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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 1999
Commission File Number 0-6964
21ST CENTURY INSURANCE GROUP (FORMERLY 20TH CENTURY INDUSTRIES)
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(Exact name of registrant as specified in its charter)
CALIFORNIA 95-1935264
---------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) number)
6301 Owensmouth Avenue, Suite 700, Woodland Hills, California 91367
- - -------------------------------------------------------------- -----
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (818) 704-3700
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 February 29, 2000, as reported by the New York Stock Exchange,
was approximately $425,000,000.
On February 29, 2000, the registrant had outstanding 85,347,922 shares of common
stock, 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 May 23, 2000, are
incorporated herein by reference into Part III hereof.
1
21ST CENTURY INSURANCE GROUP
1999 FORM 10-K ANNUAL REPORT
Table of Contents
Page
PART I
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Item 1. . Business 3
Item 2. Properties 22
Item 3. . Legal Proceedings 22
Item 4. . Submission of Matters to a Vote of Security Holders . 22
PART II
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Item 5. . Market for Registrant's Common Stock and Related
Stockholder Matters .. . 23
Item 6. Selected Financial Data 24
Item 7. . Management's Discussion and Analysis of Financial
Condition and Results of Operations 27
Item 7a.. Quantitative and Qualitative Disclosures about Market Risk 36
Item 8. Financial Statements and Supplementary Data 38
Item 9. . Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure. . 67
PART III
----------------------------------------------------------
Item 10.. Directors and Officers of the Registrant 67
Item 11. Executive Compensation 67
Item 12.. Security Ownership of Certain Beneficial Owners and
Management . . . . . . 67
Item 13. Certain Relationships and Related Transactions 68
PART IV
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Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K . 69
Signatures . . . . . . . 76
2
PART I
------
ITEM 1. BUSINESS
GENERAL
21st Century Insurance Group (formerly 20th Century Industries) 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 (formerly 20th Century Insurance Company) and 21st Century Casualty
Company, both of which are incorporated in California as property and casualty
insurance companies and licensed in California, Nevada, Oregon and Washington.
The common stock of the Company is traded on the New York Stock Exchange under
the trading symbol "TW." Effective January 1, 2000, the Company changed its
name to 21st Century Insurance Group, and 20th Century Insurance Company changed
its name to 21st Century Insurance Company.
The Company, through its subsidiaries, directly markets and underwrites
private passenger automobile, homeowners and personal umbrella insurance. As a
direct response writer, the Company has gained a reputation for excellent
customer service and being among the most efficient and low cost providers of
personal insurance in the markets it serves.
Historically, the Company's business has been concentrated in Southern
California, principally the greater Los Angeles and Orange County areas. In the
mid-1980's, however, the Company began expanding into the San Diego area and, in
the early 1990's, the Northern California area. In August 1996, 21st Century
Insurance Company of Arizona (formerly 20th Century Insurance Company of
Arizona, "21st of Arizona") began writing private passenger automobile insurance
in that state. 21st of Arizona is a joint venture between the Company, which
owns a 49% interest, and American International Group, Inc. ("AIG"), which owns
a 51% interest. Through several of its subsidiaries AIG currently owns
approximately 62% of the Company's outstanding common stock.
In a strategy intended to complement its auto business and facilitate
growth in that line, the Company initiated new sales of homeowner insurance
policies in California during September 1999
3
following approval by the California Insurance Commissioner. The Company had
been under a Department of Insurance order since June 1994, prohibiting it from
writing new homeowners business following the 1994 Northridge earthquake. The
Company ceased writing earthquake insurance in 1994 and has no plans to reenter
that market. Rather, the California requirement to offer earthquake insurance
to policyholders is satisfied by an arrangement with GeoVera Insurance Company,
a member of the St. Paul Companies.
LIMITS OF INSURANCE COVERAGE
The Company offers the following insurance coverages for private passenger
automobiles, bodily injury liability; property damage; medical payments;
uninsured and underinsured motorist; rental reimbursement; uninsured motorist
property damage and collision deductible; towing; comprehensive and collision.
Policies are written for a six-month term. 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 homeowners program utilizes an extended replacement cost policy, thereby
limiting loss 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.
Personal liability coverage limits of $100,000, $200,000 and $300,000 are
available.
The personal umbrella policy ("PUP") provides liability coverage with a limit of
$1,000,000 in excess of the underlying automobile and homeowners liability
coverage. Minimum underlying automobile limits of $100,000 per person and
$300,000 per accident are required, while homeowners must have a minimum of
$100,000 personal liability coverage. The underlying automobile coverage must
be written by the Company.
4
MARKETING
The Company through its subsidiaries and Arizona affiliate, markets
homeowner policies in California and auto policies in California, Arizona,
Nevada, Oregon and Washington. Policies are sold directly to customers without
utilizing or engaging outside agents or brokers. In addition to referrals, the
Company uses direct mail, print, radio, television, outdoor and Internet
advertising to generate sales. In California and Arizona, quotes may be
requested 24 hours a day, 7 days a week through a convenient toll-free 800
number. Prospective California policyholders may also obtain an instant auto
rate quotation on the Company's Internet site (http://www. my21st.com).
-----------------------
Traffic to the Company's website continues to increase. In addition to
offering visitors another way to request a rate quotation, the website can be
used by customers to amend policies, report a claim or obtain information about
the Company. Quotes requested through the Internet increased by 173% over 1998
while sales from Internet quotes increased by 127% over the prior year. The
Company also participates in Internet insurance malls to sell auto insurance.
The Company continues to increase penetration in Northern California
generating approximately 12% more new business in 1999 than in 1998.
Approximately 61% of all new business written in California in 1999 came from
outside the Los Angeles and Orange County areas.
UNDERWRITING AND PRICING
The regulatory system in California requires the prior approval of insurance
rates and forms. Within the regulatory framework, the Company establishes its
automobile and homeowners premium rates based primarily on actuarial analyses of
its own historical premium, 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. The primary characteristics for automobile policies
include, by statute in California, driving record,
5
annual mileage and number of years the driver has been licensed. A number of
other "optional" rating factors are also permitted in California.
The Company is required to offer insurance to any California prospect who
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
The Company continues to adapt its technological capabilities in keeping
with its business strategies. Computerized systems provide the information
resources, telecommunications and data processing capabilities necessary to
manage the Company's business. The Company continues the process, begun in
1997, to upgrade its technology infrastructure and replace aging information
systems with newer, more dynamic systems. In late 1998, business operations
supporting the states of Washington, Oregon and Nevada commenced using the
prototype of this new infrastructure. In 1999, the Company's internal
administrative processes, such as payroll and accounting, were successfully
converted to the new systems.
The Internet is fast becoming a strategic vehicle for selling and servicing the
Company's insurance products. In 1998, the ability to receive a real-time quote
for auto insurance in California was introduced. That same year, simple policy
amendments, such as address changes and vehicle additions/changes, were allowed.
In 1999, policyholders were able to submit a First Notice of Loss on a claim and
request a quote for a homeowner policy. Continued enhancement to this facility
will, over time, allow policyholder self-service over the Internet for all
products and markets covered by the Company, as an alternative to more
traditional modes of communication.
6
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 utilizes internal legal staff to handle most aspects of claims
litigation, including trial, from offices in Brea, Ontario, Long Beach, San
Diego and Woodland Hills. 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.
The Company has established claims Division Service Offices in its major
marketing territories. Each Division Service Office is a full service center,
normally staffed with between 40 and 100 employees who provide complete claims
services from initial investigation to final settlement.
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 estimate for damages prepared by
the repair facility without requiring each vehicle to be inspected by staff
adjusters. The facilities selected undergo a screening process before being
accepted, and the Company maintains an aggressive reinspection program to assure
quality results. The Company's reinspection team visits 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 the repairs are guaranteed for as long as the
customer owns the vehicle. The Company benefits by not incurring the overhead
expense of a larger staff of appraisers and by negotiating repair rates it
believes are
7
beneficial. Currently, over 30% of all damage repairs are handled using
the DRP method. The Company's policy with respect to vehicle repairs is not to
use after market "crash" parts.
The Company has three vehicle inspection centers located in Los Angeles and
Orange Counties. Each vehicle inspection center is staffed with between fifteen
and twenty employees who handle total losses, total thefts and vehicles which
are not driveable.
The Claims Services Division employs approximately 100 people who are
responsible for subrogation, medical payment claims and workers' compensation
claims arising under the homeowners policies.
The Company also maintains a Special Investigations Unit with approximately 40
personnel who investigate suspected fraudulent claims. The Company believes its
efforts in this area have been responsible for saving several million dollars
annually.
The Homeowners Division processes all homeowners property claims on a
regional basis and is made up of two units totaling approximately 30 employees.
The units are located in Brea and Woodland Hills.
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.
"Case basis" reserves are established for bodily injury liability and uninsured
motorist claims which are either expected to exceed $15,000 or are older than
two years. Such case reserves are based on the specific circumstances of the
claim.
8
Case reserves for other bodily injury and uninsured motorists claims and for all
other coverages are established at an average case reserve value. These average
values are based on a review of prior claims payments for each coverage.
The Company supplements the case basis reserve estimates with bulk loss reserves
estimated using actuarial methodologies. These reserves are designed to provide
for claims incurred but not reported ("IBNR") to or recorded by the Company 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 actuarial estimates utilize the Company's own historical
loss experience and are reviewed each quarter. The effects of inflation are
implicitly considered in the actuarial estimates and the Company does not
discount its reserves to present value for financial reporting purposes.
Reserve estimates are necessarily subject to the impact of future changes in
economic and social conditions. 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.
A rollforward of loss and loss adjustment expense reserves, including the
effects of reserve changes, loss payments and reinsurance for each of the three
years in the period ended December 31, 1999, is presented in Note 8 of the Notes
to Consolidated Financial Statements.
The following table presents the development of loss and loss adjustment
expense reserves, net of reinsurance, for the years 1989 through 1999. The top
line of the table shows the reserves at the balance sheet date, net of
reinsurance recoverables, 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
9
redundancy (deficiency) exists when the original reserve estimate is greater
(less) than the re-estimated reserves. The deficiencies shown in the 1994 and
1995 columns result from the additional earthquake losses and loss adjustment
expenses related to the 1994 Northridge Earthquake recorded subsequent to 1994.
The impact of that earthquake on the redundancy or deficiency shown is $164.75
million for 1994, $104.75 million for 1995, $64.75 million for 1996 and $40
million for each of 1997 and 1998.
10
AS OF DECEMBER 31,
(AMOUNTS IN THOUSANDS)
- - ----------------------
1989 1990 1991 1992 1993 1994 1995 1996 1997
-------- -------- -------- -------- -------- --------- --------- -------- --------
Reserves for
losses and loss
adjustment expenses,
net of reinsurance. $472,010 $525,220 $547,098 $554,034 $574,619 $755,101 $552,320 $489,033 $388,418
Paid (cumulative)
as of:
One year later. . . . . . 242,757 300,707 320,264 327,634 344,876 519,969 351,985 304,714 251,951
Two years later . . . . . 328,606 391,970 401,019 403,434 423,713 635,861 485,462 395,922 352,594
Three years later . . . . 366,369 420,853 426,412 425,671 443,055 721,445 527,908 454,246
Four years later. . . . . 377,980 429,791 433,642 432,086 457,430 745,912 574,260
Five years later. . . . . 381,507 431,791 436,522 434,949 460,857 787,262
Six years later . . . . . 382,230 432,975 437,365 436,876 461,901
Seven years later . . . . 382,108 433,096 437,758 436,982
Eight years later . . . . 382,129 433,095 437,713
Nine years later. . . . . 382,086 433,045
Ten years later . . . . . 382,001
Reserves re-
estimated as of:
One year later. . . . . . . 402,706 473,974 473,209 491,048 490,166 715,637 526,730 424,406 392,039
Two years later . . . . . . 397,847 449,348 461,343 447,880 465,036 725,098 537,635 467,958 375,674
Three years later . . . . 389,559 442,508 440,198 438,726 453,431 751,302 579,093 465,507
Four years later. . . . . 384,948 433,408 437,350 435,128 460,947 790,479 582,013
Five years later. . . . . 382,331 432,370 436,929 435,942 462,372 791,377
Six years later . . . . . 381,996 432,661 437,600 437,034 461,347
Seven years later . . . . 381,914 433,050 437,706 436,476
Eight years later . . . . 382,126 432,949 437,383
Nine years later. . . . . 381,955 432,801
Ten years later . . . . . 381,838
Redundancy
(Deficiency) . . . . . . $ 90,172 $ 92,419 $109,715 $117,558 $113,272 $(36,276) $(29,693) $ 23,526 $ 12,744
(AMOUNTS IN THOUSANDS)
- - ----------------------
1998 1999
-------- --------
Reserves for
losses and loss
adjustment expenses,
net of reinsurance. $339,815 $243,398
Paid (cumulative)
as of:
One year later. . . . . . . 265,135
Two years later
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. . . . . . . 331,119
Two years later
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) . . . . . . $ 8,696
11
Each amount in the preceding table includes the effects of all changes in
amounts for prior periods. The table does 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.
