matching contributions equal to 75% of the
lesser of 6% of an employee's compensation or the amount contributed by the
employee up to the maximum allowable under IRS regulations. Company matching
contributions charged against operations were $4.9 million, $4.4 million, and
$4.2 million in 2004, 2003 and 2002, respectively. The plan offers a variety of
investment types among which employees exercise complete discretion as to choice
and investment duration, including any amounts the employee elects to invest in
Company common stock.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
12. COMMITMENTS AND CONTINGENCIES
Contractual
Commitments
The
Company leases office space in Woodland Hills, California. The lease for the
Company's corporate office expires in February 2015 and may be renewed for two
consecutive five-year periods. During the current year, the Company entered into
a lease for a call center in Lewisville, Texas, which expires in 2016. The
Company also leases automobiles and office equipment as well as office space in
several other locations throughout California, primarily for claims services.
The Company also has software license agreements with terms greater than one
year. Minimum amounts due under the Company's noncancelable commitments at
December 31, 2004 are as follows:
|
|
Operating
Leases1
|
Capital
Lease |
2005 |
|
$ |
27,248 |
|
$ |
13,962 |
|
2006 |
|
|
24,791 |
|
|
13,962 |
|
2007 |
|
|
17,982 |
|
|
13,962 |
|
2008 |
|
|
17,063 |
|
|
— |
|
2009 |
|
|
17,003 |
|
|
— |
|
Thereafter |
|
|
90,245 |
|
|
— |
|
|
|
$ |
194,332 |
|
$ |
41,886 |
|
Less:
amount representing interest |
|
|
|
|
|
3,480 |
|
Present
value of minimum lease payments |
|
|
|
|
$ |
38,406 |
|
Total
rental expense charged to operations for the years ended December 31, 2004, 2003
and 2002 was $24.4 million, $17.5 million, and $16.4 million,
respectively.
The
Company owns an 11.11% interest in Impact, an entity whose purpose is to provide
real estate loans in economically disadvantaged areas. Through one of Impact's
subsidiaries, Impact C.I.L., the Company has a commitment to fund up to an
additional $24.0 million in loans over the next ten years.
Legal
Proceedings
In the
normal course of business, the Company is named as a defendant in lawsuits
related to claims and insurance policy issues, both on individual policy files
and by class actions seeking to attack the Company's business practices. Many
suits seek unspecified extracontractual and punitive damages as well as
contractual damages under the Company's insurance policies in excess of the
Company's estimates of its obligations under such policies. The Company cannot
estimate the amount or range of loss that could result from an unfavorable
outcome on these suits and it denies liability for any such alleged damages. The
Company has not established reserves for potential extracontractual or punitive
damages, or for contractual damages in excess of estimates the Company believes
are correct and reasonable under its insurance policies. Nevertheless,
extracontractual and punitive damages, if assessed against the Company, could be
material in an individual case or in the aggregate. The Company may choose to
settle litigated cases for amounts in excess of its own estimate of contractual
damages to avoid the expense and risk of litigation. Other than possibly for the
contingencies discussed below and in Note 16 of the Notes to Consolidated
Financial Statements, the Company does not believe the ultimate outcome of these
matters will be material to its results of operations, financial condition or
cash flows. The Company denies liability and has not established a reserve for
the matters discussed below. A range of potential losses in the event of a
negative outcome is discussed where known.
___________________
1 Includes
total amounts due under long-term software license agreements of approximately
$15.1 million.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Poss
v. 21st Century Insurance Company was filed
on June 13, 2003, in Los Angeles Superior Court. The Complaint requests
injunctive and restitutionary relief against the Company under Business and
Professions Code ("B&P") Sec. 17200 for alleged unfair business practices in
violation of California Insurance Code ("CIC") Sec. 1861.02(c) relating to
company rating practices. The plaintiffs are seeking injunctive relief and
unspecified restitutionary relief. Based on the passage of California's
Proposition 64 in November 2004, we have filed a motion to dismiss the
complaint. Because this matter is in the pleading stages and no discovery has
taken place, no estimate of the range of potential losses in the event of a
negative outcome can be made at this time.
Cecelia
Encarnacion, individually and as the Guardian Ad Litem for Nubia Cecelia
Gonzalez, a Minor, Hilda Cecelia Gonzalez, a Minor, and Ramon Aguilera v. 20th
Century Insurance was
filed on July 3, 1997, in Los Angeles Superior Court. Plaintiffs allege bad
faith, emotional distress, and estoppel involving the Company's (the Company was
formerly named 20th Century Insurance) handling of a 1994 homeowner's claim. On
March 1, 1994, Ramon Aguilera shot and killed Mr. Gonzalez (the minor children's
father) and was later sued by Ms. Encarnacion for wrongful death. On August 30,
1996, judgment was entered against Ramon Aguilera for $5.6 million. The Company
paid for Aguilera's defense costs through the civil trial; however, the
homeowner's policy did not provide indemnity coverage for the shooting incident,
and the Company refused to pay the judgment. After the trial, Aguilera assigned
a portion of his action against the Company to Encarnacion and the minor
children. Aguilera and the Encarnacion family then sued the Company alleging
that the Company had promised to pay its bodily injury policy limit if Aguilera
pled guilty to involuntary manslaughter. In August 2003, the trial court held a
bench trial on the limited issues of promissory and equitable estoppel, and
policy forfeiture. On September 26, 2003, the trial court issued a ruling that
the Company cannot invoke any policy exclusions as a defense to coverage. On May
14, 2004, the court granted the Encarnacion plaintiffs' motion for summary
adjudication, ordering that the Company must pay the full amount of the
underlying judgment of $5.6 million, plus interest, for a total of $10.5
million. The Company disagrees with this ruling as it appears inconsistent with
the court's simultaneous ruling denying the Company's motion for summary
judgment on grounds that there are triable issues of material fact as to whether
plaintiffs are precluded from recovering damages as a consequence of Aguilera's
inequitable conduct. The Company also believes that the court's decision was not
supported by the evidence in the case demonstrating that no promise to settle
was ever made. The Company has appealed the judgment as to the Encarnacions. The
trial as to Aguilera is set for May 2005 on his claims for bad faith,
emotional distress, punitive damages and attorney fees. The Company believes it
has meritorious defenses to these additional claims, but expects plaintiff's
attorney fee claim alone to approach $4.0 million.
