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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, 2002
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|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2) of the Act.
YES [X] NO: [ ]
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 26,
2003 as reported on the NASDAQ National Market System, was $405,367,423.
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 26, 2003, Registrant had outstanding 21,857,806 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the definitive Proxy Statement for Registrant's 2003 Annual
Meeting of Shareholders to be held May 1, 2003 are incorporated by
reference in Part III.
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., a Delaware insurance
holding company, and its subsidiaries of MUSA, LAIC, MHIA and Premium Finance,
are sometimes referred to herein collectively as "Liberty".
During 2002, the Company continued its growth through adherence to its
core philosophies of specialization, mixed marketing and profitable
underwriting. 2002 gross written premiums increased 40.1% to $663.7 million.
Premium growth was primarily attributable to the Company capitalizing on recent
turmoil in the property and casualty market. The turmoil created a general
environment of rate increases and conservative risk selection in the
marketplace. The Company's 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 94.3%, which was substantially
lower than the property and casualty industry as a whole. Total assets increased
to $1.4 billion, and shareholders' equity increased to $477.8 million.
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. Subsequently, a tumultus environment has emerged in the property
and casualty insurance industry in large part due to: the significant losses
caused by the terrorists events of September 11, 2001; continued rating
downgrades and insolvencies; and lower interest rates resulting in reduced
investment income. These factors have resulted in a general environment of rate
increases and conservative risk selection. Industry participants expect rate
increases and improving terms will continue possibly for an extended period of
time. Increased reinsurance costs, to some extent, offset the benefits of these
trends to the Company and to insurance companies in general.
During 2002, the Company' rate increases on renewal business
approximated 16.0%, 26.0% and 8.0% for the commercial, specialty and personal
lines segments, respectively. 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 85
"preferred agents" and a broader network of approximately 6,000 independent
agents supplement the production underwriting organization, which consisted of
172 professionals located in 36 regional and field offices across the United
States as of December 31, 2002.
The Company's commercial products include commercial multi-peril
package insurance targeting specialized niches, including, among others,
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.
2
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 developments and 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 regularly analyzing and reviewing the Company's book of business.
The Company maintains a local presence to more effectively serve its
producer and customer base, operating through 10 regional offices and 26 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 value added relationships
with its customers and producers.
The Company selects and targets industries and niches that present
specialized areas of expertise 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.
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, 2002,
2001 and 2000, 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,
-------------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
Dollars Percentage Dollars Percentage Dollars Percentage
------- ---------- ------- ---------- ------- ----------
(dollars in thousands)
Commercial Lines............... $ 473,984 71.4% $ 315,948 66.7% $ 239,446 66.2%
Specialty Lines................ 109,292 16.5 79,317 16.7 68,193 18.8
Personal Lines................. 80,463 12.1 78,300 16.6 54,233 15.0
---------- ----- ---------- ----- ---------- -----
Total.......................... $ 663,739 100.0% $ 473,565 100.0% $ 361,872 100.0%
========== ===== ========== ===== ========== =====
Commercial Lines:
Commercial Package: The Company has provided commercial multi-peril
package policies to targeted niche markets for over 15 years. The primary
customers for these policies include:
- non-profit and social service organizations;
- health and fitness organizations;
- homeowners' associations;
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- 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
primary, excess, contingent, interim and garage liability; physical damage;
property; and Guaranteed Asset Protection (GAP) to targeted markets for over 35
years. The primary customers for these policies include:
- rental car companies
- leasing companies
- banks
- credit unions
Specialty Property & Inland Marine: The Company has provided property
and inland marine coverage to targeted markets for the past 5 years. The primary
customers for these policies include:
- shopping centers
- business parks
- medical facilities
- hotels and motels
- new construction (inland marine)
Specialty Lines:
The Company has provided error and omissions (professional) and
directors and officers (D&O) liability to targeted classes of business for
approximately 14 years. The professional liability products provide errors and
omissions coverage primarily for:
- lawyers
- accountants
- miscellaneous (marketing, management, computer, marriage/family
counseling) consultants
The directors' and officers' product, with an emphasis on non-profit
institutions and private companies are offered to:
- non-profit (501(c)(3) companies)
- for-profit - public 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'
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program is also offered that excludes wind exposure. The Citizens Property
Insurance Corporation insures the wind exposure on these risks.
Geographic Distribution
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, 2002. No other
state accounted for more than 2% of total direct earned premiums for all product
lines for the year ended December 31, 2002 (dollars in thousands).
State Direct Earned Premiums Percent of Total
----- ---------------------- ----------------
Florida............................. $ 125,000 22.7%
California.......................... 60,677 11.0
New York............................ 40,328 7.3
Texas............................... 27,607 5.0
Pennsylvania........................ 23,407 4.3
Ohio................................ 22,594 4.1
Illinois............................ 22,575 4.1
New Jersey.......................... 20,623 3.7
Massachusetts....................... 19,092 3.5
Other............................... 188,540 34.3
--------- -----
Total Direct Earned Premiums........ $ 550,443 100.0%
========= =====
See Note 18 to the Company's financial statements included with this Form 10-K
for information concerning the revenues, net income and assets of the Company's
business segments.
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 Group currently consists of 38
home office and 38 regional office underwriters that are supported by
underwriting assistants, raters, and other policy administration personnel. The
Commercial Lines home office underwriting unit is responsible for underwriting,
auditing, servicing renewal business and authority referral for the regional
underwriters. The regional office underwriters have the responsibility for
pricing, underwriting, and policy issuance for new business. The underwriting
unit is under the direction of Underwriter Managers who report to the Vice
President of Commercial Lines Underwriting. The 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 its management structure.
