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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
/ / ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-18786
PICO HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-2723335
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
875 PROSPECT STREET, SUITE 301
LA JOLLA, CALIFORNIA 92037
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (619) 456-6022
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 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 OR THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. / /
APPROXIMATE AGGREGATE MARKET VALUE OF THE REGISTRANT'S COMMON STOCK HELD BY
NONAFFILIATES OF THE REGISTRANT (BASED ON THE CLOSING SALES PRICE OF SUCH STOCK
AS REPORTED IN THE NASDAQ NATIONAL MARKET) ON MARCH 24, 1997 WAS $74,222,080.
EXCLUDES SHARES OF COMMON STOCK HELD BY DIRECTORS, OFFICERS AND EACH PERSON WHO
HOLDS 5% OR MORE OF THE REGISTRANT'S COMMON STOCK.
NUMBER OF SHARES OF COMMON STOCK, $.001 PAR VALUE, OUTSTANDING AS OF MARCH 24,
1997 WAS 32,486,718. AS OF SUCH DATE, 4,572,015 SHARES OF COMMON STOCK WERE HELD
BY A SUBSIDIARY AND AN AFFILIATE OF THE REGISTRANT.
DOCUMENTS INCORPORATED BY REFERENCE
(1) PORTIONS OF THE DEFINITIVE PROXY STATEMENT FOR THE ANNUAL MEETING OF
STOCKHOLDERS SCHEDULED FOR JUNE 5, 1997 ARE INCORPORATED BY REFERENCE
IN PART III HEREIN.
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PICO HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
No.
----
PART I....................................................................... 1
Item 1. BUSINESS........................................................ 1
Item 2. PROPERTIES...................................................... 25
Item 3. LEGAL PROCEEDINGS............................................... 25
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER.............. 26
PART II...................................................................... 26
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS............................................. 26
Item 6. SELECTED FINANCIAL DATA......................................... 27
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS....................................... 28
Item 8. FINANCIAL STATEMENTS............................................ 43
Item 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE........................................ 79
PART III..................................................................... 79
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 79
Item 11. EXECUTIVE COMPENSATION......................................... 79
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT..................................................... 79
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................. 79
PART IV...................................................................... 80
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM
10-K........................................................... 80
SIGNATURES................................................................... 82
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PART I
THIS FORM 10-K CONTAINS A NUMBER OF FORWARD-LOOKING STATEMENTS,
INCLUDING, WITHOUT LIMITATION, STATEMENTS ABOUT THE COMPANY'S PLANS FOR
EXPANSION, WHICH STATEMENTS REFLECT THE COMPANY'S CURRENT VIEWS WITH RESPECT TO
FUTURE EVENTS THAT WILL HAVE AN EFFECT ON THE COMPANY'S FINANCIAL PERFORMANCE.
THE COMPANY CAUTIONS INVESTORS THAT ANY FORWARD-LOOKING STATEMENTS MADE BY THE
COMPANY ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING THOSE SET
FORTH UNDER "BUSINESS RISKS" AND ELSEWHERE HEREIN, THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS OR FROM
HISTORICAL RESULTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS.
ITEM 1. BUSINESS
INTRODUCTION
PICO Holdings, Inc. ("PICO") is a holding company principally engaged
in five industry segments; portfolio investing, property and casualty insurance,
life and health insurance, medical malpractice liability ("MPL") insurance and
other. The Company operates through a number of direct and indirect subsidiaries
(with PICO, collectively referred to herein as the "Company"). The Company's
objective is to use its resources to increase shareholder value through
investments in businesses which the Company believes are undervalued or will
benefit from additional capital, restructuring of operations or management, or
improved competitiveness through operational efficiencies with the Company's
existing operations. This business strategy has only recently been implemented.
The Company may be deemed to be controlled by Guinness Peat Group plc ("GPG"), a
strategic investment company domiciled in London, England. GPG is a publicly
held company with its shares listed on the London, Australia and New Zealand
stock exchanges.
PICO was incorporated in 1981 and began operations in 1982. Its
principal executive office is located at 875 Prospect Street, Suite 301, La
Jolla, California 92037, and its telephone number is (619) 456-6022.
SUBSIDIARIES
Unless otherwise indicated, each subsidiary is directly or indirectly
wholly-owned by PICO. The Company's operating subsidiaries and their
principal subsidiaries or affiliates are as follows:
CITATION INSURANCE COMPANY ("CIC").
CIC writes commercial property and casualty insurance in Arizona,
California, Colorado, Nevada and Utah. CIC has also written Workers Compensation
insurance, however, the Company is currently in the process of selling off that
line of business through a transfer to and sale of its wholly-owned subsidiary,
Citation National Insurance Company ("CNIC"). CNIC is licensed in California and
is not currently writing any new business. See "Recent Developments."
SUMMIT GLOBAL MANAGEMENT, INC. ("SUMMIT").
Summit is a Registered Investment Advisor that offers investment
management services to clients throughout the United States. Summit is
wholly-owned by Physicians.
PHYSICIANS INSURANCE COMPANY OF OHIO ("PHYSICIANS").
Physicians, an Ohio licensed insurance corporation, operates primarily
as a diversified investment and insurance company. Its operations and those of
its direct and indirect subsidiaries include strategic investing, investment
management, life insurance and property and casualty
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insurance. Physicians has been licensed as a property and casualty insurer by
the Ohio Department of Insurance ("Ohio Department") since 1976 and is also
licensed by the Kentucky Department of Insurance. Disclosure in this section
regarding the business of "Physicians" includes all operations of its
subsidiaries.
PHYSICIANS' SUBSIDIARIES AND AFFILIATED COMPANIES.
SEQUOIA INSURANCE COMPANY ("SEQUOIA"). Sequoia is a
California-domiciled insurance company licensed to write insurance coverage for
property and casualty risks within the state of California. Sequoia writes
business through approximately 75 independent agents and brokers covering risks
located primarily within northern and central California. Although multiple line
underwriting is conducted and at one time or another all major lines of property
and casualty insurance except workers' compensation and ocean marine have been
written, Sequoia has, over the past few years, transitioned from writing
primarily personal lines of business (automobile, homeowners, etc.) to
commercial lines.
AMERICAN PHYSICIANS LIFE INSURANCE COMPANY ("APL"). APL offers critical
illness insurance through Survivor Key policies as well as other life and health
insurance products. APL is wholly owned by Physicians Investment Company
("PIC"), a wholly-owned subsidiary of Physicians.
THE PROFESSIONALS INSURANCE COMPANY ("PRO"). Pro is an Ohio domiciled
insurance company first licensed to write property and casualty insurance in
Ohio in 1979. It is also licensed in Kentucky, West Virginia and Wisconsin.
CLM INSURANCE AGENCY, INC. ("CLM"). CLM, purchased on July 1, 1995, is
a California insurance agency which places insurance with California insurers,
including Sequoia.
GLOBAL EQUITY CORPORATION ("GEC"). Physicians owns 38.2% of GEC, a
Canadian international investment banking corporation. Set forth below are the
names and respective jurisdictions of incorporation of certain direct and
indirect subsidiaries of GEC, all of which are wholly owned except for Forbes
Ceylon Limited ("Forbes Ceylon") which was 51% owned as of December 31, 1996.
The following list includes, but is not limited to, all subsidiaries the total
assets of which constituted more than 10% of the consolidated assets of GEC as
at December 31, 1996 or the total revenues of which constituted more than 10% of
the consolidated revenues of GEC during fiscal 1996. GEC owns approximately 13%
of PICO as of December 31, 1996.
JURISDICTION
OF
SUBSIDIARY INCORPORATION
---------- -------------
Direct
Forbes & Walker Securities Limited ................................ Canada
Forbes & Walker (USA) Inc. ........................................ Delaware
Indirect
Forbes Ceylon Limited ............................................. Sri Lanka
Forbes & Walker International Limited ............................. Barbados
Forbes & Walker Limited ........................................... Sri Lanka
Vidler Water Company, Inc. ........................................ Colorado
Subsidiaries of GEC are either holding companies or inactive, with the
exception of Forbes & Walker Securities Limited ("F&WSL"), which continues to be
a broker and a member of the Toronto Stock Exchange ("TSE"); Forbes & Walker
Limited ("Forbes & Walker"), which was acquired by GEC on October 21, 1993;
Forbes Ceylon, a Colombo Stock Exchange ("CSE") listed company, which completed
an approximate Cdn. $66 million initial public offering in the fall of 1994 and
is an investment holding company; and Vidler Water Company, Inc. ("Vidler"),
which acquires and manages water-related assets that was
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acquired on November 14, 1995. The other subsidiaries may be utilized in the
future in furtherance of the international investment banking, asset management
or corporate finance activities of GEC.
HISTORY OF THE COMPANY
RECENT MERGER.
On November 20, 1996, Citation Holdings, Inc., an Ohio corporation
("Sub"), merged with and into Physicians, (the "Merger") pursuant to an
Agreement and Plan of Reorganization (the "Merger Agreement") dated as of May 1,
1996, as amended by and among Citation Insurance Group, Physicians and Sub.
Pursuant to the Merger, each outstanding share of Class A Common Stock of
Physicians (the "Physicians Stock") was converted into the right to receive
5.0099 shares of PICO's Common Stock. As a result, (i) the former shareholders
of Physicians owned approximately 80% of the outstanding Common Stock of PICO
immediately after the Merger and controlled the Board of Directors of PICO and
(ii) Physicians became a wholly owned subsidiary of PICO. Pursuant to the Merger
Agreement, PICO also assumed all outstanding options to acquire Physicians
Stock.
As a result of the Merger, the business and operations of Physicians
became a substantial majority of the business and operations of the Company.
Effective upon the Merger, PICO's name, which was previously "Citation
Insurance Group" was changed to "PICO Holdings, Inc." and the Nasdaq symbol for
the Company's stock was changed from "CITN" to "PICO."
PHYSICIANS
Physicians was incorporated under the laws of Ohio in September 1976
and was licensed by the Ohio Department in December 1976. Physicians was formed
with the sponsorship of the Ohio State Medical Association ("OSMA") to provide
MPL insurance coverage to physicians who were members of the OSMA. Physicians
was formed in response to a then-existing crisis in the MPL insurance
marketplace in Ohio. MPL claims had increased substantially in severity and
frequency. Insurance companies providing MPL coverage responded in some cases by
increasing premiums significantly or even by leaving the marketplace. The OSMA
sought to provide a stable insurance provider for its members in the face of
this volatile MPL marketplace by forming Physicians.
Until 1993, OSMA held shares representing a majority of Physicians'
voting power. Physicians' Code of Regulations also contained the requirement
that three OSMA officers sit on Physicians' Board of Directors and that
Physicians only write MPL insurance for the OSMA members. Physicians secured the
endorsement of its insurance products by the OSMA pursuant to an endorsement
contract.
The strategic direction of Physicians changed in 1993. First,
Physicians repurchased its shares from the OSMA and amended its Code of
Regulations to delete the requirements that three OSMA officers sit on
Physicians' Board. The MPL product endorsement was terminated and the three
Physicians directors who were affiliated with the OSMA resigned as directors.
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Additionally in 1993, Physicians was approached by an investor who
could provide a significant capital infusion. Physicians sold 1,428,571
newly-issued and authorized shares of Physicians stock, representing, at that
time, 32% of Physicians' voting power, for $5 million to GPG, a London-based
strategic investment company. At that same time, four designees of GPG (Messrs.
Broadbent, whose term expired in 1995, Langley and Hart and Dr. Weiss) were
elected to Physicians' Board. GPG subsequently purchased from Physicians $3.0
million of additional shares of Physicians Stock, thereby increasing GPG's
equity stake in Physicians. In May and June 1996 GPG sold a total of 850,000
shares of Physicians to GEC (which converted into 4,258,415 shares of PICO
pursuant to the Merger).
During 1995, there was another overall shift in the strategic direction
of Physicians. As discussed further below, Physicians sold its recurring MPL
business, purchased a property and casualty insurance company in California
(Sequoia) which does not write MPL insurance and made a significant investment
in GEC which operates primarily as an international investment company.
Physicians' objective is to use its resources and those of its subsidiaries and
affiliates to increase shareholder value through investments in businesses which
Physicians believes are undervalued or will benefit from additional capital,
restructuring of operations or management, or improved competitiveness through
operational efficiencies with existing Physicians operations. This business
strategy has only recently been implemented.
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On March 7, 1995, Physicians executed the Stock Purchase Agreement with
Sydney Reinsurance Corporation ("SRC") to acquire all of the outstanding stock
of SRC's wholly-owned subsidiary, Sequoia, a property and casualty insurance
company incorporated under the laws of California in 1946 and licensed to write
insurance in California. Sequoia provides light commercial and multiperil
insurance in northern and central California through an independent agency
system. The acquisition price of $1,350,000 was paid in cash on August 1, 1995.
Physicians initially capitalized Sequoia with $2.6 million in paid-in
capital and an additional $5.9 million in paid-in surplus. Subsequently,
Physicians has contributed an additional $11.8 million to Sequoia to cover 1995
net losses, to strengthen Sequoia for purposes of maintaining or improving
Sequoia's "B++" (Very Good) Best rating and its NAIC risk-based capital ratio,
and to provide capital for growth.
All policy and claims liabilities of Sequoia prior to closing are the
responsibility of SRC and have been unconditionally and irrevocably guaranteed
by QBE Insurance Group Limited, an Australian corporation of which SRC
indirectly is a wholly-owned subsidiary. Physicians is required to maintain a
minimum surplus in Sequoia of $7.5 million and, through a management agreement,
is supervising the run-off of SRC's liabilities. As part of the management
agreement, Physicians was reimbursed for certain expenses incurred in the
servicing of the business existing prior to closing. Since its acquisition by
Physicians, Sequoia has continued to write light commercial and multiperil
insurance in northern and central California.
On July 14, 1995, Physicians and PRO entered into an Agreement for the
Purchase and Sale of Certain Assets (the "Mutual Agreement") with Mutual
Assurance Inc. ("Mutual"). This transaction was approved by Physicians'
shareholders on August 25, 1995 and closed on August 28, 1995. Pursuant to the
Mutual Agreement, Physicians sold the recurring professional liability insurance
business and related liability insurance business for physicians and other
health care providers (the "Book of Business") of Physicians and PRO. Physicians
and PRO were engaged in, among other things, the business of offering MPL
insurance and related insurance to physicians and other health care providers
principally located in Ohio. Mutual acquired the Book of Business in
consideration of the payment of $6.0 million, plus interest at a rate of 6% per
annum from July 1, 1995 until the date of closing, or an aggregate of $6.1
million.
Simultaneously with execution of the Mutual Agreement, Physicians and
Mutual entered into a Reinsurance Treaty pursuant to which Mutual agreed to
assume all risks attaching after July 15, 1995 under medical professional
liability insurance policies issued or renewed by Physicians on physicians,
surgeons, nurses, and other health care providers, dental practitioner
professional liability insurance policies including corporate and professional
premises liability coverage issued by Physicians, and related commercial general
liability insurance policies issued by Physicians (the "Policies"), net of
inuring reinsurance. The premium payable to Mutual for such reinsurance is an
amount equal to 100% of the premiums paid to Physicians, net of inuring
reinsurance, on the Policies subject to a ceding commission equal to the sum of
(i) the commissions payable by Physicians, to agents procuring the Policies;
(ii) Mutual's allocable share of Physicians' premium taxes or franchise taxes,
whichever is lower; and (iii) Mutual's allocable share of any guaranty fund
assessment against Physicians with respect to premiums paid on the Policies.
Physicians and PRO have reinsured a portion of the insurance written
prior to July 16, 1995 with unaffiliated reinsurers and 100% of the insurance
written between July 16, 1995 and January 1, 1996 with Mutual. Subject to such
reinsurance, Physicians and PRO remain primarily liable to policyholders.
As part of the Mutual Agreement, Physicians and PRO agreed not to sell
the following insurance products for a period of five years ending August 27,
2000, in any state in which Physicians, PRO or Mutual was licensed to offer MPL
insurance products as of August 28, 1995: professional liability insurance for
physicians, surgeons, dentists, hospitals, ambulatory surgical clinics, and
other health care providers (collectively, "Health Care Providers"); reinsurance
for insurers writing professional liability insurance for such Health Care
Providers; comprehensive general liability insurance for Health Care Providers;
stop loss insurance for Health Care Providers who have contracted to provide
health care services at a fixed rate; and managed care liability insurance
providing coverage for liability arising from errors and omissions of a managed
care organization, for the vicarious liability of a managed care organization
for acts and omissions by contracted and employed providers, and for liability
of directors and officers of a managed care organization.
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Physicians will continue to administer the runoff of claims on policies
written or renewed prior to July 16, 1995. Physicians estimates based upon
actuarial indications that approximately 75% of Physicians' claim liabilities
will be paid out within five years.
In 1983, Physicians incorporated Summit and subsequently registered it
with the SEC as an investment adviser. Summit was inactive from 1990 through
1994, and in January 1995, Summit was reactivated. In addition to its
registration with the SEC, Summit is registered as an investment adviser in
California, Florida, Kansas, Louisiana, Oregon, Virginia and Wisconsin. Summit
maintains an office in California. Funds under management are approximately $400
million, most of which are funds which Summit is managing on behalf of
Physicians and its subsidiaries and affiliates. Summit provides an opportunity
for Physicians to be further diversified and will provide fee based revenues.
Since February 1995, Summit has provided investment management services to
Physicians and its insurance subsidiaries. Summit also offers its services to
other individuals and institutions.
On September 5, 1995, Physicians purchased 21,681,084 common shares of
GEC for $34.4 million in cash. GEC is a Canadian corporation which has its
offices in Toronto, Canada. GEC is a publicly-held corporation and is listed on
the TSE and The Montreal Exchange under the symbol "GEQ." Physicians' purchase
amounted to 38.2% of GEC's outstanding common shares. GEC operates primarily as
an international investment company. GEC currently owns 4,258,415 shares of
PICO's outstanding Common Stock.
Immediately prior to the Merger, Physicians operated in five industry
segments: property and casualty insurance, life and health insurance, portfolio
investing, MPL insurance and other. MPL insurance was written by Physicians and
its wholly-owned subsidiary, PRO, an Ohio corporation organized in 1979.
Physicians and PRO sold MPL insurance to physicians, dentists, nurses and other
allied health care professionals. Physicians and PRO discontinued writing MPL
insurance at the end of 1995, but continue to administer the adjustment of
claims and the investment of related assets for policies in force prior to July
16, 1995. Physicians conducted and continues to conduct its life and health
insurance business through APL, an Ohio-domiciled life insurer which was formed
in 1978. In July 1993, APL began aggressively marketing a critical illness
policy which Physicians and APL believe is unique to the U.S. market. The
portfolio investing segment was engaged in principally by Physicians. Property
and casualty operations were conducted by Sequoia. The Company's other
operations consisted primarily of Summit's investment adviser operations. In the
future, other segments will continue to be conducted by Summit and may also be
conducted by other subsidiaries of Physicians. The property and casualty
insurance segment was engaged in by Sequoia, which Physicians acquired on August
1, 1995.
In addition to PRO, PIC, APL, Summit and Sequoia, at December 31, 1996,
Physicians had five wholly-owned subsidiaries, none of whose current operations
are material to the financial position of the Company. CLM Insurance Agency,
Inc. ("CLM") was purchased by Physicians on July 1, 1995. CLM brokers insurance
in California for Sequoia and other unaffiliated companies. Raven Development
Company was incorporated in Ohio in 1981 as a real estate development
corporation. It is currently involved in one development in central Ohio but is
in the process of withdrawing from the real estate development industry. Medical
Premium Finance Company ("MPFC") was incorporated in Ohio to conduct insurance
premium finance business. MPFC ceased writing new loans effective September 30,
1994, and became totally dormant as of October 1, 1995. S.M.B. Financial
Planning, Inc. ("SMB") is an Ohio corporation acquired in 1983 to provide
financial planning services. SMB has not been operating for the past five years.
CITATION.
The following describes the history of PICO, which was previously known
as "Citation Insurance Group" prior to the Merger. All references to "CIG" are
references to PICO as it existed prior to the Merger. CIG was a holding company
principally engaged in writing workers' compensation and commercial property and
casualty insurance through its wholly-owned subsidiaries, CIC and CNIC. Citation
refers to CIG and its subsidiaries, excluding Citation General Insurance Company
(CGIC) as they existed before the Merger. CGIC, a wholly-owned subsidiary of
CIG, was placed into conservation in July 1995 by the State of California.
Citation had effectively written off its investment in CGIC in November, 1994.
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CIC has historically specialized in providing workers' compensation
coverage for California businesses and, more recently, in Arizona, Colorado and
Utah.
In October 1989, CIC entered the commercial property and casualty
business. Since that time, CIC has underwritten general liability and property
insurance for small and medium-sized businesses with uniform risk
characteristics and coverage needs. CIC typically provides general liability,
theft, inland marine, property, glass and incidental products liability
coverage. Commercial auto and umbrella liability are written for accounts where
CIC writes other lines of business.
In October 1993, CIG completed the acquisition of Madison Capital, Inc.
and its subsidiaries ("Madison") for which CIG issued 2,158,545 shares of its
common stock and paid $3,650,000 to the former shareholders of Madison in
exchange for all of the issued and outstanding stock of Madison. Madison was
merged with and into CIG and Madison's former wholly-owned subsidiaries, The
Canadian Insurance Company of California, California Consumers Insurance Company
and Madison Acceptance Corporation, became wholly-owned subsidiaries of CIG. In
February 1994, the names of The Canadian Insurance Company of California and
California Consumers Insurance Company were changed to Citation General
Insurance Company, (CGIC), and Citation National Insurance Company (CNIC),
respectively.
CGIC and CNIC specialized in insuring accounts in commercial
property-oriented business classifications, including investment properties,
retail operations, restaurants, wholesale distribution operations and other
service-related businesses. Until October 1994 they also provided coverage for
artisan contractors.
Madison Acceptance Corporation ("MAC") is licensed by the California
Department of Corporations as an industrial loan company empowered to transact
premium financing in California. MAC does not presently conduct premium
financing operations.
During 1994, Citation increased CGIC's loss reserves and, in the third
quarter of 1994, the increase in CGIC's loss reserves aggregated approximately
$6.2 million. These increases were due primarily to re-evaluation of potential
losses related to construction defect claims emanating from CGIC's artisan
contractor policies written in years prior to the merger. Subsequent to the
third quarter loss reserve increases, Citation notified the California
Department of Insurance (the "California Department") that the cumulative effect
of these increases brought CGIC below the minimum surplus required by the State.
Citation began working with the Department to formulate a plan for resolving the
situation. Based upon discussions with the Department regarding the possible
conservation of CGIC, Citation concluded that its control over CGIC had become
temporary and, as a result, has accounted for the results of CGIC on the equity
method since November 1994, resulting in a write off of its remaining investment
in CGIC of $4.2 million at that date. At that time, CGIC and CNIC stopped
writing any new business.
In February 1995, Citation reached an agreement in principle with the
Department regarding CGIC. Under the terms of the agreement, an inter-company
pooling reinsurance agreement between CGIC and CNIC was commuted effective
September 30, 1994. In addition, CNIC transferred approximately $1.1 million of
securities into a contingency fund for potential further development of CGIC's
loss reserves associated with accident years 1990 to 1994 during which time the
inter-company pooling agreement was in effect. Further, CIG agreed to pay
$600,000 in cash to CGIC and transfer its 25% ownership of CIG's Costa Mesa
property to CGIC. As a result of this agreement CIG recorded a liability for the
cost of the disposition of CGIC, which includes the above described payments and
transfers which, when combined with its write off of its investment in CGIC,
resulted in a $6.7 million charge to Citation's operating results in 1994.
Further, CIC agreed to acquire the in-force book of business of CGIC for
approximately $1.7 million, which amount was accrued as a liability of Citation
and recorded as an other asset at December 31, 1994.
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During July 1995, CGIC was placed into conservation by the State of
California, effectively transferring control of CGIC's assets to the California
Department. In August 1995, CGIC was placed into liquidation by the State of
California.
On November 30, 1995, CIG contributed all of the capital stock of CNIC
to CIC. This transaction increased the paid in and contributed surplus of CIC by
$5,303,731. CNIC has been essentially inactive since mid-December 1994.
In February 1994, Citation entered the personal automobile insurance
business in California by offering low limit policies marketed through a
Managing General Agent. Primarily as a result of poor operating results in this
line, Citation decided in early 1995 to withdraw from this business and focus on
its primary business segments i.e., workers' compensation and commercial
property and casualty.
CIC is currently licensed to write business in Arizona, California,
Colorado, Hawaii, Nevada, New Mexico and Utah and is currently writing business
in Arizona, California, Colorado, Nevada and Utah. CNIC is licensed in
California.
RECENT DEVELOPMENTS.
In November 1996, Physicians purchased a $2.5 million convertible
debenture from PC Quote, Inc. Physicians currently owns approximately 30% of PC
Quote, Inc.'s outstanding shares. PC Quote, Inc. is an electronic provider of
real-time securities quotations and news.
In January 1997, CIC entered into a letter of intent to sell its
workers compensation business to an unaffiliated insurance company.
On April 14, 1997, GEC and PICO entered into an agreement for the
purchase of Nevada Land and Resource Company, LLC, owner of approximately
1,365,000 acres of deeded land in Northern Nevada, for a total purchase price
of $53.7 million. The closing date is scheduled for April 23, 1997.
OPERATIONS.
The Company operates in five industry segments, portfolio investing,
property and casualty insurance, life and health insurance, MPL and other.
Physicians discontinued writing MPL insurance at the end of 1995 but continues
to administer the adjustment of claims and the investment of related assets.
Citation is currently negotiating for the sale of its workers compensation
operations, principally due to recent changes in California regulations with
regard to rating of policies and to better utilize capital and concentrate on
the synergies of the property and casualty insurance businesses common to both
Sequoia and Citation. There can be no assurance that Citation will be successful
in selling the workers compensation operations on favorable terms, if at all.
PORTFOLIO INVESTING OPERATIONS
In late 1994, Physicians began the process of changing its strategic
direction from the operation of an MPL insurance business to investing in
businesses which PICO believes are undervalued or will benefit from additional
capital, restructuring of operations or management or improved competitiveness
through operational efficiencies with existing PICO operations. Accordingly, in
January 1995, Physicians reactivated its investment advisory subsidiary, Summit,
in August 1995 Physicians acquired Sequoia and entered new lines of property and
casualty insurance, in September 1995 Physicians purchased 38.2% of GEC, a
Canadian corporation active in international investment banking, agricultural
services, water rights, and other businesses and in 1996 Physicians acquired
control of Citation pursuant to the Merger. Due to the Company's limited
experience in the operation of the businesses of each of these subsidiaries,
which currently constitute a substantial portion of the Company's operations,
there can be no assurance as to the future operating results of the Company or
the recently acquired businesses of the Company.
8
11
The Company will continue to make selective investments for the purpose
of enhancing and realizing additional value by means of appropriate levels of
shareholder influence and control. This could involve the restructuring of the
financing or management of the entities in which the Company invests and
initiating and facilitating mergers and acquisitions. This business strategy has
only recently been implemented, however, and it is not reflected in prior years'
financial statements, nor are the financial statements indicative of possible
results of this new business strategy in the future. Shareholders will be
relying on the experience and judgment of the Company's management to locate,
select and develop new acquisition and investment opportunities. There can be no
assurance that sufficient opportunities will be found or that this business
strategy will be successful. Failure to successfully implement this strategy may
negatively impact the business and financial condition and results of operations
of the Company.
Application of Physicians' new strategy since 1995 has resulted in a
greater concentration of equity investments held by Physicians, and
consequently, the Company. Market values of equity securities are subject to
changes in the stock market, which may cause the Company's shareholders' equity
to fluctuate from period to period. At times, the Company may come to hold
securities of companies for which no market exists or which may be subject to
restrictions on resale. As a result, periodically, a portion of the Company's
assets may not be readily marketable.
INSURANCE.
PREMIUMS.
The following table shows the total net premiums written (gross
premiums less premiums ceded pursuant to reinsurance treaties) by line of
business by the Company and its subsidiaries for the periods indicated as
reported in financial statements filed with the Ohio Department and the
California Department using statutory accounting principles:
NET PREMIUMS WRITTEN
BY LINE OF BUSINESS
1996 1995 1994
------- ------- -------
(IN THOUSANDS)
Property and Casualty............................. $35,757 $10,755
Medical Professional Liability.................... 28 11,824 $ 7,130
------- ------- -------
Total Property and Casualty Premiums... 36,785 22,579 7,130
------- ------- -------
Life and Health:
Individual:
Life................................... 1,232 1,122 826
Health................................. 74 86 87
Annuity................................ 2,665 1,480 1,721
Group:
Life................................... 449 475 551
Health................................. 82 274 2,578
Annuity................................ 921 462 818
------- ------- -------
Total Life and Health Insurance Premiums.......... 5,423 3,899 6,581
------- ------- -------
Total Premiums......................... $42,208 $26,478 $13,711
======= ======= =======
Physicians experienced significant declines in MPL net premiums written
over the period described. Net premiums equal direct premiums plus assumed
premiums, minus premiums ceded under reinsurance treaties. The amount of
reinsurance assumed by Physicians over the years has been negligible. However,
direct MPL premiums written have declined significantly, from $28.0 million in
9
12
1994 to $22.6 million in 1995 and to $0.2 million in 1996. Additionally, MPL
premiums ceded under reinsurance treaties have varied greatly from year to year.
