21st Century Insurance 10-Q 6-30-2005
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
quarterly period ended June 30, 2005
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
transition period from
to
Commission
File Number 0-6964
21ST
CENTURY INSURANCE GROUP
(Exact
name of registrant as specified in its charter)
Delaware
|
95-1935264
|
(State
or other jurisdiction of incorporation
or organization)
|
(I.R.S.
Employer 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)
|
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 whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act). Yes x No o
The
number of shares outstanding of the issuer’s common stock as of July 11, 2005
was 85,755,002.
Description
|
Page
Number
|
|
|
|
|
|
2
|
|
3
|
|
4
|
|
5
|
|
6
|
|
16
|
|
30
|
|
31
|
|
32
|
|
32
|
|
32
|
|
32
|
|
32
|
|
32
|
|
32
|
|
33
|
|
34
|
|
|
|
|
|
|
PART
I -
FINANCIAL
INFORMATION
21ST
CENTURY INSURANCE GROUP
|
|
|
|
|
|
CONDENSED
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
Unaudited
|
|
|
|
|
|
|
|
June
30,
|
December
31,
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
2005
|
2004
|
Assets
|
|
|
|
|
|
Fixed
maturity investments available-for-sale, at fair value (amortized
cost: $1,346,379 and $1,320,592)
|
|
$
|
1,369,612
|
|
$
|
1,342,130
|
|
Equity
securities available-for-sale, at fair value (cost: $49,492 and
$41,450)
|
|
|
49,088
|
|
|
42,085
|
|
Total
investments
|
|
|
1,418,700
|
|
|
1,384,215
|
|
Cash
and cash equivalents
|
|
|
41,322
|
|
|
34,697
|
|
Accrued
investment income
|
|
|
16,435
|
|
|
16,161
|
|
Premiums
receivable
|
|
|
105,580
|
|
|
105,814
|
|
Reinsurance
receivables and recoverables
|
|
|
5,760
|
|
|
7,160
|
|
Prepaid
reinsurance premiums
|
|
|
1,784
|
|
|
1,787
|
|
Deferred
income taxes
|
|
|
50,003
|
|
|
56,135
|
|
Deferred
policy acquisition costs
|
|
|
62,205
|
|
|
58,759
|
|
Leased
property under capital lease, net of deferred gain of
|
|
|
|
|
|
|
|
$2,325
and $3,116 and net of accumulated amortization of
|
|
|
|
|
|
|
|
$30,584
and $24,794
|
|
|
28,094
|
|
|
31,719
|
|
Property
and equipment, at cost less accumulated depreciation of
|
|
|
|
|
|
|
|
$77,334
and $68,529
|
|
|
132,376
|
|
|
129,372
|
|
Other
assets
|
|
|
30,158
|
|
|
38,495
|
|
Total
assets
|
|
$
|
1,892,417
|
|
$
|
1,864,314
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
Unpaid
losses and loss adjustment expenses
|
|
$
|
495,522
|
|
$
|
495,542
|
|
Unearned
premiums
|
|
|
336,243
|
|
|
331,036
|
|
Debt
|
|
|
134,242
|
|
|
138,290
|
|
Claims
checks payable
|
|
|
38,567
|
|
|
38,737
|
|
Reinsurance
payable
|
|
|
606
|
|
|
633
|
|
Other
liabilities
|
|
|
77,234
|
|
|
85,675
|
|
Total
liabilities
|
|
|
1,082,414
|
|
|
1,089,913
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
Common
stock, par value $0.001 per share; 110,000,000 shares
authorized;
|
|
|
|
|
|
|
|
shares
issued and outstanding 85,744,970 and 85,489,061
|
|
|
86
|
|
|
85
|
|
Additional
paid-in capital
|
|
|
422,514
|
|
|
420,425
|
|
Retained
earnings
|
|
|
374,281
|
|
|
341,196
|
|
Accumulated
other comprehensive income (loss):
|
|
|
|
|
|
|
|
Net
unrealized gains on available-for-sale investments, net of
|
|
|
|
|
|
|
|
deferred
income taxes of $7,990 and $7,760
|
|
|
14,839
|
|
|
14,412
|
|
Minimum
pension liability in excess of unamortized prior service
|
|
|
|
|
|
|
|
cost,
net of deferred income taxes of $925 and $925
|
|
|
(1,717
|
)
|
|
(1,717
|
)
|
Total
stockholders’ equity
|
|
|
810,003
|
|
|
774,401
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
1,892,417
|
|
$
|
1,864,314
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements.
21ST
CENTURY INSURANCE GROUP
|
|
|
|
|
|
|
|
|
|
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS |
|
|
|
|
|
|
|
|
|
Unaudited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended June 30,
|
Six
Months Ended June 30,
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
2005
|
2004
|
2005
|
2004
|
Revenues
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
336,845
|
|
$
|
327,021
|
|
$
|
673,209
|
|
$
|
645,241
|
|
Net
investment income
|
|
|
17,006
|
|
|
14,315
|
|
|
34,043
|
|
|
27,461
|
|
Other
|
|
|
367
|
|
|
—
|
|
|
367
|
|
|
—
|
|
Net
realized investment (losses) gains
|
|
|
(1,267
|
)
|
|
1,337
|
|
|
(1,727
|
)
|
|
8,983
|
|
Total
revenues
|
|
|
352,951
|
|
|
342,673
|
|
|
705,892
|
|
|
681,685
|
|
Losses
and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
losses and loss adjustment expenses
|
|
|
248,284
|
|
|
244,556
|
|
|
499,315
|
|
|
492,070
|
|
Policy
acquisition costs
|
|
|
63,755
|
|
|
54,782
|
|
|
128,078
|
|
|
108,472
|
|
Other
operating expenses
|
|
|
8,765
|
|
|
9,844
|
|
|
16,123
|
|
|
16,244
|
|
Interest
and fees expense
|
|
|
2,031
|
|
|
2,185
|
|
|
4,088
|
|
|
4,411
|
|
Total
losses and expenses
|
|
|
322,835
|
|
|
311,367
|
|
|
647,604
|
|
|
621,197
|
|
Income
before provision for income taxes
|
|
|
30,116
|
|
|
31,306
|
|
|
58,288
|
|
|
60,488
|
|
Provision
for income taxes
|
|
|
9,621
|
|
|
9,932
|
|
|
18,356
|
|
|
19,289
|
|
Net
income
|
|
$
|
20,495
|
|
$
|
21,374
|
|
$
|
39,932
|
|
$
|
41,199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per common share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
$
|
0.24
|
|
$
|
0.25
|
|
$
|
0.47
|
|
$
|
0.48
|
|
Weighted
average shares outstanding ¾
basic
|
|
|
85,704,165
|
|
|
85,462,774
|
|
|
85,613,043
|
|
|
85,452,194
|
|
Weighted
average shares outstanding ¾
diluted
|
|
|
85,890,984
|
|
|
85,611,192
|
|
|
85,803,214
|
|
|
85,614,711
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements.
21ST
CENTURY INSURANCE GROUP
CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS’EQUITY
Unaudited
|
|
Common
Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.001
par value
|
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS,
EXCEPT
SHARE DATA
|
|
Shares
|
Amount
|
Additional
Paid-in
Capital
|
Retained
Earnings
|
Accumulated
Other
Comprehensive
Income
(Loss)
|
Total
|
Balance
- January 1, 2005
|
|
|
85,489,061
|
|
$
|
85
|
|
$
|
420,425
|
|
|
341,196
|
|
$
|
12,695
|
|
$
|
774,401
|
|
Comprehensive
income
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
39,932
|
(1)
|
|
427
|
(2)
|
|
40,359
|
|
Cash
dividends declared on common stock ($0.08 per share)
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(6,847
|
)
|
|
—
|
|
|
(6,847
|
)
|
Other
|
|
|
255,909
|
|
|
1
|
|
|
2,089
|
|
|
—
|
|
|
—
|
|
|
2,090
|
|
Balance
- June 30, 2005
|
|
|
85,744,970
|
|
$
|
86
|
|
$
|
422,514
|
|
$
|
374,281
|
|
$
|
13,122
|
|
$
|
810,003
|
|
(2)
|
Net
change in accumulated other comprehensive income (loss) for the six
months
ended June 30, 2005, is
as follows:
|
AMOUNTS
IN THOUSANDS
|
|
|
|
Unrealized
holding losses arising during the period, net of tax of
$309
|
|
$
|
(574
|
)
|
Reclassification
adjustment for investment losses included in net income, net of tax
of
$539
|
|
|
1,001
|
|
Total
|
|
$
|
427
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements.
