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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission file number
December 31, 2000 1-12338
VESTA INSURANCE GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 63-1097283
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3760 River Run Drive, Birmingham, AL 35243
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code:
(205) 970-7000
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS CUSIP NUMBER: WHICH REGISTERED
Common Stock, $.01 Par Value 925391104 Common Stock, $.01 Par Value
Securities registered pursuant to Section 12(g) of the Act:
None
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH) 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 ((S)229.405 OF THIS CHAPTER) IS NOT CONTAINED HEREIN, AND WILL
NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR
INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K
OR ANY AMENDMENT TO THIS FORM 10-K. [ ]
THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE
REGISTRANT AS OF MARCH 20, 2001:
$ 168,819,401
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK,
AS OF MARCH 20, 2001 is 24,427,946
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE VESTA INSURANCE GROUP, INC. PROXY STATEMENT FOR ITS 2001 ANNUAL
MEETING OF STOCKHOLDERS
ARE INCORPORATED BY REFERENCE INTO PART III HEREOF.
Table of Contents
Part I Page
Item 1 Business Overview 3
Significant Developments 3
Business Segments 4
Standard Property-Casualty 4
Life and Health 7
Specialty Lines 8
Non-Standard Auto 8
Corporate and Other 9
Reserves 9
Investments 9
Regulation 12
A.M. Best 13
Competition 13
Employees 14
Item 2 Properties 14
Item 3 Legal Proceedings 14
Item 4 Submission of Matters to a Vote of Security Holders 16
Part II
Item 5 Market for Registrants' Common Equity and Related Stockholder Matters 17
Item 6 Selected Financial Data 18
Item 7 Management's Discussion and Analysis of Results of Operations and Financial Condition 19
Item 7A Quantitative and Qualitative Disclosures about Market Risk 22
Item 8 Financial Statements and Supplementary Data 23
Item 9 Changes in and disagreements with Accountants on Accounting and Financial Disclosures 49
Part III
Item 10 Directors and Executive Officers of the Registrants 50
Item 11 Executive Compensation 50
Item 12 Security Ownership of Certain Beneficial Owners and Management 50
Item 13 Certain Relationships and Related Transactions 50
Part IV
Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 51
1
Special Note Regarding Forward-Looking Statements
Any statement contained in this report which is not a historical fact, or
which might otherwise be considered an opinion or projection concerning Vesta or
its business, whether express or implied, is meant as and should be considered a
forward-looking statement as that term is defined in the Private Securities
Litigation Reform Act of 1996. Forward-looking statements are based on
assumptions and opinions concerning a variety of known and unknown risks,
including but not necessarily limited to changes in market conditions, natural
disasters and other catastrophic events, increased competition, changes in
availability and cost of reinsurance, changes in governmental regulations, and
general economic conditions, as well as other risks more completely described in
Vesta's filings with the Securities and Exchange Commission, including exhibit
99.1 to this Report on Form 10-K. If any of these assumptions or opinions proves
incorrect, any forward-looking statements made on the basis of such assumptions
or opinions may also prove materially incorrect in one or more respects.
2
PART I
Item 1. Business
Business Overview
As used in this Annual Report, unless the context otherwise requires, the
terms "Vesta," "we," and "our" refer to Vesta Insurance Group, Inc., a Delaware
corporation, and its subsidiaries, collectively.
Vesta is a holding company for a group of financial services companies that
offers a wide range of products for consumers. During 1999 and 2000, we exited
the property-casualty reinsurance assumed and commercial property-casualty
insurance and focused our efforts on personal lines insurance products. Our
remaining standard property-casualty business consists primarily of personal
auto and homeowners insurance products distributed through an independent agency
force. In 2000, we diversified our insurance operations through investments in
life insurance, accident and health insurance and non-standard auto.
Significant Developments
The following events have occurred since January 1, 2000 and have had a
significant positive impact on Vesta:
. Improved Ratings: On February 25, 2000, A.M. Best Company upgraded our
insurance subsidiaries to "B+" (Very Good) from "B" (Fair). The "B+" rating
places Vesta in the secure category of A.M. Best's classifications. A.M.
Best's upgrade reflects the agency's assessment of our improved financial
condition, including reduced debt and improved financial flexibility.
Similarly, when we reinstated the payment of dividends on the Trust
Preferred Securities, Duff & Phelps Credit Rating Co. upgraded its rating
on those securities to "B" from "DP" (dividend arrearages). Duff & Phelps
also removed all of our rated operating subsidiaries from "Rating Watch -
Down." Moody's Investor Service also revised its outlook for the ratings of
Vesta to "positive" from "negative."
. Debt Exchanges and Repurchases: During 2000 and in the first quarter of
2001, we engaged in several transactions to reduce annual interest expense
obligations and improve our debt to capital ratio:
. On March 17, 2000, we repurchased $21.6 million of the 12.5% Senior
Notes and $4.5 million of our 8.75% Senior Debentures due 2025.
. In April 2000, we redeemed $22.5 million of our 12.5% Senior Notes and
approximately $8.6 million of our 8.75% Senior Debentures.
. In December 2000, we redeemed $8 million face amount of our 8.525%
Deferrable Capital Securities for 1.2 million shares of Vesta common
stock.
. On January 30, 2001, we redeemed $3.475 million face amount of our
8.525% Deferrable Capital Securities for 380 thousand shares of Vesta
common stock.
As a result of this series of transactions, we reduced our outstanding debt
by $68.7 million and have reduced our annual ongoing interest obligations
by $7.5 million. These transactions also helped reduce our debt to total
capital ratio from 48.5% at December 31, 1999 to 36.7% at December 31,
2000.
. Acquisition of Shares Held by Torchmark: In 2000, we exercised our right
of first refusal and acquired 5.1 million shares of our common stock from
Torchmark Corporation. The shares were subsequently resold through
privately negotiated transactions.
. Shareholder Rights Plan: Our Board of Directors adopted a stockholders
rights plan on June 15, 2000 to discourage takeovers that involve abusive
tactics or that fail to provide fair value to shareholders. The plan is
similar to plans previously adopted by many other publicly traded
companies.
. Investment in American Founders Financial Corporation: On June 30, 2000, we
entered the life and annuity business through a 71% investment in American
Founders Financial Corporation, a holding company for two life insurance
companies domiciled in Texas. American Founders has approximately $1.8
billion (face value) of life products in force and approximately $339
million of annuity deposits as of December 31, 2000. American Founders is
currently rated B+ by A.M. Best and operates in 40 states and the District
of Columbia.
. Catastrophe Bond Securitization: In July 2000, we reinsured our risk of
catastrophic hurricane and tropical storm loss in Hawaii and catastrophe
hurricane loss in the northeastern United States through a securitization
transaction effected through the INEX insurance exchange. We believe that
reinsuring this risk in the capital markets is an attractive alternative to
traditional reinsurance coverages and will provide us with immediate
liquidity if a qualifying event occurs, avoiding the potential for delays
in collection and disputes with reinsurers which often arise in the
traditional reinsurance market.
3
. Acquisition of Aegis Financial Corporation: In December 2000, we agreed to
acquire, subject to regulatory approval, Aegis Financial Corporation, a
holding company for an accident and health insurance company. At December
31, 2000, Aegis had approximately $16.5 million of accident and health
premiums in force. The transaction was approved by the Texas Department of
Insurance on March 21, 2001.
. Investment in Instant Auto: In December 2000, we acquired an approximate
52% economic interest in Instant Insurance Holdings, Inc., a holding
company for a group of non-standard auto insurance agencies.
. Retirement of Preferred Stock: On January 26, 2001, we effectively retired
2,950,000 shares of Series A Convertible Preferred Stock, eliminating $2.25
million in annual dividend payments. The preferred stock holders converted
the preferred stock pursuant to their original conversion terms, and we
then repurchased the 5,900,000 shares of common stock issued upon
conversion for $15 million cash and a $32.2 million note. We subsequently
resold 5.5 million of these shares in privately negotiated transactions and
repaid the $32.2 million note in full on March 14, 2001.
In 2000, we implemented a diversification strategy by pursuing strategic
opportunities that leverage our infrastructure and excess surplus to offer
complementary products having more predictable loss patterns than our standard
property-casualty business. Our diversification strategy revolves around three
basic criteria:
. Enter new personal lines markets, with emphasis on life, annuity, health
and non-standard auto;
. Acquire proven management;
. Migrate to effective information systems to support products offered;
. Create growth opportunities for new and existing product offerings.
Applying these basic strategic criteria to several candidates that we
considered in the second half of 2000, we acquired, or made significant
investments in, three insurance operations that will enable us to offer life,
annuity, accident and health, and non-standard automobile insurance products.
In addition, we determined to pursue opportunities to leverage our various state
licenses by acting as an issuing carrier for private passenger automobile
insurance on a fee-for-service basis. We discuss each of these strategic
initiatives in detail later in this description of our business. Although we
believe that these initiatives will soon develop into more significant segments
of our consolidated operations, our standard property-casualty operations
remained our dominant segment in 2000.
Business Segments
Summary. In 2000, we changed our segment reporting to reflect the start-up of
the specialty lines business and the entry into the life markets. Going
forward, we expect to have a growing presence in non-standard auto insurance and
add health insurance products in our life segment. This data should be read in
conjunction with our Consolidated Financial Statements and related notes
thereto. For additional information on our business segments, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note K the Consolidated Financial Statements. Each segment is discussed in
detail on following pages.
Standard Property-Casualty
General. In our standard property-casualty segment, we write primarily
personal auto and homeowners insurance, along with other miscellaneous products
targeted for particular markets. During 2000, we took a more disciplined
approach to our standard property-casualty business, maintaining relationships
with only our core agencies, which reduced our independent agency force to
approximately 1,600 agencies. These agents have historically produced our most
profitable business. As a result, we are reducing our gross written premium in
this segment, while improving our profit margins. We also decided to diversify
our insurance product portfolio. Through these actions, we believe we are
positioned to achieve improved operating results from our standard property-
casualty operations, strengthen our relationships with our most profitable
independent agencies and leverage our capital and surplus to enter other lines
of business which may generate greater returns on equity.
