21st Century Insurance 10-Q 10-19-2005
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 September 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 October 14, 2005
was 85,835,838.
TABLE
OF CONTENTS
Description
|
|
Page
Number
|
PART
I - FINANCIAL INFORMATION
|
|
Item
1.
|
|
2
|
Item
2.
|
|
16
|
Item
3.
|
|
31
|
Item
4.
|
|
32
|
PART
II - OTHER INFORMATION
|
|
Item
1.
|
|
33
|
Item
2.
|
|
33
|
Item
3.
|
|
33
|
Item
4.
|
|
33
|
Item
5.
|
|
33
|
Item
6.
|
|
33
|
|
|
34
|
EXHIBIT
INDEX
|
35
|
31.1
Certification of President and Chief Executive
Officer
|
|
31.2
Certification of Chief Financial Officer
|
|
32.1
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to
Section
906 of the Sarbanes-Oxley Act of 2002
|
|
PART
I -
FINANCIAL
INFORMATION
ITEM 1. |
FINANCIAL
STATEMENTS
|
21ST
CENTURY INSURANCE GROUP
|
|
|
|
|
|
CONDENSED
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
Unaudited
|
|
|
|
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
|
|
Assets
|
|
|
|
|
|
Fixed
maturity investments available-for-sale, at fair value (amortized
cost:
$1,351,416 and $1,320,592)
|
|
$
|
1,350,411
|
|
$
|
1,342,130
|
|
Equity
securities available-for-sale, at fair value (cost: $47,059 and
$41,450)
|
|
|
46,380
|
|
|
42,085
|
|
Total
investments
|
|
|
1,396,791
|
|
|
1,384,215
|
|
Cash
and cash equivalents
|
|
|
65,264
|
|
|
34,697
|
|
Accrued
investment income
|
|
|
16,183
|
|
|
16,161
|
|
Premiums
receivable
|
|
|
116,980
|
|
|
105,814
|
|
Reinsurance
receivables and recoverables
|
|
|
5,914
|
|
|
7,160
|
|
Prepaid
reinsurance premiums
|
|
|
1,870
|
|
|
1,787
|
|
Deferred
income taxes
|
|
|
53,798
|
|
|
56,135
|
|
Deferred
policy acquisition costs
|
|
|
63,760
|
|
|
58,759
|
|
Leased
property under capital lease, net of deferred gain of $1,929
and $3,116
and net of accumulated amortization of $33,802 and $24,794
|
|
|
25,339
|
|
|
31,719
|
|
Property
and equipment, at cost less accumulated depreciation of $83,687
and
$68,529
|
|
|
145,841
|
|
|
129,372
|
|
Other
assets
|
|
|
29,930
|
|
|
38,495
|
|
Total
assets
|
|
$
|
1,921,670
|
|
$
|
1,864,314
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
Unpaid
losses and loss adjustment expenses
|
|
$
|
517,614
|
|
$
|
495,542
|
|
Unearned
premiums
|
|
|
340,055
|
|
|
331,036
|
|
Debt
|
|
|
131,095
|
|
|
138,290
|
|
Claims
checks payable
|
|
|
40,711
|
|
|
38,737
|
|
Reinsurance
payable
|
|
|
663
|
|
|
633
|
|
Other
liabilities
|
|
|
78,514
|
|
|
85,675
|
|
Total
liabilities
|
|
|
1,108,652
|
|
|
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 85,835,038 and 85,489,061
|
|
|
86
|
|
|
85
|
|
Additional
paid-in capital
|
|
|
423,795
|
|
|
420,425
|
|
Retained
earnings
|
|
|
391,949
|
|
|
341,196
|
|
Accumulated
other comprehensive (loss) income:
|
|
|
|
|
|
|
|
Net
unrealized (losses) gains on available-for-sale investments,
net of
deferred income taxes of $(589) and $7,760
|
|
|
(1,095
|
|
|
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
|
|
|
813,018
|
|
|
774,401
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
1,921,670
|
|
$
|
1,864,314
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements.
21ST
CENTURY INSURANCE GROUP
|
|
|
|
|
|
|
|
|
|
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
Unaudited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
2005
|
2004
|
2005
|
2004
|
Revenues
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
344,102
|
|
$
|
333,440
|
|
$
|
1,017,311
|
|
$
|
978,681
|
|
Net
investment income
|
|
|
17,042
|
|
|
15,118
|
|
|
51,085
|
|
|
42,579
|
|
Other
(loss) income
|
|
|
(3
|
)
|
|
—
|
|
|
364
|
|
|
—
|
|
Net
realized investment (losses) gains
|
|
|
(939
|
)
|
|
(162
|
)
|
|
(2,666
|
)
|
|
8,821
|
|
Total
revenues
|
|
|
360,202
|
|
|
348,396
|
|
|
1,066,094
|
|
|
1,030,081
|
|
Losses
and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
losses and loss adjustment expenses
|
|
|
258,105
|
|
|
252,359
|
|
|
757,420
|
|
|
744,429
|
|
Policy
acquisition costs
|
|
|
60,852
|
|
|
55,866
|
|
|
188,931
|
|
|
164,338
|
|
Other
operating expenses
|
|
|
8,786
|
|
|
8,942
|
|
|
24,908
|
|
|
25,186
|
|
Interest
and fees expense
|
|
|
1,988
|
|
|
2,116
|
|
|
6,076
|
|
|
6,527
|
|
Total
losses and expenses
|
|
|
329,731
|
|
|
319,283
|
|
|
977,335
|
|
|
940,480
|
|
Income
before provision for income taxes
|
|
|
30,471
|
|
|
29,113
|
|
|
88,759
|
|
|
89,601
|
|
Provision
for income taxes
|
|
|
9,369
|
|
|
4,554
|
|
|
27,725
|
|
|
23,843
|
|
Net
income
|
|
$
|
21,102
|
|
$
|
24,559
|
|
$
|
61,034
|
|
$
|
65,758
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.25
|
|
$
|
0.29
|
|
$
|
0.71
|
|
$
|
0.77
|
|
Diluted
|
|
$
|
0.24
|
|
$
|
0.29
|
|
$
|
0.71
|
|
$
|
0.77
|
|
Weighted
average shares outstanding ¾
basic
|
|
|
85,793,904
|
|
|
85,473,603
|
|
|
85,672,993
|
|
|
85,459,383
|
|
Weighted
average shares outstanding ¾
diluted
|
|
|
86,205,599
|
|
|
85,579,863
|
|
|
85,937,816
|
|
|
85,603,010
|
|
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 (loss)
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
61,034
|
(1)
|
|
(15,507
|
|
|
|
45,527
|
|
Cash
dividends declared on common stock ($0.12 per share)
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
(10,281
|
)
|
|
—
|
|
|
|
(10,281
|
)
|
Other
|
|
|
345,977
|
|
|
|
1
|
|
|
3,370
|
|
|
—
|
|
|
—
|
|
|
|
3,371
|
|
Balance
- September 30, 2005
|
|
|
85,835,038
|
|
|
$
|
86
|
|
$
|
423,795
|
|
$
|
391,949
|
|
$
|
(2,812
|
|
|
$
|
813,018
|
|
(1) Net
income.
