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, 2006
Commission
File Number 0-6964
(Exact
name of registrant as specified in its charter)
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Delaware
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95-1935264
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(State
or other jurisdiction of incorporation or organization)
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(I.R.S.
Employer Identification No.)
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6301
Owensmouth Avenue
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Woodland
Hills, California
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91367
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(Address
of principal executive offices)
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(Zip
Code)
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(818)
704-3700
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www.21st.com
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(Registrant’s
telephone number, including area code)
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(Registrant’s
web site)
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Securities
registered pursuant to Section 12(b) of the Act:
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Title
of each class
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Name
of each exchange on
which registered
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Common
Stock, Par Value $0.001
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New
York Stock Exchange
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Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes ¨ 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 ¨ 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
¨
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 ¨
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Accelerated
filer x
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Non-accelerated
filer ¨
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Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes ¨
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, 2006, as reported by the New York
Stock Exchange, was approximately $441,000,000.
There
were 87,242,150 shares of common stock outstanding on February 3, 2007.
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, 2006.
Description
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Page
Number
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Part
I
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Item
1.
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3
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Item
1A.
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19
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Item
1B.
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24
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Item
2.
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25
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Item
3.
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25
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Item
4.
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25
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Part
II
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Item
5.
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25
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Item
6.
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27
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Item
7.
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27
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Item
7A.
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49
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Item
8.
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51
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Item
9.
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90
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Item
9A.
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90
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Item
9B.
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90
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Part
III
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Item
10.
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91
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Item
11.
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91
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Item
12.
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91
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Item
13.
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91
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Item
14.
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91
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Part
IV |
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Item
15.
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92
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Signatures
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100
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Exhibit
Index
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93
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21
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Subsidiaries
of Registrant
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23
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Consent
of Independent Registered Public Accounting Firm
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31.1
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Certification
of President and Chief Executive Officer Pursuant to Exchange Act
Rule
13a-14(a)
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31.2
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Certification
of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a)
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32.1
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Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002
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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”, unless the context requires otherwise, are used to refer collectively
to 21st Century Insurance Group and its consolidated subsidiaries, all of which
are wholly-owned: 21st Century Insurance Company (our primary 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.
Founded
in 1958, we are a direct-to-consumer provider of personal auto insurance. With
$1.4 billion of revenue in 2006, we insure over 1.5 million vehicles in Arizona,
California, Florida, Georgia, Illinois, Indiana, Nevada, New Jersey, Ohio,
Oregon, Pennsylvania, Texas, Washington, Colorado, Minnesota, Missouri, and
Wisconsin. We provide superior policy features and customer service at a
competitive price. Customers can receive a quote, 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 over the phone and on the web, 24 hours
a day, 365 days a year.
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. 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
Company sells personal automobile insurance polices, and accordingly collects
premium payments, incurs costs for acquiring its customers, settling claims,
servicing policies, and for other operating expenses and then invests the
remaining proceeds to earn investment income. In most industries, the cost
of a
product is known before it is priced and sold. In insurance, products are sold,
but their costs are not known until a later date. Therefore, the pricing must
employ sophisticated methods to predict the product’s cost.
Business
Strategies
We
have
been consistently communicating our strategies to investors in press releases,
Securities and Exchange Commission (“SEC”) filings, and earnings calls. Prior to
2003, a majority of the Company’s time and effort was directed at (1) building
and implementing our information technology platform, (2) managing legacy
earthquake and homeowners exposures, (3) refining our reserving process that
would maintain adequate reserves, and (4) building the Company’s regular
business. Since 2003, senior management has communicated a four-point strategy:
(1) geographic expansion, (2) superior product and service offering, (3)
sophisticated pricing segmentation and (4) maintaining the Company’s position as
a low cost provider of auto insurance.
Geographic
Expansion
Geographic
expansion has several long-term benefits to the Company:
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It
increases the number of consumers and total market potential available
to
the Company. While California is the single largest personal auto
insurance market, it represents only 12% of the U.S. total personal
auto
market. In 2006, the Company entered eight new states, increasing
the
total to 17 states and raising the percentage of the U.S. market
in which
it operates from 34% at year-end 2005 to 60% at year-end 2006.
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Having
more potential customers makes the Company’s marketing and advertising
programs more cost effective. Buying national television is typically
more
cost effective than buying local
television.
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Having
multiple states to operate in reduces the risk from legislative,
regulatory, and judicial changes in any
market.
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Having
multiple states to operate in and, over time, diversifying the Company’s
distribution of customers reduces the Company’s risk to catastrophic
events, which typically are local or regional in
nature.
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Having
offices in multiple locations and time zones makes the process of
providing unending 24/7 service less difficult, plus allows the Company
to
focus hiring of new staff in states and jurisdictions with favorable
characteristics.
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Superior
Product and Service Offering
By
providing a superior product and service offering, we believe we attract
customers and retain them for longer periods of time. Generally, policy features
such as full permissive driver coverage, full replacement if a new car is
totaled in the first year, complimentary towing and roadside assistance, and
free coverage for students during holiday periods come standard with a 21st
policy contract, subject in all cases to policy terms and conditions. Similar
features cost extra with most of our competitors. On the service side, we
operate 24 hours a day, seven days a week, in English and Spanish, on the phone
and on the web. Our web site also offers sophisticated coverage and price
comparison tools that prospective customers can utilize to select the right
coverage for their financial situation and then comparison shop with quotes
from
other leading companies. If they ever have questions after using these on-line
tools, they can reach one of our licensed representatives on the phone
anytime.
Sophisticated
Pricing Segmentation
Pricing
segmentation is a very important competitive factor, as it helps a company
write
profitable business. If a company’s pricing is unsophisticated and is not linked
to a system that can accurately predict the probability of loss, that company’s
pricing will only reflect external competitive factors. This leads to cyclical
results, as companies compete on price without knowing or factoring in their
own
risk of loss. 21st employs a systematic pricing methodology that we believe
allows us to predict the risk of loss more accurately than less-sophisticated
competitors. This creates numerous competitive advantages: (1) when commencing
business in a new market, we can more accurately find customers that are
over-priced and offer them a superior policy and service package at a lower
price, which will be more profitable to us. More importantly, we can more
accurately identify customers that are under-priced and leave these to our
competitors, (2) we can factor risk of loss in our own pricing, maintain pricing
discipline and not be as subject to external market forces, and (3) maintain
profitability by precisely adjusting pricing in our own book of business when
we
see statistical anomalies.
Low
Cost Provider
The
Company strives to have a low expense structure to allow it to offer auto
insurance products with superior features and service that are priced
competitively. One of the advantages of being a direct-to-consumer writer of
auto insurance is the lack of commission fees for renewals since we do not
utilize external agents or marketing firms. Information extracted from statutory
filings by Highline
Data
for the
top ten California personal automobile insurance companies for 2005, 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 5 of our
9
largest competitors in California for 2005.
Direct
vs. Agent Distribution
Agent-based
organizations accounted for 85% ($137 billion), of the private passenger auto
market share in 2005, while direct-to-consumer organizations accounted for
the
remainder. The leading agent-based insurers are State Farm and Allstate, while
the leading direct-to-consumer insurers are GEICO, USAA, Progressive (Direct),
along with 21st Century Insurance. However, between 1999 and 2005, we estimate
that direct-to-consumer insurers have gained 4.6% of market share from the
agent-based organizations. We believe that the direct-to-consumer distribution
model has significant competitive advantages over the agent-based distribution
model, such as there are no dependencies on outside agents or marketing
organizations and therefore, we do not have to pay a recurring agent commission,
resulting in lower underwriting expenses. The direct model offers operating
flexibility, which allows direct companies to react quickly to attractive
markets, as well as unattractive markets. Most importantly, direct-to-consumer
companies own the customer relationship. In the independent agent model, the
agent owns the customer relationship and can, at any time, move the business
to
another carrier. We further believe the direct-to-consumer model is more in
line
with changing consumer preferences. Fewer and fewer consumers are willing to
pay
a large fee just to renew their auto insurance. Similar to the changes in the
airline industry, in the past, consumers used travel agents because the agent
had access to all the relevant information. Today, all of the information
consumers need is available on-line, so they feel more comfortable accessing
travel services without the help of an agent, or paying a large agent
fee.
Long-Term
Financial Goals
We
have
four key long-term financial goals:
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15%
growth in direct premiums written
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Strong
financial ratings
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Our
long-term financial goals are the framework we use for making 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
This
ratio measures an insurance company’s total underwriting profitability. It is an
important measure of our overall business profitability and effects return
on
equity and influences our financial ratings. Consequently, we consider our
96%
or less combined ratio goal as the most important of our long-term financial
goals. We strive to achieve a 96% or less combined ratio by accurately pricing
our risks, being a disciplined underwriter, expertly handling customer service
and claims, retaining our customers and controlling expenses. 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).
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 through innovation 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 and is affected by our
underwriting profit, investment yield, and our capital structure. Our goal
is to
achieve an ROE that exceeds the average ROE for our industry.
Strong
Financial Ratings
A
strong
financial rating is an important element of our public profile. Ratings provide
third party verification of the Company’s financial position and minimize our
borrowing costs. Ratings are also a proxy for financial strength, as they
require companies to maintain minimum levels of capital to support various
strategic, operational, and financial risks. We engage independent rating
agencies to measure our overall credit worthiness and financial strength. Our
goal is to achieve and maintain financial strength ratings that are investment
grade, as defined by the relevant rating agency.
The
Company’s financial stability is demonstrated by our A+ financial strength
rating, our 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:
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Financial
Ratings by Rating Agency
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2006
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2005
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2004
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2003
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2002
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A.M.
Best
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A+
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A+
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A+
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A+
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A+
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Standard
& Poor’s
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A+
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A+
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A+
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A+
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A+
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Fitch
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A+
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A+
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A
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—
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—
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SOME
USEFUL DEFINITIONS
The
insurance industry uses terminology that is unfamiliar to some people. Included
here are definitions and descriptions that should be useful as you read this
report.
Not
all
financial measures used by the insurance industry are presented in accordance
with accounting principles generally accepted in the United States of America
(“GAAP”). Throughout this Annual Report on Form 10-K, the Company presents its
operations in the way it believes will be most meaningful, as well as most
transparent. For an explanation of why the Company’s management considers these
“non-GAAP” measures useful to investors and for reconciliations of non-GAAP
financial measures to the most directly comparable GAAP measures, see
Item
7. Management’s Discussion and Analysis - Results of Operations
and
Liquidity
and Capital Resources.
Non-GAAP financial measures are not intended to replace, and should be read
in
conjunction with, the GAAP financial results.
Balance
Sheet terms
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Deferred
policy acquisition costs (“DPAC”) -
The unamortized portion of the policy acquisition costs described
below.
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Unpaid
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.
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Reinsurance
receivables and recoverables - These
amounts are reflected as assets on the consolidated balance sheets
and
consist of two components: the ceded portion of the reserves described
in
unpaid losses and LAE above are classified as recoverables, and the
actual
billings due from our reinsurers on ceded portions of payments of
losses
and LAE paid as receivables.
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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.”
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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.
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Income
statement terms
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Direct
premiums written -
This statutory measure represents the total policy premiums, net
of
cancellations, associated with policies underwritten and issued.
We use
this non-GAAP measure, which excludes the impact of premiums ceded
to
reinsurers, to assess the underlying growth of our insurance business
from
period to period. We do not currently assume premiums from other
companies.
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Net
premiums written -
This statutory measure represents the sum of direct premiums written
less
ceded premiums written. Ceded premiums written is the portion of
our
direct premiums written that we transfer to our reinsurers in accordance
with the terms of our reinsurance contracts, based upon the risks
they
accept. Similar to direct premiums written, we use this non-GAAP
measure
to assess growth. See Note 10 of the Notes
to Consolidated Financial Statements
for a summary of our reinsurance agreements.
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Net
premiums earned - Represents
the portion of net premiums written that is recognized as income
in the
consolidated financial statements for the periods presented and earned
on
a pro rata basis over the term of the policies.
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Net
losses and loss adjustment expenses incurred -
Includes the payments, as well as the change in estimates for unpaid
liabilities 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.
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Policy
acquisition costs -
Consist of premium taxes, advertising, and variable costs incurred
with
writing new and renewal business. These costs are deferred and amortized
over the typical six-month policy period in which the related premiums
are
earned.
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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.
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Underwriting
profit (loss) -
Underwriting profit (loss) is a statutory measure that consists of
net
premiums earned less losses from claims, loss adjustment expenses,
policy
acquisition costs, and underwriting expenses, as determined using
GAAP.
21st believes that underwriting profit (loss) provides investors
with
financial information that is not only meaningful, but important
to
understanding the results of property and casualty insurance operations.
The results of operations of a property and casualty insurance company
include three components: underwriting profit (loss), net investment
income and realized capital gains (losses). Without disclosure of
underwriting profit (loss), it is difficult to determine how successful
an
insurance company is in its core business activity of assessing and
underwriting risk, as including investment income and realized capital
gains (losses) in the results of operations without disclosing
underwriting profit (loss) can mask underwriting losses. Underwriting
profit (loss) is not a GAAP measure. A reconciliation of underwriting
profit (loss) to net income is located in Item
7. Management’s Discussion and Analysis - Results of
Operations.
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Income
Statement Performance Ratios
The
following operating ratios are used to measure our performance, not only
period-to-period, but as a common comparison tool against our peers in the
marketplace, and is useful in understanding our profitability. The three most
common ratios follow:
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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.
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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.
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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, one of our long-term
financial goals 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. As noted
above, underwriting profit (loss) is not a GAAP measure.
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Types
and Limits of Insurance Coverage
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·
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The
following coverages are generally made available on our private passenger
auto insurance contract: 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.
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·
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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.
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·
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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 are $100,000 per person and $300,000 per accident.
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·
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Our
personal umbrella policy (“PUP”) is written with a twelve-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.
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GEOGRAPHIC
CONCENTRATION OF BUSINESS
The
following table shows vehicles in force at the end of each of the past five
years:
December
31,
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2006
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2005
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2004
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2003
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2002
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California
vehicles in force1
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1,290,498
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1,413,909
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1,463,469
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1,369,049
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1,169,880
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Non-California
vehicles in force
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255,121
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127,001
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62,922
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33,332
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27,174
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Total
vehicles in force
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1,545,619
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1,540,910
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1,526,391
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1,402,381
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1,197,054
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California
vehicles in force1
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83.5
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%
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91.8
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%
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95.9
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%
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97.6
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%
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97.7
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%
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Non-California
vehicles in force
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16.5
|
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8.2
|
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4.1
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2.4
|
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2.3
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Total
vehicles in force
|
|
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100.0
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%
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|
100.0
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%
|
|
100.0
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%
|
|
100.0
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%
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100.0
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%
|
The
following table presents a geographical summary of our direct premiums written
for the past five years:
AMOUNTS
IN MILLIONS
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|
Direct
Premiums Written
|
|
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
2003
|
2002
|
California2
|
|
$
|
1,166.0
|
|
$
|
1,262.3
|
|
$
|
1,290.9
|
|
$
|
1,194.6
|
|
$
|
969.7
|
|
Non-California
|
|
|
149.1
|
|
|
84.1
|
|
|
46.3
|
|
|
28.9
|
|
|
28.5
|
|
Total
direct premiums written
|
|
$
|
1,315.1
|
|
$
|
1,346.4
|
|
$
|
1,337.2
|
|
$
|
1,223.5
|
|
$
|
998.2
|
|
California2
|
|
|
88.7
|
%
|
|
93.8
|
%
|
|
96.5
|
%
|
|
97.6
|
%
|
|
97.1
|
%
|
Non-California
|
|
|
11.3
|
|
|
6.2
|
|
|
3.5
|
|
|
2.4
|
|
|
2.9
|
|
Total
direct premiums written
|
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
Most
of
our policyholders are based in California, however, all of our net 2006 growth
came from expansion outside of California. Direct premiums written outside
of
California comprised 2.4% of total direct premiums written in 2003, and have
increased to 11.3% of total premiums written in 2006 as a result of our
geographic expansion efforts.
_______________________
2 |
Includes
$0.1 million and $2.4 million of homeowner and earthquake direct
premiums
written in 2003 and 2002, respectively. We no longer have any homeowner
policies
in force. We ceased writing earthquake coverage in 1994, but we had
remaining loss reserves from the 1994 Northridge earthquake. See
further
discussion in
Note 17 to the Notes
to Consolidated Financial Statements.
|
The
following timeline of our geographic expansion efforts describes our
transformation from a business that operated in 18 percent of the market in
2003
to a national competitor that operates in 60 percent of the market in
2006:
|
·
|
First
quarter of 2004 - added eight percent of the market when we 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 - added seven percent of the market when we began
writing
personal auto policies in Texas.
|
|
·
|
Second
quarter of 2006 - added 15 percent of the market when we began writing
personal auto policies in Florida, Georgia and
Pennsylvania.
|
|
·
|
Fourth
quarter of 2006 - added eleven percent of the market when we began
writing
personal auto policies in New Jersey, Colorado, Minnesota, Missouri,
and
Wisconsin.
|
Summary
of California Distribution
The
table
below summarizes the concentrations within California of our 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, 2005 data from the California Department of Motor Vehicles (the
most recent available) indicates that 22.5% 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 Los Angeles County vehicles insured
has declined from 37.2% in 2002 to 27.8% at the end of 2006, approaching a
natural distribution of business in the state.
Voluntary
Personal Auto Lines
|
|
Distribution
of California Vehicles in Force
|
|
December
31,
|
|
2006
|
2005
|
2004
|
2003
|
2002
|
Los
Angeles County
|
|
|
27.8
|
%
|
|
28.8
|
%
|
|
30.3
|
%
|
|
32.3
|
%
|
|
37.2
|
%
|
San
Diego County
|
|
|
14.5
|
|
|
13.8
|
|
|
13.6
|
|
|
13.5
|
|
|
13.4
|
|
Southern
California, excluding Los Angeles and San Diego
Counties3
|
|
|
20.0
|
|
|
20.0
|
|
|
20.3
|
|
|
21.4
|
|
|
23.5
|
|
Central
and Northern California4
|
|
|
37.7
|
|
|
37.4
|
|
|
35.8
|
|
|
32.8
|
|
|
25.9
|
|
Total
|
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
OPERATIONAL
OVERVIEW
Underwriting
and Pricing
General
For
us,
underwriting is the process of confirming that rating information (such as
the
Vehicle Identification Number (“VIN”), 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.
We
have
developed a highly segmented and sophisticated pricing model that is one of
the
best pricing models in the industry. Through a combination of rating variables
and interactions among variables, we believe we are able to achieve higher
levels of pricing accuracy than have historically 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.
Our
objective is to offer a price that, to the fullest extent possible, reflects
the
loss and expense expectations for every customer. Accurate pricing is important
because it rewards and encourages safe driving and increases stability in our
results, reducing the impact of mix changes in our book of
business.
California
We
are
required to offer insurance to any California applicant who meets the California
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.
California
law defines the primary rating characteristics that must be used for California
automobile policies and 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 make and model of
automobile, policy limits and deductibles, and gender and marital
status.
_____________________
3 |
Includes
the following counties: Imperial, Kern, Orange, Riverside, Santa
Barbara,
San Bernardino and Ventura.
|
4 |
Includes
all California counties other than Los Angeles County, San Diego
County,
and those specified above in Footnote
3.
|
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
risk
to losses and expenses. Class plan changes are intended to be revenue neutral
to
us.
In
July
2006, the CDI issued changes to regulations relating to automobile insurance
rating factors, particularly concerning territorial rating (the “Auto Rating
Factor Regulations”). The new rules required automobile insurance companies to
make a class plan and rate filing during the third quarter of 2006 to bring
their automobile insurance rates in California into compliance with the Auto
Rating Factor Regulations. Litigation to preliminarily enjoin the implementation
of the Auto Rating Factor Regulations and have them declared in violation of
California law has been unsuccessful. As a result, the Company submitted class
plan and rate filings to the CDI for its review. The Company’s rate filing
proposed an overall rate decrease of 5% of premium. The CDI approved the
Company’s class plan and rate filings. The new rates took effect January 3,
2007.
Also
in
July 2006, the CDI proposed new amended rate approval regulations (the “Rate
Approval Regulations”) that would determine how insurance rates for personal
auto and most other lines of personal and commercial property and casualty
lines
of business are established in California. In October 2006, the CDI issued
additional amendments to the Rate Approval Regulations. These regulations were
submitted in November 2006 to the Office of Administrative Law (the “OAL”) and
were approved in January of 2007. The amended regulations will become effective
on April 3, 2007. Please see Item
1A. Risk Factors
for more
information regarding these regulations.
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 in two major locations, we can deliver a highly efficient and
professional experience to 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.
According
to data published in the 2006
Nielsen Universe Estimates,
73% of
all Spanish-speaking residents in the United States live in the following states
that we write business: California, Arizona, Illinois, Indiana, Ohio, New
Jersey, Florida, Georgia, Pennsylvania, and Texas. We offer full customer
service, including policy purchase, in Spanish via our web site and bilingual
professionals 24 hours per day, 365 days per year through a dedicated toll-free
telephone number at 888-920-2121. Additionally, we utilize Spanish language
advertising and marketing materials.
The
following table summarizes advertising expenditures and new policies written
for
the past five years:
AMOUNTS
IN MILLIONS,
EXCEPT
POLICY DATA
|
|
Advertising
Expenditures and New Policies Written
|
|
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
2003
|
2002
|
Total
advertising expenditures
|
|
$
|
74.9
|
|
$
|
70.1
|
|
$
|
66.7
|
|
$
|
53.9
|
|
$
|
43.3
|
|
New
policies written
|
|
|
172,899
|
|
|
170,224
|
|
|
225,349
|
|
|
265,589
|
|
|
189,652
|
|
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 auto policies during
2005, utilized APS for all of our 2006 market entries, and plan to convert
our
other personal auto policies to APS in 2007.
Claims
It
is the
mission of our claims 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, which
were 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 study released by the Insurance Research Council
in
January 2006, 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 important that our adjusters be vigilant to recognize and
investigate suspicious claims.
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 laws and regulations 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 hours a day, 365 days a year and can assist
customers in Spanish as well as in 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 inspection and car repair
options are offered to the customer 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 (“DRP”) is a particularly easy way to get repairs
done, chosen by about 30% of our customers. The DRP is a carefully selected
network of 278 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 39% 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.
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 auto claims reported
since
that time, and over 97% 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 different 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 handle the vast
majority of this litigation. Cases involving conflict or special circumstances
may be assigned to outside defense attorneys. Outside counsel are 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 and is known as
being very effective in its efforts to detect and deter fraud.
21st
settles heavily damaged vehicle claims as total losses where warranted. 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 these
recovery proceeds, less their fee, to 21st. Vehicles so severely damaged as
to
have no salvage value are crushed to prevent the 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 believe 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 policyholders).
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 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.
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 reserves for losses and LAE. Rather, they have used
several methods and different underlying assumptions to produce a number of
point estimates for the required reserves. Management carefully reviews the
appropriateness of the assumptions underlying the various indicated loss and
LAE
ratios, and selects the ultimate loss and LAE ratios and the carried
reserves.
Estimating
the Frequency of Auto Accidents.
Actuaries study the historical lag between the actual date of loss and the
date
that the accident is reported by the customer to the claims department, and
can
make a reasonable, yet never perfect, estimate for frequency, or the number
of
claims that ultimately will be reported for a given period. 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 claims and injury claims 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 quarterly 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. Homeowners
and earthquake lines are “in runoff” because we no longer have policies in
force. As discussed in Note 17 of 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. The Company has no open earthquake cases
and
only immaterial reserves remaining at December 31, 2006. In prior years,
developing reserve estimates for the earthquake line was particularly subjective
because most of the remaining earthquake claims were in litigation.
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 month, 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
losses and LAE incurred, net of reinsurance, attributable to prior accident
years, that we recorded in each of the past five calendar years, are summarized
below:
AMOUNTS
IN THOUSANDS
|
|
Losses
and LAE Incurred, Net of
Reinsurance,
Attributable to Prior Accident Years
|
|
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
2003
|
2002
|
Personal
auto
|
|
$
|
(52,648
|
)
|
$
|
(27,473
|
)
|
$
|
(2,936
|
)
|
$
|
11,159
|
|
$
|
16,200
|
|
Homeowner
and earthquake5
|
|
|
751
|
|
|
2,333
|
|
|
2,831
|
|
|
40,048
|
|
|
56,158
|
|
Total
|
|
$
|
(51,897
|
)
|
$
|
(25,140
|
)
|
$
|
(105
|
)
|
$
|
51,207
|
|
$
|
72,358
|
|
Bracketed
amounts represent redundancies, while unbracketed amounts represent deficiencies
in prior year loss and LAE reserves.
To
understand the changes in estimates, 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 1996 through 2006. 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.
_____________________
5 |
We
no longer have any homeowner policies in force. We ceased writing
earthquake coverage in 1994, but we had 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 17 to the Notes
to Consolidated Financial Statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TABLE
1 - Auto Lines as of December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Amounts
in thousands, except claims)
|
|
1996
|
|
1997
|
|
1998
|
|
1999
|
|
2000
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
for losses and LAE, direct
|
|
$
|
468,257
|
|
$
|
403,263
|
|
$
|
329,021
|
|
$
|
261,990
|
|
$
|
286,057
|
|
$
|
301,985
|
|
$
|
333,113
|
|
$
|
419,913
|
|
$
|
489,411
|
|
$
|
521,528
|
|
$
|
480,731
|
|
Paid
(cumulative) as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later
|
|
|
260,287
|
|
|
253,528
|
|
|
247,317
|
|
|
242,579
|
|
|
268,515
|
|
|
239,099
|
|
|
249,815
|
|
|
280,534
|
|
|
283,068
|
|
|
301,703
|
|
|
|
|
Two
years later
|
|
|
336,538
|
|
|
319,064
|
|
|
307,797
|
|
|
311,659
|
|
|
332,979
|
|
|
312,909
|
|
|
328,951
|
|
|
359,719
|
|
|
385,135
|
|
|
|
|
|
|
|
Three
years later
|
|
|
354,854
|
|
|
333,349
|
|
|
324,778
|
|
|
324,740
|
|
|
352,592
|
|
|
333,955
|
|
|
349,763
|
|
|
392,665
|
|
|
|
|
|
|
|
|
|
|
Four
years later
|
|
|
357,913
|
|
|
340,907
|
|
|
326,932
|
|
|
327,745
|
|
|
358,806
|
|
|
339,004
|
|
|
356,198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later
|
|
|
363,068
|
|
|
341,446
|
|
|
327,418
|
|
|
328,557
|
|
|
360,191
|
|
|
340,961
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later
|
|
|
362,824
|
|
|
341,374
|
|
|
327,162
|
|
|
328,359
|
|
|
361,104
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later
|
|
|
362,508
|
|
|
341,076
|
|
|
326,823
|
|
|
328,309
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later
|
|
|
362,216
|
|
|
340,772
|
|
|
326,638
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later
|
|
|
361,959
|
|
|
340,582
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later
|
|
|
361,764
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
re-estimated as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later
|
|
|
365,566
|
|
|
359,262
|
|
|
313,192
|
|
|
309,953
|
|
|
352,709
|
|
|
323,791
|
|
|
348,865
|
|
|
417,225
|
|
|
462,682
|
|
|
469,132
|
|
|
|
|
Two
years later
|
|
|
366,858
|
|
|
337,258
|
|
|
321,711
|
|
|
340,914
|
|
|
354,720
|
|
|
338,338
|
|
|
354,784
|
|
|
407,344
|
|
|
440,974
|
|
|
|
|
|
|
|
Three
years later
|
|
|
359,925
|
|
|
335,246
|
|
|
341,695
|
|
|
328,190
|
|
|
361,264
|
|
|
339,965
|
|
|
360,308
|
|
|
407,362
|
|
|
|
|
|
|
|
|
|
|
Four
years later
|
|
|
357,607
|
|
|
355,605
|
|
|
326,506
|
|
|
329,182
|
|
|
361,068
|
|
|
342,321
|
|
|
360,878
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later
|
|
|
377,414
|
|
|
340,537
|
|
|
326,565
|
|
|
329,318
|
|
|
362,066
|
|
|
342,993
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later
|
|
|
361,980
|
|
|
340,552
|
|
|
327,626
|
|
|
329,042
|
|
|
362,142
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later
|
|
|
361,865
|
|
|
341,396
|
|
|
327,243
|
|
|
328,756
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later
|
|
|
362,541
|
|
|
340,967
|
|
|
326,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later
|
|
|
362,042
|
|
|
340,714
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later
|
|
|
361,839
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redundancy
(Deficiency)
|
|
$
|
106,418
|
|
$
|
62,549
|
|
$
|
2,101
|
|
$
|
(66,766
|
)
|
$
|
(76,085
|
)
|
$
|
(41,008
|
)
|
$
|
(27,765
|
)
|
$
|
12,551
|
|
$
|
48,437
|
|
$
|
52,396
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Auto Claims Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Claims
reported during the year
|
|
|
310,475
|
|
|
305,600
|
|
|
335,245
|
|
|
313,182
|
|
|
370,521
|
|
|
354,968
|
|
|
350,693
|
|
|
381,238
|
|
|
414,310
|
|
|
419,214
|
|
|
399,596
|
|
Claims
pending at year end
|
|
|
58,430
|
|
|
56,495
|
|
|
57,027
|
|
|
59,768
|
|
|
58,100
|
|
|
55,642
|
|
|
58,127
|
|
|
65,303
|
|
|
67,352
|
|
|
63,898
|
|
|
59,169
|
|
See
Note 8 of the Notes to Consolidated Financial Statements for reconciliation
to
gross liability on the balance sheet.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TABLE
2 - Homeowner and Earthquake Lines in Runoff as of December
31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Amounts
in thousands)
|
|
1996
|
|
1997
|
|
1998
|
|
1999
|
|
2000
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
for losses and LAE, direct
|
|
$
|
75,272
|
|
$
|
34,624
|
|
$
|
52,982
|
|
$
|
14,258
|
|
$
|
12,379
|
|
$
|
47,305
|
|
$
|
50,896
|
|
$
|
18,410
|
|
$
|
6,131
|
|
$
|
2,307
|
|
$
|
1,538
|
|
Paid
(cumulative) as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later
|
|
|
75,100
|
|
|
30,232
|
|
|
48,848
|
|
|
13,103
|
|
|
30,706
|
|
|
58,274
|
|
|
71,147
|
|
|
16,277
|
|
|
6,498
|
|
|
1,542
|
|
|
|
|
Two
years later
|
|
|
100,296
|
|
|
74,127
|
|
|
58,281
|
|
|
37,404
|
|
|
78,647
|
|
|
125,447
|
|
|
87,343
|
|
|
22,775
|
|
|
8,040
|
|
|
|
|
|
|
|
Three
years later
|
|
|
142,850
|
|
|
82,974
|
|
|
81,887
|
|
|
83,985
|
|
|
143,564
|
|
|
140,742
|
|
|
93,828
|
|
|
24,317
|
|
|
|
|
|
|
|
|
|
|
Four
years later
|
|
|
151,342
|
|
|
106,274
|
|
|
128,266
|
|
|
147,856
|
|
|
157,792
|
|
|
147,101
|
|
|
95,359
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later
|
|
|
174,513
|
|
|
152,592
|
|
|
192,121
|
|
|
161,560
|
|
|
163,988
|
|
|
148,744
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later
|
|
|
220,805
|
|
|
216,383
|
|
|
205,591
|
|
|
167,615
|
|
|
165,618
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later
|
|
|
284,455
|
|
|
229,808
|
|
|
211,431
|
|
|
169,117
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later
|
|
|
297,754
|
|
|
235,648
|
|
|
212,607
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later
|
|
|
303,591
|
|
|
236,818
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later
|
|
|
304,760
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves
re-estimated as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
year later
|
|
|
101,903
|
|
|
77,445
|
|
|
58,582
|
|
|
18,024
|
|
|
68,245
|
|
|
103,470
|
|
|
89,281
|
|
|
22,406
|
|
|
8,805
|
|
|
3,080
|
|
|
|
|
Two
years later
|
|
|
145,635
|
|
|
82,716
|
|
|
61,393
|
|
|
72,546
|
|
|
121,176
|
|
|
142,211
|
|
|
93,388
|
|
|
25,081
|
|
|
9,578
|
|
|
|
|
|
|
|
Three
years later
|
|
|
150,434
|
|
|
85,519
|
|
|
116,429
|
|
|
125,089
|
|
|
159,331
|
|
|
146,152
|
|
|
96,054
|
|
|
25,854
|
|
|
|
|
|
|
|
|
|
|
Four
years later
|
|
|
153,521
|
|
|
140,532
|
|
|
169,157
|
|
|
163,045
|
|
|
162,998
|
|
|
148,850
|
|
|
96,814
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five
years later
|
|
|
208,533
|
|
|
193,375
|
|
|
207,064
|
|
|
166,548
|
|
|
165,593
|
|
|
149,759
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
years later
|
|
|
261,389
|
|
|
231,217
|
|
|
210,486
|
|
|
168,994
|
|
|
166,493
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven
years later
|
|
|
299,109
|
|
|
234,661
|
|
|
212,593
|
|
|
169,786
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight
years later
|
|
|
302,550
|
|
|
236,776
|
|
|
213,224
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
years later
|
|
|
304,664
|
|
|
237,399
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten
years later
|
|
|
305,288
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redundancy
(Deficiency)
|
|
$
|
(230,016
|
)
|
$
|
(202,775
|
)
|
$
|
(160,242
|
)
|
$
|
(155,528
|
)
|
$
|
(154,114
|
)
|
$
|
(102,454
|
)
|
$
|
(45,918
|
)
|
$
|
(7,444
|
)
|
$
|
(3,447
|
)
|
$
|
(773
|
)
|
|
|
|
See
Notes 8 and 17 of the Notes to Consolidated Financial Statements for
reconciliation to gross liability on the balance sheet.