Selected Operational Ratios for Standard Property-Casualty Segment
2000 1999 1998
----- ----- ------
Loss and LAE ratio 58.6% 66.5% 67.8%
Underwriting expense ratio 37.1% 30.3% 48.5%
----- ----- ------
Combined Ratio 95.7% 96.8% 116.3%
===== ===== ======
Net premiums written to Surplus Ratio .76x .98x 2.31x
===== ===== ======
4
The following table illustrates the source of our premium revenue from our
standard property-casualty lines operations. You should read this data in
conjunction with our consolidated financial statements and related notes
appearing later in this annual report.
Standard Property-Casualty
Gross Written Premium
Year Ended December 31
2000 1999 1998
--------------- --------------- --------------
(in thousands, except percentages)
Personal Auto $ 98,449 44% $141,868 56% $223,425 64%
Homeowners 121,483 54% 107,025 42% 93,762 27%
Other 3,405 2% 6,098 2% 29,805 9%
--------------- --------------- --------------
Total $223,337 100% $254,991 100% $346,992 100%
=============== =============== ==============
Personal Auto. Our standard personal auto line targets drivers over age
thirty-five with above average driving records. We write policies with
liability limits up to $500,000, with personal umbrella liability coverage
available up to $5 million. The vast majority of our personal umbrella coverage
is written at limits of $1 million or $2 million. We write the majority of our
standard auto business in Ohio, Pennsylvania, Tennessee, West Virginia,
Illinois, and Wisconsin through The Shelby Insurance Company and its affiliated
companies. Our renewal rate for this line of business in 2000 was approximately
85% and new policy applications increased compared to 1999 levels for our active
agents.
Homeowners. Our homeowner and dwelling insurance products cover the full
range of homes, starting with lower valued dwellings in the $10,000 to $50,000
range, through middle valued homes in the $50,000 to $150,000 range, and
occasionally we insure higher valued homes valued up to $10 million. The
majority of our homeowners business covers properties valued between $40,000 and
$250,000.
We write homeowners insurance through various insurance subsidiaries, but we
generally divide it into three books of business:
. Hawaiian coverage, primarily written by our wholly-owned subsidiary, The
Hawaiian and Guaranty Company, Ltd.;
. The Property Plus business, a large book of homeowners business that we
acquired from CIGNA in 1998;
. Shelby homeowners, written through our wholly-owned subsidiary, Shelby
Insurance Company.
Our Hawaiian homeowners business generally covers higher valued dwellings
against fire and other catastrophic loss. Until recently, we did not underwrite
significant wind, or hurricane, risk of loss in Hawaii, because most
policyholders procured that coverage through a state-sponsored insurance pool.
In 2000, that state insurance pool disbanded, and many of our policyholders
began purchasing wind, or hurricane, coverage from us in Hawaii. Although this
increases the total risk in our Hawaiian portfolio, we have effectively managed
this risk through reinsurance coverage procured in the capital markets as well
as the traditional reinsurance markets. In 2000, we wrote $14.7 million in
annual premiums in this book of business.
Our Property Plus book of business covers mid-to-high valued homes primarily
in the northeastern region of the United States as well as a limited amount
across the entire country. We have taken a conservative approach in the
northeastern section of the country and minimized our exposure on the coastal
regions. This book of homeowners business was acquired from CIGNA in 1998
through a reinsurance arrangement, coupled with CIGNA's commitment to use
reasonable efforts to cause the policyholder base to renew their coverage with
us. Since that time, approximately nine out of ten policyholders with policies
coming up for renewal have elected to renew coverage with us, for a renewal
retention ratio in this Property Plus book of homeowners business of
approximately 88%. We expect the process of conversion to be completed in early
2001. In 2000, we wrote $45.0 million in annual premium in this book of
business.
The Shelby homeowners policies focus on the Midwestern and Mid Atlantic
sections of the United States covering homes primarily from $100,000 to $250,000
in value. Homes in this book of business have very minimal exposure to
hurricanes. This section of our business had a renewal rate of 86% for 2000, and
we wrote $94.7 million in annual premium.
Other Personal Lines Products. We provide miscellaneous products to particular
target markets. The majority of these products are designed to protect the
interests of financial institutions in various instances in which the borrower
fails to insure a car or a home serving as collateral in accordance with a loan
or mortgage agreement, as well as coverage for properties that are in the
process of foreclosure. We also provide fire and allied lines coverage on low-
value dwelling, mobile home, and household contents.
Underwriting. The goal of our underwriting operations is to manage the quality
of our book of business. Working in concert with our agency force, our
underwriting staff supports our agents on a daily basis. Vesta's agency force
understands our underwriting philosophy and goals and, in turn, we rely on our
agents to exercise a high degree of underwriting knowledge in the field.
5
Our target market profile is families with multiple insurance policies, who
own more than one automobile and who live in a home valued between $100,000 and
$250,000. Our underwriting staff is highly trained and operates in an efficient
manner in order to maintain and manage expenses.
Exposure to Catastrophic Events. In our standard lines operations, the
greatest risk of loss we face is property damage resulting from catastrophic
events, particularly hurricanes and tropical storms affecting Hawaii and
hurricanes affecting the northeastern United States. Our exposure to loss from
other catastrophic events, such as tornadoes and earthquakes, is not as
significant, because we do not insure significant levels of property in areas
traditionally affected by these events. While we seek to reinsure a significant
portion of our risk of catastrophic losses, there can be no assurance that our
losses will be within the coverage limits of our reinsurance programs.
Standard Property-Casualty Lines Reinsurance. We seek to manage our risk
exposure on standard property-casualty lines insurance through the purchase of
reinsurance. We obtain reinsurance principally to reduce our net liability on
individual risks and to provide protection for individual loss occurrences,
including catastrophic losses, in order to stabilize our underwriting results.
In exchange for reinsurance, we pay to our reinsurers a portion of the premiums
received under the reinsured policies.
In addition to our traditional catastrophe reinsurance program, we obtained
additional catastrophe coverage for potential hurricane and tropical storm loss
in Hawaii and hurricane loss in the northeastern United States through a
securitization transaction effected through the INEX insurance exchange. We
purchase traditional excess of loss reinsurance for our standard property-
casualty business up to a 100-year probable maximum loss (PML) reinsured by
traditional reinsurance. The securitization transaction placed through INEX
provides coverage for a 250-year PML.
Although we reinsure a significant portion of potential losses on the policies
that we issue, we initially pay all claims and seek to recover the reinsured
losses from our reinsurers. Although we report as assets the amount of claims
paid which we expect to recover from reinsurers, there is no guarantee that we
will be able to collect those amounts. The possibility exists that the reinsurer
would be unable to pay, or the reinsurer may dispute our calculation of the
amounts recoverable. In either of these circumstances, we will not have the
anticipated liquidity to pay the claims on the reinsured policies. We believe
that our procurement of a portion of our reinsurance through the capital markets
in the manner described above mitigates these credit and collection risks
inherent in the traditional reinsurance market.
Marketing. We have chosen to distribute our products through the Independent
Insurance Agent. We strive to develop and maintain relationships with agencies
in rural or suburban areas and provide them with above average compensation when
policies are issued through our companies. Our product offerings in the standard
property-casualty market fit the needs of a wide range of consumers. Vesta
supports its agency force through advertising and promotions aimed to create
top-of-mind awareness of the agency and our companies as well as creating
business to business technology that has the potential to increase agent
productivity while decreasing our operating expenses.
We believe that the Independent Agent is best able to sell and service the
needs of our target market because of the agent's close relationship with their
customers. Consumers who use independent agents typically keep using the
services of the same independent agent year after year. This means once Vesta
acquires a new customer, the likelihood that particular customer will renew
his/her policy with us the following year is very high. This will keep our
policy acquisition expenses to a minimum over time. We currently have a
marketing force of approximately 1,600 agencies in 24 states that distribute our
standard property-casualty products.
Our agency force has a voice in Vesta through the Agency Advisory Council. The
Council was created to foster ideas and give the agents the opportunity to
suggest new initiatives to improve both our businesses. In 2001, we announced
our intention to create a stock incentive plan for our agents so that top-
performing agents have the opportunity to acquire Vesta common stock at a
discount to market prices.
The following table sets forth the principal geographic distribution of our
gross premiums written in our standard property-casualty business for the three
years indicated. The geographic balance reflected allows for greater profit
protection and more cost effective management of the property catastrophe
exposures. The states listed below comprise the ten states with the largest
gross premiums written for the year ending December 31, 2000 and their
comparative amounts for prior years.
6
Standard Property-Casualty
Gross Written Premium
Year Ended December 31
2000 1999 1998
--------------- ---------------- ---------------
Pennsylvania $ 40,305 18.0% $ 48,822 19.1% $ 50,185 14.5%
West Virginia 25,258 11.3% 26,677 10.5% 27,593 8.0%
Hawaii 17,187 7.7% 18,425 7.2% 25,175 7.3%
Ohio 15,126 6.8% 19,307 7.6% 17,942 5.2%
Tennessee 14,971 6.7% 20,065 7.9% 24,924 7.2%
Illinois 11,642 5.2% 15,936 6.2% 20,029 5.8%
North Carolina 9,910 4.4% 10,426 4.1% 11,966 3.4%
Alabama 9,896 4.4% 11,375 4.5% 14,641 4.2%
New York 9,877 4.4% 1,983 0.8% 37 0.0%
Mississippi 6,164 2.8% 9,883 3.9% 11,398 3.3%
All Other 63,000 28.2% 72,092 28.3% 143,102 41.2%
--------------- ---------------- ---------------
Total $223,337 100.0% $254,991 100.0% $346,992 100.0%
======== ===== ======== ===== ======== =====
Our independent agents have limited authority to bind insurance coverages
without prior approval from us, as long as such coverages fit within our
established guidelines. However, our underwriting staff reviews all coverages
bound by these agents and ultimately decides whether to continue such coverages.
Because of the broad base of our independent agency force, the contractual
limitation on their authority to bind coverage and our underwriting review
procedures, we do not believe that the authority of our agents to bind us
presents any material risk to our operations.
