Internet Address
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
x ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For
the
fiscal year ended December 31, 2005
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)
|
Securities
registered pursuant to Section 12(b) of the Act:
|
Name
of each exchange on
|
Title
of each class
|
which
registered
|
Common
Stock, Par Value $0.001
|
New
York Stock Exchange
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes o No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes o No x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. Yes x
No
o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Act. (Check
one):
Large
accelerated filer o
|
Accelerated
filer x
|
Non-accelerated
filer o
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes o
No x
The
aggregate market value of the voting stock held by non-affiliates of 21st
Century Insurance Group, based on the average high and low prices for shares
of
the registrant’s Common Stock on June 30, 2005, as reported by the New York
Stock Exchange, was approximately $462,000,000.
There
were 85,936,476 shares of common stock outstanding on February 3,
2006.
Documents
Incorporated By Reference:
Part
III
of this Form 10-K incorporates by reference certain information from the
registrant’s definitive proxy statement for the Annual Meeting of Stockholders
to be filed with the Securities and Exchange Commission within 120 days after
the close of the year ended December 31, 2005.
Description
|
Page
Number
|
Part
I
|
|
|
Item
1.
|
|
3
|
Item
1A.
|
|
19
|
Item
1B.
|
|
22
|
Item
2.
|
|
22
|
Item
3.
|
|
23
|
Item
4.
|
|
23
|
Part
II
|
|
|
Item
5.
|
|
23
|
Item
6.
|
|
24
|
Item
7.
|
|
25
|
Item
7A.
|
|
41
|
Item
8.
|
|
43
|
Item
9.
|
|
78
|
Item
9A.
|
|
78
|
Item
9B.
|
|
78
|
Part
III
|
|
|
Item
10.
|
|
79
|
Item
11.
|
|
79
|
Item
12.
|
|
79
|
Item
13.
|
|
79
|
Item
14.
|
|
79
|
Part
IV
|
|
|
Item
15.
|
|
80
|
|
83
|
|
88
|
|
|
Exhibit
Index
|
81
|
10(r)
|
Summary
of Director Compensation
|
|
14
|
Code
of Ethics
|
|
21
|
Subsidiaries
of Registrant
|
|
23
|
Consent
of Independent Registered Public Accounting Firm
|
|
31.1
|
Certification
of President and Chief Executive Officer Pursuant to Exchange Act
Rule
13a-14(a)
|
|
31.2
|
Certification
of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a)
|
|
32.1
|
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002
|
|
PART
I
General
21st
Century Insurance Group is an insurance holding company registered on the New
York Stock Exchange. For convenience, the terms “Company”, “21st”, “we”, “us”,
or “our” are used to refer collectively to the parent company and its
subsidiaries.
Founded
in 1958, we are a direct-to-consumer provider of personal auto insurance. With
$1.4 billion of revenue in 2005, we insure over 1.5 million vehicles in
California, Texas, Illinois, and six other states. We provide superior policy
features and customer service at a competitive price. Customers can purchase
insurance, service their policy, or report a claim at www.21st.com
or on
the phone with our licensed insurance professionals at 1-800-211-SAVE. Service
is offered in English and Spanish, both on the phone and on the web, 24 hours
a
day, 365 days a year.
Effective
December 4, 2003, 21st Century Insurance Group was incorporated under the laws
of the State of Delaware. Previously, the Company was incorporated in
California. The term “Company,” unless the context requires otherwise, refers to
21st Century Insurance Group and its consolidated subsidiaries, all of which
are
wholly-owned: 21st Century Insurance Company, 21st Century Casualty Company,
21st Century Insurance Company of the Southwest, 20th Century Insurance
Services, Inc., and i21 Insurance Services. The latter two companies are not
property and casualty insurance subsidiaries, and their results are
immaterial.
The
common stock of the Company is traded on the New York Stock Exchange under
the
trading symbol “TW.” Through several of its subsidiaries, American International
Group, Inc. (“AIG”) currently owns approximately 62% of the Company’s
outstanding common stock.
Copies
of
our filings with the Securities and Exchange Commission (“SEC”) on Form 10-K,
Form 10-Q, Form 8-K and proxy statements are available, along with copies of
earnings releases, on the Company’s web site at www.21st.com
as soon
as reasonably practicable after such material is electronically filed with
or
furnished to the SEC. Copies may also be obtained free of charge directly from
the Company’s Investor Relations Department (6301 Owensmouth Avenue, Woodland
Hills, California 91367, phone 818-673-3996).
The
public may also read and copy any materials the Company files with the SEC
at
the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549 (information on the operation of the Public Reference Room is available
by
calling the SEC at 1-800-SEC-0330). The SEC also maintains a web site that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC at www.sec.gov.
Some
Useful Definitions
The
insurance industry uses terminology that is unfamiliar to many people. Included
here are definitions and descriptions that should be useful as you read this
report.
Not
all
financial measures used in insurance are presented in accordance with accounting
principles generally accepted in the United States of America (“GAAP”). Non-GAAP
financial measures are not intended to replace, and should be read in
conjunction with, the GAAP financial results. The reconciliations of non-GAAP
financial measures to the most directly comparable GAAP measures are located
in
Item
7. Management’s Discussion and Analysis - Results of Operations
and
Liquidity
and Capital Resources.
Balance
Sheet terms
|
·
|
Deferred
policy acquisition costs (“DPAC”) -
The unamortized portion of the policy acquisition costs described
below.
|
|
·
|
Unpaid
losses and loss adjustment expenses - The
estimated liabilities for Losses and Loss Adjustment Expense (“LAE”)
include the accumulation of estimates of losses for claims reported
on or
prior to the balance sheet dates, estimates (based upon actuarial
analysis
of historical data) of losses for claims incurred but not reported,
the
development of case reserves to ultimate values, and estimates of
expenses
for investigating, adjusting and settling all incurred claims. Amounts
reported are estimates of the ultimate costs of settlement, net of
estimated salvage and subrogation.
|
|
·
|
Reinsurance
receivables and recoverables - These
amounts are reflected as assets on the balance sheet and consist
of two
components: first, the ceded portion of the reserves described in
unpaid
losses and LAE above are shown as recoverables and second, the actual
billings due from our reinsurers on ceded losses and LAE paid are
recorded
as receivables.
|
|
·
|
Unearned
premiums - That
portion of our direct premiums written that has not yet been earned.
It is
the amount of premium we would return to policyholders if all policies
were cancelled as of the balance sheet date. The ceded portion of
this
liability is shown as an asset labeled “Prepaid reinsurance
premiums.”
|
|
·
|
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.
|
Income
statement terms
|
·
|
Direct
premiums written -
The total policy premiums, net of cancellations, associated with
policies
underwritten and issued. We use direct premiums written, which excludes
the impact of premiums ceded to reinsurers, as a measure of the underlying
growth of our insurance business from period to period. We do not
currently assume premiums from other
companies.
|
|
·
|
Net
premiums written -
The sum of direct premiums written less ceded premiums written. Ceded
premiums written is the portion of our direct premiums that we transfer
to
our reinsurers in accordance with the terms of our reinsurance contracts,
based upon the risks they accept. See Note 10 of the Notes to Consolidated
Financial Statements for a summary of our reinsurance agreements.
|
|
·
|
Net
premiums earned - Represents
the portion of net 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.
|
|
·
|
Net
losses and loss adjustment expenses incurred -
The estimated liability for the indemnity and settlement costs of
all
insured events occurring during the period. These estimates 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. The methods of making such estimates
and
for establishing the resulting reserves are reviewed and updated
as
applicable, and any resulting adjustments are reflected in current
operations.
|
|
·
|
Policy
acquisition costs -
Consist of 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.
|
|
·
|
Other
underwriting expenses -
Consist of all other costs involved in the support of the insurance
business other than losses, LAE and policy acquisition costs. This
includes servicing policies and all other corporate support
functions.
|
Income
statement performance ratios - The
following ratios are used to measure our performance, not only period-to-period,
but as a common comparison tool against our peers in the marketplace. The three
most common ratios follow:
|
·
|
Loss
and LAE ratio -
The result of dividing net losses and LAE incurred by net premiums
earned.
It is a measure of the percentage of our premium revenue that goes
towards
investigating and settling claims.
|
|
·
|
Underwriting
expense ratio -
The result of dividing the sum of policy acquisition costs and other
underwriting expenses by net premiums earned. It is a measure of
how
efficiently we attract, acquire, and service the business we
write.
|
|
·
|
Combined
ratio -
The sum of the loss and LAE ratio and the underwriting expense ratio.
This
ratio measures a company’s overall underwriting profitability. If the
combined ratio is at or above 100, an insurance company cannot be
profitable without investment income (and may not be profitable if
investment income is insufficient). For example, our goal as a Company
is
to maintain a combined ratio of 96% or less. This means that for
every
$1.00 of premium that we earn, we will incur $0.96 or less in related
costs. The $0.04 margin is referred to as our underwriting profit
and,
when coupled with our investment results, other income and other
expenses,
becomes our pre-tax income.
|
Types
and Limits of Insurance Coverage
|
·
|
Our
private passenger auto insurance contract generally covers: bodily
injury
liability; property damage; medical payments; personal injury protection,
uninsured and underinsured motorist; rental reimbursement; uninsured
motorist property damage; towing; comprehensive; and collision. All
of
these policies are written for a six-month term except for Involuntary
Market policies assigned to us, which are for twelve
months.
|
|
·
|
Minimum
levels of bodily injury and property damage are required by state
law and
typically cover the other party’s claims when our policyholder is at
fault. Uninsured and underinsured motorist typically are optional
coverages and cover our policyholder when the other party is at fault
and
has insufficient liability insurance to cover the insured’s injuries and
loss of income. Comprehensive and collision coverages are also optional
and cover damage to the policyholder’s automobile whether or not the
insured is at fault. Medical payments coverage typically is optional.
In
some states, we are required to offer personal injury protection
coverage.
|
|
·
|
Various
limits of liability are underwritten with maximum limits of $500,000
per
person and $500,000 per accident. Our most popular bodily injury
liability
limits in force are $100,000 per person and $300,000 per accident.
|
|
·
|
Our
personal umbrella policy (“PUP”) is written with a 12-month policy term
with liability coverage limits of $1 million to $5 million in excess
of
the underlying automobile liability coverage we write. Since May
2002, we
have required minimum underlying automobile limits, written by us,
of
$250,000 per person and $500,000 per accident for PUP policies sold.
We
reinsure 90% of any PUP loss.
|
Long-Term
Financial Goals
We
have
four key long-term financial goals:
|
·
|
15%
growth in direct premiums written
|
|
·
|
Strong
financial ratings
|
Our
financial goals are the framework we use for making critical business decisions
regarding market entries, marketing programs, product offerings and operating
plans. Although we may not achieve each of these goals in a given calendar
year,
we believe that achieving them over the long-term will help us to provide
superior returns to our shareholders.
96%
Combined Ratio Long-Term Goal
Combined
ratio is the most important measure of our overall profitability. It is
also an
important component of our return on equity and influences our financial
ratings. Consequently, we consider our 96% combined ratio goal the most
important of our long-term financial goals. We strive to achieve a 96%
combined
ratio by accurately pricing our risks, being a disciplined underwriter,
expertly
handling customer service and claims, retaining our customers and controlling
expenses.
15%
Growth Long-Term Goal
We
aim to
grow our direct premiums written profitably at a rate that exceeds the
overall
growth rate for our industry and key competitors. Although we may not achieve
our 15% growth goal in a given calendar year, over the long-term, we plan
to
achieve our growth goal by establishing and expanding our business in markets
outside of California, and by being innovative in our marketing methods
and
product offerings.
15%
Return on Equity (“ROE”) Long-Term Goal
ROE
is
net income (loss) divided by average stockholders’ equity. We aim to achieve an
ROE that exceeds our Weighted Average Cost of Capital and that also exceeds
the
average ROE for our industry. In addition, we plan to achieve an ROE that
makes
us an attractive investment when compared to other financial services companies.
Our operating metrics that influence ROE are combined ratio, investment
yield,
and the amount of capital and our capital structure.
Strong
Financial Ratings
A
strong
financial rating is an important element of our public profile. It supports
our
sales and marketing efforts, helps us attract and retain talented team
members
and minimizes our borrowing costs. We engage independent rating agencies
to
measure our overall financial strength. Our goal is to achieve and maintain
financial strength ratings that are in one of the top five rating grades
awarded
by the relevant rating agency.
The
Company’s financial stability is demonstrated by our A+ financial strength
rating, our very high capital adequacy ratios and the fact that we have
been in
business for nearly 50 years. The following are our financial ratings by
rating
agency:
|
Financial
Ratings by Rating Agency
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
A.M
Best1
|
A+
|
A+
|
A+
|
A+
|
A+
|
Standard
& Poor’s
|
A+
|
A+
|
A+
|
A+
|
A+
|
Fitch2
|
A+
|
A
|
—
|
—
|
—
|
__________________________________________
1 A.M.
Best
has placed the Company Under Review with Negative
Implications.
2 Fitch
upgraded the Company’s rating to A+ in February
2005.
Geographic
Concentration of Business
National
concentration. The
following table presents a geographical summary of our direct premiums written
for the past five years:
AMOUNTS
IN MILLIONS
|
|
Direct
Premiums Written
|
|
Years
Ended December 31,
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
Personal
auto lines3
|
|
|
|
|
|
|
|
|
|
|
|
California
|
|
$
|
1,262.3
|
|
$
|
1,290.9
|
|
$
|
1,194.5
|
|
$
|
967.3
|
|
$
|
879.4
|
|
Arizona4
|
|
|
31.5
|
|
|
27.8
|
|
|
16.2
|
|
|
13.0
|
|
|
—
|
|
Texas
|
|
|
19.1
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Illinois
|
|
|
11.4
|
|
|
4.4
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Ohio
|
|
|
8.3
|
|
|
1.6
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Nevada
|
|
|
5.3
|
|
|
6.3
|
|
|
6.7
|
|
|
8.1
|
|
|
8.9
|
|
Indiana
|
|
|
4.6
|
|
|
1.3
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Washington
|
|
|
2.9
|
|
|
3.7
|
|
|
4.6
|
|
|
5.8
|
|
|
8.5
|
|
Oregon
|
|
|
1.0
|
|
|
1.2
|
|
|
1.4
|
|
|
1.6
|
|
|
2.0
|
|
Total
personal auto lines
|
|
|
1,346.4
|
|
|
1,337.2
|
|
|
1,223.4
|
|
|
995.8
|
|
|
898.8
|
|
Lines
in runoff 5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Homeowner
and earthquake
|
|
|
—
|
|
|
—
|
|
|
0.1
|
|
|
2.4
|
|
|
30.5
|
|
Total
|
|
$
|
1,346.4
|
|
$
|
1,337.2
|
|
$
|
1,223.5
|
|
$
|
998.2
|
|
$
|
929.3
|
|
Most
of
our policyholders (94% of direct premiums written) are based in California,
however, all of our 2005 growth came from expansion outside of California.
Direct premiums written outside of California comprised 6% of total direct
premiums written in 2005, compared to 3% of total premiums written in 2004.
The
following geographic expansion efforts are part of our transformation from
a
business concentrated in California to a national competitor:
|
·
|
First
quarter of 2004 - began writing personal auto policies in Illinois,
Indiana, and Ohio.
|
|
·
|
Third
quarter of 2004 - opened a service center in Dallas, diversifying
our call
center operations.
|
|
·
|
First
quarter of 2005 - began writing personal auto policies in Texas.
|
|
·
|
Second
quarter of 2006 - planned entrance into three additional
states.
|
|
·
|
Third
quarter of 2006 - planned entrance into three additional
states.
|
California
concentration.
The
table below summarizes the concentrations of our California vehicles-in-force
for the personal auto lines, excluding Involuntary Market policies and personal
umbrella and motorcycle coverages as of the end of each of the past five years.
December 31, 2004 data from the California Department of Motor Vehicles (the
most recent available) indicates that 22.6% of its registrations were for
vehicles in Los Angeles County. Primarily as a result of our growth in other
areas of California, our concentration of LA County vehicles insured has
declined from 42.0% in 2001 to 28.8% at the end of 2005, approaching a natural
distribution of business in the state.
Voluntary
Personal Auto Lines
|
|
Concentration
of California Vehicles in Force
|
|
Years
Ended December 31,
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
Los
Angeles County
|
|
|
28.8
|
%
|
|
30.3
|
%
|
|
32.3
|
%
|
|
37.2
|
%
|
|
42.0
|
%
|
San
Diego County
|
|
|
13.8
|
|
|
13.6
|
|
|
13.5
|
|
|
13.4
|
|
|
13.4
|
|
Southern
California, excluding Los Angeles and San Diego Counties6
|
|
|
20.0
|
|
|
20.3
|
|
|
21.4
|
|
|
23.5
|
|
|
25.9
|
|
Central
and Northern California7
|
|
|
37.4
|
|
|
35.8
|
|
|
32.8
|
|
|
25.9
|
|
|
18.7
|
|
Total
|
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
______________________________
3
|
Includes
motorcycle and personal umbrella coverages, which are immaterial
for all
periods presented.
|
4
|
Excludes
$12.8 million in 2001 not consolidated prior to our acquisition
of a
majority of the voting interests in 21st Century Insurance Company
of the
Southwest (previously named 21st Century Insurance Company of
Arizona).
|
5
|
We
no longer have any homeowner policies in force. We ceased writing
earthquake coverage in 1994, but we have remaining loss reserves
from the
1994 Northridge earthquake. See further discussion in Item 7 under
the
captions Results
of Operations - Homeowner and Earthquake Lines in Runoff
Results, Critical
Accounting Estimates - Losses and Loss Adjustment
Expenses,
and in Note 16 to the Notes to Consolidated Financial
Statements.
|
6
|
Includes
the following counties: Imperial, Kern, Orange, Riverside, Santa
Barbara,
San Bernardino and Ventura.
|
7
|
Includes
all California counties other than Los Angeles County, San Diego
County,
and those specified above in Footnote
6.
|
Personal
Auto Product Innovations
Starting
in May 2002, we began offering motorcycle coverage primarily to our auto
policyholders in California. In August 2002, we introduced a new private
passenger auto policy in California that does not have certain standard features
found in our primary policy. This limited-feature product is similar in most
respects to the product offered by many of our competitors, and is positioned
as
a lower-cost alternative for customers who believe they need less coverage
than
provided by our standard product. In October 2002, we began providing quotes
at
higher rate levels to consumers who did not meet California’s statutory “good
driver” definition. The foregoing product innovations account for approximately
12.9% of new auto policies written in California in 2005.
Marketing
Our
marketing and underwriting strategy is to appeal to careful and responsible
drivers who desire a feature-rich product at a competitive price. We use direct
mail, broadcast and print media, outdoor, community events and the Internet
to
generate inbound telephone calls, which are served by company employees who
are
licensed insurance agents. Because our centralized operations are company
staffed, we can deliver a highly efficient and professional experience for
our
callers 24 hours per day, 365 days per year through a convenient, toll-free
800-211-SAVE telephone number. Consumers may also obtain an auto rate quotation
and purchase a policy on our web
site
at www.21st.com.
Over
half
of all Spanish-speaking residents in the United States live in California,
Arizona, Illinois, and Texas. We offer full service in Spanish via our web
site,
including policy purchase, and bilingual professionals 24 hours per day, 365
days per year through a dedicated toll-free telephone number at 888-920-2121.
Additionally we utilize Spanish language advertising and marketing
materials.
The
following table summarizes advertising expenditures (in millions) and total
new
policies written for the past five years:
Years
Ended December 31,
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
Total
advertising expenditures
|
|
$
|
70.1
|
|
$
|
66.7
|
|
$
|
53.9
|
|
$
|
43.3
|
|
$
|
16.9
|
|
New
policies written
|
|
|
170,224
|
|
|
225,349
|
|
|
265,589
|
|
|
189,652
|
|
|
63,264
|
|
Advertising
expenditures increased in 2005 and 2004 as a result of the Company’s geographic
expansion efforts.
Consumer
Advocacy
For
the
fifth consecutive year, we are actively engaged in a community education effort
for the 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 2 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. Our child safety program is endorsed by the California
Highway Patrol (“CHP”) and the Governors’ Offices of Arizona, Illinois,
Indiana, Ohio and Texas. Educational safety events typically include the
participation of political representatives, local media, law enforcement,
trained safety technicians and our managers and team members. Since inception,
the Company has held more than 60 education events, technicians have inspected
over 6,600 vehicles and discarded (and then destroyed) more than 2,500
broken or recalled child safety seats. We have donated over 5,200 brand-new
child safety seats so that no family leaves an education event
without every child in a properly fitted child safety seat.
We
have
also partnered with the CHP and the Arizona Department of Public Safety in
public education programs on safe driving. Using billboard advertising in
English and Spanish, we have entertained and hopefully made positive impressions
on the serious topics of “Drive Sober” and “Just Drive,” referring to distracted
driving (cell phones, eating, reading, etc. while driving). All of the materials
are co-branded by 21st, the CHP and the Arizona Department of Public Safety,
as
applicable.
We
have
several publications and community events designed to assist customers and
potential customers in making choices about their auto insurance and automobile
safety. We also publish the Child
Safety Seat: A Parent’s Guide, Crash
Test Ratings Guide,
and a
30-minute documentary, The
Golden Road - Today’s Senior Driver. The Golden Road
is
designed to help senior drivers and their families correctly assess seniors’
driving abilities and decrease driving dangers. Both guides and The
Golden Road
are
distributed through public events, direct mail promotions and downloads from
our
web site. In an unprecedented synchronization of schedules to spotlight the
second annual “Senior Safe Mobility Day”, all 14 California public broadcasting
stations aired The
Golden Road
statewide on October 25, 2005.
Competition
The
personal automobile insurance market is highly competitive and is comprised
of a
large number of well-capitalized companies, many of whom are several times
larger, operate in more states and offer a wider variety of products than we
do.
In the total US personal auto market of $160+ billion of direct premiums
written, we have a less than 1% market share. According to A.M. Best, in
California, we were the seventh largest writer of personal auto insurance in
2004 (latest year for which information is available).
Market
shares in California of the top ten writers of personal automobile insurance,
based on direct premiums written, according to A.M. Best, for the past five
years were as follows:
|
|
Market
Share in California
Based
on Direct Premiums Written
|
|
Years
Ended December 31,
|
|
2004
|
2003
|
2002
|
2001
|
2000
|
21st
Century Insurance Group
|
|
|
7
|
%
|
|
6
|
%
|
|
6
|
%
|
|
6
|
%
|
|
6
|
%
|
State
Farm Group
|
|
|
14
|
|
|
14
|
|
|
14
|
|
|
13
|
|
|
13
|
|
Farmers
Group
|
|
|
10
|
|
|
10
|
|
|
11
|
|
|
12
|
|
|
12
|
|
Mercury
General Group
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
8
|
|
|
8
|
|
Automobile
Club of Southern California Group
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
9
|
|
California
State Auto Group
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
10
|
|
|
10
|
|
Allstate
Insurance Group
|
|
|
8
|
|
|
8
|
|
|
9
|
|
|
11
|
|
|
10
|
|
Progressive
Insurance Group
|
|
|
3
|
|
|
3
|
|
|
2
|
|
|
2
|
|
|
2
|
|
USAA
Group
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
Government
Employees Group (GEICO)
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
Pricing
and Underwriting
We
have
developed a highly segmented and sophisticated pricing model that is on par
with
the best pricing models in the industry. Through a combination of rating
variables and interactions among variables, we are able to achieve higher levels
of pricing accuracy than historically have been employed. This model, which
we
employ in active markets outside of California, allows us to grow by
out-segmenting established competitors while providing greater stability in
our
results.
California
law defines the primary rating characteristics that must be used for automobile
policies include driving record (e.g., history of accidents and moving
violations), annual mileage and number of years the driver has been licensed.
A
number of other “optional” rating factors are also permitted and used in
California, which include characteristics such as automobile garaging location,
make and model of car, policy limits and deductibles, and gender and marital
status.
We
are
required to offer insurance to any California applicant who meets the statutory
definition of a “good driver.” This definition includes, but is not limited to,
all drivers licensed during the previous three years with no more than one
violation point count under criteria contained in the California Vehicle Code.
These criteria include a variety of moving violations and certain at-fault
accidents.
The
regulatory system in California requires the prior approval of insurance rates.
Within the regulatory framework, we establish our premium rates based primarily
on actuarial analyses of our own historical loss and expense data. This data
is
compiled and analyzed to establish overall rate levels as well as classification
differentials.
Our
rates
are established at levels intended to generate underwriting profits and vary
for
individual policies based on a number of rating characteristics. These rates
are
a blend of base rates and class plan filings made with the
California Department
of Insurance (“CDI”). Base rates are the primary amount projected to generate an
adequate underwriting profit. Class plan changes are filings that serve to
modify the factors that impact the base rates so that each individual receives
a
rate, to the extent permitted by regulation, that reflects their respective
losses and expenses. Class plan changes are intended to be revenue neutral
to
us.
We
regularly review the effectiveness of our rating plans and the overall adequacy
of our rates by state and program. The following table summarizes increases
(decreases) in our premium rates for each of the past five years:
|
|
Increases
(Decreases) in Our Premium Rates
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
Personal
Auto Lines excluding PUP
|
|
|
|
|
|
|
|
|
|
|
|
California
|
|
|
—
|
|
|
—
|
|
|
3.9
|
%
|
|
5.7
|
%
|
|
4.0
|
%
|
Arizona
|
|
|
0.9
|
|
|
4.8
|
|
|
3.0
|
|
|
3.7
|
|
|
16.5
|
|
Texas
|
|
|
(3.3
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Illinois
|
|
|
0.8
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Indiana
|
|
|
(8.6
|
)
|
|
(8.6
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
Ohio
|
|
|
(6.6
|
)
|
|
(7.3
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
Nevada
|
|
|
—
|
|
|
6.4
|
|
|
—
|
|
|
22.0
|
|
|
12.6
|
|
Oregon
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
3.1
|
|
|
14.0
|
|
Washington
|
|
|
—
|
|
|
7.4
|
|
|
—
|
|
|
10.7
|
|
|
44.9
|
|
Lines
in runoff
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Homeowner
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
|
13.2
|
|
|
4.0
|
|
Earthquake
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
Our
objective is to offer a price that, to the fullest extent possible, reflects
the
loss and expense expectations for every consumer. Accurate pricing is important
because it rewards and encourages safe driving. Accurate pricing also increases
stability in our results, reducing the impact of mix changes in our book of
business.
For
us,
underwriting is the process of confirming that rating information (such as
the
VIN of the vehicles, identification of all drivers in the household, accident
and violation history, etc.) is accurate, complete and properly applied in
our
rating approach. The underwriting process occurs at the inception of the policy,
whenever a change is requested and at renewal. In certain circumstances, we
will
non-renew a policy due to a substantial increase in risk.
Customer
Service
We
offer
policy support for our customers directly with our own licensed professionals.
We operate 24/7/365 and provide service in both English and Spanish. Customers
contact us through their method of choice - phone call, interactive voice
response, mail, email, or web site. A full service bilingual web site includes
options to buy a policy, pay a bill, make a policy change, or report a claim.
Our goal is accurate, prompt, comprehensive and enthusiastic customer service,
and we strive for superior customer retention.
To
maximize efficiencies, 21st Century Insurance links its multiple call centers
into one “virtual” resource. APS is our state-of-the-art, real time policy
service system. We completed the APS conversion of our California 21st Century
Insurance policies during 2005.
Underwriting
Expense Ratio - Personal Auto Lines
Under
GAAP, the underwriting expense ratio is defined as underwriting expenses divided
by net premiums earned, and underwriting expenses are recognized over the period
that net premiums are earned. The statutory underwriting expense ratio is stated
as a percentage of premiums written rather than premiums earned because most
underwriting expenses are recognized when policies are written. Information
extracted from statutory filings by A.M. Best for the top ten California
personal automobile insurance companies for 2004, the most recent year
available, indicates that our direct statutory underwriting expense ratio for
private passenger auto (defined as direct underwriting expenses on a statutory
basis divided by direct premiums written) was lower than 7 of our 9 largest
competitors in California for 2004. Our GAAP underwriting results and ratios
are
discussed in Item
6. Selected Financial Data and
Item
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Results of Operations.
Customer
Retention and Vehicles in Force
Customer
retention in California, measured based on the number of vehicles in force,
were
as follows as of the end of each of the past five years:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
Average
customer retention - California personal auto8
|
|
|
92%
|
|
|
93%
|
|
|
92%
|
|
|
93%
|
|
|
92%
|
|
California
vehicles in force9
|
|
|
1,428,358
|
|
|
1,477,625
|
|
|
1,383,175
|
|
|
1,178,459
|
|
|
1,051,982
|
|
All
other states vehicles in force
|
|
|
127,001
|
|
|
62,922
|
|
|
33,332
|
|
|
27,174
|
|
|
23,489
|
|
Total
vehicles in force
|
|
|
1,555,359
|
|
|
1,540,547
|
|
|
1,416,507
|
|
|
1,205,633
|
|
|
1,075,471
|
|
Claims
It
is the
mission of our claim operation to settle claims fairly and promptly while fully
complying with all applicable laws and regulations. We recognize that it is
important to support not only our customers’ financial recovery from an accident
but also their emotional recovery from an unpleasant and disruptive accident
experience.
The
task
of delivering on the claims promise to our customers is a challenging one,
particularly in today’s legal and regulatory environment. Of the thousands of
new claims reported weekly, involving automobile thefts, traffic accidents,
or
other types of damages or injuries, each one entails relating on an empathetic
level with a person suffering a loss who deserves individual attention. Yet
our
adjusters at the same time must remain objective and focused on the activity
necessary to investigate the facts of the loss and determine the resulting
damages. In every case, acting promptly to resolve the claim while treating
people fairly is the way we keep lawsuits to a minimum, especially while faced
with demanding claimants and their attorneys. The claim operation functions
within the bounds of an ever-expanding field of insurance regulations put in
place to protect the public and ensure fairness. The task is made more difficult
by the incidence of insurance fraud and padding of claims committed by a small
percentage of claimants and unscrupulous attorneys, medical providers and the
like. A recent study by the Insurance Research Council, for example, states
that
22% of all claims for bodily injury arising from automobile accidents in
California involve elements of fraud or buildup. So, while we wish to see that
legitimate claims are fairly and quickly paid, it is also incumbent that our
adjusters be vigilant to recognize and investigate suspicious
claims.
As
mentioned, the handling of claims is the subject of regulation by the States.
Extensive civil case law also exists on most issues covered by insurance. Laws
and regulations vary from state to state, with new ones added every year. It
is
the adjuster’s job to investigate and make fair determinations of liability
under the law while resolving the claim in compliance with regulations.
Adjusters must be trained and knowledgeable to be able to comply with the
requirements that affect their handling of each claim. We could not face these
challenges without attracting and retaining outstanding professionals through
careful hiring practices and one of the most comprehensive adjuster training
programs in the industry. Through retention of quality people, we have a very
seasoned management staff and an average tenure in the claims area of over
nine
years.
The
adjustment of claims is an involved process requiring the coordination of many
tasks. The claim operation is charged with confirming coverage for the type
of
loss, investigating liability to determine responsibility for the accident,
assessing damages resulting from the loss, and negotiating a fair resolution.
For our products to remain competitive and affordable, claim settlements must
be
fair and legitimate, and the design of our claim process must operate
efficiently and in a cost effective manner.
Our
claim
process is designed to deliver what customers expect: friendly, convenient
and
efficient service. Reports of accidents are taken by telephone or over the
web
at www.21st.com.
Our
claim call centers operate 24/7/365 and can assist customers in Spanish as
well
as English. Translation services for other languages are readily available
to
our staff. The report is digitally recorded with the customer’s permission,
which means in most cases the customer need only describe the accident to us
one
time. A variety of options are offered to the customer for inspection and car
repair to suit their particular needs. At the conclusion of the claim report,
an
assignment is routed electronically to inspect the vehicle at a location of
the
customer’s choosing, or to dispatch a tow truck to bring a heavily damaged
vehicle to one of our Vehicle Inspection Centers. Mobile inspection and repair
services are available for minor damage. Our Direct Repair Program is a
particularly easy way to get repairs done, chosen by about 35% of our customers.
The Direct Repair Program (DRP) is a carefully selected network of approximately
200 repair shops that meet our high standards for service, work quality,
equipment and training. DRPs guarantee their repairs for as long as the claimant
owns their vehicle. Repairs at a DRP shop are scheduled electronically and
managed by the shop. Quality of the repairs and accuracy of the repair invoice
is closely monitored by a thorough re-inspection program by our staff who
regularly visit the DRP shops and re-inspect about 40% of the vehicles in
various stages of the repair process. By integrating technology with
personalized service, one call to 21st is all that is necessary to expedite
an
automobile damage claim.
______________________________
8
|
Represents
an overall measure of customer retention, including new customers
as well
as long-time customers. Retention rates for new customers typically
are
lower than for long-time customers.
|
9
|
Includes
PUP and motorcycle.
|
Another
customer-friendly policy feature of 21st Century Insurance is the inclusion
of
towing and roadside service with every policy. This service is handled by a
vendor providing 24 hour a day service for our customers throughout the United
States and Canada with just a toll free call.
At
the
center of our claim handling operation is our new claim system known as APS.
Deployed in August of 2004, APS has been used for all claims reported since
that
time, and over 90% of the Company’s pending claims are now on the new system.