21ST
CENTURY INSURANCE GROUP
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
|
|
|
|
Six
Months Ended June 30,
|
|
2005
|
2004
|
Operating
activities
|
|
|
|
|
|
Net
income
|
|
$
|
39,932
|
|
$
|
41,199
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
14,995
|
|
|
10,682
|
|
Net
amortization of investment premiums and discounts
|
|
|
4,840
|
|
|
2,921
|
|
Amortization
of restricted stock grants
|
|
|
138
|
|
|
198
|
|
Provision
for deferred income taxes
|
|
|
5,903
|
|
|
14,276
|
|
Realized
losses (gains) on sale of investments
|
|
|
1,717
|
|
|
(8,983
|
)
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
Reinsurance
balances
|
|
|
1,377
|
|
|
3,633
|
|
Federal
income taxes
|
|
|
(69
|
)
|
|
5,851
|
|
Other
assets
|
|
|
2,029
|
|
|
(3,700
|
)
|
Unpaid
losses and loss adjustment expenses
|
|
|
(20
|
)
|
|
23,626
|
|
Unearned
premiums
|
|
|
5,207
|
|
|
17,873
|
|
Claims
checks payable
|
|
|
(170
|
)
|
|
(3,578
|
)
|
Other
liabilities
|
|
|
(5,638
|
)
|
|
12,035
|
|
Net
cash provided by operating activities
|
|
|
70,241
|
|
|
116,033
|
|
Investing
activities
|
|
|
|
|
|
|
|
Investments
available-for-sale
|
|
|
|
|
|
|
|
Purchases
|
|
|
(237,305
|
)
|
|
(693,343
|
)
|
Calls
or maturities
|
|
|
17,225
|
|
|
27,524
|
|
Sales
|
|
|
179,880
|
|
|
612,776
|
|
Purchases
of property and equipment
|
|
|
(12,591
|
)
|
|
(18,978
|
)
|
Net
cash used in investing activities
|
|
|
(52,791
|
)
|
|
(72,021
|
)
|
Financing
activities
|
|
|
|
|
|
|
|
Repayment
of debt
|
|
|
(5,953
|
)
|
|
(5,617
|
)
|
Dividends
paid (per share: $0.08 and $0.06)
|
|
|
(6,847
|
)
|
|
(5,126
|
)
|
Proceeds
from the exercise of stock options
|
|
|
1,975
|
|
|
407
|
|
Net
cash used in financing activities
|
|
|
(10,825
|
)
|
|
(10,336
|
)
|
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
|
6,625
|
|
|
33,676
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
34,697
|
|
|
65,010
|
|
Cash
and cash equivalents, end of period
|
|
$
|
41,322
|
|
$
|
98,686
|
|
|
|
|
|
|
|
|
|
Supplemental
information:
|
|
|
|
|
|
|
|
Income
taxes paid (refunded)
|
|
$
|
9,434
|
|
$
|
(10,480
|
)
|
Interest
paid
|
|
|
4,017
|
|
|
4,439
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
1. FINANCIAL
STATEMENT PRESENTATION
General
21st
Century Insurance Group and subsidiaries (the “Company”) prepared the
accompanying unaudited condensed consolidated financial statements in accordance
with the rules and regulations of the Securities and Exchange Commission for
interim reporting. As permitted under those rules and regulations, certain
notes
or other information that are normally required by accounting principles
generally accepted in the United States of America (“GAAP”) have been condensed
or omitted if they substantially duplicate the disclosures contained in the
annual audited consolidated financial statements. The unaudited condensed
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2004.
These
condensed consolidated financial statements include all adjustments (including
normal, recurring accruals) that are considered necessary for the fair
presentation of our financial position and results of operations in accordance
with GAAP. Intercompany accounts and transactions have been eliminated in
consolidation. Operating results for the six-month period ended June 30, 2005
are not necessarily indicative of results that may be expected for any other
interim period or the year as a whole.
Earnings
Per Share
For
each
of the quarters ended June 30, 2005 and 2004, the numerator for the calculation
of both basic and diluted earnings per common share is equal to net income
reported for that period. The difference between basic and diluted earnings
per
share denominators is due to dilutive stock options. Options
to purchase an aggregate of 7,475,427 and 7,341,859 shares of common stock
during the three and six months ended June 30, 2005, respectively, and 6,634,593
and 5,850,135 shares of common stock during the three and six months ended
June
30, 2004, respectively, were not included in the computation of diluted earnings
per share 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 June 2015.
Stock-Based
Compensation
Statement
of Financial Accounting Standard (“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. 123,
the
Company accounts for its fixed stock options using the intrinsic-value method,
prescribed in Accounting Principles Board Opinion (“APB”) 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, the Company also grants 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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Restricted
shares are forfeited if officers’ and employees’ employment with the Company is
terminated 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, proforma 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 fair-value-based method for all awards, net income
and
earnings per share would have been reduced to the proforma amounts indicated
below:
|
|
Three
Months Ended
|
Six
Months Ended
|
|
|
June
30,
|
June
30,
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
2005
|
2004
|
2005
|
2004
|
Net
income, as reported
|
|
$
|
20,495
|
|
$
|
21,374
|
|
$
|
39,932
|
|
$
|
41,199
|
|
Add:
Stock-based employee compensation expense included in reported net
income,
net of related tax effects
|
|
|
68
|
|
|
65
|
|
|
90
|
|
|
130
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deduct:
Total stock-based employee compensation expense determined under
fair-
value-based method for all awards, net of related tax
effects
|
|
|
(1,298
|
)
|
|
(1,301
|
)
|
|
(2,565
|
)
|
|
(3,280
|
)
|
Net
income, proforma
|
|
$
|
19,265
|
|
$
|
20,138
|
|
$
|
37,457
|
|
$
|
38,049
|
|
Basic
and diluted earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
0.24
|
|
$
|
0.25
|
|
$
|
0.47
|
|
$
|
0.48
|
|
Proforma
|
|
$
|
0.22
|
|
$
|
0.24
|
|
$
|
0.44
|
|
$
|
0.44
|
|
For
proforma disclosure purposes, the fair value of stock options was estimated
for
grants during the six-month periods ended June 30 using the Black-Scholes
valuation model with the following weighted-average assumptions:
|
|
Six
Months Ended
June
30,
|
|
|
2005
|
2004
|
Risk-free
interest rate:
|
|
|
|
|
|
Minimum
|
|
|
3.74
|
%
|
|
3.43
|
%
|
Maximum
|
|
|
4.28
|
%
|
|
4.24
|
%
|
|
|
|
|
|
|
|
|
Dividend
yield
|
|
|
1.13
|
%
|
|
0.56
|
%
|
|
|
|
|
|
|
|
|
Volatility
factor of the expected market price
|
|
|
|
|
|
|
|
of
the Company’s common stock:
|
|
|
|
|
|
|
|
Minimum
|
|
|
0.29
|
|
|
0.36
|
|
Maximum
|
|
|
0.32
|
|
|
0.41
|
|
|
|
|
|
|
|
|
|
Weighted-average
expected life of the options
|
|
|
6
years
|
|
|
6
years
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Recent
Accounting Standards
In
May 2005, the Financial Accounting Standards Board (“FASB”) issued
SFAS No. 154, Accounting
Changes and Error Corrections.