The Specialty Lines Underwriting Group has the underwriting
responsibility for the errors and omissions and directors and officers liability
products. The Group consists of 16 home office underwriters and underwriter
trainees and 21 regional underwriters. These underwriters and underwriter
trainees are supported by underwriting assistants, and other policy
administration personnel. The home office underwriting unit is responsible for
underwriting, auditing, servicing renewal business and authority referral for
the regional underwriters. The regional office underwriters have the
responsibility for pricing, underwriting, and policy issuance for new business.
The Specialty Lines Group is managed by three Assistant Vice Presidents who
report to the Chief Underwriting Officer.
5
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 $1.0 million layer of liability on each occurrence. Casualty,
Fidelity, professional liability and/or fiduciary liabilty 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 Converium Reinsurance North
America Inc., American Reinsurance Company, Endurance Specialty Insurance LTD,
and Liberty Mutual Insurance Company, with a pro rata participation of 35%, 25%,
20% and 20%, respectively. 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 $2.0 million layer of loss on each risk with the
reinsurers (General Reinsurance Corporation and Swiss Reinsurance American
Corporation) bearing the next layer of loss up to $15.0 million on each risk.
The Company also has an automatic facultative excess of loss cover with General
Reinsurance Corporation for each property risk in excess of $15.0 million up to
$50.0 million. To mitigate potential exposures to losses arising from terrorist
acts, the Company has purchased per risk reinsurance coverage for terrorism with
a $13.0 million aggregate policy limit for 2003. Under this reinsurance coverage
the Company bears the first $2.0 million layer of loss on each risk and
coverage. 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 $316.5 million. 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.
During 2002 the Company increased unpaid loss and loss adjustment
expense ceded to one of the Company's reinsurers as a result of adverse changes
of insured events in prior years for residual value policies utilizing the
remaining reinsurance limit available to the Company under a combined
reinsurance contract. The combined coverage reinsurance contract provided a 2002
accident year aggregate stop loss cover which had not been utilized by the
Company, reinsurance coverage for the residual value line of business, and $10.0
million excess $5.0 million catastrophe property reinsurance coverage. The
Company continues to maintain $306.5 million excess $15.0 million catastrophe
property reinsurance on its personal 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.
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.
6
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
172 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 take
advantage of 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 85 preferred agents at year-end 2002. 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 "Liberty
American In Touch(SM)" real-time policy inquiry system which allows agents to
view account data, process non-dollar endorsements, rate, quote and issue 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. Such Committee, currently composed of
the Company's President and Senior Management, 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 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 reduce fraud. Claim
files are regularly audited by claims supervisors in an attempt to ensure that
claims are being processed properly and that reserves are being set at
appropriate levels.
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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 claims department also 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. The
Special Investigations Unit Works closely with a variety of industry contacts,
including attorneys, investigators and rental car company fraud units to
identify 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 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 of and For the Years Ended December 31,
------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars in Thousands)
Unpaid loss and loss adjustment expenses at
beginning of year... .......................................... $ 250,134 $ 195,464 $ 161,353
---------- ---------- ----------
Provision for losses and loss adjustment expenses for current
year claims.................................................... 239,834 166,220 128,761
Increase (Decrease) in estimated ultimate losses and loss
adjustment expenses for prior year claims ......................... 27,599 13,435 2,543
---------- ---------- ----------
Total incurred losses and loss adjustment expenses................. 267,433 179,655 131,304
---------- ---------- ----------
Loss and loss adjustment expense payments for claims
attributable to:
Current year................................................... 58,530 54,228 36,271
Prior years.................................................... 99,326 70,757 60,922
---------- ---------- ----------
Total payments..................................................... 157,856 124,985 97,193
---------- ---------- ----------
Unpaid loss and loss adjustment expenses at end of year (1)........ $ 359,711 $ 250,134 $ 195,464
========== ========== ==========
(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 $85,837, $52,599 and
$42,030 at December 31, 2002, 2001 and 2000, respectively.
8
During 2002 the Company increased the liability for unpaid loss and loss
adjustment expenses by $68.0 million ($27.6 million net of reinsurance
recoverables), primarily for accident years 1997 through 2001. This increase in
the liability for unpaid loss and loss adjustment expense, net of reinsurance
recoverables was primarily due to the following:
-- The Company increased the estimated loss for unreported claims incurred
and related claim adjustment expenses on residual value polices issued
during the years 1998 through 2001 by $30.2 million ($20.7 million net
of reinsurance recoverables). As of December 31, 2001 the Company had
estimated a total liability for unpaid loss and loss adjustment
expenses for these policies of $14.5 million ($8.7 million net of
reinsurance recoverables). The residual value policies provide coverage
guaranteeing the value of a leased automobile at the lease termination
which can be up to five years from lease inception. During 2002 adverse
trends further deteriorated in both frequency and severity on leases
expiring in 2002. As part of the Company's monitoring and evaluation
process, consulting firms were engaged during the third quarter of 2002
to aid in evaluating this deterioration and the ultimate potential loss
exposure under these policies. As a result of the indications and
subsequent evaluation by the Company and changes in the Company's
assumptions relating to future frequency and severity of losses, the
estimate for unpaid loss and loss adjustment expenses was increased.
The Company primarily attributes this deterioration to the following
factors that led to a softening of prices in the used car market
subsequent to the September 11, 2001 terrorist attacks: prolonged 0%
new car financing rates and other incentives which increased new car
sales and the volume of trade-ins, daily rental units being sold into
the market earlier and in greater numbers than expected further adding
to the over supply of used cars; and the overall uncertain economic
conditions.
