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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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999
Commission File Number 1-7461
ACCEPTANCE INSURANCE COMPANIES INC.
(Exact Name of Registrant As Specified in Its Charter)
DELAWARE 31-0742926
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
222 S. 15th Street, Suite 600 North
Omaha, Nebraska 68102
(Address of Principal Executive Offices)
(Zip Code)
Registrant's Telephone Number, Including Area Code:
(402) 344-8800
________
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
Common Stock $.40 Par Value New York Stock Exchange, Inc.
Preferred Securities of AICI Capital Trust New York Stock Exchange, Inc.
Securities Registered Pursuant to Section 12(g) of the Act: None
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 has been 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 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]
The aggregate market value of the Registrant's voting stock held
by nonaffiliates (8,244,282 shares) on March 1, 2000 was $38,645,072.
The number of shares of each class of the Registrant's common
stock outstanding on March 1, 2000 was:
Class of Common Stock No. of Shares Outstanding
Common Stock, $.40 Par Value 14,290,246
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Registrant's 2000 Annual
Meeting of Shareholders are incorporated by reference into Part III.
GLOSSARY OF INSURANCE TERMS
Admitted Insurer: An insurance company licensed by a state
regulatory authority to transact insurance business in that state. An admitted
insurer is subject to the rules and regulations of each state in which it is
licensed governing virtually all aspects of its insurance operations and
financial condition. A nonadmitted insurer, also known as an excess and
surplus lines insurer, is not licensed to transact insurance business in a
given state but may be permitted to write certain business in that state in
accordance with the provisions of excess and surplus lines insurance laws which
generally involve less rate, form and operational regulation.
Buy-up Coverage: Multi-Peril Crop Insurance policy providing
coverage in excess of that provided by CAT Coverage. Buy-up Coverage is
offered only through private insurers.
Case Reserve: The estimated liability for loss established
by an insurance company for a reported claim.
CAT Coverage ("CAT"): The minimum available level of
Multi-Peril Crop Insurance, providing coverage for 50% of a farmer's historical
yield for eligible crops at 60% of the price per unit for such crop set by the
FCIC. This coverage is offered through private insurers and, in some states,
USDA field offices.
Combined Ratio: The sum of the expense ratio and the loss
ratio determined in accordance with GAAP or SAP.
CropRevenueCoverage ("CRC"): An extension of the MPCI
program that provides a producer of crops with varying levels of insurance
protection against loss of revenues caused by changes in crop prices, low
yields, or a combination of the two.
Crop Year: For MPCI, a crop year commences on July 1 and
ends on June 30. For crop hail insurance, the crop year is the calendar year.
Direct Written Premiums: Total premiums collected in respect
of policies issued by an insurer during a given period without any reduction
for premiums ceded to reinsurers.
Excess and Surplus Lines Insurance: The business of insuring
risks for which insurance is generally unavailable from admitted insurers in
whole or in part. Such business is placed by the broker or agent with
nonadmitted insurers in accordance with the excess and surplus lines
provisions of state insurance laws.
Excess of Loss Reinsurance: A form of reinsurance in which
the reinsurer, subject to a specified limit, agrees to indemnify the ceding
company for the amount of each loss, on a defined class of business, that
exceeds a specified retention.
Expense Ratio: Under statutory accounting, the ratio of
underwriting expenses to net premiums written. Under GAAP accounting, the ratio
of underwriting expenses to net premiums earned.
Federal Crop Insurance Corporation ("FCIC"): A wholly owned
federal government corporation within the Farm Service Agency.
Generally Accepted Accounting Principles ("GAAP"):
Accounting practices as set forth in opinions and pronouncements of the
Financial Accounting Standards Board and Accounting Principles Board and
American Institute of Certified Public Accountants Accounting Research
Bulletins and which are applicable in the circumstances as of the date in
question.
Gross Written Premiums: Direct written premiums plus
premiums collected in respect of policies assumed, in whole or in part, from
other insurance carriers.
Incurred But Not Reported ("IBNR") Reserves: The liability
for future payments on losses which have already occurred but have not yet been
reported to the insurer. IBNR reserves include LAE related to such losses and
may also provide for future adverse loss development on reported claims.
Insurance Regulatory Information System ("IRIS"): A system
of ratio analysis developed by the NAIC primarily intended to assist state
insurance departments in executing their statutory mandates to oversee the
financial condition of insurance companies.
Loss Adjustment Expenses ("LAE"): Expenses incurred in the
settlement of claims, including outside adjustment expenses, legal fees and
internal administrative costs associated with the claims adjustment process,
but not including general overhead expenses.
Loss Ratio: The ratio of losses and LAE incurred to premiums
earned.
Loss Reserves: Liabilities established by insurers to
reflect the estimated ultimate cost of claim payments as of a given date.
MPCI Imputed Premium: For purposes of the profit/loss
sharing arrangement with the FCIC, the amount of premiums credited to the
Company for all CAT Coverages it sells, as such amount is determined by formula.
MPCI Premium: For purposes of the profit/loss sharing
arrangement with the FCIC, the amount of premiums credited to the Company for
all Buy-up and Crop Revenue Coverages paid by farmers, plus the amount of any
related federal premium subsidies.
MPCI Retention: The aggregate amount of MPCI Premium and, in
respect of CAT coverages imputed MPCI premium on which the Company retains risk
after allocating farms to the three FCIC reinsurance pools.
Multi-Peril Crop Insurance ("MPCI"): A federally regulated
subsidized crop insurance program that insures a producer of crops with varying
levels of protection against loss of yield from substantially all natural
perils to growing crops.
NAIC: The National Association of Insurance Commissioners.
Net Premiums Earned: The portion of net premiums written
applicable to the expired period of policies and, accordingly, recognized as
income during a given period.
Net Premiums Written: Total premiums for insurance written
(less any return premiums) during a given period, reduced by premiums ceded in
respect to liability reinsured by other carriers.
Policyholders' or Statutory Surplus: As determined under SAP
(hereinafter defined), the excess of total admitted assets over total
liabilities.
Price Election: The maximum per unit commodity price by crop
used in computing MPCI Premiums (other than for CRC), which is set each year by
the FCIC.
Quota Share Reinsurance: A form of reinsurance whereby the
reinsurer agrees to indemnify the cedent for a stated percentage of each loss,
subject to a specified limit the cedent pays, on a defined class of business.
Reinsurance: The practice whereby a company called the
"reinsurer" assumes, for a share of the premium, all or part of a risk
originally undertaken by another insurer called the "ceding" company or
"cedent." Reinsurance may be effected by "treaty" reinsurance, where a standing
agreement between the ceding and reinsuring companies automatically covers all
risks of a defined category, amount and type, or by "facultative" reinsurance
where reinsurance is negotiated and accepted on a risk-by-risk basis.
Retention: The amount of liability, premiums or losses which
an insurance company keeps for its own account after application of reinsurance.
Risk-Based Capital ("RBC"): Capital requirements for
property and casualty insurance companies adopted by the NAIC to assess
minimum capital requirements and to raise the level of protection that
statutory surplus provides for policyholder obligations.
Risk Management Agency ("RMA"): A division of the United
States Department of Agriculture ("USDA") which, along with the FCIC
administers and provides reinsurance for the federally regulated MPCI and CRC
programs.
Standard Reinsurance Agreement ("SRA"): The reinsurance
contract related to crop reinsurance under the federal crop program between
FCIC and affiliates of the Company.
Stop Loss Reinsurance: A form of reinsurance, similar to
Excess of Loss Reinsurance, whereby the primary insurer caps its loss on a
particular risk by purchasing reinsurance in excess of such cap.
Statutory Accounting Principles ("SAP"): Accounting
practices which consist of recording transactions and preparing financial
statements in accordance with the rules and procedures prescribed or permitted
by state regulatory authorities. Statutory accounting emphasizes solvency
rather than matching revenues and expenses during an accounting period.
PART I
Item 1. Business.
Forward-Looking Information
Except for the historical information contained in this
Annual Report on Form 10-K, matters discussed herein may constitute
forward-looking information, within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking information reflects
Acceptance Insurance Companies Inc.'s current best estimates regarding future
operations, but, since these are only estimates, actual results may differ
materially from such estimates.
A variety of events, most of which are outside the control of
Acceptance Insurance Companies Inc., cannot be accurately predicted and may
materially impact estimates of future operations. Important among such
factors are weather conditions, natural disasters, changes in commodity prices,
changes in state and federal regulations, price competition impacting premium
levels, changes in tax laws, financial market performance, changes in court
decisions effecting coverages and general economic conditions.
Acceptance Insurance Companies Inc.'s results are
significantly impacted by its crop business, particularly its MPCI line.
Results from the crop lines are not generally known until the fourth quarter
of the year, after crops are harvested and final market prices are established.
Crop segment results are particularly dependent on events beyond the control of
Acceptance Insurance Companies Inc., notably weather conditions during the crop
growing seasons in the states where Acceptance Insurance Companies Inc. writes
a substantial amount of its crop insurance, the market price of grains on
various commodity exchanges, overall worldwide supply and demand, the
continuing globalization of the crop industry and its effect on the export of
crops to other countries and the volatility of crop prices resulting from
domestic and foreign policy decisions. Additionally, federal regulations
governing aspects of crop insurance are frequently modified, and any such
changes may impact crop insurance results.
Forward-looking information set forth herein does not take
into account any impact from any adverse weather conditions during the 2000
crop season, or the various other factors noted above which may affect crop and
noncrop operation results. See "Business-Uncertainties Affecting the Insurance
Business" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations-General" for additional information regarding these
events and factors.
Company Strategy
Acceptance Insurance Companies Inc. (the "Company")
underwrites and sells crop insurance and specialty property and casualty
insurance to serve niche markets or programs. Within the crop insurance
industry, the Company is the third largest writer of crop insurance products
in the United States. The Company selects niche markets or programs for which
the Company believes that its expertise affords it a competitive advantage and
believes that success in niche markets and programs requires that it be
opportunistic. The Company believes its position as both an admitted
(licensed) and nonadmitted (excess and surplus lines) carrier provides the
versatility to respond when different market conditions and opportunities are
presented. The Company's goal is to achieve underwriting profits while
managing its investment portfolio to maximize after-tax earnings and
maintaining adequate liquidity to meet all cash needs.
