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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from to
---------- ----------
COMMISSION FILE NUMBER: 0-22280
PHILADELPHIA CONSOLIDATED HOLDING CORP.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2202671
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
ONE BALA PLAZA, SUITE 100
BALA CYNWYD, Pennsylvania 19004
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 617-7900
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES: [X] NO: [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K 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.
YES: [ ] NO: [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on March 21,
2002 as reported on the NASDAQ National Market System, was $463,818,905. Shares
of Common Stock held by each executive officer and director and by each person
who is known by the Registrant to beneficially own 5% or more of the outstanding
Common Stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of March 22, 2002, Registrant had outstanding 21,558,334 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the definitive Proxy Statement for Registrant's 2002 Annual
Meeting of Shareholders to be held May 1, 2002 are incorporated by
reference in Part III.
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1
PART I
Item 1. BUSINESS
GENERAL
As used in this Annual Report on Form 10-K, (i) "Philadelphia Insurance"
refers to Philadelphia Consolidated Holding Corp., (ii) the "Company" refers to
Philadelphia Insurance and its subsidiaries, doing business as Philadelphia
Insurance Companies; (iii) the "Insurance Subsidiaries" refers to Philadelphia
Indemnity Insurance Company ("PIIC"), Philadelphia Insurance Company ("PIC"),
Mobile USA Insurance Company ("MUSA") and Liberty American Insurance Company
("LAIC"), collectively; (iv) "MIA" refers to Maguire Insurance Agency, Inc., a
captive underwriting manager; (v) "MHIA" refers to Mobile Homeowners Insurance
Agencies, Inc., a managing general agency; (vi) "Premium Finance" refers to
Liberty American Premium Finance Company; and (vii) "PCHC Investment" refers to
PCHC Investment Corp., an investment holding company. Philadelphia Insurance was
incorporated in Pennsylvania in 1984, as an insurance holding company. Liberty
American Insurance Group, Inc. (formerly The Jerger Company, Inc.), a Delaware
insurance holding company, and its subsidiaries of MUSA, LAIC, MHIA and Premium
Finance, are sometimes referred to herein collectively as "Liberty".
During 2001, the Company continued its growth through adherence to its core
philosophies of specialization, mixed marketing and profitable underwriting.
2001 gross written premiums increased 30.9% to $473.6 million. The GAAP basis
combined ratio (the sum of the net loss and loss adjustment expenses and
acquisition costs and other underwriting expenses divided by net earned
premiums) was 93.4%, which was substantially lower than the property and
casualty industry as a whole. Total assets increased to $1,017.7 million, and
shareholders' equity increased to $428.7 million.
Premium growth was also attributable to marketplace disruptions which
resulted in improving premium rates and policy terms during the second half of
2000 and through the first nine months of 2001. Additionally, the terrorist
attacks of September 11, 2001 caused the property and casualty industry to
experience significant losses. As a result, the Company anticipates that the
rate increases and improving policy terms, which started to occur in the second
half of 2000, will now continue, possibly for an extended period of time. To
better position itself to take advantage of these improving conditions the
Company issued 3.6 million shares of its common stock through a public offering
in the fourth quarter of 2001. The $114.5 million in net proceeds from this
offering are primarily being utilized to provide additional capital for the
Company's Insurance Subsidiaries and to fund general corporate purposes.
In February 2001, A.M. Best Company reaffirmed the "A+" (superior) rating
for the Insurance Subsidiaries.
INDUSTRY TRENDS
During the 1990s and into 2000, the insurance industry maintained excess
capacity, creating highly competitive market conditions, as evidenced by
declining premium rates and, in many cases, policy terms less favorable to the
insurer. As a result, the industry suffered from reduced profitability and a
contraction of capacity as insurers chose or were forced to exit the
marketplace. During the second half of 2000 and through the first nine months of
2001, reduced insurance and reinsurance supply and increased demand caused
premium rates and policy terms to show signs of significant improvement.
The terrorist attacks of September 11, 2001 caused the property and
casualty industry to experience significant losses. As a result, industry
participants expect that the rate increases and improving terms occurring before
September 11th will continue through the remainder of 2001 and possibly for an
extended period of time. Increased reinsurance costs may, to some extent, offset
the benefits of these trends to insurance companies.
The Company believes that it is favorably positioned to take advantage of
these improving conditions. The rate increase currently being experienced on
renewal business is in the 5% to 30% range. There can be no assurance, however,
that these favorable trends will continue or that these rate increases can be
sustained.
BUSINESS OVERVIEW AND STRATEGY
The Company designs, markets and underwrites specialty commercial and
personal property and casualty insurance products incorporating value-added
coverages and services for select target markets or niches. Insurance products
are distributed through a diverse multichannel delivery system centered around
the Company's direct production underwriting organization. A select group of 59
"preferred agents" and a broader network of approximately 6,000 independent
agents
2
supplement the production underwriting organization, which consisted of
148 professionals located in 36 regional and field offices across the United
States as of December 31, 2001.
The Company's commercial products include commercial multi-peril package
insurance targeting specialized niches, including non-profit organizations,
health and fitness organizations, homeowners' associations, condominium
associations, specialty schools and day care facilities; commercial automobile
insurance targeting the leasing and rent-a-car industries; property insurance
for large commercial accounts such as shopping centers, business parks and
medical facilities; and inland marine products targeting larger risks such as
new builders' risk and miscellaneous property floaters.
The Company also writes select classes of professional liability and
directors' and officers' liability products, as well as personal property and
casualty products for the manufactured housing and homeowners' markets.
The Company maintains detailed systems, records and databases that enable
the continuous monitoring of its book of business in order to identify and react
swiftly to positive or negative development trends. The Company is able to track
performance, including loss ratios, by segment, product, region, state, producer
and policyholder. Detailed profitability reports are produced and reviewed on a
routine, primarily monthly, basis as part of the policy of continuously
analyzing and reviewing the book of business.
The Company maintains a local presence to more effectively serve its
producer and customer base, operating through 9 regional offices and 27 field
offices throughout the country, which report to the regional offices. These
offices are staffed with field underwriters, marketers and, in some cases, claim
personnel, which interact closely with home office management in making key
decisions. This approach allows the Company to adapt its underwriting and
marketing strategies to local conditions and build close relationships with its
customers and producers at the local level.
The Company selects and targets industries and niches that present
specialized areas of demand where it believes it can grow business through
creatively developing insurance products with innovative features specially
designed to meet those areas of demand. The Company believes that these features
are not included in typical property and casualty policies, enabling it to
compete based on the unique or customized nature of the coverage provided as
opposed to price.
Business Segments
The Company's operations are classified into three reportable business
segments:
- Commercial Lines Underwriting Group, which has underwriting
responsibility for the commercial multi-peril package, commercial
automobile and specialty property and inland marine insurance
products;
- Specialty Lines Underwriting Group, which has underwriting
responsibility for the professional liability and directors' and
officers' liability insurance products; and
- Personal Lines Underwriting Group, which has underwriting
responsibility for personal property and casualty insurance products
for the manufactured housing and homeowners' markets.
The following table sets forth, for the years ended December 31, 2001, 2000
and 1999, the gross written premiums for each of the Company's business segments
and the relative percentages that such premiums represented.
For the Years Ended December 31,
-----------------------------------------------------------------------------------------
2001 2000 1999
------------------------ ------------------------- -------------------------
Dollars Percentage Dollars Percentage Dollars Percentage
-------- ---------- -------- ---------- -------- ----------
(dollars in thousands)
Commercial Lines $315,948 66.7% $239,446 66.2% $200,972 73.1%
Specialty Lines 79,317 16.7 68,193 18.8 48,532 17.7
Personal Lines 78,300 16.6 54,233 15.0 25,414 9.2
-------- ----- -------- ----- -------- -----
Total $473,565 100.0% $361,872 100.0% $274,918 100.0%
======== ===== ======== ===== ======== =====
3
Commercial Lines:
Commercial Package: The Company has provided commercial multi-peril package
policies to targeted niche markets for over 15 years. The customers for these
policies include:
- non-profit and social service organizations;
- health and fitness organizations;
- homeowners' associations;
- condominium associations;
- specialty schools;
- boat dealerships;
- mobile home parks; and
- day care facilities.
The package policies provide a combination of comprehensive liability,
property and automobile coverage with limits up to $1.0 million for casualty,
$50.0 million for property, and umbrella limits on an optional basis up to $10.0
million. The Company believes its ability to provide professional liability,
general liability and directors' and officers' coverages in one policy is
advantageous and convenient to producers and policyholders.
Commercial Automobile and Commercial Excess: The Company has provided
commercial automobile products to the leasing and rent-a-car industries for over
35 years. Coverages offered to the rent-a-car industry include:
- the business owner's property; and
- dual interest liability and physical damage on the rental vehicle.
The Company also offers additional coverage at the rental car counter to
rent-a-car customers through arrangements with a number of the largest
rent-a-car companies. The insurance protects against liability for bodily injury
and property damage in excess of the statutory coverage provided with the rental
vehicle and primary coverage over the customer's personal automobile insurance
coverage. A proprietary sales training program has been developed to help the
car rental companies offer this coverage to the public. This coverage also pays
claims up to the coverage limit and is primary over the renter's personal
automobile insurance coverages.
The Company also offers a wide range of liability and physical damage
coverages to companies that lease automobiles on an extended term basis and to
their customers. For the renter, coverages include both primary liability and
physical damage coverage on the vehicle. For the leasing company, coverages
include contingent and excess liability over the primary liability layer, which
protects the leasing company in the event of a loss when the primary coverage is
absent or inadequate. The following products are also offered to leasing
companies:
- interim primary liability and physical damage coverage, which protects
the leasing company before and after the vehicle is delivered to the
renter;
- residual value coverage which guarantees the value of the leased
vehicle at the termination of the lease; and
- guaranteed asset protection coverage, which protects the leasing
company and renter for the difference between the leased vehicle's
actual cash value and the lease or loan net value in instances where
the vehicle is stolen or damaged beyond repair.
Specialty Property & Inland Marine: In September 1998, the Company
introduced a new line of business utilizing experienced specialty property and
inland marine underwriters. These underwriters specialize in:
- insuring large property risks for specific classes of customers,
including shopping centers, business parks and medical facilities; and
- underwriting and providing marketing for various classes of inland
marine insurance, concentrating on the larger segments of inland
marine, including new builders' risk and miscellaneous property
floaters.