-- The Company also increased the liability for unpaid loss and loss
adjustment expenses on the Commercial Automobile Excess Liability
Insurance ("Excess Liability") product sold to rental car companies
(Commercial Lines Underwriting Segment), primarily for the 2000 and
2001 accident years, by $6.9 million ($4.9 million net of reinsurance).
As of December 31, 2001 the Company had estimated a total liability for
unpaid loss and loss adjustment expenses for the Excess Liability
policies issued in these years of $23.0 million ($21.6 million net of
reinsurance). Excess Liability provides automobile liability coverage
in excess of the state mandated limits which are provided by the rental
car company. During the third quarter of 2002, pursuant to a routine
underwriting review focusing on price adequacy and loss experience, the
Company non-renewed a significant Excess Liability customer as a result
of an unacceptable underwriting risk profile. This adverse loss
development was primarily due to pricing inadequacy and the adverse
loss experience of this customer. Additionally, the Company has
experienced a delay in both the reporting of claims and the claim
litigation discovery process as a result of this policyholder and
another Excess Liability policyholder filing for Chapter 11 during the
third quarter 2002 and fourth quarter 2001, respectively.
During 2001, 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. 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.
The following table presents the development of unpaid loss and loss
adjustment expenses, net of amounts for reinsured losses and loss adjustment
expenses, from 1992 through 2002. 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)
1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ----
UNPAID LOSS AND LOSS
ADJUSTMENT EXPENSES, AS
STATED $ 31,981 $ 38,714 $ 53,595 $ 68,246 $ 85,723 $ 108,928
Cumulative Paid as of:
1 year later 9,865 10,792 12,391 15,214 22,292 26,870
2 years later 16,290 19,297 23,139 31,410 38,848 56,488
3 years later 21,253 24,991 33,511 40,637 52,108 80,206
4 years later 24,299 28,903 38,461 47,994 63,738 95,047
5 years later 25,793 30,558 42,366 51,806 69,116 99,755
6 years later 26,321 32,748 43,860 53,198 70,779
7 years later 27,252 32,929 44,243 53,701
8 years later 27,336 33,102 44,627
9 years later 27,288 33,721
10 years later 27,624
Unpaid Loss and Loss Adjustment Expenses
re-estimated as of End of Year:
1 year later 30,538 38,603 52,670 67,281 84,007 105,759
2 years later 30,428 38,016 52,062 66,061 81,503 103,513
3 years later 29,648 37,184 51,149 63,872 76,348 104,712
4 years later 29,306 36,272 49,805 59,085 73,992 109,061
5 years later 28,553 35,783 47,366 56,673 75,672 107,796
6 years later 28,370 34,509 45,797 55,861 74,645
7 years later 27,959 33,799 45,245 55,439
8 years later 27,724 33,695 44,878
9 years later 27,623 33,622
10 years later 27,623
Cumulative Redundancy (Deficiency)
Dollars $ 4,358 $ 5,092 $ 8,717 $ 12,807 $ 11,078 $ 1,132
Percentage 13.6% 13.2% 16.3% 18.8% 12.9% 1.0%
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
(Dollars in Thousands)
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
UNPAID LOSS AND LOSS
ADJUSTMENT EXPENSES, AS
STATED $ 136,237 $ 161,353 $ 195,464 $ 250,134 $ 359,711
Cumulative Paid as of:
1 year later 43,769 60,922 70,757 99,325
2 years later 84,048 109,092 131,649
3 years later 115,900 144,435
4 years later 131,062
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 135,984 163,896 208,899 277,733
2 years later 138,245 177,782 232,582
3 years later 146,679 196,735
4 years later 151,077
5 years later
6 years later
7 years later
8 years later
9 years later
10 years later
Cumulative Redundancy (Deficiency)
Dollars $ (14,840) $ (35,382) $ (37,118) $ (27,599)
Percentage (10.9)% (21.9)% (19.0)% (11.0)%
(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 $85,837, $52,599, $42,030, $26,710, $16,120,
$13,502, $10,919, $9,440, $5,580, $5,539, and $1,770 at December 31, 2002,
2001, 2000, 1999, 1998, 1997, 1996, 1995, 1994, 1993, and 1992,
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 (1) on Page 10 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,
-------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Loss Ratio ................................................. 63.5% 60.7% 57.8% 59.7% 54.1%
Expense Ratio............................................... 28.0% 31.2% 31.3% 33.6% 31.0%
----- ----- ----- ----- -----
Combined Ratio.............................................. 91.5% 91.9% 89.1% 93.3% 85.1%
===== ===== ===== ===== =====
Industry Statutory Combined Ratio after Policyholders
Dividends................................................. 105.7% 116.0% 110.1% 107.8% 105.6%
===== ===== ===== ===== =====
(1) (2) (2) (2) (2)
(1) Source: Best's Review/Preview PC January 2003 (Estimated 2002).