SFAS
No. 154 replaces APB No. 20, Accounting
Changes,
and
SFAS No. 3, Reporting
Accounting Changes in Interim Financial Statements,
and
establishes retrospective application as the required method for reporting
a
change in accounting principle. SFAS No. 154 provides guidance for determining
whether retrospective application of a change in accounting principle is
impracticable and for reporting a change when retrospective application is
impracticable. The reporting of a correction of an error by restating previously
issued financial statements is also addressed. SFAS No. 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The Company does not anticipate that the adoption
of SFAS No. 154 will have a material impact on its consolidated results of
operations.
In
March 2005, the Securities & Exchange Commission (the “SEC”) issued
Staff Accounting Bulletin (“SAB”) No. 107, Share-Based
Payment.
SAB No.
107 summarizes the views of the SEC staff regarding the interaction between
SFAS
No. 123 (Revised 2004), Share-Based
Payment
(“SFAS
No. 123R”) and certain SEC rules and regulations, and is intended to assist in
the initial implementation of SFAS No. 123R, which for the Company is required
beginning in the first quarter 2006. 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. 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.
NOTE
2. HOMEOWNER
AND EARTHQUAKE LINES IN RUNOFF
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 earthquake. 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 June 30, 2005, was $1.5 million.
More
than
ninety-eight percent of the claims submitted and litigation brought against
the
Company as a result of SB 1899 have been resolved. 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 appeal. Current reserves
contain no provisions for extra-contractual 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 Company.
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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
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 the earthquake
reserves include only nominal amounts for them. Should the courts ultimately
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 them. A recent Court of Appeal
decision, Cordova
v. 21st Century Insurance Company,
found
that SB 1899 does not automatically bar claims brought outside its specified
time limitations and that, under certain conditions, a 1994 Northridge
earthquake claimant might be able to assert that the Company is equitably
estopped to assert a time limitation defense. The Company is seeking review
of
this decision by the California Supreme Court.
Loss
and
loss adjustment expenses for the homeowner and earthquake lines in runoff were
$0.2 million and $0.4 million for
the
three and six months ended June 30, 2005, respectively, compared to $0.2 million
and $0.5 million for the same periods in 2004.
NOTE
3. COMMITMENTS
AND CONTINGENCIES
Litigation.
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 extra-contractual 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 extra-contractual or punitive
damages, or for contractual damages in excess of estimates the Company believes
are correct and reasonable under its insurance policies. Nevertheless,
extra-contractual 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, 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.
Poss
v. 21st Century Insurance Company was
filed
on June 13, 2003, in Los Angeles Superior Court. The complaint sought injunctive
and unspecified 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. Based on California’s Proposition 64, passed in
November 2004, the court granted the Company’s motion to dismiss the complaint
on March 22, 2005, but stayed the litigation pending appellate court decisions
involving similar issues but other parties. 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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
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 September 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
pleading stage of litigation and no reasonable estimate of potential losses
in
the event of a negative outcome can be made at this time.
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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
4. 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 aforementioned 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
June
30, 2005, 4,047,137 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
and nonemployee directors for their services.
A
summary
of securities issuable and issued for the Company’s stock option plans and the
Restricted Shares Plan at June 30, 2005, follows:
AMOUNTS
IN THOUSANDS
|
|
1995
Stock Option Plan
|
2004
Stock Option Plan
|
Restricted
Shares
Plan
|
Total
number of securities authorized
|
|
|
10,000
|
|
|
4,000
|
|
|
1,422
|
|
Number
of securities issued
|
|
|
(691
|
)
|
|
—
|
|
|
(1,144
|
)
|
Number
of securities issuable upon the exercise of all outstanding
options
|
|
|
(7,368
|
)
|
|
(1,894
|
)
|
|
—
|
|
Number
of securities forfeited
|
|
|
(2,227
|
)
|
|
—
|
|
|
—
|
|
Number
of securities forfeited and returned to plan
|
|
|
2,227
|
|
|
—
|
|
|
156
|
|
Unused
options assumed by 2004 Stock Option Plan
|
|
|
(1,941
|
)
|
|
1,941
|
|
|
—
|
|
Number
of securities remaining available for future grants under each
plan
|
|
|
—
|
|
|
4,047
|
|
|
434
|
|
Exercise
prices for options outstanding at June 30, 2005, ranged from $11.68 to $29.25.
The weighted-average remaining contractual life of those options is 7.0
years.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
A
summary
of the Company’s stock option activity for the six months ended June 30, 2005,
and related information follows:
AMOUNTS
IN THOUSANDS, EXCEPT PRICE DATA
|
|
Number
of
Options
|
Weighted-
Average
Exercise
Price
|
Options
outstanding December 31, 2004
|
|
|
8,109
|
|
$
|
16.49
|
|
Granted
in 2005
|
|
|
1,725
|
|
|
14.19
|
|
Exercised
in 2005
|
|
|
(166
|
)
|
|
14.02
|
|
Forfeited
in 2005
|
|
|
(406
|
)
|
|
15.35
|
|
Options
outstanding June 30, 2005
|
|
|
9,262
|
|
|
16.16
|
|
Options
exercisable numbered 6,018,007 and 5,171,468 at June 30, 2005 and 2004,
respectively.
NOTE
5. 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.
Components
of Net Periodic Cost
Net
pension costs for all plans were comprised of the following:
|
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|
|
2005
|
2004
|
2005
|
2004
|
Service
cost
|
|
$
|
1,762
|
|
$
|
1,490
|
|
$
|
3,524
|
|
$
|
2,979
|
|
Interest
cost
|
|
|
1,855
|
|
|
1,610
|
|
|
3,710
|
|
|
3,221
|
|
Expected
return on plan assets
|
|
|
(1,830
|
)
|
|
(1,612
|
)
|
|
(3,660
|
)
|
|
(3,223
|
)
|
Amortization
of prior service cost
|
|
|
27
|
|
|
26
|
|
|
54
|
|
|
52
|
|
Amortization
of net loss
|
|
|
507
|
|
|
494
|
|
|
1,014
|
|
|
989
|
|
Total
|
|
$
|
2,321
|
|
$
|
2,008
|
|
$
|
4,642
|
|
$
|
4,018
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Employer
Contributions
The
Company previously disclosed in its financial statements for the year ended
December 31, 2004, that it did not expect to contribute to its qualified defined
benefit pension plan in 2005. As of June 30, 2005, no contributions have been
made. After consideration of currently available information, the Company
continues to anticipate that it will not contribute any funds to its qualified
defined benefit pension 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 $0.9
million in 2005.
NOTE
6. 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.
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 loss adjustment expense
(“LAE”) incurred by the pool according to its share of total homeowner direct
premiums written in the state. Participation in FAIR Plan operations is based
on
the pool from two years prior. Since the Company ceased writing homeowners
business in 2002, the Company no longer receives assignments.
The
Company evaluates segment performance based on pre-tax 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. The accounting policies
of the reportable segments are the same as those described in Note 2 of the
Notes to Consolidated Financial Statements included in our Annual Report on
Form
10-K for the year ended December 31, 2004. All revenues are generated from
external customers and the Company does not rely on any major
customer.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
following table presents net premiums earned, depreciation and amortization
expense, and segment profit (loss) for the Company’s segments.
