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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, 2003
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.
|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 10,
2004 as reported on the NASDAQ National Market System, was $510,690,534. 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 10, 2004, Registrant had outstanding 22,033,824 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the definitive Proxy Statement for Registrant's 2004 Annual
Meeting of Shareholders to be held April 29, 2004 are incorporated by
reference in Part III.
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 MUSA, LAIC, MHIA and Premium Finance, are sometimes referred to
herein collectively as "Liberty".
During 2003, the Company continued its growth through adherence to its
core philosophies of specialization, mixed marketing and profitable
underwriting. 2003 gross written premiums increased 36.5% to $906.0 million.
Premium growth was primarily attributable to the Company capitalizing on
continuing turmoil in the property and casualty market, as well as better
"brand" recognition with agents and brokers. The turmoil created a general
environment of rate increases and reduced capacity 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 91.3%, which was substantially lower than the property and
casualty industry as a whole. Total assets increased to $1.9 billion, and
shareholders' equity increased to $543.7 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 terrorist 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 a
moderation in rate increases for the foreseeable future. Increased reinsurance
costs, to some extent, offset the benefits of these trends to the Company and to
insurance companies in general.
During 2003, the Company's rate increases on renewal business approximated
4.3%, 10.2% and 9.4% 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 multi-channel delivery system centered around
the Company's direct production underwriting organization. A select group of 105
"preferred agents" and a broader network of approximately 8,500 independent
agents supplement the production underwriting organization, which consisted of
204 professionals located in 36 regional and field offices across the United
States as of December 31, 2003.
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, hotels and medical facilities; and inland marine products targeting
larger risks such as new builders' risk and miscellaneous property floaters.
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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 12 regional offices and 24 field
offices throughout the country, which report to the regional offices. These
offices are staffed with field underwriters, marketers, accounts receivable and,
in some cases, claim personnel, who 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, principally in
Florida.
The following table sets forth, for the years ended December 31, 2003,
2002 and 2001, 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,
------------------------------------------------------------------------------
2003 2002 2001
---- ---- ----
Dollars Percentage Dollars Percentage Dollars Percentage
------- ---------- ------- ---------- ------- ----------
(dollars in thousands)
Commercial Lines.......................... $ 662,339 73.1% $ 473,100 71.3% $ 315,948 66.7%
Specialty Lines........................... 154,105 17.0 110,176 16.6 79,317 16.7
Personal Lines............................ 89,549 9.9 80,463 12.1 78,300 16.6
---------- ----- ---------- ----- ---------- -----
Total..................................... $ 905,993 100.0% $ 663,739 100.0% $ 473,565 100.0%
========== ===== ========== ===== ========== =====
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;
- day care facilities; and
- mental health 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 and
general liability 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 errors 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
- excess liability
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. ("Liberty") in
1999. This personal lines platform produces and underwrites specialized
manufactured housing and homeowners' property and casualty business principally
in Florida, and to a lesser extent, in California, Arizona and Nevada. Liberty
also produces and services federal flood insurance under the National Flood
Insurance Program for both personal and commercial policyholders.
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Products offered include manufactured housing insurance for senior citizen
retirees in "preferred" parks, a program for newly constructed manufactured
homes on private property; a preferred homeowners' program that targets newer
homes valued between $100,000 and $375,000 in gated retiree communities, and a
homeowners' program excluding wind exposure in Florida coastal counties for the
in-park manufactured housing business. As a result of Florida's increased
seasonal residents during the winter months, approximately 50% of the in-park
manufactured housing business is written in the first four calendar months of
the year.
Geographic Distribution
The following table provides the geographic distribution for all
reportable business segments of the Company's risks insureds as represented by
direct earned premiums for the year ended December 31, 2003. No other state
accounted for more than 2% of total direct earned premiums for the year ended
December 31, 2003 (dollars in thousands).
State Direct Earned Premiums Percent of Total
----- ---------------------- ----------------
Florida.................................... $154,277 19.7%
California................................. 89,442 11.4
New York................................... 58,743 7.5
Texas...................................... 42,508 5.4
Illinois................................... 34,513 4.4
Pennsylvania............................... 32,447 4.1
Massachusetts.............................. 32,272 4.1
New Jersey................................. 31,850 4.1
Ohio....................................... 29,335 3.7
Minnesota.................................. 16,850 2.1
Other...................................... 262,208 33.5
-------- -----
Total Direct Earned Premiums............... $784,445 100.0%
======== =====
See Note 19 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 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 and
adherence to these underwriting guidelines is maintained through underwriting
audits conducted by the Company. Product pricing levels are monitored utilizing
a system which measures the aggregate price level of a book of business. This
system assists management and underwriters to promptly recognize and respond to
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 58
home office and 59 regional office underwriters which are supported by
underwriting assistants, raters, and other policy administration personnel. The
Commercial Lines home office underwriting unit is responsible for underwriting,
auditing, and servicing renewal business, as well as an authority referral for
the regional office underwriters for quoting new business. The regional office
underwriters have the responsibility for pricing, underwriting, and policy
issuance for new business. The commercial lines underwriting group is under the
immediate direction of Underwriter Managers who report to the Vice Presidents of
Commercial Lines Underwriting. Overall management responsibility 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 20 home office underwriters and underwriter trainees and 27
regional underwriters. These underwriters and underwriter trainees are supported
by underwriting assistants and other policy
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administration personnel. The home office underwriting unit is responsible for
underwriting, auditing and servicing renewal business, as well as an authority
referral for the regional office underwriters for quoting new business. The
regional office underwriters have the responsibility for pricing, underwriting,
and policy issuance of new business. The Specialty Lines Group is managed by
three Assistant Vice Presidents who report directly to the Chief Underwriting
Officer.