Claims. Claim costs represent actual payments made and changes in estimated
future payments to be made to or on behalf of policyholders, including expenses
required to settle claims and losses. These costs include a loss estimate for
future assignments and assessments. Claims arising under our policies are
managed by our Claims Department. When we receive notice of a loss, our claims
personnel open a claim file and establish a reserve with respect to the loss.
All claims are reviewed and all payments are made by our employees, with the
exception of claims on certain products, which are adjusted by a managing
general agency and periodically audited by our claims personnel. Management
believes that utilizing our trained employee adjusters permits faster, more
efficient service at a lower cost. In 2000, we added a reinspection manager and
a fraud examiner to our staff to increase controls and monitor our loss notices.
Claims settlement authority levels are established for each adjuster or
manager based upon each employee's ability and level of experience. Upon loss
notification, each claim is reviewed and assigned to an adjuster or manager
based upon the type of claim. Home office litigation supervisors monitor claims-
related litigation. We emphasize prompt, fair and equitable settlement of
meritorious claims, adequate reserving for claims and controlling of claims
adjustment and legal expenses.
Systems. Almost all of our policy administration functions are performed on
our own information systems. In recent years, we have upgraded our core
infrastructure, and expanded the scope of our capabilities. While this work has
been our chief focus for several years, it was greatly accelerated in 2000 when
we determined that we should move all of our policy management systems in-house.
This is the last major expense that we intend to incur as a result of the
integration of the Shelby Companies acquisition. The policy information that is
housed with a vendor is being converted to our in-house mainframe system. The
conversion began in the second quarter of 2000 and we anticipate the project to
be completed in 2001.
Our efforts in e-commerce and technology have a high priority, and during the
year we intensified our resources devoted to Internet-based technology. To
assist the marketing and servicing capabilities of our agency force, we
introduced Internet-based programs that give agents the ability to quote, enter
new business, perform endorsements and perform inquiries on policies, billing
and claims. This information is exchanged through Vesta Internet Access (VIA),
which is located on our web site -- www.vesta.com -- and provides Agent's fast,
convenient access to product, policy and claims information. In addition, we
initiated a video training program designed to assist our agents in learning to
operate the VIA Internet system. We are committed to utilizing the latest
electronic technology to allow our agency force to securely conduct
transactions, access information and communicate with our insurance
subsidiaries.
Life and Health
We diversified our product offering by entering the Life and Health Insurance
business through strategic acquisitions in 2000. Similar to the property-
casualty industry, life and health insurance is a mature industry experiencing
consolidation. One major difference, however, is that as the overall population
ages, individuals will focus on efficiently transferring wealth between
generations. As a result, we believe that consumers will be attracted to
savings-oriented products with tax-advantaged status to both fund their
retirement years and protect their accumulated savings.
7
Even though the demand for life, annuity and health products has increased in
recent years, this business remains extremely competitive. Access and retention
of distribution channels is a key factor in the success in this business, and we
utilize an independent agency force to distribute these products.
Life and health insurance is expected to have a different impact on Vesta's
earnings stream as compared to property - casualty business. Losses in the
property-casualty business are difficult to predict due to potential
catastrophes, such as hurricanes, tornadoes and other weather-related events. In
addition, losses in the property-casualty line can take years to ultimately
determine due to litigation and other factors. On the other hand, financial
results from life and health insurance businesses are easier to predict and the
ultimate results from the business can be reported sooner. Accordingly, we
believe that our earnings from the life and health segment should be more
predictable and consistent than our property-casualty segment.
Primary Products. The primary products of our life and health segment consist
of traditional life products, universal life products, annuity and pension
contracts and related products. Fixed-rate and variable annuities are a
substantial portion of our offerings. We also intend to offer a critical illness
product, a relatively new product that we believe is gaining acceptance in the
marketplace. The critical illness product is designed to bridge the gap between
disability insurance and life insurance by paying the face amount of the policy
at death or earlier in the event of the occurrence of certain critical
illnesses, such as Alzheimer's disease, organ transplants or loss of sight.
Strategy. We believe our life and health insurance business is well positioned
for growth. We intend to grow by acquisitions, joint ventures and internal
sales. The main drivers of these strategies are an efficient and flexible
operating and administrative system and maintaining seasoned management with
industry expertise to identify potential targets and successfully integrate
blocks of policies efficiently into the current administrative system.
Marketing. We distribute our life and health products through agents recruited
and contacted directly by our life and health insurance subsidiaries, American
Founders and Aegis Financial. The agents that have historically served these
companies are geographically diversified without any one dominant producer.
Reinsurance Ceded. Our life business engages in reinsurance to appropriately
spread reinsurance-ceded risks among reinsurers. American Founders maintains
excess of loss reinsurance agreements for more than $50,000 on policies issued
prior to October 24, 1990 and for more than $250,000 on policies issued
subsequently.
Systems. A key criteria in our diversification strategy was to acquire
effective information systems to support new products offered. We believe that
each of American Founders and Aegis have efficient and flexible administrative
systems that have demonstrated the ability to quickly and efficiently assimilate
and provide administration for acquired blocks of policies. The result is an
ongoing low-cost administration of the insurance and annuity policies.
Specialty Lines
- ---------------
As a holding company for 14 insurance subsidiaries, we hold certificates of
authority to write various types of insurance in 48 states. In many states, we
have several insurance company subsidiaries licensed to write the same types of
insurance business, and we are licensed to write business in other states where
we are not actively underwriting business. We use our authority to write
business in these circumstances, which would otherwise go unused, to write
certain lines of business and reinsure the risks in exchange for fees. This can
be a valuable asset to reinsurance companies desiring to underwrite insurance
business in these states but which do not hold certificates of authority to do
so. We may also decide to retain some underwriting risk on selected business, in
our discretion and we report the underwriting results of that retention in this
segment. We pursue opportunities to provide this "specialty" type of insurance
primarily for reinsurance companies.
During 2000, our specialty lines operations contracted for approximately $100
million in annualized premium, primarily in the private passenger auto insurance
segment. In addition, given our certificates of authority and infrastructure, we
believe we are well positioned internally to provide specialty insurance for
certain additional coverages. Due to external market requirements, however, we
believe our opportunities to provide additional types of specialty insurance
depends, in large part, on improved ratings from our various rating agencies,
including A. M. Best Company.
Non-Standard Auto
In 2001, we expect to begin distributing non-standard auto insurance products
through our acquisition of Instant Auto. Unlike American Founders and Aegis,
Instant Auto's principal business is not underwriting insurance. Instant Auto
operates as a non-standard auto agency, distributing the insurance products of
other carriers. Thus, Instant Auto's principal revenue stream is agents' fees
and commissions. Non-standard auto insurance covers owners and drivers seeking
to purchase insurance as required by law, drivers with accidents or violations
on their driving records, new drivers, and drivers who own high-performance
vehicles. Non-standard auto insurance customers traditionally are higher risks
than standard customers and, therefore non-standard customers premiums are
higher. According to A.M. Best, the non-standard segment is approximately 18% of
the overall personal auto insurance industry. In recent years, the non-standard
auto segment has become extremely concentrated, putting additional financial
pressure on companies as they compete for market share. This industry shakeout
has caused high-cost operators to seek merger partners and has created an
opportunity for growth.
Although our investment in Instant Auto does not immediately diversify our
product offering, we believe that it is a necessary and important step towards
growing our existing insurance business through state of the art distribution
and processing methods. We also believe
8
that it provides us with a platform to develop fee income, both through
traditional agency commissions and specialty lines fees (discussed above).
Instant Auto has two fundamental assets that we believe will enable us to
accomplish these strategic goals:
. valuable technological assets which we believe can serve as a growth
engine for various types of insurance products; and
. seasoned management to build a significant non-standard auto general
agency.
Instant Auto has developed a fully functional Internet distribution
platform. Recognizing the novelty of the Internet's "virtual business model" and
consumer reluctance to purchase financial products online, Instant Auto also
developed a highly functional call center to field customer inquiries,
facilitate policy applications and administer the process of issuing new
policies. While we believe this call center will prove to be invaluable support
for the Internet "virtual business model" as it develops and gains acceptance in
the future, we also believe that this call center can immediately enhance the
marketing of our other products and facilitate the applications for, and the
issuances of, those products. We believe that having access to this call center
is an important step towards significant growth in our newly acquired life and
annuity business. In addition, we believe this call center may ultimately be an
effective tool with which all of our independent agents may effectively cross
market all of our personal lines products.
Corporate & Other
- -----------------
Our corporate and other segment primarily consists of net investment income on
capital, interest on all debt and certain overhead expenses not directly
associated with a particular segment.
Reserves
Our insurance subsidiaries maintain reserves to cover their estimated ultimate
liability for losses with respect to reported and unreported claims incurred. To
the extent that current reserves prove to be inadequate in the future, we would
have to increase such reserves and incur a charge to earnings in the period such
reserves are increased, which could have a material adverse effect on our
results of operations and financial condition. The establishment of appropriate
reserves is an inherently uncertain process, and there can be no assurance that
ultimate losses will not materially exceed our estimates. Reserves are estimates
involving actuarial and statistical projections at a given point in time of what
we expect to be the cost of the ultimate settlement and administration of claims
based on facts and circumstances then known, estimates of future trends in
claims severity and other variable factors such as inflation.
Reserves for Property-Casualty Business
With respect to reported claims, reserves are established on a case-by-case
basis. The reserve amounts on each reported claim are determined by taking into
account the circumstances surrounding each claim and policy provision relating
to the type of loss. Loss reserves are reviewed on a regular basis, and as new
data becomes available, appropriate adjustments are made to reserves.
For incurred but not reported ("IBNR") losses, a variety of methods have been
developed in the insurance industry for determining estimates of loss reserves.
One common method of actuarial evaluation, which we use, is the loss development
method. This method uses the pattern by which losses have been reported over
time and assumes that each accident year's experience will develop in the same
pattern as the historical loss development. We also rely on industry data to
provide the basis for reserve analysis on newer lines of business (lines written
less than three years).
Provisions for inflation are implicitly considered in the reserving process.