Bryan
Speck, individually, and on behalf of others similarly situated v. 21st Century
Insurance Company, 21st Century Casualty Company, and 21st Century Insurance
Group, was
filed on June 20, 2002, in Los Angeles Superior Court. Plaintiff seeks
California class action certification, injunctive relief, and unspecified actual
and punitive damages. The complaint contends that 21st Century uses "biased"
software in determining the value of total-loss automobiles. Plaintiff alleges
that database providers use improper methodology to establish comparable auto
values and populate their databases with biased figures and that the Company and
other carriers allegedly subscribe to the programs to unfairly reduce claims
costs. This case is consolidated with similar actions against other insurers for
discovery and pre-trial motions. The Company intends to vigorously defend the
suit with other defendants in the coordinated proceedings. This matter is in the
discovery stage of litigation and no reasonable estimate of potential losses in
the event of a negative outcome can be made at this time.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Thomas
Theis, on his own behalf and on behalf of all others similarly situated v. 21st
Century Insurance, was
filed on June 17, 2002, in Los Angeles Superior Court. Plaintiff seeks
California class action certification, injunctive relief, and unspecified actual
and punitive damages. The complaint contends that after insureds receive medical
treatment, the Company used a medical-review program to adjust expenses to
reasonable and necessary amounts for a given geographic area. Plaintiff alleges
that the adjusted amount is "predetermined" and "biased," creating an unfair
pretext for reducing claims costs. This case is consolidated with similar
actions against other insurers for discovery and pre-trial motions. The Company
intends to vigorously defend the suit with other defendants in the coordinated
proceedings. This matter is in the discovery stage of litigation and no
reasonable estimate of potential losses in the event of a negative outcome can
be made at this time.
NOTE
13. CAPITAL STOCK
Effective
December 4, 2003, the Company changed its state of incorporation from California
to Delaware. In connection with the change, the Company's stock was assigned a
par value of $0.001 per share, resulting in a reclassification of $419.2 million
from common stock to additional paid-in capital. There was no impact to the
Company's financial condition or results of operations as a result of the
reincorporation.
The
Company is authorized to issue up to 500,000 shares of preferred stock, $1 par
value, and 376,126 shares of Series A convertible preferred stock, $1 par value,
none of which were outstanding at December 31, 2004 or 2003.
Shares of
common stock issued pursuant to the exercise of employee stock options and
restricted stock grants were 53,556 in 2004, 4,000 in 2003, and 69,657 in 2002.
No shares were repurchased in 2004 or 2003.
NOTE
14. STOCK-BASED COMPENSATION
2004
Stock Option Plan
The
stockholders approved the 2004 Stock Option Plan (the "2004 Plan") at the Annual
Meeting of Shareholders on May 26, 2004. The 2004 Plan supersedes the 1995 Stock
Option Plan, which will remain in effect only as to outstanding awards under it.
The 2004 Plan authorizes a Committee of the Board of Directors to grant stock
options in respect of 4,000,000 shares to eligible employees and nonemployee
directors, subject to the terms of the 2004 Plan. Additionally, under the 2004
Plan, the Committee may grant stock options in respect of shares that were
subject to outstanding awards under the 1995 Stock Option Plan to the extent
such awards expire, are terminated, are cancelled, or are forfeited for any
reason without shares being issued.
At
December 31, 2004, 5,366,518 stock options remain available for future grants
under the 2004 Plan. Options granted to employees generally have ten-year terms
and vest over various periods, generally three years. Options granted to
nonemployee directors expire one year after a nonemployee director ceases
service with the Company, or ten years from the date of grant, whichever is
sooner. Nonemployee director options vest over one year, provided that the
nonemployee director is in the service of the Company at that time. Currently,
the Company uses the intrinsic-value method to account for stock-based
compensation paid to employees for their services.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
A summary
of securities issuable and issued for the Company's stock option plans and the
Restricted Shares Plan at December 31, 2004, follows:
AMOUNTS
IN THOUSANDS |
|
1995
Stock Option Plan |
|
2004
Stock Option Plan |
|
Restricted Shares
Plan |
|
Total
securities authorized |
|
|
10,000 |
|
|
4,000 |
|
|
1,422 |
|
Number
of securities issued |
|
|
(524 |
) |
|
— |
|
|
(1,053 |
) |
Number
of securities issuable upon the exercise of all outstanding options and
rights |
|
|
(7,940 |
) |
|
(169 |
) |
|
— |
|
Number
of securities forfeited |
|
|
(1,821 |
) |
|
— |
|
|
— |
|
Number
of securities forfeited and returned to plan |
|
|
1,821 |
|
|
— |
|
|
156 |
|
Unused
options assumed by 2004 Stock Option Plan |
|
|
(1,536 |
) |
|
1,536 |
|
|
— |
|
Number
of securities remaining available for future grants under each
plan |
|
|
— |
|
|
5,367 |
|
|
525 |
|
A summary
of the Company's stock option activity and related information
follows:
|
|
|
|
Weighted- |
|
|
Number
of |
|
Average |
|
|
Options |
|
Exercise
Price |
Options
outstanding January 1, 2002 |
|
|
3,999,938 |
|
$ |
19.75 |
|
Granted
in 2002 |
|
|
1,523,708 |
|
|
16.09 |
|
Exercised
in 2002 |
|
|
(86,881 |
) |
|
16.46 |
|
Forfeited
in 2002 |
|
|
(294,865 |
) |
|
18.93 |
|
Options
outstanding December 31, 2002 |
|
|
5,141,900 |
|
$ |
18.77 |
|
Granted
in 2003 |
|
|
1,801,556 |
|
|
12.03 |
|
Exercised
in 2003 |
|
|
—
|
|
|
— |
|
Forfeited
in 2003 |
|
|
(199,538 |
) |
|
17.07 |
|
Options
outstanding December 31, 2003 |
|
|
6,743,918 |
|
$ |
17.05 |
|
Granted
in 2004 |
|
|
1,799,034 |
|
|
14.23 |
|
Exercised
in 2004 |
|
|
(49,056 |
) |
|
13.94 |
|
Forfeited
in 2004 |
|
|
(385,338 |
) |
|
16.07 |
|
Options
outstanding December 31, 2004 |
|
|
8,108,558 |
|
$ |
16.49 |
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
following table summarizes information about stock options outstanding at
December 31, 2004:
|
|
Outstanding |
|
Exercisable |
|
Range
of Exercise Prices |
|
Number
of Options
|
|
Weighted
Average Remaining Contractual Life
|
|
Weighted Average Exercise Price |
|
Number
of Options
|
|
Weighted Average Exercise Price |
|
$11.68-$13.00 |
|
|
1,754,164 |
|
|
8.2
Years |
|
$ |
11.85 |
|
|
574,675 |
|
$ |
11.74 |
|
13.01
- 15.00 |
|
|
1,530,450 |
|
|
9.1
Years |
|
|
14.40 |
|
|
55,733 |
|
|
14.56 |
|
15.01
- 17.00 |
|
|
1,635,740 |
|
|
6.9
Years |
|
|
16.12 |
|
|
1,249,881 |
|
|
16.14 |
|
17.01
- 19.00 |
|
|
1,934,122 |
|
|
5.8
Years |
|
|
18.06 |
|
|
1,934,122 |
|
|
18.06 |
|
19.01
- 22.00 |
|
|
447,582 |
|
|
2.3
Years |
|
|
20.43 |
|
|
447,582 |
|
|
20.43 |
|
22.01
- 29.25 |
|
|
806,500 |
|
|
4.4
Years |
|
|
25.39 |
|
|
806,500 |
|
|
25.39 |
|
$11.68-$29.25 |
|
|
8,108,558 |
|
|
6.8
Years |
|
$ |
16.49 |
|
|
5,068,493 |
|
$ |
18.21 |
|
Options
exercisable at the end of 2003 numbered 3,861,123.