Claims are automatically assigned to adjusters by the type of claim and handling
required. Our adjusters work in specialized areas that include liability and
damages investigations, material damage estimating, total loss evaluations,
litigation and subrogation. With APS, information is available seamlessly to
each of these specialties at all times. For example, an adjuster assigned to
contact the parties and investigate liability for an accident will view the
repair estimate and digital photos taken by the adjuster in the field. Documents
received in the mail such as medical bills or obtained over the web such as
police reports are scanned into the electronic claim file. This allows more
than
one person to work on aspects of the claim at the same time, communicate with
each other and, more importantly, with the customer about the claim. APS enables
any adjuster in any of our locations to provide service on any claim regardless
of where it occurred, reducing the need to maintain staff in every geographic
territory.
Litigation
can result when disputes of fact or damage arise among the people involved
in an
accident, and when they remain unresolved after discussion and negotiation.
Claim litigation usually involves personal injury claims made by third parties
against our insureds. It may also entail the arbitration of
uninsured/underinsured motorist claims by insureds. By providing a legal defense
of the policyholder faced with a lawsuit, we deliver another very important
part
of the insurance promise. In California, our house counsel handles over 90%
of
this litigation. Cases involving conflict or special circumstances may be
assigned to outside defense attorneys. Outside counsel is also used in states
other than California.
We
maintain a Special Investigations Unit (SIU) to investigate claims of a
suspicious nature. The SIU is also responsible for providing training to claims
and other employees on fraud detection. The SIU works closely with members
of
law enforcement, the Department of Insurance and the National Insurance Crime
Bureau. Our SIU is highly regarded in the insurance industry as being very
effective in its efforts to detect and deter fraud.
21st
settles many heavily damaged vehicle claims as total losses. As a part of the
settlement we may take title to the totaled vehicle and sell it as salvage.
An
outside salvage company conducts the auction and forwards the proceeds, less
their fee, as a recovery for 21st. Vehicles so severely damaged as to have
no
salvage value are crushed to prevent the vehicle identification number (VIN)
from being used for fraudulent purposes.
We
have
team members who specialize in subrogation, or the recovery of monies we have
paid on claims where a third party is legally responsible. We also aim to
recover the deductible for our insureds. Some collection efforts, particularly
those against uninsured motorists are outsourced to a collection vendor in
exchange for a contingency fee upon successful collection.
We
understand that the claim experience is a moment of truth for the customer
and
the customer’s decision to continue a relationship with us depends on that
experience. We deliver high quality claim service and we continuously seek
improvements in our processes.
Unpaid
Losses and Loss Adjustment Expenses
The
cost
to settle a customer’s claim includes two major components: losses and loss
adjustment expenses (“LAE”). Losses in connection with third party coverages
represent damages as a result of an insured’s act that results in property
damage or bodily injury. First party losses involve damage or injury to the
insured’s property or person. In either case, the ultimate cost of the loss is
not always immediately known and, over time, may be higher or lower than
initially estimated. When establishing initial and subsequent estimates, the
amount of loss is reduced for salvage (e.g., proceeds from the disposal of
the
wrecked automobile) and subrogation (e.g., proceeds from another party who
is
fully or partially liable, such as the insurer of the driver who caused the
accident involving one of our customers).
Loss
adjustment expenses represent the costs of adjusting, investigating and settling
claims, and are primarily comprised of the cost of our claims department,
external inspection services, and internal and external legal counsel. Corporate
support areas such as human resources, finance, and information technology
provide services to our overall operations, and, accordingly, a portion of
their
operational costs are also allocated to LAE. The LAE-allocable portion of such
corporate support cost is reviewed periodically as changes occur in our
organization. Based on these reviews, we modify the allocation percentages
as
appropriate. Such changes decreased our ratio of overhead LAE to earned premium
to 1.6% in 2005, from 1.7% in 2004 and 4.4% in 2003.
Accounting
for losses and LAE is highly subjective because these costs must be estimated
often weeks, months or even years in advance of when the payments are actually
made to claimants, attorneys, claims personnel and others involved in the claims
settlement process.
Accounting
principles require insurers to record estimates for losses and LAE in the
periods in which the insured events, such as automobile accidents, occur. This
estimation process requires us to estimate both the number of accidents that
have occurred (called “frequency”) and the ultimate amount of loss and LAE
(called “severity”) related to each accident. We employ actuaries who are
professionally trained and certified in the process of establishing estimates
for frequency and severity. Historically, our actuaries have not projected
a
range around the carried loss reserves and LAE. Rather, they have used several
methods and different underlying assumptions to produce a number of point
estimates for the required reserves. Management reviews the assumptions
underlying the loss and LAE ratios and selects the carried reserves after
carefully reviewing the appropriateness of the underlying
assumptions.
Estimating
the Frequency of Auto Accidents.
By
studying the historical lag between the actual date of loss and the date that
the accident is reported by the customer to the claims department, our actuaries
can make a reasonable, yet never perfect, estimate for the number of claims
that
ultimately will be reported for a given period. This measurement is referred
to
as frequency. The difference between the estimated ultimate number of claims
that will be made and the number that have actually been reported in any given
period is referred to as incurred but not reported (“IBNR”) claims.
Estimating
the Severity of Auto Claims.
For both
property damage and injury claims our adjusters determine what exposures exist
in open reserves. All property damage reserves and any injury reserves estimated
to be less than $15,000 are set at “average amounts” determined by our
actuaries. For both bodily injury and uninsured motorist claims estimated to
have value in excess of $15,000, adjusters in our claims department establish
loss estimates based upon various factors such as the extent of the injuries,
property damage sustained, and the age of the claim. Our actuaries review these
estimates, giving consideration to the adjusters’ historical ability to
accurately estimate the ultimate claim and length of time it will take to settle
the claim, and provide for development in the adjusters’ estimates as
applicable. Generally, the longer it takes to settle a claim, the higher the
ultimate claim cost. The ultimate amount of the loss is considered the
“severity” of the claim. In addition, the actuaries estimate the severity of the
IBNR claims.
The
severities are estimated by our actuaries each quarter based on historical
studies of average claim payments and the patterns of how the claims were paid.
Again, the fundamental assumption used in making these estimates is that past
events are reliable indicators of future outcomes.
Estimating
Losses and LAE for Lines in Runoff. While
the
personal auto lines represent our core business, we also have losses and LAE
relating to development on remaining loss reserves for homeowners and earthquake
lines. These lines are said to be “in runoff” because we no longer have policies
in force. As discussed in the Notes to Consolidated Financial Statements, we
have not written any earthquake policies since 1994 and we ceased writing
homeowners coverage at the beginning of 2002. Developing reserve estimates
for
the earthquake line is particularly subjective because most of the few remaining
earthquake claims are in litigation. Our actuaries evaluate the homeowners
reserve requirement on a quarterly basis, while personnel in our legal and
claims areas prepare quarterly evaluations of the earthquake
reserves.
Loss
and LAE Reserve Development
Management
believes that our reserves are adequate and represent our best estimate based
on
the information currently available. However, because reserve estimates are
necessarily subject to the outcome of future events, changes in estimates are
unavoidable in the property and casualty insurance business. These changes
sometimes are referred to as “loss development” or “reserve development.” See
Critical
Accounting Estimates - Losses and Loss Adjustment Expenses
for an
explanation of our reserve estimating process.
For
the
personal auto lines, our actuaries prepare a quarterly evaluation of loss and
LAE indications by accident year, and based on these evaluations, we assess
whether there is a need to adjust reserve estimates. As claims are reported
and
settled and as other new information becomes available, changes in estimates
are
made and are included in earnings of the period of the change.
The
changes in prior accident year estimates of losses and LAE incurred that we
recorded in each of the past five calendar years, net of reinsurance, are
summarized below:
AMOUNTS
IN THOUSANDS
|
Changes
in the Calendar Year of Prior
Accident
Year Estimates, Net of Reinsurance
|
|
Years
Ended December 31,
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
Personal
auto
|
|
$
|
(27,473
|
)
|
$
|
(2,936
|
)
|
$
|
11,159
|
|
$
|
16,200
|
|
$
|
45,742
|
|
Homeowner
and earthquake10
|
|
|
2,333
|
|
|
2,831
|
|
|
40,048
|
|
|
56,158
|
|
|
72,265
|
|
Total
|
|
$
|
(25,140
|
)
|
$
|
(105
|
)
|
$
|
51,207
|
|
$
|
72,358
|
|
$
|
118,007
|
|
Positive
amounts represent deficiencies in loss and LAE reserves, while negative amounts
represent redundancies.
To
understand these changes, it is useful to put them in the context of the
cumulative reserve development experienced by the Company over a longer time
frame. The tables on the following pages present the development of loss and
LAE
reserves for the personal auto lines (Table 1) and for the homeowner and
earthquake lines in runoff (Table 2), for the years 1995 through 2005. The
figures in both tables are shown gross of reinsurance.
In
Tables
1 and 2 on the following pages, a redundancy (deficiency) exists when the
original reserve estimate is greater (less) than the re-estimated reserves.
Each
amount in the tables includes the effects of all changes in amounts for prior
periods. The tables do not present accident year or policy year development
data. Conditions and trends that have affected the development of liabilities
in
the past may not necessarily occur in the future. Therefore, it would not be
appropriate to extrapolate future deficiencies or redundancies based on the
table. A detailed discussion of loss and LAE reserve development follows the
tables.
The
top
line of each table shows the reserves at the balance sheet date for each of
the
years indicated. The upper portion of the table indicates the cumulative amounts
paid as of subsequent year ends with respect to that reserve liability. The
lower portion of the table indicates the re-estimated amount of the previously
recorded reserves based on experience as of the end of each succeeding year,
including cumulative payments made since the end of the respective year. The
estimates change as more information becomes known about the frequency and
severity of claims for individual years.
______________________________
10
|
We
no longer have any homeowner policies in force. We ceased writing
earthquake coverage in 1994, but we have remaining loss reserves
from the
1994 Northridge earthquake. See further discussion in Item 7 under
the
captions Results
of Operations - Homeowner and Earthquake Lines in Runoff
Results, Critical
Accounting Estimates - Losses and Loss Adjustment
Expenses,
and Note 16 to the Notes to Consolidated Financial
Statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TABLE
1 - Auto Lines as of December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Amounts
in thousands, except claims)
|
|
1995
|
|
1996
|
|
1997
|
|
1998
|
|
1999
|
|
2000
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
for losses and LAE, direct
|
|
$
|
506,747
|
|
$
|
468,257
|
|
$
|
403,263
|
|
$
|
329,021
|
|
$
|
261,990
|
|
$
|
286,057
|
|
$
|
301,985
|
|
$
|
333,113
|
|
$
|
419,913
|
|
$
|
489,411
|
|
$
|
521,528
|
|
Paid
(cumulative) as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later
|
|
|
318,273
|
|
|
260,287
|
|
|
253,528
|
|
|
247,317
|
|
|
242,579
|
|
|
268,515
|
|
|
239,099
|
|
|
249,815
|
|
|
280,534
|
|
|
283,068
|
|
|
|
|
Two
years later
|
|
|
392,420
|
|
|
336,538
|
|
|
319,064
|
|
|
307,797
|
|
|
311,659
|
|
|
332,979
|
|
|
312,909
|
|
|
328,951
|
|
|
359,719
|
|
|
|
|
|
|
|
Three
years later
|
|
|
416,541
|
|
|
354,854
|
|
|
333,349
|
|
|
324,778
|
|
|
324,740
|
|
|
352,592
|
|
|
333,955
|
|
|
349,763
|
|
|
|
|
|
|
|
|
|
|
Four
years later
|
|
|
422,393
|
|
|
357,913
|
|
|
340,907
|
|
|
326,932
|
|
|
327,745
|
|
|
358,806
|
|
|
339,004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later
|
|
|
423,429
|
|
|
363,068
|
|
|
341,446
|
|
|
327,418
|
|
|
328,557
|
|
|
360,191
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later
|
|
|
427,723
|
|
|
362,824
|
|
|
341,374
|
|
|
327,162
|
|
|
328,359
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later
|
|
|
427,353
|
|
|
362,508
|
|
|
341,076
|
|
|
326,823
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later
|
|
|
427,059
|
|
|
362,216
|
|
|
340,772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later
|
|
|
426,844
|
|
|
361,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later
|
|
|
426,625
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
re-estimated as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later
|
|
|
440,158
|
|
|
365,566
|
|
|
359,262
|
|
|
313,192
|
|
|
309,953
|
|
|
352,709
|
|
|
323,791
|
|
|
348,865
|
|
|
417,225
|
|
|
462,682
|
|
|
|
|
Two
years later
|
|
|
424,091
|
|
|
366,858
|
|
|
337,258
|
|
|
321,711
|
|
|
340,914
|
|
|
354,720
|
|
|
338,338
|
|
|
354,784
|
|
|
407,344
|
|
|
|
|
|
|
|
Three
years later
|
|
|
425,404
|
|
|
359,925
|
|
|
335,246
|
|
|
341,695
|
|
|
328,190
|
|
|
361,264
|
|
|
339,965
|
|
|
360,308
|
|
|
|
|
|
|
|
|
|
|
Four
years later
|
|
|
424,643
|
|
|
357,607
|
|
|
355,605
|
|
|
326,506
|
|
|
329,182
|
|
|
361,068
|
|
|
342,321
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later
|
|
|
422,389
|
|
|
377,414
|
|
|
340,537
|
|
|
326,565
|
|
|
329,318
|
|
|
362,066
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later
|
|
|
442,024
|
|
|
361,980
|
|
|
340,552
|
|
|
327,626
|
|
|
329,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later
|
|
|
426,719
|
|
|
361,865
|
|
|
341,396
|
|
|
327,243
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later
|
|
|
426,636
|
|
|
362,541
|
|
|
340,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later
|
|
|
427,093
|
|
|
362,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later
|
|
|
426,625
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redundancy
(Deficiency)
|
|
$
|
80,122
|
|
$
|
106,215
|
|
$
|
62,296
|
|
$
|
1,778
|
|
$
|
(67,052
|
)
|
$
|
(76,009
|
)
|
$
|
(40,336
|
)
|
$
|
(27,195
|
)
|
$
|
12,569
|
|
$
|
26,729
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Auto Claims Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Claims
reported during the year for CA only
|
|
|
324,143
|
|
|
294,615
|
|
|
279,211
|
|
|
295,905
|
|
|
307,403
|
|
|
323,395
|
|
|
298,417
|
|
|
293,955
|
|
|
331,734
|
|
|
354,156
|
|
|
394,709
|
|
Claims
pending at year end for CA only
|
|
|
63,142
|
|
|
58,172
|
|
|
55,738
|
|
|
56,739
|
|
|
57,134
|
|
|
54,760
|
|
|
50,365
|
|
|
51,488
|
|
|
58,577
|
|
|
59,676
|
|
|
58,391
|
|
See
Note 8 of the Notes to Consolidated Financial Statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TABLE
2 - Homeowner and Earthquake Lines in Runoff as of December
31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Amounts
in thousands)
|
|
1995
|
|
1996
|
|
1997
|
|
1998
|
|
1999
|
|
2000
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
for losses and LAE, direct
|
|
$
|
78,087
|
|
$
|
75,272
|
|
$
|
34,624
|
|
$
|
52,982
|
|
$
|
14,258
|
|
$
|
12,379
|
|
$
|
47,305
|
|
$
|
50,896
|
|
$
|
18,410
|
|
$
|
6,131
|
|
$
|
2,307
|
|
Paid
(cumulative) as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later
|
|
|
55,738
|
|
|
75,100
|
|
|
30,232
|
|
|
48,848
|
|
|
13,103
|
|
|
30,706
|
|
|
58,274
|
|
|
71,147
|
|
|
16,277
|
|
|
6,498
|
|
|
|
|
Two
years later
|
|
|
119,211
|
|
|
100,296
|
|
|
74,127
|
|
|
58,281
|
|
|
37,404
|
|
|
78,647
|
|
|
125,447
|
|
|
87,343
|
|
|
22,775
|
|
|
|
|
|
|
|
Three
years later
|
|
|
139,792
|
|
|
142,850
|
|
|
82,974
|
|
|
81,887
|
|
|
83,985
|
|
|
143,564
|
|
|
140,742
|
|
|
93,828
|
|
|
|
|
|
|
|
|
|
|
Four
years later
|
|
|
180,799
|
|
|
151,342
|
|
|
106,274
|
|
|
128,266
|
|
|
147,856
|
|
|
157,792
|
|
|
147,101
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later
|
|
|
188,987
|
|
|
174,513
|
|
|
152,592
|
|
|
192,121
|
|
|
161,560
|
|
|
163,988
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later
|
|
|
211,771
|
|
|
220,805
|
|
|
216,383
|
|
|
205,591
|
|
|
167,615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later
|
|
|
257,839
|
|
|
284,455
|
|
|
229,808
|
|
|
211,431
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later
|
|
|
321,169
|
|
|
297,754
|
|
|
235,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later
|
|
|
334,053
|
|
|
303,591
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later
|
|
|
339,671
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
re-estimated as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later
|
|
|
116,741
|
|
|
101,903
|
|
|
77,445
|
|
|
58,582
|
|
|
18,024
|
|
|
68,245
|
|
|
103,470
|
|
|
89,281
|
|
|
22,406
|
|
|
8,805
|
|
|
|
|
Two
years later
|
|
|
142,071
|
|
|
145,635
|
|
|
82,716
|
|
|
61,393
|
|
|
72,546
|
|
|
121,176
|
|
|
142,211
|
|
|
93,388
|
|
|
25,081
|
|
|
|
|
|
|
|
Three
years later
|
|
|
182,616
|
|
|
150,434
|
|
|
85,519
|
|
|
116,429
|
|
|
125,089
|
|
|
159,331
|
|
|
146,152
|
|
|
96,054
|
|
|
|
|
|
|
|
|
|
|
Four
years later
|
|
|
186,631
|
|
|
153,521
|
|
|
140,532
|
|
|
169,157
|
|
|
163,045
|
|
|
162,998
|
|
|
148,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later
|
|
|
190,334
|
|
|
208,533
|
|
|
193,375
|
|
|
207,064
|
|
|
166,548
|
|
|
165,593
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later
|
|
|
245,267
|
|
|
261,389
|
|
|
231,217
|
|
|
210,486
|
|
|
168,994
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later
|
|
|
298,161
|
|
|
299,109
|
|
|
234,661
|
|
|
212,593
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later
|
|
|
335,657
|
|
|
302,550
|
|
|
236,776
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later
|
|
|
338,735
|
|
|
304,664
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later
|
|
|
340,622
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redundancy
(Deficiency)
|
|
$
|
(262,535
|
)
|
$
|
(229,392
|
)
|
$
|
(202,152
|
)
|
$
|
(159,611
|
)
|
$
|
(154,736
|
)
|
$
|
(153,214
|
)
|
$
|
(101,545
|
)
|
$
|
(45,158
|
)
|
$
|
(6,671
|
)
|
$
|
(2,674
|
)
|
|
|
|
See
Notes 8 and 16 of the Notes to Consolidated Financial
Statements.
Auto
Lines Reserve Development.
As shown
in the ten-year development table, our auto lines historically developed
redundancies prior to 1999 and exhibited adverse development for 1999 through
2002. Since 2003, there has been favorable development. The period from 1993
to
1999 was quite unusual in that, during that time, we experienced declining
frequencies and declining severities in our auto line. As Table 1 shows, we
did
not immediately have confidence in these declining trends and did not
immediately lower our reserve estimates.
Much
of
the decline in trend occurred between 1996 and 1998 because of moderation in
health care costs due to greater use of HMOs and laws that were enacted in
California that limited the ability of uninsured motorists and drunk drivers
to
collect non-economic damages. During 1999, we assumed that the past trend of
declining frequencies and severities would continue. However, in retrospect,
it
can now be seen that the favorable decline in trends ended and loss costs began
to increase. In 2000, we continued to assume lower loss severity primarily
because of what then seemed to be an acceleration in the pattern of claims
payments and the uncertainty inherent in identifying a change in multi-year
patterns. In 2001, we experienced significant, unexpected development in our
uninsured motorist coverage while the actuarial indications for most prior
accident years were adjusted upward as more data became available. The changes
in injury trends affected the entire California market and occurred, to a
greater or lesser degree, in virtually every state in the country.
Starting
in 2001, we improved the quality and timeliness of the data available to make
initial estimates and periodic changes in estimates. We have dedicated more
resources to better understand the underlying drivers of the changes in
frequency and severity trends as they begin emerging. For example, in the second
quarter of 2003 we began making accident month actuarial analyses of our
reserves for the auto lines. Our improved methodology is reflected in the small
favorable development of $2.9 million recorded in 2004 with respect to 2003
and
prior accident years and a larger favorable development of $27.5 million in
2005.
Homeowner
and Earthquake Lines in Runoff.
In
Table 2, substantially all of the development relates to the earthquake line.
A
major earthquake occurred on January 17, 1994, centered in the San Fernando
Valley community of Northridge (the “Northridge earthquake”). Through December
31, 2005, we have settled over 46,000 Northridge earthquake claims (including
auto claims) at a total cost (i.e., loss plus LAE) of over $1.2
billion.
The
loss
development in Table 2 is easiest to understand by dividing it into “pre-SB
1899” and “post-SB 1899” segments. In September 2000, the State of California
enacted Senate Bill 1899 (“SB 1899”), which allowed claims from the 1994
Northridge earthquake, barred by contract and the statute of limitations, to
be
reopened during calendar year 2001. The costs relating to the reopened claims
are displayed in the table as a 1994 event (since they all related to the
Northridge earthquake), even though the legislation allowing the re-opening
of
certain claims was not passed until almost seven years later. Before SB 1899
was
passed in late 2000, we had only approximately 50 earthquake claims remaining
to
be resolved out of an initial 35,000 homeowner earthquake claims. Although
we
settled 98% of the claims within a year of the earthquake, many upward changes
in estimates were required in 1994 and beyond as new information emerged on
the
severity of the damages and as settlements of litigated claims occurred. As
a
result, we recorded the following upward changes in loss estimates after 1994,
but before SB 1899 was adopted: 1995 - $57 million; 1996 - $40 million; 1997
-
$24.8 million; 1998 - $40 million; 1999 - $2.5 million; and 2000 - $3.5 million.
Calendar
year 2001 was the one-year window SB 1899 permitted for claimants to bring
additional insurance claims and legal actions allegedly arising out of the
Northridge earthquake. Prior to the enactment of this law, such claims were
considered by previously applicable law to be fully barred, or settled and
closed. Any additional legal actions with respect to such claims were barred
under the policy contracts, settlement agreements, and/or applicable statutes
of
limitation. As a result of the enactment of this unprecedented legislation,
claimants asserted additional claims against the Company allegedly related
to
damages that occurred in the Northridge earthquake, but which were now being
reported seven years later in 2001. Plaintiff attorneys and public adjusters
conducted extensive advertising campaigns to solicit claimants. Hundreds of
claims were filed in the final days and hours before the December 31, 2001
deadline.
During
2001, the Company recorded an additional $70.0 million of pre-tax losses related
to the Northridge earthquake, including $50.0 million in the fourth quarter
to
cover the indemnity and inspection portion of the claims. In the first two
quarters of 2002, we expensed an additional $11.9 million of legal defense
costs
as they were paid. The Company lacked sufficient information to record a
reasonable estimate of the related legal defense costs until the third quarter
of 2002, at which time an additional provision of $46.9 million was recorded.
Based on subsequent developments, we recorded additional provisions of $0.4
million, $2.2 million, and $37.0 million in the years 2005, 2004, and 2003,
respectively. See additional discussion in Note 16 of the Notes to Consolidated
Financial Statements.
Quarterly
our legal and claims personnel review the adequacy of the remaining SB 1899
reserves based on the most current information available. Based on that review,
we believe our remaining earthquake reserves are adequate as of December 31,
2005. More than ninety-nine percent of the claims submitted and litigation
brought against the Company as a result of SB 1899 have been resolved.
Substantially all of the Company’s remaining 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 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.
Reinsurance
A
reinsurance transaction occurs when an insurer transfers or cedes a portion
of
its exposure to a reinsurer for a premium. The reinsurance cession does not
legally discharge the insurer from its liability for a covered loss, but
provides for reimbursement from the reinsurer for the ceded portion of the
risk.
We monitor the appropriateness of our reinsurance arrangements to determine
that
our retention levels are reasonable and that our reinsurers are financially
sound, able to meet their obligations under the agreements and that the
contracts are competitively priced.
The
majority of our cessions are with AIG subsidiaries, which have earned A.M.
Best’s financial rating of A+. The A.M. Best financial ratings of our other
reinsurers range from A- to A+. Our reinsurance arrangements are discussed
in
more detail in Note 10 of the Notes to Consolidated Financial
Statements.
Our
net
retention of insurance risk after reinsurance for 2006 and the preceding five
years is summarized below:
|
|
Contracts
Incepting During
|
|
|
|
2006
|
2005
|
2004
|
2003
|
2002
|
2001
|
Auto
and motorcycle lines
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
97
|
%11 |
|
94
|
%
|
Personal
umbrella policies12
|
|
|
10
|
|
|
10
|
|
|
10
|
|
|
10
|
|
|
10
|
|
|
16
|
|
Homeowner
line in runoff
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
94
|
|
We
also
have catastrophe reinsurance agreements relating to the auto line, which
reinsure any covered events up to $45.0 million in excess of $20.0 million
($30.0 million in excess of $15.0 million prior to January 1,
2004).
State
Regulation of Insurance Companies
Insurance
companies are subject to regulation and supervision by the insurance departments
of the various states. The insurance departments have broad regulatory,
supervisory and administrative powers, such as:
·
|
Licensing
of insurance companies, claim adjusters, and agents;
|
·
|
Prior
approval, in California and some other jurisdictions, of premium
rates;
|
·
|
Establishment
of capital and surplus requirements and standards of
solvency;
|
·
|
Nature
of, and limitations on, investments insurers are allowed to
hold;
|
·
|
Periodic
examinations of the affairs of
insurers;
|
·
|
Annual
and other periodic reports of the financial condition and results
of
operations of insurers;
|
·
|
Establishment
of statutory accounting rules;
|
·
|
Issuance
of securities by insurers;
|
·
|
Restrictions
on payment of dividends; and
|
·
|
Restrictions
on transactions with affiliates.
|
Currently,
the California Department of Insurance (“CDI”) has primary regulatory
jurisdiction over two of our subsidiaries, 21st Century Insurance Company and
21st Century Casualty Company, including prior approval of premium rates. The
CDI typically conducts a financial examination of our affairs every three years.
The most recently completed triennial examination, for the three years ended
December 31, 2002, contained no findings or adjustments. In general, the current
regulatory requirements in the other states in which our subsidiaries are
licensed insurers are less restrictive than in California. 21st Century
Insurance Company of the Southwest (formerly 21st Century Insurance Company
of
Arizona) changed its state of domicile from Arizona to Texas effective December
31, 2004.
______________________________
11
|
Effective
September 1, 2002, we entered into an agreement to cancel future
cessions
under our quota share with AIG subsidiaries. The treaty would have
ceded
4% of premiums for the auto and motorcycle lines to AIG subsidiaries
in
the remainder of 2002 and would have declined to 2% in 2003. After
September 1, 2002, 100% of auto and motorcycle premiums are retained
by
the Company.
|
12
|
Personal
umbrella coverage is only available to our auto customers. Approximately
2% of auto customers have umbrella
coverage.
|
In
addition to regulation by the CDI, the Company and the personal lines insurance
business in general are also subject to legislative, judicial and political
action in addition to the normal business forces of competition between
companies and the choices consumers make based on their
preferences.
To
our
knowledge, no new laws were enacted in 2005 by any state in which we do business
that are expected to have a material impact on the auto insurance industry.
However, in December 2005, the California Commissioner began a regulatory
process that could ultimately result in regulations that would restrict the
use
of territory in automobile insurance rating. Such regulations, if implemented,
could negatively affect our book of business. Also in 2005, a series of
workshops were conducted by the CDI that could ultimately result in changes
to
regulations affecting the expense, investment income and profitability factors
used by the CDI in reviewing and approving insurers’ rates. Such regulations, if
implemented, may also negatively affect our California business.
Holding
Company Regulation
We
are
also subject to regulation by the CDI pursuant to the provisions of the
California Insurance Holding Company System Regulatory Act (the “Holding Company
Act”). Many transactions defined to be of an “extraordinary” nature may not be
effected without the prior approval of the CDI. In addition, the Holding Company
Act limits the amount of dividends our insurance subsidiaries may pay. An
extraordinary transaction includes a dividend which, together with other
dividends or distributions made within the preceding twelve months, exceeds
the
greater of (i) 10% of the insurance company’s policyholders’ surplus as of the
preceding December 31 or (ii) the insurance company’s statutory net income for
the preceding calendar year.
The
Company’s insurance subsidiaries currently have $704.7 million of statutory
surplus. Up to $113.0 million of this amount (the 2005 net income of the
Company’s primary insurance subsidiary) could be paid as dividends to the parent
company without prior written approval from insurance regulatory authorities
in
2006. Our insurance subsidiaries have not paid any dividends to our holding
company since 2001.
Involuntary
Business
All
50
states and the District of Columbia have established a mechanism to assure
that
automobile insurance is available to any consumer that otherwise would not
be
written voluntarily by the private market; this is called the involuntary or
residual market. These organizations are established by the respective state
regulators and administered by a governing board represented by insurance
companies and other representatives. The involuntary market consists of those
consumers who due to a variety of factors such as their driving record or status
of first-time drivers represent a high risk. Rates for the involuntary market
can be significantly higher than the voluntary market given the cost
expectations. The number of private passenger automobiles insured through the
involuntary market mechanisms is not distributed evenly among all the states.
Depending upon such factors as government regulations, the adequacy of pricing
of the involuntary market mechanisms, and industry competition, the size of
the
involuntary market varies dramatically from one state to another and over time.
Over
the
10-year period from 1994 to 2003, the involuntary market has decreased both
in
absolute and relative terms. The percentage of vehicles insured in the
involuntary market is declining in part because of sophisticated pricing models
which enable companies to appropriately price for a larger percentage of risks.
The
California Automobile Assigned Risk Plan (“CAARP”) is the involuntary private
passenger automobile market mechanism in California. The number of assignments
for each insurer is based on the total applications received by the plan and
the
insurer’s market share. As of December 31, 2005, the number of assigned risk
insured vehicles was 1,129 compared to 2,254 at the end of 2004. As of December
31, 2005, this business represented less than 1% of our total direct premiums
written. Underwriting profits were $1.0 million in 2005, compared to
underwriting losses of $0.9 million and $0.5 million in 2004 and 2003,
respectively.
Insurers
offering homeowner insurance in California are required to participate in the
California FAIR Plan (“FAIR Plan”). FAIR Plan is a state administered pool of
difficult-to-insure homeowners. Each participating insurer is allocated a
percentage of the total premiums written and losses incurred by the pool
according to its share of total homeowner direct premiums written in California.
Participation in FAIR Plan operations is based on
a company’s writings from two years prior. Since 21st 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. Our FAIR Plan underwriting results for 2004, 2003, and
2002
were immaterial.
Team
Members
The
Company employed approximately 2,600 full and part-time team members at December
31, 2005. We provide medical, pension and 401(k) savings plan benefits to
eligible team members, according to the provisions of each plan.
Debt
Offering
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.
Inaccuracies
in assumptions used in calculating reserve amounts could have a material adverse
impact on our net income.
The
reserves for losses and LAE that we have established are estimates of amounts
needed to pay reported and unreported claims and related expenses based on
facts
and circumstances known to us as of the time we established the reserves.
Reserves are based on historical claims information, industry statistics and
other factors. The establishment of appropriate reserves is an inherently
uncertain process. This uncertainty arises from a number of factors, including
the difficulty in predicting the number of claims that will ultimately occur,
the rate of inflation and the rate and direction of changes in loss payment
(severity) trends, interpretation of insurance policy provisions by courts,
inconsistent decisions in lawsuits regarding coverage and expanded theories
of
liability. In addition, changes in claims settlement practices can lead to
changes in loss payment patterns, which are used to estimate reserve levels.
There can be no assurance that our ultimate liability will not materially exceed
our reserves. See further discussion in Item
1. Business - Loss and Loss Reserve Development.
Our
earnings are influenced by our claims experience, which is subject to
significant potential variability due to a number of factors influencing claims
costs, which are not necessarily within our ability to control. If our future
claims experience does not match our pricing assumptions or past experience,
earnings could be materially adversely affected.
Our
earnings are significantly influenced by the claims paid under our insurance
contracts and will vary from period to period depending upon the amount of
claims incurred. In the event our future experience is worse than our pricing
assumptions or our past experience, our operating results could be materially
adversely affected.
Our
core business is in a highly competitive industry.
According
to A.M. Best, we were the seventh largest writer of personal automobile
insurance in California in 2004, with a 7% share of direct premiums written.
By
comparison, according to A.M. Best, State Farm Mutual Automobile Insurance
Company and Farmers Group, Inc. had shares of direct premiums written of 14%
and
10%, respectively, in 2004.
Our
business faces strong competition from other insurers. We compete for sales
of
all our products against larger competitors. Our ability to compete effectively
is affected by various factors, including, but not limited to:
|
·
|
perceived
financial strength and claims-paying
ability;
|
|
·
|
investment
performance;
|
|
·
|
size
and strength of the work force
capabilities;
|
The
level
of competition may also increase as a result of the continuing consolidation
of
the financial services industry. Mergers and acquisitions involving financial
services companies could increase, as companies seek to improve their
competitive position through increased market share, economies of scale and
diversification of products and services.
In
addition, the success of our growth strategy is dependent on our ability to
compete effectively in the new markets we enter. We may face particular
challenges in establishing brand name recognition with consumers in our new
markets and we cannot assure you that we will be able to compete
successfully.
Changes
in interest rates may negatively affect our earnings.
The
profitability of our insurance business is sensitive to interest rate changes.