In the consolidated balance sheet, the reserves for losses and loss
adjustment expenses are shown "gross," that is, before reduction for
reinsurance. The table which follows presents the development of gross losses
and loss adjustment expense reserves for calendar years 1997 through 1999. As
in the ten-year table presented net of reinsurance, each amount in the following
table includes the effects of all changes in amounts for prior periods. The
table does not present accident year or policy year development data and it
would not be appropriate to extrapolate future development based on this table.
1997 1998 1999
-------- -------- -------
(Amounts in thousands)
Gross loss and loss adjustment
expense reserves, December 31,. . $437,887 $382,003 276,248
Paid (cumulative) as of:
One year later. . . . . . . . . . 283,753 296,166
Two years later . . . . . . . . . 393,185
Gross liability re-estimated as of:
End of year . . . . . . . . . . . 437,887 382,003 276,248
One year later. . . . . . . . . . 436,699 371,774
Two years later . . . . . . . . . 419,965
Gross cumulative redundancy . . . . 17,922 10,229
The redundancies indicated above are net of additional earthquake losses
and loss adjustment expenses recorded subsequent to 1994.
OPERATING RATIOS
Combined Ratios
Underwriting profit margins are measured by the extent to which the
combined ratios (loss and loss adjustment expense ("LAE") ratio and underwriting
expense ratio) are less than 100% of premium revenues.
12
Combined ratios are used to measure the underwriting success of property
and casualty insurance companies. Losses and loss adjustment expenses are
stated as a percentage of premiums earned because losses may occur over the life
of a particular insurance policy. An important indicator of operating
efficiency, the underwriting expense ratio is based on premiums written under
statutory accounting practices ("SAP") and earned premiums for reporting under
generally accepted accounting principles ("GAAP"). The loss and LAE ratios,
underwriting expense ratios (excluding interest and fees), and combined ratios
for the Company's subsidiaries, on a SAP and GAAP basis, are shown in the
following tables.
YEARS ENDED DECEMBER 31,
-------------------------
SAP. . . . . . . . . . . . 1999 1998 1997 1996 1995
- - -------------------------- ----- ----- ----- ----- -----
Loss and LAE ratio . . . . 78.5% 81.0% 77.3% 85.8% 88.7%
Underwriting expense ratio 13.9 10.7 9.5 9.4 8.7
----- ----- ----- ----- -----
Combined ratio . . . . . . 92.4% 91.7% 86.8% 95.2% 97.4%
===== ===== ===== ===== =====
YEARS ENDED DECEMBER 31,
-------------------------
GAAP . . . . . . . . . . . 1999 1998 1997 1996 1995
- - -------------------------- ----- ----- ----- ----- -----
Loss and LAE ratio . 78.5% 81.0% 77.3% 85.8% 88.4%
Underwriting expense ratio 12.9 10.2 9.4 9.3 9.0
----- ----- ----- ----- -----
Combined ratio . 91.4% 91.2% 86.7% 95.1% 97.4%
===== ===== ===== ===== =====
The effects of the Northridge Earthquake and other non-recurring charges
(accelerated amortization of restricted stock grants in 1998, Y2K remediation
costs in 1999, 1998 and 1997 and $6.75 million in 1999 arising out of a
settlement with the California Department of Insurance ("CDOI") contributed 1.3,
6.1 and 3.3 percentage points on both a GAAP and SAP basis to the 1999, 1998 and
1997 combined ratios, respectively. In 1996 and 1995, the Northridge Earthquake
contributed 4.7 and 2.9 percentage points, respectively, on both a GAAP and SAP
basis to the combined ratios. In 1997, most of the improvement in the combined
ratio was due to favorable loss trends in the automobile line. In 1999 and
1998, the loss and LAE ratio for the automobile line increased 2.7% and 0.9% and
the underwriting expense ratio increased
13
2.2% and 1.2%, respectively. The Company's underwriting results and loss
ratios by line of business are discussed in more detail in Management's
Discussion and Analysis, Underwriting Results, and in Note 17 of the Notes to
Consolidated Financial Statements.
Premiums to Surplus Ratio
The following table shows, for the periods indicated, the Company's statutory
ratios of net premiums written to policyholders' surplus. Because each property
and casualty insurance company has different capital needs, an "appropriate"
ratio of net premiums written to policyholders' surplus for one company may not
be the same as for another company. While there is no statutory requirement
applicable to the Company, guidelines established by the National Association of
Insurance Commissioners provide that such ratio generally should be no greater
than 3 to 1 on a statutory basis.
YEARS ENDED DECEMBER 31,
------------------------
SAP 1999 1998 1997 1996 1995
- - ------------------------------------ -------- -------- -------- -------- --------
(Amounts in thousands, except ratio)
Net premium written. . . . . . . . . $768,813 $773,714 $788,600 $827,993 $958,614
Policyholders' surplus . . . . . . . $581,440 $600,654 $548,043 $436,367 $358,474
Ratio. . . . . . . . . . . . . . . . 1.3:1 1.3:1 1.4:1 1.9:1 2.7:1
The 1995 ratio was comparatively high because of the surplus strain caused
by the Northridge Earthquake. Capital infusions in 1994 and a return to
profitable operations in 1995 resulted in improved surplus levels that reduced
the ratio below 3 to 1 in 1995 and below 2 to 1 in subsequent years.
INVESTMENTS AND INVESTMENT RESULTS
The Company's investment guidelines have emphasized buying high-quality, fixed
income investments. The Investment Committee of the Company's Board of
Directors regularly reviews these guidelines and the performance of the
portfolio. Because of the net operating loss ("NOL") carryforward available for
tax purposes, the Company's investment strategy emphasized taxable securities to
maximize
14
overall cash flow following the Northridge Earthquake in 1994 until the
fourth quarter of 1998, when the Company began investing in non-taxable
securities in anticipation of fully utilizing the NOL. While the Company does
not invest with a view to achieving realized gains, securities are bought and
sold in order to meet the main objectives of the investment portfolio. These
objectives are to maximize after-tax investment income and total investment
returns while minimizing credit and liquidity risk. The Company currently has
designated all of its portfolio as "available-for-sale" as defined in Statement
of Financial Accounting Standard (SFAS) No. 115.
The following table summarizes investment results for the five most recent
years:
YEARS ENDED DECEMBER 31,
------------------------
1999 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
(Amounts in thousands)
Average invested assets, at
cost or amortized cost;
includes cash and cash
equivalents. . . . . . . . . $1,152,371 $1,147,852 $1,088,864 $1,111,396 $1,193,202
Net investment income:
Before income taxes. . . . . $ 62,668 $ 75,146 $ 73,463 $ 73,178 $ 81,658
After income taxes . . . . . $ 49,690 $ 49,248 $ 49,105 $ 52,038 $ 56,597
Average annual return on
investments:
Before income taxes. . . . . 5.44% 6.55% 6.75% 6.58% 6.84%
After income taxes . . . . . 4.31% 4.29% 4.51% 4.68% 4.74%
Net realized investment
gains (losses) after income
taxes. . . . . . . . . . . . $ (180) $ 14,716 $ 2,646 $ 4,736 $ 6,634
Net increase (decrease) in
unrealized gains on
investments after
income taxes . . . . . . . . $ (63,906) $ 3,089 $ 17,478 $ (30,688) $ 73,285
15
Net investment income before taxes decreased in 1999 compared to 1998
primarily due to the shift to tax-exempt securities beginning in the last
quarter of 1998; however, investment income after taxes increased slightly. In
addition, in 1998 and 1999, a greater portion of the portfolio was invested in
commercial paper for liquidity purposes which yielded a lower return than the
portion invested in bonds. Average invested assets increased in 1998 compared
to 1997 primarily due to the impact of $145.6 million received from AIG in the
third quarter of 1998 for the exercise of warrants to purchase common stock of
the Company. The decline in the investment portfolio from 1995 through 1997
resulted largely from the sale of investments to generate cash to cover the
severe losses and other ongoing expenses resulting from the Northridge
Earthquake. The declining after-tax return on investments in the previous table
is primarily a result of the sale, maturity or early redemption of older
securities with high yields and the re-investment in securities with lower
yields due to general market conditions.
16
The following table sets forth the composition of the Company's investments and
cash and cash equivalents at the dates indicated.
DECEMBER 31,
------------
1999 1998 1997
--------------------- ---------------------- ----------------------
Amortized Fair Amortized Fair Amortized Fair
Type of Security Cost Value Cost Value Cost Value
- - ----------------------- ------------ -------- ---------- ---------- ---------- ----------
(Amounts in thousands)
Fixed maturities:
U.S. Treasury secur-
itites and obliga-
tions of U.S. govern-
ment corporations
and agencies. . . . . $ 15,443 $ 14,667 $ 5,971 $ 6,129 $ 6,735 $ 6,758
Obligations of
states and politi-
cal subdivisions. . . 912,438 857,553 159,010 161,739 36,680 39,523
Public utilities. . . - - 162,119 171,545 171,060 175,174
Corporate securities. 77,920 70,762 705,291 727,835 838,500 861,253
------------ -------- ---------- ---------- ---------- ----------
Total fixed maturities. 1,005,801 942,982 1,032,391 1,067,248 1,052,975 1,082,708
Equity securities . . . 81 563 250 1,373 250 1,745
------------ -------- ---------- ---------- ---------- ----------
Total investments . . . 1,005,882 943,545 1,032,641 1,068,621 1,053,225 1,084,453
------------ -------- ---------- ---------- ---------- ----------
Cash and cash
equivalents . . . . . 45,034 45,034 167,856 167,856 31,268 31,268
------------ -------- ---------- ---------- ---------- ----------
Total investments
and cash and cash
equivalents . . . . . $1,050,916 $988,579 $1,200,497 $1,236,477 $1,084,493 $1,115,721
=========== ======== ========== ========== ========== ==========
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. Based on direct written premium for 1998 (latest publicly
available information), the Company is the seventh largest writer of private
passenger automobile insurance in California.
17
The Company's main competition comes from other major writers which concentrate
on the good driver market. The Company generally has sought to avoid, to the
extent regulations permit, the "non-standard," "high-risk" and similar niche
market segments.
The Company's marketing and underwriting strategy is to appeal to careful and
responsible drivers who deal directly with the Company in order to save
significant amounts of money on their insurance premiums. By selling its
products directly to the insured, the Company has eliminated agent and broker
commissions. The Company relies heavily on its centralized operations and its
efficient computerized systems to service its policyholders and claimants.
Consequently, the Company consistently operates with one of the lowest
underwriting expense ratios in the industry and is able to maintain its rates
among the lowest in the markets it serves while still providing quality service
to its customers. As a result, the Company has been able to achieve profitable
growth and to maintain policy renewal rates which it believes are significantly
above industry averages.
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 reinsurers are financially sound,
able to meet their obligations under the agreements, and that the reinsurance is
competitively priced.
The Company's insurance subsidiaries entered into a five-year (1995 to
1999) quota share reinsurance agreement with an AIG affiliate covering all
ongoing lines of business. Under this contract, which attaches to the Company's
retained risks net of all other reinsurance, 10% of each subsidiary's premiums
earned and losses and loss adjustment expenses incurred in connection with
policies incepted during the period January 1, 1995 through December 31, 1999
were ceded. The AIG affiliate has the option to renew the agreement for four
years at declining coverage percentages of 8%, 6%, 4%, and 2% for each of the
subsequent years, respectively, and has elected to do so in 2000. A ceding
commission of 10.8% was earned by the insurance subsidiaries for 1995 and,
thereafter, a commission is paid at a rate equal to the prior year's gross
statutory
18
underwriting expense ratio. The ceding commission rates were 9.36%, 9.40%
and 10.42% for 1997, 1998, and 1999 respectively.
Between mid-1996 and December 1999, the Company found it more economical to
maintain 100% quota share reinsurance arrangements for its homeowners line
rather than purchasing alternative reinsurance coverage for its exposure to
catastrophes such as fire following earthquake. Beginning January 1, 2000, the
previous homeowner reinsurance programs were cancelled and the Company entered
into a catastrophe excess of loss reinsurance program. These reinsurance
arrangements are discussed in more detail in Note 10 of the Notes to
Consolidated Financial Statements.
