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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Fiscal Year Ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Transition Period from__________ to __________
COMMISSION FILE NUMBER: 0-22280
PHILADELPHIA CONSOLIDATED HOLDING CORP.
---------------------------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2202671
------------ ----------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
ONE BALA PLAZA, SUITE 100
BALA CYNWYD, PENNSYLVANIA 19004
------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 617-7900
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
--------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO: [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
YES [ ] NO: |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2) of the Act.
YES [X] NO: [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on March 26,
2003 as reported on the NASDAQ National Market System, was $405,367,423.
Shares of Common Stock held by each executive officer and director and by each
person who is known by the Registrant to beneficially own 5% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of March 26, 2003, Registrant had outstanding 21,857,806 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the definitive Proxy Statement for Registrant's 2003 Annual
Meeting of Shareholders to be held May 1, 2003 are incorporated by
reference in Part III.
1
PART I
Item 1. BUSINESS
GENERAL
As used in this Annual Report on Form 10-K, (i) "Philadelphia
Insurance" refers to Philadelphia Consolidated Holding Corp., (ii) the "Company"
refers to Philadelphia Insurance and its subsidiaries, doing business as
Philadelphia Insurance Companies; (iii) the "Insurance Subsidiaries" refers to
Philadelphia Indemnity Insurance Company ("PIIC"), Philadelphia Insurance
Company ("PIC"), Mobile USA Insurance Company ("MUSA") and Liberty American
Insurance Company ("LAIC"), collectively; (iv) "MIA" refers to Maguire Insurance
Agency, Inc., a captive underwriting manager; (v) "MHIA" refers to Mobile
Homeowners Insurance Agencies, Inc., a managing general agency; (vi) "Premium
Finance" refers to Liberty American Premium Finance Company; and (vii) "PCHC
Investment" refers to PCHC Investment Corp., an investment holding company.
Philadelphia Insurance was incorporated in Pennsylvania in 1984, as an insurance
holding company. Liberty American Insurance Group, Inc., a Delaware insurance
holding company, and its subsidiaries of MUSA, LAIC, MHIA and Premium Finance,
are sometimes referred to herein collectively as "Liberty".
During 2002, the Company continued its growth through adherence to its
core philosophies of specialization, mixed marketing and profitable
underwriting. 2002 gross written premiums increased 40.1% to $663.7 million.
Premium growth was primarily attributable to the Company capitalizing on recent
turmoil in the property and casualty market. The turmoil created a general
environment of rate increases and conservative risk selection in the
marketplace. The Company's GAAP basis combined ratio (the sum of the net loss
and loss adjustment expenses and acquisition costs and other underwriting
expenses divided by net earned premiums) was 94.3%, which was substantially
lower than the property and casualty industry as a whole. Total assets increased
to $1.4 billion, and shareholders' equity increased to $477.8 million.
INDUSTRY TRENDS
During the 1990s and into 2000, the insurance industry maintained
excess capacity, creating highly competitive market conditions, as evidenced by
declining premium rates and, in many cases, policy terms less favorable to the
insurer. As a result, the industry suffered from reduced profitability and a
contraction of capacity as insurers chose or were forced to exit the
marketplace. Subsequently, a tumultus environment has emerged in the property
and casualty insurance industry in large part due to: the significant losses
caused by the terrorists events of September 11, 2001; continued rating
downgrades and insolvencies; and lower interest rates resulting in reduced
investment income. These factors have resulted in a general environment of rate
increases and conservative risk selection. Industry participants expect rate
increases and improving terms will continue possibly for an extended period of
time. Increased reinsurance costs, to some extent, offset the benefits of these
trends to the Company and to insurance companies in general.
During 2002, the Company' rate increases on renewal business
approximated 16.0%, 26.0% and 8.0% for the commercial, specialty and personal
lines segments, respectively. There can be no assurance, however, that these
favorable trends will continue or that these rate increases can be sustained.
BUSINESS OVERVIEW AND STRATEGY
The Company designs, markets and underwrites specialty commercial and
personal property and casualty insurance products incorporating value-added
coverages and services for select target markets or niches. Insurance products
are distributed through a diverse multichannel delivery system centered around
the Company's direct production underwriting organization. A select group of 85
"preferred agents" and a broader network of approximately 6,000 independent
agents supplement the production underwriting organization, which consisted of
172 professionals located in 36 regional and field offices across the United
States as of December 31, 2002.
The Company's commercial products include commercial multi-peril
package insurance targeting specialized niches, including, among others,
non-profit organizations, health and fitness organizations, homeowners'
associations, condominium associations, specialty schools and day care
facilities; commercial automobile insurance targeting the leasing and rent-a-car
industries; property insurance for large commercial accounts such as shopping
centers, business parks and medical facilities; and inland marine products
targeting larger risks such as new builders' risk and miscellaneous property
floaters.
2
The Company also writes select classes of professional liability and
directors' and officers' liability products, as well as personal property and
casualty products for the manufactured housing and homeowners' markets.
The Company maintains detailed systems, records and databases that
enable the continuous monitoring of its book of business in order to identify
and react swiftly to positive or negative developments and trends. The Company
is able to track performance, including loss ratios, by segment, product,
region, state, producer and policyholder. Detailed profitability reports are
produced and reviewed on a routine, primarily monthly, basis as part of the
policy of regularly analyzing and reviewing the Company's book of business.
The Company maintains a local presence to more effectively serve its
producer and customer base, operating through 10 regional offices and 26 field
offices throughout the country, which report to the regional offices. These
offices are staffed with field underwriters, marketers and, in some cases, claim
personnel, which interact closely with home office management in making key
decisions. This approach allows the Company to adapt its underwriting and
marketing strategies to local conditions and build value added relationships
with its customers and producers.
The Company selects and targets industries and niches that present
specialized areas of expertise where it believes it can grow business through
creatively developing insurance products with innovative features specially
designed to meet those areas of demand. The Company believes that these features
are not included in typical property and casualty policies, enabling it to
compete based on the unique or customized nature of the coverage provided.
Business Segments
The Company's operations are classified into three reportable business
segments:
- Commercial Lines Underwriting Group, which has underwriting
responsibility for the commercial multi-peril package,
commercial automobile and specialty property and inland marine
insurance products;
- Specialty Lines Underwriting Group, which has underwriting
responsibility for the professional liability and directors'
and officers' liability insurance products; and
- Personal Lines Underwriting Group, which has underwriting
responsibility for personal property and casualty insurance
products for the manufactured housing and homeowners' markets.
The following table sets forth, for the years ended December 31, 2002,
2001 and 2000, the gross written premiums for each of the Company's business
segments and the relative percentages that such premiums represented.
For the Years Ended December 31,
-------------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
Dollars Percentage Dollars Percentage Dollars Percentage
------- ---------- ------- ---------- ------- ----------
(dollars in thousands)
Commercial Lines............... $ 473,984 71.4% $ 315,948 66.7% $ 239,446 66.2%
Specialty Lines................ 109,292 16.5 79,317 16.7 68,193 18.8
Personal Lines................. 80,463 12.1 78,300 16.6 54,233 15.0
---------- ----- ---------- ----- ---------- -----
Total.......................... $ 663,739 100.0% $ 473,565 100.0% $ 361,872 100.0%
========== ===== ========== ===== ========== =====
Commercial Lines:
Commercial Package: The Company has provided commercial multi-peril
package policies to targeted niche markets for over 15 years. The primary
customers for these policies include:
- non-profit and social service organizations;
- health and fitness organizations;
- homeowners' associations;
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- condominium associations;
- specialty schools;
- boat dealerships;
- mobile home parks; and
- day care facilities.
The package policies provide a combination of comprehensive liability,
property and automobile coverage with limits up to $1.0 million for casualty,
$50.0 million for property, and umbrella limits on an optional basis up to $10.0
million. The Company believes its ability to provide professional liability,
general liability and directors' and officers' coverages in one policy is
advantageous and convenient to producers and policyholders.
Commercial Automobile and Commercial Excess: The Company has provided
primary, excess, contingent, interim and garage liability; physical damage;
property; and Guaranteed Asset Protection (GAP) to targeted markets for over 35
years. The primary customers for these policies include:
- rental car companies
- leasing companies
- banks
- credit unions
Specialty Property & Inland Marine: The Company has provided property
and inland marine coverage to targeted markets for the past 5 years. The primary
customers for these policies include:
- shopping centers
- business parks
- medical facilities
- hotels and motels
- new construction (inland marine)
Specialty Lines:
The Company has provided error and omissions (professional) and
directors and officers (D&O) liability to targeted classes of business for
approximately 14 years. The professional liability products provide errors and
omissions coverage primarily for:
- lawyers
- accountants
- miscellaneous (marketing, management, computer, marriage/family
counseling) consultants
The directors' and officers' product, with an emphasis on non-profit
institutions and private companies are offered to:
- non-profit (501(c)(3) companies)
- for-profit - public and private companies.
Personal Lines:
The Company entered the personal lines property and casualty business
through the acquisition of Liberty American Insurance Group, Inc. in 1999.
Through Liberty as the personal lines platform, specialized manufactured housing
and homeowners' property and casualty business is produced and underwritten,
principally in Florida, and to a lesser extent, in California, Arizona and
Nevada. The Company also writes and services federal flood insurance under the
National Flood Insurance Program for both personal and commercial policyholders.
Products offered include manufactured housing insurance for senior
citizen retirees in "preferred" parks, a program for newly constructed
manufactured homes on private property; and a preferred homeowners' program that
targets newer homes valued between $100,000 and $250,000 in gated retiree
communities. In coastal counties in Florida a homeowners'
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program is also offered that excludes wind exposure. The Citizens Property
Insurance Corporation insures the wind exposure on these risks.
Geographic Distribution
The following table provides the geographic distribution of the
Company's risks insured as represented by direct earned premiums for all
reportable business segments for the year ended December 31, 2002. No other
state accounted for more than 2% of total direct earned premiums for all product
lines for the year ended December 31, 2002 (dollars in thousands).
State Direct Earned Premiums Percent of Total
----- ---------------------- ----------------
Florida............................. $ 125,000 22.7%
California.......................... 60,677 11.0
New York............................ 40,328 7.3
Texas............................... 27,607 5.0
Pennsylvania........................ 23,407 4.3
Ohio................................ 22,594 4.1
Illinois............................ 22,575 4.1
New Jersey.......................... 20,623 3.7
Massachusetts....................... 19,092 3.5
Other............................... 188,540 34.3
--------- -----
Total Direct Earned Premiums........ $ 550,443 100.0%
========= =====
See Note 18 to the Company's financial statements included with this Form 10-K
for information concerning the revenues, net income and assets of the Company's
business segments.
Underwriting and Pricing
The Company's business segments are organized around its three
underwriting divisions: Commercial Lines, Specialty Lines, and Personal Lines.
Each underwriting division's responsibilities include: pricing, managing the
risk selection process, and monitoring loss ratios by product and insured.
The Company attempts to adhere to conservative underwriting and pricing
practices. The Company's underwriting strategy is detailed in a document which
is signed by each underwriting professional. Written underwriting guidelines are
maintained, and updated regularly, for all classes of business underwritten.
Adherence to underwriting guidelines is maintained through underwriting audits
conducted by the Company. Product price levels are measured utilizing a price
monitoring system which measures the aggregate price level of the book of
business. This system is intended to assist management and underwriters in
promptly recognizing and correcting price deterioration. When necessary, the
Company is willing to re-underwrite, sharply curtail or discontinue a product
deemed to present unacceptable risks.
The Commercial Lines Underwriting Group has underwriting responsibility
for the Company's commercial multi-peril package, commercial automobile and
large property and inland marine products. The Group currently consists of 38
home office and 38 regional office underwriters that are supported by
underwriting assistants, raters, and other policy administration personnel. The
Commercial Lines home office underwriting unit is responsible for underwriting,
auditing, servicing renewal business and authority referral for the regional
underwriters. The regional office underwriters have the responsibility for
pricing, underwriting, and policy issuance for new business. The underwriting
unit is under the direction of Underwriter Managers who report to the Vice
President of Commercial Lines Underwriting. The overall management of the book
of business resides in the home office with the senior underwriting officers.
The Company believes that its ability to deliver excellent service and build
long lasting relationships is enhanced through its management structure.
The Specialty Lines Underwriting Group has the underwriting
responsibility for the errors and omissions and directors and officers liability
products. The Group consists of 16 home office underwriters and underwriter
trainees and 21 regional underwriters. These underwriters and underwriter
trainees are supported by underwriting assistants, and other policy
administration personnel. The home office underwriting unit is responsible for
underwriting, auditing, servicing renewal business and authority referral for
the regional underwriters. The regional office underwriters have the
responsibility for pricing, underwriting, and policy issuance for new business.
The Specialty Lines Group is managed by three Assistant Vice Presidents who
report to the Chief Underwriting Officer.
5
The Personal Lines Underwriting Group is located in Pinellas Park,
Florida. The underwriting staff consists of 14 professionals who are under the
direction of the Personal Lines Underwriting Vice President. Much of the
underwriting function is automated by rating software and internet access. The
underwriting guidelines are embedded within the program and will not allow
binding of accounts if a risk does not meet the presented underwriting
guidelines. The Company has a proactive exposure distribution management system
in place to assure portfolio optimization. This is managed on a zip code level
basis through in-house software and external modeling tools. The Company
inspects all risks on its new preferred homeowners program and manufactured
homes on private property.
The Company uses a combination of Insurance Services Office, Inc.
("ISO") coverage forms and rates and independently filed forms and rates.
Coverage forms and rates are independently developed in situations where the
line of business is not supported by ISO or where management believes the ISO
forms and rates do not adequately address the risk. Departures from ISO forms
are also used to differentiate the Company's products from its competitors'
products and are independently filed.
Reinsurance
The Company has entered into various reinsurance agreements for the
purpose of limiting loss exposure and diversifying business. The Company's
casualty excess of loss reinsurance agreement provides that the Company bears
the first $1.0 million layer of liability on each occurrence. Casualty,
Fidelity, professional liability and/or fiduciary liabilty risks in excess of
$1.0 million up to $11.0 million are reinsured under a casualty treaty ("Excess
Treaty") placed through a reinsurance broker with Converium Reinsurance North
America Inc., American Reinsurance Company, Endurance Specialty Insurance LTD,
and Liberty Mutual Insurance Company, with a pro rata participation of 35%, 25%,
20% and 20%, respectively. Facultative reinsurance (reinsurance which is
provided on an individual risk basis) is placed for each casualty risk in excess
of $11.0 million.
The Company's property excess of loss reinsurance treaty provides that
the Company bears the first $2.0 million layer of loss on each risk with the
reinsurers (General Reinsurance Corporation and Swiss Reinsurance American
Corporation) bearing the next layer of loss up to $15.0 million on each risk.
The Company also has an automatic facultative excess of loss cover with General
Reinsurance Corporation for each property risk in excess of $15.0 million up to
$50.0 million. To mitigate potential exposures to losses arising from terrorist
acts, the Company has purchased per risk reinsurance coverage for terrorism with
a $13.0 million aggregate policy limit for 2003. Under this reinsurance coverage
the Company bears the first $2.0 million layer of loss on each risk and
coverage. Additionally, the Company has property catastrophe reinsurance for its
commercial and personal property books of business under which the Company bears
the first $5.0 million in catastrophe losses per event, with the reinsurers
bearing the next $316.5 million. Based upon the various modeling methods
utilized by the Company to estimate its probable maximum loss, the Company
currently maintains catastrophe reinsurance coverage for the 250 year storm
event on personal lines business.
During 2002 the Company increased unpaid loss and loss adjustment
expense ceded to one of the Company's reinsurers as a result of adverse changes
of insured events in prior years for residual value policies utilizing the
remaining reinsurance limit available to the Company under a combined
reinsurance contract. The combined coverage reinsurance contract provided a 2002
accident year aggregate stop loss cover which had not been utilized by the
Company, reinsurance coverage for the residual value line of business, and $10.0
million excess $5.0 million catastrophe property reinsurance coverage. The
Company continues to maintain $306.5 million excess $15.0 million catastrophe
property reinsurance on its personal lines business.
The Company also has an excess casualty reinsurance agreement which
provides an additional $5.0 million of coverage for protection from exposures
such as extra-contractual obligations and judgments in excess of policy limits.
Additionally, an errors and omissions insurance policy provides an additional
$10.0 million of coverage with respect to these exposures.
The Company seeks to limit the risk of a reinsurer's default in a
number of ways. First, the Company principally contracts with large reinsurers
that are rated at least "A" (Excellent) by A.M. Best. Second, the Company seeks
to collect the obligations of its reinsurers on a timely basis. This collection
effort is supported through the regular monitoring of reinsurance receivables.
Finally, the Company typically does not write casualty policies in excess of
$11.0 million or property policies in excess of $25.0 million. Although
reinsurance makes the reinsurer liable, to the extent the risk is transferred,
it doesn't relieve the Company of its liability to policyholders.
6
The Company regularly assesses its reinsurance needs and seeks to
improve the terms of its reinsurance arrangements as market conditions permit.
Such improvements may involve increases in retentions, modifications in premium
rates, changes in reinsurers and other matters.
Marketing and Distribution
Proactive risk selection based on sound underwriting criteria and
relationship selling in clearly defined target markets continues to be the
foundation of the Company's marketing plan. Within this framework, the Company's
marketing effort is designed to assure a systematic and disciplined approach to
developing business which is anticipated to be profitable.
The Company distributes its products through its direct production
underwriting organization, an extensive network of approximately 6,000
independent brokers and its "preferred agent" program. The Company's most
important distribution channel is its production underwriting organization.
Although the Company has always written business directly, the production
underwriting organization was established by the Company to coordinate its
direct sales efforts as well as act as the interface with the Company's external
producers. The production underwriting organization is currently comprised of
172 professionals located in 36 offices in major markets across the country. The
field offices are focused daily on interacting with prospective and existing
insureds. In addition to this direct marketing, relationships with approximately
6,000 brokers have been formed either because the broker has a preexisting
relationship with the insured or has sought the Company's expertise in one of
its specialty products. This mixed marketing concept provides the Company with
the flexibility to respond to changing market conditions and, when appropriate,
shift its emphasis between direct and indirect marketing approaches to take
advantage of opportunities as they arise. In addition, the production
underwriting organization's ability to gather market intelligence enables the
rapid identification of soft markets and redeployment to firmer markets, from a
product line or geographic perspective. The Company believes that its mixed
marketing platform provides a competitive edge in stable market conditions, the
strengths of which are all the more evident during periods of dislocation or
consolidation.
The Company's preferred agent program, in which business relationships
are formed with brokers specializing in certain of the Company's business
niches, consisted of 85 preferred agents at year-end 2002. Preferred Agents are
identified by the Company based on productivity and loss experience and receive
additional benefits from the Company in exchange for meeting defined production
and profitability criteria.
The Company supplements its marketing efforts through affinity
programs, trade shows, direct mailings and national advertisements placed in
trade magazines serving industries in which the Company specializes, as well as
links to industry web sites. The Company has also enhanced its marketing with
Internet-based initiatives such as the Personal Lines Division's "Liberty
American In Touch(SM)" real-time policy inquiry system which allows agents to
view account data, process non-dollar endorsements, rate, quote and issue a
policy over the Internet.
Product Development
The Company continually evaluates new product opportunities, consistent
with its strategic focus on selected market niches. Direct contacts between the
Company's field and home office personnel and its customers have produced a
number of new product ideas. All new product ideas are presented to the Product
Development Committee for consideration. Such Committee, currently composed of
the Company's President and Senior Management, meets regularly to review the
feasibility of products from a variety of perspectives, including underwriting
risk, marketing and distribution, reinsurance, long-term viability and
consistency with the Company's culture and philosophy. For each new product, an
individualized test market plan is prepared, addressing such matters as the
appropriate distribution channel (e.g., a limited number of selected production
underwriters), an appropriate cap on premiums to be generated during the test
market phase and reinsurance requirements for the test market phase. Test market
products may involve lower retentions than customarily utilized. After a new
product is approved for test marketing, the Company monitors its success based
on specified criteria (e.g., underwriting results, sales success, product demand
and competitive pressures). If expectations are not realized, the Company either
moves to improve results by initiating adjustments or abandons the product.
Claims Management and Administration
In accordance with its emphasis on underwriting profitability, the
Company actively manages claims under its policies in an effort to investigate
reported incidents at an early stage, service insureds and reduce fraud. Claim
files are regularly audited by claims supervisors in an attempt to ensure that
claims are being processed properly and that reserves are being set at
appropriate levels.
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The Company's experienced staff of claims management professionals are
assigned to dedicated claim units within specific niche markets. Each of these
units receive supervisory direction and news, legislative and product
development updates from the unit director. Claims management personnel have an
average of approximately twenty years of experience in the industry. The
dedicated claim units meet regularly to communicate findings of change within
their assigned specialty. Staff within the dedicated claim units have an average
of ten years experience in the industry.
The claims department also maintains a Special Investigations Unit to
investigate suspicious claims and to serve as a clearinghouse for information
concerning fraudulent practices, primarily within the rental car industry. The
Special Investigations Unit Works closely with a variety of industry contacts,
including attorneys, investigators and rental car company fraud units to
identify fraudulent claims.
Loss and Loss Adjustment Expenses
The Company is liable for losses and loss adjustment expenses under its
insurance policies and reinsurance treaties. While the Company's professional
liability policies are written on claims-made forms and while claims on its
other policies are generally reported promptly after the occurrence of an
insured loss, in many cases several years may elapse between the occurrence of
an insured loss, the reporting of the loss to the Company and the Company's
payment of the loss. The Company reflects its liability for the ultimate payment
of all incurred losses and loss adjustment expenses by establishing loss and
loss adjustment expense reserves, which are balance sheet liabilities
representing estimates of future amounts needed to pay claims and related
expenses with respect to insured events that have occurred.
When a claim involving a probable loss is reported, the Company
establishes a case reserve for the estimated amount of the Company's ultimate
loss and loss adjustment expense. This estimate reflects an informed judgment,
based on the Company's reserving practices and the experience of the Company's
claims staff. Management also establishes reserves on an aggregate basis to
provide for losses incurred but not reported ("IBNR"), as well as future
development on claims reported to the Company.
As part of the reserving process, historical data are reviewed and
consideration is given to the anticipated effect of various factors, including
known and anticipated legal developments, changes in societal attitudes,
inflation and economic conditions. Reserve amounts are necessarily based on
management's estimates and judgments; as new data become available and are
reviewed, these estimates and judgments are revised, resulting in increases or
decreases to existing reserves. The Insurance Subsidiaries obtain an annual
statement of opinion from an independent actuary for its statutory filings with
regulators.
The following table sets forth a reconciliation of beginning and ending
reserves for unpaid loss and loss adjustment expenses, net of amounts for
reinsured losses and loss adjustment expenses, for the years indicated.
As of and For the Years Ended December 31,
------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars in Thousands)
Unpaid loss and loss adjustment expenses at
beginning of year... .......................................... $ 250,134 $ 195,464 $ 161,353
---------- ---------- ----------
Provision for losses and loss adjustment expenses for current
year claims.................................................... 239,834 166,220 128,761
Increase (Decrease) in estimated ultimate losses and loss
adjustment expenses for prior year claims ......................... 27,599 13,435 2,543
---------- ---------- ----------
Total incurred losses and loss adjustment expenses................. 267,433 179,655 131,304
---------- ---------- ----------
Loss and loss adjustment expense payments for claims
attributable to:
Current year................................................... 58,530 54,228 36,271
Prior years.................................................... 99,326 70,757 60,922
---------- ---------- ----------
Total payments..................................................... 157,856 124,985 97,193
---------- ---------- ----------
Unpaid loss and loss adjustment expenses at end of year (1)........ $ 359,711 $ 250,134 $ 195,464
========== ========== ==========
(1) Unpaid loss and loss adjustment expenses differ from the amounts
reported in the Consolidated Financial Statements because of the
inclusion therein of reinsurance receivables of $85,837, $52,599 and
$42,030 at December 31, 2002, 2001 and 2000, respectively.
8
During 2002 the Company increased the liability for unpaid loss and loss
adjustment expenses by $68.0 million ($27.6 million net of reinsurance
recoverables), primarily for accident years 1997 through 2001. This increase in
the liability for unpaid loss and loss adjustment expense, net of reinsurance
recoverables was primarily due to the following:
-- The Company increased the estimated loss for unreported claims incurred
and related claim adjustment expenses on residual value polices issued
during the years 1998 through 2001 by $30.2 million ($20.7 million net
of reinsurance recoverables). As of December 31, 2001 the Company had
estimated a total liability for unpaid loss and loss adjustment
expenses for these policies of $14.5 million ($8.7 million net of
reinsurance recoverables). The residual value policies provide coverage
guaranteeing the value of a leased automobile at the lease termination
which can be up to five years from lease inception. During 2002 adverse
trends further deteriorated in both frequency and severity on leases
expiring in 2002. As part of the Company's monitoring and evaluation
process, consulting firms were engaged during the third quarter of 2002
to aid in evaluating this deterioration and the ultimate potential loss
exposure under these policies. As a result of the indications and
subsequent evaluation by the Company and changes in the Company's
assumptions relating to future frequency and severity of losses, the
estimate for unpaid loss and loss adjustment expenses was increased.