(2) Net
change in accumulated other comprehensive income (loss) for the nine months
ended September 30, 2005, is
as
follows:
AMOUNTS
IN THOUSANDS
|
|
|
|
Unrealized
holding losses arising during the period, net of deferred income
taxes of
$7,483
|
|
$
|
(13,899
|
)
|
Reclassification
adjustment for investment losses included in net income, net
of income
taxes of $866
|
|
|
(1,608
|
)
|
Total
|
|
$
|
(15,507
|
)
|
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
|
|
|
|
|
|
Nine
Months Ended September 30,
|
|
2005
|
2004
|
Operating
activities
|
|
|
|
|
|
Net
income
|
|
$
|
61,034
|
|
$
|
65,758
|
|
Adjustments
to reconcile net income to net cash
|
|
|
|
|
|
|
|
provided
by operating activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
24,502
|
|
|
16,182
|
|
Net
amortization of investment premiums and discounts
|
|
|
7,205
|
|
|
4,865
|
|
Amortization
of restricted stock grants
|
|
|
238
|
|
|
297
|
|
Provision
for deferred income taxes
|
|
|
10,687
|
|
|
18,781
|
|
Realized
losses (gains) on sale of investments
|
|
|
2,779
|
|
|
(8,738
|
)
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
Premiums
receivable
|
|
|
(11,166
|
)
|
|
(12,390
|
)
|
Deferred
policy acquisition costs
|
|
|
(5,001
|
)
|
|
(5,824
|
)
|
Reinsurance
balances
|
|
|
1,193
|
|
|
4,009
|
|
Federal
income taxes
|
|
|
(1,088
|
)
|
|
697
|
|
Other
assets
|
|
|
6,723
|
|
|
(110
|
)
|
Unpaid
losses and loss adjustment expenses
|
|
|
22,072
|
|
|
47,757
|
|
Unearned
premiums
|
|
|
9,019
|
|
|
29,215
|
|
Claims
checks payable
|
|
|
1,974
|
|
|
(5,560
|
)
|
Other
liabilities
|
|
|
(7,802
|
)
|
|
14,272
|
|
Net
cash provided by operating activities
|
|
|
122,369
|
|
|
169,211
|
|
Investing
activities
|
|
|
|
|
|
|
|
Investments
available-for-sale
|
|
|
|
|
|
|
|
Purchases
|
|
|
(333,513
|
)
|
|
(809,793
|
)
|
Calls
or maturities
|
|
|
24,461
|
|
|
29,847
|
|
Sales
|
|
|
262,827
|
|
|
623,157
|
|
Purchases
of property and equipment
|
|
|
(32,539
|
)
|
|
(29,567
|
)
|
Net
cash used in investing activities
|
|
|
(78,764
|
)
|
|
(186,356
|
)
|
Financing
activities
|
|
|
|
|
|
|
|
Repayment
of debt
|
|
|
(9,343
|
)
|
|
(8,495
|
)
|
Dividends
paid (per share: $0.08 and $0.06)
|
|
|
(6,850
|
)
|
|
(5,126
|
)
|
Proceeds
from the exercise of stock options
|
|
|
3,155
|
|
|
510
|
|
Net
cash used in financing activities
|
|
|
(13,038
|
)
|
|
(13,111
|
)
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
30,567
|
|
|
(30,256
|
)
|
Cash
and cash equivalents, beginning of period
|
|
|
34,697
|
|
|
65,010
|
|
Cash
and cash equivalents, end of period
|
|
$
|
65,264
|
|
$
|
34,754
|
|
|
|
|
|
|
|
|
|
Supplemental
information:
|
|
|
|
|
|
|
|
Income
taxes paid (refunded)
|
|
$
|
19,281
|
|
$
|
(474
|
)
|
Interest
paid
|
|
|
4,495
|
|
|
5,072
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
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 nine-month period ended September
30,
2005 are not necessarily indicative of results that may be expected for
the
remaining interim period or the year as a whole.
Earnings
Per Share
For
each
of the quarters and nine months ended September 30, 2005 and 2004, the
numerator
for the calculation of both basic and diluted earnings per 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 4,501,547 and 6,395,088 shares of common stock
for
the three and nine months ended September 30, 2005, respectively, and 6,568,759
and 6,091,424 shares of common stock for the three and nine months ended
September 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 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
September
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. The Company records forfeitures
of restricted stock as treasury share repurchases and any compensation
cost
previously recognized with respect to unvested stock awards is reversed
in the
period of forfeiture. This accounting treatment results in compensation
expense
being recorded in a manner consistent with that required under SFAS No.
123, and
therefore, pro forma net income and earnings per share amounts for the
Restricted Share Plan would be unchanged from those reported in the financial
statements.
Had
compensation cost for the Company’s stock-based compensation plans been
determined based on the fair-value-based method for all awards, net income
would
have been reduced by $1.2 million and $3.7 million for the three and nine
months
ended September 30, 2005, respectively, and reduced by $1.3 million and
$4.5
million for the three and nine months ended September 30, 2004, respectively.
The pro forma net income and earnings per share amounts follow:
|
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
2005
|
2004
|
2005
|
2004
|
Net
income, as reported
|
|
$
|
21,102
|
|
$
|
24,559
|
|
$
|
61,034
|
|
$
|
65,758
|
|
Add:
Stock-based employee compensation expense included in reported
net income,
net of related tax effects
|
|
|
65
|
|
|
66
|
|
|
155
|
|
|
196
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deduct:
Total stock-based employee compensation expense determined under
fair-value-based method for all awards, net of related tax
effects
|
|
|
(1,278
|
)
|
|
(1,401
|
)
|
|
(3,844
|
)
|
|
(4,681
|
)
|
Net
income, pro forma
|
|
$
|
19,889
|
|
$
|
23,224
|
|
$
|
57,345
|
|
$
|
61,273
|
|
Basic
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
0.25
|
|
$
|
0.29
|
|
$
|
0.71
|
|
$
|
0.77
|
|
Pro
forma
|
|
$
|
0.23
|
|
$
|
0.27
|
|
$
|
0.67
|
|
$
|
0.72
|
|
Diluted
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
0.24
|
|
$
|
0.29
|
|
$
|
0.71
|
|
$
|
0.77
|
|
Pro
forma
|
|
$
|
0.23
|
|
$
|
0.27
|
|
$
|
0.67
|
|
$
|
0.72
|
|
For
pro
forma disclosure purposes, the fair value of stock options was estimated
for
grants during the nine-month periods ended September 30 using the Black-Scholes
valuation model with the following weighted-average assumptions:
|
|
Nine
Months Ended
September
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
September
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Recent
Accounting Standards
In
March 2005, the Securities and 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 of 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 that the effect of adopting SFAS No. 123R will be material
to the Company’s consolidated results of operations. Had the Company adopted
SFAS No. 123R in prior periods, the impact on net income and earnings per
share
would have been similar to the pro forma net income and earnings per share
in
accordance with SFAS No. 123 as disclosed earlier in this note.