Our reserves are carried at the total estimate for ultimate expected loss
without any discount to reflect the time value of money.
Reserves are computed based upon actuarial principles and procedures
applicable to the lines of business written by us. These reserve calculations
are reviewed regularly by management, and, as required by state law, we engage
an independent actuary to render opinions as to the adequacy of statutory
reserves established by management. The actuarial opinions are filed with the
various jurisdictions in which we are licensed. Based on our practices and
procedures, management believes that reserves were adequate as of the valuation
date.
9
The following table provides a reconciliation of beginning and ending
property-casualty liability balances on a GAAP basis for the periods indicated:
Year Ended December 31,
2000 1999 1998
-------- -------- --------
Gross Losses and LAE reserves at beginning of year $ 354,709 $ 504,911 $ 596,797
Reinsurance Recoverable (186,559) (206,139) (204,336)
--------- --------- ---------
Net Losses and LAE reserves at beginning of year 168,150 298,772 392,461
Increases (decreases) in provisions for losses and
LAE for claims incurred:
Current year 169,333 268,931 396,091
Prior year (5,862) (22,167) (769)
Losses and LAE payments for claims incurred:
Current year (120,888) (198,503) (269,369)
Prior year (117,094) (178,883) (219,642)
--------- --------- ---------
Net Losses and LAE reserves at end of year 93,639 168,150 298,772
Reinsurance Recoverable 170,050 186,559 206,139
--------- --------- ---------
Gross loss and LAE Reserves $ 263,689 $ 354,709 $ 504,911
========= ========= =========
The reconciliation between statutory basis and GAAP basis reserves for each of
the three years in the period ended December 31, 2000, is shown below:
Year Ended December 31,
2000 1999 1998
-------- -------- --------
(in thousands)
Statutory reserves $142,116 $207,351 $363,139
Adjustments for salvage and subrogation (1) -- -- (11,250)
Retroactive Reinsurance and other amounts (48,477) (39,201) (53,117)
Gross-up of amounts netted against Reinsurance recoverable 170,050 186,559 206,139
-------- -------- --------
Reserves on a GAAP basis $263,689 $354,709 $504,911
======== ======== ========
- ----------
(1) Salvage and subrogation recoverable amounts were included in the 2000 and
1999 statutory reserves in accordance with Illinois Department of Insurance
regulations. Prior to 1999, we reported our statutory reserves under
Alabama regulations which do not allow such adjustments.
The following table shows the development of the reserves for unpaid losses
and LAE from 1989 through 1999 for our insurance subsidiaries on a GAAP basis
net of Reinsurance recoveries. The top line of the table shows the liabilities
at the balance sheet date for each of the indicated years. This reflects the
estimated amounts of losses and LAE for claims arising in that year and all
prior years that are unpaid at the balance sheet date, including losses incurred
but not yet reported to us. The upper portion of the table shows the cumulative
amounts subsequently paid as of successive years with respect to the liability.
The lower portion of the table shows the reestimated amount of the previously
recorded liability based on experience as of the end of each succeeding year.
The estimates change as more information becomes known about the frequency and
severity of claims for individual years. A redundancy (deficiency) exists when
the reestimated liability at each December 31 is less (greater) than the prior
liability estimate. The "cumulative redundancy (deficiency)" depicted in the
table, for any particular calendar year, represents the aggregate change in the
initial estimates over all subsequent calendar years.
10
Year Ended December 31,
------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
------- ------- ------- -------- -------- -------- -------- -------- -------- ------- ------
(in thousands)
Liability for unpaid
losses and LAE.................... $27,823 $21,919 21,976 $ 29,688 $ 66,648 $118,733 $112,932 $392,461 $298,772 168,150 93,639
Paid (cumulative) as of
One year later.................... 11,864 13,166 20,517 20,761 51,527 88,377 86,978 197,477 178,883 117,094
Two years later................... 14,949 17,054 20,272 28,766 65,360 116,388 114,704 253,109 236,301
Three years later................. 17,096 16,810 20,281 34,776 66,490 125,299 131,342 287,385
Four years later.................. 18,093 16,622 23,272 33,139 72,273 137,081 137,926
Five years later.................. 19,206 18,140 20,994 38,222 81,156 139,485
Six years later................... 20,683 16,218 22,964 46,298 82,336
Seven years later................. 20,391 17,922 31,006 47,185
Eight years later................. 22,284 25,941 31,776
Nine years later.................. 30,299 26,417
Ten years later................... 30,772
Liability reestimated as of
End of year....................... 27,823 21,919 21,976 29,688 66,648 118,733 112,932 392,461 298,772 168,150 93,639
One year later.................... 28,779 21,853 28,530 28,930 61,033 127,790 99,708 391,692 276,605 162,289
Two years later................... 29,431 19,009 27,914 34,219 66,582 110,437 144,986 353,969 255,915
Three years later................. 29,130 19,817 26,120 38,940 66,713 118,657 132,761 344,726
Four years later.................. 29,578 16,470 30,435 41,517 76,863 146,090 140,775
Five years later.................. 26,291 19,862 33,845 50,993 88,770 144,256
Six years later................... 29,493 23,760 40,317 53,330 86,357
Seven years later................. 36,400 29,574 37,953 51,482
Eight years later................. 40,568 33,388 35,850
Nine years later.................. 37,804 30,973
Ten years later................... 35,298
Cumulative redundancy/(deficiency).. (7,475) (9,054) (13,874) (21,794) (19,709) (25,523) (27,843) 47,735 42,857 5,862
We reinsured a number of casualty risks in the early 1980's which could result
in claims for coverage of asbestos related and other environmental impairment
liabilities to the extent that such liabilities were not excluded from the
underlying policies. Our exposure to a significant loss from an asbestos or
environmental claim is minimal due to the fact that our participation in the
reinsurance treaties relating to these risks is only at the higher levels and
our percentage participation in those layers is relatively low. In addition, we
carry reinsurance which would mitigate the effect of any losses under these
treaties. While there exists a possibility that we could suffer material loss in
the event of a high number of large losses under these treaties, this is
unlikely in management's judgment.
Life Insurance Reserves
Policy liabilities: Reserves for traditional life contracts are generally
calculated using the net level premium method, based on assumptions as to
mortality, withdrawals, dividends, and investment yields ranging from 2.5% to
6.5%. These assumptions are generally made at the time the contract is issued or
at the purchase date. These assumptions are based on projections from past
experience, making allowance for possible unfavorable deviation.
Our reserves for investment-type contracts are based either on the contract
account balance (if future benefit payments in excess of the account balance are
not guaranteed) or on the present value of future benefit payments (if such
payments are guaranteed).
Investments
Our consolidated investment portfolio consists primarily of investment grade
fixed income securities. Our portfolio is managed subject to investment policies
and guidelines established by management and the Board of Directors. Our cash
and investments at December 31, 2000, totaled approximately $1.0 billion and
were classified as follows:
Type of Investment
Amount at which
Shown on % of
Balance Sheet Portfolio
--------------- ---------
(in thousands)
Cash and short-term investments $ 35,960 3.5%
Fixed maturity portfolio 798,205 78.3%
Equity securities 31,285 3.1%
Mortgage and collateral loans 63,060 6.2%
Policy loans 61,413 6.0%
Other invested assets 29,343 2.9%
---------- ------
Total $1,019,266 100.0%
========== ======
11
The value of the fixed maturities portfolio, classified by category, as of
December 31, 2000, was as follows:
Amortized Fair
Cost Value
-------- --------
(in thousands)
United States Government $ 80,235 $ 82,689
Asset-backed securities 381,099 377,383
Corporate 312,412 315,533
Municipals 21,372 22,600
-------- --------
Total $795,118 $798,205
======== ========
The National Association of Insurance Commissioners ("NAIC") has a bond rating
system that assigns securities to classes called "NAIC designations" that are
used by insurers when preparing their annual statutory financial statements. The
NAIC assigns designations to publicly-traded as well as privately-placed
securities. The designations assigned by the NAIC range from class 1 to class 6,
with a rating in class 1 being of the highest quality. We invest our fixed
maturities portfolio primarily in class 1 or 2 securities as rated by the NAIC,
which are considered investment grade. The maturity and duration of our
portfolio are managed to match the maturity and duration of the underlying life
insurance and property-casualty reserves.
Regulation
General. Our insurance companies are subject to regulation by governmental
agencies in the states in which they do business. The nature and extent of such
regulation varies by jurisdiction, but typically involves prior approval of the
acquisition of control of an insurance company or of any company controlling an
insurance company, regulation of certain transactions entered into by an
insurance company with any of its affiliates, approval of premium rates for many
lines of insurance, standards of solvency and minimum amounts of capital and
surplus which must be maintained, limitations on types and amounts of
investments, restrictions on the size of risks which may be insured by a single
company, licensing of insurers and agents, deposits of securities for the
benefit of policyholders, and reports with respect to financial condition and
other matters. In addition, state regulatory examiners perform periodic
examinations of insurance companies. Such regulation is generally intended for
the protection of policyholders rather than security holders.
In addition to the regulatory supervision of our insurance subsidiaries, we
are also subject to regulation under the Ohio, Illinois, Hawaii and Texas
Insurance Holding Company System Regulatory Acts. These Holding Company Acts
contain certain reporting requirements including those requiring us (or Vesta),
as the ultimate parent company, to file information relating to our capital
structure, ownership, and financial condition and general business operations of
our insurance subsidiaries. These Holding Company Acts contain special reporting
and prior approval requirements with respect to transactions among affiliates.
The Illinois Holding Company Act is generally the most significant to us since
it governs our relationship with Vesta Fire, our principal insurance subsidiary.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation, do affect the insurance business. Recently, a
number of state legislatures have considered or have enacted legislative
proposals that alter, and in many cases increase, the authority of state
agencies to regulate insurance companies and holding company systems. In
addition, legislation has been introduced from time to time in recent years
which, if enacted, could result in the federal government assuming a more direct
role in the regulation of the insurance industry.