|
|
Personal
Auto Lines
|
Homeowner
and
Earthquake
Lines
in
Runoff
1
|
Total
|
Three
Months Ended June 30, 2005
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
336,842
|
|
$
|
3
|
|
$
|
336,845
|
|
Depreciation
and amortization expense
|
|
|
8,426
|
|
|
2
|
|
|
8,428
|
|
Segment
profit (loss)
|
|
|
16,239
|
|
|
(198
|
)
|
|
16,041
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended June 30, 2004
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
326,965
|
|
$
|
56
|
|
$
|
327,021
|
|
Depreciation
and amortization expense
|
|
|
5,364
|
|
|
30
|
|
|
5,394
|
|
Segment
profit (loss)
|
|
|
18,007
|
|
|
(168
|
)
|
|
17,839
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
Months Ended June 30, 2005
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
673,203
|
|
$
|
6
|
|
$
|
673,209
|
|
Depreciation
and amortization expense
|
|
|
14,990
|
|
|
5
|
|
|
14,995
|
|
Segment
profit (loss)
|
|
|
30,063
|
|
|
(370
|
)
|
|
29,693
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
Months Ended June 30, 2004
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
645,130
|
|
$
|
111
|
|
$
|
645,241
|
|
Depreciation
and amortization expense
|
|
|
10,612
|
|
|
70
|
|
|
10,682
|
|
Segment
profit (loss)
|
|
|
28,843
|
|
|
(388
|
)
|
|
28,455
|
|
The
following table reconciles segment profit to consolidated income before
provision for income taxes:
|
|
Three
Months Ended June 30,
|
|
|
|
2005
|
2004
|
2005
|
2004
|
Segment
profit
|
|
$
|
16,041
|
|
$
|
17,839
|
|
$
|
29,693
|
|
$
|
28,455
|
|
Net
investment income
|
|
|
17,006
|
|
|
14,315
|
|
|
34,043
|
|
|
27,461
|
|
Other
income
|
|
|
367
|
|
|
—
|
|
|
367
|
|
|
—
|
|
Realized
investment (losses) gains
|
|
|
(1,267
|
)
|
|
1,337
|
|
|
(1,727
|
)
|
|
8,983
|
|
Interest
and fees expense
|
|
|
(2,031
|
)
|
|
(2,185
|
)
|
|
(4,088
|
)
|
|
(4,411
|
)
|
Income
before provision for income taxes
|
|
$
|
30,116
|
|
$
|
31,306
|
|
$
|
58,288
|
|
$
|
60,488
|
|
1 Segment
revenue represents premium earned as a result of the Company’s participation in
the California FAIR Plan.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
7. VARIABLE
INTEREST ENTITIES
In
January 2003, the FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51 (“FIN
46”), and amended it in December 2003. An entity is subject to the consolidation
rules of FIN 46 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
46
also requires disclosures about VIEs that a company is 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 11.11% ($24.0 million) of $216.0
million of participation. The mortgages purchased with these funds may be
securitized. Otherwise, the loans will be liquidated in 10 years from the
initial date of the respective agreement.
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 an Impact
subsidiary in addition to the $5.1 million investment noted above. The Company
has voting rights and ownership of Impact in proportion to its investment
(approximately 10%).
The
Company has also committed $2.0 million to other Impact affiliates for other
community investment purposes. No amounts have been contributed to these other
investment programs as of June 30, 2005.
The
Company does not have any other material VIEs that it needs, or will need,
to
consolidate or disclose.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
|
Overview
Founded
in 1958, 21st Century Insurance Group is a direct-to-consumer provider of
personal auto insurance. With $1.3 billion of revenue in 2004, the Company
insures over 1.5 million vehicles in California, Texas, Illinois and six other
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.
Our
long-term financial goals include achieving a 96% combined ratio and 15% annual
growth in premiums written in our personal auto lines. Our direct premiums
written grew 1.2% ($3.9 million) to $328.7 million in the second quarter ended
June 30, 2005, from $324.8 million in the second quarter of 2004. All of the
second quarter 2005 growth in direct premiums written was generated outside
of
California. California direct premiums written decreased by 1.6% ($5.0 million)
to $309.2 million, compared to $314.2 million for the same period in 2004,
which
is indicative of the high level of competitor marketing activity in the state.
Non-California direct premiums written increased by 81.3% ($8.8 million) to
$19.5 million, compared to $10.7 million for the same period in 2004.
Underwriting
profit decreased 10.1% to $16.0 million in the second quarter of 2005, compared
to $17.8 million for the same period in 2004. For the six months ended June
30,
2005, underwriting profit was $29.7 million, an increase of 4.2% over
underwriting profit of $28.5 million for same period in 2004. The second quarter
2005 underwriting profit includes $11.9 million of favorable development related
to prior accident years’ reserves, compared to a $0.2 million of reserve
strengthening in the same period of 2004. The six months ended June 30, 2005
underwriting profit includes $19.6 million of favorable development related
to
prior accident years’ reserves, compared to $0.5 million of reserve
strengthening in the same period of 2004.
The
combined ratio increased 0.7% to 95.2% for the quarter ended June 30, 2005,
from
94.5% for the same period in 2004. For the six months ended June 30, 2005,
the
combined ratio remained stable at 95.6% compared to 95.6% in 2004.
Net
income for the quarter ended June 30, 2005, was $20.5 million, or $0.24 per
share, compared to net income of $21.4 million, or $0.25 per share, for the
same
period in 2004. The second quarter 2005 results include net realized capital
losses of $1.3 million, compared to net realized capital gains of $1.3 million
for the same period in 2004. For the six months ended June 30, 2005, net income
was $39.9 million, or $0.47 per share, compared to $41.2 million, or $0.48
per
share, for the same period in 2004. The 2005 six months results include net
realized capital losses of $1.7 million, compared to net realized capital gains
of $9.0 million for the same period in 2004.
For
the
quarter ended June 30, 2005, cash flow from operations decreased 47.4% to $30.8
million, compared to $58.5 million for the same period in 2004. For the six
months ended June 30, 2005, cash flow from operations decreased by 39.5% to
$70.2 million from $116.0 million for the same period in 2004. The $45.8 million
decrease in operating cash flow is primarily attributable to income tax related
items and increased underwriting expense payments. In February 2005, the Company
filed its California amended tax returns under California legislation AB 263
and
paid an associated tax liability of $6.8 million, which contrasts with the
$10.5
million in income taxes refunded during the six-month period ended June 30,
2004. Underwriting expenses and payments increased in 2005 as
a
result of our investments in the state expansion strategy, the conversion to
our
new technology platform (which currently services approximately 85% of
outstanding claims and over 65% of California policies) and the build-up of
our
Dallas service center.
Total
assets were $1,892.4 million at June 30, 2005 compared to $1,864.3 million
at
December 31, 2004. Statutory surplus increased 3.7% to $637.5 million at June
30, 2005 from $614.9 million at December 31, 2004. The net premiums written
to
statutory surplus ratio improved to 2.1 at June 30, 2005, compared to 2.2 at
December 31, 2004.
Premiums
written and statutory surplus have been presented to enhance investors’
understanding of the Company’s operations. These financial measures are not
presented in accordance with accounting principles generally accepted in the
United States of America (“GAAP”). Premiums written represent the premiums
charged on policies issued during a fiscal period. Premiums earned, the most
directly comparable GAAP measure, represents the portion of premiums written
that is recognized as income in the financial statements for the periods
presented and earned on a pro-rata basis over the term of the policies.
Statutory surplus represents equity as of the end of a fiscal period for the
Company’s insurance subsidiaries, determined in accordance with statutory
accounting principles prescribed by insurance regulatory authorities.
Stockholders’ equity is the most directly comparable GAAP measure. The
reconciliations of these financial measures to the most directly comparable
GAAP
measure are located in “Results of Operations” and “Liquidity and Capital
Resources,” respectively. These financial measures are not intended to replace,
and should be read in conjunction with, the GAAP financial results.
See
“Results of Operations” for more details as to our overall and personal auto
lines results.
The
remainder of our Management’s Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the accompanying
financial statements. It includes the following sections:
·
|
Liquidity
and Capital Resources
|
·
|
Contractual
Obligations and Commitments
|
·
|
Critical
Accounting Estimates
|
·
|
Forward-Looking
Statements
|
Financial
Condition
Investments
and cash increased $41.1 million (2.9%) since December 31, 2004, due to $70.2
million of operating cash flow primarily offset by cash outflows of $12.6
million for property and equipment, $6.8 million in shareholder dividends,
and
$6.0 million of debt repayment.
At
June
30, 2005, investment-grade bonds comprised substantially all of the carrying
value of the fixed maturity portfolio. As of June 30, 2005, three positions
in
fixed maturity securities were rated below BBB. These securities represent
approximately 0.5% of our total investments.