4
Specialty Lines:
The Company has been providing specialty professional liability products
for approximately 14 years, specializing in proprietary policies developed
primarily for the professional liability, employment practices and directors'
and officers' liability markets. The professional liability products provide
errors and omissions coverage for lawyers, accountants and other professions.
The directors' and officers' product is offered to non-profit, for-profit and
financial institutions, with an emphasis on non-profit institutions and private
companies.
Personal Lines:
The Company entered the personal lines property and casualty business
through the acquisition of Liberty American Insurance Group, Inc. in 1999.
Through Liberty as the personal lines platform, specialized manufactured housing
and homeowners' property and casualty business is produced and underwritten,
principally in Florida, and to a lesser extent, in California, Arizona and
Nevada. The Company also writes and services federal flood insurance under the
National Flood Insurance Program for both personal and commercial policyholders.
Products offered include manufactured housing insurance for senior citizen
retirees in "preferred" parks, a program for newly constructed manufactured
homes on private property; and a preferred homeowners' program that targets
newer homes valued between $100,000 and $250,000 in gated retiree communities.
In coastal counties in Florida a homeowners' program is also offered that
excludes wind exposure. The Florida Windstorm Underwriting Association insures
the wind exposure on these risks.
The following table provides the geographic distribution of the Company's
risks insured as represented by direct earned premiums for all reportable
business segments for the year ended December 31, 2001. No other state accounted
for more than 2% of total direct earned premiums for all product lines for the
year ended December 31, 2001 (dollars in thousands).
State Direct Earned Premiums Percent of Total
- ----- ---------------------- ----------------
Florida $108,175 26.4%
California 47,364 11.6
New York 24,976 6.1
Ohio 20,929 5.1
Texas 17,617 4.3
Pennsylvania 14,716 3.6
New Jersey 14,498 3.5
Illinois 13,845 3.4
Massachusetts 12,381 3.0
Other 135,313 33.0
-------- -----
Total Direct Earned Premiums $409,814 100.0%
======== =====
Underwriting and Pricing
The Company's business segments are organized around its three underwriting
divisions: Commercial Lines, Specialty Lines, and Personal Lines. Each
underwriting division's responsibilities include: pricing, managing the risk
selection process, and monitoring loss ratios by product and insured.
The Company attempts to adhere to conservative underwriting and pricing
practices. The Company's underwriting strategy is detailed in a document, which
is signed by each underwriting professional. Written underwriting guidelines are
maintained, and updated regularly, for all classes of business underwritten.
Adherence to underwriting guidelines is maintained through underwriting audits
conducted by the Company. Product price levels are measured utilizing a price
monitoring system which measures the aggregate price level of the book of
business. This system is intended to assist management and underwriters in
promptly recognizing and correcting price deterioration. When necessary, the
Company is willing to re-underwrite, sharply curtail or discontinue a product
deemed to present unacceptable risks.
The Commercial Lines Underwriting Group has underwriting responsibility for
the Company's commercial multi-peril package, commercial automobile and large
property and inland marine products. The Commercial Lines Underwriting Group
currently consists of 30 home office underwriters that are supported by
underwriting assistants, raters, and other policy administration personnel. The
Commercial Lines home office underwriters and support staff are organized into
an underwriting unit responsible for underwriting and servicing renewal business
and supporting the field underwriters. The
5
underwriting unit is under the direction of Underwriter Managers who report to
the Vice President of Commercial Lines Underwriting.
The Company has also placed underwriters in each of the Company's regional
marketing offices plus two of its field offices. These 16 underwriters have
responsibility for pricing and underwriting new business within the Company's
guidelines and policy issuance. Overall management of the book of business
resides in the home office with the senior underwriting officers. The Company
believes that its ability to deliver excellent service and build long lasting
relationships is enhanced through maintaining a localized presence.
The Specialty Lines Underwriting Group consists of 15 home office
underwriters and underwriter trainees and 14 regional underwriters. These
underwriters and underwriter trainees are supported by underwriting assistants,
raters, and other policy administration personnel. The Specialty Lines
underwriters have responsibility for underwriting specific professional
liability products within designated Company marketing regions. These regional
underwriters work closely with the marketing department.
The Personal Lines Underwriting Group is located in Pinellas Park, Florida.
The underwriting staff consists of 14 professionals who are under the direction
of the Personal Lines Underwriting Vice President. Much of the underwriting
function is automated by rating software and internet access. The underwriting
guidelines are embedded within the program and will not allow binding of
accounts if a risk does not meet the presented underwriting guidelines. The
Company has a proactive exposure distribution management system in place to
assure portfolio optimization. This is managed on a zip code level basis through
in-house software and external modeling tools. The Company inspects all risks on
its new preferred homeowners program and manufactured homes on private property.
The Company uses a combination of Insurance Services Office, Inc. ("ISO")
coverage forms and rates and independently filed forms and rates. Coverage forms
and rates are independently developed in situations where the line of business
is not supported by ISO or where management believes the ISO forms and rates do
not adequately address the risk. Departures from ISO forms are also used to
differentiate the Company's products from its competitors' products and are
independently filed.
Reinsurance
The Company has entered into various reinsurance agreements for the purpose
of limiting loss exposure and diversifying business. The Company's casualty
excess of loss reinsurance agreement provides that the Company bears the first
layer of liability on each occurrence (varying from $0.5 million to $1.0 million
based upon the specific product) with its reinsurer bearing the remaining
contractual liability, if any, up to $1.0 million. Casualty risks in excess of
$1.0 million up to $11.0 million are reinsured under a casualty treaty ("Excess
Treaty") placed through a reinsurance broker with several reinsurers.
Facultative reinsurance (reinsurance which is provided on an individual risk
basis) is placed for each casualty risk in excess of $11.0 million.
The Company's property excess of loss reinsurance treaty provides that the
Company bears the first $0.5 million layer of loss on each risk with the
reinsurers bearing the next layer of loss up to $10.0 million on each risk. The
Company has an automatic facultative excess of loss cover for each property risk
in excess of $10.0 million up to $50.0 million. To mitigate potential exposures
to losses arising from terrorist acts, the Company has purchased reinsurance
coverage for terrorism with a $10.0 million aggregate policy limit for 2002.
Additionally, the Company has property catastrophe reinsurance for its
commercial and personal property books of business under which the Company bears
the first $5.0 million in catastrophe losses per event, with the reinsurers
bearing the next $242.4 million, except that, outside of Florida, the Company
bears the first $5.0 million in catastrophe losses per event, with reinsurers
bearing the next $5.0 million on its commercial property book of business. Based
upon the various modeling methods utilized by the Company to estimate its
probable maximum loss, the Company currently maintains catastrophe reinsurance
coverage for the 250 year storm event on personal lines business and the 100
year storm event on its commercial lines business.
The Company also has an excess casualty reinsurance agreement which
provides an additional $5.0 million of coverage for protection from exposures
such as extra-contractual obligations and judgments in excess of policy limits.
Additionally, an errors and omissions insurance policy provides an additional
$10.0 million of coverage with respect to these exposures.
Effective January 1, 2001, the Company entered into a three-year aggregate
stop loss reinsurance agreement commencing with the 2001 accident year. The
agreement includes all the business written by the Company. Under the terms
6
of the agreement, the reinsurer provides reinsurance protection for a certain
aggregate dollar limit for losses and loss adjustment expenses in excess of a
predetermined loss ratio (the sum of losses and loss adjustment expenses divided
by earned premiums).
The Company seeks to limit the risk of a reinsurer's default in a number of
ways. First, the Company principally contracts with large reinsurers that are
rated at least "A-" (Excellent) by A.M. Best. Second, the Company seeks to
collect the obligations of its reinsurers on a timely basis. This collection
effort is supported through the regular monitoring of reinsurance receivables.
Finally, the Company typically does not write casualty policies in excess of
$11.0 million or property policies in excess of $25.0 million. Although
reinsurance makes the reinsurer liable, to the extent the risk is transferred,
it doesn't relieve the Company of its liability to policyholders.
The Company regularly assesses its reinsurance needs and seeks to improve
the terms of its reinsurance arrangements as market conditions permit. Such
improvements may involve increases in retentions, modifications in premium
rates, changes in reinsurers and other matters.
Marketing and Distribution
Proactive risk selection based on sound underwriting criteria and
relationship selling in clearly defined target markets continues to be the
foundation of the Company's marketing plan. Within this framework, the Company's
marketing effort is designed to assure a systematic and disciplined approach to
developing business which is anticipated to be profitable.
The Company distributes its products through its direct production
underwriting organization, an extensive network of approximately 6,000
independent brokers and its "preferred agent" program. The Company's most
important distribution channel is its production underwriting organization.
Although the Company has always written business directly, the production
underwriting organization was established by the Company to coordinate its
direct sales efforts as well as act as the interface with the Company's external
producers. The production underwriting organization is currently comprised of
148 professionals located in 36 offices in major markets across the country. The
field offices are focused daily on interacting with prospective and existing
insureds. In addition to this direct marketing, relationships with approximately
6,000 brokers have been formed either because the broker has a preexisting
relationship with the insured or has sought the Company's expertise in one of
its specialty products. This mixed marketing concept provides the Company with
the flexibility to respond to changing market conditions and, when appropriate,
shift its emphasis between direct and indirect marketing approaches to seize
opportunities as they arise. In addition, the production underwriting
organization's ability to gather market intelligence enables the rapid
identification of soft markets and redeployment to firmer markets, from a
product line or geographic perspective. The Company believes that its mixed
marketing platform provides a competitive edge in stable market conditions, the
strengths of which are all the more evident during periods of dislocation or
consolidation.
The Company's preferred agent program, in which business relationships are
formed with brokers specializing in certain of the Company's business niches,
consisted of 59 preferred agents at year-end 2001. Preferred Agents are
identified by the Company based on productivity and loss experience and receive
additional benefits from the Company in exchange for meeting defined production
and profitability criteria.
The Company supplements its marketing efforts through affinity programs,
trade shows, direct mailings and national advertisements placed in trade
magazines serving industries in which the Company specializes, as well as links
to industry web sites. The Company has also enhanced its marketing with
Internet-based initiatives such as: the Personal Lines Division's "In Touch(SM)"
real-time policy inquiry system which allows agents to view account data,
process non-dollar endorsements and in certain states, and for certain products,
rate a policy over the internet.