In 1999 the Company refined and refocused its business
strategy to achieve the goal stated above. The Company's four-pronged business
strategy, which it began to implement in late 1999 and in 2000, can be
summarized as follows:
* enhance and expand the Crop Insurance segment;
* restructure the Property and Casualty insurance segment to
achieve underwriting profits;
* continue to maintain reinsurance to manage volatility and
avoid catastrophic loss exposure; and
* continue to manage the investment portfolio to maximize
after-tax earnings.
The Company intends to enhance and expand its Crop Insurance
segment. The Company believes opportunities exist to increase its market share
in the crop insurance business and to increase the number of producers using
crop insurance. It intends to pursue these opportunities by developing new
insurance products for both previously insured and previously uninsured
commodities, increasing its presence in geographic areas presently underserved
by the crop insurance industry or where the Company believes it may have a
competitive advantage, and continuing to provide its agents and customers with
high quality service.
The Company is restructuring its property and casualty
insurance business to achieve underwriting profits in this segment of the
Company's business. The Company will remain in and enter specialized, niche
segments of the property and casualty insurance market that the Company
believes offer the best profitability and growth opportunities. Additionally,
the Company has discontinued lines of property and casualty business that are
not consistent with the Company's strategy and objectives and will continue to
do so in the future. The Company is moving away from "longer tail" casualty
business and is redirecting its underwriting focus toward "shorter tail" lines,
including "staffing" industry coverage, fine art and personal jewelry
exposures, condominiums, surety, prize indemnifications and agricultural risks.
The Company expects to continue to write some property and casualty business
on a nonrisk-bearing basis. Although the Company is discontinuing certain lines
of property and casualty business, it continues to regularly explore new
opportunities to acquire lines of business from experienced underwriters and
other managers with a long and profitable operating history.
The Company historically has maintained reinsurance to manage
volatility and avoid catastrophic loss exposure and intends to continue this
practice. Numerous domestic and foreign reinsurers provide reinsurance for the
Company's various underwriting risks. The Company's reinsurance generally is
structured into multiple layers and programs to reflect those risks.
The Company historically has managed its investment portfolio
to maximize investment earnings. The Company has no current plans for any
significant change in its investment portfolio management practices. The
Company historically has managed its investment portfolio to maximize
after-tax investment earnings. While maintaining that practice, the Company
may increase its investment in equities and mezzanine securities which may
reduce current income while generating increased earnings from capital gains.
See "Business-Business Segments," "Business-Reinsurance" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Results of Operations" for a further discussion of actions taken by
the Company to implement this strategy.
Organization
The Company underwrites its insurance products through five
wholly owned insurance company subsidiaries: Acceptance Insurance Company
("Acceptance Insurance"), Acceptance Indemnity Insurance Company ("Acceptance
Indemnity"), Acceptance Casualty Insurance Company ("Acceptance Casualty"),
American Growers Insurance Company ("American Growers") and Redland Insurance
Company ("Redland") (collectively referred to herein as the "Insurance
Companies"). On January 26, 2000 the Company reached an agreement in principle
to sell Redland to Clarendon National Insurance Company ("Clarendon") and
appoint other Company subsidiaries as the exclusive producer and representative
of Redland for business the Company currently writes through Redland. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Redland Insurance Company Subsequent Event" for additional
information regarding this pending transaction.
Collectively, the Insurance Companies are admitted in 48
states and the District of Columbia, and operate on a nonadmitted basis in 45
states, the District of Columbia, Puerto Rico and the Virgin Islands. Two of
the Insurance Companies have received their Certificate of Authority
("T" listing) from the U.S. Department of Treasury. Each of the Insurance
Companies is rated B++(Very Good) by A.M. Best Company, Inc. ("A.M. Best").
A.M. Best bases its ratings upon factors that concern policyholders and agents,
and not upon factors concerning investor protection.
On November 29, 1999, A.M. Best downgraded the Insurance
Companies' rating from A- to B++. A.M. Best noted that the downgrade reflects
the group's poor operating results, significant reliance on reinsurance and
continued volatility in reserve trends. Some agents and customers require an
A- or better rating for certain lines of business, primarily the Company's
admitted Property and Casualty segment business. The Company is attempting to
address this issue through the proposed sale of Redland to Clarendon.
The Company's insurance agency and insurance service
subsidiaries principally write and service insurance coverages placed with one
of the Insurance Companies.
The Company was incorporated in Ohio as National Fast Food
Corp. in 1968, reincorporated in Delaware in 1969 and thereafter operated under
the names NFF Corp. (1971 to 1973), Orange-co, Inc. (1973 to 1987), Stoneridge
Resources, Inc. (1987 to 1992), and was renamed Acceptance Insurance Companies
Inc. in 1992.
Business Segments
The Company has organized its insurance underwriting and
marketing business by product line into two segments, Crop Insurance and
Property and Casualty Insurance.
Crop Insurance
The principal lines of the Company's Crop Insurance segment
are MPCI, supplemental coverages and named peril insurance. MPCI is a
federally subsidized insurance program designed to encourage farmers to manage
their risk through the purchase of insurance policies. MPCI provides farmers
with yield coverage for crop damage from substantially all natural perils.
CRC is an extension of the MPCI program which provides farmers with protection
from revenue loss caused by changes in crop prices, low yields or both. As
used herein, the term MPCI includes CRC, unless the context indicates
otherwise. For the year ended December 31, 1999, the Company had gross MPCI
premiums of approximately $365 million and a market share of approximately 16%
of MPCI business written in the United States. The Company's preliminary
estimate of the MPCI premium for 2000 is $392 million based on field reports
and early applications.
Supplemental coverages are proprietary products developed and marketed
exclusively by the Company. Supplemental coverages enhance the protection
provided by MPCI. Unlike MPCI, however, supplemental coverages are
not subsidized by the federal government. During 1999 the Company's gross
premium from supplemental coverages was approximately $31.1 million. For the
2000 crop year, however, the FCIC increased the maximum coverage available
under federally reinsured policies, and agricultural producers currently appear
concerned that drought conditions will reduce yields and increase prices. As
a result of these and other market conditions, the Company expects gross
premium from supplemental coverages for 2000 to be approximately $15.6 million.
Development and marketing of supplemental coverages nevertheless remains a
significant component of the crop division. See "Management Discussion and
Analysis of Financial Condition and Results of Operations Results of
Operations."
The largest named peril crop insurance product offered by the
Company is crop hail insurance which insures growing crops against damage
resulting from hailstorms. The Company also sells a small volume of insurance
against damage to specific crops from other named perils. Like the
supplemental coverages, none of the named peril products involve federal
reinsurance or price subsidy participation. During 1999, the Companys gross
premium from named peril crop insurance including crop hail was approximately
$47.7 million. The Company's preliminary estimate for named peril crop
insurance premium in 2000 is $46.8 million.
Property and Casualty Insurance
The principle lines of the Company's Property and Casualty
segment are property and casualty coverages, primarily on an admitted basis,
for the "staffing" industry, fine art and personal jewelry exposures,
condominiums, surety, prize indemnifications and agricultural risks. These
lines are marketed through independent insurance agencies.
The Company also provides property and casualty coverages,
including general liability, garage liability, liquor liability and workers'
compensation coverage for small and medium businesses which are not served by
standard carriers due to size or location. These lines are marketed through
general agents.
During 1998 the Company discontinued writing certain product
lines. Additionally, in January 2000 the Company reached an agreement in
principle to transfer the renewal rights to all business previously produced
and serviced by the Company's Scottsdale, Arizona office and to its "long haul"
trucking business. Net earned premiums for these discontinued lines were
approximately $114 million, $168 million and $179 million in 1999, 1998 and
1997, respectively. The Company also discontinued or reduced its underwriting
in several other lines of property and casualty business.
The Company sold its nonstandard automobile business,
including Phoenix Indemnity Insurance Company (Phoenix Indemnity), in
September 1999. Net premiums earned from Phoenix Indemnity were $32 million,
$43 million and $42 million in 1999, 1998 and 1997, respectively.
The following table reflects the amount of gross premium
written and net premium written for the Crop and Property and Casualty
Insurance segments for the periods set forth below:
Years Ended December 31,
1999 1998 1997
(in thousands)
GROSS PREMIUMS WRITTEN:
Crop Insurance(1)......................................$272,904 $256,956 $248,051
Property and Casualty Insurance.........................420,037 444,004 417,759
-------- --------- --------
Total...............................................$692,941 $700,960 $665,810
======== ========= ========
NET PREMIUMS WRITTEN:
Crop Insurance(1).......................................$42,059 $ 61,013 $ 59,989
Property and Casualty Insurance.........................209,607 248,479 275,075
-------- -------- --------
Total...............................................$251,666 $309,492 $335,064
======== ======== ========
- ---------------
(1) For a discussion of the accounting treatment of MPCI premiums, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations-General."
Management
In December 1999 Michael R. McCarthy was elected Chairman of
the Company's Board of Directors and John E. Martin was elected President and
Chief Executive Officer of the Company. Other key members of management of the
Company are Georgia M. Mace, Treasurer and Chief Financial Officer, J. Michael
Gottschalk, Chief Legal Officer, General Counsel and Secretary, Stephen T.
Fitzpatrick, Chief Underwriting Officer and Raymond N. Siebert, Chief
Administrative Officer.
Marketing
The Company markets a portion of its property and casualty
insurance products and its crop insurance products through a network of
independent agents specializing in specific lines of insurance. The Company
also markets its property and casualty insurance products through general
agents who process and accept applications for insurance coverages from retail
agents who sell insurance to insurance buyers. The Company compensates its
agents through commissions based on a percentage of premiums produced. The
Company also offers most of its agents a contingent commission based on volume
and profitability and other programs designed to encourage agents to place
profitable business with the Company.
Possible regulatory changes affecting the manner in which
insurance products may be marketed and distributed in response to technological
changes and the adaptation of agents to such regulatory and technological
changes may significantly impact the results of operations of the Company and
its competitors. Insurance regulators and the RMA may permit the Company and
other insurers to sell insurance coverage directly to persons seeking coverage
using current or emerging technologies. Independent agents who currently
market and sell the Company's products under the traditional distribution
system may adopt current or emerging technologies in their routine business
practices that will alter the method used to distribute insurance products.