The
weighted average fair value for options granted during 2004, 2003 and 2002 was
$5.95, $4.80, and $6.33, respectively. The fair value of each option grant was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions:
Years
Ended December 31, |
|
2004 |
2003 |
2002 |
Risk-free
interest rate: |
|
|
|
|
|
|
|
Minimum |
|
|
3.43 |
% |
|
2.65 |
% |
|
3.75 |
% |
Maximum |
|
|
4.24 |
% |
|
3.75 |
% |
|
4.79 |
% |
Dividend
yield |
|
|
0.56 |
% |
|
0.67 |
% |
|
2.49 |
% |
Volatility
factor of the expected market price of the Company's common
stock: |
|
|
|
|
|
|
|
|
|
|
Minimum |
|
|
0.33 |
|
|
0.38 |
|
|
0.35 |
|
Maximum |
|
|
0.41 |
|
|
0.40 |
|
|
0.38 |
|
Weighted-average expected life of the options |
|
|
6
Years |
|
|
6
Years |
|
|
8
Years |
|
Restricted
Shares Plan
The
Restricted Shares Plan, which was approved by the Company's stockholders,
currently authorizes grants of up to 1,421,920 shares of common stock to be made
available to key employees. In general, twenty percent of the number of shares
granted vest on the anniversary date of each of the five years following the
year of grant. Total amortization expense relating to the Restricted Shares Plan
was $0.6 million, $0.4 million, and $0.5 million in 2004, 2003 and 2002,
respectively. Unamortized deferred compensation in connection with outstanding
restricted stock grants totaled $0.1 million, $0.7 million, and $1.0 million at
the end of 2004, 2003 and 2002, respectively.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
A summary
of activity under the Restricted Shares Plan from 2002 through 2004
follows:
|
|
Common |
|
Market
Price Per |
|
|
Shares |
|
Share
on Date of Grant |
Outstanding,
January 1, 2002 |
|
|
103,091 |
|
|
|
|
Granted
in 2002 |
|
|
—
|
|
|
— |
|
Vested
and distributed in 2002 |
|
|
(25,629 |
) |
|
|
|
Canceled
or forfeited |
|
|
(17,224 |
) |
|
|
|
Outstanding,
December 31, 2002 |
|
|
60,238 |
|
|
|
|
Granted
in 2003 |
|
|
4,000 |
|
$ |
14.45 |
|
Vested
and distributed in 2003 |
|
|
(19,345 |
) |
|
|
|
Canceled
or forfeited |
|
|
— |
|
|
|
|
Outstanding,
December 31, 2003 |
|
|
44,893 |
|
|
|
|
Granted
in 2004 |
|
|
4,500 |
|
$ |
13.67 |
|
Vested
and distributed in 2004 |
|
|
(33,137 |
) |
|
|
|
Canceled
or forfeited |
|
|
— |
|
|
|
|
Outstanding,
December 31, 2004 |
|
|
16,256 |
|
|
|
|
NOTE
15. STATUTORY FINANCIAL DATA
Statutory
surplus and statutory net income (loss) for the Company's insurance subsidiaries
were as follows:
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Statutory
surplus |
|
$ |
614,893 |
|
$ |
535,026 |
|
$ |
397,381 |
|
Statutory
net income (loss) |
|
|
110,339 |
|
|
76,063 |
|
|
(39,771 |
) |
The
Company's insurance subsidiaries file financial statements prepared in
accordance with Statutory Accounting Principles ("SAP") prescribed or permitted
by domestic insurance regulatory agencies. The Company's financial statements
are prepared in accordance with GAAP and differ from amounts reported under SAP
primarily as a result of the following:
|
· |
Commissions,
premium taxes and other variable costs incurred in connection with writing
new and renewal business are capitalized and amortized on a pro rata basis
over the period in which the related premiums are earned under GAAP,
rather than expensed as incurred, as required by
SAP. |
|
· |
Certain
assets are included in the GAAP consolidated balance sheets, but are
charged directly against statutory surplus under SAP. These assets consist
primarily of premium receivables that are outstanding over 90 days,
federal deferred tax assets in excess of statutory limitations, furniture,
equipment, application computer software, leasehold improvements and
prepaid expenses. |
|
· |
Amounts
related to ceded reinsurance, such as prepaid reinsurance premiums and
reinsurance recoverables, are shown gross, rather than netted against
unearned premium reserves and loss and loss adjustment expense reserves,
respectively, as required by SAP. |
|
· |
Investments,
which are classified as available-for-sale, are reported at current market
values, rather than at amortized cost, or the lower of amortized cost or
market, depending on the specific type of security, as required by SAP.
Equity securities are reported at quoted market values, which may differ
from the NAIC market values as required by
SAP. |
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
|
· |
The
differing treatment of income and expense items results in a corresponding
difference in federal income tax expense. Both current and deferred taxes
are recognized in the income statement for GAAP, while deferred taxes are
posted directly to surplus for SAP. |
|
· |
Costs
for application computer software developed or obtained for internal use
are capitalized and amortized over their useful life, rather then expensed
as incurred, as required by SAP. |
The
following table reconciles consolidated GAAP net income (loss) to statutory net
income (loss).
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Net
income (loss) - GAAP basis |
|
$ |
88,225 |
|
$ |
53,575 |
|
$ |
(12,256 |
) |
Deferred
federal income tax expense (benefit) |
|
|
23,130 |
|
|
24,323 |
|
|
(10,816 |
) |
Change
in deferred policy acquisition costs |
|
|
(5,680 |
) |
|
(6,889 |
) |
|
(19,032 |
) |
Net
loss from non-insurance entities |
|
|
634 |
|
|
2,369 |
|
|
4,319 |
|
Other,
net |
|
|
4,030 |
|
|
2,685 |
|
|
(1,986 |
) |
Net
income (loss) - SAP basis |
|
$ |
110,339 |
|
$ |
76,063 |
|
$ |
(39,771 |
) |
The
following table reconciles consolidated GAAP stockholders' equity to statutory
surplus.