NAIC: In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles which will replace the current NAIC Annual Statement Instructions and
Accounting Practices and Procedures manual as the NAIC's primary guidance on
statutory accounting. The Codification provides guidance for areas where
statutory accounting has been silent and changes current statutory accounting in
other areas. The implementation date established by the NAIC and our respective
domiciliary insurance departments is January 1, 2001. Management does not
believe that the impact of adopting Codification will be significant.
State insurance regulators and the NAIC periodically re-examine existing laws
and regulations and their application to insurance companies. In recent years,
the NAIC has approved and recommended to the states for adoption and
implementation, several regulatory initiatives designed to decrease the risk of
insolvency of insurance companies. These initiatives include risk-based capital
requirements for determining the levels of capital and surplus an insurer must
maintain in relation to its insurance and investment risks. Other NAIC
regulatory initiatives impose restrictions on an insurance company's ability to
pay dividends to its stockholders. These initiatives may be adopted by the
various states in which our subsidiaries are licensed; the ultimate content and
timing of any statutes and regulations adopted by the states cannot be
determined at this time. It is not possible to predict the future impact of
changing state and federal regulation on our operations, and there can be no
assurance that existing insurance related laws and regulations will not become
more restrictive in the future or that laws and regulations enacted in the
future will not be more restrictive.
Risk-based Capital: The NAIC's risk-based capital requirements are intended to
be used as an early warning tool to help insurance regulators identify
deteriorating or weakly capitalized companies in order to initiate regulatory
action. Such requirements are not intended as a
12
mechanism for ranking adequately capitalized companies. The formula defines a
minimum capital standard which supplements the low, fixed minimum capital and
surplus requirements previously implemented on a state-by-state basis.
The NAIC risk-based capital requirements require insurance companies to
calculate and report information under a risk-based formula which attempts to
measure statutory capital and surplus needs based on the risks in a company's
mix of products and investment portfolio. The formula is designed to allow state
insurance regulators to identify potential weakly capitalized companies. Under
the formula, a company determines its "risk-based capital" by taking into
account certain risks related to the insurer's assets (including risks related
to its investment portfolio and ceded Reinsurance) and the insurer's liabilities
(including underwriting risks related to the nature and experience of its
insurance business). Risk-based capital rules provide for different levels of
regulatory attention depending on the ratio of a company's total adjusted
capital to its "authorized control level" of risk-based capital.
At December 31, 2000, the total adjusted risk-based capital as a percentage of
authorized control level were as follows for our principal insurance
subsidiaries:
Vesta Fire Insurance Corporation 630%
American Founders Life Insurance Company 492%
Restrictions on Dividends to Stockholders. Our insurance subsidiaries are
subject to various state statutory and regulatory restrictions, generally
applicable to each insurance company in its state of incorporation, which limit
the amount of dividends or distributions by an insurance company to its
stockholders. The restrictions are generally based on certain levels of surplus,
and operating income, as determined under statutory accounting practices. Ohio,
Illinois and Texas law permits dividends in any year which, together with other
dividends or distributions made within the preceding 12 months, do not exceed
the greater of (i) 10% of statutory surplus as of the end of the preceding year
or (ii) the net income for the preceding year, with larger dividends payable
only after receipt of prior regulatory approval. Hawaii law limits dividends to
the lesser of (i) and (ii) without prior approval. Certain other extraordinary
transactions between an insurance company and its affiliates also are subject to
prior approval by the Department of Insurance. Future dividends from our
subsidiaries may be limited by business and regulatory considerations.
IRIS Ratios. The NAIC has developed its Insurance Regulatory Information
System ("IRIS") to assist state insurance departments in identifying significant
changes in the operations of an insurance company, such as changes in its
product mix, large Reinsurance transactions, increases or decreases in premiums
received and certain other changes in operations. Such changes may not result
from any problems with an insurance company but merely indicate changes in
certain ratios outside ranges defined as normal by the NAIC. When an insurance
company has four or more ratios falling outside "normal ranges," state
regulators may investigate to determine the reasons for the variance and whether
corrective action is warranted. In 2000, Vesta Fire had 3 ratios which varied
unfavorably from the "usual value" range and American Founders had 4 ratios
which varied unfavorably from the "usual value" range.
A.M. Best Rating
A.M. Best, which rates insurance companies based upon factors of concern to
policyholders, raised its rating on property-casualty insurance subsidiaries to
"B+" (Very Good, in the Secure Rating Category) from "B" (Good, in the
Vulnerable Rating Category) in February, 2000. Some of the factors noted by A.M.
Best as contributing to the upgrade include our improved financial condition,
debt restructuring, elimination of noncore business units and our focus on our
personal lines business. We believe that the current A.M. Best rating of "B+"
will assist us in increasing the number of new policy applications and
strengthen our retention ratios on our existing policies as they come up for
renewal. American Founders is also rated "B+" by A. M. Best.
To further strengthen our ability to increase new policy applications and
retain our existing policies, and to open up other opportunities, we believe we
must continue to work towards a higher rating from A.M. Best. To accomplish
that, we will focus on:
. Expanding our core book of business
. Continuing to lower our debt-to-capital ratio
. Continuing to demonstrate the ability to operate profitably.
Each of these three goals is related to our future operating performance which
is subject to a host of uncertainties and risk factors more fully discussed in
Exhibit 99.1 to this report.
Competition
Direct writers are making a strong push in the personal lines arena. These
companies compete almost exclusively based on price. While there is a segment of
the population that is driven exclusively by price, we believe that many
consumers desire the advice and counsel of a professional agent. We have
developed a business strategy which focuses on this segment of the market.
Accordingly, our relationships with our independent agents is perhaps the most
important component of our current competitive profile. In order to develop and
retain the independent agents loyalty, We have reaffirmed our commitment to the
independent agency distribution by providing innovative solutions to their daily
business issues, as well as, responding to the agency's needs as quickly as
possible.
The property and casualty insurance industry is highly competitive on the
basis of both price and service. We compete for direct business with other stock
companies, specialty insurance organizations, mutual insurance companies and
other underwriting organizations, some of
13
which are substantially larger and have greater financial resources than we
have. In recent years, there has been a trend in the property and casualty
industry toward consolidation which could result in even more competitive
pricing. In the future, the industry, including us, may face increasing
insurance underwriting competition from banks and other financial institutions.
Employees
As of January 10, 2001, we employed 486 persons. Our employees are neither
represented by labor unions nor are they subject to any collective bargaining
agreements. Management knows of no current efforts to establish labor unions or
collective bargaining agreements.
Item 2. Properties
Properties
We lease approximately 111,099 square feet for our home office at 3760 River
Run Drive, Birmingham, Alabama under a long-term operating lease from Torchmark
Development Corporation, which, until September 25, 1999 was a wholly owned
subsidiary of Torchmark Corporation. We lease approximately 8,140 square feet
for our Hawaiian operations in Honolulu, Hawaii under a long-term operating
lease. We lease approximately 25,000 square feet for our life insurance
operations in Phoenix, Arizona, under a long-term operating lease.
We consider the office facilities to be suitable and adequate for our current
and anticipated level of operations.
Item 3. Legal Proceedings
Securities Litigation
Subsequent to the filing of its quarterly report on Form 10-Q for the period
ended March 31, 1998 with the Securities and Exchange Commission, we commenced
an internal investigation to determine the exact scope and amount of certain
reductions of reserves and overstatement of premium income in Vesta's
reinsurance assumed business that had been recorded in the fourth quarter of
1997 and the first quarter of 1998. This investigation concluded that
inappropriate amounts had, in fact, been recorded and we determined that we
should restate our previously issued 1997 financial statements and first quarter
1998 Form 10-Q. Additionally, during our internal investigation we re-evaluated
the accounting methodology being utilized to recognize earned premium income in
our reinsurance business. We had historically reported certain assumed
reinsurance premiums as earned in the year in which the related reinsurance
contracts were entered even though the terms of those contracts frequently
bridged two years. We determined that reinsurance premiums should be recognized
as earned over the contract period and corrected the error in our accounting
methodology by restating previously issued financial statements. We issued press
releases, which were filed with the Securities and Exchange Commission, on June
1, 1998 and June 29, 1998 announcing our intention to restate our historical
financial statements.
We restated our previously issued financial statements for 1995, 1996 and 1997
and its first quarter 1998 Form 10-Q for the above items by issuance of a
current report on Form 8-K dated August 19, 1998. These restatements resulted in
a cumulative decrease to stockholder's equity of $75.2 million through March 31,
1998.
Commencing in June 1998, Vesta and several of its current and former officers
and directors were named in several purported class action lawsuits in the
United States District Court for the Northern District of Alabama. Several of
Vesta's officers and directors also have been named in a derivative action
lawsuit in the Circuit Court of Jefferson County, Alabama, in which Vesta is a
nominal defendant.
The class actions filed in the United States District Court for the Northern
District of Alabama have been consolidated into a single action in that district
and the derivative case has been placed on the administrative docket. The class
representatives in that action filed (a) a consolidated amended complaint
alleging that the defendants violated the federal securities laws and (b) a
motion for class certification, which was granted in 1999. The consolidated
amended complaint also added as defendants Torchmark Corporation and our
predecessor auditors, KPMG Peat Marwick, LLP. The consolidated amended complaint
alleges various violations of the federal securities law and seeks unspecified
but potentially significant damages. Our motion to dismiss the consolidated
amended complaint was denied in October 2000. The case was recently assigned to
another judge to explore settlement possibilities, but there is no assurance
that any compromise of the securities litigation is feasible or will be
achieved.
We have notified our directors and officers liability insurance companies of
these lawsuits and the consolidated amended complaint. The securities litigation
is presently in the discovery stage. We intend to vigorously defend this
litigation and intend to explore all available rights and remedies it may have
under the circumstances. In related litigation, in September, 1998, Cincinnati
Insurance Company ("Cincinnati"), one of Vesta's directors and officers
liability insurance carriers, filed a lawsuit in the United States District
Court for the Northern District of Alabama seeking to avoid coverage under its
directors and officers liability and other policies. We filed a motion to
dismiss Cincinnati's complaint on jurisdictional grounds in federal court (which
was granted), and filed a lawsuit against Cincinnati in the Circuit Court of
Jefferson
14
County, Alabama seeking damages arising out of Cincinnati's actions. Cincinnati
has filed an answer and counterclaim in that case again seeking to avoid
coverage. This litigation is in the discovery stage.
