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UNITED STATES
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 year ended December 31, 2003 Commission File No. 0-3978
UNICO AMERICAN CORPORATION
(Exact name of registrant as specified in its charter)
Nevada 95-2583928
(State or other jurisdiction of (I.R.S. Employee
incorporation or organization) Identification No.)
23251 Mulholland Drive, Woodland Hills, California 91364
(Address of Principal Executive Offices) (Zip Code)
(818) 591-9800
Registrant's telephone number
Securities registered pursuant to Section 12(b) of the Act:
None
(Title of each class)
Securities registered pursuant to section 12(g) of the Act:
Common Stock, No Par Value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-X is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy of information statements
incorporated by reference as Part III of this Form 10-K or any amendment to this
Form 10-K. X
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes __ No X
The aggregate market value of Registrant's voting and non-voting common equity
held by non-affiliates as of June 30, 2003, the last business day of
Registrant's most recently completed second fiscal quarter was $10,269,201.
5,489,815
Number of shares of common stock outstanding as of March 23, 2004
Portions of the definitive proxy statement that Registrant intends to file
pursuant to Regulation 14(A) by a date no later than 120 days after December 31,
2003, to be used in connection with the annual meeting of shareholders, are
incorporated herein by reference into Part III hereof. If such definitive proxy
statement is not filed in the 120 day period, the information called for by Part
III will be filed as an amendment to this Form 10-K not later than the end of
the 120 day period.
1
PART I
------
Item 1. Business
- -----------------
Unico American Corporation is an insurance holding company that underwrites
property and casualty insurance through its insurance company subsidiary;
provides property, casualty, health and life insurance through its agency
subsidiaries; and through its other subsidiaries provides claim administration
services (through December 31, 2003), insurance premium financing, and
membership association services. Unico American Corporation is referred to
herein as the "Company" or "Unico" and such references include both the
corporation and its subsidiaries, all of which are wholly owned, unless
otherwise indicated. Unico was incorporated under the laws of Nevada in 1969.
Descriptions of the Company's operations in the following paragraphs are
categorized between the Company's major segment, its insurance company
operation, and all other revenues from insurance operations. The insurance
company operation is conducted through Crusader Insurance Company (Crusader),
Unico's property and casualty insurance company. Insurance company revenues and
other revenues from insurance operations for the years ended December 31, 2003,
and December 31, 2002, are as follows:
Year ended December 31
----------------------
2003 2002
------------------------ ------------------------
Percent of Percent of
Total Total
Total Company Total Company
Revenues Revenues Revenues Revenues
-------- -------- -------- --------
Insurance Company Revenues $42,005,474 82.2% $38,813,870 84.3%
Other Revenues from Insurance Operations
Health and life insurance program commission income 3,312,715 6.5% 2,741,672 6.0%
Service fee income 3,458,559 6.7% 2,241,883 4.9%
Daily automobile rental insurance program commission and
claim administration fees 815,625 1.6% 789,483 1.7%
Association operations membership and fee income 481,366 0.9% 424,784 0.9%
Other commission and fee income 41,127 0.1% 63,202 0.1%
--------- ---- --------- ----
Total gross commission and fee income 8,109,392 15.9% 6,261,024 13.6%
Insurance premium financing operation finance charges
and fees 952,543 1.9% 878,316 1.9%
Non-insurance company investment income 47,010 0.1% 56,176 0.1%
Other income 16,020 - 19,256 0.1%
--------- ---- --------- ----
Total Other Revenues from Insurance Operations 9,124,965 17.9% 7,214,772 15.7%
--------- ---- --------- ----
Total Revenues $51,130,439 100.0% $46,028,642 100.0%
========== ===== ========== =====
INSURANCE COMPANY OPERATION
---------------------------
General
- -------
The insurance company operation is conducted through Crusader, which as of
December 31, 2003, was licensed as an admitted insurance carrier in the states
of Arizona, California, Colorado, Idaho, Montana, Nevada, Ohio, Oregon and
Washington. In 2002 the Company began to substantially reduce the offering of
insurance outside of California primarily due to the unprofitability of that
business. In 2003 almost all business outside of California had ceased. See Item
7 - Management's Discussion and Analysis of Financial Condition and Results of
Operations - Results of Operations - Insurance Company Operation. Crusader is a
multiple line property and casualty insurance company that began transacting
business on January 1, 1985. During the year ended December 31, 2003, 97% of
Crusader's business was commercial multiple peril business package insurance
policies. Commercial multiple peril policies provide a combination of property
and liability coverage for businesses. Commercial property coverages insure
against loss or damage to buildings, inventory and equipment from natural
disasters, including hurricanes, windstorms, hail, water, explosions, severe
winter weather and other events such as theft and vandalism, fires and storms
and financial loss due to business interruption resulting from covered
2
property damage. Commercial liability coverages insure against third party
liability from accidents occurring on the insured's premises or arising out of
its operations, such as injuries sustained from products sold. In addition to
commercial multiple peril policies, Crusader also writes separate policies to
insure commercial property and commercial liability risks on a mono-line basis.
All of Crusader's business is produced by Unifax Insurance Systems, Inc.,
(Unifax) its sister corporation. Unifax has substantial experience with these
classes of business. The commissions paid by Crusader to Unifax are eliminated
as intercompany transactions and are not reflected in the previous table.
Crusader is licensed in property and casualty and disability lines of insurance
by the California Department of Insurance.
Reinsurance
- -----------
A reinsurance transaction occurs when an insurance company transfers (cedes) a
portion of its exposure on business written by it to a reinsurer that assumes
that risk for a premium (ceded premium). Reinsurance does not legally discharge
the Company from primary liability under its policies. If the reinsurer fails to
meet its obligations, the Company must nonetheless pay its policy obligations.
In 2003, Crusader's primary excess of loss reinsurance agreements were with
Platinum Reinsurance (A.M. Best Rating A), Hannover Ruckversicherungs (A.M. Best
Rating A+), QBE Reinsurance Corporation (A.M. Best Rating A), and General
Reinsurance Corporation (A.M. Best Rating A+). From 2000 through 2002, Crusader
had its primary excess of loss reinsurance agreements with Partners Reinsurance
Company of the U.S. (A.M Best Rating A+). In 1999, Crusader had its primary
excess of loss reinsurance agreements with General Reinsurance Corporation.
Crusader also has catastrophe reinsurance from various highly rated California
admitted and Bermuda reinsurance companies. These reinsurance agreements help
protect Crusader against liabilities in excess of certain retentions, including
major or catastrophic losses that may occur from any one or more of the property
and/or casualty risks which Crusader insures. The Company has no reinsurance
recoverable balances in dispute.
The aggregate amount of earned premium ceded to the reinsurers was $16,648,020
for the fiscal year ended December 31, 2003, and $7,209,573 for the fiscal year
ended December 31, 2002.
On July 1, 1997, Crusader increased its retention from $150,000 to $250,000 per
risk. Concurrently, Crusader maintained catastrophe and clash covers (subject to
a maximum occurrence and annual aggregate) to help protect the Company from one
loss occurrence affecting multiple policies. Beginning January 1, 1998, an
annual aggregate deductible of $750,000 commenced on losses ceded to its
reinsurance treaty covering losses between $250,000 and $500,000. On January 1,
2000, the annual aggregate deductible decreased to $500,000, on January 1, 2002,
it increased to $675,000, and on January 1, 2003, it decreased to $500,000. In
2003 Crusader retained a participation in its excess of loss reinsurance
treaties of 5% in its 1st layer ($750,000 in excess of $250,000) 10% in its 2nd
layer ($1,000,000 in excess of $1,000,000, and 30% in its property clash treaty.
Prior to January 1, 1998, National Reinsurance Corporation (acquired by General
Reinsurance Corporation in 1996) charged a provisional rate on exposures up to
$500,000 that was subject to adjustment and was based on the amount of losses
ceded, limited by a maximum percentage that could be charged. That provisional
rated treaty was cancelled on a runoff basis and replaced by a flat rated treaty
on January 1, 1998.
On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays
a commission to Crusader that includes a reimbursement of the cost of acquiring
the portion of the premium that is ceded. Crusader does not currently assume any
reinsurance. The Company intends to continue obtaining reinsurance although the
availability and cost may vary from time to time. The unpaid losses ceded to the
reinsurer are recorded as an asset on the balance sheet.
Unpaid Losses and Loss Adjustment Expenses
- ------------------------------------------
Crusader maintains reserves for losses and loss adjustment expenses with respect
to both reported and unreported losses. When a claim for loss is reported to the
Company, a reserve is established for the expected cost to settle the claim,
including estimates of any related legal expense and other costs associated with
resolving the claim. These reserves are called "case based" reserves. In
addition, the Company also sets up reserves at the end of each reporting period
for losses that have occurred but have not yet been reported to the Company.
These incurred but not reported losses are referred to as "IBNR" reserves.
Crusader establishes reserves for reported losses based on historical
experience, upon case-by-case evaluation of facts surrounding each known loss,
and the related policy provisions. The amount of reserves for unreported losses
is estimated by analysis of historical and statistical information. The ultimate
liability of Crusader may be greater or less than estimated reserves. Reserves
are monitored and adjusted when appropriate and are
3
reflected in the statement of operations in the period of adjustment. Reserves
for losses and loss adjustment expenses are estimated to cover the future
amounts needed to pay claims and related expenses with respect to insured events
that have occurred.
The process of establishing loss and loss adjustment expense reserves involves
significant judgment. The following table shows the development of the unpaid
losses and loss adjustment expenses for fiscal years 1994 through 2003. The top
line of the table shows the estimated liability for unpaid losses and loss
adjustment expenses recorded at the balance sheet date for each of the indicated
years. This liability represents the estimated amount of losses and loss
adjustment expenses for losses arising in the current and prior years that are
unpaid at the balance sheet date. The table shows the reestimated amount of the
previously recorded liability based on experience as of the end of each
succeeding year. The estimate is increased or decreased as more information
becomes known.
The table reflects redundancies and deficiencies in Crusader's net loss and loss
adjustment expense reserves. At December 31, 2003, all periods stated in the
table reflected a cumulative deficiency. See discussion of losses and loss
adjustment expenses in Item 7- Management's Discussion and Analysis - Results of
Operations - Insurance Company Operation.
Crusader is a relatively small insurance company. Crusader is constantly
changing its product mix and exposures, including the types of businesses
insured within its business package program. Considering the uncertainties from
this changing environment, the Company recognizes the difficulties in developing
its own unique reserving statistics; therefore, it incorporates industry
standards and averages into its estimates. The Company believes that its loss
and loss adjustment expense reserves are properly stated. When subsequent loss
and loss adjustment expense development justifies changes in reserving
practices, the Company acts accordingly.
When evaluating the information in the following table, it should be noted that
each amount includes the effects of all changes in amounts of prior periods;
therefore, the cumulative redundancy or deficiency represents the aggregate
change in the estimates over all prior years. Conditions and trends that have
affected development of liability in the past may not necessarily occur in the
future. Accordingly, it may not be appropriate to extrapolate future
deficiencies or redundancies based on this table.
4
CRUSADER INSURANCE COMPANY
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
Fiscal Year Ended
Fiscal Year Ended March 31 December 31
-------------------------------- -----------------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
(Nine
Months)
Reserve for Unpaid Losses and
Loss Adjustment Expenses $21,499,778 $27,633,304 $32,682,153 $37,111,846 $40,591,248
Paid Cumulative as of
1 Year Later 7,687,180 8,814,611 7,019,175 10,996,896 12,677,646
2 Years Later 13,453,833 13,502,224 15,292,415 19,488,853 23,740,181
3 Years Later 16,597,366 18,911,104 20,898,580 25,552,756 30,217,031
4 Years Later 19,073,442 22,631,450 24,932,922 29,730,976 35,620,705
5 Years Later 21,452,429 25,509,618 27,726,438 33,893,473 40,639,328
6 Years Later 23,900,335 27,844,199 31,701,748 38,075,656 45,028,598
7 Years Later 25,687,342 31,445,057 35,482,343 41,650,221
8 Years Later 28,197,077 34,760,418 38,974,010
9 Years Later 30,710,621 38,071,916
10 Years Later 33,742,067
Reserves Reestimated as of
1 Year Later 20,912,743 25,666,251 31,232,388 32,838,369 35,730,603
2 Years Later 20,289,699 24,984,032 28,636,286 31,086,210 36,032,215
3 Years Later 21,217,766 24,575,023 28,074,691 32,347,788 38,844,953
4 Years Later 21,843,632 26,146,874 29,774,762 35,513,862 45,907,785
5 Years Later 23,767,472 28,687,265 32,382,991 43,335,778 47,940,955
6 Years Later 26,193,900 31,416,091 40,773,954 44,588,020 50,374,721
7 Years Later 28,528,744 40,165,717 41,690,986 46,146,262
8 Years Later 35,793,968 40,479,938 43,243,124
9 Years Later 35,202,700 41,979,904
10 Years Later 36,830,536
Cumulative Redundancy (Deficiency) $(15,330,758) $(14,346,600) $(10,560,971) $(9,034,416) $(9,783,473)
========== ========== ========== ========= =========
Gross Liability for Unpaid Losses
and Loss Adjustment Expenses $26,294,199 $32,370,752 $37,006,458 $39,740,865 $42,004,851
Ceded Liability for Unpaid Losses
and Loss Adjustment Expenses (4,794,421) (4,737,448) (4,324,305) (2,629,019) (1,413,603)
--------- --------- --------- --------- ---------
Net Liability for Unpaid Losses
and Loss Adjustment Expenses $21,499,778 $27,633,304 $32,682,153 $37,111,846 $40,591,248
========== ========== ========== ========== ==========
Gross Liability Reestimated $54,840,720 $63,870,583 $68,205,069 $74,592,892 $74,141,214
Ceded Liability Reestimated (18,010,184) (21,890,679) (24,961,945) (28,446,630) (23,766,493)
---------- ---------- ---------- ---------- ----------
Net Liability Reestimated $36,830,536 $41,979,904 $43,243,124 $46,146,262 $50,374,721
========== ========== ========== ========== ==========
Gross Reserve Redundancy (Deficiency) $(28,546,521) $(31,499,831) $(31,198,611) $(34,852,027) $(32,136,363)
========== ========== ========== ========== ==========
5
CRUSADER INSURANCE COMPANY
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
Fiscal Year Ended December 31
--------------------------------------------------------------------------
1998 1999 2000 2001 2002 2003
---- ---- ---- ---- ---- ----
Reserve for Unpaid Losses and
Loss Adjustment Expenses $40,374,232 $37,628,165 $34,546,026 $49,786,215 $53,596,945 $58,883,861
Paid Cumulative as of
1 Year Later 15,393,167 18,745,224 20,841,417 23,010,615 21,326,688
2 Years Later 28,570,117 34,905,359 37,976,277 39,463,106
3 Years Later 38,923,545 46,072,688 49,053,708
4 Years Later 45,425,709 53,153,491
5 Years Later 50,526,164
6 Years Later
7 Years Later
8 Years Later
9 Years Later
10 Years Later
Reserves Reestimated as of
1 Year Later 39,132,945 41,898,796 53,872,376 57,577,066 56,348,530
2 Years Later 43,164,627 56,423,375 59,746,880 60,629,814
3 Years Later 52,349,735 59,486,543 62,172,320
4 Years Later 54,291,547 61,791,428
5 Years Later 56,619,057
6 Years Later
7 Years Later
8 Years Later
9 Years Later
10 Years Later
Cumulative Redundancy (Deficiency) $(16,244,825) $(24,163,263) $(27,626,294) $(10,843,599) $(2,751,585)
========== ========== ========== ========== =========
Gross Liability for Unpaid Losses
and Loss Adjustment Expenses $41,513,945 $41,592,489 $45,217,369 $60,534,295 $74,905,284 78,139,090
Ceded Liability for Unpaid Losses
and Loss Adjustment Expenses (1,139,713) (3,964,324) (10,671,343) (10,748,080) (21,308,339) (19,255,229)
--------- --------- ---------- ---------- ---------- ----------
Net Liability for Unpaid Losses
and Loss Adjustment Expenses $40,374,232 $37,628,165 $34,546,026 $49,786,215 $53,596,945 $58,883,861
========== ========== ========== ========== ========== ==========
Gross Liability Reestimated $82,902,960 $90,575,377 $93,005,448 $90,817,802 $78,973,233
Ceded Liability Reestimated (26,283,903) (28,783,949) (30,833,128) (30,187,988) (22,624,702)
---------- ---------- ---------- ---------- ----------
Net Liability Reestimated $56,619,057 $61,791,428 $62,172,320 $60,629,814 $56,348,531
========== ========== ========== ========== ==========
Gross Reserve Redundancy (Deficiency) $(41,389,015) $(48,982,888) $(47,788,079) $(30,283,507) $(4,067,949)
========== ========== ========== ========== =========
5
Net Premium Written to Policyholders' Surplus Ratio
- ---------------------------------------------------
The following table shows, for the periods indicated, Crusader's statutory
ratios of net premiums written to statutory policyholders' surplus. Since each
property and casualty insurance company has different capital needs, an
"acceptable" ratio of net premium written to policyholders' surplus for one
company may be inapplicable to another. While there is no statutory requirement
applicable to Crusader that establishes a permissible net premium to surplus
ratio, guidelines established by the National Association of Insurance
Commissioners (NAIC) provide that such ratio should generally be no greater than
3 to 1.
Twelve months ended December 31
----------------------------------------------------------------
Statutory: 2003 2002 2001 2000 1999
- ---------- ---- ---- ---- ---- ----
Net Premiums Written $47,420,157 $38,363,201 $32,106,175 $26,406,565 $26,209,180
Policyholders' Surplus $26,103,440 $26,258,452 $27,519,538 $39,626,269 $40,952,456
Ratio 1.8 to 1 1.5 to 1 1.2 to 1 0.7 to 1 0.6 to 1
Crusader results are reported in accordance with accounting principles generally
accepted in the United States of America (GAAP). These results differ from its
financial results reported in accordance with Statutory Accounting Principles
(SAP) as prescribed or permitted by insurance regulatory authorities. Crusader
is required to file financial statements with insurance regulatory authorities
prepared on a SAP basis.
SAP differs in certain respects from GAAP. The more significant of these
differences that apply to Crusader are:
Policy acquisition costs such as commissions, premium taxes and other
variable costs incurred in connection with writing new and renewal
business are capitalized and amortized on a pro rata basis over the
period in which the related premiums are earned, rather than expensed
as incurred, as required by SAP.
Certain assets included in balance sheets under GAAP are designated as
"non-admitted assets" and charged directly against statutory surplus
under SAP. Non-admitted assets include primarily premium receivables
that are outstanding over 90 days, federal deferred tax assets in
excess of statutory limitations, furniture, equipment, leasehold
improvements and prepaid expenses.
Amounts related to ceded reinsurance are shown gross as prepaid
reinsurance premiums and reinsurance recoverable, rather than netted
against unearned premium reserves and loss and loss adjustment expense
reserves, respectively, as required by SAP.
Fixed maturity securities, which are classified as available-for sale,
are reported at current market values, rather than at amortized cost,
or the lower of amortized cost or market, depending on the specific
type of security, as required by SAP.
The differing treatment of income and expense items results in a
corresponding difference in federal income tax expense. Under GAAP
reporting, changes in deferred income taxes are reflected as an item of
income tax benefit or expense. As required by SAP, federal income taxes
are recorded when payable and deferred taxes, subject to limitations,
are recognized but only to the extent that they do not exceed 10% of
statutory surplus. Changes in deferred taxes are recorded directly to
statutory surplus.
Regulation
- ----------
The insurance company operation is subject to regulation by the California
Department of Insurance (the insurance department) and by the department of
insurance of other states in which Crusader is licensed. The insurance
department has broad regulatory, supervisory, and administrative powers. These
powers relate primarily to the standards of solvency which must be met and
maintained; the licensing of insurers and their agents; the nature and
limitation of insurers' investments; the prior approval of rates, rules and
forms; the issuance of securities by insurers; periodic financial and market
conduct examinations of the affairs of insurers; the annual and other reports
required to be filed on the financial condition and results of operations of
such insurers or for other purposes; and the establishment of reserves required
to be maintained for unearned premiums, losses, and other purposes. The
regulations and supervision by the insurance department are designed principally
for the benefit of policyholders and not for the insurance company shareholders.
The insurance department's Market Conduct Division is responsible for conducting
periodic examinations of companies to ensure compliance with California
Insurance Code and California Code of Regulations with respect to rating,
underwriting and claims
6
handling practices. The most recent examination of Crusader covered underwriting
and rating practices for the period January 1, 2000, through June 18, 2001. The
report on the results of that examination was issued on September 10, 2002. As
of December 31, 2003, the Company believes that there are no outstanding
criticisms arising from that report. The insurance department also conducts
periodic financial examinations of Crusader. The insurance department has
completed its financial examination of Crusader's December 31, 2001, statutory
financial statements. The report of examination that was filed with the
insurance department on May 30, 2003, reported no adjustments to Crusader's
statutory financial statements.
In December 1993, the NAIC adopted a Risk-Based Capital (RBC) Model Law for
property and casualty companies. The RBC Model Law is intended to provide
standards for calculating a variable regulatory capital requirement related to a
company's current operations and its risk exposures (asset risk, underwriting
risk, credit risk and off-balance sheet risk). These standards are intended to
serve as a diagnostic solvency tool for regulators that establishes uniform
capital levels and specific authority levels for regulatory intervention when an
insurer falls below minimum capital levels. The RBC Model Law specifies four
distinct action levels at which a regulator can intervene with increasing
degrees of authority over a domestic insurer if its RBC is equal to or less than
200% of its computed authorized control level RBC. A company's RBC is required
to be disclosed in its statutory annual statement. The RBC is not intended to be
used as a rating or ranking tool nor is it to be used in premium rate making or
approval. Crusader's adjusted capital at December 31, 2003, was 298% of
authorized control level risk-based capital.
The following table sets forth the different levels of risk-based capital that
may trigger regulatory involvement and the corresponding actions that may
result.
- ----------------------------- ----------------------------------- ----------------------------------------------------------
LEVEL TRIGGER CORRECTIVE ACTION
- ----------------------------- ----------------------------------- ----------------------------------------------------------
- ----------------------------- ----------------------------------- ----------------------------------------------------------
Company Action Level Adjusted Capital less than 200% The insurer must submit a comprehensive plan to the
of Authorized Control Level insurance commissioner
- ----------------------------- ----------------------------------- ----------------------------------------------------------
- ----------------------------- ----------------------------------- ----------------------------------------------------------
Regulatory Action Level Adjusted Capital less than 150% In addition to above, insurer is subject to examination,
of Authorized Control Level analysis and specific corrective action
- ----------------------------- ----------------------------------- ----------------------------------------------------------
- ----------------------------- ----------------------------------- ----------------------------------------------------------
Authorized Control Level Adjusted Capital less than 100% In addition to both of the above, insurance commissioner
of Authorized Control Level may place insurer under regulatory control
- ----------------------------- ----------------------------------- ----------------------------------------------------------
- ----------------------------- ----------------------------------- ----------------------------------------------------------
Mandatory Control Level Adjusted Capital less than 70% Insurer must be placed under regulatory control
of Authorized Control Level
- ----------------------------- ----------------------------------- ----------------------------------------------------------
Insurance Regulatory Information System (IRIS) was developed by a committee of
state insurance regulators primarily to assist state insurance departments in
executing their statutory mandate to oversee the financial condition of
insurance companies. IRIS helps those companies that merit highest priority in
the allocation of the regulators' resources on the basis of 12 financial ratios
that are calculated annually. The analytical phase is a review of annual
statements and the financial ratios. The ratios and trends are valuable in
pointing to companies likely to experience financial difficulties, but are not
themselves indicative of adverse financial condition. The ratio and benchmark
comparisons are mechanically produced and are not intended to replace the state
insurance departments' own in-depth financial analysis or on-site examinations.
An unusual range of ratio results has been established from studies of the
ratios of companies that have become insolvent or have experienced financial
difficulties. In the analytical phase, companies that receive four or more
financial ratio values outside the usual range are analyzed in order to identify
those companies that appear to require immediate regulatory action.