The Company primarily attributes this deterioration to the following
factors that led to a softening of prices in the used car market
subsequent to the September 11, 2001 terrorist attacks: prolonged 0%
new car financing rates and other incentives which increased new car
sales and the volume of trade-ins, daily rental units being sold into
the market earlier and in greater numbers than expected further adding
to the over supply of used cars; and the overall uncertain economic
conditions.
-- The Company also increased the liability for unpaid loss and loss
adjustment expenses on the Commercial Automobile Excess Liability
Insurance ("Excess Liability") product sold to rental car companies
(Commercial Lines Underwriting Segment), primarily for the 2000 and
2001 accident years, by $6.9 million ($4.9 million net of reinsurance).
As of December 31, 2001 the Company had estimated a total liability for
unpaid loss and loss adjustment expenses for the Excess Liability
policies issued in these years of $23.0 million ($21.6 million net of
reinsurance). Excess Liability provides automobile liability coverage
in excess of the state mandated limits which are provided by the rental
car company. During the third quarter of 2002, pursuant to a routine
underwriting review focusing on price adequacy and loss experience, the
Company non-renewed a significant Excess Liability customer as a result
of an unacceptable underwriting risk profile. This adverse loss
development was primarily due to pricing inadequacy and the adverse
loss experience of this customer. Additionally, the Company has
experienced a delay in both the reporting of claims and the claim
litigation discovery process as a result of this policyholder and
another Excess Liability policyholder filing for Chapter 11 during the
third quarter 2002 and fourth quarter 2001, respectively.
During 2001, as a result of changes in estimates of insured events in
prior years, the Company increased losses and loss adjustment expenses incurred
by $13.4 million. Such development was primarily due to losses emerging at a
higher rate on automobile leases expiring in 2001 on residual value policies
underwritten in prior years than had been originally anticipated when the
initial reserves were estimated.
The following table presents the development of unpaid loss and loss
adjustment expenses, net of amounts for reinsured losses and loss adjustment
expenses, from 1992 through 2002. The top line of the table shows the estimated
reserve for unpaid loss and loss adjustment expenses at the balance sheet date
for each of the indicated years. These figures represent the estimated amount of
unpaid loss and loss adjustment expenses for claims arising in the current year
and all prior years that were unpaid at the balance sheet date, including IBNR
losses. The table also shows the re-estimated amount of the previously recorded
unpaid loss and loss adjustment expenses based on experience as of the end of
each succeeding year. The estimate changes as more information becomes known
about the frequency and severity of claims for individual years.
9
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
(Dollars in Thousands)
1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ----
UNPAID LOSS AND LOSS
ADJUSTMENT EXPENSES, AS
STATED $ 31,981 $ 38,714 $ 53,595 $ 68,246 $ 85,723 $ 108,928
Cumulative Paid as of:
1 year later 9,865 10,792 12,391 15,214 22,292 26,870
2 years later 16,290 19,297 23,139 31,410 38,848 56,488
3 years later 21,253 24,991 33,511 40,637 52,108 80,206
4 years later 24,299 28,903 38,461 47,994 63,738 95,047
5 years later 25,793 30,558 42,366 51,806 69,116 99,755
6 years later 26,321 32,748 43,860 53,198 70,779
7 years later 27,252 32,929 44,243 53,701
8 years later 27,336 33,102 44,627
9 years later 27,288 33,721
10 years later 27,624
Unpaid Loss and Loss Adjustment Expenses
re-estimated as of End of Year:
1 year later 30,538 38,603 52,670 67,281 84,007 105,759
2 years later 30,428 38,016 52,062 66,061 81,503 103,513
3 years later 29,648 37,184 51,149 63,872 76,348 104,712
4 years later 29,306 36,272 49,805 59,085 73,992 109,061
5 years later 28,553 35,783 47,366 56,673 75,672 107,796
6 years later 28,370 34,509 45,797 55,861 74,645
7 years later 27,959 33,799 45,245 55,439
8 years later 27,724 33,695 44,878
9 years later 27,623 33,622
10 years later 27,623
Cumulative Redundancy (Deficiency)
Dollars $ 4,358 $ 5,092 $ 8,717 $ 12,807 $ 11,078 $ 1,132
Percentage 13.6% 13.2% 16.3% 18.8% 12.9% 1.0%
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
(Dollars in Thousands)
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
UNPAID LOSS AND LOSS
ADJUSTMENT EXPENSES, AS
STATED $ 136,237 $ 161,353 $ 195,464 $ 250,134 $ 359,711
Cumulative Paid as of:
1 year later 43,769 60,922 70,757 99,325
2 years later 84,048 109,092 131,649
3 years later 115,900 144,435
4 years later 131,062
5 years later
6 years later
7 years later
8 years later
9 years later
10 years later
Unpaid Loss and Loss Adjustment Expenses
re-estimated as of End of Year:
1 year later 135,984 163,896 208,899 277,733
2 years later 138,245 177,782 232,582
3 years later 146,679 196,735
4 years later 151,077
5 years later
6 years later
7 years later
8 years later
9 years later
10 years later
Cumulative Redundancy (Deficiency)
Dollars $ (14,840) $ (35,382) $ (37,118) $ (27,599)
Percentage (10.9)% (21.9)% (19.0)% (11.0)%
(1) Unpaid loss and loss adjustment expenses differ from the amounts reported
in the Consolidated Financial Statements because of the inclusion therein
of reinsurance receivables of $85,837, $52,599, $42,030, $26,710, $16,120,
$13,502, $10,919, $9,440, $5,580, $5,539, and $1,770 at December 31, 2002,
2001, 2000, 1999, 1998, 1997, 1996, 1995, 1994, 1993, and 1992,
respectively.
(2) 1998 Unpaid Loss and Loss Adjustment Expenses, as stated, adjusted to
include $1,207 unpaid loss and loss adjustment expenses for Mobile USA
Insurance Company as of acquisition date.
(3) The Company maintains its historical loss records net of reinsurance, and
therefore is unable to conform the presentation of this table to the
financial statements.
10
The cumulative redundancy (deficiency) represents the aggregate change
in the reserve estimated over all prior years, and does not present accident
year loss development. Therefore, each amount in the table includes the effects
of changes in reserves for all prior years.
The unpaid loss and loss adjustment expense of the Insurance
Subsidiaries, as reported in their Annual Statements prepared in accordance with
statutory accounting practices and filed with state insurance departments,
differ from those reflected in the Company's financial statements prepared in
accordance with generally accepted accounting principles ("GAAP") with respect
to recording the effects of reinsurance. Unpaid loss and loss adjustment
expenses under statutory accounting practices are reported net of the effects of
reinsurance whereas under GAAP these amounts are reported without giving effect
to reinsurance. Under GAAP, reinsurance receivables, with a corresponding
increase in unpaid loss and loss adjustment expense, have been recorded. (See
footnote (1) on Page 10 for amounts). There is no effect on net income or
shareholders' equity due to the difference in reporting the effects of
reinsurance between statutory accounting practices and GAAP as discussed above.
Operating Ratios
Statutory Combined Ratio
The statutory combined ratio, which is the sum of (a) the ratio of loss
and loss adjustment expenses incurred to net earned premiums (loss ratio) and
(b) the ratio of policy acquisition costs and other underwriting expenses to net
written premiums (expense ratio), is the traditional measure of underwriting
experience for insurance companies. Generally, if the combined ratio is below
100%, an insurance company has an underwriting profit, and if it is above 100%,
the insurer has an underwriting loss.
The following table reflects the consolidated loss, expense and
combined ratios of the Insurance Subsidiaries, together with the property and
casualty industry-wide combined ratios after policyholders' dividends.
For the Years Ended December 31,
-------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Loss Ratio ................................................. 63.5% 60.7% 57.8% 59.7% 54.1%
Expense Ratio............................................... 28.0% 31.2% 31.3% 33.6% 31.0%
----- ----- ----- ----- -----
Combined Ratio.............................................. 91.5% 91.9% 89.1% 93.3% 85.1%
===== ===== ===== ===== =====
Industry Statutory Combined Ratio after Policyholders
Dividends................................................. 105.7% 116.0% 110.1% 107.8% 105.6%
===== ===== ===== ===== =====
(1) (2) (2) (2) (2)
(1) Source: Best's Review/Preview PC January 2003 (Estimated 2002).
(2) Source: Best's Review/Preview PC January 2003
Premium-to-Surplus Ratio:
While there are no statutory provisions governing premium-to-surplus
ratios, regulatory authorities regard this ratio as an important indicator as to
an insurer's ability to withstand abnormal loss experience. Guidelines
established by the National Association of Insurance Commissioners (the "NAIC")
provide that an insurer's net premium-to-surplus ratio is satisfactory if it is
below 3 to 1.
The following table sets forth, for the periods indicated, net written
premiums to surplus as regards policyholders' for the Insurance Subsidiaries
(statutory basis):
As of and For the Years Ended December 31,
---------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ---------- ----------- -----------
(Dollars in Thousands)
Net Written Premiums.................... $ 523,962 $ 333,817 $ 263,637 $ 195,258 $ 143,036
Surplus as regards Policyholders........ $ 312,626 $ 280,960 $ 193,292 $ 179,341 $ 152,336
Premium to Surplus Ratio................ 1.7 to 1.0 1.2 to 1.0 1.4 to 1.0 1.1 to 1.0 1.0 to 1.0
11
Investments
The Company's investment objective is the realization of relatively
high levels of investment income while generating competitive after-tax total
rates of return within a prudent level of risk and within the constraints of
maintaining adequate securities in amount and duration to meet cash requirements
of current operations and long-term liabilities, as well as maintaining and
improving the Company's A.M. Best and Standard & Poor's ratings. The Company
utilizes professional investment managers for its fixed maturity and equity
investments, which consist of diversified issuers and issues.
At December 31, 2002, the Company had total investments with a carrying
value of $908.9 million, and 94.0% of the Company's total investments were fixed
maturity securities, including U.S. treasury securities and obligations of U.S.
government corporations and agencies, obligations of states and political
subdivisions, corporate debt securities, collateralized mortgage securities and
asset backed securities, with an average rating of "AA+". The collateralized
mortgage securities and asset backed securities consist of shorter tranche
securities possessing favorable pre-payment risk profiles. The remaining 6.0% of
the Company's total investments consisted primarily of publicly-traded common
stocks.
The following table sets forth information concerning the composition
of the Company's total investments at December 31, 2002:
Estimated Percent of
Market Carrying Carrying
Amortized Cost Value Value Value
-------------- ----- ----- -----
(Dollars in Thousands)
Fixed Maturities:
Obligations of States and Political
Subdivisions...................................... $279,397 $289,990 $289,990 31.9%
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies......................... 9,754 10,186 10,186 1.1
Corporate and Bank Debt Securities.................. 170,222 177,586 177,586 19.5
Collateralized Mortgage Securities.................. 89,189 90,689 90,689 10.0
Asset Backed Securities............................. 284,139 286,062 286,062 31.5
Equity Securities...................................... 51,257 54,346 54,346 6.0
-------- -------- -------- -----
Total Investments................................ $883,958 $908,859 $908,859 100.0%
======== ======== ======== =====
At December 31, 2002, approximately 98.9% of the Insurance
Subsidiaries' fixed maturity securities (cost basis) consisted of U.S.
government securities or securities rated "1" "highest quality" or "2" "high
quality" by the NAIC.
The cost and estimated market value of fixed maturity securities at
December 31, 2002, by remaining original contractual maturity, are set forth
below. Expected maturities may differ from contractual maturities because
certain borrowers have the right to call or prepay obligations, with or without
call or prepayment penalties:
Amortized Cost Estimated Market Value
-------------- ----------------------
(Dollars in Thousands)
Due in one year or less......................................... $ 23,078 $ 23,487
Due after one year through five years........................... 207,741 214,467
Due after five years through ten years.......................... 89,820 95,295
Due after ten years............................................. 138,734 144,513
Collateralized Mortgage and Asset Backed Securities............. 373,328 376,751
---------- ----------
Total..................................................... $ 832,701 $ 854,513
========== ==========
Investments of the Insurance Subsidiaries must comply with applicable
laws and regulations which prescribe the type, quality and diversification of
investments. In general, these laws and regulations permit investments, within
specified limits and subject to certain qualifications, in federal, state and
municipal obligations, corporate bonds, preferred and common equity securities,
real estate mortgages and real estate.
12
Regulation
General: The Company is subject to extensive supervision and regulation
in the states in which it operates. The supervision and regulation relate to
numerous aspects of the Company's business and financial condition. The primary
purpose of the supervision and regulation is the protection of insurance
policyholders and not the Company's investors. The extent of regulation varies
but generally is governed by state statutes. These statutes delegate regulatory,
supervisory and administrative authority to state insurance departments. This
system of regulation covers, among other things:
- issuance, renewal, suspension and revocation of licenses to engage
in the insurance business;
- standards of solvency, including risk-based capital measurements;
- restrictions on the nature, quality and concentration of
investments;
- restrictions on the types of terms that the Company can include in
the insurance policies it offers;
- certain required methods of accounting;
- maintenance of reserves for unearned premiums, losses and other
purposes; and
- potential assessments for the provision of funds necessary for the
settlement of covered claims under certain insurance policies
provided by impaired, insolvent or failed insurance companies.
The regulations or the state insurance departments may affect the cost
or demand for the Company's products and may present impediments to obtaining
rate increases or taking other actions to increase profitability. Also,
regulatory authorities have relatively broad discretion to grant, renew or
revoke licenses and approvals. If the Company does not have the requisite
licenses and approvals or does not comply with applicable regulatory
requirements, the insurance regulatory authorities could stop or temporarily
suspend the Company from carrying on some or all of its activities. In light of
several recent significant property and casualty insurance company insolvencies,
it is possible that assessments paid to state guaranty funds may increase.
Because the Insurance Subsidiaries are domiciled in Pennsylvania and Florida,
the Pennsylvania Department of Insurance and the Florida Department of Insurance
have primary authority over the Company.
Regulation of Insurance Holding Companies: Pennsylvania and Florida,
like many other states, have laws governing insurance holding companies (such as
Philadelphia Insurance). Under these laws, a person generally must obtain the
applicable Insurance Department's approval to acquire, directly or indirectly,
5% to 10% or more of the outstanding voting securities of Philadelphia Insurance
or the Insurance Subsidiaries. Such Department's determination of whether to
approve any such acquisition would be based on a variety of factors, including
an evaluation of the acquiror's financial stability, the competence of its
management, the effect of rates on coverages provided, if any, and whether
competition in Pennsylvania or Florida would be reduced.
The Pennsylvania and Florida statutes require every Pennsylvania and
Florida-domiciled insurer which is a member of an insurance holding company
system to register with Pennsylvania or Florida, respectively, by filing and
keeping current a registration statement on a form prescribed by the NAIC.
The Pennsylvania statute also specifies that at least one-third of the
board of directors and each committee thereof, of either the domestic insurer or
its publicly owned holding company (if any), must be comprised of outsiders
(i.e., persons who are neither officers, employees nor controlling shareholders
of the insurer or any affiliate). In addition, the domestic insurer or its
publicly held holding company must establish one or more committees comprised
solely of outside directors, with responsibility for recommending the selection
of independent certified public accountants; reviewing the insurer's financial
condition, the scope and results of the independent audit and any internal
audit; nominating candidates for director; evaluating the performance of
principal officers; and recommending to the board the selection and compensation
of principal officers.
Under the Florida statute, a majority of the directors must be citizens
of the United States. In addition, no Florida insurer may make any contract
whereby any person is granted or is to enjoy in fact the management of the
insurer to the substantial exclusion of its board of directors or to have the
controlling or preemptive right to produce substantially all insurance business
for the insurer, unless the contract is filed with and approved by the Florida
Insurance Department. An insurer must give the Department written notice of any
change of personnel among the directors or principal officers of the insurer
within 45 days of such change. The written notice must include all information
necessary to allow the Department to determine that the insurer will be in
compliance with state statutes.
Dividend Restrictions: As an insurance holding company, Philadelphia
Insurance will be largely dependent on dividends and other permitted payments
from the Insurance Subsidiaries to pay any cash dividends to its shareholders.
The ability of the Insurance Subsidiaries to pay dividends to the Company is
subject to certain restrictions imposed under Pennsylvania and Florida insurance
laws. Accumulated statutory profits of the Insurance Subsidiaries from which
dividends
13
may be paid totaled $123.0 million at December 31, 2002. Of this amount, the
Insurance Subsidiaries are entitled to pay a total of approximately $31.7
million of dividends in 2003 without obtaining prior approval from the
Pennsylvania or Florida Insurance Departments. During 2002 the insurance
subsidiaries paid dividends of $5.1 million to Liberty American Insurance Group,
Inc., a subsidiary of PCHC.
The National Association of Insurance Commissioners: In addition to
state-imposed insurance laws and regulations, the Insurance Subsidiaries are
subject to Statutory Accounting Principles ("SAP") as codified by the NAIC in
the "Accounting Practices and Procedures Manual" which was adopted by the
Insurance Departments of Pennsylvania and Florida effective January 1, 2001. The
NAIC also promulgates model insurance laws and regulations relating to the
financial and operational regulation of insurance companies. These model laws
and regulations generally are not directly applicable to an insurance company
unless and until they are adopted by applicable state legislatures or
departments of insurance. However, NAIC model laws and regulations have become
increasingly important in recent years, due primarily to the NAIC's state
regulatory accreditation program. Under this program, states which have adopted
certain required model laws and regulations and meet various staffing and other
requirements are "accredited" by the NAIC. Such accreditation is the cornerstone
of an eventual nationwide regulatory network and there is a certain degree of
political pressure on individual states to become accredited by the NAIC.
Because the adoption of certain model laws and regulations is a prerequisite to
accreditation, the NAIC's initiatives have taken on a greater level of practical
importance in recent years. The NAIC accredited both Pennsylvania and Florida
under the NAIC Financial Regulation Standards.
All the states have adopted the NAIC's financial reporting form, which
is typically referred to as the NAIC "Annual Statement", and most states,
including Pennsylvania and Florida, generally defer to the NAIC with respect to
SAP. In this regard, the NAIC has a substantial degree of practical influence
and is able to accomplish certain quasi-legislative initiatives through
amendments to the NAIC annual statement and applicable accounting practices and
procedures. For instance, the NAIC requires all insurance companies to have an
annual statutory financial audit and an annual actuarial certification as to
loss reserves by including such requirements within the annual statement
instructions.
Capital and Surplus Requirements: PIC's eligibility to write insurance
on a surplus lines basis in most jurisdictions is dependent on its compliance
with certain financial standards, including the maintenance of a requisite level
of capital and surplus and the establishment of certain statutory deposits. In
recent years, many jurisdictions have increased the minimum financial standards
applicable to surplus lines eligibility. For example, California and certain
other states have adopted regulations which require surplus lines companies
operating therein to maintain minimum capital of $15 million, calculated as set
forth in the regulations. PIC maintains capital to meet these requirements.
Risk-Based Capital: Risk-based capital is designed to measure the
acceptable amount of capital an insurer should have, based on the inherent
specific risks of each insurer. Insurers failing to meet this benchmark capital
level may be subject to scrutiny by the insurer's domiciliary insurance
department and ultimately rehabilitation or liquidation. Based on the standards
currently adopted, the policyholders' surplus of each of the Insurance
Subsidiaries at December 31, 2002 is in excess of the prescribed risk-based
capital requirements.
Insurance Guaranty Funds: The Insurance Subsidiaries are subject to
guaranty fund laws which can result in assessments, up to prescribed limits, for
losses incurred by policyholders as a result of the impairment or insolvency of
unaffiliated insurance companies. Typically, an insurance company is subject to
the guaranty fund laws of the states in which it conducts insurance business;
however, companies which conduct business on a surplus lines basis in a
particular state are generally exempt from that state's guaranty fund laws.
Shared Markets: As a condition of its license to do business in various
states, PIIC, MUSA and LAIC are required to participate in mandatory
property-liability shared market mechanisms or pooling arrangements which
provide various insurance coverages to individuals or other entities that
otherwise are unable to purchase coverage voluntarily provided by private
insurers. In addition, some states require automobile insurers to participate in
reinsurance pools for claims that exceed a certain amount. PIIC's participation
in such shared markets or pooling mechanisms is generally in proportion to the
amount of PIIC's direct writings for the type of coverage written by the
specific pooling mechanism in the applicable state.
Certain Legislative Initiatives and Developments: A number of new,
proposed or potential legislative or industry developments could further
increase competition in the insurance industry. These developments include:
- the enactment of the Gramm-Leach-Bliley Act of 1999 (which permits
financial services companies such as banks and brokerage firms to
engage in the insurance business), which could result in increased
competition from new entrants to the Company's markets;
- the formation of new insurers and an influx of new capital in the
marketplace as existing companies attempt to expand their business
as a result of better pricing and/or terms;
14
- programs in which state-sponsored entities provide property
insurance in catastrophe-prone areas;
- changing practices caused by the Internet, which have led to
greater competition in the insurance business.
These developments could make the property and casualty insurance
marketplace more competitive by increasing the supply of insurance capacity. In
that event, recent favorable industry trends that have reduced insurance and
reinsurance supply and increased demand could be reversed and may negatively
influence our ability to maintain or increase rates. Accordingly, these
developments could have an adverse effect on the Company's earnings.
On November 26, 2002, the federal Terrorism Risk Insurance Act of 2002
(the "Act") was signed into law. The Act established a temporary federal program
that provides for a system of shared public and private compensation for insured
commercial property and casualty losses resulting from acts of terrorism, as
defined in the Act. The Terrorism Insurance Program (the "Program") requires all
commercial property and casualty insurers licensed in the United States to
participate. The Program provides that in the event of a terrorist attack, as
defined, resulting in insurance industry losses exceeding $5 million, the U.S.
government will provide funding to the insurance industry on an annual aggregate
basis of 90% of covered losses up to $100 billion. Each insurance company is
subject to a deductible based upon a percentage of the previous year's direct
earned premium, with the percentage increasing each year. The Program requires
that insurers notify in-force commercial policyholders by February 24, 2003 that
coverage for terrorism acts is provided and the cost for this coverage. It also
requires notices to be given at certain specified times to insureds to which
policies are issued after the date of the Act's enactment. Policyholders have
the option to accept or decline the coverage, or negotiate other terms. Property
and casualty insurers, including the Company, are required to offer this
coverage at each subsequent renewal even if the policyholder elected to exclude
this coverage in the previous policy period. The Program became effective upon
enactment and runs through December 31, 2005. With the signing of the Act, all
previously approved exclusions for terrorism in any contract for property and
casualty insurance in force as of November 26, 2002 are excluded. However, an
insurer may reinstate a preexisting provision in a contract for property and
casualty insurance that is in force on the date of enactment and that excludes
coverage for an act of terrorism only:
(1) if the insurer has received a written statement from the insured
that affirmatively authorizes such reinstatement; or
(2) if
(A) the insured fails to pay any increased premium charged by the
insurer for providing such terrorism coverage; and
(B) the insurer provided notice, at least 30 days before any such
reinstatement, of (i) the increased premium for such terrorism coverage; and
(ii) the rights of the insured with respect to such coverage, including any date
upon which the exclusion would be reinstated if no payment is received.
Competition
The Company competes with a large number of other companies in its
selected line of business, including major U.S. and non-U.S. insurers and other
regional companies, as well as mutual companies, specialty insurance companies,
underwriting agencies and diversified financial services companies. Some of
these competitors have greater financial and marketing resources than the
Company. Profitability could be adversely affected if business is lost due to
competitors offering similar or better products at or below the Company's
prices. In addition, a number of new, proposed or potential legislative or
industry developments could further increase competition. New competition from
these developments could cause the demand for the Company's products to fall,
which could adversely affect profitability.
The current business climate remains competitive from a solicitation
standpoint. The Company will "walk away", if necessary, from writing business
that does not meet established underwriting standards and pricing guidelines.
Management believes though that the Company's mixed marketing strategy is a
strength in that it provides the flexibility to quickly deploy the marketing
efforts of the Company's direct production underwriters from soft market
segments to market segments with emerging opportunities. Additionally, through
the mixed marketing strategy, the Company's production underwriters have
established relationships with approximately 6,000 brokers, thus facilitating a
regular flow of submissions.
Employees
As of March 18, 2003, the Company had 719 full-time employees and 26
part-time employees. The Company actively encourages its employees to continue
their educational efforts and aids in defraying their educational costs
(including 100% of education costs related to the insurance industry).
Management believes that the Company's relations with its employees are
generally excellent.