December
31, |
|
2004 |
|
2003 |
|
Stockholders'
equity - GAAP |
|
$ |
774,401 |
|
$ |
700,690 |
|
Assets/gains
(liabilities/losses) recognized under GAAP but not under
SAP: |
|
|
|
|
|
|
|
Net
book value of fixed assets under sale-leaseback
transaction |
|
|
(34,834 |
) |
|
(47,231 |
) |
Deferred
gain under sale-leaseback transaction |
|
|
(610 |
) |
|
(305 |
) |
Capital
lease obligation |
|
|
38,405 |
|
|
49,814 |
|
Non
admitted net deferred tax assets |
|
|
(67,260 |
) |
|
(91,935 |
) |
Net
deferred tax assets relating to items nonadmitted under
SAP |
|
|
50,712 |
|
|
53,309 |
|
Intercompany
receivables |
|
|
(19,917 |
) |
|
214 |
|
Fixed
assets |
|
|
(25,017 |
) |
|
(12,162 |
) |
Deferred
policy acquisition costs |
|
|
(58,759 |
) |
|
(53,079 |
) |
Prepaid
pension costs and intangible pension asset |
|
|
(17,253 |
) |
|
(19,413 |
) |
Unrealized
gains on bonds |
|
|
(21,709 |
) |
|
(35,690 |
) |
Other
prepaid expenses |
|
|
(12,235 |
) |
|
(9,612 |
) |
Equity
in non-insurance entities |
|
|
8,082 |
|
|
1,680 |
|
Other,
net |
|
|
887 |
|
|
(1,254 |
) |
Statutory
Surplus |
|
$ |
614,893 |
|
$ |
535,026 |
|
The
Company is also regulated by the provisions of the California Insurance Holding
Company System Regulatory Act (the "Holding Company Act"). Many transactions
that are defined to be of an "extraordinary" nature may not be effected without
the prior approval of the California Department of Insurance. In addition, there
are limits on the insurance subsidiaries' dividend paying capacity. In 2005, the
Company estimates that one of its insurance subsidiaries has capacity to pay
approximately $109.8 million in dividends to its parent without prior approval
of the California Department of Insurance.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
On June
15, 2004 the CDI finalized its examination reports on the statutory financial
statements for the Company's California-domiciled insurance subsidiaries for the
three-year period ended December 31, 2002. The reports did not contain any
findings or adjustments.
NOTE
16. NORTHRIDGE EARTHQUAKE
California
Senate Bill 1899 ("SB 1899"), effective from January 1, 2001, to December 31,
2001, allowed the re-opening of previously closed earthquake claims arising out
of the 1994 Northridge earthquakeIn the first two quarters of 2002, we expensed
$11.9 million of legal defense costs as they were paid. The Company lacked
sufficient information to record a reasonable estimate of the related legal
defense costs until the third quarter of 2002, at which time an additional
provision of $46.9 million was recorded. The discovery stay imposed in early
2002 was lifted in the first quarter of 2003 and the Company obtained more
information with which to estimate the ultimate cost of resolving its SB 1899
claims. Based on events occurring during the first quarter of 2003, the Company
increased its SB 1899 reserves by $37.0 million, resulting in an after-tax
charge of $24.1 million. The revised estimate at that point was based on the
pace and cost of settlements reached thus far, the actual costs incurred during
that quarter, and the Company's assessment of the expected length and intensity
of the litigation arising out of the remaining claims. The estimate was
subsequently increased by $1.0 million during the first quarter of 2004 based on
the Company's reassessment of its remaining estimated litigation costs. Based
upon information obtained in connection with settlement discussions and
mediations conducted during the fourth quarter of 2004, the Company updated its
case-by-case review of the remaining cases and reevaluated remaining litigation
costs for resolving outstanding matters. As a result of this reassessment, the
Company increased its reserve by $1.2 million during the fourth quarter of 2004.
The Company's total reserve for SB 1899 claims as of December 31, 2004 and 2003
was approximately $4.0 million and $14.2 million, respectively.
More than
ninety-eight percent of the claims submitted and litigation brought against the
Company as a result of SB 1899 have been resolved. Substantially all of the
Company's remaining 1994 Earthquake claims are in litigation. No class actions
have been certified and the trial court has denied class action status for the
two remaining cases seeking class action status. While the reserves established
are the Company's current best estimate of the cost of resolving its 1994
Earthquake claims, including claims arising as a result of SB 1899, these
reserves continue to be highly uncertain because of the difficulty in predicting
how the remaining litigated cases will be resolved. The estimate currently
recorded by the Company assumes that relatively few of the remaining cases will
require a full trial to resolve, that any trial costs will approximate those
encountered by the Company in the past, that most cases will be settled without
need for extensive pre-trial preparation, and that the trial court's denial of
class action status for those cases seeking such status will be upheld on any
appeal. Current reserves contain no provisions for extracontractual or punitive
damages, bad faith judgments or similar unpredictable hazards of litigation that
possibly could result in the event an adverse verdict were to be sustained
against the Company1. To the
extent these and other underlying assumptions prove to be incorrect, the
ultimate amount to resolve these claims could exceed the Company's current
reserves, possibly by a material amount. The Company continues to seek
reasonable settlements of claims brought under SB 1899 and other Northridge
earthquake related theories, but will vigorously defend itself against excessive
demands and fraudulent claims. The Company may, however, settle cases in excess
of its assessment of its contractual obligations in order to reduce the future
cost of litigation.
_____________________
1 The
Company believes that the “ex post facto” clause of the U.S. Constitution
prohibits the assessment of punitive damages in cases brought under SB 1899. A
California Court of Appeal has accepted the Company’s petition for a writ of
mandate on this issue. A hearing is currently set for March 8,
2005.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
Company has received some Northridge earthquake claims reported after the
closing of the window established by SB 1899 which are based upon alternative
legal theories. The Company is contesting these claims and has only nominal
reserves for them. Should the courts determine that these claims, or additional
claims brought in the future, are not barred by the applicable statute of
limitations and the provisions of SB 1899, additional reserves may be needed to
resolve these claims.
On
October 10, 2002, a Los Angeles Superior Court granted the Company's motion for
summary judgment in the matter of 21st
Century Insurance Company vs. People of the State of California ex rel.Bill
Lockyer, Attorney General et al. The
court determined that the Company's April 21, 1999, settlement with the
California Department of Insurance ("CDI") with respect to regulatory actions
arising out of the 1994 Northridge Earthquake was fully valid and enforceable.
The Court denied the Attorney General's motion seeking to have the settlement
declared void and unenforceable, a result that may have allowed the CDI to
reinstitute regulatory proceedings with respect to the Company's handling of
claims arising out of the 1994 Northridge Earthquake. The CDI appealed the
ruling. On October 28, 2004, the California Court of Appeal unanimously upheld
the decision of the Superior Court. The CDI did not seek review by the
California Supreme Court and this matter has now been finally resolved in favor
of the Company.