The Company, however, does not know whether or when these events, or other
events based on regulatory or technological changes, may occur or the manner in
which they will affect the marketing and distribution of insurance if they do
occur. Unless the Company adapts to the changes technology causes in the
traditional system for distributing its products, and does so more effectively
than competing insurance companies, the Company's market share and its results
of operations are likely to be adversely affected.
Combined Ratios
The statutory combined ratio, which reflects underwriting
results before taking into account investment income, is a traditional measure
of the underwriting performance of a property and casualty insurer. A combined
ratio of less than 100% indicates underwriting profitability whereas a combined
ratio in excess of 100% indicates unprofitable underwriting. The following
table reflects the loss ratios, expense ratios and combined ratios of the
Company and the property and casualty insurance industry, computed in
accordance with SAP, for the periods shown.
Years Ended December 31,
1999 1998 1997
The Company
Loss Ratio............................................ 88.0%(1) 72.3%(2) 63.7%
Expense Ratio.......................................... 41.3(3) 38.9 34.0
--------- --------- -------
Combined Ratio............................................ 129.3% 111.2% 97.7%
========== ========= ========
Industry Average(4)
Loss Ratio................................................. 78.3% 76.5% 72.8%
Expense Ratio.............................................. 29.2 29.5 28.8
---------- --------- --------
Combined Ratio............................................ 107.5% 106.0% 101.6%
=========== ========= ========
- ---------------
(1) The $44.0 million reserve increase recorded by the Company in 1999,
for 1998 and prior years, accounts
for 17.7% of the loss ratio for 1999. See "Loss and Loss Adjustment
Expense Reserves."
(2) The $24.2 million reserve increase recorded by the Company in 1998,
for 1997 and prior years, accounts for
7.4% of the loss ratio for 1998.
(3) For a discussion of factors contributing to the increased expense
ratio, see "Management's Discussion and
Analysis of Results of Operations and Financial Analysis-Results of
Operations."
(4) Source: A.M. Best's Aggregates & Averages Property Casualty (1999
Edition). Ratios for 1999 are
unpublished but have been provided to the Company by A.M. Best.
Underwriting
The Company organizes its underwriting staff by product line,
enabling underwriters to focus on the unique risks associated with the
specialty coverages written by the Company. The Company seeks to ensure that
each specialty product or program fits into the Company's goals through a
strategic planning process whereby managers evaluate the historical and
expected levels of underwriting profitability of the coverages written. The
Company then allocates its capital among product lines where it believes the
best underwriting opportunities exist.
Each underwriter is required to comply with risk parameters,
retention limits and rates and forms prescribed by the Company. All
underwriting operations of the Company are subject to special periodic audit by
the Company's home office personnel and the reinsurers which accept a portion
of these risks.
Generally, the Company grants general agents the authority to
sell and bind insurance coverages in accordance with procedures and
limitations established by the Company. The Company reviews coverages bound by
agents, decides whether the insurance is written in accordance with such
procedures and limitations, and, subject to state law limits and policy terms,
may cancel coverages that are not in compliance.
The Company grants limited binding authority to certain
independent agents in certain lines of business, and provides that all other
agents submit all applications to the Company's underwriting staff in order for
such coverages to be bound.
Claims
The Company's crop and property and casualty claims
departments administer all claims and direct all legal and adjustment aspects
of the claims handling process. To assist in settling claims the Company
regularly uses independent adjusters, attorneys and investigators, as well as
third party administrators for some specialty property and casualty lines. The
Company's claims department is organized into three parts, each supervised by a
senior claims vice president. The Crop Claims Department manages all claims
arising out of the Company's crop insurance operations through its home office
staff and a system of regional claims offices which supervise specially trained
independent adjusters. The Litigation Department, which is broken down by
geographic area, handles larger litigation claims files and other complex and
serious claims. The Claims Department, which also is broken down by geographic
area, handles the other claims files and supervises the claims handlers. The
Company emphasizes the use of internal staff rather than independent adjusters,
improving claims processing systems and rapid response mechanisms. The Company
believes this structure will continue to reduce loss adjustment expense and
shorten the life of open claim files.
Loss and Loss Adjustment Expense Reserves
In the crop insurance industry, reserves for the payment of
loss and loss adjustment expense are established at the time potential losses
are reported. The amount of the initial reserve is based on the Company's
historical loss and loss adjustment expense experience and generally is uniform
for all claims arising from crops located in the same geographic area. Field
adjusters are directed to advise the Company of particular claims which appear
likely to result in payments significantly higher than historic averages and
the Company adjusts the initial reserve for those claims based upon such
reports. FCIC regulations require that claims under all federally reinsured
policies be paid within thirty, or in some circumstances, sixty days after the
reinsured company receives all documents necessary to establish the existence
and amount of the insured loss. Accordingly, reserves for crop insurance
claims arising from crops planted in the spring are established primarily in
the third and fourth quarter of each year, and typically are eliminated through
payment of the claim during the fourth quarter of the year or first quarter of
the following year. Reserves for claims arising from crops planted in the fall
normally are established and paid during the second and third quarter of the
year. Reserves for crop hail insurance are established in the same manner and
claims are typically paid within thirty to sixty days after the necessary
documents are received.
In the property and casualty insurance industry, it is not
unusual for several years to elapse between the occurrence of an insured loss,
the report of the loss to the insurer and the insurer's payment of that loss.
The liability for losses and loss adjustment expenses is estimated by
management based on historical patterns and expectations of claims reported
and paid, losses which have occurred but which are not yet reported, trends in
claim experience, information available on an industry-wide basis, changes in
the Company's claim handling procedures and premium rates and other factors.
The Company's lines of specialty insurance business are considered less
predictable than standard insurance coverages. The effects of inflation are
implicitly reflected in the Company's loss reserves through the industry data
utilized in establishing such reserves. The Company does not discount its
reserves to estimated present value for financial reporting purposes.
In monitoring reserve adequacy the Company reviews historical
data and other data and, as additional experience and data become available,
revises estimates of reserves. These revisions result in increases or
decreases to reserves for insured events of prior years. In 1999, 1998 and
1997 the Company increased its reserves through charges to earnings of $44.0
million, $24.2 million, and $6.9 million, respectively, based upon its
reestimation of liability for losses and loss adjustment expenses for prior
accident years.
In the third quarter of fiscal 1999, the Company increased
reserves for 1998 and prior accident years by approximately $44.0 million. This
increase related primarily to an unexpected increase in the number of claims
relating to general liability coverage provided in 1995 and prior years to
contractors in the State of California as a result of the California Supreme
Court decision in Montrose Chemical Corporation v. Admiral Insurance Company.
In that decision, the Court adopted the "continuous trigger" theory of
insurance coverage for third-party liability claims involving continuous,
progressive or deteriorating bodily injury or property damages. Under this
theory, the time of the insured's act which allegedly caused the accident,
event or condition resulting in a claim is largely immaterial. As long as the
potential damages remain outstanding, all of the insured contractor's or
subcontractor's successive insurance policies potentially may provide coverage.
Thus, the Court's Montrose decision created a new basis for coverage under
years of previously issued policies. Beginning in 1996, the Company altered
its underwriting criteria for construction risks and began endorsing policies
exposed to these types of continuous exposures in order to avoid coverage for
conditions which existed prior to the inception of the Company's policies.
During 1998 the Company discontinued several product lines
due to the continuation of unexpected loss development and pricing that was no
longer acceptable to the Company. These lines of business included coverages
for certain specialty automobile lines, aviation and complex general liability
risks. As a result of these developments, management modified the assumptions
used in reserving 1997 and prior accident years for these lines. This
modification created most of the unfavorable development during 1998.
The liability estimate established represents management's
best estimate based on currently available evidence, including an analysis
prepared by an independent actuary engaged by the Company. Even with such
extensive analyses, however, the Company believes its ultimate liability may
from time to time vary from such estimates.
The Company annually obtains an independent review of its
loss reserving process and reserve estimates by a independent professional
actuary as part of the annual audit of its financial statements.
The following table presents an analysis of the Company's
reserves, reconciling beginning and ending reserve balances for the periods
indicated:
Years Ended December 31,
1999 1998 1997
(in thousands)
Net loss and loss adjustment
expense reserves at beginning
of year....................................................$285,975 $263,106 $246,752
Provisions for net losses and
loss adjustment expenses for
claims occurring in the current
year....................................................... 174,762 212,894 206,597
Increase in net reserves for
claims occurring in prior years........................... 44,027 24,167 6,858
--------- --------- ----------
218,789 237,061 213,455
-------- ---------- ----------
Net losses and loss adjustment
expenses paid for claims
occurring during:
The current year............................................(76,745) (100,968) (110,372)
Prior years............................................... (123,158) (113,224) (86,729)
---------- ---------- -----------
(199,903) (214,192) (197,101)
---------- ---------- -----------
Sale of Phoenix Indemnity.................................. (26,021) -- --
---------- ----------- ------------
Net loss and loss adjustment
expense reserves at end of year............................ 278,840 285,975 263,106
Reinsurance recoverable on unpaid
losses and loss adjustment
expenses................................................... 502,537 238,769 165,547
---------- ---------- -----------
Gross loss and loss adjustment
expense reserves...........................................$781,377 $524,744 $428,653
========== ========== ============
The following table presents the development of balance sheet
net loss reserves from calendar years 1989 through 1999. The top line of the
table shows the loss reserves at the balance sheet date for each of the
indicated years. These amounts are the estimates of losses and loss adjustment
expenses for claims arising in all prior years that are unpaid at the balance
sheet date, including losses that had been incurred but not yet reported to the
Company. The middle section of the table shows the cumulative amount paid,
expressed as a percentage of the initial reserve amount, with respect to
previously recorded reserves as of the end of each succeeding year. The lower
section of the table shows the re-estimated amount, expressed as a percentage
of the initial reserve amount, of the previously recorded reserves based on
experience as of the end of each succeeding year. The estimate changes as
more information becomes known about the frequency and severity of claims for
individual years. The "Net cumulative redundancy (deficiency)" caption
represents the aggregate percentage increase (decrease) in the initial reserves
estimated. It should be noted that the table presents the "run off" of balance
sheet reserves, rather than accident or policy year loss development. The
Company computes the cumulative redundancy (deficiency) annually on a calendar
year basis.