15
Company Website and Availability of Securities and Exchange Commission ("SEC")
Filings
The Company's Internet website is www.phly.com. Information on the
Company's website is not a part of this Form 10-K. The Company makes available
free of charge on its website, or provides a link to, the Company's Forms 10-K,
10-Q and 8-K filed or furnished on or after May 14, 1996, and any amendments to
these Forms, that have been filed with the SEC on or after May 14, 1996 as soon
as reasonably practicable after the Company electronically files such material
with, or furnishes it to the SEC. To access these filings, go to the Company's
website and click on "Investor Relations", then click on "SEC Filings."
Item 2. DESCRIPTION OF PROPERTY
The Company leases certain office space in Bala Cynwyd, PA which serves
as its headquarters location, and also leases 36 offices for its field
marketing organization.
Item 3. LEGAL PROCEEDINGS
On April 30, 2002, U.S. Bank, N.A. d/b/a Firstar Bank ("Firstar"), a
bank to which one of the Company's insurance subsidiaries, Philadelphia
Indemnity Insurance Company ("PIIC"), issued insurance coverages, filed
a complaint against PIIC in the United States District Court for the
Southern District of Ohio (Western Division). The complaint asks for
damages and a declaratory judgment against PIIC. The complaint arises
principally out of a loss adjustment change and also relates to other
coverage interpretations made by PIIC under the terms of residual value
protection insurance policies issued to Firstar relating to vehicles
financed by Firstar. The complaint alleges that as a result of the loss
adjustment change Firstar may suffer damages of as much as $75,000,000.
On June 27, 2002, PIIC filed an answer to the complaint denying
liability with respect to the matters set forth above. PIIC believes
that this claim is without merit and intends to vigorously defend this
action.
The Company is not subject to any other material pending legal
proceedings other than ordinary routine litigation incidental to its
business.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 2002.
16
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
(a) The Company's common stock, no par value, trades on The Nasdaq
Stock Market under the symbol "PHLY". As of February 21, 2003, there
were 473 holders of record and 3,062 beneficial shareholders of the
Company's common stock. The high and low sales prices of the common
stock, as reported by the National Association of Securities Dealers,
were as follows:
2002 2001
------------------------- ------------------------
Quarter High Low High Low
- ------- ---------- ---------- ---------- --------
First 42.750 35.230 31.922 25.375
Second 48.150 39.610 36.000 24.250
Third 46.000 29.000 37.500 24.350
Fourth 38.100 26.240 41.300 32.900
The Company did not declare cash dividends on its common stock in 2002
and 2001, and currently intends to retain its earnings to enhance
future growth. Any future payment of dividends by the Company will be
determined by the Board of Directors and will be based on general
business conditions and legal and regulatory restrictions.
As a holding company, the Company is dependent upon dividends and other
permitted payments from its subsidiaries to pay any cash dividends to
its shareholders. The ability of the Company's insurance subsidiaries
to pay dividends to the Company is subject to regulatory limitations
(see Item 7.-Liquidity and Capital Resources and Note 2 to the
Consolidated Financial Statements).
(b) During the three years ended December 31, 2002, the Company did
not sell any of its securities which were not registered under the
Securities Act of 1933.
(c) The information concerning the Company's securities authorized for
issuance under Equity Compensation Plans required by this Item 5
is contained in Item 12(b) of this Form 10-K.
17
Item 6. SELECTED FINANCIAL DATA
As of and For the Years Ended December 31,
(In Thousands, Except Share and Per Share Data)
-----------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Operations and Comprehensive Income
Statement Data:
Gross Written Premiums................ $ 663,739 $ 473,565 $ 361,872 $ 274,918 $ 197,408
Gross Earned Premiums................. $ 555,485 $ 421,063 $ 328,350 $ 245,978 $ 174,737
Net Written Premiums.................. $ 523,171 $ 333,817 $ 263,429 $ 184,071 $ 143,036
Net Earned Premiums................... $ 421,186 $ 296,093 $ 227,292 $ 164,915 $ 122,687
Net Investment Income................. 37,516 32,426 25,803 20,695 15,448
Net Realized Investment Gain (Loss)... (3,371) 3,357 11,718 5,700 474
Other Income.......................... 911 587 8,981 4,722 219
- ------------------------------------------------------------------------------------------------------------------------------
Total Revenue.................... 456,242 332,463 273,794 196,032 138,828
- ------------------------------------------------------------------------------------------------------------------------------
Net Loss and Loss Adjustment
Expenses........................... 267,433 179,655 131,304 99,410 66,374
Acquisition Costs and Other
Underwriting Expenses.............. 129,918 97,020 75,054 53,793 38,422
Other Operating Expenses.............. 6,372 6,841 14,679 8,939 2,212
- ------------------------------------------------------------------------------------------------------------------------------
Total Losses and Expenses........ 403,723 283,516 221,037 162,142 107,008
- ------------------------------------------------------------------------------------------------------------------------------
Minority Interest: Distributions on
Company Obligated Mandatorily
Redeemable Preferred Securities of
Subsidiary Trust................... - 2,749 7,245 7,245 4,770
- ------------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes............ 52,519 46,198 45,512 26,645 27,050
Total Income Tax Expense.............. 16,514 15,639 14,742 7,802 7,022
- ------------------------------------------------------------------------------------------------------------------------------
Net Income....................... $ 36,005 $ 30,559 $ 30,770 $ 18,843 $ 20,028
- ------------------------------------------------------------------------------------------------------------------------------
Weighted-Average Common Shares
Outstanding........................ 21,611,053 16,528,601 12,177,989 12,501,165 12,249,262
Weighted-Average Share Equivalents
Outstanding........................ 682,382 656,075 2,411,552 2,614,399 2,680,165
- ------------------------------------------------------------------------------------------------------------------------------
Weighted-Average Shares and Share
Equivalents Outstanding............ 22,293,435 17,184,676 14,589,541 15,115,564 14,929,427
- ------------------------------------------------------------------------------------------------------------------------------
Basic Earnings Per Share.............. $ 1.67 $ 1.85 $ 2.53 $ 1.51 $ 1.63
- ------------------------------------------------------------------------------------------------------------------------------
Diluted Earnings Per Share........... $ 1.62 $ 1.78 $ 2.11 $ 1.25 $ 1.34
- ------------------------------------------------------------------------------------------------------------------------------
Year End Financial Position:
Total Investments and Cash
and Cash Equivalents............. $ 950,861 $ 723,318 $ 487,028 $ 420,016 $ 388,059
Total Assets....................... 1,358,334 1,017,722 730,464 599,051 476,390
Unpaid Loss and Loss Adjustment
Expenses......................... 445,548 302,733 237,494 188,063 151,150
Minority Interest in Consolidated
Subsidiaries..................... - - 98,905 98,905 98,905
Total Shareholders' Equity......... 477,823 428,692 182,325 161,440 137,483
Common Shares Outstanding.......... 21,868,877 21,509,723 13,431,408 12,590,908 12,200,563
- ------------------------------------------------------------------------------------------------------------------------------
Insurance Operating Ratios
(Statutory Basis):
Net Loss and Loss Adjustment
Expenses to Net Earned Premiums.. 63.5% 60.7% 57.8% 59.7% 54.1%
Underwriting Expenses to Net
Written Premiums................. 28.0% 31.2% 31.3% 33.6% 31.0%
- ------------------------------------------------------------------------------------------------------------------------------
Combined Ratio........................ 91.5% 91.9% 89.1% 93.3% 85.1%
==============================================================================================================================
A+ A+ A+ A+ A+
A.M. Best Rating...................... (Superior) (Superior) (Superior) (Superior) (Superior)
18
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Operations
During 2002 the Company utilized a disciplined marketing strategy in conjunction
with its underwriting capabilities to capitalize on turmoil in the property and
casualty insurance market. The turmoil created a general environment of rate
increases and conservative risk selection in the marketplace and arose in part
due to the following:
- - The significant property and casualty industry losses as a result of the
tragedy of September 11, 2001;
- - Continued rating agency downgrades and insolvencies in the industry; and
- - Lower interest rates resulting in reduced investment income and a greater
focus on underwriting margins.
In this environment, the Company continued its strong growth, with gross written
premiums increasing 40.1% to $663.7 million. The Company also believes its core
strategy of adhering to an underwriting philosophy of sound risk selection and
pricing discipline, the mixed marketing platform for its product distribution
and creating value added features not typically found in property and casualty
products have also contributed to generating premium growth above industry
averages, as well as enabling the Company to produce combined ratios (the sum of
net loss and loss adjustment expenses and acquisition costs and other
underwriting expenses, divided by net earned premiums) well below industry
averages. The GAAP combined ratio for the year ended December 31, 2002 was
94.3%, which, once again, was substantially lower than the property and casualty
industry as a whole.
Investments
The Company's investment objective is the realization of relatively high levels
of investment income while generating competitive after-tax total rates of
return within a prudent level of risk and within the constraints of maintaining
adequate securities in amount and duration to meet cash requirements of current
operations and long-term liabilities, as well as maintaining and improving the
Company's A.M. Best rating. The Company utilizes external independent
professional investment managers for its fixed maturity and equity investments.
These investments consist of diversified issuers and issues, and as of December
31, 2002, approximately 90.2% and 5.6% of the total invested assets (total
investments plus cash equivalents) on a cost basis consisted of investments in
fixed maturity and equity securities, respectively, versus 88.7% and 4.8%,
respectively, at December 31, 2001.
During 2002 the relative percentage investment in tax-exempt fixed maturity
securities versus taxable fixed maturity securities increased due to the Company
taking advantage of the more favorable after-tax yields. At the end of 2002, on
a cost basis, investment grade tax-exempt fixed maturity securities represented
30.3% of the total invested assets, compared to 14.8% as of the end of 2001.
Collateralized mortgage and asset backed securities, on a cost basis, amounted
to $89.2 million and $284.1 million, respectively, as of December 31, 2002 and
$70.4 and $272.7, respectively, as of December 31 2001. The collateralized
mortgage and asset backed investments are shorter tranche securities possessing
favorable prepayment risk profiles.
The Company regularly performs various analytical procedures with respect to its
investments, including identifying any security whose fair value is below its
cost. Upon identification of such securities, a detailed review is performed for
all securities, except interests in securitized assets, meeting predetermined
thresholds, to determine whether such decline is other than temporary. If the
Company determines a decline in value to be other than temporary, based upon its
detailed review, or if a decline in value for an equity investment has persisted
continuously for nine months the cost basis of the security is written down to
its fair value. The factors considered in reaching the conclusion that a decline
below cost is other-than-temporary include, but are not limited to, whether: the
issuer is in financial distress; the investment is secured; a significant credit
rating action has occurred; scheduled interest payments have been delayed or
missed; or changes in laws and/or regulations have impacted an issuer or
industry. The amount of any
19
write down is included in earnings as a realized loss in the period the
impairment arose. This evaluation resulted in non-cash realized investment
losses of $2.1 million and $0 million for the years ended December 31, 2002 and
2001, respectively. This $2.1 million in non-cash realized investment losses
resulted from other than temporary declines in the fair value of certain
holdings in the Company's common stock portfolio. The Company primarily
attributes these other than temporary declines in fair value to an uncertain
economic climate, the overhang of corporate governance issues, high profile
bankruptcies, and most recently, war prospects.
Additionally, the Company conducts its impairment evaluation and recognition for
interests in securitized assets in accordance with the guidance provided by the
Emerging Issues Task Force of the Financial Accounting Standards Board ("EITF").
Under this guidance, impairment losses on securities must be recognized if both
the fair value of the security is less than its book value and the net present
value of expected future cash flows is less than the net present value of
expected future cash flows at the most recent (prior) estimation date. If these
criteria are met, an impairment charge, calculated as the difference between the
current book value of the security and its fair value, is included in earnings
as a realized loss in the period the impairment arose. This evaluation resulted
in non-cash realized investment losses of $1.6 million and $5.8 million for the
years ended December 31, 2002 and 2001, respectively. These non-cash realized
investment losses were primarily due to investments in collateralized bond
obligations as a result of the current historical highs in non investment grade
default rates.
The Company's fixed maturity portfolio amounted to $854.5 million and $628.6
million, as of December 31, 2002 and 2001, respectively, of which 98.6% of the
portfolio for both years was comprised of investment grade securities. Since the
fourth quarter of 2001, U.S. investment grade securities have experienced
varying price and ratings volatility, having been affected by the uncertain
economic climate following the September 11, 2001 terrorist attacks, the
corporate governance issues following the Enron scandal and the subsequent
stream of corporate problems and high profile bankruptcies. While these
circumstances have the potential to impact investment grade securities, the high
quality of the Company's overall "AA+" rated fixed maturity portfolio and the
decline in interest rates have mitigated potential volatility. As of December
31, 2002 the Company had fixed maturity investments with unrealized losses
amounting to $9.2 million. Of this amount, interests in securitized assets had
unrealized losses amounting to $7.3 million and investments in aircraft
collateralized Enhanced Equipment Trust Certificates (EETCs) had unrealized
losses amounting to $1.3 million. As discussed above, the Company's impairment
evaluation and recognition for interests in securitized assets is conducted in
accordance with the guidance provided by the EITF. With respect to the EETCs,
these investments are current on interest and sinking fund payments, and are
subjected to a quarterly impairment review which includes performing a
liquidation collateral analysis that incorporates various stress scenarios
impacting the security's implied loan-to-value levels.
The following table identifies the period of time securities with an unrealized
loss at December 31, 2002 have continuously been in an unrealized loss position.
Included in the amounts displayed in the table are $4.0 million of unrealized
losses due to non-investment grade fixed maturity securities having a fair value
of $12.1 million. No issuer of securities or industry represents more than 3.9%
and 10.3%, respectively, of the total estimated fair value, or 13.9% and 21.2%,
respectively, of the total gross unrealized loss included in the table below. As
previously discussed, there are certain risks and uncertainties inherent in the
Company's impairment methodology. Should the Company subsequently determine a
decline in the fair value below the cost basis to be other than temporary, the
security would be written down to its fair value and the difference would be
included in earnings as a realized loss for the period such determination was
made.
20
Gross Unrealized Losses
(in millions)
----------------------------------------------------------------------------------------------------------
Fixed Maturities
Continuous Available for Sale Total
time in unrealized loss Excluding Interests Interests in Fixed Maturities
position in Securitized Assets Securitized Assets Available for Sale Equity Securities Total Investments
- ----------------------- --------------------- ------------------ ------------------ ----------------- -----------------
0 - 3 months $ 0.4 $ 0.4 $ 0.8 $ 0.3 $ 1.1
3 - 6 months 0.1 1.5 1.6 0.5 2.1
6 - 9 months 0.2 1.0 1.2 0.8 2.0
9 - 12 months - 1.1 1.1 - 1.1
12 - 18 months 1.2 1.6 2.8 - 2.8
18 - 24 months - 0.8 0.8 - 0.8
> 24 months - 0.9 0.9 - 0.9
----- ----- ------ ----- ------
Total Gross
Unrealized Losses $ 1.9 $ 7.3 $ 9.2 $ 1.6 $ 10.8
===== ===== ====== ===== ======
Estimated fair value of
securities with a gross
unrealized loss $27.3 $83.8 $111.1 $16.4 $127.5
===== ===== ====== ===== ======
The following table presents certain information with respect to individual
securities with a significant unrealized loss position as of December 31, 2002.
Significant Unrealized Losses by Security
-----------------------------------------
(in millions)
Issuer Security Type Carrying Value Unrealized Loss
------ ------------- -------------- ---------------
Continental Airlines 2000-1-C-2 Fixed Maturity $ 2.0 $1.1
Continental Airlines Fixed Maturity 1.3 0.2
Conseco Fin SEC Corp 2000-4ml Fixed Maturity - Interest in Securitized Assets 1.6 0.4
Conseco Fin SEC Corp SER 2000-4ml Fixed Maturity - Interest in Securitized Assets 0.9 0.3
Greentree Financial Corp. 99-2 B1 Fixed Maturity - Interest in Securitized Assets 1.8 1.1
Nextcard CRCN MNT 2001-1 CLB144A Fixed Maturity - Interest in Securitized Assets 3.5 1.5
----- ----
$11.1 $4.6
===== ====
During 2002 the Company's gross loss on the sale of fixed maturity and equity
securities amounted to $0.3 million and $3.2 million, respectively. The fair
value of the fixed maturity and equity securities at the time of sale was $31.6
million and $14.1 million, respectively. The decision to sell these securities
was based upon management's assessment of economic conditions and with regard to
the equity security sales the desire to limit investment exposure to the equity
market based upon this assessment. Of the equity securities sold, no equity
security had been in a continuous unrealized loss position for greater than six
months, except for one security, which had been in a continuous unrealized loss
position for seven months, and had a fair value and loss at the date of sale of
$131,000 and $33,000, respectively.
Market Risk of Financial Instruments
The Company's financial instruments are subject to the market risk of potential
losses from adverse changes in market rates and prices. The primary market risks
to the Company are equity price risk associated with investments in equity
securities and interest rate risk associated with investments in fixed
maturities. The Company has established, among other criteria, duration, asset
quality and asset allocation guidelines for managing its investment portfolio
market risk exposure. The Company's investments are held for purposes other than
trading and consist of diversified issuers and issues.
The table below provides information about the Company's financial instruments
that are sensitive to changes in interest rates. For debt obligations, the table
presents principal cash flows and related weighted average interest rates by
expected maturity dates. The information is presented in U.S. dollar
equivalents.
21
DECEMBER 31, 2002
EXPECTED MATURITY DATES TOTAL
(In thousands, except average interest rate) FAIR
2003 2004 2005 2006 2007 Thereafter TOTAL VALUE
------- -------- -------- -------- ------- ---------- -------- --------
FIXED MATURITIES
AVAILABLE FOR
SALE:
Principal Amount $52,909 $130,108 $155,199 $103,923 $83,638 $307,377 $833,154 $851,192
Book Value $52,897 $131,526 $160,201 $105,275 $84,263 $295,372 $829,534 -
Average Interest Rate 5.29% 4.30% 3.87% 4.59% 4.62% 5.11% 4.64% 3.81%
PREFERRED:
Principal Amount - - $ 5,750 $ 4,500 - $ 500 $ 10,750 $ 11,334
Book Value - - $ 5,923 $ 4,656 - $ 499 $ 11,078 -
Average Interest Rate - - 6.07% 5.88% - 5.87% 6.16% 6.02%
SHORT-TERM INVESTMENTS:
Principal Amount $39,235 - - - - - $ 39,235 $ 39,235
Book Value $39,235 - - - - - $ 39,235 -
Average Interest Rate 1.28% - - - - - 1.28% 1.28%
LOANS PAYABLE:
Principal Amount $39,113 - - - - - $ 39,113 -
Average Interest Rate 1.54% - - - - - 1.54% -
Certain Critical Accounting Estimates and Judgments
- - Investments
-- Fair values
The carrying amount for the Company's investments approximates their
estimated fair value. The Company measures the fair value of
investments based upon quoted market prices or by obtaining quotes
from third party broker-dealers. The Company's total investments
include $22.4 million in securities for which there is no readily
available independent market price. The estimated fair value of such
securities is determined by independent third party broker-dealers.
Material assumptions and factors utilized by such broker-dealers in
pricing these securities include: future cash flows, constant
default rates, recovery rates and any market clearing activity that
may have occurred since the prior month-end pricing period.
-- Other than temporary impairment, excluding interests in securitized
assets
The Company regularly performs various analytical procedures with
respect to its investments, including identifying any security whose
fair value is below its cost. Upon identification of such
securities, a detailed review is performed for all securities,
meeting predetermined thresholds, to determine whether such decline
is other than temporary. If the Company determines a decline in
value to be other than temporary, based
22
upon its detailed review, or if a decline in value for an equity
investment has persisted continuously for nine months, the cost
basis of the security is written down to its fair value. The factors
considered in reaching the conclusion that a decline below cost is
other-than-temporary include, but are not limited to, whether: the
issuer is in financial distress; the investment is secured; a
significant credit rating action has occurred; scheduled interest
payments have been delayed or missed; changes in laws and/or
regulations have impacted an issuer or industry. The amount of any
write down is included in earnings as a realized loss in the period
the impairment arose (see Investments).
-- Impairment recognition for investments in securitized assets
The Company conducts its impairment evaluation and recognition for
interests in securitized assets in accordance with the guidance
provided by the Emerging Issues Task Force of the Financial
Accounting Standards Board. Under this guidance, impairment losses
on securities must be recognized if both the fair value of the
security is less than its book value and the net present value of
expected future cash flows is less than the net present value of
expected future cash flows at the most recent (prior) estimation
date. If these criteria are met, an impairment charge, calculated as
the difference between the current book value of the security and
its fair value, is included in earnings as a realized loss in the
period the impairment arose (see Investments).
- - Liability for Unpaid Loss and Loss Adjustment Expenses:
The liability for unpaid loss and loss adjustment expenses ($445.6
million and $302.7 million as of December 31, 2002 and 2001,
respectively) reflects the Company's best estimate for future amounts
needed to pay losses and related settlement expenses with respect to
insured events. Based upon past experience this estimate has been
redundant by as much as 18.8% and deficient by as much as 21.9%. The
process of establishing the liability for property and casualty unpaid
loss and loss adjustment expenses is a complex and imprecise process,
requiring the use of informed estimates and judgments. This liability
includes an amount determined on the basis of claim adjusters'
evaluations with respect to insured events that have occurred and an
amount for losses incurred that have not been reported to the Company.
In some cases significant periods of time, up to several years or more,
may elapse between the occurrence of an insured loss and the reporting
of such to the Company. The method for determining the Company's
liability for unpaid loss and loss adjustment expenses includes but is
not limited to reviewing past loss experience and considering other
factors such as legal, social, and economic developments. The methods
of making such estimates and establishing the resulting liabilities are
regularly reviewed and updated and any adjustments resulting therefrom
are made in the accounting period in which the adjustment arose.
During 2002 the Company increased the liability for unpaid loss and
loss adjustment expenses by $68.0 million ($27.6 million net of
reinsurance) primarily for accident years 1997 through 2001. As of
December 31, 2001 the Company had estimated a total liability for
unpaid loss and loss adjustment expenses for these accident years of
$295.0 million ($243.1 million net of reinsurance). This increase in
the liability for unpaid loss and loss adjustment expense net of
reinsurance was primarily due to the following:
-- The Company increased the estimated loss for unreported claims
incurred and related claim adjustment expenses on residual value
polices issued during the years 1998 through 2001 by $30.2 million
($20.7 million net of reinsurance). As of December 31, 2001 the
Company had estimated a total liability for unpaid loss and loss
adjustment expenses for these policies of $14.5 million ($8.7
million net of reinsurance). The residual value policies provide
coverage guaranteeing the value of a leased automobile at the lease
termination which can be up to five years from lease inception.
During 2002 adverse trends further deteriorated in both frequency
and severity on leases expiring in 2002. As part of the Company's
monitoring and evaluation process, consulting firms were engaged
during the third quarter of 2002 to aid in evaluating this
deterioration and the ultimate potential loss exposure under these
policies. As a result of the indications and subsequent evaluation
by the Company and changes in the Company's assumptions relating to
future frequency and severity of losses, the estimate for unpaid
loss and loss adjustment expenses was increased. The Company
primarily attributes this deterioration to the following factors
that led to a softening of prices in the used car market subsequent
to the September 11, 2001 terrorist attacks: prolonged 0% new car
financing rates and other incentives which increased new car sales
and the volume
23
of trade-ins, daily rental units being sold into the market earlier
and in greater numbers than expected further adding to the over
supply of used cars; and the overall uncertain economic conditions.
-- The Company also increased the liability for unpaid loss and loss
adjustment expenses on the Commercial Automobile Excess Liability
Insurance ("Excess Liability") product sold to rental car companies
(Commercial Lines Underwriting Segment) primarily for the 2000 and
2001 accident years by $6.9 million ($4.9 million net of
reinsurance). As of December 31, 2001 the Company had estimated a
total liability for unpaid loss and loss adjustment expenses for the
Excess Liability policies issued in these years of $23.0 million
($21.6 million net of reinsurance). Excess Liability provides
automobile liability coverage in excess of the state mandated limits
which are provided by the rental car company. During the third
quarter of 2002, pursuant to a routine underwriting review focusing
on price adequacy and loss experience, the Company non-renewed a
significant Excess Liability customer as a result of an unacceptable
underwriting risk profile (see Results of Operations (2002 versus
2001)). This adverse loss development was primarily due to pricing
inadequacy and the adverse loss experience of this customer.
Additionally, the Company has experienced a delay in both the
reporting of claims and the claim litigation discovery process as a
result of this policyholder and another Excess Liability
policyholder filing for Chapter 11 during the third quarter 2002 and
fourth quarter 2001, respectively.
The Company further increased the liability for unpaid loss and loss
adjustment expenses by $30.8 million ($0 net of reinsurance) as a
result of the emergence of higher than expected losses in certain
products of the Commercial and Specialty lines segments primarily
occurring in accident years 1999 through 2001 and changes in the
Company's assumptions relating to future frequency and severity of
losses. Approximately 97% of such losses are reinsured with companies
rated "A" excellent or better by A.M. Best Company.