Subsequently, a more comprehensive review of the ratio results and an insurer's
annual statement is performed to confirm that an insurer's situation calls for
increased or close regulatory attention.
In 2003, the Company was outside the usual values on four of the twelve IRIS
ratio tests. Three of the IRIS tests ratios that were outside the usual values
related to the Company's adverse development of its losses and loss adjustment
expenses. These ratios were the Two Year Overall Operating Ratio, Two Year
Reserve Development to Surplus, and Estimated Current Reserve Deficiency to
Surplus. One IRIS ratio test that was outside the usual values was the
Investment Yield Ratio. A usual value for the Investment Yield Ratio is a range
greater than 4.5% and less than 10%. Crusader's 2003 statutory investment yield
was 4.5%
NAIC's Statutory Accounting Initiative
- --------------------------------------
The NAIC's project to codify accounting practices was approved by the NAIC in
March 1998. The approval included a provision for commissioners' discretion in
determining appropriate statutory accounting for insurers in
7
their states. Consequently, prescribed and permitted accounting practices may
continue to differ from state to state. Codification became effective on
January 1, 2001.
California Insurance Guarantee Association
- ------------------------------------------
The California Insurance Guarantee Association (CIGA) was created to provide for
payment of claims for which insolvent insurers of most casualty lines are liable
but which cannot be paid out of such insurers' assets. The Company is subject to
assessment by CIGA for its pro-rata share of such claims based on premiums
written in the particular line in the year preceding the assessment by insurers
writing that line of insurance in California. Such assessments are based upon
estimates of losses to be incurred in liquidating an insolvent insurer. In a
particular year, the Company cannot be assessed an amount greater than 2% of its
premiums written in the preceding year. Assessments are recouped through a
mandated surcharge to policyholders the year after the assessment. During 2002,
the Company paid $643,680 that was assessed by CIGA. In 2003, due to the growth
of premium, the Company recovered assessments from policyholders in the amount
of $1,294,128. This amount exceeded the 2002 assessed amount by $650,448. The
excess assessments recovered will be remitted to CIGA in 2004. No assessment was
made by CIGA for the 2004 calendar year.
Holding Company Act
- -------------------
Crusader is subject to regulation by the insurance department pursuant to the
provisions of the California Insurance Holding Company System Regulatory Act
(the "Holding Company Act"). Pursuant to the Holding Company Act, the insurance
department may examine the affairs of Crusader at any time. Certain transactions
defined to be of an "extraordinary" type may not be effected without the prior
approval of the insurance department. 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 the lesser
of 3% of admitted assets or 25% of policyholders' 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 10% of the insurance company's policyholders'
surplus as of the preceding December 31 or the insurance company's net income
for the preceding calendar year. An insurance company is also required to notify
the insurance department of any dividend after declaration, but prior to
payment.
The Holding Company Act also provides that the acquisition or change of
"control" of a California domiciled insurance company or of any person who
controls such an insurance company cannot be consummated without the prior
approval of the Insurance Commissioner. In general, a presumption of "control"
arises from the ownership of voting securities and securities that are
convertible into voting securities, which in the aggregate constitute 10% or
more of the voting securities of a California insurance company or a person who
controls a California insurance company, such as Crusader. A person seeking to
acquire "control," directly or indirectly, of the Company must generally file
with the Insurance Commissioner an application for change of control containing
certain information required by statute and published regulations and provide a
copy of the application to the Company. The Holding Company Act also effectively
restricts the Company from consummating certain reorganization or mergers
without prior regulatory approval. The Company is in compliance with the Holding
Company Act.
Rating
- ------
Insurance companies are rated to provide both industry participants and
insurance consumers with meaningful information on specific insurance companies.
Higher ratings generally indicate financial stability and a strong ability to
pay claims. These ratings are based upon factors relevant to policyholders and
are not directed toward protection of investors. Such ratings are neither a
rating of securities nor a recommendation to buy, hold or sell any security and
may be revised or withdrawn at any time. Ratings focus primarily on the
following factors: capital resources, financial strength, demonstrated
management expertise in the insurance business, credit analysis, systems
development, market segment position and growth opportunities, marketing, sales
conduct practices, investment operations, minimum policyholders' surplus
requirements and capital sufficiency to meet projected growth, as well as access
to such traditional capital as may be necessary to continue to meet standards
for capital adequacy.
The claims-paying abilities of insurers are rated to provide both insurance
consumers and industry participants with comparative information on specific
insurance companies. Claims-paying ratings are important for the marketing of
certain insurance products. A higher rating generally indicates greater
financial strength and a stronger ability to pay claims.
8
Primarily as a result of the underwriting losses in 2000 and 2001, the A.M. Best
Company lowered Crusader's rating from A (Excellent) to A- (Excellent) effective
March 26, 2002, based on financial information as of December 31, 2001. At the
time the rating was lowered, A.M. Best remained concerned with the potential for
further adverse loss reserve development and the negative impact it would have
on the Company's operating performance and overall capitalization and viewed the
rating outlook as negative. Due to the continued adverse development in the six
months ended June 30, 2002, on October 3, 2002, A.M. Best Company lowered
Crusader's rating to B+ (Very Good). The lowering of Crusader's rating to B+ did
not have a material adverse effect on the Company.
Terrorism Risk Insurance Act of 2002
- ------------------------------------
On November 26, 2002, the Terrorism Risk Insurance Act of 2002 (The Act) was
signed by President Bush. The Act establishes a program within the Department of
the Treasury in which the Federal Government will share the risk of loss from
acts of terrorism with the insurance industry. Federal participation will be
triggered when the Secretary of the Treasury, in concurrence with the Secretary
of State and the Attorney General of the United States, certifies an act to be
an act of terrorism committed by an individual(s) acting on behalf of any
foreign interest, provided the terrorist act results in aggregate losses in
excess of $5 million.
Under The Act, the federal government will pay 90% of covered terrorism losses
exceeding the statutorily established deductible paid by Crusader. All property
and casualty insurance companies are required to participate in the program to
the extent that they must make available property and casualty insurance
coverage for terrorism that does not differ materially from the terms, amounts,
and other coverage limitations applicable to losses arising from events other
than acts of terrorism.
The Company does not write policies on properties considered to be a target of
terrorist activities such as airports, hotels, large office structures,
amusement parks, landmark defined structures, or other public facilities. In
addition, there is not a high concentration of policies in any one area where
increased exposure to terrorist threats exist. Consequently, the Company
believes its exposure relating to acts of terrorism is low. In 2003 Crusader
received $865,529 in terrorism coverage premium from approximately 52% of its
policyholders. Crusader's 2003 terrorism deductible was $2,839,819. Crusader's
2004 terrorism deductible is $5,375,409.
OTHER INSURANCE OPERATIONS
--------------------------
General Agency Operations
- -------------------------
Unifax primarily sells and services commercial multiple peril business insurance
policies for Crusader in California. In addition, it sells and services
commercial earthquake insurance policies in California for a non-affiliated
insurer. Unifax also sells and services policies for Crusader in Arizona, Idaho,
Kentucky, Montana, Nevada, Ohio, Oregon, Pennsylvania, Texas, and Washington.
However, in 2002 the Company began placing moratoriums on non-California
business on a state-by-state basis. By July 2003, the Company had placed
moratoriums on all non-California business.
Bedford Insurance Services, Inc., (Bedford) sells and services daily automobile
rental policies in most states for a non-affiliated insurer.
As general agents, these subsidiaries market, rate, underwrite, inspect and
issue policies, bill and collect insurance premiums, and maintain accounting and
statistical data. Unifax is the exclusive general agent for Crusader. Unifax and
Bedford are non-exclusive general agents for non-affiliated insurance companies.
The Company's marketing is conducted through advertising to independent
insurance agents and brokers. For its services, the general agent receives a
commission (based on the premium written) from the insurance company and, in
some cases, a service fee from the customer. These subsidiaries all hold
licenses issued by the California Department of Insurance and other states where
applicable.
Insurance Claim Administration Operation
- ----------------------------------------
The Company's subsidiary U.S. Risk Managers, Inc., (U.S. Risk) provided
insurance claim administration services to the non-affiliated property and
casualty insurance company that Bedford represents as a general agent. These
services consisted of receiving, reserving, adjusting, paying and accounting for
insurance claims. U.S. Risk engaged independent field examiners for all work
performed outside the Company's office. U.S. Risk operates under a license
issued by the California Department of Insurance and other states where
applicable. As of December 31, 2003, the non-affiliated insurance company
assumed the claim administration responsibility for all outstanding and IBNR
claims. U.S. Risk Managers, Inc., is currently inactive.
9
All claim adjusting services for Crusader policies are administered by Crusader.
Crusader engages independent field examiners for all work performed outside the
Company's office.
Insurance Premium Finance Operation
- -----------------------------------
American Acceptance Corporation (AAC) is a licensed insurance premium finance
company that provides insurance purchasers with the ability to pay their
insurance premiums on an installment basis. The premium finance company pays the
insurance premium to the insurance company in return for a premium finance note
from the insured. These notes are paid off by the insured in nine monthly
installments and are secured by the unearned premiums held by the insurance
company. AAC provides premium financing for Crusader policies that are produced
by Unifax in California.
Health and Life Insurance Operations
- ------------------------------------
The Company's subsidiary American Insurance Brokers, Inc., (AIB) markets
medical, dental, life, and vision insurance in California through non-affiliated
insurance companies for individuals and groups. The services provided consist of
marketing, billing and collection, accounting, and customer service. For these
services, AIB receives a commission/override from the insurance company. Most of
the business is produced through independent insurance agents and brokers who
receive a commission from AIB. AIB hold licenses issued by the California
Department of Insurance. Prior to 2003, a portion of this business was conducted
by the Company's subsidiary National Insurance Brokers, Inc. (NIB). On January
1, 2003, NIB assigned all its contracts and commissions to AIB, and NIB is now
inactive.
Association Operation
- ---------------------
The Company's subsidiary Insurance Club, Inc., DBA The American Association for
Quality Health Care (AAQHC), is a membership association that provides various
consumer benefits to its members, including participation in group health care
and life insurance policies that AAQHC negotiates for the association. For these
services, AAQHC receives membership and fee income from its members.
INVESTMENTS
-----------
The investments of the Company are made by the Company's Chief Financial Officer
under the supervision of an investment committee appointed by the Company's
Board of Directors. The Company's investment guidelines on equity securities
limit investments in equity securities to an aggregate maximum of $2,000,000.
The Company's investment guidelines on fixed maturities limit fixed maturity
investments to high-grade obligations with a maximum term of eight years. The
maximum investment authorized in any one issuer is $2,000,000 and any one U.S.
government agency is $3,000,000. This dollar limitation excludes bond premiums
paid in excess of par value and U.S. government or U.S. government guaranteed
issues. All investments in municipal securities are pre-refunded and secured by
U.S. treasury securities. Short-term cash investments consist of bank money
market accounts, certificates of deposit, commercial paper, a U.S. government
obligation money market fund, and U.S. treasury bills. These short-term
investments are either U.S. government obligations, FDIC insured or are in an
institution with a Moody's rating of P2 and/or a Standard & Poor's rating of A1.
All of the Company's fixed maturity investment securities are rated and readily
marketable and could be liquidated without any material financial impact.
COMPETITION
-----------
General
- -------
The property and casualty insurance industry is highly competitive in the areas
of price and service. It is highly cyclical, characterized by periods of high
premium rates and shortages of underwriting capacity followed by periods of
severe price competition and excess capacity.
The profitability of insurers is affected by many factors including rate
competition, the frequency of claims and their average cost, natural disasters,
state regulations, interest rates, crime rates, general business conditions, and
court decisions redefining and expanding the extent of coverage and granting
higher compensation awards. One of the challenging and unique features of the
property and casualty business is the fact that, since premiums are collected
before losses are paid, its products are normally priced before its costs are
known.
10
Insurance Company and General Agency Operations (Property and Casualty)
- ----------------------------------------------------------------------
The Company's property and casualty insurance business continues to experience a
competitive marketplace. There are many substantial competitors who have larger
resources, operate in more states, and insure coverages in more lines and in
higher limits than the Company. In addition, Crusader competes not only with
other insurance companies but also with the general agents. Many of these
general agents offer more products than the Company. The principal method of
competition among competitors is price. While the Company attempts to meet this
competition with competitive prices, its emphasis is on service, promotion, and
distribution. Additional information regarding competition in the insurance
marketplace is discussed in the Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations - Results of Operations.
Insurance Premium Financing Operation
- -------------------------------------
The insurance premium financing operation currently finances only policies
written through its sister company, Unifax. Although competition is intense in
the premium finance business, the competitive pricing, the quality of its
service, and the ease and convenience of financing with AAC has made its growth
and profitability possible. AAC's growth is dependent on the growth of Crusader
and Unifax.
Health and Life Insurance Operations
- ------------------------------------
Competition in the health and life insurance business is intense. In 2003 and
2002 approximately 93% and 94% of the Company's health and life insurance
business was from the CIGNA HealthCare medical and dental plan programs. These
plans consist of both individual and family health insurance and small group
markets. Due to CIGNA's discontinuance of its individual and family health
insurance programs to new policyholders in the state of California in April 2003
and the termination of existing policyholders beginning November 1, 2003,
through October 1, 2004, the percentage of business derived from CIGNA is
expected to decrease. CIGNA's termination of their California individual and
family health insurance does not affect CIGNA's individual and family dental
program. AIB has secured both commission and override commission relationships
with other carriers including Health Net, Nationwide (formerly CalFarm), and
PacifiCare, and is continuing its efforts to diversify and offer a wider variety
of products to its customers.
EMPLOYEES
---------
On March 12, 2004, the Company employed 138 persons at its facility located in
Woodland Hills, California. The Company has no collective bargaining agreements
and believes its relations with its employees are excellent.
Item 2. Properties
- -------------------
The Company presently occupies a 46,000 square foot building located at 23251
Mulholland Drive, Woodland Hills, California, under a master lease expiring
March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin
Cheldin, the Company's president, chairman and principal stockholder, is the
owner of the building. On February 22, 1995, the Company signed an extension to
the lease with no increase in rent to March 31, 2007. The Company believes that
the terms of the lease at inception and at the time the lease extension was
signed were at least as favorable to the Company as could have been obtained
from non-affiliated third parties.
The Company utilizes for its own operations approximately 100% of the space it
leases.
Item 3. Legal Proceedings
- --------------------------
The Company, by virtue of the nature of the business conducted by it, becomes
involved in numerous legal proceedings in which it may be named as either
plaintiff or defendant. Incidental actions are sometimes brought by customers or
others that relate to disputes concerning the issuance or non-issuance of
individual insurance policies or other matters. In addition, the Company resorts
to legal proceedings from time to time in order to enforce collection of
premiums, commissions, or fees for the services rendered to customers or to
their agents. These routine items of litigation do not materially affect the
Company and are handled on a routine basis through its counsel, and they do not
materially affect the operations of the Company.
11
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
None.
PART II
-------
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
- -------------------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
The Company's common stock is traded on the NASDAQ National Market System under
the symbol "UNAM." The high and low sales prices (by quarter) and dividends
declared during the last two comparable twelve-month periods are as follows:
High Low Dividend
Quarter Ended Price Price Declared
------------- ----- ----- --------
March 31, 2003 4.750 3.050 -
June 30, 2003 4.200 3.700 -
September 30, 2003 4.740 3.960 -
December 31, 2003 8.070 4.670 -
March 31, 2002 7.100 5.000 $0.05
June 30, 2002 6.880 5.400 -
September 30, 2002 5.490 3.750 -
December 31, 2002 4.040 2.300 -
As of December 31, 2003, the approximate number of shareholders of record of the
Company's common stock was 500. In addition, the Company estimates beneficial
owners of the Company's common stock held in the name of nominees to be
approximately 600.
The Company declared a cash dividend on its common stock annually from 1991
through 2002. However, as a result of losses incurred by the Company during
fiscal years 2001 and 2002, the Company's Board of Directors concluded not to
declare an annual cash dividend for 2003 and 2004. Declaration of future annual
cash dividends will be subject to the Company's profitability and its cash
requirements. Because the Company is a holding company and operates through its
subsidiaries, its cash flow and, consequently, its ability to pay dividends are
dependent upon the earnings of its subsidiaries and the distribution of those
earnings to the Company. Also, the ability of Crusader to pay dividends to the
Company is subject to certain regulatory restrictions under the Holding Company
Act (see Item 1 - Business - Insurance Company Operation - Holding Company Act).
Based on Crusader's statutory surplus as regards policyholders as of December
31, 2003, the maximum dividend that can be made by Crusader to Unico without
prior regulatory approval in 2004 is $2,610,344.
The Company has previously announced that its Board of Directors had authorized
the repurchase in the open market from time to time of up to an aggregate of
945,000 shares of the common stock of the Company (See Note 17 of Notes to
Consolidated Financial Statements). No shares were repurchased during the year
ended December 31, 2003. As of December 31, 2003, the Company has purchased and
retired under the Board of Directors authorization an aggregate of 868,958
shares of its common stock at a cost of $5,517,465.
12
Item 6. Selected Financial Data
- --------------------------------
Fiscal year ended December 31
-----------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Total revenues $51,130,439 $46,028,642 $42,116,906 $38,367,949 $40,734,257
Total costs and expenses 48,981,068 50,842,701 58,840,015 38,174,336 33,609,368
---------- ---------- ---------- ---------- ----------
Income (loss) before taxes $2,149,371 $(4,814,059) $(16,723,109) $193,613 $7,124,889
Net income (loss) $1,068,650 $(3,224,689) $(10,870,018) $439,797 $5,131,366
Basic earnings (loss) per share $0.19 $(0.59) $(1.97) $0.07 $0.82
Diluted earnings (loss) per share $0.19 $(0.59) $(1.97) $0.07 $0.81
Cash dividends per share - $0.05 $0.05 $0.15 $0.25
Total assets $161,493,695 $148,686,605 $128,823,273 $123,945,820 $121,978,756
Stockholders' equity $38,470,857 $38,408,990 $40,620,376 $51,413,329 $54,840,797
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
-------------
Overview
--------
General
- -------
Unico American Corporation is an insurance holding company that underwrites
property and casualty insurance through its insurance company subsidiary;
provides property, casualty, health and life insurance through its agency
subsidiaries; and through its other subsidiaries provides claim administration
services (through December 31, 2003), insurance premium financing, and
membership association services.
The Company's net income was $1,068,650 in 2003, a net loss of ($3,224,689) in
2002, and a net loss of ($10,870,018) in 2001.
This overview discusses some of the relevant factors that management considers
in evaluating the Company's performance, prospects and risks. It is not
all-inclusive and is meant to be read in conjunction with the entirety of the
management discussion and analysis, the Company's financial statements and notes
thereto and all other items contained within the report on this Annual Report on
Form 10-K.
Revenue and Income Generation
- -----------------------------
The Company receives its revenue primarily from earned premium derived from the
insurance company operations, commission and fee income generated from the
insurance agency operations, finance charges and fee income from the premium
finance operations, and investment income from cash generated primarily from the
insurance operation. The insurance company operation generates approximately 82%
of the Company's total revenue. The Company's remaining operations constitute a
variety of specialty insurance services, each with unique characteristics and
individually not material to consolidated revenues.
Insurance Company Operation
- ---------------------------
The property and casualty insurance industry is highly competitive and includes
many insurers, ranging from large companies offering a wide variety of products
worldwide to smaller, specialized companies in a single state or region offering
only a single product. Many of the Company's existing or potential competitors
have considerably greater financial and other resources, have a higher rating
assigned by independent rating organizations such as A.M. Best Company, have
greater experience in the insurance industry and offer a broader line of
insurance products than the Company. Currently, Crusader is writing primarily
Commercial Multiple Peril business only in the state of California and is rated
B+ (Very Good) by A.M. Best Company.
The primary challenge of the property and casualty insurance company operation
is the fact that the Company sells its products before the ultimate costs are
actually known. When pricing its products, the Company projects the ultimate
claim and loss adjustment cost that it anticipates will be incurred after the
policy is sold. In addition, factors such as changes in, among other things,
regulations, changes in the legal environment, and inflation can all impact the
ultimate cost.
13
Over the past two years, the insurance industry has seen some difficult times as
a result of September 11, industry-wide underwriting losses, decreases in
investment yield, and increases in reinsurance cost that have all contributed to
the change from a "soft market" to a "hard market. The Company believes that a
"hard market" cycle currently exists in the insurance marketplace. The Company
has experienced beneficial market changes in its primary line of business and is
benefiting from the fact that some of its competitors have gone out of business
and others have recently raised rates or adopted more restrictive rules.
Although the Company has increased its rates and adopted more restrictive
underwriting guidelines, the beneficial market changes have contributed to a 40%
increase in direct written premiums in 2003, a 21% increase in direct written
premiums in 2002, and an increase in the number of policies issued in both 2003
and 2002. The Company cannot determine how long the existing market conditions
will continue, nor in which direction they might change. The Company's future
writings and growth are dependent on, among other things, market conditions,
competition, and the Company's ability to introduce new and profitable products.
The Company believes that rate adequacy is more important than premium growth
and underwriting profit is the Company's primary goal. Management's assessment
of trends and underwriting results is a primary factor in its decisions to
expand or contract its business. Primarily as a result of losses from liquor and
premise liability coverages, much of the Company's business outside of
California has not been profitable. In 2002 the Company began placing
moratoriums on non-California business on a state-by-state basis. By July 2003,
the Company had placed moratoriums on all non-California business. The Company
has no short-term plan to expand into additional states or to expand its
marketing channels. Instead, the Company intends to allocate its resources
toward improving its California business rates, rules, and forms.
The Company incurred underwriting losses in 2000, 2001, and 2002. As a result of
these underwriting losses, management analyzed and acted upon various components
of its underwriting activity. The Company believes that the implementation of
these actions have contributed to improved underwriting results. This is
reflected in the decrease in the Company's ratio of losses and loss adjustment
expenses to net earned premium from 139% in 2001, to 98% in 2002, and to 85% in
2003.
2003 adverse development of prior year losses was substantially lower than 2002
and the 2003 adverse development was primarily attributable to one claim. That
claim was a loss in excess-of-policy-limits, arising from a policy issued in
1993. The claim was resolved on August 1, 2003, for $4,000,000 through binding
arbitration. Available reinsurance limits in 1993 were $2,000,000 plus pro-rata
loss adjustment expenses. As a result of the binding arbitration decision, in
2003 Crusader incurred adverse development on this claim, net of reinsurance, of
approximately $2,000,000 or approximately $1,320,000 net of taxes. To help
ensure that such situations do not reoccur, the Company adopted changes in its
underwriting and claims adjusting practices, and it bought substantially more
reinsurance.
Other Operations
- ----------------
The Company's other operations generate commissions, fees, and finance charges
from various insurance products. The events that have the most significant
economic impact on other operations are as follows:
Unifax primarily sells and services insurance policies for Crusader. The
commissions paid by Crusader to Unifax are eliminated as intercompany
transactions and are not reflected as income in the financial statements. As a
result of the increase in policies sold by Unifax and the increase in the
service fee from $100 to $165 in August 2002, service fee income increased 54%
in 2003 compared to 2002.
AIB sells and services health insurance policies for individual/family and small
business groups primarily for CIGNA HealthCare and receives commission and fee
income based on the premiums that it writes. Commission and fee income in this
program increased 21% in the year ended December 31, 2003, compared to 2002, as
a result of increased premiums written in this program. However CIGNA HealthCare
is discontinuing its individual/family health insurance program over the period
from November 1, 2003 through October 1, 2004. AIB has been assisting existing
CIGNA policyholders to find health coverage with other insurance carriers that
AIB represents. The Company is unsure of the number of terminated CIGNA
policyholders it may ultimately assist with the purchase of new health coverage.
In addition, CIGNA small business group has decreased due to intense competition
in both rates and benefits offered.
14
AAC which finances Crusader policies, benefited from Crusader's 22% increase in
average policy premiums and resulted in its average loan amount increasing 23%
in 2003 compared to 2002.
