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FORM 10-K 21ST CENTURY INSURANCE GROUP
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-1935264
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification number)
6301 OWENSMOUTH AVENUE
WOODLAND HILLS, CALIFORNIA 91367
(Address of principal executive offices) (Zip Code)
(818) 704-3700
(Registrant's telephone number,
including area code) Web site: www.i21.com
SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT:
COMMON STOCK, WITHOUT PAR VALUE NEW YORK STOCK EXCHANGE
(Title of Class) (Name of each exchange
on which registered)
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant's knowledge,
in definitive proxy or information statements, incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
The aggregate market value of the voting stock held by
non-affiliates of the registrant, based on the average high and
low prices for shares of the Company's Common Stock on January
31, 2002, as reported by the New York Stock Exchange, was
approximately $422,000,000.
On January 31, 2002, the registrant had 85,362,484 shares of
common stock outstanding, without par value, which is the
Company's only class of common stock.
DOCUMENT INCORPORATED BY REFERENCE:
Portions of the definitive proxy statement used in connection
with the annual meeting of shareholders of the registrant, to be
held on June 26, 2002, are incorporated herein by reference into
Part III hereof.
PART I
ITEM 1. BUSINESS
GENERAL
21st Century Insurance Group is an insurance holding company founded in 1958 and
incorporated in California. The term "Company," unless the context requires
otherwise, refers to 21st Century Insurance Group and its wholly owned
subsidiaries, 21st Century Insurance Company and 21st Century Casualty Company,
both of which are incorporated in California as property and casualty companies.
The common stock of the Company is traded on the New York Stock Exchange under
the trading symbol "TW." Through several of its subsidiaries, American
International Group, Inc. ("AIG"), currently owns approximately 63% of the
Company's outstanding common stock.
The Company is a direct-response underwriter, which sells and services mainly
private passenger automobile insurance directly to the public without
commissioned agents. The Company has gained a reputation for excellent customer
service and for being among the most efficient and low cost providers of
personal auto insurance in the markets it serves.
The Company's business began in Los Angeles and historically has been
concentrated in Southern California, principally the greater Los Angeles
metropolitan area. In the mid-1980's, the Company expanded into the San Diego
area and, in the early 1990's, the Northern California area. In August 1996,
21st Century Insurance Company of Arizona ("21st of Arizona") began writing
private passenger automobile insurance in that state. 21st of Arizona began as a
joint venture between the Company, which owned a 49% interest, and AIG, which
owned 51% until the Company acquired that interest on January 1, 2002. In late
1998, the Company began writing private passenger automobile insurance in
Nevada, Oregon and Washington.
The Company is running off approximately 73,000 homeowner policies remaining on
its books at December 31, 2001. Under a January 1, 2002, agreement with Balboa
Insurance Company ("Balboa"), a subsidiary of Countrywide Credit Industries,
Inc. ("Countrywide"), 100% of homeowner unearned premium reserves and future
related losses are reinsured by Balboa. The Company began non-renewing homeowner
policies expiring on February 21, 2002, and thereafter. Substantially all of
these customers are expected to be offered homeowner coverage through an
affiliate of Countrywide.
The Company ceased writing earthquake coverage in 1994 but remains exposed to
possible upward development in certain loss estimates relating to the 1994
Northridge Earthquake (see further discussion in Item 7 under the captions
Underwriting Results - Homeowner and Earthquake Lines in Runoff and All Other,
Critical Accounting Policies, and in Note 16 of the Notes to Consolidated
Financial Statements).
TYPES AND LIMITS OF INSURANCE COVERAGE
The Company offers the following types of insurance coverage for private
passenger automobiles in California: bodily injury liability; property damage;
medical payments; uninsured and underinsured motorist; rental reimbursement;
uninsured motorist property damage and collision deductible waiver; towing;
comprehensive and collision. Bodily injury and property damage are required by
state law and typically cover the other party's costs when the Company's
policyholder causes an accident. Uninsured and underinsured motorist are
optional coverages and cover the Company's policyholder when the other party is
at fault and has no or insufficient liability insurance to cover the insured's
injuries and loss of income. Comprehensive and Collision coverages are also
optional and cover damage to the policyholder's automobile whether or not the
insured is at fault. In some states, the Company is required to offer personal
injury protection coverage in lieu of the medical payments coverage required in
California. Policies are written for a six-month term.
2
Various limits of liability are underwritten with maximum limits of $500,000 per
person and $500,000 per accident. The most frequent bodily injury liability
limits purchased are $100,000 per person and $300,000 per accident.
The Company's personal umbrella policy ("PUP") provides liability coverage
with a limit of $1,000,000 in excess of the underlying automobile liability
coverage. Minimum underlying automobile limits of $100,000 per person and
$300,000 per accident are required. The underlying automobile coverage must be
written by the Company. The Company reinsures 90% of any PUP loss with unrelated
reinsurers.
The homeowner program utilizes an extended replacement cost policy, thereby
limiting the insured's recovery to 150% of the amount specified in the contract
for Coverage A - Dwelling and Other Building Structures. Underwriting guidelines
provide for a minimum dwelling amount of $65,000 and a maximum dwelling amount
of $750,000.
MARKETING
The Company, through its subsidiaries, markets personal auto policies in
California, Arizona, Nevada, Oregon and Washington. As a direct writer, the
Company does not incur agent commissions. Marketing efforts currently are
focused primarily on the larger urban markets in California.
The Company offers a feature-rich product, high quality service and low cost.
This combination appeals to customers in the growing segment of the market who
are comfortable assessing their own insurance needs and distinguishing genuine
value from illusion in the marketplace.
The Company's marketing and underwriting strategy is to appeal to careful and
responsible drivers, who can obtain low cost insurance by dealing directly with
the Company and thereby avoid broker and agent commissions. In addition to
referrals, the Company uses direct mail, print, radio, television, outdoor and
Internet advertising to generate sales. Because a policy is purchased directly
by the customer, the Company focuses on making the purchasing process simple and
convenient. In California and Arizona, quotes may be requested 24 hours a day, 7
days a week through a convenient, toll-free 800 number. California prospects may
also obtain an instant auto rate quotation and purchase a policy on the
Company's Internet site (http://www. i21.com).
UNDERWRITING AND PRICING
The following table indicates the concentrations of the Company's underwriting
risks for the past five years:
Percent of Direct Premiums Written
--------------------------------------
2001 2000 1999 1998 1997
- -----------------------------------------------------------------
Personal auto lines
California 94.6% 94.6% 96.4% 97.2% 97.0%
Other states 2.1 2.2 0.8 - -
- -----------------------------------------------------------------
Total auto lines 96.7 96.8 97.2 97.2 97.0
Homeowner lines in runoff 3.3 3.2 2.8 2.8 3.0
- -----------------------------------------------------------------
100.0% 100.0% 100.0% 100.0% 100.0%
- -----------------------------------------------------------------
3
The regulatory system in California requires the prior approval of insurance
rates and forms. Within the regulatory framework, the Company establishes its
premium rates based primarily on actuarial analyses of its own historical loss
and expense data. This data is compiled and analyzed to establish overall rate
levels as well as classification differentials. The Company's rates are
established at levels intended to generate underwriting profits and vary for
individual policies based on a number of rating characteristics. California law
requires that the primary rating characteristics that must be used for
automobile policies are driving record, annual mileage and number of years the
driver has been licensed. A number of other "optional" rating factors are also
permitted and used in California.
The Company is required to offer insurance to any California prospect that meets
the statutory definition of a "Good Driver." This definition includes all
drivers who have been licensed more than three years and have had no more than
one violation point count under criteria contained in the California Vehicle
Code. These criteria include a variety of moving violations and certain at-fault
accidents.
The Company reviews many of its policies prior to the time of renewal and as
changes occur during the policy period. Some mid-term changes may result in
premium adjustments, cancellations or non-renewals because of a substantial
increase in risk.
SERVICING OF BUSINESS
Computerized systems provide the information resources, telecommunications and
data processing capabilities necessary to manage the Company's business. These
systems support the activities of employees in the Company's call centers and
marketing, policy service and claims areas that are dedicated to serving the
needs of customers. New technology investments have been focused on making it
faster and easier for customers to transact business while ultimately lowering
the cost per transaction. Using the Company's Internet site, California
consumers are now able to receive a quotation, accept the quote and bind a
policy, pay their bill, inquire about the status of their policy and billing
information, make most common policy changes, submit a first notice of loss on a
claim and access a wealth of consumer information.
New Customer Relationship Management technology began to be implemented in 2001
that provides the Company's call center representatives with integrated
knowledge about customer contacts and enables speedier and even more convenient
customer service.
CLAIMS
Claims operations include the receipt and analysis of initial loss reports,
assignment of legal counsel when necessary, and management of the settlement
process. Whenever possible, physical damage claims are handled through the use
of Company drive-in claims facilities, vehicle inspection centers and Direct
Repair Program ("DRP") providers. The claims management staff administers the
claims settlement process and oversees the work of the legal and adjuster
personnel involved in that process. Each claim is carefully analyzed to provide
for fair loss payments, compliance with the Company's contractual and regulatory
obligations and management of loss adjustment expenses. Liability and property
damage claims are handled by specialists in each area.
The Company makes extensive use of its DRP to expedite the repair process. The
program involves agreements between the Company and over 130 independent repair
facilities. The Company agrees to accept the repair facility's damage estimate
without requiring each vehicle to be reinspected by Company adjusters. All DRP
facilities undergo a screening process before being accepted, and the Company
maintains an aggressive inspection audit program to assure quality results. The
Company's inspection teams visit all repair facilities each month and performs a
quality control inspection on approximately 40% of all repairable vehicles in
this program. The customer benefits by getting the repair process started
faster, and by having the repairs guaranteed for as long as the customer owns
the vehicle. The Company benefits by not incurring the overhead expense of a
larger staff of adjusters and by negotiating repair prices it believes are
beneficial. Currently, over 30% of all damage repairs are handled using the DRP
method.