In periods of increasing interest rates, our investment income rises, but
competitive pressures could contribute to narrower underwriting margins than
presently prevail in the California private passenger automobile insurance
market. In periods of decreasing interest rates, investment income is
diminished; there can be no assurance the California Department of Insurance
will grant premium rate increases that may be necessary to maintain rates of
return.
We
had
fixed-income investments with a market value of $1,354.7 million at December
31,
2005, that are subject to the following risks:
|
·
|
Bond
defaults and impairments. We
are exposed to the risk that issuers of bonds that we hold will not
pay
principal or interest when due. Increasing credit defaults and impairments
may result in write-downs in the value of bonds we hold. Credit rating
agencies have downgraded, and may in the future downgrade, certain
issuers
and fixed-income securities. At December 31, 2005, our bond portfolio,
with the exception of a single $2.5 million fair value security that
was
rated BBB- (from Ford Motor Credit Corporation), consisted of investment
grade securities. Widespread deterioration in the credit quality
of
issuers, changes in interest rate levels, and changes in interest
rate
spreads between types of investments, could materially impact the
value of
our invested assets and our
earnings.
|
|
·
|
Reinvestment
risk. We
are exposed to the risk that investments will be redeemed during
a period
of declining interest rates and that we will not be able to reinvest
the
proceeds in a comparable investment that provides a yield equal to
or
greater than the investment that was
redeemed.
|
|
·
|
Interest
rate and market risk. We
seek to maintain a proper amount of diversity and liquidity in our
investment portfolio; however, we cannot assure you that we will
be
successful in this regard. If our portfolio were to be impaired by
market
or issuer-specific conditions to a substantial degree, our liquidity,
financial position and financial results could be materially adversely
affected. Further, our income from these investments could be materially
reduced, and write-downs of the value of certain securities could
further
reduce our profitability. In addition, a decrease in the value of
our
investment portfolio could put our subsidiaries at risk of failing
to
satisfy regulatory capital requirements. If we were not at that time
able
to supplement our capital by issuing debt or equity securities on
acceptable terms, our ability to finance working capital or fund
growth
could be adversely affected. See
further discussion in
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk.
|
In
addition, the assets in our defined benefit pension plan are invested in a
combination of high credit quality fixed-income securities and equity
securities. Adverse changes in the equity markets, reductions in long-term
interest rates and defaults in the bond market could have a significant effect
on our earnings through increased pension costs. If the equity and fixed income
markets perform poorly, reducing the value of assets in the defined benefit
pension plan, we may incur additional funding costs.
A
significant ratings downgrade may have a material adverse effect on our
business.
Financial
strength and claims-paying ability ratings issued by firms such as Standard
& Poor’s, Fitch and A.M. Best have become an increasingly important factor
in establishing the competitive position of insurance companies. Rating agencies
assign ratings based upon their evaluations of an insurance company’s ability to
meet its financial obligations.
If
our
ratings were lowered significantly relative to those of our competitors, our
ability to market products to new customers and to renew the policies of current
customers could be harmed. A lowering of our ratings could also limit our access
to the capital markets or provide us with less than deserved pricing in the
capital markets. These events, in turn, could have a material adverse effect
on
our net income and liquidity.
The
insurance industry has been the target of litigation.
In
recent
years, insurance companies have been named as defendants in lawsuits including
class actions, relating to pricing, sales practices and practices in claims
handling, among other matters. A number of these lawsuits have resulted in
substantial jury awards or settlements involving other insurers. Future
litigation relating to these or other business practices may negatively affect
us by requiring us to pay substantial awards or settlements, increasing our
legal costs, diverting management attention from other business issues or
harming our reputation with customers.
Insurance
is a regulated industry.
Our
insurance subsidiaries are highly regulated and changes in these regulations
could negatively affect our business. Our
insurance company subsidiaries are subject to government regulation in their
states of domicile and also in each of the jurisdictions in which they are
licensed or authorized to do business. Governmental agencies have broad
administrative power to regulate many aspects of the insurance business,
including trade and claim practices, accounting methods, premium rates,
marketing practices, advertising, policy forms and capital adequacy. These
agencies are concerned primarily with the protection of policyholders rather
than shareholders or creditors. Moreover, insurance laws and regulations, among
other things:
|
·
|
establish
solvency requirements, including minimum reserves and capital and
surplus
requirements;
|
|
·
|
limit
the amount of dividends, intercompany loans and other intercompany
payments our insurance company subsidiaries can make without prior
regulatory approval;
|
|
·
|
impose
restrictions on the amounts and types of investments we may
hold;
|
|
·
|
promote
the protection of policyholders rather than security holders;
|
|
·
|
controls
the amount of losses in Involuntary Markets that companies must bear;
and
|
|
·
|
require
assessments to pay claims of insolvent insurance
companies.
|
Although
in the past years we have been successful in gaining regulatory approval for
rate increases, there can be no assurance that insurance regulators will grant
future rate increases which may be necessary to offset possible future increases
in claims cost trends. As a result of such uncertainties, underwriting losses
could occur in the future. Further, we could be required to liquidate
investments to pay claims, possibly during unfavorable market conditions, which
could lead to the realization of losses on sales of investments. Adverse
outcomes to any of the foregoing uncertainties would create some degree of
downward pressure on the insurance subsidiaries’ earnings or cash flows, which
in turn could negatively impact our liquidity.
In
some
states, notably California, the Commissioner of Insurance is an elected
official, adding yet an additional source of issues to the regulatory
agenda.
In
2002,
the California Department of Insurance (“CDI”) began hearings for the purpose of
implementing generic rating factors in connection with the Commissioner’s
authority to approve insurance rates. The draft regulations made public by
the
CDI incredulously focused on restricting an insurer’s rate of return rather than
on the price charged by the insurer to the consumer. We believe the adoption
of
such adverse regulations could negatively affect our profitability.
Fluctuations
in insurance industry results may affect our
business.
The
financial results of companies in the insurance industry have historically
been
subject to significant fluctuations due to competition, economic conditions,
interest rates, changes in tort laws, weather, regulatory changes, catastrophes
and other factors. Further, differences in the organizational structure of
competitors (i.e., public stock companies like Progressive, mutual companies
like State Farm, reciprocals like AAA of Southern California, and private stock
companies) create different financial objectives and attitudes among competitor
managements.
We
are primarily a personal automobile insurance carrier, and therefore our
business may be adversely affected by conditions in this
industry.
As
a
result of our focus on personal automobile insurance business, negative
developments in the economic, competitive or regulatory conditions affecting
the
personal automobile insurance industry could have a material adverse effect
on
our results of operations and financial condition. Factors that negatively
affect cost trends and our profitability include inflation in automobile repair
costs, automobile parts, used car prices and medical care costs. Increased
litigation of claims may also adversely affect loss costs. In addition, these
developments in the personal automobile insurance industry would have a
disproportionate affect on us, compared to insurers that are more diversified
across multiple business lines.
We
write a substantial portion of our business in California, and therefore our
business may be adversely affected by judicial, legislative, and, regulatory
decisions in California, in addition to civil unrest or natural
catastrophes.
Approximately
94% of our direct premiums written for the year ended December 31, 2005, were
generated in California. Our revenues and profitability are therefore subject
to
prevailing regulatory, economic, demographic, competitive and other conditions,
including catastrophic events, and adverse judicial and legislative decisions
in
California. Changes in any of these conditions or adverse legislation or
judicial decisions could make it more costly or difficult for us to conduct
our
business. In addition, these developments would have a disproportionate effect
on us, compared to insurers that do not have such a geographic concentration.
We
cannot assure you whether our growth strategy will be
effective.
Our
future financial performance and success are dependent in part upon our ability
to successfully implement our growth strategy. Implementation of our growth
strategy could be affected by a number of factors beyond our control, such
as
increased competition, judicial or legislative developments, general economic
conditions or increased operating costs. Any failure to successfully implement
our growth strategy could materially and adversely affect our financial
condition and results of operations. We cannot assure you that we will be able
to successfully implement our growth strategy or be able to improve our
operating results.
The
majority owner of our stock may take actions conflicting with your
interests.
The
majority owner has a history of being supportive of the Company, making a
capital contribution in 1994 that helped the Company recover from the financial
impact of the Northridge earthquake and in supporting the Company’s development
of systems and new markets. However, the majority owner of our common stock
can
control the outcome of stockholder votes. In addition, three of our ten
directors, including our Chairman, are officers and employees of the majority
holder or its subsidiaries. Through its majority ownership of our stock, the
majority holder can attempt to pursue actions contrary to our interests or
your
interests as a holder of our stock. The majority holder also may have an
interest in pursuing acquisitions, divestitures, financings or other
transactions that, in its judgment, could enhance its equity investment, even
though such transactions might involve risks to you, as holders of our stock.
In
addition, subsidiaries of the majority holder sell personal automobile insurance
policies in competition with us.
ITEM
1B. |
UNRESOLVED
STAFF
COMMENTS
|
None.
The
following table summarizes our properties as of December 31, 2005:
Purpose
|
Location
|
Approximate
Square Footage
|
Owned
or Leased
|
Headquarters
|
Woodland
Hills, CA
|
406,000
|
Leased
|
Claims
offices
|
Other
Southern California
|
154,000
|
Leased
|
Claims
offices
|
Northern
California
|
25,000
|
Leased
|
Claims
offices
|
Phoenix,
AZ
|
8,400
|
Leased
|
Office
|
Las
Vegas, NV
|
1,400
|
Leased
|
Service
Center
|
Lewisville,
TX
|
136,000
|
Owned
|
We
lease
office space for our headquarters facilities, which are located in Woodland
Hills, California. The lease term expires in February 2015 and the lease may
be
renewed for two consecutive five-year periods. We also lease office space in
14
other locations, 12 of which are in California primarily for claims-related
activities and for Vehicle Inspection Centers. We anticipate no difficulty
in
extending these leases or obtaining comparable office facilities in suitable
locations and consider our facilities to be adequate for our current
needs.
Our
newest location is a customer service, sales and claims center in Lewisville,
Texas. The Company began leasing this facility in mid-2004. On September 30,
2005, the Company exercised its option under the terms of its lease agreement
to
purchase the land and building that house this service center. See Note 7 of
the
Notes to Consolidated Financial Statements for additional
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 is a party is
contained in Note 12 of the Notes to Consolidated Financial Statements.
ITEM
4. |
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
No
matters were submitted to a vote of the Company’s security holders during the
fourth quarter of 2005.
PART
II
ITEM
5. |
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
|
(a)
|
Price
Range of Common Stock
|
The
Company’s common stock is listed on the New York Stock Exchange (“NYSE”) under
the ticker symbol “TW”. The following table sets forth the high and low bid
prices on the NYSE for our common stock for the indicated periods.
|
|
2005
|
2004
|
|
|
High
|
|
Low
|
|
High
|
|
Low
|
|
Fourth
Quarter
|
|
$
|
17.92
|
|
$
|
14.83
|
|
$
|
13.82
|
|
$
|
12.39
|
|
Third
Quarter
|
|
|
16.30
|
|
|
14.40
|
|
|
14.15
|
|
|
12.50
|
|
Second
Quarter
|
|
|
15.07
|
|
|
12.90
|
|
|
15.35
|
|
|
12.50
|
|
First
Quarter
|
|
|
14.35
|
|
|
13.00
|
|
|
14.90
|
|
|
13.19
|
|
(b)
|
Holders
of Common Stock
|
The
approximate number of holders of record of our common stock on February 3,
2006
was 500.
Quarterly
dividends of $0.04 per share were declared from the first quarter through
the
fourth quarter of 2005 and $0.02 per share were declared from the first quarter
through the fourth quarter of 2004. The Company’s Board of Directors considers a
variety of factors in determining the timing and amount of dividends.
Accordingly, the Company’s past history of dividend payments does not assure
that future dividends will be paid.
Our
insurance subsidiaries are subject to state laws that restrict their ability
to
distribute dividends. In 2006, the Company estimates that its largest insurance
subsidiary has capacity to pay approximately $113.0 million in dividends
to its
parent, before the effect of California state income taxes, without prior
approval of the California Department of Insurance. See Note 14 of the Notes
to
Consolidated Financial Statements as well as Liquidity
and Capital Resources
located
in Item
7 Management’s Discussion and Analysis of Financial Condition and Results of
Operations for
additional information.
The
following selected financial data for each of the years in the five-year period
ended December 31, 2005, should be read in conjunction with the Company’s
consolidated financial statements and the accompanying notes included in Item
8
of this report. All amounts set forth in the following tables are in thousands,
except for ratios and per share data.
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
Personal
Auto Lines Data
|
|
|
|
|
|
|
|
|
|
|
|
Direct
premiums written
|
|
$
|
1,346,371
|
|
$
|
1,337,190
|
|
$
|
1,223,377
|
|
$
|
995,794
|
|
$
|
898,862
|
|
Ceded
premiums written
|
|
|
(4,952
|
)
|
|
(4,815
|
)
|
|
(4,858
|
)
|
|
(18,902
|
)
|
|
(56,205
|
)
|
Net
premiums written
|
|
|
1,341,419
|
|
|
1,332,375
|
|
|
1,218,519
|
|
|
976,892
|
|
|
842,657
|
|
Net
premiums earned
|
|
|
1,352,928
|
|
|
1,313,551
|
|
|
1,172,679
|
|
|
924,559
|
|
|
838,489
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio
|
|
|
73.7
|
%
|
|
75.4
|
%
|
|
78.6
|
%
|
|
82.9
|
%
|
|
88.1
|
%
|
Underwriting
expense ratio
|
|
|
21.0
|
|
|
19.7
|
|
|
17.9
|
|
|
15.6
|
|
|
14.9
|
|
Combined
ratio13
|
|
|
94.7
|
%
|
|
95.1
|
%
|
|
96.5
|
%
|
|
98.5
|
%
|
|
103.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All
Lines Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
premiums written
|
|
$
|
1,346,370
|
|
$
|
1,337,198
|
|
$
|
1,223,484
|
|
$
|
998,248
|
|
$
|
929,315
|
|
Ceded
premiums written
|
|
|
(4,952
|
)
|
|
(4,814
|
)
|
|
(4,854
|
)
|
|
(32,949
|
)
|
|
(60,359
|
)
|
Net
premiums written
|
|
|
1,341,418
|
|
|
1,332,384
|
|
|
1,218,630
|
|
|
965,299
|
|
|
868,956
|
|
Net
premiums earned
|
|
|
1,352,937
|
|
|
1,313,670
|
|
|
1,172,677
|
|
|
924,559
|
|
|
864,145
|
|
Total
revenues
|
|
|
1,419,128
|
|
|
1,383,332
|
|
|
1,246,464
|
|
|
981,295
|
|
|
914,078
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio
|
|
|
73.8
|
%
|
|
75.6
|
%
|
|
82.0
|
%
|
|
89.4
|
%
|
|
96.7
|
%
|
Underwriting
expense ratio
|
|
|
21.1
|
|
|
19.7
|
|
|
17.9
|
|
|
15.5
|
|
|
15.0
|
|
Combined
ratio14
|
|
|
94.9
|
%
|
|
95.3
|
%
|
|
99.9
|
%
|
|
104.9
|
%
|
|
111.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income (Loss)
|
|
$
|
87,426
|
|
$
|
88,225
|
|
$
|
53,575
|
|
$
|
(12,256
|
)
|
$
|
(27,568
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
(Loss) per Share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
$
|
1.02
|
|
$
|
1.03
|
|
$
|
0.63
|
|
$
|
(0.14
|
)
|
$
|
(0.32
|
)
|
Dividends
declared per Share
|
|
|
0.16
|
|
|
0.08
|
|
|
0.08
|
|
|
0.26
|
|
|
0.32
|
|
The
decrease in premiums ceded from 2001 through 2003 was caused primarily by
scheduled decreases in the quota share program with certain AIG subsidiaries,
which was terminated effective September 1, 2002. The remainder of our
homeowners line was 100% reinsured in 2002. The loss and LAE ratios have
decreased since 2001 primarily due to increases in net premiums earned,
improvements in our pricing and underwriting methods and the favorable impact
of
declining frequency trends and moderate claim severity trends. The increase
in
the 2002 to 2005 expense ratios is primarily due to increased advertising
expenditures, increased costs for improving customer service and opening a
service center in Texas.
______________________________
13
|
The
combined ratio for the personal auto lines was impacted by the
following
items: $13.6 million of costs associated with workforce reductions
and the
settlement of litigation matters in 2001; and (favorable) unfavorable
prior accident year loss and LAE development of $(27.5) million,
$(2.9)
million, $11.2 million, $16.2 million, and $45.7 million in 2005,
2004,
2003, 2002, and 2001, respectively.
|
14
|
In
addition to the effect of the items described in Footnote 13 above,
the
combined ratio for all lines was impacted by adverse development
on
remaining loss reserves from the homeowner and earthquake lines,
which are
in runoff, of $2.3 million in 2005, $2.8 million in 2004, $40.2
million in
2003, $58.8 million in 2002, and $77.6 million in
2001.
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
Balance
Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
Total
investments and cash
|
|
$
|
1,470,742
|
|
$
|
1,418,912
|
|
$
|
1,284,686
|
|
$
|
1,030,478
|
|
$
|
884,633
|
|
Total
assets
|
|
|
1,920,229
|
|
|
1,864,314
|
|
|
1,738,132
|
|
|
1,470,037
|
|
|
1,354,398
|
|
Unpaid
losses and LAE
|
|
|
523,835
|
|
|
495,542
|
|
|
438,323
|
|
|
384,009
|
|
|
349,290
|
|
Unearned
premiums
|
|
|
319,676
|
|
|
331,036
|
|
|
312,254
|
|
|
266,477
|
|
|
236,473
|
|
Debt15
|
|
|
127,972
|
|
|
138,290
|
|
|
149,686
|
|
|
60,000
|
|
|
—
|
|
Total
liabilities
|
|
|
1,090,257
|
|
|
1,089,913
|
|
|
1,037,442
|
|
|
814,429
|
|
|
695,092
|
|
Stockholders’
equity
|
|
|
829,972
|
|
|
774,401
|
|
|
700,690
|
|
|
655,608
|
|
|
659,306
|
|
Book
value per common share
|
|
|
9.66
|
|
|
9.06
|
|
|
8.20
|
|
|
7.67
|
|
|
7.72
|
|
Statutory
surplus16
|
|
|
704,671
|
|
|
614,893
|
|
|
535,026
|
|
|
397,381
|
|
|
393,119
|
|
Net
premiums written to surplus ratio17
|
|
|
1.9:1
|
|
|
2.2:1
|
|
|
2.3:1
|
|
|
2.4:1
|
|
|
2.2:1
|
|
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
|
Overview
Founded
in 1958, 21st Century Insurance Group is a direct-to-consumer provider of
personal auto insurance in California, Texas, Illinois and six other states.
We
also provide motorcycle and personal umbrella insurance in California. We
deliver superior policy features and customer service at a competitive price.
We
began offering personal auto insurance in Illinois, Indiana and Ohio on January
28, 2004, and in Texas on January 3, 2005.
Our
long-term financial goals include achieving a 96% or lower combined ratio,
15%
annual growth in premiums written, 15% return on stockholders’ equity, and
strong financial ratings. Please refer to Item
1. Business
for
additional information on the Company’s long-term financial goals and a
discussion of insurance terminology used throughout this document.
For
2005,
our net premiums earned grew 3.0% ($39.2 million) to $1,352.9 million from
$1,313.7 million in 2004. California direct premiums written decreased by 2.2%
to $1,262.3 million in 2005, compared to $1,290.9 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 81.6% to
$84.1
million in 2005, compared to $46.3 million for the same period in 2004. We
plan
on expanding into six additional states in 2006 to further our geographic
expansion strategy.
Conversion
to our new computer platforms, known as APS, occurred as planned. The APS:Claims
component has a client-server architecture. The APS:Policy component has a
multi-tier system architecture featuring a web client, a middle tier services
layer and a real-time relational database back-end. The Claims component began
taking 100% of new claims in the third quarter of 2004. Over 90% of the
Company’s pending claims are now on the new system. We began writing new
California 21st Century Insurance Company personal auto policies on the system
in the first quarter of 2005 and completed the conversion of these in-force
policies in the fourth quarter of 2005. Underwriting expenses have been higher
than in prior periods due to costs associated with the conversion process,
the
training of service staff and the Company’s geographic expansion
efforts.
See
Results
of Operations
for more
details as to our overall and personal auto lines results.
______________________________
15
|
Amount
shown for 2002 is a capital lease obligation (see Note 9 of the
Notes to
Consolidated Financial Statements).
|
16
|
Amount
shown for 2002 would be $343,661 were it not for the sale-leaseback
transaction described in Note 9 of the Notes to Consolidated Financial
Statements.
|
17
|
Amount
shown for 2002 would be 2.8:1 were it not for the sale-leaseback
transaction referred to
above.
|
The
remainder of our Management’s Discussion and Analysis provides a narrative on
the Company’s financial condition and performance that should be read in
conjunction with the accompanying consolidated financial statements. It includes
the following sections:
·
|
Liquidity
and Capital Resources
|
·
|
Transactions
with Related Parties
|
·
|
Contractual
Obligations and Commitments
|
·
|
Off
Balance Sheet Arrangements
|
·
|
Critical
Accounting Estimates
|
·
|
Recent
Accounting Standards
|
·
|
Forward-Looking
Statements
|
Financial
Condition
Stockholders’
equity and book value per share increased to $830.0 million and $9.66,
respectively, at December 31, 2005, compared to $774.4 million and $9.06 at
December 31, 2004. The increase for the year ended December 31, 2005, was
primarily due to net income of $87.4 million and $4.7 million of proceeds from
exercised stock options, offset by a decrease in accumulated other comprehensive
income of $23.1 million (resulting primarily from increases in treasury yields)
and dividends to stockholders of $13.7 million.
Investments
and cash increased $51.8 million (3.7%) since the prior year primarily due
to
the $160.3 million of operating cash flow offset by cash outflows of $39.1
million for property and equipment, $35.3 million for net
unrealized losses due to changes in interest rates,
$13.7
million in shareholder dividends, $12.6 million in debt repayments, and $7.8
million net change in various other accounts.
Of
our
total investments at December 31, 2005, investments in tax-exempt, fixed-income
securities remained constant with December 31, 2004, at 22.3%. At December
31,
2005, investment-grade securities comprised substantially all of the fair value
of our investment portfolio. As of December 31, 2005, two investments were
rated
below investment grade. These securities represent 0.2% of our total
investments.
The
Company also has unrated, community investments representing 0.2% of total
investments. These investments have been made in an effort to provide housing
and other services to economically disadvantaged communities. See Note 19
of
the
Notes to Consolidated Financial Statements
for
additional information.
Increased
advertising, sales and customer service costs through December 31, 2005,
contributed to an increase in deferred policy acquisitions costs (“DPAC”) of
$1.1 million to $59.9 million, compared to $58.8 million at December 31, 2004.
The Company’s 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:
AMOUNTS
IN THOUSANDS
|
|
2005
|
|
2004
|
|
Years
Ended December 31,
|
|
Gross
|
|
Net
|
|
Gross
|
|
Net
|
|
Unpaid
losses and LAE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
$
|
521,528
|
|
$
|
516,849
|
|
$
|
489,411
|
|
$
|
485,759
|
|
Homeowner
and earthquake lines in runoff
|
|
|
2,307
|
|
|
1,368
|
|
|
6,131
|
|
|
5,138
|
|
Total
|
|
$
|
523,835
|
|
$
|
518,217
|
|
$
|
495,542
|
|
$
|
490,897
|
|
Gross
unpaid losses and LAE increased by $28.3 million in 2005 primarily due to a
reserve increase of $32.1 million in the personal auto lines as a result of
growth in our customer base. The increase in the personal auto lines was offset
by the $3.8 million net decrease in the homeowner and earthquake lines, which
are in runoff (see Critical
Accounting Estimates - Losses and Loss Adjustment Expenses for
a
description of the Company’s reserving process).
Unearned
premiums decreased 3.4% to $319.7 million at the end of 2005 compared to $331.0
million at the end of 2004 primarily due to a 2.9% decrease in premiums written
in the fourth quarter of 2005 as compared to the same period in
2004.
Debt
of
$128.0 million consists of $28.1 million of capital lease obligations and $99.9
million senior notes, net of discount (see Note 9 of the Notes to Consolidated
Financial Statements). The primary purpose
of the capital leases and senior note borrowings was to increase the statutory
surplus of 21st Century Insurance Company, our wholly-owned insurance
subsidiary, which had significant adverse earthquake and auto reserve
development in 2000, 2001, and 2002. The decrease in debt of $10.3 million
is
primarily attributable to principal payments on the capital leases.
Effective
December 4, 2003, we changed our state of incorporation from California to
Delaware. In connection with the change, our common stock was assigned a par
value of $0.001 per share, resulting in a reclassification of $419.9 million
from common stock to additional paid-in capital. There was no change in the
location of company operations, location of employees, or the way we do business
as a result of the reincorporation.
Liquidity
and Capital Resources
21st
Century Insurance Group.
Our
holding company’s main sources of liquidity historically have been dividends
received from our insurance subsidiaries and proceeds from issuance of debt
or
equity securities. Apart from the exercise of stock options and restricted
stock
grants to employees, the effects of which have not been significant, we have
not
issued any equity securities since 1998 when AIG exercised its warrants to
purchase common stock for cash of $145.6 million. Our insurance subsidiaries
have not paid any dividends to our holding company since 2001 due to the
previous uncertainty surrounding the taxability of dividends received by holding
companies from their insurance subsidiaries in California. See further
discussion in Note 5 of the Notes to Consolidated Financial
Statements.
In
December 2003, we completed a private offering of $100 million principal amount
of 5.9 percent Senior Notes due in December 2013. The effective interest rate
on
the Senior Notes, when all offering costs are taken into account and amortized
over the term of the Senior Notes, is approximately 6 percent per annum. Of
the
$99.2 million net proceeds from the offering, $85.0 million was used to increase
the statutory surplus of our wholly-owned insurance subsidiary, 21st Century
Insurance Company, and the balance was retained by our holding company. On
July
8, 2004, the Company completed an exchange offer in which all of the private
offering notes were exchanged for publicly registered notes having the same
terms.
Effective
December 31, 2003, the California Department of Insurance, approved an
intercompany lease whereby 21st Century Insurance Company leases certain
computer software from our holding company. The monthly lease payment, currently
$0.7 million, started in January 2004 and is subject to upward adjustment based
on the cost incurred by the holding company to enhance the software. On November
30, 2005, the CDI permitted an amendment to a term loan line that increased
the
available amount from $40 million to $150 million that our insurance subsidiary,
21st Century Insurance Company, can loan to our holding company. See further
information in Note B of the Notes to Condensed Financial Information of
Registrant.
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), ongoing costs to enhance our computer software, 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 $16.9 million
at December 31, 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. The
effective California state income tax rate applicable to any such dividends
paid
from our subsidiaries, if taxable, is approximately 1.8%. Our insurance
subsidiaries could pay $113.0 million in 2006 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
sixteen 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% of our premium is written, underwriting
profit improved in 2005 without additional rate increases. Effective October
23,
2005, we implemented 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.
As
of
December 31, 2005, our insurance subsidiaries had a combined statutory surplus
of $704.7 million compared to $614.9 million at December 31, 2004. The increase
in statutory surplus was primarily due to statutory net income of $113.5 million
offset by a decrease in net deferred tax assets of $17.2 million, an increase
in
nonadmitted assets of $5.4 million, and an
increase in net unrealized equity investment losses of $1.6 million.
The
ratio of net premiums written to statutory surplus was 1.9 at December 31,
2005,
compared to 2.2 at December 31, 2004.
Transactions
with Related Parties
Several
subsidiaries of AIG together own approximately 62% of our outstanding common
stock and three of the ten members of our Board of Directors are employees
of
AIG. Since 1995, the Company has entered into transactions with AIG
subsidiaries, including reinsurance agreements, insurance coverage contracts,
and various services.
Reinsurance
agreements -
The
Company’s catastrophe reinsurance agreement for its personal auto lines is
provided by three participating entities, two of which are AIG subsidiaries.
Together they reinsure any covered event up to $45.0 million in excess of $20.0
million effective January 1, 2004 (up to $30.0 million in excess of $15.0
million in 2003). This coverage was renewed effective January 1, 2005 and 2006
(see Note 10 of the Notes to Consolidated Financial Statements).
Total
premiums ceded to AIG subsidiaries were $1.0 million, $1.1 million, and $1.2
million for the years ended December 31, 2005, 2004, and 2003, respectively.
Total reinsurance recoverables, net of payables, from AIG subsidiaries were
$0.6
million and $1.5 million as of December 31, 2005 and 2004,
respectively.
Corporate
insurance coverage -
The
Company has obtained the following corporate insurance policies from AIG
subsidiaries:
|
·
|
Workers’
compensation insurance
|
|
·
|
General
liability insurance
|
|
·
|
Umbrella
excess insurance
|
|
·
|
Fiduciary
liability insurance
|
|
·
|
Employment
practices liability insurance
|
Errors
and omissions insurance was carried with AIG through September 30,
2005.
Insurance
expense attributable to AIG corporate insurance coverages was $2.9 million,
$3.5
million, and $1.3 million for 2005, 2004, and 2003, respectively.
Investment
management and investment accounting -
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. The fees are determined as a percentage
of
the average invested asset balance and are classified with net investment
income. This agreement was approved by the CDI. Investment management and
accounting expense was $0.9 million, $0.9 million, and $0.1 million in 2005,
2004 and 2003, respectively.
Software
and data processing -
Through
December 31, 2004, the Company utilized certain third party software and data
processing monitoring tools under an agreement negotiated by AIG. Since January
1, 2005, the Company has negotiated its own contracts, and no longer incurs
any
software or data processing costs with AIG subsidiaries. Charges by AIG for
software and data processing were $0.3 million in 2004 and 2003. There was
no
expense in 2005.
Contractual
Obligations and Commitments
We
have
various contractual obligations that are recorded as liabilities in our
consolidated financial statements. Certain contractual obligations, such as
operating lease obligations, are not recognized as liabilities in our
consolidated financial statements, but are required to be disclosed.
The
following table summarizes our significant contractual obligations and
commitments at December 31, 2005 and the future periods in which such
obligations are expected to be settled in cash. In addition, the table reflects
the timing of principal and interest payments on outstanding senior notes.
|
|
|
|
Payments
Due by Period
|
|
AMOUNTS
IN MILLIONS
|
|
Total
|
2006
|
2007
through 2008
|
2009
through 2010
|
Remaining
years after 2010
|
Senior
notes
|
|
$
|
147.2
|
|
$
|
5.9
|
|
$
|
11.8
|
|
$
|
11.8
|
|
$
|
117.7
|
|
Capital
lease obligations
|
|
|
29.8
|
|
|
14.8
|
|
|
14.9
|
|
|
0.1
|
|
|
—
|
|
Debt
|
|
|
177.0
|
|
|
20.7
|
|
|
26.7
|
|
|
11.9
|
|
|
117.7
|
|
Operating
leases18
|
|
|
165.5
|
|
|
27.7
|
|
|
37.9
|
|
|
33.0
|
|
|
66.9
|
|
Other
long-term commitments
|
|
|
2.1
|
|
|
0.4
|
|
|
1.2
|
|
|
0.4
|
|
|
0.1
|
|
Future
pension benefit payments19
|
|
|
68.6
|
|
|
3.1
|
|
|
7.2
|
|
|
9.1
|
|
|
49.2
|
|
Expected
loss and LAE payments, net of reinsurance
|
|
|
518.2
|
|
|
354.9
|
|
|
148.7
|
|
|
12.5
|
|
|
2.1
|
|
Total20
|
|
$
|
931.4
|
|
$
|
406.8
|
|
$
|
221.7
|
|
$
|
66.9
|
|
$
|
236.0
|
|
The
table
above excludes periodic contributions to pension plans, which are discussed
below. The capital lease obligations above resulted from the sale-leaseback
transaction discussed earlier and an auto capital lease transaction (see further
discussion of these items in Notes 9 and 12 of the Notes to Consolidated
Financial Statements). We have no material purchase obligations or other on
or
off balance sheet long-term liabilities or obligations at December 31, 2005
(see
discussion about variable interest entities in Note 19 of the Notes to
Consolidated Financial Statements).
Our
largest insurance subsidiary is responsible for making payments on both the
capital lease obligations and most of the operating lease obligations.
We
sponsor defined benefit pension plans that may obligate us to make contributions
to the plans from time to time. Total contributions to the plans were $9.0
million, $2.7 million and $7.0 million in 2005, 2004, and 2003, respectively.
For the past several years we have followed the practice of contributing
sufficient amounts to the qualified defined benefit pension plan to meet or
exceed statutory funding requirements, without exceeding the maximum amount
that
would be deductible for corporate income tax purposes, and while maintaining
plan assets at a level at least equal to the actuarial present value of
accumulated plan benefits. The amount and timing of future contributions to
our
qualified defined benefit pension plan depends on a number of unpredictable
factors including statutory funding requirements, the market performance of
the
plan’s assets, cash requirements for benefit payments to retirees, and future
changes in interest rates that affect the actuarial measurement of the plan’s
obligations. Contributions to our non-qualified defined benefit pension plan
generally are limited to amounts needed to make benefit payments to retirees,
which are expected to total approximately $0.9 million in 2006.
Off
Balance Sheet Arrangements
We
currently have no letters of credit, no trading activities involving
non-exchange-traded contracts accounted for at fair value, and no obligations
under any derivative financial instruments. In addition, the Company has no
material retained interests in assets transferred to any unconsolidated entity
(see further discussion in Note 2 of the Notes to Consolidated Financial
Statements). However, 21st Century Insurance Group has issued guarantees on
behalf of its insurance subsidiaries related to the capital lease obligations
described above.