The Company has a quota share reinsurance treaty for PUP business whereby 60% of
premiums and losses are ceded to reinsurers. After the effect of the 10% quota
share treaty with AIG, the Company effectively retains 36% of the risk for this
line.
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 and agents
- Prior approval, in California and some other jurisdictions, of rates,
rules and forms
- Standards of solvency
- Nature of, and limitations on, insurance company investments
- 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
- Payment of dividends
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.
19
Changes in state insurance laws or regulations can affect the revenues and
expenses of the Company. In 1999, no new laws were enacted by any state in
which the Company does business that are expected to have a material impact on
the auto insurance industry. The Company anticipates that during 2000 the
California Insurance Commissioner will propose changes to the rating regulations
regarding prior approval of rates. There can be no assurance that adoption of
such changes would not be detrimental to the Company's future operating results.
The Company is a member of industry organizations which may advocate
legislative and initiative proposals and which provide financial support to
officeholders and candidates for California statewide public offices. The
Company also makes financial contributions to those officeholders and candidates
who, in the opinion of management, have a favorable understanding of the needs
of the property and casualty insurance industry. In 1999, these contributions
were nominal.
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"). Certain transactions defined to be
of an "extraordinary" nature may not be effected without the prior approval of
the CDOI. Such transactions include, but are not limited to, sales, purchases,
exchanges, loans and extensions of credit, and investments made within the
immediately preceding 12 months involving in the net aggregate, more than the
lesser of (i) 3% of the Company's admitted assets or (ii) 25% of the
policyholder's surplus as of the preceding December 31. An extraordinary
transaction also includes a dividend which, together with other dividends or
distributions made within the preceding twelve months, exceeds the greater of
(i) 10% of the insurance company's policyholders' surplus as of the preceding
December 31 or (ii) the insurance company's net income for the preceding
calendar year. The California code further provides that property and casualty
insurers may pay dividends only from earned surplus. The Holding Company Act
generally restricts the ability of any one person to acquire more than 10% of
the Company's voting securities without prior regulatory approval.
20
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, 1999, assigned risk vehicles insured had decreased to 2,929 from
12,133 at the end of 1997. This is a result of assigned risk participants
finding affordable coverage in the voluntary market or drivers who dropped out
of the program after initially responding to 1997 legislation requiring proof of
insurance for vehicle registration renewals. The CAARP assignments have
historically produced underwriting losses. As of December 31, 1999, this
business represented less than 0.3% of the Company's total gross premiums
written.
Insurers offering homeowners 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 homeowners direct premiums written in
the state. The Company's Fair Plan underwriting results for 1999 were
immaterial.
EMPLOYEES
The Company had 2,357 full and part-time employees at December 31, 1999. The
Company provides medical, pension and 401(k) savings plan benefits to eligible
employees according to the provisions of each plan. The Company believes that
its relationship with its employees is excellent, and employee turnover is
generally very low.
21
ITEM 2. PROPERTIES
The Company leases approximately 500,000 square feet for its Home Office
facilities, which are located in Woodland Hills, California. The lease was
amended in April 1998 to extend its term until November 2014. The lease may be
renewed for two consecutive five-year periods.
The Company also leases office space in 19 other locations throughout
California. The Company anticipates no difficulty in extending these leases or
obtaining comparable office facilities in suitable locations.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is named as a defendant in
lawsuits related to claim issues. Some of the actions request exemplary or
punitive damages. The actions are vigorously defended unless a reasonable
settlement appears appropriate.
Currently included in this class of litigation are certain actions that
arose out of the Northridge Earthquake. It is believed that a majority of these
actions were filed to resolve claims involving disputed damages or to contest
the applicability of the statute of limitations. While any litigation has an
element of uncertainty, the Company does not believe that the ultimate outcome
of any pending action will have a material effect on its consolidated financial
condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company submitted two matters to shareholders for approval in the
fourth quarter of 1999: (1) to change the Company name from 20th Century
Industries to 21st Century Insurance Group, and (2) to amend the Restricted
Shares Plan, increasing by 500,000 the number of shares of Common Stock
available for grants under the Plan. Both matters were approved by written
consent of a majority of the Company's shareholders.
22
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
(A) PRICE RANGE OF COMMON STOCK
The stock is currently traded on the New York Stock Exchange under the trading
symbol "TW." The following table sets forth the high and low bid prices for the
common stock for the indicated periods.
High Low
------- --------
1999
- - -------
Fourth Quarter 20-1/4 18-11/16
Third Quarter. 20 18-3/8
Second Quarter 18-7/8 16
First Quarter. 23-9/16 16-1/4
1998
- - -------
Fourth Quarter 25-7/8 20-15/16
Third Quarter. 29-3/16 22-15/16
Second Quarter 29-1/2 26-3/4
First Quarter. 30-3/8 24-3/8
(B) HOLDERS OF COMMON STOCK
The approximate number of record holders of common stock on December 31,
1999, was 820.
(C) DIVIDENDS
The Company has paid quarterly cash dividends on its common stock since the
first quarter of 1997. Dividends of $0.05 per share were paid in the first
three quarters of 1997 and then doubled to $0.10 per share for the fourth
quarter of 1997 and the first quarter of 1998. Dividends increased to $0.16 per
share for each of the last three quarters of 1998 and all four quarters of 1999.
23
The parent company is dependent upon dividends from its subsidiaries to service
debt and pay dividends to its stockholders. Based on 1999 operating results and
earned surplus as of December 31, 1999, the Company believes it will not require
regulatory approval in 2000 to upstream dividends from its subsidiaries.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented below as of the end of
and for each of the years in the five-year period ended December 31, 1999, are
derived from the Company's consolidated financial statements. The consolidated
financial statements as of December 31, 1999 and 1998, and for each of the years
in the three-year period ended December 31, 1999, are included elsewhere in this
Form 10-K. The earnings per share amounts prior to 1997 have been restated as
required to comply with Statement of Financial Accounting Standards No. 128,
Earnings Per Share. For further discussion of earnings per share, see Note 3 of
the Notes to Consolidated Financial Statements.
24
All dollar amounts set forth in the following tables are in thousands, except
per share data.
YEARS ENDED DECEMBER 31,
------------------------
1999 1998 1997 1996 1995
--------- -------- -------- -------- ----------
Operations Data:
Net premiums earned . . . . . . $770,423 $772,864 $785,989 $856,628 $ 963,797
Net investment income . . . . . 62,668 75,146 73,463 73,178 81,658
Realized investment
gains (losses) . . . . . . . (410) 22,640 4,071 7,287 10,207
Total Revenues . . . . . . . 832,681 870,650 863,523 937,093 1,055,662
Net losses and loss adjustment
expenses . . . . . . . . . . 605,064 626,379 607,775 734,735 851,602
Policy acquisition costs. . . . 80,514 57,523 44,851 38,175 38,647
Other operating expenses. . . . 18,856 21,100 29,047 41,496 48,311
Interest and fees expense . . . 7,020 10,278 13,722 14,260 15,897
Total Expenses . . . . . . . 711,454 715,280 695,395 828,666 954,457
--------- -------- -------- -------- ----------
Income before federal
income taxes . . . . . . . . 121,227 155,370 168,128 108,427 101,205
Federal income taxes. . . . . . 33,699 54,298 57,199 34,370 31,575
--------- -------- -------- -------- ----------
Net income. . . . . . . . . . . $ 87,528 $101,072 $110,929 $ 74,057 $ 69,630
========= ======== ======== ======== ==========
Per Share Data:
Basic . . . . . . . . . . . . . $ 1.00 $ 1.36 $ 1.76 $ 1.05 $ 0.97
========= ======== ========
Diluted . . . . . . . . . . . . $ 1.00 $ 1.19 $ 1.37 $ 0.92 $ 0.90
========= ==========
Dividends paid per common
share. . . . . . . . . . . . $ 0.64 $ 0.58 $ 0.25 $ 0.05 $ -
========= ======== ======== ======== ==========
25
In 1999, 1998 and 1997, the Company's financial statements include the
effects of certain non-recurring charges of $9.2 million, $7.7 million and $1.5
million, respectively. These charges represent a non-recurring regulatory
settlement with the CDOI in 1999, accelerated amortization of restricted stock
grants in 1998 and Year 2000 remediation costs in 1999, 1998 and 1997.
Additionally, increases in earthquake reserves in 1998 of $40 million, in 1997
of $24.75 million, in 1996 of $40 million and in 1995 of $60 million (offset
partially by a $32 million reduction in the Proposition 103 liability per an
order from the CDOI) are included in the financial statements. On an after-tax
basis, these additional charges reduced basic earnings per share by $0.08,
$0.46, $0.33, $0.51 and $0.35 for 1999, 1998, 1997, 1996 and 1995 respectively.
DECEMBER 31,
------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
Balance Sheet Data:
Total investments . . . . . $ 943,545 $1,068,621 $1,084,453 $1,064,628 $1,127,112
Total assets. . . . . . . . 1,379,332 1,593,156 1,482,454 1,513,755 1,608,886
Unpaid losses and loss
adjustment expenses. . . 276,248 382,003 437,887 543,529 584,834
Unearned premiums . . . . . 232,702 233,689 233,402 231,141 288,927
Bank loan payable . . . . . 67,500 112,500 157,500 175,000 175,000
Claims checks payable . . . 31,912 34,311 35,569 36,445 49,306
Stockholders' equity. . . . 720,837 785,602 582,961 487,707 466,585
Book value per common share $ 8.39 $ 8.97 $ 6.93 $ 5.10 $ 4.69
26
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 year ended December 31,
1999 1998 1997
-------- -------- --------
(Amounts in thousands, except per share data)
Operating cash flow . . . . . . . . . . . . . $ 29,468 $ 87,689 $ 69,673
Book value per share. . . . . . . . . . . . . $ 8.39 $ 8.97 $ 6.93
Debt to equity ratio (1). . . . . . . . . . . 0.09 0.15 0.28
Statutory surplus of insurance
subsidiaries . . . . . . . . . . . . . . . $581,440 $600,654 $548,043
Net written premiums to surplus
ratio. . . . . . . . . . . . . . . . . . . 1.3:1 1.3:1 1.4:1
A.M. Best financial rating. . . . . . . . . . A A- A-
S&P financial rating. . . . . . . . . . . . . A+ A+ A-
(1) Equity adjusted to exclude unrealized investment gains and losses.
27
RESULTS OF OPERATIONS
Units in Force
Units in force for the Company's insurance programs as of December 31 were
as follows:
1999 1998 1997
--------- --------- ---------
Private Passenger Automobile
(Number of vehicles). . . . . 1,184,797 1,130,029 1,076,876
Homeowners
(Number of policies). . . . . 55,364 55,614 61,024
Personal Umbrella Policy ("PUP")
(Number of policies). . . . . 13,261 12,404 11,683
--------- --------- ---------
Total. . . . . . . . . . . . . . 1,253,422 1,198,047 1,149,583
========= ========= =========
These counts exclude 21,312, 15,541 and 10,853 in 1999, 1998 and 1997,
respectively, of vehicles insured by 21st Century Insurance Company of Arizona.
Information about recent developments relating to units in force within each
major coverage line follows.
Private Passenger Automobile. Vehicles in force grew by 54,768 in 1999,
------------------------------
compared to an increase of 53,153 in 1998. The Company's average customer
retention rate was approximately 96% for both 1999 and 1998. The competition
for new business intensified in 1999, particularly in California. The Company
lowered overall rate levels approximately 6.8% and 3.4% in 1999 and 1998,
respectively, in anticipation of continuing favorable loss trends. However, by
mid-1999, past favorable trends had flattened or, in some cases turned
unfavorable, which began to reduce the Company's underwriting margins in the
third and fourth quarters of 1999. The Company anticipates continued pressure
on its margins and expects that a price increase may become necessary during
2000.
28
Homeowners. The Company's position in the homeowners market is intended to
- - ----------
complement its auto business and facilitate growth in that line. Units in force
for the Company's homeowners program remained comparatively stable from December
31, 1998, to December 31, 1999, due to the commencement of sales of new policies
in September 1999 for the first time since 1995, which substantially offset the
decrease caused by customer attrition.
PUP. The penetration of this coverage has averaged about 1% of the
---
vehicles in force during each of the three years ended December 31, 1999.