See "-- Reinsurance." APL's premium writings have also declined significantly
since 1994, mostly as a result of exiting the group health insurance business in
mid-1994. Interest in APL's critical illness policy, Survivor Key, has been less
than expected and not enough to offset the decline in health premiums.
Nevertheless, premiums received for this product have increased in recent
quarters. Sequoia's property and casualty premium writings are included only for
the period August 1 through December 31, 1995 and for all of 1996. Citation's
premiums are included only for the period after November 20, 1996.
PROPERTY AND CASUALTY INSURANCE
Three of the Company's subsidiaries, Sequoia, CIC and CNIC underwrite
property and casualty insurance in California and, to a lesser extent in
Arizona, Colorado, Nevada and Utah.
Sequoia is licensed to write insurance in California and is represented
by approximately 75 independent insurance agents and by Physicians' wholly-owned
subsidiary insurance agency, CLM. Sequoia writes primarily light commercial and
multiperil insurance in northern and central California. Sequoia's principal
sources of premium production represent farm insurance and small to medium-sized
commercial accounts, most of which are located outside of large urban areas. A
small amount of earthquake coverage is provided, either as an endorsement to an
existing insurance policy or as a result of participation in a state-mandated
pool. Most business is written at independently filed rates.
CIC underwrites general liability and property insurance for small and
medium-sized businesses, including restaurants, hotels and motels, retail
stores, owners of small commercial centers, and until October 1994, artisan
contractors, with uniform risk characteristics and coverage needs. CIC targets
specific types of accounts within predetermined business classifications
containing certain characteristics including low potential for loss severity, no
long delay between loss occurrence and loss reporting, and a relatively short
and uncomplicated claim settlement process. CIC typically provides general
liability, theft, inland marine, property, glass, commercial automobile,
incidental products liability coverage and umbrella liability. CIC sells
policies through approximately 400 independent producers located in its
operating territories.
Net earned premiums, incurred losses and corresponding loss ratio
(excluding LAE) for Sequoia and Citation for 1996 were (dollars in thousands)
$31,399, $13,908 and 44.3%, respectively.
Shown in the table below are results of Sequoia only by line of
business.
1996
------------------------------------------
NET
PREMIUMS NET LOSSES NET LOSS
EARNED INCURRED* RATIO*
-------- ---------- --------
(DOLLARS IN THOUSANDS)
Fire................................ $ 75 $ 70 93.3%
Allied lines........................ 37 14 37.8
Homeowners multiperil............... 87 (131) --
Commercial multiperil............... 14,495 7,343 50.7
Inland marine....................... -- 30 --
Earthquake.......................... 117 31 26.5
Other liability..................... 913 (890) --
Auto liability...................... 6,760 4,094 80.6
Auto physical damage................ 3,770 1,672 44.4
-------- --------
Total.................... $ 26,254 $ 12,233 46.6%
======== ========
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* Net losses incurred and net loss ratios shown exclude LAE.
The underwriting staffs of Sequoia, CIC, and CNIC (the "P & C Insurance
Group") are solely responsible for the ultimate acceptance, underwriting and
pricing of applications for commercial insurance. Premium pricing levels are
based on a variety of factors, including industry historical loss costs,
anticipated loss costs, acceptable profit margins and anticipated operating
expenses.
The objective of pricing structures in all product lines is to provide
sufficient funds to pay all costs of policy issuance and administration, premium
taxes and losses and related claims handling expenses and provide a profit
margin as well. Because pricing structures are based on estimates of future loss
patterns developed from historical information and because losses and expenses
may differ substantially from estimates, product pricing may ultimately prove
inadequate. Factors causing inadequate rates may include catastrophic losses or
a lack of correlation between the loss forecast for the market and that
applicable to the customers which actually purchase the policies. In addition,
if underlying statistical information understates the value of known claims,
forecasts may understate prospective claims patterns.
The P & C Insurance Group's policy is to settle valid claims promptly
and equitably. The P & C Insurance Group employs claim technicians, located in
various locations throughout California, to administer the claim settlement
process. It is the P & C Insurance Group's policy to limit the number of claims
assigned to each technician, based in part on the complexity of the individual
claims. It is also the P & C Insurance Group's policy that the most experienced
technicians handle the most complex claims. In general, claims in litigation are
the most complex and require the most experienced personnel.
The Company's claim staff, working closely with claim department
supervisors, may retain independent adjusters, appraisers and defense counsel,
based on the nature of the claim. In addition, the P & C Insurance Group has
implemented procedures and programs to detect and investigate claim fraud and
believes that, to date, these programs have resulted in substantial savings
relative to the claimed amounts involved.
Sequoia has expended considerable effort and expense in streamlining
and reordering its operations in the latter part of 1995 and in 1996. Computer
systems have been developed to facilitate decentralization of underwriting and
claims adjusting functions. As a result, in May 1996, Sequoia terminated its
home office lease agreement and entered into a short-term lease arrangement for
substantially less office space at a nearby location. This may result in a
significant savings to Sequoia over time and provides greater flexibility for
the future.
The P & C Insurance Group has emphasized the development and
maintenance of information and processing systems for use in all areas of its
business. Management believes that its information and processing systems enable
the Insurance Group to compete effectively through enhanced policyholder
services, efficient underwriting, claim support systems, reduced processing
costs and timely management information. In addition, CIC's systems are not
dependent on specific hardware vendors, thereby providing it with greater
control over hardware costs and flexibility in terms of operating hardware. An
internally integrated software system has been designed for the processing of
CIC's workers' compensation and commercial property and casualty business,
including automated policy issuance and claim processing.
CIC's claim function has been supported by its on-line automated claim
system, which has been internally developed and refined over several years.
CNIC's claims functions have been integrated into CIC's automated system and are
being supported by this system. Utilizing this system, claim technicians have
on-line, direct access to all claim files through their own computer terminal.
11
14
CIC and Sequoia collect premiums either by direct billing or producer
billing. Sequoia has recently developed its own direct billing system and began
utilizing this system for all new and renewal policies, thereby eliminating its
reliance on the outside service vendor. The workers' compensation direct billing
program is supported by CIG's in-house automated system.
CIC, CNIC and Sequoia each write property and casualty insurance
policies. Most of CIC's, CNIC's and Sequoia's net premiums are attributable to
property and casualty. The property and casualty insurance industry has been
highly cyclical, and the industry has been in a cyclical downturn over the last
several years due primarily to premium rate competition, which has resulted in
lower profitability. Premium rate levels are related to the availability of
insurance coverage, which varies according to the level of surplus in the
industry. The level of surplus in the industry varies with returns on invested
capital and regulatory barriers to withdrawal of surplus. Increases in surplus
have generally been accompanied by increased price competition among property
and casualty insurers. The cyclical trends in the industry and the industry's
profitability can also be affected significantly by volatile and unpredictable
developments, including natural disasters (such as hurricanes, windstorms,
earthquakes and fires), fluctuations in interest rates and other changes in the
investment environment which affect market prices of insurance companies'
investments and the income from those investments, inflationary pressures that
affect the size of losses and judicial decisions affecting insurers'
liabilities. The demand for property and casualty insurance can also vary
significantly, generally rising as the overall level of economic activity
increases and falling as such activity decreases.
Workers' Compensation
Workers' compensation is a no-fault statutory system, which requires an
employer to provide its employees with medical care, disability payments and
other specified benefits for work-related injuries or illnesses. Employers
typically purchase workers' compensation insurance to provide these benefits,
which are statutorily established. CIC currently writes workers compensation
policies, however, the Company has entered into a letter of intent to sell its
workers compensation business. See "- Recent Developments."
MPL
Prior to the sale of the MPL insurance business in August 1995,
Physicians and PRO sold only MPL coverage. Physicians and PRO were represented
by approximately 40 independent insurance agents and by Physicians' wholly-owned
subsidiary insurance agency, PICO Insurance Agency, Inc. While Physicians and
PRO were licensed collectively in the states of Ohio, Kentucky, Michigan, West
Virginia and Wisconsin, MPL coverage was actively sold only in Ohio and
Kentucky. Physicians and PRO continue to administer the adjustment of claims and
the investment of related assets for policies written or renewed prior to July
16, 1995.
Life and Health
APL is represented on a commission basis by approximately 400
independent agents, some of whom may also be licensed with other unaffiliated
companies. APL, an Ohio-domiciled life insurer, has written life, annuity and
group health insurance since its inception in 1978. In July, 1993, APL began
marketing a critical illness policy which APL believed was unique to the U.S.
market. In the face of heightened competition for group health insurance and to
concentrate on the Survivor Key product, on July 1, 1994, APL ceased writing
group, health and dental coverages with the exception of the Physicians Group
Plans, which were terminated in March 1996. To date, response to APL's critical
illness policy, Survivor Key, has been less than expected but is increasing. See
"Management Discussion and Analysis of Financial Condition and Results of
Operations."
Liabilities for Unpaid Loss and Loss Adjustment Expenses
Liabilities for unpaid loss and LAE are estimated based upon actual and
industry experience, and assumptions and projections as to claims frequency,
severity and inflationary trends and settlement
12
15
payments. Such estimates may vary from the eventual outcome. The inherent
uncertainty in estimating reserves is particularly acute for lines of business
for which both reported and paid losses develop over an extended period of time.
Several years or more may elapse between the occurrence of an insured
MPL, workers' compensation or casualty loss, the reporting of the loss and the
final payment of the loss. Loss reserves are estimates of what an insurer
expects to pay claimants, legal and investigative costs and claims
administrative costs. The Company's subsidiaries are required to maintain
reserves for payment of estimated losses and loss adjustment expense for both
reported claims and claims which have occurred but have not yet been reported
("IBNR"). Ultimate actual liabilities may be materially more or less than
current reserve estimates.
Reserves for reported claims are established on a case-by-case basis.
Loss and loss adjustment expense reserves for IBNR are estimated based on many
variables including historical and statistical information, inflation, legal
developments, the regulatory environment, benefit levels, economic conditions,
judicial administration of claims, general trends in claim severity and
frequency, medical costs and other factors which could affect the adequacy of
loss reserves. Management reviews and adjusts IBNR reserves regularly.
The liabilities for unpaid losses and LAE for Physicians, PRO, Sequoia,
CIC and CNIC, (the "Combined Insurance Group") were $252.0 million in 1996,
$229.8 million in 1995 and $180.7 million in 1994, net of discount on MPL
reserves. Of those amounts, the liabilities for unpaid loss and LAE of prior
years increased by $2.3 million in 1996 and $3.2 million in 1995 and decreased
by $12.7 million in 1994. These changes in reserves for prior years reserves
were due to the following:
1996 1995 1994
------ ------ -------
(Decrease) in provision for prior year claims....................... $ (2.6) $ (0.3) $ (19.6)
Retroactive reinsurance............................................. (2.4) (7.6)
Accretion of reserve discount....................................... 4.9 5.9 14.5
------ ------ -------
Net increase (decrease) in liabilities for unpaid loss
and LAE of prior years.................................. $ 2.3 $ 3.2 $ (12.7)
====== ====== =======
See schedule in Note 12 of Notes to the Company's Consolidated
Financial Statements for additional information regarding reserve changes.
Although the Combined Insurance Group's reserves are certified annually
by independent actuaries as required by state law, significant fluctuations in
reserve levels can occur based upon a number of variables used in actuarial
projections of ultimate incurred losses and LAE.
Significant changes in estimates of MPL reserves occurred at year end
1994. In part in 1993, but to a greater extent in 1994, data indicated projected
occurrence frequency had stabilized and projected severity was lower based on
current data. Both incurred and paid development methods reflected more stable
and internally consistent results which were lower than 1992 levels (and, in
1994, lower than 1993 levels). Given that all methods at December 31, 1994
affirmed the early signals of improvement in 1993, projected ultimate incurred
losses and LAE were adjusted for the prior years. Excess loss layers (losses
greater than $200,000) were more significantly impacted because the
aforementioned improvement in basic limits projections flows into the excess
loss projection estimation process and was supplemented by a more thorough study
of excess loss levels that also indicated favorable development for this layer
of exposure (Physicians' excess experience was determined to be more favorable
relative to prior indications). In combination, these changes across all
coverage types
13
16
(basic and excess limits; occurrence, claims-made and tail) resulted in the
large reduction in ultimates at December 31, 1994 versus ultimates at December
31, 1993 shown in the roll-forward of reserves schedule in Note 12 of Notes to
the Company's Consolidated Financial Statements.
Physicians' liability for unpaid MPL losses and LAE is discounted to
reflect investment income as permitted by the Ohio Department. The method of
discounting is based upon historical payment patterns and assumes an interest
rate at or below Physicians' investment yield, and is the same rate used for
statutory reporting purposes. Prior to 1994, direct and assumed MPL reserves
were discounted at a rate of 7.5% for 1987 and prior accident years, 5.5% for
the 1988 accident year, 5% for accident years 1989, 1990 and 1991, and 4% for
the 1992 and 1993 accident years. In 1994, Physicians lowered its discount rate
to 4% for all accident years resulting in a cumulative effect of a change in
accounting principle of $4.1 million.
All members of the P & C Insurance Group seek to reduce the loss that
may arise from individually significant claims or other events that cause
unfavorable underwriting results by reinsuring certain levels of risk with other
insurance carriers.
In 1994, Physicians entered into a specific excess reinsurance treaty
covering $3.0 million of losses in excess of the $2.0 million retention after a
one-time deductible of an aggregate $3.0 million of losses in excess of $2.0
million on losses incurred during the period January 1, 1992 through June 30,
1993. The $1.6 million of premiums paid under this treaty has been accounted for
as a deposit. Physicians entered into two other treaties in 1994. One treaty
covers $800,000 of losses in excess of the $200,000 retention and the other
treaty covers $4.0 million of losses in excess of $1.0 million. Both treaties
cover policies issued or renewed after July 1, 1993, and contain elements of
retroactive and prospective risk transfers. The effects on reserves of the
accounting for the retroactive portions of these treaties under SFAS No. 113 are
shown in the table above.
Reconciliation of Unpaid Loss and Loss Adjustment Expenses
An analysis of changes in the liability for unpaid loss and LAE for
1994, 1995 and 1996 is set forth in Note 12 of Notes to the Company's
Consolidated Financial Statements.
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
The following table presents the development of balance sheet
liabilities for 1986 through 1996 for all property and casualty line of business
including MPL. The "Net liability as originally estimated" line shows the
estimated liability for unpaid losses and LAE recorded at the balance sheet date
on a discounted basis for each of the indicated years. Reserves for other lines
of business that Physicians ceased writing in 1989, which are immaterial, are
excluded. The "Gross liability as originally estimated" represents the estimated
amounts of losses and LAE for claims arising in all prior years that are unpaid
at the balance sheet date on an undiscounted basis, including losses that had
been incurred but not reported.
Year Ended December 31
----------------------------------------------------------------------------------
1986 1987 1988 1989 1990 1991
(in thousands)
Net Liability as originally estimated: $ 77,041 $ 104,495 $ 109,435 $ 126,603 $128,104 $129,768
Discount 31,915 35,146 37,100 36,806 30,230 30,647
Gross liability as originally estimated: 108,956 139,641 146,535 163,409 158,334 160,413
Cumulative payments as of:
One year later 27,975 35,339 27,229 43,725 42,488 42,986
Two years later 62,794 61,228 69,335 84,463 81,536 81,489
Three years later 84,278 96,680 105,274 110,291 108,954 103,505
Four years later 112,830 123,254 122,589 128,737 120,063 120,073
Five Years later 130,606 135,034 136,454 135,170 126,100 127,725
Six years later 139,479 144,405 138,907 138,912 130,146
Seven years later 146,440 145,589 140,451 141,854
Eight years later 147,452 145,733 141,641
Nine years later 147,895 145,431
Ten years later 148,151
Liability re-estimated as of:
One year later 133,028 149,426 148,847 162,653 160,200 188,811
Two years later 142,201 145,432 148,932 162,371 179,915 184,113
Three years later 152,705 149,243 154,177 176,123 172,715 174,790
Four years later 150,504 152,427 165,596 169,488 170,847 177,811
Five years later 152,873 158,868 163,676 171,532 171,968 172,431
Six years later 152,209 160,414 165,996 170,873 165,255
Seven years later 157,366 164,727 166,144 167,341
Eight years later 162,547 164,893 161,328
Nine years later 162,212 160,683
Ten years later 160,250
Cumulative Redundancy (Deficiency) $ (51,294) $ (21,042) $ (14,793) $ (3,932) $ (6,921) $(12,018)
RECONCILIATION TO FINANCIAL STATEMENTS:
Gross Liability - end of year
Reinsurance recoverable
Net liability - end of year
Net discount
Discounted net liability-end of year
Discounted reinsurance recoverable
Discontinued personal lines insurance
Balance sheet liability (discounted)
Gross re-estimated liability - latest
Re-estimated recoverable - latest
Net re-estimated liability - latest
Net re-estimated discount - latest
Discounted net re-estimated liability - latest
Gross cumulative redundancy (deficiency)
Year Ended December 31
-------------------------------------------------------------------
1992 1993 1994 1995 1996
(in thousands)
Net Liability as originally estimated: $ 159,804 $ 179,390 $ 153,212 $136,915 $164,672
Discount 31,269 32,533 20,144 16,568 12,217
Gross liability as originally estimated: 191,073 211,923 173,356 153,483 176,889
Cumulative payments as of:
One year later 41,550 34,207 35,966 27,128
Two years later 73,012 69,037 61,263
Three years later 103,166 90,904
Four years later 116,278
Five Years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Liability re-estimated as of:
One year later 197,275 183,560 170,411 147,324
Two years later 179,763 184,138 163,472
Three years later 182,011 175,308
Four years later 176,304
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative Redundancy (Deficiency) $ 14,769 $ 35,615 $ 9,884 $ 6,159
RECONCILIATION TO FINANCIAL STATEMENTS:
Gross Liability - end of year 203,237 248,951 266,320
Reinsurance recoverable (29,881) (95,467) (89,431)
--------- -------- --------
Net liability - end of year 173,356 153,483 176,889
Net discount (20,144) (16,568) (12,217)
--------- -------- --------
Discounted net liability-end of year 153,212 136,915 164,672
Discounted reinsurance recoverable 26,303 91,697 86,174
--------- -------- --------
179,515 228,612 250,846
Discontinued personal lines insurance 1,176 1,185 1,178
--------- -------- --------
Balance sheet liability (discounted) 180,691 229,797 252,024
========= ======== ========
Gross re-estimated liability - latest 191,267 239,805
Re-estimated recoverable - latest (27,795) (92,481)
--------- --------
Net re-estimated liability - latest 163,472 147,324
Net re-estimated discount - latest (9,932) (11,687)
--------- --------
Discounted net re-estimated liability - latest 153,540 135,837
========= ========
Gross cumulative redundancy (deficiency) 9,884 6,159
Each decrease or (increase) amount includes the effects of all changes
in amounts during the current year for prior periods. For example, the amount of
the redundancy related to losses settled in 1989, but incurred in 1986, will be
included in the decrease or (increase) amount for 1986, 1987 and 1988.
Conditions and trends that have affected development of the liability in the
past may not necessarily occur in the future. For example, Physicians commuted
reinsurance contracts in several different years that significantly increased
the estimate of net reserves for prior years by reducing the recoverable loss
and LAE reserves for those years. Accordingly, it may not be appropriate to
extrapolate future increase or decreases based on this table.
14
17
The data in the above table is based on Schedule P from the Combined
Insurance Group's 1986 to 1996 Annual Statements, as filed with state insurance
departments; however, the development table above differs from the development
displayed in Schedule P, Part-2, as Schedule P, Part-2 excludes unallocated LAE.
LOSS RESERVE EXPERIENCE. The inherent uncertainties in estimating loss
reserves are greater for some insurance products than for others, and are
dependent on the length of the reporting tail associated with a given product,
the diversity of historical development patterns among various aggregations of
claims, the amount of historical information available during the estimation
process, the degree of impact that changing regulations and legal precedents may
have on open claims, and the consistency of reinsurance programs over time,
among other things. Because MPL, workers' compensation and commercial casualty
claims may not be fully paid for several years or more, estimating reserves for
such claims can be more uncertain than estimating reserves in other lines of
insurance. As a result, precise reserve estimates cannot be made for several
years following a current accident year for which reserves are initially
established.
There can be no assurance that the insurance subsidiaries in the
Combined Insurance Group and APL have established reserves adequate to meet the
ultimate cost of losses arising from such claims. It has been necessary, and
will over time continue to be necessary, for the insurance companies to review
and make appropriate adjustments to reserves for estimated ultimate losses, LAE,
future policy benefits, claims payables and annuity and other policyholder
funds. To the extent reserves prove to be inadequate, the insurance companies
would have to adjust their reserves and incur a charge to earnings, which could
have a material adverse effect on the financial results of the Company.
REINSURANCE
MPL
Prior to July 16, 1995, Physicians ceded a portion of the insurance it
wrote to unaffiliated reinsurers through reinsurance agreements. Physicians'
reinsurers for insurance policies with effective dates between July 1, 1993 and
July 15, 1995, were TIG Reinsurance Company (rated A (Excellent) by Best),
Transatlantic Reinsurance Company (rated A+ (Superior) by Best) and Cologne
Reinsurance Company of America (rated A+ (Superior) by Best). Physicians ceded
insurance to these carriers on an automatic basis when retention limits were
exceeded. Physicians retained all risks up to $200,000 per occurrence. All risks
above $200,000, up to policy limits of $5 million, were transferred to
reinsurers, subject to the specific terms and conditions of the various
reinsurance treaties. Physicians remains primarily liable to policyholders for
ceded insurance should any reinsurer be unable to meet its contractual
obligations. Physicians has not incurred any material loss resulting from a
reinsurer's breach or failure to comply with the terms of any reinsurance
agreement. MPL insurance written or renewed after July 15, 1995, was fully
reinsured by Mutual.
PROPERTY AND CASUALTY
CIC has excess of loss reinsurance treaties for its property and
casualty insurance business with Gen Re for policies written on or after October
1, 1991 through December 31, 1993, and primarily with North Star Reinsurance
Corporation, a subsidiary of Gen Re, and Western Atlantic Management
Corporation, a subsidiary of North American Reinsurance Corporation, for
policies written prior to October 1, 1991. For losses that occurred from October
1, 1989 to September 30, 1990 on policies written prior to October 1, 1990, the
reinsurers assume liability on that portion of loss which exceeds $75,000 per
occurrence, up to a maximum of $3.0 million per occurrence for property losses
and up to a maximum of $1.0 million per occurrence for casualty losses. For
losses that occur after September 30, 1990, on policies written prior to October
1, 1991, the maximum coverage for property losses is $2.0 million. For losses
occurring after October 1, 1991 on policies written between October 1, 1991
15
18
and December 31, 1993, the reinsurer assumes liability on that portion of loss
which exceeds $75,000 per occurrence, up to a maximum of $3.0 million per
occurrence for property losses and that portion of loss which exceeds $125,000
per occurrence, up to a maximum of $3.0 million per occurrence for casualty
losses occurring prior to December 31, 1993. CIC obtains facultative reinsurance
for those policies it issues with policy limits above its excess of loss
reinsurance treaties. Currently, the number of such policies is insignificant.
CGIC and CNIC's casualty excess of loss reinsurance treaty through
December 31, 1993 provided $850,000 of coverage in excess of a retention of
$150,000 per auto liability or general liability loss and was placed with
National (75%) and Prudential (25%). Another treaty, placed primarily with
Prudential, provided $3.0 million in additional limits. The $150,000 retention
has been in place since January 1, 1992. Between February 1, 1986, and December
31, 1991, the retention was $100,000. CIG believes that, before February 1,
1986, the CGIC reinsurance program had retentions ranging up to $250,000 per
occurrence.
CGIC and CNIC's property reinsurance program, which covered all
policies incepting before January 1, 1994, is structured as follows:
- A surplus share treaty providing $6.0 million in available limits is
maintained with Prudential (55%) and Munich (45%).
- A property excess of loss treaty provides $450,000 in limits in
excess of a $50,000 per occurrence retention. This treaty is maintained with
National (75%) and Prudential (25%).
- A property catastrophe program, supported by several reinsurers,
provided 95% of $8.5 million in excess of a $1.5 million per occurrence
retention.
- Several facultative reinsurance agreements provide direct access to
as much as $6.0 million in additional reinsurance coverage as needed.
CGIC's and CNIC's commercial umbrella liability treaty was placed with
Prudential for all policies incepting before January 1, 1994. Prudential
reinsures 95% of the first $1.0 million of umbrella coverage and 100% of any
limits purchased above $1.0 million. The maximum limit reinsured under this
treaty is $5.0 million. For higher umbrella limits, facultative reinsurance is
obtained.
CGIC entered into a Stop Loss reinsurance treaty with Scandinavian
Reinsurance Company, Ltd. ("Scandinavian") in 1991. Since CGIC and CNIC had
entered into an intercompany pooling reinsurance agreement, CNIC shared in the
results of this treaty. This treaty, effective November 1, 1991, involved the
transfer of $8.5 million of portfolio investments to Scandinavian in exchange
for $13,175,000 of coverage, including $6.5 million of existing loss and loss
adjustment expense reserves and $6,675,000 of coverage for potential future
adverse development of loss and loss adjustment expense reserves associated with
accident years 1991 and prior. All $6,675,000 was ceded as of December 31, 1991.
Additional limits were purchased during 1992, providing $5.1 million of coverage
for the accident years 1991 and prior. This involved the payment of $3.5 million
in April 1992 representing $3.5 million in existing loss and loss adjustment
expense reserves. All $5.1 million was ceded as of year end 1992. Other
provisions of the treaty permit CGIC and CNIC to purchase additional limits to
protect accident years 1992 through 1995. As of December 31, 1994, CGIC and CNIC
had purchased approximately $2,126,000 of limits for the 1992 accident year, all
of which has been ceded, had purchased approximately $2,182,000 of limits for
the 1993 accident year, all of which has been ceded, and had purchased
approximately $1,950,000 of limits for the 1994 accident year, $1,844,000 of
which has been ceded. The coverage provided by the Stop Loss treaty cannot be
canceled or commuted by the reinsurer. As of December 31, 1996, CNIC has
received payment for all losses ceded to this treaty for
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accident year 1992. CNIC has a letter of credit from the reinsurer for unpaid
losses ceded to this treaty for accident years 1993 and 1994.
Effective January 1, 1994, CIC and CNIC have in place reinsurance
agreements for their property and casualty business. CIC and CNIC have an excess
of loss reinsurance treaties with Gen Re for casualty losses occurring from
January 1, 1995 through December 31, 1995. This treaty provides $5,850,000 of
coverage in excess of $150,000 per occurrence. CIC and CNIC also have an excess
and commercial umbrella liability treaty with American Reinsurance Company which
reinsures 95% of the first $1.0 million of umbrella coverage and 100% of any
limits purchased above $1.0 million, up to $10.0 million. For property losses, a
surplus share treaty providing up to $4.5 million of proportional coverage is
placed with Munich. A property excess of loss treaty with National Re provides
up to $1,350,000 of coverage in excess of $150,000. Facultative reinsurance
agreements with American Re and Munich Re provide coverage of up to an
additional $6.0 million. Property catastrophe reinsurance is provided by several
reinsurers and provides 95% of $8.5 million of coverage in excess of a $1.5
million per occurrence retention.
Effective March 31, 1995, CIC entered into a reinsurance agreement with
National Re to provide coverage for property and casualty losses incurred in
excess of $50,000 per occurrence up to $150,000, at which level CIC's other
reinsurance agreements provide coverage. This reinsurance agreement provides
reinsurance commission income to CIC on the premiums ceded pursuant to the
agreement.
Effective January 1, 1996, CIC cancelled the property and casualty
excess of loss agreement described above with National Re. In addition, CIC and
CNIC cancelled on a run off basis the surplus share treaty with Munich Re and
the pro rata automatic facultative agreements with American Re and Munich Re.