NOTE
2. PROPERTY AND EQUIPMENT
A
summary
of property and equipment follows:
|
|
|
|
Land
|
|
$
|
2,484
|
|
$
|
—
|
|
Building
|
|
|
9,722
|
|
|
—
|
|
Furniture
and equipment
|
|
|
40,731
|
|
|
38,676
|
|
Automobiles
|
|
|
339
|
|
|
881
|
|
Leasehold
improvements
|
|
|
14,494
|
|
|
14,245
|
|
Software
currently in service
|
|
|
152,926
|
|
|
87,283
|
|
Software
development projects in progress
|
|
|
8,832
|
|
|
56,816
|
|
Subtotal
|
|
|
229,528
|
|
|
197,901
|
|
Less
accumulated depreciation, including $38,750 and $25,506 for software
currently in service
|
|
|
(83,687
|
)
|
|
(68,529
|
)
|
Total
|
|
$
|
145,841
|
|
$
|
129,372
|
|
On
September 30, 2005, the Company purchased the land and building that house
its
136 thousand square foot service center in Texas. The Company had been
leasing
this property since June 2004. The operating lease provisions included
a rent
holiday through June 2005 and a $2.5 million tenant improvement allowance.
As of
September 29, 2005, the accrued rent obligation and tenant improvement
allowance
totaled $1.4 million and $2.5 million, respectively. These liabilities
were
offset against the facility cash purchase price of $17.6 million to arrive
at a
net cost of $13.7 million. The net cost consists of land, building and
building
equipment of $2.5 million, $9.7 million, and $1.5 million, respectively.
The
building and its equipment have been assigned useful lives of 39.5 years
and 7
years, respectively, and will be depreciated on a straight-line basis over
their
respective useful lives.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
3. HOMEOWNER AND EARTHQUAKE LINES IN RUNOFF
More
than
ninety-eight percent of the claims submitted and litigation brought against
the
Company as a result of California Senate Bill 1899 (“SB 1899”) have been
resolved. All of the Company’s remaining Northridge 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 Northridge 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.
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 was based on the pace and cost of settlements reached as of that
point,
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
September 30, 2005, was $1.0 million.
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 California Supreme Court
denied the Company’s request for review of this decision.
Loss
and
loss adjustment expenses incurred for the homeowner and earthquake lines
in
runoff were $0.6 million and $1.0 million for
the
three and nine months ended September 30, 2005, respectively, compared
to $0.4
million and $0.9 million for the same periods in 2004.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
4.
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 Sec. 17200 for alleged unfair business practices in violation
of California Insurance Code 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, but allowed the
addition of a second plaintiff, Leacy. The court 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.
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, a homeowner policyholder, 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 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 began October 12, 2005 on his claims for bad faith,
emotional distress, punitive damages and attorney fees. The Company believes
it
has meritorious defenses to these claims. The Company’s exposure in this case
includes the aforementioned $10.5 million judgment, post-judgment interest,
plaintiff’s attorney fees (which could approach $4 million) and any award for
bad faith, emotional distress and punitive damages.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Insurance
Company cases (Ramona Goldenburg)
was
originally filed as Bryan
Speck, individually, and on behalf of others similarly situated v. 21st
Century
Insurance Company, 21st Century Casualty Company, and 21st Century Insurance
Group.
The
original action 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.
NOTE
5.
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
September 30, 2005, 4,170,209 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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
A
summary
of securities issuable and issued for the Company’s stock option plans and the
Restricted Shares Plan at September 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
|
|
|
(784
|
)
|
|
—
|
|
|
(1,144
|
)
|
Number
of securities issuable upon the exercise of all outstanding
options
|
|
|
(7,152
|
)
|
|
(1,894
|
)
|
|
—
|
|
Number
of securities forfeited
|
|
|
(2,350
|
)
|
|
—
|
|
|
—
|
|
Number
of forfeited securities returned to plan
|
|
|
2,350
|
|
|
—
|
|
|
159
|
|
Unused
options assumed by 2004 Stock Option Plan
|
|
|
(2,064
|
)
|
|
2,064
|
|
|
—
|
|
Number
of securities remaining available for future grants under each
plan
|
|
|
—
|
|
|
4,170
|
|
|
437
|
|
Exercise
prices for options outstanding at September 30, 2005, ranged from $11.68
to
$29.25. The weighted-average remaining contractual life of those options
is 6.7
years.
A
summary
of the Company’s stock option activity for the nine months ended September 30,
2005, and related information follows:
AMOUNTS
IN THOUSANDS, EXCEPT PRICE DATA
|
|
|
Weighted-Average
Exercise
Price
|
Options
outstanding December 31, 2004
|
|
|
8,109
|
|
$
|
16.49
|
|
Granted
in 2005
|
|
|
1,725
|
|
|
14.19
|
|
Exercised
in 2005
|
|
|
(259
|
)
|
|
14.47
|
|
Forfeited
in 2005
|
|
|
(529
|
)
|
|
14.89
|
|
Options
outstanding September 30, 2005
|
|
|
9,046
|
|
|
16.20
|
|
Of
the
9,046,092 and 8,108,558 in options outstanding at September 30, 2005 and
December 31, 2004, respectively, 5,901,196
and
5,068,493 options were exercisable as of September 30, 2005 and December
31,
2004, respectively. The remaining 3,144,896 and 3,040,065 options outstanding
as
of September 30, 2005 and December 31, 2004, respectively, were not yet
vested.
NOTE
6.
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.
21ST
CENTURY INSURANCE
GROUP
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Components
of Net Periodic Cost
Net
pension costs for all plans were comprised of the following:
|
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
|
|
2005
|
2004
|
2005
|
2004
|
Service
cost
|
|
$
|
1,620
|
|
$
|
1,891
|
|
$
|
5,145
|
|
$
|
4,870
|
|
Interest
cost
|
|
|
1,763
|
|
|
1,758
|
|
|
5,473
|
|
|
4,979
|
|
Expected
return on plan assets
|
|
|
(1,827
|
)
|
|
(1,608
|
)
|
|
(5,487
|
)
|
|
(4,831
|
)
|
Amortization
of prior service cost
|
|
|
78
|
|
|
29
|
|
|
131
|
|
|
81
|
|
Amortization
of net loss
|
|
|
428
|
|
|
635
|
|
|
1,442
|
|
|
1,624
|
|
Total
|
|
$
|
2,062
|
|
$
|
2,705
|
|
$
|
6,704
|
|
$
|
6,723
|
|
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 September 30, 2005, no contributions have
been made. After consideration of currently available information, the Company
anticipates that it may make a cash contribution between $6.0 million and $14.0
million to its qualified defined benefit pension plan before the end of 2005.
The amount and timing of future contributions to the Company’s qualified defined
benefit pension plan depends on a number of unpredictable factors including
the
market performance of the plan’s assets and future changes in interest rates
that affect the actuarial measurement of the plan’s obligations.
Contributions
to the Company’s 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
7. 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 California. 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 for plan years
beyond 2004, but continues to participate in prior plan year activity, which
is
in runoff.