Indemnification Agreements and Liability Insurance
Pursuant to Delaware law and our by-laws, we are obligated to indemnify our
current and former officers and directors for certain liabilities arising from
their employment with or services to Vesta, provided that their conduct complied
with certain requirements. Pursuant to these obligations, we have been
advancing costs of defense and other expenses on behalf of certain current and
former officers and directors, subject to an undertaking from such individuals
to repay any amounts advanced in the event a court determines that they are not
entitled to indemnification.
We have purchased directors' and officers' liability insurance ("D&O
insurance") for the purposes of covering among other things the costs incurred
in connection with these indemnification obligations. For the period in which
most of the claims against Vesta and certain of its directors and officers were
asserted, we had in place a primary D&O insurance policy providing $25 million
in coverage and an excess D&O insurance policy for an additional $25 million in
coverage. The issuer of the primary D&O insurance policy, Cincinnati, has
attempted to avoid coverage as discussed above, and we are vigorously resisting
its efforts to do so.
Subsequent to the initiation of the class actions described above, we secured
additional excess D&O insurance providing coverage for losses in excess of $50
million up to $110 million, or additional excess coverage of $60 million for the
class action securities litigation. We paid for this additional coverage in full
in 1998.
These matters are in their early stages and their ultimate outcome cannot be
determined. Accordingly, we have not currently set aside any financial reserves
relating to any of the above-referenced actions. Of course, we cannot predict
the outcome of any of these matters. See Exhibit 99.1.
Other Litigation and Arbitration
Vesta, through its subsidiaries, is routinely a party to pending or threatened
legal proceedings and arbitration relating to the regular conduct of its
insurance business. These proceedings involve alleged breaches of contract,
torts, including bad faith and fraud claims and miscellaneous other specified
relief. Based upon information presently available, and in light of legal and
other defenses available to Vesta and its subsidiaries, management does not
consider liability from any threatened or pending litigation regarding routine
matters to be material.
As discussed above, we corrected our accounting for assumed reinsurance
business through restatement of our previously issued financial statements.
Similar corrections were made on a statutory accounting basis through recording
cumulative adjustments in Vesta Fire's 1997 statutory financial statements. The
impact of this correction has been reflected in amounts ceded under our 20
percent whole account quota share treaty which was terminated on June 30, 1998
on a run-off basis. We believe such treatment is appropriate under the terms of
this treaty and have calculated the quarterly reinsurance billings presented to
the three treaty participants accordingly. The aggregate amount included herein
as recoverable from such reinsurers totaled $55.2 million at December 31, 2000.
We have collected approximately $48.5 million from the drawdown of collateral on
hand.
NRMA, one of the participants in the 20 percent whole account quota share
treaty, filed a lawsuit in the United States District Court for the Northern
District of Alabama contesting the Vesta's claim and the validity of the treaty,
and seeking return of the $34.5 million of drawn down collateral. Vesta filed a
demand for arbitration as provided for the treaty and filed a motion to compel
arbitration which was granted in the United States District Court action. Vesta
filed for arbitration against the other two participants on the treaty and all
those arbitrations are in their early stages. While management believes its
interpretation of the treaty's terms and computations based thereon are correct,
these matters are in their early stages and their ultimate outcome cannot be
determined at this time.
During 1999, F&G Re (on behalf of USF&G), filed for arbitration under two
aggregate stop loss reinsurance treaties whereby F&G Re assumed certain risk
from the Vesta. F&G Re is seeking to cancel the treaties and avoid its
obligation. Based on the terms of the two treaties, Vesta will be entitled to
recoveries of approximately $28.2 million as losses from prior accident years
mature. Vesta has recorded a reinsurance recoverable of $28.2 million at
December 31, 2000 and 1999 related to these two treaties. While management
believes that the treaties with F&G Re are valid and legal treaties, this
arbitration is in its early stage and the ultimate outcome cannot be determined
at this time.
A dispute has also arisen with CIGNA Property and Casualty Insurance Company
(now ACE USA) under a personal lines insurance quota share reinsurance
agreement, whereby we assumed certain risks from CIGNA. During September 2000,
CIGNA filed for arbitration under the reinsurance agreement, seeking payment of
the balances that CIGNA claims are due under the terms of the treaty. In
addition, during the fourth quarter, the treaty was terminated on a cut-off
basis. Vesta is seeking recoupment of all improper claims payments and
excessive expense allocations and charges from CIGNA. This arbitration is in
its early stages and the ultimate outcome cannot be determined at this time.
On September 23, 1999, Torchmark Corporation, formerly Vesta's largest common
stockholder, filed a lawsuit in the Circuit Court of Jefferson County, Alabama
against Vesta asserting breach of contract, conversion and breach of duty in
connection with the Company's preparation and filing of a registration statement
covering its shares in accordance with certain registration rights claimed by
Torchmark. This claim seeks an injunction requiring a registration statement to
be filed, as well as compensatory and punitive damages. During the course of
this litigation, Vesta repurchased its stock from Torchmark which was the
subject of such registration rights. This litigation is in its early stages, and
management is unable to assess the damages that may be awarded, if any. However,
management does not believe that such damages, if any, would materially and
adversely affect the Company's financial position or result of operation.
15
On June 23, 1999, a subsidiary of Torchmark filed suit in the Circuit Court of
Jefferson County, Alabama against two subsidiaries of Vesta. The lawsuit claims
that the Vesta's subsidiaries have failed to pay certain sums due under a
marketing and administrative services agreement between the parties. The suit
also seeks payment of certain commissions and administrative expenses.
Management does not believe that such damages awarded as a result of this
litigation, if any, would materially and adversely affect our financial position
or results of operation.
Item 4. Submission of Matters to a Vote of Security Holders
None.
16
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matter
Price Range of Common Stock and Dividend Policy
Market Prices. Our common stock trades on the New York Stock Exchange under
the symbol "VTA."
Quarterly high and low market prices of our common stock in 2000 and 1999 were
as follows:
Quarter Ended High Low
2000
March 31 $6.81 $3.88
June 30 7.06 4.56
September 30 6.75 4.56
December 31 5.56 4.50
1999
March 31 $7.94 $4.00
June 30 6.00 4.00
September 30 5.38 4.19
December 31 4.75 3.75
Dividend Policy and History. The declaration and payment of dividends will be
at the discretion of our Board of Directors and will depend upon many factors,
including our financial condition and earnings, the capital requirements of our
operating subsidiaries, legal requirements and regulatory constraints.
The dividends we paid on our common stock for the past three years were as
follows (in thousands):
Quarter Ended 2000 1999
----- -----
March 31 $ 235 $ 698
June 30 235 -0-
September 30 235 -0-
December 31 235 -0-
Illinois, Ohio, Hawaii and Texas impose restrictions on the payment of
dividends to us by our insurance subsidiaries under their regulatory authority
in excess of certain amounts without prior regulatory approval. See, "Business--
Regulation--Restrictions on Dividends to Stockholders."
17
Item 6. Selected Financial Data
The following information should be read in conjunction with Vesta's
Consolidated Financial Statements and related notes reported elsewhere in this
Form 10-K.
Year Ended December 31,
2000 1999 1998 1997 1996
---------- -------- ---------- ---------- --------
(in thousands, except share amounts)
Statement of Operations Data*
Net premiums written $ 210,742 $227,807 $ 264,839 $ 150,526 $ 70,803
Net premiums earned 216,999 248,076 247,063 132,333 63,206
Net Investment Income 45,903 25,949 26,565 31,960 21,374
Policy fees 2,209 -- -- -- --
Realized gains (losses) (2,061) 12,756 3,272 3,283 32
Other 2,103 4,527 5,473 2,094 188
---------- -------- ---------- ---------- --------
Total revenues 265,153 291,308 282,373 169,670 84,800
Policyholder benefits, losses and LAE incurred 135,042 165,014 167,413 69,645 25,631
Policy acquisition and other underwriting
expenses 95,821 87,451 132,032 63,702 35,366
Loss on asset impairment -- -- 65,496 -- --
Goodwill and other intangible amortization 1,591 2,118 5,177 3,065 484
Interest on debt 15,105 13,215 14,054 10,859 10,059
---------- -------- ---------- ---------- --------
Total expenses 247,559 267,798 384,172 147,271 71,540
Income (loss) from continuing operations before
taxes, minority interest, and deferrable
capital securities 17,594 23,510 (101,799) 22,399 13,260
Income taxes (benefit) 5,664 7,129 (29,395) 7,973 4,307
Minority interest, net of tax 1,595 -- -- --
Deferrable capital securities distributions, net
of tax 1,986 5,632 5,449 5,051 --
---------- -------- ---------- ---------- --------
Income (loss) from continuing operations $ 8,349 $ 10,749 $ (77,853) $ 9,375 $ 8,953
Income (loss) from discontinued operations, net
of tax (2,397) 12,706 (63,331) 27,485 27,860
Extraordinary gain on debt extinguishments, net
of tax 5,250 -- -- -- --
Preferred stock dividend (3,670) (563) -- -- --
Gain on redemption of preferred securities, net
of tax 9,190 9,548 -- -- --
---------- -------- ---------- ---------- --------
Net income available to common stockholders $ 16,722 $ 32,440 $ (141,184) $ 36,860 $ 36,813
========== ======== ========== ========== ========
Diluted net income (loss) from continuing
operations per share $ 0.34 $ 0.53 $ (4.20) $ 0.49 $ 0.47
========== ======== ========== ========== ========
Diluted net income (loss) from discontinued
operations per share $ (0.10) $ 0.63 $ (3.41) $ 1.44 $ 1.45
========== ======== ========== ========== ========
Diluted net income (loss) available to common
shareholders per share $ 0.78 $ 1.63 $ (7.61) $ 1.93 $ 1.92
========== ======== ========== ========== ========
Shares used in per share calculation 24,255 20,202 18,549 19,053 19,157
Cash dividends per share 0.05 0.04 0.15 0.15 0.20
Balance Sheet Data (at end of period)
Total investments and cash $1,019,266 $483,997 $ 634,668 $ 656,816 $427,276
Total assets 1,621,999 915,809 1,347,702 1,636,859 871,385
Reserves for losses, LAE & future policy
benefits 923,973 354,709 504,911 596,797 173,275
Long term debt 86,419 141,876 98,302 98,602 98,279
Federal Home Loan Bank advances 150,691
Total liabilities 1,373,663 674,519 1,089,675 1,239,523 599,466
Deferrable capital securities 33,225 41,225 100,000 100,000 --
Stockholders' equity 215,111 200,065 158,027 297,336 271,919
Other Data
SAP (1)
Surplus $ 275,270 $271,986 $ 213,251 $ 317,875 $352,695
========== ======== ========== ========== ========
- --------------
* As a result of Vesta's decision in 2000 to discontinue its reinsurance
assumed business, and its decision in 1999 to discontinue its commercial
lines segment, all periods presented have been reclassified to present
operations on a continuing and discontinued basis.