There were no cancellation penalties associated with the cancellation of these
reinsurance contracts. CIC and CNIC have an excess of loss treaty with National
Re for property and casualty loss occurring on or after January 1, 1996. This
treaty provides $4,750,000 of coverage in excess of $250,000 per occurrence. An
automatic facultative agreement with Munich Re provides coverage up to $6.0
million in excess of $5.0 million per occurrence. Property catastrophe
reinsurance, which is provided by several reinsurers, was increased to provide
95% of $18.5 million of coverage in excess of a $1.5 million per occurrence
retention. The commercial umbrella agreement with American Re continues to
provide coverage as described above.
Effective January 1, 1997, CIC cancelled its reinsurance contracts and
replaced them with the following coverages. For policies in force at December
31, 1996 and for policies written with effective dates from January 1, 1997
through February 28, 1997, CIC has reinsurance providing coverage for both
property and casualty business, excluding umbrella coverage, of $4,750,000
excess of $250,000. For policies written with effective dates March 1, 1997 and
after, CIC has the same reinsurance as Sequoia's 1997 reinsurance program which
is outlined as follows. For property business, reinsurance provides coverage of
$10,350,000 excess of $150,000. For casualty business, excluding umbrella
coverage, reinsurance provides coverage of $4,850,000 excess of $150,000.
Umbrella coverages are reinsured $9,900,000 excess of $100,000. The catastrophe
treaties provide coverage of 95% of $19,000,000 excess of $1,000,000 per
occurrence for the combined losses of CIC and Sequoia. Facultative reinsurance
is placed with various reinsurers.
Where the reinsurers are "not admitted" for regulatory purposes, the P
& C Insurance Group presently maintains sufficient collateral with approved
financial institutions to secure cessions of paid losses and outstanding
reserves.
With regard to Sequoia, all policy and claims liabilities prior to
August 1, 1995 have been 100% reinsured with SRC and unconditionally guaranteed
by QBE. Sequoia, however, retains primary responsibility to its policyholders
and claimants should SRC and QBE fail. Sequoia's net retention for both property
and casualty business, excluding umbrella coverage, is $150,000 per risk or
occurrence.
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The working layers provide coverage up to $5,500,000 excess of $150,000 per risk
on property losses subject to occurrence limits and unlimited reinstatements.
General liability coverage, excluding umbrella coverage, is provided up to
$3,000,000 excess of $150,000 per occurrence. Two excess catastrophe treaties
provide additional property reinsurance up to $10,000,000 each occurrence,
excess of $500,000 each occurrence, with allowances for one full reinstatement
each at pro rata pricing. Sequoia retains the first $100,000 of each umbrella
loss up to $5,000,000. Facultative reinsurance is placed with various
reinsurers.
Reinsurance Recoverable Concentration for all property and casualty
lines of business, including MPL, follows:
Reinsurance Recoverable Concentration
(in millions)
UNEARNED REPORTED UNREPORTED REINSURER
PREMIUMS CLAIMS CLAIMS BALANCES
Sydney Reinsurance $ 0.1 $ 16.8 $ 16.2 $ 33.1
Corporation
Kemper Reinsurance $ 0.0 $ 4.2 $ 3.6 $ 7.8
Company
Continental Casualty $ 1.5 $ 0.3 $ 1.2 $ 3.0
Company
San Francisco $ 0.5 $ 0.2 $ 0.4 $ 1.1
Reinsurance Company
TIG Reinsurance Group $ 0.0 $ 4.2 $ 7.1 $ 11.3
Transatlantic $ 0.0 $ 0.0 $ 9.0 $ 9.0
Reinsurance Company
Cologne Reinsurance $ 0.0 $ 0.0 $ 1.0 $ 1.0
Company of America
Mutual Assurance, Inc. $ 0.0 $ 1.3 $ 5.1 $ 6.4
The Company remains contingently liable with respect to reinsurance
contracts in the event that reinsurers are unable to meet their obligations
under the reinsurance agreements in force.
LIFE AND HEALTH
APL's net retention for life insurance products is a maximum of $50,000
per risk, except for their combined critical illness and life insurance product
which has a maximum of $25,000.
WORKERS' COMPENSATION
CIC maintains excess of loss workers' compensation reinsurance treaties
with General Reinsurance Corporation ("Gen Re") and other reinsurers. Under the
reinsurance treaties relating to losses occurring on or after January 1, 1990,
reinsurers assume liability on that portion of loss which exceeds $250,000 per
occurrence, up to a maximum of $50.0 million per occurrence through December 31,
1990, $60.0 million per occurrence in 1991, $70.0 million per occurrence through
1993 and $50.0 million per occurrence thereafter. For losses that occurred from
January 1, 1988 through December 31, 1988, CIC has aggregate coverage of $40.0
million with a $200,000 retention, and for losses that occurred from January 1,
1989 through December 31, 1989, CIC has aggregate coverage of $50.0 million with
a $200,000 retention. CIC is liable for losses in excess of the maximum amounts
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reinsured. Reinsurance does not discharge an insurer from direct responsibility
for payment of the full amount of any covered loss, but a reinsurer is liable to
the insurer for the portion it has assumed.
Effective January 1989, CIC entered into a Stop Loss Reinsurance
Agreement with Gen Re under which Gen Re assumed liability for net retained
workers' compensation loss and loss adjustment expense incurred above specified
aggregate retention amounts for each of the accident years from 1986 through
1989. The premium paid by CIC for this coverage was $10.85 million. The Stop
Loss Reinsurance Agreement provided coverage for up to $2.0 million of loss and
loss adjustment expense above a $17.5 million retention for the 1986 accident
year, $4.5 million above a $23.0 million retention for the 1987 accident year,
$1.0 million above a $30.3 million retention for the 1988 accident year and $5.7
million above a $25.0 million retention for the 1989 accident year. Any unused
coverage for a particular year may be reallocated to increase the total coverage
available for a subsequent accident year. The Stop Loss Reinsurance Agreement
provided for automatic commutation as of December 31, 1996 and contained a
profit-sharing provision pursuant to which Gen Re may have paid CIC a
profit-sharing commission in 1996 based upon the ultimate amount of losses ceded
under the Stop Loss Reinsurance Agreement, the timing of payment of such losses
and the amount of premiums ceded. The Stop Loss Reinsurance Agreement was
commuted in November 1994. Upon commutation Gen Re paid to CIC $3,563,000 of
which $2,512,000 represented the full undiscounted carried value of the
reinsured reserves (including IBNR) outstanding as of September 30, 1994 and
$1,051,000 represented the profit sharing payment, CIC reassumed liability for
all known and unknown losses as of that date and Gen Re was discharged from any
further obligations under the Stop Loss Reinsurance Agreement. The Stop Loss
Reinsurance Agreement was accounted for as a financing agreement for GAAP
purposes and, accordingly, the commutation did not have a material impact on
results of operations in 1994. The Company has entered into a letter of intent
to dispose of its workers' compensation business. See " - Recent Developments."
REINSURANCE RISKS
As with other property and casualty insurers, CIC's, CNIC's, and
Sequoia's operating results and financial condition can be adversely affected by
volatile and unpredictable natural and man-made disasters, such as hurricanes,
windstorms, earthquakes, fires and explosions. CIC, CNIC, and Sequoia generally
seek to reduce their exposure to such events through individual risk selection
and the purchase of reinsurance. CIC's, CNIC's and Sequoia's estimates of their
exposures depend on their views of the possibility of a catastrophic event in a
given area and on the probable maximum loss to CIC, CNIC or Sequoia should such
an event occur. While CIC, CNIC and Sequoia attempt to limit their exposure to
acceptable levels, it is possible that an actual catastrophic event or multiple
catastrophic events could significantly exceed the probable maximum loss
previously assumed, resulting in a material adverse effect on the financial
condition and results of operations of the Company.
The future financial results of the insurance subsidiaries could be
adversely affected by disputes with their respective reinsurers with respect to
coverage and by the solvency of such reinsurers. None of the Company's insurance
subsidiaries is aware of actual or potential disputes with any of their
respective reinsurers that could materially and adversely impact the financial
results of the Company or is aware of any insolvent reinsurer whose current
obligations to CIC, CNIC, Physicians, PRO, APL or Sequoia are material to such
companies.
COMPETITION
There are several hundred property and casualty insurers licensed in
California, many of which are larger and have greater financial resources than
the P & C Insurance Group and offer more diversified types of insurance
coverage, have greater financial resources and have greater distribution
capabilities than the P & C Insurance Group.
A.M. BEST ("BEST"). Best has recently assigned Sequoia a rating of B++
(Very Good) and APL has had a Best rating of B+ (Very Good) since 1983. CIC is
currently rated B- (Adequate) and CNIC is currently rated C (Marginal) by Best.
Physicians and PRO are currently rated, and have been for a
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number of years, NR-3 (rating procedure inapplicable). Best's ratings reflect
the assessment of A.M. Best and Company of the insurer's financial condition as
well as the expertise and experience of its management. Therefore, Best ratings
are important to policyholders. Best ratings are subject to review and change
over time. There can be no assurance that Sequoia or APL will maintain their
ratings. If Sequoia or APL fail to maintain their current ratings, it would
possibly have a material adverse effect on their ability to write new insurance
policies as well as potentially reduce their ability to maintain or increase
market share.
As a result of the reported losses and the increase in reserves,
primarily from construction defect claims, in 1994, Best reduced its rating of
CNIC from B+ to C- (which rating has subsequently been increased to C) and in
1995 reduced its rating of CIC from B+ to B-. Management believes that many
potential customers will not insure with an insurer that carries a Best rating
of less than B+, and that customers who do so will demand lower rate structures.
In addition, there can be no assurances that CIC's or CNIC's Best ratings will
be maintained or increased.
There is fierce competition in the property and casualty insurance
industry which is populated by large insurers doing business on a countrywide
basis, as well as regional and local insurers. Insurers compete on the basis of
price, product, and service. Many of the competitors in the market have higher
ratings from Best as well as other financial rating services and offer a broader
array of coverages than do CIC, CNIC, and Sequoia.
Commercial insurance markets are commodity-oriented, highly fragmented
and reflective of intense price competition. Nevertheless, because each
commercial risk is somewhat unique in terms of insurance exposure, different
insurers can develop widely divergent estimates of prospective losses. Most
insurers attempt to segment classes within commercial markets so that they
target the more profitable sub-classes with lower, although adequate rates,
given the estimated profitability of the segment. In some cases, no statistics
are available for the sub-classes involved, and the insurer implements
discounted rate structures based solely on theoretical judgment. Finally,
different insurers have widely-divergent internal expense positions, due to
method of distribution, scale economies and efficiency of operations. Therefore,
although insurance is a commodity, the price of insurance does not necessarily
reflect commodity pricing.
Sequoia's and CIC's ability to attract and retain customers results
from price structures which have been tailored to attract certain sub-segments
of the commercial insurance market. In addition, several of their competitors
have either restricted writings in California or have withdrawn from the state
due to a variety of competitive pressures and adverse litigation and regulatory
climates.
However, CIC's, CNIC's and Sequoia's marketing is focused in a limited
number of commercial business classifications. In general, these classifications
are considered preferred by most competitors because of historically profitable
results realized from underwriting such classifications. CIC's, CNIC's and
Sequoia's customer bases and prospective revenues are vulnerable to the pricing
actions of larger or more efficient competitors who target CIC's, CNIC's and
Sequoia's desired classifications or individual policyholders and offer
substantially lower rates.
The life and health insurance industry is highly competitive. There are
approximately 700 life and health insurers licensed in Ohio, many of which are
larger and have greater financial resources than APL. APL currently is rated B+
(Very Good) by Best. APL is, to the Company's knowledge, the only life insurance
company in the U.S. offering a critical illness policy which pays a lump sum
benefit equal to the face amount even if the insured is not terminally ill (in
contemplation of death within twelve months). This critical illness policy,
which is called "Survivor Key", is the main focus of APL's marketing efforts.
Physicians and its subsidiaries no longer compete in the MPL industry.
CIC and CNIC are in the process of selling their workers compensation
businesses. See " - Recent Developments."
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REGULATION
Physicians, CIC and their respective insurance subsidiaries are subject
to extensive state regulatory oversight in the jurisdictions in which they are
organized and in the jurisdictions in which they do business.
Physicians, PRO, APL, Sequoia, CIC and CNIC investments are strictly
regulated by investment statutes in their states of domicile. In general, these
investment laws place limits on the amounts of investment in any one company,
the owned percentage of any one company and the quality of investments and seek
to ensure the claims-paying ability of the insurer.
Ohio has enacted legislation that regulates insurance holding company
systems, including Physicians and its insurance subsidiaries. Each insurance
company in the holding company system is required to register with the Ohio
Department and furnish information concerning the operations of companies within
the holding company system that may materially affect the operations, management
or financial condition of the insurers within the system. Pursuant to these
laws, the Ohio Department may examine Physicians and/or its insurance
subsidiaries at any time and require disclosure of and/or approval of material
transactions involving the insurers within the system, such as extraordinary
dividends from any one of Physicians or any of its insurance subsidiaries. All
material transactions within the holding company system affecting Physicians or
its Ohio-domiciled insurance subsidiaries must be fair and reasonable. Sequoia,
CIC and CNIC are subject to similar legislation in California.
Ohio insurance law provides that no person may acquire direct or
indirect control of Physicians, PRO or APL unless it has obtained the prior
written approval of the Ohio Superintendent of Insurance for such acquisition
unless such transaction is exempt. Similarly, California insurance law provides
that no person may acquire direct or indirect control of Sequoia or CIC unless
it has obtained the prior written approval of the California Insurance
Commissioner of such acquisition.
Since Physicians, PRO and APL are domiciled in Ohio, the Ohio
Department is the principal supervisor and regulator of each of these companies.
Since Sequoia, CIC and CNIC are domiciled in California, the California
Insurance Commissioner is its principal supervisor and regulator. However, each
of the companies are also subject to supervision and regulation in the states in
which they transact business, and such supervision and regulation relate to
numerous aspects of an insurance company's business and financial condition. The
primary purpose of such supervision and regulation is to ensure financial
stability of insurance companies for the protection of policyholders. The laws
of the various states establish insurance departments with broad regulatory
powers relative to granting and revoking licenses to transact business,
regulating trade practices, required statutory financial statements, and
prescribing the types and amount of investments permitted. Although premium rate
regulations vary among states and lines of insurance, such regulations generally
require approval of the regulatory authority prior to any changes in rates.
Insurance companies are required to file detailed annual reports with
the insurance departments in each of the states in which they do business, and
their financial condition and market conduct are subject to examination by such
agencies at any time.
Physicians, PRO and APL are restricted by the insurance laws of Ohio as
to the amount of dividends they may pay without prior approval. The maximum
dividend that may be paid during any year without the prior approval of the Ohio
Department is limited to the greater of 10% of the insurer's surplus as regards
policyholders as of the preceding December 31 or the net income of the insurer
for the year ended the previous December 31. Any dividend paid from other than
earned surplus is considered to be an extraordinary dividend and must be
approved. In January 1997, approximately $21.8 million and $2.7 million will be
available for payment by Physicians and APL, respectively, without the prior
approval of the Ohio Department. No amounts were available for payment by PRO.
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The California Insurance Code limits the amount of dividends or
distributions an insurance subsidiary may pay in any 12-month period without 30
days prior written notice to the Commissioner to the greater of (a) net income
for the preceding year as determined under statutory accounting principles or
(b) 10% of statutory policyholders' surplus as of the preceding December 31.
Insurers may pay dividends only from earned surplus. Payments of dividends in
excess of these amounts may only be made if the Commissioner has not disapproved
such payment, or specifically approves such payment, within the 30 day-period.
The insurance industry is also affected by court decisions. Premium
rates are actuarially determined to enable an insurance company to generate an
underwriting profit. These rates contemplate a certain level of risk. The courts
may undercut insurers' expectations with respect to the level of risk being
assumed in a number of ways, including eliminating exclusions, multiplying
limits of coverage and creating rights for policyholders not set forth in the
contract. These decisions can adversely affect an insurer's profitability.
Recently, the NAIC and state insurance regulators have been examining
existing laws and regulations, with an emphasis on insurance company investment
and solvency issues, risk-based capital guidelines, interpretations of existing
laws, the development of new laws and the implementation of nonstatutory
guidelines. From time to time, legislation has also been introduced in Congress
that would result in the federal government assuming some role in the regulation
of the insurance industry. Each of the Company's insurance subsidiaries are also
subject to assessment by such state guaranty associations to fund the insurance
obligations of insolvent insurers. There can be no assurance that such
assessments will not have an adverse effect on the financial condition of
The Company and its insurance subsidiaries. However, assessments are calculated
based upon market share and none of the Company's insurance subsidiaries has a
significant market share in any line of business in any jurisdiction.
The regulation and supervision of insurance companies by state agencies
is designed principally for the benefit of their policyholders, not their
stockholders. In addition, MAC is subject to regulation by the California
Department of Corporations, which includes various requirements relating to the
financial condition of MAC as well as all aspects of the marketing of premium
financing.
The California Department completed its latest market conduct
examination of Sequoia and CNIC in 1992 and of CIC in 1993. The California
Department has also completed a financial examination of CGIC and CNIC in 1993
covering the three years ended December 31, 1991, but also included an extension
of the review to December 31, 1992 with regard to the adequacy of CIC's and
CNIC's loss and loss adjustment expense reserves as of that date. The California
Department's final examination report did not require either company to take any
action.
The California Department is conducting financial examinations of CIC
and CNIC covering the three-year period ended December 31, 1995. The California
Department's final examination report has not yet been released. The California
Department has also initiated a financial examination of Sequoia covering 1993
through 1995. Examinations are routinely scheduled every three years. The Ohio
Department recently completed its regular triennial examinations of Physicians,
PRO and APL. Nothing of significance was reported.
In July 1993, the California legislature enacted a series of seven
bills to significantly change the California workers' compensation system (the
"1993 Reforms"). The 1993 Reforms increase costs as a result of benefit
increases commencing July 1, 1994 and continuing through July 1, 1996. In
addition, the 1993 Reforms reduced revenues through an immediate reduction in
minimum rates of 7%. The legislation permitted the Insurance Commissioner to
approve rates even lower. Effective January 1, 1994, the Insurance Commissioner
ordered a further 12.7% reduction in minimum rates and a 16% reduction in
minimum rates effective October 1, 1994. Effective January 1995, California's
minimum rate law was replaced by a competitive rating system. The 1993 Reforms
contain numerous other provisions, including limitations on grounds for
cancellation of policies. The Company is in the process of selling its workers'
compensation business. See " - Recent Developments."
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Proposed federal legislation has been introduced from time to time in
recent years that would provide the federal government with substantial power to
regulate property and casualty insurers including state workers' compensation
systems, primarily through the establishment of uniform solvency standards.
Proposals also have been discussed to modify or repeal the antitrust exemption
for insurance companies provided by the McCarran-Ferguson Act. The adoption of
such proposals could have a material adverse impact upon the operations of
the Company.
Proposition 103, a ballot initiative passed by California voters on
November 8, 1988, requires rate rollbacks and prior approval of rates and
imposes other requirements on property and casualty insurers. Proposition 103,
by its terms, does not apply to workers' compensation insurance, but does apply
to the types of property and casualty insurance that Sequoia and CIC write. The
rate rollback provisions of Proposition 103 do not apply to CIC nor CNIC since
neither company commenced writing property and casualty insurance prior to the
effective date of Proposition 103. Beginning on November 8, 1989, insurance
rates may be increased only after application to and approval by the Insurance
Commissioner and, under certain circumstances, after a public hearing. In June
1993, CIC received final approval from the California Department for its inland
marine and other liability rate filings. Sequoia has fulfilled its Proposition
103 rate rollback obligation and received approval from California for its rate
filings.
Since 1990, numerous rates and underwriting rules have been filed by
CIC and approved by the California Department including certain rate increases.
No assurance can be given as to what actions, if any, the California Department
will take with respect to the ultimate approval of CIC's remaining interim rate
filings or future rate filings.
The California Insurance Commissioner issued emergency regulations
that, if and when adopted, would repeal the prior approval procedures and
regulations in effect when CIC's Interim Notices of Approval were received in
1990. These emergency regulations focus on rate rollbacks and procedures and
substantive standards regarding approvals of future rates (including determining
rates by reference to rates of return). Administrative proceedings and court
challenges relating to these regulations have been continuous. Most recently,
the California Supreme court reversed an earlier California Superior Court
ruling that held Proposition 103 did not authorize the California Insurance
Commissioner to adopt substantive regulations for the determination of the
liability of insurers for rate rollbacks and that each insurer is entitled to a
separate hearing to demonstrate to the California Insurance Commissioner that
the 10% cap on insurers' returns (as set forth in the emergency regulations)
should not apply to it. The United States Supreme Court has since refused to
hear an appeal of the California Supreme Court's decision. The Company cannot
predict what the ultimate outcome of these issues will be or what procedures and
substantive standards ultimately may be adopted by the Insurance Commissioner.
The Company and its insurance subsidiaries may be materially adversely affected
by such adopted regulations.
Substantially all liabilities resulting from the roll back of insurance
rates under Proposition 103 had been settled or reserved for prior to
Physicians' purchase of Sequoia.
Proposition 103 also subjects the insurance industry to California
antitrust and unfair business practices laws (although the relevant provision of
Proposition 103 may only apply to automobile and certain other insurers),
prohibits cancellation or nonrenewal of insurance policies except for specified
reasons and provides that the Insurance Commissioner shall be an elected
official.
Beginning in 1994, Physicians, PRO, APL, CIC, CNIC and Sequoia became
subject to the provisions of the Risk-Based Capital for Insurers Model Act (the
"Model Act") which has been adopted by the NAIC for the purpose of helping
regulators identify property and casualty insurers that may be in financial
difficulty. The Model Act contains a formula which takes into account asset
risk, credit risk, underwriting risk and all other relevant risks. Under this
formula, each insurer is required to report to regulators using formulas which
measure the quality of its capital and the relationship of its modified
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capital base to the level of risk assumed in specific aspects of its operations.
The formula does not address all of the risks associated with the operations of
an insurer. The formula is intended to provide a minimum threshold measure of
capital adequacy by individual insurance company and does not purport to compute
a target level of capital. Companies which fall below the threshold will be
placed into one of four categories: Company Action Level, where the insurer must
submit a plan of corrective action; Regulatory Action Level, where the insurer
must submit such a plan and the regulator will issue a corrective order;
Authorized Control Level, which includes the above actions and may include
rehabilitation or liquidation; and Mandatory Control Level, where the regulator
must rehabilitate or liquidate the insurer.
The Model Act is not expected to cause any material change in any of
the insurance companies' future operations. All companies' risk-based capital
results as of December 31, 1996 exceed their minimum thresholds.
OTHER OPERATIONS
The Company conducts its other non-insurance operations principally
through Summit. See "Introduction - Subsidiaries" and " - History." Other
operations are conducted to a lesser extent by Raven Development Corp., CLM
Insurance Agency, Stoneridge Partners AG and others. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Summit is registered as an investment adviser in California, Florida,
Kansas, Louisiana, Oregon, Virginia and Wisconsin as well as with the SEC. Since
February 1995, Summit has provided investment management services to Physicians
and its insurance subsidiaries. Summit also offers its services to other
individuals and institutions in the jurisdictions in which it is registered as
an investment adviser and in other states where registration is not required.
The investment advisory business is highly competitive. Many of
Summit's competitors are larger and have greater financial resources than
Summit. There can be no assurance that Summit will be able to compete
effectively in the markets that it serves.
As a registered investment adviser, Summit is subject to regulation by,
and files annual reports with, the SEC and the securities administrators in some
of the jurisdictions in which it is registered to do business.
EMPLOYEES
At December 31, 1996, the Company had 270 employees. 259 employees
worked in the Company's insurance operations including 219 in property and
casualty, 22 in MPL, and 18 in life and health. 4 employees worked in portfolio
investing.
EXECUTIVE OFFICERS
The executive officers of PICO are as follows:
Name Age Position
- ---- --- --------
Ronald Langley 52 Chairman of the Board, Director
John R. Hart 37 President, Chief Executive Officer and Director
Richard H. Sharpe 41 Chief Operating Officer
Gary W. Burchfield 50 Chief Financial Officer and Treasurer
James F. Mosier 49 General Counsel and Secretary
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Each executive officer of PICO was an executive officer of
Physicians prior to the Merger and became an officer of PICO in November
1996 as a result of the Merger.
Mr. Langley has been Chairman of the Board of Physicians and PRO since
July 1995, Chairman of the Board of Summit since November 1994, and Chairman of
the Board of GEC since September 1995. He has also been a self-employed Investor
since 1992. Mr. Langley has been a Director of Physicians since 1993.
Mr. Hart has been President and Chief Executive Officer of Physicians
and PRO since July 1995 and President and Chief Executive Officer of GEC since
September 1995. Prior to that he was a self-employed Investor and President of
Quaker Holdings Limited, an investment company, since 1991. Mr. Hart has been a
Director of Physicians since 1993.
Mr. Sharpe has been Chief Operating Officer of Physicians since June
1994, an officer of APL for more than 10 years, and a Director of APL since June
1993.
Mr. Burchfield has been Chief Financial Officer of Physicians since
November 1995 and Treasurer since November 1994. Mr. Burchfield was Controller
of Physicians from March 1990 to November 1995 and Chief Accounting Officer of
Physicians from December 1993 to November 1995.
Mr. Mosier has served as General Counsel and Secretary of Physicians
since October 1984 and in various other executive capacities since joining
Physicians in 1981.
ITEM 2. PROPERTIES
The Company leases approximately 5,354 square feet in La Jolla,
California for its Principal Executive Offices.
The Company's San Jose branch office and the northern California
regional claims operation share approximately 28,000 square feet of space in San
Jose, California pursuant to a lease expiring in March 2001. The Company also
leases space for branch offices located in Rancho Cordova, Denver, Colorado and
Phoenix, Arizona. The Rancho Cordova and Phoenix leases expire in 1997 and the
Denver lease expires in 1998.
Physicians own a facility with approximately 56,000 square feet in
Pickerington, Ohio. APL leases office space in Indianapolis, Indiana for its
sales office located there. APL's Cleveland Regional Sales Director leases
office space in Cleveland; APL is a party to the lease and reimburses the
Regional Sales Director for all of the lease costs. APL also leases office space
in Louisville, Kentucky for its Regional Sales Office located there. Sequoia
leases office space for its headquarters in Pleasanton, California and for its
regional claims and underwriting offices in Modesto, Monterey, Rancho Cordova,
Ventura, Visalia, and Fairfield, California. CLM's only office space consists of
a leased facility in Monterey, California.
ITEM 3. LEGAL PROCEEDINGS
Members of the Combined Insurance Group and APL are frequently a party
in claims proceedings and actions regarding insurance coverage, all of which the
Company considers routine and incidental to its business. Neither PICO nor its
subsidiaries are parties to any material pending legal proceedings.
25
28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 7, 1996 the shareholders of PICO voted to approve the
Merger at a special meeting of the shareholders. The shareholders also approved
amendments to PICO's Articles of Incorporation and Bylaws. The votes with
respect to each matter submitted to the shareholders of PICO for approval are as
follows:
Approval of the Merger
For 4,013,521
---------
Against 2,900
---------
Abstained 40,054
---------
Broker non-votes 122,331
---------
Approval of the amendments to PICO's Articles of Incorporation
For 4,049,771
---------
Against 88,818
---------
Abstained 41,054
---------
Broker non-votes 0
---------
Approval of the amendments to PICO's Bylaws
For 4,124,727
---------
Against 2,400
---------
Abstained 51,679
---------
Broker non-votes 0
---------
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of PICO is traded on the Nasdaq National Market
under the symbol PICO. Prior to November 1996, the symbol was CITN. The
following table sets forth for each period indicated, the high and low sale
prices as reported on the Nasdaq National Market. These reported prices reflect
interdealer prices without adjustments for retail markups, markdowns or
commissions.
1995 1996
-------------------- ----------------------
High Low High Low
------- ------- ------- --------
1st Quarter.......... $ 3.25 $ 2.38 $ 4.75 $ 3.50
2nd Quarter.......... 3.38 2.75 4.75 3.875
3rd Quarter.......... 4.88 2.88 4.50 3.25
4th Quarter.......... 4.88 3.50 4.50 3.25
As of March 24, 1997, the closing sale price of PICO's common stock was
$3.750 and there were 1754 holders of record of PICO's Common Stock.
PICO has not declared or paid any dividends in the last two years and
does not expect to pay any dividends in the foreseeable future.
26
29
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data of
the Company. The information set forth below is not necessarily indicative of
the results of future operations and should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 of this Form 10-K and the consolidated financial
statements and the related notes thereto included elsewhere herein.