Increased
advertising, sales and customer service costs through June 30, 2005 contributed
to an increase in deferred policy acquisition costs (“DPAC”) of $3.4 million to
$62.2 million, compared to $58.8 million at December 31, 2004. Our DPAC is
estimated to be fully recoverable (see Critical
Accounting Estimates - Deferred Policy Acquisition Costs).
The
following table summarizes unpaid losses and loss adjustment expenses (“LAE”)
with respect to our lines of business:
|
|
June 30, 2005
|
|
December 31, 2004
|
|
AMOUNTS
IN THOUSANDS
|
|
Gross
|
Net
|
Gross
|
Net
|
Unpaid
Losses and LAE
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
$
|
492,420
|
|
$
|
487,854
|
|
$
|
489,411
|
|
$
|
485,759
|
|
Homeowner
and earthquake lines in runoff
|
|
|
3,102
|
|
|
2,269
|
|
|
6,131
|
|
|
5,138
|
|
Total
|
|
$
|
495,522
|
|
$
|
490,123
|
|
$
|
495,542
|
|
$
|
490,897
|
|
The
following table summarizes losses and LAE incurred, net of applicable
reinsurance, for the periods indicated:
|
|
Three
Months Ended June
30,
|
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
2004
|
2005
|
2004
|
|
|
|
|
|
|
|
|
|
|
Net
losses and LAE:
|
|
|
|
|
|
|
|
|
|
Current
accident year:
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
$
|
260,200
|
|
$
|
244,406
|
|
$
|
518,902
|
|
$
|
491,540
|
|
Homeowner
and earthquake lines in runoff
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total
current accident year
|
|
|
260,200
|
|
|
244,406
|
|
|
518,902
|
|
|
491,540
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prior
accident years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
|
(12,116
|
)
|
|
(73
|
)
|
|
(19,963
|
)
|
|
32
|
|
Homeowner
and earthquake lines in runoff
|
|
|
200
|
|
|
223
|
|
|
376
|
|
|
498
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
prior accident years
|
|
|
(11,916
|
)
|
|
150
|
|
|
(19,587
|
)
|
|
530
|
|
Total
net losses and LAE
|
|
$
|
248,284
|
|
$
|
244,556
|
|
$
|
499,315
|
|
$
|
492,070
|
|
At
June
30, 2005, gross unpaid losses and LAE increased $3.0 million for our personal
auto lines and decreased $3.0 million for the homeowner and earthquake lines
in
runoff from the prior year end. 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 June 30, 2005. 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 materially differ from our unpaid losses and LAE as of June 30, 2005. 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 quarterly changes to unpaid losses and LAE begins with the
preparation of several point estimates, 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 and LAE 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. The basis for carried unpaid losses and LAE is the overall
actuarial point estimate. 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, severity triangles, as well as expected loss
ratio methods. Quantitative techniques frequently have to be supplemented by
subjective consideration, including managerial judgment, to assure management
satisfaction 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 that
are
based upon past loss experience. Thus, many factors are implicitly considered
in
estimating loss costs to be recognized for the quarter.
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 estimates
of ultimate severities exhibit greater variability at the same maturity.
Generally, 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 approximately 5%
from
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 of
California. These areas 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 0.13%, or $1.9 million.
While
we
have settled over ninety-eight percent of reported earthquake claims and are
making progress in resolving the remaining 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 2 of the
Notes to Condensed Consolidated Financial Statements for additional background
on the Northridge Earthquake and SB 1899.
Debt
of
$134.2 million consists of $34.3 million
of
capital lease obligations and $99.9 million of senior notes, net of discount,
issued in December 2003. The primary purpose of both borrowings was to increase
the statutory surplus of 21st Century Insurance Company, our wholly-owned
subsidiary. The decrease in debt of $4.1 million during the six months ended
June 30, 2005 is primarily attributable to principal payments on the capital
lease.
Stockholders’
equity and book value per share increased to $810.0 million and $9.45,
respectively, at June 30, 2005, compared to $774.4 million
and
$9.06 at December 31, 2004, respectively. The increase in stockholders’ equity
for the six months ended June 30, 2005 was primarily due to net income of $39.9
million and $2.1 million in proceeds from stock option exercises, offset by
dividends to stockholders of $6.8 million.
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 American International Group,
Inc.
(“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 that surrounded the
taxability of dividends received by holding companies from their insurance
subsidiaries in California. See further discussion of the Ceridian
case in
Critical
Accounting Estimates - Income Taxes.
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 (“CDI”) approved an
intercompany lease whereby 21st Century Insurance Company has leased certain
computer software from our holding company. The monthly lease payment, currently
$0.7 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,
exclusive of any dividends to stockholders that our directors may declare,
consist of interest payments on the Senior Notes (approximately $5.9 million
annually), costs to develop our California policy servicing system and the
repayment of the $100 million principal on the Senior Notes due in 2013. We
expect to be able to meet those obligations from sources of cash currently
available (i.e., cash and investments at the holding company, which totaled
$20.8 million at June 30, 2005, and payments received from the intercompany
lease, borrowing from our insurance subsidiary), additional
funds obtainable from the capital markets or from dividends received from our
insurance subsidiaries. California currently levies state income taxes of
approximately 1.8% on the amount of any such dividends received.
In
2005,
our insurance subsidiaries could pay $109.8 million 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
fourteen 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 94.3% of our premiums were written
for
the six months ended June 30, 2005, underwriting profit improved in 2004 and
2005 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 California regulatory
approval for rate increases, 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. 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
June 30, 2005, our insurance subsidiaries had a combined statutory surplus
of
$637.5 million compared to $614.9 million at December 31, 2004. The increase
in
statutory surplus was primarily due to statutory net income of $47.8 million
offset by an increase in nonadmitted assets of $14.9 million, an increase in
net
unrealized investment losses of $0.7 million, and a $9.6 million decrease in
the
deferred income tax asset. The net premiums written to statutory surplus ratio
improved to 2.1 at June 30, 2005, compared to 2.2 at December 31,
2004.
The
following is a reconciliation of our stockholders’ equity to statutory
surplus:
AMOUNTS
IN THOUSANDS
|
|
June
30,
2005
|
December
31,
2004
|
Stockholders’
equity - GAAP
|
|
$
|
810,003
|
|
$
|
774,401
|
|
Condensed
adjustments to reconcile GAAP equity
|
|
|
|
|
|
|
|
to
statutory surplus:
|
|
|
|
|
|
|
|
Net
book value of fixed assets under capital leases
|
|
|
(30,418
|
)
|
|
(34,834
|
)
|
Deferred
gain under capital lease transactions
|
|
|
(762
|
)
|
|
(610
|
)
|
Capital
lease obligation
|
|
|
34,351
|
|
|
38,405
|
|
Nonadmitted
net deferred tax assets
|
|
|
(60,205
|
)
|
|
(67,260
|
)
|
Net
deferred tax assets related to items nonadmitted under SAP
|
|
|
47,401
|
|
|
50,712
|
|
Intercompany
receivables
|
|
|
(48,640
|
)
|
|
(19,917
|
)
|
Fixed
assets
|
|
|
(23,738
|
)
|
|
(25,017
|
)
|
Equity
in non-insurance subsidiaries
|
|
|
17,597
|
|
|
8,082
|
|
Unrealized
gains on bonds
|
|
|
(23,304
|
)
|
|
(21,709
|
)
|
Deferred
policy acquisition costs
|
|
|
(62,205
|
)
|
|
(58,759
|
)
|
Prepaid
pension costs and intangible pension asset
|
|
|
(14,429
|
)
|
|
(17,253
|
)
|
Other
prepaid expenses
|
|
|
(9,522
|
)
|
|
(12,235
|
)
|
Other,
net
|
|
|
1,333
|
|
|
887
|
|
Statutory
surplus
|
|
$
|
637,462
|
|
$
|
614,893
|
|
Transactions
with Related Parties.
Since
1995, we have entered into several transactions with AIG subsidiaries, including
various reinsurance agreements. At June 30, 2005, reinsurance recoverables,
net
of payables, from AIG subsidiaries were $0.2 million, compared to $1.4 million
at December 31, 2004. 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, we entered into an agreement with an AIG subsidiary
to provide investment management and accounting services to the Company. This
agreement was approved by the California Department of Insurance.