The
Board
of our Company has made a commitment to invest a portion of policyholder surplus
in economically disadvantaged communities. In connection with this
commitment, the Company has guaranteed 11.1%, or $19.2 million, of a warehouse
financing agreement. The Company has also committed $2.8 million for other
community investment purposes. These commitments, which do not significantly
impact the Company’s liquidity or capital, are further discussed in Note 19 of
the Notes to Consolidated Financial Statements.
______________________________
18
|
Includes
amounts due under long-term software license agreements of approximately
$21.2 million.
|
19
|
Includes
benefit payments through 2015.
|
20
|
Purchase
commitments of $0.2 million were excluded from the summary, as
they are
not material.
|
Results
of Operations
Consolidated
Results.
The
following table summarizes the Company’s consolidated results of operations for
the years ended 2005, 2004, and 2003.
AMOUNTS
IN THOUSANDS, EXCEPT
SHARE DATA
|
|
Results
of Operations
|
|
Change
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
|
2005
|
2004
|
Direct
premiums written
|
|
$
|
1,346,370
|
|
$
|
1,337,198
|
|
$
|
1,223,484
|
|
|
0.7
|
%
|
|
9.3
|
%
|
Net
income
|
|
|
87,426
|
|
|
88,225
|
|
|
53,575
|
|
|
(0.9
|
)%
|
|
64.7
|
%
|
Diluted
earnings per share
|
|
|
1.02
|
|
|
1.03
|
|
|
0.63
|
|
|
(1.0
|
)%
|
|
63.5
|
%
|
The
2005
results include net realized capital losses of $3.3 million compared to net
realized capital gains of $10.8 million and $13.2 million for the same period
in
2004 and 2003, respectively. The results for 2004 include a $4.9 million
increase in income in the third quarter associated with the resolution of
California legislation (AB 263) related to holding company taxes on dividends
from insurance subsidiaries. The results for 2003 include after-tax charges
of
$24.1 million in the first quarter to strengthen earthquake reserves and an
increase in after-tax net income of $9.6 million in the second quarter,
resulting from nonrecurring, nonoperational items and a favorable tax settlement
with the IRS.
Personal
automobile insurance is our primary line of business. Vehicles insured outside
of California accounted for 6.2%, 3.5%, and 2.4% of our direct premiums written
in 2005, 2004 and 2003, respectively. This increase is
due to
our ongoing multi-state expansion program, which includes marketing in
non-California states. The Company currently plans to expand into six additional
states in 2006 to further its geographic expansion strategy.
Personal
Auto Lines Underwriting Results. The
following table presents the components of our personal auto lines underwriting
profit and the components of the combined ratio for the past three
years:
AMOUNTS
IN THOUSANDS
|
|
Personal
Auto Lines
|
|
%
Change
|
|
$
Change
|
|
%
Change
|
|
$
Change
|
|
Years
Ended December 31,
|
|
2005
|
|
2004
|
|
2003
|
|
’05
vs.‘04
|
|
’05
vs.‘04
|
|
’04
vs.‘03
|
|
’04
vs.‘03
|
|
Direct
premiums written
|
|
$
|
1,346,371
|
|
$
|
1,337,190
|
|
$
|
1,223,377
|
|
|
0.7%
|
|
$
|
9,181
|
|
|
9.3%
|
|
$
|
113,813
|
|
Net
premiums written
|
|
$
|
1,341,419
|
|
$
|
1,332,375
|
|
$
|
1,218,519
|
|
|
0.7%
|
|
$
|
9,044
|
|
|
9.3%
|
|
$
|
113,856
|
|
Net
premiums earned
|
|
$
|
1,352,928
|
|
$
|
1,313,551
|
|
$
|
1,172,679
|
|
|
3.0%
|
|
$
|
39,377
|
|
|
12.0%
|
|
$
|
140,872
|
|
Net
losses and LAE
|
|
|
996,599
|
|
|
991,008
|
|
|
922,122
|
|
|
0.6
|
|
|
5,591
|
|
|
7.5
|
|
|
68,886
|
|
Underwriting
expenses
|
|
|
284,334
|
|
|
258,571
|
|
|
209,551
|
|
|
10.0
|
|
|
25,763
|
|
|
23.4
|
|
|
49,020
|
|
Underwriting
profit
|
|
$
|
71,995
|
|
$
|
63,972
|
|
$
|
41,006
|
|
|
12.5%
|
|
$
|
8,023
|
|
|
56.0%
|
|
$
|
22,966
|
|
Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio
|
|
|
73.7
|
%
|
|
75.4
|
%
|
|
78.6
|
%
|
|
(1.7)%
|
|
|
|
|
|
(3.2)%
|
|
|
|
|
Underwriting
expense ratio
|
|
|
21.0
|
%
|
|
19.7
|
%
|
|
17.9
|
%
|
|
1.3%
|
|
|
|
|
|
1.8%
|
|
|
|
|
Combined
ratio
|
|
|
94.7
|
%
|
|
95.1
|
%
|
|
96.5
|
%
|
|
(0.4)%
|
|
|
|
|
|
(1.4)%
|
|
|
|
|
The
following table reconciles our personal auto lines underwriting profit to our
consolidated net income:
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Personal
auto lines underwriting profit
|
|
$
|
71,995
|
|
$
|
63,972
|
|
$
|
41,006
|
|
Homeowner
and earthquake lines in runoff, underwriting loss
|
|
|
(2,325
|
)
|
|
(2,714
|
)
|
|
(40,175
|
)
|
Net
investment income
|
|
|
69,096
|
|
|
58,831
|
|
|
45,833
|
|
Realized
investment (losses) gains
|
|
|
(3,272
|
)
|
|
10,831
|
|
|
13,177
|
|
Other
income
|
|
|
367
|
|
|
―
|
|
|
14,777
|
|
Other
expense
|
|
|
(410
|
)
|
|
―
|
|
|
―
|
|
Interest
and fees expense
|
|
|
(8,019
|
)
|
|
(8,627
|
)
|
|
(3,471
|
)
|
Provision
for income taxes
|
|
|
(40,006
|
)
|
|
(34,068
|
)
|
|
(17,572
|
)
|
Net
income
|
|
$
|
87,426
|
|
$
|
88,225
|
|
$
|
53,575
|
|
We
remain
focused on achieving our long-term goals of a combined ratio of 96% or lower
and
15% growth in direct premiums written. Direct premiums written increased 0.7%
in
2005, 9.3% in 2004 and 22.8% in 2003, for a three-year compound average growth
rate of 10.9%; less than our long-term goal of 15%. Market conditions in
California were somewhat less favorable for growth in 2005 than in the preceding
two years. In 2005 and 2004, we met our profitability goals, posting our best
combined ratios since 1999 and our direct premiums written grew 9.3% despite
an
increasingly competitive California marketing climate. As we proceed with our
multi-state expansion, we believe that achieving our long-term growth goal
will
steadily depend less on the California marketplace.
Net
premiums earned increased 3.0% in 2005, compared to a 12.0% increase in 2004
and
26.8% in 2003. These earned premium increases are consistent with the direct
premium written increases during the same years of 0.7%, 9.3% and 22.8%,
respectively. The Company has undertaken several geographic expansion efforts
to
increase its opportunities for growth.
Net
losses and LAE incurred increased 0.6% in 2005, 7.5% in 2004 and 20.0% in 2003.
The loss and LAE ratios were 73.7%, 75.4%, and 78.6% for the years ended
December 31, 2005, 2004 and 2003, respectively. The effects on the net loss
and
LAE ratios of changes in estimates relating to insured events of prior years
were as follows: 2.0% favorable in 2005, 0.2% favorable in 2004; 1.0%
unfavorable in 2003; and 1.8% unfavorable in 2002. For additional discussion
of
these estimates, please see Item 1 of this report under the heading Unpaid
Losses and Loss Adjustment Expenses.
In
general, changes in estimates are recorded in the period in which new
information becomes available indicating that a change is warranted, usually
in
conjunction with our quarterly actuarial review.
The
following table summarizes personal auto lines losses and LAE incurred, net
of
applicable reinsurance, for the periods indicated:
AMOUNTS
IN THOUSANDS
|
|
Personal
Auto Lines
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Net
losses and LAE:
|
|
|
|
|
|
|
|
|
|
|
Current
accident year
|
|
$
|
1,024,073
|
|
$
|
993,946
|
|
$
|
911,104
|
|
Prior
accident years
|
|
|
(27,473
|
)
|
|
(2,936
|
)
|
|
11,159
|
|
Total
net losses and LAE
|
|
$
|
996,600
|
|
$
|
991,010
|
|
$
|
922,263
|
|
The
underwriting expense ratios to net premiums earned were 21.0%, 19.7%, and 17.9%
for the years ended December 31, 2005, 2004 and 2003, respectively. The 2005
increase was primarily due to our investments in the geographic expansion
strategy, costs associated with the conversion to our new technology platform,
and facility and support costs. The increase in 2004 consists primarily of
increased advertising costs, additional sales workforce costs, and facility
and
support costs to improve service and support the Texas service center. The
increase in 2003 was primarily due to growth in advertising expenditures and
costs associated with increasing the number of new sales agents to handle record
volume of new business during 2003. Several productivity enhancement initiatives
are underway aimed at reducing per unit processing costs.
The
combined ratio was 94.7% for the year ended December 31, 2005, compared to
95.1%
and 96.5% for 2004 and 2003, respectively. The decrease was mainly due to
favorable prior accident year loss and LAE development of $27.5 million and
$2.9
million in 2005 and 2004, respectively, and unfavorable prior accident year
loss
and LAE development of $11.2 million in 2003.
Homeowner
and Earthquake Lines in Runoff Results. We
have
not written any earthquake policies since 1994 and we ceased underwriting the
homeowners coverage at the beginning of 2002. The homeowner and earthquake
lines, which are in runoff, experienced adverse development of $2.3 million
in
2005 on the remaining loss and LAE reserves, compared to adverse development
of
$2.8 million in 2004 and $40.1 million in 2003. Of these amounts, $0.4 million,
$2.2 million, and $37.0 million, respectively, related to SB 1899 earthquake
claims (see Note 16 of the Notes to Consolidated Financial
Statements).
We
have
executed various transactions to exit from our homeowner line. Under a January
1, 2002 agreement with Balboa Insurance Company (“Balboa”), a subsidiary of
Countrywide Financial Corporation (“Countrywide”), 100% of homeowner unearned
premium reserves and losses on or after that date were ceded to Balboa. Under
the terms of this agreement, we retain certain loss adjustment expenses. We
began non-renewing homeowner policies expiring on February 21, 2002, and
thereafter. Substantially all of these customers were offered homeowner coverage
through an affiliate of Countrywide. We have completed this process and no
longer have any homeowner policies in force.
The
following table summarizes homeowner and earthquake lines losses and LAE
incurred, net of applicable reinsurance, for the periods indicated:
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Net
losses and LAE:
|
|
|
|
|
|
|
|
|
|
|
Current
accident year
|
|
$
|
―
|
|
$
|
2
|
|
$
|
141
|
|
Prior
accident years
|
|
|
2,333
|
|
|
2,831
|
|
|
40,048
|
|
Total
net losses and LAE
|
|
$
|
2,333
|
|
$
|
2,833
|
|
$
|
40,189
|
|
Net
Investment Income.
We
utilize a conservative investment philosophy. No derivatives or nontraditional
securities are held in our investment portfolio and only 3.4% of the portfolio
consists of equity securities. Substantially the entire fixed maturity portfolio
is investment grade. Net investment income was $69.1 million, $58.8 million
and
$45.8 million for the years ended 2005, 2004, and 2003, respectively. Average
invested assets increased 8.8%, 23.2% and 17.9% for the years ended 2005, 2004,
and 2003, respectively.
The
average annual yields on invested assets for the periods indicated were as
follows:
|
|
Annual Yield on Invested Assets
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Pre-tax
|
|
|
4.8
|
%
|
|
4.4
|
%
|
|
4.2
|
%
|
After-tax
|
|
|
3.5
|
%
|
|
3.3
|
%
|
|
3.6
|
%
|
At
December 31, 2005, $313.0 million, or 23.1%, of our total fixed maturity
investments at fair value were invested in tax-exempt bonds, compared to 22.3%
at December 31, 2004, with the remainder, representing 76.9% of the portfolio,
invested in taxable securities, compared to 77.7% at December 31,
2004.
The
net
realized gains (losses) on the sale of investments were as follows:
AMOUNTS
IN THOUSANDS
|
|
Net Realized Gains (Losses) on Sale of
Investments
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Gross
realized gains
|
|
$
|
6,574
|
|
$
|
14,145
|
|
$
|
13,715
|
|
Gross
realized losses
|
|
|
(9,482
|
)
|
|
(2,465
|
)
|
|
(382
|
)
|
Net
realized (losses) gains
|
|
$
|
(2,908
|
)
|
$
|
11,680
|
|
$
|
13,333
|
|
Our
policy is to evaluate, on a quarterly basis, all investments for
“other-than-temporary” impairment when the fair value of a security falls below
its cost or amortized cost, based on all relevant facts and circumstances.
No
such impairments were recorded in 2005, 2004, or 2003 (see discussion under
Critical
Accounting Estimates - Investments).
Other
Income.
Other
income of $0.4 million in 2005 relates to interest income for refund claims
with
the taxing authorities. No other income was reported in 2004. Other income
of
$14.8 million in the year ended December 31, 2003, included $9.3 million
resulting from a nonrecurring, nonoperational item from the settlement of
litigation, interest income of $4.8 million relating to a favorable settlement
with the Internal Revenue Service (“IRS”), and miscellaneous items of $0.7
million.
Pension
Cost. 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. Expense recognition under the pension accounting rules is
based
upon the attribution of plan benefits over the expected life of the Company's
workforce. Pension
plan costs remained relatively constant at $8.9 million and $9.0 million for
the
years ended 2005 and 2004, respectively. The weighted average discount rate
assumption used to determine the net cost decreased to 6.0% from 6.1% for the
years ended 2005 and 2004, respectively.
Based
on
current assumptions, the Company does not expect to be required to contribute
to
its qualified pension plan in 2006, but it may make additional contributions
into its pension plans in fiscal 2006 and subsequent years depending on how
the
funded status of those plans change and also depending on the outcome of
proposed changes to the funding regulations currently being considered by the
United States Congress. Our nonqualified pension plan has an unfunded
accumulated benefit obligation of $16.5 million. In this situation, the
accounting rules require that we record an additional minimum pension liability.
The additional minimum pension liability adjustment was $4.2 million and $3.3
million as of December 31, 2005 and 2004, respectively. The increase in the
additional minimum pension liability in fiscal 2005 was primarily due to the
decrease in the discount rate from 6.0% at December 31, 2004, to 5.7% at
December 31, 2005. The accounting rules do not require that changes in the
additional minimum pension liability adjustment be recorded in current period
earnings, but rather they are recorded directly to equity through accumulated
other comprehensive income. See Note 11 to the Consolidated Financial Statements
for further discussion.
Other
Expenses.
In
November 2005, the Company vacated approximately 2% of rentable space at its
headquarters in Woodland Hills, California and plans to sublease this space.
A
loss on this vacated space has been recognized totaling $0.4 million, as future
rental costs are higher than potential market rentals.
Critical
Accounting Estimates
Our
consolidated financial statements are prepared in accordance with GAAP. The
financial information contained within these statements is, to a significant
extent, financial information that is based on estimates and assumptions. Our
significant accounting policies are described in Note 2 of the Notes to
Consolidated Financial Statements and are essential to understanding
Management’s Discussion and Analysis of Financial Condition and Results of
Operations. Some of our accounting policies require significant judgment to
estimate values of either assets or liabilities. In addition, significant
judgment may be needed to apply what often are complex accounting principles
to
individual transactions to determine the most appropriate treatment. We have
established procedures and processes to facilitate making the judgments
necessary to prepare the consolidated 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, 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.
The
methods used to determine such estimates and to establish the resulting reserves
are continually reviewed and updated. Any resulting adjustments are reflected
in
current operating income 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.
It
is
management’s belief that the reserves for losses and LAE are adequate to cover
unpaid losses and LAE as of December 31, 2005. While we perform quarterly
reviews of the adequacy of established unpaid losses and LAE reserves, there
can
be no assurance that our ultimate unpaid losses and LAE will not develop
redundancies or deficiencies and possibly differ materially from our unpaid
losses and LAE as of December 31, 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 changes to unpaid losses and LAE begins with the preparation
of several point estimates, a review of the actual claims experience, 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, and severity triangles, as well as expected
loss ratio methods. Quantitative techniques frequently have to be supplemented
by subjective consideration, including managerial judgment, to assure 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 which
are
based upon past loss experience. Thus, many factors are implicitly considered
in
estimating the loss costs recognized.
Judgment
is required in analyzing the appropriateness of the various methods and factors
to avoid overreacting to data anomalies that may distort such prior trends.
For
example, changes in limits distributions or development in the most recent
accident quarters would require more actuarial judgment. We do not believe
disclosure of specific point estimates calculated by the actuaries would be
meaningful. Any one actuarial point estimate is based on a particular series
of
judgments and assumptions of the actuary. Another actuary may make different
assumptions, and therefore reach a different point estimate.
There
is
a potential for significant variation in ultimate development of unpaid losses
and LAE. Most automobile claims are reported within two to three months whereas
the estimate of ultimate severities exhibits greater variability at the same
maturity. Generally, actual historical loss development factors are used to
project future loss development, and there can be no assurance that future
loss
development patterns will be the same as in the past. However, we believe that
our reserving methodologies are in line with other personal lines insurers
and
would normally expect ultimate unpaid losses and LAE development to vary
approximately 5% from the carried unpaid losses and LAE.
The
Company has experienced changes in the mix of business and policy limits. We
believe that the assumption with the highest likelihood of change that could
materially affect carried unpaid losses and LAE is the estimate of the frequency
of unpaid bodily injury claims. The Company has experienced approximately 12%
lower bodily injury claim frequency over the past 3 years in California. A
5%
change in the estimate of the frequency of unpaid bodily injury claims would
result in an approximate increase or decrease in total unpaid losses and LAE
of
2.8%, or $14.7 million.
Property
and Equipment.
Accounting standards require a write-off to be recognized when an asset is
vacated or an asset group’s carrying value exceeds its fair value. For purposes
of recognition and measurement of an impairment loss, long-lived 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 the asset group
for
impairment.
Income
Taxes.
Determining the consolidated provision for income tax expense, deferred tax
assets and liabilities and any related valuation allowance involves judgment.
GAAP require deferred tax assets and liabilities (“DTAs” and “DTLs,”
respectively) to be recognized for the estimated future tax effects attributed
to temporary differences and carryforwards based on provisions of the enacted
tax law. The effects of future changes in tax laws or rates are not anticipated.
Temporary differences are differences between the tax basis of an asset or
liability and its reported amount in the consolidated financial statements.
For
example, we have a DTA because the tax bases of our loss and LAE reserves are
smaller than their book bases. Similarly, we have a DTL because the book basis
of our capitalized software exceeds its tax basis. Carryforwards include such
items as alternative minimum tax credits, which may be carried forward
indefinitely, and net operating losses (“NOLs”), which can be carried forward 15
years for losses incurred before 1998 and 20 years thereafter. A summary of
the
significant DTAs and DTLs relating to the Company’s temporary differences and
carryforwards is included in Note 5 of the Notes to Consolidated Financial
Statements.
At
December 31, 2005, our DTAs total $128.5 million and our DTLs total $72.3
million. The net of those amounts, $56.2 million, represents the net deferred
tax asset reported in the consolidated balance sheet. At
December 31, 2004, our DTAs total $136.7 million and our DTLs total $80.6
million. The net of those amounts, $56.1 million, represents the net deferred
tax asset reported in the consolidated balance sheet.
We
are
required to reduce DTAs (but not DTLs) by a valuation allowance to the extent
that, based on the weight of available evidence, it is “more likely than not”
(i.e., a likelihood of more than 50%) that any DTAs will not be realized.
Recognition of a valuation allowance would decrease reported earnings on a
dollar-for-dollar basis in the year in which any such recognition were to occur.
The determination of whether a valuation allowance is appropriate requires
the
exercise of management judgment. In making this judgment, management is required
to weigh the positive and negative evidence as to the likelihood that the DTAs
will be realized.
The
Company’s net deferred tax assets include a net operating loss (“NOL”)
carryforward for regular federal corporate tax purposes of approximately $95.9
million, representing an unrealized tax benefit of $33.6 million at December
31,
2005, compared to $75.8 million, $105.3 million and $128.6 million as of the
end
of the three preceding years. The steady decline in the unrealized tax benefit
of the NOL since 2002 resulted from the generation of taxable underwriting
and
investment income in the intervening years. At the current rate of utilization,
the Company’s remaining NOL excluding 21st of Southwest should be fully utilized
by the end of 2007, but in any event long before its statutory expiration.
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
Southwest
|
SRLY21
NOL of 21st
of
Southwest
|
Consolidated
NOL
|
2017
|
|
$
|
―
|
|
$
|
1,596
|
|
$
|
1,596
|
|
2018
|
|
|
―
|
|
|
1,068
|
|
|
1,068
|
|
2019
|
|
|
―
|
|
|
1,466
|
|
|
1,466
|
|
2020
|
|
|
―
|
|
|
3,172
|
|
|
3,172
|
|
2021
|
|
|
49,149
|
|
|
2,180
|
|
|
51,329
|
|
2022
|
|
|
37,316
|
|
|
―
|
|
|
37,316
|
|
Totals
|
|
$
|
86,465
|
|
$
|
9,482
|
|
$
|
95,947
|
|
Our
ability to fully utilize the remaining NOL depends on future taxable income
either from continued operating profitability or from tax planning strategies
we
could implement, such as increasing the taxable portion of our investment
portfolio. Because of the Company’s history of profitability over the past three
years, management
believes it is reasonable to expect future underwriting profits and to conclude
it is at least more likely than not that we will be able to realize the benefits
of all of our DTAs, including our NOL. Accordingly, no valuation allowance
has
been recognized as of December 31, 2005 and 2004. However, generating future
taxable income is dependent on a number of factors, including regulatory and
competitive influences that may be beyond our ability to control. Future
underwriting losses could possibly jeopardize our ability to utilize our NOLs.
In the event adverse development or underwriting losses due to either SB 1899
matters or other causes were to occur, management might be required to reach
a
different conclusion about the realization of the DTAs and, if so, recognize
a
valuation allowance at that time.
______________________________
21
|
“SRLY”
stands for Separate Return Limitation Year. Under the Federal tax
code,
only future income generated by 21st of Southwest may be utilized
against
this portion of our NOL.
|
Deferred
Policy Acquisition Costs.
Deferred policy acquisition costs (“DPAC”) 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 DPAC 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 that these costs are fully recoverable
as of December 31, 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.
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 at inception 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. The cost of investment securities sold is determined by the specific
identification method.
We
are
obligated to assess, at each reporting date, whether there is an
“other-than-temporary” impairment to our investment securities. In general, a
security is considered a candidate for impairment if it meets any of the
following criteria:
|
·
|
Trading
at a significant (25 percent or more) discount to par, amortized cost
(if lower) or cost for an extended period of time (nine months or
longer);
|
|
·
|
The
occurrence of a discrete credit event resulting in (i) the
issuer defaulting on a material outstanding obligation; or (ii) the
issuer seeking protection from creditors under the bankruptcy laws
or any
similar laws intended for the court supervised reorganization of
insolvent
enterprises; or (iii) the
issuer proposing a voluntary reorganization pursuant to which creditors
are asked to exchange their claims for cash or securities having
a fair
value substantially lower than par value of their claims;
or
|
|
·
|
In
the opinion of the Company’s management, it is possible that the Company
may not realize a full recovery on its investment, irrespective of
the
occurrence of one of the foregoing
events.
|
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, such as when it is
determined that an issuer is unable to repay the entire principal, a charge
is
required to be reflected in income for the difference between cost or amortized
cost and the fair value.
The
determination of whether a decline in market value is “other-than-temporary” is
necessarily a matter of subjective judgment. No such charges were recorded
in
2005, 2004 or 2003. 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
following is a summary by issuer of non-investment grade securities and unrated
securities held (at fair value):
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
December
31,
|
|
2005
|
2004
|
Non-investment
grade fixed maturity securities (i.e., rated below BBB-):
|
|
|
|
|
|
Ford
Motor Credit Company22
|
|
$
|
2,495
|
|
$
|
―
|
|
Non-investment
grade equity securities:
|
|
|
|
|
|
|
|
AmerUs
Group Co.
|
|
|
864
|
|
|
―
|
|
Unrated
securities:
|
|
|
|
|
|
|
|
Impact
Community Capital, LLC23
|
|
|
2,023
|
|
|
2,023
|
|
Impact
Healthcare, LLC
|
|
|
413
|
|
|
―
|
|
Total
non-investment grade and unrated securities24
|
|
$
|
5,795
|
|
$
|
2,023
|
|
|
|
|
|
|
|
|
|
Percentage
of total investments, at fair value
|
|
|
0.4
|
%
|
|
0.1
|
%
|
The
following table summarizes realized gains and losses for the past three years.
Additional information has been provided with respect to how long investments
that were sold at a loss in each year were in an unrealized loss
position.
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Realized
losses on sales of investments:
|
|
|
|
|
|
|
|
Held
for less than one year
|
|
$
|
(8,371
|
)
|
$
|
(1,062
|
)
|
$
|
(229
|
)
|
Held
one year or more
|
|
|
|
|
|
|
|
|
|
|
In
an unrealized loss position at December 31, 2004
|
|
|
(13
|
)
|
|
―
|
|
|
―
|
|
In
an unrealized loss position at December 31, 2003
|
|
|
―
|
|
|
(1,251
|
)
|
|
―
|
|
In
an unrealized loss position at December 31, 2002
|
|
|
(646
|
)
|
|
(19
|
)
|
|
(148
|
)
|
In
an unrealized gain position at December 31, 2004
|
|
|
(114
|
)
|
|
―
|
|
|
―
|
|
In
an unrealized gain position at December 31, 2003
|
|
|
(323
|
)
|
|
(133
|
)
|
|
―
|
|
In
an unrealized gain position at December 31, 2002
|
|
|
(15
|
)
|
|
―
|
|
|
(5
|
)
|
Total
realized losses on sales of investments held one year or more25
|
|
|
(1,111
|
)
|
|
(1,403
|
)
|
|
(153
|
)
|
Total
realized losses on sales of investments
|
|
|
(9,482
|
)
|
|
(2,465
|
)
|
|
(382
|
)
|
Total
realized gains on sales of investments
|
|
|
6,574
|
|
|
14,145
|
|
|
13,715
|
|
Realized
loss on disposal of property and equipment
|
|
|
(364
|
)
|
|
(849
|
)
|
|
(156
|
)
|
Total
realized investment (losses) gains
|
|
$
|
(3,272
|
)
|
$
|
10,831
|
|
$
|
13,177
|
|
The
following table summarizes the fair values of investments sold at a loss or
at a
gain on the date of sale:
AMOUNTS
IN THOUSANDS
|
|
Fair
Value of Investments Sold
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Fair
value of investments sold at a loss on date of sale
|
|
$
|
188,327
|
|
$
|
142,222
|
|
$
|
21,002
|
|
Fair
value of investments sold at a gain on date of sale
|
|
|
636,531
|
|
|
585,252
|
|
|
297,230
|
|
______________________________
22
|
The
investment of $4.6 million in Ford Motor Credit Company was rated
BBB- by
Standard & Poor’s in December
2004.
|
23
|
Impact
Community Capital, LLC is a limited partnership that was voluntarily
established by a group of California insurers to make loans and
other
investments that provide housing and other services to economically
disadvantaged communities.
|
24
|
The
total net unrealized gain (loss) for these securities as of December
31,
2005 and 2004 was $27 thousand and $0 thousand, respectively. This
represented less than 0.1% of total investments unrealized
losses.
|
25
|
Amount
represents less than 0.1%, 0.1%, and 0.0% of total fair value
of
investments in 2005, 2004, and 2003,
respectively.
|
The
following table summarizes investments held by us, having an unrealized loss
of
$0.1 million or more, and aggregate information relating to all other
investments in unrealized loss positions:
|
|
2005
|
|
2004
|
|
AMOUNTS
IN THOUSANDS, EXCEPT NUMBER OF ISSUES
December
31,
|
|
#
issues
|
Fair
Value
|
Unrealized
Loss
|
|
#
issues
|
Fair
Value
|
Unrealized
Loss
|
Investments
with unrealized losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding
$0.1 million and in a loss position for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
than 6 months
|
|
|
16
|
|
$
|
141,034
|
|
$
|
3,074
|
|
|
|
7
|
|
$
|
88,258
|
|
$
|
1,045
|
|
6-12
months
|
|
|
16
|
|
|
129,044
|
|
|
4,072
|
|
|
|
15
|
|
|
154,284
|
|
|
3,415
|
|
More
than 1 year
|
|
|
56
|
|
|
433,368
|
|
|
16,896
|
|
|
|
2
|
|
|
4,765
|
|
|
326
|
|
Less
than $0.1 million
|
|
|
113
|
|
|
204,724
|
|
|
4,347
|
|
|
|
91
|
|
|
306,984
|
|
|
2,387
|
|
Total
fixed maturity securities with unrealized losses
|
|
|
201
|
|
|
908,170
|
|
|
28,389
|
|
|
|
115
|
|
|
554,291
|
|
|
7,173
|
|
Equity
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding
$0.1 million
|
|
|
2
|
|
|
578
|
|
|
305
|
|
|
|
―
|
|
|
―
|
|
|
―
|
|
Less
than $0.1 million
|
|
|
245
|
|
|
35,672
|
|
|
1,873
|
|
|
|
64
|
|
|
15,479
|
|
|
293
|
|
Total
equity securities with unrealized losses
|
|
|
247
|
|
|
36,250
|
|
|
2,178
|
|
|
|
64
|
|
|
15,479
|
|
|
293
|
|
Total
investments with unrealized losses26
|
|
|
448
|
|
$
|
944,420
|
|
$
|
30,567
|
|
|
|
179
|
|
$
|
569,770
|
|
$
|
7,466
|
|
A
summary
by contractual maturity of fixed maturity securities in an unrealized loss
position by year of maturity follows:
|
|
2005
|
|
2004
|
|
AMOUNTS
IN THOUSANDS
December
31,
|
|
Amortized
Cost
|
Fair
Value
|
Unrealized
Loss
|
|
Amortized
Cost
|
Fair
Value
|
Unrealized
Loss
|
Fixed
maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due
in one year or less
|
|
$
|
5,562
|
|
$
|
5,512
|
|
$
|
50
|
|
|
$
|
9,778
|
|
$
|
9,738
|
|
$
|
40
|
|
Due
after one year through five years
|
|
|
205,363
|
|
|
200,075
|
|
|
5,288
|
|
|
|
26,537
|
|
|
26,073
|
|
|
464
|
|
Due
after five years through ten years
|
|
|
415,417
|
|
|
401,533
|
|
|
13,884
|
|
|
|
318,644
|
|
|
314,898
|
|
|
3,746
|
|
Due
after ten years
|
|
|
310,216
|
|
|
301,050
|
|
|
9,167
|
|
|
|
206,505
|
|
|
203,582
|
|
|
2,923
|
|
Total
fixed maturity securities with unrealized losses
|
|
$
|
936,558
|
|
$
|
908,170
|
|
$
|
28,389
|
|
|
$
|
561,464
|
|
$
|
554,291
|
|
$
|
7,173
|
|
If
our
portfolio were to be impaired by market or issuer-specific conditions to a
substantial degree, our liquidity, financial position and financial results
could be materially adversely affected. Further, our income from these
investments could be materially reduced, and write-downs of the value of certain
securities could further reduce our profitability. In addition, a decrease
in
value of our investment portfolio could put our subsidiaries at risk of failing
to satisfy regulatory capital requirements. If we were not at that time able
to
supplement our capital by issuing debt or equity securities on acceptable terms,
our ability to continue growing could be adversely affected. See
further discussion in
Item
7A. Quantitative and Qualitative Disclosures about Market
Risk.
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 of all awards, is included
in
Notes 2 and 14 of the Notes to Consolidated Financial Statements.
______________________________
26
|
Unrealized
losses represent less than 3.2% and 1.3% of the total carrying
value of
investments in 2005 and 2004,
respectively.
|
Recent
Accounting Standards
On
September 19, 2005, FASB issued Statement of Position 05-1,
Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection
with Modifications or Exchanges of Insurance Contracts.
SOP
05-1 provides guidance on accounting for deferred acquisition costs on internal
replacements of insurance and investment contracts other than those specifically
described in FASB Statement No. 97, Accounting
and Reporting by Insurance Enterprises for Certain Long-Duration Contracts
and
for Realized Gains and Losses from the Sale of Investments.
The SOP
defines an internal replacement as a modification in product benefits, features,
rights, or coverage that occurs by the exchange of a contract for a new
contract, or by amendment, endorsement, or rider to a contract, or by the
election of a feature or coverage within a contract. The effective date of
the
implementation guidance is January 1, 2007. The Company is currently assessing
the effect of implementing this guidance.
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. 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 determined in
accordance with SFAS No. 123 as disclosed in Note 2 of the Notes to 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. A more complete discussion of various
risk factors is available in Item
1A. Risk Factors.
The
reader should not rely on forward-looking statements in this annual report
on
Form 10-K. Forward-looking statements are statements not based on historical
information and which relate to future operations, strategies, financial results
or other developments. You can usually identify forward-looking statements
by
terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,”
“believe,” “estimate,” “predict,” “intend,” “potential,” or “continue” or with
the negative of these terms or other comparable terminology.