Year Ended December 31
------------------------------------------------------------
1996 1995 1994 1993 1992
------------------------------------------------------------
OPERATING RESULTS (In thousands, except ratios and per share data)
Revenues
Premium income earned $ 40,232 $ 21,411 $ 23,948 $ 59,187 $ 72,545
Net investment income 42,432 18,314 16,278 21,442 16,434
Other income 3,104 8,220 2,056 2,684 2,465
------------------------------------------------------------
Total revenues $ 85,768 $ 47,945 42,282 $ 83,313 $ 91,444
============================================================
Income (loss) before discontinued
operations and cumulative effect 24,320 15,673 18,831 (615) (6,865)
of changes in accounting principal
Income (loss) from discontinued -- -- -- 723 --
operations
Cumulative effect of change in
accounting principal -- -- (4,110) -- --
------------------------------------------------------------
$ 24,320 $ 15,673 $ $ 14,721 $ 108 ($ 6,865)
============================================================
WEIGHTED AVERAGE SHARES OUTSTANDING 27,123,588 25,992,133 24,160,082 15,780,368 15,429,224
PER COMMON SHARE RESULTS
Income (loss) from continuing 0.90 0.60 0.78 (0.04) (0.45)
operations
Income (loss) from cumulative effect
of change in accounting principal -- -- (0.17) 0.05 --
------------------------------------------------------------
Net income (loss) $ 0.90 $ 0.60 $ 0.61 $ 0.01 ($ 0.45)
============================================================
December 31,
------------------------------------------------------------
1996 1995 1994 1993 1992
------------------------------------------------------------
(In thousands, except per share data)
FINANCIAL CONDITION
Assets $ 490,425 $ 421,816 $297,163 $ 297,887 $ 295,054
Unpaid losses and loss adjustment
expenses, net of discount $ 252,024 $ 229,797 $180,691 $ 191,735 $ 185,054
Total liabilities $ 380,222 $ 342,466 $261,419 $ 271,780 $ 273,267
Shareholders' equity $ 110,203 $ 79,350 $ 35,744 $ 26,107 $ 21,788
Book value per share $ 3.61 $ 3.04 $ 1.40 $ 1.17 $ 1.41
Note: Prior year share values have been adjusted to reflect the November 20,
1996 reverse acquisition between Physicians Insurance Company of Ohio
and Citation Insurance Group
27
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
COMPANY SUMMARY AND RECENT DEVELOPMENTS
INTRODUCTION
Readers of Citation Insurance Group's prior financial statements will
find that these financial statements differ greatly from those presented in the
past. Whereas Citation Insurance Group was predominantly engaged in property
and casualty operations, PICO Holdings, Inc. operates primarily as an insurance
and investment company, specializing in portfolio investing, property and
casualty insurance, life and health insurance, and investment management and
other services.
These changes are a result of the November 20, 1996 merger of
Physicians Insurance Company of Ohio and a subsidiary of Citation Insurance
Group, in which Physicians Insurance Company of Ohio was the surviving
corporation. Upon consummation of the Merger, Citation Insurance Group changed
its name to PICO Holdings, Inc. For accounting purposes the transaction has been
treated as a reverse acquisition with Physicians Insurance Company of Ohio being
the acquiror. As a result, these financial statements reflect prior years data
of Physicians Insurance Company of Ohio and its subsidiaries and affiliates
only. Neither Citation Insurance Group's prior years' results or account
balances, nor 1996 operating results prior to the Merger have been included in
these financial statements. See Note 3 to the Consolidated Financial Statements
entitled "Acquisitions" for further information on the accounting treatment of
the reverse acquisition.
BACKGROUND
Prior to July 16, 1995, the effective date of Physicians and PRO's 100%
quota share reinsurance of their MPL businesses with Mutual and the subsequent
sale of the rights to these MPL books of business, effective January 1, 1996,
the Physicians group of affiliated companies consisted primarily of two property
and casualty insurance companies writing MPL insurance (Physicians and PRO) and
one life and health insurance company, APL. In November 1994, the respective
boards of directors of Physicians and PRO determined that it was in the best
interests of Physicians and PRO and their respective shareholders to sell their
MPL insurance businesses. This sale was part of an overall shift in the
strategic direction of Physicians and PRO.
On August 1, 1995, Physicians purchased Sequoia, a California property
and casualty insurance company writing light commercial and multiple peril
insurance in northern and central California. Sequoia does not write MPL
insurance.
On September 5, 1995, Physicians purchased 38.2% of the common stock of
GEC, a Canadian company operating in portfolio investments, agricultural
services, and other business segments.
On November 20, 1996, Physicians and its subsidiaries merged with a
subsidiary of CIG and CIG then changed its name to PICO Holdings, Inc. This
reverse acquisition brought two more California property and casualty insurance
companies, CIC and CNIC, into the affiliated group and provided a non-insurance
holding company able to engage in portfolio investing and other activities with
fewer restrictions than those imposed upon insurance companies.
In addition to the operation of its subsidiaries, the Company's
objective is to use its resources and those of its subsidiaries and affiliates
to increase shareholder value through investments in businesses that the Company
believes are undervalued. The Company's acquisition philosophy is to make
selective investments, predominantly in public companies, for the purpose of
enhancing and realizing additional value by means of appropriate levels of
shareholder influence and control. This could involve the restructuring of the
financing or management of the companies in which the Company invests. It may
also encompass initiating and facilitating mergers and acquisitions within the
relevant industry to achieve constructive rationalization. This business
strategy was adopted in late 1994, but was not fully implemented in 1994 and
1995; therefore, the results of this business strategy are not fully reflected
in the historical financial statements.
The Company's operations are organized into five segments: portfolio
investing, life and health insurance, MPL insurance, property and casualty
insurance, and other operations.
28
31
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
SUMMARY
PICO reported net income of $24.3 million, or $0.90 per share for 1996, compared
with net income of $15.7 million, or $0.60 per share during 1995, and $14.7
million, or $0.61 per share in 1994. Prior years' per share calculations have
been adjusted for comparison purposes to reflect the November 20, 1996 merger
between Physicians and Citation. Year-to-year comparisons are somewhat distorted
as a result of the inclusion of Sequoia beginning August 1, 1995 and the
addition of the Citation group effective November 20, 1996. Excluding Sequoia's
1995 post-acquisition net loss of $2.5 million and 1996 net income of $1.5
million, in addition to Citation's 1996 post-merger income of $675,000, net
income would have been $22.1 million for 1996 and $18.2 million for 1995
compared to $14.7 million in 1994.
Shareholders' equity per share increased $0.57 during 1996, principally as a
result of the November 1996 merger with Citation and the Company's $24.3 million
net income. Shareholders' equity per share at December 31, 1996 was $3.61,
compared to $3.04 and $1.40 at December 31, 1995 and 1994, respectively. Prior
years per share amounts have been adjusted to reflect the November 1996 merger.
Unrealized appreciation of investment holdings decreased $ 12.0 million during
1996, net of taxes. Of this $12.0 million decrease, $3 million was due to the
sale of Fairfield Communities, Inc. ("Fairfield"), which produced a pre-tax
realized gain of more than $29.5 million. One of Physicians' common stock
holdings, PC Quote, declined more than $16 million in market value during 1996,
after taxes. However, at December 31, 1996, the market value of this security
was still above Physicians' cost. Excluding Fairfield and the decline in the
value of PC Quote, Physicians' unrealized investment gains actually increased
more than $7 million, after tax during 1996.
Shareholders' equity increased $30.9 million, or 39% compared to year-end 1995.
In addition to $24.3 million in net income and the $12.0 million decrease in net
unrealized appreciation, this increase included $24.3 million in equity from the
Citation reverse acquisition, and a $5.8 million reduction in equity during the
second quarter of 1996 due to recording 38.2 percent of the 850,000 pre-merger
shares of Physicians stock purchased by GEC as treasury shares. GEC is recorded
on the equity basis in the Company's financial statements, rather than at market
value, due to the Company's level of control and operational involvement.
However, this increase in shareholders' equity did not include negative goodwill
of $6.3 million recorded on the Company's books as a result of the Merger. This
$6.3 million negative goodwill will increase the Company's income by $629,000
each year over the next ten years, or until otherwise removed from PICO's books.
Realized investment gains accounted for $30.9 million of pre-tax operating
income, principally as a result of the sale of Physicians' and APL's holdings in
Fairfield common stock during the 1996 fourth quarter.
During 1996, the Company's assets increased $68.6 million to $490.4 million.
Much of this increase was due to the reverse acquisition.
Revenues increased $37.8 million over 1995 and $43.4 million over 1994.
Increases were realized in all segments except MPL insurance, which is no longer
being written. Pre-tax operating income also showed significant increases over
1995 and 1994 in all segments except "other," which was heavily influenced by
operating losses of Physicians' 76 percent-owned subsidiary, Stonebrige Partners
AG ("Stonebridge"), a European broker of annuities and other insurance products.
Revenues and pre-tax operating income by segment are shown in the following
schedules:
29
32
OPERATING REVENUES
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
----- ----- -----
(in millions)
Portfolio Investing $27.0 $ 8.0 $ 2.0
Life and Health Insurance 9.0 6.8 8.2
Property and Casualty Insurance 35.3 2.5
Medical Professional Liability Insurance 12.2 29.0 30.5
Other 2.2 1.6 1.6
----- ----- -----
Revenue from Operations $85.7 $47.9 $42.3
===== ===== =====
PRE-TAX OPERATING INCOME
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
----- ----- -----
(in millions)
Portfolio Investing $23.3 $ 5.3 $ 0.1
Life and Health Insurance 4.0 0.9 2.9
Property and Casualty Insurance 3.3 (3.7)
Medical Professional Liability Insurance 8.5 6.0 16.3
Other (1.1) (0.5)
----- ----- -----
Total Pre-Tax Operating Income $38.0 $ 8.0 $19.3
===== ===== =====
PORTFOLIO INVESTING
Portfolio investing operations are principally conducted by Physicians within
certain regulatory guidelines established by the Ohio Department. It is expected
that PICO, the holding company, will also engage in portfolio investing in the
future as assets become available at the holding company level. Investment
income revenues and realized investment gains or losses generated by Physicians
and PRO are first allocated to MPL equal to the amount of loss reserve discount
accretion recorded during the period. The remainder is shown as portfolio
investing revenue.
For a number of reasons, including the existence of an experienced claims
adjustment staff and Physicians' success in managing invested assets, Physicians
decided that it could more effectively manage the assets remaining after the
sale of the MPL business than to sell off or fully reinsure the existing
reserves. As a result, assets are managed for the maximum overall return, within
prudent safety margins and the guidelines of the Ohio Department. Assets are
not designated on an individual item basis as either MPL or portfolio investing
assets. As a result, Physicians' invested assets produce income in both MPL and
portfolio investing segments without any true segregation of assets.
Revenues from 1996 portfolio investing operations of $27.0 million increased
$19.0 million over the $8.0 million reported for 1995 and surpassed the $2.0
million 1994 level by $25.0 million. Portfolio investing revenues are shown
30
33
below:
PORTFOLIO INVESTING
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
----- ----- -----
(in millions)
REVENUES:
Realized Investment Gains $26.4 $ 5.0 $ 0.8
Investment Income 0.6 3.0 1.2
----- ----- -----
Portfolio Investing Revenues $27.0 $ 8.0 $ 2.0
===== ===== =====
Nearly all of the $27.0 million portfolio investing revenues, or $26.4 million,
was attributable to realized investment gains. These gains were principally a
result of the sale of Physicians' investment in Fairfield common stock, a
strategic "value investment" identified late in 1994. Realized investment gains
attributable to portfolio investing for 1995 and 1994 were $5.0 million and $0.8
million, respectively.
Fairfield common stock was one of the first strategic investments made by
Physicians during its transition from strictly an MPL insurance operation to an
insurance and investment company. Numerous strategic investments have since been
made. Nearly all have appreciated.
Unrealized investment gains at December 31, 1996, net of income taxes, amounted
to $ 11.8 million. This does not include all of the appreciation of PICO's
Global Equity Corporation common stock, since GEC is recorded on PICO's books at
GEC's equity value which, per share, is less than the December 31, 1996 market
value of the GEC stock. See Note 19 to the Consolidated Financial Statements.
The Company's management believes its new strategic focus is succeeding as well
as or better than expected, as evidenced by the Company's growth during the past
two to three years. The Company intends to continue to make selective
investments for the purpose of enhancing and realizing additional value by means
of appropriate levels of shareholder influence and control, as well as to
operate its subsidiaries to obtain maximum shareholder value. Nevertheless,
while past results are very encouraging, future results cannot and should not be
predicted based upon past performance alone.
The decline in 1996 investment income compared to 1995 was principally due to a
significant shift in the mix of the Company's investment portfolio from interest
bearing fixed maturity and cash equivalent securities toward equity securities.
See "PART I -- BUSINESS -- HISTORY OF THE COMPANY -- PHYSICIANS." Also, the rate
used to discount MPL loss and LAE reserves was reduced to 4% from an average of
around 5% in 1994, resulting in a reduction in discount accretion from 1995
forward. As a result, 1995 investment income attributed to portfolio investing
operations increased over 1994 due to less investment income having been
allocated to MPL operations to cover discount accretion.
Net of expenses, but before taxes, portfolio investing contributed $23.3 million
to pre-tax operating income for 1996 compared to $5.3 million during 1995 and
$0.1 million in 1994. Realized investment gains accounted for nearly all the
fluctuation between years, accompanied by the changes in investment income
discussed above. Equity securities excluding GEC, which is valued on an equity
basis, totaled $79.5 million and $99.9 million at December 31, 1996 and 1995,
respectively. Equity securities are subject to changes in the stock market which
may at times be volatile and cause PICO's shareholders' equity to fluctuate from
period to period. These equity securities, excluding GEC, made up 24% and 37% of
the Company's investments, cash and cash equivalents at year-ends 1996 and 1995,
respectively. The breakdown of pre-tax operating income from portfolio investing
operations follows:
31
34
PORTFOLIO INVESTING
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
----- ----- -----
(in millions)
PRE-TAX OPERATING INCOME:
PICO and The Professionals $22.3 $ 5.8
Equity in Unconsolidated Subsidiaries 1.0 (0.5)
Other $ 0.1
----- ----- -----
Investment Banking Operating Income $23.3 $ 5.3 $ 0.1
===== ===== =====
Equity in unconsolidated subsidiaries represents the Company's share of GEC's
net income.
LIFE AND HEALTH INSURANCE
APL produced $9.0 million in revenues during 1996, $2.2 million more than during
the comparable 1995 period and $800,000 more than 1994. The breakdown of these
revenues follows:
LIFE AND HEALTH INSURANCE
YEAR ENDED DECEMBER 31,
------------------------
1996 1995 1994
---- ---- ----
(in millions)
REVENUES:
Net Earned Premiums $1.5 $1.9 $3.9
Investment Income 3.4 4.0 3.7
Realized Investment Gains 3.9 0.1 0.1
Other Income 0.2 0.8 0.5
---- ---- ----
Revenue from Life and Health Insurance $9.0 $6.8 $8.2
==== ==== ====
PRE-TAX OPERATING INCOME:
PIC/APL $4.0 $0.9 $2.9
==== ==== ====
The principal difference between 1996 and 1995 revenues, and operating income,
was an increase in realized capital gains of $3.8 million, principally
attributable to the sale of APL's holdings of Fairfield Communities, Inc. common
stock. Partially offsetting the increase in realized investment gains were a
$400,000 decline in net earned premiums and a $600,000 reduction in investment
income. Compared to 1994, 1996 earned premiums were down $2.4 million. These
reductions in net earned premiums were primarily due to APL no longer being the
underwriting insurer for Physicians employee health and dental plans, effective
March 1, 1996. APL had ceased writing group health and dental coverages with the
exception of Physicians plans effective July 1, 1994.
32
35
The following exhibit shows the impact of the decline in health insurance
premiums upon net earned premiums over the past three years:
LIFE AND HEALTH INSURANCE NET EARNED PREMIUMS
YEAR ENDED DECEMBER 31,
1996 1995 1994
---- ---- ----
(in millions)
Life Insurance $1.3 $1.5 $1.3
Health Insurance 0.2 0.4 2.6
---- ---- ----
Net Earned Premiums $1.5 $1.9 $3.9
==== ==== ====
The exit from the group health insurance market (primarily major medical) was a
result of management's decision to concentrate APL's marketing and sales efforts
on the Survivor Key product line. This life insurance product combines the
benefits of a lump sum cash payout upon the diagnosis of certain critical
illnesses with a death benefit. Gross written premiums for Survivor Key have
increased from $96,000 in 1994 to $257,000 in 1995 and $547,000 in 1996.
Other 1996 revenues were down $600,000 compared to 1995 and $300,000 compared to
1994. This category includes APL's commission income for outside company
products as well as its fees for administrative services contracts. Beginning
January 1, 1996, APL ceased to be the agent of record on a block of group health
business. This decrease in commission revenue was directly offset by a
corresponding reduction in commission expenses which is included with the
"Insurance underwriting and other expenses" line of the income statement.
Investment income revenues were down $600,000 compared to 1995 and $300,000
compared to 1994. These decreases were principally due to an increased level of
equity securities in APL's investment portfolio.
Life and health operations resulted in 1996 pre-tax operating income of $4.0
million. This compares to $859,000 in 1995 and $2.9 million in 1994. As
discussed above, realized investment gains were the primary source of the
increase in 1996 income. The 1995 decrease as compared to 1994 was primarily
attributable to the exit from the group health insurance market. APL's claims
experience was excellent in the major medical product line in 1994, which
resulted in a reserve decrease for 1994 and contributed to the 1994 operating
income.
PROPERTY AND CASUALTY INSURANCE
Sequoia, CIC and CNIC currently account for all of the ongoing property and
casualty ("P & C") insurance revenues. These companies write predominately light
commercial and multiple peril insurance coverage in central and northern
California.
Because the Merger occurred in November 1996, only two months (approximately)
worth of CIC's and CNIC's revenues, expenses, and operating income are included
in these financial statements and in this discussion for 1996. No prior years'
data is shown for CIC and CNIC. Because Sequoia was acquired on August 1, 1995,
only five months of Sequoia's financial information is included for 1995, and
none for 1994.
Total P & C revenues for 1996 of $35.3 million far-exceeded 1995 partial year
revenues of $2.5 million.
Sequoia produced $28.7 million in revenues during 1996 as compared to $2.5
million for last five months of 1995, from the date of purchase of Sequoia to
year-end. As shown below, earned premiums made up most of these revenues.
Premiums are earned pro-rata throughout the year according to the coverage dates
of the underlying policies.
Included in the total P & C revenues shown below are $6.5 million from CIC and
CNIC for the short period of their
33
36
inclusion, including earned premiums of $5.1 million, investment income of $1.2
million, realized investment gains of $49,000 and other income of $99,000.
PROPERTY AND CASUALTY INSURANCE
YEAR ENDED DECEMBER 31,
1996 1995
----- -----
(in millions)
REVENUES:
Earned Premiums- Sequoia $26.3 $ 2.4
Earned Premiums- Citation 5.1
Investment Income 2.6 0.2
Realized Investment Gains 0.7
Other 0.6 (0.1)
----- -----
P & C Revenues $35.3 $ 2.5
===== =====
PRE-TAX OPERATING INCOME:
Sequoia and Citation $ 3.3 $(3.7)
===== =====
Sequoia's direct premium writings for 1996 were $38.0 million, down $4 million,
or 9.6% from the $42.0 million reported by Sequoia on a statutory basis for the
full year of 1995. The $42.0 million 1995 direct written premium total includes
seven months of activity prior to Physicians' purchase of Sequoia on August 1,
1995. This reduction in premium writings reflects the increased underwriting
selectivity of Sequoia's new management team. As policies came up for renewal in
1995 and through much of 1996, they were reviewed carefully by underwriting
management for excessive loss experience and unwanted risks. While new business
writings have not offset renewal policies cancelled or non-renewed, new policy
writings have been better than expected. The loss of renewal policies with
higher loss ratios and greater exposures to risk should improve Sequoia's loss
ratios in the future.
Sequoia produced a net loss of $983,000 for 1996 based upon statutory accounting
practices ("SAP") as filed with the California Department. On the basis of
generally accepted accounting principles ("GAAP"), Sequoia reported 1996 net
income of $1.5 million compared to a $2.5 million net loss for the five month
1995 period. The primary difference between the 1996 SAP net loss and GAAP net
income was attributable to the deferral of a portion of policy acquisition
expenses, which will be amortized into expense pro-rata as related premiums are
earned.
Much of Sequoia's five-month 1995 loss was attributable to expenditures which
are expected to continue to provide benefits in future years through improved
operating efficiencies. These expenses included, among others, those associated
with development of a new policy quoting and processing system and integrated
claims processing and accounting systems. Software has been developed and is now
in use which allows underwriters and agents to decentralize, rate policies in
the field, and download the information via modem to the home office, allowing
them to spend much more time in the field inspecting risks and servicing
policies.
Also contributing to the 1995 pre-tax operating loss were acquisition costs
(such as commissions) based upon written premiums, which were much higher than
net earned premiums. Since the previous owner of Sequoia took full
responsibility for the unearned premium reserve at July 31, 1995, a considerable
lag developed between Sequoia's written premiums and earned premiums. As a
result, operating expenses were high compared to earned premiums. Normally,
a portion of these acquisition expenses could have been deferred and expensed
over the underlying policy periods.
34
37
However, this was not the case in 1995 for Sequoia. A large portion of these
acquisition costs amounting to $1.3 million were expensed in the year incurred
instead of being deferred and amortized over the premium recognition period. A
write off of deferred acquisition costs is required when the sum of expected
claim costs and claim adjustment expenses, expected dividends to policyholders,
unamortized acquisition costs, and maintenance costs exceed related unearned
premiums.
The improvement in Sequoia's 1996 performance is attributable to improved loss
experience and reduced expenses. As a result of improved loss and expense
ratios, 1996 acquisition expenses have been capitalized and will be amortized
over the premium recognition period, since a premium deficiency did not exist.
Sequoia's industry ratios as determined under SAP were as follows:
1996 1995 1994
----- ----- ------
Loss and LAE Ratio 63.5% 69.8% 74.6%
Underwriting Expense Ratio 37.5% 100.8% 32.5%
----- ----- -----
Statutory Combined Ratio 101.0% 169.8% 107.1%
===== ===== =====
* Amounts shown for 1995 and 1994 include periods prior to Physicians' ownership.
Sequoia's 1996 GAAP combined ratio was 93.7%, consisting of a 62.9% loss and
LAE ratio and an expense ratio of 30.8%.
Property and casualty operations contributed pre-tax operating income of $3.3
million during 1996, consisting of $35.3 million in revenues, less losses and
loss adjustment expenses incurred of $20.3 million and operating expenses of
$11.7 million. This compares to 1995 pre-tax operating loss of $3.7 million.
MPL OPERATIONS
Physicians' and PRO's MPL insurance business was sold to Mutual on August 28,
1995. Between July 16, 1995 and December 31, 1995, all MPL business written by
Physicians and PRO was 100% reinsured by Mutual. Except for a few minor policy
coverage extensions and adjustments which are 100% reinsured by Mutual, for all
intents and purposes, the Company ceased writing MPL policies effective January
1, 1996, the date Mutual began writing the business directly. The Company
continues to administer and adjust the remaining claims and LAE reserves. Based
upon careful analysis of various alternative scenarios for handling the runoff
of the remaining claims reserves, the Company determined that the best option
was to process the existing claims internally with existing staff, rather than
through a third party administrator or through an outright sale of the claims
and LAE reserves. In addition, it is expected that shareholders' equity will be
better served by retaining the investments necessary to fund the payment of
these claims and LAE reserves, managing them along with the rest of the
Company's investment holdings, as opposed to selling of fully reinsuring these
reserves and giving up the corresponding funds. Accordingly, although the
Company ceased writing MPL insurance, MPL is treated as a separate business
segment of continuing operations due to the continued management of claims and
associated investments. Revenues from MPL operations included the following:
35
38
MEDICAL PROFESSIONAL LIABILITY INSURANCE
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
----- ----- -----
(in millions)
REVENUES:
Earned Premiums $ 7.4 $17.1 $20.0
Investment Income, Net of Expenses 4.8 5.9 10.5
Income from Sale of MPL Business 6.0
----- ----- -----
MPL Revenues $12.2 $29.0 $30.5
===== ===== =====
PRE-TAX OPERATING INCOME: $ 8.5 $ 6.0 $16.3
===== ===== =====
Since the withdrawal of Physicians and PRO from their personal automobile and
homeowners lines of business in the late 1980's, MPL has, for all intents and
purposes, been these two companies' only sources of insurance premiums. The
decline in earned premium from $20.0 million in 1994 to $17.1 million in 1995
and $7.4 million in 1996 resulted from the withdrawal from the MPL line of
business beginning with the 100 percent quota share treaty with Mutual effective
with July 16, 1995 and subsequent new and renewal business.
The following table shows the decline in Physicians' and PRO's direct written
premiums over the past five years:
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(in millions)
Direct Written Premiums $ 0.2 $22.6 $28.0 $37.6 $52.6
This decline in direct written premiums indicative of the increasing competitive
pressures within Ohio which, among other factors, led Physicians and PRO to
increase premium rates, to be more selective in underwriting and, ultimately, to
withdraw from the MPL line of business.
MPL premiums continued to be earned during 1996 based upon premiums written
prior to July 16, 1995, the effective date of the 100 percent quota share treaty
with Mutual. Very few, if any, MPL premiums will be earned beyond 1996.
Investment income revenues will continue to accrue to the MPL runoff.
MPL operations produced pre-tax operating income of $8.5 million for 1996
compared to $6.0 million and $16.3 million in income during 1995 and 1994,
respectively. Pre-tax operating results for 1996 were bolstered by a $1.4
million take down of death, disability and retirement unearned premium reserves
related to the Mutual transaction, and loss and LAE reserve reductions of
approximately $6.0 million as MPL reserves continued to develop favorably. This
favorable reserve development has been verified by two independent actuaries, as
required by the Ohio Department regulations for MPL companies. The $6.0 million
operating income recorded for 1995 was entirely attributable to the $6.0 million
realized on the sale of Physicians' and PRO's MPL businesses. The $16.3 million
recorded in 1994 benefited from more than $12.0 million in reserve reductions,
net of additional reserve discount accretion associated with reducing the
reserve discount rate to 4% from close to 5%. Investment income was also higher
in 1995 and 1994 due to greater reserve levels and higher loss reserve discount
accretion in 1994. The greater amounts of discount resulted in corresponding
allocations of investment income to these years for the MPL segment.
Physicians' claims department staff continues to process the runoff of the
remaining MPL loss and loss adjustment expense claims which is progressing
routinely. At December 31, 1996, MPL reserves totaled $112.9 million, net of
reinsurance and discount. This compares to $136.2 million and $154.4 million at
December 31, 1995 and 1994, respectively. MPL loss and LAE reserves continue to
decline as a result the disposition of claims, accompanied by the continued
favorable reserve development discussed above.
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MPL INSURANCE -- LOSS AND LAE RESERVES
DECEMBER 31,
------------
1996 1995 1994
------ ------ ------
(in millions)
Direct Reserves $158.4 $192.5 $204.3
Ceded Reserves (33.3) (38.5) (29.8)
Discount of Net Reserves (12.2) (17.8) (20.1)
------ ------ ------
Net MPL Reserves $112.9 $136.2 $154.4
====== ====== ======
Although MPL reserves are certified annually by two independent actuaries, as
required by state law, significant fluctuations in reserve levels can occur
based upon a number of variables used in actuarial projections of ultimate
incurred losses and LAE.
OTHER OPERATIONS
Other operations consists principally of Summit's investment management
operations, the wind down of Raven Development Company's ("Raven") real estate
development projects, and various other activities as summarized below:
OTHER OPERATIONS
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(in millions)
REVENUES:
Real Estate Development $1.6 $1.4 $1.5
Investment Management 0.3 0.2
Other 0.3 0.1
---- ---- ----
Revenue from Other Operations $2.2 $1.6 $1.6
==== ==== ====
PRE-TAX OPERATING INCOME
Real Estate Development $(0.2) $0.1
Investment Management $0.1 (0.1)
Other (1.2) (0.2) (0.1)
---- ---- ----
Pre-Tax Operating Income-Other Operations $(1.1) $(0.5) $0.0
==== ==== ====
Investment management revenues and operating income from Summit increased over
1995. Summit now has more than $400 million in assets under management. Summit's
revenues increased over 1995 as a result of additional funds under management,
including competitive portfolio management fees to the insurance companies.
However, intercompany fees have been eliminated in this presentation. Summit's
pre-tax operating income was $121,000 for 1996. This compares to a loss of
$105,000 for 1995, for a $226,000 improvement.
Sales of real estate remained at about the same level in 1996 as in the previous
two years. During the first quarter of 1996, consistent with Raven's plan of
orderly withdrawal from the real estate development business, management was
successful in selling a large tract of undeveloped land, which represented most
of Raven's existing inventory. Raven now holds less than $200,000 in inventory
of land for sale.