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
September
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
Runoff1
|
Total
|
Three
Months Ended September 30, 2005
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
344,099
|
|
$
|
3
|
|
$
|
344,102
|
|
Depreciation
and amortization expense
|
|
|
9,504
|
|
|
3
|
|
|
9,507
|
|
Segment
profit (loss)
|
|
|
16,972
|
|
|
(613
|
)
|
|
16,359
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended September 30, 2004
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
333,443
|
|
$
|
(3
|
)
|
$
|
333,440
|
|
Depreciation
and amortization expense
|
|
|
5,493
|
|
|
7
|
|
|
5,500
|
|
Segment
profit (loss)
|
|
|
16,709
|
|
|
(436
|
)
|
|
16,273
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
Months Ended September 30, 2005
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
1,017,302
|
|
$
|
9
|
|
$
|
1,017,311
|
|
Depreciation
and amortization expense
|
|
|
24,495
|
|
|
7
|
|
|
24,502
|
|
Segment
profit (loss)
|
|
|
47,035
|
|
|
(983
|
)
|
|
46,052
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
Months Ended September 30, 2004
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
978,573
|
|
$
|
108
|
|
$
|
978,681
|
|
Depreciation
and amortization expense
|
|
|
16,104
|
|
|
78
|
|
|
16,182
|
|
Segment
profit (loss)
|
|
|
45,552
|
|
|
(824
|
)
|
|
44,728
|
|
The
following table reconciles segment profit to consolidated income before
provision for income taxes:
|
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
|
|
2005
|
2004
|
2005
|
2004
|
Segment
profit
|
|
$
|
16,359
|
|
$
|
16,273
|
|
$
|
46,052
|
|
$
|
44,728
|
|
Net
investment income
|
|
|
17,042
|
|
|
15,118
|
|
|
51,085
|
|
|
42,579
|
|
Other
(loss) income
|
|
|
(3
|
)
|
|
—
|
|
|
364
|
|
|
—
|
|
Realized
investment (losses) gains
|
|
|
(939
|
)
|
|
(162
|
)
|
|
(2,666
|
)
|
|
8,821
|
|
Interest
and fees expense
|
|
|
(1,988
|
)
|
|
(2,116
|
)
|
|
(6,076
|
)
|
|
(6,527
|
)
|
Income
before provision for income taxes
|
|
$
|
30,471
|
|
$
|
29,113
|
|
$
|
88,759
|
|
$
|
89,601
|
|
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
September
30, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
8. VARIABLE INTEREST ENTITIES
In
January 2003, the Financial Accounting Standards Board (“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. The
Company’s Board of Directors has chosen to invest some of its assets in low
income and economically disadvantaged communities. To that end, the Company
is a
member, along with other participating insurance organizations, of Impact
Community Capital, LLC (“Impact”). Impact’s charter is to make loans and other
investments in such communities. On August 29, 2003, the Company funded a
revolving loan agreement with Impact C.I.L., LLC (“Impact C.I.L.”), a subsidiary
of Impact and 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. The Company’s maximum participation
in Impact C.I.L. is for up to 11.1% ($24.0 million) of $216.0 million of the
entity’s funding activities. These commitments consist of a $4.8 million minimum
investment and a $19.2 million guarantee of the warehouse lending facility.
Potential losses are limited to the Company’s participation as well as
associated operating fees.
At
present, the Company also has a $2.0 million note receivable from an Impact
subsidiary in addition to the $5.0 million investment noted above. The Company
has voting rights, beneficiary rights, obligations, and ownership of Impact
in
proportion to its investment (approximately 10%).
The
Company has also committed $2.8 million to three other Impact affiliates managed
by Impact, and owned by Impact members, for other community investment purposes.
An advance of $0.5 million to one of the programs was made in September 2005.
However, such funds have not been invested as of September 30, 2005. The Company
has voting rights, beneficiary rights and obligations for these Impact
affiliates.
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 (together with its subsidiaries, referred
to hereinafter as the “Company”, “we”, “us” or “our”) 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 or lower and
15% annual growth in premiums written in our personal auto lines. Third quarter
2005 direct premiums written increased 0.9% ($3.1 million) to $349.1 million
from $346.0 million in the third quarter of 2004. California direct premiums
written decreased by 2.2% to $326.0 million, compared to $333.3 million for
the
same period in 2004, as a result of the high level of competitor marketing
activity in the state. Direct premiums written outside of California increased
by 81.9% to $23.1 million, compared to $12.7 million for the same period in
2004. The Company currently plans on expanding into six additional states in
2006 to further its geographic expansion strategy.
Underwriting
profit of $16.4 million in the third quarter of 2005 was consistent with the
$16.3 million for the same period in 2004. The third quarter 2005 underwriting
profit includes $1.2 million of favorable development related to prior accident
years’ reserves, compared to $3.4 million of favorable development related to
prior accident years’ reserves in the same period of 2004. For the nine months
ended September 30, 2005, underwriting profit was $46.1 million, an increase
of
3.0% over underwriting profit of $44.7 million for same period in 2004. The
nine
months ended September 30, 2005 underwriting profit includes $20.8 million
of
favorable development related to prior accident years’ reserves, compared to
$2.9 million of favorable development related to prior accident years’ reserves
in the same period of 2004.
The
combined ratio of 95.2% for the quarter ended September 30, 2005, was consistent
with the 95.1% ratio for the same period in 2004. For the nine months ended
September 30, 2005, the combined ratio was 95.5%, compared to 95.4% in
2004.
Net
income for the quarter ended September 30, 2005, was $21.1 million, or $0.25
per
basic share, compared to net income of $24.6
million,
or $0.29 per basic share, for the same period in 2004. The third quarter results
include net realized capital losses of $0.9 million and $0.2 million in 2005
and
2004, respectively. For the nine months ended September 30, 2005, net income
was
$61.0 million, or $0.71 per share, compared to $65.8 million, or $0.77 per
share, for the same period in 2004. The 2005 nine months results include net
realized capital losses of $2.7 million, compared to net realized capital gains
of $8.8 million for the same period in 2004. The three and nine months ended
September 30, 2004 include a $4.9 million reduction in income tax expense ($0.06
per share) associated with the resolution of California legislation (AB 263)
related to holding company taxes on dividends from insurance
subsidiaries.
For
the
quarter ended September 30, 2005, cash flow from operations decreased 2.0%
to
$52.1 million, compared to $53.2 million for the same period in 2004. For the
nine months ended September 30, 2005, cash flow from operations decreased by
27.7% to $122.4 million from $169.2 million for the same period in 2004. The
$46.8 million decrease in operating cash flow is primarily attributable to
a
$19.8 million increase in income tax payments and a $20.2 million increase
in
underwriting expense payments. Federal income tax payments in the first nine
months of 2005 increased $1.8 million over the comparable period of 2004 because
the Company has fully utilized the alternative minimum tax net
operating losses (“NOLs”) that previously helped to minimize such taxes; and
state income taxes of $6.8 million were paid in February 2005 in settlement
of
our holding company’s California tax obligation for dividends received from its
insurance subsidiary and certain other disputed items for tax years 1998 to
2003. Underwriting expenses and payments increased in 2005 as a result of our
investments in the geographic expansion strategy, the conversion to our new
technology platform, and the build-up of our Dallas service center.
Total
assets were $1,921.7 million at September 30, 2005 compared to $1,864.3 million
at December 31, 2004. Statutory surplus increased 7.0% to $657.7 million at
September 30, 2005 from $614.9 million at December 31, 2004. The net premiums
written to statutory surplus ratio was 2.1 at September 30, 2005, compared
to
2.2 at December 31, 2004.
Conversion
to the Company’s new computer platforms known as APS is proceeding as planned.
The APS:Claims component began taking 100% of new claims in the third quarter
of
2004. Over 85% of the Company’s pending claims are now on the new system.
Conversion of the Company’s California personal
auto policies to APS:Policy component began in the first quarter of 2005. As
of
October 13, 2005 over 90% of these policies are on the new system. APS is a
web-based application with a multi-tier technical architecture. Underwriting
expenses have been higher than normal in prior periods due to costs of the
conversion process and the training of service staff.