NOTE
17. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The
summarized unaudited quarterly results of operations were as
follows:
Quarters
Ended |
|
March
31, |
|
June
30, |
|
September
30, |
|
December
31, |
|
2004 |
|
|
|
|
|
|
|
|
|
Net
premiums earned |
|
$ |
318,220 |
|
$ |
327,021 |
|
$ |
333,440 |
|
$ |
334,989 |
|
Net
investment income |
|
|
13,146 |
|
|
14,315 |
|
|
15,118 |
|
|
16,252 |
|
Realized
investment gains (losses) |
|
|
7,646 |
|
|
1,337 |
|
|
(162 |
) |
|
2,010 |
|
Net
income |
|
|
19,825 |
|
|
21,374 |
|
|
24,559 |
|
|
22,467 |
|
Earnings
per share1 |
|
$ |
0.23 |
|
$ |
0.25 |
|
$ |
0.29 |
|
$ |
0.26 |
|
2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned |
|
$ |
271,441 |
|
$ |
287,231 |
|
$ |
303,675 |
|
$ |
310,330 |
|
Net
investment income |
|
|
11,637 |
|
|
11,673 |
|
|
11,350 |
|
|
11,173 |
|
Realized
investment gains |
|
|
4,580 |
|
|
7,700 |
|
|
836 |
|
|
61 |
|
Net
(loss) income |
|
|
(6,711 |
) |
|
29,151 |
|
|
12,709 |
|
|
18,426 |
|
(Loss)
earnings per share1 |
|
$ |
(0.08 |
) |
$ |
0.34 |
|
$ |
0.15 |
|
$ |
0.22 |
|
Third
quarter 2004 results were increased by $4.9 million due to the effect of recent
California legislation relating to holding company taxes on dividends from
insurance subsidiaries (see additional discussion in Note 5 of the Notes to
Consolidated Financial Statements). First quarter 2003 results were impacted by
adverse development related to SB 1899 reserves of $37.0 million (pre-tax).
Second quarter 2003 results include nonrecurring, nonoperational income of $9.3
million (pre-tax) resulting from the settlement of litigation and interest
income of $4.8 million relating to a favorable settlement with the Internal
Revenue Service.
NOTE
18. SEGMENT INFORMATION
The
Company's "Personal Auto Lines" reportable segment primarily markets and
underwrites personal automobile, motorcycle and umbrella insurance. The
Company's "Homeowner and Earthquake Lines in Runoff" reportable segment, which
is in runoff, manages the wind-down of the Company's homeowner and earthquake
programs. The Company has not written any earthquake coverage since 1994 and
ceased writing homeowner policies in February 2002.
__________________
1 Basic and
diluted amounts are the same for all periods presented.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Insurers
offering homeowner insurance in California are required to participate in the
California FAIR Plan ("FAIR Plan"). FAIR Plan is a state administered pool of
difficult to insure homeowners. Each participating insurer is allocated a
percentage of the total premiums written and losses and LAE incurred by the pool
according to its share of total homeowner direct premiums written in the state.
Participation in the current year FAIR Plan operations is based on the pool from
two years prior. Since the Company ceased writing homeowners business in 2002,
the Company will continue to receive assignments in the 2005 calendar
year.
The
Company evaluates segment performance based on pretax underwriting profit
(loss). The Company does not allocate assets, net investment income, net
realized investment gains (losses), other revenues, nonrecurring items, interest
and fees expense, or income taxes to operating segments. Depreciation and
amortization expense was $22.3 million in 2004, $20.2 million in 2003 and $19.3
million in 2002. The accounting policies of the reportable segments are the same
as those described in Note 2 of the Notes to Consolidated Financial Statements.
All revenues are generated from external customers and the Company does not rely
on any major customer.
The
following table presents net premiums earned, depreciation and amortization
expense, and segment profit (loss) for the Company's segments for the years
ended December 31.
|
|
|
|
Homeowner
and |
|
|
|
|
Personal |
Earthquake |
|
|
AMOUNTS
IN THOUSANDS |
|
Auto
Lines |
Lines
in Runoff |
Total |
2004 |
|
|
|
|
|
|
|
Net
premiums earned |
|
$ |
1,313,551 |
|
$ |
119 |
|
$ |
1,313,670 |
|
Depreciation
and amortization expense |
|
|
22,156 |
|
|
104 |
|
|
22,260 |
|
Segment
profit (loss) |
|
|
63,972 |
|
|
(2,714 |
) |
|
61,258 |
|
|
|
|
|
|
|
|
|
|
|
|
2003 |
|
|
|
|
|
|
|
|
|
|
Net
premiums earned |
|
|
1,172,679 |
|
|
(2 |
) |
|
1,172,677 |
|
Depreciation
and amortization expense |
|
|
19,886 |
|
|
320 |
|
|
20,206 |
|
Segment
profit (loss) |
|
|
41,006 |
|
|
(40,175 |
) |
|
831 |
|
|
|
|
|
|
|
|
|
|
|
|
2002 |
|
|
|
|
|
|
|
|
|
|
Net
premiums earned |
|
|
924,559 |
|
|
—
|
|
|
924,559 |
|
Depreciation
and amortization expense |
|
|
18,465 |
|
|
876 |
|
|
19,341 |
|
Segment
profit (loss) |
|
|
13,383 |
|
|
(58,768 |
) |
|
(45,385 |
) |
|
|
|
|
|
|
|
|
|
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER
31, 2004
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
following table reconciles our segment profit (loss) to our consolidated income
before provision for income taxes for the years ended December
31:
AMOUNTS
IN THOUSANDS |
|
2004 |
|
2003 |
|
2002 |
|
Segment
profit (loss) |
|
$ |
61,258 |
|
$ |
831 |
|
$ |
(45,385 |
) |
Net
investment income |
|
|
58,831 |
|
|
45,833 |
|
|
46,345 |
|
Net
realized investment gains |
|
|
10,831 |
|
|
13,177 |
|
|
10,391 |
|
Other
revenues |
|
|
— |
|
|
14,777 |
|
|
— |
|
Write-off
of software |
|
|
— |
|
|
— |
|
|
(37,177 |
) |
Interest
and fees expense |
|
|
(8,627 |
) |
|
(3,471 |
) |
|
— |
|
Income
(loss) before provision for income taxes |
|
$ |
122,293 |
|
$ |
71,147 |
|
$ |
(25,826 |
) |
Personal
Auto Lines. The
growth in segment profit for the personal auto lines in 2004, 2003, and 2002 was
due to an increase in the number of insured vehicles, rate increases and
favorable claim frequency.
Homeowner
and Earthquake Lines in Runoff. The
significant segment loss for the homeowner and earthquake lines in runoff
relates to adverse earthquake development stemming from the claims submitted and
litigation brought against the Company as a result of SB 1899. See Notes 8 and
16 of the Notes to Consolidated Financial Statements.
ITEM
9. CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM
9A. CONTROLS
AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
We have
established disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated subsidiaries, is
made known to the officers who certify the Company's financial reports and to
other members of senior management and the Board of Directors.
Based on
their evaluation of the effectiveness of 21st Century Insurance Group's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934) as of December 31, 2004, the Chief
Executive Officer and Chief Financial Officer of 21st Century Insurance Group
have concluded that such disclosure controls and procedures are effective to
ensure that the information required to be disclosed by 21st Century Insurance
Group in reports that it files or submits under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the time periods
specified in SEC rules and forms.