The establishment of reserves is an inherently uncertain
process. The Company underwrites property and casualty coverages in a number
of specialty areas of business that may involve greater risks than standard
property and casualty lines. These risk components may make more difficult the
task of estimating reserves for losses, and cause the Company's underwriting
results to fluctuate. Further, conditions and trends that have affected the
development of loss reserves in the past may not necessarily occur in the
future. Accordingly, it may not be appropriate to extrapolate future
redundancies or deficiencies based on this information.
The Company adopted Statement of Financial Accounting
Standards No. 113 ("SFAS #113"), "Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts," effective January 1, 1993. The
application of SFAS #113 resulted in the reclassification of amounts ceded to
reinsurers, which amounts were previously reported as a reduction in unearned
premium and unpaid losses and loss adjustment expenses, to assets on the
consolidated balance sheet. The table below includes a reconciliation of net
loss and loss adjustment expense reserves to amounts presented on the
consolidated balance sheet after reclassifications related to the adoption
of SFAS #113. The gross cumulative deficiency is presented for 1992 through
1998, the only years on the table for which the Company has restated amounts
in accordance with SFAS #113.
Years Ended December 31,
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Net reserves for unpaid
losses and loss
adjustment expenses $43,380 $58,439 $66,132 $77,627 $115,714 $141,514 $201,356 $246,752 $263,106 $285,975 $278,840
Cumulative amount of net
liability paid through (1):
One year later 30.0% 40.6% 45.7% 36.1% 49.1% 51.0% 47.3% 44.7% 43.0% 46.7%
Two years later 59.5% 70.8% 72.3% 73.6% 80.5% 86.1% 75.2% 71.8% 71.7%
Three years later 76.1% 88.5% 96.6% 94.5% 100.9% 104.5% 93.1% 90.0%
Four years later 84.5% 101.2% 108.1% 109.0% 108.8% 115.5% 102.8%
Five years later 89.2% 107.5% 115.1% 114.9% 113.6% 121.6%
Six years later 93.4% 109.7% 118.2% 118.2% 116.0%
Seven years later 94.5% 111.4% 119.5% 119.4%
Eight years later 95.5% 111.8% 120.6%
Nine years later 95.6% 112.8%
Ten years later 96.6%
Net reserves reestimated as of:
One year later 99.1% 100.3% 103.5% 103.3% 104.4% 115.8% 104.7% 102.8% 109.2% 115.4%
Two years later 95.2% 102.3% 109.9% 109.7% 114.5% 115.7% 106.6% 112.0% 119.9%
Three years later 91.4% 107.4% 116.9% 117.9% 113.1% 120.5% 114.2% 121.7%
Four years later 92.5% 110.7% 120.1% 117.7% 116.1% 125.9% 122.6%
Five years later 94.0% 112.7% 119.9% 119.8% 118.2% 133.8%
Six years later 95.9% 112.0% 120.5% 121.5% 121.3%
Seven years later 95.4% 112.5% 121.9% 124.3%
Eight years later 96.0% 113.4% 124.3%
Nine years later 96.7% 114.8%
Ten years later 97.2%
Net cumulative redundancy
(deficiency) 2.8% (14.8)% (24.3)% (24.3)% (21.3)% (33.8)% (22.6)% (21.7)% (19.9)% (15.4)%
Gross reserves for unpaid loss and
loss adjustment expenses $127,666 $211,600 $221,325 $369,244 $432,173 $428,653 $524,744 $781,377
Reinsurance recoverable on unpaid
loss and loss adjustment expenses 50,039 95,886 79,811 167,888 185,421 165,547 238,769 502,537
-------- -------- -------- -------- -------- -------- -------- --------
Net reserves for unpaid loss and
loss adjustment expenses $ 77,627 $115,714 $141,514 $201,356 $246,752 $263,106 $285,975 $278,840
======== ======== ======== ======== ======== ======== ======== ========
Reestimated gross reserves for unpaid
loss and loss adjustment expenses 115.5% 121.2% 138.3% 117.5% 119.2% 129.6% 121.0%
Reestimated reinsurance recoverable
on unpaid loss and loss adjustment
expenses 101.8% 121.1% 146.4% 111.4% 116.0% 144.9% 127.7%
Reestimated net reserves for unpaid
loss and loss adjustment expenses 124.3% 121.3% 133.8% 122.6% 121.7% 119.9% 115.4%
======== ======== ======== ======== ====== ====== ========
Gross cumulative redundancy (deficiency) (15.5)% (21.2)% (38.3)% (17.5)% (19.2)% (29.6)% (21.0)%
======== ======== ======= ======= ======= ======= =======
(1) Cumulative amount paid includes reserves of Phoenix Indemnity as of
August 31, 1999, the date Phoenix Indemnity was sold.
Reinsurance
A significant component of the Company's business strategy
involves the structuring of reinsurance to manage volatility in its business
segments as well as to avoid large or catastrophic loss exposure. Reinsurance
involves an insurance company transferring, or ceding, all or a portion of its
insurance exposure to a reinsurer. The reinsurer assumes the ceded exposure in
return for a portion of the premium received by the insurance company.
Reinsurance does not discharge the insurer from its obligations to its insured.
If the reinsurer fails to meet its obligations, the ceding insurer remains
liable to pay the insured loss, but the reinsurer is liable to the ceding
insurer to the extent of the reinsured portion of any loss.
The Company limits its exposure under individual policies by
purchasing excess of loss and quota share reinsurance, as well as maintaining
catastrophe reinsurance to protect against catastrophic occurrences where
claims can arise under multiple policies from a single event, such as a
hurricane, earthquake, wind storm, riot, tornado or other extraordinary event.
The Company generally retains the first $500,000 of risk
under its property and casualty lines of business, ceding the next $1,500,000
(on a per risk basis) on property and $5,500,000 (on an occurrence basis) on
casualty, respectively to reinsurers. To the extent individual policies exceed
reinsurance treaty limits, the Company purchases reinsurance on a facultative
(specific policy) basis. In addition, the Company further reduces its net
exposures per risk on certain lines of business through further excess of loss
or quota share reinsurance programs.
The Company maintains catastrophe reinsurance for its
casualty lines which provides coverage for $14 million in excess of $6 million
of aggregate risk per occurrence, and for its property lines, which provides
coverage of 95% of $157.5 million in excess of a $2.5 million retention per
occurrence. The Company reviews the concentrations of property values in its
property lines of business continually and models possible losses for
catastrophic events through computer simulations of different levels of storm
activity, adjusting the required limit of liability or the concentrations of
property coverage as deemed appropriate.
In its workers' compensation line, the Company buys excess of
loss protection on a statutory basis. The Company's retention varies between
$100,000 and $ 600,000 per occurrence, depending upon the program.
In addition, the Company will often cede 90% or more of some
new programs which it regards as developmental until such time as the program
establishes a more reliable loss and premium history. On these lines of
business, the Company will typically receive a fee from reinsurers as the
issuing carrier on the program.
The Company reinsures its MPCI business with various FCIC
reinsurance pools administered by the RMA. The Company's profit or loss from
its MPCI business is determined after the crop season ends on the basis of a
profit sharing formula established by law and the RMA. The Company's net
exposure on MPCI business is further reduced by excess of loss reinsurance
purchased from private reinsurers. This excess of loss reinsurance generally
provides coverage for 95% of losses in excess of a $3,000,000 deductible after
the Company's loss ratio reaches specified limits for each line of business,
ranging from 72% to 80% on crop hail and named peril business and 100% on MPCI
business. The Company limits this coverage to an aggregate amount determined
annually consistent with the Company's anticipated premium, catastrophic loss
risk exposure and RMA regulations. Additionally the Company's named peril,
crop hail and supplemental business is reinsured through quota share
agreements, ceding from 50% to 85% to reinsurers.
In 1999 the Company was unable to obtain the desired level
of quota share reinsurance on its supplemental, proprietary CropRevenue
CoveragePlus(R) ("CRCPlus") product for cotton and rice. Consequently, the
Company developed multiple layer aggregate stop loss protection for these
coverages. The first layer of this protection is combined with aggregate stop
loss protection for the Company's MPCI business. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations." For the 2000
crop year, the Company was able to purchase the desired level of quota share
reinsurance applicable to all supplemental crop products which the Company
offered.
At December 31, 1999, 80% of the Company's outstanding
reinsurance recoverables were from domestic reinsurance companies or the
federal government, 95% of which was from reinsurance companies rated
A-(excellent) or better by A.M. Best or from the federal government. The
balance was primarily placed with major international reinsurers.
Investments
The Company's investment policy is to maximize the after-tax
yield of the portfolio while emphasizing stability and preservation of the
Company's capital base. Further, the portfolio is invested in types of
securities with average durations which reflect the Company's liabilities and
expected liquidity needs. The Company determines the strategies and parameters
for the investment of its portfolio, and an outside manager executes trades
consistent with the Company's strategies and parameters. The Company's fixed
maturity securities are classified as available-for-sale and carried at
estimated fair value. The investment portfolio at December 31, 1999 and 1998,
consisted of the following:
December 31, 1999 December 31, 1998
-------------------- ---------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
-------------------- ---------------------
Type of Investment (in thousands)
- ------------------
Fixed maturity securities
U.S. Treasury and government securities.................... $ 87,421 $ 85,094 $ 77,671 $ 78,785
States, municipalities and political
subdivisions ........................................... 132,805 126,195 161,017 167,202
Other debt securities ...................................... 19,191 17,823 56,786 53,193
Mortgage-backed securities ................................. 24,902 21,277 38,475 37,927
-------- -------- -------- --------
Total fixed maturity securities ..................... 264,319 250,389 333,949 337,107
Common stocks .............................................. 15,377 10,903 39,438 44,371
Preferred stocks ........................................... 15,111 14,178 27,246 27,316
Commercial mortgage loan ..................................... 8,914 8,914 9,549 9,549
Real estate .............................................. 3,182 3,182 3,300 3,300
Short-term investments(1) ............................... 104,702 104,702 67,754 67,754
Restricted short-term investments ...................... 31,350 31,350 -- --
-------- -------- -------- --------
Total............................................... $442,955 $423,618 $481,236 $489,397
======== ======== ======== ========
- ---------------
(1) Due to the short-term nature of crop insurance, the Company must
maintain short-term investments to fund losses. Historically, these
short-term funds are highest in the fall corresponding to the cash
flow in the agricultural industry.