Although
we believe that the expectations reflected in these forward-looking statements
are reasonable, we cannot guarantee our future results, level of activity,
performance or achievements. Forward-looking statements include, among other
things, discussions concerning our potential expectations, beliefs, estimates,
forecasts, projections and assumptions. Forward-looking statements may address,
among other things:
·
|
Our
strategy for growth;
|
·
|
Our
expected combined ratio and growth of written
premiums;
|
It
is
possible that our actual results, actions and financial condition may differ,
possibly materially, from the anticipated results, actions and financial
condition indicated in these forward-looking statements. 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;
|
·
|
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;
|
·
|
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 the senior notes, including our ability to receive
dividends and/or sufficient payments from our subsidiaries to service
our
obligations.
|
We
do not
undertake any obligation to update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
ITEM
7A. |
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
Market
risk is the risk of loss from adverse changes in market prices and interest
rates. In addition to market risk we are exposed to other risks, including
the
credit risk related to the issuers of the financial instruments in which we
invest, 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.
Fixed
maturity financial instruments.
Our cash
flow from operations and short-term cash position generally have been 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. The Company also obtained long-term fixed rate
financing as a means of increasing the statutory surplus of the Company’s
largest insurance subsidiary in 2002 and 2003. As a result, it has been
unnecessary for us to employ elaborate market risk management techniques
involving complicated asset and liability duration matching or hedging
strategies. Accordingly, the Company primarily invests in fixed maturity
investments, which at December 31, 2005, comprised 96.6% of the fair value
of
the Company’s total investments. The remainder of the Company’s investments,
representing approximately 3.4% of total investments at fair 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, cash flow, and other items.
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 changing
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 total fixed maturity portfolio
declined from approximately 5.4 years as of December 31, 2004 to 4.7 years
at
December 31, 2005.
The
graphical depiction of the relationship between the yield on bonds of the same
credit quality but with different maturities is usually referred to as a yield
curve. Because the yield on U.S. Treasury securities is the base rate (or “risk
free rate) from which non-government bond yields are normally benchmarked,
the
most commonly constructed yield curve is derived from the observation of prices
and yields in the Treasury market. An upward sloping curve, where yield rises
steadily as maturity increases, is referred to as a normal yield
curve.
The
following table shows the 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 fair values at adjusted market rates
assuming a parallel 100 basis point increase in market interest rates, given
the
effective duration noted above, for the fixed maturity investment portfolio
and
a parallel 100 basis point decrease in market interest rates for the debt
determined from a present value calculation. The following sensitivity analysis
summarizes only the exposure to market interest rate risk:
AMOUNTS
IN MILLIONS
December
31, 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
|
|
$
|
1,354.7
|
|
$
|
1,293.8
|
|
|
(4.50
|
%)
|
Debt,
amortized cost
|
|
|
128.0
|
|
|
135.0
|
|
|
5.47
|
%
|
The
discussion above provides only a limited, point-in-time view of the market
risk
sensitivity of our fixed rate financial instruments. The actual impact of
interest rate changes on our fixed maturity investments in particular may differ
significantly from those shown, as the analysis assumes a parallel shift in
market interest rates. The analysis also does not consider any actions we could
take in response to actual and/or anticipated changes in interest rates.
Market
participants usually refer to the difference between long-term Treasury yields
and short-term Treasury yields as the “slope” of the yield curve. If the spread
between the long end of the curve, where maturities are high, and the short
end
of the curve, where maturities are low, narrows, the yield curve is said to
be
“flattening”. Conversely, if the spread between the long end of the curve and
the short end of the curve widens, the yield curve is said to be “steepening”.
If the yields on the long end of the curve fall below those of the short end
of
the curve, the yield curve is said to be “inverted”.
The
analysis above assumes a parallel shift in interest rates. However, the curve
may also steepen, flatten or become inverted. This type of behavior may affect
certain sections of the curve in disproportionate amounts. For example, if
short-term Treasury yields rise and the yield curve flattens, fixed maturity
instruments with short duration may be impacted to a greater degree than fixed
maturity instruments with longer duration. Conversely, if long-term Treasury
yields rise and the yield curve steepens, fixed maturity instruments with long
duration may be impacted to a greater degree than fixed maturity instruments
with shorter duration. The following summarizes the duration distribution of
our
fixed maturity investments portfolio.
|
|
|
|
Duration
Ranges
|
|
|
|
December
31, 2005
|
|
Below
1
|
1
to 3
|
3
to 5
|
5
to 7
|
7
to 10
|
10
to 20
|
Market
value percentage of fixed maturity investment portfolio
|
|
|
1.3
|
%
|
|
8.3
|
%
|
|
57.5
|
%
|
|
30.7
|
%
|
|
2.2
|
%
|
|
0.0
|
%
|
Equity
securities.
The
common equity portfolio, which represents approximately 3.4% of total
investments at fair value, consists primarily of 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 return for a 1%
change in the return of the market. The average Beta for the Company’s equity
securities was 0.87 at December 31, 2005 and 0.50 at December 31, 2004.
The
following table presents the consolidated financial statement fair 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:
AMOUNTS
IN MILLIONS
December
31, 2005
|
|
Fair
Value
|
Estimated
Fair
Value
at Hypothetical
20%
Reduction in
Overall
Value of
Stock
Market
|
Change
in
Value
as a
Percentage
of
Fair
Value
|
Equity
securities available-for-sale, at fair value
|
|
$
|
47.4
|
|
$
|
39.2
|
|
|
(17.3
|
%)
|
The
discussion above provides only a limited, point-in-time view of the market
risk
sensitivity of our equity securities. The actual impact of price changes on
the
equity securities may differ significantly from those shown. The sensitivity
analysis is further limited because it does not consider any actions we could
take in response to actual and/or anticipated changes in equity prices.
ITEM
8. |
FINANCIAL
STATEMENTS AND SUPPLEMENTARY
DATA
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
STOCKHOLDERS
AND BOARD OF DIRECTORS
21ST
CENTURY INSURANCE GROUP
We
have
completed integrated audits of 21st Century Insurance Group’s 2005 and 2004
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2005, and an audit of its 2003 consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
Consolidated
financial
statements and
financial statement schedule
In
our
opinion, the consolidated financial statements listed in the index appearing
under Item 15(a)(1) present fairly, in all material respects, the financial
position of 21st Century Insurance Group and its subsidiaries (the “Company”) at
December 31, 2005 and 2004, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2005, in
conformity with accounting principles generally accepted in the United States
of
America. In addition, in our opinion, the financial statement schedule listed
in
the index appearing under Item 15(a)(2) presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company’s management.
Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
Internal
control over financial reporting
Also,
in
our opinion, management’s assessment, included in Management’s Report on
Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal
Control - Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”), is fairly stated, in all material respects, based on those criteria.
Furthermore, in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2005,
based on criteria established in Internal
Control - Integrated Framework
issued
by the COSO. The Company’s management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express opinions on management’s assessment and on the effectiveness
of the Company’s internal control over financial reporting based on our audit.
We conducted our audit of internal control over financial reporting in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit
to
obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. An audit of
internal control over financial reporting includes obtaining an understanding
of
internal control over financial reporting, evaluating management’s assessment,
testing and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we consider necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinions.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures
of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use,
or
disposition of the company’s assets that could have a material effect on the
financial statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/
PricewaterhouseCoopers LLP
Los
Angeles, California
February
21, 2006
21ST
CENTURY INSURANCE GROUP
CONSOLIDATED
BALANCE SHEETS
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
|
|
|
|
December
31,
|
|
2005
|
2004
|
Assets
|
|
|
|
|
|
Fixed
maturity investments available-for-sale, at fair value (amortized
cost:
$1,365,948 and $1,320,592)
|
|
$
|
1,354,707
|
|
$
|
1,342,130
|
|
Equity
securities available-for-sale, at fair value (cost: $49,210 and
$41,450)
|
|
|
47,367
|
|
|
42,085
|
|
Total
investments
|
|
|
1,402,074
|
|
|
1,384,215
|
|
Cash
and cash equivalents
|
|
|
68,668
|
|
|
34,697
|
|
Accrued
investment income
|
|
|
16,585
|
|
|
16,161
|
|
Premiums
receivable
|
|
|
100,900
|
|
|
105,814
|
|
Reinsurance
receivables and recoverables
|
|
|
6,539
|
|
|
7,160
|
|
Prepaid
reinsurance premiums
|
|
|
1,946
|
|
|
1,787
|
|
Deferred
income taxes
|
|
|
56,209
|
|
|
56,135
|
|
Deferred
policy acquisition costs
|
|
|
59,939
|
|
|
58,759
|
|
Leased
property under capital lease, net of deferred gain of $1,534 and
$3,116
and net of accumulated amortization of $36,995 and $24,794
|
|
|
22,651
|
|
|
31,719
|
|
Property
and equipment, at cost less accumulated depreciation of $89,595 and
$68,529
|
|
|
145,811
|
|
|
129,372
|
|
Other
assets
|
|
|
38,907
|
|
|
38,495
|
|
Total
assets
|
|
$
|
1,920,229
|
|
$
|
1,864,314
|
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
Unpaid
losses and loss adjustment expenses
|
|
$
|
523,835
|
|
$
|
495,542
|
|
Unearned
premiums
|
|
|
319,676
|
|
|
331,036
|
|
Debt
|
|
|
127,972
|
|
|
138,290
|
|
Claims
checks payable
|
|
|
42,681
|
|
|
38,737
|
|
Reinsurance
payable
|
|
|
643
|
|
|
633
|
|
Other
liabilities
|
|
|
75,450
|
|
|
85,675
|
|
Total
liabilities
|
|
|
1,090,257
|
|
|
1,089,913
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
Common
stock, par value $0.001 per share; 110,000,000 shares authorized;
shares
issued 85,939,889 and 85,489,061
|
|
|
86
|
|
|
85
|
|
Additional
paid-in capital
|
|
|
426,417
|
|
|
420,524
|
|
Unearned
compensation
|
|
|
(963
|
)
|
|
(99
|
)
|
Treasury
stock, at cost; 5,929 shares
|
|
|
(84
|
)
|
|
—
|
|
Retained
earnings
|
|
|
414,898
|
|
|
341,196
|
|
Accumulated
other comprehensive (loss) income
|
|
|
(10,382
|
)
|
|
12,695
|
|
Total
stockholders’ equity
|
|
|
829,972
|
|
|
774,401
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
1,920,229
|
|
$
|
1,864,314
|
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP
CONSOLIDATED
STATEMENTS OF OPERATIONS
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
|
|
|
|
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Revenues
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
1,352,937
|
|
$
|
1,313,670
|
|
$
|
1,172,677
|
|
Net
investment income
|
|
|
69,096
|
|
|
58,831
|
|
|
45,833
|
|
Other
income
|
|
|
367
|
|
|
—
|
|
|
14,777
|
|
Net
realized investment (losses) gains
|
|
|
(3,272
|
)
|
|
10,831
|
|
|
13,177
|
|
Total
revenues
|
|
|
1,419,128
|
|
|
1,383,332
|
|
|
1,246,464
|
|
Losses
and expenses
|
|
|
|
|
|
|
|
|
|
|
Net
losses and loss adjustment expenses
|
|
|
998,933
|
|
|
993,841
|
|
|
962,311
|
|
Policy
acquisition costs
|
|
|
252,541
|
|
|
222,479
|
|
|
202,189
|
|
Other
underwriting expenses
|
|
|
31,793
|
|
|
36,092
|
|
|
7,346
|
|
Other
expenses
|
|
|
410
|
|
|
—
|
|
|
—
|
|
Interest
and fees expense
|
|
|
8,019
|
|
|
8,627
|
|
|
3,471
|
|
Total
losses and expenses
|
|
|
1,291,696
|
|
|
1,261,039
|
|
|
1,175,317
|
|
Income
before provision for income taxes
|
|
|
127,432
|
|
|
122,293
|
|
|
71,147
|
|
Provision
for income taxes
|
|
|
40,006
|
|
|
34,068
|
|
|
17,572
|
|
Net
income
|
|
$
|
87,426
|
|
$
|
88,225
|
|
$
|
53,575
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per common share
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
$
|
1.02
|
|
$
|
1.03
|
|
$
|
0.63
|
|
Weighted
average shares
outstanding ― basic
|
|
|
85,661,547
|
|
|
85,466,127
|
|
|
85,432,838
|
|
Weighted
average shares outstanding ― diluted
|
|
|
86,017,994
|
|
|
85,602,567
|
|
|
85,637,672
|
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
|
|
Common
Stock
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
No
par
|
|
$0.001
par
|
|
Additional
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
value
|
|
value
|
|
Paid-
in
|
|
Unearned
|
Treasury
|
Retained
|
Comprehensive
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
Shares
|
|
Amount
|
|
Amount
|
|
Capital
|
|
Compensation
|
Stock
|
Earnings
|
Income
(Loss)
|
Total
|
|
Balance
- January 1, 2003
|
|
|
85,431,505
|
|
$
|
419,997
|
|
$
|
—
|
|
$
|
—
|
|
$
|
(1,013
|
)
|
$
|
—
|
|
$
|
213,067
|
|
$
|
23,557
|
|
$
|
655,608
|
|
Comprehensive
income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
53,575
|
(1)
|
|
(2,005
|
)
(2)
|
|
51,570
|
|
Cash
dividends declared on common stock ($0.08 per
share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,834
|
)
|
|
|
|
|
(6,834
|
)
|
Issuance
of restricted stock
|
|
|
4,000
|
|
|
57
|
|
|
|
|
|
|
|
|
(57
|
)
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Amortization
of unearned compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
374
|
|
|
|
|
|
|
|
|
|
|
|
374
|
|
Tax
effect of stock-based compensation
|
|
|
|
|
|
(28
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(28
|
)
|
Effects
of reincorporation
|
|
|
|
|
|
(420,026
|
)
|
|
85
|
|
|
419,941
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Balance
- December 31, 2003
|
|
|
85,435,505
|
|
|
—
|
|
|
85
|
|
|
419,941
|
|
|
(696
|
)
|
|
—
|
|
|
259,808
|
|
|
21,552
|
|
|
700,690
|
|
Comprehensive
income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88,225
|
(1)
|
|
(8,857
|
)
(2)
|
|
79,368
|
|
Cash
dividends declared on common stock ($0.08 per
share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,837
|
)
|
|
|
|
|
(6,837
|
)
|
Exercise
of stock options
|
|
|
49,056
|
|
|
|
|
|
|
|
|
576
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
576
|
|
Issuance
of restricted stock
|
|
|
4,500
|
|
|
|
|
|
|
|
|
62
|
|
|
(62
|
)
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Amortization
of unearned compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
659
|
|
|
|
|
|
|
|
|
|
|
|
659
|
|
Tax
effect of stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
|
(55
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(55
|
)
|
Balance
- December 31, 2004
|
|
|
85,489,061
|
|
|
—
|
|
|
85
|
|
|
420,524
|
|
|
(99
|
)
|
|
—
|
|
|
341,196
|
|
|
12,695
|
|
|
774,401
|
|
Comprehensive
income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
87,426
|
(1)
|
|
(23,077
|
)
(2)
|
|
64,349
|
|
Cash
dividends declared on common stock ($0.16 per
share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(13,724
|
)
|
|
|
|
|
(13,724
|
)
|
Exercise
of stock options
|
|
|
360,883
|
|
|
|
|
|
1
|
|
|
4,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,649
|
|
Issuance
of restricted stock
|
|
|
89,945
|
|
|
|
|
|
|
|
|
1,267
|
|
|
(1,267
|
)
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Forfeiture
of 5,929 shares of restricted stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
84
|
|
|
(84
|
)
|
|
|
|
|
|
|
|
—
|
|
Amortization
of unearned compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
319
|
|
|
|
|
|
|
|
|
|
|
|
319
|
|
Tax
effect of stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
|
(22
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(22
|
)
|
Balance
- December 31, 2005
|
|
|
85,939,889
|
|
$
|
—
|
|
$
|
86
|
|
$
|
426,417
|
|
$
|
(963
|
)
|
$
|
(84
|
)
|
$
|
414,898
|
|
$
|
(10,382
|
)
|
$
|
829,972
|
|
(1)
Net
income for the year.
(2) Net
change in accumulated other comprehensive income (loss) for the year. See Note
13 of the Notes to Consolidated Financial Statements.
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP
|
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
|
|
|
|
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Operating
activities
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
87,426
|
|
$
|
88,225
|
|
$
|
53,575
|
|
Adjustments
to reconcile net income to net cash provided
by operating activities:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
33,760
|
|
|
22,260
|
|
|
20,206
|
|
Net
amortization of investment premiums and discounts
|
|
|
9,370
|
|
|
7,011
|
|
|
3,756
|
|
Amortization
of restricted stock grants
|
|
|
319
|
|
|
659
|
|
|
346
|
|
Provision
for deferred income taxes
|
|
|
12,351
|
|
|
25,246
|
|
|
13,406
|
|
Realized
losses (gains) on sale of investments
|
|
|
3,272
|
|
|
(10,831
|
)
|
|
(13,177
|
)
|
Changes
in assets and liabilities
|
|
|
|
|
|
|
|
|
|
|
Premiums
receivable
|
|
|
4,914
|
|
|
(1,176
|
)
|
|
(13,609
|
)
|
Deferred
policy acquisition costs
|
|
|
(1,180
|
)
|
|
(5,680
|
)
|
|
(6,889
|
)
|
Reinsurance
receivables and recoverables
|
|
|
471
|
|
|
3,779
|
|
|
12,953
|
|
Federal
income taxes
|
|
|
(410
|
)
|
|
3,801
|
|
|
(2,825
|
)
|
Other
assets
|
|
|
(3,584
|
)
|
|
(3,034
|
)
|
|
(5,064
|
)
|
Unpaid
losses and loss adjustment expenses
|
|
|
28,293
|
|
|
57,219
|
|
|
54,314
|
|
Unearned
premiums
|
|
|
(11,360
|
)
|
|
18,782
|
|
|
45,777
|
|
Claims
checks payable
|
|
|
3,944
|
|
|
(6,965
|
)
|
|
6,398
|
|
Other
liabilities
|
|
|
(7,325
|
)
|
|
4,060
|
|
|
19,293
|
|
Net
cash provided by operating activities
|
|
|
160,261
|
|
|
203,356
|
|
|
188,460
|
|
Investing
activities
|
|
|
|
|
|
|
|
|
|
|
Purchases
of:
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity investments available-for-sale
|
|
|
(136,122
|
)
|
|
(813,993
|
)
|
|
(641,425
|
)
|
Equity
securities available-for-sale
|
|
|
(317,340
|
)
|
|
(123,017
|
)
|
|
(8
|
)
|
Property
and equipment
|
|
|
(39,083
|
)
|
|
(40,445
|
)
|
|
(23,355
|
)
|
Maturities
and calls of fixed maturities available-for-sale
|
|
|
38,229
|
|
|
52,579
|
|
|
38,592
|
|
Sales
of:
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity investments available-for-sale
|
|
|
40,124
|
|
|
629,019
|
|
|
314,640
|
|
Equity
securities available-for-sale
|
|
|
309,580
|
|
|
81,567
|
|
|
8
|
|
Net
cash used in investing activities
|
|
|
(104,612
|
)
|
|
(214,290
|
)
|
|
(311,548
|
)
|
Financing
activities
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from issuance of debt
|
|
|
—
|
|
|
—
|
|
|
99,871
|
|
Repayment
of debt
|
|
|
(12,603
|
)
|
|
(11,409
|
)
|
|
(10,185
|
)
|
Payment
of debt issuance costs
|
|
|
—
|
|
|
—
|
|
|
(650
|
)
|
Dividends
paid (per share: $0.16; $0.10; and $0.08)
|
|
|
(13,724
|
)
|
|
(8,546
|
)
|
|
(6,835
|
)
|
Proceeds
from the exercise of stock options
|
|
|
4,649
|
|
|
576
|
|
|
—
|
|
Net
cash (used in) provided by financing activities
|
|
|
(21,678
|
)
|
|
(19,379
|
)
|
|
82,201
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
33,971
|
|
|
(30,313
|
)
|
|
(40,887
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of year
|
|
|
34,697
|
|
|
65,010
|
|
|
105,897
|
|
Cash
and cash equivalents, end of year
|
|
$
|
68,668
|
|
$
|
34,697
|
|
$
|
65,010
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
information
|
|
|
|
|
|
|
|
|
|
|
Income
taxes paid
|
|
$
|
26,481
|
|
$
|
3,912
|
|
$
|
—
|
|
Interest
paid
|
|
|
7,878
|
|
|
8,612
|
|
|
2,975
|
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
1. DESCRIPTION OF BUSINESS
21st
Century Insurance Group is an insurance holding company founded in 1958 and,
effective December 4, 2003, was incorporated under the laws of the State of
Delaware. Previously, the Company was incorporated in California. The term
“Company,” unless the context requires otherwise, refers to 21st Century
Insurance Group and its consolidated subsidiaries, all of which are
wholly-owned: 21st Century Insurance Company, 21st Century Casualty Company,
21st Century Insurance Company of the Southwest, 20th Century Insurance
Services, Inc., and i21 Insurance Services. The latter two companies are not
property and casualty insurance subsidiaries, and their results are
immaterial.
The
common stock of the Company is traded on the New York Stock Exchange under
the
trading symbol “TW.” Through several of its subsidiaries, American International
Group, Inc. (“AIG”) currently owns approximately 62% of the Company’s
outstanding common stock.
NOTE
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Consolidation and Presentation
The
accompanying consolidated financial statements include the accounts and
operations of the Company. All intercompany accounts and transactions have
been
eliminated. The consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States
of
America (“GAAP”). The preparation of the consolidated financial statements in
conformity with GAAP requires management to make estimates and assumptions
that
affect the amounts reported in the consolidated financial statements. Actual
results could differ from these estimates.
On
October 16, 2003, the Board of Directors voted to change 21st Century Insurance
Group’s state of incorporation from California to Delaware. There was no change
in the location of Company operations, location of team members, or the way
the
Company does business. Shareholders holding a majority of the voting power
approved the reincorporation by written consent on October 17, 2003. The
reincorporation became effective December 4, 2003.
21st
Century Insurance Company of the Southwest
21st
Century Insurance Company of the Southwest (“21st of SW”), formerly 21st Century
Insurance Company of Arizona, adopted its current name on September 30, 2004,
and re-domesticated from Arizona to Texas on December 31, 2004. 21st of SW
was a
joint venture between the Company and AIG from 1995 to 2001.
Investments
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 at
inception 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
Company classifies its investment portfolio as available-for-sale and carries
it
at fair value. The fair values of our investment securities are generally
determined by reference to quoted market prices and reliable independent
sources. The cost of investment securities sold is determined by the specific
identification method.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
We
are
obligated to assess, at each reporting date, whether there is an
“other-than-temporary” impairment in the value of any of our investment
securities. The determination of whether a decline in market value is
“other-than-temporary” is a matter of subjective judgment. In general, however,
a security is considered a candidate for impairment if it meets any of the
following criteria:
|
·
|
Trading
at a significant (25 percent or more) discount to par, amortized cost
(if lower) or cost for an extended period of time (nine months or
longer);
|
|
·
|
The
occurrence of a discrete credit event resulting in (i) the
issuer defaulting on a material outstanding obligation; or (ii) the
issuer seeking protection from creditors under the bankruptcy laws
or any
similar laws intended for the court supervised reorganization of
insolvent
enterprises; or (iii) the
issuer proposing a voluntary reorganization pursuant to which creditors
are asked to exchange their claims for cash or securities having
a fair
value substantially lower than par value of their claims;
or
|
|
·
|
In
the opinion of the Company’s management, it is possible that the Company
may not realize a full recovery on its investment, irrespective of
the
occurrence of one of the foregoing
events.
|
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 the cost or amortized
cost
and the fair value.
No
such
charges were recorded in 2005, 2004 or 2003. The timing and amount of realized
losses and gains reported in income could vary if conclusions other than those
made by management were used to determine whether an other-than-temporary
impairment exists. However, there would be no impact on equity because any
unrealized losses are already included in accumulated other comprehensive income
(loss).
Cash
and Cash Equivalents
Cash
and
cash equivalents include cash, demand deposits and short-term investments in
money market mutual funds having a maturity of three months or less at the
date
of purchase.
Recognition
of Revenues
Insurance
premiums and reinsurance ceding commissions are recognized pro rata over the
terms of the policies. The unearned portion of premiums is included in the
consolidated balance sheets as a liability for unearned premiums. Installment
and other fees for services are recognized in the periods the services are
rendered.
Deferred
Policy Acquisition Costs
Deferred
policy acquisition costs (“DPAC”) 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 December 31, 2005.
The
loss
and loss adjustment expense ratio used in the recoverability estimate is based
primarily on the expected ultimate ratio provided by our actuaries. While
management believes that is a reasonable assumption, actual results could differ
materially from such estimates.
Leased
Property under Capital Lease
Leased
property under capital lease is recorded as a capital asset and amortized on
a
straight-line basis over the estimated
useful lives of the properties, which range from 3 to 10 years. The related
lease obligation is included in debt on the balance sheet.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Property
and Equipment
Property
and equipment is recorded at cost and depreciated on a straight-line basis.
We
capitalize certain consulting costs, payroll and payroll-related costs for
employees related to computer software developed for internal use.
The
following table summarizes the estimated useful lives used for depreciation
of
the Company’s assets:
AMOUNTS
IN YEARS
December
31,
|
|
Estimated
Useful Lives
|
|
Building
|
|
|
39.5
|
|
Furniture
and equipment
|
|
|
3
- 7
|
|
Automobiles
|
|
|
5
|
|
Leasehold
improvements
|
|
|
Lesser
of remaining lease term or 7
|
|
Software
currently in service
|
|
|
3
- 15
|
|
Management
assesses the Company’s property and equipment, including software development
projects in progress, for impairment. The assessment of impairment involves
a
two-step process, whereby an initial assessment for potential impairment is
performed by comparing the carrying value plus the cost to complete, if any,
to
estimates of future undiscounted cash flows from operations at the lowest level
for which identifiable cash flows are largely independent of the cash flows
of
other assets and liabilities. If future undiscounted cash flows are
insufficient, an impairment write down is recorded for the difference between
the carrying value and estimated fair value of the asset group. There have
been
no events or circumstances in 2005 that would require a reassessment of any
asset group for impairment.
Intangible
Asset
On
June
24, 2004, the Company paid $1.5 million to acquire the marketing name “21st
Century Insurance and Financial Services,” which will be used as a marketing
name for 20th Century Insurance Services. The payment has been capitalized
as an
intangible asset and is included in “Other Assets” on the accompanying balance
sheet. The marketing name has an indefinite useful life and will not be
amortized until its useful life is determined to no longer be indefinite.
On
an
annual basis, we test this intangible asset based on the estimated fair value
of
the operating cash flows associated with the long-lived asset. However, we
will
test for impairment on a more frequent basis in cases where events and changes
in circumstances would indicate that we might not recover the carrying value
of
the intangible asset. Our measurement of fair value is based on a discounted
cash flow methodology that converts expected cash flows of
our
homeowner’s agency segment
to
present value. If the fair value is greater than the carrying value of the
intangible asset, then the intangible asset is not considered impaired. The
impairment test as of December 31, 2005, indicated that the asset was not
impaired.
Losses
and Loss Adjustment Expenses
The
estimated liabilities for losses and loss adjustment expenses (“LAE”) include
the accumulation of estimates of losses for claims reported on or prior to
the
balance sheet dates, estimates (based upon actuarial analysis of historical
data) of losses for claims incurred but not reported, the development of case
reserves to ultimate values, and estimates of expenses for investigating,
adjusting and settling all incurred claims. Amounts reported are estimates
of
the ultimate costs of settlement, net of estimated salvage and subrogation.
These estimated liabilities are necessarily subject to the outcome of future
events, such as changes in medical and repair costs as well as economic and
social conditions that impact the settlement of claims. Management believes
that
the aggregate reserves are adequate and represent our best estimate based on
the
information currently available. The methods of making such estimates and for
establishing the resulting reserves are reviewed and updated as applicable,
and
any resulting adjustments are reflected in current operations.
A
necessarily more subjective process is used to estimate earthquake losses
arising out of California Senate Bill 1899 because most of the remaining
earthquake claims are in litigation. See Note 16 of the Notes to Consolidated
Financial Statements for a discussion of the factors considered by management
in
establishing those liabilities.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Reinsurance
In
the
normal course of business, the Company seeks to reduce its exposure to losses
that may arise from catastrophes and to reduce its overall risk levels by
obtaining reinsurance from other insurance enterprises or reinsurers.
Reinsurance premiums and reserves on reinsured business are accounted for on
a
basis consistent with those used in accounting for the original policies issued
and the terms of the reinsurance contracts.
Reinsurance
contracts do not relieve the Company from its obligations to policyholders.
The
Company periodically reviews the financial condition of its reinsurers to
minimize its exposure to losses from reinsurer insolvencies.
Reinsurance
receivables and recoverables include balances due from other insurance companies
for paid losses and LAE as well as ceded unpaid losses and LAE under the terms
of reinsurance agreements. Amounts applicable to ceded unearned premiums are
reported as prepaid reinsurance premiums in the accompanying balance sheets.
The
Company believes the fair value of its reinsurance recoverables approximates
their carrying amounts.
Other
Income
Other
income of $0.4 million in 2005 relates to interest income for refund claims
with
the taxing authorities. No other income was reported in 2004. Other income
of
$14.8 million in the year ended December 31, 2003, included $9.3 million
resulting from a nonrecurring, nonoperational item from the settlement of
litigation, interest income of $4.8 million relating to a favorable settlement
with the Internal Revenue Service (“IRS”), and miscellaneous items of $0.7
million.
Other
Expenses
In
November 2005, the Company vacated approximately 2% of rentable space at its
headquarters in Woodland Hills, California and plans to sublease this space.
A
loss on this vacated space has been recognized in accordance with SFAS No.
146
totaling $0.4 million, as future rental costs are higher than potential market
rentals.
Income
Taxes
Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to
taxable income in the years the differences are expected to be recovered or
settled. The Company reviews its deferred tax assets for recoverability on
a
quarterly basis.
Fair
Value of Financial Instruments
The
carrying value of financial assets and liabilities reported in the accompanying
balance sheets for cash and cash equivalents, accrued investment income and
trade accounts receivable and payable at December 31, 2005 and 2004, approximate
fair value because of the short maturity of these instruments. Investments
available-for-sale are carried at fair value in the accompanying balance sheets.
The fair value of notes payable is estimated based on the quoted market prices
for the same or similar issues, or on the current rates offered to us for debt
with the same remaining maturities. See Note 9 of the Notes to Consolidated
Financial Statements for additional information.
Considerable
judgment is required to develop estimates of fair value. Accordingly, the
estimates are not necessarily indicative of the amounts we could realize in
a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
Stock-Based
Compensation
SFAS
No.
148, Accounting
for Stock-Based Compensation-Transition and Disclosure,
amends
the disclosure requirements of SFAS No. 123, Accounting
for Stock-Based Compensation,
to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. As permitted by SFAS No. 148,
the
Company accounts for its fixed stock options using the intrinsic-value method,
prescribed in Accounting Principles Board (“APB”) Opinion No. 25, Accounting
for Stock Issued to Employees,
which
generally does not result in compensation expense recognition for stock options.
Under the intrinsic-value method, compensation cost for stock options is
measured at the date of grant as the excess, if any, of the quoted market price
of the Company’s stock over the exercise price of the options.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
In
addition to stock options, we also grant restricted stock awards to certain
officers and employees. Upon issuance of grants under the plan, unearned
compensation equivalent to the market value on the date of grant is charged
to
paid-in capital and subsequently amortized over the vesting period of the grant.
The Company becomes entitled to an income tax deduction in an amount equal
to
the taxable income reported by the holders of the restricted shares when the
restrictions are released.
Restricted
shares are forfeited if officers and employees terminate prior to the expiration
of restrictions. We record forfeitures of restricted stock as treasury share
repurchases and any compensation cost previously recognized with respect to
unvested stock awards is reversed in the period of forfeiture. This accounting
treatment results in compensation expense being recorded in a manner consistent
with that required under SFAS No. 123, and, therefore, pro forma net income
and
earnings per share amounts for the Restricted Share Plan would be unchanged
from
those reported in the consolidated financial statements.
Had
compensation cost for the Company’s stock-based compensation plans been
determined based on the estimated fair-value-based method for all awards, net
income would have been reduced by $4.9 million, $5.5 million, and $4.7 million
for the years ended 2005, 2004, and 2003, respectively. The pro forma net income
and earnings per share amounts follow:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Net
income, as reported
|
|
$
|
87,426
|
|
$
|
88,225
|
|
$
|
53,575
|
|
|
|
|
|
|
|
|
|
|
|
|
Add:
Stock-based employee compensation expense included in reported
net income,
net of related tax effects
|
|
|
207
|
|
|
381
|
|
|
215
|
|
|
|
|
|
|
|
|
|
|
|
|
Deduct:
Total stock-based employee compensation expense determined under
fair-value-based method for all awards, net of related tax
effects
|
|
|
(5,129
|
)
|
|
(5,904
|
)
|
|
(4,908
|
)
|
Net
income, pro forma
|
|
$
|
82,504
|
|
$
|
82,702
|
|
$
|
48,882
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted earnings per share
|
|
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
1.02
|
|
$
|
1.03
|
|
$
|
0.63
|
|
Pro
forma
|
|
$
|
0.96
|
|
$
|
0.97
|
|
$
|
0.55
|
|
Earnings
Per Share
Basic
earnings per share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for
the
period. Diluted earnings per share reflects the potential dilution that could
occur if options or other contracts to issue common stock were exercised or
converted into common stock.
Recent
Accounting Standards
On
September 19, 2005, FASB issued Statement of Position 05-1, Accounting
by Insurance Enterprises for Deferred Acquisition Costs in Connection with
Modifications or Exchanges of Insurance Contracts.