Contractual
Obligations and Commitments
There
were no material changes outside the ordinary course of our business in our
contractual obligations during the three and six months ended June 30,
2005.
Results
of Operations
Overall
Results.
We
reported net income of $20.5 million, or earnings per
share
(basic and diluted) of $0.24, on direct premiums written of $328.7 million
in
the quarter ended June 30, 2005, compared to a net income of $21.4 million,
or
earnings per share (basic and diluted) of $0.25, on direct premiums written
of
$324.8 million for the same quarter last year. For the six months ended June
30,
2005, net income was $39.9 million, or earnings per share (basic and diluted)
of
$0.47, on direct premiums written of $680.8 million. Net income for the six
months ended June 30, 2004, was $41.2 million, or earnings per share (basic
and
diluted) of $0.48, on direct premiums written of $665.5 million.
Personal
Auto Lines Results. The
following table presents the components of our personal auto lines underwriting
profit and the components of the combined ratio:
|
|
Three
Months Ended June
30,
|
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
2004
|
2005
|
2004
|
Direct
premiums written
|
|
$
|
328,669
|
|
$
|
324,750
|
|
$
|
680,786
|
|
$
|
665,343
|
|
Net
premiums written
|
|
$
|
327,479
|
|
$
|
323,613
|
|
$
|
678,420
|
|
$
|
663,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
336,842
|
|
$
|
326,965
|
|
$
|
673,203
|
|
$
|
645,130
|
|
Net
losses and loss adjustment expenses
|
|
|
248,083
|
|
|
244,332
|
|
|
498,939
|
|
|
491,571
|
|
Underwriting
expenses incurred
|
|
|
72,520
|
|
|
64,626
|
|
|
144,201
|
|
|
124,716
|
|
Personal
auto lines underwriting profit
|
|
$
|
16,239
|
|
$
|
18,007
|
|
$
|
30,063
|
|
$
|
28,843
|
|
Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio
|
|
|
73.7
|
%
|
|
74.7
|
%
|
|
74.1
|
%
|
|
76.2
|
%
|
Underwriting
expense ratio
|
|
|
21.5
|
%
|
|
19.8
|
%
|
|
21.4
|
%
|
|
19.3
|
%
|
Combined
ratio
|
|
|
95.2
|
%
|
|
94.5
|
%
|
|
95.5
|
%
|
|
95.5
|
%
|
The
following table reconciles our personal auto lines underwriting profit to our
consolidated net income:
|
|
Three
Months Ended
|
Six
Months Ended
|
|
|
June
30,
|
June
30,
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
2004
|
2005
|
2004
|
Personal
auto lines underwriting profit
|
|
$
|
16,239
|
|
$
|
18,007
|
|
$
|
30,063
|
|
$
|
28,843
|
|
Homeowner
and earthquake lines in runoff, underwriting loss
|
|
|
(198
|
)
|
|
(168
|
)
|
|
(370
|
)
|
|
(388
|
)
|
Net
investment income
|
|
|
17,006
|
|
|
14,315
|
|
|
34,043
|
|
|
27,461
|
|
Other
income
|
|
|
367
|
|
|
—
|
|
|
367
|
|
|
—
|
|
Realized
investment (losses) gains
|
|
|
(1,267
|
)
|
|
1,337
|
|
|
(1,727
|
)
|
|
8,983
|
|
Interest
and fees expense
|
|
|
(2,031
|
)
|
|
(2,185
|
)
|
|
(4,088
|
)
|
|
(4,411
|
)
|
Provision
for income taxes
|
|
|
(9,621
|
)
|
|
(9,932
|
)
|
|
(18,356
|
)
|
|
(19,289
|
)
|
Net
income
|
|
$
|
20,495
|
|
$
|
21,374
|
|
$
|
39,932
|
|
$
|
41,199
|
|
The
following table reconciles our direct premiums written to net premiums
earned:
|
|
Three
Months Ended
|
Six
Months Ended
|
|
|
June
30,
|
June
30,
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
2004
|
2005
|
2004
|
Direct
premiums written
|
|
$
|
328,669
|
|
$
|
324,750
|
|
$
|
680,786
|
|
$
|
665,343
|
|
Ceded
premiums written
|
|
|
(1,190
|
)
|
|
(1,137
|
)
|
|
(2,366
|
)
|
|
(2,326
|
)
|
Net
premiums written
|
|
|
327,479
|
|
|
323,613
|
|
|
678,420
|
|
|
663,017
|
|
Net
change in unearned premiums
|
|
|
9,363
|
|
|
3,352
|
|
|
(5,217
|
)
|
|
(17,887
|
)
|
Net
premiums earned
|
|
$
|
336,842
|
|
$
|
326,965
|
|
$
|
673,203
|
|
$
|
645,130
|
|
Comments
relating to the underwriting results of the personal auto and the homeowner
and
earthquake lines in runoff are presented below.
Personal
Auto. Personal
automobile insurance is our primary line of business. Vehicles insured outside
of California accounted for 3.3% and 3.0% of our direct premiums written in
the
three and six months ended June 30, 2004, respectively, but increased to 5.9%
and 5.7% for our direct premiums written for the three and six months ended
June
30, 2005, respectively.
Direct
premiums written in the three months ended June 30, 2005, increased $3.9 million
(1.2%) to $328.7 million compared to $324.8 million for the same period in
2004.
This increase was primarily due to a higher number of insured vehicles from
non-California states. Direct premiums written for the six months ended June
30,
2005, increased $15.5 million (2.3%) to $680.8 million, compared to $665.3
million for the same period in 2004, primarily due to a higher number of insured
vehicles from non-California states.
Net
premiums earned increased $9.8 million (3.0%) to $336.8 million for the three
months ended June 30, 2005, compared to $327.0 million for the same period
a
year ago, attributable to the higher number of insured vehicles, as previously
mentioned. Net premiums earned increased $28.1 million (4.4%) to $673.2 million
for the six months ended June 30, 2005, compared to $645.1 million for the
same
period in 2004.
Auto
retention was 92% for the quarter ended June 30, 2005, compared to 92% for
the
three months ended June 30, 2004. Auto retention for the six months ended June
30, 2005, was 93%, compared to 93% for the same period in 2004.
Net
losses and LAE incurred increased $3.8 million (1.5%) to $248.1 million for
the
three months ended June 30, 2005, compared to $244.3 million for the same period
last year. For the six months ended June 30, 2005, net losses and LAE incurred
increased $7.3 million (1.5%) to $498.9 million, compared to $491.6 million
for
the same period in 2004. The second quarter 2005 underwriting profit includes
$11.9 million of favorable development related to prior accident years, compared
to a $0.2 million of reserve strengthening in the same period of 2004. The
six
months ended June 30, 2005 underwriting profit includes $19.6 million of
favorable development related to prior accident years, compared to $0.5 million
of reserve strengthening in the same period of 2004. The effect on the loss
and
LAE ratios of changes in estimates relating to insured events of prior years
during the second quarter of 2005 was approximately 3.6%, compared to 0.0%
in
the same quarter last year. For the six months ended June 30, 2005, the effect
on the loss and LAE ratios of changes in estimates relating to uninsured events
in prior years was 2.9%, compared to 0.0% for the same period in 2004. 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
quarterly actuarial review.
The
ratios of net underwriting expenses to net premiums earned were 21.5% and 19.8%
for the quarters ended June 30, 2005 and 2004, respectively. The ratios of
net
underwriting expenses to net premiums earned were 21.4% and 19.3% for the six
months ended June 30, 2005 and 2004, respectively. The increase was primarily
due to growth in advertising costs, investments in the development of new
markets, costs associated with the conversion to our new technology platform,
and facility and support costs.
The
combined ratio was 95.2% for the quarter ended June 30, 2005, compared to 94.5%
for the same period a year ago. The combined ratios for the six months ended
June 30, 2005 and 2004 were 95.5% and 95.5%, respectively.