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 through internet accessed rating software.
Underwriting guidelines are embedded within this software which prohibit binding
of accounts if a risk does not meet the underwriting guidelines. The Company has
a proactive exposure distribution management system in place to aid in portfolio
optimization. The risk portfolio is managed at a zip code level through the use
of 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 for 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.
Reinsurance
The Company has entered into various reinsurance agreements for the
purpose of limiting loss exposure. 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 liability 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. Effective January 1, 2004 the Company's casualty excess of loss
reinsurance agreement provides that the Company bears the first $1.0 million
layer of liability on umbrella risks for policies where the Company provides the
first $1.0 million primary layer of coverage.
The Company's property excess of loss reinsurance treaty provides that the
Company bears the first $2.0 million of loss on each risk with its reinsurers
bearing two layers of loss up to $15.0 million on each risk (General Reinsurance
Corporation provides limits of $8.0 million in excess of $2.0 million, and Swiss
Reinsurance American Corporation, provides limits of $5.0 million in excess of
$10.0 million). The Company also has automatic facultative excess of loss
reinsurance with General Reinsurance Corporation for each property loss 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.
Effective April 1, 2003, the Company entered into a quota share
reinsurance agreement covering substantially all of the Company's lines of
business. Under this agreement, the Company cedes 22% of its net written premium
(including 22% of net unearned premium reserves at April 1, 2003) and loss and
loss adjustment expenses. The Company also receives a provisional ceding
commission of 33.0%, adjusted pro-rata based upon the ratio of losses incurred
to premiums earned. Pursuant to this reinsurance agreement the Company withholds
the reinsurance premium due the reinsurers in a Funds Held Payable to Reinsurer
account.
The Company has also purchased property catastrophe reinsurance covering
both its commercial and personal lines losses. For catastrophe losses occurring
in the State of Florida the Company's reinsurance coverage is approximately
$289.0 million in excess of the Company's $4.0 million per occurrence retention.
For catastrophe property losses occurring outside the State of Florida the
Company's reinsurance coverage is approximately $46.0 million for commercial
lines catastrophe losses and $6.0 million for personal lines catastrophe losses
in excess of the Company's $4.0 million retention. 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 its personal lines business in Florida.
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.
6
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. Secondly, 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 the
Company purchases reinsurance to limit its loss exposure by transferring the
risk to its reinsurers, reinsurance doesn't relieve the Company of its liability
to policyholders.
The Company regularly assesses its reinsurance needs and seeks to improve
the terms of its reinsurance arrangements as market conditions permit. Such
improvements may involve increases in retentions, modifications in premium
rates, changes in reinsurers and other matters.
Marketing and Distribution
Proactive risk selection based on sound underwriting criteria and
relationship selling in clearly defined target markets continues to be the
foundation of the Company's marketing plan. Within this framework, the Company's
marketing effort is designed to promote 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 8,500
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 stimulate new sales
through independent agents. The production underwriting organization is
currently comprised of 204 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 prospecting,
relationships with approximately 8,500 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 to different product lines
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 105 preferred agents at year-end 2003. 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, preferred agent council 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 members of senior
management, meets regularly to review the feasibility of products from a variety
of perspectives, including profitability, 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
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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.
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' actuary provides the
Company's with an annual statement of opinion 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.
8
As of and For the Years Ended December 31,
------------------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in Thousands)
Unpaid loss and loss adjustment expenses at
beginning of year ............................................. $359,711 $250,134 $195,464
-------- -------- --------
Provision for losses and loss adjustment expenses for
current year claims ........................................... 314,609 239,834 166,220
Increase in estimated ultimate losses and loss adjustment expenses
for prior year claims ............................................ 44,568 27,599 13,435
-------- -------- --------
Total incurred losses and loss adjustment expenses ............... 359,177 267,433 179,655
-------- -------- --------
Loss and loss adjustment expense payments for claims
attributable to:
Current year .................................................. 69,905 58,530 54,228
Prior years ................................................... 167,488 99,326 70,757
-------- -------- --------
Total payments ................................................... 237,393 157,856 124,985
-------- -------- --------
Unpaid loss and loss adjustment expenses at end of year (1)....... $481,495 $359,711 $250,134
======== ======== ========
(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 $145,591, $85,837 and $52,599 at December
31, 2003, 2002 and 2001, respectively.