Product Development
The Company continually evaluates new product opportunities, consistent
with its strategic focus on selected market niches. Direct contacts between the
Company's field and home office personnel and its customers have produced a
number of new product ideas. All new product ideas are presented to the Product
Development Committee for consideration. That committee, currently composed of
the Company's Executive Vice President and officers from the underwriting,
claims and compliance departments, meets regularly to review the feasibility of
products from a variety of perspectives, including underwriting risk, marketing
and distribution, reinsurance, long-term viability and consistency with the
Company's culture and philosophy. For each new product, an individualized test
market plan is prepared, addressing such matters as the appropriate distribution
channel (e.g., a limited number of selected production underwriters), an
appropriate cap on premiums to be generated during the test market phase and
reinsurance requirements for the test market phase. Test market products
7
may involve lower retentions than customarily utilized. After a new product is
approved for test marketing, the Company monitors its success based on specified
criteria (e.g., underwriting results, sales success, product demand and
competitive pressures). If expectations are not realized, the Company either
moves to improve results by initiating adjustments or abandons the product.
Claims Management and Administration
In accordance with its emphasis on underwriting profitability, the Company
actively manages claims under its policies in an effort to investigate reported
incidents at an early stage, service insureds and minimize fraud. Claim files
are regularly audited by claims supervisors and the Company's reinsurers in an
attempt to ensure that claims are being processed properly and that reserves are
being set at appropriate levels.
The Company's experienced staff of claims management professionals are
assigned to dedicated claim units within specific niche markets. Each of these
units receive supervisory direction and news, legislative and product
development updates from the unit director. Claims management personnel have an
average of approximately twenty years of experience in the industry. The
dedicated claim units meet regularly to communicate findings of change within
their assigned specialty. Staff within the dedicated claim units have an average
of ten years experience in the industry.
The Company maintains a Special Investigations Unit to investigate
suspicious claims and to serve as a clearinghouse for information concerning
fraudulent practices primarily within the rental car industry. Working closely
with a variety of industry contacts, including attorneys, investigators and
rental car company fraud units, this unit has uncovered a number of fraudulent
claims.
Loss and Loss Adjustment Expenses
The Company is liable for losses and loss adjustment expenses under its
insurance policies and reinsurance treaties. While the Company's professional
liability policies are written on claims-made forms and while claims on its
other policies are generally reported promptly after the occurrence of an
insured loss, in many cases several years may elapse between the occurrence of
an insured loss, the reporting of the loss to the Company and the Company's
payment of the loss. The Company reflects its liability for the ultimate payment
of all incurred losses and loss adjustment expenses by establishing loss and
loss adjustment expense reserves, which are balance sheet liabilities
representing estimates of future amounts needed to pay claims and related
expenses with respect to insured events that have occurred.
When a claim involving a probable loss is reported, the Company establishes
a case reserve for the estimated amount of the Company's ultimate loss and loss
adjustment expense. This estimate reflects an informed judgment, based on the
Company's reserving practices and the experience of the Company's claims staff.
Management also establishes reserves on an aggregate basis to provide for losses
incurred but not reported ("IBNR"), as well as future development on claims
reported to the Company.
As part of the reserving process, historical data are reviewed and
consideration is given to the anticipated effect of various factors, including
known and anticipated legal developments, changes in societal attitudes,
inflation and economic conditions. Reserve amounts are necessarily based on
management's estimates and judgments; as new data become available and are
reviewed, these estimates and judgments are revised, resulting in increases or
decreases to existing reserves. The Insurance Subsidiaries obtain an annual
statement of opinion from an independent actuary firm for its statutory filings
with regulators.
The following table sets forth a reconciliation of beginning and ending
reserves for unpaid loss and loss adjustment expenses, net of amounts for
reinsured losses and loss adjustment expenses, for the years indicated. As a
result of changes in estimates of insured events in prior years, the Company
increased losses and loss adjustment expenses incurred by $13.4 million in 2001.
Such development was primarily due to losses emerging at a higher rate on
automobile leases expiring in 2001 on residual value policies underwritten in
prior years than had been originally anticipated when the initial reserves were
estimated.
8
As of and For the Years Ended December 31,
------------------------------------------
2001 2000 1999
-------- -------- ---------
(Dollars in Thousands)
Unpaid loss and loss adjustment expenses at
beginning of year (1) $195,464 $161,353 $137,205
-------- -------- --------
Provision for losses and loss adjustment expenses for
current year claims 166,220 128,761 99,663
Increase (Decrease) in estimated ultimate losses and loss adjustment
expenses for prior year claims 13,435 2,543 (253)
-------- -------- --------
Total incurred losses and loss adjustment expenses 179,655 131,304 99,410
-------- -------- --------
Loss and loss adjustment expense payments for claims
attributable to:
Current year 54,228 36,271 31,493
Prior years 70,757 60,922 43,769
-------- -------- --------
Total payments 124,985 97,193 75,262
-------- -------- --------
Unpaid loss and loss adjustment expenses at end of year (2) $250,134 $195,464 $161,353
======== ======== ========
(1) 1999 balance adjusted to include $2,175 net unpaid loss and loss
adjustment expenses for MUSA as of acquisition date.
(2) Unpaid loss and loss adjustment expenses differ from the amounts
reported in the Consolidated Financial Statements because of the
inclusion therein of reinsurance receivables of $52,599, $42,030 and
$26,710 at December 31, 2001, 2000 and 1999, respectively.
The following table presents the development of unpaid loss and loss
adjustment expenses, net of amounts for reinsured losses and loss adjustment
expenses, from 1991 through 2001. The top line of the table shows the estimated
reserve for unpaid loss and loss adjustment expenses at the balance sheet date
for each of the indicated years. These figures represent the estimated amount of
unpaid loss and loss adjustment expenses for claims arising in the current year
and all prior years that were unpaid at the balance sheet date, including IBNR
losses. The table also shows the re-estimated amount of the previously recorded
unpaid loss and loss adjustment expenses 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.
9
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
(Dollars in Thousands)
---------------------------------------------------------
1991 1992 1993 1994 1995 1996
------- ------- ------- ------- ------- -------
UNPAID LOSS AND LOSS
ADJUSTMENT EXPENSES, AS
STATED $22,248 $31,981 $38,714 $53,595 $68,246 $85,723
Cumulative Paid as of:
1 year later 6,698 9,865 10,792 12,391 15,214 22,292
2 years later 12,485 16,290 19,297 23,139 31,410 38,848
3 years later 16,288 21,253 24,991 33,511 40,637 52,108
4 years later 17,780 24,299 28,903 38,461 47,994 63,738
5 years later 19,406 25,793 30,558 42,366 51,806 69,116
6 years later 19,898 26,321 32,748 43,860 53,198
7 years later 20,246 27,252 32,929 44,243
8 years later 20,625 27,336 33,102
9 years later 20,611 27,288
10 years later 20,599
Unpaid Loss and Loss Adjustment
Expenses re-estimated as of End of Year:
1 year later 22,056 30,538 38,603 52,670 67,281 84,007
2 years later 21,327 30,428 38,016 52,062 66,061 81,503
3 years later 21,198 29,648 37,184 51,149 63,872 76,348
4 years later 21,118 29,306 36,272 49,805 59,085 73,992
5 years later 21,399 28,553 35,783 47,366 56,673 75,672
6 years later 21,106 28,370 34,509 45,797 55,861
7 years later 21,013 27,959 33,799 45,245
8 years later 20,854 27,724 33,695
9 years later 20,703 27,623
10 years later 20,668
Cumulative Redundancy (Deficiency)
Dollars $ 1,580 $ 4,358 $ 5,019 $ 8,350 $12,385 $10,051
Percentage 7.1% 13.6% 13.0% 15.6% 18.1% 11.7%
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
(Dollars in Thousands)
------------------------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
UNPAID LOSS AND LOSS
ADJUSTMENT EXPENSES, AS
STATED $108,928 $136,237 $161,353 $195,464 $250,134
Cumulative Paid as of:
1 year later 26,870 43,769 60,922 70,757
2 years later 56,488 84,048 109,092
3 years later 80,206 115,900
4 years later 95,047
5 years later
6 years later
7 years later
8 years later
9 years later
10 years later
Unpaid Loss and Loss Adjustment
Expenses re-estimated as of End of Year:
1 year later 105,759 135,984 163,896 208,899
2 years later 103,513 138,245 177,782
3 years later 104,712 146,679
4 years later 109,061
5 years later
6 years later
7 years later
8 years later
9 years later
10 years later
Cumulative Redundancy (Deficiency)
Dollars $ (133) $(10,442) $(16,429) $(13,435)
Percentage (0.1)% (7.7)% (10.2)% (6.9)%
(1) Unpaid loss and loss adjustment expenses differ from the amounts reported
in the Consolidated Financial Statements because of the inclusion therein
of reinsurance receivables of $52,599, $42,030, $26,710, $16,120, $13,502,
$10,919, $9,440, $5,580, $5,539, $1,770, and $1,267 at December 31, 2001,
2000, 1999, 1998, 1997, 1996, 1995, 1994, 1993, 1992, and 1991,
respectively.
(2) 1998 Unpaid Loss and Loss Adjustment Expenses, as stated, adjusted to
include $1,207 unpaid loss and loss adjustment expenses for Mobile USA
Insurance Company as of acquisition date.
(3) The Company maintains its historical loss records net of reinsurance and
therefore is unable to conform the presentation of this table to the
financial statements.
10
The cumulative redundancy (deficiency) represents the aggregate change in
the reserve estimated over all prior years, and does not present accident year
loss development. Therefore, each amount in the table includes the effects of
changes in reserves for all prior years.
The unpaid loss and loss adjustment expense of the Insurance Subsidiaries,
as reported in their Annual Statements prepared in accordance with statutory
accounting practices and filed with state insurance departments, differ from
those reflected in the Company's financial statements prepared in accordance
with generally accepted accounting principles ("GAAP") with respect to recording
the effects of reinsurance. Unpaid loss and loss adjustment expenses under
statutory accounting practices are reported net of the effects of reinsurance
whereas under GAAP these amounts are reported without giving effect to
reinsurance. Under GAAP, reinsurance receivables, with a corresponding increase
in unpaid loss and loss adjustment expense, have been recorded. (See footnote
(2) on Page 9 for amounts). There is no effect on net income or shareholders'
equity due to the difference in reporting the effects of reinsurance between
statutory accounting practices and GAAP as discussed above.