Investments and Liquidity
- -------------------------
The Company generates revenue from its investment portfolio, which consisted of
approximately $118.6 million (at amortized cost) at December 31, 2003, compared
to $102.7 million (at amortized cost) at December 31, 2002. Although the
portfolio increased in 2003, investment income decreased approximately $600,000.
The decrease in investment income is primarily the result of a decline in short
and long-term yields in the marketplace and a shorter weighted average maturity
of the portfolio. Due to the interest rate environment, management believed it
was prudent to purchase fixed maturity investments with shorter maturities with
minimal credit risk.
Primarily as a result of the Company's growth in premiums in 2003 and 2002, the
Company generated positive cash flows from operations, which was approximately
$15.5 million in 2003 and $8.0 million in 2002. The increased cash flows from
operations contributed to the increase in the Company's investment portfolio.
Liquidity and Capital Resources:
-------------------------------
Due to the nature of the Company's business (insurance and insurance services)
and whereas Company growth does not normally require material reinvestments of
profits into property or equipment, the cash flow generated from operations
usually results in improved liquidity for the Company. Because the Company is a
holding company and operates through its subsidiaries, its cash flow is
dependent upon the earnings of its subsidiaries and the distributions of those
earnings to the Company.
The cash flow provided by operations in the year ended December 31, 2003, was
$15,525,386, an increase in cash flow of $7,512,162 compared to the cash flow
for the year ending December 31, 2002. The increase in cash flow from operations
in 2003 was primarily the result of Crusader's 2003 growth in written premiums
(unearned premium reserves increased $10,293,597). Cash flow provided by
operations for the year ended December 31, 2002, was $8,013,224, an increase of
$9,302,165 in cash provided compared to the year ended December 31, 2001.
The most significant liquidity risk faced by the Company would be continued
adverse development of the insurance company claims, both reported and
unreported. The Company has taken measures to address the underlying causes of
the adverse development; however, no assurance can be given that the measures
taken will be successful or that the Company's estimate of ultimate losses and
loss adjustment expenses will be sufficient. Based on the Company's current loss
and loss expense reserves and expected current and future payments, the Company
believes that there are no current liquidity issues.
Crusader generates a significant amount of cash as a result of its holdings of
unearned premium reserves, its reserves for loss payments, and its capital and
surplus. Crusader's loss and loss adjustment expense payments are the most
significant cash flow requirement of the Company. These payments are continually
monitored and projected to ensure that the Company has the liquidity to cover
these payments without the need to liquidate its investments. Cash and
investments (excluding net unrealized gains or losses) at December 31, 2003,
were $118,592,895 compared to $102,693,616 at December 31, 2002, a 15% increase.
Crusader's cash and investments at December 31, 2003, was $116,736,763 or 98% of
the total held by the Company, compared to $99,920,299 or 97% of the total held
by the Company at December 31, 2002.
15
The Company's investments are as follows:
December 31, 2003 December 31, 2002 December 31, 2001
----------------- ----------------- -----------------
Amount % Amount % Amount %
------ - ------ - ------ -
Fixed maturities (at amortized cost)
Certificates of deposit $500,000 - $400,000 - $400,000 -
U.S. treasury securities 38,305,041 34 8,517,578 10 5,459,019 6
U. S. government agency securities 11,997,264 11 9,000,000 9 - -
Industrial and miscellaneous (taxable) 58,493,396 53 73,000,830 78 77,739,699 85
State and municipal (tax exempt) 2,029,891 2 2,731,060 3 8,213,141 9
----------- --- ----------- --- ---------- ---
Total fixed maturity investments 111,325,592 100 93,649,468 100 91,811,859 100
----------- === ---------- === ---------- ===
Short-term cash investments (at cost)
Certificates of deposit 425,000 6 225,000 2 225,000 8
Cash deposited in lieu of bond * 752,659 10 - - - -
Commercial paper 2,000,000 28 1,525,000 17 - -
Bank money market accounts 902,517 13 724,842 8 2,050,006 72
U.S. gov't obligation money market fund 147,666 2 6,546,602 73 585,699 20
Short-term U.S. treasury 2,998,850 41 - - - -
Bank savings accounts 2,623 - 2,938 - 2,917 -
--------- --- --------- --- --------- ---
Total short-term cash investments 7,229,315 100 9,024,382 100 2,863,622 100
--------- === --------- === --------- ===
Equity investments (at cost) - - 216
----------- ----------- ----------
Total investments $118,554,907 $102,673,850 $94,675,697
=========== =========== ==========
* Deposited with Superior courts to stay execution of judgments pending appeal
of two Crusader Claims.
In accordance with Statement of Financial Accounting Standard No. 115,
Accounting for Certain Investments in Debt and Equity Securities, the Company is
required to classify its investment securities into one of three categories:
held-to-maturity, available-for-sale or trading securities. Although all of the
Company's investments are classified as available-for-sale and the Company may
sell investment securities from time to time in response to economic and market
conditions, its investment guidelines place primary emphasis on buying and
holding high-quality investments to maturity.
The tax-exempt interest income earned (net of bond premium and discount
amortization) during the year ended December 31, 2003, was $117,892 compared to
$283,856 in the year ended December 31, 2002. In the year ended December 31,
2001, tax-exempt interest income earned totaled $752,189.
The Company's investment policy limits investments in any one company to
$2,000,000 and any one U.S. government agency to $3,000,000. This limitation
excludes bond premiums paid in excess of par value and U.S. government or U.S.
government guaranteed issues. The Company's investment guidelines on equity
securities limit investments in equity securities to an aggregate maximum of
$2,000,000. As of December 31, 2003, all of the Company's fixed maturity
investments were investment grade, the Company held no non-traded fixed maturity
or equity securities, all state and municipal tax exempt fixed maturity
investments were pre-refunded issues, and all certificates of deposit were FDIC
insured.
On November 15, 2002, the Company borrowed $500,000 from Erwin Cheldin, a
director and the Company's principal shareholder, president and chief executive
officer, and $250,000 from The Cary and Danielle Cheldin Family Trust. Cary L.
Cheldin is a director and the Company's executive vice president. In the quarter
ended June 30, 2003, the Company repaid the above-mentioned notes in full.
In 2003, Unico made capital contributions totaling $3,000,000 to its Crusader
subsidiary. The contributions were made to ensure that Crusader's capital
remained above $25,000,000. The funding of Unico's capital contribution to
Crusader was derived from available cash from the Company's other operations and
the proceeds of two notes. On September 29, 2003, the Company borrowed
$1,000,000 from Erwin Cheldin, a director and the Company's principal
shareholder, president and chief executive officer, and $500,000 from The Cary
and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the
Company's executive vice president. The notes are due and payable upon demand of
lender (on no less than fourteen days' notice) and, if no demand is made, then
the notes are payable in full on September 28, 2007. The notes may be prepaid at
any time without penalty. The notes are unsecured and bear interest as follows:
Interest on the $1,000,000 note is 5% and is adjustable in April 1, 2004,
16
and every third month thereafter by adding a margin of one percentage point to
the prime rate; interest on the $500,000 note is 7% per annum. Interest is
payable monthly on both notes.
Crusader's statutory capital and surplus as of December 31, 2003, was
$26,103,440, a decrease of $155,012 (0.6%) from December 31, 2002. Crusader's
statutory capital and surplus as of December 31, 2002, was $26,258,452, a
decrease of $1,261,086, (4.6%) from December 31, 2001.
There were no dividends paid by Crusader to Unico in 2003, 2002 or 2001. Based
on Crusader's statutory surplus as regards policyholders as of December 31,
2003, the maximum dividend that can be made by Crusader to Unico without prior
regulatory approval in 2004 is $2,610,344.
The Company has previously announced that its Board of Directors had authorized
the repurchase in the open market from time to time of up to an aggregate of
945,000 shares of the common stock of the Company (see Note 17 of Notes to
Consolidated Financial Statements). During the year ended December 31, 2003, the
Company did not repurchase any shares of the Company's common stock. As of
December 31, 2003, the Company has purchased and retired under the Board of
Directors authorization an aggregate of 868,958 shares of its common stock at a
cost of $5,517,465.
Although material capital expenditures may also be funded through borrowings,
the Company believes that its cash and short-term investments at year end, net
of trust restriction of $939,491, statutory deposits of $2,825,000, cash
deposited (with Superior courts) in lieu of bond of $752,659 and dividend
restriction between Crusader and Unico (see Item 1 - Business - Insurance
Company Operation - Holding Company Act) plus the cash to be generated from
operations, should be sufficient to meet its operating requirements during the
next twelve months without the necessity of borrowing funds. There are no
material commitments for capital expenditures as of the date of this report.
As a California insurance company, Crusader is obligated to pay a premium tax on
gross premiums written in all states that Crusader is admitted. Premium taxes
are deferred and amortized as the related premiums are earned. The premium tax
is in lieu of state franchise taxes and is not included in the provision for
state taxes.
A recent court ruling in Ceridian vs. Franchise Tax Board held that the
California statute permitting the tax deductibility of dividends received from a
wholly owned insurance subsidiary was unconstitutional because it discriminated
against out-of-state holding companies and thus was in violation of the
interstate commerce clause of the United States Constitution. The ruling
concluded that the discriminatory sections of the statute are not severable and
the entire statute is invalid and unenforceable. California law provides that
the proper remedy in such circumstances is to disallow the deduction to those
taxpayers that benefited from the deduction. As a result of the court ruling, in
February 2003, the Franchise Tax Board (FTB) notified the Company that it would
issue a Notice of Proposed Assessment (NPA) for the tax years 1999 and 2000 of
approximately $287,000 representing California state franchise taxes plus
related interest of approximately $80,000.
The Company is following the progress of current legislation that would address
the unconstitutionality of the California statue by restructuring the rate at
which California taxes dividends for in and out of state insurance holding
companies. The legislation would also resolve the issue regarding the
retroactive assessments due to the disallowance of the deduction. If the
legislation were enacted, it would result in the Company paying a relatively
small amount of California franchise taxes on dividends received from its
insurance company subsidiary. Without a legislative solution, the Company
anticipates the ultimate outcome of the dividend received deduction will be
settled by future litigation.
The Company intends to pay the NPA to stop the interest from accruing and to
file a protective claim for refund to preserve its rights if legislation or
litigation resolves the issue. The full amount of the NPA has been accrued in
the financial statement as of December 31, 2003. After the federal tax benefit
of deducting the state taxes and interest related to the NPA, the effect on net
income in the quarter ended December 31, 2003, is approximately $242,000. An
unsatisfactory conclusion to the inter-company dividend issue could affect
Unico's future dividend policy to its shareholders.
17
The Company has certain obligations to make future payments under contracts and
credit-related financial instruments and commitments. At December 31, 2003,
certain long-term aggregate contractual obligations and credit-related
commitments are summarized as follows:
Within 1-3 3-5 After
Contractual Obligations Total 1 Year Years Years 5 years
- ----------------------- ----- ------ ----- ----- -------
Building Lease $3,334,344 $1,025,952 $2,051,904 $256,488 -
Notes Payable - Related Parties 1,500,000 - - 1,500,000 -
--------- --------- --------- ---------
Total $4,834,344 $1,025,952 $2,051,904 $1,756,488 -
========= ========= ========= =========
Results of Operations:
---------------------
General
- -------
The Company had a net income of $1,068,650 for the year ended December 31, 2003,
compared to a net loss of $3,224,689 for the year ended December 31, 2002, and
net loss of $10,870,018 for the year ended December 31, 2001. Total revenue for
the year ended December 31, 2003, was $51,130,439 compared to $46,028,642 for
the year ended December 31, 2002, and $42,116,906 for the year ended December
31, 2001.
For the year ended December 31, 2003, the Company had income before taxes of
$2,149,371 compared to a loss before taxes of $4,814,059 in the year ended
December 31, 2002, an increase in income before taxes of $6,963,430. The
increase in pre-tax income was primarily due to a decrease of $6,086,381 in the
underwriting loss (net earned premium less losses and loss adjustment expenses
and policy acquisition costs) from Crusader. The Company had a net earnings for
the year ended December 31, 2003, of $1,068,650 compared to a net loss of
$3,224,689 for the year ended December 31, 2002, an increase in net earnings of
$4,293,339.
For the year ended December 31, 2002, the Company had a loss before taxes of
$4,814,059 compared to a loss before taxes of $16,723,109 in the year ended
December 31, 2001, a decrease in loss before taxes of $11,909,050. The decrease
in pre-tax loss was primarily due to a decrease of $11,836,195 in the
underwriting loss (net earned premium less losses and loss adjustment expenses
and policy acquisition costs) from Crusader. The Company had a net loss for the
year ended December 31, 2002, of $3,224,689 compared to a net loss of
$10,870,018 for the year ended December 31, 2001, a decrease in net loss of
$7,645,329.
The effect of inflation on the net income of the Company during the years ended
December 31, 2003, 2002, and 2001 was not significant.
The Company derives revenue from various sources as discussed below.
Insurance Company Operation
- ---------------------------
Premium and loss information of Crusader are as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Gross written premium $64,047,717 $45,622,280 $37,637,396
Net written premium (net of reinsurance ceded) $47,420,157 $38,363,201 $32,106,175
Earned premium before reinsurance ceded $53,754,119 $40,568,845 $35,409,174
Earned premium (net of reinsurance ceded) $37,106,099 $33,359,272 $29,893,844
Losses and loss adjustment expenses $31,720,533 $32,727,023 $41,677,016
Unpaid losses and loss adjustment expenses $78,139,090 $74,905,284 $60,534,295
Crusader's primary line of business is commercial multiple peril business
package policies. This line of business represented approximately 97% of
Crusader's total written premium for the years ended December 31, 2003 and 2002,
and 96% for the year ended December 31, 2001.
As of December 31, 2003, Crusader was licensed as an admitted insurance company
in the states of Arizona, California, Colorado, Idaho, Montana, Nevada, Ohio,
Oregon, and Washington and is approved as a non-admitted surplus lines writer in
other states.
18
Crusader's gross written premium by state is as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
California $64,029,493 100.0% $42,590,674 93.4% $32,374,357 86.0%
Arizona 26,259 - 632,566 1.4% 1,001,640 2.7%
Idaho 1,591 - 36,495 0.1% 32,769 0.1%
Kentucky - - - - 24,293 0.1%
Montana 17,369 - 393,966 0.9% 513,735 1.4%
Nevada 12,288 - 210,244 0.4% 380,835 1.0%
Ohio (20,343) - 743,010 1.6% 1,269,026 3.4%
Oregon (11,993) - 340,336 0.7% 401,960 1.0%
Pennsylvania (4,371) - 372,748 0.8% 614,317 1.6%
Texas 318 - 23,962 0.1% 303,393 0.8%
Washington (2,894) - 278,279 0.6% 721,071 1.9%
---------- ----- ---------- ----- ---------- -----
Total gross written premium $64,047,717 100.0% $45,622,280 100.0% $37,637,396 100.0%
========== ===== ========== ===== ========== =====
For the year ended December 31, 2003, gross written premium increased by
$18,425,437 (40%) compared to the year ended December 31, 2002.
The above-mentioned growth in written premium was due to an increase in written
premium in the state of California. The increase in written premium in the state
of California in 2003 was primarily the result of the continued subsidence in
priced-based competition in the property casualty insurance market that has
resulted in the Company's products becoming more competitive. In addition, the
Company has increased rates on some of its California products, is in the
process of filing for rate increases on some of its California products, and is
waiting for regulatory approval of rate increases on some of its products that
have already been filed with California regulatory authorities. The Company
believes that a "hard market" cycle exists in California. Industry-wide
underwriting losses, decreases in investment yield, and increases in reinsurance
cost have all contributed to the change from the "soft market" to the "hard
market." The Company is also benefiting from the fact that some of its
competitors have gone out of business and others have recently raised rates or
adopted more restrictive rules. The Company cannot determine how long the
existing market conditions will continue, nor in which direction they might
change. The Company's future writings and growth are dependent on market
conditions, competition, and the Company's ability to introduce new and
profitable products.
Premiums written outside of California in 2003 decreased $3,013,382 (99%).
Primarily as a result of losses from liquor and premise liability coverages,
much of the Company's business outside of California has not been profitable. In
2002 the Company began placing moratoriums on non-California business on a
state-by-state basis. By July 2003, the Company had placed moratoriums on all
non-California business. As a result of these moratoriums, written premium
outside California decreased significantly to $18,224 for the year ended
December 31, 2003, as compared to $3,031,606 for the year ended December 31,
2002, and $5,263,039 for the year ended December 31, 2001. There were no
premiums written outside the state of California in the quarter ended December
31, 2003. The Company has no short-term plan to expand into additional states,
or to expand its marketing channels. Instead, the Company intends to allocate
its resources toward improving its California business rates, rules, and forms.
The Company's average premium per policy issued is as follows:
Year Ended Direct Written Policies Average
December 31 Premium Issued Premium
----------- ------- ------ -------
2003 $64,047,717 21,425 $2,989
2002 $45,622,280 18,603 $2,452
2001 $37,637,396 18,114 $2,078
As discussed above, the fact that some of the Company's competitors have gone
out of business and others have recently raised rates or adopted more
restrictive rules resulted in a 15% increase in the number of policies issued by
the Company in 2003 as compared to 2002. The number of policies issued in 2002
increased 3% over 2001.
19
The Company continues to believe that it can compete effectively and profitably
by offering better service and by marketing its policies through its current
independent agents and brokers.
The Company writes annual policies and, therefore, earns written premium daily
over the one-year policy term. Premium earned before reinsurance increased
$13,185,274 (33%) in the year ended December 31, 2003, compared to the year
ended December 31, 2002, and increased $5,159,671 (15%) in the year ended
December 31, 2002, compared to the year ended December 31, 2001. The increase in
earned premium before reinsurance in 2003 and 2002 was directly related to the
increase in written premium in 2003 and 2002.
Earned ceded premiums increased in 2002 and 2003 primarily as a result of rate
increases by the Company's reinsurers effective January 1, 2002, and on January
1, 2003, and the related increase in direct earned premium on which these rates
are based. The rate increases are primarily due to the Company's ceded loss
experience and the hardening of the reinsurance marketplace. Ceding commissions
increased in 2003 from 25% to 35%. Ceding commission is a component of policy
acquisition costs. The annual aggregate deductible on Crusader's primary excess
of loss treaty was $500,000 in 2001, $675,000 in 2002, and $500,000 in 2003. In
2003 Crusader retained a participation in its excess of loss reinsurance
treaties of 5% in its 1st layer ($750,000 in excess of $250,000) 10% in its 2nd
layer ($1,000,000 in excess of $1,000,000), and 30% in its property clash
treaty. Premium ceded under the provisionally rated contract, which was canceled
on a runoff basis effective December 31, 1997, is subject to adjustment based on
the amount of losses ceded, limited by a maximum percentage that can be charged
by the reinsurer. Crusader's 2003 1st layer primary excess of loss treaty
provides for a contingent commission equal to 45% of the net profit, if any,
accruing to the reinsurer. The first accounting period for the contingent
commission covers the combined accident years 2003 through 2005, and therefore
no contingent commission has been accrued.
Crusader's direct earned premium, earned ceded premium, and ceding commission
are as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Direct earned premium $53,754,119 $40,568,845 $35,409,174
Earned ceded premium
Excluding provisionally rated ceded premium 16,414,611 6,336,551 3,661,213
Provisionally rated ceded premium 233,409 873,022 1,854,117
---------- --------- ---------
Total earned ceded premium 16,648,020 7,209,573 5,515,330
Ceding commission 5,429,330 1,356,061 759,260
----------- --------- ---------
Earned ceded premium, net of ceding commission $11,218,690 $5,853,512 $4,756,070
========== ========= =========
Ratios to direct earned premium
Direct ceded premium 31% 18% 16%
Earned ceded premium, net of ceding commission 21% 14% 13%
The combined ratio is the sum of (1) the net ratio of losses and loss adjustment
expenses incurred (including a provision for incurred-but-not-reported losses
"IBNR") to net premiums earned (loss ratio) and (2) the ratio of policy
acquisition costs to net premiums earned (expense ratio). The following table
shows the loss ratios, expense ratios, and combined ratios of Crusader as
derived from data prepared in accordance with GAAP. As shown on the table below,
the loss ratio decreased to 85.5% in 2003 from 98.1% in 2002 and decreased from
139.4% in 2001. This decrease in the loss ratio since 2001 was primarily due to
a decrease in prior years' incurred losses.
Generally, if the combined ratio is below 100%, an insurance company has an
underwriting profit; if it is above 100%, a company has an underwriting loss.
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Loss ratio 85.5% 98.1% 139.4%
Expense ratio 21.4% 27.8% 29.1%
----- ----- -----
Combined ratio 106.9% 125.9% 168.5%
===== ===== =====
20
Reserves for losses and loss adjustment expenses before reinsurance were
$78,139,090 at December 31, 2003, compared to $74,905,284 at December 31, 2002,
and to $60,534,295 at December 31, 2001. The increase in loss and loss
adjustment expense reserves in 2003 is primarily a result of increased IBNR
reserves as a result of the 32% increase in earned premium in the year ended
December 31, 2003 as discussed above. The increase in reserves at December 31,
2002 and 2001 reflects both an increase in claim severities and adverse
development of prior years in the Company's Commercial Multiple Peril (CMP) and
Other Liability lines of business.
Reserves for losses and loss adjustment expenses before reinsurance for each of
Crusader's lines of business were as follows:
Year ended December 31
----------------------
Line of Business 2003 2002 2001
- ---------------- -------------------- -------------------- --------------------
CMP $73,708,553 94.3% $69,111,825 92.3% $56,215,479 92.9%
Other Liability $4,279,021 5.5% $5,564,214 7.4% $4,004,449 6.6%
Other $151,516 0.2% $229,245 0.3% $314,367 0.5%
---------- ----- ---------- ----- ---------- -----
Total $78,139,090 100.0% $74,905,284 100.0% $60,534,295 100.0%
========== ===== ========== ===== ========== =====
The Company`s consolidated financial statements include estimated reserves for
unpaid losses and related claim settlement or loss adjustment expenses of our
insurance company operation. Crusader sets loss and loss adjustment expense
reserves at each balance sheet date at management's best estimate of the
ultimate payments that it anticipates will be made to settle all losses incurred
and related expenses incurred as of that date for both reported and unreported
losses. The process of estimating loss and loss adjustment reserves involves
significant judgment and is complex and imprecise due to the number of variables
and assumptions inherent in the estimating process. Crusader establishes
reserves for reported losses based on historical experience, upon case-by-case
evaluation of facts surrounding each known loss, and the related policy
provisions. The amount of reserves for unreported losses is estimated by
analysis of historical and statistical information. Reserves are monitored and
adjusted when appropriate and reflected in the statement of operations in the
period of adjustment.
2003 losses and loss adjustment expenses
- ----------------------------------------
Losses and loss adjustment expenses were $31,720,533 (85%) of net premium earned
for the year ended December 31, 2003, compared to $32,727,023 (98%) of net
premium earned for the year ended December 31, 2002. The decrease in losses for
the year ended December 31, 2003, is primarily the result of a decrease in the
adverse development of prior year losses in 2003 compared to 2002. The adverse
loss development in 2003 was $2,751,585 compared to $7,790,851 in 2002. The
adverse development in 2003 was primarily attributable to one claim. That claim
was a loss in excess-of-policy-limits, arising from a policy issued in 1993. The
claim was resolved on August 1, 2003, for $4 million through binding
arbitration. Available reinsurance limits in 1993 were $2,000,000 plus pro-rata
loss adjustment expenses. As a result of the binding arbitration decision, in
2003 Crusader incurred adverse development on this claim, net of reinsurance, of
approximately $2,000,000 or approximately $1,320,000 net of taxes. To help
assure that such situations do not reoccur, the Company adopted changes in its
underwriting and claims adjusting practices, and it bought substantially more
reinsurance.
The remaining adverse development in 2003 was attributable to continued losses
due to the impact of changes in California case law that expanded coverage and
increased loss exposure primarily on construction defect claims for claims
occurring on or prior to the Company's revision of its policy forms in 1995.