Homeowner
and Earthquake Lines in Runoff. Underwriting
results of the homeowner and earthquake lines, which are in runoff, were losses
and LAE incurred of $0.2 million for the three months ended June 30, 2005,
compared to $0.2 million for the same period a year ago. For the six months
ended June 30, 2005 and 2004, losses and LAE for those same lines were $0.4
million and $0.5 million, respectively, of which the earthquake lines accounted
for $0.0 million and $1.0 million, respectively. We have not written any
earthquake policies since 1994 and we exited the homeowners insurance business
at the beginning of 2002. Earthquake LAE incurred was $1.0 million in the first
quarter of 2004, as reserves were increased to provide for additional legal
defense costs expected to be incurred in settling outstanding
claims.
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.
Investment
Income
We
utilize a conservative investment philosophy. No derivatives or nontraditional
securities are held in our investment portfolio and only 3.5% of the portfolio
consists of equity securities. Substantially the entire fixed maturity portfolio
is investment grade. Net investment income was $17.0 million for the three
months ended June 30, 2005 compared to $14.3 million for the same period in
2004. Net
investment income for the six months ended June 30, 2005 and 2004, was $34.0
million and $27.5 million, respectively. The increase in net investment income
is the result of higher average investment balances and higher pre-tax
yields.
At
June
30, 2005, $287.8 million, or 21.0%, of our total fixed maturity investments
at
fair value were invested in tax-exempt bonds with the remainder, representing
79.0% of the portfolio, invested in taxable securities, compared to 22.3% and
77.7%, respectively, at December 31, 2004.
The
average annual yields on invested assets for the three and six months ended
June
30, were as follows:
|
|
Three
Months Ended
|
Six
Months Ended
|
|
|
June
30,
|
June
30,
|
|
|
2005
|
2004
|
2005
|
2004
|
Pre-tax
|
|
|
4.8
|
%
|
|
4.4
|
%
|
|
4.8
|
%
|
|
4.3
|
%
|
After-tax
|
|
|
3.5
|
%
|
|
3.3
|
%
|
|
3.5
|
%
|
|
3.3
|
%
|
Net
realized losses on the sale of investments1
were
$1.3
million (realized gains of $1.9 million and realized losses of $3.2 million)
and
$1.7 million (realized gains were $3.3 million and realized losses were $5.0
million) for the three and six months ended June 30, 2005, compared to a $1.3
million gain (realized gains were $2.3 million and realized losses were $1.0
million) and $9.0 million gain (realized gains were $11.3 million and realized
losses were $2.3 million) for the second quarter and six months ended June
30,
2004. Our policy is to investigate, on a quarterly basis, an investment for
possible “other-than-temporary” impairment in the event the fair value of the
security falls below its amortized cost, based on all relevant facts and
circumstances. No such impairments were recorded in the three and six months
ended June 30, 2005 or 2004.
Other
Revenues
Other
revenue in the second quarter of 2005 included interest income of $0.4 million
relating to a refund claim with the IRS.
Critical
Accounting Estimates
Our
financial statements are prepared in accordance with GAAP. 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 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 financial
statements.
1 Includes
loss on disposal of fixed assets of $187 and $609 in 2005 and 2004,
respectively.
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 LAE include estimates of losses for known
claims reported on or prior to the balance sheet dates, estimates of losses
for
claims incurred but not reported, 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, on average 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. The methods of estimating losses and
establishing the resulting reserves are reviewed and updated monthly and any
resulting adjustments are reflected in current operations.
Changes
in these recorded reserves 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. There have been
no events or circumstances in 2005 that would require a reassessment of any
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.
GAAP requires 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.
At
June
30, 2005, our DTAs totaled $131.7 million and our DTLs totaled $81.7 million.
The net of those amounts, $50.0 million, represents the net deferred tax asset
reported in the condensed 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 thousands):
Year
of
Expiration
|
NOL
Excluding
21st
of the
Southwest
|
SRLY
2 NOL
of
21st
of the
Southwest
|
Consolidated
NOL
|
2017
|
$ —
|
$
1,684
|
$ 1,684
|
2018
|
—
|
1,068
|
1,068
|
2019
|
—
|
1,466
|
1,466
|
2020
|
—
|
3,172
|
3,172
|
2021
|
106,876
|
2,180
|
109,056
|
2022
|
37,316
|
—
|
37,316
|
Totals
|
$
144,192
|
$
9,570
|
$
153,762
|
Our
auto
business has generated an underwriting profit for the past fourteen quarters.
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 June 30, 2005. 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 reach a different
conclusion about the realization of the DTAs and, if so, recognize a valuation
allowance at that time.
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 dividends-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 allowed 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 of 2004, which
reduced the effective tax rate for 2004. In the first quarter of 2005, the
Company filed amended California tax returns and paid the State of California
approximately $6.8 million to cover all issues outstanding with the FTB,
including certain matters paid under protest as to which the Company has
reserved all its rights to file for refunds and appeal any adverse rulings
the
FTB may make in the course of finalizing its audit.
2 “SRLY”
stands for Separate Return Limitation Year. Under the Federal tax code, only
future income generated by 21st Century Insurance Company of the Southwest
(“21st of the Southwest”) (formerly 21st Century Insurance Company of Arizona)
may be utilized against this portion of our NOL.
Deferred
Policy Acquisition Costs.
Deferred policy acquisition costs (“DPAC”) primarily include premium taxes,
advertising, 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.
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 a matter of
subjective judgment. No such charges were recorded in the three or six months
ended June 30, 2005 and 2004. 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 fixed maturity
securities and unrated securities held at June 30, 2005 and December 31, 2004
(at fair value):
|
|
June
30,
|
December
31,
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
2004
|
Non-investment
grade securities (i.e., rated below BBB):
|
|
|
|
|
|
Cox
Communications, Inc.
|
|
$
|
2,238
|
|
$
|
2,240
|
|
Ford
Motor Credit Company
|
|
|
|
|
|
4,615
|
|
General
Motors Acceptance Corp
|
|
|
|
|
|
5,643
|
|
News
America, Inc.
|
|
|
1,627
|
|
|
|
|
Xcel
Energy, Inc.
|
|
|
2,924
|
|
|
|
|
Unrated
securities:
|
|
|
|
|
|
|
|
Impact
Community Capital LLC3
|
|
|
2,024
|
|
|
2,023
|
|
Impact
C.I.L. Parent
|
|
|
4,977
|
|
|
5,111
|
|
Total
non-investment grade and unrated securities4
|
|
$
|
13,790
|
|
$
|
19,632
|
|
3 Impact
Community Capital LLC is a limited liability corporation that was voluntarily
established by a group of California insurers to provide funding for low-income
communities.
4
The
total net unrealized (loss) gain for these securities as of June 30, 2005
and
December 31, 2004 was $0.1 million and $0.4 million,
respectively.