Under the category of "Other," Stonebridge Partners AG ("Stonebridge"), a Swiss
corporation 76 percent owned by Physicians which brokers annuities and other
insurance products within Europe, produced a pre-tax operating loss of $1
million for 1996. The pre-tax loss for 1995 was $234,000. Stonebridge began
operations in late 1995, resulting in significant start-up costs in 1995, which
continued into 1996. Management believes that the Stonebridge concept is a good
one which fits well with the Company's other businesses; however, for various
reasons, Stonebridge has been unsuccessful in marketing their brokerage
business, as well as in collecting accounts which they believe are due them from
clients.
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Management has recently taken steps to limit additional downside exposure.
Additional operating losses will most likely be incurred in 1997 as a result of
Stonebridge.
LIQUIDITY AND CAPITAL RESOURCES -- YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
In 1995, Physicians took a significant step in changing its strategic direction
by selling its ongoing MPL insurance business and related liability insurance
business. All assets and liabilities of Physicians related to insurance policies
written prior to the sale of the recurring book of business were retained by
Physicians. During 1995, Physicians reactivated its investment advisory
subsidiary, Summit; acquired a California property and casualty insurance
company, Sequoia; and purchased 38.2% of GEC, a Canadian corporation active in
investment banking, agricultural services, water rights, and other businesses.
See "Item 1--Business--History of the Company." In 1996, Physicians took another
large step in the continuing process of changing its strategic direction, with
the reverse acquisition of Citation.
It is expected that each of the major companies currently within the PICO group
will be able to stand on its own and cover its own cash flow needs without the
need for borrowing or additional capital infusions, with the possible exceptions
of additional capital requirements of Sequoia and CIC to maintain or improve
their AMBest ratings or to meet minimum capital requirements.
As a result of ceasing to write MPL insurance, Physicians' operating cash flows
have become, and should continue for the foreseeable future, to be negative.
Cash flows from other sources within Physicians, primarily reinsurance
recoveries, investment income and the sale of invested assets will provide the
necessary funds. Major cash outflows most likely will include the funding of
claims and loss adjustment expenses, investment purchases, dividend
distributions, and operating costs. The Company's active insurance P & C
subsidiaries, Sequoia and CIC, should provide positive cash flows from premium
writings, investment income, and the sale of invested assets. Cash will be used
to fund the payment of their own claims and operating expenses, as well as in
purchasing investments. Summit should produce positive cash flow in the form of
investment management fees in excess of operating costs.
Although Sequoia's positive operating cash flows exceeded more than $10 million
in 1996, and CIC's cash flows should become significant in 1997 and later years,
Physicians' cash flows have had the greatest impact on the consolidated group
during the past three years and should continue to do so for a number of years
into the future.
As of December 31, 1995, Physicians reported discounted unpaid loss and loss
adjustment expense reserves of approximately $140 million, net of reinsurance.
Based upon projections from past actuarial information, more than 75%, or $105
million, of these reserves are expected to be settled by the end of the year
2000. Past experience indicates that funding requirements should be greatest in
the first through third years, accounting for more than 60% of the total
eventual reserve and loss adjustment expense payments. As expected, loss and LAE
reserves at December 31, 1996 declined more than 22% to $109 million after
payment of more than $30 million in claims and LAE. Operating expenses
associated with the discontinued MPL line of business have been significantly
reduced in 1995 and in 1996 and are expected to continue to decline. As evidence
of PICO's cutbacks, employee counts have been reduced by nearly two-thirds
compared to the year-end 1994 level.
The Company's insurance subsidiaries attempt to structure the duration of their
invested assets to match the cash flows required to settle the related unpaid
claims liabilities. Their invested assets provide adequate liquidity to fund
projected claims and LAE payments for the coming years.
To the extent that funds necessary for settling claims and paying operating
expenses are not provided by existing cash and cash equivalents, investment
income, reinsurance recoveries, and rental other income, invested assets will be
liquidated. Short term and fixed maturity investments are managed to mature
according to projected cash flow needs. Equity securities will be converted to
cash as additional funds are required, with an anticipated maximum liquidation
lead-time of approximately six months.
At December 31, 1996, Physicians' investment portfolio on a stand-alone basis
contained invested assets of
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approximately $177.3 million, plus cash and cash equivalents of $12.5 million.
These invested assets are in excess of the present value of expected future
payouts of losses and loss adjustment expenses (discounted at 4%) of $109
million, even if $77 million in investments in affiliates (GEC, Sequoia, Summit,
PRO, APL and other affiliates) were excluded.
Disregarding any appreciation or depreciation of Physicians' investment
portfolio and the results of the operations of its subsidiaries and affiliates,
on a stand alone basis Physicians should experience a decline in total assets
and total liabilities as a result of the payment of claims, loss adjustment
expenses and operating expenses. Absent unfavorable loss experience and
operating and other expenses in excess of investment income, shareholders'
equity should remain relatively unaffected. Income in excess of expenses,
favorable claims experience, appreciation of investments and increases in the
equities of subsidiaries and affiliates all would increase shareholders' equity
and, ultimately, total assets.
PICO management hopes to maximize the return of all assets, including those
needed to fund the eventual wrap-up of the MPL reserves through, among other
things, value investing and managing the invested assets internally rather than
liquidating assets to pay a third party to oversee the runoff of the existing
claims. Management also elected to handle the runoff of the MPL claims
internally to continue to maintain a high standard of claims handling and to
maximize shareholder values. While management expects that the Company's current
and future investments will increase in value, offsetting some of the decline in
assets during the period of runoff and increasing shareholder value, the impact
of future market fluctuations on the value of the Company's invested assets
cannot be accurately predicted. Although assets will be managed to mature or
liquidate according to expected payout projections, at times, in response to
abnormal funding demands, some invested assets may need to be sold at
inopportune times during periods of decline in the stock market or declines in
the market values of the individual securities. Such forced sales are expected
to occur infrequently and only under extreme circumstances; however, this cannot
be guaranteed.
As previously mentioned, reinsurance recoveries (reimbursement of covered losses
from reinsurers) will be a significant source of incoming funds in upcoming
years as claims are settled. As shown in the accompanying financial statements,
consolidated reinsurance receivables amounted to $97.0 million at December 31,
1996 compared to $100.7 million at December 31, 1995. Physicians' reinsurance
receivables were $38.0 million at December 31, 1996 and $35.9 million at
December 31, 1995. Of the $59 million difference between the $97.0 million
consolidated total at December 31, 1996 and the $38.0 million of Physicians,
$49.2 million was recorded on Sequoia's financial statements, most of which is
due from SRC and guaranteed by QBE. See "Item 1--Business--History of the
Company." Of the remainder, $6.6 million resulted from the inclusion of
Citation.
Unsecured reinsurance risk is concentrated in the companies and amounts shown in
the table under Note 11 ("Reinsurance") to the Consolidated Financial Statements
as of December 31, 1996. All companies listed are highly rated companies with
significant sources of capital.
As an additional source of funding, PICO's subsidiaries as they grow and
accumulate increasing amounts of retained earnings may be able to return some of
PICO's investment in the form of dividend distributions; however, this cannot be
assured. On December 30, 1996, Physicians paid a dividend of $13.2 million to
PICO for further investment by PICO. This dividend was the maximum dividend that
could be paid under Ohio insurance regulations without specific approval by the
Ohio department. State insurance departments do not regulate funds
invested at the holding company level.
As shown in the accompanying Consolidated Statements of Cash Flows, the Company
used cash flows of $10.8 million for operations in 1996 and $15.1 million in
1995, compared to $5.0 million in 1994. Cash used for 1994 operations was
greatly inflated by an approximate $20 million increase in MPL reinsurance
premiums as a result of significant changes in the Company's reinsurance
treaties. The increased cash outflows for 1995 principally relate to a $27
million reduction in MPL premium collections as compared to 1994, increased
claims payments of $1.3 million, increased operating expenses of approximately
$2 million, increased federal income tax payments of $1.5, and increased
deposits with reinsurers of $4.2 million, partially offset by a $11.7 million
decrease in reinsurance cessions. Cash consumed by operations in 1996 decreased
from the $15.1 million level to $10.8 million, even though MPL premium
collections decreased by more than $16 million and investment income receipts,
excluding capital gains, decreased more than $3.4 million. Partially offsetting
the decline in MPL premiums, MPL claims payments decreased $7 million during
1996 as compared to 1995. Most of the remaining positive cash flow increase from
operations was attributable to
39
42
Sequoia, not only due to its inclusion in the consolidation for the full year,
but also as a result of reduced claims and expense payments and increased
premiums.
Cash provided by investing activities in 1996 of $31.4 million principally
reflects fixed income securities maturities and investment gains realized from
the sale of Fairfield. Cash provided in 1995 of $37.6 million and 1994 of $9.4
million reflect PICO's liquidation of much of its fixed income investment
portfolio in limiting its exposure to the fluctuations of market values due to
changing interest rates and, at the same time, providing the Company flexibility
and liquidity to take advantage of consolidation and market opportunities. Also
reflected in the 1995 cash provided by investing activities is $6 million in
proceeds from the sale of Physicians' MPL business. Excluding cash invested in
Sequoia, Summit and Stonebridge, 1995 investment cash inflows were $47.4
million.
Financing activities provided cash in all three years ($69,000 in 1996, $439,000
in 1995, and $3.6 million in 1994). Most of the cash provided related to capital
infusions by GPG in 1994 ($3 million) and the issuance of common stock in 1995
($350,000) pursuant to the exercise of stock options issued under PICO's 1993
Stock Option Plan. Life and annuity insurance products also provided financing
cash flows of $ 306,000 in 1996, $166,000 in 1995, and $743,000 in 1994.
At December 31, 1996, the Company had no significant commitment for future
capital expenditures, other than in the ordinary course of business and to
provide certain funding for Stonebridge, which has subsequently been limited.
The Company has also committed to maintain Sequoia's capital and statutory
policyholder surplus level at a minimum of $7.5 million. Sequoia was well above
this level as of December 31, 1996. The Company has also committed to make every
attempt to maintain Sequoia's AMBest rating at or above the "B++" (Very Good)
level, which may at some time in the future require additional capital infusions
into Sequoia by the Company. Subsequent to year-end 1996, the Company has
committed to purchase for approximately $30 million a debenture from GEC. The
Company has committed to invest approximately $16 million in a limited liability
corporation which owns land in Nevada. GEC has committed to purchase the
remaining interest of this limited liability corporation.
CAPITAL RESOURCES
In the past three years, Physicians has completed significant transactions
impacting shareholders' equity and its ownership. In 1994, GPG infused capital
into Physicians by exercising $3.0 million of its option to purchase $5 million
of Physicians stock. GPG had previously invested $5 million in Physicians. In
August 1995, Physicians purchased Sequoia for $1,350,000. In September 1995,
Physicians acquired an approximate 38.2 percent interest in the common stock of
GEC for approximately $34 million. In 1996, GPG sold approximately 16% of its
interest in Physicians (850,000 pre-merger shares) to GEC. As a result of this
ownership of each other's stock, treasury stock increased by $5.8 million--a
reduction of shareholders' equity. Also, in November 1996, Physicians and
Citation combined in a reverse acquisition, increasing shareholders' equity,
assets and liabilities of the Company. This reverse acquisition resulted in the
creation of $6.3 million of "negative goodwill" on the balance sheet of the
Company, which will be amortized into income equally over 10 years.
During 1994, Physicians adopted the provisions of SFAS No. 115, which resulted
in an increase in shareholders' equity upon adoption of $7.4 million.
Shareholder dividends payable by Physicians or its insurance subsidiaries are
subject to certain limitations imposed by Ohio or California law, according to
the state of domicile. Generally, the limitations are determined using the
greater of the prior year's statutory net income or 10% of statutory
policyholder surplus. On December 30, 1996, Physicians paid a dividend to PICO
in the amount of $13.2 million, the maximum amount allowable without Ohio
Department approval. On April 14, 1997, Physicians paid a dividend of
approximately $8.6 million to PICO. See Note 20 to the Consolidated Financial
Statements entitled "Subsequent Events." No dividends were eligible to be paid
out of Sequoia, CIC or CNIC as of January 1, 1997.
In the past few years, the NAIC has developed risk-based capital ("RBC")
measurements for both property and casualty and life insurers. The measures
provide the various state regulators with varying levels of authority based on
40
43
the adequacy of an insurer's RBC. The State of Ohio enacted the NAIC's RBC rules
effective March 3, 1996. However, disclosure of each company's RBC adequacy was
required to be reported in their statutory annual statements filed with the
various departments of insurance for 1994 and 1995. At December 31, 1996, the
Physicians, PRO, APL, Sequoia, CIC, and CNIC annual statements reported more
than adequate RBC levels. The actual percentages of Total Adjusted Surplus to
Policyholders to Authorized Control Level Risk-Based Capital as shown on page 22
of the 1996 statutory Annual Statements for Physicians, PRO, APL, Sequoia, CIC
and CNIC were 218%, 1,980%, 872%, 278%, 349%, and 4,545%, respectively.
Anything above 200% (i.e. two times Authorized Control Level RBC) required no
further action on the part of the insurance company. Any company having results
between 150% and 199% is classified as being at the Company Action Level. Lower
levels of RBC such as the Regulatory Action Level (100% to 149%), the Authorized
Control Level (70% to 99%) and the Mandatory Control Level (below 70%) require
some form of insurance department action. Under the Regulatory Action Level, the
insurer must submit a plan as in the Company Action Level. The Insurance
Commissioner will perform an examination or other analysis and, based upon such
exam or analysis, issue a corrective order. Under the Authorized Control Level,
the same actions taken under the Regulatory Action Level will occur. In
addition, the Commissioner may take action to rehabilitate or liquidate the
insurer. Under the Mandatory Control Level, the Commissioner must rehabilitate
or liquidate the insurer.
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ADDITIONAL RISK FACTORS AND UNCERTAINTIES:
In addition to the risks and uncertainties discussed in the
preceding sections entitled "Business" and "Managements' Discussion and
Analysis of Financial Condition and Results of Operations," the following risk
factors are also inherent in the Company's business operations:
INTEGRATION OF CERTAIN OPERATIONS. Citation and Physicians completed
the Merger with the expectation that the Merger would result in certain benefits
for the combined company. Achieving the anticipated benefits of the Merger will
depend in part upon whether certain of the two companies' business operations
can be integrated in an efficient and effective manner. There can be no
assurance that this will occur or that cost savings in operations will be
achieved. The successful combination of the two companies will require, among
other things, integration of the companies' respective product offerings,
medical management of health care claims and management information systems
enhancements. The difficulties of such integration may be increased by the
necessity of coordinating geographically separated organizations. The
integration of certain operations following the Merger will require the
dedication of management resources which may temporarily distract attention from
the day-to-day business of the combined companies. There can be no assurance
that integration will be accomplished smoothly or successfully. Failure to
effectively accomplish the integration of the two companies' operations could
have an adverse effect on the Company's results of operations and financial
condition following the Merger.
DEPENDENCE ON KEY PERSONNEL. The Company has several key executive
officers, the loss of whom could have a significant adverse effect on the
Company. In particular, Ronald Langley, PICO's Chairman, and John R. Hart,
PICO's President and Chief Executive Officer, play key roles in the Company's
and GEC's investment decisions. Although neither officer is party to an
employment agreement, they have entered into consulting agreements with PICO and
various of its subsidiaries. Messrs. Langley and Hart are key to the
implementation of the Company's new strategic focus, and the ability of the
Company to implement its current strategy is dependent on its ability to retain
the services of Messrs. Langley and Hart.
RISKS REGARDING PHYSICIANS; CONTINUING MPL LIABILITY. In August 1995,
Physicians sold its and PRO's MPL insurance business and related liability
insurance business. Physicians and PRO retained all assets and liabilities
related to insurance policies written prior to the sale of the recurring book of
business. Physicians and PRO will continue to administer claims and loss
adjustment expenses under MPL insurance policies issued or renewed prior to July
16, 1995.
Cash flow needed to fund the day-to-day operations and the payment of
claims and claims expenses will be provided by investment income, lease income,
and proceeds from the sale or maturity of securities. Physicians and PRO have
established reserves to cover losses and loss adjustment expense ("LAE") on
claims incurred under the MPL policies issued or renewed to date. The amounts
established and to be established by Physicians and PRO for loss and LAE
reserves are estimates of future costs based on various assumptions and, in
accordance with Ohio law, have been discounted (adjusted to reflect the time
value of money). These estimates are based on actual and industry experience and
assumptions and projections as to claims frequency, severity and inflationary
trends and settlement payments. In accordance with Ohio law, Physicians and PRO
annually obtain a certification that their respective reserves for losses and
LAE are adequate from an independent actuary. Physicians and PRO also obtain a
concurring actuarial opinion. Physicians' and PRO's reserves for losses and LAE
for prior years developed favorably in 1994, and these reserves were decreased
by $12.7 million in 1994. Reserves also developed favorably in 1995; however,
accretion of reserve discount exceeded the amount of favorable development and
retroactive reinsurance, resulting in a $3.2 million increase in liabilities for
prior years' claims. As a result of continued favorable claims experience,
reserves for prior years' claims were further reduced in the first and fourth
quarters of 1996. Management believes that the reserving methods and assumptions
are reasonable and prudent and that Physicians' and PRO's reserves for losses
and LAE are adequate. Due to the inherent uncertainties in the reserving process
there is a risk, however, that Physicians' and PRO's reserves for losses and LAE
could prove to be inadequate which could result in a decrease in earnings and
shareholders' equity. Adverse reserve development can reduce statutory surplus
or otherwise limit the growth of such surplus.
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Under Ohio law the statute of limitations is one year after the cause
of action accrues. Also under Ohio law there is a four-year statutory time bar;
however this has been construed judicially to be unconstitutional in situations
where the plaintiff could not have reasonably discovered the injury in that
four-year period. Claims of minors must be brought within one year of the date
of majority.
RISKS REGARDING SUMMIT GLOBAL MANAGEMENT. Summit is registered as an
investment adviser in California, Florida, Kansas, Louisiana, Oregon, Virginia
and Wisconsin, as well as with the Securities and Exchange Commission (the
"SEC"). Summit must file periodic reports with the SEC and must be available for
periodic examination by the SEC. Summit is subject to Section 206 of the
Investment Advisers Act of 1940, which prohibits material misrepresentations and
fraudulent practices in connection with the rendering of investment advice, and
to the general prohibitions of Section 208 of such Act. If Summit were to
violate the Investment Advisers Act prohibitions, it would risk criminal
prosecution, SEC injunctive actions and the imposition of sanctions ranging from
censure to revocation of registration in an administrative hearing.
The investment adviser business is highly competitive. There are
several thousand investment advisers registered in the states in which Summit
does business, many of which are larger and have greater financial resources
than Summit. There can be no assurance that Summit will be able to compete
effectively in the markets that it serves.
GLOBAL DIVERSIFICATION OF INVESTMENTS. As a result of global
diversification investment decisions already made and which may be made in the
future, particularly with regard to GEC, the Company's revenues may be adversely
affected by economic, political and governmental conditions in countries where
it maintains investments or operations, such as volatile interest rates or
inflation, the imposition of exchange controls which could restrict the
Company's ability to withdraw funds, political instability and fluctuations in
currency exchange rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements as of December 31, 1996 and 1995 and
for each of the three years in the period ended December 31, 1996 and the report
of independent accountants are included in this report as listed in the index on
page 45 of this report.
SELECTED QUARTERLY FINANCIAL DATA
Summarized unaudited quarterly financial data (in thousands, except share and
per share amounts) for 1995 and 1996 are shown below. In management's opinion,
the interim financial data contains all adjustments, consisting of only normal
recurring accruals, necessary for a fair presentation of results for such
interim periods.
THREE MONTHS ENDED
--------------------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1995 1995 1995 1995 1996 1996 1996 1996
--------- -------- ------------- ------------ --------- -------- ------------- ------------
Net premiums earned........... $ 529 $4,861 $ 5,331 $6,311 $ 4,644 $ 7,319 $ 8,357 $14,631
Net investment income......... 3,148 3,487 7,101 3,377 3,914 4,581 4,965 31,569
Total revenues................ 4,292 9,472 18,629 15,553 14,966 10,596 13,713 46,489
Net income (loss) 1,134 413 14,875 (749) 1,972 (772) 1,355 21,965
------ ------ ------- ------ ------- ------- ------- -------
Net income (loss) per share $ .04 $ .02 $ .57 $ (.03) $ .07 $ (.03) $ .05 $ .72
------ ------ ------- ------ ------- ------- ------- -------
Weighted average common and
equivalent shares
outstanding.............. 25,570,014 25,865,993 26,005,494 25,992,133 27,281,355 26,410,349 25,921,976 30,065,026
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PICO HOLDINGS, INC. AND SUBSIDIARIES
AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1996 AND 1995
AND FOR EACH OF THE
THREE YEARS IN THE PERIOD
ENDED DECEMBER 31, 1996
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47
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants ..................................... 46
Consolidated Balance Sheets as of December 31, 1996 and 1995 .......... 47-48
Consolidated Statements of Operations for the Years
Ended December 31, 1996, 1995 and 1994 .......................... 49
Consolidated Statement of Changes in Shareholders' Equity for the Years
Ended December 31, 1996, 1995, and 1994 ......................... 50-51
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1996, 1995 and 1994 .......................... 52
Notes to Consolidated Financial Statements ............................ 53
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48
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of
PICO Holdings, Inc.
We have audited the accompanying consolidated balance sheets of PICO Holdings,
Inc. and subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1996. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of PICO Holdings,
Inc. and subsidiaries as of December 31, 1996 and 1995, and the consolidated
results of their operations and cash flows for each of the three years in the
period ended December 31, 1996, in conformity with generally accepted accounting
principles.
As discussed in Note 12, the Company changed the discount rate used to record
loss and loss adjustment expense reserves and related reinsurance balances in
1994.
Coopers & Lybrand L.L.P.
San Diego, California
April 7, 1997
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49
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
ASSETS
1996 1995
------------ ------------
Investments:
Available for sale:
Fixed maturities, at fair value $156,864,826 $ 81,573,579
Equity securities, at fair value 79,534,612 99,857,295
Investment in affiliate, at equity 28,047,764 32,974,930
Short-term investments, at cost 848,658 9,162,925
Real estate 1,546,445 3,038,750
------------ ------------
Total investments 266,842,305 226,607,479
Cash and cash equivalents 64,581,056 43,987,805
Premiums and other receivables, net 14,876,282 10,927,156
Reinsurance receivables 96,984,261 100,719,416
Prepaid deposits and reinsurance premiums 5,225,054 16,623,918
Accrued investment income 3,372,715 1,716,672
Property and equipment, net 4,717,366 5,538,348
Deferred policy acquisition costs 7,921,570 2,894,644
Deferred income taxes 5,625,922 --
Other assets 7,588,351 6,439,127
Net assets of acquired business held for sale 7,088,508 --
Assets held in separate accounts 5,601,828 6,361,040
------------ ------------
Total assets $490,425,218 $421,815,605
============ ============
The accompanying notes are an integral part
of the consolidated financial statements.
47
50
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, Continued
December 31, 1996 and 1995
LIABILITIES AND SHAREHOLDERS' EQUITY
1996 1995
------------- -------------
Policy liabilities and accruals:
Unpaid losses and loss adjustment expenses, net of discount $ 252,023,546 $ 229,796,606
Future policy benefits 13,776,207 15,576,716
Annuity and other policyholders' funds 31,739,736 31,976,176
Unearned premiums 35,296,803 30,858,612
Reinsurance balance payable 7,315,939 8,376,110
Deferred gain on retroactive reinsurance 3,355,409 3,500,544
Other liabilities 22,394,118 11,749,700
Taxes payable 776,784 --
Integration liability 1,368,000 --
Deferred income taxes -- 4,174,461
Excess of fair value of net assets aquired over purchase price 6,293,084 --
Liabilities related to separate accounts 5,601,828 6,361,040
------------- -------------
Total liabilities 379,941,454 342,369,965
------------- -------------
Minority Interest 280,184 96,295
------------- -------------
Commitments
Preferred stock, $.01 par value, authorized 2,000,000 shares in 1996,
authorized 1,000,000 shares in 1995; none issued
Common stock, $.001 par value; authorized 100,000,000 shares in 1996, and
40,079,200 shares in 1995; issued 32,486,718 and 27,436,191
shares in 1996 and 1995, respectively 32,487 27,436
Additional paid-in capital 42,965,063 17,382,279
Net unrealized appreciation (depreciation) on investments 11,837,511 23,827,817
Cumulative foreign currency translation adjustment (27,159) (14,792)
Equity changes of investee company (986,361) (979,066)
Retained earnings 64,226,714 39,906,703
------------- -------------
118,048,255 80,150,377
Less treasury stock, at cost (common shares 1,940,315 in 1996 and 1,365,188 in 1995) (7,844,675) (801,032)
------------- -------------
Total shareholders' equity 110,203,580 79,349,345
------------- -------------
Total liabilities and shareholders' equity $ 490,425,218 $ 421,815,605
============= =============
The accompanying notes are an integral part of the
consolidated financial statements.
48
51
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1996, 1995 and 1994
1996 1995 1994
------------ ------------ ------------
Revenues:
Premium income $ 40,231,791 $ 21,411,496 $ 23,948,154
Investment income, net 11,482,866 13,171,624 15,376,995
Realized gains on investments 30,949,863 5,142,275 901,303
Real estate sales 1,547,423 1,336,501 1,537,500
Gain on sale of MPL business -- 6,000,000 --
Other income 1,556,183 883,072 518,029
------------ ------------ ------------
Total revenues 85,768,126 47,944,968 42,281,981
------------ ------------ ------------
Expenses:
Loss and loss adjustment expenses 22,932,490 23,171,588 11,638,611
Policy benefits 1,298,365 701,305 79,247
Interest credited to policyholders 2,314,071 2,438,036 2,222,560
Policy acquisition costs 2,205,530 1,090,874 1,135,542
Cost of land sales 1,458,781 1,501,421 1,177,295
Insurance underwriting and other expenses 18,593,275 10,579,994 6,745,916
------------ ------------ ------------
Total expenses 48,802,512 39,483,218 22,999,171
------------ ------------ ------------
Equity in earnings (losses) of investee 1,013,385 (459,928) --
------------ ------------ ------------
Income before income taxes and cumulative effect 37,978,999 8,001,822 19,282,810
of change in discount rate
(Benefit) provision for federal income taxes 13,658,988 (7,671,154) 451,881
------------ ------------ ------------
Income before cumulative effect of change in discount rate 24,320,011 15,672,976 18,830,929
Cumulative effect of change in discount rate -- -- (4,109,941)
------------ ------------ ------------
Net income $ 24,320,011 $ 15,672,976 $ 14,720,988
============ ============ ============
Net income per common share (primary and fully diluted):
Income before cumulative effect of change in discount rate $ .90 $ .60 $ .78
Cumulative effect of change in discount rate .00 .00 (0.17)
------------ ------------ ------------
Net income $ .90 $ .60 $ .61
============ ============ ============
Weighted average shares outstanding 27,123,588 25,992,133 24,160,082
============ ============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
49
52
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended December 31, 1996, 1995 and 1994
Net
Unrealized Foreign
Class B Additional Appreciation Currency
Common Common Paid-In (Depreciation) Retained Translation
Stock Stock Capital on Investments Earnings Adjustment
------------ ------------ ------------ ------------ ------------ ------------
Balance, January 1, 1994 $ 24,272 $ 36,000 $ 14,329,443 $ 3,335,431 $ 10,476,740 $ --
Cumulative effect of change in
accounting for investments,
net of adjustment to deferred
policy acquisition costs of
$635,756 and deferred taxes
of $497,091 -- -- -- 7,419,901 -- --
Net income -- -- -- -- 14,720,988 --
Net unrealized depreciation on
investments, net of adjustment
to deferred policy acquisition
costs of $1,123,648 and deferred
taxes of $939,248 -- -- -- (15,503,681) -- --
Issuance of common stock 3,164 -- 2,996,836 -- -- --
Retirement of treasury stock
(all Class B shares) -- (36,000) -- -- (964,000) --
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1994 27,436 -- 17,326,279 (4,748,349) 24,233,728 --
------------ ------------ ------------ ------------ ------------ ------------
Net income -- -- -- -- 15,672,975 --
Foreign currency translation
adjustment -- -- -- -- -- $ (14,792)
Equity changes of investee company -- -- -- -- -- --
Net unrealized appreciation on
investments, net of adjustment
to deferred policy acquisition
costs of $544,162 and deferred
taxes of $12,246,591 -- -- -- 28,576,166 -- --
Issuance of common stock upon
exercise of options -- -- 56,000 -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1995 $ 27,436 $ -- $ 17,382,279 $ 23,827,817 $ 39,906,703 $ (14,792)
============ ============ ============ ============ ============ ============
Equity
Changes
of Investee Treasury
Company Stock Total
------------ ------------ ------------
Balance, January 1, 1994 $ -- $ (2,095,032) $ 26,106,854
Cumulative effect of change in
accounting for investments,
net of adjustment to deferred
policy acquisition costs of
$635,756 and deferred taxes
of $497,091 -- -- 7,419,901
Net income -- -- 14,720,988
Net unrealized depreciation on
investments, net of adjustment
to deferred policy acquisition
costs of $1,123,648 and deferred
taxes of $939,248 -- -- (15,503,681)
Issuance of common stock -- -- 3,000,000
Retirement of treasury stock
(all Class B shares) -- 1,000,000 --
------------ ------------ ------------
Balance, December 31, 1994 -- (1,095,032) 35,744,062
------------ ------------ ------------
Net income -- -- 15,672,975
Foreign currency translation
adjustment -- -- (14,792)
Equity changes of investee company (979,066) -- (979,066)
Net unrealized appreciation on
investments, net of adjustment
to deferred policy acquisition
costs of $544,162 and deferred
taxes of $12,246,591 -- -- 28,576,166
Issuance of common stock upon
exercise of options -- 294,000 350,000
------------ ------------ ------------
Balance, December 31, 1995 $ (979,066) $ (801,032) $ 79,349,345
============ ============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
50
53
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended December 31, 1996, 1995 and 1994
Net
Unrealized Foreign Equity
Additional Appreciation Currency Changes
Common Paid-In (Depreciation) Retained Translation of Investee
Stock Capital on Investments Earnings Adjustment Company
------------- ------------- ------------- ------------- ------------- -------------
Balance, December 31, 1995 $ 27,436 $ 17,382,279 $ 23,827,817 $ 39,906,703 $ (14,792) $ (979,066)
Net income -- -- -- 24,320,011 -- --
Foreign currency translation
adjustment -- -- -- -- (12,367) --
Equity changes of investee company -- -- -- -- -- (7,295)
Net unrealized depreciation on
investments, net of adjustment
to deferred policy acquisition
costs of $17,556 and deferred
taxes of $6,590,684 -- -- (11,990,306) -- -- --
Issuance of common stock upon
exercise of options -- 73,920 -- -- -- --
Purchase of common stock by
an affiliate, held in treasury -- -- -- -- -- --
Retirement of treasury stock in
in connection with merger (1,330) (779,122) -- -- -- --
Issuance of common stock in
connection with Merger 6,381 26,287,986 -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
Balance, December 31, 1996 $ 32,487 $ 42,965,063 $ 11,837,511 $ 64,226,714 $ (27,159) $ (986,361)
============= ============= ============= ============= ============= =============
Treasury
Stock Total
------------- -------------
Balance, December 31, 1995 $ (801,032) $ 79,349,345
Net income -- 24,320,011
Foreign currency translation
adjustment -- (12,367)
Equity changes of investee company -- (7,295)
Net unrealized depreciation on
investments, net of adjustment
to deferred policy acquisition
costs of $17,556 and deferred
taxes of $6,590,684 -- (11,990,306)
Issuance of common stock upon
exercise of options 20,580 94,500
Purchase of common stock by
an affiliate, held in treasury (5,844,600) (5,844,600)
Retirement of treasury stock in
in connection with merger 780,452 --
Issuance of common stock in
connection with Merger (2,000,075) 24,294,292
------------- -------------
Balance, December 31, 1996 $ (7,844,675) $ 110,203,580
============= =============
The accompanying notes are an integral part of the
consolidated financial statements.