Operating Ratios
Statutory Combined Ratio
The statutory combined ratio, which is the sum of (a) the ratio of loss and
loss adjustment expenses incurred to net earned premiums (loss ratio) and (b)
the ratio of policy acquisition costs and other underwriting expenses to net
written premiums (expense ratio), is the traditional measure of underwriting
experience for insurance companies. Generally, if the combined ratio is below
100%, an insurance company has an underwriting profit, and if it is above 100%,
the insurer has an underwriting loss.
The following table reflects the consolidated loss, expense and combined
ratios of the Insurance Subsidiaries together with the property and casualty
industry-wide combined ratios after policyholders' dividends.
For the Years Ended December 31,
-----------------------------------------------------------------
2001 2000 1999 1998 1997
----- ----- ----- ----- -----
Loss Ratio 60.7% 57.8% 59.7% 54.1% 55.3%
Expense Ratio 31.2% 31.3% 33.6% 31.0% 29.1%
----- ----- ----- ----- -----
Combined Ratio 91.9% 89.1% 93.3% 85.1% 84.4%
===== ===== ===== ===== =====
Industry Statutory Combined Ratio after
Policyholders Dividends 117.0% 110.1% 107.8% 105.6% 101.6%
===== ===== ===== ===== =====
(1) (2) (2) (2) (2)
(1) Source: Best's Review/Preview PC January 2002 (Estimated 2001).
(2) Source: Best's Review/Preview PC January 2002
Premium-to-Surplus Ratio:
While there are no statutory provisions governing premium-to-surplus
ratios, regulatory authorities regard this ratio as an important indicator as to
an insurer's ability to withstand abnormal loss experience. Guidelines
established by the National Association of Insurance Commissioners (the "NAIC")
provide that an insurer's net premium-to-surplus ratio is satisfactory if it is
below 3 to 1.
The following table sets forth, for the periods indicated, net written
premiums to surplus as regards policyholders' for the Insurance Subsidiaries
(statutory basis):
As of and For the Years Ended December 31,
--------------------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Net Written Premiums (1) $333,817 $263,637 $195,258 $143,036 $110,790
Surplus as regards Policyholders $280,960 $193,292 $179,341 $152,336 $105,985
Premium to Surplus Ratio (1) 1.2 to 1.0 1.4 to 1.0 1.1 to 1.0 1.0 to 1.0 1.0 to 1.0
(1) 1999 includes $11,187 net written premiums for MUSA from January 1, 1999 to
date of acquisition.
11
Investments
The Company's investment objective is the realization of relatively high
levels of investment income while generating competitive after-tax total rates
of return within a prudent level of risk and within the constraints of
maintaining adequate securities in amount and duration to meet cash requirements
of current operations and long-term liabilities, as well as maintaining and
improving the Company's A.M. Best and Standard & Poor's ratings. The Company
utilizes professional investment managers for its fixed maturity and equity
investments, which consist of diversified issuers and issues.
At December 31, 2001, the Company had total investments with a carrying
value of $673.4 million, and 93.9% of the Company's total investments were fixed
maturity securities, including U.S. treasury securities and obligations of U.S.
government corporations and agencies, obligations of states and political
subdivisions, corporate debt securities, collateralized mortgage securities and
asset backed securities, with an average rating of "AA". The collateralized
mortgage securities and asset backed securities consist of shorter tranche
securities possessing favorable pre-payment risk profiles. The remaining 6.1% of
the Company's total investments consisted primarily of publicly-traded common
stocks.
The following table sets forth information concerning the composition of
the Company's total investments at December 31, 2001:
Estimated Percent of
Market Carrying Carrying
Amortized Cost Value Value Value
-------------- --------- --------- ----------
(Dollars in Thousands)
Fixed Maturities:
Obligations of States and Political
Subdivisions $104,628 $106,184 $106,184 15.8%
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies 21,024 21,694 21,694 3.2
Corporate and Bank Debt Securities 157,657 160,326 160,326 23.8
Collateralized Mortgage Securities 70,362 70,873 70,873 10.5
Asset Backed Securities 272,655 273,339 273,339 40.6
Equity Securities 34,065 40,992 40,992 6.1
-------- -------- -------- -----
Total Investments $660,391 $673,408 $673,408 100.0%
======== ======== ======== =====
At December 31, 2001, approximately 98.7% of the Insurance Subsidiaries'
fixed maturity securities (cost basis) consisted of U.S. government securities
or securities rated "1" or "2" by the NAIC.
The cost and estimated market value of fixed maturity securities at
December 31, 2001, by remaining original contractual maturity, are set forth
below. Expected maturities may differ from contractual maturities because
certain borrowers have the right to call or prepay obligations, with or without
call or prepayment penalties:
Amortized Cost Estimated Market Value
-------------- ----------------------
(Dollars in Thousands)
Due in one year or less $ 26,096 $ 26,703
Due after one year through five years 125,719 127,916
Due after five years through ten years 48,799 50,107
Due after ten years 82,695 83,478
Collateralized Mortgage and Asset Backed Securities 343,017 344,212
-------- --------
Total $626,326 $632,416
======== ========
Investments of the Insurance Subsidiaries must comply with applicable laws
and regulations which prescribe the type, quality and diversification of
investments. In general, these laws and regulations permit investments, with
specified limits and subject to certain qualifications, in federal, state and
municipal obligations, corporate bonds, preferred and common equity securities,
real estate mortgages and real estate.
12
Regulation
General: The Company is subject to extensive supervision and regulation in
the states in which it operates. The supervision and regulation relate to
numerous aspects of the Company's business and financial condition. The primary
purpose of the supervision and regulation is the protection of insurance
policyholders and not the Company's investors. The extent of regulation varies
but generally is governed by state statutes. These statutes delegate regulatory,
supervisory and administrative authority to state insurance departments. This
system of regulation covers, among other things:
- standards of solvency, including risk-based capital measurements;
- restrictions on the nature, quality and concentration of investments;
- restrictions on the types of terms that the Company can include in the
insurance policies it offers;
- certain required methods of accounting;
- reserves for unearned premiums, losses and other purposes; and
- potential assessments for the provision of funds necessary for the
settlement of covered claims under certain insurance policies provided
by impaired, insolvent or failed insurance companies.
The regulations or the state insurance departments may affect the cost or
demand for the Company's products and may present impediments to obtaining rate
increases or taking other actions to increase profitability. Also, regulatory
authorities have relatively broad discretion to grant, renew or revoke licenses
and approvals. If the Company does not have the requisite licenses and approvals
or does not comply with applicable regulatory requirements, the insurance
regulatory authorities could stop or temporarily suspend the Company from
carrying on some or all of its activities. In light of several recent
significant property and casualty insurance company insolvencies, it is possible
that assessments paid to state guaranty funds may increase. Because the
Insurance Subsidiaries are domiciled in Pennsylvania and Florida, the
Pennsylvania Department of Insurance and the Florida Department of Insurance
have primary authority over the Company.
Regulation of Insurance Holding Companies: Pennsylvania and Florida, like
many other states, have laws governing insurance holding companies (such as
Philadelphia Insurance). Under these laws, a person generally must obtain the
applicable Insurance Department's approval to acquire, directly or indirectly,
5% to 10% or more of the outstanding voting securities of Philadelphia Insurance
or the Insurance Subsidiaries. Such Department's determination of whether to
approve any such acquisition would be based on a variety of factors, including
an evaluation of the acquiror's financial stability, the competence of its
management, the effect of rates on coverages provided, if any, and whether
competition in Pennsylvania or Florida would be reduced.
The Pennsylvania and Florida statutes require every Pennsylvania and
Florida-domiciled insurer which is a member of an insurance holding company
system to register with Pennsylvania or Florida, respectively, by filing and
keeping current a registration statement on a form prescribed by the NAIC.
The Pennsylvania statute also specifies that at least one-third of the
board of directors and each committee thereof, of either the domestic insurer or
its publicly owned holding company (if any), must be comprised of outsiders
(i.e., persons who are neither officers, employees nor controlling shareholders
of the insurer or any affiliate). In addition, the domestic insurer or its
publicly held holding company must establish one or more committees comprised
solely of outside directors, with responsibility for recommending the selection
of independent certified public accountants; reviewing the insurer's financial
condition, the scope and results of the independent audit and any internal
audit; nominating candidates for director; evaluating the performance of
principal officers; and recommending to the board the selection and compensation
of principal officers.
Under the Florida statute, a majority of the directors must be citizens of
the United States. In addition, no Florida insurer may make any contract whereby
any person is granted or is to enjoy in fact the management of the insurer to
the substantial exclusion of its board of directors or to have the controlling
or preemptive right to produce substantially all insurance business for the
insurer, unless the contract is filed with and approved by the Florida Insurance
Department. An insurer must give the Department written notice of any change of
personnel among the directors or principal officers of the insurer within 45
days of such change. The written notice must include all information necessary
to allow the Department to determine that the insurer will be in compliance with
state statutes.
Dividend Restrictions: As an insurance holding company, Philadelphia
Insurance will be largely dependent on dividends and other permitted payments
from the Insurance Subsidiaries to pay any cash dividends to its shareholders.
The ability of the Insurance Subsidiaries to pay dividends to the Company is
subject to certain restrictions imposed under Pennsylvania and Florida insurance
laws. Accumulated statutory profits of the Insurance Subsidiaries from which
dividends
13
may be paid totaled $111.3 million at December 31, 2001. Of this amount, the
Insurance Subsidiaries are entitled to pay a total of approximately $27.4
million of dividends in 2002 without obtaining prior approval from the
Pennsylvania or Florida Insurance Departments. During 2001 the insurance
subsidiaries paid dividends of $13.0 million to PCHC and $3.8 million to Liberty
American Insurance Group, Inc., a subsidiary of PCHC.