The method for determining reinsurance recoverables and estimated
recoverability are regularly reviewed and adjustments resulting from
this review are included in earnings in the period the adjustment
arose.
- - Deferred Acquisition Costs:
Policy acquisition costs ($61.3 million and $41.5 million as of
December 31, 2002 and 2001, respectively) which include commissions,
premium taxes, fees, and certain other costs of underwriting policies,
are deferred and amortized over the same period in which the related
premiums are earned. Deferred acquisition costs are limited to the
estimated amounts recoverable after providing for losses and expenses
that are expected to be incurred, based upon historical and current
experience. Anticipated investment income is considered in determining
whether a premium deficiency exists. The methods of making such
estimates and establishing the deferred costs are continually reviewed
by the Company, and any adjustments therefrom are made in the
accounting period in which the adjustment arose.
RESULTS OF OPERATIONS
(2002 versus 2001)
Premiums: Gross written premiums grew $190.1 million (40.1%) to $663.7 million
in 2002 from $473.6 million in 2001; gross earned premiums grew $134.4 million
(31.9%) to $555.5 million in 2002 from $421.1 million in 2001; net written
premiums increased $189.4 million (56.7%) to $523.2 million in 2002 from $333.8
million in 2001; and net earned premiums grew $125.1 million (42.2%) to $421.2
million in 2002 from $296.1 million in 2001.
The respective gross written premium increases for the commercial lines,
specialty lines and personal lines segments for the years ended December 31,
2002 vs. December 31, 2001 amount to $157.9 million (50.0%), $30.0 million
(37.8%) and $2.2 million (2.8%), respectively. The overall growth in gross
written premiums is primarily attributable to the following:
- - Further rating downgrades of certain major competitor property and
casualty insurance companies have led to their diminished presence in
the Company's commercial and specialty lines business segments and
continue to result in additional prospects and increased premium
writings, most notably for the Company's various commercial package and
non-profit D&O product lines.
24
- - The continued consolidation of certain competitor property and casualty
insurance companies has led to the displacement of certain of their
independent agency relationships. This consolidation continues to
result in new agency relationship opportunities for the Company, which
have resulted in additional prospects and premium writings for the
Company's commercial and specialty lines segments.
- - Continued expansion of marketing efforts relating to commercial lines
and specialty lines products through the Company's field organization
and preferred agents.
- - As a result of firming prices in the property and casualty industry,
rate increases on renewal business have approximated 16.0%, 26.0%, and
8.0% for the commercial, specialty and the personal lines segments,
respectively. Additionally, in force policy counts have increased 43.0%
and 13.0% for the commercial and specialty lines segments,
respectively, primarily as a result of the factors discussed above.
Policy counts have decreased approximately 7.0% for the personal lines
segment as a result of restricting new business and not renewing
certain business to manage overall property exposures and the related
catastrophe loss considerations.
Overall premium growth has been offset in part by the following factors:
- - Specialty Lines Segment - The Company's decision not to renew
approximately 2,000 policies in the professional liability product
lines due to inadequate pricing levels being experienced as a result of
market conditions and/or an unacceptable underwriting risk profile.
- - Personal Lines Segment - The Company's decision to restrict new
business and not renew approximately 9,000 policies in designated areas
of Florida in the Company's manufactured housing and homeowners product
lines, based on an evaluation of property exposures and the related
catastrophe loss considerations.
Pursuant to a routine underwriting review which focused on pricing adequacy and
loss experience, as well as other underwriting criteria, the Company cancelled a
Commercial Automobile Excess Liability Insurance customer (Commercial Lines
Underwriting Group) effective October 22, 2002 as a result of an unacceptable
underwriting risk profile. Such customer's gross written premium and net written
premium amounted to $36.7 million and $10.9 million, respectively, for the year
ended December 31, 2002.
Additionally, the respective net written premium increases (decreases) for
commercial lines, specialty lines and personal lines segments for the year ended
December 31, 2002 vs. December 31, 2001 amount to $160.5 million (71.7%), $31.8
million (45.6%) and ($2.9) million (7.1%) respectively. The differing percentage
increases (decreases) in net written premiums versus gross written premiums for
the year is primarily due to the Company commuting a 2001 accident year
aggregate stop loss reinsurance program during the quarter ended June 30, 2002
whereby net written and net earned premiums increased by $3.6 million ($2.4
million Commercial Lines, $0.8 million Specialty Lines, $0.4 million Personal
Lines), and in part to other various changes in, or pricing of, the Company's
reinsurance program.
Net Investment Income: Net investment income approximated
$37.5 million in 2002 and $32.4 million in 2001. Total investments grew to
$908.9 million at December 31, 2002 from $673.4 million at December 31, 2001.
The growth in investment income is due to investing net cash flows provided from
operating activities and the proceeds of the Company's fourth quarter 2001
equity offering. The capital market environment during 2001 and most of 2002
(low U.S. Treasury yields) had the effect of increasing the level of prepayments
in certain of the Company's interest rate sensitive investments. The Company's
average duration of its fixed income portfolio approximated 3.2 years at
December 31, 2002, compared to 2.7 years at December 31, 2001. Additionally, due
to the capital market environment, the Company has invested approximately $75.1
million in overall "AAA" rated floating rate and shorter amortizing securities
to reduce interest rate risk with the expectation of reinvesting these funds
into longer duration investments at higher future fixed income rates. The
Company's tax equivalent book yield on its fixed income holdings was 5.2% at
December 31, 2002, compared to 6.0% at December 31, 2001.
The total return, which includes the effect of realized and
unrealized gains and losses, of the Company's fixed income portfolio was 9.09%
and 7.30% for the years ended December 31, 2002 and 2001, respectively versus
the Lehman Brothers US Aggregate Bond Index ("the Index") total return of 9.51%
and 8.67% for the same periods, respectively. While the performance during 2002
and 2001 was similar to the total return of the Index, performance differed from
the Index due primarily to the following factors:
25
- - the Company's fixed income portfolio is overweighted in the spread
sectors, versus the Index, to capture the incremental spread available
in non-Treasury securities consistent with its investment objective of
achieving the highest after-tax risk adjusted yields;
- - the Company maintains a higher level of credit quality in the portfolio
versus the Index; and
- - the Company maintains a shorter portfolio duration versus the Index.
Net Realized Investment Gain (Loss): Net realized investment
gains (losses) were ($3.4) million for the year ended December 31, 2002 and $3.4
million for the same period in 2001. The Company realized net investment losses
of $3.1 million from the sales of common stock equity securities and $3.4
million in net investment gains from the sale of fixed maturity securities
during the year ended December 31, 2002. Additionally, $2.1 million and $1.6
million in non-cash realized investment losses were recorded for common stock
and fixed maturity investments, respectively, as a result of the Company's
impairment evaluation (see Investments). The Company realized net investment
gains of $8.3 million from the sales of common stock equity securities and $0.9
million from the sales of fixed maturity securities during the year ended
December 31, 2001. These realized net investment gains were offset by $5.8
million in non-cash realized investment losses experienced on certain securities
as a result of the Company's impairment evaluation (see Investments). The
proceeds from the sales were reinvested in fixed maturity securities to increase
current investment income and decrease the overall percentage of investments in
common stock securities.
Other Income: Other income approximated $0.9 million for the
year ended December 31, 2002 and $0.6 million for the same period of 2001. Other
income primarily consists of commissions earned on brokered personal lines
business, and to a lesser extent brokered commercial lines business. The Company
is seeking to increase brokering activities in its personal lines segment, as it
is restricting new business and not renewing certain policies in designated
areas of Florida as a result of its property exposures in these areas and the
related catastrophe loss considerations.
Net Loss and Loss Adjustment Expenses: Net loss and loss
adjustment expenses increased $87.7 million (48.8%) to $267.4 million for the
year ended December 31, 2002 from $179.7 million for the same period of 2001 and
the loss ratio increased to 63.5% in 2002 from 60.7% in 2001. This increase in
net loss and loss adjustment expenses was due principally to the 42.2% growth in
net earned premiums, and in part to the Company increasing loss and loss
adjustment expenses incurred as a result of changes in estimates of insured
events in prior years by: $27.6 million ($68.0 million gross of reinsurance) due
to deterioration in frequency and severity trends on automobile leases currently
expiring on residual value policies issued during the years 1998 through 2001
(see Certain Critical Accounting Estimates and Judgments - Liability for Unpaid
Loss and Loss Adjustment Expense); and by $4.9 million ($6.9 million gross of
reinsurance) due to adverse loss experience on the Commercial Automobile Excess
Liability Insurance product (see Certain Critical Accounting Estimates and
Judgments - Liability for Unpaid Loss and Loss Adjustment Expense). The Company
also commuted a 2001 accident year aggregate stop loss reinsurance program in
the second quarter of 2002, resulting in net written and net earned premium
increasing by $3.6 million. The Company had not ceded any losses to the 2001
accident year aggregate stop loss reinsurance program. The year ended December
31, 2001 included a $4.0 million increase to unpaid loss and loss adjustment
expenses arising from business interruption, business personal property,
business property and workers' compensation exposures relating to the September
11, 2001 terrorist attacks. The Company has entered into various reinsurance
agreements for the purpose of limiting its loss exposure. Net reinsurance
recoveries as a percentage of loss and loss adjustment expenses may vary
considerably from period to period based upon the number and/or severity of our
individual losses in excess of the amount retained under the Company's
reinsurance agreements in any one period.
Acquisition Costs and Other Underwriting Expenses: Acquisition
costs and other underwriting expenses increased $32.9 million (33.9%) to $129.9
million for the year ended December 31, 2002 from $97.0 million for the same
period of 2001. This increase was due primarily to the 42.2% growth in net
earned premiums, offset in part by:
26
- - A lower weighted average effective commission rate incurred on the
commercial and specialty lines segment products of approximately 12.7%
for the year ended December 31, 2002 compared to a weighted average
effective commission rate of approximately 13.9% for the year ended
December 31, 2001. The Company has been able to incur a relatively
lower commission rate on business produced by independent agents in the
current market environment.
- - Incremental written premium growth without a corresponding incremental
increase in operating costs.
Other Operating Expenses: Other operating expenses decreased
$0.4 million to $6.4 million for the year ended December 31, 2002 from $6.8
million for the same period of 2001. The decrease in other operating expenses
was primarily due to the discontinuance of goodwill amortization effective
January 1, 2002, which amounted to $1.5 million for the year ended December 31,
2001. This decrease has been partially offset by an increase in expenses
attributable to increased operating activities.
Income Tax Expense: The Company's effective tax rate for the
year ended December 31, 2002 and 2001 was 31.4% and 33.9%, respectively. The
effective rates differed from the 35% statutory rate principally due to
investments in tax-exempt securities and in part due to the discontinuance of
goodwill amortization. The decrease in the effective tax rate is principally due
to a greater investment of cash flows in tax-exempt securities relative to
taxable securities.
RESULTS OF OPERATIONS
(2001 versus 2000)
Premiums: Gross written premiums grew $111.7 million (30.9%) to $473.6 million
in 2001 from $361.9 million in 2000; gross earned premiums grew $92.7 million
(28.2%) to $421.1 million in 2001 from $328.4 million in 2000; net written
premiums increased $70.4 million (26.7%) to $333.8 million in 2001 from $263.4
in 2000; and net earned premiums grew $68.8 million (30.3%) to $296.1 million in
2001 from $227.3 million in 2000.
The respective gross written premium increases for the commercial lines,
specialty lines and personal lines segments for the years ended December 31,
2001 vs. December 31, 2000 amount to $76.5 million (31.9%), $11.1 million
(16.3%) and $24.1 million (44.4%), respectively. The overall growth in gross
written premiums is primarily attributable to the following:
- - Rating downgrades of certain major competitor property and casualty
insurance companies have led to their diminished presence in the
Company's commercial and specialty lines business segments and continue
to result in additional prospects and increased premium writings, most
notably for the Company's various commercial package and non-profit D&O
product lines.
- - The consolidation of certain competitor property and casualty insurance
companies has led to the displacement of certain of their independent
agency relationships. This consolidation continues to result in new
agency relationship opportunities for the Company. These relationships
have resulted in additional prospects and premium writings for the
Company's commercial and specialty lines segments.
- - Continued expansion of marketing efforts relating to commercial lines
and specialty lines products through the Company's field organization
and preferred agents.
- - Rate increases on renewal business.
Overall premium growth in the specialty lines segment has been offset in part by
the Company's decision not to renew certain policies in the professional
liability product lines due to inadequate pricing levels being experienced as a
result of market conditions and/or loss experience emerging at higher than
expected levels.
The respective net written premium increases for the commercial lines, specialty
lines and personal lines segments for the years ended December 31, 2001 vs.
December 31, 2000 amount to $60.3 million (36.9%), $1.9 million (2.8%) and $8.2
million (25.5%), respectively. The differing percentage increases in net written
premiums versus gross written premiums for the period is primarily due to the
various changes in the Company's reinsurance programs.
27
Net Investment Income: Net investment income was $32.4 million for the year
ended December 31, 2001 and $25.8 million for the same period of 2000. Total
investments grew to $673.4 million at December 31, 2001 from $437.3 million at
December 31, 2000. The growth in investment income is attributable to investing
net cash flows provided by operating activities and the proceeds of the
Company's equity offering received late in the fourth quarter. In addition, the
Company increased the percentage invested in taxable investments versus tax
exempt investments in order to achieve the incremental after tax net investment
income available from taxable investments. The low level of U.S. Treasury yields
persisted throughout 2001. This capital markets environment had the effect of
both increasing the level of prepayments in certain of the Company's interest
rate sensitive investments and causing the Company to slightly shorten its
duration position in the expectation of higher future fixed income yields. As a
result, the Company's average duration on its fixed income portfolio
approximated 2.7 years at December 31, 2001, compared to 3.5 years at December
31, 2000. As a consequence of the above factors, the Company's tax equivalent
book yield on its fixed income holdings was 6.00% at December 31, 2001, compared
to 7.37% at December 31, 2000.
Net Realized Investment Gain: Net realized investment gains were $3.4 million
for the year ended December 31, 2001 and $11.7 million for the same period in
2000. The Company realized net investment gains of $8.3 million from the sales
of common stock securities and $0.9 million from the sales of fixed maturity
securities during the year ended December 31, 2001. These realized net
investment gains were offset by $5.8 million in non-cash realized investment
losses experienced on certain structured securities as a result of an impairment
evaluation in accordance with the recent EITF 99-20 guidance. The proceeds from
the sales are being reinvested in fixed maturity securities to increase current
investment income and decrease the overall percentage of investments in common
stock securities. The net realized investment gains of $11.7 million for the
year ended December 31, 2000 were due to sales of certain equity investments
which resulted in realized net investment gains amounting to $15.1 million, and
were offset by $3.4 million of realized net investment losses from sales of
certain fixed income securities. The proceeds from these sales were reinvested
principally in fixed maturity securities.
Other Income: Other income approximated $0.6 million for the year ended December
31, 2001 and $9.0 million for the same period of 2000. Other income primarily
consists of commissions earned on brokered personal lines business. Such
commissions earned continued to decrease, as planned, as brokering activities
were lessened in 2001 in favor of writing business directly.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses
increased $48.4 million (36.9%) to $179.7 million for the year ended December
31, 2001 from $131.3 million for the same period of 2000 and the loss ratio
increased to 60.7% in 2001 from 57.8% in 2000. The year ended December 31, 2001
included a $4.0 million increase to net loss and loss adjustment expenses
arising from business interruption, business personal property, business
property and workers' compensation exposures relating to the September 11, 2001
terrorist attacks. Excluding this item, net loss and loss adjustment expenses
increased by $44.4 million (33.8%). The increase in net loss and loss adjustment
expenses was due principally to:
- - The 30.3% growth in net earned premiums; and
- - Losses emerging at a higher rate on automobile leases expiring in 2001
on residual value policies underwritten in prior years than had been
originally anticipated when the initial reserves were estimated.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other
underwriting expenses increased $21.9 million (29.2%) to $97.0 million for the
year ended December 31, 2001 from $75.1 million for the same period of 2000.
This increase was due primarily to the 30.3% growth in net earned premiums,
offset by relative changes in the Company's product mix and associated
distribution channel expense, primarily the weighted average commission rate,
which approximated 13.9% for the year ended December 31, 2001 versus 14.6% for
the year ended December 31, 2000.
Other Operating Expenses: Other operating expenses decreased $7.9 million to
$6.8 million for the year ended December 31, 2001 from $14.7 million for the
same period of 2000. The decrease in other operating expenses was primarily due
to the decrease in brokering activities resulting in a decrease in the amount of
broker commissions (see "Other Income" above). Goodwill amortization of $1.5
million per year, both for 2001 and 2000 ceased on
28
January 1, 2002 due to the adoption of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
Income Tax Expense: The Company's effective tax rate for the years ended
December 31, 2001 and 2000 was 33.9% and 32.4%, respectively. The effective
rates differed from the 35% statutory rate principally due to investments in
tax-exempt securities, offset in part by non-deductible goodwill amortization.
The increase in the effective tax rate is principally due to a greater
investment of cash flows in taxable securities relative to tax-exempt
securities.
LIQUIDITY AND CAPITAL RESOURCES
Philadelphia Consolidated Holding Corp. (PCHC) is a holding company whose
principal assets currently consist of 100% of the capital stock of its
subsidiaries. The Company's primary sources of funds are dividends from its
subsidiaries and payments received pursuant to tax allocation agreements with
the insurance subsidiaries. For the year ended December 31, 2002, payments to
PCHC pursuant to such tax allocation agreements totaled $20.1 million. The
payment of dividends to PCHC from the insurance subsidiaries is subject to
certain limitations imposed by the insurance laws of the Commonwealth of
Pennsylvania and State of Florida. Accumulated statutory profits or
policyholders' surplus of the insurance subsidiaries from which dividends may be
paid totaled $123.0 million at December 31, 2002. Of this amount, the insurance
subsidiaries are entitled to pay a total of approximately $31.7 million of
dividends in 2003 without obtaining prior approval from the Insurance
Commissioner of the Commonwealth of Pennsylvania or State of Florida. During
2002 the insurance subsidiaries paid dividends of $5.1 million to Liberty
American Insurance Group, Inc., a subsidiary of PCHC. Also, during 2002 the
Company repurchased 75,000 shares of the Company's common stock for
approximately $2.0 million under the stock repurchase authorization. At December
31, 2002 the remaining stock repurchase authorization is $25.0 million.
The Company produced net cash from operations of $205.0 million in 2002, $115.1
million in 2001 and $47.0 million in 2000. Sources of operating funds consist
primarily of net premiums written and investment income. Funds are used
primarily to pay claims and operating expenses and for the purchase of
investments. The source of cash from operations in 2002 was primarily generated
from strong premium growth during the current year due to increases in the
number of policies written and price increases realized on renewal business. Net
loss and loss expense payments were $157.9 million in 2002, $125.0 million in
2001, and $97.2 million in 2000. Net cash from operations also included cash
provided from tax savings as a result of the exercise of employee stock options
amounting to $1.3 million, $25.8 million and $0.1 million for 2002, 2001 and
2000, respectively. Management believes that the Company has adequate liquidity
to pay all claims and meet all other cash needs.
Two of the Company's Insurance Subsidiaries are members of the Federal Home Loan
Bank of Pittsburgh ("FHLB"). A primary advantage of FHLB membership is the
ability of members to access credit products from a reliable capital markets
provider. The availability of any one member's access to credit is based upon
its FHLB eligible collateral. At December 31, 2002 the Insurance Subsidiaries
borrowing capacity with the FHLB was $85.1 million. The Insurance Subsidiaries
have utilized a portion of its borrowing capacity to purchase a diversified
portfolio in investment grade floating rate securities. These purchases were
funded by floating rate FHLB borrowings to achieve a positive spread between the
rate of interest on these securities and borrowing rates. The remaining
borrowing capacity provides an immediately available line of credit. Borrowings
aggregated $39.1 million at December 31, 2002, bear interest at adjusted LIBOR
and mature twelve months from inception. The weighted-average interest rate on
borrowings outstanding as of December 31, 2002 was 1.54% per annum. These
borrowings are collateralized by investment securities, principally asset backed
securities, with a carrying value of $49.2 million.
In the normal course of business, the Company has entered into various
reinsurance contracts with unrelated reinsurers. The Company participates in
such agreements for the purpose of limiting loss exposure and diversifying
business. Reinsurance contracts do not relieve the Company from its obligations
to policyholders. To reduce the potential for a write off of amounts due from
reinsurers, the Company: evaluates the financial condition of its reinsurers;
principally contracts with large reinsurers that are rated at least "A-"
(Excellent) by A.M. Best Company; regularly monitors its reinsurance
receivables; and attempts to collect the obligations of its reinsurers on a
timely basis.
29
Under certain reinsurance agreements, the Company is required to maintain
investments in trust accounts to secure its reinsurance obligations (primarily
the payment of losses and loss adjustment expenses on business it does not write
directly). At December 31, 2002, the investment and cash balances in such trust
accounts totaled approximately $1.6 million. In addition, various insurance
departments of states in which the Company operates require the deposit of funds
to protect policyholders within those states. At December 31, 2002, the balance
on deposit for the benefit of such policyholders totaled approximately $13.5
million.
The insurance subsidiaries, which operate under an intercompany reinsurance
pooling agreement, must have certain levels of surplus to support premium
writings. Guidelines of the National Association of Insurance Commissioners (the
"NAIC") suggest that a property and casualty insurer's ratio of annual statutory
net premium written to policyholders' surplus should not exceed 3-to-1. The
ratio of combined annual statutory net premium written by the insurance
subsidiaries to their combined policyholders' surplus was 1.7-to-1.0 and
1.2-to-1.0 for 2002 and 2001, respectively.
Risk-based capital is a method developed by the NAIC designed to measure the
acceptable amount of capital and surplus an insurer should have based on the
inherent specific risks of each insurer. The adequacy of a company's actual
capital and surplus is evaluated by a comparison to the risk-based capital
results. Insurers failing to meet minimum risk-based capital requirements may be
subject to scrutiny by the insurer's domiciliary insurance department and
ultimately rehabilitation or liquidation. As of December 31, 2002, PIIC, PIC,
MUSA and LAIC exceeded their minimum risk-based capital requirement of $75.9
million, $10.0 million, $11.7 million and $11.7 million, respectively, by 234%,
135%, 48% and 56%, respectively.
The Company has certain contractual obligations and commitments which are
summarized below:
Payments Due by Period
----------------------
(in thousands)
----------------------------------------------------------------------------------
Certain Contractual Obligations Less than
Total 1 year 1-3 years 4-5 years After 5 years
----- ------ --------- --------- -------------
Loans Payable (1) $ 39,113 $ 39,113 $ - $ - $ -
Operating Leases 12,069 3,991 4,338 3,472 268
Other Commercial Commitments (2) 4,498 4,498 - - -
-------- -------- ------- -------- ------
Total $ 55,680 $ 47,602 $ 4,338 $ 3,472 $ 268
======== ======== ======= ======== ======
(1) Represents 12 month collateralized borrowings from the Federal Home Loan
Bank of Pittsburgh, the proceeds from which are invested to achieve a
positive spread between the investment and borrowing interest rates.
(2) Represents open commitments under certain limited partnership and
information technology development agreements.
INFLATION
Property and casualty insurance premiums are established before the amount of
losses and loss adjusted expenses, or the extent to which inflation may affect
such amounts, is known. The Company attempts to anticipate the potential impact
of inflation in establishing its premiums and reserves. Substantial future
increases in inflation could result in future increases in interest rates,
which, in turn, are likely to result in a decline in the market value of the
Company's investment portfolio and resulting unrealized losses and/or reductions
in shareholders' equity.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure ("SFAS No. 148") which amends SFAS
Statement No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). The
objective of SFAS No. 148 is to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. SFAS No. 148 does not change the provisions of SFAS No.
30
123 that permit entities to continue to apply the intrinsic value method of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB No. 25"). In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company continues to maintain its accounting for stock-based compensation in
accordance with APB No. 25, but has adopted the disclosure provisions of SFAS
No. 148 (See Note 12 in Notes to Consolidated Financial Statements).
FASB Interpretation 45 "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" became
effective December 15, 2002. This interpretation elaborates on the disclosures
to be made by a guarantor in its financial statements about its obligations
under certain guarantees that it has issued. Management has determined that this
interpretation will have no effect on the Company's consolidated financial
statements.
FASB Interpretation 46 "Consolidation of Variable Interest Entities" was issued
in January 2003 and is effective at various dates for various requirements. This
interpretation addresses consolidation of variable interest entities (formerly
known as special purpose entities). Management has determined that this
interpretation will have no effect on the Company's consolidated financial
statements.