SOP
05-1 provides guidance on accounting for deferred acquisition costs on internal
replacements of insurance and investment contracts other than those specifically
described in FASB Statement No. 97, Accounting
and Reporting by Insurance Enterprises for Certain Long-Duration Contracts
and
for Realized Gains and Losses from the Sale of Investments.
The SOP
defines an internal replacement as a modification in product benefits, features,
rights, or coverage that occurs by the exchange of a contract for a new
contract, or by amendment, endorsement, or rider to a contract, or by the
election of a feature or coverage within a contract. The effective date of
the
implementation guidance is January 1, 2007. The Company is currently assessing
the effect of implementing this guidance.
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. 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 above.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Reclassifications
Certain
prior year amounts have been reclassified to conform to the current year
presentation.
NOTE
3. EARNINGS PER SHARE (“EPS”)
For
each
of the three years ended December 31, 2005, 2004, and 2003, the numerator for
the calculation of both basic and diluted EPS is equal to net income reported
for that year. The difference between basic and diluted EPS denominators is
due
to dilutive common stock equivalents (stock options and restricted stock).
Basic
earnings per share excludes dilution and reflects net income divided by the
weighted average shares of common stock outstanding during the periods
presented. The denominator for the computation of basic EPS was 85,661,547
shares, 85,466,127 shares, and 85,432,838 shares for 2005, 2004 and 2003,
respectively.
Diluted
earnings per share is based upon the weighted average shares of common stock
and
dilutive common stock equivalents outstanding during the periods presented.
Common stock equivalents arising from dilutive stock options and restricted
common stock are computed using the treasury stock method; for the years ended
December 31, 2005, 2004 and 2003, this amounted to 86,017,994 shares, 85,602,567
shares and 85,637,672 shares, respectively, which include 356,447, 136,440
and
204,834 dilutive common stock, respectively.
Options
to purchase an aggregate of 5,600,376 shares, 6,156,772 shares, and 5,121,446
shares of common stock were considered anti-dilutive during 2005, 2004 and
2003,
respectively, and were not included in the computation of diluted EPS because
the options’ exercise prices were greater than the average market price of the
common stock for each respective period. These options expire at various points
in time through June 2015 (see Note 14 of the Notes to Consolidated Financial
Statements).
NOTE
4. INVESTMENTS
A
summary
of net investment income follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Interest
on fixed maturities
|
|
$
|
63,122
|
|
$
|
57,729
|
|
$
|
45,668
|
|
Interest
on cash and cash equivalents
|
|
|
1,188
|
|
|
585
|
|
|
857
|
|
Dividends
on equity securities
|
|
|
5,849
|
|
|
1,484
|
|
|
—
|
|
Investment
expense
|
|
|
(1,063
|
)
|
|
(967
|
)
|
|
(692
|
)
|
Net
investment income
|
|
$
|
69,096
|
|
$
|
58,831
|
|
$
|
45,833
|
|
A
summary
of net realized investment gains (losses) follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Realized
gains on sales of fixed maturity securities
|
|
$
|
272
|
|
$
|
11,419
|
|
$
|
13,715
|
|
Realized
gains on equity securities
|
|
|
6,302
|
|
|
2,726
|
|
|
—
|
|
Total
realized gains on sales of investments
|
|
|
6,574
|
|
|
14,145
|
|
|
13,715
|
|
Realized
losses on sales of fixed maturity securities
|
|
|
(1,183
|
)
|
|
(1,708
|
)
|
|
(382
|
)
|
Realized
losses on equity securities
|
|
|
(8,299
|
)
|
|
(757
|
)
|
|
—
|
|
Total
realized losses on sales of investments
|
|
|
(9,482
|
)
|
|
(2,465
|
)
|
|
(382
|
)
|
Realized
losses on disposal of property and equipment
|
|
|
(364
|
)
|
|
(849
|
)
|
|
(156
|
)
|
Total
net realized investment (losses) gains
|
|
$
|
(3,272
|
)
|
$
|
10,831
|
|
$
|
13,177
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
A
summary
of changes in unrealized investment gains (losses) less applicable income taxes
for fixed maturities and equity securities, is as follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Fixed
maturities:
|
|
|
|
|
|
|
|
Net
decrease in unrealized (losses) gains
|
|
$
|
(32,779
|
)
|
$
|
(14,612
|
)
|
$
|
(2,384
|
)
|
Income
tax benefit
|
|
|
11,473
|
|
|
5,114
|
|
|
834
|
|
Total
decrease in net unrealized investment gains and losses after
taxes
|
|
$
|
(21,306
|
)
|
$
|
(9,498
|
)
|
$
|
(1,550
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Equity
securities:
|
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in unrealized (losses) gains
|
|
$
|
(2,477
|
)
|
$
|
635
|
|
$
|
—
|
|
Income
tax benefit (expense)
|
|
|
867
|
|
|
(222
|
)
|
|
—
|
|
Total
(decrease) increase in net unrealized investment gains and losses
after
taxes
|
|
$
|
(1,610
|
)
|
$
|
413
|
|
$
|
—
|
|
A
summary
of investments follows:
|
|
Cost
or
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
Fair
Value
|
December
31, 2005
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury securities and obligations of U.S. Government corporations
and
agencies
|
|
$
|
51,763
|
|
$
|
297
|
|
$
|
(878
|
)
|
$
|
51,182
|
|
Mortgage-backed
securities
|
|
|
323,838
|
|
|
78
|
|
|
(9,135
|
)
|
|
314,781
|
|
Obligations
of states and political subdivisions
|
|
|
327,173
|
|
|
14,912
|
|
|
(194
|
)
|
|
341,891
|
|
Corporate
securities
|
|
|
663,174
|
|
|
1,861
|
|
|
(18,182
|
)
|
|
646,853
|
|
Total
fixed maturity investments
|
|
|
1,365,948
|
|
|
17,148
|
|
|
(28,389
|
)
|
|
1,354,707
|
|
Equity
securities
|
|
|
49,210
|
|
|
335
|
|
|
(2,178
|
)
|
|
47,367
|
|
Total
investments
|
|
$
|
1,415,158
|
|
$
|
17,483
|
|
$
|
(30,567
|
)
|
$
|
1,402,074
|
|
December
31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury securities and obligations of U.S. Government corporations
and
agencies
|
|
$
|
56,927
|
|
$
|
885
|
|
$
|
(245
|
)
|
$
|
57,567
|
|
Mortgage-backed
securities
|
|
|
325,624
|
|
|
1,150
|
|
|
(2,902
|
)
|
|
323,872
|
|
Obligations
of states and political subdivisions
|
|
|
292,149
|
|
|
20,057
|
|
|
(51
|
)
|
|
312,155
|
|
Corporate
securities
|
|
|
645,892
|
|
|
6,619
|
|
|
(3,975
|
)
|
|
648,536
|
|
Total
fixed maturity investments
|
|
|
1,320,592
|
|
|
28,711
|
|
|
(7,173
|
)
|
|
1,342,130
|
|
Equity
securities
|
|
|
41,450
|
|
|
928
|
|
|
(293
|
)
|
|
42,085
|
|
Total
investments
|
|
$
|
1,362,042
|
|
$
|
29,639
|
|
$
|
(7,466
|
)
|
$
|
1,384,215
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
Company has no non-interest bearing fixed maturity investments, investments
accounted for on a non-accrual basis or any individual securities in excess
of
10% of stockholders’ equity. Fixed maturities available-for-sale, at December
31, 2005, are summarized by contractual maturity year as follows:
|
|
Amortized
Cost
|
Fair
Value
|
Fixed
maturities due:
|
|
|
|
|
|
2006
|
|
$
|
10,077
|
|
$
|
10,103
|
|
2007-2010
|
|
|
227,052
|
|
|
222,192
|
|
2011-2015
|
|
|
633,328
|
|
|
627,154
|
|
2016
and thereafter
|
|
|
171,653
|
|
|
180,477
|
|
Mortgage-backed
securities
|
|
|
323,838
|
|
|
314,781
|
|
Total
|
|
$
|
1,365,948
|
|
$
|
1,354,707
|
|
Expected
maturities of the Company’s investments may differ from contractual maturities
because certain borrowers have the right to call or prepay obligations with
or
without call or prepayment penalties.
The
following table summarizes the Company’s gross unrealized losses and estimated
fair values on investments, aggregated by investment category and length of
time
that individual securities have been in a continuous unrealized loss
position.
|
|
|
|
|
|
|
|
|
|
Less
than 12 Months
|
12
Months or More
|
Total
|
December
31, 2005
|
|
#
issues
|
Fair
Value
|
Unrealized
Losses
|
#
issues
|
Fair
Value
|
Unrealized
Losses
|
#
issues
|
Fair
Value
|
Unrealized
Losses
|
U.S.
Treasury securities and obligations of U.S. Government corporations
and
agencies
|
|
|
11
|
|
$
|
19,692
|
|
$
|
314
|
|
|
7
|
|
$
|
18,212
|
|
$
|
564
|
|
|
18
|
|
$
|
37,904
|
|
$
|
878
|
|
Mortgage-backed
securities
|
|
|
21
|
|
|
128,236
|
|
|
2,867
|
|
|
24
|
|
|
169,733
|
|
|
6,268
|
|
|
45
|
|
|
297,969
|
|
|
9,135
|
|
Obligations
of states and political subdivisions
|
|
|
5
|
|
|
15,527
|
|
|
135
|
|
|
1
|
|
|
1,008
|
|
|
59
|
|
|
6
|
|
|
16,535
|
|
|
194
|
|
Corporate
securities
|
|
|
70
|
|
|
254,958
|
|
|
6,197
|
|
|
62
|
|
|
300,804
|
|
|
11,985
|
|
|
132
|
|
|
555,762
|
|
|
18,182
|
|
Total
fixed maturity investments
|
|
|
107
|
|
|
418,413
|
|
|
9,513
|
|
|
94
|
|
|
489,757
|
|
|
18,876
|
|
|
201
|
|
|
908,170
|
|
|
28,389
|
|
Equity
securities
|
|
|
247
|
|
|
36,250
|
|
|
2,178
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
247
|
|
|
36,250
|
|
|
2,178
|
|
Total
investments
|
|
|
354
|
|
$
|
454,663
|
|
$
|
11,691
|
|
|
94
|
|
$
|
489,757
|
|
$
|
18,876
|
|
|
448
|
|
$
|
944,420
|
|
$
|
30,567
|
|
|
|
|
|
|
|
|
|
|
|
Less
than 12 Months
|
12
Months or More
|
Total
|
December
31, 2004
|
|
#
issues
|
Fair
Value
|
Unrealized
Losses
|
#
issues
|
Fair
Value
|
Unrealized
Losses
|
#
issues
|
Fair
Value
|
Unrealized
Losses
|
U.S.
Treasury securities and obligations of U.S. Government corporations
and
agencies
|
|
|
14
|
|
$
|
25,640
|
|
$
|
176
|
|
|
1
|
|
$
|
1,927
|
|
$
|
68
|
|
|
15
|
|
$
|
27,567
|
|
$
|
244
|
|
Mortgage-backed
securities
|
|
|
27
|
|
|
200,607
|
|
|
2,902
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
27
|
|
|
200,607
|
|
|
2,902
|
|
Obligations
of states and political subdivisions
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1
|
|
|
1,030
|
|
|
51
|
|
|
1
|
|
|
1,030
|
|
|
51
|
|
Corporate
securities
|
|
|
66
|
|
|
314,363
|
|
|
3,448
|
|
|
6
|
|
|
10,724
|
|
|
528
|
|
|
72
|
|
|
325,087
|
|
|
3,976
|
|
Total
fixed maturity investments
|
|
|
107
|
|
|
540,610
|
|
|
6,526
|
|
|
8
|
|
|
13,681
|
|
|
647
|
|
|
115
|
|
|
554,291
|
|
|
7,173
|
|
Equity
securities
|
|
|
64
|
|
|
15,479
|
|
|
293
|
|
|
|
|
|
—
|
|
|
—
|
|
|
64
|
|
|
15,479
|
|
|
293
|
|
Total
investments
|
|
|
171
|
|
$
|
556,089
|
|
$
|
6,819
|
|
|
8
|
|
$
|
13,681
|
|
$
|
647
|
|
|
179
|
|
$
|
569,770
|
|
$
|
7,466
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
Company held 448 investment positions with unrealized losses as of December
31,
2005. Of the 448 investment positions, 247 positions were in equity securities,
which have been held for less than one year, as the Company typically holds
equity securities for 90 days or less.
The
remaining 201 investment positions were fixed maturity securities and all are
investment grade, with the exception of the investment in Ford Motor Credit
Company. The Company’s $2.5 million investment in Ford Motor Company, which
matured on February 1, 2006, had an unrealized loss of $6 thousand at December
31, 2005, and was fully collected in February 2006, thus eliminating the
previous unrealized loss. Unrealized losses in fixed maturity investments
primarily arose from rising interest rates in the current year. None of the
unrealized losses are considered credit related, except for the investment
position in Ford Motor Company. The unrealized losses do not appear to represent
other-than-temporary impairments based on the Company’s impairment accounting
policy summarized in Note 2 of the Notes to Consolidated Financial Statements.
Of the 201 fixed maturity securities in an unrealized loss position, the Company
had 94 investments that were in an unrealized loss position for 12 months or
more. However, the unrealized loss for such investments, which are all
investment grade, comprised less than 4% of amortized cost.
Cash
and
securities with carrying values of $7.0 million and $7.1 million as of December
31, 2005 and 2004 were on deposit with state regulatory authorities in
accordance with the related statutory insurance requirements.
NOTE
5. INCOME TAXES
Income
tax expense consists of:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Current
tax expense
|
|
$
|
27,655
|
|
$
|
8,822
|
|
$
|
4,166
|
|
Deferred
tax expense
|
|
|
12,351
|
|
|
25,246
|
|
|
13,406
|
|
Total
tax expense
|
|
$
|
40,006
|
|
$
|
34,068
|
|
$
|
17,572
|
|
A
reconciliation of income tax expense computed at the federal statutory tax
rate
of 35% to total income tax expense follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Federal
income tax expense at statutory rate
|
|
$
|
44,601
|
|
$
|
42,803
|
|
$
|
24,902
|
|
Tax-exempt
income, net
|
|
|
(4,179
|
)
|
|
(4,888
|
)
|
|
(8,581
|
)
|
State
and local taxes, net of federal benefit
|
|
|
102
|
|
|
(4,477
|
)
|
|
560
|
|
Dividends
received deduction
|
|
|
(630
|
)
|
|
(294
|
)
|
|
—
|
|
Research
and experimentation tax credit
|
|
|
—
|
|
|
—
|
|
|
(374
|
)
|
Nondeductible
political contributions
|
|
|
239
|
|
|
497
|
|
|
135
|
|
Effect
from settlement of prior years tax dispute
|
|
|
75
|
|
|
—
|
|
|
949
|
|
Effect
of nondeductible executive compensation
|
|
|
—
|
|
|
435
|
|
|
—
|
|
Other
- net
|
|
|
(202
|
)
|
|
(8
|
)
|
|
(19
|
)
|
Income
tax expense
|
|
$
|
40,006
|
|
$
|
34,068
|
|
$
|
17,572
|
|
The
significant components of deferred income tax expense (benefit) attributable
to
income from continuing operations are as follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Deferred
tax (benefit) expense exclusive of the items shown below
|
|
$
|
(4,985
|
)
|
$
|
9,201
|
|
$
|
(8,592
|
)
|
Net
operating loss carryforward deduction
|
|
|
42,265
|
|
|
29,470
|
|
|
23,264
|
|
Increase
in alternative minimum tax credit
|
|
|
(24,929
|
)
|
|
(13,425
|
)
|
|
(1,266
|
)
|
Total
deferred tax expense
|
|
$
|
12,351
|
|
$
|
25,246
|
|
$
|
13,406
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
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 reserved all its rights to file for refunds and appeal any
adverse rulings by the FTB to the California State Board of Equalization
(“SBE”). In September 2005, the FTB completed its audit and denied the Company’s
refund claims. In December 2005, the Company filed an appeal with the SBE.
The
Company is unable to assess the likelihood that any refunds ultimately will
be
received from the State of California.
Income
tax payments for the year ended December 31, 2005, and December 31, 2004,
totaled $26.5 million and $16.4 million, respectively. No income tax payments
were required for the year ended December 31, 2003. During 2004, we received
$12.5 million from the Internal Revenue Service (“IRS”) to settle the majority
of the prior year receivable. As of December 31, 2005, the Company’s net federal
income tax payable was $2.4 million.
The
Company’s net deferred tax asset is comprised of:
December
31,
|
|
2005
|
2004
|
Deferred
tax assets (“DTAs”):
|
|
|
|
|
|
|
|
Alternative
minimum tax credit
|
|
$
|
49,071
|
|
$
|
24,142
|
|
Net
operating loss carryforward
|
|
|
33,582
|
|
|
75,847
|
|
Unearned
premiums
|
|
|
22,927
|
|
|
23,825
|
|
Unpaid
losses and LAE
|
|
|
7,101
|
|
|
7,828
|
|
Unrealized
investment losses
|
|
|
4,579
|
|
|
—
|
|
Research
credit
|
|
|
2,423
|
|
|
2,423
|
|
Minimum
pension liability
|
|
|
1,011
|
|
|
925
|
|
Other
DTAs - net
|
|
|
7,796
|
|
|
1,778
|
|
Total
DTAs
|
|
|
128,490
|
|
|
136,768
|
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities (“DTLs”):
|
|
|
|
|
|
|
|
EDP
software development costs
|
|
|
44,509
|
|
|
48,871
|
|
Deferred
policy acquisition costs
|
|
|
20,979
|
|
|
20,566
|
|
Unrealized
investment gains
|
|
|
—
|
|
|
7,760
|
|
Other
DTLs - net
|
|
|
6,793
|
|
|
3,436
|
|
Total
DTLs
|
|
|
72,281
|
|
|
80,633
|
|
Net
deferred tax asset
|
|
$
|
56,209
|
|
$
|
56,135
|
|
The
Company’s net deferred tax assets include a net operating loss (“NOL”)
carryforward for regular federal corporate tax purposes of approximately $95.9
million, representing an unrealized tax benefit of $33.6 million at December
31,
2005, compared to $75.8 million as of December 31, 2004. The steady decline
in
the unrealized tax benefit of the NOL since 2002 resulted from the generation
in
the intervening years of taxable underwriting and investment income. At the
current rate of utilization, the Company’s remaining NOL excluding 21st of SW
should be fully utilized by the end of 2007, but in any event long before its
statutory expiration.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
We
are
required to reduce DTAs (but not DTLs) by a valuation allowance to the extent
that, based on the weight of available evidence, it is “more likely than not”
(i.e., a likelihood of more than 50%) that any DTAs will not be realized.
Recognition of a valuation allowance would decrease reported earnings on a
dollar-for-dollar basis in the year in which any such recognition were to occur.
The determination of whether a valuation allowance is appropriate requires
the
exercise of management judgment. In making this judgment, management is required
to weigh the positive and negative evidence as to the likelihood that the DTAs
will be realized.
Our
core
business has generated an underwriting profit for the past four years.
Management believes it is reasonable to expect future underwriting profits
and
to conclude it is at least more likely than not that we will be able to realize
the benefits of our DTAs. If necessary, we believe we could implement
tax-planning strategies to generate sufficient future taxable income to utilize
the NOL carryforwards prior to their expiration. Accordingly, no valuation
allowance has been recognized as of December 31, 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.
If so, management might be required to reach a different conclusion about the
realization of the DTAs and recognize a valuation allowance at that
time.
NOTE
6. DEFERRED POLICY ACQUISITION COSTS
Following
is a summary of policy acquisition costs deferred for amortization against
future income and the related amortization charged to income from operations
(policy acquisition costs are amortized over the 6-month policy
period):
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Deferred
policy acquisition costs, beginning of year
|
|
$
|
58,759
|
|
$
|
53,079
|
|
$
|
46,190
|
|
Acquisition
costs deferred
|
|
|
253,721
|
|
|
228,159
|
|
|
209,078
|
|
Acquisition
costs amortized and charged to income during the year
|
|
|
(252,541
|
)
|
|
(222,479
|
)
|
|
(202,189
|
)
|
Deferred
policy acquisition costs, end of year
|
|
$
|
59,939
|
|
$
|
58,759
|
|
$
|
53,079
|
|
Total
advertising costs included in acquisition costs deferred during 2005, 2004
and
2003 were $70.1 million, $66.7 million, and $53.9 million, respectively.
NOTE
7. PROPERTY AND EQUIPMENT
A
summary
of property and equipment follows:
December
31,
|
|
2005
|
2004
|
Land
|
|
$
|
2,484
|
|
$
|
—
|
|
Building
|
|
|
9,720
|
|
|
—
|
|
Furniture
and equipment
|
|
|
39,573
|
|
|
38,676
|
|
Automobiles
|
|
|
302
|
|
|
881
|
|
Leasehold
and building improvements
|
|
|
16,215
|
|
|
14,245
|
|
Software
currently in service
|
|
|
157,446
|
|
|
87,283
|
|
Software
development projects in progress
|
|
|
9,666
|
|
|
56,816
|
|
Subtotal
|
|
|
235,406
|
|
|
197,901
|
|
Less
accumulated depreciation, including $43,689 and $25,506 for software
currently in service
|
|
|
(89,595
|
)
|
|
(68,529
|
)
|
Total
|
|
$
|
145,811
|
|
$
|
129,372
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
A
summary
of leased property under capital lease follows:
December
31,
|
|
2005
|
2004
|
Furniture
and equipment
|
|
$
|
10,391
|
|
$
|
10,391
|
|
Leasehold
and building improvements
|
|
|
5,390
|
|
|
5,390
|
|
Software
currently in service
|
|
|
43,150
|
|
|
43,848
|
|
Leased
autos under capital lease
|
|
|
2,249
|
|
|
—
|
|
Subtotal
|
|
|
61,180
|
|
|
59,629
|
|
Less:
|
|
|
|
|
|
|
|
Accumulated
amortization
|
|
|
(36,995
|
)
|
|
(24,794
|
)
|
Deferred
gain
|
|
|
(1,534
|
)
|
|
(3,116
|
)
|
Total
|
|
$
|
22,651
|
|
$
|
31,719
|
|
A
summary
of property and equipment depreciation expense follows:
December
31,
|
|
2005
|
2004
|
2003
|
Building
|
|
$
|
61
|
|
$
|
—
|
|
$
|
—
|
|
Furniture
and equipment
|
|
|
2,463
|
|
|
3,449
|
|
|
3,860
|
|
Automobiles
|
|
|
62
|
|
|
191
|
|
|
351
|
|
Leasehold
and building improvements
|
|
|
1,166
|
|
|
817
|
|
|
578
|
|
Software
currently in service
|
|
|
18,643
|
|
|
6,975
|
|
|
4,228
|
|
Total
|
|
$
|
22,395
|
|
$
|
11,432
|
|
$
|
9,017
|
|
Depreciation
expense for leased property under capital lease was $12.8 million, $12.4
million, and $12.4 million for the years 2005, 2004, and 2003.
During
June 2004, the Company entered into a lease for a service center in Lewisville,
Texas, which was set to expire in 2016. The operating lease provisions included
a rent holiday through June 2005 and a $2.5 million tenant improvement
allowance. On September 30, 2005, the Company purchased the land and building
that house its 136 thousand square foot service center in Texas per the purchase
option in our lease. 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.
NOTE
8. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Accounting
for losses and LAE is highly subjective because these costs must be estimated,
often weeks, months or even years in advance of when the payments are actually
made to claimants, attorneys, claims personnel and others involved in the claims
settlement process.
Accounting
principles require insurers to record estimates for loss and LAE in the periods
in which the insured events, such as automobile accidents, occur. This
estimation process requires the Company to estimate both the number of accidents
that have occurred and the ultimate amount of loss and LAE related to each
accident. The Company employs actuaries who are professionally trained and
certified in the process of establishing estimates for frequency and severity.
The
methods used to determine such estimates and to establish the resulting reserves
are continually reviewed and updated. Any resulting adjustments are reflected
in
current operating income. It is management’s belief that the reserve for losses
and LAE are adequate to cover unpaid losses and LAE as of December 31, 2005.
While the Company performs quarterly reviews of the adequacy of established
unpaid losses and LAE reserves, there can be no assurance that ultimate amounts
will not differ materially, higher or lower, from the recorded liability for
unpaid losses and LAE as of December 31, 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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
following analysis provides a reconciliation of the activity in the reserve
for
unpaid losses and loss adjustment expenses:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
At
beginning of year:
|
|
|
|
|
|
|
|
Reserve
for losses and LAE, gross of reinsurance
|
|
$
|
495,542
|
|
$
|
438,323
|
|
$
|
384,009
|
|
Reinsurance
recoverable
|
|
|
(4,645
|
)
|
|
(8,964
|
)
|
|
(20,351
|
)
|
Reserve
for losses and LAE, net of reinsurance
|
|
|
490,897
|
|
|
429,359
|
|
|
363,658
|
|
Losses
and LAE incurred, net of reinsurance:
|
|
|
|
|
|
|
|
|
|
|
Current
year
|
|
|
1,024,073
|
|
|
993,946
|
|
|
911,104
|
|
Prior
years
|
|
|
(25,140
|
)
|
|
(105
|
)
|
|
51,207
|
|
Total
|
|
|
998,933
|
|
|
993,841
|
|
|
962,311
|
|
Losses
and LAE paid, net of reinsurance:
|
|
|
|
|
|
|
|
|
|
|
Current
year
|
|
|
684,474
|
|
|
642,664
|
|
|
590,678
|
|
Prior
years
|
|
|
287,138
|
|
|
289,639
|
|
|
305,932
|
|
Total
|
|
|
971,612
|
|
|
932,303
|
|
|
896,610
|
|
At
end of year:
|
|
|
|
|
|
|
|
|
|
|
Reserve
for losses and LAE, net of reinsurance
|
|
|
518,218
|
|
|
490,897
|
|
|
429,359
|
|
Reinsurance
recoverable
|
|
|
5,617
|
|
|
4,645
|
|
|
8,964
|
|
Reserve
for losses and LAE, gross of reinsurance
|
|
$
|
523,835
|
|
$
|
495,542
|
|
$
|
438,323
|
|
The
change in prior accident year estimates recorded in each of the past three
years, net of applicable reinsurance, are summarized below:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Personal
auto
|
|
$
|
(27,473
|
)
|
$
|
(2,936
|
)
|
$
|
11,159
|
|
Homeowner
and earthquake1
|
|
|
2,333
|
|
|
2,831
|
|
|
40,048
|
|
Total
|
|
$
|
(25,140
|
)
|
$
|
(105
|
)
|
$
|
51,207
|
|
Positive
amounts represent deficiencies in loss and LAE reserves, while negative amounts
represent redundancies.
The
provision for losses and LAE recorded in 2003 for insured events of prior years
primarily resulted from the Company’s recognition of earthquake losses under SB
1899, as discussed in Note 16 of the Notes to Consolidated Financial Statements,
and from adverse development in personal auto loss severity.
The
process of making periodic changes to unpaid losses and LAE begins with the
preparation of several point estimates of unpaid losses and LAE, a review of
the
actual claims experience in the period, actual rate changes achieved, actual
changes in coverage, mix of business, and changes in certain other factors
such
as weather and recent tort activity that may affect the loss ratio. Other
relevant internal and external factors considered include a qualitative
assessment of inflation and other economic conditions, changes in the legal,
regulatory, judicial and social environments, underlying policy pricing,
exposure and policy forms, claims handling, and geographic distribution shifts.
The Company’s actuaries prepare several point estimates of unpaid losses and LAE
for each of the coverages, and use experience and judgment to arrive at an
overall actuarial point estimate of the unpaid losses and LAE for that coverage.
Meetings are held with appropriate departments to discuss significant issues
as
a result of the review. This process culminates in a reserve meeting to review
the unpaid losses and LAE. The basis for carried unpaid losses and LAE is the
overall actuarial point estimate.
______________________________
1
|
The
Company no longer has any homeowners policies in force. The Company
ceased
writing earthquake coverage in 1994, but has remaining loss reserves
from
the 1994 Northridge earthquake.
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
As
a
result of this process, unpaid losses and LAE are finalized and changes are
recorded for each of our coverages. The unpaid losses and LAE for each coverage
is the difference between the estimated and net ultimate losses and LAE and
the
net paid losses and LAE recorded through the end of the period. The overall
change in our unpaid losses and LAE is based on the sum of these coverage level
changes.
The
following table shows unpaid losses and LAE gross and net of
reinsurance:
|
|
2005
|
|
|
2004
|
|
December
31,
|
|
Gross
|
Net
|
|
Gross
|
Net
|
Unpaid
losses and LAE
|
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
$
|
521,528
|
|
$
|
516,849
|
|
|
$
|
489,411
|
|
$
|
485,759
|
|
Homeowner
and earthquake
|
|
|
2,307
|
|
|
1,368
|
|
|
|
6,131
|
|
|
5,138
|
|
Total
|
|
$
|
523,835
|
|
$
|
518,217
|
|
|
$
|
495,542
|
|
$
|
490,897
|
|
NOTE
9. DEBT
Debt
consisted of:
December
31,
|
|
2005
|
2004
|
Senior
Notes (5.9%; maturing in 2013)
|
|
$
|
99,897
|
|
$
|
99,884
|
|
Obligation
under capital leases (5.7%; maturing through 2007)
|
|
|
26,327
|
|
|
38,406
|
|
Obligation
under auto leases (ranging up to 4.26%; maturing through
2011)
|
|
|
1,748
|
|
|
—
|
|
Total
debt
|
|
$
|
127,972
|
|
$
|
138,290
|
|
The
primary purpose of both of the senior notes and capital leases enumerated above
was to increase the statutory surplus of the Company’s largest insurance
subsidiary. The carrying values of our debt were $128.0 million and $138.3
million and the estimated fair values were $127.9 million and $140.9 million
as of December 31, 2005 and 2004, respectively. The obligation under auto leases
relates to the Company’s lease agreement with GE Fleet Services.
In
December 2003, the Company completed a private offering of $100 million
principal amount of 5.9 percent Senior Notes due in December 2013 at a discount
of $0.8 million. The effective interest rate on the Senior Notes, when all
offering costs are taken into account and amortized over the term of the Senior
Notes, is approximately 6 percent per annum. Of the $99.2 million in net
proceeds from the Senior Notes, $85.0 million was used to increase the statutory
surplus of 21st Century Insurance Company, a wholly-owned subsidiary of the
Company, and the balance was retained by the holding company.
The
Senior Notes are redeemable at the Company’s option, at any time in whole, or
from time to time in part, prior to maturity at a redemption price equal to
the
greater of (A) 100% of the principal amount of the notes or (B) the sum of
the
present values of the remaining scheduled payments of principal and interest
thereon (exclusive of interest accrued through the date of redemption)
discounted to the redemption date on a semi-annual basis (assuming a 360-day
year consisting of twelve 30-day months) at the Treasury Rate, plus 25 basis
points (plus in each case, accrued interest thereon to the date of
redemption).
On
April
6, 2004, pursuant to a registration rights agreement executed in connection
with
the offering, the Company filed a registration statement with the SEC enabling
holders to exchange the private offering notes for publicly registered notes.
On
July 8, 2004, the Company completed an exchange offer in which all of the
private offering notes were exchanged for publicly registered notes having
the
same terms.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
On
December 31, 2002, the Company entered into a sale-leaseback transaction for
$15.8 million of equipment and leasehold improvements and $44.2 million of
software. The transaction is accounted for as a capital lease. The lease
includes a covenant that if AIG ceases to have a majority interest in the
Company, or if statutory surplus falls below $300.0 million, or if the net
premiums written to surplus ratio is greater than 3.8:1, or if claims paying
ratings fall below BBB+ (as rated by Standard & Poor’s), Baa1 (as rated by
Moody’s) or B++ (as rated by A.M. Best), the Company will either deliver a
letter of credit to the lessor or pay the lessor the then outstanding balance,
including a prepayment penalty of up to 3% of the outstanding balance. The
lessor has been granted a security interest in the property and equipment,
subject to the sale-leaseback, and also certain software in process of
development. See Note 12 of the Notes to Consolidated Financial Statements
for
the related contractual commitment schedule.
Aggregate
principal payments on debt outstanding at December 31, 2005 are $13.5 million
for 2006, $14.1 million for 2007, $0.3 million for 2008, $0.1 million for 2009,
and $100.0 million thereafter.
NOTE
10. REINSURANCE
The
Company has a catastrophe reinsurance agreement for the comprehensive coverage
portion of its auto physical damage lines with AIG subsidiaries Transatlantic
Reinsurance Company (20%) and National Union Reinsurance Company of Pittsburgh,
PA (60%), which reinsures any covered events up to $45.0 million in excess
of
$20.0 million. The remaining 20% is reinsured by an unrelated entity. The
agreement became effective January 1, 2004, and was renewed on January 1, 2005,
and 2006 (see Note 20 of the Notes to Consolidated Financial Statements for
additional information). In 2003, covered events under the catastrophe
reinsurance agreement were up to $30.0 million in excess of $15.0 million and
the reinsures were AIG subsidiaries Transatlantic Reinsurance Company (16.7%)
and National Union Insurance Company of Pittsburgh, PA (60%). The remaining
23.3% was reinsured by an unrelated entity.
Effective
January 1, 2004, the 90% quota share reinsurance treaty covering the Company’s
Personal Umbrella Policies (“PUP”) was amended so that the reinsurers were as
follows: Swiss RE Underwriters - 55%, Hannover Ruckversicherungs - 35%. The
treaty was renewed January 1, 2005 and 2006, with the same reinsurers and
related participation rates.