(2) Source: Best's Review/Preview PC January 2003
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,
---------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ---------- ----------- -----------
(Dollars in Thousands)
Net Written Premiums.................... $ 523,962 $ 333,817 $ 263,637 $ 195,258 $ 143,036
Surplus as regards Policyholders........ $ 312,626 $ 280,960 $ 193,292 $ 179,341 $ 152,336
Premium to Surplus Ratio................ 1.7 to 1.0 1.2 to 1.0 1.4 to 1.0 1.1 to 1.0 1.0 to 1.0
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, 2002, the Company had total investments with a carrying
value of $908.9 million, and 94.0% 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 6.0% 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, 2002:
Estimated Percent of
Market Carrying Carrying
Amortized Cost Value Value Value
-------------- ----- ----- -----
(Dollars in Thousands)
Fixed Maturities:
Obligations of States and Political
Subdivisions...................................... $279,397 $289,990 $289,990 31.9%
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies......................... 9,754 10,186 10,186 1.1
Corporate and Bank Debt Securities.................. 170,222 177,586 177,586 19.5
Collateralized Mortgage Securities.................. 89,189 90,689 90,689 10.0
Asset Backed Securities............................. 284,139 286,062 286,062 31.5
Equity Securities...................................... 51,257 54,346 54,346 6.0
-------- -------- -------- -----
Total Investments................................ $883,958 $908,859 $908,859 100.0%
======== ======== ======== =====
At December 31, 2002, approximately 98.9% of the Insurance
Subsidiaries' fixed maturity securities (cost basis) consisted of U.S.
government securities or securities rated "1" "highest quality" or "2" "high
quality" by the NAIC.
The cost and estimated market value of fixed maturity securities at
December 31, 2002, 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......................................... $ 23,078 $ 23,487
Due after one year through five years........................... 207,741 214,467
Due after five years through ten years.......................... 89,820 95,295
Due after ten years............................................. 138,734 144,513
Collateralized Mortgage and Asset Backed Securities............. 373,328 376,751
---------- ----------
Total..................................................... $ 832,701 $ 854,513
========== ==========
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, within
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:
- issuance, renewal, suspension and revocation of licenses to engage
in the insurance business;
- 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;
- maintenance of 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 $123.0 million at December 31, 2002. Of this amount, the
Insurance Subsidiaries are entitled to pay a total of approximately $31.7
million of dividends in 2003 without obtaining prior approval from the
Pennsylvania or Florida Insurance Departments. During 2002 the insurance
subsidiaries paid dividends of $5.1 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 Statutory Accounting Principles ("SAP") as codified by the NAIC in
the "Accounting Practices and Procedures Manual" which was adopted by the
Insurance Departments of Pennsylvania and Florida effective January 1, 2001. 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, the NAIC requires 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, 2002 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.
Certain Legislative Initiatives and Developments: 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.
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.
On November 26, 2002, the federal Terrorism Risk Insurance Act of 2002
(the "Act") was signed into law. The Act established a temporary federal program
that provides for a system of shared public and private compensation for insured
commercial property and casualty losses resulting from acts of terrorism, as
defined in the Act. The Terrorism Insurance Program (the "Program") requires all
commercial property and casualty insurers licensed in the United States to
participate. The Program provides that in the event of a terrorist attack, as
defined, resulting in insurance industry losses exceeding $5 million, the U.S.
government will provide funding to the insurance industry on an annual aggregate
basis of 90% of covered losses up to $100 billion. Each insurance company is
subject to a deductible based upon a percentage of the previous year's direct
earned premium, with the percentage increasing each year. The Program requires
that insurers notify in-force commercial policyholders by February 24, 2003 that
coverage for terrorism acts is provided and the cost for this coverage. It also
requires notices to be given at certain specified times to insureds to which
policies are issued after the date of the Act's enactment. Policyholders have
the option to accept or decline the coverage, or negotiate other terms. Property
and casualty insurers, including the Company, are required to offer this
coverage at each subsequent renewal even if the policyholder elected to exclude
this coverage in the previous policy period. The Program became effective upon
enactment and runs through December 31, 2005. With the signing of the Act, all
previously approved exclusions for terrorism in any contract for property and
casualty insurance in force as of November 26, 2002 are excluded. However, an
insurer may reinstate a preexisting provision in a contract for property and
casualty insurance that is in force on the date of enactment and that excludes
coverage for an act of terrorism only:
(1) if the insurer has received a written statement from the insured
that affirmatively authorizes such reinstatement; or
(2) if
(A) the insured fails to pay any increased premium charged by the
insurer for providing such terrorism coverage; and
(B) the insurer provided notice, at least 30 days before any such
reinstatement, of (i) the increased premium for such terrorism coverage; and
(ii) the rights of the insured with respect to such coverage, including any date
upon which the exclusion would be reinstated if no payment is received.
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 18, 2003, the Company had 719 full-time employees and 26
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.
15
Company Website and Availability of Securities and Exchange Commission ("SEC")
Filings
The Company's Internet website is www.phly.com. Information on the
Company's website is not a part of this Form 10-K. The Company makes available
free of charge on its website, or provides a link to, the Company's Forms 10-K,
10-Q and 8-K filed or furnished on or after May 14, 1996, and any amendments to
these Forms, that have been filed with the SEC on or after May 14, 1996 as soon
as reasonably practicable after the Company electronically files such material
with, or furnishes it to the SEC. To access these filings, go to the Company's
website and click on "Investor Relations", then click on "SEC Filings."
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
On April 30, 2002, U.S. Bank, N.A. d/b/a Firstar Bank ("Firstar"), a
bank to which one of the Company's insurance subsidiaries, Philadelphia
Indemnity Insurance Company ("PIIC"), issued insurance coverages, filed
a complaint against PIIC in the United States District Court for the
Southern District of Ohio (Western Division). The complaint asks for
damages and a declaratory judgment against PIIC. The complaint arises
principally out of a loss adjustment change and also relates to other
coverage interpretations made by PIIC under the terms of residual value
protection insurance policies issued to Firstar relating to vehicles
financed by Firstar. The complaint alleges that as a result of the loss
adjustment change Firstar may suffer damages of as much as $75,000,000.
On June 27, 2002, PIIC filed an answer to the complaint denying
liability with respect to the matters set forth above. PIIC believes
that this claim is without merit and intends to vigorously defend this
action.
The Company is not subject to any other material pending legal
proceedings other than ordinary routine litigation incidental to its
business.