During 2003 the Company increased the liability for unpaid loss and loss
adjustment expenses by $51.7 million ($44.6 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 gross and net loss for
unreported claims incurred and related claim adjustment expenses on
residual value polices issued during the years 1998 through 2002 by
$38.8 million. As of December 31, 2003 the Company's total liability
for gross and net unpaid loss and loss adjustment expenses for these
policies is estimated to be $30.3 million. 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. The increase in the estimated gross and net
loss was a result of:
- Adverse trends further deteriorating in both claims
frequency and severity for leases expiring in 2003.
During the second quarter of 2003, the Company engaged a
consulting firm to aid in evaluating the ultimate
potential loss exposure under these policies. Based upon
the study and subsequent evaluation by the Company the
Company changed its assumptions relating to future
frequency and severity of losses, and increased the
estimate for unpaid loss and loss adjustment expenses by
$33.0 million. 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 entering into an agreement with U.S. Bank,
N.A. d/b/a Firstar Bank ("Firstar") for residual value
insurance policies purchased by Firstar. Under the terms
of the agreement, the Company paid Firstar $27.5 million
in satisfaction of any and all claims made or which
could have been made by Firstar under the residual value
policies. The Company increased the gross and net
reserves for loss and loss adjustment expenses from
$21.7 million to $27.5 million pursuant to this
agreement.
-- The Company increased its estimate for unpaid loss and loss
adjustment expenses for non residual value policies by $43.5 million
($30.8 million net of reinsurance recoverables) primarily for
accident years 1999 to 2001 and decreased its estimate of the unpaid
loss and loss adjustment expenses by $30.6 million ($25.0 million
net of reinsurance recoverables) for the 2002 accident year. The
increase in accident years 1999 to 2001 is principally attributable
to:
- $19.6 million ($13.7 million net of reinsurance
recoverables) of development in claims made professional
liability products as a result of case reserves
developing greater than anticipated from the year-end
2002
9
ultimate loss estimate; $18.1 million ($11.1 million net
of reinsurance recoverables) of development in the
automobile and general liability coverages for
commercial package products due to the frequency and
severity of the losses developing beyond the underlying
pricing assumptions; and $5.8 million ($6.0 million net
of reinsurance recoverables) of development in the
commercial automobile excess liability insurance and GAP
commercial automobile products due to losses developing
beyond the underlying pricing assumptions.
-- The decrease in unpaid loss and loss adjustment expenses in accident
year 2002 is principally attributable to:
- $4.2 million ($4.7 million net of reinsurance
recoverables) and $26.4 million ($20.3 million net of
reinsurance recoverables) of favorable development in
professional liability products and commercial package
products, respectively, due to favorable loss experience
as a result of favorable product pricing.
The following table presents the development of unpaid loss and loss
adjustment expenses, net of amounts for reinsured losses and loss adjustment
expenses, from 1993 through 2003. 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.
10
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
(Dollars in Thousands)
1993 1994 1995 1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ---- ---- ---- ----
UNPAID LOSS AND LOSS
ADJUSTMENT EXPENSES,
AS STATED $38,714 $53,595 $68,246 $85,723 $108,928 $136,237 $161,353 $195,464 $250,134
Cumulative Paid as
of:
1 year later 10,792 12,390 15,214 22,292 26,870 43,769 60,922 70,757 99,325
2 years later 19,297 23,139 31,410 38,848 56,488 84,048 109,092 131,649 211,851
3 years later 24,991 33,511 40,637 52,108 80,206 115,900 144,435 213,286
4 years later 28,903 38,461 47,994 63,738 95,047 131,062 201,779
5 years later 30,558 42,366 51,806 69,116 99,755 151,753
6 years later 32,748 43,860 53,198 70,779 106,915
7 years later 32,929 44,243 53,701 73,939
8 years later 33,102 44,627 55,541
9 years later 33,721 45,902
10 years later 33,923
Unpaid Loss and Loss
Adjustment Expenses
re-estimated as of
End of Year:
1 year later 38,603 52,671 67,281 84,007 105,758 135,983 163,896 208,899 277,733
2 years later 38,016 52,062 66,061 81,503 103,513 138,245 177,782 232,582 334,802
3 years later 37,184 51,149 63,872 76,348 104,712 146,679 196,735 274,166
4 years later 36,272 49,805 59,085 73,992 109,061 151,077 228,082
5 years later 35,783 47,366 56,673 75,672 107,796 163,657
6 years later 34,509 45,797 55,861 74,645 110,845
7 years later 33,799 45,245 55,439 75,272
8 years later 33,695 44,878 55,606
9 years later 33,622 45,764
10 years later 33,782
Cumulative Redundancy
(Deficiency)
Dollars $4,932 $7,831 $12,640 $10,451 $(1,917) $(27,420) $(66,729) $(78,702) $(84,668)
Percentage 12.7% 14.6% 18.5% 12.2% (1.8)% (20.1)% (41.4)% (40.3)% (33.8)%
2002 2003
---- ----
UNPAID LOSS AND LOSS
ADJUSTMENT EXPENSES,
AS STATED $359,711 $481,496
Cumulative Paid as
of:
1 year later 167,489
2 years later
3 years later
4 years later
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 404,279
2 years later
3 years later
4 years later
5 years later
6 years later
7 years later
8 years later
9 years later
10 years later
Cumulative Redundancy
(Deficiency)
Dollars $(84,668) $(44,568)
Percentage (33.8)% (12.4%)
(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 $145,591, $85,837, $52,599, $42,030,
$26,710, $16,120, $13,502, $10,919, $9,440, $5,580, and $5,539 at December
31, 2003, 2002, 2001, 2000, 1999, 1998, 1997, 1996, 1995, 1994, and 1993,
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.