Auto
Lines Reserve Development
As
shown
in the ten-year development table, our auto lines historically developed
redundancies from 1996 to 1998 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 1999 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 recorded since 2004 with respect to prior accident years
and larger favorable developments of $27.5 million in 2005 and $52.6 million
in
2006.
Homeowner
and Earthquake Lines in Runoff
During
2006, 2005, 2004, 2003, 2002, and 2001, the Company recorded losses related
to
Senate Bill 1899 (“SB 1899”) for $0.1 million, $0.4 million, $2.2 million, $37.0
million, $52.6 million, and $70.0 million, respectively. The information below
explains historical earthquake developments for which the Company no longer
has
any significant exposure.
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,
2006, 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 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 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.
Reinsurance
A
reinsurance transaction occurs when an insurer transfers, or cedes, a portion
of
its exposure to another insurer (“reinsurer”) for a ceding 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.
Some
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 auto and motorcycle lines
was
97% in 2002. Effective September 1, 2002, we entered into an agreement to cancel
future cessions under our quota share with AIG subsidiaries. From
2003
to 2007, the net retention of insurance risk after reinsurance for auto and
motorcycle lines has been unchanged at 100%. Our net retention of insurance
risk
for personal umbrella policies has been 10% from 2002 to 2007. Personal umbrella
coverage is only available to our California auto insurance customers.
Approximately 2% of auto insurance customers have umbrella coverage. We also
have catastrophe reinsurance agreements relating to the auto line, which
reinsures any covered events up to $45.0 million in excess of $20.0
million.
Investment
Portfolio
We
utilize a conservative investment philosophy. We continuously monitor the
portfolio to minimize interest rate and reinvestment risk. No derivatives are
held in our investment portfolio. At December 31, 2005, the Company held
publicly traded equity securities, but all were sold in the first quarter of
2006. Substantially all of our fixed maturity portfolio is investment grade,
having a weighted-average Standard & Poor’s credit quality of “AA”. In
October 2003, as a result of a competitive bidding process, we entered into
an
agreement with AIG Global Investment Corp. (“AIGGIC”) to provide investment
management and investment accounting services. The fees are determined as a
percentage of the average invested asset balance and are included in net
investment income. In November of 2006, the Company engaged Cardinal Investment
Advisors, LLC as a third party advisor to assist the Company in such things
as
setting investment strategy, evaluating AIGGIC’s performance, and monitoring the
portfolio’s risk/reward profile.
Consumer
Advocacy
For
the
sixth 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. More than 50%
of
passenger vehicle occupants killed from birth through age 15 were completely
unrestrained while riding in the motor vehicle. The 21st child safety program
is
endorsed by partners in eight states, including California,
Arizona, Florida, Georgia, Illinois, Indiana, Ohio and Texas.
Educational safety events typically include the participation of local media,
law enforcement, trained safety technicians and our managers. Since
inception, the
Company has held more than 94 child safety seat awareness and education events
in eight states. At the 21st events, technicians have completed over 10,000
child safety seat inspections and discarded (and then destroyed) more than
3,500 unsafe, broken or recalled child safety seats. 21st has donated over
8,000
brand-new child safety seats so that no family leaves an education event
without every child riding in a properly fitted child safety
seat.
21st
has
also partnered with the California Highway Patrol (“CHP”) and the Arizona
Department of Public Safety in public education programs on safe driving. Using
billboard advertising in English and Spanish, we have educated 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.
21st
also
makes the streets safer through its ongoing support of the Los Angeles Police
Academy Magnet School, a unique partnership between 21st, the Los Angeles
Unified School District and the Los Angeles Police Department (“LAPD”) that
prepares young people for careers in law enforcement. Since
1996, 21st has provided approximately $0.5 million to support the program and
provide scholarships to graduating cadets entering college. Since the program
began, more than 25 Magnet alumni graduates have become LAPD officers.
Currently, 33 Magnet alumni are enrolled in the LAPD Police
Academy.
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 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.
Team
Members
The
Company employed approximately 2,900 full and part-time team members at December
31, 2006. We provide medical, pension and 401(k) savings plan benefits to
eligible team members, according to the provisions of each plan. The Company
also utilized approximately 300 contractors primarily for software development
projects.
INDUSTRY
AND COMPETITION
Private
passenger automobile insurance represents the largest component of the U.S.
Property and Casualty (“P&C”) insurance industry. In 2005, direct premiums
written in the U.S. private passenger auto market was over $160 billion, or
slightly over one-third of the P&C industry total. Market share is
concentrated among the top writers, with the top 10 private passenger auto
writers accounting for over 60% of market share. Unless otherwise noted, all
industry and market share data were derived directly from data reported by
Highline
Data LLC,
or were
estimated using Highline
Data
as the
primary source.
We
have
been the seventh largest writer of personal automobile insurance in California.
Market shares in California of the top ten writers of personal automobile
insurance, based on direct premiums written, according to Highline
Data,
for the
past five years were as follows:
|
|
Market
Share in California
Based
on Direct Premiums Written
|
|
Years
Ended December 31,
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
21st
Century Insurance Group
|
|
|
6
|
%
|
|
7
|
%
|
|
6
|
%
|
|
6
|
%
|
|
6
|
%
|
State
Farm Group
|
|
|
13
|
|
|
14
|
|
|
14
|
|
|
14
|
|
|
13
|
|
Farmers
Group
|
|
|
10
|
|
|
10
|
|
|
10
|
|
|
11
|
|
|
12
|
|
Mercury
General Group
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
8
|
|
Automobile
Club of Southern California Group
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
9
|
|
California
State Auto Group
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
9
|
|
|
10
|
|
Allstate
Insurance Group
|
|
|
9
|
|
|
8
|
|
|
8
|
|
|
9
|
|
|
11
|
|
Progressive
Insurance Group
|
|
|
4
|
|
|
3
|
|
|
3
|
|
|
2
|
|
|
2
|
|
USAA
Group
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
Government
Employees Group (GEICO)
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
REGULATORY
ENVIRONMENT
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 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. On June 15, 2004, the CDI finalized its
examination reports on the statutory financial statements of 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.
In
general, the current regulatory requirements in the other states in which our
subsidiaries are licensed insurers are less restrictive than in California.
The
CDI and Texas Department of Insurance are currently examining the three-year
period ended December 31, 2005.
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, as well as the normal business forces of competition between companies
and the choices consumers make based on their preferences.
To
our
knowledge, no new laws or regulations were enacted in 2006 by any state in
which
we do business that are expected to have a material impact on the auto insurance
industry. In 2006, the California Commissioner adopted regulations that would
restrict the use of territory in automobile insurance rating, which potentially
could adversely affect the Company’s book of business. The Company has until
late 2008 to fully comply with the regulations. Litigation by an insurance
trade
association challenging the validity of the regulations is currently in
progress. Also in 2006, the CDI promulgated regulations specifying various
expense, investment income and profitability factors to be used by the CDI
in
reviewing and approving insurers’ rates. These regulations, which will become
effective April 3, 2007, may also negatively affect our California business.
See
Item
1A. Risk Factors
for more
information regarding these regulations.
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”). Transactions defined to be of an “extraordinary” nature may not be
effected without the prior approval of the CDI. 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 $771.0 million of statutory
surplus. Approximately $124.0 million of this amount (the 2006 net income of
the
Company’s primary insurance subsidiary) could be paid as dividends to the parent
company without prior approval from the CDI in 2007. In 2006, our primary
insurance subsidiary paid $110.0 million in dividends to our holding company.
Previously, no dividends had been paid 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 programs were established by the respective state
regulators and are 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 as 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 1997 to 2006, 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 program 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, 2006, the number of assigned risk
insured vehicles was 437 compared to 1,129 at the end of 2005. As of December
31, 2006, this business represented less than 1% of our total direct premiums
written. Underwriting profits were $0.5 million in 2006, compared to
underwriting profits of $1.0 million in 2005 and underwriting losses of $0.9
million in 2004.
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 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 2006, 2005, and 2004 were immaterial.
Availability
of Filings
Copies
of
our filings with the SEC on Form 10-K, Form 10-Q, Form 8-K and proxy statements
are available, along with copies of earnings releases, in the Investor Relations
section of 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 Station Place, 100 F Street, N.E., Room 1580,
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.
In
addition to the other information set forth in this report, you should carefully
consider the following factors, which could materially affect our business,
financial condition or future results. The risks described below are not the
only risks facing our Company. Additional risks and uncertainties not currently
known to us or that we currently deem to be immaterial also may materially
adversely affect our business, financial condition and/or operating results.
We
compete in the automobile insurance market, which is highly
competitive.
We
face
vigorous competition from large, well-capitalized national companies as well
as
smaller regional insurers. Other large national and international insurance
or
financial services companies may also enter these markets in the future. Many
of
these companies may have greater financial, marketing and management resources
than we have. In addition, competitors may offer consumers combinations of
auto
policies and other insurance products or financial services, which we do not
offer. We could be adversely affected by a loss of business to competitors
offering similar insurance products at lower prices or offering bundled products
or services and by other competitor initiatives.
From
time
to time, we undertake distinctive advertising campaigns and other efforts to
improve brand recognition and generate growth. If these campaigns or efforts
are
unsuccessful or are less effective than those of competitors, our business
could
be materially adversely affected.
The
highly competitive nature of the markets in which we compete could also result
in the failure of one or more major competitors. In the event of a failure
of a
major insurer, we could be adversely affected, as our Company and other
insurance companies may be required under state-mandated plans to absorb the
losses of the failed insurer, and we could be faced with an unexpected surge
in
new business from the failed insurer’s former policyholders.
The
ability of the Company to attract, develop and retain talented employees,
managers and executives, and to maintain appropriate staffing levels, is
critical to the Company’s success.
Our
success depends on our ability to attract, develop and retain talented
employees, including executives and other key managers. Our loss of certain
key
officers and employees or the failure to attract and develop talented new
executives and managers could have a materially adverse effect on our business.
In
addition, we must forecast the changing business environments in many geographic
markets with reasonable accuracy and adjust our hiring programs and/or
employment levels accordingly. Our failure to recognize the need for such
adjustments, or our failure or inability to react appropriately on a timely
basis, could lead either to over-staffing, which would adversely affect our
cost
structure, or under-staffing, impairing our ability to service our ongoing
and
new business in one or more business units or locations. In either such event,
our financial results could be materially adversely affected.
We
further believe that our success depends, in large part, on our ability to
maintain and improve the staffing models and employee culture that we have
developed over the years. Our ability to do so may be impaired as a result
of
litigation against us, legislation or regulations at the state or federal level
or other factors in the employment marketplace. In such events, the productivity
of certain of our workers could be adversely affected, which could lead to
an
erosion of our operating performance and margins.
The
Company’s insurance subsidiaries are subject to a variety of complex state laws
and regulations.
The
insurance industry is highly regulated and constantly subject to changes in
these regulations, many of which could negatively affect our business. Our
insurance company subsidiaries are subject to extensive laws and regulations
in
their states of domicile as well as 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 handling practices, accounting methods, premium
pricing, marketing practices, advertising, policy forms, insurance products,
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;
|
|
·
|
Control
the amount and exposure of losses in Involuntary Markets that companies
must bear;
|
|
·
|
Require
assessments to pay claims of insolvent insurance companies;
and
|
|
·
|
Require
that we submit to periodic financial and operational examinations
by the
state of domicile of our respective insurance company
subsidiaries.
|
The
failure to comply with these laws and regulations also could result in actions
by regulators or other law enforcement officials, potentially leading to fines
and penalties, adverse publicity and damage to our reputation in the
marketplace, and in extreme cases, revocation of a subsidiary’s authority to do
business in one or more jurisdictions. In addition, 21st and its subsidiaries
can face individual and class action lawsuits by its insureds and other parties
for alleged violations of certain of these laws or regulations.
New
legislation or regulations may be adopted in the future, which could adversely
affect our operations or ability to write business profitably in one or more
states. In addition, from time to time, the United States Congress and certain
federal agencies investigate the current condition of the insurance industry
to
determine whether federal regulation is necessary. We are unable to predict
whether any such laws will be enacted and how and to what extent such laws
and
regulations would affect our businesses.
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.
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. Such litigation is inherently
unpredictable. Except to the extent we have established reserves with respect
to
particular lawsuits that are currently pending against us, we are unable to
predict the effect, if any, that these pending or future lawsuits may have
on
our business, operations, profitability or financial condition. For further
information on pending litigation, see Notes 12 and 19 of the Notes
to Consolidated Financial Statements.
Our
success is reliant on our ability to properly assess underwriting risks and
charge appropriate premiums to policyholders.
Our
financial condition, liquidity, cash flows and results of operations are reliant
on our ability to accurately assess our underwriting risks and charge
appropriate premiums based on these risks. The premium we charge must be
sufficient to offset losses, loss adjustment expenses, and underwriting
expenses, and allow us to earn a profit.
Our
ability to price accurately is subject to a number of risks and uncertainties,
including, without limitation:
|
·
|
The
availability of sufficient reliable data;
|
|
·
|
Uncertainties
inherent in estimates and assumptions, generally;
|
|
·
|
Our
ability to conduct a complete and accurate analysis of available
data;
|
|
·
|
Our
ability to timely recognize changes in trends and to project both
the
severity and frequency of losses with reasonable accuracy;
|
|
·
|
Our
ability to project changes in certain operating expenses with reasonable
certainty;
|
|
·
|
The
development, selection and application of appropriate rating formulae
or
other pricing methodologies;
|
|
·
|
Our
ability to innovate with new pricing strategies, and the success
of those
innovations;
|
|
·
|
Our
ability to predict policyholder retention
accurately;
|
|
·
|
Unanticipated
court decisions, legislation or regulatory
action;
|
|
·
|
Ongoing
changes in our claim settlement
practices;
|
|
·
|
Unexpected
changes in the medical sector of the
economy;
|
|
·
|
Unanticipated
changes in auto repair costs, auto parts prices and used car prices;
and
|
|
·
|
Changing
driving patterns.
|
The
realization of such risks may result in our pricing being based on stale,
inadequate or inaccurate data or inappropriate analyses, assumptions or
methodologies, and may cause us to estimate incorrectly future changes in the
frequency or severity of claims. As a result, we could underprice risks, which
would negatively affect our margins, or we could overprice risks, which could
reduce our volume and competitiveness. In either event, our operating results,
financial condition and cash flows could be materially adversely
affected.
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.
As
a property and casualty insurer, we may face significant losses from
catastrophic events.
We
are
subject to claims arising from natural catastrophic events such as earthquakes,
tornadoes, hurricanes, hailstorms, wildfires, and from man-made events such
as
riots and terrorism. There is typically an increase in the frequency and
severity of auto claims whenever one of these events occur. We cannot accurately
predict when or where these events will occur and, though we believe we have
in
place strong catastrophe management initiatives, we are still exposed to
catastrophic events and cannot guarantee that our business will not be
materially adversely affected should one occur.
Further,
subsequent to a catastrophic event there can be increases in involuntary market
assessments to pay for insolvent companies and uninsured individuals as well
as
restrictions on the Company’s operations imposed by regulatory
entities.
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 represent our best
estimates of amounts needed to pay reported and unreported claims and related
expenses, after considering known facts and our interpretation of circumstances.
Reserve estimates 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
availability of sufficient reliable
data;
|
|
·
|
The
difficulty in predicting the rate and direction of changes in frequency
and severity trends in multiple
markets;
|
|
·
|
Unexpected
changes in medical and repair
costs;
|
|
·
|
Unanticipated
changes in governing statutes and
regulations;
|
|
·
|
New
or changing interpretations of insurance policy provisions by
courts;
|
|
·
|
Inconsistent
decisions in lawsuits regarding coverage and changing theories of
liability;
|
|
·
|
Ongoing
changes in claims settlement
practices;
|
|
·
|
The
accuracy of our estimates of the number or severity of claims that
have
been incurred but not reported as of the date of the financial
statement;
|
|
·
|
The
accuracy and adequacy of actuarial techniques and databases used
in
estimating loss reserves; and
|
|
·
|
The
accuracy of estimates of total loss and loss adjustment expenses
as
determined by our employees for different categories of claims.
|
There
can
be no assurance that our ultimate liability will not materially exceed our
reserves. If loss reserves are not sufficient to cover our actual losses, our
results of operations, liquidity, and financial position may be materially
adversely affected. See further discussion in Item
1. Business - Loss and LAE Reserve Development.
The
Company relies on its information technology systems to manage many aspects
of
its business, and any failure of these systems to function properly or any
interruption in their operation could result in a material adverse effect on
the
Company’s business, financial condition and results of operations.
We
are
highly dependent upon technology systems to effectively manage areas of our
business including: underwriting, acquisition of policies, policy servicing,
claims handling, accounting and reporting, actuarial reserving functions, and
to
maintain our policyholder data. We have developed a new information technology
platform that
is
intended to allow us to more efficiently manage our operations as we expand
into
new states. The failure of any part of this system could cause a disruption
to
our operations, which could result in a loss of premiums, increased operating
costs, an inability to provide customer service or process claims, and delays
to
or incorrect reporting. Although decreasing over time, we still rely to some
extent on the capabilities of our previous system.
A
security breach of our computer systems could also interrupt or damage our
operations or harm our reputation. In addition, we could be subject to liability
if confidential customer information is misappropriated from our computer
systems. Despite the implementation of security measures, including hiring
an
independent firm to perform intrusion vulnerability testing of our computer
systems, these systems may be vulnerable to physical break-ins, computer
viruses, programming errors, attacks by third parties or similar disruptive
problems. Any compromise of security could deter people from entering into
transactions that involve transmitting confidential information to our systems,
which could have a material, adverse effect on our business.
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
89% of our direct premiums written for the year ended December 31, 2006, 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.
In
July
2006, the CDI issued changes to regulations relating to automobile insurance
rating factors, particularly concerning territorial rating (the “Auto Rating
Factor Regulations”). The previous regulation had been validated by a court
decision. The new rules required automobile insurance companies to make a class
plan and rate filing during the third quarter of 2006 to bring their automobile
insurance rates in California into compliance with the Auto Rating Factor
Regulations (the current percentage of compliance required is 15% of what will
ultimately be required if the regulations remain in effect). Litigation to
preliminarily enjoin the implementation of the Auto Rating Factor Regulations
and have them declared in violation of California law has been unsuccessful.
As
a result, the Company submitted class plan and rate filings to the CDI for
its
review. The Company’s rate filing proposed an overall rate decrease of 5% of
premium. The CDI approved the Company’s class plan and rate filings. The new
rates took effect January 3, 2007. Because the new Auto Rating Factor
Regulations required every company to make a rate filing, competitive rate
levels have changed and consumer shopping behavior may increase in the future.
As of this date, most of the Company’s main competitors have also had approved
overall rate decreases of varying amounts, while some have not substantially
changed overall rate levels while attempting to comply with the new regulations.
It is not possible at this time to predict the ultimate impact of these
proceedings and changes, which could have either a materially favorable or
materially adverse impact on the Company.
Also
in
July 2006, the CDI proposed new amended rate approval regulations (the “Rate
Approval Regulations”) that would determine how insurance rates for personal
auto and most other lines of personal and commercial property and casualty
lines
of business are established in California. In October 2006, the CDI issued
additional amendments to the Rate Approval Regulations. These regulations were
submitted in November 2006 to the Office of Administrative Law (the “OAL”) and
were approved in January of 2007. The amended regulations will become effective
on April 3, 2007. Multiple changes from the current regulations include capping
the maximum permitted after-tax rate of return on derived capital at a floating
rate equal to a “risk free” rate of return plus 6% for all affected lines of
insurance. The amended Rate Approval Regulations do provide for several
“variances” from the rates specified by the formula, upon approval by the
Insurance Commissioner. The amended Rate Approval Regulations could have a
materially adverse impact on the Company’s results. If the newly elected
insurance commissioner does not modify, suspend or withdraw the regulations
before they become effective, an industry lawsuit could be brought to challenge
the regulations as contrary to current law. Also, the Company could consider
bringing its own legal action, once the regulations are applied to
it.
We
cannot assure you that 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. We cannot assure you that we will
be
able to successfully implement our growth strategy or be able to improve our
operating results.
The
Company may be adversely affected by the cyclical nature of the property and
casualty business.
The
property and casualty market is cyclical and has experienced periods
characterized by relatively high levels of price competition, less restrictive
underwriting standards and relatively low premium rates, followed by periods
of
relatively lower levels of competition, more selective underwriting standards
and relatively high premium rates. A downturn in the profitability cycle of
the
property and casualty business could have a material adverse effect on our
financial condition and results of operations.
Changes
in accounting standards issued by the Financial Accounting Standards Board
(“FASB”) or other standard-setting bodies may adversely affect the Company’s
consolidated financial statements.
Our
financial statements are subject to the application of GAAP, which is
periodically revised and/or expanded. Accordingly, we are required to adopt
new
or revised accounting standards from time to time issued by recognized
authoritative bodies, including the FASB. It is possible that future changes
we
are required to adopt could change the current accounting treatment that we
apply to our consolidated financial statements and that such changes could
have
a material adverse effect on our results and financial condition. For a
description of potential changes in accounting standards that could affect
us
currently, see Note 2 of the Notes
to Consolidated Financial Statements.
The
performance of our fixed maturity securities portfolio is subject to investment
risks.
Our
fixed
maturity securities portfolio is subject to a number of risks,
including:
|
·
|
Interest
rate risk
-
The Company’s investment portfolio contains interest rate sensitive
investments, such as municipal and corporate bonds. Increases in
market
interest rates may have an adverse impact on the value of the investment
portfolio by decreasing unrealized capital gains on fixed income
securities. Declining market interest rates could have an adverse
impact
on the Company’s investment income as it invests positive cash flows from
operations and as it reinvests proceeds from maturing and called
investments into new investments that could yield lower rates than
the
Company’s investments have historically generated. Interest rates are
highly sensitive to many factors, including governmental monetary
policies, domestic and international economic and political conditions
and
other factors beyond the Company’s control. Although the Company takes
measures to manage the risks of investing in a changing interest
rate
environment, it may not be able to mitigate interest rate sensitivity
effectively. The Company’s mitigation efforts include maintaining a high
quality portfolio with a relatively short duration to reduce the
effect of
interest rate changes on book value. Despite its mitigation efforts,
a
significant increase in interest rates could have a material adverse
effect on the Company’s book value.
|
|
·
|
Credit
risk -
The risk that issuers of bonds that we hold will not pay principal
or
interest when due. Credit defaults and impairments may result in
a charge
to income as we are forced to write-down the value of bonds we hold.
Credit rating agencies have downgraded, and may downgrade in the
future,
certain issuers of fixed maturity securities. At December 31, 2006,
our
bond portfolio consisted of investment grade securities. Widespread
deterioration in the credit quality of issuers could materially impact
the
value of our invested assets, as well as our earnings, liquidity,
and
capital.
|
|
·
|
Concentration
risk -
The risk that the portfolio may be too heavily concentrated in the
securities of one or more issuers, sectors or industries, which could
result in a significant decrease in the value of the portfolio in
the
event of a deterioration of the financial condition of those issuers
or
the market value of their
securities.
|
|
·
|
Prepayment
or extension risk (applicable to certain securities in the portfolio,
such
as residential mortgage-backed securities) -
The risk that, as interest rates change, the principal of such securities
may be repaid earlier than anticipated, adversely affecting the value
of,
or income from, such securities and the
portfolio.
|
|
·
|
Reinvestment
risk - The
risk that an investor will not be able to reinvest funds at as favorable
a
yield as the original investment yields.
|
In
addition, the assets in our defined benefit pension plan are invested in a
combination of high credit quality fixed maturity 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.
Our
insurance subsidiaries are limited in the amount of dividends that they can
pay
to the holding company, which in turn may limit the holding company’s ability to
pay dividends to shareholders, repay indebtedness or make capital contributions
to its other subsidiaries or affiliates.
Our
Company is a holding company with no business operations of its own.
Consequently, if our subsidiaries are unable to pay dividends or make other
distributions to the holding company, or are able to pay only limited amounts,
we may be unable to pay dividends to shareholders, make payments on its
indebtedness, meet its other obligations, or make capital contributions to
or
otherwise fund its subsidiaries.
Each
insurance subsidiary’s ability to pay dividends to the holding company may be
limited by one or more of the following factors:
|
·
|
State
insurance regulatory authorities require insurance companies to maintain
specified minimum levels of statutory capital and surplus.
|
|
·
|
Competitive
pressures require our insurance subsidiaries to maintain financial
strength ratings.
|
|
·
|
In
certain situations, prior approval must be obtained from state regulatory
authorities for the insurance subsidiaries to pay dividends or make
other
distributions to affiliated entities, including the holding company.
|
Our
access to capital markets, our financing arrangements, and our business
operations are dependent on favorable evaluations and ratings by credit and
other rating agencies.
Financial
strength and claims-paying ability ratings issued by firms such as Standard
& Poor’s, Fitch, Moody’s, and A.M. Best have become an increasingly
important factor in establishing the competitive position of insurance
companies. Our ability to attract and retain policies is affected by our ratings
with these agencies. Rating agencies assign ratings based upon their evaluations
of an insurance company’s ability to meet its financial obligations.
Our
financial strength ratings with A.M. Best, Standard & Poor’s, and Fitch are
A+, A+, and A+, respectively; our respective debt ratings are aa-, BBB+, and
BBB+; and our outlook is stable with all three agencies. Since these ratings
are
subject to continuous review, we cannot guarantee the continuation of our
favorable ratings. If our ratings were lowered significantly by any one of
these
agencies 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 on new debt sought in the capital
markets. These events, in turn, could have a material adverse effect on our
net
income and liquidity.
The
majority owner of our stock may take actions conflicting with your
interests.
The
majority owner of our common stock can control the outcome of shareholder votes.
In addition, four of our eleven directors, including our Chairman, are current
or former officers and employees of the majority holder or its subsidiaries.
Through its majority ownership of our stock, the majority holder has the ability
to and may influence actions that may conflict with the interest of other
shareholders and holders of debt securities. For example, the majority holder
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.
On
January 24, 2007, the majority owner, AIG, made a proposal to acquire the
remaining shares of the Company common stock it does not own. The proposal
is
subject to several conditions, including the approval of the transaction by
a
Special Committee of the Company’s Board of Directors who are independent of
AIG. The pendency of this proposal for an extended period of time, as well
as
the failure of the proposed transaction to ultimately be consummated, may have
a
negative impact on the Company’s ability to attract and retain qualified
management and employees and consequently effectively carry out its business
plans. Please see Note 19 of the Notes
to the Consolidated Financial Statements
for
further information on this proposal.
Failure
to maintain an effective system of internal control over financial reporting
may
have an adverse effect on the Company’s stock price.
Section 404
of the Sarbanes-Oxley Act of 2002 and the related rules and regulations
promulgated by the SEC require the Company to include in its Form 10-K a
report by its management regarding the effectiveness of the Company’s internal
control over financial reporting. The report includes, among other things,
an
assessment of the effectiveness of the Company’s internal control over financial
reporting as of the end of its fiscal year, including a statement as to whether
or not the Company’s internal control over financial reporting is effective.
This assessment must include disclosure of any material weaknesses in the
Company’s internal control over financial reporting identified by management.
Areas of the Company’s internal control over financial reporting may require
improvement from time to time. If management is unable to assert that the
Company’s internal control over financial reporting is effective now or in any
future period, or if the Company’s auditors are unable to express an opinion on
the effectiveness of those internal controls, investors may lose confidence
in
the accuracy and completeness of the Company’s financial reports, which could
have an adverse effect on its stock price.
General
economic factors may adversely affect the Company’s business, financial
condition and results of operations.
General
economic conditions in one or more of the current markets we write business
in
may adversely affect our financial performance. An increase in interest rates,
inflation, energy costs, unemployment levels, consumer debt levels, tax rates,
and other economic factors may adversely affect consumer preferences and buying
habits. These factors, along with an increase in medical and repair costs could
also have an adverse effect on the Company’s results of operations.
ITEM
1B.
|
UNRESOLVED
STAFF
COMMENTS
|
None.
The
following table summarizes our significant properties as of December 31,
2006:
Purpose
|
Location
|
Approximate
Square
Footage
|
Owned
or
Leased
|
Headquarters
|
Woodland
Hills, California
|
406,000
|
Leased
|
Claims
offices
|
Other
California
|
159,000
|
Leased
|
Claims
offices
|
Arizona
|
13,000
|
Leased
|
Legal
offices
|
Other
California
|
21,100
|
Leased
|
Service
Center
|
Lewisville,
Texas
|
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
12
other locations. 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.
The
Company purchased a customer service, sales and claims center in Lewisville,
Texas, in September 2005 after exercising its option under the terms of its
lease agreement to purchase the land and building that house this service
center.
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 Notes 12 and 19 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 2006.
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, low, and close
bid prices and dividends per share on the NYSE for our common stock for the
indicated periods.
|
|
|
|
|
|
|
|
|
|
Quarter
|
|
High
|
Low
|
Close
|
Dividends
per
Share
|
2006
|
|
|
|
|
|
|
|
|
|
1
|
|
$
|
17.02
|
|
$
|
15.28
|
|
$
|
15.80
|
|
$
|
0.08
|
|
2
|
|
|
16.49
|
|
|
13.58
|
|
|
14.40
|
|
|
0.08
|
|
3
|
|
|
15.98
|
|
|
14.04
|
|
|
14.95
|
|
|
0.08
|
|
4
|
|
|
18.02
|
|
|
14.63
|
|
|
17.65
|
|
|
0.08
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
$
|
14.35
|
|
$
|
13.00
|
|
$
|
13.95
|
|
$
|
0.04
|
|
2
|
|
|
15.07
|
|
|
12.90
|
|
|
14.84
|
|
|
0.04
|
|
3
|
|
|
16.30
|
|
|
14.40
|
|
|
15.95
|
|
|
0.04
|
|
4
|
|
|
17.92
|
|
|
14.83
|
|
|
16.18
|
|
|
0.04
|
|
(b)
|
Holders
of Common Stock
|
The
approximate number of holders of record of our common stock on February 3,
2007
was 500.
On
February 21, 2007, the Company's Board of Directors declared a quarterly
dividend of $0.16 per share. The frequency and amount of cash dividends paid
per
share for the last two years are summarized in the table above. 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. Our primary insurance subsidiary has capacity to pay
approximately $124.0 million in dividends to its parent in 2007 without prior
approval of the California Department of Insurance. See Notes 13 and 15 of
the
Notes
to Consolidated Financial Statements
as well
as Liquidity
and Capital Resources
located
in Item 7 of this report for additional information.