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 2002.
16
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 21, 2003, there
were 473 holders of record and 3,062 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:
2002 2001
------------------------- ------------------------
Quarter High Low High Low
- ------- ---------- ---------- ---------- --------
First 42.750 35.230 31.922 25.375
Second 48.150 39.610 36.000 24.250
Third 46.000 29.000 37.500 24.350
Fourth 38.100 26.240 41.300 32.900
The Company did not declare cash dividends on its common stock in 2002
and 2001, and currently intends to retain its earnings to enhance
future growth. Any future 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 Item 7.-Liquidity and Capital Resources and Note 2 to the
Consolidated Financial Statements).
(b) During the three years ended December 31, 2002, the Company did
not sell any of its securities which were not registered under the
Securities Act of 1933.
(c) The information concerning the Company's securities authorized for
issuance under Equity Compensation Plans required by this Item 5
is contained in Item 12(b) of this Form 10-K.
17
Item 6. SELECTED FINANCIAL DATA
As of and For the Years Ended December 31,
(In Thousands, Except Share and Per Share Data)
-----------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Operations and Comprehensive Income
Statement Data:
Gross Written Premiums................ $ 663,739 $ 473,565 $ 361,872 $ 274,918 $ 197,408
Gross Earned Premiums................. $ 555,485 $ 421,063 $ 328,350 $ 245,978 $ 174,737
Net Written Premiums.................. $ 523,171 $ 333,817 $ 263,429 $ 184,071 $ 143,036
Net Earned Premiums................... $ 421,186 $ 296,093 $ 227,292 $ 164,915 $ 122,687
Net Investment Income................. 37,516 32,426 25,803 20,695 15,448
Net Realized Investment Gain (Loss)... (3,371) 3,357 11,718 5,700 474
Other Income.......................... 911 587 8,981 4,722 219
- ------------------------------------------------------------------------------------------------------------------------------
Total Revenue.................... 456,242 332,463 273,794 196,032 138,828
- ------------------------------------------------------------------------------------------------------------------------------
Net Loss and Loss Adjustment
Expenses........................... 267,433 179,655 131,304 99,410 66,374
Acquisition Costs and Other
Underwriting Expenses.............. 129,918 97,020 75,054 53,793 38,422
Other Operating Expenses.............. 6,372 6,841 14,679 8,939 2,212
- ------------------------------------------------------------------------------------------------------------------------------
Total Losses and Expenses........ 403,723 283,516 221,037 162,142 107,008
- ------------------------------------------------------------------------------------------------------------------------------
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............ 52,519 46,198 45,512 26,645 27,050
Total Income Tax Expense.............. 16,514 15,639 14,742 7,802 7,022
- ------------------------------------------------------------------------------------------------------------------------------
Net Income....................... $ 36,005 $ 30,559 $ 30,770 $ 18,843 $ 20,028
- ------------------------------------------------------------------------------------------------------------------------------
Weighted-Average Common Shares
Outstanding........................ 21,611,053 16,528,601 12,177,989 12,501,165 12,249,262
Weighted-Average Share Equivalents
Outstanding........................ 682,382 656,075 2,411,552 2,614,399 2,680,165
- ------------------------------------------------------------------------------------------------------------------------------
Weighted-Average Shares and Share
Equivalents Outstanding............ 22,293,435 17,184,676 14,589,541 15,115,564 14,929,427
- ------------------------------------------------------------------------------------------------------------------------------
Basic Earnings Per Share.............. $ 1.67 $ 1.85 $ 2.53 $ 1.51 $ 1.63
- ------------------------------------------------------------------------------------------------------------------------------
Diluted Earnings Per Share........... $ 1.62 $ 1.78 $ 2.11 $ 1.25 $ 1.34
- ------------------------------------------------------------------------------------------------------------------------------
Year End Financial Position:
Total Investments and Cash
and Cash Equivalents............. $ 950,861 $ 723,318 $ 487,028 $ 420,016 $ 388,059
Total Assets....................... 1,358,334 1,017,722 730,464 599,051 476,390
Unpaid Loss and Loss Adjustment
Expenses......................... 445,548 302,733 237,494 188,063 151,150
Minority Interest in Consolidated
Subsidiaries..................... - - 98,905 98,905 98,905
Total Shareholders' Equity......... 477,823 428,692 182,325 161,440 137,483
Common Shares Outstanding.......... 21,868,877 21,509,723 13,431,408 12,590,908 12,200,563
- ------------------------------------------------------------------------------------------------------------------------------
Insurance Operating Ratios
(Statutory Basis):
Net Loss and Loss Adjustment
Expenses to Net Earned Premiums.. 63.5% 60.7% 57.8% 59.7% 54.1%
Underwriting Expenses to Net
Written Premiums................. 28.0% 31.2% 31.3% 33.6% 31.0%
- ------------------------------------------------------------------------------------------------------------------------------
Combined Ratio........................ 91.5% 91.9% 89.1% 93.3% 85.1%
==============================================================================================================================
A+ A+ A+ A+ A+
A.M. Best Rating...................... (Superior) (Superior) (Superior) (Superior) (Superior)
18
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Operations
During 2002 the Company utilized a disciplined marketing strategy in conjunction
with its underwriting capabilities to capitalize on turmoil in the property and
casualty insurance market. The turmoil created a general environment of rate
increases and conservative risk selection in the marketplace and arose in part
due to the following:
- - The significant property and casualty industry losses as a result of the
tragedy of September 11, 2001;
- - Continued rating agency downgrades and insolvencies in the industry; and
- - Lower interest rates resulting in reduced investment income and a greater
focus on underwriting margins.