--
Underwriting Results
Premium revenue and underwriting results for the Company's insurance
programs follow, presented in conformity with generally accepted accounting
principles ("GAAP"). To facilitate comparability, the effects of the
earthquake, non-recurring costs and the Proposition 103 settlement have been
isolated from the core business in the tables below.
29
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
-------- -------- --------
(Amounts in thousands)
GROSS PREMIUMS WRITTEN
Automobile. . . . . . . . . . . . . $853,004 $858,263 $871,996
Homeowners. . . . . . . . . . . . 24,748 24,806 27,367
Personal Umbrella . . . . . . . . 2,782 2,548 2,406
-------- -------- ---------
Total . . . . . . . . . . . . . . . $880,534 $885,617 $901,769
======== ======== ========
NET PREMIUMS EARNED
Automobile. . . . . . . . . . . . . $769,168 $772,267 $781,288
Homeowners. . . . . . . . . . . 189 (294) 3,917
Personal Umbrella . . . . . . . 1,066 891 784
-------- -------- ---------
Total . . . . . . . . . . . . . . . $770,423 $772,864 $785,989
======== ======== ========
UNDERWRITING PROFIT (LOSS)
Automobile - excluding effects of
non-recurring costs. . . . . . . $ 80,659 $120,369 $135,622
Homeowners. . . . . . . . . (5,195) (5,544) (5,557)
Personal Umbrella . . . . . 792 703 493
-------- -------- ---------
Subtotal Core Business. . . 76,256 115,528 130,558
Earthquake and non-recurring costs (10,267) (47,666) (26,242)
-------- -------- ---------
Total . . . . . . . . . . . . . . . $ 65,989 $ 67,862 $104,316
======== ======== ========
30
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
-------- -------- --------
COMBINED RATIOS
Core Business - GAAP
- - --------------------
Loss and LAE ratio . . . . 78.4% 75.9% 74.2%
Underwriting expense ratio 11.7 9.2 9.2
-------- -------- ---------
Combined ratio . . . . . . 90.1% 85.1% 83.4%
======== ======== ========
Company Totals - GAAP
- - ---------------------
Loss and LAE ratio . . . . 78.5% 81.0% 77.3%
Underwriting expense ratio 12.9 10.2 9.4
-------- -------- --------
Combined ratio . . . . . . 91.4% 91.2% 86.7%
======== ======== ========
Automobile - Excluding Non-recurring Costs
Automobile insurance is the primary line of business written by the Company
and has been consistently profitable, although the Company experienced a
combined ratio of 100.3% in this line in the fourth quarter of 1999 as a result
of the factors discussed previously under Units in Force that have contributed
to lower margins. The majority of the Company's insured autos are located in
Southern California. The Company continues to expand its coverage throughout the
West by marketing its business in Northern California, San Diego County, Nevada,
Oregon and Washington which, combined, accounted for approximately 59% of all
new business written in 1999.
The auto line experienced an $80.7 million underwriting profit in 1999
compared to $120.4 million and $135.6 million in 1998 and 1997, respectively, as
adjusted for the effects of non-recurring costs. The decrease in underwriting
results in 1999 and 1998 is primarily due to increases in losses and loss
expenses coupled with rate decreases of 6.8% and 3.2% effective February 15,
1999 and January 1, 1998, respectively.
These rate reductions caused gross written premiums to decrease two years
in a row, despite increases in insured units of 4.9% and 4.2% for 1999 and 1998,
respectively.
31
Since 1996, the Company has reduced average California auto premiums by
more than 25%. Although the reduction in premium revenues produced lower
top-line and investment income growth, underwriting margins continued to be
favorable until the third quarter of 1999, as previously discussed under "Units
in Force."
Homeowners - Excluding Earthquake
Underwriting results for this program are subject to variability caused by
weather-related claims and by infrequent disasters. No significant losses were
incurred in this line in 1997, 1998 or 1999.
From July 1, 1996, to December 31, 1999 the Company maintained a 100% quota
share reinsurance program for its homeowners policies, as discussed in Note 10
of the Notes to Consolidated Financial Statements. Written premiums ceded under
this program totaled $24.7 million in 1999 compared to $24.5 million in 1998 and
$24.4 million in 1997.
Effective January 1, 2000, the 100% quota share reinsurance program was
terminated and replaced by a more traditional catastrophe excess of loss
reinsurance program. (See Note 10 of the Notes to Consolidated Financial
Statements.)
Personal Umbrella Policy
The personal umbrella program has remained stable over the three-year
period ended December 31, 1999, producing approximately $2 million in gross
written premiums each year. Underwriting profits for this business can vary
significantly with the number of claims which occur infrequently.
Earthquake
Although the Company has not written new or renewal earthquake premiums
since 1994, the Company assumes a small amount of earthquake premium from the
California FAIR Plan, a state-administered pool of difficult-to-insure risks.
Insurers are required to participate in the pool in proportion to their share of
direct written homeowners coverage in the state.
32
The Company recorded additional provisions for the 1994 Northridge Earthquake in
1998 and 1997 of $40 million and $24.75 million, respectively. No additional
provision was made in 1999. Although the Company remains exposed to possible
further upward development in the estimated cost to resolve certain Northridge
Earthquake claims, management believes current reserves are adequate.
Policy Acquisition and General Operating Expenses
The Company's policy acquisition and general operating expense ratio
continues to be among the most competitive in the industry. As a direct writer,
the Company does not incur agent commissions and, thus, enjoys an expense
advantage over most of its competitors. The ratios of underwriting expenses
(excluding interest and fees) to earned premiums were 12.9% in 1999, 10.2% in
1998 and 9.4% in 1997. Excluding non-recurring charges related to the CDOI
settlement, Y2K costs and the amortization of stock grants, the expense ratios
would be 11.7% in 1999 and 9.2% in both 1998 and 1997. The increase in the
expense ratio from 1998 to 1999 primarily results from the rate decrease taken
in February 1999 and increases in advertising expense.
Impact of Year 2000 on Computer Systems
The Y2K issue arose because some computer programs and hardware were
designed to use two digits rather than four to define the applicable year. The
Company took what it believed to be a comprehensive approach to remediating its
Y2K issues, including the preparation of risk assessments, system upgrades,
system replacements, system testing and contingency planning. The Company
passed the critical Year 2000 dates January 1, 2000, and February 29, 2000, with
no problems and, as such believes it has no further exposure to Year 2000
computer issues.
The total Year 2000 project cost was approximately $9.6 million, which was
expensed as incurred. Approximately one third of that amount represented the
direct cost of certain personnel in the Company's Information Services
department who were dedicated to this project, with most of the remainder
representing external consultants. Costs incurred during 1999, 1998 and 1997
were $2.4 million, $5.7 million and $1.5 million, respectively.
33
Investment Income
Net pre-tax investment income was $62.7 million in 1999 compared to $75.1
million in 1998 and $73.5 million in 1997. Average invested assets increased
0.4% in 1999 and 5.4% in 1998 compared to a decrease of 2.0% in 1997. The
increase in 1998 is primarily due to additional cash received from the exercise
of AIG's common stock warrants in the third quarter of 1998 as discussed in Note
12 of the Notes to Consolidated Financial Statements. The decline in invested
assets for 1997 resulted from the decline in net earned premiums and the
liquidation of investments to meet the payment requirements of both developing
earthquake losses and reinsurance premiums. The average annual pre-tax yield on
invested assets was 5.4% in 1999, 6.6% in 1998 and 6.7% in 1997. The average
annual after-tax yield on invested assets was 4.3% in 1999, 4.3% in 1998 and
4.5% in 1997.
Realized capital losses on the sale of investments were $0.4 million in
1999 compared to capital gains of $22.6 million for 1998 and $4.1 million for
1997. The 1998 increase in realized gains is primarily due to the Company's
decision to begin switching its investment portfolio from taxable to non-taxable
securities during 1998 in anticipation of fully utilizing its remaining net
operating loss deduction and selling into a declining bond market. At December
31, 1999, $846.3 million of the Company's total investments at fair value were
invested in tax-exempt bonds with the balance, representing 14.4% of the
portfolio, invested in taxable securities compared to 88.6% at December 31,
1998.
As of December 31, 1999, the Company had a pre-tax unrealized loss on fixed
maturity investments of $62.3 million compared to an unrealized capital gain of
$34.9 million in 1998 and $29.7 million in 1997. Interest rates rose in 1999,
which decreased the fair value of our bond portfolio. Conversely, in 1998 and
1997, interest rates fell, which increased the fair value of the bond portfolio
in those years.
Liquidity and Capital Resources
Premiums and investment income represent the Company's major sources of
cash, while loss and loss adjustment expense payments are the most significant
cash out-flows. The Company continually monitors loss payments to provide
projections of future cash requirements. Additional cash requirements include
servicing the bank debt and paying dividends as approved from time to time by
the Company's Board of Directors.
34
Funds required by 21st Century Insurance Group to pay dividends and meet
its debt obligations are provided by the insurance subsidiaries. Information
regarding the Company's debt service requirements is included in Note 9 of the
Notes to Consolidated Financial Statements. The ability of the insurance
subsidiaries to pay dividends to the parent company is regulated by state law.
Based upon 1999 operating results and earned surplus as of December 31, 1999,
the Company believes it will not require regulatory approval in 2000 for any
extraordinary dividends.
In 1997, the Company embarked on a major project to upgrade its
technological infrastructure and to conform certain of its operational
procedures to "industry best practices." Although the ultimate cost of this
project is expected to be about $100 million, to be paid through the end of
2001, management believes cash flow from operations as well as expected
improvements in operational efficiencies will be more than adequate to fund the
project's implementation which is expected to be completed over the next several
years.
During the second quarter of 1999, the Company's Board of Directors
authorized the expenditure of $50 million to purchase shares of the Company's
common stock. As of February 29, 2000, 2,,321,084 shares had been repurchased
at a cost of approximately $44.0 million.
Risk-Based Capital
The National Association of Insurance Commissioners requires property and
casualty insurance companies to calculate and report information under a
Risk-Based Capital ("RBC") formula in their Annual Statements. The RBC
requirements are intended to assist regulators in identifying inadequately
capitalized companies. The RBC calculation is based on the type and mix of
risks inherent in the Company's business and includes components for
underwriting, asset, interest rate and other risks. To the extent that a
subsidiary's surplus fell below prescribed levels, it would be the parent
company's intention to infuse necessary capital to support that entity. The
Company's insurance subsidiaries exceeded their RBC statutory surplus standards
by a considerable margin as of December 31, 1999.
Home Office Lease
The Company leases approximately 500,000 square feet for its Home Office
facilities in Woodland Hills, California. The Company expanded its headquarters
to nearly double the size of its former facility in
35
late 1999, with the completion of construction of the new 21st Century Plaza.
The leases on these Home Office facilities expire in 2014 and may be renewed for
two consecutive five-year periods.
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 and claims experience; (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) the effect of changes in laws and regulations
affecting the Company's business, including changes in tax laws affecting
insurance products; (f) market risks related to interest rates; (g) the
Company's ability to develop information technology and management information
systems to support strategic goals while continuing to control costs and
expenses; (h) the costs of defending litigation and the risk of unanticipated
material adverse outcomes in such litigation; (i) changes in accounting and
reporting practices; and (j) 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 values of the Company's
financial instruments. The Company's investment portfolio is carried at fair
value; the fair value of the Company's variable-rate bank loan payable
36
is presumed to equal its carrying value. The second column shows the effect on
current carrying values and estimated fair values assuming a 100 basis point
increase in market interest rates and a 10% decline in equity prices. The
following sensitivity analysis summarizes only the exposure to market risk as of
December 31, 1999.
Estimated Fair
Value at
Adjusted Market
Rates/Prices as
Carrying Value Indicated Below
---------------------- ----------------
(Amounts in millions)
Interest Rate Risk:*
Fixed Maturities Available for Sale $ 943.5 $ 928.0
Bank Loan Payable . . . . . . . . . 67.5 67.5
Equity Price Risk:**
Marketable Equity Securities. . . . 0.6 0.5
* Adjusted interest rates assume a 100 basis point increase in market rates at
December 31, 1999.
** Adjusted equity prices assume a 10 percent decline in values at December 31,
1999.
Because the Company historically has generated an underwriting profit, its
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, the Company generally has the ability to hold
its investments to maturity, and 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 its financial
assets and liabilities, the Company seeks to maintain reasonable average
durations, consistent with the maximization of income without sacrificing
investment quality and providing for liquidity and diversification. Financial
instruments are not used for trading purposes.
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 actions the Company could take in
response to actual and/or anticipated changes in interest rates and equity
prices.