(e)
|
Shareholder
Return Performance Graph
|
Set
forth
below is a line graph comparing the cumulative total shareholder return on
the
Company’s Common Stock against the cumulative total return of the Standard &
Poor’s 500 Stock Index and the Standard & Poor’s Property & Casualty
Insurance Index for the period of five years commencing December 31, 2001,
and
ended December 31, 2006. The graph and table assume $100 was invested on
December 31, 2001, in each of the Company’s Common Stock, the Standard &
Poor’s 500 Stock Index and the Standard & Poor’s Property & Casualty
Insurance Index, and that all dividends were reinvested.
The
following selected financial data for each of the years in the five-year period
ended December 31, 2006, 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 per share data.
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
2003
|
2002
|
Total
revenues
|
|
$
|
1,375,287
|
|
$
|
1,419,128
|
|
$
|
1,383,332
|
|
$
|
1,246,464
|
|
$
|
981,295
|
|
Net
income (loss)
|
|
|
97,228
|
|
|
87,426
|
|
|
88,225
|
|
|
53,575
|
|
|
(12,256
|
)
|
Basic
earnings (loss) per share
|
|
|
1.13
|
|
|
1.02
|
|
|
1.03
|
|
|
0.63
|
|
|
(0.14
|
)
|
Diluted
earnings (loss) per share |
|
|
1.12 |
|
|
1.02 |
|
|
1.03 |
|
|
0.63 |
|
|
(0.14 |
) |
Dividends
declared per share
|
|
|
0.32
|
|
|
0.16
|
|
|
0.08
|
|
|
0.08
|
|
|
0.26
|
|
Total
assets
|
|
|
1,951,697
|
|
|
1,920,229
|
|
|
1,864,314
|
|
|
1,738,132
|
|
|
1,470,037
|
|
Debt
|
|
|
115,895
|
|
|
127,972
|
|
|
138,290
|
|
|
149,686
|
|
|
60,000
|
|
Total
liabilities
|
|
|
1,053,148
|
|
|
1,090,257
|
|
|
1,089,913
|
|
|
1,037,442
|
|
|
814,429
|
|
Stockholders’
equity
|
|
|
898,549
|
|
|
829,972
|
|
|
774,401
|
|
|
700,690
|
|
|
655,608
|
|
Book
value per common share
|
|
|
10.39
|
|
|
9.66
|
|
|
9.06
|
|
|
8.20
|
|
|
7.67
|
|
Net
income in 2006 includes the effect of stock-based compensation expense of $6.9
million, or $0.08 per share after tax that was not present in prior years (see
further discussion in Note 14 of the Notes
to Consolidated Financial Statements).
The
adoption of Statement 158 reduced stockholders’ equity by approximately $14.2
million as of December 31, 2006 (see Note 11 of the Notes
to Consolidated Financial Statements).
The
Company entered into a $60.0 million sale-leaseback transaction in 2002 and
issued $100.0 million of Senior Notes in 2003 (see Note 9 of the Notes
to Consolidated Financial Statements).
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
|
Management’s
Discussion and Analysis of Financial Condition and Results of Operations
(“MD&A”) is intended to help the reader understand the Company, our
operations and our present business environment. MD&A should be read in
conjunction with the accompanying consolidated financial statements and the
accompanying notes thereto contained in Item 8 of this report. MD&A includes
the following sections:
|
·
|
Liquidity
and Capital Resources
|
|
·
|
Contractual
Obligations and Commitments
|
|
·
|
Transactions
with Related Parties
|
|
·
|
Critical
Accounting Estimates
|
|
·
|
Recent
Accounting Pronouncements
|
|
·
|
Forward-Looking
Statements
|
OVERVIEW
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 2006, we insure over 1.5 million vehicles in Arizona,
California, Florida, Georgia, Illinois, Indiana, Nevada, New Jersey, Ohio,
Oregon, Pennsylvania, Texas, Washington, Colorado, Minnesota, Missouri, and
Wisconsin. We provide superior policy features and customer service at a
competitive price. Customers can receive a quote, purchase a policy, service
their policy, or report a claim at www.21st.com
or over
the phone with our licensed insurance professionals at 1-800-211-SAVE. Service
is offered in English and Spanish, both over the phone and on the web, 24 hours
a day, 365 days a year. Our insurance subsidiaries, 21st Century Insurance
Company (our primary insurance subsidiary), 21st Century Casualty Company,
and
21st Century Insurance Company of the Southwest (“21st of the Southwest”), are
rated A+ by A.M. Best, Fitch Ratings and Standard & Poor’s. The Company’s A+
rating was affirmed by A.M. Best on June 13, 2006.
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”) owned approximately 62% of the Company’s outstanding common
stock as of December 31, 2006.
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.
National
Expansion
The
Company is implementing a multi-year strategy for national expansion to realize
benefits from economies of scale, lower unit marketing costs due to the cost
efficiency of buying advertising on a national basis, less dependency on any
single market and the operating flexibility to focus resources on attractive
markets and deemphasize less attractive markets. In execution of this strategy,
21st expanded its operations into the Midwest (2004); Texas (2005); Florida,
Georgia and Pennsylvania (second quarter of 2006); New Jersey (October 2006);
and Colorado, Minnesota, Missouri, and Wisconsin (fourth quarter 2006). During
2006, the Company has increased the percentage of the U.S. personal auto market
in which it operates from 34 percent to 60 percent. Year over year growth in
direct premiums written in non-California markets in 2006 was 77.3% versus
81.6%
in 2005. Non-California direct premiums written comprised 11.3% of our total
direct premiums written in 2006, versus 6.2% in 2005. Continued implementation
of our growth strategy could be affected by a number of factors beyond our
control, such as increased competition, judicial, regulatory, or legislative
developments, general economic conditions or increased operating costs.
Highlights
The
following table summarizes our consolidated results of operations:
AMOUNTS
IN
THOUSANDS
|
|
2006
|
2005
|
2004
|
|
%
Change
’06
vs.‘05
|
%
Change
’05
vs.‘04
|
Direct
premiums written
|
|
$
|
1,315,107
|
|
$
|
1,346,370
|
|
$
|
1,337,198
|
|
|
|
(2.3
|
)%
|
|
0.7
|
%
|
Net
premiums written
|
|
|
1,309,687
|
|
|
1,341,418
|
|
|
1,332,384
|
|
|
|
(2.4
|
)
|
|
0.7
|
|
Net
premiums earned
|
|
|
1,307,585
|
|
|
1,352,937
|
|
|
1,313,670
|
|
|
|
(3.4
|
)
|
|
3.0
|
|
Net
losses and LAE
|
|
|
(920,846
|
) |
|
(998,933
|
) |
|
(993,841
|
) |
|
|
(7.8
|
)
|
|
0.5
|
|
Underwriting
expenses
|
|
|
(303,782
|
) |
|
(284,334
|
) |
|
(258,571
|
) |
|
|
6.8
|
|
|
10.0
|
|
Underwriting
profit
|
|
$
|
82,957
|
|
$
|
69,670
|
|
$
|
61,258
|
|
|
|
19.1
|
|
|
13.7
|
|
Financial
highlights for the years ended December 31, 2006, 2005, and 2004:
|
·
|
Total
direct premiums written decreased 2.3% to $1,315.1 million in 2006,
from
$1,346.4 million and $1,337.2 million in 2005 and 2004,
respectively.
|
|
·
|
California
direct premiums written decreased 7.6% to $1,166.0 million in 2006,
compared to $1,262.3 million and $1,290.9 million in 2005 and 2004,
respectively.
|
|
·
|
Non-California
direct premiums written increased 77.3% to $149.1 million in 2006,
compared to $84.1 million and $46.3 million in 2005 and 2004,
respectively.
|
|
·
|
The
2006 consolidated combined ratio was 93.7%, versus 94.9% and 95.3%
for
2005 and 2004, respectively. 2006 was positively impacted by 4.0
points of
favorable prior accident year loss and LAE reserve development in
2006,
while 2005 was favorably impacted by 1.9 points of prior accident
year
development. 2004 was not impacted by prior accident year
development.
|
For
2006,
21st’s insurance subsidiaries achieved underwriting profitability, but total
direct premiums written declined for the year. The California market, which
represented 88.7% of our total direct premiums written during 2006, has seen
stable to declining rates from competitors and a reduced level of shopping
behavior by consumers, which reduced our opportunities for profitable growth
in
this state. However, 21st realized 77.3% of
growth
in non-California states during 2006 as a result of the Company’s national
expansion efforts. Our non-California direct premiums written grew from 6.2%
in
2005 to 11.3% of out total book of business in 2006.
The
loss
and LAE ratios of 70.5%, 73.8%, and 75.6% for 2006, 2005, and 2004,
respectively, have decreased since 2002 primarily due to favorable loss
development, improvements in our pricing and underwriting methods and the
favorable impact of declining frequency trends and moderate claim severity
trends.
The
underwriting expense to net premiums earned ratio increased to 23.2% in 2006
from 21.1% and 19.7% for 2005 and 2004, respectively. These underwriting expense
ratio increases are primarily the result of expenses associated with
the
Company’s national expansion efforts and the 2006 recognition of stock-based
compensation, which were partially offset by deferred policy acquisition costs.
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.
Net
income increased 11.2% to $97.2 million for the year ended December 31, 2006,
or
$1.13 per basic share, compared to $87.4 million, or $1.02 per basic share,
and
$88.2 million, or $1.03 per basic share for 2005 and 2004, respectively. The
2006 results include prior year favorable reserve development totaling $51.9
million, versus $25.1 million and $0.1 million in 2005 and 2004, respectively.
The
recognition of stock-based compensation resulted from our adoption of Statement
of Financial Accounting Standards No. 123 (revised 2004), Share-Based
Payment
(“FAS
123R”). FAS 123R requires the recognition of compensation expense in the
Consolidated Statements of Operations based on the estimated fair value of
the
employee share-based options. See Critical
Accounting Estimates - Stock-Based Compensation Cost
for
further discussion. Stock-based compensation classified as underwriting expense
for 2006 was $6.1 million.
In
July
2006, the California Department of Insurance (the “CDI”) obtained approval for
changes to regulations (the “Auto Rating Factor Regulations”) relating to
automobile insurance rating factors, particularly concerning territorial rating.
Because the new Auto Rating Factor Regulations require every personal auto
insurance company operating in California to make a class plan and rate filing
in the third quarter of 2006, competitive rate levels have changed and consumer
shopping behavior may increase in the future. As of this date, the Company
has
filed for an overall rate decrease in California of approximately 5% of premium.
The CDI approved the Company’s class plan and rate filings. The new rates took
effect January 3, 2007. Most of the Company’s main competitors have also had
approved overall rate decreases of varying amounts, while some have not
substantially changed overall rate levels while attempting to comply with the
new regulations. It is not possible at this time to predict the ultimate impact
of these changes, which could have either a materially favorable or materially
adverse impact on the Company. All rate changes and class plan filings must
be
approved by the CDI. See further discussion in Item
1A. Risk
Factors.
Also
in
July 2006, the CDI proposed new amended rate approval regulations (the “Rate
Approval Regulations”), affecting personal auto, homeowners and most lines of
commercial property and casualty insurance written in California. The
regulations become effective on April 3, 2007. If newly elected insurance
commissioner does not modify, suspend or withdraw the regulations before they
become effective, an industry lawsuit could be brought to challenge the
regulations as contrary to current law. Also, the Company could consider
bringing its own legal action, once the regulations are applied to it. See
further discussion in Item
1A. Risk Factors.
Proposal
for Offer
On
January 24, 2007, the majority owner, AIG, made a proposal to acquire the
remaining shares of the Company common stock it does not own. The proposal
is
subject to several conditions, including the approval of the transaction by
a
Special Committee of the Company’s Board of Directors who are independent of
AIG. The proposal could have a negative impact on the Company’s ability to carry
out its business plans. See further discussion in Item
1A. Risk Factors and
Note
19 of the Notes
to the Consolidated Financial Statements.
Streamlining
of Operations
On
February 26, 2007, the Company announced it expects to incur approximately
$3.7
million in severance costs during the first quarter of 2007 in connection with
a
four percent reduction of its total work force.
Non-GAAP
Measures
Information
concerning premiums written, underwriting profit, combined ratios, and statutory
surplus have been presented to enhance readers’ understanding of the Company’s
operations. These are widely used financial measures in the insurance industry
that happen not to have formal definitions currently under accounting principles
generally accepted in the United States of America (“GAAP”).
Premiums
written represent the premiums charged on policies issued during a fiscal
period. We use premiums written as a measure of the underlying growth of our
insurance business from period to period. The most directly comparable GAAP
measure, premiums earned, represents the portion of premiums written that is
recognized as income on a pro rata basis over the terms of the policies.
Underwriting
profit (loss) consists of net premiums earned less losses from claims, loss
adjustment expenses and underwriting expenses. 21st believes that underwriting
profit (loss) provides investors with financial information that is not only
meaningful, but critically important to understanding the results of property
and casualty insurance operations. The results of operations of a property
and
casualty insurance company include three components: underwriting profit (loss),
net investment income and realized capital gains (losses). Without disclosure
of
underwriting profit (loss), it is difficult to determine how successful an
insurance company is in its core business activity of assessing and underwriting
risk, as including investment income and realized capital gains (losses) in
the
results of operations without disclosing underwriting profit (loss) can mask
underwriting losses.
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 to statutory surplus.
The
reconciliations of these financial measures to the most directly comparable
GAAP
measures are located in the following: premiums written and underwriting profit
are located in the Results
of Operations
and
statutory surplus is located in Liquidity
and Capital Resources.
These
financial measures are not intended to replace, and should be read in
conjunction with, the GAAP financial measures.
See
Results
of Operations
for more
details as to our overall and personal auto lines results.
RESULTS
OF OPERATIONS
Consolidated
Results
The
following table reconciles our
personal auto lines underwriting profit
to our
consolidated results of operations:
AMOUNTS
IN THOUSANDS
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
|
%
Change
’06
vs.‘05
|
%
Change
’05
vs.‘04
|
Personal
auto lines underwriting profit
|
|
$
|
83,708
|
|
$
|
71,995
|
|
$
|
63,972
|
|
|
|
16.3
|
%
|
|
12.5
|
%
|
Homeowner
and earthquake lines in runoff, underwriting loss
|
|
|
(751
|
)
|
|
(2,325
|
)
|
|
(2,714
|
)
|
|
|
(67.7
|
)
|
|
(14.3
|
)
|
Net
investment income
|
|
|
68,493
|
|
|
69,096
|
|
|
58,831
|
|
|
|
(0.9
|
)
|
|
17.4
|
|
Other
income
|
|
|
638
|
|
|
367
|
|
|
―
|
|
|
|
73.8
|
|
|
N/M1
|
|
Net
realized investment (losses) gains
|
|
|
(1,429
|
)
|
|
(3,272
|
)
|
|
10,831
|
|
|
|
(56.3
|
)
|
|
(130.2
|
)
|
Other
expense
|
|
|
(1,860
|
)
|
|
(410
|
)
|
|
―
|
|
|
|
N/M1
|
|
|
N/M1
|
|
Interest
and fees expense
|
|
|
(7,348
|
)
|
|
(8,019
|
)
|
|
(8,627
|
)
|
|
|
(8.4
|
)
|
|
(7.0
|
)
|
Provision
for income taxes
|
|
|
(44,223
|
)
|
|
(40,006
|
)
|
|
(34,068
|
)
|
|
|
10.5
|
|
|
17.4
|
|
Net
income
|
|
$
|
97,228
|
|
$
|
87,426
|
|
$
|
88,225
|
|
|
|
11.2
|
|
|
(0.9
|
)
|
Basic
earnings per share
|
|
$
|
1.13
|
|
$
|
1.02
|
|
$
|
1.03
|
|
|
|
10.7
|
|
|
(1.0
|
)
|
Diluted
earnings per share
|
|
$
|
1.12
|
|
$
|
1.02
|
|
$
|
1.03
|
|
|
|
10.2
|
|
|
(1.0
|
)
|
Underwriting
results above include the effect of prior years’ reserve redundancy recorded in
the current year. The following table summarizes losses and loss adjustment
expenses (“LAE”) incurred, net of applicable reinsurance, for the periods
indicated:
AMOUNTS
IN THOUSANDS
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Net
losses and LAE:
|
|
|
|
|
|
|
|
Current
accident year
|
|
$
|
972,743
|
|
$
|
1,024,073
|
|
$
|
993,948
|
|
Prior
accident years
|
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
|
(52,648
|
)
|
|
(27,473
|
)
|
|
(2,936
|
)
|
Homeowner
and earthquake lines in runoff
|
|
|
751
|
|
|
2,333
|
|
|
2,831
|
|
Total
prior years’ redundancy recorded in current year
|
|
|
(51,897
|
)
|
|
(25,140
|
)
|
|
(105
|
)
|
Total
net losses and LAE incurred
|
|
$
|
920,846
|
|
$
|
998,933
|
|
$
|
993,843
|
|
___________________
1 |
Ratio
is not meaningful.
|
We
perform quarterly reviews of the adequacy of carried unpaid losses and LAE.
These estimates depend on many assumptions about the outcome of future events.
Consequently, there can be no assurance that our ultimate unpaid losses and
LAE
will not develop redundancies or deficiencies and materially differ from our
unpaid losses and LAE at December 31, 2006, 2005, or 2004. In the future, if
the
unpaid losses and LAE develop redundancies or deficiencies, such redundancy
or
deficiency would have a positive or adverse impact, respectively, on future
results of operations. See Critical
Accounting Estimates - Losses and Loss Adjustment Expenses
for
additional discussion of our reserving policy.
Personal
Auto Lines Underwriting Results
Personal
automobile insurance is our primary line of business. Non-California vehicles
accounted for 11.3%, 6.2%, and 3.5% of our direct premiums written in 2006,
2005
and 2004, respectively. This increase is due to our ongoing national expansion
program, which includes marketing in non-California states. The Company
currently plans to expand into additional states to further its national
expansion strategy.
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
|
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
|
’06
vs.‘05
|
|
’05
vs.‘04
|
Direct
premiums written
|
|
$
|
1,315,107
|
|
$
|
1,346,371
|
|
$
|
1,337,190
|
|
|
|
(2.3
|
)%
|
|
|
0.7
|
%
|
Net
premiums written
|
|
$
|
1,309,687
|
|
$
|
1,341,419
|
|
$
|
1,332,375
|
|
|
|
(2.4
|
)
|
|
|
0.7
|
|
Net
premiums earned
|
|
$
|
1,307,585
|
|
$
|
1,352,928
|
|
$
|
1,313,551
|
|
|
|
(3.4
|
)
|
|
|
3.0
|
|
Net
losses and LAE
|
|
|
(920,095
|
) |
|
(996,599
|
) |
|
(991,008
|
) |
|
|
(7.7
|
)
|
|
|
0.6
|
|
Underwriting
expenses
|
|
|
(303,782
|
) |
|
(284,334
|
) |
|
(258,571
|
) |
|
|
6.8
|
|
|
|
10.0
|
|
Underwriting
profit
|
|
$
|
83,708
|
|
$
|
71,995
|
|
$
|
63,972
|
|
|
|
16.3
|
|
|
|
12.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and LAE ratio
|
|
|
70.4
|
%
|
|
73.7
|
%
|
|
75.4
|
%
|
|
|
(3.3
|
)
|
|
|
(1.7
|
)
|
Underwriting
expense ratio
|
|
|
23.2
|
|
|
21.0
|
|
|
19.7
|
|
|
|
2.2
|
|
|
|
1.3
|
|
Combined
ratio
|
|
|
93.6
|
%
|
|
94.7
|
%
|
|
95.1
|
%
|
|
|
(1.1
|
)
|
|
|
(0.4
|
)
|
The
following table reconciles our personal auto lines direct premiums written
to
net premiums earned:
AMOUNTS
IN THOUSANDS
|
|
2006
|
2005
|
2004
|
Direct
premiums written
|
|
$
|
1,315,107
|
|
$
|
1,346,371
|
|
$
|
1,337,190
|
|
Ceded
premiums written
|
|
|
(5,420
|
)
|
|
(4,952
|
)
|
|
(4,815
|
)
|
Net
premiums written
|
|
|
1,309,687
|
|
|
1,341,419
|
|
|
1,332,375
|
|
Net
change in unearned premiums
|
|
|
(2,102
|
)
|
|
11,509
|
|
|
(18,824
|
)
|
Net
premiums earned
|
|
$
|
1,307,585
|
|
$
|
1,352,928
|
|
$
|
1,313,551
|
|
Direct
premiums written decreased 2.3% in 2006, while increasing 0.7% in 2005 and
9.3%
in 2004; less than our long-term goal of 15%. Market conditions in California
were somewhat less favorable for growth in 2006 than in the preceding two years.
Since 2004, we have met our profitability goals, posting our best combined
ratios since 1999 and our direct premiums written grew 9.3% in 2004 despite
an
increasingly competitive California marketing climate. As discussed in the
Highlights,
the CDI
issued changes to regulations relating to automobile insurance rating factors,
particularly concerning territorial rating in July 2006. It is not possible
at
this time to predict the impact of these changes, which could have either a
favorable or adverse impact on the Company. Also in July 2006, the CDI proposed
new amended rate approval regulations, subsequently amended in October of 2006
and approved in January of 2007 with an effective date of April 3, 2007. The
regulations could have a materially adverse impact on the Company’s California
results. See further discussion of both regulations in Item
1A. Risk Factors.
As
the
Company proceeds with its national expansion, we believe that achieving our
long-term growth goal will steadily depend less on the California marketplace.
The Company’s national expansion efforts will provide us with flexibility to use
combinations of local and national marketing media, as appropriate, and the
ability to focus our marketing expenditures and Company resources on attractive
markets, while minimizing costs in less attractive markets.
The
declines in the loss and LAE ratios for the years ended December 31, 2006,
2005,
and 2004, of 3.3 points, 1.7 points, and 3.1 points, respectively, are primarily
due to the effect of favorable development related to prior accident years
and
lower accident frequency. The effects on the net loss and LAE ratios of changes
in estimates relating to insured events of prior years were as follows: 4.0
points ($52.6 million) of favorable reserve development in 2006, 2.0 points
($27.5 million) of favorable reserve development in 2005, and 0.2 points ($2.9
million) of favorable reserve development in 2004. 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
underwriting expense ratios to net premiums earned increased for the years
ended
December 31, 2006, 2005 and 2004. The 2006 increase was primarily due to our
investments in the Company’s national
expansion efforts and the 2006 recognition of stock-based compensation,
partially offset by an increase in deferred policy acquisition costs.
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.
Homeowner
and Earthquake Lines in Runoff Results
We
have
not written any earthquake policies since 1994 and exited the voluntary
homeowner insurance business in 2002. Underwriting results of the homeowner
and
earthquake lines, which are in runoff, include losses and LAE incurred of $0.8
million, $2.3 million, and $2.8 million in 2006, 2005, and 2004, of which the
earthquake lines accounted for $0.1 million, $0.4 million, and $2.2 million,
respectively.
Net
Investment Income
We
utilize a conservative investment philosophy. Substantially the entire fixed
maturity securities portfolio is investment grade, having a weighted-average
Standard & Poor’s credit quality of “AA”. No derivatives are held in our
investment portfolio and there were no publicly traded equity securities at
December 31, 2006. We previously held publicly traded equities, but sold them
in
the first quarter of 2006, lowering the risk and yield of the overall investment
portfolio. The components of net investment income were as follows:
|
|
Net
Investment Income
|
AMOUNTS
IN THOUSANDS
|
|
2006
|
2005
|
2004
|
Interest
on fixed maturity securities
|
|
$
|
67,449
|
|
$
|
63,122
|
|
$
|
57,729
|
|
Interest
on cash and cash equivalents
|
|
|
1,272
|
|
|
1,188
|
|
|
585
|
|
Interest
on other long-term investments
|
|
|
63
|
|
|
—
|
|
|
—
|
|
Dividends
on equity securities
|
|
|
811
|
|
|
5,848
|
|
|
1,484
|
|
Total
investment income
|
|
|
69,595
|
|
|
70,159
|
|
|
59,798
|
|
Investment
expense
|
|
|
(1,102
|
)
|
|
(1,063
|
)
|
|
(967
|
)
|
Net
investment income
|
|
$
|
68,493
|
|
$
|
69,096
|
|
$
|
58,831
|
|
The
fixed
maturity securities portfolio comprised 99%, 97%, and 97% of the total
investment portfolio at December 31, 2006, 2005, and 2004, respectively. The
average annual yields on fixed maturity securities were as follows:
|
|
Average
Annual Yields on Fixed Maturity Securities
|
|
Years
Ended December 31,
|
|
2006
|
|
2005
|
|
2004
|
|
Pre-tax
- fixed maturity securities
|
|
|
4.6%
|
|
|
4.6%
|
|
|
4.4%
|
|
After-tax
- fixed maturity securities
|
|
|
3.3%
|
|
|
3.3%
|
|
|
3.2%
|
|
At
December 31, 2006, $379.4 million, or 26.4%, of our total fixed maturity
securities at fair value were invested in tax-exempt bonds, compared to 23.1%
at
December 31, 2005, with the remainder, representing 73.6% of the portfolio,
invested in taxable securities, compared to 76.9% at December 31, 2005. At
December 31, 2006, no investments were rated below investment
grade.
The
net
realized (losses) gains on investments were as follows:
AMOUNTS
IN THOUSANDS
|
|
Net
Realized Gains (Losses) on Investments
|
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Gross
realized gains
|
|
$
|
1,953
|
|
$
|
6,574
|
|
$
|
14,145
|
|
Gross
realized losses
|
|
|
(2,603
|
)
|
|
(9,482
|
)
|
|
(2,465
|
)
|
Net
realized (losses) gains
|
|
$
|
(650
|
)
|
$
|
(2,908
|
)
|
$
|
11,680
|
|
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 2006, 2005, or 2004 (see discussion under
Critical
Accounting Estimates - Investments).
Other
Income and Expense
Other
income of $0.6 million and $0.4 million in 2006 and 2005, respectively, consists
of interest income relating to claims with taxing authorities. Other expense
of
$1.8 million in 2006 consists of the following: a $0.9 million impairment
charge for vacated space in our headquarters in Woodland Hills, California,
and
a $0.9 million write-off of software projects due to impairment. Other expense
of $0.4 million in 2005 also relates to an impairment charge for vacated
space in our headquarters. No other income or expense was reported in 2004.
FINANCIAL
CONDITION
Investments
and cash were $1.5 billion at December 31, 2006 and December 31, 2005. The
Company sold its investments in equity securities during the first quarter
of
2006, with the proceeds primarily reinvested in fixed maturity securities.
The
Company did not hold any publicly traded equity securities at December 31,
2006.
However, we executed a $35 million funding commitment for a private equity
investment program during the second quarter of 2006, as described in Note
3 of
the Notes
to Consolidated Financial Statements.
The
Company funded $14.4 million of the commitment in 2006.
At
December 31, 2006, 26.2% of our total investments were in tax-exempt,
fixed-income securities, compared to 22.3% at December 31, 2005. At December
31,
2006, investment-grade securities comprised substantially all of the fair value
of our investment portfolio. As of December 31, 2006, no investments were rated
below investment grade.
The
Company also has unrated, community investments representing 1.4% of total
investments. These investments have been made in an effort to provide housing
and other services to economically disadvantaged communities. See Note 18
of
the
Notes
to Consolidated Financial Statements
for
additional information.
Increased
advertising, sales and customer service costs through December 31, 2006
contributed to a $3.7 million increase in deferred policy acquisitions costs
(“DPAC”) to $63.6 million, compared to $59.9 million at December 31, 2005. 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 LAE, gross and net of applicable
reinsurance, with respect to our lines of business:
AMOUNTS
IN THOUSANDS
|
|
2006
|
|
2005
|
Years
Ended December 31,
|
|
Gross
|
Net
|
|
Gross
|
Net
|
Unpaid
losses and LAE:
|
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
$
|
480,731
|
|
$
|
475,261
|
|
|
$
|
521,528
|
|
$
|
516,849
|
|
Homeowner
and earthquake lines in runoff
|
|
|
1,538
|
|
|
808
|
|
|
|
2,307
|
|
|
1,369
|
|
Total
|
|
$
|
482,269
|
|
$
|
476,069
|
|
|
$
|
523,835
|
|
$
|
518,218
|
|
The
following analysis provides a reconciliation of the activity in the reserve
for
unpaid losses and LAE:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
At
beginning of year:
|
|
|
|
|
|
|
|
Reserve
for losses and LAE, gross of reinsurance
|
|
$
|
523,835
|
|
$
|
495,542
|
|
$
|
438,323
|
|
Reinsurance
recoverable
|
|
|
(5,617
|
)
|
|
(4,645
|
)
|
|
(8,964
|
)
|
Reserve
for losses and LAE, net of reinsurance
|
|
|
518,218
|
|
|
490,897
|
|
|
429,359
|
|
Losses
and LAE incurred, net of reinsurance:
|
|
|
|
|
|
|
|
|
|
|
Current
year
|
|
|
972,743
|
|
|
1,024,073
|
|
|
993,946
|
|
Prior
years
|
|
|
(51,897
|
)
|
|
(25,140
|
)
|
|
(105
|
)
|
Total
|
|
|
920,846
|
|
|
998,933
|
|
|
993,841
|
|
Losses
and LAE paid, net of reinsurance:
|
|
|
|
|
|
|
|
|
|
|
Current
year
|
|
|
662,036
|
|
|
684,474
|
|
|
642,664
|
|
Prior
years
|
|
|
300,959
|
|
|
287,138
|
|
|
289,639
|
|
Total
|
|
|
962,995
|
|
|
971,612
|
|
|
932,303
|
|
At
end of year:
|
|
|
|
|
|
|
|
|
|
|
Reserve
for losses and LAE, net of reinsurance
|
|
|
476,069
|
|
|
518,218
|
|
|
490,897
|
|
Reinsurance
recoverable
|
|
|
6,200
|
|
|
5,617
|
|
|
4,645
|
|
Reserve
for losses and LAE, gross of reinsurance
|
|
$
|
482,269
|
|
$
|
523,835
|
|
$
|
495,542
|
|
At
December 31, 2006, gross unpaid losses and LAE decreased $41.6 million,
primarily due to a reserve decrease of $40.8 million in the personal auto lines
as a result of $52.6 million of favorable loss development related to prior
accident years recorded during the year ended December 31, 2006 and a decline
in
the number of insured vehicles. The gross unpaid losses and LAE in the homeowner
and earthquake lines decreased $0.8 million as the result of continued runoff
activity (see
Critical
Accounting Estimates - Losses and Loss Adjustment Expenses for
a
description of the Company’s reserving process).
Debt
of
$115.9 million at December 31, 2006, compared to $128.0 million at December
31,
2005, consists of $16.0 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
decrease in debt of $12.1 million during the year ended December 31, 2006 is
primarily attributable to principal payments on the capital leases.
Stockholders’
equity and book value per share increased to $898.5 million and $10.39,
respectively, at December 31, 2006, compared to $830.0 million and $9.66 at
December 31, 2005. The increase for the year ended December 31, 2006, was
primarily due to net income of $97.2 million, stock-based compensation cost
of
$10.4 million, and $5.7 million of proceeds from exercised stock options. This
was partially offset by dividends to stockholders of $27.6 million, a decrease
of $14.2 million due to the adoption of Statement of Financial Accounting
Standards No. 158, as disclosed in Recent
Accounting Pronouncements,
and an
increase in net unrealized losses on available-for-sale investments of $3.5
million.
LIQUIDITY
AND CAPITAL RESOURCES
Holding
Company
Our
holding company’s main sources of liquidity historically have been dividends
received from our insurance subsidiaries, borrowing from our primary insurance
subsidiary, 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 16 million
shares of common stock for cash of $145.6 million. Our insurance subsidiaries
did not pay any dividends to our holding company from 2001 to 2004 due to the
previous uncertainty surrounding the taxability of dividends received by holding
companies from their insurance subsidiaries in California, which was resolved
in
2004. Our primary insurance subsidiary, 21st Century Insurance Company, declared
and paid a $110.0 million dividend in December 2006.
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. The term loan line had a zero balance at December 31, 2006. See further
information in the Notes
to Condensed Financial Information of Registrant.
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
$0.8 million, started in January 2004 and has been subject to upward adjustments
based on the cost incurred by the holding company to enhance the software.