11
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. 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,
----------------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Loss Ratio ............................................ 63.1% 63.5% 60.7% 57.8% 59.7%
Expense Ratio ......................................... 27.2% 28.0% 31.2% 31.3% 33.6%
------ ------ ------ ------ ------
Combined Ratio ........................................ 90.3% 91.5% 91.9% 89.1% 93.3%
====== ====== ====== ====== ======
Industry Statutory Combined Ratio, after Policyholders'
Dividends ........................................... 101.1% 107.4% 115.9% 110.4% 108.1%
====== ====== ====== ====== ======
(1) (2) (2) (2) (2)
(1) Source: Best's Special Report "Keeping Pace" February 9, 2004 (Estimated
2003).
(2) Source: Best's Special Report "Keeping Pace" February 9, 2004
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,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------- ------------ ------------ ------------
(Dollars in Thousands)
Net Written Premiums.................. $601,253 $523,962 $333,817 $263,637 $195,258
Surplus as regards Policyholders...... $415,900 $312,626 $280,960 $193,292 $179,341
Premium to Surplus Ratio.............. 1.5 to 1.0 1.7 to 1.0 1.2 to 1.0 1.4 to 1.0 1.1 to 1.0
12
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 professional
investment managers for its fixed maturity and equity investments, which consist
of diversified issuers and issues.
At December 31, 2003, the Company had total investments with a carrying
value of $1,172.1 million, and 92.3% 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, asset backed securities, mortgage
pass-through securities and collateralized mortgage obligations, with a weighted
average rating of "AA+". The asset backed, mortgage pass-through and
collateralized mortgage obligation securities amortizing securities possessing
favorable prepayment risk and/or extension profiles. The remaining 7.7% 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, 2003:
Estimated Percent of
Market Carrying Carrying
Amortized Cost Value Value Value
-------------- ----- ----- -----
(Dollars in Thousands)
Fixed Maturities:
Obligations of States and Political
Subdivisions............................. $ 476,762 $ 488,976 $ 488,976 41.7%
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies................ 51,480 51,918 51,918 4.4
Corporate and Bank Debt Securities.......... 142,264 147,054 147,054 12.6
Asset Backed Securities..................... 183,065 177,675 177,675 15.1
Mortgage Pass-Through Securities............ 159,160 162,529 162,529 13.9
Collateralized Mortgage Obligations......... 53,792 53,542 53,542 4.6
Equity Securities............................. 79,813 90,358 90,358 7.7
----------- ----------- ----------- -----
Total Investments........................ $ 1,146,336 $ 1,172,052 $ 1,172,052 100.0%
=========== =========== =========== =====
At December 31, 2003, approximately 98.7% 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, 2003, by remaining original contractual maturity, is 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....................................... $ 53,845 $ 54,545
Due after one year through five years......................... 223,676 229,476
Due after five years through ten years........................ 177,412 182,132
Due after ten years........................................... 215,573 221,795
Asset Backed, Mortgage Pass-Through and
Collateralized Mortgage Obligation Securities................. 396,017 393,746
------------- --------------
Total.................................................... $ 1,066,523 $ 1,081,694
============= ==============
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.
13
Regulation
General: The Company is subject to extensive supervision and regulation in
the states in which it operates. Such 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 Office of Insurance
Regulation 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 acquirer'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 Office of
Insurance Regulation. 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
14
may be paid totaled $179.2 million at December 31, 2003. Of this amount, the
Insurance Subsidiaries are entitled to pay a total of approximately $50.7
million of dividends in 2004 without obtaining prior approval from the
Pennsylvania Insurance Department or Florida Office of Insurance Regulation.
During 2003 the insurance subsidiaries paid dividends of $4.0 million to Liberty
American Insurance Group, Inc., a subsidiary of Philadelphia Insurance.
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
Pennsylvania Insurance Department and Florida Office of Insurance Regulation
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, 2003 is in excess of the minimum 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, MUSA's and
LAIC's participation in such shared markets or pooling mechanisms is generally
in proportion to the amount of their direct writings for the type of coverage
written by the specific pooling mechanism in the applicable state.