In this environment, the Company continued its strong growth, with gross written
premiums increasing 40.1% to $663.7 million. 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, 2002 was
94.3%, which, once again, was substantially lower than the property and casualty
industry as a whole.
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 rating. The Company utilizes external independent
professional investment managers for its fixed maturity and equity investments.
These investments consist of diversified issuers and issues, and as of December
31, 2002, approximately 90.2% and 5.6% 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 88.7% and 4.8%,
respectively, at December 31, 2001.
During 2002 the relative percentage investment in tax-exempt fixed maturity
securities versus taxable fixed maturity securities increased due to the Company
taking advantage of the more favorable after-tax yields. At the end of 2002, on
a cost basis, investment grade tax-exempt fixed maturity securities represented
30.3% of the total invested assets, compared to 14.8% as of the end of 2001.
Collateralized mortgage and asset backed securities, on a cost basis, amounted
to $89.2 million and $284.1 million, respectively, as of December 31, 2002 and
$70.4 and $272.7, respectively, as of December 31 2001. The collateralized
mortgage and asset backed investments are shorter tranche securities possessing
favorable prepayment risk profiles.
The Company regularly 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 for
all securities, except interests in securitized assets, meeting predetermined
thresholds, to determine whether such decline is other than temporary. If the
Company determines a decline in value to be other than temporary, based upon its
detailed review, or if a decline in value for an equity investment has persisted
continuously for nine months the cost basis of the security is written down to
its fair value. The factors considered in reaching the conclusion that a decline
below cost is other-than-temporary include, but are not limited to, whether: the
issuer is in financial distress; the investment is secured; a significant credit
rating action has occurred; scheduled interest payments have been delayed or
missed; or changes in laws and/or regulations have impacted an issuer or
industry. The amount of any
19
write down is included in earnings as a realized loss in the period the
impairment arose. This evaluation resulted in non-cash realized investment
losses of $2.1 million and $0 million for the years ended December 31, 2002 and
2001, respectively. This $2.1 million in non-cash realized investment losses
resulted from other than temporary declines in the fair value of certain
holdings in the Company's common stock portfolio. The Company primarily
attributes these other than temporary declines in fair value to an uncertain
economic climate, the overhang of corporate governance issues, high profile
bankruptcies, and most recently, war prospects.
Additionally, the Company conducts its impairment evaluation and recognition for
interests in securitized assets in accordance with the guidance provided by the
Emerging Issues Task Force of the Financial Accounting Standards Board ("EITF").
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, calculated as 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. This evaluation resulted
in non-cash realized investment losses of $1.6 million and $5.8 million for the
years ended December 31, 2002 and 2001, respectively. These non-cash realized
investment losses were primarily due to investments in collateralized bond
obligations as a result of the current historical highs in non investment grade
default rates.
The Company's fixed maturity portfolio amounted to $854.5 million and $628.6
million, as of December 31, 2002 and 2001, respectively, of which 98.6% of the
portfolio for both years was comprised of investment grade securities. Since the
fourth quarter of 2001, U.S. investment grade securities have experienced
varying price and ratings volatility, having been affected by the uncertain
economic climate following the September 11, 2001 terrorist attacks, the
corporate governance issues following the Enron scandal and the subsequent
stream of corporate problems and high profile bankruptcies. While these
circumstances have the potential to impact investment grade securities, the high
quality of the Company's overall "AA+" rated fixed maturity portfolio and the
decline in interest rates have mitigated potential volatility. As of December
31, 2002 the Company had fixed maturity investments with unrealized losses
amounting to $9.2 million. Of this amount, interests in securitized assets had
unrealized losses amounting to $7.3 million and investments in aircraft
collateralized Enhanced Equipment Trust Certificates (EETCs) had unrealized
losses amounting to $1.3 million. As discussed above, the Company's impairment
evaluation and recognition for interests in securitized assets is conducted in
accordance with the guidance provided by the EITF. With respect to the EETCs,
these investments are current on interest and sinking fund payments, and are
subjected to a quarterly impairment review which includes performing a
liquidation collateral analysis that incorporates various stress scenarios
impacting the security's implied loan-to-value levels.
The following table identifies the period of time securities with an unrealized
loss at December 31, 2002 have continuously been in an unrealized loss position.
Included in the amounts displayed in the table are $4.0 million of unrealized
losses due to non-investment grade fixed maturity securities having a fair value
of $12.1 million. No issuer of securities or industry represents more than 3.9%
and 10.3%, respectively, of the total estimated fair value, or 13.9% and 21.2%,
respectively, of the total gross unrealized loss included in the table below. As
previously discussed, there are certain risks and uncertainties inherent in the
Company's impairment methodology. Should the Company subsequently determine a
decline in the fair value below the cost basis to be other than temporary, the
security would be written down to its fair value and the difference would be
included in earnings as a realized loss for the period such determination was
made.
20
Gross Unrealized Losses
(in millions)
----------------------------------------------------------------------------------------------------------
Fixed Maturities
Continuous Available for Sale Total
time in unrealized loss Excluding Interests Interests in Fixed Maturities
position in Securitized Assets Securitized Assets Available for Sale Equity Securities Total Investments
- ----------------------- --------------------- ------------------ ------------------ ----------------- -----------------
0 - 3 months $ 0.4 $ 0.4 $ 0.8 $ 0.3 $ 1.1
3 - 6 months 0.1 1.5 1.6 0.5 2.1
6 - 9 months 0.2 1.0 1.2 0.8 2.0
9 - 12 months - 1.1 1.1 - 1.1
12 - 18 months 1.2 1.6 2.8 - 2.8
18 - 24 months - 0.8 0.8 - 0.8
> 24 months - 0.9 0.9 - 0.9
----- ----- ------ ----- ------
Total Gross
Unrealized Losses $ 1.9 $ 7.3 $ 9.2 $ 1.6 $ 10.8
===== ===== ====== ===== ======
Estimated fair value of
securities with a gross
unrealized loss $27.3 $83.8 $111.1 $16.4 $127.5
===== ===== ====== ===== ======
The following table presents certain information with respect to individual
securities with a significant unrealized loss position as of December 31, 2002.