The following table sets forth, as of December 31, 1999, the
composition of the Company's fixed maturity securities portfolio by time to
maturity:
Estimated
Maturity Fair Value Percent
-------- ---------- --------
(in thousands, except percentages)
1 year or less.............................................................$ 14,480 5.8%
More than 1 year through 5 years............................................ 55,696 22.2%
More than 5 years through 10 years.......................................... 42,700 17.1%
More than 10 years......................................................... 119,690 47.8%
Mortgage-backed securities.................................................. 17,823 7.1%
-------- ------
Total.................................................................$250,389 100.0%
======== ======
The Company's investment results for the periods indicated
are set forth below:
Years Ended December 31,
--------------------------------
1999 1998 1997
------ ----- ------
(in thousands, except percentages)
Net investment income..........................................................$ 25,064 $ 28,320 $ 28,016
Average investment
portfolio(1)................................................................. 472,569 497,649 453,876
Pre-tax return on average
investment portfolio......................................................... 5.3% 5.7% 6.2%
Net realized gains.............................................................$ 10,203 $ 6,825 $ 7,321
Change in unrealized gain (loss) on available-for-sale securities .......... $(27,497) $ (2,431) $ 12,863
- ---------------
(1) Represents the average of the beginning and ending investment
portfolio (excluding real estate) computed on a quarterly basis.
Regulation
As a general rule, an insurance company must be licensed to
transact insurance business in each jurisdiction in which it operates, and
almost all significant operations of a licensed insurer are subject to
regulatory scrutiny. Licensed insurance companies are generally known as
"admitted" insurers. Most states provide a limited exemption from licensing
for insurers issuing insurance coverages that generally are not available from
admitted insurers. These coverages are referred to as "surplus lines"
insurance, and these insurers as "surplus lines" or "nonadmitted" companies.
The Company's admitted insurance business is subject to
comprehensive, detailed regulation throughout the United States under statutes
which delegate regulatory, supervisory and administrative powers to state
insurance commissioners. The primary purpose of such regulations and
supervision is the protection of policyholders and claimants rather than
stockholders or other investors. Depending on whether the insurance company
is domiciled in the state and whether it is an admitted or nonadmitted insurer,
state regulatory authority may extend to: (i) periodic reporting of the
insurer's financial condition; (ii) periodic financial examination; (iii)
approval of rates and policy forms; (iv) loss reserve adequacy; (v) insurer
solvency; (vi) the licensing of insurers and their agents; (vii) restrictions
on the payment of dividends and other distributions; (viii) approval of changes
in control; and (ix) the type and amount of permitted investments.
The Company also is subject to laws governing insurance
holding companies in Nebraska, Iowa and Texas, where the Insurance Companies
are domiciled. These laws, among other things, require the Company to file
periodic information with state regulatory authorities including information
concerning its capital structure, ownership, financial condition and general
business operations. The insurance holding company laws also regulate
certain transactions between the Company, its affiliates and the Insurance
Companies, including the amount of dividends and other distributions and the
terms of surplus notes, and restrict the ability of any one person to acquire
certain levels of the Company's voting securities (generally 10%) without prior
regulatory approval.
Except for interest on surplus notes issued by the Insurance
Companies and payments from American Agrisurance, Inc. ("American Agrisurance")
under a profit sharing agreement, the Company is dependent for funds to pay its
operating and other expenses upon dividends and other distributions from the
Insurance Companies, the payment of which are subject to review and
authorization by state insurance regulatory authorities. Under Nebraska law,
where American Growers, Acceptance Indemnity and Acceptance Insurance are
domiciled, no domestic insurer may make a dividend or distribution which,
together with dividends or distributions paid during the preceding 12 months,
exceeds the greater of (i) 10% of such insurer's policyholders' surplus as of
the preceding December 31 or (ii) such insurer's statutory net income
(excluding realized capital gains) for the preceding calendar year, until
either it has been approved, or a 30-day waiting period shall have passed
during which it has not been disapproved, by the Nebraska Insurance Director.
Iowa and Texas have similar laws governing the payment of dividends or
distributions of insurance companies domiciled in their state. In any case,
the maximum amount of dividends the Insurance Companies may pay to the Company
is limited to its earned surplus, also known as unassigned funds. The tiered
structure of the Company's insurance subsidiaries effectively imposes two
levels of dividend restriction on the payment of dividends to the Company by
Acceptance Indemnity, American Growers and Acceptance Casualty. During 2000
the statutory limitation on dividends from the Insurance Companies to the
Company without further insurance department approval is approximately $7.4
million. If the proposed transactions related to the proposed sale of Redland
are completed, the Company expects that the statutory limitation on dividends
from the Insurance Companies to the Company without further insurance
department approval will increase to approximately $21.8 million for the
remainder of 2000. This anticipated increase would result from the additional
dividends that are expected to be available from American Growers if the
proposed transactions are completed. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations-Liquidity and Capital
Resources The Company-Parent Only" and "-Redland Insurance Company Subsequent
Event."
Other regulatory and business considerations may further
limit the ability of the Insurance Companies to pay dividends. For example,
the impact of dividends on surplus could effect an insurers' competitive
position, the amount of premiums that it can write and its ability to pay
future dividends. Further, the insurance laws and regulations of Nebraska,
Iowa and Texas require the statutory surplus of an insurance company domiciled
therein, following any dividend or distribution by such company, be reasonable
in relation to its outstanding liabilities and adequate for its financial
needs.
While the Company's noninsurance company subsidiaries are not
subject directly to the dividend and other distribution limitations, insurance
holding company regulations govern the amount which a subsidiary within the
holding company system may charge any of the Insurance Companies for services
(e.g., agents'commissions).
The Company's MPCI program is federally regulated and
supported by the federal government through premium subsidies to agricultural
producers and expense reimbursement and federal reinsurance pools for private
insurers. Consequently, the MPCI program is subject to oversight by the
legislative and executive branches of the federal government, including the
RMA. The MPCI program regulations prescribe the premiums which may be charged
and generally require compliance with detailed federal guidelines with respect
to underwriting, rating and claims administration. The Company also is
required to perform continuous internal audit procedures and is subject to
audit by several federal government agencies.
During the past several years, various regulatory and
legislative bodies have adopted or proposed new laws or regulations to deal
with the cyclical nature of the insurance industry, catastrophic events and
insurance capacity and pricing. These regulations include: (i) the creation
of "market assistance plans" under which insurers are induced to provide
certain coverages; (ii) restrictions on the ability of insurers to cancel
certain policies in mid-term; (iii) advance notice requirements or limitations
imposed for certain policy nonrenewals or termination of certain agent
relationships; and (iv) limitations upon or decreases in rates permitted to
be charged.
The NAIC has approved and recommended states adopt and
implement several regulatory initiatives designed to provide regulators an
early warning tool to identify deteriorating or weakly capitalized insurance
companies and to decrease the risk of insolvency of insurance companies. These
initiatives include the implementation of Risk Based Capital ("RBC") standards
for determining adequate levels of capital and surplus to support four areas of
risk facing property and casualty insurers: (i) asset risk (default on fixed
income assets and market decline); (ii) credit risk (losses from unrecoverable
reinsurance and inability to collect agents' balances and other receivables);
(iii) underwriting risk (premium pricing and reserve estimates); and
(iv) off-balance sheet/growth risk (excessive premium growth and unreported
liabilities). At December 31, 1999 the Insurance Companies met the RBC
requirements as promulgated by the domiciliary states of the Insurance
Companies and the NAIC.
The NAIC also maintains an Insurance Regulatory Information
System ("IRIS") to assist state insurance departments in identifying
significant changes in the operations of an insurance company, such as changes
in its product mix, large reinsurance transactions, increases or decreases in
premiums received and certain other changes in operations. Such changes may
not result from any problems with an insurance company but may merely indicate
changes in certain ratios outside ranges defined as normal by the NAIC. When
an insurance company has four or more ratios falling outside "normal ranges",
state regulators may investigate to determine the reasons for the variance
and whether corrective action is warranted. At December 31, 1999 Redland and
Acceptance Casualty each had four ratios falling outside "normal ranges."
The increase in the number of ratios falling outside "normal ranges" for both
companies was primarily related to the increase in loss reserves and the
changes in the intercompany pooling percentages.
The eligibility of the Insurance Companies to write insurance
on a surplus lines basis is dependent on their compliance with certain
financial standards, including the maintenance of a requisite level of capital
and surplus and the establishment of certain statutory deposits. State
surplus lines laws typically: (i) require the insurance producer placing the
business to show that he or she was unable to place the coverage with admitted
insurers; (ii) establish minimum financial requirements for surplus lines
insurers operating in the state; and (iii) require the insurance producer to
obtain a special surplus lines license. In recent years, many jurisdictions
have increased the minimum financial standards applicable to surplus lines
eligibility.
The Insurance Companies also may be required under the
solvency or guaranty laws of most states in which they are licensed to pay
assessments (up to certain prescribed limits) to fund policyholder losses and
other liabilities of insolvent or rehabilitated insurance companies. These
assessments may be deferred or forgiven under most guaranty laws if they would
threaten an insurer's financial strength and, in certain instances, may be
offset against future premium taxes. Some state laws and regulations further
require participation by the Insurance Companies in pools or funds to provide
types of insurance coverages which they ordinarily would not accept.
Uncertainties Affecting the Insurance Business
The property and casualty insurance business is highly
competitive, with over 3,000 insurance companies in the United States, many of
which have substantially greater financial and other resources, and may offer
a broader variety of coverages than those offered by the Company. Beginning in
the latter half of the 1980s, there has been severe price competition in the
insurance industry which has resulted in a reduction in the volume of premiums
written by the Company in some of its lines of businesses because of its
unwillingness to reduce prices to meet competition. In the crop insurance
business, the Company competes with other crop insurance companies primarily
on the basis of service, supplemental products and commissions to agents.
The specialty property and casualty coverages underwritten by
the Company may involve greater risks than more standard property and casualty
lines. These risks may include a lack of predictability, and in some
instances, the absence of a long-term, reliable historical data base upon which
to estimate future losses.