The
Company retains 100% of its auto policies and has no current reinsurance on
its
auto lines other than the catastrophe reinsurance agreement discussed above.
The
Company retains 10% of the exposure on its PUP policies.
The
effect of reinsurance on premiums written and earned is as follows:
|
|
2005
|
2004
|
2003
|
Years
Ended December 31,
|
|
Written
|
Earned
|
Written
|
Earned
|
Written
|
Earned
|
Gross
|
|
$
|
1,346,370
|
|
$
|
1,357,730
|
|
$
|
1,337,198
|
|
$
|
1,318,417
|
|
$
|
1,223,484
|
|
$
|
1,177,705
|
|
Ceded
|
|
|
(4,952
|
)
|
|
(4,793
|
)
|
|
(4,814
|
)
|
|
(4,747
|
)
|
|
(4,854
|
)
|
|
(5,028
|
)
|
Net
|
|
$
|
1,341,418
|
|
$
|
1,352,937
|
|
$
|
1,332,384
|
|
$
|
1,313,670
|
|
$
|
1,218,630
|
|
$
|
1,172,677
|
|
Gross
losses and loss adjustment expenses have been reduced by reinsurance ceded
as
follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Gross
losses and LAE incurred
|
|
$
|
1,002,342
|
|
$
|
997,612
|
|
$
|
966,512
|
|
Ceded
losses and LAE incurred
|
|
|
(3,409
|
)
|
|
(3,771
|
)
|
|
(4,201
|
)
|
Net
losses and LAE incurred
|
|
$
|
998,933
|
|
$
|
993,841
|
|
$
|
962,311
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
11. EMPLOYEE BENEFIT PLANS
The
Company has both funded and unfunded non-contributory defined benefit pension
plans, which together cover essentially all employees who have completed at
least one year of service. For certain key employees designated by the Board
of
Directors, the Company sponsors an unfunded non-qualified supplemental executive
retirement plan. The supplemental plan benefits are based on years of service
and compensation during the three highest of the last ten years of employment
prior to retirement and are reduced by the benefit payable from the pension
plan
and 50% of the social security benefit. For other eligible employees, the
pension benefits are based on employees’ compensation during all years of
service. The Company’s funding policy is to make annual contributions as
required by applicable regulations. In 2005, 2004, and 2003, the Company made
additional contributions to fully fund the accumulated benefit obligation of
its
qualified plan.
Other
information regarding the Company’s defined benefit pension plans
follows:
Years
Ended December 31,
|
|
2005
|
2004
|
Change
in projected benefit obligation:
|
|
|
|
|
|
|
|
Benefit
obligation at beginning of year
|
|
$
|
116,475
|
|
$
|
100,933
|
|
Service
cost
|
|
|
6,860
|
|
|
6,493
|
|
Interest
cost
|
|
|
7,297
|
|
|
6,639
|
|
Plan
amendments
|
|
|
831
|
|
|
—
|
|
Actuarial
loss
|
|
|
4,737
|
|
|
4,873
|
|
Benefits
paid
|
|
|
(2,587
|
)
|
|
(2,463
|
)
|
Projected
benefit obligation at end of year
|
|
$
|
133,613
|
|
$
|
116,475
|
|
Change
in plan assets:
|
|
|
|
|
|
|
|
Fair
value of plan assets at beginning of year
|
|
$
|
86,585
|
|
$
|
77,099
|
|
Actual
return on plan assets net of expenses
|
|
|
6,282
|
|
|
9,290
|
|
Employer
contributions
|
|
|
9,964
|
|
|
2,659
|
|
Benefits
paid
|
|
|
(2,587
|
)
|
|
(2,463
|
)
|
Fair
value of plan assets at end of year
|
|
$
|
100,244
|
|
$
|
86,585
|
|
Reconciliation
of funded status:
|
|
|
|
|
|
|
|
Funded
status
|
|
$
|
(33,369
|
)
|
$
|
(29,890
|
)
|
Unrecognized
net loss
|
|
|
39,735
|
|
|
36,267
|
|
Unrecognized
prior service cost
|
|
|
1,333
|
|
|
678
|
|
Net
pension asset recognized at year end
|
|
$
|
7,699
|
|
$
|
7,055
|
|
Amounts
recognized in the balance sheet consist of:
|
|
|
|
|
|
|
|
Prepaid
pension cost - qualified plan
|
|
$
|
20,007
|
|
$
|
16,610
|
|
Accrued
benefit liability - non-qualified plan
|
|
|
(12,308
|
)
|
|
(9,555
|
)
|
Additional
minimum liability - non-qualified plan
|
|
|
(4,191
|
)
|
|
(3,285
|
)
|
Intangible
asset
|
|
|
1,302
|
|
|
643
|
|
Accumulated
other comprehensive income, pre-tax
|
|
|
2,889
|
|
|
2,642
|
|
Net
pension asset recognized at year end
|
|
$
|
7,699
|
|
$
|
7,055
|
|
The
accumulated benefit obligation for all defined benefit pension plans was $113.7
million and $95.3 million at December 31, 2005 and 2004, respectively, of which
90.3% and 90.7%, respectively, were vested.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Information
for the unfunded supplemental executive retirement plan, which has an
accumulated benefit obligation in excess of plan assets, is as follows:
Years
Ended December 31,
|
|
2005
|
2004
|
Projected
benefit obligation
|
|
$
|
22,702
|
|
$
|
19,232
|
|
Accumulated
benefit obligation
|
|
|
16,499
|
|
|
12,840
|
|
Fair
value of plan assets
|
|
|
—
|
|
|
—
|
|
Net
periodic benefit costs for all plans were as follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Service
cost
|
|
$
|
6,860
|
|
$
|
6,493
|
|
$
|
4,607
|
|
Interest
cost
|
|
|
7,297
|
|
|
6,638
|
|
|
5,627
|
|
Expected
return on plan assets
|
|
|
(7,317
|
)
|
|
(6,441
|
)
|
|
(4,857
|
)
|
Amortization
of prior service cost
|
|
|
175
|
|
|
111
|
|
|
105
|
|
Amortization
of net loss
|
|
|
1,923
|
|
|
2,163
|
|
|
2,012
|
|
Net
periodic benefit cost
|
|
$
|
8,938
|
|
$
|
8,964
|
|
$
|
7,494
|
|
Additional
information
The
increase (decrease) in minimum liability included in accumulated other
comprehensive income, net of deferred income taxes, for the years ended December
31, 2005 and 2004 was $0.2 million and $(0.5) million, respectively.
Assumptions
December
31,
|
|
2005
|
2004
|
|
|
Weighted-average
assumptions used to determine the benefit obligations:
|
|
|
|
|
|
|
|
|
|
|
Discount
rate
|
|
|
5.65
|
%
|
|
6.00
|
%
|
|
|
|
Rate
of compensation increase
|
|
|
4.60
|
%
|
|
4.60
|
%
|
|
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Weighted-average
assumptions used to determine the net cost:
|
|
|
|
|
|
|
|
Discount
rate
|
|
|
6.00
|
%
|
|
6.10
|
%
|
|
6.75
|
%
|
Expected
return on plan assets
|
|
|
8.50
|
%
|
|
8.50
|
%
|
|
8.50
|
%
|
Rate
of compenation increase
|
|
|
4.60
|
%
|
|
4.60
|
%
|
|
5.60
|
%
|
December
31 is the measurement date for the plans. The discount rate can vary from year
to year and is determined by developing a hypothetical bond portfolio matched
to
our projected benefit costs.
The
overall expected long-term rate of return on assets is a weighted-average
expectation for the return on plan assets. The Company considers historical
performance and current benchmarks to arrive at expected long-term rates of
return in each asset category. The Company assumed that 75% of its portfolio
would be invested in equity securities, with the remainder invested in debt
securities.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Plan
Assets
The
Company’s pension plan weighted-average asset allocations for 2005 and 2004, and
target allocation for 2006, by asset category are as follows:
|
|
Percentage
of Plan Assets at December 31,
|
|
|
Target
Allocation
|
Asset
Category
|
|
2005
|
2004
|
|
|
2006
|
Equity
Securities
|
|
|
70
|
%
|
|
76
|
%
|
|
|
|
|
66-84
|
%
|
Debt
Securities
|
|
|
20
|
|
|
21
|
|
|
|
|
|
22-28
|
|
Other
|
|
|
10
|
|
|
3
|
|
|
|
|
|
0-12
|
|
Total
|
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
The
Company’s pension plan assets are managed by outside investment managers. The
Company’s investment strategy is to maximize return on investments while
minimizing risk. The Company believes the best way to accomplish this goal
is to
take a conservative approach to its investment strategy by investing in
high-grade equity and debt securities.
Pension
Plan Contributions
The
Company contributed $2.7 million and $7.0 million to its pension plans in 2004
and 2003, respectively. After consideration of currently available information,
the Company contributed $9.0 million to its qualified defined benefit pension
plan in 2005. Based on current assumptions, the Company does not expect to
be
required to contribute to its qualified plan in 2006. However, the amount and
timing of future contributions to the Company’s qualified defined benefit
pension plan depends on a number of unpredictable factors including statutory
funding requirements, 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 our non-qualified defined benefit pension plan
generally are limited to amounts needed to make benefit payments to retirees,
which are expected to total approximately $0.9 million in 2006.
Estimated
Future Benefit Payments
Benefit
payments for the Company’s defined benefit pension plans, which reflect expected
future service, are expected to be paid as follows:
Years
Ended December 31,
|
|
Pension
Plan and Benefit Payments
|
2006
|
|
$
|
3,060
|
|
2007
|
|
|
3,329
|
|
2008
|
|
|
3,843
|
|
2009
|
|
|
4,192
|
|
2010
|
|
|
4,951
|
|
2011-2015
|
|
|
49,191
|
|
Total
|
|
$
|
68,566
|
|
Defined
Contribution Plans
The
Company sponsors a contributory savings and security plan for eligible employees
and officers. The Company provides matching contributions equal to 75% of the
lesser of 6% of an employee’s compensation or the amount contributed by the
employee up to the maximum allowable under IRS regulations. Company matching
contributions charged against operations were $5.0 million, $4.9 million, and
$4.4 million in 2005, 2004 and 2003, respectively. The plan offers a variety
of
investment types among which employees exercise complete discretion as to choice
and investment duration.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
12. COMMITMENTS AND CONTINGENCIES
Contractual
Commitments
The
Company leases office space in Woodland Hills, California. The lease for the
Company’s corporate office expires in February 2015 and may be renewed for two
consecutive five-year periods.
On
December 31, 2002, the Company entered into a sale-leaseback transaction for
$15.8 million of equipment and leasehold improvements and $44.2 million of
software. The leaseback transaction has been accounted for as a capital lease.
In November 2005, the Company subleased a portion of the seventh floor of the
Woodland Hills Headquarters building and recorded an impairment charge as
discussed in Note 2.
The
Company also leases automobiles, office and telecom equipment as well as office
space in several other locations, primarily for claims services. The Company
also has software license agreements with terms greater than one year. Minimum
amounts due under the Company’s noncancelable commitments at December 31, 2005
are as follows:
Years
Ended December 31,
|
|
Software
Commitments
|
Operating2
Leases
|
Capital
Leases
|
2006
|
|
$
|
6,117
|
|
$
|
21,679
|
|
$
|
14,765
|
|
2007
|
|
|
2,374
|
|
|
17,793
|
|
|
14,510
|
|
2008
|
|
|
2,697
|
|
|
15,113
|
|
|
362
|
|
2009
|
|
|
1,553
|
|
|
14,412
|
|
|
139
|
|
2010
|
|
|
1,553
|
|
|
15,464
|
|
|
11
|
|
Thereafter
|
|
|
7,035
|
|
|
59,862
|
|
|
—
|
|
Total
|
|
$
|
21,329
|
|
$
|
144,323
|
|
|
29,787
|
|
Less:
amount representing interest
|
|
|
|
|
|
|
|
|
(1,712
|
)
|
Present
value of minimum lease payments
|
|
|
|
|
|
|
|
$
|
28,075
|
|
The
following table summarizes total rental and licensing expense charged to
operations:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Facilities
|
|
$
|
16,869
|
|
$
|
14,925
|
|
$
|
15,257
|
|
Equipment
and other
|
|
|
4,557
|
|
|
4,338
|
|
|
2,627
|
|
Software
related
|
|
|
8,667
|
|
|
7,896
|
|
|
5,394
|
|
Sublease
income
|
|
|
(408
|
)
|
|
(385
|
)
|
|
(301
|
)
|
Total
|
|
$
|
29,685
|
|
$
|
26,774
|
|
$
|
22,977
|
|
Legal
Proceedings
In
the
normal course of business, the Company is named as a defendant in lawsuits
related to claims and insurance policy issues, both on individual policy files
and by class actions seeking to attack the Company’s business practices. Many
suits seek unspecified 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 and in Note 16 of the Notes to Consolidated
Financial Statements, the Company does not believe the ultimate outcome of
these
matters will be material to its results of operations, financial condition
or
cash flows. The Company denies liability and has not established a reserve
for
the matters discussed below. A range of potential losses in the event of a
negative outcome is discussed where known.
______________________________
2
|
Includes
total amounts due to the Company under current sublease agreement
of
approximately $1.1 million.
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Poss
v. 21st Century Insurance Company was
filed
on June 13, 2003, in Los Angeles Superior Court. The complaint 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 discovery in this
litigation pending
appellate court decisions involving similar issues by 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 concluded on December 9, 2005, on his claims for bad faith,
emotional distress, punitive damages and attorney fees. A jury found he
sustained no damages as to these claims. The Company’s exposure in this case
includes the aforementioned $10.5 million judgment plus post-judgment interest,
which currently totals $1.5 million.
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. Specifically, 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. A court-ordered appraisal of Speck’s vehicle was favorable to
the Company and Ramona Goldenberg was substituted as a Plaintiff, replacing
Speck. 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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Thomas
Theis, on his own behalf and on behalf of all others similarly situated v.
21st
Century Insurance
was
filed on June 17, 2002, in Los Angeles Superior Court. Plaintiff seeks
California class action certification, injunctive relief, and unspecified actual
and punitive damages. The complaint contends that after insureds receive medical
treatment, the Company used a medical-review program to adjust expenses to
reasonable and necessary amounts for a given geographic area and the adjusted
amount is “predetermined” and “biased.” This case is consolidated with similar
actions against other insurers for discovery and pre-trial motions. Depositions
have recently been taken and the Company intends to vigorously defend the suit.
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.
Silvia
Quintana, on her own behalf and on behalf of all others similarly situated
v.
21st Century Insurance
was
filed on November 16, 2005.
This
purported class action, filed in San Diego, names the Company in four causes
of
action: 1) violation of B&P Section 17200, 2) conversion, 3) unjust
enrichment and, 4) declaratory relief. Silvia Quintana alleges that the
Company’s demand for reimbursement of the medical payments it made to her
pursuant to her insurance contract violates the “made-whole rule.” The Company
anticipates that if the matter survives the initial pleading stage, it will
be
consolidated,
for discovery and pre-trial motions, with actions alleging similar facts against
other insurers. This matter is in the initial stages of pleading and no
reasonable estimate of potential losses in the event of a negative outcome
can
be made at this time.
NOTE
13. CAPITAL STOCK AND ACCUMULATED OTHER COMPREHENSIVE
INCOME
Effective
December 4, 2003, the Company changed its state of incorporation from California
to Delaware. In connection with the change, the Company’s stock was assigned a
par value of $0.001 per share, resulting in a reclassification of $419.9 million
from common stock to additional paid-in capital. There was no impact to the
Company’s financial condition or results of operations as a result of the
reincorporation.
The
Company is authorized to issue up to 500,000 shares of preferred stock, $1
par
value, and 376,126 shares of Series A convertible preferred stock, $1 par value,
none of which were outstanding at December 31, 2005 or 2004.
As
of
December 31, 2005 and 2004, there were 85,933,960 and 85,489,061 shares of
the
Company’s common stock outstanding, respectively. No shares were repurchased in
2005 or 2004.
Accumulated
other comprehensive income is a component of stockholders’ equity and includes
all changes in unrealized appreciation and depreciation; reclassification
adjustments for investment losses and gains included in net income; and changes
in minimum pension liability in excess of unamortized prior service cost.
A
summary
of accumulated other comprehensive income follows:
December
31,
|
|
2005
|
2004
|
Net
unrealized (losses) gains on available-for-sale investments, net
of
deferred income taxes of $(4,579) and of $7,760
|
|
$
|
(8,504
|
)
|
$
|
14,412
|
|
Minimum
pension liability in excess of unamortized prior service cost, net
of
deferred income taxes of $1,011 and of $925
|
|
|
(1,878
|
)
|
|
(1,717
|
)
|
Total
accumulated other comprehensive (loss) income
|
|
$
|
(10,382
|
)
|
$
|
12,695
|
|
Net
change in accumulated other comprehensive income (loss) follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Unrealized
holding (losses) gains arising during the period, net of tax
benefit
(expense) of $13,357, $804, and $(3,833), respectively
|
|
$
|
(24,806
|
)
|
$
|
(1,493
|
)
|
$
|
7,116
|
|
Reclassification
adjustment for investment losses (gains) included in net income,
net of
tax benefit (expense) of $1,018, $(4,089), and $(4,667),
respectively
|
|
|
1,890
|
|
|
(7,592
|
)
|
|
(8,666
|
)
|
Change
in minimum pension liability in excess of unamortized prior service
cost,
net of deferred income tax benefit (expense) of $86, $(123),
and $245,
respectively
|
|
|
(161
|
)
|
|
228
|
|
|
(455
|
)
|
Total
|
|
$
|
(23,077
|
)
|
$
|
(8,857
|
)
|
$
|
(2,005
|
)
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
14. STOCK-BASED COMPENSATION
2004
Stock Option Plan
The
stockholders approved the 2004 Stock Option Plan (the “2004 Plan”) at the Annual
Meeting of Shareholders on May 26, 2004. The 2004 Plan supersedes the 1995
Stock
Option Plan, which will remain in effect only as to outstanding awards under
it.
The 2004 Plan authorizes a Committee of the Board of Directors to grant stock
options in respect of 4,000,000 shares to eligible employees and nonemployee
directors, subject to the terms of the 2004 Plan. Additionally, under the 2004
Plan, the Committee may grant stock options in respect of shares that were
subject to outstanding awards under the 1995 Stock Option Plan to the extent
such awards expire, are terminated, are cancelled, or are forfeited for any
reason without shares being issued.
At
December 31, 2005, 4,244,982 stock options remain available for future grants
under the 2004 Plan. Options granted to employees generally have ten-year terms
and vest over various periods, generally three years. Options granted to
nonemployee directors expire one year after a nonemployee director ceases
service with the Company, or ten years from the date of grant, whichever is
sooner. Nonemployee director options vest over one year, provided that the
nonemployee director is in the service of the Company at that time. Currently,
the Company uses the intrinsic-value method to account for stock-based
compensation paid to employees for their services.
A
summary
of securities issuable and issued for the Company’s stock option plans and the
Restricted Shares Plan at December 31, 2005, follows:
AMOUNTS
IN THOUSANDS
|
|
1995
Stock
Option
Plan
|
2004
Stock
Option
Plan
|
Restricted
Shares
Plan
|
Total
securities authorized
|
|
|
10,000
|
|
|
4,000
|
|
|
1,422
|
|
Number
of securities issued
|
|
|
(886
|
)
|
|
—
|
|
|
(1,144
|
)
|
Number
of securities issuable upon the exercise of all outstanding options
and
rights
|
|
|
(6,975
|
)
|
|
(1,894
|
)
|
|
—
|
|
Number
of securities forfeited
|
|
|
(2,425
|
)
|
|
—
|
|
|
—
|
|
Number
of securities forfeited and returned to plan
|
|
|
2,425
|
|
|
—
|
|
|
162
|
|
Unused
options assumed by 2004 Stock Option Plan
|
|
|
(2,139
|
)
|
|
2,139
|
|
|
—
|
|
Number
of securities remaining available for future grants under each
plan
|
|
|
—
|
|
|
4,245
|
|
|
440
|
|
A
summary
of the Company’s stock option activity and related information
follows:
|
|
|
Weighted-
|
|
|
Number
of
|
Average
|
|
|
Options
|
Exercise
Price
|
Options
outstanding January 1, 2003
|
|
|
5,141,900
|
|
$
|
18.77
|
|
Granted
in 2003
|
|
|
1,801,556
|
|
|
12.03
|
|
Exercised
in 2003
|
|
|
—
|
|
|
—
|
|
Forfeited
in 2003
|
|
|
(199,538
|
)
|
|
17.07
|
|
Options
outstanding December 31, 2003
|
|
|
6,743,918
|
|
$
|
17.05
|
|
Granted
in 2004
|
|
|
1,799,034
|
|
|
14.23
|
|
Exercised
in 2004
|
|
|
(49,056
|
)
|
|
13.94
|
|
Forfeited
in 2004
|
|
|
(385,338
|
)
|
|
16.07
|
|
Options
outstanding December 31, 2004
|
|
|
8,108,558
|
|
$
|
16.49
|
|
Granted
in 2005
|
|
|
1,725,123
|
|
|
14.19
|
|
Exercised
in 2005
|
|
|
(360,883
|
)
|
|
15.16
|
|
Forfeited
in 2005
|
|
|
(601,587
|
)
|
|
14.69
|
|
Expired
in 2005
|
|
|
(2,000
|
)
|
|
13.00
|
|
Options
outstanding December 31, 2005
|
|
|
8,869,211
|
|
$
|
16.22
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
following table summarizes exercisable and non-vested options as of December
31
for the years presented.
AMOUNTS
IN THOUSANDS, EXCEPT FOR PRICES
December
31,
|
|
2005
|
2004
|
2003
|
Total
options outstanding
|
|
|
8,869
|
|
|
8,108
|
|
|
6,743
|
|
Non-vested
options
|
|
|
(3,097
|
)
|
|
(3,040
|
)
|
|
(2,882
|
)
|
Exercisable
options
|
|
|
5,772
|
|
|
5,068
|
|
|
3,861
|
|
Weighted
average exercise price for exercisable options
|
|
$
|
17.49
|
|
$
|
18.21
|
|
$
|
19.36
|
|
The
following table summarizes information about stock options outstanding at
December 31, 2005:
|
|
Outstanding
|
|
Exercisable
|
Range
of Exercise
Prices
|
|
Number
of
Options
|
|
Weighted-
Average
Remaining
Contractual
Life
|
|
Weighted-
Average
Exercise
Price
|
|
Number
of
Options
|
|
Weighted-
Average
Exercise
Price
|
$11.68
-$13.00
|
|
1,474,419
|
|
7.4
Years
|
|
$11.86
|
|
901,972
|
|
$11.77
|
13.01
- 15.00
|
|
2,998,373
|
|
8.7
Years
|
|
14.28
|
|
473,797
|
|
14.41
|
15.01
- 17.00
|
|
1,372,777
|
|
6.1
Years
|
|
16.13
|
|
1,372,777
|
|
16.13
|
17.01
- 19.00
|
|
1,804,810
|
|
4.7
Years
|
|
18.05
|
|
1,804,810
|
|
18.05
|
19.01
- 22.00
|
|
432,582
|
|
1.2
Years
|
|
20.38
|
|
432,582
|
|
20.38
|
22.01
- 29.25
|
|
786,250
|
|
3.4
Years
|
|
25.43
|
|
786,250
|
|
25.43
|
$11.68
-$29.25
|
|
8,869,211
|
|
6.4
Years
|
|
16.22
|
|
5,772,188
|
|
17.49
|
The
weighted average fair value for options granted during 2005, 2004 and 2003
was
$4.74, $5.95, and $4.80, respectively. The fair value of each option grant
was
estimated on the date of grant using the Black-Scholes option-pricing model
with
the following assumptions:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Risk-free
interest rate:
|
|
|
|
|
|
|
|
Minimum
|
|
|
3.74
|
%
|
|
3.43
|
%
|
|
2.65
|
%
|
Maximum
|
|
|
4.28
|
%
|
|
4.24
|
%
|
|
3.75
|
%
|
Dividend
yield
|
|
|
1.13
|
%
|
|
0.56
|
%
|
|
0.67
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Volatility
factor of the expected market price of the Company’s common
stock:
|
|
|
|
|
|
|
|
|
|
|
Minimum
|
|
|
0.29
|
|
|
0.33
|
|
|
0.38
|
|
Maximum
|
|
|
0.32
|
|
|
0.41
|
|
|
0.40
|
|
Weighted-average
expected life of the options
|
|
|
6
Years
|
|
|
6
Years
|
|
|
6
Years
|
|
Restricted
Shares Plan
The
Restricted Shares Plan, which was approved by the Company’s stockholders,
currently authorizes grants of up to 1,421,920 shares of common stock to be
made
available to key employees. In general, twenty percent of the number of shares
granted vest on the anniversary date of each of the five years following the
year of grant. Total amortization expense relating to the Restricted Shares
Plan
was $0.3 million, $0.6 million, and $0.4 million in 2005, 2004 and 2003,
respectively. Unamortized deferred compensation in connection with outstanding
restricted stock grants totaled $1.0 million, $0.1 million, and $0.7 million
at
the end of 2005, 2004 and 2003, respectively.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
A
summary
of activity under the Restricted Shares Plan from 2003 through 2005
follows:
|
|
Common
Shares
|
Average
Market
Price
Per Share
on
Date of Grant
|
Outstanding,
January 1, 2003
|
|
|
60,238
|
|
|
|
|
Granted
in 2003
|
|
|
4,000
|
|
$
|
14.45
|
|
Vested
and distributed in 2003
|
|
|
(19,345
|
)
|
|
|
|
Outstanding,
December 31, 2003
|
|
|
44,893
|
|
|
|
|
Granted
in 2004
|
|
|
4,500
|
|
$
|
13.67
|
|
Vested
and distributed in 2004
|
|
|
(33,137
|
)
|
|
|
|
Outstanding,
December 31, 2004
|
|
|
16,256
|
|
|
|
|
Granted
in 2005
|
|
|
89,945
|
|
$
|
14.09
|
|
Vested
and distributed in 2005
|
|
|
(13,256
|
)
|
|
|
|
Forfeited
in 2005
|
|
|
(5,929
|
)
|
|
|
|
Outstanding,
December 31, 2005
|
|
|
87,016
|
|
|
|
|
NOTE
15. STATUTORY FINANCIAL DATA
Statutory
surplus and statutory net income for the Company’s insurance subsidiaries were
as follows:
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Statutory
surplus
|
|
$
|
704,671
|
|
$
|
614,893
|
|
$
|
535,026
|
|
Statutory
net income
|
|
|
113,523
|
|
|
110,339
|
|
|
76,063
|
|
The
Company’s insurance subsidiaries file financial statements prepared in
accordance with Statutory Accounting Principles (“SAP”) prescribed or permitted
by domestic insurance regulatory agencies. The Company’s financial statements
are prepared in accordance with GAAP and differ from amounts reported under
SAP
primarily as a result of the following:
|
·
|
Commissions,
premium taxes and other variable costs incurred in connection with
writing
new and renewal business are capitalized and amortized on a pro rata
basis
over the period in which the related premiums are earned under GAAP,
rather than expensed as incurred, as required by
SAP.
|
|
·
|
Certain
assets are included in the GAAP consolidated balance sheets, but
are
charged directly against statutory surplus under SAP. These assets
consist
primarily of premium receivables that are outstanding over 90 days,
federal deferred tax assets in excess of statutory limitations,
intercompany balances due from the parent, furniture, equipment,
application computer software, leasehold improvements and prepaid
expenses.
|
|
·
|
Amounts
related to ceded reinsurance, such as prepaid reinsurance premiums
and
reinsurance recoverables, are shown gross, rather than netted against
unearned premium reserves and LAE reserves, respectively, as required
by
SAP.
|
|
·
|
Investments,
which are classified as available-for-sale, are reported at fair
values,
rather than at amortized cost, or the lower of amortized cost or
market,
depending on the specific type of security, as required by SAP. Equity
securities are reported at fair values, which may differ from the
NAIC
market values as required by SAP.
|
|
·
|
The
differing treatment of income and expense items results in a corresponding
difference in federal income tax expense. Both current and deferred
taxes
are recognized in the income statement for GAAP, while deferred taxes
are
posted directly to surplus for SAP.
|
|
·
|
Costs
for application computer software developed or obtained for internal
use
are capitalized and amortized over their useful life, rather then
expensed
as incurred, as required by SAP.
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
The
following table reconciles consolidated GAAP net income to statutory net
income.
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Net
income - GAAP basis
|
|
$
|
87,426
|
|
$
|
88,225
|
|
$
|
53,575
|
|
Deferred
federal income tax expense
|
|
|
16,800
|
|
|
23,130
|
|
|
24,323
|
|
Change
in deferred policy acquisition costs
|
|
|
(1,180
|
)
|
|
(5,680
|
)
|
|
(6,889
|
)
|
Net
loss from non-insurance entities
|
|
|
9,754
|
|
|
634
|
|
|
2,369
|
|
Other,
net
|
|
|
723
|
|
|
4,030
|
|
|
2,685
|
|
Net
income - SAP basis
|
|
$
|
113,523
|
|
$
|
110,339
|
|
$
|
76,063
|
|
The
following table reconciles stockholders’ equity to statutory
surplus.
December
31,
|
|
2005
|
2004
|
Stockholders’
equity - GAAP
|
|
$
|
829,972
|
|
$
|
774,401
|
|
Condensed
adjustments to reconcile GAAP shareholders’ equity to statutory
surplus:
|
|
|
|
|
|
|
|
Net
book value of fixed assets under capital leases
|
|
|
(24,185
|
)
|
|
(34,834
|
)
|
Deferred
gain under capital lease transactions
|
|
|
(914
|
)
|
|
(610
|
)
|
Capital
lease obligation
|
|
|
28,074
|
|
|
38,405
|
|
Non
admitted net deferred tax assets
|
|
|
(34,936
|
)
|
|
(67,260
|
)
|
Net
deferred tax assets relating to items nonadmitted under
SAP
|
|
|
38,544
|
|
|
50,712
|
|
Intercompany
receivables
|
|
|
(57,683
|
)
|
|
(19,917
|
)
|
Fixed
assets
|
|
|
(22,492
|
)
|
|
(25,017
|
)
|
Equity
in non-insurance entities
|
|
|
26,798
|
|
|
8,082
|
|
Unrealized
losses (gains) on investments
|
|
|
10,788
|
|
|
(21,709
|
)
|
Deferred
policy acquisition costs
|
|
|
(59,939
|
)
|
|
(58,759
|
)
|
Prepaid
pension costs and intangible pension asset
|
|
|
(21,309
|
)
|
|
(17,253
|
)
|
Other
prepaid expenses
|
|
|
(11,049
|
)
|
|
(12,235
|
)
|
Other,
net
|
|
|
3,002
|
|
|
887
|
|
Statutory
Surplus
|
|
$
|
704,671
|
|
$
|
614,893
|
|
The
Company has estimated the risk-based capital requirements of each of its
insurance subsidiaries as of December 31, 2005 in accordance with the guidelines
issued by the National Association of Insurance Commissioners. Policyholders’
surplus for each of the Company’s insurance subsidiaries exceeded the highest
level of minimum required capital.
The
Company is also regulated by the provisions of the California Insurance Holding
Company System Regulatory Act (the “Holding Company Act”). Many transactions
that are defined to be of an “extraordinary” nature may not be effected without
the prior approval of the California Department of Insurance (“CDI”). In
addition, there are limits on the insurance subsidiaries’ dividend paying
capacity. In 2006, the Company estimates that one of its insurance subsidiaries
has capacity to pay approximately $113.0 million in dividends to its parent
without prior approval of the CDI.
On
June
15, 2004 the CDI finalized its examination reports on the statutory financial
statements for the Company’s two California-domiciled insurance subsidiaries for
the three-year period ended December 31, 2002. The reports did not contain
any
findings or adjustments. The CDI and Texas Department of Insurance will examine
the three-year period ended December 31, 2005 during 2006.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
16. NORTHRIDGE EARTHQUAKE
California
Senate Bill 1899 (“SB 1899”), effective from January 1, 2001 to December 31,
2001, allowed the re-opening of previously closed earthquake claims arising
out
of the 1994 Northridge earthquake. More than ninety-nine percent of the claims
submitted and litigation brought against the Company as a result of California
SB 1899 have been resolved. The Company’s loss and LAE reserve for SB 1899
claims were increased by approximately $0.4 million in the fourth quarter of
2005 based on a revised estimate of the cost of resolving the few remaining
claims. The Company’s total loss and LAE reserves for SB 1899 claims as of
December 31, 2005, 2004, and 2003 were $0.5 million, $4.0 million, and $14.2
million, respectively.