The National Association of Insurance Commissioners: In addition to
state-imposed insurance laws and regulations, the Insurance Subsidiaries are
subject to the general SAP and reporting formats established by the NAIC. The
NAIC also promulgates model insurance laws and regulations relating to the
financial and operational regulation of insurance companies. These model laws
and regulations generally are not directly applicable to an insurance company
unless and until they are adopted by applicable state legislatures or
departments of insurance. However, NAIC model laws and regulations have become
increasingly important in recent years, due primarily to the NAIC's state
regulatory accreditation program. Under this program, states which have adopted
certain required model laws and regulations and meet various staffing and other
requirements are "accredited" by the NAIC. Such accreditation is the cornerstone
of an eventual nationwide regulatory network and there is a certain degree of
political pressure on individual states to become accredited by the NAIC.
Because the adoption of certain model laws and regulations is a prerequisite to
accreditation, the NAIC's initiatives have taken on a greater level of practical
importance in recent years. The NAIC accredited both Pennsylvania and Florida
under the NAIC Financial Regulation Standards.
All the states have adopted the NAIC's financial reporting form, which is
typically referred to as the NAIC "Annual Statement", and most states, including
Pennsylvania and Florida, generally defer to the NAIC with respect to SAP. In
this regard, the NAIC has a substantial degree of practical influence and is
able to accomplish certain quasi-legislative initiatives through amendments to
the NAIC annual statement and applicable accounting practices and procedures.
For instance, in recent years the NAIC has required all insurance companies to
have an annual statutory financial audit and an annual actuarial certification
as to loss reserves by including such requirements within the annual statement
instructions.
Capital and Surplus Requirements: PIC's eligibility to write insurance on a
surplus lines basis in most jurisdictions is dependent on its compliance with
certain financial standards, including the maintenance of a requisite level of
capital and surplus and the establishment of certain statutory deposits. In
recent years, many jurisdictions have increased the minimum financial standards
applicable to surplus lines eligibility. For example, California and certain
other states have adopted regulations which require surplus lines companies
operating therein to maintain minimum capital of $15 million, calculated as set
forth in the regulations. PIC maintains capital to meet these requirements.
Risk-Based Capital: Risk-based capital is designed to measure the
acceptable amount of capital an insurer should have, based on the inherent
specific risks of each insurer. Insurers failing to meet this benchmark capital
level may be subject to scrutiny by the insurer's domiciliary insurance
department and ultimately rehabilitation or liquidation. Based on the standards
currently adopted, the policyholders' surplus of each of the Insurance
Subsidiaries at December 31, 2001 is in excess of the prescribed risk-based
capital requirements.
Insurance Guaranty Funds: The Insurance Subsidiaries are subject to
guaranty fund laws which can result in assessments, up to prescribed limits, for
losses incurred by policyholders as a result of the impairment or insolvency of
unaffiliated insurance companies. Typically, an insurance company is subject to
the guaranty fund laws of the states in which it conducts insurance business;
however, companies which conduct business on a surplus lines basis in a
particular state are generally exempt from that state's guaranty fund laws.
Shared Markets: As a condition of its license to do business in various
states, PIIC, MUSA and LAIC are required to participate in mandatory
property-liability shared market mechanisms or pooling arrangements which
provide various insurance coverages to individuals or other entities that
otherwise are unable to purchase coverage voluntarily provided by private
insurers. In addition, some states require automobile insurers to participate in
reinsurance pools for claims that exceed a certain amount. PIIC's participation
in such shared markets or pooling mechanisms is generally in proportion to
the amount of PIIC's direct writings for the type of coverage written by the
specific pooling mechanism in the applicable state.
Possible New Legislation, Regulations or Interpretations: A number of new,
proposed or potential legislative or industry developments could further
increase competition in the insurance industry. These developments include:
- the enactment of the Gramm-Leach-Bliley Act of 1999 (which permits
financial services companies such as banks and brokerage firms to
engage in the insurance business), which could result in increased
competition from new entrants to the Company's markets;
- the formation of new insurers and an influx of new capital in the
marketplace as existing companies attempt to expand their business as
a result of better pricing and/or terms;
14
- programs in which state-sponsored entities provide property insurance
in catastrophe-prone areas;
- changing practices caused by the Internet, which have led to greater
competition in the insurance business; and
- as a result of the terrorist attacks on September 11, the
Administration and Congress have been engaged in discussions with
the insurance industry as to the possible involvement of the federal
government with respect to terrorism insurance. There can be no
assurance as to whether there will be any federal government role in
insuring losses from terrorism or the precise nature of any role, and
there is no assurance as to the extent of any federal government role
on the Company's business and results of operations.
These developments could make the property and casualty insurance
marketplace more competitive by increasing the supply of insurance capacity. In
that event, recent favorable industry trends that have reduced insurance and
reinsurance supply and increased demand could be reversed and may negatively
influence our ability to maintain or increase rates. Accordingly, these
developments could have an adverse effect on the Company's earnings.
Competition
The Company competes with a large number of other companies in its selected
line of business, including major U.S. and non-U.S. insurers and other regional
companies, as well as mutual companies, specialty insurance companies,
underwriting agencies and diversified financial services companies. Some of
these competitors have greater financial and marketing resources than the
Company. Profitability could be adversely affected if business is lost due to
competitors offering similar or better products at or below the Company's
prices. In addition, a number of new, proposed or potential legislative or
industry developments could further increase competition. New competition from
these developments could cause the demand for the Company's products to fall,
which could adversely affect profitability.
The current business climate remains competitive from a solicitation
standpoint. The Company will "walk away", if necessary, from writing business
that does not meet established underwriting standards and pricing guidelines.
Management believes though that the Company's mixed marketing strategy is a
strength in that it provides the flexibility to quickly deploy the marketing
efforts of the Company's direct production underwriters from soft market
segments to market segments with emerging opportunities. Additionally, through
the mixed marketing strategy, the Company's production underwriters have
established relationships with approximately 6,000 brokers, thus facilitating a
regular flow of submissions.
Employees
As of March 19, 2002, the Company had 592 full-time employees and 23
part-time employees. The Company actively encourages its employees to continue
their educational efforts and aids in defraying their educational costs
(including 100% of education costs related to the insurance industry).
Management believes that the Company's relations with its employees are
generally excellent.
Item 2. DESCRIPTION OF PROPERTY
The Company leases certain office space in Bala Cynwyd, PA which serves as
its headquarters location, and also leases 36 offices for its field
marketing organization.
Item 3. LEGAL PROCEEDINGS
In connection with the action filed in the U.S. District Court in the
Middle District of Florida by two of the Company's subsidiaries, Liberty
American Insurance Group Inc. and Mobile Homeowners Insurance Agency Inc.,
against Westpoint Underwriters LLC, a managing general agent, two former
employees of Liberty American and a third individual (which action was
reported in Item 1 of Part II of the Company's Form 10-Q for the period
ended March 31, 2001), a federal magistrate judge issued a report and
recommendations to the Federal District Court on October 17, 2001. With
respect to Liberty American's request for preliminary relief, the findings
and recommendations stated that one of the former employees had
misappropriated Liberty American's trade secrets by using its software to
write WestPoint's software. The magistrate judge recommended against
injunctive relief, finding that damages may be available as a remedy. Both
Liberty American and the defendant have objected, in part, to the findings,
and these objections are now being considered by the court.
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 2001.
15
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) The Company's common stock, no par value, trades on The Nasdaq Stock
Market under the symbol "PHLY". As of February 22, 2002, there were 397
holders of record and 2,233 beneficial shareholders of the Company's common
stock. The high and low sales prices of the common stock, as reported by
the National Association of Securities Dealers, were as follows:
2001 2000
------------------ ------------------
Quarter High Low High Low
------- ------ ------ ------ ------
First 31.922 25.375 16.000 14.250
Second 36.000 24.250 18.090 14.580
Third 37.500 24.350 20.880 15.690
Fourth 41.300 32.900 30.880 20.000
The Company did not declare cash dividends on its common stock in 2001 and
2000, and currently intends to retain its earnings to enhance future
growth. The payment of dividends by the Company will be determined by the
Board of Directors and will be based on general business conditions and
legal and regulatory restrictions.
As a holding company, the Company is dependent upon dividends and other
permitted payments from its subsidiaries to pay any cash dividends to its
shareholders. The ability of the Company's insurance subsidiaries to pay
dividends to the Company is subject to regulatory limitations (see Note 3
to the Consolidated Financial Statements).
(b) During the three years ended December 31, 2001, the Company did not
sell any of its securities which were not registered under the Securities
Act of 1933, except as follows:
On July 16, 1999 the Company issued an aggregate of 1,037,772 shares of its
common stock to the four shareholders of The Jerger Company, Inc. in
connection with the merger of The Jerger Company, Inc. into a subsidiary of
the Company. This issuance was exempt from registration under Section 4(2)
of the Securities Act of 1933 as a result of the limited number of persons
to whom the shares were issued and the fact that the shares were issued in
a negotiated merger transaction.