37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors
21st Century Insurance Group
We have audited the accompanying consolidated balance sheets of 21st
Century Insurance Group (formerly 20th Century Industries) and subsidiaries as
of December 31, 1999 and 1998, and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1999. 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, 1999 and 1998, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1999, 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.
Los Angeles, California
January 28, 2000
38
21ST CENTURY INSURANCE GROUP
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
-------------
1999 1998
------------- ----------
(Amounts in thousands)
Investments, available-for-sale, at fair value:
Fixed maturities . . . . . . . . . . . . . . $ 942,982 $1,067,248
Equity securities. . . . . . . . . . . . . . 563 1,373
------------- ----------
Total investments - Note 4 . . . . . . . . 943,545 1,068,621
Cash and cash equivalents. . . . . . . . . . . . 45,034 167,856
Accrued investment income. . . . . . . . . . . . 15,403 19,542
Premiums receivable. . . . . . . . . . . . . . . 70,796 70,884
Reinsurance receivables and recoverables . . . . 56,616 66,823
Prepaid reinsurance premiums . . . . . . . . . . 32,212 31,589
Deferred income taxes - Note 5 . . . . . . . . . 91,251 74,330
Deferred policy acquisition costs - Note 6 . . . 22,156 16,100
Other assets . . . . . . . . . . . . . . . . . . 102,319 77,411
------------- ----------
$ 1,379,332 $1,593,156
============= ==========
See accompanying notes to financial statements.
39
21ST CENTURY INSURANCE GROUP
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31,
--------------
1999 1998
-------------- ----------
(Amounts in thousands, except share data)
Unpaid losses and loss adjustment expenses - Note 8. . $ 276,248 $ 382,003
Unearned premiums. . . . . . . . . . . . . . . . . . . 232,702 233,689
Bank loan payable - Note 9 . . . . . . . . . . . . . . 67,500 112,500
Claims checks payable. . . . . . . . . . . . . . . . . 31,912 34,311
Reinsurance payable. . . . . . . . . . . . . . . . . . 22,311 20,628
Other liabilities. . . . . . . . . . . . . . . . . . . 27,822 24,423
-------------- ----------
Total liabilities. . . . . . . . . . . . . . . . 658,495 807,554
Commitments and contingencies - Notes 11 and 14
Stockholders' equity - Note 12
Capital Stock
Preferred stock, par value $1.00 per share;
authorized 500,000 shares, none issued . . . . . - -
Series A convertible preferred stock, par value
$1.00 per share, stated value $1,000 per share;
authorized 376,126 shares, none outstanding
in 1999 or 1998. . . . . . . . . . . . . . . . . - -
Common stock, without par value; authorized
110,000,000 shares, outstanding 85,918,680
in 1999 and 87,624,531 in 1998 . . . . . . . . . 429,623 462,268
Accumulated other comprehensive income - Note 4 . . (40,519) 23,387
Retained earnings . . . . . . . . . . . . . . . . . 331,733 299,947
-------------- ----------
Total stockholders' equity . . . . . . . . . . . 720,837 785,602
-------------- ----------
$ 1,379,332 $1,593,156
============== ==========
See accompanying notes to financial statements.
40
21ST CENTURY INSURANCE GROUP
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------
1999 998 1997
--------- -------- --------
(Amounts in thousands, except per share data)
REVENUES
Net premiums earned - Note 10 . . . . . . . . $770,423 $772,864 $785,989
Net investment income - Note 4. . . . . . . . 62,668 75,146 73,463
Realized investment gains (losses) - Note 4 . (410) 22,640 4,071
--------- -------- --------
832,681 870,650 863,523
LOSSES AND EXPENSES
Net losses and loss adjustment
expenses - Note 8 . . . . . . 605,064 626,379 607,775
Policy acquisition costs - Note 6 80,514 57,523 44,851
Other operating expenses. . . . . . 18,856 21,100 29,047
Interest and fees expense - Note 9. . 7,020 10,278 13,722
--------- -------- --------
711,454 715,280 695,395
--------- -------- --------
Income before federal
income taxes . . . . . . . . . . . . . 121,227 155,370 168,128
Federal income taxes - Note 5 . . . . . 33,699 54,298 57,199
--------- -------- --------
NET INCOME . . . . . . . . . . . . . . . . $ 87,528 $101,072 $110,929
========= ======== ========
EARNINGS PER COMMON
- - -------------------
SHARE - Note 3
- - -----------------
BASIC. . . . . . . . . . . . . . . . . . . $ 1.00 $ 1.36 $ 1.76
========= ======== ========
DILUTED. . . . . . . . . . . . . . . . . . $ 1.00 $ 1.19 $ 1.37
========= ======== ========
See accompanying notes to financial statements.
41
21ST CENTURY INSURANCE GROUP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(Amounts in thousands, except per share data)
Accumulated
Convertible Other
Preferred Common Retained Comprehensive
Stock Stock Earnings Income Total
------------- --------- ---------- --------------- --------
Balance at January 1, 1997 . . . . . . $ 224,950 $ 86,263 $ 173,674 $ 2,820 $487,707
--------
Comprehensive income:
Net income for the year . . . . . . 110,929 110,929
Change in accumulated other
comprehensive income, net -
Note 4. . . . . . . . . . . . . . 17,478 17,478
--------
Total comprehensive income. . . . . 128,407
Cash dividends paid on common
stock ($0.25 per share). . . . . (12,906) (12,906)
Cash dividends paid on
preferred stock . . . . . . . . . (20,245) (20,245)
Other . . . . . . . . . . . . . . . 967 (969) (2)
------------- --------- ---------- --------------- --------
Balance at December 31, 1997 . . . . . 224,950 87,230 250,483 20,298 582,961
--------
Comprehensive income:
Net income for the year . . . . . . 101,072 101,072
Change in accumulated other
comprehensive income, net -
Note 4. . . . . . . . . . . . . . 3,089 3,089
--------
Total comprehensive income. . . . . 104,161
Cash dividends paid on common
stock ($0.58 per share) . . . . . (41,485) (41,485)
Cash dividends paid on
preferred stock. . . . . . . . . (10,123) (10,123)
Effects of conversion of preferred
stock and exercise of common
stock warrants. . . . . . . . . . (224,950) 370,550 145,600
Other . . . . . . . . . . . . . . . 4,488 4,488
------------- --------- ---------- --------------- --------
Balance at December 31, 1998 . . . . . - 462,268 299,947 23,387 785,602
--------
Comprehensive income:
Net income for the year . . . . . . 87,528 87,528
Change in accumulated other
comprehensive income, net -
Note 4. . . . . . . . . . . . . . (63,906) (63,906)
--------
Total comprehensive income. . . . . 23,622
Cash dividends paid on common
stock ($0.64 per share) . . . . . (55,742) (55,742)
Stock repurchased . . . . . . . . . (33,285) (33,285)
Other . . . . . . . . . . . . . . . 640 640
------------- --------- ---------- --------------- --------
Balance at December 31, 1999 . . . . . $ - $429,623 $ 331,733 $ (40,519) $720,837
============= ========= ========== =============== ========
See accompanying notes to financial statements.
42
21ST CENTURY INSURANCE GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
-------- --------- --------
(Amounts in thousands)
OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . $ 87,528 $101,072 $110,929
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for depreciation and amortization . 13,029 10,179 5,598
Provision for deferred income taxes . . . . . . 17,598 50,884 54,569
Realized (gains) losses on sale of investments. 410 (22,640) (4,071)
Federal income taxes. . . . . . . . . . . . . . 10,932 (10,658) 502
Reinsurance balances. . . . . . . . . . . . 11,267 5,073 9,616
Unpaid losses and loss adjustment expenses. . (105,755) (55,884) (105,642)
Unearned premiums . . . . . . . . . . . . . . . (987) 287 2,261
Claims checks payable . . . . . . . . . . . . . (2,399) (1,258) (876)
Other . . . . . . . . . . . . . . . . . . . (2,155) 10,634 (3,213)
-------- --------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES . . . . . . . . . 29,468 87,689 69,673
43
21ST CENTURY INSURANCE GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
--------- --------- ---------
(Amounts in thousands)
INVESTING ACTIVITIES:
Investments available-for-sale:
Purchases . . . . . . . . . . . . . . . . $(771,769) $(848,131) $(660,903)
Calls or maturities . . . . . . . . . . . 7,890 23,248 6,981
Sales . . . . . . . . . . . . . . . . . . 789,590 867,441 664,675
Net purchases of property and
equipment . . . . . . . . . . . . . . . . (43,974) (42,651) (16,585)
--------- --------- ---------
NET CASHUSED IN
INVESTING ACTIVITIES . . . . . . . . (18,263) (93) (5,832)
FINANCING ACTIVITIES:
Repurchase of common stock, net of options
exercised. . . . . . . . . . . . . . . . (33,285) - -
Proceeds from exercise of common stock
warrants . . . . . . . . . . . . . . . - 145,600 -
Bank loan principal repayment . . . . . . . (45,000) (45,000) (17,500)
Dividends paid. . . . . . . . . . . . . . (55,742) (51,608) (33,151)
--------- --------- ---------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES . . . . . . . (134,027) 48,992 (50,651)
--------- --------- ---------
Net increase (decrease) in cash. . . . . . . (122,822) 136,588 13,190
Cash and cash equivalents, beginning of year . 167,856 31,268 18,078
--------- --------- ---------
Cash and cash equivalents, end of year . . . . $ 45,034 $ 167,856 $ 31,268
========= ========= =========
See accompanying notes to financial statements.
44
21ST CENTURY INSURANCE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 1. DESCRIPTION OF BUSINESS
21st Century Insurance Group (formerly 20th Century Industries), through
its wholly owned subsidiaries, 21st Century Insurance Company and 21st Century
Casualty Company (collectively, the "Company"), is engaged in the sale of
private passenger automobile insurance policies in California, Nevada, Oregon
and Washington and homeowners and personal umbrella insurance policies in
California. At this time, almost all of the Company's business is concentrated
in California. The Company also provides private passenger automobile insurance
in Arizona through a joint venture with American International Group, Inc.
("AIG"), which owned a majority of the Company's outstanding common stock at
December 31, 1999.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation and Presentation
The accompanying consolidated financial statements include the accounts and
operations of 21st Century Insurance Group and its wholly owned subsidiaries.
All material intercompany accounts and transactions have been eliminated. The
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles ("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.
45
Investments
The Company classifies its investment portfolio as available-for-sale and
carries it at fair value with unrealized gains and losses, net of any tax
effect, reported as accumulated other comprehensive income in 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.
The Company's 49% interest in 21st Century Insurance Company of Arizona,
which is a joint venture between the Company and AIG and which began operations
in August 1996, has a carrying value of $3,548,000 at December 31, 1999, and is
included in other assets in the consolidated balance sheet. The Company's
equity in the net loss of this venture amounted to $451,000, $373,000 and
$656,000 in 1999, 1998 and 1997, respectively, and is included in investment
income in the consolidated statements of income.
Cash and Cash Equivalents
Cash and cash equivalents include cash and short-term investments in demand
deposits having a maturity of three months or less at the date of purchase.
Recognition of Revenues
Insurance premiums are recognized as revenue pro rata over the terms of the
policies. The unearned portion is included in the balance sheet as a liability
for unearned premiums.
Losses and Loss Adjustment Expenses
The estimated liabilities for losses and loss adjustment expenses 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 estimates of expenses for
investigating and adjusting all incurred and unadjusted claims. Amounts
reported are
46
estimates of the ultimate costs of settlement, net of estimated salvage and
subrogation, which are necessarily subject to the outcome of future events
including the effects of changes in economic and social conditions. 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 earnings.
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. 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 that the
fair value of its reinsurance recoverables approximates their carrying amounts.
Policy Acquisition Costs
Policy acquisition costs, principally direct and indirect costs related to
production of business, are deferred and amortized to expense as the related
premiums are earned.
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.