Our
holding company’s significant cash obligations over the next several years
consist of the following:
|
·
|
Ongoing
costs to enhance our computer
software;
|
|
·
|
Implementing
the Company’s geographic growth
strategy;
|
|
·
|
The
repayment of the $100 million principal on the Senior Notes due in
2013;
|
|
·
|
Related
interest on the Senior Notes above;
and
|
|
·
|
Any
dividends to stockholders that our directors may
declare.
|
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 $42.1 million
at December 31, 2006, dividends received from our insurance subsidiaries,
payments received from the intercompany lease, and borrowing from our primary
insurance subsidiary), or additional funds obtainable from the capital markets.
The effective California state income tax rate applicable to dividends received
from our insurance subsidiaries is approximately 1.8%, or 1.2% net of federal
benefit. Our primary insurance subsidiary could pay up to approximately $124.0
million in 2007 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 since 2001
and have thereby enhanced our liquidity. Our cash flows 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. Our underwriting
results are impacted by rate changes. Although in the past years we have been
successful in gaining California regulatory approval for rate changes, there
can
be no assurance that insurance regulators will grant future rate changes that
may be necessary to offset possible future increases in claims cost trends.
As
discussed in the Highlights,
in July
2006, the CDI issued changes to regulations relating to automobile insurance
rating factors, particularly concerning territorial rating. It is not possible
at this time to predict the ultimate timing or impact of these changes, which
could have either a materially favorable or materially adverse impact on the
Company. Also in July 2006, the CDI proposed new amended rate approval
regulations, subsequently amended in October of 2006, could have a materially
adverse impact on the Company’s California results. The regulations become
effective April 3, 2007. If the newly elected insurance commissioner does not
modify, suspend or withdraw the regulations before they become effective, an
industry lawsuit could be brought to challenge the regulations as contrary
to
current law. Also, the Company could consider bringing its own legal action,
once the regulations are applied to it. See further discussion of both
regulations in Item
1A. Risk Factors.
Also,
in
the event of adverse claims results, we could be forced 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.
The
NAIC
employs a risk-based capital formula for property and casualty insurance
companies that establishes recommended minimum capital requirements. The formula
was designed to capture the widely varying elements of risks undertaken by
writers of different lines of insurance having differing risk characteristics,
as well as writers of similar lines where differences in risk may be related
to
corporate structure, investment policies, reinsurance arrangements and a number
of other factors. Based on the formula adopted by the NAIC, the Company has
calculated a combined Company Action Level risk-based capital requirement of
$172.9 million for its insurance subsidiaries as of December 31, 2006. Each
of the insurance companies’ statutory surplus exceeded their respective level of
minimum required capital.
As
of
December 31, 2006, our insurance subsidiaries had a combined statutory surplus
of $771.0 million compared to $704.7 million at December 31, 2005. The increase
in statutory surplus was primarily due to statutory net income of $124.5 million
and
a
decrease in nonadmitted assets of $64.2 million, partially offset by
dividends
to the Parent of
$110.0
million
and a
$15.6 million decrease in the deferred income tax asset.
The
following table reconciles stockholders’ equity to statutory
surplus.
December
31,
|
|
2006
|
2005
|
Stockholders’
equity - GAAP
|
|
$
|
898,549
|
|
$
|
829,972
|
|
Condensed
adjustments to reconcile GAAP shareholders’ equity to statutory
surplus:
|
|
|
|
|
|
|
|
Net
book value of fixed assets under capital leases
|
|
|
(20,373
|
)
|
|
(24,185
|
)
|
Deferred
gain under capital lease transactions
|
|
|
(79
|
)
|
|
(914
|
)
|
Capital
lease obligation
|
|
|
15,985
|
|
|
28,074
|
|
Nonadmitted
portion of net deferred tax assets
|
|
|
(17,419
|
)
|
|
(34,936
|
)
|
Difference
in net deferred tax assets reported under Statutory Accounting
Principles
|
|
|
24,200
|
|
|
38,544
|
|
Intercompany
receivables
|
|
|
(11,488
|
)
|
|
(57,683
|
)
|
Fixed
assets
|
|
|
(22,955
|
)
|
|
(22,492
|
)
|
Equity
in non-insurance entities
|
|
|
(47,006
|
)
|
|
26,798
|
|
Net
unrealized losses on investments
|
|
|
17,881
|
|
|
10,788
|
|
Deferred
policy acquisition costs
|
|
|
(63,581
|
)
|
|
(59,939
|
)
|
Pension
related liabilities (assets)
|
|
|
15,648
|
|
|
(14,126
|
)
|
Other
prepaid expenses
|
|
|
(14,195
|
)
|
|
(11,049
|
)
|
Other,
net
|
|
|
(4,158
|
)
|
|
(4,181
|
)
|
Statutory
surplus
|
|
$
|
771,009
|
|
$
|
704,671
|
|
The
net
premiums written to statutory surplus ratio, which shows a company’s premium
growth capacity and is required to be below 3.0 by the insurance regulators,
was
1.7 at December 31, 2006, compared to 1.9 at December 31, 2005.
Cash
Flows
Our
net
increase (decrease) in cash and cash equivalents were as follows:
AMOUNTS
IN THOUSANDS
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
|
‘06
vs.‘05
Increase/(Decrease)
|
‘05
vs.‘04
Increase/(Decrease)
|
Net
cash and cash equivalents provided by operating activities
|
|
$
|
116,270
|
|
$
|
160,261
|
|
$
|
203,356
|
|
|
$
|
(43,991
|
)
|
$
|
(43,095
|
)
|
Net
cash and cash equivalents used in investing activities
|
|
|
(97,395
|
)
|
|
(104,612
|
)
|
|
(214,290
|
)
|
|
$
|
7,217
|
|
$
|
109,678
|
|
Net
cash and cash equivalents used in financing activities
|
|
|
(35,544
|
)
|
|
(21,678
|
)
|
|
(19,379
|
)
|
|
$
|
(13,866
|
)
|
$
|
(2,299
|
)
|
Net
(decrease) increase in cash and cash equivalents
|
|
$
|
(16,669
|
)
|
$
|
33,971
|
|
$
|
(30,313
|
)
|
|
$
|
(50,640
|
)
|
$
|
64,284
|
|
Operating
Activities
Net
cash
and cash equivalents provided by operating activities decreased primarily due
to
a decline in direct premiums collected resulting from the decline in premiums
written and an increase in taxes paid as a result of the utilization of the
carryforward of net operating losses during 2006. This was partially offset
by
decreases in loss and LAE payments. Also, while underwriting expenses and policy
acquisition costs increased over the prior year, cash outflows for those
expenses decreased slightly due to the increase in unpaid other liabilities
of
$14.0 million which deferred payment of expenditures incurred in connection
with
our national expansion efforts.
Investing
Activities
Our
cash
and cash equivalents used in investing activities is primarily impacted by
the
sales, maturities and purchases of our available-for-sale investment securities.
Our investment objective is to maintain a low level of risk and to preserve
principal by investing in high quality, investment grade securities while
maintaining liquidity in each portfolio sufficient to meet our cash flow
requirements.
Net
cash
and cash equivalents used in investing activities increased due to a $1.4
million decrease in net acquisitions (purchases, net of maturities, calls and
sales) of investments primarily as a result of the redeployment of cash
equivalents and a $5.8 million decrease in purchases of property and
equipment.
Financing
Activities
Net
cash
and cash equivalents used in financing activities decreased due to the doubling
of the quarterly dividend since the prior year from $0.04 per share to $0.08
per
share, resulting in a $13.9 million increase in dividends paid, and a $1.2
million increase in debt payments, partially offset by a $1.0 million increase
in cash receipts provided by stock option exercises.
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, 2006 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
|
2007
|
2008
through 2009
|
2010
through 2011
|
Remaining
years after 2011
|
Senior
notes
|
|
$
|
141.3
|
|
$
|
5.9
|
|
$
|
11.8
|
|
$
|
11.8
|
|
$
|
111.8
|
|
Capital
lease obligations
|
|
|
16.7
|
|
|
14.9
|
|
|
1.3
|
|
|
0.5
|
|
|
—
|
|
Debt
|
|
|
158.0
|
|
|
20.8
|
|
|
13.1
|
|
|
12.3
|
|
|
111.8
|
|
Operating
leases 2
|
|
|
154.2
|
|
|
26.1
|
|
|
41.3
|
|
|
35.8
|
|
|
51.0
|
|
Other
long-term commitments
|
|
|
2.2
|
|
|
0.7
|
|
|
0.8
|
|
|
0.5
|
|
|
0.2
|
|
Future
pension benefit payments 3
|
|
|
72.1
|
|
|
3.3
|
|
|
8.0
|
|
|
11.1
|
|
|
49.7
|
|
Expected
loss and LAE payments, net of reinsurance
|
|
|
476.0
|
|
|
322.2
|
|
|
140.0
|
|
|
11.6
|
|
|
2.2
|
|
Total4
|
|
$
|
862.5
|
|
$
|
373.1
|
|
$
|
203.2
|
|
$
|
71.3
|
|
$
|
214.9
|
|
The
table
above excludes periodic contributions to pension plans, which are discussed
below, and commitments for investment purchases discussed in Transactions
with Related Parties.
The
capital lease obligations above resulted from a sale-leaseback transaction
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, 2006 (see discussion about variable
interest entities in Note 18 of the Notes
to Consolidated Financial Statements).
Our
primary 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 $0.9
million, $10.0 million and $2.7 million in 2006, 2005, and 2004, 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 2007.
It
is
management’s belief that the total net loss and LAE reserve amount of $476.0
million at December 31, 2006 is adequate to cover unpaid losses and LAE as
of
December 31, 2006. The amount and timing of the reserve payments may be 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
variability of the ultimate settlement amount is likely to increase as the
time
between the occurrence and settlement of the claim is increased.
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.
Our
Board
of Directors 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 $42.2 million, of a warehouse
financing agreement. The Company has also committed $20.1 million for other
community investment purposes. These commitments, which do not significantly
impact the Company’s liquidity or capital, are further discussed in Note 18 of
the Notes
to Consolidated Financial Statements.
__________________
2 |
Includes
amounts due under long-term software license agreements of approximately
$23.8 million.
|
3 |
Includes
benefit payments through 2015.
|
4 |
Purchase
commitments of $0.2 million were excluded from the summary, as they
are
not material.
|
TRANSACTIONS
WITH RELATED PARTIES
Several
subsidiaries of AIG together own approximately 62% of our outstanding common
stock and four of the eleven members of our Board of Directors, including our
Chairman, are current or former officers and employees of AIG or its
subsidiaries. Since 1995, the Company has entered into transactions with AIG
subsidiaries, including reinsurance agreements, corporate insurance coverage,
and investment management and investment accounting.
Reinsurance
Agreements
The
Company has a catastrophe reinsurance agreement for the comprehensive portion
of
its auto physical damage lines that 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. This coverage was renewed effective
January 1, 2006 and 2007 (see Note 10 of the Notes
to Consolidated Financial Statements).
Total
premiums ceded to AIG subsidiaries were $1.0 million, $1.0 million, and $1.1
million for the years ended December 31, 2006, 2005, and 2004, respectively.
Total reinsurance recoverables, net of payables, from AIG subsidiaries were
$0.4
million and $0.6 million at December 31, 2006 and 2005,
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.
Total
expense attributable to AIG corporate insurance coverages was $3.7 million,
$2.9
million, and $3.5 million for the years ended December 31,2006, 2005, and 2004,
respectively.
Investment
management and investment accounting
In
October 2003, as a result of a competitive bidding process, we entered into
an
agreement with AIG Global Investment Corp. (“AIGGIC”) to provide investment
management and investment accounting services. 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 $1.1 million, $0.9 million,
and
$0.9 million for the years ended December 31, 2006, 2005 and 2004,
respectively.
In
June
2006, the Company executed a $35 million funding commitment for a private equity
investment program, which is managed by AIGGIC. In the event that we do not
respond to a capital call during the investment term, the General Partner of
the
fund (“GP”) may apply the following default provisions: withhold 50% of
distributions due to us at the time of the default and 50% of future
distributions due to the Company; hold the Company liable for fund expenses
above and beyond investments made by us (with the right of offset); terminate
our Limited Partner status and not allow it any further investments; or charge
interest on the defaulted capital commitment amount and fees at LIBOR + 4%
(with
the right of offset). However, the GP may choose not to designate the Company
a
“defaulting limited partner” and waive the default provisions. The investment
term ends after the underlying investments are liquidated, but in no event
is
longer than 10 years. Multiple investments are expected to be purchased and
liquidated over the investment term. The Company funded $14.4 million of the
commitment in 2006.
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. There was no expense
in
either 2005 or 2006.
CRITICAL
ACCOUNTING ESTIMATES
The
preparation of financial statements in accordance with GAAP requires management
to make estimates and assumptions that affect reported amounts and related
disclosures. 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. Management considers an accounting estimate
to be critical if:
|
·
|
It
requires assumptions to be made that were uncertain at the time the
estimate was made; and
|
|
·
|
Change
in the estimate or different estimates that could have been selected
could
have a material impact on the Company’s consolidated results of operations
or financial condition.
|
The
following is a summary of the more critical accounting estimates. 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 the development and selection of our critical accounting estimate
with the Audit Committee of our Board of Directors.
Losses
and Loss Adjustment Expenses
The
estimated liabilities for losses and LAE include estimates of the ultimate
resolution for known claims reported on or prior to the balance sheet dates,
estimates of losses for claims incurred but not reported, and estimates of
expenses for investigating, adjusting and settling all incurred claims. Amounts
reported are estimates of the ultimate costs of settlement, net of estimated
salvage and subrogation. The estimated liabilities are necessarily subject
to
the outcome of future events, such as changes in medical and repair costs,
as
well as economic and social conditions that impact the settlement of claims.
In
addition, time can be a critical part of reserving determinations since the
variability of the ultimate settlement amount is likely to increase as the
time
between the occurrence and settlement of the claim increased.
The
methods used to determine such estimates and to establish the resulting reserves
are continually monitored, 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 at December 31, 2006. 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
recorded at December 31, 2006. 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.
Because
these are unknown future events, there is uncertainty in the Company’s estimates
of ultimate losses and LAE. This uncertainty comes from various factors, both
positive and negative, that may include changes in claims reporting and
settlement patterns, changes in regulatory and legal environment, and inflation
rates. The Company does not make a specific provision for these uncertainties;
however, they are considered in establishing the reserves by analyzing
historical patterns and trends.
The
process of estimating unpaid losses and LAE begins with the 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. Based on this review,
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 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 several commonly accepted actuarial methods
utilizing paid and incurred loss histories, claim frequency and severity, and
expected loss ratios.
The
incurred loss development method analyzes historical case incurred loss (paid
loss plus case reserves) development to estimate ultimate losses. The Company
applies loss development factors against case incurred losses by accident period
to calculate ultimate losses. The paid loss development method is similar to
the
incurred loss development method except only paid losses are used.
The
claim
count development method analyzes historical claim count development to estimate
ultimate claim counts. The Company applies these development factors against
claim counts by accident period to calculate ultimate claim counts. Severity
is
the amount of loss per claim. The average severity method analyzes historical
severity development to calculate an ultimate average cost per claim. From
this,
the ultimate severity can be estimated. The claim count development method
coupled with the average severity method also provides useful information
regarding frequency and inflationary trends that the Company believes is useful
in setting reserves.
In
states
with little operating history the Company’s experience is supplemented with
industry statistics.
The
Company uses similar methods for LAE. The Company estimates the loss IBNR
reserves as the difference between its projection of ultimate losses and the
sum
of the payments and case reserves for losses.
Quantitative
techniques frequently have to be supplemented by subjective consideration,
including managerial judgment, to assure management satisfaction that the
overall unpaid losses and LAE are adequate to meet projected losses. For
example, in property damage coverages, repair cost trends by geographic region
vary significantly. These factors are periodically reviewed and subsequently
adjusted, as appropriate, to reflect emerging trends that are based upon past
loss experience. Thus, many factors are implicitly considered in estimating
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 months would require more judgment. We do not believe disclosure of
specific indicated point estimates as calculated by the various methods 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.
Volatility
of Reserve Estimates and Sensitivity Analysis
The
Company uses numerous assumptions in determining its best estimates of reserves
for losses and LAE for each coverage of the personal auto business. If actual
experience differs from key assumptions used in establishing reserves, there
is
potential for significant variation in the development of loss and LAE reserves.
Set forth below is a sensitivity analysis that estimates the effect on the
loss
and LAE reserve position of using alternative loss cost trend or loss
development factor assumptions rather than those actually used in determining
the best estimates in the year-end loss and LAE reserve analyses for 2006.
The
analysis addresses the personal auto business in California for which a material
deviation to the Company’s overall reserve position is believed reasonably
possible, and uses what the Company believes is a reasonably likely range of
potential deviation. There can be no assurance, however, that actual reserve
development will be consistent with either the original or the adjusted loss
cost trend or loss development assumptions, or that other assumptions made
in
the reserving process will not materially affect reserve development for a
particular coverage.
After
evaluating the historical loss cost trends from prior years since 1994, in
Management’s judgment, it is reasonably likely that actual loss cost trends
applicable to the year-end 2006 loss and LAE reserve analysis will range from
negative 13% to positive six percent, or approximately 12% lower and seven
percent higher than the assumptions utilized in the year-end 2006 reserve
analysis. These changes in the assumed loss cost trend would cause approximately
an $84 million decrease or a $47 million increase in the loss and LAE reserves.
It should be emphasized that these deviations are not considered the highest
possible deviations that might be expected, but rather what is considered by
the
Company to reflect a reasonably likely range of potential deviation.
The
assumed loss development factors are also a key assumption. After evaluating
the
historical loss development factors from prior accident years since 1999, in
Management’s judgment, it is reasonably likely that actual loss development
factors will range from approximately 1.6 percent lower than those actually
utilized in the year-end 2006 loss and LAE reserve analysis to approximately
0.8
percent higher than those actually utilized. If the loss development factor
assumptions were reduced by 1.6 percent and increased by 0.8 percent, the loss
and LAE reserves would decrease by approximately $86 million under the lower
assumptions or increase by approximately $42 million under the higher
assumptions. Generally, historical loss development factors are used to project
future loss development. However there can be no assurance that future loss
development patterns will be the same as in the past, or that they will not
deviate by more than the amounts illustrated above. Thus, there is the potential
for the reserves with respect to a number of accident years to be significantly
affected by changes in the loss cost trends or loss development factors that
were initially relied upon in setting the reserves. These changes in loss cost
trends or loss development factors could be attributable to changes in inflation
or in the judicial environment, or in other social or economic conditions
affecting claims. Thus, there is the potential for variations greater than
the
amounts cited above, either negatively or positively.
The
primary responsibility of an insurance company is paying claims of its
policyholders in a fair and timely manner. Having adequate loss reserves, with
special consideration for the upside potential of claims not yet paid is central
to this responsibility. The company experienced significant losses from the
1995
Northridge earthquake and the subsequent reopening of claims resulting from
SB
1899. The costs related to both the original event and SB 1899 illustrate the
uncertainty that can result from estimating loss reserves. The number and
severity of claims far exceeded initial estimates of losses. The two Northridge
events point to the importance of the adequacy of loss reserves and the inherent
estimating uncertainties of the loss reserving process.
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 other-than-temporary impairment based
upon 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 the debtor defaulting
or seeking bankruptcy or insolvency protection or voluntary
reorganization, and
|
|
·
|
The
probability of non-realization of a full recovery on our 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 we have 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 fair value is “other-than-temporary” is
necessarily a matter of subjective judgment. The Company’s intent is to hold all
of its fixed securities with unrealized losses for a period of time sufficient
to allow a market recovery or to maturity as long as these securities continue
to be consistent with our investment strategy. If our strategy were to change
and these securities were impaired, we would recognize a write down in
accordance with our stated policy. Additionally, it is possible that future
information will become available about our current investments that would
require accounting for them as realized losses due to other-than-temporary
declines in value. No such charges were recorded in 2006, 2005 or 2004. The
timing and amount of realized losses and gains reported in income could vary
if
conclusions other than those made by management were to determine whether an
other-than-temporary impairment exists. However, there would be no impact on
equity at the end of the periods presented because any unrealized losses would
have been already included in accumulated other comprehensive loss.
Substantially
the entire fixed maturity securities portfolio is investment grade. The
following is a summary of the Standard & Poor’s credit rating for the fixed
maturity securities portfolio (the weighted average is “AA”):
|
|
2006
|
2005
|
AMOUNTS
IN THOUSANDS
|
|
#
issues
|
Fair
Value
|
#
issues
|
Fair
Value
|
AAA
|
|
|
322
|
|
$
|
728,033
|
|
|
286
|
|
$
|
604,812
|
|
AA
|
|
|
106
|
|
|
165,216
|
|
|
116
|
|
|
169,708
|
|
A
|
|
|
109
|
|
|
423,429
|
|
|
118
|
|
|
486,338
|
|
BBB
|
|
|
42
|
|
|
113,162
|
|
|
44
|
|
|
88,918
|
|
BB
|
|
|
—
|
|
|
—
|
|
|
3
|
|
|
2,495
|
|
Unrated
|
|
|
4
|
|
|
5,176
|
|
|
2
|
|
|
2,436
|
|
Total
fixed maturity securities
|
|
|
583
|
|
$
|
1,435,016
|
|
|
569
|
|
$
|
1,354,707
|
|
The
following is a summary by issuer of non-investment grade securities and unrated
securities held:
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
December
31,
|
|
2006
|
2005
|
Non-investment
grade investments (fair value):
|
|
|
|
|
|
Ford
Motor Credit Company 5
|
|
$
|
—
|
|
$
|
2,495
|
|
AmerUs
Group Co. 6
|
|
|
—
|
|
|
864
|
|
Total
non-investment grade investments
|
|
|
—
|
|
|
3,359
|
|
Unrated
fixed maturity securities (fair value):
|
|
|
|
|
|
|
|
Impact
Community Capital, LLC 7
|
|
|
1,999
|
|
|
2,023
|
|
Impact
Healthcare, LLC 7
|
|
|
510
|
|
|
413
|
|
Impact
Childcare, LLC 7
|
|
|
810
|
|
|
—
|
|
Impact
Commercial Opportunities, LLC 7
|
|
|
1,857
|
|
|
—
|
|
Total
unrated fixed maturity securities
|
|
|
5,176
|
|
|
2,436
|
|
Unrated
other long-term investments (equity method):
|
|
|
|
|
|
|
|
Impact
Workforce, LLC 7
|
|
|
320
|
|
|
—
|
|
AIG
PEP 8
|
|
|
14,385
|
|
|
—
|
|
Total
unrated other long-term investments
|
|
|
14,705
|
|
|
—
|
|
Total
non-investment grade and unrated investments
|
|
$
|
19,881
|
|
$
|
5,795
|
|
|
|
|
|
|
|
|
|
Percentage
of total investments, at fair value
|
|
|
1.4
|
%
|
|
0.4
|
%
|
Percentage
of total unrealized losses
|
|
|
0.0
|
%
|
|
0.0
|
%
|
___________________
5 |
The
Ford Motor Credit Company security matured in the first quarter of
2006
and the Company received all amounts due, thereby incurring no
loss.
|
6 |
The
AmerUs Group Co. was a preferred stock holding that had an unrealized
gain
as of December 31, 2005.
|
7 |
Impact
Community Capital 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. See further discussion in Note 18 of the Notes
to the Consolidated Financial Statements.
|
8 |
AIG
PEP is a private equity investment program managed by AIGGIC.
See further discussion in Note 3 of the Notes
to the Consolidated Financial Statements.
|
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,
|
|
2006
|
2005
|
2004
|
Realized
losses on sales of investments:
|
|
|
|
|
|
|
|
Held
for less than one year
|
|
$
|
(911
|
)
|
$
|
(8,371
|
)
|
$
|
(1,062
|
)
|
Held
one year or more
|
|
|
|
|
|
|
|
|
|
|
In
an unrealized loss position at December 31, 2005
|
|
|
(1,654
|
)
|
|
―
|
|
|
―
|
|
In
an unrealized loss position at December 31, 2004
|
|
|
(13
|
)
|
|
(13
|
)
|
|
―
|
|
In
an unrealized loss position at December 31, 2003
|
|
|
(25
|
)
|
|
―
|
|
|
(1,251
|
)
|
In
an unrealized loss position at December 31, 2002
|
|
|
—
|
|
|
(646
|
)
|
|
(19
|
)
|
In
an unrealized gain position at December 31, 2005
|
|
|
―
|
|
|
―
|
|
|
―
|
|
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
|
)
|
|
―
|
|
Total
realized losses on sales of investments held one year or more
9
|
|
|
(1,692
|
)
|
|
(1,111
|
)
|
|
(1,403
|
)
|
Total
realized losses on sales of investments
|
|
|
(2,603
|
)
|
|
(9,482
|
)
|
|
(2,465
|
)
|
Total
realized gains on sales of investments
|
|
|
1,953
|
|
|
6,574
|
|
|
14,145
|
|
Realized
loss on disposal of property and equipment
|
|
|
(779
|
)
|
|
(364
|
)
|
|
(849
|
)
|
Total
realized investment (losses) gains
|
|
$
|
(1,429
|
)
|
$
|
(3,272
|
)
|
$
|
10,831
|
|
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,
|
|
2006
|
2005
|
2004
|
Fair
value of investments sold at a loss on date of sale
|
|
$
|
81,981
|
|
$
|
173,403
|
|
$
|
142,222
|
|
Fair
value of investments sold at a gain on date of sale
|
|
|
99,041
|
|
|
176,301
|
|
|
585,252
|
|
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:
|
|
2006
|
|
2005
|
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
|
|
|
2
|
|
$
|
12,075
|
|
$
|
216
|
|
|
|
16
|
|
$
|
141,034
|
|
$
|
3,074
|
|
6-12
months
|
|
|
1
|
|
|
9,625
|
|
|
375
|
|
|
|
16
|
|
|
129,044
|
|
|
4,072
|
|
More
than 1 year
|
|
|
88
|
|
|
698,674
|
|
|
25,919
|
|
|
|
56
|
|
|
433,368
|
|
|
16,896
|
|
Less
than $0.1 million
|
|
|
142
|
|
|
304,838
|
|
|
4,764
|
|
|
|
113
|
|
|
204,724
|
|
|
4,347
|
|
Total
fixed maturity securities with unrealized losses
|
|
|
233
|
|
|
1,025,212
|
|
|
31,274
|
|
|
|
201
|
|
|
908,170
|
|
|
28,389
|
|
Equity
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding
$0.1 million
|
|
|
―
|
|
|
―
|
|
|
―
|
|
|
|
2
|
|
|
578
|
|
|
305
|
|
Less
than $0.1 million
|
|
|
―
|
|
|
―
|
|
|
―
|
|
|
|
245
|
|
|
35,672
|
|
|
1,873
|
|
Total
equity securities with unrealized losses
|
|
|
―
|
|
|
―
|
|
|
―
|
|
|
|
247
|
|
|
36,250
|
|
|
2,178
|
|
Total
investments with unrealized losses10
|
|
|
233
|
|
$
|
1,025,212
|
|
$
|
31,274
|
|
|
|
448
|
|
$
|
944,420
|
|
$
|
30,567
|
|
___________________
9 |
Amount
represents 0.1%, less than 0.1%, and 0.1% of total fair value of
investments in 2006, 2005, and 2004,
respectively.
|
10 |
Unrealized
losses represent less than 3.0% and 3.2% of the total carrying
value of
investments in 2006 and 2005,
respectively.
|
A
summary
by contractual maturity of fixed maturity securities in an unrealized loss
position by year of maturity follows:
|
|
2006
|
|
2005
|
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
|
|
$
|
3,040
|
|
$
|
2,983
|
|
$
|
57
|
|
|
$
|
5,562
|
|
$
|
5,512
|
|
$
|
50
|
|
Due
after one year through five years
|
|
|
602,148
|
|
|
584,279
|
|
|
17,869
|
|
|
|
205,363
|
|
|
200,075
|
|
|
5,288
|
|
Due
after five years through ten years
|
|
|
96,077
|
|
|
93,043
|
|
|
3,034
|
|
|
|
415,417
|
|
|
401,533
|
|
|
13,884
|
|
Due
after ten years
|
|
|
355,222
|
|
|
344,907
|
|
|
10,314
|
|
|
|
310,216
|
|
|
301,050
|
|
|
9,167
|
|
Total
fixed maturity securities with unrealized losses
|
|
$
|
1,056,487
|
|
$
|
1,025,212
|
|
$
|
31,274
|
|
|
$
|
936,558
|
|
$
|
908,170
|
|
$
|
28,389
|
|
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.
Income
Taxes
Determining
the consolidated provision for income tax expense, deferred tax assets and
liabilities and any related valuation allowance involves judgment. GAAP requires
deferred tax assets and liabilities (“DTAs” and “DTLs,” respectively) to be
recognized for the estimated future tax effects attributed to temporary
differences and carryforwards based on provisions of the enacted tax law. The
effects of future changes in tax laws or rates are not anticipated. Temporary
differences are differences between the tax basis of an asset or liability
and
its reported amount in the 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 may be carried forward 20 years for losses
incurred after 1998. 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, 2006, our DTAs total $117.9 million and our DTLs total $69.5
million, for a net DTA of $48.4 million. At December 31, 2005, our DTAs were
$121.5 million and our DTLs were $65.3 million, for a net DTA of $56.2 million.
The net DTAs are classified as an asset, “Deferred income taxes”, in the
consolidated balance sheets.
We
are
required to reduce DTAs (but not DTLs) by a valuation allowance to the extent
that, based on the weight of available evidence, it is “more likely than not”
(i.e., a likelihood of more than 50%) that any DTAs will not be realized.
Recognition of a valuation allowance would decrease reported earnings on a
dollar-for-dollar basis in the year in which any such recognition were to occur.
The determination of whether a valuation allowance is appropriate requires
the
exercise of management judgment. In making this judgment, management is required
to weigh the positive and negative evidence as to the likelihood that the DTAs
will be realized.
The
Company’s net deferred tax assets include a net operating loss (“NOL”)
carryforward for regular federal corporate tax purposes of approximately $9.3
million, representing an unrealized tax benefit of $3.3 million at December
31,
2006, compared to $33.6 million, $75.8 million and $105.3 million at the end
of
the three preceding years, respectively. As a result of taxable income since
2002, our NOL has been fully utilized through December 31, 2006 except for
the
amount relating to 21st Century Insurance Company of the Southwest that is
subject to the IRS separate return limitation year provisions.
The
remaining NOL expires as follows: $1.4 million in 2017; $1.1 million in 2018;
$1.5 million in 2019; $3.2 million in 2020; and $2.1 million in
2021.
Our
ability to fully utilize the NOL of 21st of the Southwest and our other DTAs
depends primarily on future taxable income from operations and tax planning
strategies. Because of the Company’s profitable operating history and the
availability of tax planning strategies, management
believes it is reasonable to conclude that it is at least more likely than
not
that we will be able to realize the benefits of all of our DTAs. Accordingly,
no
valuation allowance has been recognized at December 31, 2006. 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.
Implementation of tax planning strategies to effect realization of our remaining
NOL may require regulatory approvals, which although reasonably expected cannot
be assured by management. Future operating losses could possibly jeopardize
our
ability to realize our other DTAs. Future unfavorable regulatory actions or
operating losses would lead management to reach a different conclusion about
the
likelihood of realizing the DTAs and, if so, to recognize a valuation allowance
at that time for some or all of the DTAs.
Deferred
Policy Acquisition Costs
Deferred
policy acquisition costs (“DPAC”) include premium taxes, advertising after it
takes place, and other variable costs incurred with writing business. While
our
customers typically renew their policies numerous times and on average stay
with
us for over five years, these costs are deferred and amortized over the
six-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
at December 31, 2006.
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.
Property
and Equipment
At
December 31, 2006, net property and equipment included $131.0 million in
software, net of related accumulated depreciation. This amount represented
84.5%
of total net property and equipment, with the remaining balance consisting
of
furniture and equipment, leasehold and building improvements, building, and
land.