(1) Statutory data have been derived from the financial statements of Vesta
prepared in accordance with SAP and filed with insurance regulatory
authorities.
18
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Overview
Vesta writes insurance on selected personal lines risks only. Our Standard-
Property Casualty writings are balanced between risks of property damage (faster
determination of ultimate loss but is highly unpredictable) and casualty
exposure (more predictable but takes longer to determine the ultimate loss). We
also write life and annuity business, and in 2001 will write accident and health
insurance business. Additionally, we are actively involved in the writing of
insurance on our policies for the benefit of reinsurance companies, commonly
referred to as servicing carrier or fronting, which generates fee-for-service
income.
Our revenues from operations are derived primarily from net premiums earned on
risks written by our insurance subsidiaries, investment income and investment
gains or losses. Our expenses consist primarily of payments for claims and
underwriting expenses, including agents' commissions and operating expenses.
Comparison of Fiscal Year 2000 to Fiscal Year 1999
Income available to common shareholders decreased by $15.7 million, or 48.4%
to $16.7 million for the year ended December 31, 2000, from $32.4 million for
the year ended December 31, 1999. On a diluted per share basis, income available
to common shareholders for 2000 was $0.78 per share versus income of $1.63 per
share for 1999. The decrease in income available to common shareholder is
primarily attributable to $8.3 million of after tax realized gains recognized
during 1999 and the recognition of a $1.1 million after tax loss from the sale
of a building in Shelby, Ohio in 2000. Also, in the fourth quarter of 2000, our
last active reinsurance assumed contract was cancelled and we are presenting its
reinsurance assumed segment as a discontinued operation. In 1999, our
discontinued operations, which include the former commercial and reinsurance
assumed segments, reported net income of $12.7 million compared to a loss of
$2.4 million in 2000. The 1999 results for our discontinued operations included
a $15 million pre-tax gain related to the sale of the bulk of our reinsurance
assumed operations.
Standard Property-Casualty
Net premiums written for standard property-casualty lines decreased by $22.4
million, or 9.8%, to $205.4 million for the year ended December 31, 2000, from
$227.8 million for the year ended December 31, 1999. Net premiums earned for
standard property-casualty lines decreased $35.3 million, or 14.2% to $ 212.8
million for the year ended December 31, 2000, from $248.1 million for the year
ended December 31, 1999. The decrease in net premiums written and net premiums
earned are primarily attributable to the decrease in new policy applications
that occurred when we were temporarily downgraded by A.M. Best to a B (good) and
to our strategy of only maintaining relationships with our core agencies,
partially offset by the continued rollover of the Property Plus homeowners
policies acquired in 1998. In February 2000, A.M. Best upgraded Vesta to B+
(secure).
Loss and loss adjustment expenses ("LAE") for standard property-casualty
lines decreased by $40.2 million, or 24.4%, to $124.8 million for the year ended
December 31, 2000, from $165.0 million for the year ended December 31, 1999. The
loss and LAE ratio for property-casualty lines for the year ended December 31,
2000 was 58.6% as compared to 66.5% at December 31, 1999. The decrease in loss
and LAE incurred is primarily attributable to the decline in earned premium. The
decrease in the loss and LAE ratio is primarily attributable to a decrease in
catastrophe losses in the current versus the prior year and to the recognition
of increased estimated salvage and subrogation from prior years.
Policy acquisition expenses increased by $6.1 million, or 13.2 % to $52.4
million for the year ended December 31, 2000, from $46.3 million for the year
ended December 31, 1999 primarily due to an increase in contingent commissions
owed on profitable business and the additional premium earned on our Property
Plus book of business, which pays a higher commission than our other books of
business. Operating expenses decreased by $2.2 million or 7.6% to $26.6 million
as we continued our efforts to control costs.
Life Insurance
On June 30, 2000, we entered the life and annuity business through a 71%
investment in American Founders Financial Corporation , a holding company for
two life insurance companies domiciled in Texas. American Founders has
approximately $1.8 billion (face value) of life products in force and
approximately $339 million of annuity deposits as of December 31, 2000.
Premiums and policy fees were $5.3 million for the year ended December 31, 2000
compared to zero for the comparable prior period due to the acquisition of
American Founders on June 30, 2000. American Founders has approximately $2.1
billion face amount of life insurance and annuities in force at December 31,
2000.
Specialty Lines
Net premiums written for specialty lines were $2.2 million for the year ended
December 31, 2000. Net premiums earned for specialty lines were $1.1million for
the year ended December 31, 2000. For the year ended December 31, 2000, we
earned approximately $1.0 million of fronting fees.
19
Net Investment Income
Net investment income increased by $20.0 million, or 77.2%, to $45.9 million
for the year ended December 31, 2000, from $25.9 million for the year ended
December 31, 1999. The weighted average yield on invested assets (excluding
realized and unrealized gains) was 6.7% for the year ended December 31, 2000,
compared with 6.5% for the year ended December 31, 1999. The increase in
investment income is primarily attributable to an increase in average invested
assets from the American Founders acquisition and an increased investment yield
resulting from a lower percentage of tax-exempt securities in the current
portfolio.
Income Taxes
Income taxes decreased by $1.4 million, or 19.7%, to $5.7 million for the
year ended December 31, 2000. The effective rate on pre-tax income increased to
32.2% for the year ended December 31, 2000 versus 30.3% for the year ended
December 31, 1999 due to lower tax exempt investment income in 2000 versus 1999.
Comparison of Fiscal Year 1999 to Fiscal Year 1998
Income available to common shareholders increased by $173.6 million to $32.4
million for the year ended December 31, 1999, from a $141.2 million loss for the
year ended December 31, 1998. On a diluted per share basis, income available to
common shareholders for 1999 was $1.63 per share versus a loss of $7.61 per
share for 1998. The increase in income available to common shareholders is
primarily attributable to a $42.6 million after tax loss on goodwill impairment
recorded in 1998 and $12.7 million of net income from the our discontinued
segments, reinsurance assumed and commercial lines, in 1999 versus a net loss of
$63.3 million in 1998. The $12.7 million of net income from our discontinued
segments in 1999, was primarily a result of a $15 million pre-tax gain from the
sale of a portion of our reinsurance assumed segment.
Standard Property-Casualty
Net premiums written for standard property-casualty lines decreased by $37
million, or 14.0%, to $227.8 million for the year ended December 31, 1999, from
$264.8 million loss for the year ended December 31, 1998. Net premiums earned
for standard property-casualty lines increased $1.0 million, or .4% to $248.1
million for the year ended December 31, 1999, from $247.1 million for the year
ended December 31, 1998. Net premiums written decreased primarily due to the
sale of Vesta County Mutual in early 1999.
Loss and loss adjustment expenses ("LAE") for standard property-casualty
lines decreased by $2.4 million, or 1.4%, to $165.0 million for the year ended
December 31, 1999, from $167.4 million for the year ended December 31, 1998. The
loss and LAE ratio for property-casualty lines for the year ended December 31,
1999 was 66.5% as compared to 67.8% at December 31, 1998. The decrease in loss
and LAE incurred is primarily attributable to the decline in earned premium. The
changes in losses incurred and the Loss and LAE ratio is due to normal
variations in claims from year to year.
Policy acquisition expenses decreased by $12.9 million, or 21.8% to $46.3
million for the year ended December 31, 1999, from $59.2 million for the year
ended December 31, 1998 primarily due to the decrease in earned premium.
Operating expenses decreased 31.8 million or 52% as we reduced costs in line
with reductions in written premium.
Net Investment Income
Net investment income decreased by $.7 million, or 2.6%, to $25.9 million for
the year ended December 31, 1999, from $26.6 million for the year ended December
31, 1998. The weighted average yield on invested assets (excluding realized and
unrealized gains) was 6.5% for the year ended December 31, 1999, compared with
5.8% for the year ended December 31, 1998.
Income Taxes
Income taxes increased by $36.5 million, to 7.1 million for the year ended
December 31, 1999. The effective rate on pre-tax income increased to 30.3% for
the year ended December 31, 1999 versus 28.9% for the year ended December 31,
1998 due to lower tax exempt investment income.
Liquidity and Capital Resources
Vesta is a holding company whose principal asset is its investment in the
capital stock of the companies constituting the Vesta Insurance Group, a group
of wholly owned property and casualty insurance companies including Vesta Fire
and a majority ownership in a life insurance holding company which includes
American Founders Life Insurance Company. The insurance subsidiaries comprising
the Vesta Group are individually supervised by various state insurance
regulators. Vesta Fire and American Founders are our principal operating
subsidiaries.
20
Dividends and Management Fees
The principal uses of funds at the holding company level are to pay operating
expenses, principal and interest on outstanding indebtedness and deferrable
capital securities and dividends to stockholders if declared by the Board of
Directors. During the last three years, our insurance subsidiaries have produced
operating results and paid dividends sufficient to fund our needs. Except for
the regulatory restrictions described above, we are not aware of any demands or
commitments of the insurance subsidiaries that would prevent them from paying
dividends sufficient to meet our anticipated needs (including debt service) for
at least the next twelve months. See, "Business--Regulation."