Mold Contamination: The property-casualty insurance industry experienced
an increase in claim activity in the last few years pertaining to mold
contamination. Significant plaintiffs' verdicts and increased media attention to
the subject have caused insurers to develop and/or refine relevant insurance
policy language that excludes mold coverage. The insurance industry foresees
increased state legislative activity pertaining to mold contamination in 2004.
The Company will closely monitor litigation trends in 2004, and continue to
review relevant insurance policy exclusion language. There were few insurance
laws or regulations enacted in 2003 regarding mold coverages. The regulatory
emphasis appears to focus on
15
personal lines rather than commercial lines. The Company has experienced an
immaterial impact from mold claims and attaches a mold exclusion to policies
where applicable.
Health Insurance Portability and Accessibility Act: Regulations under the
Health Insurance Portability and Accessibility Act of 1996 (HIPAA) were adopted
on April 14, 2003 to protect the privacy of individual health information. While
property/casualty insurers are not required to comply with the various
administrative requirements of the act, the regulations have an impact on
obtaining information within the context of claims information. The Company
continues to monitor regulatory developments under HIPAA.
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;
- 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 the Company's ability to maintain or increase rates. Accordingly,
these developments could have an adverse effect on the Company's earnings.
The federal Terrorism Risk Insurance Act of 2002 (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.
Sarbanes-Oxley Act of 2002: The Sarbanes-Oxley Act of 2002, enacted on
July 30, 2002, presents a significant expansion of securities law regulation of
corporate governance, accounting practices, reporting and disclosure that
affects publicly traded companies. The act, in part, sets forth requirements for
certification by company CEOs and CFOs of certain reports filed with the SEC,
disclosures pertaining to the adoption of a code of ethics applicable to certain
management personnel, and safeguards against actions to fraudulently influence,
manipulate or mislead independent public or certified accountants of the
issuer's financial statements. It also requires stronger guidance for
development and evaluation of internal control procedures, as well as provisions
pertaining to a company's audit committee of the board of directors. The Company
16
continues its efforts toward compliance with the act, particularly related to
Section 404 dealing with our system of internal controls.
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 8,500 brokers, thus facilitating a
regular flow of submissions.
Employees
As of February 25, 2004, the Company had 876 full-time employees and 30
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.
17
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 at One Bala Plaza, Bala Cynwyd, PA
which serves as its headquarters location, and also leases 36 offices for
its field marketing organization.
Item 3. LEGAL PROCEEDINGS
The Company is not subject to any 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 2003.
18
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY 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 24, 2004, there were 482
holders of record and 2,828 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:
2003 2002
----------------------------- -------------------------------
Quarter High Low High Low
------- ------------ ------------- ----------- ------------
First 38.700 28.571 42.750 35.230
Second 41.050 35.550 48.150 39.610
Third 46.270 38.000 46.000 29.000
Fourth 52.730 45.000 38.100 26.240
The Company did not declare cash dividends on its common stock in 2003 or
2002, 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, 2003, the Company did not
sell any of its securities which were not registered under the
Securities Act of 1933.
(c) The Company's purchases of its common stock during the fourth
quarter of 2003 are shown in the following table:
(c) Total
Number of (d) Approximate
Shares Dollar Value of
Purchased as Shares That May
Part of Yet Be
(a) Total Number (b) Average Publicly Purchased Under
of Shares Price Paid per Announced Plans the Plans or
Period Purchased Share or Programs Programs
----------------------------- ---------------- -------------- --------------- -----------------
October 1 - October 31 1,962 (1) $28.11 -- --
-- $24,700,000 (2)
November 1 - November 30 197 (1) $25.35 -- --
$24,700,000 (2)
December 1 - December 31 500 (1) $25.35 -- --
-----
$24,700,000 (2)
Total 2,659
=====
(1) Such shares were issued under the Company's Employee Stock Purchase Plan
and were repurchased by the Company upon the Employee's termination.
(2) The Company's total stock purchase authorization which was publicly
announced in August 1998, amounts to $55.0 million, of which $30.3 million
has been utilized.