Since
2002, the Company has been actively engaged in a community education effort
concerning proper installation and use of child safety seats. According to
the
National Highway Traffic Safety Administration, motor vehicle crashes are the
leading cause of death for children from two to 14 years of age. Data show
that
80% of child safety seats are improperly installed and are a potential source
of
injury for children, up from 73% in 2004. The Company’s program is endorsed by
the California Highway Patrol and the Governors’ Offices of Texas,
Illinois, Indiana, Ohio and Arizona. Education events typically include the
participation of political representatives, local media, law enforcement,
trained safety technicians and 21st managers and staff. Since inception, the
Company has held 58 education events, technicians have inspected over 5,000
vehicles and discarded (and then destroyed) over 2,200 defective child
safety seats. The Company has donated over 4,000 new seats so that no family
leaves an education event without every child in a properly fitted child
safety seat.
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
condensed consolidated 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 $43.1 million (3.0%) to $1,462.0 million, compared to
$1,418.9 million at December 31, 2004, due to $122.4 million of operating cash
flow primarily offset by cash outflows of $32.5 million for property and
equipment, $6.9 million in shareholder dividends, $23.9 million in net
unrealized losses during the nine month period ended September 30, 2005 due
to
changes in interest rates, and $9.3 million of debt repayment.
At
September 30, 2005, investment-grade bonds comprised substantially all of the
carrying value of the fixed maturity portfolio. As of September 30, 2005, six
positions in fixed maturity securities were rated below BBB. These securities
represent approximately 0.9% of our total investments.
Increased
advertising, sales and customer service costs through September 30, 2005
contributed to an increase in deferred policy acquisition costs (“DPAC”) of $5.0
million to $63.8 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”),
gross and net of applicable reinsurance, with respect to our lines of business:
|
|
September
30, 2005
|
|
December
31, 2004
|
|
AMOUNTS
IN THOUSANDS
|
|
Gross
|
|
Net
|
|
Gross
|
|
Net
|
|
Unpaid
Losses and LAE
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
$
|
514,892
|
|
$
|
510,181
|
|
$
|
489,411
|
|
$
|
485,759
|
|
Homeowner
and earthquake lines in runoff
|
|
|
2,722
|
|
|
1,901
|
|
|
6,131
|
|
|
5,138
|
|
Total
|
|
$
|
517,614
|
|
$
|
512,082
|
|
$
|
495,542
|
|
$
|
490,897
|
|
The
following table summarizes losses and LAE incurred, net of applicable
reinsurance, for the periods indicated:
|
|
Three
Months Ended September 30,
|
|
Nine
Months Ended September 30,
|
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Net
losses and LAE:
|
|
|
|
|
|
|
|
|
|
Current
accident year:
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
$
|
259,301
|
|
$
|
255,747
|
|
$
|
778,203
|
|
$
|
747,287
|
|
Homeowner
and earthquake lines in runoff
|
|
|
—
|
|
|
39
|
|
|
—
|
|
|
39
|
|
Total
current accident year
|
|
|
259,301
|
|
|
255,786
|
|
|
778,203
|
|
|
747,326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prior
accident years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
|
(1,811)
|
|
|
(3,822)
|
|
|
(21,774)
|
|
|
(3,790)
|
|
Homeowner
and earthquake lines in runoff
|
|
|
615
|
|
|
395
|
|
|
991
|
|
|
893
|
|
Total
prior accident years
|
|
|
(1,196)
|
|
|
(3,427)
|
|
|
(20,783)
|
|
|
(2,897)
|
|
Total
net losses and LAE
|
|
$
|
258,105
|
|
$
|
252,359
|
|
$
|
757,420
|
|
$
|
744,429
|
|
At
September 30, 2005, gross unpaid losses and LAE increased $25.5 million for
our
personal auto lines and decreased $3.4 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 September 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
September 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 ultimate development of 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 3 of the
Notes to Condensed Consolidated Financial Statements for additional background
on the 1994 Northridge earthquake and SB 1899.
Debt
of
$131.1 million consists of $29.4 million
of
capital lease obligations, $1.8 million of capital auto lease obligations,
and
$99.9 million of senior notes, net of discount. The primary purpose of the
capital lease and senior note borrowings was to increase the statutory surplus
of 21st Century Insurance Company, our wholly-owned insurance subsidiary. The
decrease in debt of $7.2 million during the nine months ended September 30,
2005
is primarily attributable to principal payments on the capital
lease.
Stockholders’
equity and book value per share increased $38.6 million (5.0%) to $813.0 million
and $9.47, respectively, at September 30, 2005, compared to $774.4
million
and
$9.06 at December 31, 2004, respectively. The increase in stockholders’ equity
for the nine months ended September 30, 2005 was primarily due to net income
of
$61.0 million and $3.2 million in proceeds from stock option exercises, offset
by dividends to stockholders of $10.3 million and unrealized losses on
investments of $15.5 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 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
$22.0 million at September 30, 2005, payments received from the intercompany
lease, and borrowing from our insurance subsidiary), additional
funds obtainable from the capital markets or 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
fifteen 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 94.0% of our premiums were written
for
the nine months ended September 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 2002,
both of which continued a series of actions we began taking in 2000 to restore
underwriting profitability. Effective October 23, 2005, we will be implementing
a class plan revision for our California business. This is a rate neutral change
overall, but is intended to improve the accuracy of our pricing and make us
more
competitive in Southern California.
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. Furthermore, 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
September 30, 2005, our insurance subsidiaries had a combined statutory surplus
of $657.7 million compared to $614.9 million at December 31, 2004. The increase
in statutory surplus was primarily due to statutory net income of $74.7 million
offset by an increase in nonadmitted assets of $15.5 million, an increase in
net
unrealized investment losses of $0.9 million and a $15.5 million decrease in
the
deferred income tax asset. The net premiums written to statutory surplus ratio
was 2.1 at September 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
|
|
September
30, 2005
|
December
31, 2004
|
Stockholders’
equity - GAAP
|
|
$
|
813,018
|
|
$
|
774,401
|
|
Condensed
adjustments to reconcile GAAP shareholders’ equity to statutory
surplus:
|
|
|
|
|
|
|
|
Net
book value of fixed assets under capital leases
|
|
|
(27,268
|
)
|
|
(34,834
|
)
|
Deferred
gain under capital lease transactions
|
|
|
(838
|
)
|
|
(610
|
)
|
Capital
lease obligation
|
|
|
31,201
|
|
|
38,405
|
|
Nonadmitted
net deferred tax assets
|
|
|
(61,070
|
)
|
|
(67,260
|
)
|
Net
deferred tax assets related to items nonadmitted under SAP
|
|
|
38,394
|
|
|
50,712
|
|
Intercompany
receivables
|
|
|
(50,146
|
)
|
|
(19,917
|
)
|
Fixed
assets
|
|
|
(23,154
|
)
|
|
(25,017
|
)
|
Equity
in non-insurance entities
|
|
|
22,073
|
|
|
8,082
|
|
Unrealized
losses (gains) on investments
|
|
|
644
|
|
|
(21,709
|
)
|
Deferred
policy acquisition costs
|
|
|
(63,760
|
)
|
|
(58,759
|
)
|
Prepaid
pension costs and intangible pension asset
|
|
|
(13,050
|
)
|
|
(17,253
|
)
|
Other
prepaid expenses
|
|
|
(9,590
|
)
|
|
(12,235
|
)
|
Other,
net
|
|
|
1,212
|
|
|
887
|
|
Statutory
surplus
|
|
$
|
657,666
|
|
$
|
614,893
|
|
Transactions
with Related Parties.