Pricing in the property and casualty insurance industry is
cyclical in nature, fluctuating from periods of intense price competition,
which led to record underwriting losses during the early 1980s, to periods of
increased market opportunity as some carriers withdrew from certain market
segments in the mid 1980s, back to a period of intense competition during the
1990s. This increase in the competitive environment has been one of the
principal causes in the Company's declining property and casualty revenues
over the past three years.
The property and casualty industry has experienced a more
rapid growth in policyholders' surplus than in premiums written during the
last decade, resulting in substantially reduced operating leverage and,
consequently, lower returns on equity. In 1990, the industry ratio of net
premiums written to policyholders' surplus was 1.57 to 1.0. By 1999, this
ratio decreased to .88 to 1.0. Even with relatively constant operating
margins, the industry's return on equity has decreased. This reduction in
operating leverage will continue to negatively affect industry and individual
company return on equity results unless it returns to historically higher
levels.
The Company's results also may be influenced by factors
influencing the insurance industry generally and which are largely beyond the
Company's control. Such factors include (i) weather-related catastrophes;
(ii) taxation and regulatory changes at both the federal and state level;
(iii) changes in industry standards regarding rating and policy forms;
(iv) significant changes in judicial attitudes towards one or more types of
liability claims; (v) the cyclical nature of pricing in the industry; and
(vi) changes in the rate of inflation, interest rates and general
economic conditions.
The Company's results may also be influenced by the rating
downgrade by A.M. Best. On November 29, 1999, A.M. Best downgraded the rating
of the Insurance Companies from A- to B++. Some agents require an A- or
better rating for certain lines of business, particularly some of the Company's
better performing property and casualty programs. This rating downgrade will
have a negative impact on the Company's ability to write business in the most
profitable lines within its Property and Casualty segment. The Company is
attempting to address this issue through the proposed sale of Redland to
Clarendon. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations-Redland Insurance Company Subsequent Event"
regarding this proposed sale. While this transaction, if completed, will
provide the Company with an A rated issuing carrier, it will also increase the
company's operating expense levels.
The Company's results are significantly impacted by its crop
business, particularly its MPCI line. Since the Company's products insure crop
prices, yields or both, the Company's results are subject to numerous factors
and events that it cannot control. Results from the crop lines are not
currently known until the fourth quarter of the year, after crops are harvested
and final market prices are established. Crop results are particularly
dependent on events beyond the Company's control, notably weather conditions
during the crop growing seasons in the states where the Company writes
substantial amounts of crop insurance, the market price of grains on various
commodity exchanges, overall worldwide supply and demand, the continuing
globalization of the crop industry and its effect on the export of crops to
other countries and the volatility of crop prices resulting from domestic and
foreign policy decisions. Additionally, federal regulations governing aspects
of crop insurance are frequently modified, and all such changes may impact the
results of the Company's crop insurance business. Forward-looking information
set forth herein does not take into account any impact from any adverse weather
conditions during the 2000 crop season, or the various other factors noted
herein which may affect crop and noncrop operation results. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-General."
The insurance business is highly regulated and supervised in
the states in which the Insurance Companies conduct business. The crop
insurance lines are partially subject to state regulation and also are subject
to significant additional federal regulation. The regulations relating to the
property and casualty and crop insurance business at both the state and federal
level are frequently modified and such modifications may impact future
insurance operations. See "Regulation."
Adverse loss experience for prior years resulted in an
increase in loss reserves for the years ended December 31, 1999 and 1998, in
the amounts of $44.0 million and $24.2 million, respectively. The
establishment of appropriate loss reserves is an inherently uncertain process
and it has been necessary, and may be necessary in the future, to revise
estimated loss reserve liabilities. See "Loss and Loss Adjustment Reserves,"
for a further discussion of factors which may, in the future, influence loss
reserve estimates.
Property and casualty insurance is a capital intensive
business and the Company is obliged to maintain minimum levels of surplus in
the Insurance Companies in order to continue writing insurance at current
levels or to increase its writings, and also to meet various operating ratio
standards established by state insurance regulatory authorities and by
insurance rating bureaus. The Company continually reviews the surplus needs
of the Insurance Companies, and from time to time may determine to seek
additional funding. For a discussion of the Company's liquidity and capital
resources, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity and Capital Resources."
Employees
At March 1, 2000 the Company had 426 employees in its Crop
Insurance segment, 191 employees in its Property and Casualty Insurance
segment and 181 employees that were not allocated to the two segments, for a
total of 798 employees. Acceptance believes that relations with its employees
are good.
Item 2. Properties.
The following table sets forth certain information regarding
the principal properties of the Company:
General Leased/
Location Character Size Owned(1)
- --------- --------- ---------------- ------------
Omaha, NE.......................................Office 58,000 sq. ft. Leased(2)
Council Bluffs, IA..............................Office 142,000 sq. ft. Leased
Council Bluffs, IA..............................Office 33,000 sq. ft. Owned
Phoenix, AZ.....................................Office 33,000 sq. ft. Assigned(3)
Whitsett, NC....................................Office 7,000 sq. ft. Leased
Burlington, NC..................................Office 16,655 sq. ft. Subleased (4)
Macon, MO.......................................Office 850 sq. ft. Subleased (5)
Scottsdale, AZ..................................Office 27,000 sq. ft. Leased(6)
Itasca, IL......................................Office 4,000 sq. ft. Leased
Overland Park, KS...............................Office 4,000 sq. ft. Leased(7)
- ---------------
(1) The range of expiration dates for these leases is November 30, 2001
(Omaha), December 31, 2001 with five-year option (Council Bluffs),
December 31, 2000 (Whitsett), December 31, 2001 (Scottsdale),
August 31, 2001 (Itasca), and December 31, 2001 (Overland Park).
(2) 21,167 square feet are subleased to a third party. The sublease
expires on November 30, 2001.
(3) This lease was assigned to Millers American Group Inc. in September
1999 in conjunction with the sale of Phoenix Indemnity.
(4) 8,300 square feet are subleased to a third party and 8,355 square
feet are subleased to another third party. Both subleases expire on
November 30, 2000.
(5) 850 square feet are subleased to a third party. The sublease expires
on March31, 2000.
(6) 3,840 square feet are subleased to Levy Latham Global LLC.
(7) 2,907 square feet are subleased to a third party. The sublease
expires on December 31, 2000.
Item 3. Legal Proceedings.
The Company or one or more of the Insurance Companies are
parties to certain legal proceedings which are not ordinary routine litigation
incidental to its business. These proceedings are:
American Agrisurance, Inc., et al. adv. James M.
Wallace, III, et al. (USDC, ED, Arkansas, No.LR-C-99-669). This action was
filed in Arkansas state court on August 17,1999 and removed by the defendants
to the United States District Court for the Eastern District of Arkansas.
Claimants are five individual Arkansas residents; defendants currently are the
Company, American Agrisurance, American Growers and Redland. Claimants seek to
represent "all rice farmers, wherever situated, who applied for a 1999 Rice
CRCPlus crop insurance policy at the originally offered 3 cents per
pound . . . but who were subsequently notified that they would only receive
1.5 cents per pound of supplemental coverage." They claim defendants breached
a contract of insurance with each plaintiff and intentionally made false
representations in violation of the Arkansas deceptive trade practices statute.
Claimants seek compensatory damages, interest, attorneys' fees and "all other
appropriate damages or relief." In an Order entered March 10, 2000, the Court
denied claimants motion for class certification. Until March 24, 2000
claimants may apply to the United States Court of Appeals for the Eighth
Judicial Circuit for permission to immediately appeal from
this order. Such an application, however, would not stay this action.
Acceptance Insurance Companies Inc., et al. adv. Lawrence I.
Batt, P.C. Profit Sharing Plan and Trust (USDC, Nebraska, No. 8:99CV547). This
action was filed in the United States District Court for the District of
Nebraska on December 29, 1999. Claimant seeks to represent a class consisting
of "all persons who purchased Acceptance common stock between March 10, 1998
and November 16, 1999." The Company and two of its officers are the only named
defendants. Claimant's sole claim for relief is that defendants failed to
disclose material information in violation of federal securities laws, and
specifically Rule 10b-5 of the U.S. Securities and Exchange Commission. In
essence, the complaint alleges defendants knowingly and intentionally
understated the Company's liabilities in order to maintain the market price of
the Company's common stock at artificially high levels, and repeatedly made
untrue statements of material fact. Claimant seeks compensatory damages,
reasonable costs and expenses incurred in this action and "such other and
further relief as the Court may deem just and proper."
AICI Capital Trust, et al. adv. Barbara Winer Revocable Trust
(USDC, Nebraska, No. 8:00CV82). This action was filed in the United States
District Court for the District of Nebraska on February 7, 2000. Claimant
seeks to represent a class consisting of all persons "who purchased AICI
Capital Trust preferred securities on or traceable to the public
offering . . . on July 29, 1997 through November 25, 1999." The Company, a
business trust established by the Company to issue preferred securities, the
Company's Directors and various other individuals, as well as the financial
underwriters for the Company's preferred securities, are defendants in this
action. The allegations in this action are essentially indistinguishable from
the allegations in the Batt action. In the Winer action, Claimant seeks
damages in an amount to be determined at trial, costs and expenses in this
action, including reasonable attorney fees, and such other and further relief
as may be just and proper under the circumstances.
The Wallace action is in the discovery phase and the
remaining actions remain in their earliest procedural phases. While the
Company believes each of these actions is without merit, their ultimate
outcome cannot be predicted at this time and the Company currently is unable
to determine the potential effect of this litigation on the Company's financial
position, results of operations or cash flows. The Company intends to
vigorously contest these three lawsuits. As of March 1, 2000 the Company
noted published reports of two additional suits which may include allegations
substantially similar to the allegations in the Batt and Winer actions. The
Company's professional liability insurer has asserted the Company's insurance
coverage does not include the acts, errors and omissions alleged in the
Wallace action. The Company disputes this assertion.
State Insurance Department Proceedings. The insurance
departments of Arkansas, Iowa, Louisiana, Mississippi, Missouri and Nebraska
participated in a Multi-State Market Conduct Examination with respect to
transactions by the Insurance Companies and affiliates during the period from
January 1, 1997 through April 5, 1999, particularly regarding the Company's
proprietary CRCPlus crop insurance product. The Company resolved all issues
raised by the Arkansas Department of Insurance and the Arkansas Attorney
General in conjunction with the Spring 1999 sale of CRCPlus in January 2000.