FORWARD-LOOKING INFORMATION
Certain information included in this report and other statements or materials
published or to be published by the Company are not historical facts but are
forward-looking statements relating to such matters as anticipated financial
performance, business prospects, technological developments, new and existing
products, expectations for market segment and growth, and similar matters. In
connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company provides the following cautionary
remarks regarding important factors which, among others, could cause the
Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's
forward-looking statements. The risks and uncertainties that may affect the
operations, performance, development, results of the Company's business, and the
other matters referred to above include, but are not limited to: (i) changes in
the business environment in which the Company operates, including inflation and
interest rates; (ii) changes in taxes, governmental laws, and regulations; (iii)
competitive product and pricing activity; (iv) difficulties of managing growth
profitably; (v) claims development and the adequacy of our liability for unpaid
loss and loss adjustment expenses; (vi) severity of natural disasters and other
catastrophes; (vii) adequacy of reinsurance coverage which may be obtained by
the Company; (viii) ability and willingness of our reinsurers to pay; and (ix)
future terrorist attacks.
31
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The table below provides information about the Company's financial instruments
that are sensitive to changes in interest rates. The Company does not have any
derivative financial instruments. For debt obligations, the table presents
principal cash flows and related weighted average interest rates by expected
maturity dates. The information is presented in U.S. dollar equivalents, which
is the Company's reporting currency.
DECEMBER 31, 2002
EXPECTED MATURITY DATES
(In thousands, except average interest rate) TOTAL FAIR
2003 2004 2005 2006 2007 Thereafter TOTAL VALUE
-------- --------- --------- -------- --------- ---------- ---------- ----------
FIXED MATURITIES AVAILABLE
FOR SALE:
Principal Amount $ 52,909 $ 130,108 $ 155,199 $103,923 $ 83,638 $ 307,377 $ 833,154 $ 851,192
Book Value $ 52,897 $ 131,526 $ 160,201 $105,275 $ 84,263 $ 295,372 $ 829,534 -
Average Interest Rate 5.29% 4.30% 3.87% 4.59% 4.62% 5.11% 4.64% 3.81%
PREFERRED:
Principal Amount - - $ 5,750 $ 4,500 - $ 500 $ 10,750 $ 11,334
Book Value - - $ 5,923 $ 4,656 - $ 499 $ 11,078 -
Average Interest Rate - - 6.07% 5.88% - 5.87% 6.16% 6.02%
SHORT-TERM INVESTMENTS:
Principal Amount $ 39,235 - - - - - $ 39,235 $ 39,235
Book Value $ 39,235 - - - - - $ 39,235 -
Average Interest Rate 1.28% - - - - - 1.28% 1.28%
LOANS PAYABLE:
Principal Amount $ 39,113 - - - - - $ 39,113 -
Average Interest Rate 1.54% - - - - - 1.54% -
32
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Philadelphia Consolidated Holding Corp. and Subsidiaries
Index to Financial Statements and Schedules
Financial Statements Page
- -------------------- ----
Report of Independent Accountants 34
Consolidated Balance Sheets - As of December 31, 2002 and 2001 35
Consolidated Statements of Operations and Comprehensive Income
- For the Years Ended December 31, 2002, 2001 and 2000 36
Consolidated Statements of Changes in Shareholders' Equity - For the Years Ended
December 31, 2002, 2001 and 2000 37
Consolidated Statements of Cash Flows - For the Years Ended December 31,
2002, 2001, and 2000 38
Notes to Consolidated Financial Statements 39-56
Financial Statement Schedules:
Schedule
I Summary of Investments - Other Than Investments in
Related Parties As of December 31, 2002 S-1
II Condensed Financial Information of Registrant As of
December 31, 2002 and 2001 and For Each of the Three
Years in the Period Ended December 31, 2002 S-2 -- S-4
III Supplementary Insurance Information As of and For the
Years Ended December 31, 2002, 2001 and 2000 S-5
IV Reinsurance For the Years ended December 31, 2002,
2001 and 2000 S-6
VI Supplementary Information Concerning Property-Casualty
Insurance Operations As of and For the Years Ended
December 31, 2002, 2001 and 2000 S-7
33
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Philadelphia Consolidated Holding
Corp.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations and comprehensive income, changes in
shareholders' equity and cash flows present fairly, in all material respects,
the financial position of Philadelphia Consolidated Holding Corp. and
Subsidiaries (the "Company") at December 31, 2002 and 2001, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, in 2002 the
Company changed its method of accounting for goodwill to conform with Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets."
/s/ PricewaterhouseCoopers LLP
Philadelphia, PA
February 7, 2003
34
PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
As of December 31,
--------------------------------
2002 2001
------------ ------------
ASSETS
Investments:
Fixed Maturities Available for Sale at Market
(Amortized Cost $832,701 and $622,551)..................... $ 854,513 $ 628,586
Equity Securities at Market (Cost $51,257 and $37,840)....... 54,346 44,822
------------ ------------
Total Investments........................................ 908,859 673,408
Cash and Cash Equivalents.................................... 42,002 49,910
Accrued Investment Income.................................... 8,571 6,582
Premiums Receivable.......................................... 130,007 96,025
Prepaid Reinsurance Premiums and Reinsurance Receivables..... 151,352 99,601
Deferred Income Taxes........................................ 7,541 6,196
Deferred Acquisition Costs................................... 61,272 41,526
Property and Equipment, Net.................................. 12,794 10,082
Goodwill..................................................... 25,724 25,724
Other Assets................................................. 10,212 8,668
------------ ------------
Total Assets............................................. $ 1,358,334 $ 1,017,722
============ ============
LIABILITIES and SHAREHOLDERS' EQUITY
Policy Liabilities and Accruals:
Unpaid Loss and Loss Adjustment Expenses..................... $ 445,548 $ 302,733
Unearned Premiums............................................ 306,093 197,839
------------ ------------
Total Policy Liabilities and Accruals.................... 751,641 500,572
Loans Payable................................................ 39,113 31,341
Premiums Payable............................................. 33,553 25,659
Other Liabilities............................................ 56,204 31,458
------------ ------------
Total Liabilities........................................ 880,511 589,030
------------ ------------
Commitments and Contingencies
Shareholders' Equity:
Preferred Stock, $.01 Par Value,
10,000,000 Shares Authorized,
None Issued and Outstanding................................ - -
Common Stock, No Par Value,
100,000,000 Shares Authorized, 21,868,877 and
21,509,723 Shares Issued and Outstanding .................. 276,945 268,509
Notes Receivable from Shareholders........................... (6,407) (3,373)
Accumulated Other Comprehensive Income....................... 16,185 8,461
Retained Earnings............................................ 191,100 155,095
------------ ------------
Total Shareholders' Equity............................... 477,823 428,692
------------ ------------
Total Liabilities and Shareholders' Equity............... $ 1,358,334 $ 1,017,722
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
35
PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
For the Years Ended December 31,
------------------------------------------------
2002 2001 2000
------------ ------------ ------------
Revenue:
Net Earned Premiums................................... $ 421,186 $ 296,093 $ 227,292
Net Investment Income................................. 37,516 32,426 25,803
Net Realized Investment Gain (Loss)................... (3,371) 3,357 11,718
Other Income.......................................... 911 587 8,981
------------ ------------ ------------
Total Revenue.................................... 456,242 332,463 273,794
------------ ------------ ------------
Losses and Expenses:
Loss and Loss Adjustment Expenses..................... 361,154 222,581 175,163
Net Reinsurance Recoveries............................ (93,721) (42,926) (43,859)
------------ ------------ ------------
Net Loss and Loss Adjustment Expenses................. 267,433 179,655 131,304
Acquisition Costs and Other
Underwriting Expenses.............................. 129,918 97,020 75,054
Other Operating Expenses.............................. 6,372 6,841 14,679
------------ ------------ ------------
Total Losses and Expenses......................... 403,723 283,516 221,037
------------ ------------ ------------
Minority Interest: Distributions on Company Obligated
Mandatorily Redeemable Preferred Securities of
Subsidiary Trust...................................... - 2,749 7,245
------------ ------------ ------------
Income Before Income Taxes.............................. 52,519 46,198 45,512
------------ ------------ ------------
Income Tax Expense (Benefit):
Current............................................... 22,018 18,216 17,666
Deferred.............................................. (5,504) (2,577) (2,924)
------------ ------------ ------------
Total Income Tax Expense.......................... 16,514 15,639 14,742
------------ ------------ ------------
Net Income........................................ $ 36,005 $ 30,559 $ 30,770
============ ============ ============
Other Comprehensive Income (Loss), Net of Tax:
Holding Gain (Loss) Arising during Year.............. $ 5,533 $ (2,851) $ 7,604
Reclassification Adjustment.......................... 2,191 (2,182) (7,617)
------------ ------------ ------------
Other Comprehensive Income (Loss)....................... 7,724 (5,033) (13)
------------ ------------ ------------
Comprehensive Income.................................... $ 43,729 $ 25,526 $ 30,757
============ ============ ============
Per Average Share Data:
Basic Earnings Per Share.............................. $ 1.67 $ 1.85 $ 2.53
============ ============ ============
Diluted Earnings Per Share............................ $ 1.62 $ 1.78 $ 2.11
============ ============ ============
Weighted-Average Common Shares Outstanding.............. 21,611,053 16,528,601 12,177,989
Weighted-Average Share Equivalents Outstanding.......... 682,382 656,075 2,411,552
------------ ------------ ------------
Weighted-Average Shares and Share Equivalents
Outstanding........................................... 22,293,435 17,184,676 14,589,541
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
36
PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
For the Years Ended December 31,
-----------------------------------------------
2002 2001 2000
------------- ------------- -------------
Common Shares:
Balance at Beginning of Year............................... 21,509,723 13,431,408 13,381,924
Issuance of Shares Pursuant to Public Offering............. - 3,600,000 -
Issuance of Shares Pursuant to Stock Purchase Contracts.... - 3,993,006 -
Exercise of Employee Stock Options......................... 107,000 391,083 -
Issuance of Shares Pursuant to Stock Purchase Plans, net... 252,154 94,226 49,484
------------- ------------- -------------
Balance at End of Year................................. 21,868,877 21,509,723 13,431,408
------------- ------------- -------------
Treasury Shares:
Balance at Beginning of Year............................... - - 791,016
Exercise of Employee Stock Options......................... - - (1,626,159)
Issuance of Shares Pursuant to Stock Purchase Plans, net... (75,000) - 14,021
Shares Repurchased Pursuant to Authorization............... 75,000 - 821,122
------------- ------------- -------------
Balance at End of Year................................. - - -
------------- ------------- -------------
Common Stock:
Balance at Beginning of Year............................... $ 268,509 $ 46,582 $ 68,859
Issuance of Shares Pursuant to Public Offering............. - 114,518 -
Issuance of Shares Pursuant to Stock Purchase Contracts.... - 98,905 -
Exercise of Employee Stock Options......................... 2,115 6,437 (23,132)
Issuance of Shares Pursuant to Stock Purchase Plans........ 6,321 2,067 855
------------- ------------- -------------
Balance at End of Year................................. 276,945 268,509 46,582
------------- ------------- -------------
Notes Receivable from Shareholders:
Balance at Beginning of Year............................... (3,373) (2,287) (2,506)
Notes Receivable Issued Pursuant to Employee
Stock Purchase Plans..................................... (4,017) (2,158) (414)
Collection of Notes Receivable............................. 983 1,072 633
------------- ------------- -------------
Balance at End of Year................................. (6,407) (3,373) (2,287)
------------- ------------- -------------
Accumulated Other Comprehensive Income,
Net of Deferred Income Taxes:
Balance at Beginning of Year............................. 8,461 13,494 13,507
Other Comprehensive Income (Loss), Net of Taxes.......... 7,724 (5,033) (13)
------------- ------------- -------------
Balance at End of Year................................. 16,185 8,461 13,494
------------- ------------- -------------
Retained Earnings:
Balance at Beginning of Year............................... 155,095 124,536 93,766
Net Income................................................. 36,005 30,559 30,770
------------- ------------- -------------
Balance at End of Year................................. 191,100 155,095 124,536
------------- ------------- -------------
Common Stock Held in Treasury:
Balance at Beginning of Year............................... - - (12,186)
Common Shares Repurchased.................................. (2,023) - (40,766)
Exercise of Employee Stock Options......................... - - 52,712
Issuance of Shares Pursuant to Stock Purchase Plans........ 2,023 - 240
------------- ------------- -------------
Balance at End of Year................................. - - -
------------- ------------- -------------
Total Shareholders' Equity............................. $ 477,823 $ 428,692 $ 182,325
============= ============= =============
The accompanying notes are an integral part of the consolidated financial
statements.
37
PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
For the Years Ended December 31,
-------------------------------------------
2002 2001 2000
----------- ----------- -----------
Cash Flows from Operating Activities:
Net Income................................................... $ 36,005 $ 30,559 $ 30,770
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Net Realized Investment (Gain) Loss...................... 3,371 (3,357) (11,718)
Depreciation and Amortization Expense.................... 2,142 2,528 3,856
Deferred Income Tax Benefit.............................. (5,504) (2,577) (2,924)
Change in Premiums Receivable............................ (33,982) (26,648) (20,201)
Change in Other Receivables.............................. (53,740) (26,944) (19,292)
Change in Deferred Acquisition Costs..................... (19,746) (8,202) (7,270)
Change in Income Taxes Payable........................... 367 (6,083) (12,504)
Change in Other Assets................................... (2,438) (840) (959)
Change in Unpaid Loss and Loss Adjustment Expenses....... 142,815 65,239 49,431
Change in Unearned Premiums.............................. 108,254 52,355 33,878
Change in Other Liabilities.............................. 26,173 13,320 3,740
Tax Benefit from Exercise of Employee Stock Options...... 1,251 25,799 145
----------- ----------- -----------
Net Cash Provided by Operating Activities.............. 204,968 115,149 46,952
----------- ----------- -----------
Cash Flows from Investing Activities:
Proceeds from Sales of Investments in Fixed
Maturities................................................. 226,981 112,676 122,795
Proceeds from Maturity of Investments in Fixed
Maturities................................................. 147,850 72,650 22,110
Proceeds from Sales of Investments in Equity
Securities................................................. 18,546 20,864 50,230
Cost of Fixed Maturities Acquired............................ (576,564) (424,852) (208,513)
Cost of Equity Securities Acquired........................... (36,421) (22,529) (18,861)
Purchase of Property and Equipment, Net...................... (5,191) (1,808) (3,184)
----------- ----------- -----------
Net Cash Used for Investing Activities................. (224,799) (242,999) (35,423)
----------- ----------- -----------
Cash Flows from Financing Activities:
Net Proceeds from Public Offering of Common Stock............ - 114,518 -
Proceeds from Loans Payable.................................. 9,923 31,341 22,000
Repayments on Loans Payable.................................. (2,151) (22,000) -
Proceeds from Exercise of Employee Stock Options............. 864 3,041 1,853
Proceeds from Collection of Notes Receivable................. 983 1,072 633
Proceeds from Shares Issued Pursuant to Stock Purchase Plans. 4,327 46 188
Cost of Common Stock Repurchased............................. (2,023) - (12,691)
------------ ----------- -----------
Net Cash Provided by Financing Activities.............. 11,923 128,018 11,983
----------- ----------- -----------
Net Increase (Decrease) in Cash and Cash Equivalents........... (7,908) 168 23,512
Cash and Cash Equivalents at Beginning of Year................. 49,910 49,742 26,230
----------- ----------- -----------
Cash and Cash Equivalents at End of Year....................... $ 42,002 $ 49,910 $ 49,742
=========== =========== ===========
Cash Paid During the Year for:
Income Taxes................................................. $ 20,110 $ 7,023 $ 7,760
Interest 616 689 200
Non-Cash Transactions:
Acceptance of Mature Shares for Exercise Cost of
Employee Stock Options..................................... $ - $ - $ 6,811
Issuance of Shares Pursuant to Employee
Stock Purchase Plans in Exchange for Notes Receivable...... $ 4,017 $ 2,158 $ 414
The accompanying notes are an integral part of the consolidated financial
statements.
38
Philadelphia Consolidated Holding Corp. and Subsidiaries
Notes to Consolidated Financial Statements
1. General Information and Significant Accounting Policies
Philadelphia Consolidated Holding Corp. ("Philadelphia Insurance"), and its
subsidiaries (collectively the "Company") doing business as Philadelphia
Insurance Companies, include four property and casualty insurance companies,
Philadelphia Indemnity Insurance Company ("PIIC") and Philadelphia Insurance
Company ("PIC"), which are domiciled in Pennsylvania; and Mobile USA Insurance
Company ("MUSA") and Liberty American Insurance Company ("LAIC"), which are
domiciled in Florida (collectively the "Insurance Subsidiaries"); an
underwriting manager, Maguire Insurance Agency, Inc.; a managing general agency,
Mobile Homeowners Insurance Agencies, Inc; a premium finance company Liberty
American Premium Finance Company; and an investment subsidiary, PCHC Investment
Corp. The Company designs, markets, and underwrites specialty commercial and
personal property and casualty insurance products for select target industries
or niches including, among others, nonprofit organizations; the health, fitness
and wellness industry; select classes of professional liability; the rental car
industry; automobile leasing industry; and personal property and casualty
insurance products for the manufactured housing and homeowners markets. All
marketing, underwriting, claims management, investment, and general
administration is provided by the underwriting manager and managing general
agency.
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company
prepared in conformity with accounting principles generally accepted in the
United States of America ("GAAP"). All significant intercompany balances and
transactions have been eliminated in consolidation. The preparation of financial
statements requires making estimates and assumptions that affect the reported
amounts of 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. Actual results could differ
from those estimates. Certain prior years' amounts have been reclassified for
comparative purposes.
(a) Investments
Fixed maturity investments, classified as Available for Sale, are carried at
market value with the change in unrealized appreciation (depreciation) credited
or charged directly to shareholders' equity, net of applicable deferred income
taxes. Income on fixed maturities is recognized on the accrual basis.
The carrying amount for the Company's investments approximates their estimated
fair value. The Company measures the fair value of investments based upon quoted
market prices or by obtaining quotes from third party broker-dealers. The
Company's total investments include $22.4 million in securities for which there
is no readily available independent market price. The estimated fair value of
such securities is determined by independent third party broker-dealers.
Material assumptions and factors utilized by such broker-dealers in pricing
these securities include: future cash flows, constant default rates, recovery
rates and any market clearing activity that may have occurred since the prior
month-end pricing period.
The decision to purchase or sell investments is based on management's assessment
of various factors such as foreseeable economic conditions, including current
interest rates and the interest rate risk, and the liquidity and capital
positions of the Company.
Investments in fixed maturities are adjusted for amortization of premiums and
accretion of discounts to maturity date, except for collateralized mortgage and
asset backed securities which are adjusted for amortization of premiums and
accretion of discounts over their estimated lives. Certain collateralized
mortgage and asset backed securities repayment patterns will change based on
interest rate movements and, accordingly, could impact future investment income
if the reinvestment of the repayment amounts are at lower interest rates than
the underlying securities. Collateralized mortgage and asset backed securities
amounted to $90.7 million and $286.1 million, respectively, at December 31, 2002
and $70.9 million and $273.3 million, respectively, at December 31, 2001. The
collateralized mortgage and asset backed securities held as of December 31, 2002
and 2001 are shorter tranche securities possessing favorable prepayment risk
profiles.
Equity securities are carried at market value with the change in unrealized
appreciation (depreciation) credited or charged directly to shareholders'
equity, net of applicable deferred income taxes.
Realized investment gains and losses are calculated on the specific
identification basis and recorded as income when the securities are sold.
39
The Company regularly performs various analytical procedures with respect to its
investments, including identifying any security whose fair value is below its
cost. Upon identification of such securities, a detailed review is performed for
all securities, except interests in securitized assets, meeting predetermined
thresholds, to determine whether such decline is other than temporary. If the
Company determines a decline in value to be other than temporary, the cost basis
of the security is written down to its fair value with the amount of the write
down included in earnings as a realized loss in the period the impairment arose.
This evaluation resulted in non-cash realized investment losses of $2.1 million
for the year ended December 31, 2002. No impairment losses were recorded for the
years ended December 31, 2001 and 2000, respectively.
Additionally, the Company's impairment evaluation and recognition for interests
in securitized assets is conducted in accordance with the guidance provided by
the Emerging Issues Task Force of the Financial Accounting Standards Board.
Under this guidance, impairment losses on securities must be recognized if both
the fair value of the security is less than its book value and the net present
value of expected future cash flows is less than the net present value of
expected future cash flows at the most recent (prior) estimation date. If these
criteria are met, an impairment charge, calculated as the difference between the
current book value of the security and its fair value, is included in earnings
as a realized loss in the period the impairment arose. This re-evaluation
resulted in non-cash realized investment losses of $1.6 million, $5.8 and $0
million for the years ended December 31, 2002, 2001 and 2000, respectively.
The provisions of Statement of Financial Accounting Standards No. 133 ("SFAS
133"), "Accounting for Derivative Instruments and Hedging Activities" require,
among other things, that all derivatives be recognized in the consolidated
balance sheets as either assets or liabilities and measured at fair value. The
corresponding derivative gains and losses should be reported based upon the
hedge relationship, if such a relationship exists. Changes in the fair value of
derivatives that are not designated as hedges or that do not meet the hedge
accounting criteria in SFAS 133 are required to be reported in income. The
Company held no derivative financial instruments, nor embedded financial
derivatives, as of December 31, 2002 and 2001.
(b) Cash and Cash Equivalents
Cash equivalents, consisting of fixed maturity investments with maturities of
three months or less when purchased and money market funds, are stated at cost
which approximates market value.
(c) Deferred Acquisition Costs
Policy acquisition costs, which include commissions, premium taxes, fees, and
certain other costs of underwriting policies, are deferred and amortized over
the same period in which the related premiums are earned. Deferred acquisition
costs are limited to the estimated amounts recoverable from future income,
including anticipated investment income, after providing for losses and expenses
included in future income that are expected to be incurred, based upon
historical and current experience. If such costs are estimated to be
unrecoverable, they are expensed.
(d) Property and Equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over the estimated useful lives of the respective assets.
Costs incurred in developing information systems technology are capitalized and
included in property and equipment. These costs are amortized over their useful
lives from the dates the systems technology becomes operational. Upon disposal
of assets, the cost and related accumulated depreciation are removed from the
accounts and the resulting gain or loss is included in earnings. The carrying
value of property and equipment is reviewed for recoverability including an
evaluation of the estimated useful lives of such assets.
(e) Goodwill
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets" on
January 1, 2002. SFAS No. 142 eliminates the practice of amortizing goodwill
through periodic charges to earnings and establishes a two-step impairment test
to identify potential goodwill impairment and measure the amount of a goodwill
impairment loss to be recognized (if any). As a result of the impairment
analysis, no change in the carrying amount of goodwill was recorded by the
Company for the year ended December 31, 2002. Goodwill amortization was $1.5
million for the years ended December 31, 2001 and 2000, respectively.
(f) Liability for Unpaid Loss and Loss Adjustment Expenses
The liability for unpaid loss and loss adjustment expenses reflects the
Company's best estimate for future amounts needed to pay losses and related
settlement expenses with respect to insured events. Based upon past experience
this estimate has been
40
redundant by as much as 18.8% and deficient by as much as 21.9%. The process of
establishing the ultimate claims liability is necessarily a complex imprecise
process, requiring the use of informed estimates and judgments using data
currently available. The liability includes an amount determined on the basis of
claim adjusters' evaluations with respect to insured events that have occurred
and an amount for losses incurred that have not been reported to the Company. In
some cases significant periods of time, up to several years or more, may elapse
between the occurrence of an insured loss and the reporting of such to the
Company. The method for determining the Company's liability for unpaid loss and
loss adjustment expenses includes, but is not limited to, reviewing past loss
experience and considering other factors such as legal, social, and economic
developments. The methods of making such estimates and establishing the
resulting liabilities are regularly reviewed and updated and any adjustments
therefrom are made in the accounting period in which the adjustment arose. If
the Company's ultimate losses, net of reinsurance, prove to differ substantially
from the amounts recorded at December 31, 2002, the related adjustments could
have a material adverse impact on the Company's financial condition, and results
of operations.
(g) Premiums
Premiums are generally earned on a pro rata basis over the terms of the
policies. Premiums applicable to the unexpired terms of the policies in-force
are reported as unearned premiums. The Company records an allowance for doubtful
accounts for premiums receivable balances estimated to be uncollectible. At
December 31, 2002 and 2001 the allowance for doubtful accounts amounted to $1.7
million and $1.0 million, respectively.
(h) Reinsurance Ceded
In the normal course of business, the Company seeks to reduce the loss that may
arise from events that cause unfavorable underwriting results by reinsuring
certain levels of risk in various areas of exposure with reinsurers. Amounts
recoverable from reinsurers are estimated in a manner consistent with the
reinsured policy. Amounts for reinsurance assets and liabilities are reported
gross.