Management
evaluates the recoverability of long-lived assets upon indication of possible
impairment when events or changes in circumstances indicate that the carrying
amount may not be recoverable by measuring the carrying amount of the assets
against the related estimated undiscounted cash flows. 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. When an evaluation indicates that the future undiscounted cash
flows are not sufficient to recover the carrying value of the assets, the assets
are adjusted to their estimated fair value. The determination of what
constitutes an indication of possible impairment, the estimation of future
cash
flows, and the determination of estimated fair value are all significant
judgments. During 2006, the Company reassessed an asset group comprised of
capitalized software dedicated to the administration of certain policies and
concluded that such assets were impaired. An impairment of $0.9 million,
classified as other expense, was recorded during the fourth quarter of 2006.
Pension
Cost
The
Company has a qualified defined benefit pension plan, which covers essentially
all employees who have completed at least one year of service. The pension
benefits under the qualified plan are based on employees’ compensation during
all years of service. The Company’s funding policy for the qualified plan is to
make annual contributions as required by applicable regulations; employees
may
not make contributions to this plan. For certain key employees designated by
the
Board of Directors, the Company sponsors a 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 qualified
pension plan and 50% of the social security benefit. Because the internal
revenue code does not allow current deductions for advance funding of a
non-qualified plan, the Company’s funding policy with respect to this plan is to
make contributions as benefits become payable to participants.
In
September 2006, Financial
Accounting Standards Board (“FASB”)
issued
FAS 158,
Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans - an
Amendment of FASB Statements No. 87, 88, 106 and 132(R)
("FAS
158"), which the Company was required to adopt effective December 31, 2006.
FAS
158 requires the Company to (1) recognize the funded
status of the defined benefit plans in its statement of financial position,
(2)
recognize as a component of other comprehensive income, net of tax, the
actuarial gains or
losses
and prior service costs or credits that arise during the period, but are not
recognized as components of net periodic benefit cost, (3) measure defined
benefit plan assets and obligations as of the date of the employer's fiscal
year
end statement of financial position and (4) disclose in the notes to
financial statements additional information about certain effects on net
periodic benefit cost for the next fiscal year that arise from
delayed recognition
of the gains or losses, prior service costs or credits, and transition asset
or
obligations. Adoption
of FAS 158 had the effect of reducing stockholders’ equity by $14.2 million at
December 31, 2006, as explained further in Note 11 of the Notes
to the Consolidated Financial Statements.
Adoption of FAS 158 had no effect on the Company's compliance with its financial
covenants.
The
Company makes a number of assumptions relating to its pension plans to measure
the financial position of the plans and the net periodic benefit cost. The
most
significant assumptions relate to the discount rate, the expected long term
return on plan assets (“ROA”) and the rate of future compensation increase. The
effects of changes in these assumptions affect both the Company’s earnings and
its financial position. The earnings effects generally are accounted for
initially as deferred actuarial gains or losses, which in turn prospectively
affect the determination of the amortization component of net periodic pension
cost. Changes in the discount rate and future compensation assumptions also
affect the actuarial measurement of the plans’ projected benefit obligations,
which in turn impacts the plans’ funded status and results in an increase or
decrease in shareholders’ equity absent any offsetting changes in the fair value
of plan assets. The effects of such changes in assumptions could be material
to
the Company’s earnings and financial condition.
The
effects of such changes in assumptions are complex but can be summarized as
shown in the following table:
|
|
Increase
in
Discount
Rate
|
|
Increase
in Future
Compensation
Rate
|
|
Increase
in Assumed
Return
on Assets
|
Effect
on projected benefit obligation and funded status
|
|
Decrease
|
|
Increase
|
|
None
|
Effect
on service cost
|
|
Decrease
in pension cost
|
|
Increase
in pension cost
|
|
None
|
Effect
on interest cost
|
|
Increase
in pension cost
|
|
Increase
in pension cost
|
|
None
|
Effect
on expected return on assets
|
|
None
|
|
None
|
|
Decrease
in pension cost
|
Effect
on amortization cost
|
|
Decrease
in pension cost
|
|
Increase
in pension cost
|
|
Decrease
in pension cost
|
The
discussion below illustrates the sensitivity of the pre-tax pension measurements
to hypothetical changes in assumptions, but is not intended to represent a
prediction of the future performance of our defined benefit plans.
Discount
Rate
Because
by definition it is intended to be market sensitive, the discount rate
assumption typically varies from year to year and is determined by developing
a
hypothetical portfolio of high quality bonds with cash flows matched to our
projected benefit costs. The weighted-average discount rate assumption for
determining net periodic pension cost is 5.9% for 2007, compared with 5.7%
in
2006, 6.0% in 2005 and 6.1% in 2004. An increase or decrease of 0.25% in the
discount rate assumption for 2008 would increase or decrease the Company’s
pension expense for 2008 by approximately $0.7 million.
Return
on Assets
The
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 utilizes consulting pension actuaries to perform
stochastic modeling services to assist the Company in determining the assumed
expected long-term rate of return on assets, based on an assumption that 75%
of
the plan asset portfolio will be invested in equity securities, with the
remainder invested in debt securities. Historical returns are not adjusted
for
purposes of performing the stochastic modeling. The long-term ROA assumption
for
the Company’s pension plans in 2007 is 8.5%, unchanged from 2006, 2005 and 2004.
By way of comparison, the actual returns on plan assets were 13.6% in 2006,
7.3%
in 2005 and 12.0% in 2004, representing a three-year weighted average of 11.0%.
Net periodic benefit cost was $9.2 million, $8.9 million, and $9.0 million
in
2006, 2005, and 2004, respectively, and included expected return on plan assets
of $8.4 million, $7.3 million, and $6.4 million in 2006, 2005 and 2004,
respectively. The difference between the actual and expected return on plan
assets caused actuarial gains (losses) of approximately $5.4 million, ($1.0)
million, and $2.8 million in 2006, 2005 and 2004, respectively. An increase
or
decrease of 0.25% in the expected ROA assumption would increase or decrease
the
Company’s pension expense in 2008 by approximately $0.3 million. For every 2.5%
that the actual pension plan asset return exceeds or is less than the long-term
ROA assumption for 2007, the Company’s pension expense for 2008 would change by
approximately $0.5 million.
Future
Compensation
To
develop the assumed rate of future compensation, the Company considers the
historical compensation of the plan participants and future wage expectations
taking into consideration inflation indicators such as the consumer price index.
An increase or decrease of 1.0% in the expected rate of future compensation
assumption would increase or decrease the Company’s pension expense in 2008 by
approximately $0.9 million.
See
Note
11 of the Notes
to Consolidated Financial Statements
for
further discussion.
Stock-based
Compensation Cost
For
periods prior to January 1, 2006, the Company accounted for share-based payment
transactions with employees in accordance with Statement of Financial Accounting
Standard No. (“FAS”) 123, Accounting
for Stock-Based Compensation (“FAS
123”). Under the provisions of FAS 123, we had 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.
We did
not recognize in income any compensation expense for the fair value of stock
options awarded to employees as all employee stock options were granted at
the
closing market price on the grant date. However, stock-based employee
compensation cost relating to restricted stock was recognized in the statements
of operations for periods prior to January 1, 2006. Effective January 1, 2006,
we adopted the fair value recognition provisions of FAS 123R. Unlike FAS 123,
which was elective, FAS 123R requires that companies use a fair value method
to
value share-based payments and recognize the related compensation expense in
net
earnings. We use the Black-Scholes option-pricing model to calculate the fair
value of the employee stock options.
The
Company adopted FAS 123R using the modified-prospective application method,
and
accordingly, financial statement amounts for the prior periods presented in
this
Form 10-K have not been restated to reflect the fair value method of expensing
share-based compensation under FAS 123R. The modified-prospective application
method provides for the recognition of the fair value with respect to
stock-based awards granted on or after January 1, 2006 and all previously
granted, but unvested awards at January 1, 2006.
The
adoption of FAS 123R in 2006 resulted in additional stock-based compensation
cost of $9.6 million for the year ended December 31, 2006, which previously
would have been only presented in a pro forma footnote disclosure. FAS 123R
also
requires the Company to estimate forfeitures in calculating the expense relating
to stock-based compensation, as opposed to recognizing these forfeitures and
corresponding reduction in expense as they occur. No cumulative adjustment
was
necessary for prior year forfeitures as these were estimated in the Company’s
prior year pro forma financial statements. In addition, FAS 123R requires us
to
reflect the cash savings resulting from excess tax benefits (i.e., the benefit
of the tax deduction for a share-based payment that exceeds the recognized
compensation cost for that award) in its consolidated financial statements
as a
financing cash flow, rather than as an operating cash flow as in prior periods.
The remaining unrecognized compensation cost related to unvested awards at
December 31, 2006, was $8.7 million and the weighted-average period over which
this cost will be recognized is 1.8 years.
For
grants made on or after January 1, 2006, the Company applied the non-substantive
vesting period approach, which requires recognition of compensation expense
from
the grant date to the earlier of the vesting date or the date retirement
eligibility is achieved for awards with retirement eligibility options. The
use
of the non-substantive vesting approach does not affect the overall amount
of
compensation expense recognized, but does accelerate the recognition of expense.
This resulted in $0.7 million in accelerated vesting of awards incurred during
the first quarter of 2006. In the first quarter of 2006, we recognized $1.4
million in stock-based compensation expense in connection with the accelerated
vesting of awards as part of an executive retention agreement. For the remaining
portion of awards that were unvested and granted prior to January 1, 2006,
we
will continue to follow the nominal vesting period approach, and accordingly
recognize the expense from the grant date to the earlier of the actual date
of
retirement or the vesting date.
Calculating
the fair value of stock option awards using the Black-Scholes option-pricing
model requires the input of subjective assumptions, including the stock price
volatility. Volatility is a measure of stock price fluctuation in a given
period. The objective of estimating volatility is to ascertain the assumption
about expected volatility that marketplace participants would likely use in
determining a price for an option. The Company is excluded from relying
exclusively on the historical volatility of its publicly traded common stock
as
the Company’s stock has been impacted by significant “one-time” events. As such,
the Company develops its volatility for each stock option grant by combining
the
volatility
of its competitors in the Property & Casualty insurance industry.
In
addition to the volatility calculation, other assumptions used in calculating
the fair value of stock option awards involve inherent uncertainties and the
application of management judgment. As a result, if factors change and we use
different assumptions, the computed fair value and resulting stock-based
compensation expense could be materially different in the future. Furthermore,
we are required to estimate the expected forfeiture rate and recognize expense
only for those shares expected to vest. If our actual forfeiture rate is
materially different from our estimate, the stock-based compensation expense
could be significantly different from what we have recorded in the current
period.
The
2006
grants had a weighed fair value of $4.99 that was derived using the
Black-Scholes model. The table below illustrates the sensitivity of the weighed
fair value to hypothetical changes in assumptions, but is not intended to
represent a prediction of the future fair values.
|
|
Actual
weighted- average assumption
|
|
Weighted-average
assumption adjusted upward to:
|
Weighted-average
fair value after upward adjustment
|
|
Weighted
average assumption adjusted downward to:
|
Weighted
average fair value after downward adjustment
|
Weighted
volatility assumption
|
|
|
29.40
|
%
|
|
|
31.40
|
%
|
$
|
5.24
|
|
|
|
27.40
|
%
|
$
|
4.75
|
|
Weighted
dividend rate assumption
|
|
|
1.94
|
|
|
|
2.94
|
|
|
4.39
|
|
|
|
0.94
|
|
|
5.66
|
|
See
additional discussion in Notes 2 and 14 of the Notes
to Consolidated Financial Statements.
RECENT
ACCOUNTING PRONOUNCEMENTS
In
September 2006, the
FASB
issued
FAS 158,
which requires an employer that is a business entity and sponsors one or more
single employer benefit plans to (1) recognize the funded
status of the defined benefit plans in its statement of financial position,
(2)
recognize as a component of other comprehensive income, net of tax, the
actuarial gains or
losses
and prior service costs or credits that arise during the period, but are not
recognized as components of net periodic benefit cost, (3) measure defined
benefit plan assets and obligations as of the date of the employer's fiscal
year
end statement of financial position and (4) disclose in the notes to
financial statements additional information about certain effects on net
periodic benefit cost for the next fiscal year that arise from
delayed recognition
of the gains or losses, prior service costs on credits, and transition asset
or
obligations. At
December 31, 2006, the Company adopted FAS 158, which had the effect of reducing
stockholders’ equity by approximately $14.2 million. The adoption of FAS 158
did not
have
any effect on the Company’s compliance with its financial covenants.
See
Note
11 of
the
Notes
to Consolidated Financial Statements for
further discussion.
In
September 2006, the FASB issued FAS 157, Fair
Value Measurements (“FAS
157”). FAS 157 clarifies the principle that fair value should be based on the
assumptions market participants would use when pricing an asset or liability
and
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. Under the standard, fair value measurements would
be
separately disclosed by level within the fair value hierarchy. FAS 157 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007 and interim periods within those fiscal years, with early
adoption permitted. We have not yet determined the effect, if any, that the
implementation of FAS 157 will have on our results of operations or financial
condition.
In
September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulletin No. 108, Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements
(“SAB
108”). SAB 108 provides interpretive guidance on how the effects of the
carryover or reversal of prior year misstatements should be considered in
quantifying a current year misstatement. The SEC staff believes that registrants
should quantify errors using both a balance sheet and an income statement
approach and evaluate whether either approach results in quantifying a
misstatement that, when all relevant quantitative and qualitative factors are
considered, is material. SAB 108 is effective for the Company’s fiscal year
ended December 31, 2006. The adoption of SAB 108 did not have a material effect
on the financial statements.
In
June
2006, the FASB issued Financial Interpretation No. 48, Accounting
for Uncertainty in Income Taxes - an Interpretation of FAS No.
109
(“FIN
48”). This interpretation clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with FAS
109, Accounting
for Income Taxes.
FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to
be
taken in a tax return. This interpretation also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. This interpretation will be effective
January 1, 2007. We expect the adoption of FIN 48 will result in the recognition
of a reduction of retained earnings of approximately $2.5 million effective
January 1, 2007.
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”),
becomes
effective January 1,
2007.
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 FAS 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. We are currently assessing
the effect of implementing this guidance.
FORWARD-LOOKING
STATEMENTS
The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements made by or on behalf of the Company. This report
contains statements that constitute “forward-looking” information. Readers 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. Forward-looking statements include,
but are not limited to, discussions concerning our potential expectations,
beliefs, estimates, forecasts, projections, and assumptions.
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. These
statements are made on the basis of management’s views and assumptions at the
time the statements are made. There can be no assurance, however, that our
expectations will necessarily come to pass. Significant factors affecting these
expectations are set forth under Item 1A.
Risk Factors
of this
Report on Form 10-K.
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 automobile lines insurance business, as a regulated
industry, to legal, legislative, judicial, political and regulatory action.
Financial instruments are not used for trading purposes. 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. 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
flows 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. 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.
For
all
of our fixed maturity securities, which comprises the majority of the Company’s
investment portfolio, we seek to provide for liquidity and diversification
while
maximizing income without sacrificing investment quality. The value of the
fixed
maturity securities portfolio is subject to interest rate risk where the value
of the fixed maturity securities portfolio decreases as market interest rates
increase, and conversely, when market interest rates decrease, the value of
the
fixed maturity securities 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 securities 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 in 2004, management, in consultation with the
Investment Committee, targeted a lower duration for the Company’s fixed maturity
security 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 4.7 years at December 31, 2005 to 4.0
years at December 31, 2006.
The
graphical depiction of the relationship between the yield on bonds of the same
credit quality 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 securities,
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
|
|
Carrying
Value
|
Estimated
Carrying
Value
at
Adjusted
Market
Rates/Prices
Indicated
Above
|
Change
in
Value
as a
Percentage
of
Carrying
Value
|
December
31, 2006
|
|
|
|
|
|
|
|
Fixed
maturity securities available-for-sale, at fair value
|
|
$
|
1,435.0
|
|
$
|
1,379.3
|
|
|
(3.9
|
%)
|
Debt,
at amortized cost
|
|
|
115.9
|
|
|
121.9
|
|
|
5.3
|
|
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 securities 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.
The
difference between long-term Treasury yields and short-term Treasury yields
are
usually referred 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 effective duration distribution of our fixed maturity
securities portfolio.
|
|
|
|
Duration
Ranges
|
|
|
|
December
31, 2006
|
|
Below
1
|
|
1
to 3
|
|
3
to 5
|
|
5
to 7
|
|
7
to 10
|
|
10
to 20
|
|
Fair
value percentage of fixed maturity securities portfolio
|
|
|
1.7%
|
|
|
22.0%
|
|
|
61.8%
|
|
|
13.3%
|
|
|
1.2%
|
|
|
0.0%
|
|
Equity
investments
In
an
effort to enhance yield and provide some non-correlated diversification to
our
fixed income portfolio, the Company has invested in equity securities. In the
first quarter of 2006, the Company sold its publicly traded equity security
portfolio and subsequently invested in a private equity portfolio.
The
Company committed $35 million to an AIGGIC-managed fund of private equity
investments and funded $14.4 million of the $35 million commitment in 2006.
The
value of these private equity investments are calculated on a quarterly basis,
as AIGGIC consolidates the performance of each fund partner and each particular
investment. The primary risk in this portfolio is event-driven risk. This is
managed via diversification across fund managers and styles, as well as by
AIGGIC’s long history of experience in the asset class. The Company also has a
small portion, $0.3 million, of its community-related investment portfolio
invested in a single private equity transaction.
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 consolidated
financial statements and of its internal control over financial reporting as
of
December 31, 2006, 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, 2006 and 2005, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2006, 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.
As
discussed in Note 2 to the consolidated financial statements, during the year
ended December 31, 2006, the Company changed its accounting for stock-based
compensation costs as of January 1, 2006 and employee benefit plans as of
December 31, 2006.
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, 2006, 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, 2006,
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
26, 2007
21ST
CENTURY INSURANCE GROUP
|
|
|
|
|
|
CONSOLIDATED
BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
|
|
|
|
December
31,
|
|
2006
|
2005
|
Assets
|
|
|
|
|
|
Investments
available-for-sale
|
|
|
|
|
|
Fixed
maturity securities, at fair value (amortized cost: $1,453,468 and
$1,365,948)
|
|
$
|
1,435,016
|
|
$
|
1,354,707
|
|
Equity
securities, at fair value (cost: $0 and $49,210)
|
|
|
—
|
|
|
47,367
|
|
Other
long-term investments, equity method
|
|
|
14,705
|
|
|
—
|
|
Total
investments
|
|
|
1,449,721
|
|
|
1,402,074
|
|
Cash
and cash equivalents
|
|
|
51,999
|
|
|
68,668
|
|
Accrued
investment income
|
|
|
17,215
|
|
|
16,585
|
|
Premiums
receivable
|
|
|
110,115
|
|
|
100,900
|
|
Reinsurance
receivables and recoverables
|
|
|
6,338
|
|
|
6,539
|
|
Prepaid
reinsurance premiums
|
|
|
2,095
|
|
|
1,946
|
|
Deferred
income taxes
|
|
|
48,437
|
|
|
56,209
|
|
Deferred
policy acquisition costs
|
|
|
63,581
|
|
|
59,939
|
|
Leased
property under capital leases, net of deferred gain of $1,092 and
$1,534
and net of accumulated amortization of $42,149 and $36,995
|
|
|
19,281
|
|
|
22,651
|
|
Property
and equipment, at cost less accumulated depreciation of $104,279
and
$89,595
|
|
|
154,966
|
|
|
145,811
|
|
Other
assets
|
|
|
27,949
|
|
|
38,907
|
|
Total
assets
|
|
$
|
1,951,697
|
|
$
|
1,920,229
|
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
Unpaid
losses and loss adjustment expenses
|
|
$
|
482,269
|
|
$
|
523,835
|
|
Unearned
premiums
|
|
|
321,927
|
|
|
319,676
|
|
Debt
|
|
|
115,895
|
|
|
127,972
|
|
Claims
checks payable
|
|
|
42,931
|
|
|
42,681
|
|
Reinsurance
payable
|
|
|
680
|
|
|
643
|
|
Other
liabilities
|
|
|
89,446
|
|
|
75,450
|
|
Total
liabilities
|
|
|
1,053,148
|
|
|
1,090,257
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
Common
stock, par value $0.001 per share; 110,000,000 shares authorized;
shares
issued 86,489,082 and 85,939,889
|
|
|
86
|
|
|
86
|
|
Additional
paid-in capital
|
|
|
441,969
|
|
|
425,454
|
|
Treasury
stock, at cost; shares 17,328 and 5,929
|
|
|
(259
|
)
|
|
(84
|
)
|
Retained
earnings
|
|
|
484,539
|
|
|
414,898
|
|
Accumulated
other comprehensive loss
|
|
|
(27,786
|
)
|
|
(10,382
|
)
|
Total
stockholders’ equity
|
|
|
898,549
|
|
|
829,972
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
1,951,697
|
|
$
|
1,920,229
|
|
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,
|
|
2006
|
2005
|
2004
|
Revenues
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
1,307,585
|
|
$
|
1,352,937
|
|
$
|
1,313,670
|
|
Net
investment income
|
|
|
68,493
|
|
|
69,096
|
|
|
58,831
|
|
Other
income
|
|
|
638
|
|
|
367
|
|
|
—
|
|
Net
realized investment (losses) gains
|
|
|
(1,429
|
)
|
|
(3,272
|
)
|
|
10,831
|
|
Total
revenues
|
|
|
1,375,287
|
|
|
1,419,128
|
|
|
1,383,332
|
|
Losses
and expenses
|
|
|
|
|
|
|
|
|
|
|
Net
losses and loss adjustment expenses
|
|
|
920,846
|
|
|
998,933
|
|
|
993,841
|
|
Policy
acquisition costs
|
|
|
256,125
|
|
|
252,541
|
|
|
222,479
|
|
Other
underwriting expenses
|
|
|
47,657
|
|
|
31,793
|
|
|
36,092
|
|
Other
expense
|
|
|
1,860
|
|
|
410
|
|
|
—
|
|
Interest
and fees expense
|
|
|
7,348
|
|
|
8,019
|
|
|
8,627
|
|
Total
losses and expenses
|
|
|
1,233,836
|
|
|
1,291,696
|
|
|
1,261,039
|
|
Income
before provision for income taxes
|
|
|
141,451
|
|
|
127,432
|
|
|
122,293
|
|
Provision
for income taxes
|
|
|
44,223
|
|
|
40,006
|
|
|
34,068
|
|
Net
income
|
|
$
|
97,228
|
|
$
|
87,426
|
|
$
|
88,225
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.13
|
|
$
|
1.02
|
|
$
|
1.03
|
|
Diluted
|
|
|
1.12
|
|
|
1.02
|
|
|
1.03
|
|
Weighted-average
shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
86,071,808
|
|
|
85,661,547
|
|
|
85,466,127
|
|
Additional
common shares assumed issued under treasury
stock method
|
|
|
441,033
|
|
|
356,447
|
|
|
136,440
|
|
Diluted
|
|
|
86,512,841
|
|
|
86,017,994
|
|
|
85,602,567
|
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.001
par
value
|
|
Additional
|
|
|
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
Issued
Shares
|
Amount
|
Paid-
in
Capital
|
Treasury
Stock
|
|
|
|
Comprehensive
Income
(Loss)
|
|
|
Total
|
Balance
- January 1, 2004
|
|
|
85,435,505
|
|
$
|
85
|
|
$
|
419,245
|
|
$
|
—
|
|
$
|
259,808
|
|
|
|
|
$
|
21,552
|
|
|
|
|
$
|
700,690
|
|
Comprehensive
income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88,225
|
(1) |
|
|
|
|
(8,857
|
)
|
(2) |
|
|
|
|
79,368
|
|
Cash
dividends declared on common stock ($0.08 per
share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,837
|
)
|
|
|
|
|
|
|
|
|
|
|
(6,837
|
)
|
Exercise
of stock options
|
|
|
49,056
|
|
|
|
|
|
576
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
576
|
|
Issuance
of restricted stock
|
|
|
4,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Amortization
of unearned compensation
|
|
|
|
|
|
|
|
|
659
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
659
|
|
Tax
effect of stock-based compensation
|
|
|
|
|
|
|
|
|
(55
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(55
|
)
|
Balance
- December 31, 2004
|
|
|
85,489,061
|
|
$
|
85
|
|
|
420,425
|
|
$
|
—
|
|
$
|
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
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
|
|
$
|
425,454
|
|
$
|
(84
|
)
|
$
|
414,898
|
|
|
|
|
$
|
(10,382
|
)
|
|
|
|
$
|
829,972
|
|
Comprehensive
income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
97,228
|
(1) |
|
|
|
|
(3,216
|
)
|
(2) |
|
|
|
|
94,012
|
|
Incremental
effect of adopting FAS 158, net of deferred taxes of
$7,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14,188
|
)
|
|
|
|
|
(14,188
|
)
|
Cash
dividends declared on common stock ($0.32 per
share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(27,587
|
)
|
|
|
|
|
|
|
|
|
|
|
(27,587
|
)
|
Exercise
of stock options
|
|
|
432,643
|
|
|
|
|
|
5,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,675
|
|
Issuance
of restricted stock
|
|
|
116,550
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Forfeiture
of 11,399 shares of restricted stock
|
|
|
|
|
|
|
|
|
175
|
|
|
(175
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Stock-based
compensation cost
|
|
|
|
|
|
|
|
|
10,416
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,416
|
|
Excess
tax benefit from stock-based compensation
|
|
|
|
|
|
|
|
|
249
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
249
|
|
Balance
- December 31, 2006
|
|
|
86,489,082
|
|
$
|
86
|
|
$
|
441,969
|
|
$
|
(259
|
)
|
$
|
484,539
|
|
|
|
|
$
|
(27,786
|
)
|
|
|
|
$
|
898,549
|
|
(1)
Net
income for the year.
(2) Other
comprehensive 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,
|
|
2006
|
2005
|
2004
|
Operating
activities
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
97,228
|
|
$
|
87,426
|
|
$
|
88,225
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
27,395
|
|
|
33,760
|
|
|
22,260
|
|
Net
amortization of investment premiums and discounts
|
|
|
10,318
|
|
|
9,370
|
|
|
7,011
|
|
Stock-based
compensation cost
|
|
|
10,416
|
|
|
319
|
|
|
659
|
|
Provision
for deferred income taxes
|
|
|
17,237
|
|
|
12,351
|
|
|
25,246
|
|
Provision
for premium receivable losses
|
|
|
2,183
|
|
|
3,372
|
|
|
3,558
|
|
Lease
and software impairments
|
|
|
1,860
|
|
|
410
|
|
|
—
|
|
Net
realized investment losses (gains)
|
|
|
1,429
|
|
|
3,272
|
|
|
(10,831
|
)
|
Changes
in assets and liabilities
|
|
|
|
|
|
|
|
|
|
|
Premiums
receivable
|
|
|
(11,398
|
)
|
|
1,542
|
|
|
(4,734
|
)
|
Deferred
policy acquisition costs
|
|
|
(3,642
|
)
|
|
(1,180
|
)
|
|
(5,680
|
)
|
Reinsurance
receivables and recoverables
|
|
|
89
|
|
|
471
|
|
|
3,779
|
|
Federal
income taxes
|
|
|
(5,808
|
)
|
|
(410
|
)
|
|
3,801
|
|
Other
assets
|
|
|
(1,623
|
)
|
|
(3,584
|
)
|
|
(3,034
|
)
|
Unpaid
losses and loss adjustment expenses
|
|
|
(41,566
|
)
|
|
28,293
|
|
|
57,219
|
|
Unearned
premiums
|
|
|
2,251
|
|
|
(11,360
|
)
|
|
18,782
|
|
Claims
checks payable
|
|
|
250
|
|
|
3,944
|
|
|
(6,965
|
)
|
Other
liabilities
|
|
|
9,651
|
|
|
(7,735
|
)
|
|
4,060
|
|
Net
cash provided by operating activities
|
|
|
116,270
|
|
|
160,261
|
|
|
203,356
|
|
Investing
activities
|
|
|
|
|
|
|
|
|
|
|
Purchases
of:
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities available-for-sale
|
|
|
(231,805
|
)
|
|
(136,122
|
)
|
|
(813,993
|
)
|
Equity
securities available-for-sale
|
|
|
(35,627
|
)
|
|
(317,340
|
)
|
|
(123,017
|
)
|
Other
long-term investments, equity method
|
|
|
(14,385
|
)
|
|
—
|
|
|
—
|
|
Property
and equipment
|
|
|
(33,242
|
)
|
|
(39,083
|
)
|
|
(40,445
|
)
|
Maturities
and calls of fixed maturity securities available-for-sale
|
|
|
38,729
|
|
|
38,229
|
|
|
52,579
|
|
Sales
of:
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities available-for-sale
|
|
|
94,099
|
|
|
40,124
|
|
|
629,019
|
|
Equity
securities available-for-sale
|
|
|
84,836
|
|
|
309,580
|
|
|
81,567
|
|
Net
cash used in investing activities
|
|
|
(97,395
|
)
|
|
(104,612
|
)
|
|
(214,290
|
)
|
Financing
activities
|
|
|
|
|
|
|
|
|
|
|
Repayment
of debt
|
|
|
(13,786
|
)
|
|
(12,603
|
)
|
|
(11,409
|
)
|
Dividends
paid (per share: $0.32; $0.16; and $0.10)
|
|
|
(27,587
|
)
|
|
(13,724
|
)
|
|
(8,546
|
)
|
Proceeds
from the exercise of stock options
|
|
|
5,675
|
|
|
4,649
|
|
|
576
|
|
Excess
tax benefit from stock-based compensation
|
|
|
154
|
|
|
—
|
|
|
—
|
|
Net
cash used in financing activities
|
|
|
(35,544
|
)
|
|
(21,678
|
)
|
|
(19,379
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash and cash equivalents
|
|
|
(16,669
|
)
|
|
33,971
|
|
|
(30,313
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of year
|
|
|
68,668
|
|
|
34,697
|
|
|
65,010
|
|
Cash
and cash equivalents, end of year
|
|
$
|
51,999
|
|
$
|
68,668
|
|
$
|
34,697
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
information:
|
|
|
|
|
|
|
|
|
|
|
Income
taxes paid
|
|
$
|
35,772
|
|
$
|
26,481
|
|
$
|
3,912
|
|
Interest
paid
|
|
|
7,164
|
|
|
7,878
|
|
|
8,612
|
|
See
accompanying Notes to Consolidated Financial Statements.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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 (our primary 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”) owned approximately 62% of the Company’s outstanding common
stock at December 31, 2006.
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.
Investments
available-for-sale
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 other-than-temporary impairment based
upon 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 the debtor defaulting
or seeking bankruptcy or insolvency protection or voluntary
reorganization; and
|
|
·
|
The
probability of non-realization of 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 we have 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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
The
determination of whether a decline in fair value is “other-than-temporary” is
necessarily a matter of subjective judgment. The Company’s intent is to hold all
of its fixed maturity securities with unrealized losses for a period of time
sufficient to allow a market recovery or to maturity as long as these securities
continue to be consistent with our investment strategy. If our strategy were
to
change and these securities were impaired, we would recognize a write down
in
accordance with our stated policy. Additionally, it is possible that future
information will become available about our current investments that would
require accounting for them as realized losses due to other-than-temporary
declines in value. No such charges were recorded in 2006, 2005 or 2004. The
timing and amount of realized losses and gains reported in income could vary
if
conclusions other than those made by management were to determine whether an
other-than-temporary impairment exists. However, there would be no impact on
equity for the periods presented because any unrealized losses would have been
already included in accumulated other comprehensive income (loss).
Other
long-term investments, equity method
The
Company started investing in limited partnerships and limited liability
corporations during the third quarter of 2006, as further discussed in Note
3 of
the Notes
to Consolidated Financial Statements.
Since
our share of a partnership’s or corporation’s capital is greater than 3%, but
less than 50%, we account for these investments using the equity method,
and the carrying values of our investments, which approximates fair value,
are
adjusted to reflect our share of the underlying equity of the partnerships
or
corporations, as applicable. The change in our share of the underlying equity
of
the partnerships or corporations is recorded in net investment income.
Cash
and Cash Equivalents
Cash
and
cash equivalents include cash, demand deposits and short-term investments in
money market mutual funds having a maturity of three months or less at the
date
of purchase.