As a holding company with no other business operations, we rely primarily on
fees generated by our management agreement with our insurance subsidiaries and
dividend payments from Vesta Fire to meet our cash requirements (including our
debt service) and to pay dividends to our stockholders. Transactions between
Vesta and its insurance subsidiaries, including the payment of dividends and
management fees to Vesta by such subsidiaries, are subject to certain
limitations under the insurance laws of those subsidiaries' domiciliary states.
The insurance laws of the state of Illinois, where Vesta Fire is domiciled,
permit the payment of dividends in any year which, together with other dividends
or distributions made within the preceding 12 months, do not exceed the greater
of 10% of statutory surplus as of the end of the preceding year or the net
income for the preceding year, with larger dividends payable only after receipt
of prior regulatory approval.
Commercial Credit Facilities
On March 3, 2000 we established a revolving credit facility with First
Commercial Bank, Birmingham, Alabama ("First Commercial") which consists of the
following lines of credit:
. a $7.5 million unsecured line which bears interest at First Commercial's
prime rate + 1/4%;
. an additional $7.5 million line, secured by a pledge of the management
contract between our wholly owned management company, J. Gordon Gaines,
Inc., and our operating insurance subsidiaries, which carries interest
at First Commercial's prime rate.
Each of these newly established credit facilities mature on December 31, 2002.
In addition, the credit agreements related to these facilities contain typical
financial covenants which require us to maintain certain financial standards.
As of December 31, 2000, $10 million of the credit facility is available.
Long Term Debt, Deferrable Capital Securities and Preferred Stock
We extinguished $13.1 million of our 8.75% Senior Debentures for approximately
$9.8 million plus accrued interest and all $44.1 million of our 12.5% Senior
Notes for approximately $38.2 million, plus accrued interest. In December 2000,
we completed two debt for equity swaps in which we exchanged 1.2 million shares
of common stock for $8.0 million face amount of deferrable capital securities.
We recognized a total after-tax gain of $6.6 million from these transactions. In
the fourth quarter of 2000, Vesta redeemed preferred stock of a subsidiary with
a stated value of $21 million and a carrying value of $18 million for $7.0
million. We recognized an after-tax gain of $7.9 million, net of minority
interest, on this transaction.
Annual distribution obligations for our long term debt, deferrable capital
securities and preferred stock outstanding at December 31, 2000 were as follows:
Security Principal Annual Interest
Obligation
8.75% Senior Debentures due 2025 $87 million $7.6 million
8.525% Deferrable Capital Securities due 2027 $33.3million $2.8 million
Series A Convertible Preferred Stock $25 million $2.25 million
Subsidiary Preferred Stock $7 million $.5 million
Subsequent to December 31, 2000, the holders of the Series A convertible
preferred stock converted their holding to common stock, and we repurchased the
5.9 million converted shares for $47.2 million. We also completed an additional
debt for equity swap in January 2001, exchanging 380 thousand shares of common
stock for $3.5 million face amount of deferrable capital securities.
Cash flows
The principal sources of funds for our insurance subsidiaries are premiums,
investment income and proceeds from the sale or maturity of invested assets.
Such funds are used principally for the payment of claims, operating expenses,
commissions and the purchase of investments. As is typical in the insurance
industry, we collect cash in the form of premiums and invest that cash until
claims are paid. Cash collected from
21
premiums and cash paid for claims is included in cash flow from operations,
while the cash impact from our investing activities is included in cash flow
from investing activities. In periods such as 1999 and 2000, where we are
exiting certain lines of business such as commercial lines and reinsurance
assumed lines we are funding the payout of commercial and reinsurance assumed
claims through the liquidation of invested assets, consistent with the
historical insurance business model. However, this generates cash outflows from
operations that can be misleading.
On a consolidated basis, net cash used in operations for the years ended
December 31, 2000 and 1999, was $59.0 million and $103.3 million, respectively.
Of those amounts, for the years ended December 31, 2000 and 1999, approximately,
$ 47.9 million and $117.3 million, respectively represented the cash outflows
from our reinsurance assumed and commercial lines, funded with the liquidation
of their corresponding invested assets. Net cash provided by investing
activities was $128.7 million and $136.4 million for the years ended December
31, 2000 and 1999, respectively as we funded the discontinuance of the
reinsurance assumed and commercial lines of business. We also utilized the
excess cash generated by our investing activities to retire debt and other
financing activities. Net cash used in financing activities was $73.9 million
and $40.8 million for the years ending December 31, 2000 and 1999, respectively
as we aggressively repurchased outstanding debt.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk of Financial Instruments
Vesta's principal assets are financial instruments, which are subject to the
market risk of potential losses from adverse changes in market rates and prices.
Our primary risk exposures on assets are interest rate risk on fixed maturity
investments, and mortgage and collateral loans and equity price risk for
domestic stocks. In addition, our outstanding annuity liabilities are subject to
interest rate risk, although, many of our products contain surrender charges and
other features that reward persistency and penalize early withdrawal of funds.
Vesta manages its exposure to market risk by selecting investment assets with
characteristics such as duration, yield and liquidity to reflect the underlying
characteristics of the related insurance.
The following table sets forth the estimated market values of our fixed
maturity investments, mortgage and collateral loans, annuities, and equity
investments resulting from a hypothetical immediate 100 basis point adverse
change in interest rates and a 10% decline in market prices for equity
exposures, respectively from levels prevailing at December 31, 2000.
Amount
(in thousands)
--------------
Fixed Maturity Investments $768,813
Equity Investments 28,157
Mortgage and collateral loans 60,003
Annuity liabilities 327,465
The decrease in fair values based on an adverse change in interest rates for
fixed maturity investments, mortgage and collateral loans, and annuity
liabilities, was determined by estimating the present value of future cash flows
using various models, primarily duration modeling.
The decrease in fair value of equity securities based on a decrease in the
market prices of all equity securities was estimated as 10% of the fair value.
22
Item 8. Financial Statements and Supplementary Data
Page
----
Report of Independent Accountants 24
Consolidated Balance Sheets at December 31, 2000 and 1999 25
Consolidated Statements of Operations and Comprehensive Income (loss)
for each of the years in the three-year period ended December 31, 2000 26
Consolidated Statements of Stockholders' Equity for each of the years
in the three-year period ended December 31, 2000 27
Consolidated Statements of Cash Flows for each of the years
in the three-year period ended December 31, 2000 28
Notes to Consolidated Financial Statements 29
23
Report of Independent Accountants
To the Stockholders of
Vesta Insurance Group, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) present fairly, in all material respects, the
financial position of Vesta Insurance Group, Inc. and its subsidiaries at
December 31, 2000 and 1999, and the results of their operations and their cash
flows for the three years in the period ended December 31, 2000 in conformity
with accounting principles generally accepted in the United States of America.
In addition, in our opinion, the financial statement schedules listed in the
index appearing under Item 14(a)(2) present fairly, in all material respects,
the information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedules are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedules based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles and estimates made by management, and evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Birmingham, Alabama
March 1, 2001
24
Vesta Insurance Group, Inc
Consolidated Balance Sheets
(amounts in thousands, except share data)
December 31,
2000 1999
---------- --------
Assets:
Investments:
Fixed maturities available for sale - at fair value (cost: 2000 - $795,118;
1999 - $348,760) $ 798,205 $339,429
Equity securities--at fair value: (cost: 2000-- $30,221; 1999-- $2,092) 31,285 1,865
Mortgage and collateral loans 63,060 --
Policy loans 61,413 --
Short-term investments 22,586 125,026
Other invested assets 29,343 --
---------- --------
Total investments 1,005,892 466,320
Cash 13,374 17,677
Accrued investment income 17,017 5,460
Premiums in course of collection (net of allowances for losses
of $3,937 in 2000 and $2,412 in 1999) 23,882 41,206
Reinsurance balances receivable 353,949 193,345
Reinsurance recoverable on paid losses 57,325 77,925
Deferred policy acquisition costs 45,954 40,357
Property and equipment 14,010 15,602
Deferred income taxes 22,457 13,489
Other assets 68,139 44,428
---------- --------
Total assets $1,621,999 $915,809
========== ========
Liabilities:
Policy liabilities $ 660,284 --
Losses and loss adjustment expenses 263,689 $354,709
Unearned premiums 104,755 133,029
Federal Home Loan Bank advances 150,691 --
Short term debt 5,000 5,000
Long term debt 86,419 141,876
Other liabilities 102,825 39,905
---------- --------
Total liabilities 1,373,663 674,519
Commitments and contingencies: See Note F
Deferrable Capital Securities 33,225 41,225
Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized, issued:
2000 - 2,950,000 and 1999 - 2, 950,000 30 30
Common stock, $.01 par value, 32,000,000 shares authorized, issued:
2000 - 18,964,322 and 1999 - 18,964,322 190 190
Additional paid-in capital 167,382 172,272
Accumulated other comprehensive income, net of tax (benefit)
expense of $1,453 and $(3,346) in 2000 and 1999, respectively 2,698 (6,213)
Retained earnings 57,643 41,862
Treasury stock (166,294 shares and 138,490 shares at cost)
at December 31, 2000 and 1999, respectively (5,865) (6,274)
Unearned stock (6,967) (1,802)
---------- --------
Total stockholders' equity 215,111 200,065
---------- --------
Total liabilities, deferrable capital securities and
stockholders' equity $1,621,999 $915,809
========== ========
See accompanying Notes to Consolidated Financial Statements
25
Vesta Insurance Group, Inc.
Consolidated Statements of Operations and Comprehensive Income (Loss)
(amounts in thousands, except share data)
Statements of Operations
For the Year Ended
December 31,
2000 1999 1998
-------- -------- ---------
Revenues:
Net premiums written $210,742 $227,807 $ 264,839
Decrease (increase) in unearned premium 6,257 20,269 (17,776)
-------- -------- ---------
Net premiums earned 216,999 248,076 247,063
Investment product policy fees 2,209 -- --
Net investment income 45,903 25,949 26,565
Realized (losses) gains (2,061) 12,756 3,272
Other 2,103 4,527 5,473
-------- -------- ---------
Total revenues