(i) Assessments
The Insurance Subsidiaries are subject to state guaranty fund assessments, which
provide for the payment of covered claims or meet other insurance obligations
from insurance company insolvencies, and other assessments related to its
insurance activities. Each state has enacted legislation establishing guaranty
funds and other insurance activity related assessments resulting in a variety of
assessment methodologies. Expense for guaranty fund and insurance activity
related assessments are recognized when it is probable that an assessment will
be imposed, the obligatory event has occurred and the amount of the assessment
is reasonably estimated.
(j) Income Taxes
The Company files a consolidated federal income tax return. Deferred income
taxes are recognized for the tax consequences of temporary differences by
applying enacted statutory tax rates applicable to the differences between the
financial statement carrying amounts and the tax bases of existing assets and
liabilities. The effect on deferred taxes for a change in tax rates is
recognized in income in the period that includes the enactment date.
(k) Earnings Per Share
Basic earnings per share has been calculated by dividing net income by the
weighted-average common shares outstanding. Diluted earnings per share has been
calculated by dividing net income by the weighted-average common shares
outstanding and the weighted-average share equivalents outstanding.
(l) Comprehensive Income
Components of comprehensive income, as detailed in the Consolidated Statements
of Operations and Comprehensive Income, are net of tax. The related tax effect
of Holding Gains (Losses) arising during the year was $3.0 million, ($1.5)
million and $4.1 million in 2002, 2001 and 2000, respectively. The related tax
effect of Reclassification Adjustments was ($1.2) million, $1.2 million, and
$4.1 million in 2002, 2001 and 2000, respectively.
2. Statutory Information
Accounting Principles: The Codification of Statutory Accounting Principles
provides guidance for areas where statutory accounting was previously silent and
changed previous statutory accounting in some areas (e.g., deferred income
taxes,
41
electronic data processing equipment and software, and uncollected premiums).
The Insurance Departments of Pennsylvania and Florida adopted the Codification
guidance, effective January 1, 2001. The effect of adoption of the Codification
of Statutory Accounting Principles, recorded as a direct increase to the
Company's combined statutory unassigned surplus of it's subsidiaries, was $15.7
million.
GAAP differs in certain respects from SAP prescribed or permitted by the
Insurance Department of the Commonwealth of Pennsylvania and/or the State of
Florida. The principal differences between SAP and GAAP are as follows:
- - Under SAP, investments in debt securities are carried at amortized cost,
while under GAAP, investments in debt securities classified as Available
for Sale are carried at fair value.
- - Under SAP, policy acquisition costs, such as commissions, premium taxes,
fees, and other costs of underwriting policies are charged to current
operations as incurred, while under GAAP, such costs are deferred and
amortized on a pro rata basis over the period covered by the policy.
- - Under SAP, certain assets, designated as "Non-admitted Assets" (such as
prepaid expenses) are charged against surplus.
- - Under SAP, net deferred income tax assets are admitted following the
application of certain criteria, with the resulting admitted deferred tax
amount being credited directly to policyholder surplus.
- - Under SAP, premiums receivable are considered nonadmitted if determined to
be uncollected based upon aging criteria as defined in SAP.
- - Under SAP, the costs and related recoverables for guaranty funds and other
assessments are recorded based on management's estimate of the ultimate
liability and related recoverable settlement, while under GAAP, such costs
are accrued when the liability is probable and reasonably estimatable and
the related recoverable amount is based on future premium collections or
policy surcharges from in-force policies.
Financial Information: The combined statutory capital and surplus of the
Insurance Subsidiaries as of December 31, 2002 and 2001 was $312.6 million and
$281.0 million, respectively. Combined statutory net income for the years ended
December 31, 2002, 2001 and 2000 was $14.5 million, $28.3 million, and $26.2
million, respectively. The Company made capital contributions of $20.0 million
and $73.0 million to the Insurance Subsidiaries for the years ended December 31,
2002 and 2001, respectively.
Dividend Restrictions: The Insurance Subsidiaries are subject to various
regulatory restrictions which limit the maximum amount of annual shareholder
dividends allowed to be paid. The maximum dividend which the Insurance
Subsidiaries may pay to Philadelphia Insurance during 2003 without prior
approval is $31.7 million. Dividends paid for the years ended December 31, 2002
and 2001 were $5.1 million and $16.8 million, respectively.
Risk-Based Capital: Risk-based capital is a method developed by the National
Association of Insurance Commissioners ("NAIC") designed to measure the
acceptable amount of capital and surplus an insurer should have based on the
inherent specific risks of each insurer. The adequacy of a company's actual
capital and surplus is evaluated by a comparison to the risk-based capital
results. Insurers failing to meet minimum risk-based capital requirements may be
subject to scrutiny by the insurer's domiciliary insurance department and
ultimately rehabilitation or liquidation. As of December 31, 2002, PIIC, PIC,
MUSA and LAIC exceeded their minimum risk-based capital requirement of $75.9
million, $10.0 million, $11.7 million and $11.7 million, respectively, by 234%,
135%, 48% and 56%, respectively.
3. Investments
The Company invests primarily in investment grade fixed maturities which
possessed an average quality rating of AA+ at December 31, 2002. The cost, gross
unrealized gains and losses and estimated market value of investments as of
December 31, 2002 and 2001 are as follows (in thousands):
42
Gross Gross Estimated
Unrealized Unrealized Market
Cost(1) Gains Losses Value(2)
---- ----- ------ -----
December 31, 2002
Fixed Maturities:
Available for Sale
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $ 9,754 $ 433 $ 1 $ 10,186
Obligations of States and
Political Subdivisions 279,397 10,600 7 289,990
Corporate and Bank Debt Securities 170,222 9,283 1,919 177,586
Collateralized Mortgage Securities 89,189 1,771 271 90,689
Asset Backed Securities 284,139 8,960 7,037 286,062
- -----------------------------------------------------------------------------------------------------------
Total Fixed Maturities
Available for Sale 832,701 31,047 9,235 854,513
- -----------------------------------------------------------------------------------------------------------
Equity Securities 51,257 4,679 1,590 54,346
- -----------------------------------------------------------------------------------------------------------
Total Investments $ 883,958 $ 35,726 $ 10,825 $ 908,859
===========================================================================================================
December 31, 2001
Fixed Maturities:
Available for Sale
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $ 21,024 $ 670 $ - $ 21,694
Obligations of States and
Political Subdivisions 104,628 2,006 450 106,184
Corporate and Bank Debt Securities 153,882 4,157 1,543 156,496
Collateralized Mortgage Securities 70,362 831 320 70,873
Asset Backed Securities 272,655 2,988 2,304 273,339
- -----------------------------------------------------------------------------------------------------------
Total Fixed Maturities
Available for Sale 622,551 10,652 4,617 628,586
- -----------------------------------------------------------------------------------------------------------
Equity Securities 37,840 7,294 312 44,822
- -----------------------------------------------------------------------------------------------------------
Total Investments $ 660,391 $ 17,946 $ 4,929 $ 673,408
===========================================================================================================
(1) Original cost of equity securities; original cost of fixed maturities
adjusted for amortization of premiums and accretion of discounts. All
amounts are shown net of impairment losses.
(2) Estimated market values have been based on quoted market prices.
The Company had no debt or equity investments in a single issuer totaling in
excess of 10% of shareholders' equity at December 31, 2002.
The cost and estimated market value of fixed maturity securities at December 31,
2002, by remaining contractual maturity, are shown below (in thousands).
Expected maturities may differ from contractual maturities because certain
borrowers have the right to call or prepay obligations with or without call or
prepayment penalties.
43
Estimated
Market
Cost(1) Value(2)
------------ ---------------
Due in One Year or Less $ 23,078 $ 23,487
Due After One Year Through Five Years 207,741 214,467
Due After Five Years through Ten Years 89,820 95,295
Due After Ten Years 138,734 144,513
Collateralized Mortgage and Asset Backed Securities 373,328 376,751
- -----------------------------------------------------------------------------------------------------------------
$ 832,701 $ 854,513
=================================================================================================================
(1) Original cost adjusted for amortization of premiums and accretion of
discounts. All amounts are shown net of impairment losses.
(2) Estimated market values have been based on quoted market prices.
The sources of net investment income for the years ended December 31, 2002,
2001, and 2000 are as follows (in thousands):
2002 2001 2000
--------------- --------------- -----------
Fixed Maturities $ 37,959 $ 30,962 $ 23,396
Equity Securities 706 1,343 1,414
Cash and Cash Equivalents 1,113 1,908 1,961
- ---------------------------------------------------------------------------------------------
Total Investment Income 39,778 34,213 26,771
Investment Expense (2,262) (1,787) (968)
- ---------------------------------------------------------------------------------------------
Net Investment Income $ 37,516 $ 32,426 $ 25,803
=============================================================================================
There are no material investments in fixed maturity securities that were
non-income producing for the twelve month periods ended December 31, 2002, 2001,
or 2000. Investment expense includes $77,000, $107,000, and $182,000, in
investment management fees paid to a director of the Company in 2002, 2001, and
2000, respectively. These transactions are in the ordinary course of business at
negotiated prices comparable to those of transactions with other investment
advisors.
Realized pre-tax gains (losses) on the sale of investments for the years ended
December 31, 2002, 2001, and 2000 are as follows (in thousands):
2002 2001 2000
--------------- --------------- ----------
Fixed Maturities
Gross Realized Gains $ 3,771 $ 5,023 $ 242
Gross Realized Losses (1,952) (9,979) (3,607)
- --------------------------------------------------------------------------------------------------------------
Net Gain (Loss) 1,819 (4,956) (3,365)
- --------------------------------------------------------------------------------------------------------------
Equity Securities
Gross Realized Gains 177 10,259 18,685
Gross Realized Losses (5,367) (1,946) (3,602)
- --------------------------------------------------------------------------------------------------------------
Net Gain (Loss) (5,190) 8,313 15,083
- --------------------------------------------------------------------------------------------------------------
Total Net Realized
Investment Gain (Loss) $ (3,371) $ 3,357 $ 11,718
==============================================================================================================
4. Restricted Assets
The Insurance Subsidiaries have investments, principally U.S. Treasury
securities, on deposit with the various states in which they are licensed
insurers. At December 31, 2002 and 2001, the carrying value of the securities on
deposit totaled $13.5 million.
Additionally, the Insurance Subsidiaries have investments, principally asset
backed securities, which collateralize the borrowings from the Federal Home Loan
Bank of Pittsburgh, see Note 9. The carrying value of these investments was
$49.2 million and $33.9 million as of December 31, 2002 and 2001, respectively.
44
5. Trust Accounts
The Company maintains investments in trust accounts under reinsurance agreements
with unrelated insurance companies. These investments collateralize the
Company's obligations under the reinsurance agreements. The Company possesses
sole responsibility for investment and reinvestment of the trust account assets.
All dividends, interest and other income, resulting from investment of these
assets are distributed to the Company on a monthly basis. At December 31, 2002
and 2001 the carrying value of these trust fund investments were $1.6 million
and $11.9 million, respectively.
The Company's share of the investments in the trust accounts is included in
investments and cash equivalents, as applicable, in the accompanying
consolidated balance sheets.
6. Property and Equipment
The following table summarizes property and equipment at December 31, 2002 and
2001 (dollars in thousands):
Estimated Useful
December 31, Lives (Years)
-------------------------- -------------
2002 2001
---- ----
Furniture, Fixtures and Automobiles $ 4,491 $ 3,854 5
Software, Computer Hardware and
Telephone Equipment 18,755 14,897 3 - 7
Land and Building 3,588 3,585 40
Leasehold Improvements 1,881 1,489 10 -12
- --------------------------------------------------------------------------
28,715 23,825
Accumulated Depreciation and
Amortization (15,921) (13,743)
- --------------------------------------------------------------------------
Property and Equipment $ 12,794 $ 10,082
==========================================================================
Included in property and equipment are costs incurred in developing or
purchasing information systems technology of $8.2 million and $6.3 million in
2002 and 2001, respectively. Amortization of these costs was $1.0 million, $0.8
million and $0.6 million for the years ended December 31, 2002, 2001 and 2000,
respectively. Depreciation expense, excluding amortization of capitalized
information systems technology costs, was $1.5 million, $1.4 million and $1.4
million, for the years ended December 31, 2002, 2001, and 2000, respectively.
7. Goodwill
The following table provides a reconciliation of the prior two year's ended
December 31 reported net income to adjusted net income had SFAS No. 142 been
applied at the beginning of fiscal 2000 (in thousands, except per share
amounts):
For the Year Ended December 31,
------------------------------------------------------
2002 2001 2000
--------- ---------- ---------
Reported net income $ 36,005 $ 30,559 $ 30,770
Adjustment for goodwill amortization - 1,500 1,500
--------- ---------- ---------
Adjusted net income $ 36,005 $ 32,059 $ 32,270
========= ========== =========
Reported basic earnings per share $ 1.67 $ 1.85 $ 2.53
Adjustment for goodwill amortization - 0.09 0.12
--------- ---------- ---------
Adjusted basic earnings per share $ 1.67 $ 1.94 $ 2.65
========= ========== =========
Reported diluted earnings per share $ 1.62 $ 1.78 $ 2.11
Adjustment for goodwill amortization - 0.09 0.10
--------- ---------- ---------
Adjusted diluted earnings per share $ 1.62 $ 1.87 $ 2.21
========= ========== =========
45
8. Liability for Unpaid Loss and Loss Adjustment Expenses
Activity in the liability for Unpaid Loss and Loss Adjustment Expenses is
summarized as follows (in thousands):
2002 2001 2000
---------- ---------- ----------
Balance at January 1, $ 302,733 $ 237,494 $ 188,063
Less Reinsurance Recoverables 52,599 42,030 26,710
---------- ---------- ----------
Net Balance at January 1, 250,134 195,464 161,353
---------- ---------- ----------
Incurred related to:
Current Year 239,834 166,220 128,761
Prior Years 27,599 13,435 2,543
---------- ---------- ----------
Total Incurred 267,433 179,655 131,304
---------- ---------- ----------
Paid related to:
Current Year 58,530 54,228 36,271
Prior Years 99,326 70,757 60,922
---------- ---------- ----------
Total Paid 157,856 124,985 97,193
---------- ---------- ----------
Net Balance at December 31, 359,711 250,134 195,464
Plus Reinsurance Recoverables 85,837 52,599 42,030
---------- ---------- ----------
Balance at December 31, $ 445,548 $ 302,733 $ 237,494
========== ========== ==========
During 2002, the Company increased the estimated loss for unreported claims
incurred and related claim adjustment expenses on residual value polices issued
during the years 1998 through 2001 by $30.2 million ($20.7 million net of
reinsurance). As of December 31, 2001 the Company had estimated a total
liability for unpaid loss and loss adjustment expenses for these policies of
$14.5 million ($8.7 million net of reinsurance recoverables). The residual value
policies provide coverage guaranteeing the value of a leased automobile at the
lease termination which can be up to five years from lease inception. During
2002 adverse trends further deteriorated in both frequency and severity on
leases expiring in 2002. As part of the Company's monitoring and evaluation
process, consulting firms were engaged during the third quarter of 2002 to aid
in evaluating this deterioration and the ultimate potential loss exposure under
these policies. As a result of the indications and subsequent evaluation by the
Company and changes in the Company's assumptions relating to future frequency
and severity of losses, the estimate for unpaid loss and loss adjustment
expenses was increased. The Company primarily attributes this deterioration to
the following factors that led to a softening of prices in the used car market
subsequent to the September 11, 2001 terrorist attacks: prolonged 0% new car
financing rates and other incentives which increased new car sales and the
volume of trade-ins, daily rental units being sold into the market earlier and
in greater numbers than expected further adding to the over supply of used cars;
and the overall uncertain economic conditions.
The Company also increased the liability for unpaid loss and loss adjustment
expenses on the Commercial Automobile Excess Liability Insurance ("Excess
Liability") product sold to rental car companies (Commercial Lines Underwriting
Segment) primarily for the 2000 and 2001 accident years by $6.9 million ($4.9
million net of reinsurance). As of December 31, 2001 the Company had estimated a
total liability for unpaid loss and loss adjustment expenses for the Excess
Liability policies issued in these years of $23.0 million ($21.6 million net of
reinsurance). Excess Liability provides automobile liability coverage in excess
of the state mandated limits which are provided by the rental car company.
During the third quarter of 2002, pursuant to a routine underwriting review
focusing on price adequacy and loss experience, the Company non-renewed a
significant Excess Liability customer as a result of an unacceptable
underwriting risk profile (Results of Operations (2002 versus 2001)). This
adverse loss development was primarily due to pricing inadequacy and the adverse
loss experience of this customer. Additionally, the Company has experienced a
delay in both the reporting of claims and the claim litigation discovery process
as a result of this policyholder and another Excess Liability policyholder
filing for Chapter 11 during the third quarter 2002 and fourth quarter 2001,
respectively.
During 2001, as a result of changes in estimates of insured events in prior
years, the Company increased losses and loss adjustment expenses incurred by
$13.4 million. Such development was primarily due to losses emerging at a higher
rate on automobile leases expiring in 2001 on residual value policies
underwritten in prior years than had been originally anticipated when the
initial reserves were estimated.
46
9. Loans Payable
The Company had aggregate borrowings of $39.1 million and $31.3 million as of
December 31, 2002 and 2001, respectively, from the Federal Home Loan Bank of
Pittsburgh. These borrowings bear interest at adjusted LIBOR and mature twelve
months from inception. The proceeds from these borrowings were invested in asset
backed securities and collateralized mortgage obligations to achieve a positive
spread between the rate of interest on these securities and the borrowing rates.
The weighted-average interest rate on borrowings outstanding as of December 31,
2002 was 1.54%.
In November 2000 the Company, pursuant to a Board of Directors authorization,
entered into an unsecured revolving credit facility for aggregate borrowings of
up to $22.0 million at any one time outstanding with a maturity date of 364 days
after closing. During 2000, $22.0 million of the facility was utilized by the
Company to pay a withholding tax liability as a result of the CEO electing to
have shares otherwise issuable withheld in satisfaction of the minimum
withholding tax attributable to the exercise of stock options. Borrowings under
the facility bore interest at adjusted LIBOR and unused commitments under the
facility were subject to a fee of 20 basis points per annum. Interest expense
amounted to $0.1 million and $0.2 million for the years ended December 31, 2001
and 2000, respectively. During the first quarter 2001 the Company repaid all
aggregate borrowings and cancelled the commitment under this revolving credit
facility.
10. Income Taxes
The composition of deferred tax assets and liabilities and the related tax
effects as of December 31, 2002 and 2001 are as follows (in thousands):
December 31,
------------------------------
2002 2001
---- ----
Assets:
Loss Reserve Discounting $ 16,461 $ 12,308
Excess of Tax Over Financial Reporting Earned Premium 18,838 11,492
Excess of Financial Reporting Over Tax Net Realized Investment Losses 3,315 2,029
Deferred Compensation 107 97
Other Assets 633 399
- --------------------------------------------------------------------------------------------------------------------
Total Assets 39,354 26,325
====================================================================================================================
Liabilities:
Deferred Acquisition Costs 21,445 14,534
Unrealized Appreciation of Securities 8,715 4,556
Property and Equipment Basis 803 548
Other Liabilities 850 491
- --------------------------------------------------------------------------------------------------------------------
Total Liabilities 31,813 20,129
- --------------------------------------------------------------------------------------------------------------------
Net Deferred Income Tax Asset $ 7,541 $ 6,196
====================================================================================================================
The following table summarizes the differences between the Company's effective
tax rate for financial statement purposes and the federal statutory rate
(dollars in thousands):
47
Amount of Tax Percent
------------- -------
For the year ended December 31, 2002:
Federal Tax at Statutory Rate $ 18,382 35%
Nontaxable Municipal Bond Interest and Dividends Received Exclusion (2,525) (5)
Other, Net 657 1
- ---------------------------------------------------------------------------------------------------------------------
Income Tax Expense $ 16,514 31%
=====================================================================================================================
For the year ended December 31, 2001:
Federal Tax at Statutory Rate $ 16,169 35%
Nontaxable Municipal Bond Interest and Dividends Received Exclusion (1,456) (3)
Nondeductible Goodwill Amortization 523 1
Other, Net 403 1
- ---------------------------------------------------------------------------------------------------------------------
Income Tax Expense $ 15,639 34%
=====================================================================================================================
For the year ended December 31, 2000:
Federal Tax at Statutory Rate $ 15,929 35%
Nontaxable Municipal Bond Interest and Dividends Received Exclusion (1,884) (4)
Nondeductible Goodwill Amortization 522 1
Other, Net 175 -
- ---------------------------------------------------------------------------------------------------------------------
Income Tax Expense $ 14,742 32%
=====================================================================================================================
Philadelphia Insurance has entered into tax sharing agreements with each of its
subsidiaries. Under the terms of these agreements, the income tax provision is
computed as if each subsidiary were filing a separate federal income tax return,
including adjustments for the income tax effects of net operating losses and
other special tax attributes, regardless of whether those attributes are
utilized in the Company's consolidated federal income tax return.
11. Minority Interest in Consolidated Subsidiaries
During 1998, the Company issued 10.350 million FELINE PRIDES(SM) at $10.00 per
security and PCHC Financing I, the Company's business trust subsidiary, issued
1,000,000 7.0% Trust Originated Preferred Securities with a stated liquidation
amount per trust preferred security equal to $10.00. The 10.350 million FELINE
PRIDES(SM) consisted of 9.350 million units referred to as Income Prides and
1.000 million units referred to as Growth Prides. Each Income Prides consisted
of a unit comprised of (a) a purchase contract under which the holder purchased
a number of shares of Philadelphia Consolidated Holding Corp. common stock on
May 16, 2001 (equal to .3858 shares per FELINE PRIDES(SM) under the terms
specified in the stock purchase contract and (b) beneficial ownership of a 7.0%
Trust Originated Preferred Security issued by PCHC Financing I and representing
an undivided beneficial ownership in the assets of PCHC Financing I. Each holder
received aggregate cumulative cash distributions at the annual rate of 7.00% of
the $10.00 stated amount for the security, payable quarterly in arrears. Each
Growth Prides consisted of a unit with a face amount of $10.00 comprised of (a)
a purchase contract under which (i) the holder purchased a number of shares of
Philadelphia Consolidated Holding Corp. common stock on May 16, 2001 (equal to
..3858 shares per FELINE PRIDES(SM) under the terms specified in the stock
purchase contract and (ii) the Company paid the holder contract adjustment
payments at the rate of .50% of the stated amount per annum and (b) a 1/100
undivided beneficial ownership interest in a treasury security having a
principal amount at maturity equal to $1,000 and maturing on May 15, 2001.
On May 16, 2001, the Company issued 4.0 million common shares to satisfy the
stock purchase contract obligation from the Company's 1998 FELINE PRIDES(SM)
offering. The issuance of such shares resulted in a $98.9 million increase in
Shareholders' Equity and a corresponding decrease in the Minority Interest In
Consolidated Subsidiaries balance.
12. Shareholders' Equity
Basic and diluted earnings per share are calculated as follows (dollars and
share data in thousands, except per share data):
48
As of and For the Years Ended December 31,
------------------------------------------
2002 2001 2000
---------- ---------- ---------
Weighted-Average Common Shares Outstanding 21,611 16,529 12,178
Weighted-Average Share Equivalents Outstanding 682 656 2,412
---------- ---------- ---------
Weighted-Average Shares and Share Equivalents Outstanding 22,293 17,185 14,590
========== ========== =========
Net Income $36,005 $30,559 $30,770
========== ========== =========
Basic Earnings Per Share $ 1.67 $ 1.85 $ 2.53
======= ======= =======
Diluted Earnings Per Share $ 1.62 $ 1.78 $ 2.11
======= ======= =======
The number of weighted share equivalents not included in the weighted-average
share equivalents outstanding calculation amounted to 9,620, 122 and 20,291 for
the years ended December 31, 2002, 2001 and 2000, respectively.
During the fourth quarter of 2001, the Company closed on its public offering of
an aggregate of 3.6 million shares of its common stock. Proceeds from the
offering amounted to $114.5 million (after underwriting and associated costs).
The Company contributed $70.0 million of the net proceeds to its subsidiaries in
2001, of which $60.0 million was contributed to the Insurance Subsidiaries. The
remaining proceeds are presently being held for general corporate purposes.
Under the Company's stock option plan, stock options may be granted for the
purchase of common stock at a price not less than the fair market value on the
date of grant. Options are primarily exercisable after the expiration of five
years following the grant date. Under this plan, as amended, the Company has
reserved 3,500,000 shares of common stock for issuance pursuant to options
granted under the plan. As of December 31, 2002, 2,460,800 shares of common
stock remain reserved for future issuance pursuant to options granted under this
plan.
In addition to stock options granted pursuant to the Company's stock option
plan, the Company's Board of Directors have granted previous awards of 2,613,492
stock options. During 2000 all such stock options were exercised.