2002 losses and loss adjustment expenses
- ----------------------------------------
The adverse development in the year ending December 31, 2002, of $7,790,851 was
primarily the result of liquor and premises liability outside of California for
the accident years 1999 through 2001 and higher than anticipated costs of
construction defect and apartment house habitability claims for accident years
prior to 1998. The liquor liability claims arose from the liability of tavern
owners related to the sale of alcoholic beverages. Based on the development in
2002 of the liquor and premises liability claims the Company increased its
estimate of ultimate losses for 1999 and subsequent years.
21
Adverse (favorable) development of prior years losses in 2002 by line of
business is as follows:
Accident Years ended December 31
-------------------------------------------------------
1998
Line of Business 2001 2000 1999 and Prior Total
---- ---- ---- --------- -----
CMP $2,022,752 $2,812,554 $1,078,477 $1,769,710 $7,683,493
Other Liability 30,152 31,387 49,877 136,328 247,744
Other (136,557) (32,605) (6,999) 35,775 (140,386)
--------- --------- --------- --------- ---------
Total $1,916,347 $2,811,336 $1,121,355 $1,941,813 $7,790,851
========= ========= ========= ========= =========
Losses and loss adjustment expenses were $32,727,023 (98%) of net premium earned
for the year ended December 31, 2002, compared to $41,677,016 (139%) of net
premium earned for the year ended December 31, 2001. The decrease in losses for
the year ended December 31, 2002, is primarily the result of a decrease in the
adverse development of prior year losses in 2002 compared to 2001. The adverse
loss development in 2002 was $7,790,851 compared to $19,326,349 in 2001. The
adverse development in the year ending December 31, 2002, of $7,790,851 was
primarily the result of liquor and premises liability outside of California for
the accident years 1999 through 2001, and the result of higher than anticipated
costs of construction defect and apartment house habitability claims for
accident years prior to 1998. The liquor liability claims arise from the
liability of tavern owners related to the sale of alcoholic beverages. Based on
the development in 2002 of the liquor and premises liability claims the Company
increased its estimate of ultimate losses for 1999 and subsequent. In the year
ended December 31, 2001, the Company increased its estimates of ultimate losses
for both reported and unreported claims primarily occurring from 1998 through
2000 and from 1993 through 1995 (the years most impacted by construction defect
claims). Adverse development of prior years' losses of $19,326,349 as of
December 31, 2001, was primarily the result of an increase in the Company's
estimate of ultimate reported and unreported claims for construction defect
claims, non-California liquor liability claims and apartment house habitational
type of claims.
The Company believed that it had adequately addressed its estimate of ultimate
losses and loss adjustment expenses as of December 31, 2001, and anticipated
that underwriting changes in problematic business such as reducing coverages,
modifying policy forms, more restrictive underwriting, reductions in
non-California business, and increasing rates would be reflected in the 2002
development. However, continued adverse development in 2002 indicated that the
underwriting changes implemented through December 31, 2001, were not sufficient
to fully address the losses primarily occurring on accident years 1999 through
2001 on the Company's business outside of California (primarily liquor and
premises liability), and on the Company's special risk class of business. Liquor
liability claims arise from the liability of tavern owners related to the sale
of alcoholic beverages. The Company's special risk class of business represents
risks written within current underwriting programs that have a higher degree of
exposure and require special pricing and underwriting. Based on the development
in 2002 primarily on the business discussed above, the Company increased its
estimate of ultimate losses for accident years 1999 and subsequent. The adverse
development in 2002 for accident years 1998 and prior was primarily due to
higher than anticipated cost of construction defect and apartment house
habitability claims. Construction defect claims arise from the liability of
contractors for their defective work in the construction of habitation
structures (such as apartments, condominiums and single-family dwellings) or
commercial type structures. Apartment house habitability claims arise from
uninhabitable conditions related to dilapidated structures and insect and vermin
infestation.
In light of the adverse development in 2001, the Company increased the frequency
and scope of its reserve studies. The continued adverse development in 2002,
discussed above, was first observed in June 2002 when the Company determined
that losses for accident years 2002 and 2001 were developing higher than
anticipated and the underwriting actions had not mitigated loss exposure to the
extent previously estimated. Of the total adverse development in 2002 of
$7,790,851, $6,332,812 was reflected as of June 30, 2002. Adverse development of
prior years losses in 2002 represented 15.6% of net reserves as of December 31,
2001.
22
The following table provides an analysis of the roll forward of Crusader's
losses and loss adjustment expenses, including a reconciliation of the ending
balance sheet liability for the periods indicated:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Reserve for unpaid losses and loss adjustment expenses
at beginning of year - net of reinsurance $53,596,945 $49,786,215 $34,546,026
---------- ---------- ----------
Incurred losses and loss adjustment expenses
Provision for insured events of current year 28,968,948 24,936,172 22,350,667
Increase in provision for events of prior years 2,751,585 7,790,851 19,326,349
---------- ---------- ----------
Total losses and loss adjustment expenses 31,720,533 32,727,023 41,677,016
---------- ---------- ----------
Payments
Losses and loss adjustment expenses attributable to
insured events of the current year 5,106,929 5,905,678 5,595,410
Losses and loss adjustment expenses attributable to
insured events of prior years 21,326,688 23,010,615 20,841,417
---------- ---------- ----------
Total payments 26,433,617 28,916,293 26,436,827
---------- ---------- ----------
Reserve for unpaid losses and loss adjustment expenses
at end of year - net of reinsurance 58,883,861 53,596,945 49,786,215
Reinsurance recoverable on unpaid losses and loss
Adjustment expenses at end of year 19,255,229 21,308,339 10,748,080
---------- ---------- ----------
Reserve for unpaid losses and loss adjustment expenses at
end of year per balance sheet, gross of reinsurance (*) $78,139,090 $74,905,284 $60,534,295
========== ========== ==========
(*) In accordance with Financial Accounting Standards Board Statement No. 113,
Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts, reinsurance recoverable on unpaid losses and loss adjustment expenses
are reported for GAAP as assets rather than netted against the corresponding
liability for such items on the balance sheet.
Estimating loss reserves is a difficult process as there are many factors that
can ultimately affect the final settlement of a claim and, therefore, the
reserve that is needed. Changes in the regulatory and legal environment, results
of litigation, medical costs, the cost of repair materials and labor rates can
all impact ultimate claim costs. In addition, time can be a critical part of
reserving determinations since the longer the span between the incidence of a
loss and the payment or settlement of the claim, the more variable the ultimate
settlement amount can be. Accordingly, short-tail claims, such as property
damage claims, tend to be more reasonably predictable than long-tail liability
claims. The liability for unpaid losses and loss adjustment expenses is based
upon the accumulation of individual case estimates for losses reported prior to
the close of the accounting period plus estimates based on experience and
industry data for development of case estimates and for unreported losses and
loss adjustment expenses. Since the emergence and disposition of claims are
subject to uncertainties, the net amounts that will ultimately be paid to settle
claims may vary significantly from the estimated amounts provided for in the
accompanying consolidated financial statements. Any adjustments to reserves are
reflected in the operating results of the periods in which they are made.
Management believes that the aggregate reserves for losses and loss adjustment
expenses are reasonable and adequate to cover the cost of claims, both reported
and unreported.
Crusader incurred underwriting losses in 2000, 2001, and 2002. As a result of
these underwriting losses, Crusader's management analyzed and acted upon the
following components of its underwriting activity:
1. Business Outside of California
2. Habitability Exposure
3. Construction Defect Exposure
4. Special Risk Class of Business
5. Increased Cost of Settling Claims, Indemnity and Expense
6. Increased Cost of Reinsurance
7. Mold Exposure
8. Terrorism Exposure
9. Market Conditions and Competition
23
The following is a discussion of the above items. Crusader believes that except
for one aberrational claim previously discussed under the 2003 adverse
development, the implementation of the above items have contributed to improved
operating results.
1. Business Outside of California: As reflected on the table below,
collectively, the insurance underwritten by the Company outside of
California has been very unprofitable, particularly with respect to the
Liquor and Premises types of liability coverage. The Company adopted
substantial rate increases and coverage restrictions beginning in June of
2001 for all Liquor Liability written outside of California and Nevada. The
rate increases caused a dramatic decline in sales, causing the Company to
be concerned about adverse selection. The Company determined that under
current market conditions, it could not sell its policies at an adequate
rate outside of California and ceased writing in those states. Direct
written premium outside California decreased from $5,263,039 in 2001, to
$3,031,606 in 2002, to $18,224 in 2003.
Non-California Non-California
Accident Direct Written Direct Earned
Year Premium Premium
---- ------- -------
1997 $9,464,473 $9,287,644
1998 5,813,949 8,085,720
1999 4,429,266 4,783,426
2000 4,746,126 4,473,864
2001 5,263,039 5,112,715
2002 3,031,606 4,431,289
2003 $18,224 $1,198,006
2. Habitability Exposure: In 2000 and 2001, the Company began experiencing
adverse development on its apartment house business, due primarily to the
effect of settlements on habitability claims. Those settlements were
substantially influenced by a statute that provides for the payment of
plaintiff attorney fees without regard to policy limits, and by the
Montrose Chemical Corp. v. Admiral Insurance Company decision of 1995.
Starting in October 2000, the Company significantly changed its
underwriting practice with respect to the type of apartment buildings
thought to cause these claims. These changes included:
A. In September 2000, the Company identified a subcategory of
apartment building risk, referred to as the "Big and Old" group.
The Company believes that members of this group pose a
greater-than-average probability of habitability loss.
B. On September 28, 2000, the Company imposed more stringent
underwriting restrictions and requirements upon members of the
"Big and Old" group, including the adoption of more restrictive
coverage forms and use of maintenance warranties for members of
this group.
C. On September 7, 2002, the Company changed its coverage forms to
limit the "costs taxed against the insured" clause of the
"Supplementary Provisions" coverage grant, from unlimited to
$100,000.
D. In September 2003, the Company adopted an 80% liability rate
increase for all of its apartment risks.
Since 2002, no additional claims of any significance have been reported to
Crusader. The Company believes that the combination of improved
underwriting and policy language limiting supplemental payments have
substantially reduced the exposure.
3. Construction Defect Exposure: The Company continuously modifies its
underwriting practice with respect to subcontractors in an effort to
improve loss experience. For example, subcontractors performing
"waterproofing, weather-coating, or decking" were deemed ineligible by the
Company in 1995; and, to minimize the adverse effects of the Montrose
decision of 1995, the Company changed its coverage forms in 1996; and, the
Company adopted numerous, program-specific questions to its applications,
inspections, and survey forms. Although the Company believes that the
ultimate results of its post-1996 underwriting of this class of business
will prove to be profitable, the results will not be known until the 10
year statute runs. Therefore, on April 18, 2002, the Company sought
regulatory approval for a change in or discontinuation of its experience
rating plan. When the regulator disapproved that filing, on June 18, 2002,
the Company imposed
24
a moratorium on all new offers of artisan contractors' insurance. In
January 2003 Crusader received regulatory approval of its plan to
discontinue experience rating, which translates into a 21% rate increase
for all coverages offered to artisan contractors. However, because the
Company is cautious about underwriting this type of business, it has not
lifted the underwriting moratorium that started on June 18, 2002. Since
that date, attrition was significant, reducing the number of policies in
force. Until such time that the Company can change this program to make
underwriting more predictable, the moratorium will not be lifted.
4. The Special Risks Division: The Company's Special Risk class of business
represents risks written within current underwriting programs that have a
higher degree of exposure and require special pricing and underwriting. In
November 2000 after a change of program management, the Company reviewed
those policies underwritten by its Special Risks division. That review
resulted in the cancellation of a significant number of policies, those
thought to be generating most of the losses.
Special Risk Special Risk Special Risk
Direct Written Direct Earned Policies
Year Premium Premium In Force
---- ------- ------- --------
1998 $2,734,635 $3,380,747 259 as of 12/31/98
1999 2,595,032 2,636,451 235 as of 12/31/99
2000 2,851,194 2,731,012 250 as of 12/31/00
2001 2,922,257 2,925,365 201 as of 12/31/01
2002 2,329,771 2,582,673 131 as of 12/31/02
2003 $1,804,249 $2,222,707 115 as of 12/31/03
5. Increased Cost of Settling Claims: In 2002 the Company noticed a trend
of increasing costs but does not believe that the trend reflects
operational changes. The Company believes that the trend is most likely
attributable to several changes in the law, including an increased
propensity for trial courts to award large plaintiff verdicts. However,
several favorable decisions were recently published, including the Federal
Supreme Court's limitation on punitive damages (see Campbell vs. State
Farm, 2003), and the California Supreme Court's limitation on public policy
reformations (see Rosen vs. State Farm, 2003). It is difficult to quantify
and predict the continuation of this trend. In 2003, an outside actuary was
engaged to assist the Company in reviewing the premium rate adequacy of
certain key Crusader programs and to assist in the regulatory rate filings.
Crusader raises its premium rates whenever the adequacy is in doubt.
6. Increased Cost of Reinsurance: In 2003, the cost of reinsurance
significantly increased primarily as a result of losses sustained outside
of California that the Company no longer underwrites. The Company received
a slight decrease in its reinsurance rates in 2004.
7. Mold Exposure: The Company has not seen any significant mold-based claim
and all of its policies are now being endorsed with a "Mold Exclusion." In
addition, numerous articles from respected medical authorities were
recently published, making plaintiffs task of proving mold-based injuries
much more difficult.
8. Terrorism Exposure: All policies are endorsed with a "Terrorism
Endorsement" that conforms with the Federal Terrorism Risk Insurance Act of
November 26, 2002. All policyholders that reject the federal coverage will
get a policy containing a Terrorism Exclusion endorsement.
9. Market Conditions, Competition: The Company continues to benefit from the
"hard market conditions." Although some new competitors have entered the
marketplace, their pricing seems to be reasonable and therefore the
Company's products continue to remain competitive.
Primarily as a result of the underwriting losses in 2000 and 2001, the A.M. Best
Company lowered Crusader's rating from A (Excellent) to A- (Excellent) effective
March 26, 2002, based on financial information as of December 31, 2001. At the
time the rating was lowered, A.M. Best remained concerned with the potential for
further adverse loss reserve development and the negative impact it would have
on the Company's operating performance and overall capitalization and viewed the
rating outlook as negative. Due to the continued adverse development in the six
months ended June 30, 2002, on October 3, 2002, A.M. Best Company lowered
Crusader's rating to B+ (Very Good) and continues to view its rating outlook as
negative. The lowering of Crusader's rating to B+ did not have a material
adverse effect on the Company.
25
Other Insurance Operations
- --------------------------
Health and Life Insurance Program
---------------------------------
Commission income from the health and life insurance sales of NIB and AIB is as
follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Commission income $3,312,715 $2,741,672 $2,582,290
AIB markets health and life insurance in California through non-affiliated
insurance companies for individuals and groups. In January 2003, NIB assigned
all its contracts and commissions to AIB, and NIB is now inactive.
In 2003 and 2002 approximately 93% and 94% of the health and life commission
income accordingly was from the CIGNA HealthCare medical and dental plan
programs. Revenues for the year ended December 31, 2003, increased $571,043
(21%) compared to the year ended December 31, 2002. The increase in health and
life insurance program commission and fee income is primarily due to an increase
in premium written. This increase in health and life insurance income is
primarily due to both increased marketing efforts and the fact that in November
2002 CIGNA terminated their contract with another administrator and
approximately 2,000 affected members were transitioned into the Company's health
and life insurance program effective January 1, 2003. Approximately 65% were
enrolled in the CIGNA individual health and family program and 35% were enrolled
in CIGNA's small group program.
Beginning in April 2003, CIGNA discontinued its individual and family health
insurance program to new policyholders in the state of California. On November
1, 2003, CIGNA began terminating approximately 2,200 individual and family
policyholders on a runoff basis. The termination of policyholders will continue
through October 1, 2004. Beginning April 2003, AIB began assisting affected
policyholders with the purchase of new health coverage through other insurance
carriers. AIB has secured both commission and override commission relationships
with other carriers including Health Net, Nationwide (formerly CalFarm), and
PacifiCare, and is continuing its efforts to diversify and offer a wider variety
of products to its customers. Overall, the commissions/overrides from other
carriers are generally higher than the commission structure paid by CIGNA.
Due to CIGNA's discontinuation of its individual and family health insurance
program, some policyholders have decided to terminate their policy prior to the
date issued by CIGNA. As of December 31, 2003, approximately 1,800 policyholders
have terminated their CIGNA policies. Of this amount, the Company has placed
approximately 600 policyholders with other carriers. The Company cannot
determine the percentage of affected policyholders that will leave through
normal attrition or that will not be accepted by the Company's other insurance
carriers due to pre-existing health conditions.
The discontinuance of CIGNA's individual and family health insurance program
does not affect the CIGNA small group program. Due to intense competition in
both rates and benefits offered, CIGNA small group program membership decreased
in 2003. As of December 31, 2003, CIGNA small group program membership is
comprised of 1,935 subscribers and 1,149 dependents compared to 2,368
subscribers and 1,475 dependents as of December 31, 2002.
Revenues for the year ended December 31, 2002, increased $159,382 (6%) compared
to the year ended December 31, 2001. The increase in commission income in the
health and life insurance programs is primarily due to an increase in premiums
written in the CIGNA HealthCare programs.
Service Fee Income
------------------
Unifax sells and services insurance policies for Crusader. The service fee
charged to the policyholder by Unifax is recognized as income in the
consolidated financial statements. Service fee income of Unifax is as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Service fee income $3,458,559 $2,241,883 $1,726,811
Policies written 21,425 18,603 18,114
Service fee income increased $1,216,676 (54%) in the year ended December 31,
2003, compared to the year ended December 31, 2002. The increase in service fee
is primarily due to an increase in the fee from $100 to
26
$165 per policy written in California. This increase was approved by California
regulatory authorities on June 21, 2002, and was implemented for policies
effective on and after the latter part of August 2002. The increase in service
fee income is also related to the number of policies written by Unifax. Policies
issued increased by 2,822 (15%) in the year ended December 31, 2003, compared to
the year ended December 31, 2002. Service fee income increased $515,072 (30%)
and policies issued increased by 489 (3%) in the year ended December 31, 2002,
compared to the year ended December 31, 2001.
Daily Automobile Rental Insurance Program
-----------------------------------------
The daily automobile rental insurance program is produced by Bedford. Bedford
receives a commission and a claim administration fee from a non-affiliated
insurance company based on premium written. Commission and fee income from the
daily automobile rental insurance program are as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Rental program commission $574,197 $642,005 $585,252
Claim administration fee 241,428 80,531 72,021
Contingent commission - 66,947 10,145
------- ------- -------
Total commission and fee income $815,625 $789,483 $667,418
======= ======= =======
Commission and fee income during the year ended December 31, 2003, were
$815,625, an increase of $26,142 (3%) compared to the same period of the prior
year. Revenue for the year ended December 31, 2002, increased by $122,065 (18%)
compared to the year ended December 31, 2001.
The daily automobile rental insurance program commission income (excluding
contingent commission) decreased $67,808 (11%) in 2003 compared to 2002. The
daily automobile rental insurance program commission income (excluding
contingent commission) increased $56,753 (10%) in 2002 compared to 2001. Premium
written in 2003 decreased 11% compared to prior year, and premium written in
2002 increased 7% compared to premium written in 2001. The decrease in written
premium in 2003 is primarily due to the continued intense price competition in
the daily automobile rental insurance program, which is causing these
fluctuations in the Company's written premium and related commission income. To
avoid underwriting losses for the non-affiliated insurance Company that it
represents, Bedford continues to produce business only at rates that it believes
to be adequate. The Company cannot determine how long the existing market
conditions will continue, nor in which direction they might change.
The increase in claim administration fee income in 2003 is primarily due to the
recognition of $200,000 of claim administration fees that were unearned as of
December 31, 2002. The Company is responsible for all claim administration cost
arising from losses covered by premiums for which it received a claim
administration fee. These costs may be incurred by the Company or the
non-affiliated insurer should it assume the claim administration responsibility.
The Company maintains an unearned claim administration reserve to cover these
future costs. On January 1, 2003, the non-affiliated insurer assumed the claim
administration for all new policies effective in 2003. The Company did not
receive any claim administration fees on those policies. As of December 31,
2003, the non-affiliated insurer assumed the claim administration for the
remaining outstanding and IBNR claims. The Company will no longer receive any
claim administration fees and will not incur any future internal claim
administration costs. The unearned claim administration reserve as of December
31, 2003 reflects the estimated costs to complete the claim administration by
the non-affiliated insurer. The non-affiliated insurer will bill the Company for
these costs as they are incurred.
Association Operation
---------------------
Membership and fee income from the association program of AAQHC is as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Membership and fee income $481,366 $424,784 $398,677
Membership and fee income for the year ended December 31, 2003, increased
$56,582 (13%), compared to the year ended December 31, 2002. This increase in
membership and fee income is primarily a result of increased marketing efforts
and the fact that in November 2002 CIGNA terminated its contract with another
administrator
27
and approximately 2,000 affected members were transitioned into the Company's
health and life insurance program effective January 1, 2003. However, beginning
in April 2003, CIGNA discontinued its individual and family health insurance
program to new policyholders in the State of California. On November 1, 2003,
CIGNA began terminating approximately 2,200 individual and family policyholders
on a runoff basis. The termination of policyholders will continue through
October 1, 2004. Due to the discontinuance of CIGNA's individual and family
health insurance program, membership and fee income is expected to decrease as
these terminated members will no longer be members of the association.
Revenue for 2002 and 2001 were relatively unchanged as the membership base
remained constant.
Other Commission and Fee Income
-------------------------------
Other commission and fee income are as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Earthquake program commission income $40,015 $51,576 $51,029
Workers' compensation program
commission income 1,042 12,258 19,730
Commercial liability program
commission and fee income - (741) 62,839
Miscellaneous fee income 70 109 161
------ ------ -------
Total other commission and fee income $41,127 $63,202 $133,759
====== ====== =======
Unifax began producing commercial earthquake insurance policies in California
for non-affiliated insurance companies in 1999. Unifax receives a commission
from these insurance companies based on premium written. Commission income on
the earthquake program for the year ended December 31, 2003, decreased $11,561
(22%) compared to the prior year. The 22% decrease in commission income on
earthquake policies in the year ended December 31, 2003, is directly related to
a 23% decrease in written premium in 2003 compared to 2002.
Unifax produced workers' compensation policies primarily in California for
non-affiliated insurers and received a commission from them based on premium
written. Unifax discontinued its sales of workers' compensation insurance
policies for non-affiliated insurers in 2002. The Company continues to receive
commissions on policies, which were renewed in 2002. The Company's decision to
discontinue selling this business was due to underwriting constraints of the
non-affiliated insurance companies that limited the types and classes of
business that they would accept. These constraints resulted in the decrease in
commission income for the years ended December 31, 2003 and 2002.
Unifax began producing commercial liability insurance policies in California for
non-affiliated insurance companies in 1999. Unifax received a commission from
the insurance company based on premium written and a service fee from the
policyholder. Effective December 2001 the Company discontinued the program. The
Company took this action in order to better utilize its resources and focus on
those markets that offer a greater potential. As such, Unifax had no commission
and fee income on the commercial liability program in the year ended December
31, 2003.
The commissions paid by Crusader to Unifax are eliminated as intercompany
transactions and are not reflected in commission income or commission expense.
Premium Finance Program
-----------------------
Premium finance charges and late fees earned from financing policies are as
follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Premium finance charges and
fees earned $952,543 $878,316 $868,496
New loans 6,216 6,340 7,148
28
AAC provides premium financing to Crusader policies produced by Unifax in
California. The growth of this program is dependent and directly related to the
growth of Crusader's written premium and AAC's ability to market its competitive
rates and service to finance those policies. Revenue increased $74,227 (8%) in
the year ended December 31, 2003, compared to the prior year although there were
124 (2%) fewer loans financed in the current year. The increase in revenue in
2003 is primarily due to an increase of approximately 23% in the amount of
average loan financed. Although AAC financed approximately 81% of all Unifax
policies financed compared to 77% in the prior year, the percentage of all
Unifax policies that are financed decreased from approximately 44% in 2002 to
approximately 36% in 2003.