4
The Company's policy with respect to vehicle repairs is not to use after market
"crash" parts. As a result, the Company believes it does not face exposure to
the types of class action suits some competitors have drawn over their use of
such parts.
The Company has established 14 claims Division Service Offices in areas of major
customer concentrations. The three Vehicle Inspection Centers, located in Los
Angeles and Orange Counties, handle total losses, thefts and vehicles which are
not driveable.
The Claims Services Division is responsible for subrogation and medical payment
claims. The Company also maintains a Special Investigations Unit, which
investigates suspected fraudulent claims. The Company believes its efforts in
this area have been responsible for saving several million dollars annually.
The Company utilizes internal legal staff to handle most aspects of claims
litigation. In-house attorneys handle approximately 70% of all lawsuits. Suits
directly against the Company and those which may involve a conflict of interest
are assigned to outside counsel.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The Company establishes a liability at each accounting date for losses and loss
adjustment expenses arising from claims, both reported and unreported, which
have been incurred but which remain to be paid. Such reserves are estimates, as
of a particular date, of the amount the Company will ultimately pay, net of any
recoverable salvage and subrogation, for claims incurred as of the accounting
date.
The Company establishes case basis reserves based upon various factors such as
the severity of the injuries and property damage sustained, and the age of the
claim.
The Company supplements the case basis reserve estimates with bulk loss
reserves, which are estimated using actuarial methodologies. These reserves are
designed to provide for claims incurred but not reported ("IBNR") as of the
accounting date, changes over time in case reserve estimates and loss adjustment
expenses which include estimates of the legal and other costs of settling
claims. The Company's reserving methodology uses aggregate trends regarding loss
frequency and severity that implicitly consider the effects of inflation, which
management believes is appropriate given the relatively short-term nature of the
Company's personal lines exposures. Management believes the use of explicit
inflation assumptions would unnecessarily complicate its methodology without
appreciably improving its accuracy or reliability. The Company does not discount
its reserves to present value for financial reporting purposes.
Reserve estimates are necessarily subject to the outcome of future events, such
as changes in medical and repair costs as well as economic and social conditions
that impact the settlement of claims. Management believes that, given the
inherent variability in any such estimates, the aggregate reserves are within a
reasonable and acceptable range of adequacy. The methods of making such
estimates and for establishing the resulting reserves are reviewed and updated
quarterly with any resulting adjustments reflected in earnings currently.
The Company believes that the earthquake loss and loss adjustment reserves
resulting from California Senate Bill 1899 ("SB 1899") cannot be estimated by
conventional reserving techniques. See further discussion in Item 7 under the
captions Underwriting Results - Homeowner and Earthquake Lines in Runoff and All
Other, Critical Accounting Policies, and Note 16 of the Notes to Consolidated
Financial Statements.
5
In the Consolidated Balance Sheets, the reserves for losses and loss adjustment
expenses are shown "gross," that is before reduction for reinsurance. A
rollforward of loss and loss adjustment expense reserves, including the effects
of changes in estimates recorded in the current year that pertain to loss events
of prior years, loss payments and reinsurance for each of the three years in the
period ended December 31, 2001, is presented in the Notes to Consolidated
Financial Statements.
The tables on the following two pages present the development of loss and loss
adjustment expense reserves, net of reinsurance (Table 1) and direct (Table 2),
for the years 1991 through 2001.
The top line of each table shows the reserves at the balance sheet date for each
of the years indicated. The upper portion of the table indicates the cumulative
amounts paid as of subsequent year-ends with respect to that reserve liability.
The lower portion of the table indicates the re-estimated amount of the
previously recorded reserves based on experience as of the end of each
succeeding year, including cumulative payments made since the end of the
respective 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 original reserve estimate is greater (less) than
the re-estimated reserves.
Each amount in the tables includes the effects of all changes in amounts for
prior periods. The tables do not present accident year or policy year
development data. Conditions and trends that have affected the development of
liabilities in the past may not necessarily occur in the future. Therefore, it
would not be appropriate to extrapolate future deficiencies or redundancies
based on the table.
Excluding the effects of the homeowner and earthquake lines shown in the tables,
which are discussed under the caption Underwriting Results - Homeowner and
Earthquake Lines In Runoff and All Other and in Note 16 of the Notes to
Financial Statements, the deficiency that emerged in the 1999 column is
primarily due to the Company's initial over-estimate of the beneficial effect on
loss costs of laws passed in prior years which limited the rights of uninsured
motorists and drunk drivers to collect non-economic damages. The deficiency in
the 2000 column, excluding the effects of the homeowner and earthquake lines, is
mainly due to the Company's under-estimate of the changes in loss severity
trends that became apparent in 2001.
6
TABLE 1 - As of December 31,
(Amounts in thousands) 1991 1992 1993 1994 1995 1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------------------------
RESERVES FOR LOSSES AND LOSS ADJUSTMENT
EXPENSES, NET OF REINSURANCE $547,098 $554,034 $574,619 $ 755,101 $ 552,320 $ 489,033 $ 388,418 $339,815
PAID (CUMULATIVE) AS OF:
One year later 320,264 327,634 344,876 519,969 351,985 304,714 251,951 265,135
Two years later 401,019 403,434 423,713 635,861 485,462 395,922 352,594 327,971
Three years later 426,412 425,671 443,055 721,445 527,908 454,246 373,841 365,407
Four years later 433,642 432,086 457,430 745,912 574,260 465,353 403,375
Five years later 436,522 434,949 460,857 787,262 583,397 493,331
Six years later 437,365 436,876 461,901 795,331 610,472
Seven years later 437,758 436,982 462,647 818,078
Eight years later 437,713 437,125 462,609
Nine years later 437,876 437,115
Ten years later 437,839
RESERVES RE-ESTIMATED AS OF:
One year later 473,209 491,048 490,166 715,637 526,730 424,406 392,039 331,119
Two years later 461,343 447,880 465,036 725,098 537,635 467,958 375,674 341,338
Three years later 440,198 438,726 453,431 751,302 579,093 465,507 376,692 415,827
Four years later 437,350 435,128 460,947 790,479 582,013 466,284 451,795
Five years later 436,929 435,942 462,372 791,377 583,536 541,432
Six years later 437,600 437,034 461,347 795,037 658,288
Seven years later 437,706 436,476 462,075 865,785
Eight years later 437,383 436,738 462,341
Nine years later 437,603 436,905
Ten years later 437,696
---------------------------------------------------------------------------------------
Redundancy (deficiency) 109,402 117,129 112,278 (110,684) (105,968) (52,399) (63,377) (76,012)
Less effect of Homeowner and Earthquake
lines in runoff * 2,959 2,978 10,524 (228,232) (181,961) (147,575) (120,767) (78,790)
---------------------------------------------------------------------------------------
Redundancy (deficiency) excluding
Homeowner and Earthquake lines $106,443 $114,151 $101,754 $ 117,548 $ 75,993 $ 95,176 $ 57,390 $ 2,778
=======================================================================================
TABLE 1 - As of December 31,
(Amounts in thousands) 1999 2000 2001
- --------------------------------------------------------------------------
RESERVES FOR LOSSES AND LOSS ADJUSTMENT
EXPENSES, NET OF REINSURANCE $ 243,398 $ 266,953 $325,778
PAID (CUMULATIVE) AS OF:
One year later 227,230 271,116
Two years later 310,570
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
RESERVES RE-ESTIMATED AS OF:
One year later 288,421 384,960
Two years later 371,946
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
--------------------------------
Redundancy (deficiency) (128,548) (118,007)
Less effect of Homeowner and Earthquake
lines in runoff * (73,128) (72,201)
--------------------------------
Redundancy (deficiency) excluding
Homeowner and Earthquake lines $ (55,420) $ (45,806)
================================
*See Note 16 of the Notes to Consolidated Financial Statements
7
TABLE 2 - As of December 31,
(Amounts in thousands) 1991 1992 1993 1994 1995 1996 1997
- -----------------------------------------------------------------------------------------------------------------------------
DIRECT RESERVES FOR LOSSES AND LOSS ADJUSTMENT
EXPENSES GROSS OF REINSURANCE $548,377 $554,541 $577,490 $ 756,243 $ 584,834 $ 543,529 $ 437,887
PAID (CUMULATIVE) AS OF:
One year later 322,273 328,193 346,874 555,203 374,011 335,387 283,760
Two years later 403,302 404,143 428,448 671,879 511,631 436,834 393,191
Three years later 428,699 428,367 447,860 757,374 556,333 497,704 416,323
Four years later 437,841 434,859 462,144 782,031 603,192 509,255 447,181
Five years later 440,795 437,631 465,571 823,376 612,416 537,581
Six years later 441,547 439,559 466,614 831,442 639,494
Seven years later 441,940 439,664 467,359 822,176
Eight years later 441,894 439,806 467,321
Nine years later 442,056 439,796
Ten years later 442,019
GROSS RESERVES RE-ESTIMATED AS OF:
One year later 489,908 507,278 492,739 751,720 556,899 467,469 436,707
Two years later 470,605 448,700 469,791 761,209 566,162 512,493 419,974
Three years later 442,513 441,436 458,233 787,392 608,020 510,359 420,765
Four years later 441,563 437,898 465,655 826,596 611,274 511,128 496,137
Five years later 441,202 438,620 467,085 827,492 612,723 585,947
Six years later 441,780 439,715 466,061 831,149 687,291
Seven years later 441,888 439,158 466,787 869,885
Eight years later 441,564 439,420 467,053
Nine years later 441,784 439,586
Ten years later 441,876
----------------------------------------------------------------------------
Redundancy (deficiency) 106,501 114,955 110,437 (113,642) (102,457) (42,418) (58,250)
Less effect of Homeowner and Earthquake
lines in runoff* 1,014 1,214 9,148 (230,036) (182,180) (148,261) (120,908)
----------------------------------------------------------------------------
Redundancy (deficiency) excluding
Homeowner and Earthquake lines $105,487 $113,741 $101,289 $ 116,394 $ 79,723 $ 105,843 $ 62,658
============================================================================
TABLE 2 - As of December 31,
(Amounts in thousands) 1998 1999 2000 2001
- --------------------------------------------------------------------------------------------
DIRECT RESERVES FOR LOSSES AND LOSS ADJUSTMENT
EXPENSES GROSS OF REINSURANCE $382,003 $ 276,248 $ 298,436 $349,290
PAID (CUMULATIVE) AS OF:
One year later 296,165 255,682 299,221
Two years later 366,078 349,063
Three years later 406,665
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
GROSS RESERVES RE-ESTIMATED AS OF:
One year later 371,774 327,977 420,954
Two years later 383,104 413,460
Three years later 458,124
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
---------------------------------
Redundancy (deficiency) (76,121) (137,212) (122,518)
Less effect of Homeowner and Earthquake
lines in runoff* (78,447) (73,288) (70,866)
---------------------------------
Redundancy (deficiency) excluding
Homeowner and Earthquake lines $ 2,326 $ (63,924) $ (51,652)
=================================
*See Note 16 of the Notes to Consolidated Financial Statements
8
COMPETITION
The personal automobile insurance market is highly competitive and is comprised
of a large number of well-capitalized companies, many of which operate in a
number of states and offer a wider variety of products than the Company. Several
of these competitors are larger and have greater financial resources than the
Company on a stand-alone basis. Based on direct premiums written for 2000
(latest publicly available information), the Company is the seventh largest
writer of private passenger automobile insurance in California. The Company's
main competition comes from other major writers who concentrate on the good
driver market.