51
54
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH
FLOWS For the years ended December 31,
1996, 1995, and 1994
-------
1996 1995 1994
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 24,320,011 $ 15,672,975 $ 14,720,988
Adjustments to reconcile net income to net cash used in
operating activities:
Deferred taxes 1,990,334 (7,891,246) (34,119)
Depreciation and amortization 2,131,742 2,114,986 2,382,285
Realized gains on investments (30,949,863) (4,018,672) (901,303)
Gain from disposition of MPL business (6,000,000) --
Equity in (earnings) losses of investee (1,013,385) 459,928 --
Changes in assets and liabilities, net of effects from acquisition of
businesses:
Premiums and other receivables 4,803,716 (5,241,564) 2,581,834
Reinsurance recoverable and payable 23,417,931 (75,607,649) (9,397,648)
Accrued investment income (302,998) 1,800,431 484,708
Deferred policy acquisition costs 4,034,743 (1,716,745) (33,162)
Unpaid losses and loss adjustment expenses (31,097,669) 49,105,562 (11,044,212)
Future policy benefits and claims payable (2,011,233) 1,512,337 (2,023,440)
Unearned premiums (14,378,764) 14,746,411 (3,579,272)
Other 8,197,478 (79,729) 1,850,249
------------- ------------- -------------
Net cash used in operating activities (10,857,957) (15,142,975) (4,993,092)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of investments:
Available for sale:
Fixed maturities 23,236,398 121,651,938 36,137,317
Equity securities 88,415,361 9,258,500 1,468,258
Proceeds from maturity of fixed maturity investments 10,731,369 19,471,068 31,313,920
Purchases of investments:
Available for sale:
Fixed maturities (40,871,986) (24,776,663) (45,470,637)
Equity securities (59,995,893) (53,145,781) (14,471,269)
Net sales (purchases) of short-term investments 8,314,267 (7,364,404) (222,540)
Net sales of real estate 1,564,389 1,062,798 688,483
Proceeds from sale of property and equipment 106,996 70,782 16,769
Purchases of property and equipment (106,110) (1,023,317) (88,231)
Proceeds from disposition of MPL business -- 6,000,000 --
Investment in affiliate -- (35,986,088) --
Purchased cash from acquiring consolidated subsidiary -- 2,428,623 --
------------- ------------- -------------
Net cash provided by investing activities 31,394,791 37,647,456 9,372,070
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of bank and other borrowings (331,895) (77,129) (100,081)
Net increase in annuity and other policyholders' funds 306,179 166,476 743,459
Issuance of common stock 94,500 350,000 3,000,000
------------- ------------- -------------
Net cash provided by financing activities 68,784 439,347 3,643,378
------------- ------------- -------------
Effect of exchange rate changes on cash (12,367) (14,792) --
------------- ------------- -------------
Net increase in cash and cash equivalents 20,593,251 22,929,036 8,022,356
Cash and cash equivalents, beginning of year 43,987,805 21,058,769 13,036,413
------------- ------------- -------------
Cash and cash equivalents, end of year $ 64,581,056 $ 43,987,805 $ 21,058,769
============= ============= =============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest, net of amounts capitalized $ -- $ 2,427 $ 13,923
============= ============= =============
Federal income taxes (recovered) paid $ (1,546,045) $ 2,347,000 $ 481,000
============= ============= =============
The accompanying notes are an integral part of the
financial statements.
52
55
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------
1. ORGANIZATION AND OPERATIONS:
ORGANIZATION:
PICO Holdings, Inc. and subsidiaries (the "Company") is predominately
an insurance and investment company, specializing in life and health
insurance, property and casualty insurance, portfolio investing and
other services. As discussed in Note 3, Physicians Insurance Company of
Ohio consummated a reverse merger transaction on November 20, 1996 with
a wholly-owned subsidiary of Citation Insurance Group, with Physicians
Insurance Company of Ohio being the accounting acquiror. Pursuant to
the merger, each outstanding share of the Common Stock of Physicians
Insurance Company of Ohio was converted into the right to receive
5.0099 shares of Citation Insurance Group common stock. Upon the
consummation of the merger, Citation Insurance Group changed its name
to PICO Holdings, Inc., which is the continuing registrant.
Any references to "the Company" herein as of dates or for
periods prior to the merger, refer to Physicians Insurance Company of
Ohio and its subsidiaries, which included Summit Global Management,
Inc. prior to the consummation of the merger. The Company's principal
subsidiaries and investee carried on the equity basis as of December
31, 1996 are as follows:
WHOLLY OWNED SUBSIDIARIES (DIRECT AND INDIRECT):
- Physicians Insurance Company of Ohio ("Physicians"), which
owns the following subsidiaries:
- The Professionals Insurance Company ("PRO")
- Physicians Investment Company ("PIC"), (100%, 100%
and 97% owned in 1996, 1995 and 1994, respectively),
which owns American Physicians Life Insurance Company
("APL"), which owns Living Benefit Administrators
Agency, Inc.
- Sequoia Insurance Company ("Sequoia")
- Raven Development Company ("Raven")
- CLM Insurance Agency, Inc.
- Citation Insurance Company ("CIC"), which owns Citation
National Insurance Company ("CNIC")
- Summit Global Management, Inc. ("SGM")
MAJORITY-OWNED SUBSIDIARY:
Stonebridge Partners AG ("Stonebridge") is 76% owned by the Company. In
October 1995, the Company formed Stonebridge, a corporation in Zurich,
Switzerland. Stonebridge is a distributor of investment products and
fund management services to institutions and insurance companies in
Europe. Operating results for the year ended December 31, 1996 and for
the period October 1995 through December 1995 were comprised of certain
operating and startup expenses.
EQUITY INVESTMENT:
Investments in entities in which the Company owns between 20 to 50% of
the voting interest and has the ability to exercise significant
influence and which are made for long term operating purposes, are
accounted for on the equity method of accounting. The Company acquired
an approximate 38% interest in Global Equity Corporation ("GEC") during
1995 and accounts for this investment under the equity method of
accounting. The Company's share of net income or loss from GEC is
translated from its foreign currency at average rates of exchange in
effect during the year.
53
56
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
OPERATIONS:
APL provides life and health insurance coverage in a number of states.
Sequoia, acquired August 1, 1995, writes property and casualty
insurance (primarily light commercial and multi-peril) in California
(Note 3). CIC and its wholly-owned subsidiary, CNIC, were acquired
November 20, 1996 through a reverse acquisition (Note 3). CIC writes
workers' compensation and commercial property and casualty. Insurance
in Arizona, California, Colorado, and Utah. However, as discussed in
Notes 3 and 20, the Company entered into a Letter of Intent in January
1997 to sell the net assets related to CIC's workers' compensation
business. Such net assets are reflected in the accompanying
consolidated balance sheet as "Net Assets of Acquired Business Held for
Sale." CNIC previously wrote commercial property and casualty insurance
primarily in the state of California, but ceased writing new business
effective December 1994. For the years ended December 31, 1996 and
1995, approximately 89% and 95%, respectively, of CIC's direct written
premiums were in California. Consequently, CIC's and Sequoia's
operating results are expected to be largely dependent on their ability
to write profitable insurance in California.
SGM offers investment management services, primarily to its affiliates.
GEC provides investment banking and other services, operating primarily
in Canada, the United States, Asia, Europe, and the Caribbean. At
times, GEC may come to hold securities of companies for which no market
exists or which may be subject to restrictions on resale. As a result,
a portion of GEC's assets may not be liquid. Furthermore, as a result
of its global diversification with respect to existing investments,
GEC's revenues may be adversely affected by economic, political and
governmental conditions in countries where it maintains investments or
operations, such as volatile interest rates or inflation, the
imposition of exchange controls which could restrict or prohibit GEC's
ability to withdraw funds, political instability and fluctuations in
currency exchange rates.
Prior to selling its book of medical malpractice business in 1995,
Physicians engaged in providing medical professional liability coverage
to physicians, surgeons, dentists and nurses, primarily in the state of
Ohio. On August 28, 1995, Physicians entered into an agreement with
Mutual Assurance, Inc. ("Mutual") pursuant to which Physicians sold its
recurring medical professional liability insurance ("MPL") business and
that of its wholly owned subsidiary, PRO, to Mutual. Physicians and PRO
still hold MPL unpaid losses and loss adjustment expense liabilities
that are being settled.
As discussed in Note 10, approximately 19% and 40% of the Company's
common stock was owned by Guinness Peat Group plc as of December 31,
1996 and 1995, respectively. In addition, GEC and CIC own approximately
13% and 1%, respectively, of the Company's common stock as of December
31, 1996. The Company's common stock owned by GEC and CIC has been
accounted for as treasury stock in the Company's consolidated financial
statements.
2. SIGNIFICANT ACCOUNTING PRINCIPLES:
The following is a description of the significant accounting policies
and practices followed in the preparation of the Company's consolidated
financial statements:
PRINCIPLES OF CONSOLIDATION:
The accompanying consolidated financial statements include the accounts
of the Company and its subsidiaries (Note 1). All significant
intercompany accounts and transactions have been eliminated in
consolidation.
BASIS OF PRESENTATION:
The accompanying consolidated financial statements have been prepared
in conformity with generally accepted accounting principles.
54
57
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
INVESTMENTS:
Effective January 1, 1994, the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 115,
Accounting for Certain Investments in Debt and Equity Securities. Under
SFAS No. 115, investments in available for sale securities are recorded
at estimated fair value. Unrealized holding gains and losses on
investments classified as available-for-sale, net of the adjustment to
deferred policy acquisition costs and deferred income taxes, are
excluded from earnings and are reported as a separate component of
shareholders' equity. Upon the adoption of SFAS No. 115 effective
January 1, 1994, the Company classified its entire portfolio of debt
and equity securities as available for sale and reported the cumulative
effect of this accounting change, represented by the unrealized
appreciation on available-for-sale securities of $7,419,901, net of
adjustment to deferred policy acquisition costs of $635,756 and
deferred taxes of $497,091, as an increase in shareholders' equity. The
Company's entire portfolio of debt and equity securities as of December
31, 1996 and 1995 has been designated as available-for-sale.
The estimated fair value of fixed maturity and equity securities other
than those carried at equity is based upon quoted market prices or
dealer quotes for comparable securities. In addition, the Company owns
certain warrants to purchase the common stock of a publicly traded
company. The estimated fair value of such warrants is their intrinsic
value based on the quoted market price of the underlying common stock
of the investee company.
A decline in the market value of any available for sale security below
cost that is deemed other than temporary is charged to earnings and
results in the establishment of a new cost basis for the security.
There were no such declines in 1996, 1995, or 1994.
Investment income includes amortization of premium and accretion of
discount on the level yield method relating to bonds acquired at other
than par value. Realized investment gains and losses are included in
income and are determined on the identified certificate basis and are
recorded on a trade date basis.
Short-term investments, which consist of certificates of deposit with
an original maturity of greater than three months, are stated at cost,
which approximates fair value.
Real estate represents costs incurred in connection with certain land
development projects and commercial real estate held for resale.
Indirect costs associated with the land development projects, including
interest, are capitalized as part of real estate costs. Selling,
general and administrative expenses related to development projects are
expensed as incurred.
CASH EQUIVALENTS:
The Company and its subsidiaries consider highly liquid debt
instruments purchased with an original maturity of three months or less
to be cash equivalents.
PROPERTY AND EQUIPMENT:
Property and equipment are carried at cost, net of accumulated
depreciation. Depreciation is computed on the straight-line method over
the estimated lives of the assets ranging from 5 to 45 years.
Maintenance, repairs and minor renewals are charged to expense as
incurred, while significant renewals and betterments are capitalized.
The cost and related accumulated depreciation of assets sold are
removed from the related accounts, and the resulting gains or losses
are reflected in operations.
55
58
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
DEFERRED ACQUISITION COSTS:
Certain costs of acquiring new insurance business, net of reinsurance
ceding commissions, are deferred and amortized over the terms of the
policy for property and liability insurance and over the average lives
of investment and universal life-type contracts, based on the present
value of the estimated gross profit amounts expected to be realized
over the lives of the contracts, and over the premium paying periods of
ordinary and group life insurance contracts. Future investment income
has been taken into considered in determining the recoverability of
such costs.
GOODWILL:
Goodwill represents the difference between the purchase price and the
fair value of the net assets (including tax attributes) of companies
acquired in purchase transactions. Both positive and negative goodwill
are amortized on a straight-line basis over a period of 10 years. There
was negative goodwill (i.e., excess of fair value of assets acquired
over purchase price) as of December 31, 1996 resulting from the
acquisition of Citation Insurance Group in November 1996 (Note 3).
The Company periodically evaluates whether events or circumstances have
occurred that may affect the estimated useful life or the
recoverability of the remaining balance of positive goodwill. Positive
goodwill is included in "Other Assets" in the accompanying consolidated
balance sheets. Impairment of positive goodwill is triggered when the
estimated future undiscounted cash flows (excluding interest charges)
do not exceed the carrying amount of the positive goodwill. If the
events or circumstances indicate that the remaining balance of the
positive goodwill may be permanently impaired, such potential
impairment will be measured based upon the difference between the
carrying amount of the positive goodwill and the fair value of such
assets determined using the estimated future discounted cash flows
(excluding interest charges) generated from the use and ultimate
disposition of the respective acquired entity.
REINSURANCE:
The Company records all reinsurance assets and liabilities on the gross
basis, including amounts due from reinsurers and amounts paid to
reinsurers relating to the unexpired portion of reinsured contracts
(prepaid reinsurance premiums).
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES:
As more fully described in Note 12, reserves for MPL and property and
casualty unpaid losses and loss adjustment expenses include amounts
determined on the basis of actuarial estimates of ultimate claim
settlements, which include estimates of individual reported claims and
estimates of incurred but not reported claims. The methods of making
such estimates and for establishing the resulting liabilities are
continually reviewed and updated based on current circumstances, and
any adjustments resulting therefrom are reflected in current
operations. Reserves for MPL unpaid losses and loss adjustment expenses
for medical professional liability claims have been adjusted to reflect
the time value of money (discounting).
FUTURE POLICY BENEFITS AND ANNUITY AND OTHER POLICYHOLDERS' FUNDS:
Liabilities for future policy benefits have been calculated using the
net level premium method based on actuarial assumptions as to
anticipated mortality, withdrawals and interest rates ranging from 3.5%
to 8%. Annuity and other policyholders' funds have been calculated
based on contract-holders' contributions plus interest credited, less
applicable contract charges.
56
59
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
RECOGNITION OF PREMIUM REVENUE:
MPL and other property and casualty insurance premiums written are
earned principally on a monthly pro rata basis over the life of the
policy. The premiums applicable to the unexpired terms of the policies
are included in unearned premiums.
Amounts charged on universal life-type contracts that represent the
cost of the insurance component of payments received are recognized as
premium income when earned. Amounts assessed against universal life
policyholder funds to compensate the Company for future services are
reported in unearned premiums and are recognized in income using the
same assumptions and factors used to amortize capitalized acquisition
costs.
Premiums on ordinary and group life contracts, including critical
illness, are recognized when due, and premiums on accident and health
contracts are recognized over the contract period. Unearned premiums
have been principally calculated using the monthly pro rata method,
resulting in the earning of premiums evenly over the terms of the
policies
INCOME TAXES:
The Company's income tax expense includes deferred income taxes arising
from temporary differences between the tax and financial reporting
bases of assets and liabilities. The liability method of accounting for
income taxes also requires the Company to reflect the effect of a tax
rate change on accumulated deferred income taxes in income in the
period in which the change is enacted.
In assessing the realization of deferred income taxes, the Company's
management considers whether it is more likely than not that the
deferred income tax assets will be realized. The ultimate realization
of deferred income tax assets is dependent upon the generation of
future taxable income during the period in which temporary differences
become deductible. If future income does not occur as expected, a
deferred income tax valuation allowance may need to be established.
EARNINGS PER SHARE:
Primary net income per share is computed by dividing net income by the
weighted average number of common stock and common stock equivalents
outstanding for the period with the average number of common stock
equivalents outstanding calculated using the treasury stock method
based on the average market price of the shares during the period.
Fully diluted net income per share is computed on the same basis,
except that, if it results in a more dilutive impact, the number of
common stock equivalents related to stock options is based on the
period-end market value of the shares instead of the average market
value during the period. The weighted average number of shares
outstanding for the years ended December 31, 1995 and 1994 used in the
calculation of earnings per share have been recomputed to give effect
to the stock exchange ratio utilized in connection with the reverse
acquisition of Citation Insurance Group consummated on November 20,
1996 (Note 3).
SEPARATE ACCOUNTS:
Separate account assets and liabilities represent contract-holders'
funds that have been segregated into accounts with specific investment
objectives and are recorded at estimated fair market value based upon
quoted market prices. The investment income and gains or losses of
these accounts accrue directly to the contract-holders. The activity of
the separate accounts is not reflected in the consolidated statements
of operations and cash flows, except for the fees that the Company
receives for administrative services.
57
60
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
TRANSLATION OF FOREIGN CURRENCY:
Revenues and expenses of foreign operations are translated at average
rates of exchange in effect during the year. Assets and liabilities are
translated at the exchange rates in effect at the balance sheet date.
Unrealized exchange gains and losses arising on translation, net of
applicable deferred income taxes, are reflected in shareholders'
equity.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make 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 for each reporting period. The significant estimates made
in the preparation of the Company's consolidated financial statements
relate to the assessment of the carrying value of unpaid losses and
loss adjustment expenses, future policy benefits, deferred policy
acquisition costs, deferred income taxes and contingent liabilities.
While management believes that the carrying value of such assets and
liabilities are appropriate as of December 31, 1996 and 1995, it is
reasonably possible that actual results could differ from the estimates
upon which the carrying values were based.
RECLASSIFICATIONS:
Certain amounts in the financial statements for prior periods have been
reclassified to conform with the 1996 presentation.
RECENT ACCOUNTING PRONOUNCEMENTS:
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128 Earnings per
Share ("SFAS No. 128"). SFAS No. 128 requires dual presentation of
newly defined basic and diluted earnings per share on the face of the
income statement for all entities with complex capital structures. The
accounting standard is effective for fiscal years ending after December
15, 1997, including interim periods. The Company does not believe that
the adoption of SFAS No. 128 will have a material impact on the
computation of its earnings per share in future periods.
3. ACQUISITIONS:
On November 20, 1996, Physicians consummated a transaction (the
"Merger") pursuant to which Citation Holdings, Inc. ("Holdings"), a
wholly owned subsidiary of Citation Insurance Group ("CIG"), merged
with and into Physicians pursuant to an Agreement and Plan of
Reorganization dated as of May 1, 1996 with Physicians being the
accounting acquiror. Pursuant to the Merger, each outstanding share
of the common stock of Physicians was converted into the right to
receive 5.0099 shares of CIG's common stock. CIG's other significant
direct and indirect subsidiaries just prior to the merger were CIC and
CNIC. Upon the consummation of the merger, CIG changed its name to PICO
Holdings, Inc., which is the continuing registrant.
58
61
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
As a result of the Merger, the former shareholders of Physicians own
approximately 80% of the outstanding common stock of the Company and
control the Board of Directors of the Company. Accordingly, for
accounting purposes, the merger has been treated as a recapitalization
of Physicians with Physicians as the acquirer (i.e., a reverse
acquisition). Therefore, the balance sheets as of December 31, 1995 and
the statements of operations, changes in shareholders' equity and cash
flows for each of the two years in the period ended December 31, 1995
represent the historical results of Physicians and its subsidiaries,
which is the predecessor entity. Physicians' equity as of December 31,
1995 and the changes in its equity for the years ended December 31,
1995 and 1994 have been retroactively recapitalized for the equivalent
number of shares of PICO Holdings, Inc.'s common stock received in the
merger transaction. The difference between the par value of Physicians'
and PICO Holdings, Inc.'s common stock has been added to additional
paid-in capital.
The Merger was accounted for under the purchase method of accounting.
Financial results for the year ended December 31, 1996 include the
operations of CIG as if the Merger had occurred on November 1, 1996.
Financial activity for the period November 1, 1996 through November 20,
1996 was not significant.
The allocation of the purchase price of CIG was as follows:
Purchase Price
Value of CIG approximately 6,381,000 shares exchanged $ 23,231,667
Acquisition costs 979,000
Value of CIG options assumed 83,625
------------
$ 24,294,292
============
Allocation of Purchase Price
Historic CIG shareholders' equity $ 34,060,405
Adjust assets and liabilities:
Write down of workers' compensation net assets held for sale (2,864,092)
Write down of property and equipment (820,500)
Deferred income taxes 2,410,280
Integration liability (1,368,000)
Other (830,717)
Excess of fair value of net assets acquired over purchase price (6,293,084)
------------
$ 24,294,292
============
The excess of the fair value of the net assets acquired over the
purchase price of such net assets (negative goodwill) is being
amortized over a 10 year period using the straight-line method. As
discussed in Note 20, the Company entered into a Letter of Intent in
January 1997 to sell the net assets related to CIC's workers'
compensation operations. The sale of the net assets related to CIC's
workers' compensation operations is expected to be completed in the
second quarter of 1997.
The FASB's Emerging Issues Task Force Abstract 87-11 "Allocation of
Purchase Price to Assets to be Sold" ("EITF 87-11") provides guidance
on the accounting for the purchase price allocation to components of
acquired businesses expected to be sold within one year of the
acquisition date. The guidance in EITF 87-11 states the following:
- expected cash flows from the operations of the net assets of
acquired entities that are expected to be sold within one year
of the date of acquisition should be considered in the
purchase price allocation, and
- earnings or losses relating to the operation of the net assets
to be sold should not affect earnings or losses of the
acquiring company during the holding period (i.e., the date of
acquisition to the date of sale).
59
62
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
The Company has accounted for the allocation of the purchase price and
the net assets of CIC's workers' compensation line of business in
accordance with the EITF 87-11 guidance stated above. Accordingly, the
net assets related to CIC's workers' compensation line of business as
of December 31, 1996 have been reflected on a single line item in the
accompanying balance sheet as Net Assets of Acquired Business Held for
Sale. The fair value assigned to such net assets was based upon
management's estimate of the proceeds from the sale of CIC's workers'
compensation line of business of approximately $7.7 million less the
estimated loss from operations for such line of business during the
expected holding period of November 1996 through April 1997 of
approximately $0.5 million.
The pre-tax loss from operations related to CIC's workers' compensation
line of business excluded from the Company's statement of operations
from November 21, 1996 to December 31, 1996 was approximately $101,000.
The difference between the carrying amount of the net assets of CIC's
workers compensation line of business at the date of sale and the
actual proceeds from such sale will result in a reallocation of the
purchase price of CIG.
On August 1, 1995, the Company acquired from Sydney Reinsurance
Corporation ("SRC") all the outstanding stock of SRC's wholly owned
subsidiary, Sequoia, a property and casualty insurance company. The
acquisition price of $1,350,000 was paid in cash August 1, 1995.
Approximately $350,000 was paid to acquire Sequoia's fixed assets,
while the remaining $1,000,000 was used in the purchase of intangible
assets and goodwill. These intangible assets are being amortized over a
10-year period using the straight-line method. The Company used
available working capital to make the purchase. All policy and claims
liabilities of Sequoia prior to closing are the responsibility of SRC
and have been unconditionally and irrevocably guaranteed by QBE
Insurance Group Limited ("QBE"), a publicly-held corporation based in
Sydney, Australia, of which SRC indirectly is a wholly-owned
subsidiary. Sequoia's operating results are included in the
consolidated statements of operations for the year ended December 31,
1996 and for the period August 1, 1995 to December 31, 1995.
The Company is required to maintain a minimum surplus in Sequoia of
$7.5 million and, through a management agreement, will supervise the
run-off of SRC's liabilities. As part of the management agreement,
Sequoia will be reimbursed $4.8 million in management fees by the
seller for processing the run off of claims and policy receivables and
servicing the business existing prior to closing. This management fee
is to be received from SRC over a three-year period and is recognized
based on the percentage of completion method based on total anticipated
claims. Approximately $1.7 million and $1.6 million have been
recognized as management fee income and for the year ended December 31,
1996 and for the period August 1, 1995 through December 31, 1995,
respectively.
The following unaudited pro forma information presents (i) a summary of
consolidated results of operations of the Company and CIG and its
subsidiaries for the years ended December 31, 1996 and 1995 as if the
acquisition of CIG and its subsidiaries occurred at the beginning of
1995, with proforma adjustments to give effect to the amortization of
goodwill and the accounting for CIC's workers' compensation line of
business held for sale in accordance with EITF 87-11, as discussed
above (in thousands, except per share data) and (ii) a summary of
consolidated results of operations of the Company and Sequoia for the
years ended December 31, 1995 and 1994 as if the acquisition of Sequoia
had occurred at the beginning of 1994, with pro forma adjustments to
give effect to the amortization of goodwill and related income tax
effects (in thousands, except per share data):
(Unaudited)
1996 1995 1994
-------- ------------- --------
Total
Total revenues $133,539 $118,658 $ 88,337
Income before income taxes 35,572 8,588 17,917
Net income 16,564 16,076 13,347
Net income per share $ 0.61 $ 0.62 $ 0.55
60
63
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
These unaudited pro forma results have been prepared for comparative
purposes and do not purport to be indicative of the results of
operations which actually would have resulted had the combinations been
in effect on January 1, 1995 and 1994 or of future results of
operations of the consolidated entities.