Revenue for the year ended December 31, 2002, increased $9,820 (1%) compared to
the year ended December 31, 2001. The number of new loans decreased by 808 (11%)
in the year ending December 31, 2002, compared to the prior year. The increase
in revenues despite the decrease in the number of new loans in 2002 is primarily
due to the fact that the average policy loan being financed is approximately 22%
greater than the prior year.
Investment Income and Net Realized Gains
- ----------------------------------------
Investment income and net realized gains are as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Interest income
Insurance Company operations $4,801,133 $5,401,870 $5,647,026
Other operations 47,010 56,176 156,387
--------- --------- ---------
Total interest income 4,848,143 5,458,046 5,803,413
Net realized investment gains - 3,690 9,572
--------- --------- ---------
Total investment income and
realized gains $4,848,143 $5,461,736 $5,812,985
========= ========= =========
In the year ended December 31, 2003, while the Company's average invested assets
(at amortized value) increased $11,939,605 (12%) compared to the year ended
December 31, 2002, investment income earned (excluding net realized gains)
decreased $609,903 (11%) compared to the year ended December 31, 2002. The
decrease in investment income is primarily the result of a continued decline in
the average return on invested assets in the Company's investment portfolio due
to both a general decline in short and long-term yield in the marketplace and a
shorter weighted average maturity of the portfolio. Due to the current interest
rate environment, management believes it prudent to purchase fixed maturity
investments with shorter maturities and therefore, the weighted average maturity
of the Company's fixed maturity investments has decreased from 2.4 years as of
December 31, 2002, to 1.9 years as of December 31, 2003. In the year ended
December 31, 2003, the Company's average yield on invested assets (at amortized
value) was 4.38% compared to 5.53% at the year ended December 31, 2002. The
Company's average invested assets increased in the year ending December 31,
2003, primarily as a result of increased cash flows from operations. The mix of
taxable and tax-exempt securities in the portfolio affects the investment income
return percentage. Tax-exempt securities generally carry a lower yield than
taxable securities. These securities (at amortized value) decreased to
$2,029,891 (2% of total investments) at December 31, 2003, compared to
$2,731,060 (3% of total investments) at December 31, 2002.
In the year ended December 31, 2002, while the Company's average invested assets
(at amortized value) increased $2,247,249 (2%) compared to the year ended
December 31, 2001, investment income earned (excluding net realized gains)
decreased $345,367 (6%) compared to the year ended December 31, 2001. The
decrease in investment income is primarily the result of a decline in the
average return on invested assets in the Company's investment portfolio due to
both a general decline in short and long-term yield in the marketplace and a
shorter weighted average maturity of the portfolio. Due to the interest rate
environment, management believed it was prudent to purchase fixed maturity
investments with shorter maturities and therefore, the weighted average maturity
of the Company's fixed maturity investments has decreased from 2.8 years as of
December 31, 2001, to 2.4 years as of December 31, 2002. In the year ended
December 31, 2002, the Company's average yield on invested assets (at amortized
value) was 5.53% compared to 6.02% at the year ended December 31, 2001. The
Company's average invested assets increased in the year ending December 31,
2002, primarily as a result of increased cash flows from operations. The mix of
taxable and tax-exempt securities in the portfolio affects the investment income
return percentage. Tax-exempt securities generally carry a lower yield than
taxable securities. These securities (at amortized value) decreased to
$2,731,060 (3% of total investments) at December 31, 2002, compared to
$8,213,141 (9% of total investments) at December 31, 2001.
29
The following table sets forth the composition of the investment portfolio of
the Company at the dates indicated:
(Amounts in Thousands)
As of December 31
-----------------
2003 2002 2001
---- ---- ----
Amortized Market Amortized Market Amortized Market
Type of Security Cost Value Cost Value Cost Value
- ---------------- ---- ----- ---- ----- ---- -----
Certificates of deposit $500 $500 $400 $400 $400 $400
U.S. treasury securities 38,305 38,550 8,518 8,901 5,459 5,802
U. S. government agency securities 11,997 11,987 9,000 9,024 - -
Industrial and miscellaneous
taxable bonds 58,494 61,447 73,001 77,221 77,740 79,990
8 8
State and municipal tax-exempt bonds 2,030 2,040 2,731 2,828 8,213 8,436
------- ------- ------ ------ ------ ------
Total fixed maturity investments 111,326 114,524 93,650 98,374 91,812 94,628
Short-term cash investments 7,229 7,229 9,024 9,024 2,864 2,864
------- ------- ------- ------- ------ ------
Total investments $118,555 $121,753 $102,674 $107,398 $94,676 $97,492
======= ======= ======= ======= ====== ======
The amortized cost and estimated market value of fixed maturity investments at
December 31, 2003, by contractual maturity are as follows. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without penalties.
(Amounts in Thousands)
As of December 31, 2003
-----------------------
Amortized Market
Fixed maturities due Cost Value
-------------------- ---- -----
Within 1 year $26,151 $26,525
Beyond 1 year but within 5 years 77,963 80,292
Beyond 5 years but within 10 years 7,212 7,707
------- -------
Total $111,326 $114,524
======= =======
At December 31, 2003, the Company held securities with unrealized appreciation
of $3,236,623 and securities with unrealized depreciation of $38,169. The
securities with unrealized depreciation consisted of six fixed maturity
investments with a total par value of $9,990,000. Only one of the fixed maturity
investments with a par value of $15,000 and unrealized depreciation of $355 has
been in a continuous unrealized depreciation position over 12 months. The
Company does not deem the unrealized depreciation to be significant or
indicative of an other-than-temporary decline, either individually or in the
aggregate. Out of the six fixed maturity investments with unrealized
depreciation, three are U.S. treasury notes with a total par value of $6,100,000
with a total of $6,485 of unrealized depreciation as of December 31, 2003, and
one fixed maturity is a U.S. agency with a par value of $3,000,000, with an
unrealized depreciation in the amount of $24,360 as of December 31, 2003.
The Company continually evaluates the recoverability of its investment holdings.
All securities held by the Company are rated. When a decline in value of fixed
maturities or equity securities is considered other than temporary, a loss is
recognized in the consolidated statements of operations. In 2003, there were no
other than temporary declines in the value of fixed maturity or equity
securities recognized in the consolidated statements of operations. During 2002,
the Company realized a loss of $216 on one equity security where a decline in
market value was considered other than temporary. The Company had recognized a
loss on this equity security of $25,704 in 2001 and $138,250 in 2000. No
securities were sold at a loss during 2003, 2002 or 2001.
The Company did not sell any bonds in the year ending December 31, 2003. The
Company sold one bond in the year ending December 31, 2002, and recognized a
short-term capital gain of $3,906. The single bond was sold in order to maintain
conformity with the Company's investment guidelines. In the year ending December
31, 2001, the Company sold three bonds and recognized capital gains aggregating
$35,276. Two of these bonds were sold to maintain conformity with the Company's
investment guidelines, and one bond was sold to fund the repurchase of the
Company's common stock.
Operating Expenses
- ------------------
Policy Acquisition Costs consist of commissions, premium taxes, inspection fees,
and certain other underwriting costs that are directly related to and vary with
the production of Crusader insurance policies. These costs include
30
both Crusader expenses and allocated expenses of other Unico subsidiaries. On
certain reinsurance treaties, Crusader receives a ceding commission from its
reinsurer that represents a reimbursement of the acquisition costs related to
the premium ceded. No ceding commission is received on provisionally rated ceded
premium. Policy acquisition costs, net of ceding commission, are deferred and
amortized as the related premiums are earned. The ratio of policy acquisition
cost to net earned premium in 2003 was lower than the ratio in 2002 and 2001
primarily due to the increase in the Company's ceding commission from its
reinsurer as of January 1, 2003 from 25% in 2002 to 35% in 2003. Policy
acquisition costs, net of ceding commission, are as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Policy acquisition costs $7,941,199 $9,274,263 $8,695,037
Ratio to net earned premium (GAAP ratio) 21% 28% 29%
Salaries and Employee Benefits increased $586,888 (13%) for the year ended
December 31, 2003, compared to the year ended December 31, 2002. Factors that
affected the increase include the hiring of higher-level employees, general
salary increases (less than 6%), increases in employee benefits costs, and the
composition of employees whose salaries and employee benefits are capitalized to
policy acquisition cost versus those being directly expensed. Salaries and
employee benefits increased $52,241 (1%) for the year ended December 31, 2002,
compared to the year ended December 31, 2001.
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Salaries and employee benefits $4,960,766 $4,373,878 $4,321,637
Commissions to Agents/Brokers (not including commissions on Crusader policies
that are reflected in policy acquisition costs) are generally related to gross
commission income from the health and life insurance program, the daily
automobile rental insurance program, the earthquake program, and the commercial
liability program. Commissions to agents and brokers increased $241,374 (20%)
for the year ended December 31, 2003, compared to the year ended December 31,
2002. Commissions to agents and brokers decreased $40,749 (3%) for the year
ended December 31, 2002, compared to the year ended December 31, 2001.
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Commission to agents/brokers $1,460,684 $1,219,310 $1,260,059
Other Operating Expenses generally do not change significantly with changes in
production. This is true for both increases and decreases in production.
Operating expenses decreased $350,341 (11%) for the year ended December 31,
2003, compared to the year ended December 31, 2002. The decrease is primarily
the result of the settlement of litigation with the Company's former stock
transfer agent that resulted in the receipt of $527,500 to reimburse damages and
legal expenses that were incurred from 2001 through 2003.
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Other operating expenses $2,897,886 $3,248,227 $2,886,266
Income Taxes
- ------------
The income tax expense for the year ended December 31, 2003, was $1,080,721
compared to an income tax benefit of $1,589,370 for the year ended December 31,
2002. The effective combined income tax rates for 2003 and 2002 were 50% and
33%, respectively. The pre-tax income increased $6,963,430 for the year ended
December 31, 2003, compared to the year ended December 31, 2002, which resulted
in an increased income tax expense in 2003. Also contributing to the income tax
expense in 2003 was the recognition of an assessment of $287,000 for the years
1999 and 2000 from the California Franchise Tax Board. A recent court ruling in
Ceridian vs. Franchise Tax Board held that the California statute permitting the
tax deductibility of dividends received from a wholly owned insurance subsidiary
was unconstitutional because it discriminated against out-of-state holding
companies and thus was in violation of the interstate commerce clause of the
United States Constitution. The
31
ruling concluded that the discriminatory sections of the statute are not
severable and the entire statute is invalid and unenforceable. California law
provides that the proper remedy in such circumstances is to disallow the
deduction to those taxpayers that benefited from the deduction. As a result of
the court ruling, in February 2003, the Franchise Tax Board (FTB) notified the
Company that it would issue a Notice of Proposed Assessment (NPA) for tax years
1999 and 2000 of approximately $287,000 representing California state franchise
taxes plus related interest of approximately $80,000. The income tax benefit for
the year ended December 31, 2002, was $1,589,370 compared to an income tax
benefit of $5,853,091 for the year ended December 31, 2001. The effective
combined income tax rates for 2002 and 2001 were 33% and 35%, respectively. The
pre-tax loss was significantly lower in 2002 compared to 2001, which resulted in
the difference in the effective tax rates between 2002 and 2001. The income tax
benefit for 2002 and 2001 arises primarily from the Company's ability to recover
prior income taxes paid due to the carryback of those years net operating losses
(see Note 16 of Notes to Consolidated Financial Statements).
Recently Issued Accounting Standards
- ------------------------------------
In April 2003, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities (SFAS No. 149). SFAS No. 149
amends and clarifies accounting for derivative instruments and improves
financial reporting by requiring that contracts with comparable characteristics
be accounted for similarly. The amendments to SFAS No. 133 fall principally into
three categories: amendments related to SFAS No. 133 implementation issues,
amendments clarifying the definition of a derivative instrument, and amendments
relating to the definition of expected cash flows contained in FASB Concepts
Statement No. 7 Using Cash Flow Information and Present Value in Accounting
Measurements. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003. SFAS No. 149 does not alter current valuation or
disclosures. The implementation of SFAS No. 149 did not have an impact on the
Company's consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity (SFAS No. 150). SFAS No. 150 addresses certain financial
instruments that, under previous guidelines, could be accounted for as equity,
but now must be classified as liabilities in the statement of financial
position. These financial instruments include: 1) mandatory redeemable financial
instruments, 2) obligations to repurchase the issuer's equity shares by
transferring assets, and 3) obligations to issue a variable number of shares.
SFAS No. 150 is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The implementation of SFAS No. 150
did not have an impact on the Company's consolidated financial statements.
In December 2003, FASB Statement No. 132 (revised), Employers' Disclosures about
Pensions and Other Postretirement Benefits, was issued. Statement 132 (revised)
prescribes employers' disclosures about pension plans and other postretirement
benefit plans; it does not change the measurement or recognition of those plans.
The Statement retains and revises the disclosure about the assets, obligations,
cash flows, and net periodic benefit cost of defined benefit pension plans and
other postretirement benefit plans. The Statement generally is effective for
fiscal years ending after December 15, 2003. The Company's disclosures in Note
13 incorporate the requirements of Statement 132 (revised).
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities, which addresses how a
business enterprise should evaluate whether it has controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46.
Consolidation of Variable Interest Entities, which was issued in January 2003.
The implementation of FASB Interpretation No. 46 did not have an impact on the
Company's consolidated financial statements.
Significant Accounting Policies
- -------------------------------
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
certain assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. While every effort is made to
ensure the integrity of such estimates, actual results could differ.
32
Management believes the Company's current critical accounting policies comprise
the following:
Losses and Loss Adjustment Expenses
-----------------------------------
The preparation of the Company's financial statements requires judgments and
estimates. The most significant is the estimate of loss reserves as required by
Statement of Financial Accounting Standards No 60 (SFAS No. 60), Accounting and
Reporting by Insurance Enterprises and Statement of Financial Accounting
Standards No. 5 (SFAS No. 5), Accounting for Contingencies. Estimating loss
reserves is a difficult process as there are many factors that can ultimately
affect the final settlement of a claim and, therefore, the reserve that is
needed. Changes in the regulatory and legal environment, results of litigation,
medical costs, the cost of repair materials and labor rates can all impact
ultimate claim costs. In addition, time can be a critical part of reserving
determinations since the longer the span between the incidence of a loss and the
payment or settlement of the claim, the more variable the ultimate settlement
amount can be. Accordingly, short-tail claims, such as property damage claims,
tend to be more reasonably predictable than long-tail liability claims. The
liability for unpaid losses and loss adjustment expenses is based upon the
accumulation of individual case estimates for losses reported prior to the close
of the accounting period plus estimates based on experience and industry data
for development of case estimates and for unreported losses and loss adjustment
expenses. Since the emergence and disposition of claims are subject to
uncertainties, the net amounts that will ultimately be paid to settle claims may
vary significantly from the estimated amounts provided for in the accompanying
consolidated financial statements. Any adjustments to reserves are reflected in
the operating results of the periods in which they are made. Management believes
that the aggregate reserves for losses and loss adjustment expenses are
reasonable and adequate to cover the cost of claims, both reported and
unreported.
Investments
-----------
In accordance with Statement of Financial Accounting Standard No. 115,
Accounting for Certain Investments in Debt and Equity Securities, the Company is
required to classify its investments in debt and equity securities into one of
three categories: held-to-maturity, available-for-sale or trading securities.
Although all of the Company's investments are classified as available-for-sale
and although the Company may sell investment securities from time to time in
response to economic and market conditions, its investment guidelines place
primary emphasis on buying and holding high-quality investments to maturity.
Short-term investments are carried at cost, which approximates market value.
Investments in equity securities are carried at market value. The unrealized
gains or losses from fixed maturities and equity securities are reported as
accumulated other comprehensive income (loss), which is a separate component of
stockholders' equity, net of any deferred tax effect. When a decline in value of
a fixed maturity or equity security is considered other than temporary, a loss
is recognized in the consolidated statements of operations. Realized gains and
losses are included in the consolidated statements of operations based on the
specific identification method.
Related Party Transactions
- --------------------------
The Company presently occupies a 46,000 square foot building located at 23251
Mulholland Drive, Woodland Hills, California, under a master lease expiring
March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin
Cheldin, the Company's president, chairman and principal stockholder, is the
owner of the building. On February 22, 1995, the Company signed an extension to
the lease with no increase in rent to March 31, 2007. The Company believes that
the terms of the lease at inception and at the time the lease extension was
signed were at least as favorable to the Company as could have been obtained
from non-affiliated third parties. The Company utilizes for its own operations
approximately 100% of the space it leases.
On November 15, 2002, the Company borrowed $500,000 from Erwin Cheldin, a
director and the Company's principal shareholder, president and chief executive
officer, and $250,000 from The Cary and Danielle Cheldin Family Trust. Cary L.
Cheldin is a director and the Company's executive vice president. In the quarter
ended June 30, 2003, the Company repaid the above-mentioned notes in full.
On September 29, 2003, the Company borrowed $1,000,000 from Erwin Cheldin, a
director and the Company's principal shareholder, president and chief executive
officer, and $500,000 from The Cary and Danielle Cheldin Family Trust. Cary L.
Cheldin is a director and the Company's executive vice president. The notes are
due and payable upon demand of lender (on no less than fourteen days' notice)
and, if no demand is made, then the notes are payable in full on September 28,
2007. The notes may be prepaid at any time without penalty. The notes are
unsecured and bear interest as follows: interest on the $1,000,000 note is 5%
and is adjustable in April1, 2004, and every third month thereafter by adding a
margin of one percentage point to the prime rate; interest on the $500,000 note
is 7% per annum. Interest is payable monthly on both notes.
33
Forward Looking Statements
- --------------------------
Certain statements contained herein, including the Sections entitled "Business,"
"Legal Proceedings" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations," that are not historical facts are forward
looking. These statements, which may be identified by forward looking words or
phrases such as "anticipate," "appears," "believe," "estimates," "expect,"
"intend," "may," "should," and "would," involve risks and uncertainties, many of
which are beyond the control of the Company. Such risks and uncertainties could
cause actual results to differ materially from these forward looking statements.
Factors which could cause actual results to differ materially include those
described under Item 1 - Business - Competition; premium rate adequacy relating
to competition or regulation; actual versus estimated claim experience; success
of the Company's underwriting and pricing actions that it believes addresses the
adverse development on its construction defect, apartment house habitability,
special risk class of business, and non-California liquor liability claims; the
outcome of existing and planned filings with regulatory authorities seeking rate
increases; acceptance by insureds of rate increases; adequacy of rate increases;
possible reductions in Crusader's A.M. Best rating; regulatory changes or
developments; the outcome of regulatory proceedings; unforeseen calamities;
general market conditions; and the Company's ability to introduce new profitable
products.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
The Company's consolidated balance sheet includes a substantial amount of
invested assets whose fair values are subject to various market risk exposures
including interest rate risk and equity price risk.
The Company's invested assets at December 31, 2003 and 2002 consisted of the
following:
2003 2002
---- ----
Fixed maturity bonds (at amortized cost) $110,925,592 $93,249,468
Short-term cash investments (at cost) 7,229,315 9,024,382
Certificates of deposit - over 1 year (at cost) 400,000 400,000
----------- -----------
Total invested assets $118,554,907 $102,673,850
=========== ===========
The Company's interest rate risk is primarily in its fixed maturity bond
portfolio. As market interest rates decrease, the value of the portfolio
increases with the opposite holding true in rising interest rate environments.
In addition, the longer the maturity, the more sensitive the asset is to market
interest rate fluctuations. The Company limits this risk by investing in
securities with maturities no greater than eight years. In addition, although
fixed maturity bonds are classified as available-for-sale, the Company's
investment guidelines place primary emphasis on buying and holding high-quality
bonds to maturity. Because fixed maturity bonds are primarily held to maturity,
the change in the market value of these bonds resulting from interest rate
movements is unrealized and no gains or losses are recognized in the
consolidated statements of operations. Unrealized gains and losses are reported
as separate components of stockholders' equity, net of any deferred tax effect.
As of December 31, 2003, the Company's unrealized gains (net of unrealized
losses) before income taxes on its fixed maturity bond portfolio were $3,198,454
compared to $4,723,882 as of December 31, 2002. Given a hypothetical parallel
increase of 100 basis points in interest rates, the fair value of the fixed
maturity bond portfolio as of December 31, 2003, would decrease by approximately
$2 million. This decrease would not be reflected in the statements of operations
except to the extent that the securities were sold.
The Company's short-term investments and certificates of deposit have only
minimal interest rate risk.
34
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
Page
Number
------
Independent Auditors' Report 36
Consolidated Balance Sheets as of December 31, 2003, and
December 31, 2002 37
Consolidated Statements of Operations for the years ended
December 31, 2003, December 31, 2002, and December 31, 2001 38
Consolidated Statements of Comprehensive Income for the years
ended December 31, 2003, December 31, 2002, and December 31, 2001 39
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 2003, December 31, 2002, and December 31, 2001 40
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, December 31, 2002, and December 31, 2001 41
Notes to Consolidated Financial Statements 42
35
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Unico American Corporation:
We have audited the accompanying consolidated balance sheets of Unico American
Corporation and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of operations, comprehensive income, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 financial position of Unico American
Corporation and subsidiaries as of December 31, 2003 and 2002, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.
KPMG LLP
Los Angeles, California
March 26, 2004
36
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31 December 31
2003 2002
---- ----
ASSETS
------
Investments
Available for sale:
Fixed maturities, at market value (amortized cost: December 31,
2003 $111,325,592; December 31, 2002 $93,649,468) $114,524,046 $98,373,350
Short-term investments, at cost 7,229,315 9,024,382
----------- -----------
Total Investments 121,753,361 107,397,732
Cash 37,988 19,766
Accrued investment income 1,251,126 1,470,333
Premiums and notes receivable, net 8,290,169 6,699,909
Reinsurance recoverable:
Paid losses and loss adjustment expenses 622,964 2,805,048
Unpaid losses and loss adjustment expenses 19,255,229 21,308,339
Prepaid reinsurance premiums 81,872 95,304
Deferred policy acquisition costs 8,054,363 5,947,010
Property and equipment (net of accumulated depreciation) 323,090 354,194
Deferred income taxes 975,701 57,951
Income taxes receivable - 1,548,827
Other assets 847,832 982,192
----------- -----------
Total Assets $161,493,695 $148,686,605
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES
- -----------
Unpaid losses and loss adjustment expenses $78,139,090 $74,905,284
Unearned premiums 34,675,180 24,381,583
Advance premium and premium deposits 1,118,618 1,607,272
Income taxes payable 614,662 -
Notes payable - related parties 1,500,000 750,000
Accrued expenses and other liabilities 6,975,288 8,633,476
----------- -----------
Total Liabilities $123,022,838 $110,277,615
----------- -----------
STOCKHOLDERS' EQUITY
- --------------------
Common stock, no par - authorized 10,000,000 shares, issued and outstanding
shares 5,489,815 at December 31, 2003, and 5,489,533
at December 31, 2002 $2,700,272 $2,700,272
Accumulated other comprehensive income 2,110,979 3,117,762
Retained earnings 33,659,606 32,590,956
---------- ----------
Total Stockholders' Equity $38,470,857 $38,408,990
---------- ----------
Total Liabilities and Stockholders' Equity $161,493,695 $148,686,605
=========== ===========
See accompanying notes to consolidated financial statements.