REINSURANCE
A reinsurance transaction occurs when an insurer transfers or cedes a portion of
its exposure to a reinsurer for a premium. The reinsurance cession does not
legally discharge the insurer from its liability for a covered loss, but
provides for reimbursement from the reinsurer for the ceded portion of the risk.
The Company periodically monitors the continuing appropriateness of its
reinsurance arrangements to determine that its retention levels are reasonable
and that its reinsurers are financially sound, able to meet their obligations
under the agreements and are competitively priced.
The majority of the Company's cessions are with AIG subsidiaries, which have an
A.M. Best financial rating of A++. The A.M. Best financial ratings of the
Company's other reinsurers range from A- to A+. The Company's reinsurance
arrangements are discussed in more detail in the Notes to Consolidated Financial
Statements.
REGULATION
Insurance companies are subject to regulation and supervision by the insurance
departments of the various states. The insurance departments have broad
regulatory, supervisory and administrative powers, such as:
- - Licensing of insurance companies, agents and customer service employees
- - Prior approval, in California and some other jurisdictions, of rates, rules
and forms
- - Establishment of capital and surplus requirements and standards of solvency
- - Nature of, and limitations on, investments insurers are allowed to hold
- - Periodic examinations of the affairs of insurers
- - Annual and other periodic reports of the financial condition and results of
operations of insurers
- - Establishment of accounting rules
- - Issuance of securities by insurers
- - Restrictions on payment of dividends
- - Restrictions on transactions with affiliates
The California Department of Insurance ("CDOI") typically conducts a financial
examination of the Company's affairs every three years. The most recently
completed triennial examination was for the year ended December 31, 1996. The
triennial examination for the year ended December 31, 1999, has been extended to
cover a review of earthquake claims filed pursuant to SB 1899 and is still in
process.
Changes in state insurance laws or regulations can have a material effect on the
revenues and expenses of the Company. Currently, the CDOI has primary regulatory
jurisdiction over the Company. In general, the current regulatory requirements
in the other states in which the Company is a licensed insurer are no more
stringent than in California.
9
To the Company's knowledge, no new laws were enacted in 2001 by any state in
which the Company does business that are expected to have a material impact on
the auto insurance industry.
HOLDING COMPANY ACT
The Company's subsidiaries are also subject to regulation by the CDOI pursuant
to the provisions of the California Insurance Holding Company System Regulatory
Act (the "Holding Company Act"). Many transactions defined to be of an
"extraordinary" nature may not be effected without the prior approval of the
CDOI. In addition, there are limits on the subsidiaries' dividend paying
capacity. In 2002, the Company estimates that its insurance subsidiaries, in the
aggregate, have capacity to pay approximately $20 million in dividends to their
parent without prior approval of the CDOI.
EFFECTS OF EVENTS OF SEPTEMBER 11, 2001
The Company has no direct exposure from the events of September 11, 2001.
However, some of the Company's reinsurers do have such exposure, which could
impact their ability to meet their obligations to the Company. Based on
preliminary information received from its reinsurers, the Company does not
consider any of its reinsurance recoverables to be of doubtful collectibility.
NON-VOLUNTARY BUSINESS
Automobile liability insurers in California are required to participate in the
California Automobile Assigned Risk Plan ("CAARP"). Drivers whose driving
records or other relevant characteristics make them difficult to insure in the
voluntary market may be eligible to apply to CAARP for placement as "assigned
risks." The number of assignments for each insurer is based on the total
applications received by the plan and the insurer's market share. As of December
31, 2001, assigned risk vehicles insured remained relatively stable at 1,750
compared to 1,530 at the end of 2000. The CAARP assignments have historically
produced underwriting losses. As of December 31, 2001, this business represented
less than 1% of the Company's total direct premiums written.
Insurers offering homeowner insurance in California are required to participate
in the California FAIR Plan ("FAIR Plan"). FAIR Plan is a state administered
pool of difficult to insure homeowners. Each participating insurer is allocated
a percentage of the total premiums written and losses incurred by the pool
according to its share of total homeowner direct premiums written in the state.
The Company's FAIR Plan underwriting results for 2001 and 2000 were immaterial.
EMPLOYEES
The Company had approximately 2,500 full and part-time employees at December 31,
2001. The Company provides medical, pension and 401(k) savings plan benefits to
eligible employees according to the provisions of each plan. Employee turnover
is generally low, and the Company believes that its relationship with its
employees is excellent.
ITEM 2. PROPERTIES
The Company leases approximately 400,000 square feet of office space for its
headquarters facilities, which are located in Woodland Hills, California. The
lease term expires in February 2015, and the lease may be renewed for two
consecutive five-year periods.
The Company also leases office space in 14 other locations of which 13 locations
are in California. The Company anticipates no difficulty in extending these
leases or obtaining comparable office facilities in suitable locations.
10
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is named as a defendant in
lawsuits related to claim and insurance policy issues. Some of the actions
request extra-contractual and/or punitive damages. The actions are vigorously
defended unless a reasonable settlement appears appropriate.
Except as disclosed in the Notes to Financial Statements, the Company does not
believe the outcome of any pending legal proceedings will have a material
adverse effect on its financial position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) PRICE RANGE OF COMMON STOCK
The following table sets forth the high and low bid prices for the common stock
for the indicated periods.
2001 2000
HIGH LOW High Low
- -------------- -------------- --------------
Fourth Quarter $19.45 $14.43 $17.13 $13.13
Third Quarter 19.33 16.20 17.13 14.00
Second Quarter 18.44 15.99 22.94 15.50
First Quarter 18.66 13.26 21.50 15.56
(b) HOLDERS OF COMMON STOCK
The approximate number of holders of common stock on December 31, 2001, was 690.
(c) DIVIDENDS
Quarterly dividends of $0.16 per share were paid from the first quarter of 1999
through the second quarter of 2000. Dividends of $0.08 per share were paid from
the third quarter of 2000 through the fourth quarter of 2001.
The Company's Board of Directors considers a variety of factors in determining
the timing and amount of dividends. Accordingly, the Company's past history of
dividend payments does not assure that future dividends will be paid.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below as of the end of and for each of the
years in the five-year period ended December 31, 2001, are derived from, or
supplemental to, the Company's consolidated financial statements. The
consolidated financial statements as of December 31, 2001 and 2000, and for each
of the years in the three-year period ended December 31, 2001, are included
elsewhere in this Form 10-K.
11
All amounts set forth in the following tables are in thousands, except for the
ratios and per share data.
Years Ended December 31, 2001 2000 1999 1998 1997
- ---------------------------------------------------------------------------------------------------
PERSONAL AUTO LINES DATA
Insured vehicles at end of year 1,061 1,167 1,185 1,130 1,077
Net premiums earned $ 838,489 $ 803,770 $ 770,234 $ 773,158 $ 782,072
Loss and LAE ratio 88.1% 90.8% 77.4% 74.8% 73.5%
Expense ratio - GAAP(2) 14.9 14.2 12.3 10.5 9.3
- ---------------------------------------------------------------------------------------------------
Combined ratio(1) 103.0% 105.0% 89.7% 85.3% 82.8%
- ---------------------------------------------------------------------------------------------------
ALL LINES DATA
Net premiums earned $ 864,145 $ 825,486 $ 770,423 $ 772,864 $ 785,989
Total revenues 914,078 869,762 832,681 870,650 863,523
Loss and LAE ratio 96.7% 90.8% 78.6% 81.0% 77.3%
Expense ratio - GAAP(2) 15.0 14.4 12.9 10.2 9.4
- ---------------------------------------------------------------------------------------------------
Combined ratio(3) 111.7% 105.2% 91.5% 91.2% 86.7%
- ---------------------------------------------------------------------------------------------------
NET INCOME (LOSS) (27,568) 12,945 87,528 101,072 110,929
EARNINGS (LOSS) PER SHARE
Basic $ (0.32) $ 0.15 $ 1.00 $ 1.36 $ 1.76
Diluted (0.32) 0.15 1.00 1.19 1.37
DIVIDENDS DECLARED AND PAID 0.32 0.48 0.64 0.58 0.25
BALANCE SHEET DATA:
Total investments 855,724 913,088 943,545 1,068,621 1,084,453
Total assets 1,352,016 1,338,075 1,379,332 1,593,156 1,482,454
Unpaid losses and loss
adjustment expenses 349,290 298,436 276,248 382,003 437,887
Unearned premiums 236,473 236,519 232,702 233,689 233,402
Bank debt - - 67,500 112,500 157,500
Total liabilities 692,710 617,514 658,495 807,554 899,493
Stockholders' equity 659,306 720,561 720,837 785,602 582,961
Book value per common
share 7.72 8.46 8.39 8.97 6.93
Statutory surplus 393,119 475,640 581,440 600,654 548,003
Net premiums written to
surplus ratio 2.2:1 1.7:1 1.3:1 1.3:1 1.4:1
(1) The combined ratio for the personal auto lines was impacted by the following items: $13.6
million of costs associated with workforce reductions and the settlement of litigation
matters in 2001: Year 2000 remediation costs of $2.4 million in 1999, $5.7 million in 1998
and $1.5 million in 1997; and acceleration of restricted stock grants of $2.0
million in 1998.