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure ("SFAS No. 148") which amends SFAS
Statement No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). The
objective of SFAS No. 148 is to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. SFAS No. 148 does not change the provisions of SFAS No.
123 that permit entities to continue to apply the intrinsic value method of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB No. 25"). In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company continues to maintain its accounting for stock-based compensation in
accordance with APB No. 25, but has adopted the disclosure provisions of SFAS
No. 148.
The following table is presented in accordance with SFAS No. 148. The Company
uses the Black-Scholes pricing model; to calculate the fair value of the options
awarded as of the date of grant.
49
2002 2001 2000
----------------------------- ----------------------------- ------------------------------
Exercise Exercise Exercise
Price Price Price
Options Per Option(1) Options Per Option(1) Options Per Option(1)
--------- ------------- --------- -------------- ---------- --------------
Outstanding at beginning of
year 1,453,075 $ 19.32 1,330,075 $ 12.68 3,835,917 $ 5.55
Granted 549,500 $ 36.14 572,500 $ 27.09 272,500 $ 18.32
Exercised (107,000) $ 8.07 (392,000) $ 8.09 (2,640,842) $ 2.61
Canceled (5,500) $ 29.60 (57,500) $ 19.68 (137,500) $ 18.28
--------- --------- ----------
Outstanding at end of year 1,890,075 $ 24.82 1,453,075 $ 19.32 1,330,075 $ 12.68
========= ========= ==========
Exercisable at end of year 194,950 296,950 21,050
Weighted-average fair
value of options granted
during the year $ 14.46 $ 10.99 $ 7.75
Exercise Remaining Exercisable Exercise
Outstanding Price Contractual at December Price
At December Per Life 31, 2002 Per
Range of Exercise Prices 31, 2002 Option(1) (Years)(1) Option(1)
- ------------------------------------------------------------------------------------------------------------------------------------
$2.61 to $9.31 189,950 $ 8.98 3.4 189,950 $ 8.98
$13.88 to $19.75 463,625 $ 15.93 6.4 5,000 16.38
$20.50 to $27.00 557,500 $ 25.01 7.8 - -
$27.31 to $34.63 302,500 $ 30.02 9.2 - -
$36.55 to $42.49 376,500 $ 39.87 9.4 - -
--------- -------
1,890,075 $ 24.82 194,950 $ 9.17
========= =======
(1) Weighted Average.
The Company has established the following non-qualified stock purchase plans:
Employee Stock Purchase Plan (the "Stock Purchase Plan"): The aggregate maximum
number of shares that may be issued pursuant to the Stock Purchase Plan as
amended is 1,000,000. Shares may be purchased under the Stock Purchase Plan by
eligible employees during designated one-month offering periods established by
the Compensation Committee of the Board of Directors at a purchase price of the
lesser of 85% of the fair market value of the shares on the first business day
of the offering period or the date the shares are purchased. The purchase price
of shares may be paid by the employee over six years pursuant to the execution
of a promissory note. The promissory note(s) are collateralized by such shares
purchased under the Stock Purchase Plan and are interest free. Under the Stock
Purchase Plan, the Company issued 77,730 and 103,855 shares in 2002 and 2001,
respectively. The weighted-average fair value of those purchase rights granted
in 2002 and 2001 was $4.47 and $3.85, respectively.
In May 2002, the Nonqualified Employee Stock Purchase Plan was approved by the
Company's shareholders (the "Nonqualified Stock Plan"): The aggregate maximum
number of shares that may be issued pursuant to the Nonqualified Stock Plan is
1,000,000. Shares may be purchased under the Nonqualified Stock Plan by eligible
employees during designated one-month offering periods established by the
Compensation Committee of the Board of Directors at a purchase price of the
lesser of 85% of the fair market value of the shares on the first business day
of the offering period or the date the shares are purchased. The purchase price
of shares may be paid by the employee over nine years pursuant to the execution
of a promissory note. The promissory note(s) are collateralized by such shares
purchased under the Nonqualified Stock Plan and are interest free. Under the
Nonqualified Stock Plan, the Company issued 242,444 shares in 2002. The
weighted-average fair value of those purchase rights granted in 2002 was $4.47.
Directors Stock Purchase Plan ("Directors Plan"): The Directors Plan has been
established for the benefit of non-employee Directors. The aggregate maximum
number of shares that may be issued pursuant to the Directors Plan is 50,000.
Non-employee Directors, during monthly offerings periods, may designate a
portion of his or her fees to be used for the purchase of shares under the terms
of the Directors Plan at a purchase price of the lesser of 85% of the fair
market value of the shares on the first business day of the offering period or
the date the shares are purchased. Under the Directors Plan, the Company
50
issued 2,237 and 1,709 shares in 2002 and 2001, respectively. The
weighted-average fair value of those purchase rights granted in 2002 and 2001
was $5.63 and $4.56, respectively.
Preferred Agents Stock Purchase Plan ("Preferred Agents Plan"): The Preferred
Agents Plan has been established for the benefit of eligible Preferred Agents.
The aggregate maximum number of shares that may be issued pursuant to the
Preferred Agents Plan is 200,000. Eligible Preferred Agents during designated
offering periods may either remit cash or have the Company withhold from
commissions or other compensation amounts to be used for the purchase of shares
under the terms of the Preferred Agents Plan at a purchase price of the lesser
of 85% of the fair market value of the shares on the first business day of the
offering period or the date the shares are purchased. Under the Preferred Agents
Plan, the Company issued 10,966 and 0 shares in 2002 and 2001, respectively. The
weighted-average fair value of those purchase rights granted in 2002 was $6.07.
The following represents pro forma information as if the Company recorded
compensation costs using the fair value of the issued compensation instruments
(the results may not be indicative of the actual effect on net income in future
years) (in thousands, except per average common share data):
2002 2001 2000
--------- --------- ---------
Net Income As Reported $ 36,005 $ 30,559 $ 30,770
Assumed Stock Compensation Cost 2,254 1,543 947
--------- --------- ---------
Pro Forma Net Income $ 33,751 $ 29,016 $ 29,823
========= ========= =========
Diluted Earnings Per Average Common Share as Reported $ 1.62 $ 1.78 $ 2.11
========= ========= =========
Pro Forma Diluted Earnings Per Average Common Share $ 1.51 $ 1.69 $ 2.04
========= ========= =========
The fair value of options at date of grant was estimated using the Black-Scholes
valuation model with the following weighted-average assumptions:
2002 2001 2000
------ ------ ------
Expected Stock Volatility 33.0% 32.0% 30.6%
Risk-Free Interest Rate 4.1% 4.7% 6.2%
Expected Option Life (Years) 6.0 6.0 6.0
Expected Dividends 0.0% 0.0% 0.0%
13. Stock Repurchase Authorization
During the three years ended December 31, 2002, the Company repurchased 0.9
million shares for approximately $15.0 million under its stock repurchase
authorization. At December 31, 2002, $25.0 million remains under a $55.0 million
stock purchase authorization.
14. Reinsurance
In the normal course of business, the Company has entered into various
reinsurance contracts with unrelated reinsurers. The Company participates in
such agreements for the purpose of limiting loss exposure and diversifying
business. Reinsurance contracts do not relieve the Company from its obligation
to policyholders.
The loss and loss adjustment expense reserves ceded under such arrangements were
$85.8 million and $52.6 million at December 31, 2002 and 2001, respectively. The
Company evaluates the financial condition of its reinsurers to minimize its
exposure to losses from reinsurer insolvencies. The percentage of ceded
reinsurance reserves (excluding reserves ceded to voluntary and mandatory pool
mechanisms) that are with companies rated "A" (Excellent) or better by A.M. Best
Company is 97.0% as of December 31, 2002 and 2001, respectively. Additionally,
approximately 1%, 3% and 4% of the Company's net written premiums for the years
ended December 31, 2002, 2001, and 2000, respectively, were assumed from an
unrelated reinsurance company.
51
The effect of reinsurance on premiums written and earned is as follows (in
thousands):
Written Earned
For the Year Ended December 31, 2002: ------- ------
Direct Business $ 660,789 $ 550,443
Reinsurance Assumed 2,950 5,042
Reinsurance Ceded 140,568 134,299
- ----------------------------------------------------------------------------------------------------------------
Net Premiums $ 523,171 $ 421,186
- ----------------------------------------------------------------------------------------------------------------
Percentage Assumed of Net 1.2%
================================================================================================================
For the Year Ended December 31, 2001:
Direct Business $ 464,491 $ 409,814
Reinsurance Assumed 9,074 11,249
Reinsurance Ceded 139,748 124,970
- ----------------------------------------------------------------------------------------------------------------
Net Premiums $ 333,817 $ 296,093
- ----------------------------------------------------------------------------------------------------------------
Percentage Assumed of Net 3.8%
================================================================================================================
For the Year Ended December 31, 2000:
Direct Business $ 350,603 $ 319,591
Reinsurance Assumed 11,256 8,747
Reinsurance Ceded 98,430 101,046
- ----------------------------------------------------------------------------------------------------------------
Net Premiums $ 263,429 $ 227,292
- ----------------------------------------------------------------------------------------------------------------
Percentage Assumed of Net 3.8%
================================================================================================================
15. Compensation Plans
The Company has a defined contribution Profit Sharing Plan, which includes a
401K feature, covering substantially all employees. Under the plan, employees
may contribute up to an annual maximum of the lesser of 15% of eligible
compensation or the applicable Internal Revenue Code limit in a calendar year.
The Company makes a matching contribution in an amount equal to 75% of the
participant's pre-tax contribution, subject to a maximum of 6% of the
participant's eligible compensation. The Company may also make annual
discretionary profit sharing contributions at each plan year end. Participants
are fully vested in the Company's contribution upon completion of four years of
service. The Company's total contributions to the plan were $0.8 million, $0.6
million and $0.6 million in 2002, 2001, and 2000, respectively.
The Company sponsors an unfunded nonqualified key employee deferred compensation
plan. Under the plan deferred compensation benefits are provided through
deferrals of base salary and bonus compensation ("Employee Deferrals") and
discretionary contributions by the Company ("Employer Contributions") for a
select group of management and highly compensated employees of the Company and
its subsidiaries. Each participant is permitted to specify an investment or
investments from among permissible investments which shall be the basis for
determining the gain or loss adjustment applicable to such participant's plan
deferral account. A participant's interest in the portion of his or her plan
deferral account that is attributable to Employee Deferrals are fully vested at
all times. That portion of a participant's plan deferral account attributable to
Employer Contributions generally will vest over the course of a five year period
beginning on the last day of the first year after the plan year for which the
Employer Contribution was made. The amounts in each participant's plan deferral
account represent an obligation of the Company to pay the participant at some
time in the future. At December 31, 2002 the Company had a $0.1 million deferred
compensation obligation pursuant to this plan.
The Company also sponsors an unfunded nonqualified executive deferred
compensation plan. Under the plan deferred compensation benefits are provided by
the Company through deferrals of base salary and bonus compensation for
management and highly compensated executives designated by the Board of
Directors. Each participant is permitted to specify an investment or investments
from among permissible investments which shall be the basis for determining the
gain or loss adjustment applicable to such participant's plan deferral account.
A participant's benefit under the plan is the amount of such participant's plan
deferral amount. At December 31, 2002 the Company had a $0.5 million deferred
compensation obligation pursuant to this plan.
16. Commitments and Contingencies
The Company is a defendant in a lawsuit to which PIIC issued insurance coverages
to a policyholder for residual value protection. The complaint asks for damages
and a declaratory judgment against PIIC. The complaint arises principally out
52
of a loss adjustment change and also relates to other coverage interpretations
made by PIIC under the terms of residual value protection insurance policies
issued to the plaintiff. The complaint alleges that as a result of the loss
adjustment change the plaintiff may suffer damages as much as $75 million. On
June 27, 2002, PIIC filed an answer to the complaint denying liability with
respect to the matters set forth above. PIIC believes that this claim is without
merit and is vigorously defending this action.
The Company is subject to routine legal proceedings in connection with its
property and casualty insurance business. The Company also is not involved in
any other pending or threatened legal or administrative proceedings which
management believes can reasonably be expected to have a material adverse effect
on the Company's financial condition or results of operations.
The Company currently leases office space to serve as its headquarters location
and 36 field offices for its production underwriters. In addition, the Company
leases certain computer equipment. Rental expense for these operating leases was
$3.1 million, $2.6 million and $2.2 million for the years ended December 31,
2002, 2001, and 2000, respectively.
At December 31, 2002 the Company has open commitments of $4.5 million under
certain limited partnership and information technology development agreements.
The future minimum rental payments required under operating leases that have
initial or remaining non-cancelable lease terms in excess of one year as of
December 31, 2002 were as follows (in thousands):
Year Ending December 31:
2003 $ 3,991
2004 2,306
2005 2,032
2006 1,851
2007 and Thereafter 1,889
- ---------------------------------------------------------
Total Minimum Payments Required $12,069
=========================================================
17. Summary of Quarterly Financial Information - Unaudited
The following quarterly financial information for each of the three months ended
March 31, June 30, September 30 and December 31, 2002 and 2001 is unaudited.
However, in the opinion of management, all adjustments (consisting of normal
recurring adjustments) necessary to present fairly the results of operations for
such periods, have been made for a fair presentation of the results shown (in
thousands, except share and per share data):
53
Three Months Ended
--------------------------------------------------------------------
March 31, June 30, September 30, December 31,
2002(2) 2002(1)(2) 2002(2) 2002(2)
----------- ----------- ------------ -----------
Net Earned Premiums $ 89,244 $ 100,273 $ 106,146 $ 125,523
Net Investment Income $ 8,855 $ 9,375 $ 9,497 $ 9,789
Net Realized Investment Gain (Loss) $ 47 $ (3,181) $ 199 $ (436)
Net Loss and Loss Adjustment Expenses $ 53,049 $ 60,832 $ 78,349 $ 75,203
Acquisition Costs and Other
Underwriting Expenses $ 27,821 $ 31,057 $ 32,343 $ 38,697
Net Income $ 10,677 $ 8,953 $ 2,892 $ 13,483
Basic Earnings Per Share $ 0.50 $ 0.41 $ 0.13 $ 0.62
Diluted Earnings Per Share $ 0.48 $ 0.40 $ 0.13 $ 0.61
Weighted-Average Common Shares
Outstanding 21,528,091 21,578,045 21,625,799 21,710,121
Weighted-Average Share Equivalents
Outstanding 724,311 753,575 636,828 558,100
----------- ----------- ------------ -----------
Weighted-Average Shares and Share
Equivalents Outstanding 22,252,402 22,331,620 22,262,627 22,268,221
=========== =========== ============ ===========
March 31, June 30, September 30, December 31,
2001 2001(3) 2001(3) 2001
----------- ----------- ------------ -----------
Net Earned Premiums $ 66,523 $ 71,703 $ 77,755 $ 80,112
Net Investment Income $ 8,042 $ 8,091 $ 8,238 $ 8,055
Net Realized Investment Gain $ 2,299 $ 318 $ 488 $ 252
Net Loss and Loss Adjustment Expenses $ 39,152 $ 42,866 $ 50,640 $ 46,997
Acquisition Costs and Other
Underwriting Expenses $ 22,468 $ 22,695 $ 25,880 $ 25,977
Minority Interest:
Distributions on Company Obligated
Mandatorily Redeemable Preferred
Securities Of Subsidiary Trust $ 1,811 $ 938 $ - $ -
Net Income $ 7,714 $ 7,736 $ 5,972 $ 9,137
Basic Earnings Per Share $ 0.57 $ 0.50 $ 0.34 $ 0.48
Diluted Earnings Per Share $ 0.54 $ 0.48 $ 0.32 $ 0.46
Weighted-Average Common Shares
Outstanding 13,477,940 15,587,962 17,808,317 19,147,755
Weighted-Average Share Equivalents
Outstanding 701,604 692,256 704,534 684,796
----------- ----------- ------------ -----------
Weighted-Average Shares and Share
Equivalents Outstanding 14,179,544 16,280,218 18,512,851 19,832,551
=========== =========== ============ ===========
(1) During the three months ended June 30, 2002, a 2001 accident year
aggregate stop loss reinsurance program was commuted. As a result of
this commutation, net earned premiums and net income increased by $3.6
million and $2.3 million, respectively.
(2) Net Realized Investment Gain (Loss) for the three months ended June 30,
2002, September 30, 2002 and December 31, 2002 includes non-cash
realized losses of $1.2 million, $0.3 million, and $2.2 million,
respectively, as a result of impairment evaluations.
(3) Net Realized Investment Gain (Loss) for the three months ended June 30,
2001 and December 31, 2001 includes non-cash realized losses of $4.3
million and $1.5 million, respectively, as a result of impairment
evaluations.
54
18. Segment Information
The Company's operations are classified into three reportable business segments
which are organized around its three underwriting divisions: The Commercial
Lines Underwriting Group which has underwriting responsibility for the
Commercial Automobile and Commercial Property and Commercial multi-peril package
insurance products; The Specialty Lines Underwriting Group which has
underwriting responsibility for the professional liability insurance products;
and The Personal Lines Group which designs, markets and underwrites personal
property and casualty insurance products for the Manufactured Housing and
Homeowners markets. Effective June 30, 2000, due to a change in market focus,
the previously reported Specialty Property Underwriting Group segment was
restructured resulting in the combination of this Underwriting Group with the
Commercial Lines Underwriting Group. Accordingly, prior information has been
reclassified to reflect this change. Each business segment's responsibilities
include: pricing, managing the risk selection process, and monitoring the loss
ratios by product and insured. The reportable segments operate solely within the
United States and have not been aggregated.
The segments follow the same accounting policies used for the Company's
consolidated financial statements as described in the summary of significant
accounting policies. Management evaluates a segment's performance based upon
premium production and the associated loss experience which includes paid
losses, an amount determined on the basis of claim adjusters' evaluation with
respect to insured events that have occurred and an amount for losses incurred
that have not been reported. Investments and investment performance including
investment income and net realized investment gain (loss); acquisition costs and
other underwriting expenses including commissions, premium taxes and other
acquisition costs; and other operating expenses are managed at a corporate level
by the corporate accounting function in conjunction with other corporate
departments and are included in "Corporate".
Following is a tabulation of business segment information for each of the past
three years. Corporate information is included to reconcile segment data to the
consolidated financial statements (in thousands):
55
Commercial Specialty Personal
Lines Lines Lines Corporate Total
------------------------------------------------------------------------
2002:
Gross Written Premiums $ 473,984 $ 109,292 $ 80,463 $ - $ 663,739
------------------------------------------------------------------------
Net Written Premiums $ 384,060 $ 101,618 $ 37,493 $ - $ 523,171
------------------------------------------------------------------------
Revenue:
Net Earned Premiums $ 300,057 $ 85,672 $ 35,457 $ - $ 421,186
Net Investment Income - - - 37,516 37,516
Net Realized Investment Loss - - - (3,371) (3,371)
Other Income - - 645 266 911
------------------------------------------------------------------------
Total Revenue 300,057 85,672 36,102 34,411 456,242
------------------------------------------------------------------------
Losses and Expenses:
Net Loss and Loss Adjustment Expenses 202,604 43,310 21,519 - 267,433
Acquisition Costs and Other Underwriting
Expenses - - - 129,918 129,918
Other Operating Expenses - - 130 6,242 6,372
------------------------------------------------------------------------
Total Losses and Expenses 202,604 43,310 21,649 136,160 403,723
------------------------------------------------------------------------
Income Before Income Taxes 97,453 42,362 14,453 (101,749) 52,519
Total Income Tax Expense - - - 16,514 16,514
------------------------------------------------------------------------
Net Income $ 97,453 $ 42,362 $ 14,453 $ (118,263) $ 36,005
========================================================================
Total Assets $ - $ - $ 135,753 $ 1,222,581 $ 1,358,334
========================================================================
2001:
Gross Written Premiums $ 315,948 $ 79,317 $ 78,300 $ - $ 473,565
------------------------------------------------------------------------
Net Written Premiums $ 223,700 $ 69,772 $ 40,345 $ - $ 333,817
------------------------------------------------------------------------
Revenue:
Net Earned Premiums $ 189,835 $ 68,156 $ 38,102 $ - $ 296,093
Net Investment Income - - - 32,426 32,426
Net Realized Investment Gain - - - 3,357 3,357
Other Income - - 2,964 (2,377) 587
------------------------------------------------------------------------
Total Revenue 189,835 68,156 41,066 33,406 332,463
------------------------------------------------------------------------
Losses and Expenses:
Net Loss and Loss Adjustment Expenses 117,429 42,840 19,386 - 179,655
Acquisition Costs and Other Underwriting
Expenses - - - 97,020 97,020
Other Operating Expenses - - 1,546 5,295 6,841
------------------------------------------------------------------------
Total Losses and Expenses 117,429 42,840 20,932 102,315 283,516
------------------------------------------------------------------------
Minority Interest: Distributions on Company
Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust - - - 2,749 2,749
------------------------------------------------------------------------
Income Before Income Taxes 72,406 25,316 20,134 (71,658) 46,198
Total Income Tax Expense - - - 15,639 15,639
------------------------------------------------------------------------
Net Income $ 72,406 $ 25,316 $ 20,134 $ (87,297) $ 30,559
========================================================================
Total Assets $ - $ - $ 167,940 $ 849,782 $ 1,017,722
========================================================================
2000:
Gross Written Premiums $ 239,446 $ 68,193 $ 54,233 $ - $ 361,872
------------------------------------------------------------------------
Net Written Premiums $ 163,430 $ 67,860 $ 32,139 $ - $ 263,429
------------------------------------------------------------------------
Revenue:
Net Earned Premiums $ 142,250 $ 56,884 $ 28,158 $ - $ 227,292
Net Investment Income - - - 25,803 25,803
Net Realized Investment Gain - - - 11,718 11,718
Other Income - - 11,720 (2,739) 8,981
------------------------------------------------------------------------
Total Revenue 142,250 56,884 39,878 34,782 273,794
------------------------------------------------------------------------
Losses and Expenses:
Net Loss and Loss Adjustment Expenses 85,677 32,448 13,179 - 131,304
Acquisition Costs and Other Underwriting
Expenses - - - 75,054 75,054
Other Operating Expenses - - 10,227 4,452 14,679
------------------------------------------------------------------------
Total Losses and Expenses 85,677 32,448 23,406 79,506 221,037
------------------------------------------------------------------------
Minority Interest: Distributions on Company
Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust - - - 7,245 7,245
------------------------------------------------------------------------
Income Before Income Taxes 56,573 24,436 16,472 (51,969) 45,512
Total Income Tax Expense - - - 14,742 14,742
------------------------------------------------------------------------
Net Income $ 56,573 $ 24,436 $ 16,472 $ (66,711) $ 30,770
========================================================================
Total Assets $ - $ - $ 154,874 $ 575,590 $ 730,464
========================================================================
56
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Certain information required by Part III is omitted from this Report in that the
Company will file a definitive proxy statement pursuant to Regulation 14A (the
"Proxy Statement") not later than 120 days after the end of the fiscal year
covered by this Report, and certain information included therein is incorporated
herein by reference.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Company's director and executive
officers required by this Item is incorporated by reference to the
Proxy Statement under the caption "Management-Directors and Executive
Officers".
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
the Proxy Statement under the captions "Executive Compensation", "Stock
Option Grants", "Stock Option Exercises and Holdings" and "Directors
Compensation".
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) The information required by this Item is incorporated by
reference to the Proxy Statement under the caption "Security
Ownership of Certain Beneficial Owners and Management".
(b) Equity Compensation Plan Information
The following table sets forth certain information relating to
the Company's equity compensation plans as of December 31,
2002:
Number of securities
remaining available for
future issuance under
Number of securities to Weighted-average equity compensation
be issued upon exercise exercise price of plans (excluding
of outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan Category (a) (b) (c)
- ---------------------------- ----------------------- --------------------- -----------------------
Equity compensation plans
approved by security holders 1,890,075 $ 24.82 1,760,735 (1)
Equity compensation plans
not approved by security
holders - - 175,506 (2)
----------------------- --------------------- -----------------------
Total 1,890,075 $ 24.82 1,936,241
======================= ===================== =======================
(1) Includes 758,718, 412,445 and 18,847 shares of the Company's common stock
available for future issuance under the Company's Nonqualified Employee
Stock Purchase Plan, Employee Stock Purchase Plan and Directors Stock
Purchase Plan, respectively.
57
(2) These shares of the Company's common stock are available for future
issuance under a stock purchase plan for the Company's eligible
Preferred Agents approved by the Company's Board of Directors. Under
this Plan the Company's eligible Preferred Agents may purchase shares
of the Company's common stock during 30 day offering periods as
designated by the Company's Preferred Agent Committee at a per share
price equal to 85% of the lesser of the fair market value of a share of
the Company's common stock on the first business day of the offering
period or the last day of the offering period. Any shares purchased
pursuant to the Plan are restricted for a period of two-years, measured
from the first day of the relevant offering period, and no eligible
Preferred Agent is permitted to purchase shares under the plan during
any three consecutive calendar years having an aggregate value in
excess of $100,000.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to
the Proxy Statement under the caption "Additional Information Regarding
the Board".