37
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31
2003 2002 2001
---- ---- ----
REVENUES
- --------
Insurance Company Revenues
Premium earned $53,754,119 $40,568,845 $35,409,174
Premium ceded 16,648,020 7,209,573 5,515,330
---------- ---------- ----------
Net premium earned 37,106,099 33,359,272 29,893,844
Net investment income 4,801,133 5,401,870 5,647,026
Net realized investment gains - 3,690 6,359
Other income 98,242 49,038 16,399
---------- ---------- ----------
Total Insurance Company Revenues 42,005,474 38,813,870 35,563,628
Other Revenues from Insurance Operations
Gross commissions and fees 8,109,392 6,261,024 5,508,955
Investment income 47,010 56,176 156,387
Net realized investment gains - - 3,213
Finance charges and fees earned 952,543 878,316 868,496
Other income 16,020 19,256 16,227
---------- ---------- ----------
Total Revenues 51,130,439 46,028,642 42,116,906
---------- ---------- ----------
EXPENSES
- --------
Losses and loss adjustment expenses 31,720,533 32,727,023 41,677,016
Policy acquisition costs 7,941,199 9,274,263 8,695,037
Salaries and employee benefits 4,960,766 4,373,878 4,321,637
Commissions to agents/brokers 1,460,684 1,219,310 1,260,059
Other operating expenses 2,897,886 3,248,227 2,886,266
--------- ---------- ----------
Total Expenses 48,981,068 50,842,701 58,840,015
---------- ---------- ----------
Income (Loss) Before Taxes 2,149,371 (4,814,059) (16,723,109)
Income Tax (Benefit) 1,080,721 (1,589,370) (5,853,091)
--------- --------- ---------
Net Income (Loss) $1,068,650 $(3,224,689) $(10,870,018)
========= ========= ==========
PER SHARE DATA:
- --------------
Basic Shares Outstanding 5,489,604 5,487,311 5,505,398
Basic Earnings (Loss) Per Share $0.19 $(0.59) $(1.97)
Diluted Shares Outstanding 5,533,112 5,487,311 5,505,398
Diluted Earnings (Loss) Per Share $0.19 $(0.59) $(1.97)
See accompanying notes to consolidated financial statements.
38
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31
2003 2002 2001
---- ---- ----
Net income (loss) $1,068,650 $(3,224,689) $(10,870,018)
Other changes in comprehensive income, net of tax:
Unrealized gains (losses) on securities classified as
available-for-sale arising during the period (1,006,783) 1,261,358 1,743,127
Less: reclassification adjustment for (gains) included in net income - (2,435) (6,093)
------ --------- ---------
Comprehensive Income (Loss) $61,867 $(1,965,766) $(9,132,984)
====== ========= =========
See accompanying notes to consolidated financial statements.
39
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
Accumulated
Common Sharees Other
-------------- Comprehensive
Issued and Income Retained
Outstanding Amount (Losses) Earnings Total
----------- ------ ------ -------- -----
Balance - December 31, 2000 5,692,699 $2,789,494 $121,805 $48,502,030 $51,413,329
Net shares issued for exercise of
stock options 28,827 37 - - 37
Shares canceled or adjusted 120 - - - -
Shares repurchased (240,358) (118,116) - (1,269,281) (1,387,397)
Cash dividend paid ($0.05 per share) - - - (272,609) (272,609)
Change in comprehensive income,
net of deferred income tax - - 1,737,034 - 1,737,034
Net (loss) - - - (10,870,018) (10,870,018)
--------- --------- -------- ---------- ----------
Balance - December 31, 2001 5,481,288 $2,671,415 $1,858,839 $36,090,122 $40,620,376
========= ========= ========= ========== ==========
Net shares issued for exercise of
stock options 8,245 28,857 - - 28,857
Cash dividend paid ($0.05 per share) - - - (274,477) (274,477)
Change in comprehensive income,
net of deferred income tax - - 1,258,923 - 1,258,923
Net (loss) - - - (3,224,689) (3,224,689)
--------- --------- --------- ---------- ----------
Balance - December 31, 2002 5,489,533 $2,700,272 $3,117,762 $32,590,956 $38,408,990
========= ========= ========= ========== ==========
Shares canceled or adjusted 282 - - - -
Change in comprehensive income,
net of deferred income tax - - (1,006,783) - (1,006,783)
Net income - - - 1,068,650 1,068,650
--------- --------- --------- ---------- ----------
Balance - December 31, 2003 5,489,815 $2,700,272 $2,110,979 $33,659,606 $38,470,857
========= ========= ========= ========== ==========
See accompanying notes to consolidated financial statements.
40
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31
2003 2002 2001
---- ---- ----
Cash flows from operating activities:
Net income (loss) $1,068,650 $(3,224,689) $(10,870,018)
Adjustments to reconcile net income to net cash from operations
Depreciation and amortization 89,821 84,951 71,205
Bond amortization, net 317,389 376,657 349,597
Net realized (gain) on sale of securities - (3,690) (9,572)
Changes in assets and liabilities
Premium, notes and investment income receivable (1,371,053) (153,857) (300,107)
Reinsurance recoverable 4,235,194 (12,633,253) (415,593)
Prepaid reinsurance premiums 13,432 (57,621) (8,152)
Deferred policy acquisition costs (2,107,353) (867,475) (579,388)
Other assets 134,360 (532,394) (4,694,674)
Reserve for unpaid losses and loss adjustment expenses 3,233,806 14,370,989 15,316,926
Unearned premium reserve 10,293,597 5,053,433 2,228,223
Advance premium and premium deposits (488,654) 523,277 (1,232,021)
Accrued expenses and other liabilities (1,658,188) 1,377,019 (642,722)
Income taxes current/deferred 215,558 (150,235) (502,645)
Federal income tax recoverable 1,548,827 3,850,112 (5,398,939)
---------- --------- ---------
Net Cash Provided (Used) from Operations 15,525,386 8,013,224 (1,288,941)
---------- --------- ---------
Investing Activities
Purchase of fixed maturity investments (55,234,166) (19,300,366) (17,806,300)
Proceeds from maturity of fixed maturity investments 37,228,000 15,086,100 19,083,025
Proceeds from sale of fixed maturity investments - 2,003,906 1,365,055
Net (increase) decrease in short-term investments 1,807,719 (6,160,760) 521,849
Additions to property and equipment (58,717) (171,719) (224,524)
---------- --------- ---------
Net Cash Provided (Used) by Investing Activities (16,257,164) (8,542,839) 2,939,105
---------- --------- ---------
Financing Activities
Proceeds from issuance of common stock - 28,857 37
Proceeds from notes payable - related parties 1,500,000 750,000 -
Repayment of notes payable - related parties (750,000) - -
Repurchase of common stock - - (1,387,397)
Dividends paid to shareholders - (274,477) (272,609)
------- ------- ---------
Net Cash Provided (Used) by Financing Activities 750,000 504,380 (1,659,969)
------- ------- ---------
Net increase (decrease) in cash 18,222 (25,235) (9,805)
Cash at beginning of year 19,766 45,001 54,806
------ ------ ------
Cash at End of Year $37,988 $19,766 $45,001
====== ====== ======
Supplemental cash flow information Cash paid during the period for:
Interest $124,788 $6,575 $75
Income taxes $370,520 $150,636 $65,584
See accompanying notes to consolidated financial statements.
41
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Nature of Business
- ------------------
Unico American Corporation is an insurance holding company that underwrites
property and casualty insurance through its insurance company subsidiary;
provides property, casualty, health and life insurance through its agency
subsidiaries; and provides insurance premium financing, claim administration
services, and membership association services through its other subsidiaries.
Unico American Corporation is referred to herein as the "Company" or "Unico" and
such references include both the corporation and its subsidiaries, all of which
are wholly owned, unless otherwise indicated. Unico was incorporated under the
laws of Nevada in 1969.
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of Unico American
Corporation and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Basis of Presentation
- ---------------------
The consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America (GAAP).
As described in Note 14, the Company's insurance subsidiary also files financial
statements with regulatory agencies prepared on a statutory basis of accounting
that differs from GAAP.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
certain assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. While every effort is made to
ensure the integrity of such estimates, actual results could differ.
Investments
- -----------
All of the Company's fixed maturity investments are classified as
available-for-sale and are stated at market value. Although all of the Company's
investments are classified as available-for-sale and the Company may sell
investment securities from time to time in response to economic and market
conditions, its investment guidelines place primary emphasis on buying and
holding high-quality investments to maturity. Short-term investments are carried
at cost, which approximates market value. Investments in equity securities are
carried at market value. The unrealized gains or losses from fixed maturities
and equity securities are reported as accumulated other comprehensive income
(loss), which is a separate component of stockholders' equity, net of any
deferred tax effect. When a decline in value of a fixed maturity or equity
security is considered other than temporary, a loss is recognized in the
consolidated statements of operations. Realized gains and losses are included in
the consolidated statements of operations based on the specific identification
method.
The Company had net unrealized investment gains, net of deferred taxes, of
$2,110,979 as of December 31, 2003, and $3,117,762 as of December 31, 2002.
Property and Equipment
- ----------------------
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using accelerated depreciation methods over the
estimated useful lives of the related assets.
Income Taxes
- ------------
The provision for federal income taxes is computed on the basis of income as
reported for financial reporting purposes. Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes, and are measured using the enacted tax rates and laws expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Income tax expense provisions increase or
decrease in the same period in which a change in tax rates is enacted.
42
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value of Financial Instruments
- -----------------------------------
The Company has used the following methods and assumptions in estimating its
fair value disclosures:
Investment Securities - Fair values for fixed maturity securities are
obtained from a national quotation service. The fair values for equity
securities are based on quoted market prices.
Cash and Short-Term Investments - The carrying amounts reported in the
balance sheet for these instruments approximate their fair values.
Premiums and Notes Receivable - The carrying amounts reported in the
balance sheet for these instruments approximate their fair values.
Earnings Per Share
- ------------------
Basic earnings per share exclude the impact of common share equivalents and are
based upon the weighted average common shares outstanding. Diluted earnings per
share utilize the average market price per share when applying the treasury
stock method in determining common share dilution. When dilutive, outstanding
stock options are treated as common share equivalents for purposes of computing
diluted earnings per share and represent the difference between basic and
diluted weighted average shares outstanding. In loss periods, options are
excluded from the calculation of diluted earnings per share, as the inclusion of
such options would have antidilutive effect.
Revenue Recognition
- -------------------
a. General Agency Operations
-----------------------------
Commissions and service fees due the Company are recognized as income on
the effective date of the insurance policies.
b. Insurance Company Operations
--------------------------------
Premiums are earned on a pro-rata basis over the terms of the policies.
Premiums applicable to the unexpired terms of policies in force are
recorded as unearned premiums. The Company earns a commission on policies
that are ceded to its reinsurers. This commission is considered earned on a
pro-rata basis over the terms of the policies.
c. Insurance Premium Financing Operations
------------------------------------------
Premium finance interest is charged to policyholders who choose to finance
insurance premiums. Interest is charged at rates that vary with the amount
of premium financed. Premium finance interest is recognized using a method
that approximates the interest (actuarial) method.
Losses and Loss Adjustment Expenses
- -----------------------------------
The liability for unpaid losses and loss adjustment expenses is based upon the
accumulation of individual case estimates for losses reported prior to the close
of the accounting period plus estimates based on experience and industry data
for development of case estimates and for unreported losses and loss adjustment
expenses.
There is a high level of uncertainty inherent in the evaluation of the required
loss and loss adjustment expense reserves for the Company. The long-tailed
nature of liability claims and the volatility of jury awards exacerbate that
uncertainty. Crusader sets loss and loss adjustment expense reserves at each
balance sheet date at management's best estimate of the ultimate payments that
it anticipates will be made to settle all losses incurred and related expenses
incurred as of that date for both reported and unreported losses. The ultimate
cost of claims is dependent upon future events, the outcomes of which are
affected by many factors. Company claim reserving procedures and settlement
philosophy, current and perceived social and economic inflation, current and
future court rulings and jury attitudes, improvements in medical technology, and
many other economic, scientific, legal, political, and social factors all can
have significant effects on the ultimate costs of claims. Changes in Company
operations and management philosophy also may cause actual developments to vary
from the past. Since the emergence and disposition of claims are subject to
uncertainties, the net amounts that will ultimately be paid to settle claims may
vary significantly from the estimated amounts provided for in the accompanying
consolidated financial statements. Any adjustments to reserves are reflected in
the operating results of the periods in which they are made. Management believes
that the aggregate reserves for losses and loss adjustment expenses are
reasonable and adequate to cover the cost of claims, both reported and
unreported.
43
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Restricted Funds
- ----------------
Restricted funds are as follows:
Year ended December 31
----------------------
2003 2002
---- ----
Restricted Funds:
Premium trust funds (1) $939,491 $1,114,403
Cash deposited in lieu of bond (2) 752,659 -
Assigned to state agencies (3) 2,825,000 2,725,000
--------- ---------
Total restricted funds $4,517,150 $3,839,403
========= =========
(1) As required by law, the Company segregates from its operating
accounts the premiums collected from insurers which are payable to
insurance companies into separate trust accounts. These amounts are
included in cash and short-term investments.
(2) Included in short-term investments are two deposits assigned and held
by Travis County and the Los Angeles Superior courts. These deposits
are filed with the superior courts in lieu of a bond, in order to
stay execution of judgments and allow the Company to appeal the
judgment in these matters.
.
(3) Included in fixed maturity investments are statutory deposits
assigned to and held by the California State Treasurer and the
Insurance Commissioner of the State of Nevada. These deposits are
required for writing certain lines of business in California and for
admission in states other than California.
Deferred Policy Acquisition Costs
- ---------------------------------
Policy acquisition costs consist of costs associated with the production of
insurance policies such as commissions, premium taxes, and certain other
underwriting expenses that vary with and are primarily related to the production
of the insurance policy. Policy acquisition costs are deferred and amortized as
the related premiums are earned and are limited to their estimated realizable
value based on the related unearned premiums plus investment income less
anticipated losses and loss adjustment expenses. Ceding commission applicable to
the unexpired terms of policies in force is recorded as unearned ceding
commission, which is included in deferred policy acquisition costs.
Reinsurance
- -----------
The Company cedes reinsurance to provide for greater diversification of
business, to allow management to control exposure to potential losses arising
from large risks by reinsuring certain levels of risk in various areas of
exposure, to reduce the loss that may arise from catastrophes, and to provide
additional capacity for growth. Prepaid reinsurance premiums and reinsurance
receivables are reported as assets and represent ceded unearned premiums and
reinsurance recoverable on both paid and unpaid losses, respectively. Amounts
recoverable from reinsurers are estimated in a manner consistent with the claim
liability associated with the reinsured policies.
Segment Reporting
- -----------------
Statement of Financial Accounting Standards No. 131 (SFAS No. 131), Disclosures
about Segments of an Enterprise and Related Information, became effective for
fiscal years effective after December 15, 1997. SFAS No. 131 establishes
standards for the way information about operating segments is reported in
financial statements. The Company has identified its insurance company operation
as its primary reporting segment. Revenues from this segment comprised 82.2% of
consolidated revenues in the year ended December 31, 2003, 84.3% of consolidated
revenues in the year ended December 31, 2002, and 84.4% for the year ended
December 31, 2001. The Company's remaining operations constitute a variety of
specialty insurance services, each with unique characteristics and individually
insignificant to consolidated revenues.
The insurance company operation is conducted through the Company's wholly owned
subsidiary Crusader Insurance Company, (Crusader) which as of December 31, 2003,
was licensed as an admitted insurance carrier in the states of Arizona,
California, Colorado, Idaho, Montana, Nevada, Ohio, Oregon, and Washington.
Crusader is a multiple-line property and casualty insurance company, which began
transacting business on January 1, 1985.
44
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2003, 97% of Crusader's business was commercial multiple
peril business package insurance policies. Commercial multiple peril policies
provide a combination of property and liability coverage for businesses.
Commercial property coverages insure against loss or damage to buildings,
inventory and equipment from natural disasters, including hurricanes,
windstorms, hail, water, explosions, severe winter weather and other events such
as theft and vandalism, fires and storms and financial loss due to business
interruption resulting from covered property damage. Commercial liability
coverages insure against third party liability from accidents occurring on the
insured's premises or arising out of its operations, such as injuries sustained
from products sold or operation of the insured premises. In addition to
commercial multiple peril policies, Crusader also writes separate policies to
insure commercial property and commercial liability risks on a mono-line basis.
Revenues, income before income taxes and assets by segment are as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Revenues
- --------
Insurance company operation $42,005,474 $38,813,870 $35,563,628
---------- ---------- ----------
Other insurance operations 26,684,721 20,469,400 17,799,932
Intersegment elimination (1) (17,559,756) (13,254,628) (11,246,654)
--------- --------- ----------
Total other insurance operations 9,124,965 7,214,772 6,553,278
--------- --------- ---------
Total revenues $51,130,439 $46,028,642 $42,116,906
========== ========== ==========
Income (loss) before income taxes
- ---------------------------------
Insurance company operation $(3,208,657) $(7,069,522) $(17,570,829)
Other insurance operations 5,358,028 2,255,463 847,720
--------- --------- ---------
Total income (loss) before income taxes $2,149,371 $(4,814,059) $(16,723,109)
========= ========= ==========
Assets
- ------
Insurance company operation $138,247,845 $131,574,608 $109,293,988
Intersegment eliminations (2) (2,302,224) (1,245,711) (1,647,653)
----------- ----------- -----------
Total insurance company operation 135,945,621 130,328,897 107,646,335
Other insurance operations 25,548,074 18,357,708 21,176,938
----------- ----------- -----------
Total assets $161,493,695 $148,686,605 $128,823,273
=========== =========== ===========
(1) Intersegment revenue eliminations reflect commissions paid by Crusader to
Unifax.
(2) Intersegment asset eliminations reflect the elimination of Crusader
receivables and Unifax payables.
Concentration of Risks
- ----------------------
In 2003 approximately 100% of Crusader's gross premium written was derived from
California. In 2003, approximately 92% of the $3,681,513 commission income from
the Company's health and life insurance program was from CIGNA HealthCare
medical and dental plan programs.
At December 31, 2003, the Company's reinsurance recoverable on paid and unpaid
losses and loss adjustment expenses of $19,878,193 were as follows:
A.M. Best Amount
Name of Reinsurer Rating Recoverable
- ----------------- ------ -----------
General Reinsurance Corporation A++ $ 3,774,936
Partners Reinsurance of the U.S A+ 10,103,257
Platinum Reinsurance A 3,158,000
QBE Reinsurance Corporation A 947,000
Hannover Ruckversicherungs A+ 1,895,000
----------
Total $19,878,193
==========
45
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock-Based Compensation
- ------------------------
The Company applies the intrinsic-value based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations including FASB Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation, an
interpretation of APB Opinion No. 25, to account for its fixed-plan stock
options. Under this method, compensation expense is recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. FASB Statement No. 123, Accounting for Stock-Based Compensation
and FASB Statement No. 148, Accounting for Stock Based Compensation - Transition
and Disclosure, an amendment of FASB Statement No. 123, established accounting
and disclosure requirements using a fair-value based method of accounting for
stock-based employee compensation plans. As permitted by existing accounting
standards, the Company has elected to continue to apply the intrinsic-value
based method of accounting described above and has adopted only the disclosure
requirements of Statement 123, as amended. Had compensation cost for the
Company's stock-based compensation plan been reflected in the accompanying
consolidated financial statements based on the fair value at the grant dates for
option awards consistent with the method of SFAS 123, the Company's net income
would have been reduced to the pro forma amounts indicated below:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Net income (loss)
As reported $1,068,650 $(3,224,689) $(10,870,018)
Pro forma $1,017,011 $(3,275,995) $(10,886,339)
Income (loss) per share
As reported $0.19 $(0.59) $(1.97)
Pro forma $0.19 $(0.60) $(1.98)
Income (loss) per share - assuming dilution:
As reported $0.19 $(0.59) $(1.97)
Pro forma $0.18 $(0.60) $(1.98)
Calculations of the fair value under the method prescribed by SFAS No. 123 were
made using the Black-Scholes Option-Price Model with the following weighted
average assumptions used for the 1999 and 2002 grants:
2002 1999
---- ----
Dividend yield 1.40% 2.46%
Expected volatility 34% 43%
Expected lives 10 Years 10 Years
Risk-free interest rates 4.05% 6.09%
Fair value of options granted $1.32 $4.30
Recently Issued Accounting Standards
- ------------------------------------
In April 2003, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities (SFAS No. 149). SFAS No. 149
amends and clarifies accounting for derivative instruments and improves
financial reporting by requiring that contracts with comparable characteristics
be accounted for similarly. The amendments to SFAS No. 133 fall principally into
three categories: amendments related to SFAS No. 133 implementation issues,
amendments clarifying the definition of a derivative instrument, and amendments
relating to the definition of expected cash flows contained in FASB Concepts
Statement No. 7 Using Cash Flow Information and Present Value in Accounting
Measurements. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003. SFAS No. 149 does not alter current valuation or
disclosures. The implementation of SFAS No. 149 did not have an impact on the
Company's consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity (SFAS No. 150). SFAS No. 150 addresses certain financial
instruments that, under previous guidelines, could be accounted for as equity,
but now must be classified as liabilities in the statement of financial
position. These financial instruments include: 1) mandatory
46
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
redeemable financial instruments, 2) obligations to repurchase the issuer's
equity shares by transferring assets, and 3) obligations to issue a variable
number of shares. SFAS No. 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003. The implementation of
SFAS No. 150 did not have an impact on the Company's consolidated financial
statements.
In December 2003, FASB Statement No. 132 (revised), Employers' Disclosures about
Pensions and Other Postretirement Benefits, was issued. Statement 132 (revised)
prescribes employers' disclosures about pension plans and other postretirement
benefit plans; it does not change the measurement or recognition of those plans.
The Statement retains and revises the disclosure about the assets, obligations,
cash flows, and net periodic benefit cost of defined benefit pension plans and
other postretirement benefit plans. The Statement generally is effective for
fiscal years ending after December 15, 2003. The Company's disclosures in Note
13 incorporate the requirements of Statement 132 (revised).
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities, which addresses how a
business enterprise should evaluate whether it has controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46.
Consolidation of Variable Interest Entities, which was issued in January 2003.
The implementation of FASB Interpretation No. 46 did not have an impact on the
Company's consolidated financial statements.
NOTE 2 - ADVANCE PREMIUM AND PREMIUM DEPOSITS
- ---------------------------------------------
Some of the Company's health and life programs require payments of premium prior
to the effective date of coverage; and, accordingly, invoices are sent out as
early as two months prior to the coverage effective date. Insurance premiums
received for coverage months effective after the balance sheet date are recorded
as advance premiums. The Company received deposits to guarantee the payment of
premiums for past coverage months on its daily automobile rental program. These
deposits are required when information such as gross receipts or number of
rental cars is required to compute the actual premium due, but is not available
until after the coverage month.
NOTE 3 - INVESTMENTS
- ---------------------
The Company manages its own investment portfolio. A summary of net investments
and related income is as follows:
Investment income is summarized as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Fixed maturities $4,742,204 $5,354,707 $5,628,698
Short-term investments 105,939 103,339 174,720
--------- --------- ---------
Total investment income 4,848,143 5,458,046 5,803,418
Less investment expenses - - 5
--------- --------- ---------
Net investment income $4,848,143 $5,458,046 $5,803,413
========= ========= =========
Net realized investment gains and (losses) are summarized as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Gross realized gains on fixed maturities: - $3,906 $35,276
Gross realized (losses) on equity securities: - (216) (25,704)
----- ------
Net realized investment gains (losses) - $3,690 $9,572
===== =====
47
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the unrealized appreciation (depreciation) on investments carried
at market and the applicable deferred federal income taxes is shown below:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Gross unrealized appreciation of fixed maturities: $3,236,623 $4,828,956 $3,030,903
Gross unrealized (depreciation) of fixed maturities: (38,169) (105,074) (214,480)
--------- --------- ---------
Net unrealized appreciation on investments 3,198,454 4,723,882 2,816,423
Deferred federal tax (expense) (1,087,475) (1,606,120) (957,584)
--------- --------- ---------
Net unrealized appreciation, net of deferred income taxes $2,110,979 $3,117,762 $1,858,839
========= ========= =========
The amortized cost and estimated market value of fixed maturity investments at
December 31, 2003, by contractual maturity are as follows. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without penalties.