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 as of June 30, 2005 and December 31,
2004:
|
|
June
30, 2005
|
December
31, 2004
|
AMOUNTS
IN THOUSANDS,
EXCEPT
NUMBER OF ISSUES
|
|
#
issues
|
|
Carrying
Value
|
|
Unrealized
Loss
|
|
#
issues
|
|
Carrying
Value
|
|
Unrealized
Loss
|
|
Investments
with unrealized losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding
$0.1 million and for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
than 6 months
|
|
|
2
|
|
$
|
13,536
|
|
$
|
370
|
|
|
7
|
|
$
|
88,258
|
|
$
|
1,045
|
|
6-12
months
|
|
|
1
|
|
|
9,775
|
|
|
150
|
|
|
15
|
|
|
154,284
|
|
|
3,415
|
|
More
than 1 year
|
|
|
15
|
|
|
170,339
|
|
|
2,615
|
|
|
2
|
|
|
4,765
|
|
|
326
|
|
Less
than $0.1 million
|
|
|
112
|
|
|
401,075
|
|
|
2,519
|
|
|
91
|
|
|
306,984
|
|
|
2,387
|
|
Total
fixed maturity securities with unrealized losses
|
|
|
130
|
|
|
594,725
|
|
|
5,654
|
|
|
115
|
|
|
554,291
|
|
|
7,173
|
|
Equity
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding
$0.1 million and for less than 6 months:
|
|
|
2
|
|
|
368
|
|
|
349
|
|
|
|
|
|
|
|
|
|
|
Less
than $0.1 million
|
|
|
148
|
|
|
25,386
|
|
|
543
|
|
|
64
|
|
|
15,479
|
|
|
293
|
|
Total
equity securities with unrealized
losses
|
|
|
150
|
|
|
25,754
|
|
|
892
|
|
|
64
|
|
|
15,479
|
|
|
293
|
|
Total
investments with unrealized losses
5
|
|
|
280
|
|
$
|
620,479
|
|
$
|
6,546
|
|
|
179
|
|
$
|
569,770
|
|
$
|
7,466
|
|
A
summary
by contractual maturity of fixed maturity securities in an unrealized loss
position by year of maturity follows:
|
|
June
30, 2005
|
|
December
31, 2004
|
|
AMOUNTS
IN THOUSANDS
|
|
Amortized
Cost
|
|
Carrying
Value
|
|
Unrealized
Loss
|
|
Amortized
Cost
|
|
Carrying
Value
|
|
Unrealized
Loss
|
|
Fixed
maturity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due
in one year or less
|
|
$
|
4,737
|
|
$
|
4,716
|
|
$
|
21
|
|
$
|
9,778
|
|
$
|
9,738
|
|
$
|
40
|
|
Due
after one year through five years
|
|
|
84,931
|
|
|
84,029
|
|
|
902
|
|
|
26,537
|
|
|
26,073
|
|
|
464
|
|
Due
after five years through ten years
|
|
|
328,442
|
|
|
324,651
|
|
|
3,791
|
|
|
318,644
|
|
|
314,898
|
|
|
3,746
|
|
Due
after ten years
|
|
|
182,269
|
|
|
181,329
|
|
|
940
|
|
|
206,505
|
|
|
203,582
|
|
|
2,923
|
|
Total
fixed maturity securities with unrealized losses
|
|
$
|
600,379
|
|
$
|
594,725
|
|
$
|
5,654
|
|
$
|
561,464
|
|
$
|
554,291
|
|
$
|
7,173
|
|
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 proforma 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
compensation cost for the Company’s stock-based compensation plans been
determined based on the fair value based method for of all awards, is included
in Note 1 of the Notes to Condensed Consolidated Financial
Statements.
5 Unrealized
losses represent 1.1% and 1.3% of the total carrying value of investments
with
unrealized losses at June 30, 2005 and December 31, 2004,
respectively.
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. You should not rely on
forward-looking statements in this quarterly report on Form 10-Q.
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. Other 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 experience 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 Southern California;
|
|
·
|
Information
system problems, including failures to implement information technology
projects on time and within budget;
|
|
·
|
Control
environment failures;
|
|
·
|
Adverse
developments in financial markets or interest rates;
|
|
·
|
Results
of legislative, regulatory or legal actions, including the inability
to
obtain approval for necessary licenses, rate increases and product
changes
and possible adverse actions taken by state regulators in market
conduct
examinations; and
|
|
·
|
Our
ability to service our debt, 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.
|
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 June 30, 2005,
comprised 96.5% of the fair value of the Company’s total investments. The
remainder of the Company’s investments, representing approximately 3.5% 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. 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 5.4 years as of December 31, 2004 to 5.0 years at June 30,
2005.
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 amortized cost. 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:
DOLLAR
AMOUNTS IN MILLIONS
June
30, 2005
|
|
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, at fair value
|
|
$
|
1,369.6
|
|
$
|
1,273.1
|
|
|
(7.05
|
%)
|
Debt
|
|
|
134.2
|
|
|
141.8
|
|
|
5.66
|
%
|
The
equity securities portfolio, which represents approximately 3.5% of total
investments at market value, consists primarily of financial services,
industrial, and miscellaneous stocks. Beta is a measure of a security’s
systematic (non-diversifiable) risk, which is the percentage change in an
individual security’s price for a 1% change in the return of the market. The
average Beta for the Company’s common stock holdings was 0.57.
The
following table presents the financial statement carrying value of our equity
securities 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 portfolio:
DOLLAR
AMOUNTS IN MILLIONS
June
30, 2005
|
|
Carrying
Value
|
Estimated
Carrying
Value
at Hypothetical
20%
Reduction in
Overall
Value of
Stock
Market
|
Change
in Value
as
a Percentage
of
Carrying
Value
|
Equity
securities available for sale
|
|
$
|
49.1
|
|
$
|
43.5
|
|
|
(11.4
|
%)
|
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.
We
have
established disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated subsidiaries,
is
communicated to our management, including the Chief Executive Officer and Chief
Financial Officer, to allow timely decisions regarding required
disclosure.
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 June 30, 2005, 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.
Management,
with the participation of the Chief Executive Officer and Chief Financial
Officer, has evaluated any changes in 21st Century Insurance Group’s internal
control over financial reporting that occurred during the most recent fiscal
quarter. Based on the evaluation, management, including the Chief Executive
Officer and Chief Financial Officer, have concluded that no change in our
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Securities Exchange Act of 1934) occurred during the quarter ended June
30,
2005 that has materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.
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 3 of the Notes to Condensed Consolidated
Financial Statements.
|
UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
|
None.
|
DEFAULTS
UPON SENIOR SECURITIES
|
None.
|
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
The
annual meeting of shareholders occurred on May 25, 2005, in which the following
individuals were elected as directors: Steven
J.
Bensinger, John
B.
De Nault, III, Carlene M. Ellis, R. Scott Foster, M.D., Roxani M. Gillespie,
Jeffrey L. Hayman, Phillip L. Isenberg, Bruce W. Marlow, James P. Miscoll,
Keith
W. Renken and Robert M. Sandler. The shareholders also ratified the appointment
of PricewaterhouseCoopers LLP as the Company’s independent registered
public accounting firm for 2005.
The
shareholders voted as follows:
Proposals
|
For
|
Against
|
Withhold
or
Abstain
|
|
|
|
|
Election
of Directors
|
|
|
|
S.
J. Bensinger
|
69,474,704
|
7,622,565
|
|
J.
B. De Nault, III
|
76,565,429
|
537,840
|
|
C.
M. Ellis
|
71,036,705
|
6,066,564
|
|
R.
S. Foster, M.D.
|
71,037,014
|
6,066,255
|
|
R.
M. Gillespie
|
68,470,687
|
8,632,582
|
|
J.
L. Hayman
|
70,026,192
|
7,077,077
|
|
P.
L. Isenberg
|
71,788,807
|
5,314,462
|
|
B.
W. Marlow
|
69,679,225
|
7,424,044
|
|
J.
P. Miscoll
|
68,984,546
|
8,118,723
|
|
K.
W. Renken
|
71,817,685
|
5,285,584
|
|
R.
M. Sandler
|
68,735,030
|
8,368,239
|
|
|
|
|
|
Appointment
of PricewaterhouseCoopers LLP
|
76,212,591
|
817,453
|
73,223
|
|
|
|
|
None.
See
accompanying exhibit index.
Pursuant
to the requirements of the Securities and Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
|
|
21ST
CENTURY INSURANCE GROUP
|
|
|
(Registrant)
|
|
|
|
|
|
|
|
|
|
Date:
|
July
21, 2005
|
|
/s/
Bruce W. Marlow
|
|
|
BRUCE
W. MARLOW
|
|
|
President
and Chief Executive Officer
|
|
|
|
|
|
|
|
|
|
Date:
|
July
21, 2005
|
|
/s/
Lawrence P. Bascom
|
|
|
LAWRENCE
P. BASCOM
|
|
|
Sr.
Vice President and Chief Financial
Officer
|
|
|
Certification
of President and Chief Executive Officer Pursuant to Exchange Act
Rule
13a-14(a).
|
|
|
Certification
of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a).
|
|
|
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002.
|
34