19
Item 6. SELECTED FINANCIAL DATA
As of and For the Years Ended December 31,
(In Thousands, Except Share and Per Share Data)
-------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------ ----------- ----------- -----------
Operations and Comprehensive Income
Statement Data:
Gross Written Premiums ................. $ 905,993 $ 663,739 $ 473,565 $ 361,872 $ 274,918
Gross Earned Premiums .................. $ 789,498 $ 555,485 $ 421,063 $ 328,350 $ 245,978
Net Written Premiums ................... $ 599,361 $ 523,171 $ 333,817 $ 263,429 $ 184,071
Net Earned Premiums .................... $ 571,579 $ 421,186 $ 296,093 $ 227,292 $ 164,915
Net Investment Income .................. 38,806 37,516 32,426 25,803 20,695
Net Realized Investment Gain (Loss) .... 794 (3,371) 3,357 11,718 5,700
Other Income ........................... 5,519 911 587 8,981 4,722
----------- ------------ ----------- ----------- -----------
Total Revenue ..................... 616,698 456,242 332,463 273,794 196,032
----------- ------------ ----------- ----------- -----------
Net Loss and Loss Adjustment
Expenses ............................ 359,177 267,433 179,655 131,304 99,410
Acquisition Costs and Other
Underwriting Expenses ............... 162,912 129,918 97,020 75,054 53,793
Other Operating Expenses ............... 7,822 6,372 6,841 14,679 8,939
----------- ------------ ----------- ----------- -----------
Total Losses and Expenses ......... 529,911 403,723 283,516 221,037 162,142
----------- ------------ ----------- ----------- -----------
Minority Interest: Distributions on
Company Obligated Mandatorily
Redeemable Preferred Securities of
Subsidiary Trust .................... -- -- 2,749 7,245 7,245
----------- ------------ ----------- ----------- -----------
Income Before Income Taxes ............. 86,787 52,519 46,198 45,512 26,645
Total Income Tax Expense ............... 26,510 16,514 15,639 14,742 7,802
----------- ------------ ----------- ----------- -----------
Net Income ........................ $ 60,277 $ 36,005 $ 30,559 $ 30,770 $ 18,843
----------- ------------ ----------- ----------- -----------
Weighted-Average Common Shares
Outstanding ......................... 21,908,788 21,611,053 16,528,601 12,177,989 12,501,165
Weighted-Average Share Equivalents
Outstanding ......................... 751,600 682,382 656,075 2,411,552 2,614,399
----------- ------------ ----------- ----------- -----------
Weighted-Average Shares and Share
Equivalents Outstanding ............. 22,660,388 22,293,435 17,184,676 14,589,541 15,115,564
----------- ------------ ----------- ----------- -----------
Basic Earnings Per Share ............... $ 2.75 $ 1.67 $ 1.85 $ 2.53 $ 1.51
----------- ------------ ----------- ----------- -----------
Diluted Earnings Per Share ............. $ 2.66 $ 1.62 $ 1.78 $ 2.11 $ 1.25
----------- ------------ ----------- ----------- -----------
Year End Financial Position:
Total Investments and Cash
and Cash Equivalents .............. $ 1,245,994 $ 950,861 $ 723,318 $ 487,028 $ 420,016
Total Assets ........................ 1,869,031 1,358,334 1,017,722 730,464 599,051
Unpaid Loss and Loss Adjustment
Expenses .......................... 627,086 445,548 302,733 237,494 188,063
Minority Interest in Consolidated
Subsidiaries ...................... -- -- -- 98,905 98,905
Total Shareholders' Equity .......... 543,736 477,823 428,692 182,325 161,440
Common Shares Outstanding ........... 22,007,552 21,868,877 21,509,723 13,431,408 12,590,908
----------- ------------ ----------- ----------- -----------
Insurance Operating Ratios
(Statutory Basis):
Net Loss and Loss Adjustment
Expenses to Net Earned Premiums ... 63.1% 63.5% 60.7% 57.8% 59.7%
Underwriting Expenses to Net
Written Premiums .................. 27.2% 28.0% 31.2% 31.3% 33.6%
----------- ------------ ----------- ----------- -----------
Combined Ratio ......................... 90.3% 91.5% 91.9% 89.1% 93.3%
----------- ------------ ----------- ----------- -----------
A.M. Best Rating...................... A+ A+ A+ A+ A+
(Superior) (Superior) (Superior) (Superior) (Superior)
20
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
OVERVIEW
The Company designs, markets, and underwrites specialty commercial and personal
property and casualty insurance products for select target industries or niches.
The Company's operations are classified into three reportable business segments
which are organized around its three underwriting divisions: The Commercial
Lines Underwriting Group which has underwriting responsibility for the
Commercial Automobile and Commercial Property and Commercial multi-peril package
insurance products; The Specialty Lines Underwriting Group which has
underwriting responsibility for the professional liability insurance products;
and The Personal Lines Group has responsibility for personal property and
casualty insurance products for the Manufactured Housing and Homeowners markets.
The company operates solely within the United States through its 12 regional and
24 field offices.
The Company generates its revenues through the sale of commercial property and
casualty insurance policies. The insurance policies are sold through the
Company's five distribution channels which include direct sales, retail
insurance agents/open brokerage, wholesalers, preferred agents and the internet.
The Company believes that consistency in its field office representation has
created excellent relationships with local insurance agencies across the
country.
The Company also generates revenue from its investment portfolio, which
approximated $1.2 billion at December 31, 2003 and generated $43.4 million in
gross pretax investment income during 2003. The Company utilizes external
independent professional investment managers with the objective of realizing
relatively high levels of investment income while generating competitive after
tax total rates of return within duration and credit quality targets.
Management measures the results of operations through monitoring certain
measures of growth and profitability, including, but not limited to: number of
policies written, pricing, risk selection, loss ratio (sum of net loss and loss
adjustment expenses divided by net earned premiums) and expense levels.