Amortized Estimated
Cost Market Value
---- ------------
Due in one year or less $26,150,904 $26,524,679
Due after one year through five years 77,962,487 80,292,227
Due after five years through ten years 7,212,201 7,707,140
----------- -----------
Total fixed maturities $111,325,592 $114,524,046
=========== ===========
The amortized cost and estimated market values of investments in fixed
maturities by categories are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
December 31, 2003
- -----------------
Available for sale:
Fixed maturities
----------------
Certificates of deposit $500,000 - - $500,000
U.S. treasury securities 38,305,041 $251,713 $6,485 38,550,269
U. S. government agency securities 11,997,264 13,976 24,360 11,986,880
State and municipal tax-exempt bonds 2,029,891 17,316 7,324 2,039,883
Industrial and miscellaneous taxable bonds 58,493,396 2,953,618 - 61,447,014
----------- --------- ------ -----------
Total fixed maturities $111,325,592 $3,236,623 $38,169 $114,524,046
=========== ========= ====== ===========
December 31, 2002
- -----------------
Available for sale:
Fixed maturities
----------------
Certificates of deposit $400,000 - - $400,000
U.S. treasury securities 8,517,578 $382,869 - 8,900,447
U. S. government agency securities 9,000,000 24,410 - 9,024,410
State and municipal tax-exempt bonds 2,731,060 97,156 $313 2,827,903
Industrial and miscellaneous taxable bonds 73,000,830 4,324,521 104,761 77,220,590
---------- --------- ------- ----------
Total fixed maturities $93,649,468 $4,828,956 $105,074 $98,373,350
========== ========= ======= ==========
The following table illustrates the gross unrealized losses included in the
Company's investment portfolio and the fair value of those securities,
aggregated by investment category. The table also illustrates the length of time
that they have been in a continuous unrealized loss position as of December 31,
2003.
48
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Less than 12 Months 12 Months or More Total
------------------- ----------------- -----
Unrealized Fair Unrealized Fair Unrealized Fair
Loss Value Loss Value Loss Value
---- ----- ---- ----- ---- -----
U.S. treasury securities $(6,485) $6,111,750 - - $(6,485) $6,111,750
U.S. government agency
securities (24,360) 2,975,640 - - (24,360) 2,975,640
State and municipal tax-
exempt bonds (6,969) 983,876 (355) 15,048 (7,324) 998,924
------ ---------- --- ------ ------ ----------
Total $(37,814) $10,071,266 $(355) $15,048 $(38,169) $10,086,314
====== ========== === ====== ====== ==========
Short-term investments have an initial maturity of one year or less and consist
of the following:
Year ended December 31
2003 2002
---- ----
Certificates of deposit $425,000 $225,000
Cash deposited in lieu of bond * 752,659 -
Commercial paper 2,000,000 1,525,000
U.S. treasury bills 2,998,850 -
Commercial bank money market accounts 902,517 724,842
U.S. government obligation money market fund 147,666 6,546,602
Savings account 2,623 2,938
--------- ---------
Total short-term investments $7,229,315 $9,024,382
========= =========
* Deposited with Superior courts to stay execution of judgments pending appeal
of two Crusader Claims.
NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION)
- ----------------------------------------------------------------
Property and equipment consist of the following:
Year ended December 31
----------------------
2003 2002
---- ----
Furniture, fixtures, computer, office,
and transportation equipment $1,570,716 $1,768,856
Accumulated depreciation 1,247,626 1,414,662
--------- ---------
Net property and equipment $323,090 $354,194
======= =======
NOTE 5 - PREMIUMS AND NOTES RECEIVABLE, NET
- -------------------------------------------
Premiums and notes receivable are substantially secured by unearned premiums and
funds held as security for performance.
Year ended December 31
----------------------
2003 2002
---- ----
Premiums receivable $2,851,189 $2,364,150
Premium finance notes receivable 5,457,797 4,350,685
--------- ---------
Total premiums and notes receivable 8,308,986 6,714,835
Less allowance for doubtful accounts 18,817 14,926
--------- ---------
Net premiums and notes receivable $8,290,169 $6,699,909
========= =========
Bad debt expense for the fiscal year ended December 31, 2003, and the fiscal
year ended December 31, 2002, was $23,895 and $25,857, respectively. Premium
finance notes receivable represent the balance due to the Company's premium
finance subsidiary from policyholders who elect to finance their premiums over
the policy term. These notes are net of unearned finance charges.
49
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - NOTES PAYABLE - RELATED PARTIES
- ----------------------------------------
On November 15, 2002, the Company borrowed $500,000 from Erwin Cheldin, a
director and the Company's principal shareholder, president and chief executive
officer, and $250,000 from The Cary and Danielle Cheldin Family Trust. Cary L.
Cheldin is a director and the Company's executive vice president. In the quarter
ended June 30, 2003, the Company repaid the above-mentioned notes in full.
In 2003, Unico made capital contributions totaling $3,000,000 to its Crusader
subsidiary. The contributions were made to ensure that Crusader's capital
remained above $25,000,000. The funding of Unico's capital contribution to
Crusader was derived from available cash from the Company's other operations and
the proceeds of two notes. On September 29, 2003, the Company borrowed
$1,000,000 from Erwin Cheldin, a director and the Company's principal
shareholder, president and chief executive officer, and $500,000 from The Cary
and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the
Company's executive vice president. The notes are due and payable upon demand of
lender (on no less than fourteen days' notice) and, if no demand is made, then
the notes are payable in full on September 28, 2007. The notes may be prepaid at
any time without penalty. The notes are unsecured and bear interest as follows:
Interest on the $1,000,000 note is 5% and is adjustable in April 1, 2004, and
every third month thereafter by adding a margin of one percentage point to the
prime rate; interest on the $500,000 note is 7% per annum. Interest is payable
monthly on both notes.
Year ended December 31
----------------------
2003 2002
---- ----
Note payable - Erwin Cheldin $1,000,000 $500,000
Note payable - The Cary and Danielle
Cheldin Family Trust 500,000 250,000
--------- -------
Notes payable - related parties $1,500,000 $750,000
========= =======
NOTE 7 - UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
- ---------------------------------------------------
The following table provides an analysis of the roll forward of Crusader's
losses and loss adjustment expenses, including a reconciliation of the ending
balance sheet liability for the periods indicated:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Reserve for unpaid losses and loss adjustment expenses
at beginning of year - net of reinsurance $53,596,945 $49,786,215 $34,546,026
---------- ---------- ----------
Incurred losses and loss adjustment expenses
Provision for insured events of current year 28,968,948 24,936,172 22,350,667
Increase in provision for events of prior years 2,751,585 7,790,851 19,326,349
---------- ---------- ----------
Total losses and loss adjustment expenses 31,720,533 32,727,023 41,677,016
---------- ---------- ----------
Payments
Losses and loss adjustment expenses attributable to
insured events of the current year 5,106,929 5,905,678 5,595,410
Losses and loss adjustment expenses attributable to
insured events of prior years 21,326,688 23,010,615 20,841,417
---------- ---------- ----------
Total payments 26,433,617 28,916,293 26,436,827
---------- ---------- ----------
Reserve for unpaid losses and loss adjustment expenses
at end of year - net of reinsurance 58,883,861 53,596,945 49,786,215
Reinsurance recoverable on unpaid losses and loss
adjustment expenses at end of year 19,255,229 21,308,339 10,748,080
---------- ---------- ----------
Reserve for unpaid losses and loss adjustment expenses at
end of year per balance sheet, gross of reinsurance (*) $78,139,090 $74,905,284 $60,534,295
========== ========== ==========
(*) In accordance with Financial Accounting Standards Board Statement No. 113,
Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts, reinsurance recoverable on unpaid losses and loss adjustment expenses
are reported for GAAP as assets rather than netted against the corresponding
liability for such items on the balance sheet.
50
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loss and loss adjustment expense reserves by line of business before reinsurance
are as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Line of Business
CMP $73,708,553 94.3% $69,111,825 92.3% $56,215,479 92.9%
Other Liability 4,279,021 5.5% 5,564,214 7.4% 4,004,449 6.6%
Other 151,516 0.2% 229,245 0.3% 314,367 0.5%
---------- ----- --------- ----- --------- -----
Total $78,139,090 100.0% $74,905,284 100.0% $60,534,295 100.0%
========== ===== ========== ===== ========== =====
The Company`s consolidated financial statements include estimated reserves for
unpaid losses and related claim settlement or loss adjustment expenses of our
insurance company operation. Crusader sets loss and loss adjustment expense
reserves at each balance sheet date at management's best estimate of the
ultimate payments that it anticipates will be made to settle all losses incurred
and related expenses incurred as of that date for both reported and unreported
losses. The process of estimating loss and loss adjustment reserves involves
significant judgment and is complex and imprecise due to the number of variables
and assumptions inherent in the estimating process. Crusader establishes
reserves for reported losses based on historical experience, upon case-by-case
evaluation of facts surrounding each known loss, and the related policy
provisions. The amount of reserves for unreported losses is estimated by
analysis of historical and statistical information. Reserves are monitored and
adjusted when appropriate and reflected in the statement of operations in the
period of adjustment.
Losses and loss adjustment expenses were $31,720,533, for the year ended
December 31, 2003, compared to $32,727,023 for the year ended December 31, 2002.
The decrease in losses and loss adjustment expenses for the year ended December
31, 2003, is primarily the result of a decrease in the adverse development of
prior year losses in 2003 compared to 2002. The adverse loss development in 2003
was $2,751,586 compared to $7,790,851 in 2002. The adverse development in 2003
was primarily the result of an adverse binding arbitration decision on a 1993
claim that exceeded Crusader's reinsurance coverage. As a result of this
decision the Company incurred adverse development on this claim, net of
reinsurance of approximately $2,000,000. The other adverse development in 2003
was a result of continued losses due to the impact of changes in California case
law that expanded coverage and increased loss exposure primarily on construction
defect claims for claims occurring in or prior to the Company's revision of its
policy forms in 1995.
Losses and loss adjustment expenses were $32,727,023, for the year ended
December 31, 2002, compared to $41,677,016 for the year ended December 31, 2001.
The decrease in losses for the year ended December 31, 2002, is primarily the
result of a decrease in the adverse development of prior year losses in 2002
compared to 2001. The adverse loss development in 2002 was $7,790,851 compared
to $19,326,349 in 2001. The adverse development in the year ending December 31,
2002, of $7,790,851 was primarily the result of liquor and premises liability
outside of California for the accident years 1999 through 2001 and higher than
anticipated costs of construction defect and apartment house habitability claims
for accident years prior to 1998. The liquor liability claims arose from the
liability of tavern owners related to the sale of alcoholic beverages. Based on
the development in 2002 of the liquor and premises liability claims, the Company
increased its estimate of ultimate losses for 1999 and subsequent years.
Adverse development of prior years' losses of $19,326,349 as of December 31,
2001, was primarily the result of an increase in the Company's estimate of
ultimate reported and unreported claims for construction defect claims,
non-California liquor liability claims and apartment house habitational type of
claims. In the year ended December 31, 2001, the Company increased its estimates
of ultimate losses for both reported and unreported claims primarily occurring
from 1998 through 2000 and from 1993 through 1995 (the years most impacted by
construction defect claims).
NOTE 8 - DEFERRED POLICY ACQUISITION COSTS
- ------------------------------------------
Deferred policy acquisition costs consist of commissions (net of ceding
commission), premium taxes, inspection fees, and certain other underwriting
costs, which are related to and vary with the production of Crusader policies.
51
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Policy acquisition costs are deferred and amortized as the related premiums are
earned. Deferred acquisition costs are reviewed to determine if they are
recoverable from future income, including investment income.
The following table provides an analysis of the roll forward of Crusader's
deferred policy acquisition costs:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Deferred policy acquisition costs at beginning of year $5,947,010 $5,079,535 $4,500,147
Policy acquisition costs incurred during year 10,048,552 10,141,738 9,274,425
Policy acquisition costs amortized during year (7,941,199) (9,274,263) (8,695,037)
--------- --------- ---------
Deferred policy acquisition costs at end of year $8,054,363 $5,947,010 $5,079,535
========= ========= =========
The decrease in policy acquisition amortized during the year ended December 31,
2003, was primarily due to the increase in ceding commissions from 25% in 2002
to 35% in 2003.
NOTE 9 - LEASE COMMITMENT TO RELATED PARTY
- ------------------------------------------
The Company presently occupies a 46,000 square foot building located at 23251
Mulholland Drive, Woodland Hills, California, under a master lease expiring
March 31, 2007. The total rent expense under this lease agreement was $1,025,952
for the year ended December 31, 2003; $1,025,952 for the year ended December 31,
2002; and $1,025,952 for the year ended December 31, 2001.
The lease provides for the following minimum annual rental commitments:
Year ending
-----------
December 31, 2004 $1,025,952
December 31, 2005 1,025,952
December 31, 2006 1,025,952
December 31, 2007 (through March 31, 2007) 256,488
---------
Total minimum payments $3,334,344
=========
Erwin Cheldin, the Company's president, chairman, and principal stockholder, is
the owner of the building. On February 22, 1995, the Company signed an extension
to the lease with no increase in rent to March 31, 2007. The Company believes
that the terms of the lease at inception and at the time the lease extension was
signed were at least as favorable to the Company as could have been obtained
from non-affiliated third parties. The Company utilizes for its own operations
100% of the space it leases.
NOTE 10 - ACCRUED EXPENSES AND OTHER LIABILITIES
- ------------------------------------------------
Accrued expenses and other liabilities consist of the following:
Year ended December 31
----------------------
2003 2002
---- ----
Premium payable $4,241,811 $4,708,648
Unearned claim administration income 100,000 300,000
Profit sharing contributions 477,000 291,144
Accrued salaries 250,803 451,347
Security purchases payable - 2,000,000
Assessments due California Insurance
Guarantee Association 650,448 -
Other 1,255,226 882,337
--------- ---------
Total accrued expenses and other liabilities $6,975,288 $8,633,476
========= =========
52
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - COMMITMENT AND CONTINGENCIES
- --------------------------------------
The Company, by virtue of the nature of the business conducted by it, becomes
involved in numerous legal proceedings as either plaintiff or defendant. The
Company is also required to resort to legal proceedings from time to time in
order to enforce collection of premiums, commissions, or fees for the services
rendered to customers or to their agents. These routine items of litigation do
not materially affect the Company and are handled on a routine basis by the
Company through its general counsel.
Likewise, the Company is sometimes named as a cross-defendant in litigation,
which is principally directed against that insurer who was issued a policy of
insurance directly or indirectly through the Company. Incidental actions are
sometimes brought by customers or others, which relate to disputes concerning
the issuance or non-issuance of individual policies. These items are also
handled on a routine basis by the Company's general counsel, and they do not
materially affect the operations of the Company. Management is confident that
the ultimate outcome of pending litigation should not have an adverse effect on
the Company's consolidated operation or financial position.
A recent court ruling in Ceridian vs. Franchise Tax Board held that the
California statute permitting the tax deductibility of dividends received from a
wholly owned insurance subsidiary was unconstitutional because it discriminated
against out-of-state holding companies and thus was in violation of the
interstate commerce clause of the United States Constitution. The ruling
concluded that the discriminatory sections of the statute are not severable and
the entire statute is invalid and unenforceable. California law provides that
the proper remedy in such circumstances is to disallow the deduction to those
taxpayers that benefited from the deduction. As a result of the court ruling, in
February 2003, the Franchise Tax Board (FTB) notified the Company that it would
issue a Notice of Proposed Assessment (NPA) for tax years 1999 and 2000 of
approximately $287,000 representing California state franchise taxes plus
related interest of approximately $80,000.
The Company is following the progress of current legislation that would address
the unconstitutionality of the California statue by restructuring the rate at
which California taxes dividends for in and out of state insurance holding
companies. The legislation would also resolve the issue regarding the
retroactive assessments due to the disallowance of the deduction. If the
legislation were enacted, it would result in the Company paying a relatively
small amount of California franchise taxes on dividends received from its
insurance company subsidiary. Without a legislative solution, the Company
anticipates the ultimate outcome of the dividend received deduction will be
settled by future litigation.
The Company intends to pay the NPA to stop the interest from accruing and to
file a protective claim for refund to protect its interest when or if
legislation or litigation resolves the issue. The full amount of the NPA has
been accrued in the financial statement as of December 31, 2003. After the
federal tax benefit of deducting the state taxes and interest related to the
NPA, the effect on net income in the quarter ended December 31, 2003, is
approximately $242,000. An unsatisfactory conclusion to the inter-company
dividend issue could affect Unico's future dividend policy to its shareholders.
NOTE 12 - REINSURANCE
- ---------------------
A reinsurance transaction occurs when an insurance company transfers (cedes) a
portion of its exposure on business written by it to a reinsurer that assumes
that risk for a premium (ceded premium). Reinsurance does not legally discharge
the Company from primary liability under its policies. If the reinsurer fails to
meet its obligations, the Company must nonetheless pay its policy obligations.
In 2003, Crusader's primary excess of loss reinsurance agreements are with
Hannover Ruckversicherungs (A.M. Best Rating A+), Platinum Reinsurance (A.M.
Best Rating A), QBE Reinsurance Corporation (A.M. Best Rating A), and General
Reinsurance Corporation (A.M. Best Rating A+). From 2000 to 2002, Crusader had
its primary excess of loss reinsurance agreements with Partners Reinsurance
Company of the U.S. (A.M Best Rating A+). In 1999, Crusader had its primary
excess of loss reinsurance agreements with General Reinsurance Corporation.
Crusader also has catastrophe reinsurance from various highly rated California
admitted and Bermuda reinsurance companies. These reinsurance agreements help
protect Crusader against liabilities in excess of certain retentions, including
major or catastrophic losses that may occur from any one or more of the property
and/or casualty risks which Crusader insures. The Company has no reinsurance
recoverable balances in dispute.
53
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays
a commission to Crusader, which includes a reimbursement of the cost of
acquiring the portion of the premium, which is ceded. Crusader does not
currently assume any reinsurance. The Company intends to continue obtaining
reinsurance although the availability and cost may vary from time to time. The
unpaid losses ceded to the reinsurer are recorded as an asset on the balance
sheet.
The increase in earned ceded premiums in 2003 and 2002 were primarily the result
of rate increases by the Company's reinsurers and the increase in the related
direct earned premiums on which those rates were based. The rate increases are
primarily due to the Company's ceded loss experience and the hardening of the
reinsurance marketplace.
The effect of reinsurance on premiums written, premiums earned, and incurred
losses is as follows:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Premiums written:
Direct business $64,047,717 $45,622,280 $37,637,396
Reinsurance assumed - - -
Reinsurance ceded (16,627,560) (7,259,079) (5,531,221)
---------- ---------- ----------
Net premiums written $47,420,157 $38,363,201 $32,106,175
========== ========== ==========
Premiums earned:
Direct business $53,754,119 $40,568,845 $35,409,174
Reinsurance assumed - - -
Reinsurance ceded (16,648,020) (7,209,573) (5,515,330)
---------- ---------- ----------
Net premiums earned $37,106,099 $33,359,272 $29,893,844
========== ========== ==========
Incurred losses and loss adjustment expenses:
Direct $39,036,895 $54,352,403 $52,939,238
Assumed - - -
Ceded (7,316,362) (21,625,380) (11,262,222)
---------- ---------- ----------
Net incurred losses and loss adjustment expenses $31,720,533 $32,727,023 $41,677,016
========== ========== ==========
NOTE 13 - PROFIT SHARING PLAN
- -----------------------------
During the fiscal year ended March 31, 1986, the Company adopted the Unico
American Corporation Profit Sharing Plan. Employees who are at least 21 years of
age and have been employed by the Company for at least two years are
participants in the Plan. Pursuant to the terms of the Plan, the Company
annually contributes to the account of each participant an amount equal to a
percentage of the participant's eligible compensation as determined by the Board
of Directors. Participants are entitled to receive benefits under the plan upon
the later of the following: the date 60 days after the end of the plan year in
which the participant's retirement occurs or one year and 60 days after the end
of the plan year following the participant's termination with the Company.
However, the participant's interest must be distributed in its entirety no later
than April 1 of the calendar year following the calendar year in which the
participant attains age 70 1/2 or otherwise in accordance with the Treasury
Regulations promulgated under the Internal Revenue Code of 1954 as amended.
Employer contributions to the plan were as follows:
Year ended December 31, 2003 $674,977
Year ended December 31, 2002 $434,789
Year ended December 31, 2001 $554,111
54
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - STATUTORY CAPITAL AND SURPLUS
- ---------------------------------------
Crusader is required to file an annual statement with insurance regulatory
authorities prepared on an accounting basis prescribed or permitted by such
authorities (statutory). Statutory accounting practices differ in certain
respects from GAAP. The more significant of these differences for statutory
accounting are (a) premium income is taken into earnings over the periods
covered by the policies, whereas the related acquisition and commission costs
are expensed when incurred; (b) ) fixed maturity securities are reported at
amortized cost, or the lower of amortized cost or market value, depending on the
quality of the security as specified by the NAIC; (c) equity securities are
valued by the NAIC as required by Statutory Accounting Principles; d)
non-admitted assets are charged directly against surplus; (e) loss reserves and
unearned premium reserves are stated net of reinsurance; and (f) federal income
taxes are recorded when payable and deferred taxes, subject to limitations, are
recognized but only to the extent that they do not exceed 10% of statutory
surplus; changes in deferred taxes are recorded directly to surplus as regards
policyholders. Additionally, the cash flow presentation is not consistent with
generally accepted accounting principles and reconciliation from net income to
cash provided by operations is not presented. Comprehensive income is not
presented under statutory accounting.
Crusader Insurance Company statutory capital and surplus are as follows:
As of December 31, 2003 $26,103,440
As of December 31, 2002 $26,258,452
Crusader Insurance Company statutory net (loss) is as follows:
Year ended December 31, 2003 $(3,106,103)
Year ended December 31, 2002 $(5,331,777)
Year ended December 31, 2001 $(12,110,967)
The insurance department has completed its financial examination of Crusader's
December 31, 2001, statutory financial statements. The report of examination
that was filed with the insurance department on May 30, 2003, reported no
adjustments to Crusader's statutory financial statements.
The Company believes that Crusader's statutory capital and surplus were
sufficient to support the insurance premiums written based on guidelines
established by the NAIC.
Crusader is restricted in the amount of dividends it may pay to its parent in
any twelve (12) month period without prior approval of the California Department
of Insurance. Presently, without prior approval, Crusader may pay a dividend in
any twelve (12) month period to its parent equal to the greater of (a) 10% of
Crusader's statutory policyholders' surplus or (b) Crusader's statutory net
income for the preceding calendar year. There were no dividends paid by Crusader
to Unico in 2003, 2002, or in 2001. Based on Crusader's statutory surplus as
regards policyholders as of December 31, 2003, the maximum dividend that could
be made by Crusader to Unico without prior regulatory approval in 2004 is
$2,610,344.
In December 1993, the National Association of Insurance Commissioners (NAIC)
adopted a Risk-Based Capital (RBC) Model Law for property and casualty
companies. The RBC Model Law is intended to provide standards for calculating a
variable regulatory capital requirement related to a company's current
operations and its risk exposures (asset risk, underwriting risk, credit risk
and off-balance sheet risk). These standards are intended to serve as a
diagnostic solvency tool for regulators that establishes uniform capital levels
and specific authority levels for regulatory intervention when an insurer falls
below minimum capital levels. The RBC Model Law specifies four distinct action
levels at which a regulator can intervene with increasing degrees of authority
over a domestic insurer if its RBC is equal to or less than 200% of its computed
authorized control level RBC. A company's RBC is required to be disclosed in its
statutory annual statement. The RBC is not intended to be used as a rating or
ranking tool nor is it to be used in premium rate making or approval. Crusader's
adjusted capital at December 31, 2003, was 298% of authorized control level
risk-based capital.
55
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Insurance Regulatory Information System (IRIS) was developed by a committee of
state insurance regulators primarily to assist state insurance departments in
executing their statutory mandate to oversee the financial condition of
insurance companies. IRIS helps those companies that merit highest priority in
the allocation of the regulators' resources on the basis of 12 financial ratios
that are calculated annually. The analytical phase is a review of annual
statements and the financial ratios. The ratios and trends are valuable in
pointing to companies likely to experience financial difficulties, but are not
themselves indicative of adverse financial condition. The ratio and benchmark
comparisons are mechanically produced and are not intended to replace the state
insurance departments' own in-depth financial analysis or on-site examinations.