On September 5, 1995, Physicians purchased 38.2% of the outstanding
common shares of GEC for $34.4 million. Approximately $33.5 million was
paid to acquire the net assets, while the remaining $887,000 was
allocated to goodwill. The goodwill is being amortized over a 10-year
period using the straight-line method. Physicians used available
working capital to make the purchase. GEC is a publicly-held
corporation and is listed on the Toronto Stock Exchange and The
Montreal Exchange under the symbol "GEQ". The Chairman of the Board of
Directors ("Chairman") and the Chief Executive Officer ("CEO") of the
Company are the Chairman and CEO of GEC, respectively.
The Company carries its investment in GEC using the equity method of
accounting. The consolidated statements of operations of the Company
for the years ended December 31, 1996 and December 31, 1995 include the
Company's 38.2% share of GEC's net income (loss) for the year ended
December 31, 1996, and from October 1, 1995 to December 31, 1995,
respectively.
4. INVESTMENTS:
At December 31, the cost (amortized cost for fixed maturities) and
estimated fair value of investments are as follows:
Gross Gross Estimated
Unrealized Unrealized Fair
1996: Cost Gains Losses Value
------------ ------------ ------------- ------------
Available for sale
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 74,508,884 $ 319,041 $ (439,085) $ 74,388,840
Corporate securities 108,858,788 1,191,257 (369,254) 109,680,791
Mortgage-backed and
other securities 25,212,464 100,847 (50,326) 25,262,985
------------ ------------ ------------- ------------
208,580,136 1,611,145 (858,665) 209,332,616
Equity securities 61,688,546 19,907,520 (2,061,454) 79,534,612
------------ ------------ ------------- ------------
Total $270,268,682 $ 21,518,665 $ (2,920,119) $288,867,228
============ ============ ============= ============
Fixed maturity investments with an estimated fair value of $52,467,790
have been classified as net assets of acquired business held for sale.
61
64
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
Gross Gross Estimated
Unrealized Unrealized Fair
1995: Cost Gains Losses Value
------------ ------------ ------------ ------------
Available for sale
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 32,171,232 $ 401,798 $ (389,695) $ 32,183,335
Corporate securities 29,729,110 323,160 (65,207) 29,987,063
Mortgage-backed and
other securities 19,426,148 37,870 (60,837) 19,403,181
------------ ------------ ------------ ------------
81,326,490 762,828 (515,739) 81,573,579
Equity securities 63,945,369 37,051,426 (1,139,500) 99,857,295
------------ ------------ ------------ ------------
Total $145,271,859 $ 37,814,254 $ (1,655,239) $181,430,874
============ ============ ============ ============
Equity securities include certain warrants to purchase the common stock
of a publicly traded company. The estimated fair value of such warrants
is their intrinsic value based on the quoted market price of the
underlying common stock of the investee company. The estimated fair
value and cost of such warrants were $14,530,957 and $240,000,
respectively, as of December 31, 1996 and $4,737,500 and $240,000,
respectively, as of December 31, 1995.
The amortized cost and estimated fair value of investments in fixed
maturities at December 31, 1996, by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with
or without call or prepayment penalties.
Amortized Estimated
Cost Fair Value
------- -------
Due in one year or less $ 59,821,218 $ 60,629,665
Due after one year through five years 78,186,033 78,843,065
Due after five years through ten years 34,464,117 33,606,303
Due after ten years 10,896,304 10,990,598
Mortgage-backed and other securities 25,212,464 25,262,985
------------ ------------
$208,580,136 $209,332,616
============ ============
Investment income is summarized as follows for the years ended December
31, 1996, 1995, and 1994:
1996 1995 1994
------------ ------------ ------------
Investment income from:
Available for sale:
Fixed maturities $ 6,323,707 $ 8,829,957 $ 15,152,173
Equity securities 1,860,232 607,429 60,372
Short-term investments
and other 4,123,532 4,112,255 595,079
------------ ------------ ------------
Total investment income 12,307,471 13,549,641 15,807,624
Investment expenses (824,605) (378,017) (430,629)
------------ ------------ ------------
Net investment income $ 11,482,866 $ 13,171,624 $ 15,376,995
============ ============ ============
62
65
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
All available-for-sale investments were income-producing in the last 12
months except for nine equity securities with a carrying amount
totaling approximately $6,138,568.
Pre tax net realized gains (losses) on investments were as follows for
each of the years ended December 31:
1996 1995 1994
------------ ------------ ------------
Gross realized gains:
Available for sale:
Fixed maturities $ 70,019 $ 1,023,621 $ 826,744
Equity securities 31,326,294 6,241,593 222,350
------------ ------------ ------------
Total gains 31,396,313 7,265,214 1,049,094
------------ ------------ ------------
Gross realized losses:
Available for sale:
Fixed maturities (292,612) (1,836,582) (72,563)
Equity securities (153,838) (286,357) (75,228)
------------ ------------ ------------
Total losses (446,450) (2,122,939) (147,791)
------------ ------------ ------------
Net realized gains $ 30,949,863 $ 5,142,275 $ 901,303
============ ============ ============
Approximately $29.5 million of the total gross realized gains for the
year ended December 31, 1996 were generated from the sale of the
Company's investment in Fairfield Communities, Inc. in November 1996.
At December 31, 1996, the following available-for-sale securities
exceeded 10% of shareholders' equity of the Company:
Estimated Fair Value
Equity securities:
Resource America, Inc., warrants $14,530,957
-----------
$14,530,957
===========
In addition, Resource America, Inc., has guaranteed certain mortgage
notes held by APL with a carrying amount of $8,000,000 as of December
31, 1996.
5. INVESTMENT IN AFFILIATE:
The following information presents a summary of the financial position
of GEC as of December 31, 1996 and 1995 along with the results of
operations for the year ended December 31, 1996 and the three month
period ended December 31, 1995.
1996 1995
---- ----
Total assets $ 121,897,000 $ 121,749,000
Total liabilities 11,880,000 15,261,000
Minority interest 22,724,000 22,429,000
Shareholders' equity 87,293,000 84,059,000
Total revenue 22,051,000 6,685,000
Income (loss) before income taxes 4,997,000 (340,000)
Net income (loss) 2,653,000 (1,204,000)
The Company's ownership interest in PC Quote and Nooney Realty equity
securities exceeded 20% of the total equity ownership interest of those
companies as of December 31, 1996. However, these investments are
carried at estimated fair value as opposed to on the equity basis as
the investment was not made for long-term operating purposes.
63
66
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
6. PREMIUMS AND OTHER RECEIVABLES:
Premiums and other receivables consisted of the following at December
31:
1996 1995
------------ ------------
Agents' balances and unbilled premiums $ 14,993,199 $ 10,871,700
Other accounts receivable -- 133,456
------------ ------------
14,993,199 11,005,156
Allowance for doubtful accounts (116,917) (78,000)
------------ ------------
$ 14,876,282 $ 10,927,156
============ ============
7. FEDERAL INCOME TAX:
The Company and its U.S. subsidiaries file a consolidated life/nonlife
federal income tax return. Non-U.S. subsidiaries file tax returns in
various foreign countries.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes.
Significant components of the Company's deferred tax assets and
liabilities at December 31, 1996 and 1995 are as follows:
1996 1995
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 6,719,612 --
Loss reserves 19,018,582 $ 16,109,534
Future policy benefits 798,894 749,342
Unearned premium reserves 2,011,642 2,986,855
Alternative minimum tax credits -- 661,265
Deferred gain on retroactive reinsurance 1,140,839 1,190,185
Integration liability 527,341 --
Other, net 1,154,432 636,858
------------ ------------
Total deferred tax assets 31,371,342 22,334,039
Deferred tax liabilities:
Reinsurance receivables 10,325,734 10,701,283
Prepaid reinsurance -- 1,921,446
Deferred policy acquisition costs 2,563,812 1,086,584
Unrealized appreciation on securities 6,060,413 12,274,933
Accretion of bond discount 106,529 40,291
Depreciation 24,932 483,963
------------ ------------
Total deferred tax liabilities 19,081,420 26,508,500
------------ ------------
Net deferred tax assets (liabilities)
before valuation allowance 12,289,922 (4,174,461)
Less valuation allowance (6,664,000) --
------------ ------------
Net deferred tax assets (liabilities) $ 5,625,922 $ (4,174,461)
============ ============
64
67
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
At December 31, 1994 and prior, the Company had recorded a valuation
allowance for nearly all its net deferred tax assets, as management
believed the realizability of the net deferred tax assets did not
exceed the "more likely than not" criteria required by SFAS No. 109.
During 1995, because of the significant increase in the net unrealized
appreciation in the Company's available-for-sale securities, the
Company reconsidered its need for a valuation allowance for its net
deferred tax assets. The Company reduced its valuation allowance,
resulting in a decrease in deferred federal income tax expense of
approximately $9.4 million. The deferred tax asset valuation allowance
as of December 31, 1996 relates to the net operating loss carryforwards
(NOL's) of CIG and Sequoia. Such NOL's are subject to the separate
return limitation year rules and, therefore, can only be used to offset
the respective future taxable income generated by CIG and Sequoia.
Given management's uncertainty as to the ability of CIG and Sequoia to
generate sufficient future taxable income to utilize such NOL's, they
do not currently believe that it is more likely than not that the
deferred tax asset related to such NOL's will be realized. Net deferred
tax assets, the recorded valuation allowance and federal income tax
expense in future years can be significantly affected by changes in
enacted tax rates or by changes in circumstances that would influence
management's conclusions as to the ultimate realizability of deferred
tax assets.
At December 31, income tax expense (benefit) consists of the following:
1996 1995 1994
------------ ------------ ------------
Current $ 11,668,654 $ 220,092 $ 486,000
Deferred 1,990,334 (7,891,246) (34,119)
------------ ------------ ------------
$ 13,658,988 $ (7,671,154) $ 451,881
============ ============ ============
The difference between income taxes provided at the Company's effective
tax rate and federal statutory rate is as follows:
1996 1995 1994
------------ ------------ ------------
Federal income tax at statutory rate $ 13,292,650 $ 2,720,619 $ 6,556,155
Small life company deduction (608,949) (134,073) (573,715)
Change in the valuation allowance (53,323) (9,408,371) (5,317,367)
Other 1,028,610 (849,329) (213,192)
------------ ------------ ------------
Federal income tax expense (benefit) $ 13,658,988 $ (7,671,154) $ 451,881
============ ============ ============
The aggregate NOL's of approximately $19,760,000 expire between 1999
and 2010. There is an annual limitation on the NOL's of approximately
$1,400,000.
8. PROPERTY AND EQUIPMENT:
The major classifications of property and equipment at December 31 are
as follows:
1996 1995
------------ ------------
Land $ 500,016 $ 500,016
Home office 4,841,059 4,841,059
Office furniture, fixtures and equipment 4,361,510 5,869,013
Building and leasehold improvements 678,223 529,732
------------ ------------
10,380,808 11,739,820
Accumulated depreciation (5,663,442) (6,201,472)
------------ ------------
Net book value $ 4,717,366 $ 5,538,348
============ ============
Depreciation expense was $751,000, $589,000, and $688,000 in 1996,
1995, and 1994 respectively.
65
68
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
9. DEFERRED POLICY ACQUISITION COSTS:
Changes in deferred policy acquisition costs are as follows:
1996 1995 1994
----------- ----------- -----------
Balance, January 1 $ 2,894,644 $ 2,812,936 $ 3,427,425
Additions:
Commissions 4,158,421 3,303,513 1,803,173
Other 1,860,247 582,763 437,181
Acquired in merger 1,593,930 -- --
Ceding commissions (397,698) (864,432) (2,207,193)
----------- ----------- -----------
Deferral of expense 7,214,900 3,021,844 33,161
----------- ----------- -----------
Adjustment for expected
gross profits on
investment and universal
life-type contracts resulting from
SFAS 115 mark-to-market 17,556 (544,163) 487,892
Adjustment for premium
deficiency -- (1,305,099) --
Amortization to expense (2,205,530) (1,090,874) (1,135,542)
----------- ----------- -----------
Balance, December 31 $ 7,921,570 $ 2,894,644 $ 2,812,936
=========== =========== ===========
10. SHAREHOLDERS' EQUITY (ALL SHARE AMOUNTS HAVE BEEN RESTATED TO GIVE
EFFECT TO THE STOCK EXCHANGE RATIO UTILIZED IN CONNECTION WITH THE
REVERSE ACQUISITION OF CIG (NOTE 3)):
In December 1993, the Company issued 7,156,997 common shares (adjusted
for the merger exchange rate) to Guinness Peat Group plc for
$5,000,000. In accordance with their original stock purchase agreement,
Guinness Peat Group plc was entitled to purchase additional common
shares at a price based upon the average closing bid price of the stock
for a period prior to the date of notice of intent to buy up to an
aggregate purchase price of $5,000,000. In June 1994, the Company
issued 3,164,147 common shares (adjusted for the merger exchange rate)
to Guinness Peat Group plc for $3,000,000, increasing their ownership
to approximately 40%. At December 31, 1996 and 1995, Guinness Peat
Group plc was entitled to purchase additional common shares up to an
aggregate purchase price of $2,000,000.
On May 9, 1996, the Company, Guinness Peat Group plc ("GPG"), and GEC
entered into an agreement whereby GPG agreed to sell 4,258,415 common
shares (adjusted for the merger exchange rate) of the Company's common
stock to GEC in two blocks, subject to regulatory approval, at an
average price of approximately US $3.60 per share. GPG agreed to sell
the shares to GEC at a discount to market due to their status as
restricted stock and in consideration of the quantity of shares to be
purchased. On May 13, and June 4, 1996 GEC purchased the shares. Prior
to these transactions, GPG owned approximately 40% of the Company's
common stock. Following these transactions, GPG and GEC owned
approximately 23% and 16% of the Company's common stock, respectively.
GPG and GEC owned approximately 19% and 13%, respectively, of the
Company's common stock subsequent to the merger with CIG in November
1996. The shares of the Company owned by GEC have been accounted for as
treasury shares as of December 31, 1996 in the Company's consolidated
financial statements.
66
69
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
In connection with the merger, PICO Holdings, Inc. Board of Directors
adopted a Stockholders' Rights Plan and, pursuant to such Plan,
declared a dividend on its common stock of one right (a "Right") for
each share of common stock outstanding. Upon the occurrence of certain
events, each Right becomes exercisable to purchase 1/100 of a share of
Series A Junior Participating Cumulative Preferred Stock at an initial
price of $35.00. The Rights expire on July 22, 2001 and prior to the
occurrence of certain events, may be redeemed at a price of $.01 per
Right. Of the Company's 2,000,000 authorized shares of preferred stock,
1,000,000 shares have been designated as Series A Junior Participating
cumulative Preferred Stock. Each share of Series A Junior Participating
Preferred Stock shall entitle the holder thereof to 100 votes on all
matters submitted to a vote of the stockholders of the Company.
In connection with the merger, CIG's existing Employee Stock Ownership
Plan was adopted. Such plan covers substantially all of the employees
of the Company and its subsidiaries. Contributions are made to the plan
at the discretion of the Board of Directors. No contributions were made
to the plan in 1996.
The Company sponsors various stock-based incentive compensation plans
(the "Plans"). The Company applies APB Opinion 25 and related
interpretations in accounting for the Plans and, therefore, does not
recognize any compensation cost related to such plans. In 1995, the
FASB issued SFAS Statement No. 123 "Accounting for Stock-Based
Compensation" ("SFAS 123"). Adoption of the cost recognition provisions
of SFAS 123 is optional and the Company has decided not to elect these
provisions of SFAS 123. However, pro forma disclosures of the impact on
the Company's net income and earnings per share for the years ended
December 31, 1996 and 1995 as if the Company adopted the cost
recognition provisions of SFAS 123 are presented below.
Under the Plans, Physicians is authorized to issue 2,955,148 shares of
Common Stock pursuant to awards granted in various forms, including
incentive stock options (intended to qualify under Section 422 of the
Internal Revenue Code of 1986, as amended), non-qualified stock
options, and other similar stock-based awards to full-time employees
(including officers) and directors. The total options available for
future grants as of December 31, 1996 were 70,377. The Company granted
stock options in 1996 and 1995 under the Plans in the form of incentive
stock options and non-qualified stock options. In conjunction with the
Merger, the Company assumed all of Physicians' options outstanding. The
exercise price of all options granted was equal to the fair market
value of the Company's common stock at the date of grant.
The Company granted stock options in 1996 and 1995 to employees and
directors. The stock options granted in 1996 and 1995 have terms of 10
years. The options granted to directors were vested immediately on the
grant date. The options granted to employees vest either (I) at the
rate of 25%, 33% or 50% per year on each of the first four, three or
two year anniversaries of the date of grant, as applicable, or (ii) at
a rate of 33% upon grant and 33% per year on each of the first two
anniversaries of the date of grant. All options granted under the CIG
plan became fully vested upon consummation of the merger.
67
70
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
A summary of the status of the Company's stock options as of December
31, 1996 and 1995 and the changes during the years then ended is
presented below:
1996 1995
-------------------- ------------------------
Weighted Weighted
# Shares of Average # Shares of Average
Underlying Exercise Underlying Exercise
Options Prices Options Prices
Outstanding at beginning of the
Year 2,580,095 $2.69 500,990 $ 0.70
Granted 70,138 2.69 2,580,095 2.69
Exercised (35,069) 2.69 (500,990) .70
Canceled (70,138) 2.69 -- --
Options assumed in merger 214,480 4.49 -- --
Outstanding at end of year 2,759,506 2.83 2,580,095 2.69
Exercisable at end of year 2,495,651 2,029,009
Weighted-average fair value
of options granted during
the year $ 3.62 $ 1.62
The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions for grants in 1996 and 1995, respectively:
no dividend yield for all years; risk-free interest rates are different
for each grant and range from 5.94% to 6.97%; the expected lives of
options are estimated at 7 years; and a volatility of 50% for all
grants.
The following table summarizes information about stock options
outstanding at December 31, 1996:
Options Outstanding Options Exercisable
----------------------------------- -------------------------
Weighted
Average Weighted
Number Remaining Average Number Weighted
Range of Outstanding Contractual Exercise Exercisable Average
Exercise Prices at 12/13/96 Life Price at 12/31/96 Exercise Price
- --------------- ----------- ---- ----- --------------------------
$2.69 to $4.75 2,690,006 8.64 3.03 2,426,151 2.74
$5.75 to $10.25 69,500 6.11 7.29 69,500 7.29
--------- ---------
$2.69 to 10.25 2,759,506 8.57 2.83 2,495,651 2.86
68
71
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Had the compensation cost for the Company's stock-based compensation
plans been determined consistent with SFAS 123, the Company's net
income and net income per common share for 1996 and 1995 would
approximate the pro forma amounts below:
December 31, December 31,
1996 1995
------------ ------------
Net income, as reported $ 24,320,011 $ 15,672,976
SFAS 123 charge (1,954,185) (1,005,921)
------------ ------------
Pro forma net income $ 22,365,826 $ 14,667,055
============ ============
Pro forma net income per common share $ .82 $ .56
============ ============
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. SFAS 123 does not apply to awards prior
to 1995.
11. REINSURANCE:
In the normal course of business, the Company's insurance subsidiaries
have entered into various reinsurance contracts with unrelated
reinsurers. The Company's insurance subsidiaries participate in such
agreements for the purpose of limiting their loss exposure and
diversifying their business. Reinsurance contracts do not relieve the
Company's insurance subsidiaries from their obligations to
policyholders.
All reinsurance assets and liabilities are shown on a gross basis in
the accompanying consolidated financial statements. Amounts recoverable
from reinsurers are estimated in a manner consistent with the claim
liability associated with the reinsured policy. Such amounts are
included in "reinsurance receivables" in the consolidated balance
sheets as follows:
1996 1995
------------ ------------
Estimated reinsurance recoverable on:
Unpaid losses and loss adjustment expense (net of
discount of $3,259,190 and $3,770,779, respectively) $ 89,493,139 $ 92,474,112
Future policy benefits 2,537,789 2,036,394
------------ ------------
92,030,928 94,510,506
Other balances receivable from reinsurers 4,953,333 6,208,910
------------ ------------
Reinsurance receivables $ 96,984,261 $100,719,416
============ ============
Unsecured reinsurance risk is concentrated in the companies shown in
the table below. The Company remains contingently liable with respect
to reinsurance contracts in the event that reinsurers are unable to
meet their obligations under the reinsurance agreements in force.
69
72
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
CONCENTRATION OF REINSURANCE
(in millions)
Unearned Reported Unreported Reinsurer
Premiums Claims Claims Balances
-------- ------ ------ --------
Sydney Reinsurance Corporation -- $16.8 $16.2 $33.0
Kemper Reinsurance Company -- $ 4.2 $ 3.6 $ 7.8
Continental Casualty Company $ 1.5 $ 0.3 $ 1.2 $ 3.0
San Francisco Reinsurance Company $ 0.5 $ 0.2 $ 0.4 $ 1.1
TIG Reinsurance Group -- $ 4.2 $ 7.1 $11.3
Transatlantic Reinsurance Company -- -- $ 9.0 $ 9.0
Cologne Reinsurance Company of America -- -- $ 1.0 $ 1.0
Mutual Assurance, Inc. -- $ 1.3 $ 5.1 $ 6.4
General Reinsurance $ 0.1 $ 7.4 $ 1.2 $ 8.7
As more fully described in Note 3, immediately prior to the sale of
Sequoia to Physicians by SRC, Sequoia and SRC entered into a
reinsurance treaty whereby all policy and claims liabilities of Sequoia
prior to the date of purchase by the Company are the responsibility of
SRC. Payment of these reinsurance liabilities has been unconditionally
and irrevocably guaranteed by QBE.
The Company entered into a reinsurance treaty in 1995 with Mutual in
connection with the sale of Physicians' MPL business to Mutual. This
treaty is a 100% quota share treaty covering all claims arising from
policies issued or renewed with an effective date after July 15, 1995.
At the same time, Physicians terminated two treaties entered into in
1994 and renewed in 1995. The first of these was a claims-made
agreement under which Physicians' retention was $200,000, for both
occurrence and claims-made insurance policies. Claims are covered up to
$1 million. The second treaty reinsured claims above $1 million up to
policy limits of $5 million on a trueoccurrence and claims-made basis,
depending on the underlying insurance policy.
In 1994, the Company entered into a retrospective reinsurance
arrangement with respect to its MPL business. As a result, Physicians
initially recorded a deferred gain on retroactive reinsurance of
$3,445,123 in 1994. Deferred gains are being amortized into income over
the expected payout of the underlying claims using the interest method.
The unamortized gain as of December 31, 1996 and 1995 was $2,874,128
and $3,188,811, respectively.
70
73
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The following is a summary of the net effect of reinsurance activity on
the consolidated financial statements for 1996, 1995, and 1994:
1996 1995 1994
------------ ------------ ------------
Direct premiums written $ 47,172,118 $ 38,896,155 $ 34,179,637
Reinsurance premiums assumed 274,296 140,303 8,565
Reinsurance premiums ceded (8,418,267) (13,332,228) (18,174,791)
------------ ------------ ------------
Net premiums written $ 39,028,147 $ 25,704,230 $ 16,013,411
============ ============ ============
Direct premiums earned $ 60,808,306 $ 31,931,286 $ 37,697,822
Reinsurance premiums assumed 281,019 141,496 45,438
Reinsurance premiums ceded (20,857,534) (10,661,286) (13,795,106)
------------ ------------ ------------
Net premiums earned $ 40,231,791 $ 21,411,496 $ 23,948,154
============ ============ ============
Losses and loss adjustment expenses incurred:
Direct $ 35,969,535 $ 47,057,111 $ 13,010,447
Assumed 69,541 33,285 (2,764,335)
Ceded (17,458,446) (27,305,248) (9,991,964)
------------ ------------ ------------
$ 18,580,630 19,785,148 254,148
Effect of discounting on
losses and loss adjustment
expenses (Note 12) 4,351,860 3,386,440 11,384,463
------------ ------------ ------------
Net losses and loss adjustment
expenses $ 22,932,490 $ 23,171,588 $ 11,638,611
============ ============ ============
12. RESERVES FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES:
Reserves for unpaid losses and loss adjustment expenses on MPL and
property and casualty business represent management's estimate of
ultimate losses and loss adjustment expenses and fall within an
actuarially determined range of reasonably expected ultimate unpaid
losses and loss adjustment expenses.
Reserves for unpaid losses and loss adjustment expenses are estimated
based on both company-specific and industry experience, and assumptions
and projections as to claims frequency, severity, and inflationary
trends and settlement payments. Such estimates may vary significantly
from the eventual outcome. In management's judgment, information
currently available has been appropriately considered in estimating the
loss reserves and reinsurance recoverable of the insurance
subsidiaries.
Physicians prepares its statutory financial statements in accordance
with accounting practices prescribed or permitted by the Ohio
Department of Insurance ("ODI"). CIC, CNIC and Sequoia prepare their
statutory financial statements in accordance with accounting practices
prescribed or permitted by the California Department of Insurance.
Prescribed statutory accounting practices include guidelines
contained in various publications of the National Association of
Insurance Commissioners, as well as state laws, regulations, and
general administrative rules. Permitted statutory accounting practices
encompass all accounting practices not so prescribed. The ODI's
prescribed accounting practices do not allow for discounting of claim
liabilities. However, for the years ended December 31, 1996, 1995, and
1994, the ODI permitted Physicians to discount its losses and loss
adjustment expenses related to its MPL claims to reflect investment
income. Such permission was granted due primarily to the longer claims
settlement period related to MPL business as compared to most other
types of property and casualty insurance lines of business. Property
and casualty insurance companies are permitted to discount claims
liabilities under generally accepted accounting principles to the
extent that the discounting of claims liabilities by such entities is
prescribed or permitted by statutory accounting principles.
71
74
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The method of discounting utilized by Physicians is based on historical
payment patterns and assumes an interest rate at or below Physicians'
investment yield, and is the same rate used for statutory reporting
purposes. Prior to 1994, direct and assumed MPL loss reserves and
reinsurance recoverables were discounted at a rate of 7.5% (an
investment yield rate) for 1987 and prior accident years. Physicians
used 5.5% for the 1988 accident year, 5% for the accident years 1989,
1990 and 1991, and 4% for the 1992 and 1993 accident years, which rates
were agreed to between Physicians and the Ohio Department of Insurance.
These rates represented a level somewhat below Physicians' investment
yield rate as required by such agreement. During 1994, Physicians
changed its accounting for the discount rate retroactively and lowered
its discount rate to 4% for all accident years, including all prior
accident years. Physicians considered this change in discount rate to
be a change to a preferable rate, the maximum rate currently prescribed
for discounting by the Ohio Department of Insurance. The cumulative
effect of this change, as of January 1, 1994, was $4,109,941 and was
charged to earnings in 1994. The carrying value of MPL reserves gross
as to reinsurance was approximately $141.8 million, net of discounting
of $15.5 million at December 31, 1996 and $167.3 million, net of
discounting of $20.3 million at December 31, 1995.
Activity in the reserve for unpaid claims and claim adjustment expenses
for the year ended December 31 was as follows:
1996 1995 1994
------------- ------------- -------------
Balance at January 1 $ 229,796,606 $ 180,691,044 $ 191,735,256
Less reinsurance recoverables (92,474,112) (26,335,327) (11,020,783)
------------- ------------- -------------
Net balance at January 1 137,322,494 154,355,717 180,714,473
------------- ------------- -------------
Incurred loss and loss adjustment expenses
for current accident year claims 20,806,194 17,886,560 21,465,081
Incurred loss and loss adjustment expenses
for prior accident year claims (2,609,907) (335,958) (19,616,968)
Retroactive reinsurance (2,422,308) (7,556,845)
Provision for deferral of gain on retroactive
reinsurance (145,135) 2,115,011 6,934,113
Increase due to commutation of reinsurance treaties
Accretion of discount 4,881,338 5,928,283 10,413,230
------------- ------------- -------------
Total incurred 22,932,490 23,171,588 11,638,611
------------- ------------- -------------
Net balances acquired in merger 41,293,239 -- --
------------- ------------- -------------
Effect of change in discount rate -- -- 4,109,941
------------- ------------- -------------
Effect of retroactive reinsurance 145,135 (2,115,011) (6,934,113)
------------- ------------- -------------
Payments for claims occurring during:
Current accident year (6,964,436) (1,357,986) (803,390)
Prior accident years (32,198,515) (36,731,814) (34,369,805)
------------- ------------- -------------
Total paid (39,162,951) (38,089,800) (35,173,195)
------------- ------------- -------------
Net balance at December 31 162,530,407 137,322,494 154,355,717
Plus reinsurance recoverables 89,493,139 92,474,112 26,335,327
------------- ------------- -------------
Balance at December 31 $ 252,023,546 $ 229,796,606 $ 180,691,044
============= ============= =============
In 1996 and 1995, the lower accretion of discount compared to that of
1994 is due to the lower MPL reserves in 1996 and 1995 compared to
1994, and an additional $3.6 million of discount accretion added to
1994 as a result of large prior years' reserve reductions taken in 1994
due to favorable loss experience.