(2) Increase in expense ratio from 1997 to 2001 reflects higher depreciation charges due to
investments in new technology and the effects of rate decreases taken in 1997
to 1999.
(3) In addition to the effect of the items described in Note (1) above, the combined ratio for
all lines was impacted by underwriting losses from the homeowner and earthquake lines,
which are in runoff, of $77.6 million in 2001, $2.7 million in 2000, $13.1 million in
1999, $45.5 million in 1998 and $30.3 million in 1997.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
The following table summarizes certain information pertaining to the Company's
financial condition as of or for the years ended December 31,
(Amounts in thousands, except per share data) 2001 2000 1999
- --------------------------------------------------------------------------------
Operating cash flow from auto line $ 77,037 $ 56,906 $ 78,950
Operating cash flow used by homeowner and
earthquake lines in runoff and all other (24,503) (454) (50,123)
- ---------------------------------------------------------------------------------
Net operating cash flow $ 52,534 $ 56,452 $ 28,827
- ---------------------------------------------------------------------------------
Book value per share $ 7.72 $ 8.46 $ 8.39
Statutory surplus of insurance subsidiaries 393,119 475,640 581,440
Stockholders' equity - GAAP 659,306 720,561 720,837
Net premiums written to statutory surplus ratio 2.2:1 1.7:1 1.3:1
A.M. Best financial rating A+ A+ A
S&P financial rating A+ A+ A+
The operating cash flow from the auto line for 2001 improved over 2000 primarily
due to rate increases coupled with a decrease in the quota share cession with
AIG from 8% to 6% in 2001 that offset the effects of a decline in the number of
insured units. The decline in cash flow from auto line operations from 1999 to
2000 reflected increased losses and LAE and the effects of rate decreases taken
in 1999.
Book value per share at the end of 2001 declined 9% from the end of 2000
primarily because of losses from the homeowner and earthquake lines, which are
in runoff. See further discussion below under the caption Underwriting Results -
Homeowner and Earthquake Lines in Runoff and All Other and in Note 16 of the
Notes to Consolidated Financial Statements.
The decrease in statutory surplus from 2000 to 2001 is due primarily to a net
statutory loss of $53 million and a $64 million increase in nonadmitted assets,
which includes developed software. This was partially offset by a one-time
increase of approximately $35 million resulting from the adoption of new
codified statutory accounting rules relating mainly to the admissibility of net
deferred tax assets. The decrease from 1999 to 2000 was primarily due to $95
million in dividends upstreamed to the holding company, an increase in
non-admitted assets of $26 million, which consisted primarily of developed
software, partially offset by $11 million in statutory net income.
UNDERWRITING RESULTS
The tables presented in the Notes to Consolidated Financial Statements summarize
the Company's unaudited quarterly results of operations for each of the two
years in the period ended December 31, 2001, and the results of operations by
line of business for each of the three years then ended. The following
discussion of underwriting results by line of business should be read in
conjunction with the information presented in those tables and elsewhere herein.
Personal Auto. Automobile insurance is the primary line of business written by
the Company. The Company was licensed to write automobile insurance in 21 states
at the end of 2001, compared to 7 states at the end of 2000. Vehicles insured
outside of California have accounted for less than 3% of the total in each of
the three years ended December 31, 2001. The Company will explore expansion to
new states in 2002.
13
Vehicles in force were 1,060,752, 1,166,971 and 1,184,797 as of December 31,
2001, 2000 and 1999, respectively. The decrease in 2001 and 2000 resulted from
actions taken to improve underwriting results (discussed further below). The
Company's retention rate was approximately 92% for 2001, 95% for 2000 and 96%
for 1999.
Direct premiums written were $898.9 million in 2001, $881.2 million in 2000 and
$855.8 million in 1999. The increases in 2001 and 2000 were due to rate
increases that more than offset the decline in the number of insured vehicles.
The ability of the Company to implement rate changes in California is subject to
regulation by the CDOI, which could materially affect the Company's future
operating results.
Net premiums earned were $838.5 million in 2001, $803.8 million in 2000 and
$770.2 million in 1999. The increases in 2001 and 2000 are greater than the
proportional increase in the corresponding direct premiums written because of
the decrease in the quota share reinsurance arrangement with AIG from 8% in 2000
to 6% in 2001 and from 10% in 1999 to 8% in 2000.
Underwriting results were losses of $24.4 million in 2001 and $39.8 million in
2000 compared to an underwriting profit of $79.1 million in 1999. The Company
had reduced its California rates by more than 25% from 1996 to 1999, and the
rate decreases in 1998 and 1999 had anticipated the continuation of favorable
loss trends that failed to materialize. The resultant underpricing caused the
loss and LAE ratio to grow from 77.4% in 1999 to 90.8% for 2000, with the
higher-than-anticipated losses first becoming evident in the third quarter of
1999. The loss and LAE ratio decreased to 88.1% in 2001 as corrective measures
were implemented in late 2000 and throughout 2001. Such measures included
increasing California auto rates by 6.4% in November 2000 and 4.0% in July 2001
and Oregon auto rates by 21% in November 2000. Rate increases in 2001 of 44.9%,
14.0% and 12.6% were taken in Washington, Oregon and Nevada, respectively, and a
further 23.9% rate increase has been approved for 2002 in Nevada. A further 6.9%
rate increase currently is pending approval of the CDOI.
The underwriting expense ratio for the auto line of business was 14.9% in 2001,
14.2% in 2000 and 12.3% in 1999. The increase in the ratios for 2001 and 2000
compared to 1999 were mainly caused by increases in occupancy costs, data
processing and depreciation expense.
Homeowner and Earthquake Lines in Runoff and All Other. The Company has not
written any earthquake coverage since 1994 and ceased writing new homeowner
policies in September 2001 but, as discussed below, remains exposed to possible
upward development in certain loss estimates relating to the 1994 Northridge
Earthquake. Under a January 1, 2002 agreement, the Company ceded 100% of its
in-force homeowner coverages to an unrelated company and will begin non-renewing
homeowner policies expiring on February 21, 2002, and thereafter.
Underwriting results of the homeowners and earthquake lines, which are in
runoff, were losses of $77.6 million in 2001, $2.7 million in 2000 and $13.1
million in 1999.
In the fourth quarter of 2001, a provision was recorded for the run-off of the
homeowner line, primarily due to earthquake claims arising from SB 1899
(discussed further below and in Note 16 of the Notes to Consolidated Financial
Statements). Total earthquake losses and expenses charged to income were $70.0
million in 2001, including $50.0 million in the fourth quarter, compared to $3.5
million in 2000 and $2.5 million in 1999.
California SB 1899, effective from January 1, 2001, to December 31, 2001,
allowed the re-opening of previously closed earthquake claims arising out of the
1994 Northridge Earthquake. The Company believes this law to be unconstitutional
because it impairs contract rights by extending the normal contractual
limitations period by more than six years. The Company has pursued its legal
rights without success in the California courts and has now submitted a writ to
the United States Supreme Court. Despite the Company's challenge to the
constitutionality of the law, claim reports have been accepted and losses
adjusted and paid under a reservation of rights since the law took effect. The
time period to make claims under SB 1899 ended on December 31, 2001. The Company
is now able to make an estimate of the loss payment and inspection cost portion
of the potential liability created by this law. The Company believes it is
impracticable to make a reasonable estimate of the defense costs associated with
settling these claims.
14
The Company cautions that the recorded estimate for this event is subject to a
greater than normal degree of uncertainty for a variety of reasons. For example,
some of the claimants allege facts about earthquake damages that ostensibly
occurred on January 17, 1994, but many of the claimants are represented by
public adjusters or legal counsel who are acting to prevent or delay access of
Company personnel to inspect the allegedly damaged property. Thus, in many
cases, the best information currently available to the Company is several years
old. As new information becomes available in the near term, the Company's
estimate of its ultimate exposure may change by an amount that could be
material.
The Company has not written any earthquake coverage since 1994 and ceased
writing new homeowner policies in September 2001 but remains exposed to possible
upward development in certain loss estimates relating to the 1994 Northridge
Earthquake.
This line also included $9.6 million associated with workforce reductions and
the settlement of litigation matters in the fourth quarter of 2001, and a charge
of $6.75 million to settle certain matters with the CDOI in 1999.