16
Item 6. SELECTED FINANCIAL DATA
As of and For the Years Ended December 31,
(In Thousands, Except Share and Per Share Data)
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
Operations and Comprehensive Income
Statement Data:
Gross Written Premiums $ 473,565 $ 361,872 $ 274,918 $ 197,408 $ 159,091
Gross Earned Premiums $ 421,063 $ 328,350 $ 245,978 $ 174,737 $ 150,128
Net Written Premiums $ 333,817 $ 263,429 $ 184,071 $ 143,036 $ 111,797
Net Earned Premiums $ 296,093 $ 227,292 $ 164,915 $ 122,687 $ 100,555
Net Investment Income 32,426 25,803 20,695 15,448 9,703
Net Realized Investment Gain (Loss) 3,357 11,718 5,700 474 (16)
Other Income 587 8,981 4,722 219 228
- ------------------------------------------------------------------------------------------------------------------------------
Total Revenue 332,463 273,794 196,032 138,828 110,470
- ------------------------------------------------------------------------------------------------------------------------------
Net Loss and Loss Adjustment
Expenses 179,655 131,304 99,410 66,374 55,009
Acquisition Costs and Other
Underwriting Expenses 97,020 75,054 53,793 38,422 31,344
Other Operating Expenses 6,841 14,679 8,939 2,212 1,909
- ------------------------------------------------------------------------------------------------------------------------------
Total Losses and Expenses 283,516 221,037 162,142 107,008 88,262
- ------------------------------------------------------------------------------------------------------------------------------
Minority Interest: Distributions on
Company Obligated Mandatorily
Redeemable Preferred Securities of
Subsidiary Trust 2,749 7,245 7,245 4,770 --
- ------------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 46,198 45,512 26,645 27,050 22,208
Total Income Tax Expense 15,639 14,742 7,802 7,022 5,338
- ------------------------------------------------------------------------------------------------------------------------------
Net Income $ 30,559 $ 30,770 $ 18,843 $ 20,028 $ 16,870
- ------------------------------------------------------------------------------------------------------------------------------
Weighted-Average Common Shares
Outstanding 16,528,601 12,177,989 12,501,165 12,249,262 12,193,659
Weighted-Average Share Equivalents
Outstanding 656,075 2,411,552 2,614,399 2,680,165 2,736,039
- ------------------------------------------------------------------------------------------------------------------------------
Weighted-Average Shares and Share
Equivalents Outstanding 17,184,676 14,589,541 15,115,564 14,929,427 14,929,698
- ------------------------------------------------------------------------------------------------------------------------------
Basic Earnings Per Share $ 1.85 $ 2.53 $ 1.51 $ 1.63 $ 1.38
- ------------------------------------------------------------------------------------------------------------------------------
Diluted Earnings Per Share $ 1.78 $ 2.11 $ 1.25 $ 1.34 $ 1.13
- ------------------------------------------------------------------------------------------------------------------------------
Year End Financial Position:
Total Investments and Cash
and Cash Equivalents $ 723,318 $ 487,028 $ 420,016 $ 388,059 $ 229,599
Total Assets 1,017,722 730,464 599,051 476,390 292,724
Unpaid Loss and Loss Adjustment
Expenses 302,733 237,494 188,063 151,150 122,430
Minority Interest in Consolidated
Subsidiaries -- 98,905 98,905 98,905 --
Total Shareholders' Equity 428,692 182,325 161,440 137,483 111,284
Common Shares Outstanding 21,509,723 13,431,408 12,590,908 12,200,563 12,242,431
- ------------------------------------------------------------------------------------------------------------------------------
Insurance Operating Ratios
(Statutory Basis):
Net Loss and Loss Adjustment
Expenses to Net Earned Premiums 60.7% 57.8% 59.7% 54.1% 55.3%
Underwriting Expenses to Net
Written Premiums 31.2% 31.3% 33.6% 31.0% 29.1%
- ------------------------------------------------------------------------------------------------------------------------------
Combined Ratio 91.9% 89.1% 93.3% 85.1% 84.4%
==============================================================================================================================
A+ A+ A+ A+ A
A.M. Best Rating (Superior) (Superior) (Superior) (Superior) (Excellent)
17
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Operations
During 2001 the Company continued its growth, with gross written premium
increasing 30.9% to $473.6 million. This growth is attributable to a number of
varying factors, the most notable of which were:
- - Continued benefits from marketplace disruptions due to rating agency
downgrades, insolvencies and merger and acquisition activity. These
disruptions have resulted in new independent agency relationships, improved
premium rates and policy terms and increased market share in certain of the
Company's commercial lines segment niche products;
- - The 44.4% growth in the personal lines segment, primarily attributable to
the Company's "preferred homeowners" insurance program, which was
introduced during 2000 to retirees in gated communities; and
- - The 20.0% growth in production from the Company's preferred agent force,
which is comprised of independent brokers specializing in various of the
Company's product niches.
The Company also believes its core strategy of adhering to an underwriting
philosophy of sound risk selection and pricing discipline, the mixed marketing
platform for its product distribution and creating value added features not
typically found in property and casualty products have also contributed to
generating premium growth above industry averages, as well as enabling the
Company to produce combined ratios (the sum of net loss and loss adjustment
expenses and acquisition costs and other underwriting expenses, divided by net
earned premiums) well below industry averages. The GAAP combined ratio for the
year ended December 31, 2001 was 93.4%, which, once again, was substantially
lower than the property and casualty industry as a whole.
As noted above, during the second half of 2000 and through the first nine months
of 2001 marketplace disruptions resulted in improving premium rates and policy
terms. Additionally, the terrorist attacks of September 11, 2001 caused the
property and casualty industry to experience significant losses. As a result,
the Company anticipates that the rate increases and improving policy terms,
which started to occur in the second half of 2000, will now continue, possibly
for an extended period of time. To better position itself to take advantage of
these improving conditions the Company issued 3.6 million shares of its common
stock through a public offering in the fourth quarter of 2001. The $114.5
million in net proceeds from this offering are primarily being utilized to
provide additional capital for the Company's insurance subsidiaries and to fund
general corporate purposes.
Furthermore, as a result of the terrorist attacks of September 11, 2001, the
Company has endorsed its commercial insurance polices issued during 2002 with
the Insurance Services Office ("ISO") terrorism exclusion in states where
approved by the respective Insurance Departments. Currently, not all states have
approved this ISO terrorism exclusion, and the Company cannot determine whether
the state insurance departments which have not yet approved this exclusion will
ultimately do so. In its capacity as primary insurer the Company may have a
potential gap in its reinsurance protection and could be exposed to potential
losses as a result of any terrorist acts. To mitigate this potential exposure to
losses arising from terrorist acts, the Company has purchased reinsurance
coverage for terrorism with a $10.0 million aggregate policy limit for 2002.
In February 2001, A.M. Best Company reaffirmed the "A+" (Superior) rating for
Philadelphia Indemnity Insurance Company, Philadelphia Insurance Company, Mobile
USA Insurance Company and Liberty American Insurance Company (collectively the
"Insurance Subsidiaries").
18
Investments
Investments consist of diversified issuers and issues, and as of December 31,
2001, approximately 88.7% and 4.8% of the total invested assets (total
investments plus cash equivalents) on a cost basis consisted of investments in
fixed maturity and equity securities, respectively, versus 84.2% and 5.2%,
respectively, at December 31, 2000.
During 2001, based upon guidance from the Financial Accounting Standards Board
Emerging Issues Task Force (EITF) regarding Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets ("EITF 99-20"), certain of the Company's structured securities
were subject to re-evaluation as a result of meeting the recognition for
impairment losses in EITF 99-20. This re-evaluation resulted in non-cash
realized investment losses of $5.8 million. The Company expects to receive full
contract value and recover the writedowns. Any such recovery will be recognized
prospectively through net investment income.
Also, during 2001 the relative percentage investment in taxable fixed maturity
securities versus tax-exempt fixed maturity securities continued to increase due
to the Company taking advantage of the more favorable after-tax yields. At the
end of 2001, on a cost basis, investment grade taxable fixed maturity securities
represented 73.9% of the total invested assets, compared to 66.5% as of the end
of 2000.
Collateralized mortgage and asset backed securities, on a cost basis, amounted
to $70.4 million and $272.7 million, respectively, as of December 31, 2001 and
$65.6 and $106.8, respectively, as of December 31 2000. The increased investment
in collateralized mortgage and asset backed securities was due to the relatively
higher after tax rates of return compared to other investment options within the
Company's investment objective. This objective is to generate competitive
after-tax total rates of return within a prudent level of risk and the
constraints of maintaining adequate securities in amount and duration to meet
cash requirements of current operations and long-term liabilities, as well as
maintaining and improving the Company's A.M. Best rating. The collateralized
mortgage and asset backed investments are shorter tranche securities possessing
favorable prepayment risk profiles. The Company utilizes professional investment
managers for its investments.
Market Risk of Financial Instruments
The Company's financial instruments are subject to the market risk of potential
losses from adverse changes in market rates and prices. The primary market risks
to the Company are equity price risk associated with investments in equity
securities and interest rate risk associated with investments in fixed
maturities. The Company has established, among other criteria, duration, asset
quality and asset allocation guidelines for managing its investment portfolio
market risk exposure. The Company's investments are held for purposes other than
trading and consist of diversified issuers and issues.
The table below provides information about the Company's financial instruments
that are sensitive to changes in interest rates. For debt obligations, the table
presents principal cash flows and related weighted average interest rates by
expected maturity dates. The information is presented in U.S. dollar
equivalents.
19
DECEMBER 31, 2001
EXPECTED MATURITY DATES TOTAL
(In thousands, except average interest rate) FAIR
2002 2003 2004 2005 2006 Thereafter TOTAL VALUE
------- ------- -------- ------- ------- ---------- -------- --------
FIXED MATURITIES
AVAILABLE FOR SALE:
Principal Amount $73,573 $60,291 $112,656 $76,438 $77,866 $220,418 $621,242 $624,050
Book Value $73,629 $60,172 $112,339 $77,283 $78,254 $216,412 $618,089 --
Average Interest Rate 6.38% 5.15% 5.23% 5.83% 5.43% 5.66% 5.61% 4.88%
PREFERRED:
Principal Amount $ 2,395 $ 2,250 $ 1,000 $ 2,500 -- -- $ 8,145 $ 8,366
Book Value $ 2,400 $ 2,240 $ 1,040 $ 2,557 -- -- $ 8,237 --
Average Interest Rate 5.27% 6.07% 6.84% 6.41% -- -- 6.04% 5.97%
SHORT-TERM DEBT:
Principal Amount $45,583 -- -- -- -- -- $ 45,583 $ 45,583
Book Value $45,583 -- -- -- -- -- $ 45,583 --
Average Interest Rate 1.87% -- -- -- -- -- 1.87% 1.87%
Certain Critical Accounting Estimates and Judgments
- - Investments
-- Fair values
The carrying amounts for the Company's investments approximates
their estimated fair value except for investments in limited
partnerships which are valued at cost. The Company measures the
fair value of investments based upon quoted market prices or by
obtaining quotes from dealers.
-- Other than temporary impairment excluding interests in securitized
assets
The Company performs various analytical procedures with respect
to its investments, including identifying any security whose fair
value is below its cost. Upon identification of such securities,
a detailed review is performed to determine whether a decline in
fair value below a security's cost basis is other than temporary.
If the Company determines a decline in value to be other than
temporary, the cost basis of the security is written down to its
fair value with the amount of the write down included in earnings
as a realized loss in the period the impairment arose.