In conjunction with this resolution the Company contributed $750,000 to a fund
for the exclusive purpose of providing risk management education and other
benefits to rice producers; the Company also agreed to contribute an additional
amount of approximately $750,000 to this fund in November, 2000 and an
additional $250,000 in February 2001 if it fails to offer a form of
supplemental insurance coverage for rice producers.
In March, 2000 the Company resolved all issues raised by the
Missouri Department of Insurance in conjunction with the Spring 1999 sale of
CRCPlus. In conjunction with this resolution the Company paid $50,000 to the
Missouri State School Fund.
The Company is engaged in an active dialogue with insurance
regulatory officials in Louisiana and Mississippi regarding various issues
raised by each of those states in conjunction with the Multi-State Market
Conduct Examination. The Company does not believe any regulatory proceedings
will be initiated by these states, or by insurance regulatory officials in
Nebraska or Iowa, nor that any proceedings which might be initiated would be
material.
Risk Management Agency Proceedings. In June 1999 the Company
entered into an agreement with the RMA related to the unforeseen demand for
CRCPlus during the 1999 Crop Year. Under the agreement, the Company
established a $1 million research and education fund to benefit rice producers,
agreed to create a strengthened system of checks and balances and management
oversight with respect to its crop insurance operations, and reimbursed the
FCIC approximately $1.2 million under the SRA. In conjunction with the
Company's settlement with the Arkansas Department of Insurance and Attorney
General as described above, the RMA acknowledged that the Company had
fulfilled its obligations with respect to the $1 million research and
education fund. The Company is required to report annually to the RMA in
2000 and 2001 regarding its strengthened checks and balances and management
oversight with respect to crop operations.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders
during the fourth quarter of the fiscal year ended December 31, 1999.
PART II.
Item 5. Market for Registrant's Equity and Related Stockholder Matters.
The Common Stock is listed and traded on the New York Stock
Exchange ("NYSE"). The following table sets forth the high and low sales
prices per share of Common Stock as reported on the NYSE Composite Tape for
the fiscal quarters indicated.
High Low
------ -------
Year Ended December 31, 1998
First Quarter............................................................. 25 3/8 22 5/8
Second Quarter............................................................ 25 1/4 21 1/2
Third Quarter............................................................. 24 11/16 17 7/16
Fourth Quarter............................................................ 20 13/16 17 1/16
Year Ended December 31, 1999
First Quarter............................................................. 20 7/16 13 5/16
Second Quarter............................................................ 15 11/16 12 1/16
Third Quarter............................................................. 15 15/16 11 3/4
Fourth Quarter............................................................ 15 1/8 4 7/8
As of March 7, 2000, there were approximately 982 holders of record of the
Common Stock.
The Company has not paid cash dividends to its shareholders
during the periods indicated above and does not anticipate that it will pay
cash dividends in the foreseeable future. The Company's credit agreement
with its lenders prohibits the payment of cash dividends to shareholders. See
"Regulation" for a description of restrictions on payment of dividends to the
Company from the Insurance Companies; and see "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and
Capital Resources" for a description of the Company's credit agreement.
Item 6. Selected Consolidated Financial Data.
The following table sets forth certain selected consolidated
financial data and should be read in conjunction with, and is qualified in its
entirety by, the Consolidated Financial Statements and the notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere herein. This selected consolidated financial
data has been derived from the audited Consolidated Financial Statements
of the Company and its subsidiaries.
Years Ended December 31,
--------------------------------------------------------------------------
1999(1) 1998(1) 1997(1) 1996(1) 1995(1)
-------- --------- -------- ---------- ---------
(in thousands, except per share data and ratios)
Income Statement Data:
Revenues:
Gross premiums written ...................... $692,941 $700,960 $665,810 $651,060 $537,349
======== ======== ======== ======== ========
Net premiums written ........................ $251,666 $309,492 $335,064 $366,949 $286,183
======== ======== ======== ======== ========
Net premiums earned ......................... $248,712 $328,044 $335,215 $348,653 $271,584
Net investment income........................ 25,064 28,320 28,016 26,491 20,651
Net realized capital gains ................. 10,203 6,825 7,321 5,216 2,707
Agency income .......................... -- -- -- 1,035 2,863
-------- -------- -------- -------- --------
Total revenues 283,979 363,189 370,552 381,395 297,805
Costs and expenses:
Losses and loss adjustment
expenses ................................... 218,789 237,061 213,455 243,257 212,337
Underwriting and other expenses ............. 108,529 104,736 97,109 95,803 72,602
Agency expenses ................................ -- -- -- 1,024 2,596
General and administrative expenses ............ 4,592 3,502 2,063 2,015 2,165
-------- -------- -------- -------- ---------
Total expenses................................ 331,910 345,299 312,627 342,099 289,700
--------- -------- -------- -------- ---------
Operating profit (loss) ................ (47,931) 17,890 57,925 39,296 8,105
Other expense:
Interest expense ........................... (9,058) (8,994) (6,569) (4,896) (2,591)
Other expense, net ......................... (67) (816) (51) (910) (171)
-------- -------- --------- --------- ----------
Income (loss) before income taxes
and cumulative effect of change
in accounting principle................... (57,056) 8,080 51,305 33,490 5,343
Income tax expense (benefit) ................. (21,436) 2,544 15,992 3,210 1,188
Cumulative effect of change in
accounting principle ....................... (338) -- -- -- --
---------- -------- --------- -------- -------
Net income................................. $ (35,958) $ 5,536 $ 35,313 $ 30,280 $ 4,155
========== ======== ========= ======== =======
Net income
per share:
- Basic ................................. $ (2.52) $ .37 $ 2.34 $2.03 $ .28
- Diluted .................................. (2.52) .37 2.30 1.99 .28
GAAP Ratios:
Loss ratio ................................. 88.0% 72.3% 63.7% 69.7% 78.2%
Expense ratio .............................. 43.6% 31.9% 28.9% 27.5% 26.7%
--------- --------- -------- -------- ---------
Combined loss and expense ratio .......... 131.6% 104.2% 92.6% 97.2% 104.9%
========= ========= ======== ======== =========
Years Ended December 31,
---------------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ----------- --------- --------- ---------
Balance Sheet Data:
Investments ................................... $423,618 $489,397 $452,717 $405,926 $368,001
Total assets................................ 1,278,312 1,092,943 979,453 884,380 781,034
Loss and loss adjustment
expense reserves ............................. 781,377 524,744 428,653 432,173 369,244
Unearned premiums............................. 127,938 162,037 157,134 140,217 124,122
Borrowings and term debt ....................... -- 15,000 -- 69,000 69,000
Company-obligated mandatorily
redeemable Preferred Securities
of AICI Capital Trust, holding
solely Junior Subordinated
Debentures of the Company ..................... 94,875 94,875 94,875 -- --
Stockholders' equity.......................... 180,958 236,154 253,670 207,820 177,787
Other Data:
Statutory Surplus of Insurance
Companies(2) ............................... 158,551 236,041 238,520 191,455 169,628
__________________
(1) For a discussion of the Company's discontinued lines of business, see
"Business-Company Strategy" and "-Business Segments" and for a
discussion of the accounting treatment of the Company's MPCI business,
see "Management's Discussion and Analysis of Financial Condition and
Results of Operations-General."
(2) Statutory data has been derived from the separate financial statements
of the Insurance Companies prepared in accordance with SAP. The
decline in statutory surplus from 1998 to 1999 was partially related
to the net loss incurred by the Insurance Companies, the repayment of
a $20 million surplus note and $6.0 million dividend payment by
Redland.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis of financial condition
and results of operations of the Company and its consolidated subsidiaries
should be read in conjunction with the Company's Consolidated Financial
Statements and the notes thereto included elsewhere herein.
General
The Company continues to focus its emphasis on its crop
segment which has recorded operating profits during each of the last six years.
The principal lines of the Company's Crop Insurance segment are MPCI,
supplemental coverages, and named peril insurance. MPCI is a federally
subsidized risk management program designed to encourage farmers to manage
their risk through the purchase of insurance policies. MPCI provides farmers
with yield coverage for crop damage from substantially all natural perils.
CRC is an extension of the MPCI program which provides farmers with protection
from revenue loss caused by changes in crop prices, low yields or both. As
used herein, the term MPCI includes CRC, unless the context indicates
otherwise. For the year ended December 31, 1999, the Company had a market
share of approximately 16% of MPCI business written in the United States.
The accounting treatment for MPCI is different than the more
traditional property and casualty insurance lines. For income statement
purposes, gross premiums written consist of the aggregate amount of MPCI
premiums paid by farmers, and does not include any related federal premium
subsidies. The Company's profit or loss from its MPCI business is determined
after the crop season ends on the basis of a profit sharing formula established
by law and the RMA. For income statement purposes, any such profit share
earned by the Company, net of the cost of third party reinsurance, is shown as
net premiums written, which equals net premiums earned for MPCI business;
whereas, any share of losses payable by the Company is charged to losses and
loss adjustment expenses. Due to various factors, including timing and
severity of losses from storms and other natural perils and crop production
cycles, the profit or loss on MPCI premiums is primarily recognized in the
second half of the calendar year. The Company relies on loss information
from the field to determine (utilizing a formula established by the RMA) the
level of losses that should be considered in estimating the profit or loss
during this period. Based upon available loss information, the Company has
historically recorded an estimate of the profit or loss during the third
quarter and then re-evaluated the estimate using additional loss information
available. Due to the nature of the CRC product whereby results are influenced
by changes in the market prices of various commodities in the fourth quarter
and the increasing significance of CRC as a percentage of MPCI, the Company
intends to record its initial estimate of the profit or loss for the 2000 crop
results in the fourth quarter of 2000.
Certain characteristics of the Company's crop business may
affect comparisons, including: (i) the seasonal nature of the business whereby
profits or losses are generally recognized predominately in the second half of
the year; (ii) the nature of crop business whereby losses are known within a
one year period; and (iii) the limited amount of investment income associated
with crop business. In addition, cash flows from such business differ from
cash flows from certain more traditional lines. See "Liquidity and Capital
Resources" below. With the Company's increased emphasis on the crop segment,
the seasonal and short term nature of the Company's crop business, as well
as the impact on the crop business of weather and other natural perils, may
produce more volatility in the Company's operating results on a quarter to
quarter or year to year basis than has historically been the case.