INVESTMENT INCOME
The Company utilizes a conservative investment philosophy. No equities,
derivatives or nontraditional securities are held in the Company's investment
portfolio, substantially all of which is investment grade. Net investment income
was $45.9 million in 2001 compared to $50.3 million in 2000 and $63.1 million in
1999. Average invested assets decreased 8.0% in 2001 from the prior year and
14.6% in 2000 compared to an increase of 0.4% in 1999. The decreases in 2001 and
2000 were primarily due to the sale of investments to cover incurred loss costs,
the acquisitions of property and equipment and the payment of dividends to
shareholders. The payoff of the $67.5 million bank loan also contributed to the
2000 decrease. The average annual pre-tax yield on invested assets was 5.1% in
2001, 5.2% in 2000 and 5.5% in 1999. The average annual after-tax yield on
invested assets was 4.5% in 2001, 4.6% in 2000 and 4.3% in 1999.
Net realized gains on the sale of investments were $5.0 million in 2001 compared
to net realized losses of $5.0 million in 2000 and $0.4 million in 1999. At
December 31, 2001, $709.3 million (80.2%) of the Company's total investments at
fair value were invested in tax-exempt bonds with the remainder, representing
19.8% of the portfolio, invested in taxable securities compared to 90.3% and
9.7%, respectively, at December 31, 2000.
As of December 31, 2001, the Company had a pre-tax net unrealized loss on fixed
maturity investments of $1.5 million compared to a net unrealized gain of $3.7
million in 2000 and a net unrealized loss of $62.8 million in 1999.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The parent company's main sources of liquidity historically have been
dividends received from its insurance subsidiaries and proceeds from issuance of
debt or equity securities. The parent company paid off a $67.5 million bank loan
in 2000 and currently has no debt outstanding. The parent's only equity security
currently outstanding is its common stock, which has no mandatory dividend
obligations. The parent's significant operating expenses are all allocated to
and paid for by its insurance subsidiaries. During 2002, the insurance
subsidiaries have the capacity to pay dividends to the parent aggregating
approximately $20 million under current insurance regulations. At December 31,
2001, the parent had $52.8 million of cash and investments on hand and a payable
to one of its insurance subsidiaries amounting to approximately $28.6 million,
of which $15 million was repaid in January 2002, and the balance is due on June
30, 2002.
15
Recent court rulings may subject certain dividends from the insurance
subsidiaries to California State income tax. The Company believes the sources of
funds referred to above will be adequate to meet its cash needs for dividends to
shareholders or other purposes without receiving additional dividends from its
insurance subsidiaries until this tax issue is resolved. If necessary, the
Company believes it can access the capital markets should the need arise for
additional capital to support its growth objectives, although it has no present
intentions of doing so.
A possible liquidity risk faced by the parent would be if it were required to
contribute additional capital to its insurance subsidiaries under unfavorable
conditions in the reinsurance, debt or equity markets, which could drive up the
cost of capital and prevent the Company from paying dividends to its
shareholders. Regulators generally require property and casualty insurance
companies to maintain a ratio of net premium written to statutory surplus of no
greater than three-to-one. Growth in net premiums written raises the numerator
in this ratio, while statutory operating losses have the effect of depressing
the denominator. The Company's ratio stood at 2.2:1 at December 31, 2001.
The Company believes it has taken the proper actions to restore underwriting
profitability in its core auto insurance operations and thereby enhance its
liquidity. However, there can be no assurance that California regulators will
grant the rate increases recently requested by the Company. Also, the resolution
of Northridge Earthquake claims pursuant to SB1899 (discussed further above
under the caption Underwriting Results - Homeowner and Earthquake Lines in
Runoff and All Other, also below under the caption Critical Accounting Policies,
and in Note 16 of the Notes to Consolidated Financial Statements) possibly may
require more outlays than the recorded estimates. As a result of such
contingencies, underwriting losses could recur in the future. Further, the
Company could be required to liquidate investments to pay claims, possibly
during unfavorable market conditions, which could lead to the realization of
losses on sales of investments. Each of the foregoing contingencies would create
some degree of downward pressure on the insurance subsidiaries' statutory
surplus, which in turn could negatively impact the Company's liquidity.
In 1997, the Company embarked on a major project to upgrade its technological
infrastructure and to conform certain of its operational procedures to "best
practices." Capital expenditures relating to this project totaled $45.3
million, $20.7 million and $26.3 million in 2001, 2000 and 1999, respectively.
The estimated cost to complete this project over the next three years is
approximately $40 million. Management believes cash flow from operations as well
as expected improvements in operational efficiencies will be more than adequate
to fund the project's remaining implementation.
During the second quarter of 1999, the Company's Board of Directors authorized
$50 million to purchase shares of the Company's common stock. As a result,
2,632,084 common shares were repurchased in the open market and retired through
April 2000.
The Company has not identified any other trends, demands, commitments, events or
uncertainties that have or are considered to have a reasonable possibility of
having a material impact on the Company's liquidity.
16
Off Balance Sheet Obligations, Letters of Credit, Guarantees and Transactions
with Related Parties. The Company currently has no off-balance sheet obligations
other than the operating leases for its office facilities, which call for
minimum lease payments totaling $168.8 million as follows: $15.6 million in
2002, $14.6 million in 2003, $13.5 million in 2004, $13.5 million in 2005, $12.7
million in 2006, and $98.9 million thereafter.
The Company currently has no unused letters of credit, has issued no guarantees
on behalf of others, and has no trading activities involving non-exchange-traded
contracts accounted for at fair value. The Company has entered into no material
transactions with related parties other than the reinsurance transactions with
AIG subsidiaries that are discussed in the Notes to Consolidated Financial
Statements.
CRITICAL ACCOUNTING POLICIES
Management believes the Company's current critical accounting policies comprise
the following:
Unpaid Losses & Loss Adjustment Expenses. The Company is required to estimate
its liability for loss and loss adjustment expenses. The estimated liability for
unpaid losses and loss adjustment expenses recorded on the Company's balance
sheet at the end of any given period should be adequate to cover all future
payments required to be made on account of insured events that occurred on or
before the balance sheet date. However, because the future cannot be predicted
with certainty, the actual future payments are usually different from the
previously recorded estimates, and sometimes the differences may be material.
These differences are included in the Company's results of operations in the
future periods in which they become known.
In particular, the Company cautions that the earthquake loss and loss adjustment
expense reserves resulting from SB 1899 cannot be estimated by conventional
reserving techniques for a variety of reasons. See further discussion above
under the caption Underwriting Results - Homeowner and Earthquake Lines in
Runoff and All Other and in Note 16 of the Notes to the Consolidated Financial
Statements.
Property & Equipment. The Company's assets at December 31, 2001, include
approximately $91.5 million of software development projects in progress (see
Note 7 of Notes to Consolidated Financial Statements), which comprise the
capitalized costs relating to software systems that are not yet ready for their
intended use. Upon completion, which is expected to be in 2004, the software
will be depreciated by the straight-line method over its estimated useful life,
which is currently estimated at no less than ten years. However, the remaining
useful life of the software will necessarily depend on facts and circumstances
in the future, such as possible future technological innovations or changes in
operation strategies. If at any time the software is determined to have a lesser
value than its carrying value, the Company would be required to record a
write-down as a charge to operations.
Deferred Income Taxes. The Company is required to establish a "valuation
allowance" for any portion of the deferred tax asset, which amounted to $96.2
million at December 31, 2001, that management believes will not be realized. The
Company believes that because of its historically strong earnings performance
and tax planning strategies available, it is more likely than not that the
Company will realize the full benefit of its deferred tax assets. Accordingly,
no valuation allowance has been established.
Deferred Policy Acquisition Costs. Deferred policy acquisition costs ("DPAC")
include premium taxes and other variable costs incurred in connection with
writing business. These costs are deferred and amortized over the period in
which the related premiums are earned. The Company does not consider anticipated
investment income in determining the recoverability of these costs. Based on
current indications and an assumed loss and loss adjustment expense ratio of
85.2%, management believes that these costs will be fully recoverable and,
accordingly, no reduction in DPAC or premium deficiency has been recognized.
17
FORWARD-LOOKING STATEMENTS
The Company's management has made in this report, and from time to time may make
in its public filings, press releases, and oral presentations and discussions,
forward-looking statements concerning the Company's operations, economic
performance and financial condition. Forward-looking statements include, among
other things, discussions concerning the Company's potential, expectations,
beliefs, estimates, forecasts, projections and assumptions. Forward-looking
statements are subject to risks and uncertainties. Actual results could differ
materially from those anticipated by forward-looking statements due to a number
of important factors including, but not limited to, those discussed elsewhere in
this report and in the Company's other public communications, as well as the
following: (a) the intensity of competition from other companies in the
insurance industry; (b) the Company's experience with respect to persistency,
underwriting and claims experience including revived claims under SB 1899; (c)
the Company's ability to distribute and administer competitive services in a
timely, cost-effective manner; (d) the Company's visibility in the marketplace
and its financial and claims-paying ratings; (e) regulatory approval for rate
increases and product changes; (f) the effect of changes in laws and regulations
affecting the Company's business, including changes in tax laws affecting
insurance products; (g) market risks related to interest rates; (h) the
Company's ability to develop and deploy information technology and management
information systems to support strategic goals while continuing to control costs
and expenses; (i) the costs of defending litigation or regulating proceedings
and the risk of unanticipated material adverse outcomes in such litigation or
proceedings; (j) changes in accounting and reporting practices; and (k) the
Company's access to adequate financing to support its future business. The
Company does not undertake any obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
interest rates. In addition to market risk, the Company is exposed to other
risks, including the credit risk related to its financial instruments and the
underlying insurance risk related to its core business. The first column in the
following table shows the financial statement carrying value of the Company's
financial instruments. The Company's investment portfolio is carried at fair
value. The second column shows the effect on the current carrying value and
estimated fair value assuming a 100 basis point increase in market interest
rates. The following sensitivity analysis summarizes only the exposure to market
interest rate risk as of December 31, 2001.