Since
1995, we have entered into several transactions with AIG subsidiaries, including
various reinsurance agreements. At September 30, 2005, reinsurance recoverables,
net of payables, from AIG subsidiaries were $0.2 million, compared to $1.4
million at December 31, 2004. 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 investment accounting services to the Company. This
agreement was approved by the California Department of Insurance. AIG also
provides corporate insurance for the Company, including Errors and Omissions,
Workers Compensation, and General Liability coverages, for which we paid $1.1
million and $3.3 million for the three and nine months ended September 30,
2005,
respectively, and $0.3 million and $1.5 million for the three and nine months
ended September 30, 2004, respectively.
Contractual
Obligations and Commitments
See
our
discussion about variable interest entities and commitments in Note 8 of the
Notes to Condensed Consolidated Financial Statements. There were no material
changes outside the ordinary course of our business in our contractual
obligations during the three and nine months ended September 30,
2005.
Results
of Operations
Overall
Results.
We
reported net income of $21.1 million, or earnings per
share
(basic and diluted) of $0.25 and $0.24, respectively, on direct premiums written
of $349.1 million in the quarter ended September 30, 2005, compared to a net
income of $24.6 million, or earnings per share (basic and diluted) of $0.29,
on
direct premiums written of $346.0 million for the same quarter last year. For
the nine months ended September 30, 2005, net income was $61.0 million, or
earnings per share (basic and diluted) of $0.71, on direct premiums written
of
$1,029.9 million. Net income for the nine months ended September 30, 2004,
was
$65.8 million, or earnings per share (basic and diluted) of $0.77, on direct
premiums written of $1,011.4 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
September
30,
|
Nine
Months Ended
September
30,
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
2004
|
2005
|
2004
|
Direct
premiums written
|
|
$
|
349,119
|
|
$
|
346,087
|
|
$
|
1,029,905
|
|
$
|
1,011,430
|
|
Net
premiums written
|
|
$
|
347,827
|
|
$
|
344,823
|
|
$
|
1,026,247
|
|
$
|
1,007,840
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
344,099
|
|
$
|
333,443
|
|
$
|
1,017,302
|
|
$
|
978,573
|
|
Net
loss and loss adjustment expenses
|
|
|
257,489
|
|
|
251,926
|
|
|
756,428
|
|
|
743,497
|
|
Underwriting
expenses incurred
|
|
|
69,638
|
|
|
64,808
|
|
|
213,839
|
|
|
189,524
|
|
Personal
auto lines underwriting profit
|
|
$
|
16,972
|
|
$
|
16,709
|
|
$
|
47,035
|
|
$
|
45,552
|
|
Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio
|
|
|
74.8
|
%
|
|
75.6
|
%
|
|
74.4
|
%
|
|
76.0
|
%
|
Underwriting
expense ratio
|
|
|
20.3
|
%
|
|
19.4
|
%
|
|
21.0
|
%
|
|
19.3
|
%
|
Combined
ratio
|
|
|
95.1
|
%
|
|
95.0
|
%
|
|
95.4
|
%
|
|
95.3
|
%
|
The
following table reconciles our personal auto lines underwriting profit to our
consolidated net income:
|
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
2004
|
2005
|
2004
|
Personal
auto lines underwriting profit
|
|
$
|
16,972
|
|
$
|
16,709
|
|
$
|
47,035
|
|
$
|
45,552
|
|
Homeowner
and earthquake lines in runoff,
underwriting loss
|
|
|
(613
|
)
|
|
(436
|
)
|
|
(983
|
)
|
|
(824
|
)
|
Net
investment income
|
|
|
17,042
|
|
|
15,118
|
|
|
51,085
|
|
|
42,579
|
|
Other
(loss) income
|
|
|
(3
|
)
|
|
—
|
|
|
364
|
|
|
—
|
|
Realized
investment (losses) gains
|
|
|
(939
|
)
|
|
(162
|
)
|
|
(2,666
|
)
|
|
8,821
|
|
Interest
and fees expense
|
|
|
(1,988
|
)
|
|
(2,116
|
)
|
|
(6,076
|
)
|
|
(6,527
|
)
|
Provision
for income taxes
|
|
|
(9,369
|
)
|
|
(4,554
|
)1 |
|
(27,725
|
)
|
|
(23,843
|
)
|
Net
income
|
|
$
|
21,102
|
|
$
|
24,559
|
|
$
|
61,034
|
|
$
|
65,758
|
|
1 |
Includes
the effect of a favorable
adjustment in tax provision of approximately $4.9 million due to
the
effect of California legislation
(AB 263) relating to holding company taxes on dividends from insurance
subsidiaries.
|
The
following table reconciles our direct premiums written to net premiums
earned:
|
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
AMOUNTS
IN THOUSANDS
|
|
2005
|
2004
|
2005
|
2004
|
Direct
premiums written
|
|
$
|
349,119
|
|
$
|
346,087
|
|
$
|
1,029,905
|
|
$
|
1,011,430
|
|
Ceded
premiums written
|
|
|
(1,292
|
)
|
|
(1,264
|
)
|
|
(3,658
|
)
|
|
(3,590
|
)
|
Net
premiums written
|
|
|
347,827
|
|
|
344,823
|
|
|
1,026,247
|
|
|
1,007,840
|
|
Net
change in unearned premiums
|
|
|
(3,728
|
)
|
|
(11,380
|
)
|
|
(8,945
|
)
|
|
(29,267
|
)
|
Net
premiums earned
|
|
$
|
344,099
|
|
$
|
333,443
|
|
$
|
1,017,302
|
|
$
|
978,573
|
|
Comments
relating to the underwriting results of the personal auto lines and the
homeowner and earthquake lines in runoff are presented below.
Underwriting
Results
Personal
Auto Lines. Personal
automobile insurance is our primary line of business. Vehicles insured outside
of California accounted for 6.6% and 6.0% of our direct premiums written in
the
three and nine months ended September 30, 2005, respectively, compared to 3.7%
and 3.3% for our direct premiums written for the three and nine months ended
September 30, 2004, respectively.
Direct
premiums written in the three months ended September 30, 2005, increased $3.0
million (0.9%) to $349.1 million compared to $346.1 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 nine months ended
September 30, 2005, increased $18.5 million (1.8%) to $1,029.9 million, compared
to $1,011.4 million for the same period in 2004, primarily due to a higher
number of insured vehicles from non-California states.
Net
premiums earned increased $10.7 million (3.2%) to $ 344.1 million for the three
months ended September 30, 2005, compared to $333.4 million for the same period
a year ago, attributable to the higher number of insured vehicles, as previously
mentioned. Net premiums earned increased $38.7 million (4.0%) to $1,017.3
million for the nine months ended September 30, 2005, compared to $978.6 million
for the same period in 2004.