In its Property and Casualty segment, the Company sold its
nonstandard automobile business, including Phoenix Indemnity in 1999 and in
2000 reached agreements in principle to transfer its general agency
business produced by its Scottsdale office and its transportation business to
other carriers. These transactions are part of the Company's strategy in this
segment. See "Business-Company Strategy" and " Business-Segments."
Forward-Looking Information
Except for the historical information contained in this
Annual Report on Form 10-K, matters discussed herein may constitute
forward-looking information, within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking information reflects the
Company's current best estimates regarding future operations, but, since these
are only estimates, actual results may differ materially from such estimates.
A variety of events, most of which are outside the Company's
control, cannot be accurately predicted and may materially impact estimates of
future operations. Important among such factors are weather conditions,
natural disasters, changes in commodity prices, changes in state and federal
regulations, price competition impacting premium levels, changes in tax laws,
financial market performance, changes in court decisions effecting coverages
and general economic conditions.
The Company's results are significantly impacted by its crop
business, particularly its MPCI line. Results from the crop lines are not
generally known until the fourth quarter of the year, after crops are
harvested and final market prices are established. Crop segment results are
particularly dependent on events beyond the Company's control, notably weather
conditions during the crop growing seasons in the states where the Company
writes a substantial amount of its crop insurance, the market price of grains
on various commodity exchanges and overall worldwide supply and demand, the
continuing globalization of the crop industry and its effect on the export of
crops to other countries and the volatility of crop prices resulting from
domestic and foreign policy decisions. Additionally, federal regulations
governing aspects of crop insurance are frequently modified, and any such
changes may impact crop insurance results.
Forward-looking information set forth herein does not take
into account any impact from any adverse weather conditions during the 2000
crop season, or the various other factors noted above which may affect
crop and noncrop operation results. See "Business-Uncertainties Affecting the
Insurance Business" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations-General" above for additional information
regarding these events and factors.
Results of Operations
Year ended December 31, 1999
Compared to Year ended December 31, 1998
The Company's net income decreased from $5.5 million for the
year ended December 31, 1998 to a net loss of $36.0 million for the year ended
December 31, 1999. The results for 1999 were impacted by a strengthening
of the Company's reserves for loss and loss adjustment expense, a reduction in
net premiums written in the Company's Property and Casualty segment, an
increase in net operating expenses as well as an increase in reinsurance costs
in the Company's crop segment, a decline in MPCI profit share, and a decline
in investment income. Additionally, certain special and nonrecurring charges
affected the comparison of results from 1998 to 1999. Results in 1999 were
negatively impacted by charges associated primarily with the divestitures of
various lines of property and casualty business. They include severance costs,
charges relating to discontinued software development, reduction of certain
deferred policy acquisition costs and an increased allowance for doubtful
accounts. As part of a retirement agreement, a former employee has the right to
put to the Company 274,635 previously issued shares of Common Stock at $15 per
share between June 30, 2002 and July 30, 2002. As a result of this redemption
feature, the Company has recorded the related redemption amount as temporary
equity. Also included in 1999 results are charges associated with the
Company's recent and anticipated resolutions of disputes with state regulatory
authorities regarding its crop insurance business and the evaluation of
strategic and capital alternatives.
Historically, the Company has performed an analysis of its
loss and loss adjustment expense reserves quarterly, and has conducted an
analysis, in conjunction with its independent actuary, as of September 30 of
each year that includes an actuarial study by its independent actuary. This
study indicated a significant increase in the number of claims incurred by the
Company but not previously reported (IBNR) at September 30, 1999. The increase
in previously unreported claims was principally under policies covering the
1990 through 1995 accident years, and primarily were new construction defect
claims reported under general liability policies insuring contractors in the
state of California. To a lesser extent, the Company also experienced an
increase in reported claims for the 1998 year in its commercial automobile
lines.
California construction defect claims increased as a result
of the 1995 California Supreme Court decision in Montrose Chemical Corporation
vs. Admiral Insurance Company. In that decision, the Court adopted the
"continuous trigger" theory of insurance coverage for third party cases
involving claims of continuous, progressive or deteriorating bodily injury or
property damage. Under this theory, the timing of the insured's act which
allegedly caused the accident, event or condition resulting in a claim is
largely immaterial. As long as the potential damages remain outstanding, all
of the contractor's or subcontractor's successive policies potentially may
provide coverage. Thus, the Court's Montrose decision created a whole new
basis for coverage under years of previously issued policies. Beginning
in 1996, the Company altered its underwriting criteria for construction risks
and began endorsing policies exposed to these types of continuous exposures in
order to avoid coverage for conditions which existed prior to the inception of
Company policies. Primarily as a result of the unexpected increase in claims
from the 1990 through 1995 accident years, the Company increased its loss
reserves during 1999 for 1998 and prior years by approximately $44.0 million.
In February 1999, the Company announced a restructuring of
its Property and Casualty segment in which approximately one-third of its
property and casualty gross written premiums for 1998 were discontinued. As a
part of this restructuring, the Company ceded the unearned premium from its
discontinued lines, as well as new premiums written during the run-off of the
discontinued lines, to an independent reinsurer. Additionally, the Company
sold its nonstandard automobile business, including Phoenix Indemnity, in
September 1999. Accordingly, during the year ended December 31, 1999, the
Company's property and casualty net earned premiums declined by approximately
23% as compared to 1998. While the Company reduced operating expenditures in
conjunction with the reduced premium writings, the Company's property and
casualty underwriting expense ratio increased from 33.7% in 1998 to 39.7% in
1999. The increase primarily resulted from costs totaling approximately $9.0
million relating primarily to the divestitures of various lines of property and
casualty business. The Company expects further reductions in its Property and
Casualty segment net written premiums in 2000 as a result of these and other
divestitures and premium transfer transactions.
The Company experienced increased demand for its crop segment
products during 1999 as compared to 1998, particularly products sold under the
federally subsidized Multi-Peril Crop Insurance (MPCI) program and the
Company's proprietary CRCPlus product. During 1999, the Company's MPCI
premiums increased to approximately $365 million from $274 million in 1998.
The Company's preliminary estimate of the MPCI premium for 2000 is $392
million based on field reports and early applications. The actual amount of
MPCI premium will not be known until final acreage reports are received in the
third quarter. Accordingly, the actual amount of MPCI premium for 2000 may
vary substantially from the preliminary estimate. In 1999 the Company's net
expenses as a percentage of written premiums increased from 1998 to 1999 due to
a decrease in the rate at which the Company is reimbursed by the federal
government for the expenses of operating its MPCI program. In 1998 the
Company's reimbursement rate was approximately 24.7%, while in 1999 this
reimbursement rate fell to 21.6%. Due to competitive pressures, the Company
was unable to pass any of this expense reduction along to its agents as agents'
commissions remained relatively constant. The Company does not expect a
similar reduction in its expense reimbursements from the federal government
during the 2000 crop year, but a change in the Company's mix of business could
result in a reduction in its total reimbursement rate for the 2000 crop
season.
The increased demand for the Company's proprietary CRCPlus
product in 1999 exceeded the Company's traditional reinsurance program. Five
factors generally contributed to this demand: steadily declining commodity
prices during the primary sales season, increased federal subsidies for
purchasers of crop insurance, rapid market acceptance of this product for
newly offered specialty crops, a technical error in the quoting software for
one specialty crop which understated the applicable premium for that crop, and
disproportionately high coverage levels for certain crops. As a result, the
Company elected to close its sales season early and limit available coverage
for some crops. The Company experienced additional costs in 1999 of $1.5
million in the placement of its quota share reinsurance program for CRCPlus.
The Company also experienced higher operating expenses associated with the
early sales closing for it CRCPlus product. These expenses totaled $5.4
million for 1999.
The Company ceded a portion of the profit share related to
approximately $35.0 million of its retained premiums under the MPCI program for
1999 to reinsurers participating in its overall crop reinsurance programs. The
Company expects to continue to cede portions of its premiums under MPCI program
in the future in order to secure the required reinsurance capacity for its
crop programs and currently estimates ceding approximately $79 million of such
premiums for the 2000 crop year. Additionally, in order to maintain its
aggregate retained risk near historic levels, the Company's excess reinsurance
costs increased by $8.2 million during 1999 as compared to 1998. The Company
expects $7.5 million of these additional excess reinsurance costs to continue
each year for up to seven years in the future. The Company has obtained a
letter of credit to secure the expected future ceded premiums.
During 1999 the Company earned a profit share of $40.1
million on its MPCI retained pool of approximately $246.1 million while in
1998 the Company earned a profit share of $49.1 million on $196.5 million
retained premium pool. Also, in 1999 and 1998, the Company recorded additional
profit share relating to previous years of approximately $.8 million and $4.0
million, respectively.
The decreases in operating profits from $33.9 million in 1998
to $0.8 million in 1999 were primarily attributable to the decrease in
reimbursement rate, increase in reinsurance costs, the higher operating costs
and less profit share.
The Company's net investment income declined from
approximately $28.3 million for the year ended December 31, 1998 to $25.1
million for 1999. This decline in the investment income of the Company was
affected by a decline in the size of the average outstanding portfolio of the
Company from $498 million during the year ended December 31, 1998 to $473
million for 1999. In addition, the yield on the portfolio declined from 5.7%
during the year ended December 31, 1998 to 5.3% for 1999. This decrease in
yield primarily resulted from several of the Company's higher yielding
preferred stock investments being called and a decrease in the Company's
mortgage backed security portfolio. The mortgage backed securities were on
average, $23 million less for 1999 versus 1998 as the Company reduced both the
interest rate risk and the investment yield on its mortgage backed portfolio
through the elimination of substantially all of its inverse floating rate
collateralized mortgage obligations. Net realized gains approximated $10.2
million for the year ended December 31, 1999 as compared to $6.8 million 1998.
Year Ended December 31, 1998
Compared to Year Ended December 31, 1997
The Company's net income decreased 84.3% from $35.3 million in
the year ended December 31, 1997 to $5.5 million in the year ended December 31,
1998. The Company's operating income decreased 69.1% from $57.9 million in the
year ended December 31, 1997 to $17.9 million in the year ended December 31,
1998. These deteriorating results occurred due to a decline in the Company's
net premiums earned, an increase in the