Significant Unrealized Losses by Security
-----------------------------------------
(in millions)
Issuer Security Type Carrying Value Unrealized Loss
------ ------------- -------------- ---------------
Continental Airlines 2000-1-C-2 Fixed Maturity $ 2.0 $1.1
Continental Airlines Fixed Maturity 1.3 0.2
Conseco Fin SEC Corp 2000-4ml Fixed Maturity - Interest in Securitized Assets 1.6 0.4
Conseco Fin SEC Corp SER 2000-4ml Fixed Maturity - Interest in Securitized Assets 0.9 0.3
Greentree Financial Corp. 99-2 B1 Fixed Maturity - Interest in Securitized Assets 1.8 1.1
Nextcard CRCN MNT 2001-1 CLB144A Fixed Maturity - Interest in Securitized Assets 3.5 1.5
----- ----
$11.1 $4.6
===== ====
During 2002 the Company's gross loss on the sale of fixed maturity and equity
securities amounted to $0.3 million and $3.2 million, respectively. The fair
value of the fixed maturity and equity securities at the time of sale was $31.6
million and $14.1 million, respectively. The decision to sell these securities
was based upon management's assessment of economic conditions and with regard to
the equity security sales the desire to limit investment exposure to the equity
market based upon this assessment. Of the equity securities sold, no equity
security had been in a continuous unrealized loss position for greater than six
months, except for one security, which had been in a continuous unrealized loss
position for seven months, and had a fair value and loss at the date of sale of
$131,000 and $33,000, respectively.
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.
21
DECEMBER 31, 2002
EXPECTED MATURITY DATES TOTAL
(In thousands, except average interest rate) FAIR
2003 2004 2005 2006 2007 Thereafter TOTAL VALUE
------- -------- -------- -------- ------- ---------- -------- --------
FIXED MATURITIES
AVAILABLE FOR
SALE:
Principal Amount $52,909 $130,108 $155,199 $103,923 $83,638 $307,377 $833,154 $851,192
Book Value $52,897 $131,526 $160,201 $105,275 $84,263 $295,372 $829,534 -
Average Interest Rate 5.29% 4.30% 3.87% 4.59% 4.62% 5.11% 4.64% 3.81%
PREFERRED:
Principal Amount - - $ 5,750 $ 4,500 - $ 500 $ 10,750 $ 11,334
Book Value - - $ 5,923 $ 4,656 - $ 499 $ 11,078 -
Average Interest Rate - - 6.07% 5.88% - 5.87% 6.16% 6.02%
SHORT-TERM INVESTMENTS:
Principal Amount $39,235 - - - - - $ 39,235 $ 39,235
Book Value $39,235 - - - - - $ 39,235 -
Average Interest Rate 1.28% - - - - - 1.28% 1.28%
LOANS PAYABLE:
Principal Amount $39,113 - - - - - $ 39,113 -
Average Interest Rate 1.54% - - - - - 1.54% -
Certain Critical Accounting Estimates and Judgments
- - Investments
-- Fair values
The carrying amount for the Company's investments approximates their
estimated fair value. The Company measures the fair value of
investments based upon quoted market prices or by obtaining quotes
from third party broker-dealers. The Company's total investments
include $22.4 million in securities for which there is no readily
available independent market price. The estimated fair value of such
securities is determined by independent third party broker-dealers.
Material assumptions and factors utilized by such broker-dealers in
pricing these securities include: future cash flows, constant
default rates, recovery rates and any market clearing activity that
may have occurred since the prior month-end pricing period.
-- Other than temporary impairment, excluding interests in securitized
assets
The Company regularly 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 for all securities,
meeting predetermined thresholds, to determine whether such decline
is other than temporary. If the Company determines a decline in
value to be other than temporary, based
22
upon its detailed review, or if a decline in value for an equity
investment has persisted continuously for nine months, the cost
basis of the security is written down to its fair value. The factors
considered in reaching the conclusion that a decline below cost is
other-than-temporary include, but are not limited to, whether: the
issuer is in financial distress; the investment is secured; a
significant credit rating action has occurred; scheduled interest
payments have been delayed or missed; changes in laws and/or
regulations have impacted an issuer or industry. The amount of any
write down is included in earnings as a realized loss in the period
the impairment arose (see Investments).
-- Impairment recognition for investments in securitized assets
The Company conducts its impairment evaluation and recognition for
interests in securitized assets in accordance with the guidance
provided by the Emerging Issues Task Force of the Financial
Accounting Standards Board. 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, calculated as
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 (see Investments).
- - Liability for Unpaid Loss and Loss Adjustment Expenses:
The liability for unpaid loss and loss adjustment expenses ($445.6
million and $302.7 million as of December 31, 2002 and 2001,
respectively) reflects the Company's best estimate for future amounts
needed to pay losses and related settlement expenses with respect to
insured events. Based upon past experience this estimate has been
redundant by as much as 18.8% and deficient by as much as 21.9%. The
process of establishing the liability for property and casualty unpaid
loss and loss adjustment expenses is a complex and imprecise process,
requiring the use of informed estimates and judgments. 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
regularly reviewed and updated and any adjustments resulting therefrom
are made in the accounting period in which the adjustment arose.