72
75
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
13. EMPLOYEE BENEFITS PLANS:
Physicians, Sequoia, APL and Summit maintain a 401(k) defined
contribution plan (the "Plan") covering substantially all employees.
Physicians', Sequoia's, APL's and Summit's matching contributions to
the Plan are based on a percentage of employee compensation, as well as
amounts contributed by employees. During 1996, 1995, and 1994,
Physicians', Sequoia's, APL's and Summit's expenses for contributions
made to the Plan were $392,000, $207,000, and $154,000, respectively.
Plan assets for the defined contribution plan are held by one of the
Company's subsidiaries. Another subsidiary is responsible for
management of the Plan's assets.
14. REGULATORY MATTERS:
The regulations of the Departments of Insurance in the states where the
Company's insurance subsidiaries are domiciled generally restrict the
ability of insurance companies to pay dividends or make other
distributions. Based upon statutory financial statements filed with the
insurance departments as of December 31, 1996, $8.6 million was
available for distribution by the Company's wholly-owned insurance
subsidiaries to the parent company without the prior approval of the
Department of Insurance in the states in which the Company's insurance
subsidiaries are domiciled, through December 29, 1997. The total
eligible distributions in 1997 are approximately $21.8 million. See
Note 20, "Subsequent Events". A dividend payment of $13,212,593 was
made on December 30, 1996 from Physicians to PICO Holdings, Inc.
15. COMMITMENTS AND CONTINGENCIES:
The Company leases some of its offices under noncancellable operating
leases which expire through February 2001. Total rental expense for the
years ended December 31, 1996 and 1995 was $1,714,265 and $307,155,
respectively. Future minimum rental payments required under the leases
are as follows:
Years Ending December 31, (in thousands)
1997 ..................................................... $1,035
1998 ..................................................... 984
1999 ..................................................... 1,020
2000 ..................................................... 1,040
2001 ..................................................... 132
------
$4,211
The Company is subject to various litigation which arises in the
ordinary course of its business. Based upon information presently
available, management is of the opinion that such litigation will not
have a material adverse effect on the consolidated financial position
or results of operations of the Company.
16. RELATED-PARTY TRANSACTIONS:
In 1994, the Company entered into a consulting agreement for a combined
annual fee of $200,000 with two of its directors for consulting
services related to the Company's investment activities, investment
banking services and analysis of operations. Effective January 1, 1995,
the Company revised the agreement with these directors to a combined
annual fee of $300,000. Effective September 11, 1995, the previous
agreements were terminated and the Company entered into consulting
arrangements with the same two Directors for a three-year period at a
combined fee of $300,000 annually for their services as officers of the
Company related to analysis of the Company's operations, investment
banking activities, and analysis and recommendation on the Company's
investment portfolio. The Company paid a combined fee of $300,000,
$305,000 and $200,000 to each of these two Directors for 1996, 1995 and
1994, respectively. In addition, the aforementioned directors were
awarded a bonus of $450,000 each in 1996.
73
76
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
SGM is a Registered Investment Advisor providing investment advisory
services to managed accounts including the Company's subsidiaries.
Although dormant for several years, SGM commenced active operations on
January 1, 1995. SGM's President and CEO has an option expiring
December 31, 2004 to purchase 49% of SGM's common shares for a nominal
amount. Two of the Company's directors were instrumental in
establishing the operations of SGM and are entitled to receive 50% of
the first $1,000,000 of profits attributed to Physicians' ownership of
common stock. The compensation paid to each of those Directors under
this arrangement was $0 and $0 in 1996 and 1995, respectively.
Effective January 1, 1996, SGM entered into a contract to provide
investment management services to Physicians, PRO, Sequoia, APL, and
Separate Accounts A and B of APL.
Effective September 11, 1995, the same two directors also entered into
consulting contracts with a subsidiary of GEC. They are to render
services in the areas of investment banking, investment portfolio
analysis, and management and operational analysis. The compensation
paid to each of those Directors under this arrangement was $150,000 and
$45,445 in 1996 and 1995, respectively. Each was to receive $150,000
annually for rendering such services through September 11, 1998. These
contracts were superseded by the January 1997 contracts described
below.
On September 26, 1995, the same two directors of the Company, who are
also officers and directors of GEC, were granted options by GEC to
purchase up to 1,549,833 shares of common stock of GEC at an exercise
price of $2.50 (Canadian) per share, which was the closing market price
of GEC shares on the Toronto Stock Exchange on the date of grant. Such
options are immediately exercisable. In addition, on October 24, 1995,
each was granted options by GEC to purchase an additional 950,167
shares of common stock of GEC at an exercise price of $2.45 (Canadian)
per share. Such options do not become exercisable until the earlier to
occur of (a) approval by the shareholders of GEC or (b) shares becoming
available as a result of the cancellation of options held by other
option holders.
In January 1997, the consulting arrangements described above between
two of the Company's directors and the Company, SGM, and GEC were
terminated and were replaced with a single consulting arrangement
between each of the directors, GEC and the Company. Under the new
consulting arrangement, the Company's Board of Directors increased the
annual base consulting fees for the two directors who perform
consulting services related to investment activities, investment
banking services and analysis of operations to $800,000 each beginning
January 1, 1997. In addition, each is entitled to an incentive award
based on the growth of the Company's book value during 1997, above a
threshold rate of return. Physicians will be responsible for two-thirds
of the consulting fee and GEC will be responsible for one-third.
17. STATUTORY INFORMATION:
The Company and its insurance subsidiaries are subject to regulation by
the insurance departments of the states of domicile and other states in
which the companies are licensed to operate and file financial
statements using statutory accounting practices prescribed or permitted
by the respective Departments of Insurance. Prescribed statutory
accounting practices include a variety of publications of the NAIC, as
well as state laws, regulations and general administrative rules.
Permitted statutory accounting practices encompass all accounting
practices not so prescribed. Physicians has received written approval
from the Ohio Department of Insurance to discount its MPL unpaid loss
and loss adjustment expense reserves, including related reinsurance
recoverables using a 4% discount rate. Statutory practices vary in
certain respects from generally accepted accounting principles. The
principal variances are as follows:
1) Certain assets are designated as "non-admitted assets" and
charged to shareholders' equity for statutory accounting
purposes (principally certain agents' balances and office
furniture and equipment).
2) Deferred policy acquisition costs are expensed for statutory
accounting purposes.
74
77
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
3) Deferred federal income taxes are not recognized for statutory
accounting purposes.
4) Equity in net income of subsidiaries and affiliates is
credited directly to shareholders' equity for statutory
accounting purposes.
5) Fixed maturity securities classified as available for sale are
carried at amortized cost.
6) Loss and loss adjustment expense reserves and unearned
premiums are reported net of the impact of reinsurance for
statutory accounting purposes.
The Company and its wholly owned insurance subsidiaries' net income
(loss) for the years ended December 31, 1996, 1995 and 1994 and
policyholders' surplus as of December 31, 1996, 1995, and 1994 on the
statutory accounting basis are as follows:
1996 1995 1994
------------ ------------ ------------
Physicians Insurance Company of Ohio:
Statutory net income $ 12,807,610 $ 13,212,594 $ 11,870,620
Policyholders' surplus 69,464,034 83,380,498 44,517,831
The Professionals Insurance Company:
Statutory net income $ 1,330,733 $ 403,378 $ 4,716,477
Policyholders' surplus 7,684,701 6,024,645 9,649,826
American Physicians Life Insurance:
Statutory net income $ 2,709,570 $ 731,813 $ 2,548,619
Policyholders' surplus 11,809,784 9,658,540 8,975,713
Sequoia Insurance Company*
Statutory net income $ (982,953) $ (3,319,089) --
Policyholders' surplus 14,445,550 10,254,113 --
Citation Insurance Company**
Statutory net income $ (3,069,661) -- --
Policyholders' surplus 25,596,903 -- --
Citation National Insurance Company**
Statutory net income $ 498,168 -- --
Policyholders' surplus 4,483,111 -- --
* Purchased August 1, 1995
** Purchased November 20, 1996
Certain insurance subsidiaries are owned by other insurance
subsidiaries. In the table above, investments in such subsidiary-owned
insurance companies are reflected in statutory surplus of both the
parent and subsidiary-owned insurance company. As a result, at December
31, 1996, 1995, and 1994, statutory surplus of approximately
$38,423,146, $25,937,298 and $18,625,539, respectively, is reflected in
both the parent and subsidiary-owned insurance companies.
75
78
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
18. SEGMENT REPORTING:
The Company's operations are organized into four principal segments:
portfolio investing, life and health insurance, MPL insurance (see Note
1), and property & casualty insurance. Other operations include the
Company's real estate development and other activities.
At December 31, the principal industry segments are as follows (in
thousands):
Property
Portfolio Life and and
1996: Investing (A) Health Casualty MPL Other Consolidated
- ----- ------------- ------ -------- --- ----- ------------
Revenues $ 26,994 $ 9,032 $ 35,280 $ 12,244 $ 2,218 $ 85,768
Income before income taxes 23,310 4,002 3,307 8,469 (1,109) 37,979
Identifiable assets 56,264 68,746 204,124 151,341 9,950 490,425
Depreciation and
amortization 447 27 1,315 -- 11 1,800
Capital expenditures 55 -- 51 -- -- 106
1995:
Revenues $ 8,021 $ 6,756 $ 2,485 $ 29,049 $ 1,634 $ 47,945
Income before income taxes 5,349 859 (3,722) 6,026 (510) 8,002
Identifiable assets 57,800 68,302 100,978 193,133 1,603 421,816
Depreciation and
amortization 2,622 343 139 -- 4 3,108
Capital expenditures 267 -- 720 -- 36 1,023
1994:
Revenues $ 2,016 $ 8,208 -- $ 30,439 $ 1,619 $ 42,282
Income before income taxes
and cumulative change
in discount rate 118 2,902 -- 16,263 -- 19,283
Identifiable assets 25,603 62,383 -- 206,219 2,958 297,163
Depreciation and
amortization 2,074 290 -- -- 18 2,382
Capital expenditures 88 -- -- -- -- 88
(A) Portfolio investing identifiable assets include certain
investments held by one of the Company's regulated insurance
subsidiaries which is no longer writing new business.
Management believes that this component of the insurance
subsidiary's assets is in excess of the amount of the
subsidiary's assets that will be required to settle its claims
liabilities. The amount of the insurance subsidiary's assets
included in the portfolio investing segment were approximately
$56 million, $58 million and $26 million as of December 31,
1996, 1995, and 1994, respectively. Investment income revenue
thereon was approximately $27 million, $8 million and $2
million, for the years ended December 31, 1996, 1995, and
1994, respectively.
19. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is
practicable to estimate that fair value:
- CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS: The
carrying amounts of cash and cash equivalents and short-term
investments approximate their estimated fair values.
76
79
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
- FIXED MATURITIES AND EQUITY INVESTMENT SECURITIES: Fair values
are based upon quoted market prices, or dealer quotes for
comparable securities. In addition, the Company owns certain
warrants to purchase the common stock of a publicly traded
company. The estimated fair value of such warrants is their
intrinsic value based on the quoted market price of the
underlying common stock of the investee company.
- PREMIUM NOTES RECEIVABLE: The carrying amounts of premium
notes receivable are reasonable estimates of fair value.
- DEPOSITS WITH REINSURERS AND REINSURANCE RECOVERABLES: The
carrying amounts of deposits with reinsurers and reinsurance
recoverables with fixed amounts due are reasonable estimates
of fair value.
- INVESTMENT IN AFFILIATE: Estimated fair value of GEC is based
upon its quoted market price on the Toronto Stock Exchange
translated at the exchange rates in effect at the balance
sheet date.
- SEPARATE ACCOUNTING: Separate account assets and liabilities
are carried at market value, which is based upon quoted market
prices.
- POLICYHOLDER LIABILITIES FOR ANNUITY AND OTHER POLICYHOLDER
FUNDS: Policyholder liabilities for annuity and other
policyholder funds include reserves without mortality or
morbidity risks. The fair value is estimated by discounting
future payments at rates currently offered for similar
financial instruments.
December 31, 1996 December 31, 1995
------------------------------ ------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------ ------------ ------------
Financial assets:
Cash and cash equivalents and
short-term investments $ 65,429,714 $ 65,429,714 $ 53,150,730 $ 53,150,730
Investment securities 290,413,673 290,413,673 184,469,624 184,469,624
Deposits with reinsurers and
reinsurance recoverables 5,878,483 5,878,483 12,005,160 11,787,091
Investment in affiliate 28,047,764 52,143,007 32,974,930 56,154,007
Assets held in separate accounts 5,601,828 5,601,828 6,361,040 6,361,040
Financial liabilities:
Policyholder liabilities for
investment-type insurance
contracts 44,116,065 42,362,323 42,611,466 40,866,413
Liabilities related to separate
accounts 5,601,828 5,601,828 6,361,040 6,361,040
77
80
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
20. SUBSEQUENT EVENTS:
In January 1997, the Company signed a Letter of Intent to sell the net
assets related to CIC's workers' compensation business. Under the terms
of the Letter of Intent, the transaction will be structured as a
purchase of all the issued and outstanding shares of stock of CNIC. CIC
will reinsure all of its workers' compensation business into CNIC and
transfer all employees working on the workers' compensation business to
CNIC prior to the closing. The purchase price is estimated to be
approximately $7.7 million and would be paid in cash. Consummation of
the transaction is conditioned upon certain factors including
negotiation and execution of a definitive agreement, negotiation of
reinsurance treaties and any requisite approvals from the Commissioner
of Insurance of the State of California.
On April 14, 1997, GEC and PICO announced an agreement for the purchase
of Nevada Land and Resource Company, LLC, owner of approximately
1,365,000 acres of deeded land in northern Nevada. The total purchase
price is approximately $53.7 million, with the closing date set for
April 23, 1997. GEC will own approximately 75 percent of Nevada Land
and Resource. PICO Holdings, Inc. will pay approximately $12 million
for the remaining interest. PICO Holdings, Inc. and Physicians have
committed to purchase a debenture from GEC for approximately $30
million to help finance GEC's portion.
Also on April 14, 1997, Physicians paid a dividend of approximately
$8.6 million to PICO Holdings, Inc. This dividend was not considered
an "extraordinary" dividend requiring specific regulatory approval,
since (1) it was paid out of statutory earned surplus and (2) it, plus
all other dividends paid by Physicians within the previous twelve
months, did not exceed Physicians net income as filed with the ODI for
the previous calendar year ended December 31, 1996 of approximately
$21.8 million.
21. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
Summarized unaudited financial data for 1995 and 1996 are shown below.
In management's opinion, the interim financial data contains all
adjustments, consisting of only normal recurring accruals, necessary
for a fair presentation of results for such interim periods.
The Company computes earnings per common share for each quarter
independently of earnings per share for the year. The sum of the
quarterly earnings per share may not equal the earnings per share for
the year because of: (i) transactions affecting the weighted average
number of shares outstanding in each quarter; and (ii) the uneven
distribution of earnings during the year.
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------------ ------------ ------------ ------------
1996
Revenues $ 14,965,795 $ 10,596,083 $ 13,717,099 $ 46,489,149
Net Income 1,971,720 (771,762) 1,354,993 21,765,060
Earnings per common share 0.07 (0.03) 0.05 .72
Number of shares used in calculation 27,281,355 26,410,349 25,921,976 30,065,026
1995
Revenues $ 4,291,606 $ 9,471,692 $ 18,629,143 $ 15,552,527
Net Income 1,133,900 413,142 14,874,844 (748,910)
Earnings per common share 0.04 0.02 .57 (.03)
Number of shares used in calculation 25,570,014 25,865,993 26,005,494 25,992,133
78
81
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
No disclosure is required.
PART III
Certain information required by Part III is omitted from this Report,
in that PICO will file its Proxy Statement pursuant to Regulation 14A 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 relating to the directors of PICO is incorporated by
reference from the PICO's Proxy Statement filed in connection with its Annual
Meeting of Stockholders to be held on June 5, 1997 (the "Proxy Statement") as
set forth under the caption "Election of Directors". Information relating to the
executive officers of PICO is set forth in Part I of this Report under the
caption "Executive Officers."
Information with respect to delinquent filings pursuant to Item 405 of
Regulation S-K is incorporated by reference to the Proxy Statement as set forth
under the caption "Executive Compensation and Other Matters -- Section 16(a)
Beneficial Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive compensation is incorporated by
reference to the Proxy Statement under the caption "Executive Compensation and
Other Matters."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to ownership of equity securities of PICO
by certain beneficial owners and management is incorporated by reference
to the Proxy Statement as set forth under the caption "General Information ---
Stock Ownership of Certain Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related
transactions is incorporated by reference to the Proxy Statement under the
captions "Executive Compensation and Other Matters -- Certain Transactions" and
"Executive Compensation and Other Matters -- Compensation Committee Interlocks
and Insider Participation."
79
82
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 10-K
(a) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS.
1. Financial Statements.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants ..................................... 46
Consolidated Balance Sheets as of December 31, 1996 and 1995 .......... 47-48
Consolidated Statements of Operations for the Years
Ended December 31, 1996, 1995 and 1994 .......................... 49
Consolidated Statement of Changes in Shareholders' Equity for the Years
Ended December 31, 1996, 1995, and 1994 ......................... 50-51
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1996, 1995 and 1994 .......................... 52
Notes to Consolidated Financial Statements ............................ 53
2. Financial Statement Schedules.
PICO will submit Schedule 2 ("Condensed Financial
Information of Registrant"), Schedule 3
("Supplementary Insurance Information") and Schedule
5 ("Valuation and Qualifying Accounts") in an
amendment to this Form 10-K.
3. Exhibits
Exhibit
Number Description
------- -----------
+ 2.2 Agreement and Plan of Reorganization, dated as of May 1,
1996, among PICO, Citation Holdings, Inc. and Physicians
and amendment thereto dated August 14, 1996 and related
Merger Agreement.
+++++ 2.3 Second Amendment to Agreement and Plan of Reorganization
dated November 12, 1996.
2.4 Agreement and Debenture, dated November 14, 1996 and
November 27, 1996, respectively, by and between
Physicians and PC Quote, Inc.
+++++ 3.1 Amended and Restated Articles of Incorporation of PICO.
+ 3.2.2 Amended and Restated By-laws of PICO.
+++++ 4.2 First Amendment to Rights Agreement dated April 30, 1996.
+++++ 4.3 Second Amendment to Rights Agreement dated November 20,
1996.
-* 10.7 Key Officer Performance Recognition Plan.
* 10.8 Flexible Benefit Plan
-* 10.9 Amended and Restated 1983 Employee Stock Option Plan.
-**** 10.10 Salary Reduction Profit Sharing Plan as amended and
restated effective January 1, 1994 and Amendments Nos. 1
and 2 thereto dated March 13, 1995 and March 15, 1995,
respectively.
-* 10.11 Employee Stock Ownership Plan and Trust Agreement.
-*** 10.11.1 Amended Employee Stock Ownership Plan and Trust Agreement.
-***** 10.11.2 Amendment to Employee Stock Ownership Plan dated October
1, 1992.
-**** 10.11.3 Amendment to Employee Stock Ownership Plan dated March 15,
1995.
* 10.16 Office Lease between CIC and North Block Partnership dated
July, 1990.
*** 10.16.1 Amendments Nos. 1 and 2 to Office Lease between CIC and
North Block Partnership dated January 6, 1992 and February
5, 1992, respectively.
80
83
**** 10.16.2 Amendments Nos. 3 and 4 to Office Lease between CIC and
North Block Partnership dated December 6, 1993 and October
4, 1994, respectively.
-* 10.22 1991 Employee Stock Option Plan
-***** 10.23 PICO Severance Plan for Certain Executive Officers, Senior
Management and Key Employees of the Company and its
Subsidiaries, including form of agreement.
-10.55 Consulting Agreements, effective January 1, 1997,
regarding retention of Ronald Langley and John R. Hart as
consultants by Physicians and GEC.
++ 10.57 PICO 1995 Stock Option Plan
-+++ 10.58 Key Employee Severance Agreement and Amendment No. 1
thereto, each made as of November 1, 1992, between PICO
and Richard H. Sharpe and Schedule A identifying other
substantially identical Key Employee Severance Agreements
between PICO and certain of the executive officers of PICO
+++ 10.59 Agreement for Purchase and Sale of Shares, dated May 9,
1996, among Physicians, GPG and GEC.
++ 10.60 Agreement for the Purchase and Sale of Certain Assets,
dated July 14, 1995 between Physicians, PRO and Mutual
Assurance, Inc.
++ 10.61 Stock Purchase Agreement dated March 7, 1995 between
Sydney Reinsurance Corporation and Physicians.
++ 10.62 Letter Agreement, dated September 5, 1995, between
Physicians, Christopher Ondaatje and the South East Asia
Plantation Corporation Limited.
++++ 10.63 Amendment No. 1 to Agreement for Purchase and Sale of
Certain Assets, dated July 30, 1996 between Physicians,
PRO and Mutual Assurance, Inc.
+++++ 16.1 Letter regarding change in Certifying Accountant from
Deloitte & Touche, LLP, independent auditors.
21. Subsidiaries of PICO.
27. Financial Data Schedule.
- ------------------------
* Incorporated by reference to exhibit of same number filed
with Registration statement on Form S-1 (File No.
33-36383).
*** Incorporated by reference to exhibit of same number filed
With 1992 Form 10-K.
**** Incorporated by reference to exhibit of same number filed
with 1994 Form 10-K.
***** Incorporated by reference to exhibit bearing the same
number filed with Registration Statement on Form S-4 (File
No. 33-64328).
+ Filed as Appendix to the prospectus in Part I of
Registration Statement on Form S-4 (File No. 333-06671)
++ Incorporated by reference to exhibit filed with
Physicians' Registration Statement No. 33-99352 on Form
S-1 filed with the SEC on November 14, 1995.
+++ Incorporated by reference to exhibit filed with
Registration Statement on Form S-4 (File no. 333-06671).
++++ Incorporated by reference to exhibit filed with Amendment
No. 1 to Registration Statement No. 333-06671 on Form S-4.
+++++ Incorporated by reference to exhibit of same number filed
with Form 8-K dated December 4, 1996.
- Executive Compensation Plans and Agreements.
81
84
(b) REPORTS ON FORM 8-K.
On December 4, 1996 and December 30, 1996, PICO filed a Form
8-K and a Form 8-K/A, respectively, with the Securities and
Exchange Commission. The Form 8-K reported the consummation of
the Merger, the amendment of PICO's Articles of Incorporation
and By-laws and a change in the Company's accountants. The
Form 8-K/A provided the pro forma financial information of
PICO for the quarter ended and as of September 30, 1996 with
respect to the Merger.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: April 15, 1997 PICO Holdings, Inc.
By: /s/ John R. Hart
--------------------------
John R. Hart
Chief Executive Officer
President and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below on April 15, 1997 by the following persons in
the capacities indicated.
/s/ Ronald Langley Chairman of the Board
- ----------------------------------
Ronald Langley
/s/ John R. Hart Chief Executive Officer, President and Director
- ----------------------------------
John R. Hart
/s/ Gary W. Burchfield Chief Financial Officer and Treasurer
- ----------------------------------
Gary W. Burchfield
/s/ S. Walter Foulkrod, III Director
- ----------------------------------
S. Walter Foulkrod, III
/s/ Richard D. Ruppert, M.D. Director
- ----------------------------------
Richard D. Ruppert, M.D.
Director
- ----------------------------------
Dr. Gary H. Weiss
/s/ Dr. Marshall J. Burak Director
- ----------------------------------
Dr. Marshall J. Burak
/s/ Robert R. Broadbent Director
- ----------------------------------
Robert R. Broadbent
/s/ John D. Weil Director
- ----------------------------------
John D. Weil
82
85
Exhibit
Number Description
------- -----------
+ 2.2 Agreement and Plan of Reorganization, dated as of May 1,
1996, among PICO, Citation Holdings, Inc. and Physicians
and amendment thereto dated August 14, 1996 and related
Merger Agreement.
+++++ 2.3 Second Amendment to Agreement and Plan of Reorganization
dated November 12, 1996.
2.4 Agreement and Debenture, dated November 14, 1996 and
November 27, 1996, respectively, by and between
Physicians and PC Quote, Inc.
+++++ 3.1 Amended and Restated Articles of Incorporation of PICO.
+ 3.2.2 Amended and Restated By-laws of PICO.
+++++ 4.2 First Amendment to Rights Agreement dated April 30, 1996.
+++++ 4.3 Second Amendment to Rights Agreement dated November 20,
1996.
-* 10.7 Key Officer Performance Recognition Plan.
* 10.8 Flexible Benefit Plan
-* 10.9 Amended and Restated 1983 Employee Stock Option Plan.
-**** 10.10 Salary Reduction Profit Sharing Plan as amended and
restated effective January 1, 1994 and Amendments Nos. 1
and 2 thereto dated March 13, 1995 and March 15, 1995,
respectively.
-* 10.11 Employee Stock Ownership Plan and Trust Agreement.
-*** 10.11.1 Amended Employee Stock Ownership Plan and Trust Agreement.
-***** 10.11.2 Amendment to Employee Stock Ownership Plan dated October
1, 1992.
-**** 10.11.3 Amendment to Employee Stock Ownership Plan dated March 15,
1995.
* 10.16 Office Lease between CIC and North Block Partnership dated
July, 1990.
*** 10.16.1 Amendments Nos. 1 and 2 to Office Lease between CIC and
North Block Partnership dated January 6, 1992 and February
5, 1992, respectively.
**** 10.16.2 Amendments Nos. 3 and 4 to Office Lease between CIC and
North Block Partnership dated December 6, 1993 and October
4, 1994, respectively.
-* 10.22 1991 Employee Stock Option Plan
-***** 10.23 PICO Severance Plan for Certain Executive Officers, Senior
Management and Key Employees of the Company and its
Subsidiaries, including form of agreement.
-10.55 Consulting Agreements, effective January 1, 1997,
regarding retention of Ronald Langley and John R. Hart as
consultants by Physicians and GEC.
++ 10.57 PICO 1995 Stock Option Plan
-+++ 10.58 Key Employee Severance Agreement and Amendment No. 1
thereto, each made as of November 1, 1992, between PICO
and Richard H. Sharpe and Schedule A identifying other
substantially identical Key Employee Severance Agreements
between PICO and certain of the executive officers of PICO
+++ 10.59 Agreement for Purchase and Sale of Shares, dated May 9,
1996, among Physicians, GPG and GEC.
++ 10.60 Agreement for the Purchase and Sale of Certain Assets,
dated July 14, 1995 between Physicians, PRO and Mutual
Assurance, Inc.
++ 10.61 Stock Purchase Agreement dated March 7, 1995 between
Sydney Reinsurance Corporation and Physicians.
++ 10.62 Letter Agreement, dated September 5, 1995, between
Physicians, Christopher Ondaatje and the South East Asia
Plantation Corporation Limited.
83
86
++++ 10.63 Amendment No. 1 to Agreement for Purchase and Sale of
Certain Assets, dated July 30, 1996 between Physicians,
PRO and Mutual Assurance, Inc.
+++++ 16.1 Letter regarding change in Certifying Accountant from
Deloitte & Touche, LLP, independent auditors.
21. Subsidiaries of PICO.
27. Financial Data Schedule.
- ------------------------
* Incorporated by reference to exhibit of same number filed
with Registration statement on Form S-1 (File No.
33-36383).
*** Incorporated by reference to exhibit of same number filed
With 1992 Form 10-K.
**** Incorporated by reference to exhibit of same number filed
with 1994 Form 10-K.
***** Incorporated by reference to exhibit bearing the same
number filed with Registration Statement on Form S-4 (File
No. 33-64328).
+ Filed as Appendix to the prospectus in Part I of
Registration Statement on Form S-4 (File No. 333-06671)
++ Incorporated by reference to exhibit filed with
Physicians' Registration Statement No. 33-99352 on Form
S-1 filed with the SEC on November 14, 1995.
+++ Incorporated by reference to exhibit filed with
Registration Statement on Form S-4 (File no. 333-06671).
++++ Incorporated by reference to exhibit filed with Amendment
No. 1 to Registration Statement No. 333-06671 on Form S-4.
+++++ Incorporated by reference to exhibit of same number filed
with Form 8-K dated December 4, 1996.
- Executive Compensation Plans and Agreements.
84