Estimated Fair Value
at Adjusted Market
Carrying Rates/Prices
(Amounts in millions) Value Indicated Below *
- --------------------------------------------------------------------------------
Fixed maturity investments available for sale $ 855.7 $ 793.7
* Adjusted interest rates assume a 100 basis point increase in market rates
at December 31, 2001.
The Company's cash flow from operations and short-term cash position generally
is more than sufficient to meet its obligations for claim payments, which by the
nature of the personal automobile insurance business tend to have an average
duration of less than a year. As a result, it has been unnecessary for the
Company to employ elaborate market risk management techniques involving
complicated asset and liability duration matching or hedging strategies. For all
of its financial assets and liabilities, the Company seeks to maintain
reasonable average durations, currently 6.9 years, consistent with the
maximization of income without sacrificing investment quality and providing for
liquidity and diversification. Financial instruments are not used for trading
purposes.
18
The sensitivity analysis provides only a limited, point-in-time view of the
market risk sensitivity of the Company's financial instruments. The actual
impact of market interest rate and price changes on the financial instruments
may differ significantly from those shown in the analysis. This analysis is
further limited as it does not consider any mitigating actions the Company could
take in response to changes in interest rates.
19
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
STOCKHOLDERS AND BOARD OF DIRECTORS
21ST CENTURY INSURANCE GROUP
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 44 present fairly, in all material
respects, the financial position of 21st Century Insurance Group and its
subsidiaries at December 31, 2001, and the results of their operations and their
cash flows for the year ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule for the year ended December 31,
2001 listed in the index appearing under Item 14(a)(2) on page 44 presents
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 schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audit. We
conducted our audit 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 used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Los Angeles, California
February 6, 2002
20
REPORT OF INDEPENDENT AUDITORS
STOCKHOLDERS AND BOARD OF DIRECTORS
21ST CENTURY INSURANCE GROUP
We have audited the accompanying consolidated balance sheet of 21st Century
Insurance Group and subsidiaries as of December 31, 2000 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the two years in the period ended December 31, 2000. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards 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. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of 21st
Century Insurance Group and subsidiaries at December 31, 2000 and the
consolidated results of their operations and their cash flows for each of the
two years in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
Ernst & Young LLP
Los Angeles, California
January 26, 2001
21
21ST CENTURY INSURANCE GROUP
CONSOLIDATED BALANCE SHEETS
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
December 31, 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
Fixed maturity investments available-for-sale, at fair value
(amortized cost: $857,209 and $909,039) $ 855,724 $ 913,088
Cash and cash equivalents 28,909 7,240
- -----------------------------------------------------------------------------------------------------------------------------
Total investments and cash 884,633 920,328
Accrued investment income 11,733 12,569
Premiums receivable 75,559 78,983
Reinsurance receivables and recoverables 40,138 50,075
Prepaid reinsurance premiums 15,444 20,300
Deferred income taxes 96,216 72,434
Deferred policy acquisition costs 24,662 22,387
Property and equipment, at cost less accumulated depreciation
of $66,462 and $45,900 178,672 138,062
Other assets 24,959 22,937
- -----------------------------------------------------------------------------------------------------------------------------
Total assets $1,352,016 $1,338,075
- -----------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses $ 349,290 $ 298,436
Unearned premiums 236,473 236,519
Claims checks payable 36,105 35,982
Reinsurance payable 12,993 15,989
Other liabilities 57,849 30,588
- -----------------------------------------------------------------------------------------------------------------------------
Total liabilities 692,710 617,514
- -----------------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Common stock, without par value; authorized 110,000,000
shares, outstanding 85,361,848 in 2001 and 85,145,817 in 2000 416,991 415,064
Retained earnings 248,635 303,714
Accumulated other comprehensive income (loss) (6,320) 1,783
- -----------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 659,306 720,561
- -----------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $1,352,016 $1,338,075
- -----------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
22
21ST CENTURY INSURANCE GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
Years Ended December 31, 2001 2000 1999
- ---------------------------------------------------------------------------
REVENUES
Net premiums earned $864,145 $825,486 $770,423
Net investment income 45,930 50,346 63,119
Other (998) (1,060) (451)
Realized investment gains (losses) 5,001 (5,010) (410)
- ------------------------------------------ --------- --------- ---------
Total revenues 914,078 869,762 832,681
- ------------------------------------------ --------- --------- ---------
LOSSES AND EXPENSES
- ------------------------------------------ --------- --------- ---------
Net losses and loss adjustment expenses 836,236 749,388 605,064
Policy acquisition costs 102,558 91,386 80,514
Other operating expenses 27,359 27,180 18,856
Interest and fees expense - 2,901 7,020
- ------------------------------------------ --------- --------- ---------
Total losses and expenses 966,153 870,855 711,454
- ------------------------------------------ --------- --------- ---------
Income (loss) before federal income taxes (52,075) (1,093) 121,227
Federal income tax expense (benefit) (24,507) (14,038) 33,699
- ------------------------------------------ --------- --------- ---------
Net income (loss) $(27,568) $ 12,945 $ 87,528
- ------------------------------------------ --------- --------- ---------
EARNINGS (LOSS) PER COMMON SHARE
Basic $ (0.32) $ 0.15 $ 1.00
- ------------------------------------------ --------- --------- ---------
Diluted $ (0.32) $ 0.15 $ 1.00
- ------------------------------------------ --------- --------- ---------
See accompanying notes to consolidated financial statements.
23
21ST CENTURY INSURANCE GROUP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Other
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA Common Retained Comprehensive
Years Ended December 31, 2001, 2000 and 1999 Stock Earnings Income (Loss) Total
- -----------------------------------------------------------------------------------------------------
Balance - January 1, 1999 $462,268 $ 299,947 $ 23,387 $785,602
Comprehensive income 87,528(1) (63,906)(2) 23,622
Cash dividends paid on common
stock ($0.64 per share) (55,742) (55,742)
Stock repurchased and retired (33,285) (33,285)
Other 640 640
- -----------------------------------------------------------------------------------------------------
Balance - December 31, 1999 429,623 331,733 (40,519) 720,837
Comprehensive income 12,945(1) 42,302 (2) 55,247
Cash dividends paid on common
stock ($0.48 per share) (40,964) (40,964)
Stock repurchased and retired (16,598) (16,598)
Other 2,039 2,039
- -----------------------------------------------------------------------------------------------------
Balance - December 31, 2000 415,064 303,714 1,783 720,561
Comprehensive loss (27,568)(1) (8,103)(2) (35,671)
Cash dividend paid on common
stock ($0.32 per share) (27,310) (27,310)
Other 1,927 (201) 1,726
- -----------------------------------------------------------------------------------------------------
Balance - December 31, 2001 $416,991 $ 248,635 $ (6,320) $659,306
- -----------------------------------------------------------------------------------------------------
(1) Net income (loss) for the year
(2) Change in accumulated other comprehensive income (loss) (see Note 4).
See accompanying notes to consolidated financial statements.
24
21ST CENTURY INSURANCE GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
Years Ended December 31, 2001 2000 1999
- -------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ (27,568) $ 12,945 $ 87,528
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Provision for depreciation and amortization 21,031 14,605 13,029
Amortization of restricted stock grants 695 180 -
Provision (benefit) for deferred income taxes (19,418) (3,961) 17,598
Realized losses (gains) on sale of investments (5,098) 5,010 410
Federal income taxes (benefit) 5,759 (6,698) 10,932
Reinsurance balances 11,797 12,131 11,267
Unpaid losses and loss adjustment expenses 50,854 22,188 (105,755)
Unearned premiums (46) 3,817 (987)
Claims checks payable 123 4,070 (2,399)
Other assets (5,721) (15,634) (5,953)
Other liabilities 20,126 7,799 3,157
- -------------------------------------------------------------------------------------------
Net cash provided by operating activities 52,534 56,452 28,827
- -------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Fixed maturities available-for-sale
Purchases (461,578) (208,957) (771,769)
Calls or maturities 15,783 2,809 7,890
Sales 502,254 298,044 789,590
Net purchases of property and equipment (61,247) (62,940) (43,974)
- -------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (4,788) 28,956 (18,263)
- -------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Bank loan principal repayment - (67,500) (45,000)
Dividends declared and paid (per share: $0.32; $0.48;
and $0.64) (27,310) (40,964) (55,742)
Common stock repurchased - (16,598) (33,285)
Proceeds from the exercise of stock options 1,233 1,860 641
- -------------------------------------------------------------------------------------------
Net cash used in financing activities (26,077) (123,202) (133,386)
- -------------------------------------------------------------------------------------------
Net increase (decrease) in cash 21,669 (37,794) (122,822)
Cash and cash equivalents, beginning of year 7,240 45,034 167,856
- -------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 28,909 $ 7,240 $ 45,034
- -------------------------------------------------------------------------------------------
SUPPLEMENTAL INFORMATION
Income taxes refunded (paid) $ 11,435 $ 3,555 $ (9,499)
Interest paid - (2,204) (5,306)
See accompanying notes to consolidated financial statements.
25
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 1. DESCRIPTION OF BUSINESS
- --------------------------------
21st Century Insurance Group, through its wholly owned subsidiaries, 21st
Century Insurance Company and 21st Century Casualty Company (collectively, the
"Company"), is engaged primarily in the sale of private passenger automobile
insurance policies in California, Nevada, Oregon and Washington. Substantially
all of the Company's business is concentrated in California. The Company also
provides private passenger automobile insurance through 21st Century Insurance
Company of Arizona ("21st of Arizona"), which was a 49% owned unconsolidated
affiliate in 2001 and prior years (see Note 19). American International Group,
Inc. ("AIG"), owned a majority of the Company's outstanding common stock at
December 31, 2001.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
BASIS OF CONSOLIDATION AND PRESENTATION
The accompanying consolidated financial statements include the accounts and
operations of the Company. All material intercompany accounts and transactions
have been eliminated. The consolidated financial statements have been prepared
in conformity with accounting principles generally accepted in the United States
of America ("GAAP") which differ from statutory accounting practices ("SAP")
prescribed or permitted by insurance regulatory authorities. The preparation of
the financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements. Actual results could differ from these estimates.