20
-- Impairment recognition for investments in securitized assets
The Company's impairment evaluation and recognition for interests
in securitized assets is conducted in accordance with the
guidance provided by EITF 99-20. Under this guidance, impairment
losses on securities must be recognized if both the fair value of
the security is less than its book value and the net present
value of expected future cash flows is less than the net present
value of expected future cash flows at the most recent (prior)
estimation date. If these criteria are met an impairment charge,
the difference between the current book value of the security and
its fair value, is included in earnings as a realized loss in the
period the impairment arose.
- - Liability for Unpaid Loss and Loss Adjustment Expenses:
The liability for unpaid loss and loss adjustment expenses ($302.7 million
and $237.5 million as of December 31, 2001 and 2000, respectively) reflects
the Company's best estimate for future amounts needed to pay losses and
related settlement expenses with respect to insured events. This liability
includes an amount determined on the basis of claim adjusters' evaluations
with respect to insured events that have occurred and an amount for losses
incurred that have not been reported to the Company. In some cases
significant periods of time, up to several years or more, may elapse
between the occurrence of an insured loss and the reporting of such to the
Company. The method for determining the Company's liability for unpaid loss
and loss adjustment expenses includes but is not limited to reviewing past
loss experience and considering other factors such as legal, social, and
economic developments. The methods of making such estimates and
establishing the resulting liabilities are continually reviewed and updated
and any adjustments resulting therefrom are made in the accounting period
in which the adjustment arose.
- - Deferred Acquisition Costs:
Policy acquisition costs ($41.5 million and $33.3 million as of December
31, 2001 and 2000, respectively) which include commissions, premium taxes,
fees, and certain other costs of underwriting policies, are deferred and
amortized over the same period in which the related premiums are earned.
Deferred acquisition costs are limited to the estimated amounts recoverable
after providing for losses and expenses that are expected to be incurred,
based upon historical and current experience. Anticipated investment income
is considered in determining whether a premium deficiency exists. The
methods of making such estimates and establishing the deferred costs are
continually reviewed by the Company, and any adjustments therefrom are made
in the accounting period in which the adjustment arose.
RESULTS OF OPERATIONS
(2001 versus 2000)
Premiums: Gross written premiums grew $111.7 million (30.9%) to $473.6 million
in 2001 from $361.9 million in 2000; gross earned premiums grew $92.7 million
(28.2%) to $421.1 million in 2001 from $328.4 million in 2000; net written
premiums increased $70.4 million (26.7%) to $333.8 million in 2001 from $263.4
in 2000; and net earned premiums grew $68.8 million (30.3%) to $296.1 million in
2001 from $227.3 million in 2000.
The respective gross written premium increases for the commercial lines,
specialty lines and personal lines segments for the years ended December 31,
2001 vs. December 31, 2000 amount to $76.5 million (31.9%), $11.1 million
(16.3%) and $24.1 million (44.4%), respectively. The overall growth in gross
written premiums is primarily attributable to the following:
- - Rating downgrades of certain major competitor property and casualty
insurance companies have led to their diminished presence in the Company's
commercial and specialty lines business segments and continue to result in
additional prospects and increased premium writings, most notably for the
Company's various commercial package and non-profit D&O product lines.
- - The consolidation of certain competitor property and casualty insurance
companies has led to the displacement of certain of their independent
agency relationships. This consolidation continues to result in new agency
21
relationship opportunities for the Company. These relationships have
resulted in additional prospects and premium writings for the Company's
commercial and specialty lines segments.
- - Continued expansion of marketing efforts relating to commercial lines and
specialty lines products through the Company's field organization and
preferred agents.
- - Rate increases on renewal business.
Overall premium growth in the specialty lines segment has been offset in part by
the Company's decision not to renew certain policies in the professional
liability product lines due to inadequate pricing levels being experienced as a
result of market conditions and/or loss experience emerging at higher than
expected levels.
The respective net written premium increases for the commercial lines, specialty
lines and personal lines segments for the years ended December 31, 2001 vs.
December 31, 2000 amount to $60.3 million (36.9%), $1.9 million (2.8%) and $8.2
million (25.5%), respectively. The differing percentage increases in net written
premiums versus gross written premiums for the period is primarily due to the
various changes in the Company's reinsurance programs.
Net Investment Income: Net investment income was $32.4 million for the year
ended December 31, 2001 and $25.8 million for the same period of 2000. Total
investments grew to $673.4 million at December 31, 2001 from $437.3 million at
December 31, 2000. The growth in investment income is attributable to investing
net cash flows provided by operating activities and the proceeds of the
Company's equity offering received late in the fourth quarter. In addition, the
Company increased the percentage invested in taxable investments versus tax
exempt investments in order to achieve the incremental after tax net investment
income available from taxable investments. The low level of U.S. Treasury yields
persisted throughout 2001. This capital markets environment had the effect of
both increasing the level of prepayments in certain of the Company's interest
rate sensitive investments and causing the Company to slightly shorten its
duration position in the expectation of higher future fixed income yields. As a
result, the Company's average duration on its fixed income portfolio
approximated 2.7 years at December 31, 2001, compared to 3.5 years at December
31, 2000. As a consequence of the above factors, the Company's tax equivalent
book yield on its fixed income holdings was 6.00% at December 31, 2001, compared
to 7.37% at December 31, 2000.
Net Realized Investment Gain: Net realized investment gains were $3.4 million
for the year ended December 31, 2001 and $11.7 million for the same period in
2000. The Company realized net investment gains of $8.3 million from the sales
of common stock securities and $0.9 million from the sales of fixed maturity
securities during the year ended December 31, 2001. These realized net
investment gains were offset by $5.8 million in non-cash realized investment
losses experienced on certain structured securities as a result of an impairment
evaluation in accordance with the recent EITF 99-20 guidance. The proceeds from
the sales are being reinvested in fixed maturity securities to increase current
investment income and decrease the overall percentage of investments in common
stock securities. The net realized investment gains of $11.7 million for the
year ended December 31, 2000 were due to sales of certain equity investments
which resulted in realized net investment gains amounting to $15.1 million, and
were offset by $3.4 million of realized net investment losses from sales of
certain fixed income securities. The proceeds from these sales were reinvested
principally in fixed maturity securities.
Other Income: Other income approximated $0.6 million for the year ended December
31, 2001 and $9.0 million for the same period of 2000. Other income primarily
consists of commissions earned on brokered personal lines business. Such
commissions earned continued to decrease, as planned, as brokering activities
were lessened in 2001 in favor of writing business directly.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses
increased $48.4 million (36.9%) to $179.7 million for the year ended December
31, 2001 from $131.3 million for the same period of 2000 and the loss ratio
increased to 60.7% in 2001 from 57.8% in 2000. The year ended December 31, 2001
included a $4.0 million increase to net loss and loss adjustment expenses
arising from business interruption, business personal property, business
property and workers' compensation exposures relating to the September 11, 2001
terrorist attacks. Excluding this item, net loss and loss adjustment expenses
increased by $44.4 million (33.8%). The increase in net loss and loss adjustment
expenses was due principally to:
- - The 30.3% growth in net earned premiums; and
22
- - Losses emerging at a higher rate on automobile leases expiring in 2001 on
residual value policies underwritten in prior years than had been
originally anticipated when the initial reserves were estimated.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other
underwriting expenses increased $21.9 million (29.2%) to $97.0 million for the
year ended December 31, 2001 from $75.1 million for the same period of 2000.
This increase was due primarily to the 30.3% growth in net earned premiums,
offset by relative changes in the Company's product mix and associated
distribution channel expense.
Other Operating Expenses: Other operating expenses decreased $7.9 million to
$6.8 million for the year ended December 31, 2001 from $14.7 million for the
same period of 2000. The decrease in other operating expenses was primarily due
to the decrease in brokering activities resulting in a decrease in the amount of
broker commissions (see "Other Income" above). Goodwill amortization of $1.5
million per year, both for 2001 and 2000 will cease on January 1, 2002 due to
the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets."
Income Tax Expense: The Company's effective tax rate for the years ended
December 31, 2001 and 2000 was 33.9% and 32.4%, respectively. The effective
rates differed from the 35% statutory rate principally due to investments in
tax-exempt securities, offset in part by non-deductible goodwill amortization.
The increase in the effective tax rate is principally due to a greater
investment of cash flows in taxable securities relative to tax-exempt
securities.
RESULTS OF OPERATIONS
(2000 versus 1999)
Premiums: Gross written premiums grew $87.0 million (31.6%) to $361.9 million in
2000 from $274.9 million in 1999; gross earned premiums grew $82.4 million
(33.5%) to $328.4 million in 2000 from $246.0 million in 1999; net written
premiums increased $79.3 million (43.1%) to $263.4 million in 2000 from $184.1
million in 1999; and net earned premiums grew $62.4 million (37.8%) to $227.3
million in 2000 from $164.9 million in 1999.
The respective gross written premium increases for the commercial lines,
specialty lines and personal lines segments for the years ended December 31,
2000 vs. December 31, 1999 amount to $38.5 million (19.2%), $19.7 million
(40.6%) and $28.8 million (113.4%) respectively. The overall growth in gross
written premiums is primarily attributable to the following:
- - The growth of Liberty, resulting in an increase of $28.8 million in gross
manufactured housing, preferred homeowners and National Flood Insurance
Program written premiums.
- - Recent rating downgrades of certain major competitor property and casualty
insurance companies has led to their diminished presence in the Company's
commercial and specialty lines business segments and continues to result in
additional prospects and increased premium writings most notably for the
Company's various commercial package and non-profit D&O product lines.
- - The consolidation of certain competitor property and casualty insurance
companies has led to the displacement of certain of its independent agency
relationships which continues to result in new agency relationships for the
Company which have been bringing additional prospects and premium writings
for the Company's commercial and specialty lines segments.
- - Continued expansion of marketing efforts relating to commercial lines and
specialty lines products through the Company's field organization and
preferred agents.
- - Realized rate increases commencing during the latter part of 2000 on
certain renewal business.
- - Overall premium growth in the commercial lines segment has been offset in
part by the Company's decision not to renew certain policies in the
commercial automobile and specialty property product lines due to
inadequate pricing levels being experienced as a result of market
conditions and/or loss experience emerging at higher than expected levels.
23
The respective net written premium increases for the commercial lines, specialty
lines and personal lines segments for the years ended December 31, 2000 vs.