47
NOTE 3. EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per
common share:
YEARS ENDED DECEMBER 31,
-------------------------
1999 1998 1997
-------- -------- --------
(Amounts in thousands, except per share data)
Numerator:
Net income . . . . . . . . . . . . . . . . . . . $ 87,528 $101,072 $110,929
Preferred stock dividends. . . . . . . . . . - (10,123) (20,245)
-------- -------- --------
Numerator for basic earnings per share:
Income available to common stockholders . . . 87,528 90,949 90,684
Effect of dilutive securities:
Dividends on convertible preferred stock. . . - 10,123 20,245
-------- -------- --------
Numerator for diluted earnings per share:
Income available to common stockholders
after assumed conversions . . . . . . . . . . $ 87,528 $101,072 $110,929
======== ======== ========
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding . . . 87,145 66,976 51,500
Effect of dilutive securities:
Restricted stock grants . . . . . . . . . . . 49 79 121
Employee stock options. . . . . . . . . . 59 315 171
Warrants. . . . . . . . . . . . . . . . - 6,146 9,079
Convertible preferred stock . . . . . . . . . - 11,368 19,854
-------- -------- --------
108 17,908 29,225
Denominator for diluted earnings per share:
Adjusted weighted-average shares outstanding. 87,253 84,884 80,725
======== ======== ========
Basic earnings per common share . . . . . . . . $ 1.00 $ 1.36 $ 1.76
======== ======== ========
Diluted earnings per common share. . . . . . . . $ 1.00 $ 1.19 $ 1.37
======== ======== ========
48
NOTE 4. INVESTMENTS
A summary of net investment income follows:
YEARS ENDED DECEMBER 31,
---------------------------
1999 1998 1997
------- ------- -------
(Amounts in thousands)
Interest on fixed maturities. $56,638 $70,358 $72,140
Interest on cash equivalents. 6,954 5,593 2,333
Other . . . . . . . . . . (431) (371) (654)
------- ------- -------
Total investment income. . 63,161 75,580 73,819
Investment expense. . . . . . 493 434 356
------- ------- -------
Net investment income. . . $62,668 $75,146 $73,463
======= ======= =======
A summary of realized investment gains and losses before income taxes follows:
YEARS ENDED DECEMBER 31,
---------------------------
1999 1998 1997
------- ------- -------
(Amounts in thousands)
Fixed maturities available-for-sale:
Gross realized gains . . . .$13,475 $23,030 $ 6,958
Gross realized losses. . . .(14,697) (390) (2,887)
------- ------- -------
Net realized gain (loss) on
fixed maturities . . . . . (1,222) 22,640 4,071
------- ------- -------
Equity securities
Gross realized gains . . 945 - -
Gross realized loss. . . . - - -
------- ------- -------
Net realized gain on equity
securities . . . . . . . 945 - -
Other. . . . . . . (133) - -
------- ------- -------
Net realized investment
gain (loss) . $ (410) $22,640 $ 4,071
======= ======= =======
49
The amortized cost, gross unrealized gains and losses, and fair values of
investments as of December 31, 1999 and 1998, are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- - ----------------------------- ---------- ----------- ----------- ----------
(Amounts in thousands)
1999
- - ----
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 15,443 $ 9 $ 785 $ 14,667
Obligations of states and
political subdivisions 912,438 1,099 55,984 857,553
Corporate securities 77,920 67 7,225 70,762
---------- ----------- ----------- ----------
Total fixed maturities 1,005,801 1,175 63,994 942,982
Equity securities 81 482 - 563
---------- ----------- ----------- ----------
Total investments $1,005,882 $ 1,657 $ 63,994 $ 943,545
========== =========== =========== ==========
1998
- - ----
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 5,971 $ 158 $ - $ 6,129
Obligations of states and
political subdivisions 159,010 3,332 603 161,739
Public utilities 162,119 9,445 19 171,545
Corporate securities 705,291 27,069 4,525 727,835
---------- ----------- ----------- ----------
Total fixed maturities 1,032,391 40,004 5,147 1,067,248
Equity securities 250 1,123 - 1,373
---------- ----------- ----------- ----------
Total investments $1,032,641 $ 41,127 $ 5,147 $1,068,621
========== =========== =========== ==========
50
The amortized cost and fair value of the Company's fixed maturity investments at
December 31, 1999, are summarized by contractual maturity, as follows:
(Amounts in thousands) Available-for-sale
-----------------------
Amortized Fair
Fixed maturities due: Cost Value
- - ---------------------- ------------- --------
2000 . . . . . . . . . $ 2,009 $ 2,076
2001 - 2004. . . . . . 5,369 5,227
2005 - 2009. . . . . . 111,441 104,352
2010 - 2019. . . . . . 877,144 822,121
2020 and after . . . . 9,838 9,206
------------- --------
Total. . . . . . $ 1,005,801 $942,982
============= ========
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.
Details follow concerning the change in the after-tax net unrealized gain
(loss) on investments for 1999, 1998, and 1997, which is included in the equity
section of the consolidated balance sheets under the caption "accumulated other
comprehensive income."
YEARS ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
-------- --------- --------
(Amounts in thousands)
Unrealized gain (loss) on available-for-sale
investments, net of tax expense (benefit)
of $(34,508), $9,587 and $10,836,
respectively . . . . . . . . . . . . . . . . $(64,086) $17,805 $20,124
Less: reclassification adjustment for gains
(losses) included in net income, net of tax
expense (benefit) of $(97), $7,924 and
$1,425, respectively . . . . . . . . . . . . 180 (14,716) (2,646)
-------- --------- --------
Total . . . . . . . . . . . . . . . . . . . . . $(63,906) $ 3,089 $17,478
======== ========= ========
51
NOTE 5. FEDERAL INCOME TAXES
Federal income tax expense consists of:
YEARS ENDED DECEMBER 31,
-------------------------
1999 1998 1997
-------- ------- -------
(Amounts in thousands)
Current tax expense. . $ 16,101 $ 3,414 $ 2,630
Deferred tax expense . 17,598 50,884 54,569
-------- ------- -------
$ 33,699 $54,298 $57,199
======== ======= =======
The Company's net deferred income tax asset is comprised of:
DECEMBER 31,
----------------
1999 1998
------- -------
(Amounts in thousands)
Deferred tax assets:
Net operating loss carryforward . . . . . . $33,172 $53,587
Alternative minimum tax credit. . . . . . . 33,029 16,930
Unearned premiums . . . . . . . . . . . . . 14,041 14,147
Unpaid losses and loss adjustment expenses. 5,307 6,741
Non-qualified retirement plans. . . . 3,623 3,418
Unrealized investment losses. . . . . . 21,817 -
Other . . . . . . . . . . . . . . . . 3,890 3,591
------- -------
114,879 98,414
------- -------
Deferred tax liabilities:
Unrealized investment gains . . . . . . . . - 12,593
Deferred policy acquisition costs . . . 9,065 5,635
Salvage and subrogation . . . . . . . . 890 745
EDP software development costs. . . . . 13,673 5,111
------- -------
23,628 24,084
------- -------
Net deferred tax asset . . . . . . . . . . . . $91,251 $74,330
======= =======
Ordinarily, the Company's principal deferred tax assets arise from the
discounting of loss reserves for tax purposes, which delays a portion of the
loss deduction, and from the acceleration of 20% of the unearned premium reserve
into taxable income before it is earned. During 1999, the
52
Company utilized net operating loss carryforwards of approximately
$59,000,000 to reduce current taxable income. As of December 31, 1999, the
Company has a net operating loss carryforward of approximately $97,000,000 for
regular tax purposes expiring in the year 2009 and an alternative minimum tax
credit carryforward of $33,029,000. 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 the deferred tax asset, and
therefore, no valuation allowance has been established.
A reconciliation of income tax computed at the federal statutory tax rate,
which was 35% for 1997 through 1999, to total income tax expense follows:
YEARS ENDED DECEMBER 31,
----------------------------
1999 1998 1997
-------- -------- --------
(Amounts in thousands)
Federal income taxes at
statutory rate. . . . . $42,429 $54,380 $58,845
Decrease due to:
Tax-exempt income, net. (8,662) (403) (1,354)
Other . . . . . . . . . (68) 321 (292)
-------- -------- --------
Federal taxes on income. . $33,699 $54,298 $57,199
======== ======== ========
Payments for income taxes were $19,500,000, $13,661,000, and $3,150,000 for
the years ended December 31, 1999, 1998 and 1997, respectively.
53
NOTE 6. POLICY ACQUISITION COSTS
Following is a summary of policy acquisition costs deferred for
amortization against future income and the related amortization charged to
income from operations:
YEARS ENDED DECEMBER 31,
----------------------------
1999 1998 1997
-------- -------- --------
(Amounts in thousands)
Deferred policy acquisition costs
at beginning of year . . . . . . .$ 16,100 $ 11,510 $ 9,127
Acquisition costs deferred. . . . . 86,570 62,113 47,234
Acquisition costs amortized and
charged to income during the year. (80,514) (57,523) (44,851)
-------- -------- --------
Deferred policy acquisition costs
at end of year . . . . . . . . . $ 22,156 $ 16,100 $ 11,510
======== ======== =========
NOTE 7. EMPLOYEE BENEFITS
Pension Plan and Supplemental Executive Retirement Plan
The Company sponsors a non-contributory defined benefit pension plan which
covers essentially all employees who have completed at least one year of
service. The benefits are based on employees' compensation during all years of
service. The Company's funding policy is to make annual contributions as
required by applicable regulations. The pension plan's assets consist of
high-grade fixed income securities and cash equivalents.
The Company also sponsors an unfunded supplemental executive retirement
plan that covers certain key employees designated by the Board of Directors.
The supplemental plan benefits are based on years of service and compensation
during the last three years of employment, and are reduced by the benefit
payable from the pension plan.
54
The net periodic pension cost for these plans was $4,357,000, $4,117,000
and $4,012,000 in 1999, 1998 and 1997, respectively. Accrued pension costs
included in the consolidated balance sheets at December 31, 1999 and 1998 are
$2,499,000 and $3,083,000, respectively.
Savings and Security Plan
The Company sponsors a contributory savings and security plan for eligible
employees. The Company provides matching contributions equal to 75% of the
lesser of 6% of an employee's compensation or the amount contributed by the
employee. Contributions charged against operations were $2,963,000, $2,728,000
and $2,697,000 in 1999, 1998 and 1997, respectively.
55
NOTE 8. LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
liability for unpaid losses and loss adjustment expenses ("LAE"):
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- -------
(Amounts in thousands)
Reserves for losses and LAE, net of reinsurance
recoverables, at beginning of year . . . . . . . $339,815 $388,418 $489,033
Add:
Provision for losses and LAE for claims
occurring in the current year, net of
reinsurance. . . . . . . . . . . . . . . 613,760 622,758 672,402
Increase (decrease) in provision for insured
events of prior years, net of reinsurance. (8,696) 3,621 (64,627)
-------- -------- -------
Total incurred losses and loss adjustment
expenses, net of reinsurance. . . 605,064 626,379 607,775
-------- -------- -------
Deduct losses and LAE payments for claims,
net of reinsurance, occurring during:
The current year . . . . . . . . . . . . . 436,346 423,031 403,676
Prior years. . . . . . . . . . 265,135 251,951 304,714
-------- -------- -------
Total payments, net of reinsurance . . 701,481 674,982 708,390
-------- -------- -------
Reserve for unpaid losses and LAE, net of
reinsurance recoverables, at year end . . . 243,398 339,815 388,418
Reinsurance recoverables on unpaid
losses, at year end . . . . . . . . . . . 32,850 42,188 49,469
-------- -------- -------
Reserves for losses and LAE, gross of
reinsurance recoverables on unpaid losses,
at year end . . . . . . . . . . . . . . . . . $276,248 $382,003 $437,887
======== ======== ========
56
The 1998 increase in the provision for insured events of prior years
included $40 million related to the Northridge Earthquake. The 1997 decrease in
the provision for insured events of prior years was partially offset by an
increase in earthquake losses of $24.75 million.
NOTE 9. BANK LOAN PAYABLE
The Company has entered into a revolving credit facility ("the Facility")
that provides an aggregate commitment of $67.5 million at December 31, 1999.
The commitment decreases by $11.25 million on the first day of each quarter
until April 1, 2001. Principal repayments are required when total outstanding
advances exceed the aggregate commitment. The Company may prepay principal
amounts of the advances, as well as voluntarily cause the aggregate commitment
to be reduced at any time during the term of the Facility.
As of December 31, 1999, the Company's outstanding advances against the
Facility totaled $67.5 million, which approximated its fair value. Interest is
charged at a variable rate based, at the option of the Company, on either (1)
the contractually defined Alternate Base Rate ("ABR") plus a margin of 0.25% or
(2) the Eurodollar Rate plus a margin of .75%. Margins are adjusted in relation
to certain financial and operational levels of the Company. The ABR is defined
as a daily rate which is the higher of (a) the prime rate for such day or (b)
the Federal Funds Effective Rate for such day plus .5% per annum. Interest is
payable at the end of each interest period. The stock of the Company's
insurance subsidiaries is pledged as collateral under the Facility. At December
31, 1999, the annual interest rate for the specified interest period was
approximately 7.25%. Interest paid was $5,306,000 in 1999, $8,660,000 in 1998,
and $12,758,000 in 1997.