Insurance
Premiums and Receivables
Insurance
premiums written and reinsurance ceding commissions are recognized pro rata
over
the period of the policies. Accordingly, unearned premiums represent the portion
of premium written that is applicable to the unexpired term of the policy.
Installment and other fees for services are recognized in the periods the
services are rendered. Premiums receivable represent premiums written and not
yet collected, net of an allowance for uncollectible premiums. Generally,
premiums are collected prior to providing risk coverage, minimizing the
Company’s exposure to credit risk.
Deferred
Policy Acquisition Costs
Deferred
policy acquisition costs (“DPAC”) primarily include premium taxes, advertising
after it takes place, and other variable costs incurred with acquiring and
renewing policies. These costs are deferred and amortized over the six-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 at December 31, 2006.
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 shorter of the estimated
useful lives of the properties, which range from 3 to 10 years, or the term
of
the lease. The related lease obligation is included in debt on the balance
sheet.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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 of
employees who develop computer software for internal use.
The
following table summarizes the estimated useful lives used for calculating
depreciation of the Company’s assets:
|
Estimated
Useful
Lives
(Years)
|
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 possible impairment when events or changes in
circumstances indicate that the carrying amount may not be recoverable. 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 estimated 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. During 2006, the Company reassessed an asset group comprised of
capitalized software dedicated to the administration of certain policies and
concluded that such assets were impaired. An impairment of $0.9 million,
classified as other expense, was recorded during the fourth quarter of 2006.
Intangible
Asset
The
Company paid $1.5 million in 2004 to acquire the marketing name “21st Century
Insurance and Financial Services,” which is used as a marketing name for 20th
Century Insurance Services. The payment was capitalized as an intangible asset
and is included in “Other Assets” on the accompanying balance sheets. 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
broker 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, 2006, indicated that the asset was not
impaired.
Unpaid
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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Reserves
for Contingent Liabilities
In
the
normal course of business, the Company is named as a defendant in lawsuits
related to its insurance operations and business practices that expose it to
potential losses. We recognize an estimated loss, which may represent damages,
settlement costs, legal expenses or a combination of the foregoing, as
appropriate, from such loss contingencies when it is both probable that a loss
will be incurred and that the amount of the loss can be reasonably estimated.
Our loss estimates are based in part on an analysis of potential results, the
stage of the proceedings, consultation with outside counsel and any other
relevant available information.
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 $0.6 million and $0.4 million in 2006 and 2005, respectively, consists
of interest income relating to refund claims with taxing authorities.
Other
Expenses
The
Company vacated excess space at its Woodland Hills, California headquarters
in
both 2006 and 2005. Losses recognized on these vacated spaces were $0.9 million
and $0.4 million in 2006 and 2005, respectively, as future rental costs are
higher than potential market rentals. 2006 also includes an impairment of $0.9
million that was recognized for certain capitalized software. No other expense
was reported in 2004.
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. State
income taxes attributable to dividends from insurance subsidiaries are accrued
in the period in which they are declared. Commencing in 2006, concurrent
with the adoption of Statement of Financial
Accounting Standards No.
(“FAS”) 123 (revised 2004), Shared-Based
Payment (“FAS
123R”),
the
Company follows the tax-law-ordering approach with respect to recognition of
excess tax benefits relating to stock compensation. The Company had no excess
tax benefits available in additional paid-in capital to offset possible future
tax deficiencies relating to exercising of stock options on December 31, 2006
or
at the date of adoption of FAS 123R.
Fair
Value of Financial Instruments
The
carrying value of financial assets and liabilities reported in the accompanying
consolidated balance sheets for cash and cash equivalents, accrued investment
income and trade accounts receivable and payable at December 31, 2006 and 2005,
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 carrying value of the other long-term investments
approximates its fair value. The fair value of investments in limited
partnerships and corporations is obtained from information provided by the
general partner or manager of the investments, the accounts of which generally
are audited on an annual basis. The fair value of notes payable is estimated
based on the quoted market prices for the same or similar issues, or on the
current rates offered to us for debt with the same remaining maturities.
The
carrying values of our debt were $115.9 million and $128.0 million and the
estimated fair values were $121.9 million and $135.0 million
at December 31, 2006 and 2005, respectively.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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.
Earnings
Per Share (“EPS”)
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 EPS excludes dilution and reflects net income divided
by the weighted-average shares of common stock outstanding during the periods
presented. Diluted EPS 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 were computed using the treasury stock method.
Common
stock equivalents excluded from calculation of diluted EPS because their
inclusion would have been anti-dilutive (i.e., their inclusion under the
treasury stock method would have increased EPS) were 5,406,095, 5,660,376,
and
6,156,772 at December 31, 2006, 2005, and 2004, respectively.
Recent
Accounting Pronouncements
In
September 2006, Financial
Accounting Standards Board (“FASB”)
issued
FAS 158,
Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans - an
Amendment of FASB Statements No. 87, 88, 106 and 132(R)
("FAS
158"). FAS 158 requires an employer that is a business entity and sponsors
one
or more single employer benefit plans to (1) recognize the funded
status of the defined benefit plans in its statement of financial position,
(2)
recognize as a component of other comprehensive income, net of tax, the
actuarial gains or
losses
and prior service costs or credits that arise during the period, but are not
recognized as components of net periodic benefit cost, (3) measure defined
benefit plan assets and obligations at the date of the employer's fiscal year
end statement of financial position and (4) disclose in the notes to
financial statements additional information about certain effects on net
periodic benefit cost for the next fiscal year that arise from
delayed recognition
of the gains or losses, prior service costs on credits, and transition asset
or
obligations. At
December 31, 2006, the Company adopted FAS 158. The adoption of FAS 158
did not
have
any effect on the Company’s compliance with its financial covenants.
See
Note
11 of
the
Notes
to Consolidated Financial Statements for
further discussion.
In
September 2006, the FASB issued FAS 157, Fair
Value Measurements (“FAS
157”). FAS 157 clarifies the principle that fair value should be based on the
assumptions market participants would use when pricing an asset or liability
and
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. Under the standard, fair value measurements would
be
disclosed separately by level within the fair value hierarchy. FAS 157 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007 and interim periods within those fiscal years, with early
adoption permitted. We have not yet determined the effect, if any, that the
implementation of FAS 157 will have on our results of operations or financial
condition.
In
September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulletin No. 108, Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements
(“SAB
108”). SAB 108 provides interpretive guidance on how the effects of the
carryover or reversal of prior year misstatements should be considered in
quantifying a current year misstatement. The SEC staff believes that registrants
should quantify errors using both a balance sheet and an income statement
approach and evaluate whether either approach results in quantifying a
misstatement that, when all relevant quantitative and qualitative factors are
considered, is material. SAB 108 is effective for the Company’s fiscal year
ended December 31, 2006. The adoption of SAB 108 did not have a material effect
on the financial statements.
In
June
2006, the FASB issued Financial Interpretation No. 48, Accounting
for Uncertainty in Income Taxes - an Interpretation of FAS No.
109
(“FIN
48”). This interpretation clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with FAS
109, Accounting
for Income Taxes.
FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to
be
taken in a tax return. This interpretation also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. This interpretation will be effective
January 1, 2007. We expect the adoption of FIN 48 will result in the recognition
of a reduction in retained earnings of approximately $2.5 million effective
January 1, 2007.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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”),
becomes
effective January 1,
2007.
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 FAS 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. We are currently assessing
the effect of implementing this guidance.
Prior
to
January 1, 2006, the Company accounted for its stock-based compensation plans
under the measurement and recognition provisions of Accounting Principles Board
Opinion No. 25 (“APB 25”), Accounting
for Stock Issued to Employees,
and
related Interpretations, as permitted by FAS 123, Accounting
for Stock-Based Compensation.
Under
the intrinsic-value method prescribed by APB 25, compensation cost for stock
options was 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. All
employee stock options were granted at the closing market price on the grant
date. Accordingly, no compensation cost was recognized for fixed stock option
grants in prior periods; however, stock-based compensation measured in
accordance with the fair-value based method was included as a pro forma
disclosure in the consolidated financial statement footnotes.
Effective
January 1, 2006, the Company adopted FAS 123R, which requires all stock-based
payments to employees, including grants of employee stock options, to be
recognized in the statements of operations based on their fair values.
Determining the fair value of share-based awards at the grant date requires
judgment in estimating the volatility and dividends over the expected term
that
the stock options will be outstanding prior to exercise. Judgment is also
required in estimating the amount of stock-based awards expected to be forfeited
prior to vesting. If actual forfeitures differ significantly from our estimates,
stock-based compensation expense could be materially impacted.
Reclassifications
Certain
prior year amounts have been reclassified to conform to the current year
presentation.
NOTE
3. TRANSACTIONS WITH RELATED PARTIES
Several
subsidiaries of AIG together own approximately 62% of our outstanding common
stock and four of the eleven members of our Board of Directors, including our
Chairman, are current or former officers and employees of AIG or its
subsidiaries. Since 1995, the Company has entered into transactions with AIG
subsidiaries, including reinsurance agreements, corporate insurance coverage,
and investment management and investment accounting.
Reinsurance
Agreements
Two
AIG
subsidiaries are 80% participants
in a catastrophe reinsurance agreement for auto physical damage losses
incurred by the Company under the comprehensive coverage portion
of its auto policies. The AIG subsidiaries are all rated A+
or
higher.
Total
premiums ceded to AIG subsidiaries were $1.0 million, $1.0 million, and $1.1
million for the years ended December 31, 2006, 2005, and 2004, respectively.
Total reinsurance recoverables, net of payables, from AIG subsidiaries were
$0.4
million and $0.6 million at December 31, 2006 and 2005,
respectively.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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.
Total
insurance expense attributable to AIG corporate insurance coverages was $3.7
million, $2.9 million, and $3.5 million for 2006, 2005, and 2004, respectively.
Investment
Management and Investment Accounting
In
October 2003, as a result of a competitive bidding process, we entered into
an
agreement with AIG Global Investment Corp. (“AIGGIC”) to provide investment
management and investment accounting services. 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 California Department
of
Insurance (“CDI”). Investment
management and accounting expense was $1.1 million, $0.9 million, and $0.9
million for the years ended December 31, 2006, 2005 and 2004,
respectively.
In
June
2006, the Company executed a $35 million funding commitment for a private equity
investment program, which is managed by AIGGIC. In the event that the Company
does not respond to a capital call during the investment term, the General
Partner of the fund (“GP”) may apply the following default provisions: withhold
50% of distributions due to the Company at the time of the default and 50%
of
future distributions due to the Company; hold the Company liable for fund
expenses above and beyond investments made by the Company (with the right of
offset); terminate the Company’s Limited Partner status and not allow it any
further investments; or charge interest on the defaulted capital commitment
amount and fees at LIBOR + 4% (with the right of offset). However, the GP may
choose not to designate the Company a “defaulting limited partner” and waive the
default provisions. The investment term ends after the underlying investments
are liquidated, but in no event is longer than 10 years. Multiple investments
are expected to be purchased and liquidated over the investment term. The
Company funded $14.4 million of the commitment during 2006.
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. There was no expense
in
2006 or 2005.
NOTE
4. INVESTMENTS
A
summary
of net investment income follows:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Interest
on fixed maturity securities
|
|
$
|
67,449
|
|
$
|
63,122
|
|
$
|
57,729
|
|
Interest
on cash and cash equivalents
|
|
|
1,272
|
|
|
1,188
|
|
|
585
|
|
Interest
on other long-term investments
|
|
|
63
|
|
|
—
|
|
|
—
|
|
Dividends
on equity securities
|
|
|
811
|
|
|
5,849
|
|
|
1,484
|
|
Total
investment income
|
|
|
69,595
|
|
|
70,159
|
|
|
59,798
|
|
Investment
expense
|
|
|
(1,102
|
)
|
|
(1,063
|
)
|
|
(967
|
)
|
Net
investment income
|
|
$
|
68,493
|
|
$
|
69,096
|
|
$
|
58,831
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
A
summary
of net realized investment gains (losses) follows:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Realized
gains on sales of fixed maturity securities
|
|
$
|
755
|
|
$
|
272
|
|
$
|
11,419
|
|
Realized
gains on sales of equity securities
|
|
|
1,198
|
|
|
6,302
|
|
|
2,726
|
|
Total
realized gains on sales of investments
|
|
|
1,953
|
|
|
6,574
|
|
|
14,145
|
|
Realized
losses on sales of fixed maturity securities
|
|
|
(49
|
)
|
|
(1,183
|
)
|
|
(1,708
|
)
|
Realized
losses on sales of equity securities
|
|
|
(2,554
|
)
|
|
(8,299
|
)
|
|
(757
|
)
|
Total
realized losses on sales of investments
|
|
|
(2,603
|
)
|
|
(9,482
|
)
|
|
(2,465
|
)
|
Realized
losses on disposal of property and equipment
|
|
|
(779
|
)
|
|
(364
|
)
|
|
(849
|
)
|
Total
net realized investment (losses) gains
|
|
$
|
(1,429
|
)
|
$
|
(3,272
|
)
|
$
|
10,831
|
|
A
summary
of changes in net unrealized investment gains and losses less applicable income
taxes for fixed maturity securities and equity securities is as
follows:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Fixed
maturity securities:
|
|
|
|
|
|
|
|
Net
decrease in unrealized losses
|
|
$
|
(7,212
|
)
|
$
|
(32,779
|
)
|
$
|
(14,612
|
)
|
Income
tax benefit
|
|
|
2,524
|
|
|
11,473
|
|
|
5,114
|
|
Total
decrease in net unrealized investment losses after taxes
|
|
$
|
(4,688
|
)
|
$
|
(21,306
|
)
|
$
|
(9,498
|
)
|
Equity
securities:
|
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in unrealized gains (losses)
|
|
$
|
1,843
|
|
$
|
(2,477
|
)
|
$
|
635
|
|
Income
tax (expense) benefit
|
|
|
(645
|
)
|
|
867
|
|
|
(222
|
)
|
Total
increase (decrease) in net unrealized investment losses and gains
after
taxes
|
|
$
|
1,198
|
|
$
|
(1,610
|
)
|
$
|
413
|
|
A
summary
of investments available-for-sale follows:
|
|
Cost
or
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
Fair
Value
|
December
31, 2006
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury securities and obligations of U.S.Government corporations
and
agencies
|
|
$
|
50,113
|
|
$
|
132
|
|
$
|
(886
|
)
|
$
|
49,359
|
|
Mortgage-backed
securities
|
|
|
321,431
|
|
|
32
|
|
|
(8,516
|
)
|
|
312,947
|
|
Obligations
of states and political subdivisions
|
|
|
395,144
|
|
|
11,763
|
|
|
(457
|
)
|
|
406,450
|
|
Corporate
securities
|
|
|
686,780
|
|
|
895
|
|
|
(21,415
|
)
|
|
666,260
|
|
Total
investments available-for-sale
|
|
$
|
1,453,468
|
|
$
|
12,822
|
|
$
|
(31,274
|
)
|
$
|
1,435,016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 securities
|
|
|
1,365,948
|
|
|
17,148
|
|
|
(28,389
|
)
|
|
1,354,707
|
|
Equity
securities
|
|
|
49,210
|
|
|
335
|
|
|
(2,178
|
)
|
|
47,367
|
|
Total
investments available-for-sale
|
|
$
|
1,415,158
|
|
$
|
17,483
|
|
$
|
(30,567
|
)
|
$
|
1,402,074
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
The
Company has no non-interest bearing fixed maturity securities, investments
accounted for on a non-accrual basis or any individual securities in excess of
10% of stockholders’ equity. Fixed maturity securities available-for-sale, at
December 31, 2006, are summarized by contractual maturity year as
follows:
|
|
Amortized
Cost
|
Fair
Value
|
Fixed
maturity securities, excluding mortgage-backed securities,
due:
|
|
|
|
|
|
2007
|
|
$
|
6,547
|
|
$
|
6,506
|
|
2008-2011
|
|
|
648,748
|
|
|
631,671
|
|
2012-2016
|
|
|
322,175
|
|
|
326,748
|
|
2017
and thereafter
|
|
|
154,567
|
|
|
157,144
|
|
Mortgage-backed
securities
|
|
|
321,431
|
|
|
312,947
|
|
Total
fixed maturity securities
|
|
$
|
1,453,468
|
|
$
|
1,435,016
|
|
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, 2006
|
|
#
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
|
|
|
6
|
|
$
|
1,332
|
|
$
|
2
|
|
|
17
|
|
$
|
38,622
|
|
$
|
884
|
|
|
23
|
|
$
|
39,954
|
|
$
|
886
|
|
Mortgage-backed
securities
|
|
|
21
|
|
|
71,944
|
|
|
902
|
|
|
32
|
|
|
237,274
|
|
|
7,614
|
|
|
53
|
|
|
309,218
|
|
|
8,516
|
|
Obligations
of states and political subdivisions
|
|
|
11
|
|
|
53,260
|
|
|
246
|
|
|
4
|
|
|
9,107
|
|
|
211
|
|
|
15
|
|
|
62,367
|
|
|
457
|
|
Corporate
securities
|
|
|
28
|
|
|
83,999
|
|
|
1,921
|
|
|
114
|
|
|
529,674
|
|
|
19,494
|
|
|
142
|
|
|
613,673
|
|
|
21,415
|
|
Total
investments in an unrealized loss position
|
|
|
66
|
|
$
|
210,535
|
|
$
|
3,071
|
|
|
167
|
|
$
|
814,677
|
|
$
|
28,203
|
|
|
233
|
|
$
|
1,025,212
|
|
$
|
31,274
|
|
|
|
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 securities
|
|
|
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 in an unrealized loss position
|
|
|
354
|
|
$
|
454,663
|
|
$
|
11,691
|
|
|
94
|
|
$
|
489,757
|
|
$
|
18,876
|
|
|
448
|
|
$
|
944,420
|
|
$
|
30,567
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
A
summary
follows of the unrealized gains and losses on investments available-for-sale,
net of tax, that are included in accumulated other comprehensive loss on the
consolidated balance sheets:
December
31,
|
|
2006
|
2005
|
Fixed
maturity securities available-for sale:
|
|
|
|
|
|
Unrealized
gains
|
|
$
|
12,822
|
|
$
|
16,904
|
|
Unrealized
losses
|
|
|
(31,274
|
)
|
|
(28,144
|
)
|
Tax
effect
|
|
|
6,458
|
|
|
3,934
|
|
Net
unrealized losses on fixed maturity securities
available-for-sale
|
|
$
|
(11,994
|
)
|
$
|
(7,306
|
)
|
Equity
securities available-for-sale:
|
|
|
|
|
|
|
|
Unrealized
gains
|
|
$
|
—
|
|
$
|
315
|
|
Unrealized
losses
|
|
|
—
|
|
|
(2,157
|
)
|
Tax
effect
|
|
|
—
|
|
|
644
|
|
Net
unrealized losses on equity securities available-for-sale
|
|
$
|
—
|
|
$
|
(1,198
|
)
|
Total
net unrealized losses on investments available-for-sale
|
|
$
|
(11,994
|
)
|
$
|
(8,504
|
)
|
None
of
the Company’s 233 investment positions with unrealized losses at December 31,
2006 were judged to have any fundamental issues that would lead the Company
to
believe that they were other-than-temporarily impaired. Of the 233 fixed
maturity securities in an unrealized loss position, the Company had 167
investments that were in an unrealized loss position for 12 months or more.
The
related unrealized losses primarily arose as a result of rising interest rates.
The unrealized loss for all investments in an unrealized loss position, which
are all investment grade, comprised 3.3% of the related amortized cost.
The
Company has the intent and ability to hold these fixed maturity securities
to
recovery or maturity/redemption, and will do so, as long as the security
positions continue to adhere to the Company’s investment strategy. If the
Company’s strategy were to change and these securities were determined to be
other-than-temporarily impaired, the Company would recognize a write-down in
accordance with its stated policy.
Cash
and
securities with fair values of $7.2 million and $7.0 million at December 31,
2006 and 2005 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,
|
|
2006
|
2005
|
2004
|
Current
tax expense
|
|
$
|
26,986
|
|
$
|
27,655
|
|
$
|
8,822
|
|
Deferred
tax expense
|
|
|
17,237
|
|
|
12,351
|
|
|
25,246
|
|
Total
tax expense
|
|
$
|
44,223
|
|
$
|
40,006
|
|
$
|
34,068
|
|
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,
|
|
2006
|
2005
|
2004
|
Federal
income tax expense at statutory rate
|
|
$
|
49,508
|
|
$
|
44,601
|
|
$
|
42,803
|
|
Tax-exempt
income, net
|
|
|
(4,861
|
)
|
|
(4,179
|
)
|
|
(4,888
|
)
|
Stock-based
compensation
|
|
|
950
|
|
|
—
|
|
|
—
|
|
State
and local taxes, net of federal benefit
|
|
|
(2,320
|
)
|
|
102
|
|
|
(4,477
|
)
|
Dividends
received deduction
|
|
|
(150
|
)
|
|
(630
|
)
|
|
(294
|
)
|
Nondeductible
political contributions
|
|
|
536
|
|
|
239
|
|
|
497
|
|
Effect
of nondeductible executive compensation
|
|
|
285
|
|
|
—
|
|
|
435
|
|
Other
- net
|
|
|
275
|
|
|
(127
|
)
|
|
(8
|
)
|
Income
tax expense
|
|
$
|
44,223
|
|
$
|
40,006
|
|
$
|
34,068
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
The
significant components of deferred income tax expense attributable to income
from continuing operations are as follows:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Net
operating loss carryforward deduction
|
|
$
|
30,324
|
|
$
|
42,265
|
|
$
|
29,470
|
|
Increase
in alternative minimum tax credit, net of $115 credited to additional
paid-in capital in 2006
|
|
|
(10,854
|
)
|
|
(24,929
|
)
|
|
(13,425
|
)
|
Other
- net
|
|
|
(2,233
|
)
|
|
(4,985
|
)
|
|
9,201
|
|
Total
deferred tax expense
|
|
$
|
17,237
|
|
$
|
12,351
|
|
$
|
25,246
|
|
The
Company’s net deferred tax asset is comprised of:
December
31,
|
|
2006
|
2005
|
Deferred
tax assets (“DTAs”):
|
|
|
|
|
|
Alternative
minimum tax credit
|
|
$
|
59,681
|
|
$
|
48,712
|
|
Net
operating loss carryforward
|
|
|
3,258
|
|
|
33,582
|
|
Unearned
premiums
|
|
|
23,021
|
|
|
22,927
|
|
Unpaid
losses and LAE
|
|
|
6,112
|
|
|
6,407
|
|
Unrealized
investment losses
|
|
|
6,458
|
|
|
4,579
|
|
Employee
benefits
|
|
|
5,690
|
|
|
675
|
|
Research
credit
|
|
|
2,423
|
|
|
2,423
|
|
Pension
liability
|
|
|
8,503
|
|
|
1,011
|
|
Other
DTAs - net
|
|
|
2,727
|
|
|
1,172
|
|
Total
DTAs
|
|
|
117,873
|
|
|
121,488
|
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities (“DTLs”):
|
|
|
|
|
|
|
|
EDP
software development costs
|
|
|
(45,007
|
)
|
|
(44,300
|
)
|
Deferred
policy acquisition costs
|
|
|
(22,253
|
)
|
|
(20,979
|
)
|
Other
DTLs - net
|
|
|
(2,176
|
)
|
|
—
|
|
Total
DTLs
|
|
|
(69,436
|
)
|
|
(65,279
|
)
|
Net
deferred tax asset
|
|
$
|
48,437
|
|
$
|
56,209
|
|
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 less than “more likely
than not” (i.e., a likelihood of more than 50%) that any DTA will 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 $9.3
million, representing an unrealized tax benefit of $3.3 million at December
31,
2006, compared to $33.6 million at December 31, 2005. As a result of taxable
income since 2002, our NOL has been fully utilized through December 31, 2006,
except for the amount relating to 21st Century Insurance Company of the
Southwest (“21st
of
the Southwest”) that
is
subject to the Internal Revenue Service (“IRS”) separate return limitation year
provisions. The remaining NOL expires as follows: $1.4 million in 2017; $1.1
million in 2018; $1.5 million in 2019; $3.2 million in 2020; and $2.1 million
in
2021.
Our
ability to fully utilize the NOL of 21st of the Southwest and our other DTAs
depends primarily on future taxable income from operations and tax planning
strategies. Because of the Company’s profitable operating history and the
availability of tax planning strategies, management
believes it is reasonable to conclude that it is at least more likely than
not
that we will be able to realize the benefits of all of our DTAs. Accordingly,
no
valuation allowance has been recognized at December 31, 2006 or 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.
Implementation of tax planning strategies to effect realization of our remaining
NOL may require regulatory approvals, which although reasonably expected cannot
be assured by management. Future operating losses could possibly jeopardize
our
ability to realize our other DTAs. Future unfavorable regulatory actions or
operating losses would lead management to reach a different conclusion about
the
likelihood of realizing the DTAs and, if so, to recognize a valuation allowance
at that time for some or all of the DTAs.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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 Franchise Tax Board (“FTB”), including certain matters paid
under protest as to which the Company reserved all its rights to file for
refunds and appeal to the California State Board of Equalization (“SBE”) any
adverse rulings by the California FTB. In September 2005, the FTB completed
its
audit and denied our refund claims. In December 2005, the Company filed an
appeal with the SBE. In the fourth quarter of 2006, the Company executed a
settlement agreement with the FTB, for
which
the final required regulatory approval was obtained in February 2007.
Accordingly, the tax refund and accrued interest totaling approximately $2.9
million ($1.9 million net of federal tax effect) was recorded as a reduction
of
state income tax expense effective December 31, 2006.
During
2004, we received $12.5 million from the IRS to settle a prior year receivable.
At December 31, 2006 and 2005, the Company’s net federal income tax receivable
(payable) was $2.6 million and ($3.2) million, which are included in other
assets and liabilities, respectively, in the accompanying consolidated balance
sheets. The Company has no current liability recorded for any contingent
income tax items at December 31, 2006 or 2005.
The
Company has claimed certain items in prior years tax returns for which ultimate
realization is uncertain. At December 31, 2006, due to the Company’s NOL and AMT
credit carryforwards, these items have not yet reduced any taxes currently
payable. Furthermore, due to the uncertainty, deferred tax assets have not
been
recorded with respect to these items. In the future, when these items actually
reduce current tax payments, it is expected that a current liability will be
recorded.
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 six-month policy
period):
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Deferred
policy acquisition costs, beginning of year
|
|
$
|
59,939
|
|
$
|
58,759
|
|
$
|
53,079
|
|
Policy
acquisition costs deferred
|
|
|
259,767
|
|
|
253,721
|
|
|
228,159
|
|
Policy
acquisition costs amortized and charged to income during the
year
|
|
|
(256,125
|
)
|
|
(252,541
|
)
|
|
(222,479
|
)
|
Deferred
policy acquisition costs, end of year
|
|
$
|
63,581
|
|
$
|
59,939
|
|
$
|
58,759
|
|
Total
advertising costs after it takes place included in policy acquisition costs
deferred during 2006, 2005 and 2004 were $74.9 million, $70.1 million, and
$66.7
million, respectively.
We
provide services in certain states that assess premium taxes based on direct
premiums written. These taxes generally are in lieu of state income taxes and
totaled $36.9 million, $36.0 million, and $33.4 million in 2006, 2005 and 2004,
respectively. These amounts are included in policy acquisition costs and are
deferred and amortized over the six-month policy period in accordance with
our
deferred policy acquisition cost policy.
NOTE
7. PROPERTY AND EQUIPMENT
A
summary
of property and equipment follows:
December
31,
|
|
2006
|
2005
|
Land
|
|
$
|
2,484
|
|
$
|
2,484
|
|
Building
|
|
|
9,720
|
|
|
9,720
|
|
Furniture,
equipment and auto
|
|
|
43,244
|
|
|
39,875
|
|
Leasehold
and building improvements
|
|
|
15,445
|
|
|
16,215
|
|
Software
currently in service
|
|
|
170,820
|
|
|
157,446
|
|
Software
projects in progress
|
|
|
17,532
|
|
|
9,666
|
|
Subtotal
|
|
|
259,245
|
|
|
235,406
|
|
Less
accumulated depreciation, including $57,375 and $43,689 for software
currently in service
|
|
|
(104,279
|
)
|
|
(89,595
|
)
|
Total
|
|
$
|
154,966
|
|
$
|
145,811
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
A
summary
of leased property under capital lease follows:
December
31,
|
|
2006
|
2005
|
Furniture
and equipment
|
|
$
|
11,306
|
|
$
|
10,391
|
|
Leasehold
improvements
|
|
|
5,390
|
|
|
5,390
|
|
Software
currently in service
|
|
|
43,150
|
|
|
43,150
|
|
Leased
autos under capital lease
|
|
|
2,676
|
|
|
2,249
|
|
Subtotal
|
|
|
62,522
|
|
|
61,180
|
|
Less:
|
|
|
|
|
|
|
|
Accumulated
amortization
|
|
|
(42,149
|
)
|
|
(36,995
|
)
|
Deferred
gain
|
|
|
(1,092
|
)
|
|
(1,534
|
)
|
Total
|
|
$
|
19,281
|
|
$
|
22,651
|
|
A
summary
of property and equipment depreciation expense follows:
December
31,
|
|
2006
|
2005
|
2004
|
Building
|
|
$
|
246
|
|
$
|
61
|
|
$
|
—
|
|
Furniture
and equipment
|
|
|
2,437
|
|
|
2,525
|
|
|
3,640
|
|
Leasehold
and building improvements
|
|
|
1,427
|
|
|
1,166
|
|
|
817
|
|
Software
currently in service
|
|
|
18,272
|
|
|
18,643
|
|
|
6,975
|
|
Total
|
|
$
|
22,382
|
|
$
|
22,395
|
|
$
|
11,432
|
|
Depreciation
expense for leased property under capital lease was $5.2 million, $12.8 million,
and $12.4 million for the years 2006, 2005, and 2004, respectively.
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, 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 reserves for losses
and LAE are adequate to cover unpaid losses and LAE at December 31, 2006. 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 at December 31, 2006. 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 (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
The
following is a reconciliation of the activity in the reserve for unpaid losses
and LAE:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
At
beginning of year:
|
|
|
|
|
|
|
|
Reserve
for losses and LAE, gross of reinsurance
|
|
$
|
523,835
|
|
$
|
495,542
|
|
$
|
438,323
|
|
Reinsurance
recoverable
|
|
|
(5,617
|
)
|
|
(4,645
|
)
|
|
(8,964
|
)
|
Reserve
for losses and LAE, net of reinsurance
|
|
|
518,218
|
|
|
490,897
|
|
|
429,359
|
|
Losses
and LAE incurred, net of reinsurance:
|
|
|
|
|
|
|
|
|
|
|
Current
year
|
|
|
972,743
|
|
|
1,024,073
|
|
|
993,946
|
|
Prior
years
|
|
|
(51,897
|
)
|
|
(25,140
|
)
|
|
(105
|
)
|
Total
|
|
|
920,846
|
|
|
998,933
|
|
|
993,841
|
|
Losses
and LAE paid, net of reinsurance:
|
|
|
|
|
|
|
|
|
|
|
Current
year
|
|
|
662,036
|
|
|
684,474
|
|
|
642,664
|
|
Prior
years
|
|
|
300,959
|
|
|
287,138
|
|
|
289,639
|
|
Total
|
|
|
962,995
|
|
|
971,612
|
|
|
932,303
|
|
At
end of year:
|
|
|
|
|
|
|
|
|
|
|
Reserve
for losses and LAE, net of reinsurance
|
|
|
476,069
|
|
|
518,218
|
|
|
490,897
|
|
Reinsurance
recoverable
|
|
|
6,200
|
|
|
5,617
|
|
|
4,645
|
|
Reserve
for losses and LAE, gross of reinsurance
|
|
$
|
482,269
|
|
$
|
523,835
|
|
$
|
495,542
|
|
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,
|
|
2006
|
2005
|
2004
|
Personal
auto
|
|
$
|
(52,648
|
)
|
$
|
(27,473
|
)
|
$
|
(2,936
|
)
|
Homeowner
and earthquake1
|
|
|
751
|
|
|
2,333
|
|
|
2,831
|
|
Total
|
|
$
|
(51,897
|
)
|
$
|
(25,140
|
)
|
$
|
(105
|
)
|
Positive
amounts represent deficiencies in loss and LAE reserves, while negative amounts
represent redundancies.