December 31, 1999 amount to $34.4 million (26.6%), $26.9 million (65.8%) and
$18.1 million (128.6%) respectively. The higher percentage increase in net
written premiums versus gross written premiums for the period is primarily due
to the Company, effective January 2000, increasing its liability retention on
each occurrence from $250,000 to $1.0 million for all specialty lines segment
business, thus reducing its reinsurance cost (ceded written premiums) and
increasing its retained premiums (net written premiums).
Net Investment Income: Net investment income approximated $25.8 million in 2000
and $20.7 million in 1999. Total investments grew to $437.3 million at December
31, 2000 from $393.8 million at December 31, 1999. The growth in investment
income is due primarily to investing net cash flows provided from operating
activities; the net investable assets acquired in the Company's acquisition of
Liberty; the reinvestment of $31.4 million in proceeds from the net decrease in
common stock holdings which were reinvested into fixed maturity securities; and
the increase in the Company's tax equivalent book yield on its fixed income
holdings to 7.37% at December 31, 2000 versus 7.08% at December 31, 1999. The
Company's average duration on its fixed income portfolio approximated 3.5 years
at December 31, 2000 and 4.0 years at December 31, 1999.
Net Realized Investment Gain: Net realized investment gains were $11.7 million
for 2000 and $5.7 million for 1999. The Company realized net investment gains of
$15.1 million from the sales of common stock equity securities offset by $3.4
million of realized net investment losses from sales of certain fixed maturity
securities during the year ended December 2000. The proceeds from these common
stock sales were reinvested in fixed maturity securities to increase current
investment income, lessen the Company's holdings in certain common stock
positions, and decrease the overall percentage of investments in common stock
securities. The proceeds realized from the fixed maturity sales were reinvested
in fixed maturity securities with higher relative book yields than the fixed
income securities sold. The net realized investment gains of $5.7 million for
the year ended December 31, 1999 were due to the sales of certain fixed maturity
and equity investments. A portion of the proceeds from these sales were utilized
for the cash purchase price and repayment of certain obligations of the Liberty
acquisition. The remaining proceeds were repositioned within the fixed maturity
portfolio.
Other Income: Other income approximated $9.0 million for the year ended December
31, 2000 and $4.7 for the same period of 1999. Other income primarily consists
of commissions earned by Liberty on brokered personal lines business, and for
the year ended December 31, 1999 only included such income from the July 1999
acquisition date to December 31, 1999. Prospectively the Company anticipates
commissions earned on brokered personal lines business to significantly decrease
as the Company discontinues brokering activities in favor of writing the
business directly.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses
increased $31.9 million (32.1%) to $131.3 million in 2000 from $99.4 million in
1999 and the loss ratio decreased to 57.8% in 2000 from 60.3% in 1999. The year
ended December 31, 1999 included a $5.0 million increase to unpaid loss and loss
adjustment expenses for Nursing Home and Assisted Living commercial multi-peril
package policies which had been issued in prior periods and $6.1 million for
unpaid loss and loss adjustment expenses related to property catastrophe losses.
Excluding these items, net loss and loss adjustment expenses increased by $43.0
million (48.7%) and the loss ratio for the year ending December 31, 1999 was
53.6%. This increase in net loss and loss adjustment expenses was due
principally to the following:
- - 37.8% growth in net earned premiums;
- - The increase in the loss ratio due to the relatively higher net earned
premium growth on products (specialty lines) with higher relative loss
experience; and
- - Losses emerging during 2000 at a higher rate than had been originally
anticipated for certain products in the commercial lines segment when the
initial reserves were estimated.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other
underwriting expenses increased $21.3 million (39.6%), to $75.1 million in 2000
from $53.8 million in 1999. This increase was due primarily to the 37.8% growth
in net earned premiums and to relative changes in the Company's product mix and
associated distribution expense.
24
Other Operating Expenses: Other operating expenses increased $5.8 million to
$14.7 million in 2000 from $8.9 million for 1999. The increase in other
operating expenses was primarily due to the inclusion of the operating expenses
of Liberty's brokered personal lines business ($4.2 million), and goodwill
amortization ($.7 million) arising from the acquisition of Liberty. Such
expenses have been incurred for the entire year ending December 31, 2000, while
the 1999 expenses include the period from the July 1999 acquisition date to
December 31, 1999. Prospectively the Company anticipates operating expenses on
brokered personal lines business to significantly decrease as the Company
discontinues brokering activities in favor of writing the business directly.
Income Tax Expense: The Company's effective tax rates for 2000 and 1999 were
32.4% and 29.3%, respectively. The effective rates differed from the 35%
statutory rate principally due to investments in tax-exempt securities offset in
part by non-deductible goodwill amortization. The increase in the effective tax
rate is principally due to a greater investment of cash flows in taxable
securities relative to tax-exempt securities.
GROWTH OPPORTUNITIES
The Company believes that it can continue its premium growth due to: its
national presence via 36 production underwriting offices located across the
United States from which the production underwriting organization markets the
Company's products and services directly to its customers, as well as
coordinating the efforts of the Company's external producers; the evaluation and
development of new product opportunities and differentiation of policy and
service features; the disruption in the marketplace as a result of consolidation
activity and certain distressed situations along with the improving fundamentals
(premium rates and policy terms) in the property and casualty industry; and
expansion of its personal lines business into new states in addition to seeking
premium growth in its current markets. The Company also anticipates cross
selling opportunities to arise between its personal and commercial lines
business niches as well as cross selling opportunities within its preferred
agency base for its portfolio of commercial niche insurance products.
Overall future premium growth may be offset in part due to the continuing
adverse affects the September 11th terrorist attacks have had on the Company's
rental car customers offering its excess liability (SLI) insurance coverage to
the business and leisure traveler. This product is sold at the rental car
counters through arrangements with a number of the largest rent-a-car companies
and protects rent-a-car customers against liability for bodily injury and
property damage excess of the statutory coverage provided with the rental
vehicle. The SLI product represented approximately 8.0% of the 2001 commercial
lines segment total net written premium.
The Company believes its unique product features and mixed marketing strategy is
a strength, in that it provides the market intelligence and flexibility to
quickly deploy the marketing efforts of the Company's direct production
underwriters from market segments where pricing is soft to market segments with
emerging opportunities.
LIQUIDITY AND CAPITAL RESOURCES
Philadelphia Consolidated Holding Corp. (PCHC) is a holding company whose
principal assets currently consist of 100% of the capital stock of its
subsidiaries. The Company's primary sources of funds are dividends from its
subsidiaries and payments received pursuant to tax allocation agreements with
the insurance subsidiaries. For the year ended December 31, 2001, payments to
PCHC pursuant to such tax allocation agreements totaled $18.6 million. The
payment of dividends to PCHC from the insurance subsidiaries is subject to
certain limitations imposed by the insurance laws of the Commonwealth of
Pennsylvania and State of Florida. Accumulated statutory profits or
policyholders' surplus of the insurance subsidiaries from which dividends may be
paid totaled $111.3 million at December 31, 2001. Of this amount, the insurance
subsidiaries are entitled to pay a total of approximately $27.4 million of
dividends in 2002 without obtaining prior approval from the Insurance
Commissioner of the Commonwealth of Pennsylvania or State of Florida. During
2001 the insurance subsidiaries paid dividends of $13.0 million to PCHC and $3.8
million to Liberty American Insurance Group, Inc., a subsidiary of PCHC.
On May 16, 2001, the Company issued 4.0 million common shares to satisfy the
stock purchase contract obligation from the Company's 1998 FELINE PRIDESSM
offering. The issuance of such shares resulted in a $98.9 million increase in
Shareholders' Equity and a corresponding decrease in the Minority Interest In
Consolidated Subsidiaries balance.
25
On November 27, 2001 the Company closed on its public offering of an aggregate
of 3.6 million shares of its common stock. Proceeds from the offering were
$114.5 million (after underwriting and associated costs). The Company
contributed $70.0 million of the net proceeds to its subsidiaries in 2001, of
which $60.0 million was contributed to the Insurance Subsidiaries. The remaining
proceeds are presently being held for general corporate purposes.
On September 14, 2001, the Company's Board of Directors authorized the
repurchase of an additional $15.0 million of the Company's common stock. This
authorization is in addition to the previously announced $40.0 million common
stock buyback authorization, bringing the total current remaining authorization
to $30.1 million. Purchases are made from time to time in the open market or
through privately negotiated transactions.
Two of the Company's Insurance Subsidiaries are members of the Federal Home Loan
Bank of Pittsburgh ("FHLB"). A primary advantage of FHLB membership is the
ability of members to access credit products from a reliable capital markets
provider. The availability of any one member's access to credit is based upon
its FHLB eligible collateral. At December 31, 2001 the Insurance Subsidiaries
borrowing capacity was $80.8 million. The Insurance Subsidiaries have utilized a
portion of its borrowing capacity to purchase a diversified portfolio in
investment grade floating rate securities. These purchases were funded by
floating rate FHLB borrowings to achieve a positive spread between the rate of
interest on these securities and borrowing rates. The remaining borrowing
capacity will provide an immediately available line of credit. Borrowings
aggregated $31.3 million at December 31, 2001 and bear interest at adjusted
LIBOR and mature twelve months from inception. The weighted-average interest
rate on borrowings outstanding as of December 31, 2001 was 2.07%.
Under certain reinsurance agreements, the Company is required to maintain
investments in trust accounts to secure its reinsurance obligations (primarily
the payment of losses and loss adjustment expenses on business it does not write
directly). At December 31, 2001, the investment and cash balances in such trust
accounts totaled approximately $11.9 million. In addition, various insurance
departments of states in which the Company operates require the deposit of funds
to protect policyholders within those states. At December 31, 2001, the balance
on deposit for the benefit of such policyholders totaled approximately $13.5
million.
The Company produced net cash from operations of $115.1 million in 2001, $47.0
million in 2000 and $47.4 million in 1999. Operating cash included cash provided
from tax benefits as a result of the exercise of employee stock options
amounting to $25.8 million, $0.1 million and $0.3 million for 2001, 2000 and
1999, respectively. Management believes that the Company has adequate liquidity
to pay all claims and meet all other cash needs.
In the normal course of business, the Company has entered into various
reinsurance contracts with unrelated reinsurers. The Company participates in
such agreements for the purpose of limiting loss exposure and diversifying
business. Reinsurance contracts do not relieve the Company from its obligations
to policyholders. To minimize