The
Company intends to review and evaluate the design and effectiveness of its
disclosure controls and procedures on an ongoing basis and to improve its
controls and procedures over time and to correct any deficiencies that may be
discovered in the future in order to ensure that senior management has timely
access to all material financial and non-financial information concerning the
Company's business. While the present design of the Company's disclosure
controls and procedures is effective to achieve these results, future events
affecting the Company's business may cause management to modify its disclosure
controls and procedures.
Management's
Report on Internal Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). Under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission. Based on our evaluation under the framework in
Internal Control - Integrated Framework, our management concluded that
our internal control over financial reporting was effective as of December 31,
2004.
Our management's evaluation of the effectiveness of our
internal control over financial reporting as of December 31, 2004 has been
audited by PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in their report which is included
herein.
Changes in Internal
Controls
There were no changes in the Company's internal controls
over financial reporting that occurred during the fourth quarter that have
materially affected or are reasonably likely to materially affect internal
controls over financial reporting.
ITEM
9B. |
OTHER
INFORMATION |
None.
PART
III
ITEM
10. |
DIRECTORS
AND EXECUTIVE OFFICERS OF THE
REGISTRANT |
Information
related to directors, executive officers, and beneficial ownership required in
Item 10 is incorporated by reference from the Company's definitive proxy
statement to be filed in connection with the Company's 2004 Annual Meeting of
Stockholders pursuant to Instruction G(3) of Form 10-K.
In the
wake of well-publicized corporate scandals, the Securities and Exchange
Commission and the New York Stock Exchange have issued multiple regulations that
require the implementation of policies and procedures in the corporate
governance area. The Company has adopted Corporate Governance Guidelines and
charters for its Audit Committee, Nominating and Corporate Governance Committee,
and other Committees of its Board of Directors. It has also adopted a Code of
Business Conduct covering all Employees and a Code of Ethics for the Chief
Executive Officer, Chief Financial Officer, and Financial Managers. Each of
these documents are available on the Company's Web site, www.21st.com, and a
copy will be mailed upon request from the
Company's Investor Relations Department (6301 Owensmouth Avenue, Woodland Hills,
California 91367, phone 818-673-3996). The Company intends to disclose any
amendments to, or waivers of, the Code of Ethics on behalf of the Company's
Chief Executive Officer, Chief Financial Officer, Controller, and persons
performing similar functions on the Company's Web site, at www.21st.com under
the "About Us" caption, promptly following the date of any such amendment or
waiver.
ITEM
11. |
EXECUTIVE
COMPENSATION |
Information
in response to Item 11 is incorporated by reference from the Company's
definitive proxy statement to be filed in connection with the Company's 2005
Annual Meeting of Stockholders pursuant to Instruction G(3) of Form
10-K.
ITEM
12. |
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
|
Information
in response to Item 12 is incorporated by reference from the Company's
definitive proxy statement to be filed in connection with the Company's 2005
Annual Meeting of Stockholders pursuant to Instruction G(3) of Form
10-K.
ITEM
13. |
CERTAIN
RELATIONSHIPS AND RELATED
TRANSACTIONS |
Certain
Information in response to Item 13 is incorporated by reference from the
Company's definitive proxy statement to be filed in connection with the
Company's 2005 Annual Meeting of Stockholders pursuant to Instruction G(3) of
Form 10-K. All related party transactions, which require disclosure, are
included in the Management's Discussion and Analysis or the Notes to
Consolidated Financial Statements.
ITEM
14. |
PRINCIPAL
ACCOUNTANT FEES AND SERVICES |
Information
in response to Item 14 is incorporated by reference from the Company's
definitive proxy statement to be filed in connection with the Company's 2005
Annual Meeting of Stockholders pursuant to Instruction G(3) of Form
10-K.
PART
IV
ITEM
15. |
EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES |
(a) |
DOCUMENTS
FILED WITH THIS REPORT |
(1)
FINANCIAL STATEMENTS
The
following consolidated financial statements of the Company are filed as a part
of this report:
|
|
PAGE |
(i) |
Report
of independent registered public accounting firm |
40 |
(iii) |
Consolidated
balance sheets - December 31, 2004 and 2003; |
42 |
(iv) |
Consolidated
statements of operations - Years ended December 31, |
|
|
2004,
2003 and 2002; |
43 |
(v) |
Consolidated
statements of stockholders' equity - Years ended |
|
|
December
31, 2004, 2003 and 2002; |
44 |
(vi) |
Consolidated
statements of cash flows - Years ended December 31, |
|
|
2004,
2003 and 2002; |
45 |
(vii) |
Notes
to consolidated financial statements |
46 |
The
following financial statement schedule required to be filed by Item 8 and by
paragraph (d) of Item 15 of Form 10-K is submitted as a separate section of this
report:
Schedule
II - Condensed Financial Information of Registrant |
81 |
Schedules
I, III, IV, V and VI have been omitted as all required data is included in the
Notes to Consolidated Financial Statements.
All other
schedules for which provision is made in the applicable accounting regulations
of the Securities and Exchange Commission are not required under the related
instructions or are inapplicable and, therefore, have been omitted.