NOTE
17. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The
summarized unaudited quarterly results of operations were as
follows:
Quarters
Ended
|
|
March
31,
|
June
30,
|
September
30,
|
December
31,
|
2005
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
336,364
|
|
$
|
336,845
|
|
$
|
344,102
|
|
$
|
335,626
|
|
Net
investment income
|
|
|
17,037
|
|
|
17,006
|
|
|
17,042
|
|
|
18,011
|
|
Realized
investment losses
|
|
|
(460
|
)
|
|
(1,267
|
)
|
|
(939
|
)
|
|
(606
|
)
|
Income
before provision for income taxes
|
|
|
28,172
|
|
|
30,116
|
|
|
30,471
|
|
|
38,673
|
|
Net
income
|
|
|
19,437
|
|
|
20,495
|
|
|
21,102
|
|
|
26,392
|
|
Basic
earnings per share3
|
|
$
|
0.23
|
|
$
|
0.24
|
|
$
|
0.25
|
|
$
|
0.31
|
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
318,220
|
|
$
|
327,021
|
|
$
|
333,440
|
|
$
|
334,989
|
|
Net
investment income
|
|
|
13,146
|
|
|
14,315
|
|
|
15,118
|
|
|
16,252
|
|
Realized
investment gains (losses)
|
|
|
7,646
|
|
|
1,337
|
|
|
(162
|
)
|
|
2,010
|
|
Income
before provision for income taxes
|
|
|
29,182
|
|
|
31,306
|
|
|
29,113
|
|
|
32,692
|
|
Net
income
|
|
|
19,825
|
|
|
21,374
|
|
|
24,559
|
|
|
22,467
|
|
Basic
earnings per share3
|
|
$
|
0.23
|
|
$
|
0.25
|
|
$
|
0.29
|
|
$
|
0.26
|
|
Third
quarter 2004 results were increased by $4.9 million due to the effect of recent
California legislation relating to holding company taxes on dividends from
insurance subsidiaries (see additional discussion in Note 5 of the Notes to
Consolidated Financial Statements).
NOTE
18. SEGMENT INFORMATION
The
Company’s “Personal Auto Lines” reportable segment primarily markets and
underwrites personal auto, motorcycle and personal 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”). The FAIR Plan is a state administered pool
of difficult to insure homeowners exposures. Each participating insurer is
allocated a percentage of the total premiums written and losses and LAE incurred
by the pool according to its share of total homeowner direct premiums written
in
the state. Participation in the current year FAIR Plan operations is based
on
the pool from two years prior. Since the Company ceased writing homeowners
business in 2002, the Company no longer receives assignments for plan years
beyond 2004, but continues to participate in prior plan year activity, which
is
in runoff.
______________________________
3
|
Basic
and diluted amounts are the same for all periods
presented.
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
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. All revenues are generated from
external customers and the Company does not rely on any major
customer.
The
following table presents net premiums earned, depreciation and amortization
expense, and segment profit (loss) for the Company’s segments for the years
ended December 31.
AMOUNTS
IN THOUSANDS
|
|
Personal
Auto Lines
|
Homeowner
and Earthquake Lines in Runoff4
|
Total
|
2005
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
1,352,928
|
|
$
|
9
|
|
$
|
1,352,937
|
|
Depreciation
and amortization expense
|
|
|
33,744
|
|
|
16
|
|
|
33,760
|
|
Segment
profit (loss)
|
|
|
71,995
|
|
|
(2,325
|
)
|
|
69,670
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
1,313,551
|
|
$
|
119
|
|
$
|
1,313,670
|
|
Depreciation
and amortization expense
|
|
|
22,156
|
|
|
104
|
|
|
22,260
|
|
Segment
profit (loss)
|
|
|
63,972
|
|
|
(2,714
|
)
|
|
61,258
|
|
|
|
|
|
|
|
|
|
|
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
1,172,679
|
|
$
|
(2
|
)
|
$
|
1,172,677
|
|
Depreciation
and amortization expense
|
|
|
19,886
|
|
|
320
|
|
|
20,206
|
|
Segment
profit (loss)
|
|
|
41,006
|
|
|
(40,175
|
)
|
|
831
|
|
The
following table reconciles our total segment profit to our consolidated income
before provision for income taxes for the years ended December 31:
AMOUNTS
IN THOUSANDS
|
|
2005
|
|
2004
|
|
2003
|
|
Segment
profit
|
|
$
|
69,670
|
|
$
|
61,258
|
|
$
|
831
|
|
Net
investment income
|
|
|
69,096
|
|
|
58,831
|
|
|
45,833
|
|
Net
realized investment (losses) gains
|
|
|
(3,272
|
)
|
|
10,831
|
|
|
13,177
|
|
Other
income
|
|
|
367
|
|
|
—
|
|
|
14,777
|
|
Other
expenses
|
|
|
(410
|
)
|
|
—
|
|
|
—
|
|
Interest
and fees expense
|
|
|
(8,019
|
)
|
|
(8,627
|
)
|
|
(3,471
|
)
|
Income
before provision for income taxes
|
|
$
|
127,432
|
|
$
|
122,293
|
|
$
|
71,147
|
|
Personal
Auto Lines.
Personal
automobile insurance is our primary line of business. The growth in segment
profit for the personal auto lines in 2005, 2004, and 2003 was due to an
increase in the number of insured vehicles, a rate increase in 2003 and
favorable claim frequency.
Homeowner
and Earthquake Lines in Runoff. The
significant segment loss for the homeowner and earthquake lines in runoff
relates to adverse earthquake development stemming from the claims submitted
and
litigation brought against the Company as a result of SB 1899. See Notes 8
and
16 of the Notes to Consolidated Financial Statements.
______________________________
4
|
Segment
revenue represents premiums earned as a result of the Company’s
participation in the California FAIR
Plan.
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
NOTE
19. 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 has decided to purchase investments that provide housing and other
services to economically disadvantaged communities. To that end, the Company
is
a voluntary 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.
The
VIE
structure provides a wider range of investment options through which insurance
companies and other institutional investors can address the investment needs
of
these communities. The
Company’s maximum participation in Impact C.I.L., LLC (“Impact C.I.L.”), a
subsidiary of Impact and a VIE, 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 a warehouse lending
facility. Potential losses are limited to the Company’s participation as well as
associated operating fees. As of December 31, 2005, the Company’s pro rata share
of these advances was approximately 11.1%, or $5.0 million and $5.1 million
as
of December 31, 2005 and 2004, respectively. Potential losses are limited to
the
Company’s participation as well as associated operating fees. The revolving
member loan and the warehouse financing agreement do not significantly impact
the Company’s liquidity or capital.
The
Company is not the primary beneficiary of any of the VIEs as the Company has
voting rights, beneficiary rights, obligations, and ownership in proportion
to
each of its Impact related investments, none of which exceeds
11.1%.
In
addition to the above, the Company consistently held $6.2 million in other
Impact related investments as of December 31, 2005 and 2004. Total
Impact related investment income was $1.1 million, $0.8 million, and $0.7
million for the years ended 2005, 2004, and 2003, respectively.
NOTE
20. TRANSACTIONS WITH RELATED PARTIES
Several
subsidiaries of AIG together own approximately 62% of our outstanding common
stock and three of the ten members of our Board of Directors are employees
of
AIG. Since 1995, the Company has entered into several transactions with AIG
subsidiaries, including reinsurance agreements, insurance coverage contracts,
and various services.
Reinsurance
agreements -
The
Company’s catastrophe reinsurance agreement for its auto lines is provided by
three participating entities, two of which are AIG subsidiaries. Together they
reinsure any covered event up to $45.0 million in excess of $20.0 million
effective January 1, 2004 (up to $30.0 million in excess of $15.0 million in
2003). This coverage was renewed effective January 1, 2005 and 2006 (see Note
10
of the Notes to Consolidated Financial Statements).
Total
premiums ceded to AIG subsidiaries were $1.0 million, $1.1 million, and $1.2
million for the years ended December 31, 2005, 2004, and 2003, respectively.
Total reinsurance recoverables, net of payables, from AIG subsidiaries were
$0.6
million and $1.5 million as of December 31, 2005 and 2004,
respectively.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005
DOLLAR
AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
Corporate
insurance coverage -
The
Company has obtained the following corporate insurance policies from AIG
subsidiaries:
|
·
|
Workers’
compensation insurance
|
|
·
|
General
liability insurance
|
|
·
|
Umbrella
excess insurance
|
|
·
|
Fiduciary
liability insurance
|
|
·
|
Commercial
auto insurance
|
|
·
|
Employment
practices liability insurance
|
Errors
and omissions insurance was carried with AIG through September 30,
2005.
Insurance
expense attributable to AIG corporate insurance coverages was $2.9 million,
$3.5
million, and $1.3 million for 2005, 2004, and 2003, respectively.
Investment
management and investment accounting -
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. The fees are determined as a percentage
of
the average invested asset balance, and are classified with net investment
income. This agreement was approved by the CDI. Investment management and
accounting expense was $0.9 million, $0.9 million, and $0.1 million for the
years ended December 31, 2005, 2004 and 2003, respectively.
Software
and data processing -
Through
December 31, 2004, the Company utilized certain third party software and data
processing monitoring tools under an agreement negotiated by AIG. Since January
1, 2005, the Company has negotiated its own contracts, and no longer incurs
any
software or data processing costs with AIG subsidiaries. Software and data
processing expense was $0.3 million and $0.3 million in 2004 and 2003,
respectively. There was no expense in 2005.
ITEM
9. |
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
|
None.
Evaluation
of Disclosure Controls and Procedures
We
have
established disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated subsidiaries,
is
made known to the officers who certify the Company’s financial reports and to
other members of senior management and the Board of Directors.
Based
on
their evaluation of the effectiveness of 21st Century Insurance Group’s
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934) as of December 31, 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.
The
Company intends to review and evaluate the design and effectiveness of its
disclosure controls and procedures on an ongoing basis and to improve its
controls and procedures over time and to correct any deficiencies that may
be
discovered in the future in order to ensure that senior management has timely
access to all material financial and non-financial information concerning the
Company’s business. While the present design of the Company’s disclosure
controls and procedures is effective to achieve these results, future events
affecting the Company’s business may cause management to modify its disclosure
controls and procedures.
Management’s
Report on Internal Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). Under the supervision and with the participation of
our
management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in Internal
Control - Integrated Framework issued
by
the Committee of Sponsoring Organizations of the Treadway Commission. Based
on
our evaluation under the framework in Internal
Control - Integrated Framework,
our
management concluded that our internal control over financial reporting was
effective as of December 31, 2005.
Our
management’s evaluation of the effectiveness of our internal control over
financial reporting as of December 31, 2005 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm,
as
stated in their report which is included herein.
Inherent
Limitations on Effectiveness of Controls
A
control
system, no matter how well designed and operated, can provide only reasonable,
not absolute, assurance that the control system’s objectives will be met.
Further, no evaluation of controls can provide absolute assurance that
misstatements due to error or fraud will not occur or that all control issues
and instances of fraud, if any, have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple error or mistake. Controls can also
be
circumvented by the individual acts of some persons, or by collusion of two
or
more people.
Changes
in Internal Controls
There
were no changes in the Company’s internal controls over financial reporting that
occurred during the fourth quarter that have materially affected or are
reasonably likely to materially affect internal controls over financial
reporting.
None.
PART
III
ITEM
10. |
DIRECTORS
AND EXECUTIVE OFFICERS OF THE
REGISTRANT
|
Information
related to directors, executive officers, and beneficial ownership required
in
Item 10 is incorporated by reference from the Company’s definitive proxy
statement to be filed in connection with the Company’s 2006 Annual Meeting of
Stockholders pursuant to Instruction G(3) of Form 10-K.
The
Company has adopted Corporate Governance Guidelines and charters for its Audit
Committee, Nominating and Corporate Governance Committee, and other Committees
of its Board of Directors. It has also adopted a Code of Business Conduct
covering all Employees and a Code of Ethics for the Chief Executive Officer,
Chief Financial Officer, and Financial Managers. Each of these documents is
available on the Company’s web site, www.21st.com,
and a
copy will be mailed upon request from the Company’s Investor Relations
Department (6301 Owensmouth Avenue, Woodland Hills, California 91367, phone
818-673-3996). The Company intends to disclose any amendments to, or waivers
of,
the Code of Ethics on behalf of the Company’s Chief Executive Officer, Chief
Financial Officer, Controller, and persons performing similar functions on
the
Company’s web site, at www.21st.com
under
the “About Us” caption, promptly following the date of any such amendment or
waiver.
Information
in response to Item 11 is incorporated by reference from the Company’s
definitive proxy statement to be filed in connection with the Company’s 2006
Annual Meeting of Stockholders pursuant to Instruction G(3) of Form
10-K.
ITEM
12. |
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER
MATTERS
|
Information
in response to Item 12 is incorporated by reference from the Company’s
definitive proxy statement to be filed in connection with the Company’s 2006
Annual Meeting of Stockholders pursuant to Instruction G(3) of Form
10-K.
Securities
Authorized for Issuance under Equity Compensation Plans
Securities
authorized for issuance under equity compensation plans at December 31, 2005
are
as follows:
|
|
COLUMN
A
|
|
COLUMN
B
|
|
COLUMN
C
|
|
|
|
|
|
|
|
|
|
Plan
Category
|
|
Number
of Securities to
be
Issued Upon
Exercise
of Outstanding
Options,
Warrants and
Rights
(in
thousands)
|
|
Weighted-Average
Exercise
Price of
Outstanding
Options,
Warrants
and
Rights
|
|
Number
of Securities Remaining
Available
for Future Issuance
Under
Equity Compensation Plans
(Excluding
Securities Reflected in
Column
(A))
(in
thousands)
|
|
Equity
compensation plans approved by stockholders
|
|
|
8,869
|
|
|
|
|
|
4,245
|
|
Equity
compensation plans not approved by stockholders
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
Total
|
|
|
8,869
|
|
|
|
|
|
4,245
|
|
ITEM
13. |
CERTAIN
RELATIONSHIPS AND RELATED
TRANSACTIONS
|
Certain
Information in response to Item 13 is incorporated by reference from the
Company’s definitive proxy statement to be filed in connection with the
Company’s 2006 Annual Meeting of Stockholders pursuant to Instruction G(3) of
Form 10-K. All related party transactions, which require disclosure, are
included in the Management’s Discussion and Analysis or the Notes to
Consolidated Financial Statements.
ITEM
14. |
PRINCIPAL
ACCOUNTING FEES AND
SERVICES
|
Information
in response to Item 14 is incorporated by reference from the Company’s
definitive proxy statement to be filed in connection with the Company’s 2006
Annual Meeting of Stockholders pursuant to Instruction G(3) of Form
10-K.
PART
IV
ITEM
15. |
EXHIBITS,
FINANCIAL STATEMENT SCHEDULES
|
(a)
DOCUMENTS FILED WITH THIS REPORT
(1)
FINANCIAL STATEMENTS
The
following consolidated financial statements of the Company are filed as a part
of this report:
|
|
|
PAGE
|
(i)
|
|
Report
of independent registered public accounting firm
|
43
|
(iii)
|
|
Consolidated
balance sheets - December 31, 2005 and 2004;
|
45
|
(iv)
|
|
Consolidated
statements of operations - Years ended December 31, 2005, 2004
and
2003;
|
46
|
(v)
|
|
Consolidated
statements of stockholders’ equity - Years ended December 31, 2005, 2004
and 2003;
|
47
|
(vi)
|
|
Consolidated
statements of cash flows - Years ended December 31, 2005, 2004
and
2003;
|
48
|
(vii)
|
|
Notes
to consolidated financial statements
|
49
|
(2)
SCHEDULES
The
following financial statement schedule required to be filed by Item 8 and by
paragraph (d) of Item 15 of Form 10-K is submitted as a separate section of
this
report:
Schedule
II - Condensed Financial Information of Registrant
|
83
|
Schedules
I, III, IV, V and VI have been omitted as all required data is included in
the
Notes to Consolidated Financial Statements.
All
other
schedules for which provision is made in the applicable accounting regulations
of the Securities and Exchange Commission are not required under the related
instructions or are inapplicable and, therefore, have been omitted.
(b)
EXHIBITS REQUIRED
The
following exhibits required by Item 601 of Regulation S-K and by paragraph
(c)
of Item 15 of Form 10-K are listed by number corresponding to the Exhibit Table
of Item 601 of Regulation S-K and are filed as part of this Annual Report on
Form 10-K or are incorporated herein by reference:
Exhibit
No.
|
|
Description
of Exhibit
|
|
Location
|
3(i)
|
|
Certificate
of Incorporation of the Company.
|
|
Information
Statement on Form DEF 14C (filed with SEC on November 13, 2003; Appendix
B
therein).
|
3(ii)
|
|
By-laws
of the Company.
|
|
Information
Statement on Form DEF 14C (filed with SEC on November 13, 2003; Appendix
C
therein).
|
4.1
|
|
Indenture,
dated December 9, 2003, between 21st Century Insurance Group and
The Bank
of New York, as trustee.
|
|
Annual
Report on Form 10-K (filed with SEC on February 11, 2004; Exhibit
4.1
therein).
|
4.2
|
|
Exchange
and Registration Rights Agreement, dated December 9, 2003.
|
|
Annual
Report on Form 10-K (filed with SEC on February 11, 2004; Exhibit
4.2
therein).
|
10(a)
|
|
Amendment
to Registrant’s Restricted Shares Plan.
|
|
Annual
Report on Form 10-K (filed with SEC on March 4, 2002; Exhibit 10(a)
therein).
|
10(b)
|
|
Split
Dollar Insurance Agreement between Registrant and Stanley M. Burke,
as
trustee of the 1983 Foster Insurance Trust.
|
|
Annual
Report on Form 10-K (filed with SEC on March 4, 2002; Exhibit 10(b)
therein).
|
10(c)
|
|
Registrant’s
Supplemental Executive Retirement Plan as amended.
|
|
Annual
Report on Form 10-K (filed with SEC on March 4, 2002; Exhibit 10(h)
therein).
|
10(d)
|
|
Registrant’s
Pension Plan, 1994 Amendment and Restatement.
|
|
Annual
Report on Form 10-K (filed with SEC on March 4, 2002; Exhibit 10(i)
therein).
|
10(e)
|
|
Investment
and Strategic Alliance Agreement.
|
|
Annual
Report on Form 10-K (filed with SEC on March 4, 2002; Exhibit 10(c)
therein).
|
10(f)
|
|
Amendment
to the Investment and Strategic Alliance Agreement.
|
|
Annual
Report on Form 10-K (filed with SEC on March 4, 2002; Exhibit 10(d)
therein).
|
10(g)
|
|
Registrant’s
1995 Stock Option Plan incorporated herein by reference from the
Registrant’s Form S-8 dated July 26, 1995.
|
|
Securities
Offered on Form S-8 (filed with SEC on July 28, 1995
therein).
|
10(h)
|
|
Amendment
to Registrant’s 1995 Stock Option Plan.
|
|
Proxy
Statement on Form DEF 14A (filed with SEC on April 18, 1997
therein).
|
10(i)
|
|
Short
Term Incentive Plan.
|
|
Annual
Report on Form 10-K (filed with SEC on February 17, 2005; Exhibit
10(i)
therein).
|
10(j)
|
|
Amendment
to Registrant’s 1995 Stock Option Plan.
|
|
Proxy
Statement on Form DEF 14A (filed with SEC on April 27, 2001
therein).
|
10(k)
|
|
Registrant’s
Savings and Security Plan.
|
|
Annual
Report on Form 10-K (filed with SEC on March 4, 2002; Exhibit 10(j)
therein).
|
10(l)
|
|
Lease
Agreements for Registrant’s Principal Offices substantially in the form of
this Exhibit.
|
|
Annual
Report on Form 10-K (filed with SEC on February 11, 2004; Exhibit
10(l)
therein).
|
10(m)
|
|
Forms
of Amended and Restated Stock Option Agreements.
|
|
Annual
Report on Form 10-K (filed with SEC on February 11, 2004; Exhibit
10(m)
therein).
|
10(n)
|
|
Form
of Restricted Shares Agreement.
|
|
Annual
Report on Form 10-K (filed with SEC on February 11, 2004; Exhibit
10(n)
therein).
|
10(o)
|
|
Retention
agreement substantially in the form of this exhibit for executives
Richard
A. Andre, Michael J. Cassanego, and Dean E. Stark.
|
|
Annual
Report on Form 10-K (filed with SEC on February 11, 2004; Exhibit
10(o)
therein).
|
Exhibit
No.
|
|
Description
of Exhibit
|
|
Location
|
10(p)
|
|
Sale
and Leaseback Agreement between 21st Century Insurance Company and
General
Electric Capital Corporation, for itself, and as agent for Certain
Participants, as amended, dated December 31, 2002.
|
|
Annual
Report on Form 10-K (filed with SEC on February 11, 2004; Exhibit
10(p)
therein).
|
10(q)
|
|
Registrant’s
2004 Stock Option Plan incorporated herein by reference from the
Registrant’s DEF 14A dated April 21, 2004.
|
|
Proxy
Statement on Form DEF 14A (filed with SEC on April 21, 2004
therein).
|
10(r)
|
|
Summary
of Director Compensation.
|
|
Filed
herewith.
|
10(s)
|
|
Chief
Executive Officer Short Term Incentive Plan.
|
|
Proxy
Statement on Form DEF 14A (filed with SEC on April 21, 2004
therein).
|
10(t)
|
|
Retention
Agreement between Lawrence P. Bascom, CFO, and 21st Century Insurance
Group, dated November 29, 2004.
|
|
Current
Report on Form 8-K (filed with SEC on December 1, 2004; Exhibit 10.1
therein).
|
10(u)
|
|
License
Agreement between Registrant and Century 21 Real Estate Corporation,
dated
November 30, 2004.
|
|
Current
Report on Form 8-K (filed with SEC on December 9, 2004; Exhibit 10.1
therein).
|
10(v)
|
|
Amendments
to Lease Agreements for Registrant’s Principal.
|
|
Annual
Report on Form 10-K (filed with SEC on February 17, 2005; Exhibit
10(v)
therein).
|
10(w)
|
|
Registrant’s
Supplemental Pension Plan, Restatement No. 1, effective as of January
1,
1996.
|
|
Annual
Report on Form 10-K (filed with SEC on February 17, 2005; Exhibit
10(w)
therein).
|
10(x)
|
|
Supplemental
401(k) Plan, of 21st Century Insurance Company, Amendment and Restatement
dated January 1, 2001 and Amendment dated January 1, 2004.
|
|
Annual
Report on Form 10-K (filed with SEC on February 17, 2005; Exhibit
10(x)
therein).
|
10(y)
|
|
Registrant’s
Executive Medical Reimbursement Plan.
|
|
Annual
Report on Form 10-K (filed with SEC on February 17, 2005; Exhibit
10(z)
therein).
|
10(z)
|
|
Retention
Agreement between Bruce Marlow, President and CEO, and 21st Century
Insurance Group, dated September 14, 2005.
|
|
Current
Report on Form 8-K (filed with SEC on September 19, 2005; Exhibit
10.1
therein).
|
14
|
|
Code
of Ethics.
|
|
Filed
herewith.
|
21
|
|
Subsidiaries
of Registrant.
|
|
Annual
Report on Form 10-K (filed with SEC on February 17, 2005; Exhibit
21
therein).
|
23
|
|
Consent
of Independent Registered Public Accounting Firm.
|
|
Filed
herewith.
|
31.1
|
|
Certification
of President and Chief Executive Officer Pursuant to Exchange Act
Rule
13a-14(a).
|
|
Filed
herewith.
|
31.2
|
|
Certification
of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a).
|
|
Filed
herewith.
|
32.1
|
|
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002.
|
|
Filed
herewith.
|
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
CONDENSED
FINANCIAL INFORMATION OF REGISTRANT
BALANCE
SHEETS
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
December
31,
|
|
2005
|
2004
|
Assets
|
|
|
|
|
|
Cash
|
|
$
|
2,667
|
|
$
|
1,693
|
|
Fixed
maturity investments available-for-sale, at fair value (amortized
cost:
$14,648 and $14,681)
|
|
|
14,197
|
|
|
14,510
|
|
Accounts
receivable from subsidiaries
|
|
|
7,429
|
|
|
—
|
|
Investment
in unconsolidated insurance subsidiaries, at equity
|
|
|
858,144
|
|
|
784,348
|
|
Property
and equipment, at cost less accumulated depreciation of $35,498 and
$23,769, including software leased to a subsidiary of $106,741 and
$100,498 (net of accumulated depreciation of $34,960 and $23,108,
respectively)
|
|
|
106,741
|
|
|
100,525
|
|
Other
assets
|
|
|
3,296
|
|
|
2,103
|
|
Total
assets
|
|
$
|
992,474
|
|
$
|
903,179
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
Senior
notes
|
|
$
|
99,897
|
|
$
|
99,884
|
|
Term
loan due to subsidiary
|
|
|
58,000
|
|
|
18,000
|
|
Other
liabilities
|
|
|
4,605
|
|
|
9,088
|
|
Accounts
payable to subsidiaries
|
|
|
—
|
|
|
1,806
|
|
Total
liabilities
|
|
|
162,502
|
|
|
128,778
|
|
Stockholders’
equity
|
|
|
829,972
|
|
|
774,401
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
992,474
|
|
$
|
903,179
|
|
See
accompanying Notes to Condensed Financial Information of Registrant.
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
CONDENSED
FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS
OF OPERATIONS
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Revenues
|
|
|
|
|
|
|
|
Rental
income from software lease to subsidiary
|
|
$
|
8,151
|
|
$
|
6,735
|
|
$
|
—
|
|
Interest
and other income
|
|
|
708
|
|
|
326
|
|
|
708
|
|
Total
revenues
|
|
|
8,859
|
|
|
7,061
|
|
|
708
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
Loan
interest and fees
|
|
|
7,302
|
|
|
6,035
|
|
|
378
|
|
Depreciation
expense
|
|
|
12,311
|
|
|
5,017
|
|
|
—
|
|
Other
expenses
|
|
|
3,776
|
|
|
3,867
|
|
|
3,114
|
|
Total
expenses
|
|
|
23,389
|
|
|
14,919
|
|
|
3,492
|
|
Loss
before provision for income taxes
|
|
|
(14,530
|
)
|
|
(7,858
|
)
|
|
(2,784
|
)
|
Provision
for income taxes
|
|
|
(5,267
|
)
|
|
(7,267
|
)
|
|
(415
|
)
|
Net
loss before equity in undistributed loss of subsidiaries
|
|
|
(9,263
|
)
|
|
(591
|
)
|
|
(2,369
|
)
|
Equity
in undistributed income of subsidiaries
|
|
|
96,689
|
|
|
88,816
|
|
|
55,944
|
|
Net
income
|
|
$
|
87,426
|
|
$
|
88,225
|
|
$
|
53,575
|
|
See
accompanying Notes to Condensed Financial Information of Registrant.
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
CONDENSED
FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS
OF CASH FLOWS
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
Net
cash provided by (used in) operating activities
|
|
$
|
15,495
|
|
$
|
22,133
|
|
$
|
(2,912
|
)
|
Investing
activities
|
|
|
|
|
|
|
|
|
|
|
Capital
contributed to subsidiaries
|
|
|
—
|
|
|
—
|
|
|
(37,917
|
)
|
Net
(purchases of) proceeds from investments
available-for-sale
|
|
|
—
|
|
|
(14,768
|
)
|
|
1,000
|
|
Net
(purchases of) proceeds from property and equipment
|
|
|
(18,686
|
)
|
|
(22,960
|
)
|
|
3,641
|
|
Net
cash used in investing activities
|
|
|
(18,686
|
)
|
|
(37,728
|
)
|
|
(33,276
|
)
|
Financing
activities
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from exercise of options
|
|
|
4,649
|
|
|
576
|
|
|
—
|
|
Proceeds
from senior notes
|
|
|
—
|
|
|
—
|
|
|
99,871
|
|
Proceeds
from term loan due to subsidiary
|
|
|
40,000
|
|
|
18,000
|
|
|
—
|
|
Payment
of debt issuance costs
|
|
|
—
|
|
|
—
|
|
|
(650
|
)
|
Advance
from subsidiary
|
|
|
—
|
|
|
—
|
|
|
9,300
|
|
Repayment
of advance from subsidiary
|
|
|
(26,760
|
)
|
|
(17,103
|
)
|
|
(47,083
|
)
|
Dividends
paid
|
|
|
(13,724
|
)
|
|
(8,546
|
)
|
|
(6,835
|
)
|
Net
cash provided by (used in) financing activities
|
|
|
4,165
|
|
|
(7,073
|
)
|
|
54,603
|
|
Net
increase (decrease) in cash
|
|
|
974
|
|
|
(22,668
|
)
|
|
18,415
|
|
Cash,
beginning of year
|
|
|
1,693
|
|
|
24,361
|
|
|
5,946
|
|
Cash,
end of year
|
|
$
|
2,667
|
|
$
|
1,693
|
|
$
|
24,361
|
|
See
accompanying Notes to Condensed Financial Information of Registrant.
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
NOTES
TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
DECEMBER
31, 2005
NOTE
A. BASIS OF PRESENTATION
21st
Century Insurance Group’s (the “Registrant”) investment in subsidiaries is
stated at cost plus equity in undistributed income (loss) of subsidiaries.
The
accompanying condensed financial statements of the Registrant should be read
in
conjunction with the consolidated financial statements and notes thereto of
21st
Century Insurance Group and subsidiaries included in the Registrant’s 2005
Annual Report on Form 10-K.
The
balance sheets of the Registrant include accounts receivable from, or payable
to, its subsidiaries, the investment in unconsolidated subsidiaries, and term
loans due to subsidiary. These balances are eliminated in the related
consolidated financial statements.
The
Registrant includes in its statement of operations equity in undistributed
income of subsidiaries, which represents the net income of each of its
wholly-owned subsidiaries. The Registrant also leases certain software to its
subsidiaries and receives rental income. The base amount upon which monthly
rent
is calculated is the cost of the software acquired. Interest at a rate of 7.02%
is then charged to the subsidiaries. In addition, loan interest is charged
to
the Registrant by its subsidiary for a series of term loans drawn under a term
loan line made available by the subsidiary. All of these transactions
(undistributed income of subsidiaries, rental income and interest expense on
term loan due to subsidiary) are eliminated in the related consolidated
financial statements.
NOTE
B. SENIOR NOTES AND TERM LOANS DUE TO SUBSIDIARY
Senior
Notes.
Senior
notes in the amount of $100.0 million net of discount are due and payable in
2013. Interest accrues at 5.9% per annum and is payable semi-annually. The
Registrant used the funds from the senior notes to contribute capital to one
of
its insurance subsidiaries and for other long-term purposes. Future commitments
to repay the senior note and interest are as follows: 2006 - 2012 - $5.9 million
per annum; 2013 - $105.9 million.
Term
Loans Due to Subsidiary.
An
intercompany term loan line was structured in October 2004. Under the original
terms of this term loan line agreement, the Registrant’s subsidiary
(21st Century
Insurance Company) made funds available to the Registrant, which could draw
up
to $40.0 million under the line. Proceeds from the loan were used to provide
working capital for projects to modify, update and improve information
technology for use by the Registrant and its affiliates, and other purposes.
The
term
of the term loan line is twelve months with automatic renewal, while the note’s
term is three years. The effective interest rate on the notes is the three-year
Applicable Federal Rate (“AFR”) at the time of a draw, plus a margin of 1.58%.
The AFR is the minimum interest rate under tax law that avoids the IRS
below-market interest loan rules. Interest is accrued and payable at the end
of
the term of the note.
In
December 2004, the Registrant made an initial $18.0 million draw on the
intercompany term loan line. Under this agreement, the Registrant made $15.0
in
additional draws during 2005.
In
December 2005, an amendment was approved by the California Department of
Insurance that increased the maximum draw amount from $40.0 million to $150.0
million. The Registrant then drew an additional $25.0 million bringing the
total
intercompany term loan balance to $58.0 million with interest rates varying
from
4.06% to 5.92%. Interest expense on the term loan due to the subsidiary for
the
year ended December 31, 2005 was $1.3 million. No significant interest expense
was payable at December 31, 2004. Future commitments to repay the intercompany
term loan are as follows: 2007 - $20.3 million; 2008 - $47.0 million.
The
Registrant has also guaranteed the obligation under capital lease of 21st
Century Insurance Company.
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
NOTES
TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
DECEMBER
31, 2005
NOTE
C. COMMITMENTS AND CONTINGENCIES
The
Registrant has guaranteed the obligation under capital auto lease of 21st
Century Insurance Company. The Registrant is also party to a number of operating
leases for occupied premises and software commitments. The Company’s
noncancelable commitments at December 31, 2005 are included in Note 12 of the
Notes to Consolidated Financial Statements.
SIGNATURES
OF OFFICERS AND BOARD OF DIRECTORS
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf
by
the undersigned, thereunto duly authorized.
Date:
February 23, 2006
|
21ST
CENTURY INSURANCE GROUP
|
|
(Registrant)
|
|
By:
/s/ Bruce W. Marlow
|
|
Bruce
W. Marlow
|
|
President
and Chief Executive Officer
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated on the 23rd of February 2006.
Signature
|
|
Title
|
/s/
Bruce W. Marlow
|
|
|
Bruce
W. Marlow
|
|
President
and Chief Executive Officer and Director (Principal Executive
Officer)
|
|
|
|
/s/
Lawrence P. Bascom
|
|
|
Lawrence
P. Bascom
|
|
Sr.
Vice President and Chief Financial Officer (Principal Financial Officer)
|
|
|
|
/s/
Robert M. Sandler
|
|
|
Robert
M. Sandler
|
|
Chairman
of the Board
|
|
|
|
/s/
Steven J. Bensinger
|
|
|
Steven
J. Bensinger
|
|
Director
|
|
|
|
/s/
John B. De Nault, III
|
|
|
John
B. De Nault, III
|
|
Director
|
|
|
|
/s/
Carlene M. Ellis
|
|
|
Carlene
M. Ellis
|
|
Director
|
|
|
|
/s/
R. Scott Foster, M.D.
|
|
|
R.
Scott Foster, M.D.
|
|
Director
|
|
|
|
/s/
Roxani M. Gillespie
|
|
|
Roxani
M. Gillespie
|
|
Director
|
|
|
|
/s/
Jeffrey L. Hayman
|
|
|
Jeffrey
L. Hayman
|
|
Director
|
|
|
|
/s/
Phillip L. Isenberg
|
|
|
Phillip
L. Isenberg
|
|
Director
|
|
|
|
/s/
Keith W. Renken
|
|
|
Keith
W. Renken
|
|
Director
|
88