The
auto
renewal ratio was 92.0% for the quarter ended September 30, 2005, compared
to
92.5% for the three months ended September 30, 2004. The auto renewal ratio
for
the nine months ended September 30, 2005, was 92.7%, compared to 92.7% for
the
same period in 2004.
Net
losses and LAE incurred increased $5.6 million (2.2%) to $257.5 million for
the
three months ended September 30, 2005, compared to $251.9 million for the same
period last year. For the nine months ended September 30, 2005, net losses
and
LAE incurred increased $12.9 million (1.7%) to $756.4 million, compared to
$743.5 million for the same period in 2004. The third quarter 2005 underwriting
profit includes $1.2 million of favorable development related to prior accident
years’ reserves, compared to $3.4 million of favorable development related to
prior accident years’ reserves in the same period of 2004. The nine months ended
September 30, 2005 underwriting profit includes $20.8 million of favorable
development related to prior accident years’ reserves, compared to $2.9 million
of favorable development related to prior accident years’ reserves 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 third quarter of 2005
was
approximately 0.5%, compared to 1.2% in the same quarter last year. For the
nine
months ended September 30, 2005, the effect on the loss and LAE ratios of
changes in estimates relating to insured events in prior years was 2.1%,
compared to 0.4% 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 20.3% and 19.4%
for the quarters ended September 30, 2005 and 2004, respectively. The ratios
of
net underwriting expenses to net premiums earned were 21.0% and 19.3% for the
nine months ended September 30, 2005 and 2004, respectively. The increase was
primarily due to growth in advertising costs, the development of new markets,
costs associated with the conversion to our new technology platform, and
facility and support costs.
The
combined ratio was 95.1% for the quarter ended September 30, 2005, compared
to
95.0% for the same period a year ago. The combined ratios for the nine months
ended September 30, 2005 and 2004 were 95.4% and 95.3%, 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 $0.6 million for the three months ended September 30, 2005,
compared to $0.4 million for the same period a year ago. For the nine months
ended September 30, 2005 and 2004, losses and LAE for those same lines were
$1.0
million and $0.8 million, respectively. We have not written any earthquake
policies since 1994 and we exited the homeowner 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 3.3% 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 September 30, 2005 compared to $15.1 million for the same period
in
2004. Net
investment income for the nine months ended September 30, 2005 and 2004, was
$51.1 million and $42.6 million, respectively. The increase in net investment
income is the result of higher average investment balances and higher pre-tax
yields.
At
September 30, 2005, $304.1 million, or 22.5%, of our total fixed maturity
investments at fair value were invested in tax-exempt bonds with the remainder,
representing 77.5% 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 nine months ended
September 30, were as follows:
|
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
|
|
2005
|
2004
|
2005
|
2004
|
Pre-tax
|
|
|
4.7%
|
|
|
4.4%
|
|
|
4.8%
|
|
|
4.3%
|
|
After-tax
|
|
|
3.4%
|
|
|
3.2%
|
|
|
3.5%
|
|
|
3.3%
|
|
Net
realized losses on the sale of investments2 were
$0.9
million (realized gains of $1.3 million and realized losses of $2.2 million)
and
$2.7 million (realized gains were $4.6 million and realized losses were $7.3
million) for the three and nine months ended September 30, 2005, respectively.
This compares to a $0.2 million net realized loss (realized gains were $0.1
million and realized losses were $0.3 million) and an $8.8 million net realized
gain (realized gains were $11.3 million and realized losses were $2.5 million)
for the three and nine months ended September 30, 2004, respectively. Our policy
is to investigate, on a quarterly basis, all investments for possible
“other-than-temporary” impairment when the fair value of a security falls below
its amortized cost, based on all relevant facts and circumstances. No such
impairments were recorded in the three and nine months ended September 30,
2005
or 2004.
2
|
Includes
loss on disposal of fixed assets of $0.0 million and $0.2 million
for the
three and nine months ended September 30, 2005, respectively, and
$0.2
million and $0.8 million for the three and nine months ended September
30,
2004, respectively.
|
Other
Revenues
Other
revenues of $0.4 million in 2005 relate to interest income for refund claims
with the taxing authorities.
Critical
Accounting Estimates
Our
condensed consolidated 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.
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 quarterly 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
NOL, which can be carried forward 15 years for losses incurred before 1998
and
20 years thereafter.
At
September 30, 2005, our DTAs totaled $127.1 million and our DTLs totaled $73.3
million. The net of those amounts, $53.8 million, represents the net deferred
tax asset reported in the condensed consolidated balance sheets.
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
3 NOL
of
21st
of the
Southwest
|
Consolidated
NOL
|
2017
|
|
$
|
|
|
$
|
1,644
|
|
$
|
1,644
|
|
2018
|
|
|
|
|
|
1,068
|
|
|
1,068
|
|
2019
|
|
|
|
|
|
1,466
|
|
|
1,466
|
|
2020
|
|
|
|
|
|
3,172
|
|
|
3,172
|
|
2021
|
|
|
81,759
|
|
|
2,180
|
|
|
83,939
|
|
2022
|
|
|
37,316
|
|
|
|
|
|
37,316
|
|
Total
|
|
$
|
119,075
|
|
$
|
9,530
|
|
$
|
128,605
|
|
Our
auto
business generated underwriting profit of $47.0 million for the nine months
ended September 30, 2005 and has generated an underwriting profit for the past
fifteen quarters. The consolidated NOL decreased to $128.6 million as of
September 30, 2005, from $216.7 million as of December 31, 2004. 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 September 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.
3
|
“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.
|
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.
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, management believes these costs
are
fully recoverable as of September 30, 2005.
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.
Under
the provisions of Statement of Financial Accounting Standards No. 115,
Accounting
for Certain Investments in Debt and Equity Securities,
investment securities generally must be classified as held-to-maturity,
available-for-sale or trading. The appropriate classification is based partially
on our ability to hold the securities to maturity and largely on management’s
intentions with respect to either holding or selling the securities. The
classification of investment securities is significant since it directly impacts
the accounting for unrealized gains and losses on securities. Unrealized gains
and losses on trading securities flow directly through earnings during the
periods in which they arise, whereas for available-for-sale securities, they
are
recorded as a separate component of stockholders’ equity (accumulated other
comprehensive income or loss) and do not affect earnings until realized. The
fair values of our investment securities are generally determined by reference
to quoted market prices and reliable independent sources.
We
are
obligated to assess, at each reporting date, whether there is an
“other-than-temporary” impairment to our investment securities. 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 nine months
ended September 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 (loss).