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. Based on
this review, our actuaries prepare 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 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 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
favorable development in 2006 and 2005 was primarily due to favorable impact
of
declining frequency and moderate claim severity trends.
___________________
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 (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
The
following table shows unpaid losses and LAE gross and net of
reinsurance:
|
|
2006
|
|
2005
|
December
31,
|
|
Gross
|
Net
|
|
Gross
|
Net
|
Unpaid
losses and LAE
|
|
|
|
|
|
|
|
|
|
|
Personal
auto lines
|
|
$
|
480,731
|
|
$
|
475,261
|
|
|
$
|
521,528
|
|
$
|
516,849
|
|
Homeowner
and earthquake
|
|
|
1,538
|
|
|
808
|
|
|
|
2,307
|
|
|
1,369
|
|
Total
|
|
$
|
482,269
|
|
$
|
476,069
|
|
|
$
|
523,835
|
|
$
|
518,218
|
|
NOTE
9. DEBT
Debt
consisted of:
December
31,
|
|
2006
|
2005
|
Senior
Notes, net of discount (5.9%; maturing in 2013)
|
|
$
|
99,910
|
|
$
|
99,897
|
|
Obligation
under capital leases - sale-leaseback (5.7%; maturing through
2007)
|
|
|
13,539
|
|
|
26,327
|
|
Obligation
under other capital leases - equipment (ranging up to 6.9%; maturing
through 2011)
|
|
|
2,446
|
|
|
1,748
|
|
Total
debt
|
|
$
|
115,895
|
|
$
|
127,972
|
|
The
primary purpose of both of the Senior Notes and sale-leaseback enumerated above
was to increase the statutory surplus of the Company’s largest insurance
subsidiary.
In
December 2003, the Company completed a private offering of $100 million
principal amount of 5.9 percent Senior Notes due in December 2013 at a discount
of $0.8 million. The effective interest rate on the Senior Notes, when all
offering costs are taken into account and amortized over the term of the Senior
Notes, is approximately 6 percent per annum. Of the $99.2 million in net
proceeds from the Senior Notes, $85.0 million was used to increase the statutory
surplus of 21st Century Insurance Company, a wholly-owned subsidiary of the
Company, and the balance was retained by the holding company. In July 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.
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).
The estimated value of redemption was $105.8 million as of December 31,
2006.
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.
The
remaining capital lease obligation is for certain other longer term operating
leases.
Aggregate
principal payments on debt outstanding at December 31, 2006 are $14.3 million
for 2007, $0.7 million for 2008, $0.5 million for 2009, $0.4 million for 2010,
and $100.0 million thereafter.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
NOTE
10. REINSURANCE
The
Company has a catastrophe reinsurance agreement for auto physical damage losses
incurred under the comprehensive coverage portion of its auto policies. Three
participating entities, two of which are AIG subsidiaries (see further
discussion in Note 3 of the Notes
to Consolidated Financial Statements - Transactions with Related
Parties),
reinsure covered events up to $45.0 million in excess of $20.0 million. The
Company has no current reinsurance on its auto lines other than the
aforementioned catastrophe reinsurance agreement.
The
Company reinsures 90% of its exposure to its Personal Umbrella Policies through
90% quota share reinsurance treaty policies with Swiss RE Underwriters (55%)
and
Hannover Ruckversicherungs (35%). All of the aforementioned reinsurers are
rated
A+ or
higher.
The
effect of reinsurance on premiums written and earned is as follows:
|
|
2006
|
2005
|
2004
|
Years
Ended December 31,
|
|
Written
|
Earned
|
Written
|
Earned
|
Written
|
Earned
|
Gross
|
|
$
|
1,315,107
|
|
$
|
1,312,856
|
|
$
|
1,346,370
|
|
$
|
1,357,730
|
|
$
|
1,337,198
|
|
$
|
1,318,417
|
|
Ceded
|
|
|
(5,420
|
)
|
|
(5,271
|
)
|
|
(4,952
|
)
|
|
(4,793
|
)
|
|
(4,814
|
)
|
|
(4,747
|
)
|
Net
|
|
$
|
1,309,687
|
|
$
|
1,307,585
|
|
$
|
1,341,418
|
|
$
|
1,352,937
|
|
$
|
1,332,384
|
|
$
|
1,313,670
|
|
Gross
losses and loss adjustment expenses have been reduced by reinsurance ceded
as
follows:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Gross
losses and LAE incurred
|
|
$
|
923,716
|
|
$
|
1,002,342
|
|
$
|
997,612
|
|
Ceded
losses and LAE incurred
|
|
|
(2,870
|
)
|
|
(3,409
|
)
|
|
(3,771
|
)
|
Net
losses and LAE incurred
|
|
$
|
920,846
|
|
$
|
998,933
|
|
$
|
993,841
|
|
NOTE
11. EMPLOYEE BENEFIT PLANS
Pension
Plans
The
Company has a qualified defined benefit pension plan, which covers essentially
all employees who have completed at least one year of service. The pension
benefits under the qualified plan are based on employees’ compensation during
all years of service. The Company’s funding policy for the qualified plan is to
make annual contributions as required by applicable regulations; employees
may
not make contributions to this plan. For certain key employees designated by
the
Board of Directors, the Company sponsors a non-qualified supplemental executive
retirement plan (“SERP”). The SERP 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. Because the internal revenue code does
not
allow current deductions for advance funding of a non-qualified plan, the
Company’s funding policy with respect to this plan is to make contributions as
benefits become payable to participants.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Incremental
Effect of Adopting Statement 158
On
December 31, 2006, the Company adopted FAS 158, as discussed in Note 2 of the
Notes
to Consolidated Financial Statements.
Adoption of FAS 158 had the effect of increasing accumulated other
comprehensive loss, a component of stockholders’ equity, by approximately $14.2
million at December 31, 2006, as shown in the following table. The column
labeled “Before Adopting FAS 158” includes the effects of the additional minimum
liability adjustment that would have been recognized under previously applicable
FAS 87 at December 31, 2006:
|
|
Before
Adopting
FAS
158
|
Adjustments
to
Adopt
FAS 158
|
After
Adopting
FAS
158
|
Deferred
income taxes
|
|
$
|
40,797
|
|
$
|
7,640
|
|
$
|
48,437
|
|
Other
assets
|
|
|
43,335
|
|
|
(15,386
|
)
|
|
27,949
|
|
Total
assets
|
|
$
|
1,959,443
|
|
$
|
(7,746
|
)
|
$
|
1,951,697
|
|
Other
liabilities
|
|
$
|
83,004
|
|
$
|
6,442
|
|
$
|
89,446
|
|
Accumulated
other comprehensive loss
|
|
|
(13,598
|
)
|
|
(14,188
|
)
|
|
(27,786
|
)
|
Total
liabilities and stockholders’ equity
|
|
$
|
1,959,443
|
|
$
|
(7,746
|
)
|
$
|
1,951,697
|
|
Benefit
Obligations
The
accumulated benefit obligation for all defined benefit pension plans was $120.6
million and $113.7 million at December 31, 2006 and 2005, respectively.
Accumulated benefit obligations represent the present value of both vested
and
nonvested pension benefits earned at December 31, 2006 based on actual service
and compensation through December 31, 2006 and taking into consideration other
actuarial assumptions, such as retirement ages, termination, disability, or
death.
Projected
benefit obligations for defined benefit plans represent the present value of
pension benefits earned at December 31, 2006 as described above plus the effects
of projected future salary increases to the assumed age of retirement,
termination, or death. The following table sets forth the change in the
projected benefit obligation of the defined benefit pension plans, including
the
supplemental plan, at December 31, 2006 and 2005:
Years
Ended December 31,
|
|
2006
|
2005
|
Projected
benefit obligation at beginning of year
|
|
$
|
133,613
|
|
$
|
116,475
|
|
Service
cost
|
|
|
7,130
|
|
|
6,860
|
|
Interest
cost
|
|
|
7,739
|
|
|
7,297
|
|
Plan
amendments
|
|
|
68
|
|
|
831
|
|
Actuarial
(gain) loss
|
|
|
(8,691
|
)
|
|
4,737
|
|
Benefits
paid
|
|
|
(2,808
|
)
|
|
(2,587
|
)
|
Projected
benefit obligation at end of year
|
|
$
|
137,051
|
|
$
|
133,613
|
|
Weighted-average
assumptions used to determine the benefit obligations follow:
December
31,
|
|
2006
|
|
2005
|
|
Discount
rate
|
|
|
5.9%
|
|
|
5.7%
|
|
Rate
of compensation increase
|
|
|
4.6%
|
|
|
4.6%
|
|
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 portfolio of high quality
bonds with cash flows matched to our projected benefit costs.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Both
of
the Company’s defined benefit pension plans have projected benefit obligations
in excess of plan assets at December 31, 2006 and 2005, as noted under the
discussion of Funded
Status.
The
following table sets forth the projected benefit obligation and accumulated
benefit obligation for the unfunded SERP, which has an accumulated benefit
obligation in excess of plan assets at December 31, 2006 and 2005:
December
31,
|
|
2006
|
2005
|
Projected
benefit obligation
|
|
$
|
21,997
|
|
$
|
22,702
|
|
Accumulated
benefit obligation
|
|
|
18,404
|
|
|
16,499
|
|
Funded
Status
The
following table sets forth the funded status of the plans at the end of the
year
and related amounts reported on the consolidated balance sheets:
December
31,
|
|
2006
|
2005
|
Fair
value of plan assets
|
|
$
|
112,204
|
|
$
|
100,244
|
|
Projected
benefit obligations
|
|
|
(137,051
|
)
|
|
(133,613
|
)
|
Funded
status
|
|
|
(24,847
|
)
|
|
(33,369
|
)
|
Unrecognized
net actuarial loss
|
|
|
—
|
|
|
39,735
|
|
Unrecognized
prior service cost
|
|
|
—
|
|
|
1,333
|
|
Amount
recognized, end of year
|
|
$
|
(24,847
|
)
|
$
|
7,699
|
|
|
|
|
|
|
|
|
|
Amounts
recognized in the balance sheets consist of:
|
|
|
|
|
|
|
|
Pension
liability
|
|
$
|
(24,847
|
)
|
$
|
(16,499
|
)
|
Prepaid
pension cost
|
|
|
—
|
|
|
20,007
|
|
Intangible
asset
|
|
|
—
|
|
|
1,302
|
|
Accumulated
other comprehensive income
|
|
|
—
|
|
|
2,889
|
|
Amount
recognized, end of year
|
|
$
|
(24,847
|
)
|
$
|
7,699
|
|
|
|
|
|
|
|
|
|
Amounts
recognized in accumulated other comprehensive loss consist
of:
|
|
|
|
|
|
|
|
Net
actuarial loss
|
|
$
|
(23,040
|
)
|
$
|
—
|
|
Prior
service cost
|
|
|
(1,255
|
)
|
|
—
|
|
Deferred
tax benefits
|
|
|
8,503
|
|
|
—
|
|
Amount
recognized, end of year
|
|
$
|
(15,792
|
)
|
$
|
—
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Changes
in Pension-Related Amounts Included in Accumulated Other Comprehensive
Loss
The
following table shows pension related amounts included in accumulated other
comprehensive loss for the years ended December 31, 2006, 2005, and
2004:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Balances
at beginning of year:
|
|
|
|
|
|
|
|
Additional
minimum pension liability in excess of unamortized prior service
cost
|
|
$
|
2,889
|
|
$
|
2,642
|
|
$
|
2,992
|
|
Deferred
income tax benefits
|
|
|
(1,011
|
)
|
|
(925
|
)
|
|
(1,047
|
)
|
Total
at beginning of year
|
|
|
1,878
|
|
|
1,717
|
|
|
1,945
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
effects of minimum liability adjustments required under FAS 87,
net of
deferred income expense (benefit) of $147, $(86) and $123,
respectively
|
|
|
(274
|
)
|
|
161
|
|
|
(228
|
)
|
Incremental
effect of adopting FAS 158 in 2006, net of deferred taxes of
$7,640
|
|
|
14,188
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at end of year:
|
|
|
|
|
|
|
|
|
|
|
Additional
minimum pension liability in excess of unamortized prior service
cost
|
|
|
—
|
|
|
2,889
|
|
|
2,642
|
|
Net
actuarial loss
|
|
|
23,040
|
|
|
—
|
|
|
—
|
|
Prior
service cost
|
|
|
1,255
|
|
|
—
|
|
|
—
|
|
Deferred
tax benefits
|
|
|
(8,503
|
)
|
|
(1,011
|
)
|
|
(925
|
)
|
Total
at end of year
|
|
$
|
15,792
|
|
$
|
1,878
|
|
$
|
1,717
|
|
Change
in Plan Assets
The
following table sets forth the change in plan assets at December 31, 2006
and
2005:
Years
Ended December 31,
|
|
2006
|
2005
|
Fair
value of plan assets at beginning of year
|
|
$
|
100,244
|
|
$
|
86,585
|
|
Actual
return on plan assets net of expenses
|
|
|
13,832
|
|
|
6,282
|
|
Employer
contributions
|
|
|
936
|
|
|
9,964
|
|
Benefits
paid
|
|
|
(2,808
|
)
|
|
(2,587
|
)
|
Fair
value of plan assets at end of year
|
|
$
|
112,204
|
|
$
|
100,244
|
|
The
Company’s pension plan weighted-average asset allocations for 2006 and 2005, and
target allocation for 2007, by asset category are as follows:
|
|
Percentage
of Plan Assets at
December
31,
|
|
Target
Allocation
|
|
Asset
Category
|
|
2006
|
|
2005
|
|
2007
|
|
Equity
securities
|
|
|
78%
|
|
|
70%
|
|
|
66-84%
|
|
Debt
securities
|
|
|
21
|
|
|
20
|
|
|
22-28
|
|
Other
|
|
|
1
|
|
|
10
|
|
|
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.
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 utilizes consulting pension actuaries to perform stochastic modeling
services to assist the Company in determining the assumed expected long-term
rate of return on assets, based on an assumption that 75% of the plan asset
portfolio will be invested in equity securities, with the remainder invested
in
debt securities. Historical returns were not adjusted for purposes of performing
the stochastic modeling. Neither the Company nor either of the defined benefit
plans have engaged in any prohibited transactions.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Components
of Net Periodic Benefit Cost
The
following table presents the components of net periodic benefit cost for the
years ended December 31, 2006, 2005, and 2004:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Components
of net periodic benefit cost:
|
|
|
|
|
|
|
|
Service
cost
|
|
$
|
7,130
|
|
$
|
6,860
|
|
$
|
6,493
|
|
Interest
cost
|
|
|
7,739
|
|
|
7,297
|
|
|
6,638
|
|
Expected
return on plan assets
|
|
|
(8,440
|
)
|
|
(7,317
|
)
|
|
(6,441
|
)
|
Amortization
of actuarial net loss
|
|
|
2,612
|
|
|
1,923
|
|
|
2,163
|
|
Amortization
of prior service cost
|
|
|
146
|
|
|
175
|
|
|
111
|
|
Net
periodic benefit cost
|
|
$
|
9,187
|
|
$
|
8,938
|
|
$
|
8,964
|
|
The
estimated actuarial net loss and prior service cost for the defined benefit
pension plans that will be amortized from accumulated other comprehensive loss
into net periodic benefit cost in 2007 are $1.0 million and $0.1 million,
respectively.
The
weighted-average assumptions used to determine net periodic benefit cost were
as
follows:
Years
Ended December 31,
|
|
2006
|
|
2005
|
|
2004
|
|
Discount
rate
|
|
|
5.7%
|
|
|
6.0%
|
|
|
6.1%
|
|
Expected
return on plan assets
|
|
|
8.5%
|
|
|
8.5%
|
|
|
8.5%
|
|
Rate
of compensation increase
|
|
|
4.6%
|
|
|
4.6%
|
|
|
4.6%
|
|
Pension
Plan Contributions
The
amount and timing of future contributions to the Company’s qualified defined
benefit pension plan depends on a number of assumptions 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. The Company did not make any contributions to its qualified defined
benefit pension plan in 2006, contributed $9.0 million in 2005, and contributed
$2.5 million in 2004. Based on current assumptions, the Company does not expect
to be required to contribute to its qualified plan in 2007.
The
Company contributed $0.9 million, $1.0 million, and $0.2 million to its
non-qualified defined benefit pension plan in 2006, 2005, and 2004,
respectively. 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 2007.
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
|
2007
|
|
$
|
3,311
|
|
2008
|
|
|
3,812
|
|
2009
|
|
|
4,226
|
|
2010
|
|
|
5,118
|
|
2011
|
|
|
5,935
|
|
2012-2016
|
|
|
49,726
|
|
Total
|
|
$
|
72,128
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Defined
Contribution Plans
The
Company sponsors a qualified 401(k) 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 eligible compensation or the
amount contributed by the employee up to the maximum allowable under IRS
regulations. The plan offers a variety of investments among which employees
exercise complete discretion as to choice and investment duration. The Company
also sponsors a 401(k) supplemental plan to provide specified benefits to a
select group of management and highly compensated employees. Company matching
contributions charged against operations were $6.0 million, $5.0 million, and
$4.9 million in 2006, 2005 and 2004, respectively. The plan offers a variety
of
investment types among which employees exercise complete discretion as to choice
and investment duration.
NOTE
12. COMMITMENTS AND CONTINGENCIES
Contractual
Commitments
The
Company leases office space in Woodland Hills, California. The lease for the
Company’s headquarters expires in February 2015 and may be renewed for two
consecutive five-year periods. See Note 2 of the Notes
to Consolidated Financial Statements for
the
discussion of excess space that the Company vacated at its headquarters.
The
Company also leases automobiles, office and telecom equipment as well as office
space in several other locations, primarily for claims services. Rent expense
for leases with predetermined minimum rental escalations is recognized on a
straight-line basis, and the difference between the recognized rental expense
and amounts payable under the leases, or deferred rent, is included in other
liabilities. The deferred rent liability was $5.8 million and $4.3 million
at
December 31, 2006 and 2005, respectively. The Company also has software license
agreements with terms greater than one year.
Minimum
amounts due under the Company’s noncancelable commitments, excluding its
commitment to purchase investments discussed in Notes 3 and 18 of the
Notes
to Consolidated Financial Statements,
at
December 31, 2006 are as follows:
Years
Ended December 31,
|
|
Software
Commitments
|
Operating2
Leases
|
Capital
Leases
|
2007
|
|
$
|
6,471
|
|
$
|
19,615
|
|
$
|
14,896
|
|
2008
|
|
|
6,885
|
|
|
17,044
|
|
|
774
|
|
2009
|
|
|
1,690
|
|
|
15,676
|
|
|
542
|
|
2010
|
|
|
1,690
|
|
|
16,285
|
|
|
384
|
|
2011
|
|
|
1,622
|
|
|
16,224
|
|
|
90
|
|
Thereafter
|
|
|
5,482
|
|
|
45,491
|
|
|
—
|
|
Total
|
|
$
|
23,840
|
|
$
|
130,335
|
|
$
|
16,686
|
|
Less:
amount representing interest
|
|
|
|
|
|
|
|
|
(701
|
)
|
Present
value of minimum lease payments
|
|
|
|
|
|
|
|
$
|
15,985
|
|
The
following table summarizes total rental and licensing expense charged to
operations:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Facilities
|
|
$
|
15,458
|
|
$
|
16,869
|
|
$
|
14,925
|
|
Equipment
and other
|
|
|
3,286
|
|
|
4,557
|
|
|
4,338
|
|
Software
related
|
|
|
9,576
|
|
|
8,667
|
|
|
7,896
|
|
Sublease
income
|
|
|
(678
|
)
|
|
(408
|
)
|
|
(385
|
)
|
Total
|
|
$
|
27,642
|
|
$
|
29,685
|
|
$
|
26,774
|
|
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.
____________________
2 |
Includes
total amounts due to the Company under current sublease agreement
of
approximately $2.9 million.
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Legal
Proceedings
In
the
normal course of business, the Company is named as a defendant in lawsuits
related to its insurance operations and 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 the possibility
of the contingencies discussed below, the Company does not believe the ultimate
outcome of these matters will be material to its results of operations,
financial condition or cash flows. In addition, the Company denies liability
and
has not established a reserve for the matters discussed below. A range of
potential losses in the event of a negative outcome is discussed where
known.
Poss
v. 21st Century Insurance Company was
filed
on June 13, 2003, in Los Angeles Superior Court and Axen
v. 21st Century Insurance Company
was
filed on April 14, 2004 in Alameda County Superior Court. Both complaints seek
injunctive and unspecified restitutionary relief against the Company under
Business and Professions Code (“B&P”) Sec. 17200 for alleged unfair business
practices in violation of California Insurance Code Sec. 1861.02(c) relating
to
Company rating practices. The court in the Poss
case
granted the Company’s motion to dismiss the complaint, based on California’s
Proposition 64, but allowed the addition of a second plaintiff, Leacy. Discovery
has been stayed in both cases and, because these matters are 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. In January
of 2007, a settlement agreement for an immaterial amount was reached with the
Axen plaintiff, which the Company is finalizing.
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 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 could
not 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 $2.5 million. This matter is now subject to three separate
appeals by the parties. The Company’s Motion to Consolidate the three appeals
was recently denied by the Court of Appeal.
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 contended that the
Company uses “biased” software in determining the value of total-loss
automobiles. Specifically, Plaintiff alleged that database providers use
improper methodology to establish comparable auto values, that the providers
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, and a new appraisal was ordered. On October 13,
2006, Plaintiff’s counsel offered to dismiss this case, with prejudice, in
exchange for the Company waiving its costs. The Company has accepted the offer
from the Plaintiff’s counsel to dismiss the matter and will support a motion,
containing the agreed terms.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Thomas
Theis, on his own behalf and on behalf of all others similarly situated v.
21st
Century Insurance Company
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. On January
11, 2007, Plaintiff’s motion to certify a “med-pay” class was granted. This
matter is in the discovery state of litigation and no reasonable estimate of
potential losses in the event of a negative outcome can be made at this time.
The Company intends to vigorously defend the suit.
Silvia
Quintana, on her own behalf and on behalf of all others similarly situated
v.
21st Century Insurance Company
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 pleading stage and no
reasonable estimate of potential losses in the event of a negative outcome
can
be made at this time. In July 2006, the trial court denied the Company’s
demurrer and motion to strike and the Company has filed a writ to the Court
of
Appeal for review of this decision. In November 2006, the Court of Appeal
ordered the trial court to show cause why the relief the Company requested
should not be granted. Oral arguments have not yet been scheduled.
Ronald
A.Katz Technology Licensing, L.P. v. American International Group, Inc. et
al was
filed
on September 1, 2006, in the United States District Court for the District
of
Delaware. The defendants include American International Group, Inc., its
subsidiaries and affiliates, including 21st Century Insurance Group, 21st
Century Insurance Company, and 21st Century Casualty Company. The complaint
alleges infringement of various patents relating to automated call processing
applications. The matter is in the initial pleading stage 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
LOSS
The
Company is authorized to issue up to 500,000 shares of preferred stock, $0.001
par value, none of which was outstanding at December 31, 2006 or
2005.
At
December 31, 2006 and 2005, there were 86,471,754 and 85,933,960 shares of
the
Company’s common stock outstanding, respectively. No shares were repurchased in
2006 or 2005. However, forfeited restricted shares are deemed treasury share
purchases.
Accumulated
other comprehensive income (loss) is a component of stockholders’ equity and
includes all net changes in the unrealized appreciation and depreciation in
value of available-for-sale investments, changes in minimum pension liability
in
excess of unamortized prior service cost, and changes in unamortized prior
service cost and actuarial loss of defined benefit pension plans.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
A
summary
of accumulated other comprehensive loss follows:
December
31,
|
|
2006
|
2005
|
Net
unrealized losses on available-for-sale investments, net of deferred
income taxes of $(6,458) and of $(4,579)
|
|
$
|
(11,994
|
)
|
$
|
(8,504
|
)
|
Minimum
pension liability in excess of unamortized prior service cost, net
of
deferred income taxes of $1,011
|
|
|
N/A
|
|
|
(1,878
|
)
|
Unamortized
prior service cost and net actuarial loss of defined benefit pension
plans, net of deferred income taxes of $8,503
|
|
|
(15,792
|
)
|
|
N/A
|
|
Total
accumulated other comprehensive loss
|
|
$
|
(27,786
|
)
|
$
|
(10,382
|
)
|
Net
change in accumulated other comprehensive loss follows:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Unrealized
holding losses arising during the period, net of tax benefit of $2,107,
$13,357, and $804, respectively
|
|
$
|
(3,913
|
)
|
$
|
(24,806
|
)
|
$
|
(1,493
|
)
|
Reclassification
adjustment for investment losses (gains) included in net income,
net of
tax benefit (expense) of $227, $1,018, and $(4,088),
respectively
|
|
|
423
|
|
|
1,890
|
|
|
(7,592
|
)
|
Net
effects of minimum pension liability adjustments required under FAS
87,
net of tax (expense) benefit of $(147), $86, and $(123),
respectively
|
|
|
274
|
|
|
(161
|
)
|
|
228
|
|
Total
net other comprehensive loss
|
|
|
(3,216
|
)
|
|
(23,077
|
)
|
|
(8,857
|
)
|
Incremental
effect of adopting FAS 158, net of deferred taxes of
$7,640
|
|
|
(14,188
|
)
|
|
—
|
|
|
—
|
|
Total
net change in accumulated other comprehensive loss
|
|
$
|
(17,404
|
)
|
$
|
(23,077
|
)
|
$
|
(8,857
|
)
|
NOTE
14. STOCK-BASED COMPENSATION
In
accordance with FAS 123R, the Company began recognizing the cost of all employee
stock options on a straight-line basis over their respective vesting periods,
net of estimated forfeitures, using the modified-prospective transition method.
Under this transition method, results for prior periods have not been restated
and 2006 results include:
|
·
|
Stock-based
compensation cost related to stock options granted on or prior to,
but not
vested at December 31, 2005, based on the grant date fair value originally
estimated for the pro forma disclosures in accordance with the original
provisions of FAS 123; and
|
|
·
|
All
stock-based payments granted subsequent to December 31, 2005, based
on the
grant date fair value estimated in accordance with the provisions
of FAS
123R.
|
FAS
123R
also prescribes the recognition of expense using the non-substantive vesting
period approach for grants made after December 31, 2005. This expense
attribution method requires recognition of compensation expense from the date
of
grant to the earlier of the vesting date or the date retirement eligibility
is
achieved for awards with retirement eligibility provisions. The use of the
non-substantive vesting period approach will not affect the overall amount
of
compensation expense recognized, but will accelerate the recognition of expense
for grants made since January 1, 2006. However, the Company will continue to
follow the nominal vesting approach (i.e., recognize expense from the grant
date
to the earlier of the actual date of retirement or the vesting date) for the
remaining portion of unvested awards that were granted prior to January 1,
2006.
Generally,
stock-based awards are forfeited when employees terminate prior to the vesting
date, and any compensation cost previously recognized with respect to such
unvested stock awards is reversed in the period of forfeiture. Upon restricted
share grant or share option exercise, the Company issues new shares, unless
the
Company elects to use available treasury shares. The Company records forfeitures
of restricted stock as treasury share repurchases.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Prior
to
the adoption of FAS 123R, the Company previously presented all benefits of
tax
deductions resulting from the exercise of share-based compensation as operating
cash flows in the Consolidated Statements of Cash Flows. FAS 123R requires
the
benefits of tax deductions in excess of the compensation cost recognized for
those options (excess tax benefits) to be classified as financing cash
flows.
2006
Stock-Based Compensation Summary
The
effect of the adoption of FAS 123R on the consolidated statements of operations
for the year ended December 31, 2006 is as follows:
|
|
|
|
|
|
|
|
AMOUNTS
IN THOUSANDS, EXCEPT PER SHARE DATA
|
|
Without
FAS
123R
|
FAS
123R
Impact
|
With
FAS
123R
|
Net
losses and loss adjustment expenses
|
|
$
|
917,552
|
|
$
|
3,294
|
|
$
|
920,846
|
|
Policy
acquisition costs
|
|
|
253,601
|
|
|
2,524
|
|
|
256,125
|
|
Other
underwriting expenses
|
|
|
44,115
|
|
|
3,542
|
|
|
47,657
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before provision for income taxes
|
|
|
150,811
|
|
|
(9,360
|
)
|
|
141,451
|
|
Provision
for income taxes
|
|
|
46,681
|
|
|
(2,458
|
)
|
|
44,223
|
|
Net
income
|
|
$
|
104,130
|
3 |
$
|
(6,902
|
)
|
$
|
97,228
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share
|
|
$
|
1.21
|
|
$
|
(0.08
|
)
|
$
|
1.13
|
|
Diluted
earnings per share
|
|
$
|
1.20
|
|
$
|
(0.08
|
)
|
$
|
1.12
|
|
The
year
ended December 31, 2006 results include $0.7 million of accelerated costs
incurred during the first quarter to recognize the effect of retirement
eligibility in accordance with the non-substantive vesting period approach
and
$1.4 million of actual vesting in accordance with an executive retention
agreement. As compensation costs for certain employees are included in deferred
policy acquisition costs, pre-tax compensation cost related to stock-based
compensation of $0.2 million was deferred, at December 31, 2006. The remaining
unrecognized compensation cost related to unvested awards at December 31, 2006,
was $8.7 million and the weighted-average period over which this cost will
be
recognized is 1.8 years. As a result of the adoption of FAS 123R, $0.3 million
of excess tax benefits in 2006 are classified as a financing cash inflow instead
of as an operating inflow in the consolidated statement of cash
flows.
2005
Stock-Based Compensation Pro Forma Summary
Had
compensation cost for the Company’s stock-based compensation plans been
determined in the prior year based on the fair-value based method for all
awards, net income would have been reduced by $4.9 million and $5.5 million
for
the years ended 2005 and 2004, respectively. The Company followed the nominal
vesting period approach, which recognizes compensation cost over the vesting
period unless the employee retired before the end of the vesting period at
which
time the Company recognizes any remaining unrecognized compensation cost at
the
date of retirement. The Company did not determine the amount of stock-based
compensation cost that would have been deferred as policy acquisition costs
in
its pro forma footnotes under FAS 123.
_______________________
3 |
Includes
$0.9 million stock-based compensation related to restricted shares
and
$0.3 million associated tax, as the previous accounting
under APB 25 was consistent with
that of FAS 123R, for the year ended December 31,
2006.
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
The
pro
forma net income and earnings per share amounts follow for the years ended
December 31:
AMOUNTS
IN THOUSANDS, EXCEPT FOR SHARE DATA
|
|
2005
|
2004
|
Net
income, as reported
|
|
$
|
87,426
|
|
$
|
88,225
|
|
Add:
Stock-based employee compensation expense included in reported
net income,
net of related tax effects
|
|
|
207
|
|
|
381
|
|
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
|
)
|
Net
income, pro forma
|
|
$
|
82,504
|
|
$
|
82,702
|
|
|
|
|
|
|
|
|
|
Basic
and diluted earnings per share
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
1.02
|
|
$
|
1.03
|
|
Pro
forma
|
|
$
|
0.96
|
|
$
|
0.97
|
|
Stock
Option Plans
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 (the “1995 Plan”), which remains in effect only as to outstanding
awards under the 1995 Plan. The 2004 Plan authorizes a Committee of the Board
of
Directors to grant stock options for the issuance of up to 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
that were subject to outstanding awards under the 1995 Plan to the extent such
awards expire, are terminated, are canceled, or are forfeited for any reason
without shares being issued.
Options
granted to employees generally have ten-year terms and vest ratably over three
years. Nonemployee director options vest over one year, provided that the
nonemployee director is in the service of the Company during that time. 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.