The
following exhibits required by Item 601 of Regulation S-K and by paragraph (c)
of Item 15 of Form 10-K are listed by number corresponding to the Exhibit Table
of Item 601 of Regulation S-K and are filed as part of this Annual Report on
Form 10-K or are incorporated herein by reference:
3(i) |
Certificate
of Incorporation incorporated herein by reference to Appendix B from the
Registrant's Information Statement on Form DEF 14C filed on November 13,
2003. |
3(ii) |
By-laws
incorporated herein by reference to Appendix C from the Registrant's
Information Statement on Form DEF 14C dated November 13,
2003. |
4.1 |
Indenture,
dated December 9, 2003, between 21st Century Insurance Group and The Bank
of New York, as trustee, incorporated herein by reference from the
Registrant's Form 10-K for year ended December 31,
2003. |
4.2 |
Exchange
and Registration Rights Agreement, dated December 9, 2003, incorporated
herein by reference from the Registrant's Form 10-K for year ended
December 31, 2003. |
10(a) |
Amendment
to Registrant's Restricted Shares Plan incorporated herein by reference
from the Registrant's Form 10-K for year ended December 31,
2001. |
10(b) |
Split
Dollar Insurance Agreement between Registrant and Stanley M. Burke, as
trustee of the 1983 Foster Insurance Trust incorporated herein by
reference from the Registrant's Form 10-K for year ended December 31,
2001. |
10(c) |
Registrant's
Supplemental Executive Retirement Plan as amended incorporated herein by
reference from the Registrant's Form 10-K for year ended December 31,
2001. |
10(d) |
Registrant's
Pension Plan, 1994 Amendment and Restatement, incorporated herein by
reference from the Registrant's Form 10-K for year ended December 31,
2001. |
10(e) |
Investment
and Strategic Alliance Agreement incorporated herein by reference from the
Registrant's Form 10-K for year ended December 31,
2001. |
10(f) |
Amendment
to the Investment and Strategic Alliance Agreement incorporated herein by
reference from the Registrant's Form 10-K for year ended December 31,
2001. |
10(g) |
Registrant's
1995 Stock Option Plan incorporated herein by reference from the
Registrant's Form S-8 dated July 26, 1995. |
10(e) |
Investment
and Strategic Alliance Agreement incorporated herein by reference from the
Registrant's Form 10-K for year ended December 31,
2001. |
10(f) |
Amendment
to the Investment and Strategic Alliance Agreement incorporated herein by
reference from the Registrant's Form 10-K for year ended December 31,
2001. |
10(g) |
Registrant's
1995 Stock Option Plan incorporated herein by reference from the
Registrant's Form S-8 dated July 26, 1995. |
10(h) |
Amendment
to Registrant's 1995 Stock Option Plan incorporated herein by reference
from the Registrant's DEF 14A dated April 18, 1997. |
10(i) |
Short
Term Incentive Plan. |
10(j) |
Amendment
to Registrant's 1995 Stock Option Plan incorporated herein by reference
from the Registrant's DEF 14A dated April 30, 2001. |
10(k) |
Registrant's
Savings and Security Plan incorporated herein by reference from the
Registrant's Form 10-K for year ended December 31,
2001. |
10(l) |
Lease
Agreements for Registrant's Principal Offices substantially in the form of
this Exhibit incorporated herein by reference from the Registrant's Form
10-K for year ended December 31, 2003. |
10(m) |
Forms
of Amended and Restated Stock Option Agreements incorporated herein by
reference from the Registrant's Form 10-K for year ended December 31,
2003. |
10(n) |
Form
of Restricted Shares Agreement incorporated herein by reference from the
Registrant's Form 10-K for year ended December 31,
2003. |
10(o)
|
Retention
agreement substantially in the form of this exhibit for executives Richard
A. Andre, Michael J. Cassanego, G. Edward Combs and Dean E. Stark
incorporated herein by reference from the Registrant's Form 10-K for year
ended December 31, 2003. |
10(p)
|
Sale
and Leaseback Agreement between 21st Century Insurance Company and General
Electric Capital Corporation, for itself, and as agent for Certain
Participants, as amended, dated December 31, 2002 incorporated herein by
reference from the Registrant's Form 10-K for year ended December 31,
2003. |
10(q) |
Registrant's
2004 Stock Option Plan incorporated herein by reference from the
Registrant's DEF 14A dated April 21, 2004. |
10(r) |
Summary
of Director Compensation. |
10(s) |
Chief
Executive Officer Short Term Incentive Plan incorporated herein by
reference from the Registrant's DEF 14A dated April 21,
2004. |
10(t) |
Retention
Agreement between Lawrence P. Bascom, CFO, and 21st Century Insurance
Group, dated November 29, 2004 incorporated herein by reference from the
Registrant's Form 8-K dated December 1, 2004. |
10(u) |
License
Agreement between Registrant and Century 21 Real Estate Corporation, dated
November 30, 2004 incorporated herein by reference from the Registrant's
Form 8-K dated December 9, 2004. |
10(v) |
Amendments
to Lease Agreements for Registrant's Principal Offices substantially in
the form of these Exhibits. |
10(w) |
Registrant's
Supplemental Pension Plan, Restatement No. 1, effective as of January 1,
1996. |
10(x) |
Supplemental
401(k) Plan, of 21st Century Insurance Company, Amendment and Restatement
dated January 1, 2001 and Amendment dated January 1,
2004. |
10(y) |
Settlement
Agreement and Release between Registrant and G. Edward Combs dated
December 8, 2004. |
10(z) |
Registrant's
Executive Medical Reimbursement Plan. |
14 |
Code
of Ethics. |
21 |
Subsidiaries
of Registrant. |
23 |
Consent
of Independent Registered Public Accounting Firm. |
31.1 |
Certification
of President and Chief Executive Officer Pursuant to Exchange Act Rule
13a-14(a). |
31.2 |
Certification
of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a). |
32.1 |
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
|
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
CONDENSED
FINANCIAL INFORMATION OF REGISTRANT
BALANCE
SHEETS
AMOUNTS
IN THOUSANDS |
|
|
|
|
|
December
31, |
|
2004 |
|
2003 |
|
Assets |
|
|
|
|
|
Cash |
|
$ |
1,693 |
|
$ |
24,361 |
|
Fixed
maturity investments available-for-sale, at fair value
(amortized
cost:
$14,681) |
|
|
14,510 |
|
|
— |
|
Accounts
receivable from subsidiaries |
|
|
— |
|
|
242 |
|
Unamortized
debt issuance costs |
|
|
1,147 |
|
|
1,274 |
|
Investment
in unconsolidated insurance subsidiaries and affiliates, at
equity |
|
|
784,348 |
|
|
702,580 |
|
Property
and equipment, at cost less accumulated
depreciation of $23,769 and
$19,430, including software leased to a subsidiary of
$100,498 and $84,242 (net of
accumulated depreciation of $23,108 and $18,591,
respectively) |
|
|
100,525 |
|
|
84,361 |
|
Other
assets |
|
|
956 |
|
|
5 |
|
Total
assets |
|
$ |
903,179 |
|
$ |
812,823 |
|
Liabilities
and stockholders' equity |
|
|
|
|
|
|
|
Debt
|
|
$ |
117,884 |
|
$ |
99,871 |
|
Dividends
payable |
|
|
— |
|
|
1,709 |
|
Accounts
payable and accrued expenses |
|
|
6,701 |
|
|
10,324 |
|
Deferred
tax liabilities |
|
|
2,387 |
|
|
229 |
|
Accounts
payable to subsidiaries |
|
|
1,806 |
|
|
— |
|
Total
liabilities |
|
|
128,778 |
|
|
112,133 |
|
|
|
|
|
|
|
|
|
Stockholders'
equity |
|
|
774,401 |
|
|
700,690 |
|
Total
liabilities and stockholders' equity |
|
$ |
903,179 |
|
$ |
812,823 |
|
See
accompanying Notes to Condensed Financial Information of Registrant.
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
CONDENSED
FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS
OF OPERATIONS
AMOUNTS
IN THOUSANDS |
|
|
|
|
|
|
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Revenues |
|
|
|
|
|
|
|
Interest
and other income |
|
$ |
663 |
|
$ |
792 |
|
$ |
1,100 |
|
Realized
investment (losses) gains |
|
|
(58 |
) |
|
— |
|
|
289 |
|
Total
revenues |
|
|
605 |
|
|
792 |
|
|
1,389 |
|
Expenses |
|
|
|
|
|
|
|
|
|
|
Loan
interest and fees |
|
|
6,035 |
|
|
378 |
|
|
—
|
|
General
and administrative |
|
|
2,428 |
|
|
3,198 |
|
|
72 |
|
Total
expenses |
|
|
8,463 |
|
|
3,576 |
|
|
72 |
|
(Loss)
income before provision for income taxes |
|
|
(7,858 |
) |
|
(2,784 |
) |
|
1,317 |
|
Provision
for income taxes |
|
|
(7,267 |
) |
|
415 |
|
|
5,436 |
|
Net
loss before equity in undistributed income (loss)
of
subsidiaries |
|
|
(591 |
) |
|
(3,199 |
) |
|
(4,119 |
) |
Equity
in undistributed income (loss) of subsidiaries |
|
|
88,816 |
|
|
56,774 |
|
|
(8,137 |
) |
Net
income (loss) |
|
$ |
88,225 |
|
$ |
53,575 |
|
$ |
(12,256 |
) |
See
accompanying Notes to Condensed Financial Information of Registrant.