The
Company had total investments of $1,396.8 million and $1,384.2 million as of
September 30, 2005 and December 31, 2004, respectively. Non-investment grade
and
unrated securities represented 1.4% of our total portfolio as of September
30,
2005 and December 31, 2004. The following is a summary by issuer of
non-investment grade securities and unrated securities held at September 30,
2005 and December 31, 2004 (at fair value):
AMOUNTS
IN THOUSANDS
|
|
|
|
Non-investment
grade fixed maturity securities (i.e., rated below BBB):
|
|
|
|
|
|
Cox
Communications, Inc.
|
|
$
|
2,187
|
|
$
|
2,240
|
|
Ford
Motor Credit Company
|
|
|
|
|
|
4,615
|
|
General
Motors Acceptance Corp
|
|
|
|
|
|
5,643
|
|
News
America, Inc.
|
|
|
1,601
|
|
|
|
|
The
Kroger Co.
|
|
|
4,763
|
|
|
|
|
Xcel
Energy, Inc.
|
|
|
2,895
|
|
|
|
|
Non-investment
grade equity securities:
|
|
|
|
|
|
|
|
AmerUs
Group Co.
|
|
|
824
|
|
|
|
|
Southern
California Edison Company
|
|
|
511
|
|
|
|
|
Unrated
securities:
|
|
|
|
|
|
|
|
Impact
Community Capital, LLC4
|
|
|
2,024
|
|
|
2,023
|
|
Impact
Health, LLC
|
|
|
445
|
|
|
|
|
Impact
C.I.L., LLC
|
|
|
4,977 |
|
|
5,111 |
|
Total
non-investment grade and unrated securities5
|
|
$
|
20,227
|
|
$
|
19,632
|
|
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 September 30, 2005 and December 31,
2004:
|
|
September
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 in a loss position for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
than 6 months
|
|
|
15
|
|
$
|
159,194
|
|
$
|
2,451
|
|
|
7
|
|
$
|
88,258
|
|
$
|
1,045
|
|
6-12
months
|
|
|
29
|
|
|
268,079
|
|
|
7,192
|
|
|
15
|
|
|
154,284
|
|
|
3,415
|
|
More
than 1 year
|
|
|
22
|
|
|
183,676
|
|
|
6,271
|
|
|
2
|
|
|
4,765
|
|
|
326
|
|
Less
than $0.1 million
|
|
|
131
|
|
|
295,906
|
|
|
4,920
|
|
|
91
|
|
|
306,984
|
|
|
2,387
|
|
Total
fixed maturity securities with unrealized
losses
|
|
|
197
|
|
|
906,855
|
|
|
20,834
|
|
|
115
|
|
|
554,291
|
|
|
7,173
|
|
Equity
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding
$0.1 million
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
than $0.1 million
|
|
|
165
|
|
|
25,798
|
|
|
1,105
|
|
|
64
|
|
|
15,479
|
|
|
293
|
|
Total
equity securities with unrealized
losses
|
|
|
165
|
|
|
25,798
|
|
|
1,105
|
|
|
64
|
|
|
15,479
|
|
|
293
|
|
Total
investments with unrealized losses
6
|
|
|
362
|
|
$
|
932,653
|
|
$
|
21,939
|
|
|
179
|
|
$
|
569,770
|
|
$
|
7,466
|
|
4
|
Impact
Community Capital, LLC is a limited liability corporation that was
voluntarily established by a group of California insurers to make
loans
and other investments in economically disadvantaged
areas.
|
5
|
The
total net unrealized (loss) gain for these securities as of September
30,
2005 and December 31, 2004 was $(0.1) million and $0.4 million,
respectively.
|
6
|
Unrealized
losses represent 2.4% and 1.3% of the total carrying value of investments
with unrealized losses at September 30, 2005 and December 31, 2004,
respectively.
|
A
summary
by contractual maturity of fixed maturity securities in an unrealized loss
position by year of maturity follows:
|
|
September
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
|
|
$
|
4,021
|
|
$
|
4,010
|
|
$
|
11
|
|
$
|
9,778
|
|
$
|
9,738
|
|
$
|
40
|
|
Due
after one year through five years
|
|
|
153,705
|
|
|
151,016
|
|
|
2,689
|
|
|
26,537
|
|
|
26,073
|
|
|
464
|
|
Due
after five years through ten years
|
|
|
470,550
|
|
|
458,919
|
|
|
11,631
|
|
|
318,644
|
|
|
314,898
|
|
|
3,746
|
|
Due
after ten years
|
|
|
299,413
|
|
|
292,910
|
|
|
6,503
|
|
|
206,505
|
|
|
203,582
|
|
|
2,923
|
|
Total
fixed maturity securities with unrealized losses
|
|
$
|
927,689
|
|
$
|
906,855
|
|
$
|
20,834
|
|
$
|
561,464
|
|
$
|
554,291
|
|
$
|
7,173
|
|
Stock-based
compensation.
Under
the provisions of Statement of Financial Accounting Standard No. 123,
Accounting
for Stock-Based Compensation,
we have
elected to continue using the intrinsic-value method of accounting for
stock-based awards granted to employees in accordance with Accounting Principles
Board Opinion No. 25, Accounting
for Stock Issued to Employees.
Accordingly, we have not recognized in income any compensation expense for
the
fair value of stock options awarded to employees. Companies electing to continue
to follow the intrinsic-value method must make pro forma disclosures, as if
the
fair-value-based method of accounting had been applied. A summary of the expense
that would have been recorded, together with the underlying assumptions, had
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.
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;
|
·
|
Changes
in consumer preferences or buying
habits;
|
·
|
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 September 30, 2005,
comprised 96.7% of the fair value of the Company’s total investments. The
remainder of the Company’s investments, representing approximately 3.3% of total
investments at market value, is held in equity securities.
For
all
of our fixed maturity investments, we seek to provide for liquidity and
diversification while maximizing income, without sacrificing investment quality.
The value of the fixed maturity portfolio is subject to interest rate risk
where
the value of the fixed maturity portfolio decreases as market interest rates
increase, and conversely, when market interest rates decrease, the value of
the
fixed maturity portfolio increases. Duration is a common measure of the
sensitivity of a fixed maturity security’s value to changes in interest rates.
The higher the duration, the more sensitive a fixed maturity security is to
market interest rate fluctuations. Effective duration also measures this
sensitivity, but it takes into account call terms, as well as changes in
remaining term, coupon rate, and cash flow.
Since
fixed maturity investments with longer remaining terms to maturity tend to
realize higher yields, the Company’s investment philosophy typically resulted in
a portfolio with an effective duration of over 6 years. 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 4.8 years at September 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
September
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
|
|
$
|
1,350.4
|
|
$
|
1,285.0
|
|
|
(4.84
|
%)
|
Debt
|
|
|
131.1
|
|
|
138.6
|
|
|
5.72
|
%
|
The
equity securities portfolio, which represents approximately 3.3% 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 equity securities portfolio was 0.86.
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
September
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, at fair value
|
|
$
|
46.4
|
|
$
|
38.4
|
|
|
(17.2
|
%)
|
The
discussion above provides only a limited, point-in-time view of the market
risk
sensitivity of our financial instruments. The actual impact of market interest
rate and price changes on the financial instruments may differ significantly
from those shown.
ITEM
4. |
CONTROLS
AND PROCEDURES
|
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 September 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 September
30, 2005 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
PART
II -
OTHER
INFORMATION
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 4 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
|
None.
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:
|
October 27, 2005
|
|
/s/
Bruce W. Marlow
|
|
|
|
BRUCE
W. MARLOW
|
|
|
|
President
and Chief Executive Officer
|
|
|
|
|
|
|
|
|
Date:
|
October 27, 2005
|
|
/s/
Lawrence P. Bascom
|
|
|
|
LAWRENCE
P. BASCOM
|
|
|
|
Sr.
Vice President and Chief Financial Officer
|
|
|
|
|
|
|
|
|
EXHIBIT
INDEX
Exhibit
No.
|
Description
|
|
|
31.1
|
Certification
of President and Chief Executive Officer Pursuant to Exchange Act
Rule
13a-14(a).
|
31.2
|
Certification
of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a).
|
32.1
|
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002.
|