Issuable
and Issued Securities
A
summary
of securities issuable and issued for the Company’s stock option plans at
December 31, 2006, follows:
AMOUNTS
IN THOUSANDS
|
|
1995
Stock
Option
Plan
|
2004
Stock
Option
Plan
|
Total
number of securities authorized
|
|
|
10,000
|
|
|
4,000
|
|
Number
of securities issued
|
|
|
(1,102
|
)
|
|
(216
|
)
|
Number
of securities issuable upon the exercise of all outstanding
options
|
|
|
(6,546
|
)
|
|
(3,397
|
)
|
Number
of securities expired, forfeited, and canceled
|
|
|
(2,637
|
)
|
|
(293
|
)
|
Number
of expired, forfeited, and canceled securities returned to
plan
|
|
|
2,637
|
|
|
293
|
|
Unused
options assumed by 2004 Stock Option Plan
|
|
|
(2,352
|
)
|
|
2,352
|
|
Number
of securities available for future grants under each plan
|
|
|
—
|
|
|
2,739
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Current
Activity
A
summary
of the Company’s stock option activity and related information
follows:
AMOUNTS
IN THOUSANDS
|
|
Number
of
Options
|
Weighted-Average
Exercise
Price
|
Options
outstanding at December 31, 2005
|
|
|
8,869
|
|
$
|
16.22
|
|
Granted
in 2006
|
|
|
2,012
|
|
|
16.54
|
|
Exercised
in 2006
|
|
|
(433
|
)
|
|
13.12
|
|
Expired
in 2006
|
|
|
(180
|
)
|
|
19.88
|
|
Forfeited
in 2006
|
|
|
(245
|
)
|
|
15.14
|
|
Canceled
in 2006
|
|
|
(80
|
)
|
|
18.48
|
|
Options
outstanding at December 31, 2006
|
|
|
9,943
|
|
$
|
16.36
|
|
A
summary
of the Company’s stock option activity and related information at December 31,
for the years presented follows:
AMOUNTS
IN THOUSANDS
|
|
2006
|
2005
|
2004
|
Fair
value of stock options granted
|
|
$
|
10,040
|
|
$
|
8,186
|
|
$
|
10,710
|
|
Intrinsic
value of options exercised
|
|
|
967
|
|
|
821
|
|
|
108
|
|
Grant
date fair value of options vested
|
|
|
7,431
|
|
|
5,335
|
|
|
9,221
|
|
Proceeds
from exercise of stock options
|
|
|
5,675
|
|
|
4,649
|
|
|
576
|
|
Tax
benefit realized as a result of stock option exercises
|
|
|
338
|
|
|
284
|
|
|
38
|
|
Black-Scholes
Fair Values
The
weighted-average grant-date fair value for options granted during 2006, 2005
and
2004 was $4.99, $4.74, and $5.95, 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,
|
|
2006
|
|
2005
|
|
2004
|
|
Risk-free
interest rate:
|
|
|
|
|
|
|
|
Minimum
|
|
|
4.5%
|
|
|
3.7%
|
|
|
3.4%
|
|
Maximum
|
|
|
5.0%
|
|
|
4.3%
|
|
|
4.2%
|
|
Dividend
yield
|
|
|
1.9%
|
|
|
1.1%
|
|
|
0.6%
|
|
Volatility
factor of the expected market price of the Company’s common
stock:
|
|
|
|
|
|
|
|
|
|
|
Minimum
|
|
|
0.29
|
|
|
0.29
|
|
|
0.33
|
|
Maximum
|
|
|
0.29
|
|
|
0.32
|
|
|
0.41
|
|
Expected
option term
|
|
|
6
Years
|
|
|
6
Years
|
|
|
6
Years
|
|
The
expected term for options granted during the year ended December 31, 2006,
was
calculated using the simplified method in accordance with Staff Accounting
Bulletin No. 107, Shared-Based
Payment.
The
expected volatility of employee stock options was based on the historical
volatility of key competitors in the property and casualty insurance industry
(based on six years of closing stock prices). The Company believes that the
use
of historical competitor volatility better reflects current market expectations
of the Company’s stock price volatility. The Company’s own historical stock
price volatility is not representative of expected volatility due to significant
prior year events, such as the effects of the 1994 Northridge earthquake and
California Senate Bill 1899 (“SB 1899”), which would not be expected to
significantly impact results in the future. The annual risk-free interest rate
is based on a traded zero-coupon U.S. Treasury bond on the grant date with
a
term equal to the option’s expected term. The dividend yield is calculated based
on the expected annual dividend over the closing stock price on the grant
date.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Outstanding
Options
The
following table summarizes information about stock options outstanding and
exercisable at December 31, 2006 (amounts in thousands, except price and term
data):
|
Outstanding
|
|
Exercisable
|
Range
of Exercise Prices
|
Number
of Options
|
Weighted-
Average Remaining Contractual Term
|
Weighted-
Average Exercise Price
|
Aggregate
Intrinsic Value
|
|
Number
of Options
|
Weighted-
Average Remaining Contractual Term
|
Weighted-
Average Exercise Price
|
Aggregate
Intrinsic Value
|
|
1,178
|
6.2
Years
|
$
11.73
|
$
6,970
|
|
1,174
|
|
|
$
6,949
|
13.01
- 15.00
|
2,739
|
7.7
Years
|
14.28
|
9,224
|
|
1,384
|
7.5
Years
|
14.31
|
4,628
|
15.01 - 17.00
|
3,236
|
7.4
Years
|
16.38
|
4,117
|
|
1,458
|
5.3
Years
|
16.19
|
2,130
|
17.01 - 19.00
|
1,769
|
3.7
Years
|
18.05
|
2
|
|
1,769
|
3.7
Years
|
18.05
|
2
|
19.01 - 22.00
|
131
|
1.2
Years
|
19.65
|
—
|
|
131
|
1.2
Years
|
19.65
|
—
|
22.01 - 29.25
|
890
|
2.1
Years
|
24.99
|
—
|
|
890
|
2.1
Years
|
24.99
|
—
|
|
9,943
|
6.2
Years
|
16.36
|
$
20,313
|
|
6,806
|
5.0
Years
|
16.74
|
$ 13,709
|
The
aggregate intrinsic value in the preceding table represents the pre-tax amount
that would have been received by the option holders had all option holders
exercised their options at December 31, 2006. Vested and expected-to-vest
options at December 31, 2006, included in the table above, totaled 9,865,170
with a weighted-average exercise price of $16.37, a weighted-average contractual
term of 6.1 years and an aggregate intrinsic value of $20.1
million.
Restricted
Shares Plan
The
Restricted Shares Plan, which was approved by the Company’s stockholders in
1982, currently authorizes grants of up to 1,421,920 shares of common stock
to
be made available to key employees. In general, one third of the shares granted
vest on the anniversary date of each of the three years following the year
of
grant. The Company may also grant vested shares that contain sale restrictions.
The Company becomes entitled to an income tax deduction in an amount equal
to
the taxable income reported by the holders upon vesting of the restricted
shares.
Total
compensation expense relating to the Restricted Shares Plan was $0.9 million,
$0.3 million, and $0.6 million in 2006, 2005 and 2004, respectively.
Unrecognized compensation cost in connection with restricted stock grants
totaled $1.7 million, $1.0 million, and $0.1 million at December 31, 2006,
2005
and 2004, respectively. The cost is expected to be recognized over a
weighted-average period of 1.9 years.
Restricted
Shares Issuable and Issued
A
summary
of securities issuable and issued for the Company’s Restricted Shares Plan at
December 31, 2006, follows:
AMOUNTS
IN THOUSANDS
|
|
Restricted
Shares
Plan
|
Total
number of securities authorized
|
|
|
1,422
|
|
Number
of securities issued
|
|
|
(1,260
|
)
|
Number
of forfeited securities returned to plan
|
|
|
173
|
|
Number
of securities remaining available for future grants under the
plan
|
|
|
335
|
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
Current
Restricted Shares Activity
A
summary
of activity under the Restricted Shares Plan for the year ended December 31,
2006 follows:
AMOUNTS
IN THOUSANDS, EXCEPT SHARE DATA
|
|
Number
of
Shares
|
Weighted-Average
Market
Price Per
Share
on
Date
of Grant
|
Non-vested
at December 31, 2005
|
|
|
87
|
|
$
|
14.08
|
|
Vested
in 2006
|
|
|
(34
|
)
|
|
14.35
|
|
Granted
in 2006
|
|
|
116
|
|
|
15.83
|
|
Forfeited
in 2006
|
|
|
(11
|
)
|
|
15.38
|
|
Non-vested
at December 31, 2006
|
|
|
158
|
|
$
|
15.28
|
|
A
summary
of the Restricted Shares Plan activity and related information follows for
the
years ended December 31:
AMOUNTS
IN THOUSANDS
|
|
2006
|
2005
|
2004
|
Fair
value of restricted stock awards granted
|
|
$
|
1,845
|
|
$
|
1,267
|
|
$
|
61
|
|
Fair
value of restricted stock awards vested
|
|
|
495
|
|
|
232
|
|
|
462
|
|
SHARE
DATA
|
|
|
|
|
|
|
|
Weighted-average
fair value per share for restricted shares granted
|
|
$
|
15.83
|
|
$
|
14.09
|
|
$
|
13.67
|
|
NOTE
15. STATUTORY FINANCIAL DATA
Statutory
surplus and statutory net income for the Company’s insurance subsidiaries were
as follows:
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Statutory
surplus
|
|
$
|
771,009
|
|
$
|
704,671
|
|
$
|
614,893
|
|
Statutory
net income
|
|
|
124,522
|
|
|
113,523
|
|
|
110,339
|
|
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. However, SAP
requires the net book value of the assets to be
nonadmitted.
|
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
The
following table reconciles consolidated GAAP net income to statutory net
income.
Years
Ended December 31,
|
|
2006
|
2005
|
2004
|
Net
income - GAAP basis
|
|
$
|
97,228
|
|
$
|
87,426
|
|
$
|
88,225
|
|
Deferred
federal income tax expense
|
|
|
11,730
|
|
|
16,800
|
|
|
23,130
|
|
Change
in deferred policy acquisition costs
|
|
|
(3,642
|
)
|
|
(1,180
|
)
|
|
(5,680
|
)
|
Net
loss from non-insurance entities
|
|
|
14,454
|
|
|
9,754
|
|
|
634
|
|
Other,
net
|
|
|
4,752
|
|
|
723
|
|
|
4,030
|
|
Net
income - SAP basis
|
|
$
|
124,522
|
|
$
|
113,523
|
|
$
|
110,339
|
|
The
following table reconciles stockholders’ equity to statutory
surplus.
December
31,
|
|
2006
|
2005
|
Stockholders’
equity - GAAP
|
|
$
|
898,549
|
|
$
|
829,972
|
|
Condensed
adjustments to reconcile GAAP shareholders’ equity to statutory
surplus:
|
|
|
|
|
|
|
|
Net
book value of fixed assets under capital leases
|
|
|
(20,373
|
)
|
|
(24,185
|
)
|
Deferred
gain under capital lease transactions
|
|
|
(79
|
)
|
|
(914
|
)
|
Capital
lease obligation
|
|
|
15,985
|
|
|
28,074
|
|
Nonadmitted
portion of net deferred tax assets
|
|
|
(17,419
|
)
|
|
(34,936
|
)
|
Difference
in net deferred tax assets reported under SAP
|
|
|
24,200
|
|
|
38,544
|
|
Intercompany
receivables
|
|
|
(11,488
|
)
|
|
(57,683
|
)
|
Fixed
assets
|
|
|
(22,955
|
)
|
|
(22,492
|
)
|
Equity
in non-insurance entities
|
|
|
(47,006
|
)
|
|
26,798
|
|
Unrealized
losses on investments
|
|
|
17,881
|
|
|
10,788
|
|
Deferred
policy acquisition costs
|
|
|
(63,581
|
)
|
|
(59,939
|
)
|
Pension
related liabilities (assets)
|
|
|
15,648
|
|
|
(14,126
|
)
|
Other
prepaid expenses
|
|
|
(14,195
|
)
|
|
(11,049
|
)
|
Other,
net
|
|
|
(4,158
|
)
|
|
(4,181
|
)
|
Statutory
surplus
|
|
$
|
771,009
|
|
$
|
704,671
|
|
Combined
Company Action Level risk-based capital for the Company's insurance subsidiaries
was calculated to be $172.9 million as of December 31, 2006. These calculations
were made in accordance with the guidelines issued by the National
Association of Insurance Commissioners. Each of the Company’s insurance
subsidiaries exceeded its respective 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”). Transactions that are
defined to be of an “extraordinary” nature may not be effected without the prior
approval of the CDI. There are limits on the insurance subsidiaries’ dividend
paying capacity. In 2007, the Company estimates that its primary insurance
subsidiary has capacity to pay approximately $124.0 million in dividends to
its
parent without prior approval of the CDI. The Parent received a $110 million
dividend from its primary insurance subsidiary in
the
form of a non-cash settlement of the $86.0 million term loan due to that
subsidiary and a $24.0 million cash payment in the fourth quarter of
2006.
On
June
15, 2004, the CDI finalized its examination reports on the statutory financial
statements of 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 are currently
examining the three-year period ended December 31, 2005.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
NOTE
16. 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,
|
2006
|
|
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
325,824
|
|
$
|
325,512
|
|
$
|
327,325
|
|
$
|
328,924
|
|
Net
investment income
|
|
|
17,755
|
|
|
17,174
|
|
|
16,897
|
|
|
16,667
|
|
Realized
investment (losses) gains
|
|
|
(1,067
|
)
|
|
30
|
|
|
159
|
|
|
(551
|
)
|
Income
before provision for income taxes
|
|
|
32,185
|
|
|
42,464
|
|
|
42,551
|
|
|
24,251
|
|
Net
income
|
|
|
21,317
|
|
|
28,321
|
|
|
28,407
|
|
|
19,183
|
|
Basic
and diluted earnings per share
|
|
|
0.25
|
|
|
0.33
|
|
|
0.33
|
|
|
0.22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
and diluted earnings per share
|
|
|
0.23
|
|
|
0.24
|
|
|
0.25
|
|
|
0.31
|
|
NOTE
17. 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 manages
the runoff of the Company’s homeowner and earthquake programs. The Company has
not written any earthquake coverage since 1994 and ceased writing voluntary
homeowner policies in 2002.
The
Company evaluates segment performance based on pre-tax underwriting profit
or
loss. The Company does not allocate assets, net investment income, net realized
investment gains or 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.
21ST
CENTURY INSURANCE GROUP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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 Runoff 4
|
Total
|
2006
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
1,307,585
|
|
$
|
—
|
|
$
|
1,307,585
|
|
Depreciation
and amortization expense
|
|
|
27,392
|
|
|
3
|
|
|
27,395
|
|
Segment
profit (loss)
|
|
|
83,708
|
|
|
(751
|
)
|
|
82,957
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
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
|
|
2006
|
2005
|
2004
|
Segment
profit
|
|
$
|
82,957
|
|
$
|
69,670
|
|
$
|
61,258
|
|
Net
investment income
|
|
|
68,493
|
|
|
69,096
|
|
|
58,831
|
|
Other
income
|
|
|
638
|
|
|
367
|
|
|
—
|
|
Net
realized investment (losses) gains
|
|
|
(1,429
|
)
|
|
(3,272
|
)
|
|
10,831
|
|
Other
expense
|
|
|
(1,860
|
)
|
|
(410
|
)
|
|
—
|
|
Interest
and fees expense
|
|
|
(7,348
|
)
|
|
(8,019
|
)
|
|
(8,627
|
)
|
Income
before provision for income taxes
|
|
$
|
141,451
|
|
$
|
127,432
|
|
$
|
122,293
|
|
NOTE
18. VARIABLE INTEREST ENTITIES
In
January 2003, the FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities - an Interpretation of Accounting Research
Bulletin No. 51 (“FIN
46”), and amended it in December 2003. An entity is subject to the consolidation
rules of FIN 46 and is referred to as a variable interest entity (“VIE”) if it
lacks sufficient equity to finance its activities without additional financial
support from other parties or if its equity holders lack adequate decision
making ability based on criteria set forth in the interpretation. FIN 46 also
requires disclosures about VIEs that a company is not required to consolidate,
but in which a company has a significant variable interest.
The
Company has purchased 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 facilitate 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 VIE and a subsidiary of Impact, is for up to 11.1% ($52.8
million) of $475.0 million of the entity’s funding activities. These commitments
consist of a $10.6 million minimum investment and a $42.2 million guarantee
of a
warehouse lending facility. Potential losses are limited to the Company’s
participation as well as associated operating fees. The Company’s pro rata share
of these advances to Impact C.I.L., which in turn makes housing investments
in
economically disadvantaged communities, was approximately 11.1%, or $8.6 million
and $5.0 million at December 31, 2006 and 2005, respectively. The revolving
member loan and the warehouse financing agreement do not significantly impact
the Company’s liquidity or capital.
_____________________
4 |
Homeowner
and earthquake 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 (Continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
The
Company is not the primary beneficiary of any of the VIEs as the Company has
a
non-controlling interest with voting rights, beneficiary rights, obligations,
and ownership in proportion to each of its Impact related
investments.
In
addition to the above, the Company held $8.2 million and $6.2 million in other
Impact related fixed-income investments at December 31, 2006 and 2005,
respectively. The
Company also held $0.3 million in other Impact related private equity
investments at December 31, 2006. There were no other Impact related private
equity investments at December 31, 2005. Total Impact related investment income
was $1.0 million, $1.1 million, and $0.8 million for the years ended 2006,
2005,
and 2004, respectively.
NOTE
19. SUBSEQUENT EVENTS
Proposal
for Offer
On
January 24, 2007, the majority owner, AIG, made a proposal to acquire the
remaining shares of the Company common stock it does not own. The proposal
is
subject to several conditions, including the approval of the transaction by
a
Special Committee of the Company’s Board of Directors who are independent of
AIG. Provisions in certain agreements, including the supplemental executive
retirement plan and stock-based compensation plans could be triggered by an
offer or acquisition, resulting in the accelerated recognition of expense that
could materially impact the Company’s future results of operations. The
Company’s retirement and stock option valuation assumptions have not been
altered as of December 31, 2006 for the subsequent proposal made by
AIG.
Further,
the Company may need to incur future costs for the retention of personnel,
the
proposal, and/or litigation stemming from the proposal.
Edward
Bronstein v. 21st Century Insurance Group, et al
and a
companion case, Francis
A. Sliwinski v. 21st Century Insurance Group, et al
allege
the Company, its directors and AIG have, or will, breach fiduciary duties as
a
result of AIG’s January 24, 2007 merger proposal to acquire the remaining shares
of Company stock which AIG does not yet own. Both actions were filed in the
Los
Angeles Superior Court in January 2007 and seeks class action certification
and
equitable relief. The Company has formed a special committee of directors,
independent of AIG, to evaluate the terms of any merger proposal. The Company
believes the action is without merit.
Streamlining
of Operations
On
February 26, 2007, the Company announced it expects to incur approximately
$3.7
million in severance costs during the first quarter of 2007 in connection
with a
four percent reduction of its total work force.
ITEM
9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
|
None.
Evaluation
of Disclosure Controls and Procedures
The
Company has established disclosure controls and procedures designed 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.
As
required by Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange
Act”), our management, which includes our Principal Executive Officer and
Principal Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act).
Based on that evaluation the Principal Executive Officer and Principal Financial
Officer have concluded that such disclosure controls and procedures are
effective as of the end of the period covered by this report in providing a
reasonable level of assurance that information we are required to disclose
in
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms, and a reasonable level of assurance that
information required to be disclosed by us in such reports is accumulated and
communicated to our management, including our Principal Executive Officer and
Principal Financial Officer, as appropriate to allow timely decisions regarding
required disclosure.
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). 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, 2006.
Our
management’s evaluation of the effectiveness of our internal control over
financial reporting as of December 31, 2006 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm,
as
stated in their report which is included herein.
Changes
in Internal Controls
There
were no changes in the Company’s internal controls over financial reporting that
occurred during the fourth quarter that have materially affected or are
reasonably likely to materially affect internal controls over financial
reporting.
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.
None.
PART
III
ITEM
10.
|
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
|
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 2007 Annual Meeting of
Stockholders pursuant to Instruction G(3) of Form 10-K.
The
Company has adopted Corporate Governance Guidelines and charters for the Audit
Committee, Compensation Committee, Executive Committee, Investment Committee,
Public Policy Committee, and 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 2007
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
|
Securities
Authorized for Issuance under Equity Compensation Plans
Securities
authorized for issuance under equity compensation plans at December 31, 2006
are
as follows:
Plan
Category
|
|
COLUMN
A
Number
of Securities to
be
Issued Upon Exercise
of
Outstanding Options,
Warrants
and Rights
(in
thousands)
|
COLUMN
B
Weighted-Average
Exercise
Price of
Outstanding
Options,
Warrants
and
Rights
|
COLUMN
C
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
|
|
|
9,943
|
|
$
|
16.36
|
|
|
3,0741
|
|
Equity
compensation plans not approved by stockholders
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
Total
|
|
|
9,943
|
|
$
|
16.36
|
|
|
3,074
|
|
Other
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 2007 Annual Meeting of Stockholders pursuant to Instruction G(3) of
Form 10-K.
ITEM
13.
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
|
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 2007 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 2007
Annual Meeting of Stockholders pursuant to Instruction G(3) of Form
10-K.
_______________________
1 |
Includes
335 shares of stock that could be issued pursuant to the Company’s
Restricted Shares Plan.
|
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
|
51
|
(iii)
|
Consolidated
balance sheets - December 31, 2006 and 2005;
|
53
|
(iv)
|
Consolidated
statements of operations - Years ended December 31, 2006, 2005
and
2004;
|
54
|
(v)
|
Consolidated
statements of stockholders’ equity - Years ended December 31, 2006, 2005
and 2004;
|
55
|
(vi)
|
Consolidated
statements of cash flows - Years ended December 31, 2006, 2005
and
2004;
|
56
|
(vii)
|
Notes
to consolidated financial statements
|
57
|
(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
|
95
|
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 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.
|
|
Annual
Report on Form 10-K (filed with SEC on February 23, 2006; Exhibit
10(r)
therein).
|
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 Registrant, 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 Registrant,
dated
September 14, 2005.
|
|
Current
Report on Form 8-K (filed with SEC on September 19, 2005; Exhibit
10.1
therein).
|
10(aa)
|
|
Amendments
to form of stock option agreements between certain executives and
Registrant.
|
|
Current
Report on Form 8-K (filed with SEC on February 28, 2006; Exhibits
99.1 and
99.2 therein).
|
10(bb)
|
|
Amendment
to retention agreements between certain executives and
Registrant.
|
|
Current
Report on Form 8-K (filed with SEC on February 28, 2006; Exhibits
99.3
therein).
|
10(cc)
|
|
Employment
agreement between Steven P. Erwin, Sr. Vice President and CFO, and
Registrant, dated May 5, 2006.
|
|
Current
Report on Form 8-K (filed with SEC on May 11, 2006; Exhibit 10.1
therein).
|
14
|
|
Code
of Ethics.
|
|
Annual
Report on Form 10-K (filed with SEC on February 23,
2006).
|
|
|
Subsidiaries
of Registrant.
|
|
Filed
herewith.
|
|
|
Consent
of Independent Registered Public Accounting Firm.
|
|
Filed
herewith.
|
|
|
Certification
of President and Chief Executive Officer Pursuant to Exchange Act
Rule
13a-14(a).
|
|
Filed
herewith.
|
|
|
Certification
of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a).
|
|
Filed
herewith.
|
|
|
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002.
|
|
Filed
herewith.
|
SCHEDULE
II
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
CONDENSED
FINANCIAL INFORMATION OF REGISTRANT
BALANCE
SHEETS
AMOUNTS
IN THOUSANDS
|
|
|
|
|
|
December
31,
|
|
2006
|
2005
|
Assets
|
|
|
|
|
|
Cash
|
|
$
|
25,921
|
|
$
|
2,667
|
|
Fixed
maturity securities available-for-sale, at fair value (amortized
cost:
$16,769 and $14,648)
|
|
|
16,197
|
|
|
14,197
|
|
Accounts
receivable from subsidiaries *
|
|
|
—
|
|
|
7,429
|
|
Investment
in unconsolidated insurance subsidiaries, at equity *
|
|
|
852,978
|
|
|
858,144
|
|
Property
and equipment, at cost less accumulated depreciation of $44,159 and
$35,498, including software leased to a subsidiary of $114,738 and
$106,741 (net of accumulated depreciation of $43,780 and $34,960,
respectively)
|
|
|
114,738
|
|
|
106,741
|
|
Other
assets
|
|
|
6,569
|
|
|
3,296
|
|
Total
assets
|
|
$
|
1,016,403
|
|
$
|
992,474
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
Senior
notes
|
|
$
|
99,910
|
|
$
|
99,897
|
|
Term
loan due to subsidiary *
|
|
|
—
|
|
|
58,000
|
|
Other
liabilities
|
|
|
6,949
|
|
|
4,605
|
|
Accounts
payable to subsidiaries *
|
|
|
10,995
|
|
|
—
|
|
Total
liabilities
|
|
|
117,854
|
|
|
162,502
|
|
Stockholders’
equity
|
|
|
898,549
|
|
|
829,972
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
1,016,403
|
|
$
|
992,474
|
|
*
Eliminated in consolidation
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,
|
|
2006
|
2005
|
2004
|
Revenues
|
|
|
|
|
|
|
|
Dividends
received from subsidiaries *
|
|
$
|
110,000
|
|
$
|
—
|
|
$
|
—
|
|
Rental
income from software lease to subsidiary *
|
|
|
9,438
|
|
|
8,151
|
|
|
6,735
|
|
Interest
and other income
|
|
|
952
|
|
|
708
|
|
|
326
|
|
Total
revenues
|
|
|
120,390
|
|
|
8,859
|
|
|
7,061
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
Loan
interest and fees
|
|
|
9,777
|
|
|
7,302
|
|
|
6,035
|
|
Depreciation
expense
|
|
|
11,602
|
|
|
12,311
|
|
|
5,017
|
|
Other
expenses
|
|
|
6,924
|
|
|
3,776
|
|
|
3,867
|
|
Total
expenses
|
|
|
28,303
|
|
|
23,389
|
|
|
14,919
|
|
Income
(loss) before provision for income taxes
|
|
|
92,087
|
|
|
(14,530
|
)
|
|
(7,858
|
)
|
Provision
for income tax benefit
|
|
|
3,397
|
|
|
5,267
|
|
|
7,267
|
|
Net
income (loss) before equity in undistributed loss of
subsidiaries
|
|
|
95,484
|
|
|
(9,263
|
)
|
|
(591
|
)
|
Equity
in undistributed income of subsidiaries
|
|
|
1,744
|
|
|
96,689
|
|
|
88,816
|
|
Net
income
|
|
$
|
97,228
|
|
$
|
87,426
|
|
$
|
88,225
|
|
*
Eliminated in consolidation
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,
|
|
2006
|
2005
|
2004
|
Net
cash provided by operating activities
|
|
$
|
39,940
|
|
$
|
15,495
|
|
$
|
22,133
|
|
Investing
activities
|
|
|
|
|
|
|
|
|
|
|
Net
purchases of investments available-for-sale
|
|
|
(2,172
|
)
|
|
—
|
|
|
(14,768
|
)
|
Net
purchases of property and equipment
|
|
|
(20,756
|
)
|
|
(18,686
|
)
|
|
(22,960
|
)
|
Net
cash used in investing activities
|
|
|
(22,928
|
)
|
|
(18,686
|
)
|
|
(37,728
|
)
|
Financing
activities
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from exercise of options
|
|
|
5,675
|
|
|
4,649
|
|
|
576
|
|
Proceeds
from term loan due to subsidiary *
|
|
|
28,000
|
|
|
40,000
|
|
|
18,000
|
|
Excess
tax benefit from stock-based compensation
|
|
|
154
|
|
|
—
|
|
|
—
|
|
Repayment
of advance from subsidiary *
|
|
|
—
|
|
|
(26,760
|
)
|
|
(17,103
|
)
|
Dividends
paid
|
|
|
(27,587
|
)
|
|
(13,724
|
)
|
|
(8,546
|
)
|
Net
cash provided by (used in) financing activities
|
|
|
6,242
|
|
|
4,165
|
|
|
(7,073
|
)
|
Net
increase (decrease) in cash
|
|
|
23,254
|
|
|
974
|
|
|
(22,668
|
)
|
Cash,
beginning of year
|
|
|
2,667
|
|
|
1,693
|
|
|
24,361
|
|
Cash,
end of year
|
|
$
|
25,921
|
|
$
|
2,667
|
|
$
|
1,693
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash
financing activity:
|
|
|
|
|
|
|
|
|
|
|
Settlement
of term loan due to subsidiary with a portion of the dividend from
subsidiary*
|
|
$
|
(86,000
|
)
|
|
—
|
|
|
—
|
|
*
Eliminated in consolidation
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
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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 2006
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 dividends from its
subsidiaries and 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 intercompany transactions are
eliminated in the related consolidated financial statements.
Property
and Equipment
A
summary
of property and equipment follows:
December
31,
|
|
2006
|
2005
|
Furniture
and equipment
|
|
$
|
379
|
|
$
|
538
|
|
Software
currently in service
|
|
|
144,311
|
|
|
132,632
|
|
Software
projects in progress
|
|
|
14,207
|
|
|
9,069
|
|
Subtotal
|
|
|
158,897
|
|
|
142,239
|
|
Less
accumulated depreciation, including $43,780 and $34,960 for software
currently in service
|
|
|
(44,159
|
)
|
|
(35,498
|
)
|
Total
|
|
$
|
114,738
|
|
$
|
106,741
|
|
Intercompany
Lease Arrangement
Effective
December 31, 2003, the California Department of Insurance approved an
intercompany lease, whereby 21st Century Insurance Company, a wholly-owned
subsidiary, leases certain computer software from the Registrant. The monthly
lease payment, currently $0.8 million, started in January 2004 and is subject
to
upward adjustment based on the cost incurred by the Registrant.
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: 2007 - 2012 - $5.9 million
per annum; 2013 - $105.9 million.
Term
Loans Due to Subsidiary
An
intercompany term loan line was structured with the Registrant’s primary
insurance subsidiary, 21st Century Insurance Company, in October 2004. Funds
are
made available under the term loan line, which automatically renews every twelve
months, to the Registrant through individual notes with three year maturities.
Proceeds from the loan have been 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.
.
21ST
CENTURY INSURANCE GROUP (PARENT COMPANY ONLY)
NOTES
TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(continued)
TABULAR
DOLLAR AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
DECEMBER
31, 2006
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
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, with
interest rates varying from 4.06% to 5.92%. Interest expense on the term loan
due to the subsidiary for the years ended December 31, 2006 and 2005 was $3.7
million and $1.3 million, respectively. Interest payable on the term loan at
December 31, 2006 and 2005 was $0.2 million and $1.3 million, respectively.
The
term loan line had a zero balance at December 31, 2006.
Commitments
and Contingencies
The
Registrant has guaranteed the obligation under capital 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, 2006 are included in Note 12 of the Notes
to Consolidated Financial Statements.
Dividends
The
Registrant’s primary insurance subsidiary, 21st Century Insurance Company,
declared a $110.0 million dividend that was distributed to the Registrant in
the
form of a non-cash settlement of the $86.0 million term loan due to that
subsidiary and a $24.0 million cash payment. No dividends were received from
any
of its subsidiaries in 2005 and 2004.
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 26, 2007
|
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 26th of February 2007.
Signature
|
|
Title
|
/s/
Bruce W. Marlow
|
|
|
Bruce
W. Marlow
|
|
President
and Chief Executive Officer and Director (Principal Executive
Officer)
|
|
|
|
/s/
Steven P. Erwin
|
|
|
Steven
P. Erwin
|
|
Sr.
Vice President and Chief Financial Officer (Principal Financial Officer)
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/s/
Jesús C. Zaragoza
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Jesús
C. Zaragoza
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Vice
President and Controller
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/s/
Robert M. Sandler
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Robert
M. Sandler
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Chairman
of the Board
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/s/
Steven J. Bensinger
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Steven
J. Bensinger
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Director
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/s/
John B. De Nault, III
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John
B. De Nault, III
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Director
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/s/
Carlene M. Ellis
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Carlene
M. Ellis
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Director
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/s/
R. Scott Foster, M.D.
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R.
Scott Foster, M.D.
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Director
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Roxani
M. Gillespie
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Director
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Jeffrey
L. Hayman
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Director
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/s/
Phillip L. Isenberg
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Phillip
L. Isenberg
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Director
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/s/
Keith W. Renken
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Keith
W. Renken
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Director
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/s/
Thomas R. Tizzio
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Thomas
R. Tizzio
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Director
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