An unusual range of ratio results has been established from studies of the
ratios of companies that have become insolvent or have experienced financial
difficulties. In the analytical phase, companies that receive four or more
financial ratio values outside the usual range are analyzed in order to identify
those companies that appear to require immediate regulatory action.
Subsequently, a more comprehensive review of the ratio results and an insurer's
annual statement are performed to confirm that an insurer's situation calls for
increased or close regulatory attention.
In 2003, the Company was outside the usual values on 4 of the 12 IRIS ratio
tests, primarily as a result of adverse loss and loss adjustment expense
development and investment yield. The IRIS tests outside the usual values
related to adverse loss and loss adjustment expenses were the Two Year Overall
Operating Ratio, Two Year Reserve Development to Surplus, and Estimated Current
Reserve Deficiency to Surplus. A usual value for the IRIS test for investment
yield is a range greater than 4.5% and less than 10%. Crusader's 2003 statutory
investment yield of 4.5% was, therefore, also outside the usual value.
NOTE 15 - STOCK PLANS
- ---------------------
The Company's 1999 Omnibus Stock Plan that covers 500,000 shares of the
Company's common stock (subject to adjustment in the case of stock splits,
reverse stock splits, stock dividends, etc.) was approved by shareholders June
4, 1999. On August 26, 1999, the Company granted 135,000 incentive stock options
of which 40,000 were terminated and 95,000 were outstanding as of December 31,
2003. These options expire 10 years from the date of the grant and were not
exercisable prior to September 1, 2000. Options covering 10,000 or less shares
become exercisable at the rate of 2,500 shares per year commencing September 1,
2000; and options covering more than 10,000 shares become exercisable at the
rate of 5,000 shares per year commencing September 1, 2000. At December 31,
2003, there were 95,000 options under the 1999 stock option plan that were
exercisable.
On December 18, 2002, the Company granted an additional 182,000 incentive stock
options under the Company's 1999 Omnibus Stock Plan. All of these options were
outstanding as of December 31, 2003. These options expire 10 years from the date
of the grant and are not exercisable prior to January 1, 2004. Options become
exercisable as follows:
Date Exercisable
-------------------------------------------------
Number of January 1, January 1, January 1, January 1,
Options Granted 2004 2005 2006 2007
- --------------- ---- ---- ---- ----
2,500 2,500
5,000 2,500 2,500
7,500 2,500 2,500 2,500
10,000 2,500 2,500 2,500 2,500
12,500 2,500 2,500 2,500 5,000
15,000 5,000 5,000 5,000
20,000 5,000 5,000 5,000 5,000
35,000 5,000 10,000 10,000 10,000
56
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The changes in the number of common shares under option are summarized as
follows:
Weighted Average
Options Exercise Price
------- --------------
Outstanding at December 31, 2000 203,775 $7.239
Options granted - -
Options exercised (59,860) $3.500
Options terminated (27,500) $9.250
-------
Outstanding at December 31, 2001 116,415 $8.686
Options granted 182,000 $3.110
Options exercised (8,245) $3.500
Options terminated (3,170) $3.500
-------
Outstanding at December 31, 2002 287,000 $5.356
Options granted - -
Options exercised - -
Options terminated (10,000) $9.250
-------
Outstanding at December 31, 2003 277,000 $5.216
=======
Options exercisable were 95,000 at December 31, 2003, at a weighted average
exercise price of $9.25; 92,500 at December 31, 2002, at a weighted average
exercise price of $9.25; 81,145 at December 31, 2001, at a weighted average
exercise price of $8.44.
The following table summarizes information regarding the stock options
outstanding at December 31, 2003:
Weighted Weighted Weighted
Average Average Average
Number of Remaining Exercise Price Exercise Price
Exercise Options Contractual Life of Outstanding Number of Options of Exercisable
Price Outstanding (Years) Options Exercisable Options
----- ----------- ----- ------- ----------- -------
$9.25 95,000 5.65 9.25 95,000 9.25
$3.11 182,000 8.96 3.11 - -
NOTE 16 - TAXES ON INCOME
- -------------------------
The provision for taxes on income consists of the following:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Current provision:
Federal $703,663 $(1,599,760) $(5,375,381)
State 572,822 160,626 24,935
--------- --------- ---------
Total federal and state 1,276,485 (1,439,134) (5,350,446)
Deferred (195,764 (150,236) (502,645)
--------- --------- ---------
Provision for taxes $1,080,721 $(1,589,370) $(5,853,091)
========= ========= =========
The income tax provision reflected in the consolidated statements of operations
is different than the expected federal income tax on income as shown in the
table below:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Computed tax expense (benefit) $730,786 $(1,636,780) $(5,685,857)
Tax effect of:
Tax exempt income (34,071) (82,034) (217,383)
State tax, net of federal tax benefit 370,784 114,413 20,568
Other 13,222 15,031 29,581
--------- --------- ---------
Tax per financial statements $1,080,721 $(1,589,370) $(5,853,091)
========= ========= =========
57
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On March 9, 2002, the Job Creation and Workers Assistance Act of 2002 was signed
into law. This act was effective for tax years ending in 2001 and provided that
a net operating loss for tax years ending in 2001 or 2002 is carried back five
years, rather than the previously allowed two years. This act allowed the
Company to carryback its entire 2002 net operating loss. The carryback of the
2002 Federal tax benefit was allocated as follows:
Tax year ended Amount Applied
- -------------- --------------
December 31, 1998 $(1,548,427)
---------
Total Federal income tax carryback (1,548,427)
Adjustment to 2001 tax provision ( 51,333)
---------
2002 Federal income tax provision $(1,599,760)
=========
The components of the net federal income tax asset included in the financial
statements as required by the assets and liability method are as follows:
Year ended December 31
----------------------
2003 2002
---- ----
Deferred tax assets:
Discount on loss reserves $2,246,793 $2,111,565
Unearned premiums 2,351,751 1,650,395
AMT credit 203,340 -
Other 210,777 131,141
--------- ---------
Total deferred tax assets $5,012,661 $3,893,101
--------- ---------
Deferred tax liabilities:
Deferred acquisition costs $2,738,484 $2,021,984
Discount on salvage and subrogation 5,802 6,992
Unrealized gain on investments 1,087,474 1,606,120
Other 205,200 200,054
--------- ---------
Total deferred tax liabilities $4,036,960 $3,835,150
--------- ---------
Net deferred tax assets $975,701 $57,951
======= ======
Although realization is not assured, management believes it is more likely than
not that all of the deferred tax assets will be realized. The amount of the
deferred tax assets considered realizable could be reduced in the near term if
estimates of future taxable income during the carryforward period are reduced.
The Company and its wholly owned subsidiaries file consolidated federal and
combined California income tax returns. Pursuant to the a tax allocation
agreement, Crusader and American Acceptance Corporation are allocated taxes or
(in the case of losses) tax credits at current corporate rates based on their
own taxable income or loss.
As a California insurance company, Crusader is obligated to pay a premium tax on
gross premiums written in all states that Crusader is admitted. Premium taxes
are deferred and amortized as the related premiums are earned. The premium tax
is in lieu of state franchise taxes and is not included in the provision for
state taxes.
A recent court ruling in Ceridian vs. Franchise Tax Board held that the
California statute permitting the tax deductibility of dividends received from a
wholly owned insurance subsidiary was unconstitutional because it discriminated
against out-of-state holding companies and thus was in violation of the
interstate commerce clause of the United States Constitution. The ruling
concluded that the discriminatory sections of the statute are not severable and
the entire statute is invalid and unenforceable. California law provides that
the proper remedy in such circumstances is to disallow the deduction to those
taxpayers that benefited from the deduction. As a result of the court ruling, in
February 2003, the Franchise Tax Board (FTB) notified the Company that it would
issue a Notice of Proposed Assessment (NPA) for tax years 1999 and 2000 of
approximately $287,000 representing California state franchise taxes plus
related interest of approximately $80,000.
58
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company is following the progress of current legislation that would address
the unconstitutionality of the California statue by restructuring the rate at
which California taxes dividends for in and out of state insurance holding
companies. The legislation would also resolve the issue regarding the
retroactive assessments due to the disallowance of the deduction. If the
legislation were enacted, it would result in the Company paying a relatively
small amount of California franchise taxes on dividends received from its
insurance company subsidiary. Without a legislative solution, the Company
anticipates the ultimate outcome of the dividend received deduction will settled
by future litigation.
The Company intends to pay the NPA to stop the interest from accruing and to
file a protective claim for refund to protect its interest when or if
legislation or litigation resolves the issue. The full amount of the NPA has
been accrued in the financial statement as of December 31, 2003. After the
federal tax benefit of deducting the state taxes and interest related to the
NPA, the effect on net income in the quarter ended December 31, 2003, is
approximately $242,000. An unsatisfactory conclusion to the inter-company
dividend issue could affect Unico's future dividend policy to its shareholders.
NOTE 17 - REPURCHASE OF COMMON STOCK - EFFECT ON STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------
The Company has previously announced that its Board of Directors had authorized
the repurchase in the open market from time to time of up to an aggregate of
945,000 shares of the common stock of the Company. During the year ended
December 31, 2003, the Company did not purchase any shares of the Company's
common stock. As of December 31, 2003, the Company had purchased and retired
under the Board of Directors authorization an aggregate of 868,958 shares of its
common stock at a cost of $5,517,465.
NOTE 18 - EARNINGS PER SHARE
- ----------------------------
A reconciliation of the numerator and denominator used in the basic and diluted
earnings per share calculation is presented below:
Year ended December 31
----------------------
2003 2002 2001
---- ---- ----
Basic Earnings (Loss) Per Share
- -------------------------------
Net income (loss) numerator $1,068,650 $(3,224,689) $(10,870,018)
========= ========= ==========
Weighted average shares outstanding denominator 5,489,604 5,487,311 5,505,398
========= ========= =========
Per share amount $0.19 $(0.59) $(1.97)
Diluted Earnings (Loss) Per Share
- ---------------------------------
Net income (loss) numerator $1,068,650 $(3,224,689) $(10,870,018)
========= ========= ==========
Weighted average shares outstanding 5,489,604 5,487,311 5,505,398
Effect of diluted securities * 43,508 - -
--------- --------- ---------
Diluted shares outstanding denominator 5,533,112 5,487,311 5,505,398
========= ========= =========
Per share amount $0.19 $(0.59) $(1.97)
*In loss periods, options are excluded from the calculation of diluted EPS, as
the inclusion of such options would have an antidilutive effect. Therefore,
1,428 options were excluded from the calculation of diluted EPS for the years
ended December 31, 2002 and 26,725 options were excluded for the year ended
December 31, 2001.
59
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
- ------------------------------------------------------
Summarized unaudited quarterly financial data for each of the calendar years
2003 and 2002 is set forth below:
Comparable Period by Quarter Ended
----------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
Calendar Year 2003
------------------
Total revenues $11,416,591 $12,292,016 $13,228,806 $14,193,026
Income (loss) before taxes 360,080 871,597 (1,024,454) 1,942,148
Net income (loss) 233,083 561,276 (733,562) 1,007,853
Earnings (loss) per share: Basic $0.04 $0.10 $(0.13) $0.18
Diluted $0.04 $0.10 $(0.13) $0.18
Calendar Year 2002
------------------
Total revenues $10,651,993 $11,328,455 $12,080,314 $11,967,880
Income (loss) before taxes 136,438 (5,537,121) 278,899 307,725
Net income (loss) 106,052 (3,662,872) 146,345 185,786
Earnings (loss) per share: Basic $0.02 $(0.67) $0.03 $0.03
Diluted $0.02 $(0.67) $0.03 $0.03
60
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure
--------------------
None
Item 9A. Controls and Procedures
- ---------------------------------
An evaluation was carried out by the Company's management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
December 31, 2003 (as defined in Rule 13a-15(e) or 15d-15(e) under the
Securities Exchange Act of 1934). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the design and
operation of these disclosure controls and procedures were effective.
During the period covered by this report, there have been no changes in the
Company's internal control over financial reporting that have materially
affected or are reasonably likely to materially affect the Company's internal
control over financial reporting.
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
Information in response to Item 10 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
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 to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
- ----------------------------------------------------------------------------
Related Stockholder Matters
---------------------------
Information in response to Item 12 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
Information in response to Item 13 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
Item 14. Principal Accountant Fees and Services
- ------------------------------------------------
Information in response to Item 14 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
61
PART IV
-------
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- --------------------------------------------------------------------------
(a) Financial Statements and Schedules Filed as a Part of this Report:
1. Financial statements:
The consolidated financial statements for the fiscal year ended December
31, 2003, are contained herein as listed in the index to consolidated
financial statements on page 35.
2. Financial schedules:
Index to Consolidated Financial Statements
------------------------------------------
Independent Auditors' Report on Financial Statement Schedules
Schedule II - Condensed Financial Information of Registrant
Schedule III - Supplemental Insurance Information
Schedules other than those listed above are omitted, since they are not
applicable, not required, or the information required being set forth is
included in the consolidated financial statements or notes.
3. Exhibits:
3.1 Articles of Incorporation of Registrant, as amended. (Incorporated
herein by reference to Exhibit 3.1 to the Registrant's Annual Report
on Form 10-K for the fiscal year ended March 31, 1984.)
3.2 By-Laws of Registrant, as amended. (Incorporated herein by
reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-K
for the fiscal year ended March 31, 1991.)
10.1 Unico American Corporation Profit Sharing Plan & Trust.
(Incorporated herein by reference to Exhibit 10.1 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
March 31, 1985.) (*)
10.2 The Lease dated July 31, 1986, between Unico American Corporation and
Cheldin Management Company. (Incorporated herein by reference to
Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the
fiscal year ended March 31, 1987.)
10.3 The Lease Amendment #1 dated February 22, 1995, between Unico
American Corporation and Cheldin Management amending the lease dated
July 31, 1986. (Incorporated herein by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year ended
March 31, 1995.)
10.4 2000 Omnibus Stock Plan of Unico American Corporation (Incorporated
herein by reference to Exhibit A to Registrant's Proxy Statement for
its Annual Meeting of Shareholders held June 4, 2000.) (*)
10.5 Employment Agreement between the Company and Cary Cheldin dated
November 27, 1996. (Incorporated herein by reference to Exhibit 10.2
to Registrant's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2000.) (*)
10.6 Amendment to Employment Agreement between the Company and Cary
Cheldin dated January 10, 2000. (Incorporated herein by reference to
Exhibit 10.3 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2000.) (*)
21 Subsidiaries of Registrant. (Incorporated herein by reference to
Exhibit 22 to Registrant's Annual Report on Form 10-K for the fiscal
year ended March 31, 1984.)
23 Consent of Independent Public Accountants - KPMG LLP.
62
31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(*) Indicates management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K:
On November 7, 2003, the Company filed a Form 8-K furnishing under Item 12
its earnings press release for the quarter ended September 30, 2003.
63
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.
Date: March 24, 2004
UNICO AMERICAN CORPORATION
By: /s/ Erwin Cheldin
-----------------
Erwin Cheldin
Chairman of the Board
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.
Signature Title Date
- --------- ----- ----
/s/ Erwin Cheldin Chairman of the Board, March 24, 2004
- ----------------- President and Chief
Erwin Cheldin Executive Officer,
(Principal Executive Officer)
/s/ Lester A. Aaron Treasurer, Chief Financial March 24, 2004
- ------------------- Officer and Director
Lester A. Aaron (Principal Accounting and
Principal Financial Officer)
/s/ Cary L. Cheldin Executive Vice President March 24, 2004
- ------------------- and Director
Cary L. Cheldin
/s/ George C. Gilpatrick Vice President, Secretary March 24, 2004
- ------------------------ and Director
George C. Gilpatrick
/s/ David A. Lewis Director March 24, 2004
- ------------------
David A. Lewis
/s/ Warren D. Orloff Director March 24, 2004
- --------------------
Warren D. Orloff
/s/ Donald B. Urfrig Director March 24, 2004
- --------------------
Donald B. Urfrig
64
INDEPENDENT AUDITORS' REPORT
----------------------------
The Board of Directors
Unico American Corporation:
Under date of March 26, 2004, we reported on the consolidated balance sheets of
Unico American Corporation and subsidiaries as of December 31, 2003 and 2002,
and the related consolidated statements of operations, comprehensive income,
changes in stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 2003, as contained in the annual report on
Form 10-K for the year 2003. In connection with our audits of the aforementioned
consolidated financial statements, we also audited the related consolidated
financial statement schedules as listed under Item 15(a)2. These financial
statement schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statement schedules
based on our audits.
In our opinion, such financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
KPMG LLP
Los Angeles, California
March 26, 2004
65
SCHEDULE II
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS - PARENT COMPANY ONLY
December 31 December 31
2003 2002
---- ----
ASSETS
------
Investments
Short-term investments $9,097 $9,062
----- -----
Total Investments 9,097 9,062
Cash 17,119 8,450
Accrued investment and other income 12,000 6,000
Investments in subsidiaries 55,369,327 54,307,296
Property and equipment (net of accumulated depreciation) 323,090 354,194
Income taxes receivable - 1,548,427
Other assets 158,560 137,597
---------- ----------
Total Assets $55,889,193 $56,371,026
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES
- -----------
Accrued expenses and other liabilities $288,340 $332,678
Payables to subsidiaries (net of receivables) (1) 15,015,334 16,879,358
Income taxes payable 614,662 -
Notes Payable - related parties 1,500,000 750,000
---------- ----------
Total Liabilities $17,418,336 $17,962,036
---------- ----------
STOCKHOLDERS' EQUITY
- --------------------
Common stock $2,700,272 $2,700,272
Net unrealized investment gains 2,110,979 3,117,762
Retained earnings 33,659,606 32,590,956
---------- ----------
Total Stockholders' Equity $38,470,857 $38,408,990
---------- ----------
Total Liabilities and Stockholders' Equity $55,889,193 $56,371,026
========== ==========
(1) The Company and its wholly owned subsidiaries file consolidated Federal and
combined California income tax returns. Pursuant to a tax allocation
agreement, Crusader Insurance Company and American Acceptance Corporation
are allocated taxes or (in the case of losses) tax credits at current
corporate rates based on their own taxable income or loss. The payable to
subsidiaries includes their income tax receivable or liability included in
the consolidated return.
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes.
66
SCHEDULE II (continued)
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS - PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31
2003 2002 2001
---- ---- ----
REVENUES
- --------
Net investment income $9,315 $476 $54,764
Net realized investment gains - - 3,212
Other income 15,974 18,706 12,974
------ ------ ------
Total Revenue 25,289 19,182 70,950
EXPENSES
- --------
General and administrative expenses (*) 18,670 16,166 46,146
------ ------ ------
Income before equity in net income of subsidiaries 6,619 3,016 24,804
Equity in net income (loss) of subsidiaries 1,062,031 (3,227,705) (10,894,822)
--------- --------- ----------
Net Income (Loss) $1,068,650 $(3,224,689) $(10,870,018)
========= ========= ==========
(*) In 2001, the parent company transferred most of their employees and the
related salaries, payroll taxes, and administrative expenses directly to
its subsidiaries.
The Company and its subsidiaries file a consolidated federal income tax return.
Unico received cash dividends of $200,000 from American Acceptance Corporation
in the year ended December 31, 2002; $250,000 from American Acceptance
Corporation in the year ended December 31, 2001.
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes.
67
SCHEDULE II (continued)
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS - PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31
2003 2002 2001
---- ---- ----
Cash flows from operating activities: Cash flows from operating activities:
Net income (loss) $1,068,650 $(3,224,689) $(10,870,018)
Adjustments to reconcile net income to net cash
from operations
Undistributed equity in net (income) loss of subsidiaries (1,062,031) 3,227,705 10,894,822
Net realized (gain) on sale of securities - - (3,212)
Depreciation and amortization 89,821 84,951 70,940
Accrued expenses and other liabilities (44,338) (32,111) (708,804)
Accrued investment and other income (6,000) (5,750) 22,002
Income taxes receivable 1,548,427 3,850,512 (5,398,939)
Other assets (20,963) 81,276 (21,576)
--------- --------- ---------
Net cash provided (used) from operations 1,573,566 3,981,894 (6,014,785)
--------- --------- ---------
Cash flows from investing activities
Proceeds from maturity of fixed maturity investments - - 650,000
Proceeds from sale of fixed maturity investments - - 853,055
(Increase) decrease in short-term investments (35) (184) 108,938
Additions to property and equipment (58,717) (171,719) (224,524)
------ ------- ---------
Net cash provided (used) by investing activities (58,752) (171,903) 1,387,469
------ ------- ---------
Cash flows from financing activities
Proceeds from issuance of common stock - 28,857 37
Repurchase of common stock - - (1,387,397)
Proceeds from notes payable - related parties 1,500,000 750,000 -
Repayment of notes payable - related parties (750,000) - -
Dividends paid to shareholders - (274,477) (272,609)
Net change in payables and receivables
from subsidiaries (2,256,145) (4,325,348) 6,290,306
--------- --------- ---------
Net cash provided (used) by financing activities (1,506,145) (3,820,968) 4,630,337
--------- --------- ---------
Net increase (decrease) in cash 8,669 (10,977) 3,021
Cash at beginning of year 8,450 19,427 16,406
----- ------ ------
Cash at end of year $17,119 $8,450 $19,427
====== ===== ======
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes.
68
SCHEDULE III
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
Future
Benefits, Benefits, Amortization
Deferred Losses, Claims, of Deferred
Policy and Loss Net Losses and Policy Other
Acquisition Adjustment Unearned Premium Investment Settlement Acquisition Operating Premium
Cost Expenses Premiums Revenue Income Expenses Costs Costs Written
---- -------- -------- ------- ------ -------- ----- ----- -------
Year Ended
December 31, 2003
Property &
Casualty $8,054,363 $78,139,090 $34,675,180 $37,106,099 $4,801,133 $31,720,533 $7,941,199 $2,418,935 $47,420,157
Year Ended
December 31, 2002
Property &
Casualty $5,947,010 $74,905,284 $24,381,583 $33,359,272 $5,401,870 $32,727,023 $9,274,263 $2,151,332 $38,363,201
Year Ended
December 31, 2001
Property &
Casualty $5,079,535 $60,534,295 $19,328,150 $29,893,844 $5,647,026 $41,677,016 $8,695,037 $1,687,754 $32,106,175
70
EXHIBIT INDEX
-------------
Exhibit
No. Description
-- -----------
3.1 Articles of Incorporation of Registrant, as amended. (Incorporated
herein by reference to Exhibit 3.1 to the Registrant's Annual Report
on Form 10-K for the fiscal year ended March 31, 1984.)
3.2 By-Laws of Registrant, as amended. (Incorporated herein by
reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-K
for the fiscal year ended March 31, 1991.)
10.1 Unico American Corporation Profit Sharing Plan & Trust.
(Incorporated herein by reference to Exhibit 10.1 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
March 31, 1985.) (*)
10.2 The Lease dated July 31, 1986, between Unico American Corporation and
Cheldin Management Company. (Incorporated herein by reference to
Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the
fiscal year ended March 31, 1987.)
10.3 The Lease Amendment #1 dated February 22, 1995, between Unico
American Corporation and Cheldin Management amending the lease dated
July 31, 1986. (Incorporated herein by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year ended
March 31, 1995.)
10.4 2000 Omnibus Stock Plan of Unico American Corporation (Incorporated
herein by reference to Exhibit A to Registrant's Proxy Statement for
its Annual Meeting of Shareholders held June 4, 2000.) (*)
10.5 Employment Agreement between the Company and Cary Cheldin dated
November 27, 1996. (Incorporated herein by reference to Exhibit 10.2
to Registrant's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2000.) (*)
10.6 Amendment to Employment Agreement between the Company and Cary
Cheldin dated January 10, 2000. (Incorporated herein by reference to
Exhibit 10.3 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2000.) (*)
21 Subsidiaries of Registrant. (Incorporated herein by reference to
Exhibit 22 to Registrant's Annual Report on Form 10-K for the fiscal
year ended March 31, 1984.)
23 Consent of Independent Public Accountants - KPMG LLP.
31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(*) Indicates management contract or compensatory plan or arrangement.