During 2003, the prior year market trends of premium rate increases and turmoil
in the property and casualty insurance market continued. Although further
premium rate increases were realized during 2003, the increases moderated from
those realized in 2002. The increases have primarily arisen due to the
significant property and casualty industry losses as a result of the tragic
terrorist attacks of September 11, 2001, lower interest rates, and diminished
risk capacity. Rating agency downgrades, insolvencies and consolidations in the
industry also continued to be market factors during 2003.
In this environment, the Company continued its strong growth, with gross written
premiums increasing 36.5% to $906.0 million. Gross written premium growth was
strong across all the Company's business segments with in-force policy counts
increasing 22.8% and 39.7% for the commercial and specialty lines segments,
respectively, remaining flat for the personal lines segment, and weighted
average premium rate increases on renewal business approximating 4.3%, 10.2% and
9.4% for the commercial, specialty and personal lines segments, respectively.
($'s in millions) Commercial Specialty Personal
Lines Lines Lines Total
----- ----- ----- -----
2003 Gross Written Premium $662.4 $154.1 $89.5 $906.0
2002 Gross Written Premium $473.1 $110.2 $80.5 $663.8
Percentage Increase 40.0% 39.9% 11.3% 36.5%
2003 Weighted Average Premium Rate Increase on
Renewal Business 4.3% 10.2% 9.4%
2002 Weighted Average Premium Rate Increase on
Renewal Business 10.0% 26.0% 8.0%
21
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 the creation of 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, 2003 was 91.3%, which,
once again, was substantially lower than the property and casualty industry as a
whole. Included in the 2003 calendar year net loss and loss adjustment expenses
was $44.6 million of prior accident year development, of which, $38.8 million
was attributable to the Company's run-off residual value line of business. The
following table illustrates the 2003 calendar year and accident year loss ratios
by segment.
Commercial Specialty Personal
Lines Lines Lines Total
----- ----- ----- -----
2003 calendar year loss and loss adjustment expense ratio 63.9% 59.6% 60.1% 62.8%
2003 accident year loss and loss adjustment expense ratio 55.4% 53.2% 57.0% 55.0%
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, 2003, approximately 87.8% and 6.6% 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 90.2% and 5.6%,
respectively, at December 31, 2002.
During 2003 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
2003, on a cost basis, investment grade tax-exempt fixed maturity securities
represented 39.2% of the total invested assets, compared to 30.3% as of the end
of 2002.
Asset backed, mortgage pass through, and collateralized mortgage obligation
securities, on a cost basis, amounted to $183.0 million, $159.2 million and
$53.8 million, respectively, as of December 31, 2003 and $202.8 million, $81.3
million and $89.2 million, respectively, as of December 31, 2002. The asset
backed, mortgage pass through, and collateralized mortgage obligation
investments are amortizing securities possessing favorable prepayment risk
and/or extension 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 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 $1.0 million and $2.1 million for the years ended
December 31, 2003 and 2002, respectively. Such 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 occurring primarily in the
fourth quarter of 2002
22
and the first quarter of 2003. The Company primarily attributes these other than
temporary declines in fair value to the uncertain economic climate, the overhang
of corporate governance issues, and the high profile bankruptcies occurring
during 2002 into early 2003.
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")
in EITF 99-20. Under this guidance, impairment losses on securities must be
recognized if both the fair value of the security is less than its book value
and the net present value of expected future cash flows is less than the net
present value of expected future cash flows at the most recent (prior)
estimation date. If these criteria are met, an impairment charge, 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 $9.3
million and $1.6 million for the years ended December 31, 2003 and 2002,
respectively. These non-cash realized investment losses were primarily due to
investments in collateralized bond obligations as a result of the non investment
grade default rates which remain higher than historic averages.
The Company's fixed maturity portfolio amounted to $1,081.7 million and $854.5
million, as of December 31, 2003 and December 31, 2002, respectively, of which
98.6% of the portfolio for both years was comprised of investment grade
securities. From the fourth quarter of 2001 into early 2003 following the war in
Iraq, U.S. investment grade securities experienced varying price and ratings
volatility, having been affected by the uncertain economic climate, corporate
governance issues, and the subsequent stream of corporate scandals and high
profile bankruptcies. More recently certain sectors of the investment grade
security market have continued to lag despite a return to a more favorable
economic climate. However, the high quality of the Company's overall "AA+" rated
fixed maturity portfolio, has mitigated potential volatility. The Company had
fixed maturity investments with unrealized losses amounting to $10.6 million and
$9.2 million as of December 31, 2003 and December 31, 2002, respectively. Of
these amounts, interests in securitized assets had unrealized losses amounting
to $9.2 million and $7.3 million as of December 31, 2003 and December 31, 2002,
respectively. 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. Investments in aircraft collateralized
Enhanced Equipment Trust Certificates (EETCs) had unrealized losses amounting to
$0 and $1.3 million as of December 31, 2003 and December 31, 2002, respectively.