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
CONDENSED
FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS
OF CASH FLOWS
AMOUNTS
IN THOUSANDS |
|
|
|
|
|
|
|
Years
Ended December 31, |
|
2004 |
|
2003 |
|
2002 |
|
Net
cash provided by (used in) operating activities |
|
$ |
22,133 |
|
|
(2,912 |
) |
|
(1,276 |
) |
Investing
activities |
|
|
|
|
|
|
|
|
|
|
Capital
contributed to subsidiaries |
|
|
— |
|
|
(37,917 |
) |
|
(1,000 |
) |
Net
proceeds from investments available for sale |
|
|
(14,768 |
) |
|
1,000 |
|
|
23,726
|
|
Net
(purchases) proceeds from property and equipment |
|
|
(22,960 |
) |
|
3,641
|
|
|
(236 |
) |
Net
cash (used in) provided by investing activities |
|
|
(37,728 |
) |
|
(33,276 |
) |
|
22,490 |
|
Financing
activities |
|
|
|
|
|
|
|
|
|
|
Proceeds
from exercise of options |
|
|
576 |
|
|
— |
|
|
1,488 |
|
Proceeds
from issuance of debt |
|
|
18,000 |
|
|
99,871 |
|
|
— |
|
Payment
of debt issuance costs |
|
|
— |
|
|
(650 |
) |
|
— |
|
Advance
from subsidiary |
|
|
— |
|
|
9,300 |
|
|
— |
|
Repayment
of advance from subsidiary |
|
|
(17,103 |
) |
|
(47,083 |
) |
|
(2,688 |
) |
Dividends
paid |
|
|
(8,546 |
) |
|
(6,835 |
) |
|
(22,210 |
) |
Net
cash (used in) provided by financing activities |
|
|
(7,073 |
) |
|
54,603 |
|
|
(23,410 |
) |
Net
(decrease) increase in cash |
|
|
(22,668 |
) |
|
18,415 |
|
|
(2,196 |
) |
Cash
and cash equivalents, beginning of year |
|
|
24,361 |
|
|
5,946 |
|
|
8,142 |
|
Cash
and cash equivalents, end of year |
|
$ |
1,693 |
|
$ |
24,361 |
|
$ |
5,946 |
|
See
accompanying Notes to Condensed Financial Information of Registrant.
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
NOTES
TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
DECEMBER
31, 2004
NOTE
A. BASIS OF PRESENTATION
21st
Century Insurance Group's (the "Registrant") investment in subsidiaries is
stated at cost plus equity in undistributed income (loss) of subsidiaries. The
accompanying condensed financial statements of the Registrant should be read in
conjunction with the consolidated financial statements and notes thereto of 21st
Century Insurance Group and subsidiaries included in the Registrant's 2004
Annual Report on Form 10-K.
NOTE
B. DEBT
Debt at
December 31 consisted of:
Amounts
in Thousands |
|
2004 |
|
2003 |
|
Senior
Notes (5.9%; maturing in 2013) |
|
$ |
99,884 |
|
$ |
99,871
|
|
Intercompany
term loan payable (4.06%; maturing in 2007) |
|
|
18,000 |
|
|
— |
|
Total
debt |
|
$ |
117,884 |
|
$ |
99,871 |
|
The
senior notes represent amounts the Registrant has borrowed and contributed to
the capital of its insurance subsidiaries or borrowed for other long-term
purposes. The entire principal amount is due at maturity.
In
December 2004, the Registrant made an initial $18.0 million draw on the
intercompany term loan line that was structured in October 2004. Under the term
loan agreement, the Registrant's subsidiary (21st Century
Insurance Company) will make funds available to the Registrant, which can draw
up to $40.0 million under the line. Proceeds from the loan will be used to
provide working capital for projects to modify, update and improve information
technology for use by the Registrant and its affiliates.
The term
of the line is twelve months with automatic renewal, while the note's term is
three years. The effective interest rate on the note is the three-year
Applicable Federal Rate ("AFR") at the time of a draw, plus a margin of 1.58%.
The AFR is the minimum interest rate under tax law that avoids the IRS
below-market interest loan rules. At the date the $18.0 million draw was taken,
the AFR was 2.48%. Interest is accrued and payable at the end of the term of the
note.
The
Registrant has also guaranteed the obligation under capital lease of 21st
Century Insurance Company.
SIGNATURES
OF OFFICERS AND BOARD OF DIRECTORS
Pursuant
to the requirements of Section 13 or 15 (d) 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.
Date:
February 16, 2005 |
21ST
CENTURY INSURANCE GROUP |
|
(Registrant) |
|
By:
/s/ Bruce W. Marlow |
|
Bruce
W. Marlow |
|
President
and Chief Executive Officer |
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated on the 16th of February 2005.
Signature |
|
Title |
|
|
|
/s/
Bruce W. Marlow |
|
|
Bruce
W. Marlow |
|
President
and Chief Executive Officer and Director |
|
|
(Principal
Executive Officer) |
/s/
Lawrence P. Bascom |
|
|
Lawrence
P. Bascom |
|
Sr.
Vice President and Chief Financial Officer |
|
|
(Principal
Financial Officer) |
/s/
Robert M. Sandler |
|
|
Robert
M. Sandler |
|
Chairman
of the Board |
|
|
|
/s/
John B. De Nault, III |
|
|
John
B. De Nault, III |
|
Director |
|
|
|
/s/
Carlene M. Ellis |
|
|
Carlene
M. Ellis |
|
Director |
|
|
|
/s/
R. Scott Foster, M.D. |
|
|
R.
Scott Foster, M.D. |
|
Director |
|
|
|
/s/
Roxani M. Gillespie |
|
|
Roxani
M. Gillespie |
|
Director |
|
|
|
/s/
Jeffrey L. Hayman |
|
|
Jeffrey
L. Hayman |
|
Director |
|
|
|
/s/
Phillip L. Isenberg |
|
|
Phillip
L. Isenberg |
|
Director |
|
|
|
/s/
James P. Miscoll |
|
|
James
P. Miscoll |
|
Director |
|
|
|
/s/
Keith W.Renken |
|
|
Keith
W. Renken |
|
Director |
|
|
|
/s/
Howard I. Smith |
|
|
Howard
I. Smith |
|
Director |