INVESTMENTS
The Company classifies its investment portfolio as available-for-sale and
carries it at fair value. Unrealized investment gains and losses, net of any tax
effect, are included as an element of accumulated other comprehensive income
(loss), which is classified as a separate component of stockholders' equity.
Fair values for fixed maturity and equity securities are based on quoted market
prices. The cost of investment securities sold is determined by the specific
identification method. Where declines in values of securities below cost or
amortized cost are considered to be other than temporary, a charge is reflected
in income for the difference between cost or amortized cost and estimated net
realizable value.
21ST CENTURY INSURANCE COMPANY OF ARIZONA
Prior to 2002, 21st of Arizona was a joint venture between the Company and AIG.
On January 1, 2002, the Company acquired AIG's 51% interest in 21st of Arizona
(see Note 19). This entity began operations in August 1996, has a carrying value
of $3.6 million at December 31, 2001, and is included in other assets in the
Consolidated Balance Sheets. The Company's equity in the net loss of this
venture amounted to $1.0 million, $1.1 million, and $0.5 million in 2001, 2000
and 1999, respectively, and is included in other revenues in the Consolidated
Statements of Operations.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash, demand deposits and short-term
investments in money market mutual funds having a maturity of three months or
less at the date of purchase.
26
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 (CONTINUED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
RECOGNITION OF REVENUES
Insurance premiums and reinsurance ceding commissions are recognized pro rata
over the terms of the policies. Installment and other fees for services are
recognized in the periods the services are rendered. The unearned portion of
premiums is included in the Consolidated Balance Sheets as a liability for
unearned premiums. Unearned ceding commissions are reported as a reduction of
deferred policy acquisition costs in the balance sheet.
DEFERRED POLICY ACQUISITION COSTS
Deferred policy acquisition costs ("DPAC") include premium taxes and other
variable costs incurred in connection with writing business. These costs are
deferred and amortized over the period in which the related premiums are earned.
The Company does not consider anticipated investment income in determining the
recoverability of these costs. Based on current indications, management believes
that these costs will be fully recoverable and, accordingly, no reduction in
DPAC or premium deficiency has been recognized.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost and depreciated on a straight-line
basis. The estimated useful lives used for depreciation purposes are: furniture
and leasehold improvements - 7 years; equipment - 3 to 5 years; automobiles - 5
years; software currently in service - 3 to 10 years.
LOSSES AND LOSS ADJUSTMENT EXPENSES
The estimated liabilities for losses and loss adjustment expenses ("LAE")
include the accumulation of estimates of losses for claims reported prior to the
balance sheet dates, estimates (based upon actuarial analysis of historical
data) of losses for claims incurred but not reported and for the development of
case reserves to ultimate values, and estimates of expenses for investigating,
adjusting and settling all incurred claims. Amounts reported are estimates of
the ultimate costs of settlement, net of estimated salvage and subrogation.
These estimated liabilities are necessarily subject to the outcome of future
events, such as changes in medical and repair costs as well as economic and
social conditions that impact the settlement of claims. Management believes
that, given the inherent variability in any such estimates, the aggregate
reserves are within a reasonable and acceptable range of adequacy. The methods
of making such estimates and for establishing the resulting reserves are
reviewed and updated quarterly and any adjustments resulting therefrom are
reflected in current operations.
The Company believes that the earthquake loss and loss adjustment expense
reserves resulting from SB 1899 cannot be estimated by conventional reserving
techniques. See Note 16 for a discussion of the factors considered by management
in establishing those reserves.
REINSURANCE
In the normal course of business, the Company seeks to reduce its exposure to
losses that may arise from catastrophes and to reduce its overall risk levels by
obtaining reinsurance from other insurance enterprises or reinsurers.
Reinsurance premiums and reserves on reinsured business are accounted for on a
basis consistent with those used in accounting for the original policies issued
and the terms of the reinsurance contracts.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. The Company periodically reviews the financial condition of its
reinsurers to minimize its exposure to losses from reinsurer insolvencies. It is
the Company's policy to hold collateral under related reinsurance agreements in
the form of letters of credit for unpaid losses for all reinsurers not licensed
to do business in the Company's state of domicile.
27
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 (CONTINUED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
Reinsurance assets include balances due from other insurance companies under the
terms of reinsurance agreements. Amounts applicable to ceded unearned premiums,
ceded loss payments and ceded claim liabilities are reported as assets in the
accompanying balance sheets. The Company believes the fair value of its
reinsurance recoverables approximates their carrying amounts.
STOCK-BASED COMPENSATION
In management's opinion, existing stock option valuation models do not provide
an entirely reliable measure of the fair value of non-transferable employee
stock options with vesting restrictions. Accordingly, the Company has elected to
follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees (APB 25), and related interpretations in accounting for its
stock-based compensation. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized. See Note 13 for
disclosure of the required pro forma information as if stock option compensation
expense had been determined by the alternative fair value method. The fair value
of stock grants made under the Restricted Shares Plan is amortized to expense
under APB 25 over the vesting period of the grants. This accounting treatment
results in compensation expense being recorded in a manner consistent with that
required under SFAS No. 123, and, therefore, pro forma net income and earnings
per share amounts for the Restricted Share Plan would be unchanged from those
reported in the financial statements.
INCOME TAXES
Deferred income tax assets and liabilities are determined based on the
differences between the financial reporting and the tax bases of assets and
liabilities and are measured using the enacted tax rates and laws.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
NOTE 3. EARNINGS (LOSS) PER COMMON SHARE
- -----------------------------------------
For each of the three years in the period ending December 31, 2001, the
numerator for the calculation of both basic and diluted earnings per common
share is equal to net income reported for that year. The denominator for the
computation of basic earnings (loss) per share was 85,340,461 shares, 85,186,084
shares and 87,144,939 shares for 2001, 2000 and 1999, respectively. The
denominator for diluted earnings (loss) per share was 85,340,461 shares,
85,397,099 shares and 87,252,674 shares for 2001, 2000 and 1999, respectively.
The difference between basic and diluted earnings per share denominators is due
to employee restricted stock grants and stock options.
NOTE 4. INVESTMENTS
- --------------------
Cash and securities with carrying values of $12.4 million and $0.5 million were
deposited by the Company's subsidiaries under requirements of regulatory
authorities as of December 31, 2001 and 2000.
28
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 (CONTINUED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
A summary of net investment income follows:
Years Ended December 31, 2001 2000 1999
- --------------------------------------------------------------------------------------------
Interest on fixed maturities $44,722 $48,411 $ 56,638
Interest on cash equivalents 1,602 2,265 6,954
Investment expense (394) (330) (473)
- --------------------------------------------------------------------------------------------
Net investment income $45,930 $50,346 $ 63,119
- --------------------------------------------------------------------------------------------
A summary of realized investment gains and losses before income taxes follows:
Years Ended December 31, 2001 2000 1999
- --------------------------------------------------------------------------------------------
Gross realized gains on fixed maturities available-for-sale $ 5,912 $ 1,685 $ 13,475
Gross realized losses on fixed maturities available-for-sale (1,111) (6,561) (14,697)
Other 200 (134) 812
- --------------------------------------------------------------------------------------------
Realized investment gains (losses) $ 5,001 $(5,010) $ (410)
- --------------------------------------------------------------------------------------------
A summary of fixed maturity investments follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------
December 31, 2001
U.S. Treasury securities and obligations of U.S.
government corporations and agencies $ 40,363 $ 461 $ (91) $ 40,733
Obligations of states and political subdivisions 719,411 6,209 (7,016) 718,604
Corporate securities 97,435 623 (1,671) 96,387
- -------------------------------------------------------------------------------------------------
Total fixed maturity investments $ 857,209 $ 7,293 $ (8,778) $855,724
- -------------------------------------------------------------------------------------------------
December 31, 2000
U.S. Treasury securities and obligations of U.S.
government corporations and agencies $ 14,605 $ 40 $ (194) $ 14,451
Obligations of states and political subdivisions 834,580 10,480 (3,219) 841,841
Corporate securities 59,854 456 (3,514) 56,796
- -------------------------------------------------------------------------------------------------
Total fixed maturity investments $ 909,039 $ 10,976 $ (6,927) $913,088
- -------------------------------------------------------------------------------------------------
Fixed maturities available-for-sale at December 31, 2001, are summarized by
contractual maturity year as follows:
Amortized Fair
Cost Value
- -------------------------------------------
Fixed maturities due:
2002 $ 2,009 $ 2,064
2003-2006 27,007 28,157
2007-2011 143,646 145,363
2012 and thereafter 684,547 680,140
- -------------------------------------------
Total $ 857,209 $855,724
- -------------------------------------------
Expected maturities of the Company's investments may differ from contractual
maturities because certain borrowers have the right to call or prepay
obligations with or without call or prepayment penalties.
29
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 (CONTINUED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
Details follow concerning the changes in the after-tax items included in
"Accumulated other comprehensive income (loss)" in the Consolidated Statement
of Stockholders' Equity for 2001, 2000 and 1999.