The following table identifies the period of time securities with an unrealized
loss at December 31, 2003 have continuously been in an unrealized loss position.
Included in the amounts displayed in the table are $6.5 million of unrealized
losses due to non-investment grade fixed maturity securities having a fair value
of $15.6 million. No issuer of securities or industry represents more than 4.4%
and 15.5%, respectively, of the total estimated fair value, or 18.1% and 39.7%,
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, such as the financial condition of specific
industry sectors and the resultant effect on underlying security collateral
values. 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.
23
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 $ 0.2 $ 0.3 $ 0.5 $1.5 $ 2.0
(Greater Than) 3 - 6 months 0.3 0.5 0.8 0.1 0.9
(Greater Than) 6 - 9 months 0.5 0.6 1.1 -- 1.1
(Greater Than) 9 - 12 months -- -- -- -- --
(Greater Than) 12 - 18 months -- 1.9 1.9 -- 1.9
(Greater Than) 18 - 24 months -- 3.4 3.4 -- 3.4
(Greater Than) 24 months 0.4 2.5 2.9 -- 2.9
------ ----- ------ ---- ------
Total Gross Unrealized
Losses $ 1.4 $ 9.2 $ 10.6 $1.6 $ 12.2
====== ===== ====== ==== ======
Estimated fair value of
securities with a gross
unrealized loss $101.9 $96.9 $198.8 $6.8 $205.6
====== ===== ====== ==== ======
The following table presents certain information with respect to individual
securities with a significant unrealized loss position as of December 31, 2003.
Significant Unrealized Losses by Security
-----------------------------------------
(in millions)
Issuer Security Type Carrying Value Unrealized Loss
- ------ ------------- -------------- ---------------
Batterson Park CBO I CLC 144A Equity Security-Equity Tranche of Securitized Asset $ 0.0 $ 1.2
Conseco Fin SEC Corp 2000-4 M1 Fixed Maturity - Interest in Securitized Assets 0.5 1.6
Conseco Fin SEC Corp SER 2000-4 M2 Fixed Maturity - Interest in Securitized Assets 0.1 1.0
Greentree Financial Corp. 99-2 B1 Fixed Maturity - Interest in Securitized Assets 0.3 2.2
Nextcard CRCN MNT 2001-1 CLB144A Fixed Maturity - Interest in Securitized Assets 3.7 1.3
----- ------
$ 4.6 $ 7.3
===== ======
During 2003 the Company recorded impairment losses of $1.1 million, $0.1
million, $0.5 million for the Batterson Park CBO I CLC 144A, Conseco Fin SEC
Corp SER 2000-4M2, and Greentree Financial Corp 99-2-B1 securities,
respectively. Based upon the Company's impairment evaluation as of December 31,
2003 utilizing cash flow assumptions of the supporting collateral, estimated
default and recovery rates it was concluded that the remaining unrealized losses
in the significant unrealized losses by security table are not other than
temporary.
During 2003 the Company's gross loss on the sale of fixed maturity and equity
securities amounted to $0.7 million and $0.8 million, respectively. The fair
value of the fixed maturity and equity securities at the time of sale was $20.1
million and $4.4 million, respectively. 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.
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
24
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.
25
DECEMBER 31, 2003
EXPECTED MATURITY DATES TOTAL
(In thousands, except average interest rate) FAIR
2004 2005 2006 2007 2008 Thereafter TOTAL VALUE
-------- -------- -------- -------- -------- ---------- ---------- -----------
FIXED MATURITIES AVAILABLE
FOR SALE:
Principal Amount $119,372 $150,850 $128,609 $106,668 $127,667 $412,502 $1,045,668 $ 1,078,394
Book Value $120,047 $153,444 $130,874 $107,360 $129,818 $421,813 $1,063,356
Average Interest Rate 4.03% 3.80% 3.59% 4.78% 4.27% 4.11% 4.08% 4.29%
PREFERRED:
Principal Amount $ 1,500 $ 1,000 $ 3,625 -- -- -- $ 6,125 $ 6,572
Book Value $ 1,489 $ 1,040 $ 3,792 -- -- -- $ 6,321
Average Interest Rate 6.06% 6.84% 6.46% -- -- -- 6.43% 6.18%
SHORT-TERM INVESTMENTS:
Principal Amount $ 68,469 -- -- -- -- -- $ 68,469 $ 68,469
Book Value $ 68,469 -- -- -- -- -- $ 68,469 --
Average Interest Rate 1.24% -- -- -- -- -- 1.24% 1.24%
LOANS PAYABLE:
Principal Amount $ 48,482 -- -- -- -- -- $ 48,482 --
Average Interest Rate 1.23% -- -- -- -- -- 1.23% --
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. 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. The Company's total investments include
$13.7 million in securities for which there is no readily available
independent market price.
-- 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 upon its detailed review, or
if a decline
26
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 ($627.1 million
and $445.6 million as of December 31, 2003 and 2002, 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
18.5% and deficient by as much as 41.4%. 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