NOTE 10. REINSURANCE
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.
57
The effect of reinsurance on premiums written and earned is as follows
(amounts in thousands):
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------
1999 1998 1997
--------------------- --------------------- ---------------------
Written Earned Written Earned Written Earned
--------- --------- --------- --------- --------- ---------
Gross . . . $ 880,534 $ 881,523 $ 885,617 $ 885,332 $ 901,769 $ 899,506
Ceded . . . (111,721) (111,100) (111,903) (112,468) (113,169) (113,517)
--------- --------- --------- --------- --------- ---------
Net . . . . $ 768,813 $ 770,423 $ 773,714 $ 772,864 $ 788,600 $ 785,989
========= ========= ========= ========= ========= =========
Losses and loss adjustment expenses have been reduced by reinsurance ceded
as follows (amounts in thousands):
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Gross losses and loss
adjustment expenses incurred $682,519 $706,316 $688,436
Ceded losses and loss
adjustment expenses incurred (77,455) (79,937) (80,661)
-------- -------- --------
Net losses and loss
adjustment expenses incurred $605,064 $626,379 $607,775
======== ======== ========
In connection with an investment agreement executed in 1994 with AIG, each
of the Company's insurance subsidiaries entered into a five-year (1995 to 1999)
quota share reinsurance agreement with an AIG affiliate to provide coverage for
all ongoing lines of business. Under this contract, which attaches to the
Company's retained risks net of all other reinsurance, the subsidiaries cede 10%
of their premiums earned and losses incurred in connection with policies
incepted during the period January 1, 1995, through December 31, 1999. The
majority of the Company's reinsurance receivables are due from the AIG
affiliate. The AIG affiliate has the option to renew the agreement for each of
the four years at declining coverage percentages of 8%, 6%, 4% and 2%,
respectively, and has elected to do so in 2000. Ceding commissions of 10.42%,
9.40% and 9.36% were earned by the insurance subsidiaries for 1999, 1998 and
1997, respectively. The ceding commission is adjusted annually to equal the
prior year's gross SAP underwriting expense ratio.
58
Homeowners policies renewed February 15, 1997, and through December
31,1999, are covered in full by quota share reinsurance agreements with three
reinsurers, as follows: National Union Fire Insurance Co. of Pittsburgh, PA
(50%), a subsidiary of AIG, F&G Re (25%) and Risk Capital Re (25%). The
Company's insurance subsidiaries earn a commission on ceded premiums based on a
sliding scale dependent on the incurred loss ratio.
Losses on homeowner policies inforce or incepting between July 1, 1996, and
September 30, 1996, are ceded 100% under a separate quota share agreement which
is now in run-off.
After December 31, 1999, a castastrophe reinsurance program provides for
recoveries of homeowner losses of up to $65 million in excess of a $10 million
retention. Because the Company's homeowner policies do not include any
earthquake coverage, its principle catastrophe exposure relates to the potential
for fire following an earthquake.
The Company has a quota share treaty for its Personal Umbrella Policy line
of business whereby it cedes 60% of premiums and losses. After the effect of
the 10% quota share treaty with AIG discussed earlier, the Company effectively
retains 36% of the risk for this line of business.
NOTE 11. LEASE COMMITMENTS
The Company leases office space in Woodland Hills, California. The lease
expires in November 2014, and may be renewed for two consecutive five-year
periods. The Company also leases office space in several other locations
throughout California, primarily for claims services.
Minimum rental commitments under the Company's lease obligations are as
follows:
2000 . . . $ 13,903,043
2001 . . . 14,496,928
2002 . . . 14,371,768
2003 . . . 14,393,717
2004 . . . 14,412,187
Thereafter 144,121,870
59
Rental expense charged to operations for the years ended December 31, 1999,
1998 and 1997, was $14,415,000, $12,879,000 and $11,969,000, respectively.
NOTE 12. STOCKHOLDERS' EQUITY
Dividends which may be paid by the Company's insurance subsidiaries to the
parent company within any one year without the approval of the California
Department of Insurance ("CDOI") are subject to restriction. The California
Insurance Code provides that amounts may be paid as dividends from earned
surplus on an annual, non-cumulative basis, without prior approval by the CDOI,
up to the greater of (1) net income for the preceding year, or (2) 10% of
statutory surplus as regards policyholders as of the preceding December 31. As
of December 31, 1999, the amount of dividends the Company's insurance
subsidiaries could declare without prior regulatory approval was approximately
$100.1 million.
Surplus of the insurance subsidiaries on a statutory basis at December 31,
1999 and 1998, was $581,440,000 and $600,654,000, respectively. Statutory net
income for the insurance subsidiaries was $100,063,000, $154,916,000, and
$178,727,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
NOTE 13. STOCK-BASED COMPENSATION
The Company has two separate stock compensation plans: the 1995 Stock
Option Plan, which provides for grants of stock options to key employees and
non-employee directors of the Company, and the Restricted Shares Plan, which
provides for stock grants to key employees.
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. SFAS No. 123, Accounting for Stock-Based Compensation,
requires disclosure of the pro forma net income and earnings per share as if the
Company had accounted for its employee stock options under the fair value method
of that Statement. The fair value of stock
60
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.
1995 Stock Option Plan
The aggregate number of common shares issued and issuable under the Plan
currently is limited to 4,000,000. At December 31, 1999, 1,912,353 common
shares remain available for future grants. All options granted have ten-year
terms. As a consequence of AIG's acquiring a controlling interest in the
Company, vesting was accelerated for all options previously granted through July
27, 1998. Options granted after July 27, 1998, vest over various future
periods.
Exercise prices for options outstanding at December 31, 1999 ranged from
$12.50 to $29.25. The weighted-average remaining contractual life of those
options is 7.9 years.
A summary of the Company's stock option activity and related information
follows:
Weighted-Average
Number of Exercise
Options Price
----------------- ---------
Options outstanding January 1, 1997 . 541,500 $ 17.41
Granted in 1997 . . . . . . . . . . . 649,750 $ 19.81
Exercised in 1997 . . . . . . . . . . (27,000) $ 17.14
Forfeited in 1997 . . . . . . . . . . (12,500) $ 17.68
-----------------
Options outstanding December 31, 1997 1,151,750 $ 18.76
Granted in 1998 . . . . . . . . . . . 606,250 $ 29.09
Exercised in 1998 . . . . . . . . . . (122,320) $ 18.80
Forfeited in 1998 . . . . . . . . . . (16,000) $ 28.36
-----------------
Options outstanding December 31, 1998 1,619,680 $ 22.53
Granted in 1999 . . . . . . . . . . . 598,800 $ 17.81
Exercised in 1999 . . . . . . . . . . (42,833) $ 15.03
Forfeited in 1999 . . . . . . . . . . (88,000) $ 23.43
-----------------
Options outstanding December 31, 1999 2,087,647 $ 21.30
=================
61
The Company's pro forma information using the Black-Scholes valuation model
follows:
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
------- ------- --------
Estimated weighted-average of the fair
value of options granted . . . . . . $ 4.03 $ 8.88 $ 7.90
Pro forma net income (in thousands) . . $87,574 $94,659 $108,541
Pro forma earnings per share - Basic. . $ 1.00 $ 1.26 $ 1.71
Pro forma earnings per share - Diluted. $ 1.00 $ 1.12 $ 1.34
For pro forma disclosure purposes, the fair value of stock options was
estimated at each date of grant using a Black-Scholes option pricing model using
the following assumptions: Risk-free interest rates of 5.48% for 1999, 5.02% to
5.65% for 1998 and 6.23% to 6.67% for 1997 ; dividend yields of 3.59% in 1999,
ranging from 1.98% to 2.33% in 1998 and 1.14% to 1.44% in 1997; volatility
factors of the expected market price of the Company's common stock of .23, for
both 1999 and 1998 and .27 for 1997; and a weighted-average expected life of
the options of 8 years in 1999, 1998 and 1997.
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.
Restricted Shares Plan
The Restricted Shares Plan currently provides for grants of up to 921,920
shares of common stock to be made available to key employees as determined by
the Key Employee Incentive Committee of the Board of Directors. Subsequent to
December 31, 1999, the Company registered 500,000 additional shares under the
Restricted Shares Plan. The common shares granted are restricted. Restrictions
are removed on 20% of the shares of each employee on January 1 of each of the
five years following the year of grant. Upon issuance of grants of common
shares under the plan, unearned compensation equivalent to the market value on
the date of grant is charged to common stock and subsequently amortized in equal
monthly installments over the five-year vesting period of the grant. As a
consequence of AIG's acquiring a controlling interest in the Company, the
previously unamortized balance of $2,280,000 as of July 27, 1998, was recognized
as a charge to income. Total
62
amortization expense relating to the Restricted Shares Plan was $2,698,000 and
$534,900 in 1998 and 1997. There was no amortization expense in 1999.
A summary of grants under the plan from 1997 through 1999 follows:
Common Market Price Per
Shares Share on Date of Grant
--------- -----------------------
Outstanding, January 1, 1997 . 48,683
Granted in 1997. . . . . . . . 89,355 $16.50-$17.50
Vested in 1997 . . . . . . . . (18,444)
Canceled or forfeited. . . . . -
---------
Outstanding, December 31, 1997 119,594
Granted in 1998. . . . . . . . 44,100 $26.00
Vested in 1998 . . . . . . . . (163,694)
Canceled or forfeited. . . . . -
---------
Outstanding, December 31, 1998 -
Granted in 1999. . . . . . . . 49,275 $18.06
Vested in 1999 . . . . . . . . -
Canceled or forfeited. . . . . -
---------
Outstanding, December 31, 1999 49,275
=========
NOTE 14. LITIGATION
In the normal course of business, the Company is named as a defendant in
lawsuits related to claim issues. Some of the actions request exemplary or
punitive damages. These actions are vigorously defended unless a reasonable
settlement appears appropriate.
Currently included in this class of litigation are certain actions that
arose out of the Northridge Earthquake. It is believed that a majority of these
actions were filed to resolve claims involving disputed damages or to contest
the applicability of the statute of limitations. While any litigation has an
element of uncertainty, the Company does not believe that the ultimate outcome
of any pending action will have a material effect on its consolidated financial
condition or results of operations.
63
NOTE 15. NORTHRIDGE EARTHQUAKE
The Northridge Earthquake, which occurred on January 17, 1994,
significantly affected the operating results and the financial position of the
Company. Provisions charged to income for this event amounted to $40 million
and $24.75 million in 1998 and 1997, respectively. No provision was recorded in
1999.
NOTE 16. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The summarized unaudited quarterly results of operations were as follows:
QUARTER ENDED
---------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- --------- -------------- -------------
(Amounts in thousands, except per share data)
1999
- - ----
Net premiums earned. . . $ 194,345 $ 192,299 $ 191,234 $ 192,545
Investment income. . . . $ 17,899 $ 16,201 $ 14,681 $ 13,887
Realized gains (losses). $ 7,249 $ 3,290 $ (7,195) $ (3,754)
Net income . . . . . . $ 28,913 $ 32,923 $ 18,372 $ 7,320
Basic earnings
per common share. . $ 0.33 $ 0.38 $ 0.21 $ 0.08
Diluted earnings
per common share. .. $ 0.33 $ 0.38 $ 0.21 $ 0.08
1998
- - ----
Net premiums earned $ 193,501 $ 191,883 $ 193,506 $ 193,974
Investment income $ 18,332 $ 18,262 $ 19,197 $ 19,355
Realized gains $ 3,234 $ 7,683 $ 6,920 $ 4,803
Net income (loss) $ 27,868 $ 40,173 $ 38,184 $ (5,153)
Basic earnings (loss)
per common share $ 0.44 $ 0.68 $ 0.49 $ (0.06)
Diluted earnings (loss)
per common share $ 0.34 $ 0.49 $ 0.44 $ (0.06)
64
The quarterly earnings per share amounts do not necessarily add to annual
amounts due to the changing dilutive effect of common stock equivalents as the
price of the common stock fluctuates.
NOTE 17. RESULTS OF OPERATIONS BY LINE OF BUSINESS
The following table presents premium revenue and underwriting profit (loss)
for the Company's insurance lines on a GAAP basis for the years ended December
31.