Years Ended December 31, 2001 2000 1999
- ---------------------------------------------------------------------------------------------
Unrealized gain (loss) on available-for-sale investments, net
of tax expense (benefit) of $(152), $21,608 and $(34,508),
respectively $ (282) $40,128 $(63,884)
Reclassification adjustment for investment gains (losses)
included in net income, net of tax expense (benefit) of
$1,784, $(1,627) and $(97), respectively (3,314) 3,022 180
Minimum pension liability in excess of unamortized prior
service cost, net of deferred income tax benefit of $2,427,
$457, and $109, respectively (4,507) (848) (202)
- ---------------------------------------------------------------------------------------------
Total $(8,103) $42,302 $(63,906)
- ---------------------------------------------------------------------------------------------
A summary of accumulated other comprehensive income (loss) follows:
December 31, 2001 2000
- ---------------------------------------------------------------------------------------------
Unrealized gains (losses), net of tax of $(520) and income tax
benefit of $1,417, respectively $ (965) $ 2,631
Minimum pension liability in excess of unamortized prior service
cost, net of deferred income tax benefit of $2,883 and $565 (5,355) (848)
- ---------------------------------------------------------------------------------------------
$(6,320) $ 1,783
- ---------------------------------------------------------------------------------------------
NOTE 5. FEDERAL INCOME TAXES
- -----------------------------
Federal income tax expense (benefit) consists of:
Years Ended December 31, 2001 2000 1999
- ---------------------------------------------------------------------------------------------
Current tax expense (benefit) $ (5,089) $(10,077) $16,101
Deferred tax expense (benefit) (19,418) (3,961) 17,598
- ---------------------------------------------------------------------------------------------
Total $(24,507) $(14,038) $33,699
- ---------------------------------------------------------------------------------------------
30
The Company's net deferred tax asset is comprised of:
December 31, 2001 2000
- ----------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforward $104,137 $ 61,534
Alternative minimum tax credit 17,701 22,776
Unearned premiums 16,047 15,593
Unpaid losses and loss adjustment expenses 9,218 6,037
Employee benefits 5,146 4,812
Unrealized investment losses 3,512 -
Other - 2,508
- ----------------------------------------------------------------
155,761 113,260
- ----------------------------------------------------------------
Deferred tax liabilities:
EDP software development costs 46,833 31,145
Deferred policy acquisition costs 9,465 8,830
Unrealized investment gains - 851
Other 3,247 -
- ----------------------------------------------------------------
59,545 40,826
- ----------------------------------------------------------------
Net deferred tax asset $ 96,216 $ 72,434
- ----------------------------------------------------------------
During 2001, the Company had a tax net operating loss of approximately $112
million. As of December 31, 2001, the Company has a tax net operating loss
carryforward of approximately $298 million for regular tax purposes of which
approximately $105 million expires in the year 2009 and $193 million expires on
or after 2020; and an alternative minimum tax credit carryforward of $18
million. Alternative minimum tax credits may be carried forward indefinitely to
offset future regular tax liabilities.
The Company is required to establish a "valuation allowance" for any portion
of the deferred tax asset that management believes will not be realized. The
Company believes that because of its historically strong earnings performance
and tax planning strategies available, it is more likely than not that the
Company will realize the full benefit of its deferred tax assets. Accordingly,
no valuation allowance has been established.
A reconciliation of income tax computed at the federal statutory tax rate of 35%
to total income tax expense follows:
Years Ended December 31, 2001 2000 1999
- ------------------------------------------------------ --------- --------- --------
Federal income tax expense (benefit) at statutory rate $(18,227) $ (382) $42,429
Tax-exempt income, net (11,067) (12,546) (8,662)
State and local taxes, net of federal benefit 4,706 - -
Research and experimentation tax credit - (1,193) -
Other - net 81 83 (68)
- ------------------------------------------------------ --------- --------- --------
Federal income tax (benefit) expense $(24,507) $(14,038) $33,699
- ------------------------------------------------------ --------- --------- --------
There were no income tax payments required for the years ended December 31, 2001
and 2000. Payments for income taxes were $19.5 million for the year ended
December 31, 1999. As of December 31, 2001, the Company has a federal income tax
refund receivable of $4.5 million.
31
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 (CONTINUED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 6. DEFERRED POLICY ACQUISITION COSTS
- -----------------------------------------
Following is a summary of policy acquisition costs deferred for amortization
against future income and the related amortization charged to income from
operations:
Years Ended December 31, 2001 2000 1999
- --------------------------------------------------------------------------------------
Deferred policy acquisition costs, beginning of year $ 22,387 $ 22,156 $ 16,100
Acquisition costs deferred 104,833 91,617 86,570
Acquisition costs amortized and charged to income
during the year (102,558) (91,386) (80,514)
- --------------------------------------------------------------------------------------
Deferred policy acquisition costs, end of year $ 24,662 $ 22,387 $ 22,156
- --------------------------------------------------------------------------------------
Total advertising costs included in deferred acquisition costs in 2001, 2000 and
1999 were $18.7 million, $9.7 million, and $21.3 million, respectively.
NOTE 7. PROPERTY AND EQUIPMENT
- -------------------------------
A summary of property and equipment follows:
December 31, 2001 2000
- ------------------------------------------------------------------------------------
Furniture and equipment $ 57,324 $ 47,288
Automobiles 3,593 3,575
Leasehold improvements 17,780 14,153
Software currently in service 74,980 44,504
Software development projects in progress 91,457 74,442
- ------------------------------------------------------------------------------------
Subtotal 245,134 183,962
Less accumulated depreciation, including $19,827 and $9,464 on
software currently in service (66,462) (45,900)
- ------------------------------------------------------------------------------------
$178,672 $138,062
- ------------------------------------------------------------------------------------
Depreciation expense on software currently in service was $10.4 million, $4.1
million and $2.6 million in 2001, 2000 and 1999, respectively. Substantially
all software development projects in progress are expected to be completed by
2004.
32
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 (CONTINUED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 8. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
- ---------------------------------------------------
The following analysis provides a reconciliation of the activity in the reserve
for unpaid losses and loss adjustment expenses:
Years Ended December 31, 2001 2000 1999
- ---------------------------------------------------------------------------------
At beginning of year:
Reserve for losses and LAE, gross of reinsurance $298,436 $276,248 $382,003
Reinsurance recoverable 31,483 32,850 42,188
- ---------------------------------------------------------------------------------
Reserve for losses and LAE, net of reinsurance 266,953 243,398 339,815
- ---------------------------------------------------------------------------------
Losses and LAE incurred, net of reinsurance:
Current year 718,229 704,365 613,760
Prior years 118,007 45,023 (8,696)
- ---------------------------------------------------------------------------------
Total 836,236 749,388 605,064
- ---------------------------------------------------------------------------------
Losses and LAE paid, net of reinsurance:
Current year 506,294 498,602 436,346
Prior years 271,117 227,231 265,135
- ---------------------------------------------------------------------------------
Total 777,411 725,833 701,481
- ---------------------------------------------------------------------------------
At end of year:
Reserve for losses and LAE, net of reinsurance 325,778 266,953 243,398
Reinsurance recoverable 23,512 31,483 32,850
- ---------------------------------------------------------------------------------
Reserve for losses and LAE, gross of reinsurance $349,290 $298,436 $276,248
- ---------------------------------------------------------------------------------
The provision for losses and LAE recorded in 2001 for insured events of prior
years primarily resulted from the Company's recognition of earthquake losses
under SB 1899, as discussed in Note 16, and from the Company's under-estimate of
changes in personal auto loss severity trends that became apparent in 2001. The
loss and LAE provision recorded in 2000 for insured events of prior years
primarily resulted from the Company's over-estimate in 1999 of the beneficial
effect on loss costs of laws passed in prior years that limited the ability of
uninsured motorists and drunk drivers to collect non-economic damages.
NOTE 9. REINSURANCE
- --------------------
The Company's insurance subsidiaries cede business to AIG subsidiaries under a
quota share reinsurance agreement. Under this contract, which attaches to the
Company's retained risks net of all other reinsurance, the subsidiaries ceded
10% of their premiums earned and losses and loss adjustment expenses incurred in
connection with policies incepted during the period January 1, 1995, through
December 31, 1999, 8% in 2000, 6% in 2001 and 4% in 2002. The majority of the
Company's reinsurance receivables are due from the AIG subsidiaries.
The following summarizes the approximate percentage of business retained and
ceded under various reinsurance programs with AIG subsidiaries and unrelated
insurers. Most programs provide for ceding commissions that approximate the
Company's direct policy acquisition costs and other operating expenses.
33
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 (CONTINUED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
Contracts Incepting During
--------------------------------
2002 2001 2000 1999
--------------------------------
- -------------------------------------------------------------------------
AUTO POLICIES
Retained 96% 94% 92% 90%
Ceded 4% 6% 8% 10%
HOMEOWNER POLICIES(1)
Retained - 94% 92% -
Ceded 100% 6% 8% 100%
Catastrophe cover excess $10 million - $75,000 $65,000 -
PUP POLICIES
Retained 10% 16% 37% 36%
Ceded 90% 84% 63% 64%
(1) The Company's homeowner policies do not include any earthquake coverage.
This catastrophe coverage does provide protection from the potential for
fire following an earthquake and other catastrophes. See Note 18.
Reinsurance coverages related to historical earthquake losses have been
exhausted.
The effect of reinsurance on premiums written and earned is as follows:
2001 2000 1999
- --------------------------------------------------------------------------------------------
Years Ended December 31, Written Earned Written Earned Written Earned
- --------------------------------------------------------------------------------------------
Gross $929,315 $929,361 $910,720 $906,903 $ 880,534 $ 881,523
Ceded (60,360) (65,216) (78,593) (81,417) (111,721) (111,100)
- --------------------------------------------------------------------------------------------
Net $868,955 $864,145 $832,127 $825,486 $ 768,813 $ 770,423
- --------------------------------------------------------------------------------------------
Losses and loss adjustment expenses have been reduced by reinsurance ceded as
follows:
Years Ended December 31,