Item 14. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to
ensure that information required to be disclosed in the Company's
reports filed under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission rules and forms,
and that such information is accumulated and communicated to the
Company's management, including its Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow for timely decisions
regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that any
controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control
objectives.
Within 90 days prior to the date of this report, the Company carried
out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive
Officer and the Company's Chief Financial Officer, of the effectiveness
of the design and operation of the Company's disclosure controls and
procedures. Based on the foregoing, the Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective.
There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect the
internal controls subsequent to the date the Company's Chief Executive
Officer and Chief Financial Officer completed their evaluation.
58
PART IV
Item 15. - EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Exhibits
1. The Financial Statements and Financial Statement Schedules
listed in the accompanying index on page 33 are filed as part of this Report.
2. Exhibits: The Exhibits listed below are filed as part of, or
incorporated by reference into, this Report.
Exhibit No. Description
- ----------- -----------
3.1 A Articles of Incorporation of Philadelphia Insurance, as amended to date.
3.1.1 A Amendment to Articles of Incorporation of Philadelphia Insurance.
3.1.2 L Amendment to Articles of Incorporation, Philadelphia Consolidated Holding Corp.
3.2 A By-laws of Philadelphia Insurance, as amended to date.
10.1 A (1) Amended and Restated Key Employees' Stock Option Plan.
10.1.1 H (1) Amended and Restated Key Employees' Stock Option Plan.
10.2 A (1) Key Employees' Stock Bonus Plan.
10.2.1 A (1) Excerpt of Board of Directors and Shareholders Resolution amending Key Employees' Stock
Bonus Plan.
10.6 A Casualty Excess of Loss Reinsurance Agreement No. 14P-106,401,402, effective January 1, 1990, with Swiss
Re, as amended to date.
10.7 A Property Quota Share Reinsurance Agreement No. 14P-202, effective December 9, 1989, with Swiss Re, as
amended to date.
10.8 A Casualty Quota Share Reinsurance Agreement No. 14P-201, effective January 1, 1989, with Swiss Re, as
amended to date.
10.9 A Retrocession Contract No. 80101, effective October 1, 1990, with Swiss Re, as amended to date, together
with related Casualty Quota Share Reinsurance Agreement No. X21-201, as amended to date.
10.10 A Retrocession Contract No. 81100/81101, effective October 1, 1990, with Swiss Re, as amended to date,
together with related Property Quota Share Reinsurance Agreement No. DP2AB, effective October 1, 1990,
as amended to date.
10.11 A Retrocession Contract No. 80100/80103, effective October 1, 1990, with Swiss Re, as amended to date,
together with related Casualty Quota Share Reinsurance Agreement No. DC2ABC, effective October 1, 1990,
as amended to date.
10.12 A Agreement of Reinsurance no. B367, dated June 11, 1991, with General Reinsurance Corporation, as amended
to date.
10.13 A Agreement of Reinsurance No. A271, dated July 2, 1993, with General Reinsurance Corporation.
10.14 A General Agency Agreement, effective December 1, 1987, between MIA and Providence Washington Insurance
Company, as amended to date, together with related Quota Share Reinsurance Agreements, as amended to date.
10.15 A E & O Insurance Policy effective July 20, 1993.
10.15.1 G E & O Insurance Policy effective July 20, 1996.
10.15.2 I E & O Insurance Policy effective July 20, 1997.
10.16 A Minutes of the Board of Directors Meeting dated October 20, 1992, and excerpts from the Minutes of the
Board of Directors Meeting dated November 16, 1992.
10.17 A (1) Letter dated July 9, 1993 from James J. Maguire, confirming verbal agreements concerning options.
10.18 A (1) James J. Maguire Stock Option Agreements.
10.18.1 C (1) Amendment to James J. Maguire Stock Option Agreements.
10.19 A (1) Wheelways Salary Savings Plus Plan Summary Plan Description.
10.20 A Key Man Life Insurance Policies on James J. Maguire
10.21 A Reinsurance Pooling Agreement dated August 14, 1992, between PIIC and PIC.
10.22 A Tax Sharing Agreement, dated July 16, 1987, between Philadelphia Insurance and PIC, as amended to date.
10.23 A Tax Sharing Agreement, dated November 1, 1986, between Philadelphia Insurance and PIIC, as amended to date.
10.24 A (1) Management Agreement dated May 20, 1991, between PIIC and MIA, as amended to date.
59
10.24.1 G (1) Management Agreement dated May 20, 1991, between PIIC and MIA, as amended September 25, 1996.
10.25 A (1) Management Agreement dated October 23, 1991, between PIC and MIA, as amended to date.
10.25.1 G (1) Management Agreement dated October 23, 1991, between PIC and MIA, as amended
September 25, 1996.
10.26 A General Mutual Release and Settlement of All Claims dated July 2, 1993, with the Liquidator of Integrity
Insurance Company.
10.27 A Settlement Agreement and General Release with Robert J. Wilkin, Jr., dated August 18, 1993.
10.28 B Lease tracking portfolio assignment agreement.
10.29 D (1) James J. Maguire Split Dollar Life Insurance Agreement, Collateral Assignment and Joint and Last Survivor
Flexible Premium Adjustable Life Insurance Policy Survivorship Life.
10.30 E Allenbrook Software License Agreement, dated September 26, 1995.
10.31 E Sublease Agreement dated August 24, 1995 with CoreStates Bank, N.A.
10.32 E Lease Agreement dated August 30, 1995 with The Prudential Insurance Company of America.
10.33 F (1) Employee Stock Purchase Plan.
10.34 F (1) Cash Bonus Plan.
10.35 F (1) Executive Deferred Compensation Plan.
10.36 H (1) Directors Stock Purchase Plan
10.37 I Lease Agreement dated May 8, 1997 with Bala Plaza, Inc.
10.38 I Casualty Excess of Loss Reinsurance Agreement effective January 1, 1997, together with Property
Per Risk Excess of Loss Reinsurance Agreement effective January 1, 1997 and Property Facultative Excess
of Loss Automatic Reinsurance Agreement effective January 1, 1997.
10.39 I Automobile Leasing Residual Value Excess of Loss Reinsurance Agreement effective January 1, 1997, together
with Second Casualty Excess of Loss Reinsurance Agreement, effective January 1, 1997.
10.40 J Inspire Software License Agreement, dated December 31, 1998.
10.41 J Lease Agreement dated July 6, 1998 with Bala Plaza, Inc.
10.42 K Plan and Agreement of Merger Between Philadelphia Consolidated Holding Corp. and The Jerger Co. Inc.
10.43 L Philadelphia Insurance Companies Non Qualified Employee Stock Purchase Plan - incorporated by reference
to Exhibit 4 to Registration Statement on Form S-8 (file no. 333-91216) filed with the Securities and
Exchange Commission on June 26, 2002.
10.44 L Philadelphia Consolidated Holding Corp. Employee's Stock Option Plan (Amended and Restated Effective
March 24, 2002) - incorporated by reference to Exhibit 4 to Registration Statement on Form S-8
(file no. 333-91218) filed with the Securities and Exchange Commission on June 26, 2002.
10.45 L Philadelphia Insurance Companies Key Employee Deferred Compensation Plan - incorporated by reference
to Exhibit 4.1 to Registration Statement on Form S-8 (file no. 333-90534) filed with the Securities
and Exchange Commission on June 14, 2002.
10.46 L (1) Employment Agreement with James J. Maguire, Jr. effective June 1, 2002.
10.47 L (1) Employment Agreement with Sean S. Sweeney effective June 1, 2002.
10.48 L (1) Employment Agreement with Craig P. Keller effective June 1, 2002.
10.49 M (1) Employment Agreement with James J. Maguire effective June 1, 2002.
10.50 M (1) Employment Agreement with Christopher J. Maguire effective June 1, 2002.
10.51 N AQS, Inc. Software License Agreement, dated October 1, 2002.
10.52 N (1) Employment Agreement with P. Daniel Eldridge effective October 1, 2002.
11 N Statement regarding computation of earnings per share.
21 N List of Subsidiaries of the Registrant.
23 N Consent of PricewaterhouseCoopers LLP.
24 A Power of Attorney
99.1 N Report of Independent Accountants of PricewaterhouseCoopers LLP on Financial Statement Schedules.
99.2 N Certification of the Company's chief executive officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.3 N Certification of the Company's chief financial officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
60
A Incorporated by reference to the Exhibit filed with the Registrant's Form S-1 Registration Statement under the
Securities Act of 1933 (Registration No. 33-65958).
B Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 and
incorporated by reference.
C Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30,
1994 and incorporated by reference.
D Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1995
and incorporated by reference.
E Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1995
and incorporated by reference.
F Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30,
1996 and incorporated by reference.
G Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1996
and incorporated by reference.
H Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997
and incorporated by reference.
I Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
J Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1998.
K Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999.
L Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002
and incorporated by reference.
M Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30,
2002 and incorporated by reference.
N Filed herewith.
(1) Compensatory Plan or Arrangement, or Management Contract.
(b) Reports on Form 8-K:
The Company has not filed any reports on Form 8-K during the quarterly
period ended December 31, 2002.
61
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.
Philadelphia Consolidated Holding Corp.
By: /s/ James J. Maguire, Jr.
---------------------------------------
James J. Maguire, Jr.
President and Chief Executive Officer
March 28, 2003
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/ James J. Maguire, Jr. President & Chief Executive Officer, March 28, 2003
- --------------------------- (Principal Executive Officer)
James J. Maguire, Jr.
/s/ Craig P. Keller Executive Vice President, Secretary, March 28, 2003
- --------------------------- Treasurer, and Chief Financial Officer
Craig P. Keller (Principal Financial and
Accounting Officer)
/s/ James J. Maguire Chairman of the Board of March 28, 2003
- --------------------------- Directors
James J. Maguire
/s/ Sean S. Sweeney Executive Vice President, Director March 28, 2003
- ---------------------------
Sean S. Sweeney
Michael J. Cascio Director March 28, 2003
- ---------------------------
Michael J. Cascio
/s/ Elizabeth H. Gemmill Director March 28, 2003
- ---------------------------
Elizabeth H. Gemmill
/s/ William J. Henrich, Jr. Director March 28, 2003
- ---------------------------
William J. Henrich, Jr.
/s/ Paul R. Hertel, Jr. Director March 28, 2003
- ---------------------------
Paul R. Hertel, Jr.
/s/ Margaret M. Mattix Director March 28, 2003
- ---------------------------
Margaret M. Mattix
/s/ Maureen H. McCullough Director March 28, 2003
- ---------------------------
Maureen H. McCullough
Thomas J. McHugh Director March 28, 2003
- ---------------------------
Thomas J. McHugh
/s/ Michael J. Morris Director March 28, 2003
- ---------------------------
Michael J. Morris
62
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/ J. Eustace Wolfington Director March 28, 2003
- ---------------------------
J. Eustace Wolfington
/s/ James L. Zech Director March 28, 2003
- ---------------------------
James L. Zech
63
CERTIFICATION
I, James J. Maguire, Jr., President and Chief Executive Officer of Philadelphia
Consolidated Holding Corp., certify that:
1. I have reviewed this annual report on Form 10-K of Philadelphia
Consolidated Holding Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 28, 2003 Signed: /s/ James J. Maguire, Jr.
-----------------------------
Name: James J. Maguire, Jr.
Title: President and Chief Executive
Officer
64
CERTIFICATION
I, Craig P. Keller, Chief Financial Officer of Philadelphia Consolidated Holding
Corp., certify that:
1. I have reviewed this annual report on Form 10-K of Philadelphia
Consolidated Holding Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 28, 2003 Signed: /s/ Craig P. Keller
-----------------------------
Name: Craig P. Keller
Title: Chief Financial Officer
65
Philadelphia Consolidated Holding Corp. and Subsidiaries
Schedule I - Summary of Investments - Other than Investments in Related Parties
As of December 31, 2002
(Dollars in Thousands)
COLUMN C COLUMN D
Estimated Amount at which
COLUMN A COLUMN B Market shown in the
Type of Investment Cost * Value Balance Sheet
- ------------------------------------------------------------------------------------------------------------------
Fixed Maturities:
Bonds:
United States Government and Government
Agencies and Authorities $ 91,114 $ 96,272 $ 96,272
States, Municipalities and Political Subdivisions 279,397 289,990 289,990
Public Utilities 36,543 37,737 37,737
All Other Corporate Bonds 422,479 427,193 427,193
Redeemable Preferred Stock 3,168 3,321 3,321
----------- ----------- ---------------
Total Fixed Maturities 832,701 854,513 854,513
----------- ----------- ---------------
Equity Securities:
Common Stocks:
Public Utilities 97 103 103
Banks, Trust and Insurance Companies 8,727 8,671 8,671
Industrial, Miscellaneous and all other 34,522 37,559 37,559
Non-redeemable Preferred Stocks 7,911 8,013 8,013
----------- ----------- ---------------
Total Equity Securities 51,257 54,346 54,346
----------- ----------- ---------------
Total Investments $ 883,958 $ 908,859 $ 908,859
=========== =========== ===============
* Original cost of equity securities; original cost of fixed maturities
adjusted for amortization of premiums and accretion of discounts. All
amounts are shown net of impairment losses.
S-1
Philadelphia Consolidated Holding Corp. and Subsidiaries
Schedule II
Condensed Financial Information of Registrant
(Parent Only)
Balance Sheets
(In Thousands, Except Share Data)
As of December 31,
--------------------------
2002 2001
---- ----
ASSETS
Cash and Cash Equivalents $ 124 $ -
Equity in and Advances to Unconsolidated Subsidiaries (a) 479,560 428,578
Income Taxes Recoverable from affiliates - 689
Other Assets 1 1
---------- ----------
Total Assets $ 479,685 $ 429,268
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Income Taxes Payable $ 1,247 $ -
Other Liabilities 615 576
---------- ----------
Total Liabilities 1,862 576
---------- ----------
Commitments and Contingencies
Shareholders' Equity
Preferred Stock, $.01 Par Value, 10,000,000 Shares
Authorized, None Issued and Outstanding - -
Common Stock, No Par Value, 100,000,000 Shares
Authorized, 21,868,877 and 21,509,723 Shares
Issued and Outstanding 276,945 268,509
Notes Receivable from Shareholders (6,407) (3,373)
Accumulated Other Comprehensive Income 16,185 8,461
Retained Earnings 191,100 155,095
---------- ----------
477,823 428,692
---------- ----------
Total Liabilities and Shareholders' Equity $ 479,685 $ 429,268
========== ==========
(a) This item has been eliminated in the Company's Consolidated Financial
Statements.
See Notes to Consolidated Financial Statements included in
Item 8, pages 39-56.
S-2
Philadelphia Consolidated Holding Corp. and Subsidiaries
Schedule II, Continued
Condensed Financial Information of Registrant
(Parent Only)
Statements of Operations
(In Thousands)
For the Years Ended December 31,
------------------------------------------
2002 2001 2000
---- ---- ----
Revenue:
Dividends from Subsidiaries (a) $ 27,804 $ 21,074 $ 20,122
---------- ---------- ----------
Total Revenue 27,804 21,074 20,122
---------- ---------- ----------
Other Expenses 1,062 1,248 1,077
---------- ---------- ----------
Total Expenses 1,062 1,248 1,077
---------- ---------- ----------
Minority Interest: Distributions on Company
Mandatorily Redeemable Preferred Securities of Subsidiary Trust - 2,749 7,245
---------- ---------- ----------
Income, Before Income Taxes and Equity in Earnings of
Unconsolidated Subsidiaries 26,742 17,077 11,800
Income Tax Benefit (372) (1,399) (2,913)
---------- ---------- ----------
Income, Before Equity in Earnings of Unconsolidated
Subsidiaries 27,114 18,476 14,713
Equity in Earnings of Unconsolidated Subsidiaries 8,891 12,083 16,057
---------- ---------- ----------
Net Income $ 36,005 $ 30,559 $ 30,770
========== ========== ==========
(a) This item has been eliminated in the Company's Consolidated Financial
Statements.
See Notes to Consolidated Financial Statements included in
Item 8, pages 39-56.
S-3
Philadelphia Consolidated Holding Corp. and Subsidiaries
Schedule II, Continued
Condensed Financial Information of Registrant
(Parent Only)
Statements of Cash Flows
(In Thousands)
For the Years Ended December 31,
------------------------------------------
2002 2001 2000
---- ---- ----
Cash Flows From Operating Activities:
Net Income $ 36,005 $ 30,559 $ 30,770
Adjustments to Reconcile Net Income to Net
Cash Provided (Used) by Operating Activities:
Equity in Earnings of Unconsolidated Subsidiaries (8,891) (12,083) (16,057)
Change in Other Liabilities 39 (611) 46
Change in Other Assets - 3 (1)
Change in Income Taxes Recoverable 1,936 (20,911) 455
Tax Benefit from Exercise of Employee Stock Options 1,251 25,799 145
---------- ---------- ----------
Net Cash Provided by Operating Activities 30,340 22,756 15,358
---------- ---------- ----------
Cash Flows Used by Investing Activities:
Net Transfers to Subsidiaries (a) (34,367) (119,679) (27,080)
---------- ---------- ----------
Net Cash Used by Investing Activities (34,367) (119,679) (27,080)
Cash Flows From Financing Activities:
Net Proceeds From Public Offering of Common Stock - 114,518 -
Proceeds from Loans Payable - - 22,000
Repayments on Loans Payable - (22,000) -
Proceeds from Exercise of Employee Stock Options 864 3,041 1,853
Proceeds from Collection of Notes Receivable 983 1,072 633
Proceeds from Shares Issued Pursuant to Stock Purchase Plans 4,327 46 188
Cost of Common Stock Repurchased (2,023) - (12,691)
---------- ---------- ----------
Net Cash Provided by Financing Activities 4,151 96,677 11,983
---------- ---------- ----------
Net Increase (Decrease) in Cash and Equivalents 124 (246) 261
Cash and Cash Equivalents at Beginning of Year - 246 (15)
---------- ---------- ----------
Cash and Cash Equivalents at End of Year $ 124 $ - $ 246
========== ========== ==========
Cash Dividends Received From Unconsolidated Subsidiaries $ 27,804 $ 21,074 $ 20,122
========== ========== ==========
Non-Cash Transactions:
Acceptance of Mature Shares for Exercise Cost of Employee Stock Options $ - $ - $ 6,811
Issuance of Shares Pursuant to Employee Stock Purchase Plan in exchange
for Notes Receivable $ 4,017 $ 2,158 $ 414
(a) This item has been eliminated in the Company's Consolidated Financial
Statements.
See Notes to Consolidated Financial Statements included in
Item 8, pages 39-56.
S-4
Philadelphia Consolidated Holding Corp. and Subsidiaries
Schedule III - Supplementary Insurance Information
As of and For the Year Ended December 31, 2002, 2001 and 2000
(In Thousands)
COLUMN C
Future
Policy COLUMN H COLUMN I
COLUMN B Benefits, COLUMN E Benefits, Amortization
Deferred Losses, Other Policy COLUMN G Claims, of Deferred
Policy Claims and COLUMN D Claims and COLUMN F Net Losses, and Policy
COLUMN A Acquisition Loss Unearned Benefits Premium Investment Settlement Aquisition
Segment Costs Expenses Premiums Payable Revenue Income Expenses Costs
- ------------------ ----------- ---------- --------- ------------ --------- ---------- ----------- ------------
2002:
Commercial Lines $ - $ 337,791 $ 214,021 $ 300,057 $ - $ 202,604 $ -
Specialty Lines - 96,837 55,251 85,672 - 43,310 -
Personal Lines - 10,920 36,821 35,457 - 21,519 -
Corporate 61,272 - - - 37,516 - 108,097
----------- ---------- --------- --------- ---------- ----------- ------------
Total $ 61,272 $ 445,548 $ 306,093 $ 421,186 $ 37,516 $ 267,433 $ 108,097
=========== ========== ========= ========= ========== =========== ============
2001:
Commercial Lines $ - $ 212,134 $ 124,522 $ 189,835 $ - $ 117,429 $ -
Specialty Lines - 82,735 39,725 68,156 - 42,840 -
Personal Lines - 7,864 33,592 38,102 - 19,386 -
Corporate 41,526 - - - 32,426 - 80,239
----------- ---------- --------- --------- ---------- ----------- ------------
Total $ 41,526 $ 302,733 $ 197,839 $ 296,093 $ 32,426 $ 179,655 $ 80,239
=========== ========== ========= ========= ========== =========== ============
2000:
Commercial Lines $ - $ 161,801 $ 84,418 $ 142,250 $ - $ 85,677 $ -
Specialty Lines - 67,260 35,549 56,884 - 32,448 -
Personal Lines - 8,433 25,517 28,158 - 13,179 -
Corporate 33,324 - - - 25,803 - 60,415
----------- ---------- --------- --------- ---------- ----------- ------------
Total $ 33,324 $ 237,494 $ 145,484 $ 227,292 $ 25,803 $ 131,304 $ 60,415
=========== ========== ========= ========= ========== =========== ============
COLUMN J
Other COLUMN K
COLUMN A Operating Premiums
Segment Expenses Written
- ------------------ ----------- ----------
2002:
Commercial Lines $ - $ 384,060
Specialty Lines - 101,618
Personal Lines - 37,493
Corporate 21,821 -
----------- ----------
Total $ 21,821 $ 523,171
=========== ==========
2001:
Commercial Lines $ - $ 223,700
Specialty Lines - 69,772
Personal Lines - 40,345
Corporate 16,781 -
----------- ----------
Total $ 16,781 $ 333,817
=========== ==========
2000:
Commercial Lines $ - $ 163,430
Specialty Lines - 67,860
Personal Lines - 32,139
Corporate 14,639 -
----------- ----------
Total $ 14,639 $ 263,429
=========== ==========
S-5
Philadelphia Consolidated Holding Corp. and Subsidiaries
Schedule IV - Reinsurance
Earned Premiums
For the Years Ended December 31, 2002, 2001 and 2000
(Dollars in Thousands)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- -------------------------------------------------------------------------------------------------------------------------
Ceded to Assumed from Percentage of
Gross Other Other Amount
Amount Companies Companies Net Amount Assumed to Net
- -------------------------------------------------------------------------------------------------------------------------
2002
Property and Casualty Insurance $ 550,443 $ 134,299 $ 5,042 $ 421,186 1.2%
===================================================================================================================
2001
Property and Casualty Insurance $ 409,814 $ 124,970 $ 11,249 $ 296,093 3.8%
===================================================================================================================
2000
Property and Casualty Insurance $ 319,591 $ 101,046 $ 8,747 $ 227,292 3.8%
===================================================================================================================
S-6
Philadelphia Consolidated Holding Corp. and Subsidiaries
Schedule VI - Supplemental Information Concerning Property - Casualty Insurance
Operations As of and For the Years Ended December 31, 2002, 2001 and 2000
(Dollars in Thousands)
Claims and Claims Adjustment
Expenses Incurred Related to
Reserve for
Unpaid
Deferred Claims and Discount if
Policy Claim any Net Net (1) (2)
Affiliation with Acquisition Adjustment deducted in Unearned Earned Investment Current Prior
Registrant Costs Expenses Column C Premiums Premiums Income Year Year
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H
Consolidated Property
- - Casualty Entities
December 31, 2002 $ 61,272 $ 445,548 $ 0 $306,093 $421,186 $ 37,516 $239,834 $27,599
December 31, 2001 $ 41,526 $ 302,733 $ 0 $197,839 $296,093 $ 32,426 $166,220 $13,435
December 31, 2000 $ 33,324 $ 237,494 $ 0 $145,484 $227,292 $ 25,803 $128,761 $ 2,543
Amortization of Paid Claims
deferred policy and Claim
Affiliation with acquisition Adjustment Net Written
Registrant costs Expenses Premiums
COLUMN A COLUMN I COLUMN J COLUMN K
Consolidated Property
- - Casualty Entities
December 31, 2002 $ 108,097 $ 157,856 $ 523,171
December 31, 2001 $ 80,239 $ 124,985 $ 333,817
December 31, 2000 $ 60,415 $ 97,193 $ 263,429
S-7
PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Exhibit Index
For the Year Ended December 31, 2002
Exhibit No. Page No. Description
- ----------- -------- -----------
10.51 74 AQS, Inc. Software License Agreement, dated October 1, 2002.
10.52 (1) 94 Employment Agreement with P. Daniel Eldridge effective October 1, 2002.
11 104 Statement regarding computation of earnings per share.
21 105 List of subsidiaries of the registrant.
23 106 Consent of PricewaterhouseCoopers LLP.
99.1 107 Report of Independent Accountants of PricewaterhouseCoopers LLP on
Financial Statement Schedules.
99.2 108 Certification of the Company's chief executive officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.3 109 Certification of the Company's chief financial officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(1) Compensatory Plan or Arrangement, or Management Contract.
(E-1)