1999
------------------------------
Personal
Umbrella
(Amounts in thousands) Auto Homeowners Policy
-------- ---------- --------
Gross premiums written $853,004 $ 24,748 $ 2,782
Net premiums earned $769,168 $ 189 $ 1,066
Underwriting profit (loss) $ 78,302 $ (13,105) $ 792
1998
------------------------------
Personal
Umbrella
Auto Homeowners Policy
-------- ---------- --------
Gross premiums written $858,263 $ 24,806 $ 2,548
Net premiums earned $772,267 $ (294) $ 891
Underwriting profit (loss) $112,703 $ (45,544) $ 703
1997
------------------------------
Personal
Umbrella
Auto Homeowners Policy
-------- ---------- --------
Gross premiums written $871,996 $ 27,367 $ 2,406
Net premiums earned $781,288 $ 3,917 $ 784
Underwriting profit (loss) $134,130 $ (30,307) $ 493
Auto. Underwriting profit in the auto line decreased by $34.4 million in 1999
- - ----
compared to 1998. The decrease was caused mainly by a 6.85% rate decrease that
became effective in February 1999 and a reversal of previously favorable loss
trends that became particularly evident in the third quarter of
65
1999. The GAAP combined ratio for the auto line was 100.3% in the fourth
quarter of 1999 and 89.6% in the third quarter of 1999, compared to 84.7% for
the first half of the year and 85.4% for 1998 and 82.8% in 1997. The Company
expects that it may be necessary to seek a rate increase in California during
2000 although there can be no assurance that the requisite approval will be
granted by the regulator. The $21.4 million decline in underwriting profits in
the auto line from 1997 to 1998 was caused mainly by the effects of an increase
in claims frequency that emerged principally in the 1998 fourth quarter, and
successive premium rate reductions effective October 31, 1997, and January 1,
1998, of 3.2% and 3.4%, respectively.
Homeowners. The smaller underwriting loss in the homeowners line in 1999
- - ----------
principally is due to the absence of any provision for additional earthquake
reserves, which totaled $40 million in 1998 and $24.75 million in 1997. The
1999 underwriting loss includes a charge of $6.75 million taken in the second
quarter in connection with a settlement of the Company reached in April 1999
with the California Department of Insurance. The settlement enabled the Company
to resume sales of new homeowner policies in September 1999.
66
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no disagreements with the Company's independent auditors on any
matters of accounting principles or practices, financial statement disclosure or
auditing scope or procedure, or any reportable events.
PART III
--------
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
Information in response to Item 10 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's 2000
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to Item 11 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's 2000
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to Item 12 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's 2000
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
67
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain Information in response to Item 13 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's 2000
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K. All
related party transactions which require disclosure are included in the
Management's Discussion and Analysis or the Notes to Consolidated Financial
Statements.
68
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K
(a) DOCUMENTS FILED WITH THIS REPORT PAGE
----
(1) FINANCIAL STATEMENTS
The following consolidated financial statements of the Company
are filed as a part of this report:
(i) Report of independent auditors . . . . . . . . . . . . . . . . 38
(ii) Consolidated balance sheets - December 31, 1999 and 1998; . . . 39
(iii) Consolidated statements of income - Years ended December 31,
1999, 1998 and 1997; . . . . . . . . . . . . . . . . . . 41
(iv) Consolidated statements of stockholders' equity - Years ended December
31, 1999, 1998 and 1997; . . . . . . . . . . . . . . . . . . . . 42
(v) Consolidated statements of cash flows - Years ended December 31, 1999, 43
(vi) Notes to consolidated financial statements . . . . . . . . . . . 45
(2) SCHEDULES
The following financial statement schedule required to be filed by Item 8
and by paragraph (d) of Item 14 of Form 10-K is submitted as a separate
section of this report.
Schedule II - Condensed Financial Information of Registrant . . . . . . . . 73
Schedules I, III, IV and VI have been omitted as all required data is
included in the Notes to Consolidated Financial Statements.
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under
the related instructions or are inapplicable and, therefore, have been
omitted.
69
(3) EXHIBITS REQUIRED
The following exhibits required by Item 601 of Regulation S-K and by paragraph
(c) of Item 14 of Form 10-K are listed by number corresponding to the Exhibit
Table of Item 601 of Regulation S-K and are incorporated by reference as
indicated below.
3(a) Articles of Incorporation, as amended, incorporated herein by
reference from the Registrant's Form 10-K for the year ended
December 31, 1994
3(b) By Laws, as amended, filed herewith
The following contract is incorporated herein by reference from the Registrant's
Form 10-K for the year ended December 31, 1985:
10(a) Life Insurance Agreement for key officers
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1987:
10(b) Amendment to 20th Century Industries Restricted Shares Plan
10(c) Split Dollar Insurance Agreement between the Company and
Stanley M. Burke, as trustee of the 1983 Foster Insurance Trust
The following contract is incorporated herein by reference from the Registrant's
Form 10-K for the year ended December 31, 1988:
10(d) Amendment to 20th Century Industries Supplemental Executive
Retirement Plan
70
The following contracts are incorporated herein by reference from the
Registrant's Form 8-K dated October 5, 1994:
10(e) Letter of intent between the Company and American International
Group, Inc.
10(f) Stock Option Agreement between the Company and American
International Group, Inc.
The following contract is incorporated herein by reference from the Registrant's
Form 10-Q dated November 13, 1994:
10(g) Investment and Strategic Alliance Agreement between the Company
and American International Group, Inc.
The following contract is incorporated herein by reference from the Registrant's
Form 10-K for the year ended December 31, 1994:
10(h) Amendment No. 1 to Investment and Strategic Alliance Agreement
between the Company and American International Group, Inc.
The following contract is incorporated herein by reference from the Registrant's
Form S-8 dated July 26, 1995:
10(i) 20th Century Industries Stock Option Plan for eligible employees
and non-employee directors
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1995:
10(j) Amended and Restated Credit Agreement among the Company,
Union Bank, The First National Bank of Chicago, et. al.
10(k) Quota Share Reinsurance Agreement between the Company and
American International Group, Inc., as amended
71
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1996:
10(l) Forms of Stock Option Agreements
10(m) Form of Restricted Shares Agreement
10(n) 20th Century Industries Supplemental Executive Retirement Plan, as
amended
10(o) 20th Century Industries Pension Plan, 1994 Amendment and Restatement
10(p) Amendment No. 1 to 20th Century Industries Pension Plan
The following exhibits are incorporated by reference or filed herewith as
indicated:
21 Subsidiaries of the Registrant, incorporated herein by
reference from "Item 1. Business" in the Registrant's Form 10-K
for the year ended December 31, 1998
23 Consent of Independent Auditors, filed herewith
(b) REPORTS ON FORM 8-K.
There were no reports on Form 8-K filed for the three months ended
December 31, 1999.
72
SCHEDULE II
21ST CENTURY INSURANCE GROUP (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
DECEMBER 31,
------------------------
1999 1998
-------------- --------
(Amounts in thousands, except share data)
ASSETS
Cash . . . . . . . . . . . . . . . . . . . . . . . $ 41,986 $154,768
Prepaid loan fees. . . . . . . . . . . . . . . . . 613 2,409
Other current assets . . . . . . . . . . . . . . . 1,617 2,343
Accounts receivable from subsidiaries and
Affiliates, net of payables . . . . . . . . . 41,983 -
Investment in unconsolidated insurance
subsidiaries and affiliates, at equity. . . . 649,273 733,140
Other assets . . . . . . . . . . . . . . . . . . . 67,949 38,114
-------------- --------
$ 803,421 $930,774
============== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses. . . . . . . $ 15,084 $ 20,288
Accounts payable to subsidiaries and affiliates,
net of receivables. . . . . . . . . . . . . . - 12,384
Bank loan payable. . . . . . . . . . . . . . . . . 67,500 112,500
-------------- --------
Total liabilities . . . . . . . . . . . . . . 82,584 145,172
-------------- --------
Stockholders' equity:
Capital Stock
Preferred stock, par value $1.00 per share;
authorized 500,000 shares, no shares issued. . . . - -
Series A convertible preferred stock, par value
1.00 per share, stated value $1,000 per share;
authorized 376,126 shares, no shares outstanding . - -
Common stock, without par value; authorized
110,000,000 shares, outstanding 85,918,680
in 1999 and 87,624,531 in 1998 . . . . . . . . . . 429,623 462,268
Accumulated other comprehensive income of
insurance subsidiaries - net. . . . . . . . . (40,519) 23,387
Retained earnings. . . . . . . . . . . . . . . . . 331,733 299,947
Total stockholders' equity . . . . . . . . . . 720,837 785,602
-------------- --------
$ 803,421 $930,774
============== ========
73
SCHEDULE II
21ST CENTURY INSURANCE GROUP (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
-------- -------- ---------
(Amounts in thousands, except per share data)
REVENUES
Dividends received from subsidiaries(1). . $ 20,000 $ 97,256 $ 69,000
Interest . . . . . . . . . . . . . . . . 4,972 3,810 (94)
-------- -------- ---------
Total . . . . . . . . . . . . . . . . 24,972 101,066 68,906
EXPENSES
Loan interest and fees . . . . . . . . . 7,020 10,278 12,942
General and administrative . . . . . . . 110 820 991
-------- -------- ---------
Total . . . . . . . . 7,130 11,098 13,933
Income before income taxes . 17,842 89,968 54,973
Income tax benefit. . . . . 756 2,139 4,940
-------- -------- ---------
Net income before equity in
undistributed income of subsidiaries
18,598 92,107 59,913
Equity in undistributed income of
subsidiaries . . . . . . . . . . 68,930 8,965 51,016
-------- -------- ---------
NET INCOME. . . . . . . . . . $ 87,528 $101,072 $110,929
======== ======== =========
EARNINGS PER COMMON SHARE
Basic . . . . . . . . . . . . . . . . . . . . $ 1.00 $ 1.36 $ 1.76
======== ======== =========
Diluted . . . . . . . . . . . . . . . . . . . $ 1.00 $ 1.19 $ 1.37
======== ======== =========
(1) Excludes accrued dividends of $90 million at December 31, 1999.
74
SCHEDULE II
21ST CENTURY INSURANCE GROUP (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
-------- --------- ---------
(Amounts in thousands)
NET CASH PROVIDED BY
OPERATING ACTIVITIES . . . . . . . . . . . $ 54,447 $117,045 $ 62,844
INVESTING ACTIVITIES:
Capital contributed to 21st Century
Casualty Company . . . . . . . . . . . . . - - (2,000)
Capital contributed to 21st Century Insurance
Company of Arizona. . . . . . . . . . . (343) (1,470) (1,430)
Net purchases of equipment . . . . . . (32,859) (25,063) (8,301)
-------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES. . (33,202) (26,533) (11,731)
FINANCING ACTIVITIES:
Repurchase of common stock,
net of options exercised. . . . . (33,285) - -
Proceeds from exercise of warrants . . - 145,600 -
Bank loan principal repayment. . . . . (45,000) (45,000) (17,500)
Dividends paid . . . . . . . . . . . . (55,742) (51,608) (33,151)
-------- --------- ---------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES. . . . . (134,027) 48,992 (50,651)
-------- --------- ---------
Net increase in cash . . . . . . . . . . . (112,782) 139,504 462
Cash, beginning of year. . . . . . . 154,768 15,264 14,802
-------- --------- ---------
Cash, end of year. . . . . . . . . . . . . . . $ 41,986 $ 154,768 $ 15,264
======== ========= =========
75
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
21st CENTURY INSURANCE GROUP
(Registrant)
Date: March 23, 2000 By: /s/ Bruce W. Marlow
-------------- -----------------------------------
Bruce W. Marlow
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated on the 23rd of
March, 2000.
SIGNATURE TITLE
--------- -----
/s/ Bruce W. Marlow President and Chief Executive Officer
- - -------------------------- (Principal Executive Officer)
Bruce W. Marlow
Senior Vice President
/s/ Robert B. Tschudy and Chief Financial Officer
- - -------------------------- (Principal Financial Officer)
Robert B. Tschudy
/s/ John M. Lorenta Controller
- - ------------------------- (Principal Accounting Officer)
John M. Lorentz
76
SIGNATURE TITLE
--------- -----
/s/ Rovert M. Sandler Chairman of the Board
- - --------------------------
Robert M. Sandler
/s/ John B. De Nault, III Director
- - --------------------------
John B. De Nault, III
/s/ William N. Dooley Director
- - --------------------------
William N. Dooley
- - -------------------------- Director
R. Scott Foster, M.D.
- - -------------------------- Director
Roxani M. Gillespie
/s/ Bruce W. Marlow Chief Executive Officer and Director
- - --------------------------
Bruce W. Marlow
- - -------------------------- Director
James P. Miscoll
- - -------------------------- Director
Gregory M. Shepard
/s/ Howard I. Smith Director
- - --------------------------
Howard I. Smith
77