During 2002 the Company increased the liability for unpaid loss and
loss adjustment expenses by $68.0 million ($27.6 million net of
reinsurance) primarily for accident years 1997 through 2001. As of
December 31, 2001 the Company had estimated a total liability for
unpaid loss and loss adjustment expenses for these accident years of
$295.0 million ($243.1 million net of reinsurance). This increase in
the liability for unpaid loss and loss adjustment expense net of
reinsurance was primarily due to the following:
-- The Company increased the estimated loss for unreported claims
incurred and related claim adjustment expenses on residual value
polices issued during the years 1998 through 2001 by $30.2 million
($20.7 million net of reinsurance). As of December 31, 2001 the
Company had estimated a total liability for unpaid loss and loss
adjustment expenses for these policies of $14.5 million ($8.7
million net of reinsurance). The residual value policies provide
coverage guaranteeing the value of a leased automobile at the lease
termination which can be up to five years from lease inception.
During 2002 adverse trends further deteriorated in both frequency
and severity on leases expiring in 2002. As part of the Company's
monitoring and evaluation process, consulting firms were engaged
during the third quarter of 2002 to aid in evaluating this
deterioration and the ultimate potential loss exposure under these
policies. As a result of the indications and subsequent evaluation
by the Company and changes in the Company's assumptions relating to
future frequency and severity of losses, the estimate for unpaid
loss and loss adjustment expenses was increased. The Company
primarily attributes this deterioration to the following factors
that led to a softening of prices in the used car market subsequent
to the September 11, 2001 terrorist attacks: prolonged 0% new car
financing rates and other incentives which increased new car sales
and the volume
23
of trade-ins, daily rental units being sold into the market earlier
and in greater numbers than expected further adding to the over
supply of used cars; and the overall uncertain economic conditions.
-- The Company also increased the liability for unpaid loss and loss
adjustment expenses on the Commercial Automobile Excess Liability
Insurance ("Excess Liability") product sold to rental car companies
(Commercial Lines Underwriting Segment) primarily for the 2000 and
2001 accident years by $6.9 million ($4.9 million net of
reinsurance). As of December 31, 2001 the Company had estimated a
total liability for unpaid loss and loss adjustment expenses for the
Excess Liability policies issued in these years of $23.0 million
($21.6 million net of reinsurance). Excess Liability provides
automobile liability coverage in excess of the state mandated limits
which are provided by the rental car company. During the third
quarter of 2002, pursuant to a routine underwriting review focusing
on price adequacy and loss experience, the Company non-renewed a
significant Excess Liability customer as a result of an unacceptable
underwriting risk profile (see Results of Operations (2002 versus
2001)). This adverse loss development was primarily due to pricing
inadequacy and the adverse loss experience of this customer.
Additionally, the Company has experienced a delay in both the
reporting of claims and the claim litigation discovery process as a
result of this policyholder and another Excess Liability
policyholder filing for Chapter 11 during the third quarter 2002 and
fourth quarter 2001, respectively.
The Company further increased the liability for unpaid loss and loss
adjustment expenses by $30.8 million ($0 net of reinsurance) as a
result of the emergence of higher than expected losses in certain
products of the Commercial and Specialty lines segments primarily
occurring in accident years 1999 through 2001 and changes in the
Company's assumptions relating to future frequency and severity of
losses. Approximately 97% of such losses are reinsured with companies
rated "A" excellent or better by A.M. Best Company.
The method for determining reinsurance recoverables and estimated
recoverability are regularly reviewed and adjustments resulting from
this review are included in earnings in the period the adjustment
arose.
- - Deferred Acquisition Costs:
Policy acquisition costs ($61.3 million and $41.5 million as of
December 31, 2002 and 2001, 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
(2002 versus 2001)
Premiums: Gross written premiums grew $190.1 million (40.1%) to $663.7 million
in 2002 from $473.6 million in 2001; gross earned premiums grew $134.4 million
(31.9%) to $555.5 million in 2002 from $421.1 million in 2001; net written
premiums increased $189.4 million (56.7%) to $523.2 million in 2002 from $333.8
million in 2001; and net earned premiums grew $125.1 million (42.2%) to $421.2
million in 2002 from $296.1 million in 2001.
The respective gross written premium increases for the commercial lines,
specialty lines and personal lines segments for the years ended December 31,
2002 vs. December 31, 2001 amount to $157.9 million (50.0%), $30.0 million
(37.8%) and $2.2 million (2.8%), respectively. The overall growth in gross
written premiums is primarily attributable to the following:
- - Further 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.
24
- - The continued 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 relationship opportunities for the Company, which
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.
- - As a result of firming prices in the property and casualty industry,
rate increases on renewal business have approximated 16.0%, 26.0%, and
8.0% for the commercial, specialty and the personal lines segments,
respectively. Additionally, in force policy counts have increased 43.0%
and 13.0% for the commercial and specialty lines segments,
respectively, primarily as a result of the factors discussed above.
Policy counts have decreased approximately 7.0% for the personal lines
segment as a result of restricting new business and not renewing
certain business to manage overall property exposures and the related
catastrophe loss considerations.
Overall premium growth has been offset in part by the following factors:
- - Specialty Lines Segment - The Company's decision not to renew
approximately 2,000 policies in the professional liability product
lines due to inadequate pricing levels being experienced as a result of
market conditions and/or an unacceptable underwriting risk profile.
- - Personal Lines Segment - The Company's decision to restrict new
business and not renew approximately 9,000 policies in designated areas
of Florida in the Company's manufactured housing and homeowners product
lines, based on an evaluation o