SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___to___
Commission file number 1-7411
ALLCITY INSURANCE COMPANY
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(Exact name of registrant as specified in its charter)
New York 13-2530665
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(State of incorporation) (I.R.S. Employer Identification Number)
45 Main Street, Brooklyn, N.Y 11201-3731
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 718-422-4000
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
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None
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Securities registered pursuant to Section 12(g) of the Act:
None
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(Title of Class)
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [x]
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
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The aggregate market value of the voting stock held by nonaffiliates of
the registrant as of March 14, 2002 was $192,143.
The number of shares outstanding of each of the registrant's classes of
common shares, as of March 14, 2002, was 7,078,625.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2002 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
Exhibit Index on Page 23. Total number of pages 53.
TABLE OF CONTENTS
PART I
PAGE
----
Item 1- Business.................................................... 1
Item 2- Properties.................................................. 10
Item 3- Legal Proceedings........................................... 10
PART II
Item 5- Market for the Registrant's Common Equity and Related
Stockholder Matters.................................... 11
Item 6- Selected Financial Data..................................... 12
Item 7- Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 13
Item 7A- Quantitative and Qualitative Disclosures about Market Risk.. 19
Item 8- Financial Statements and Supplementary Data................. 20
Item 9- Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................... 20
PART III
Item 10- Directors and Executive Officers of the Registrant.......... 20
Item 11- Executive Compensation...................................... 20
Item 12- Security Ownership of Certain Beneficial Owners and
Management............................................ 20
Item 13- Certain Relationships and Related Transactions.............. 20
PART IV
Item 14- Exhibits, Financial Statement Schedules, and Reports on Form 8-K 21
Signatures........................................................... 22
-i-
PART I
ITEM 1. BUSINESS
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GENERAL
Allcity Insurance Company (the "Registrant", "Allcity" or the "Company") is a
property and casualty insurer. Empire Insurance Company ("Empire"), a property
and casualty insurer, owns approximately 84.6% of the outstanding common shares
of the Company. Empire's common shares are 100% owned and controlled, through
subsidiaries, by Leucadia National Corporation ("Leucadia"). Additionally,
Leucadia indirectly owns an additional 6.7% of the outstanding common shares of
the Company. The Company and Empire are sometimes hereinafter collectively
referred to as the Group. Prior to December 31, 2001, the Group also included
Empire's wholly-owned insurance subsidiary Centurion Insurance Company
("Centurion"), which was merged into Empire effective December 31, 2001.
Historically, the Group specialized in commercial and personal property and
casualty insurance business primarily in the New York metropolitan area. The
Group offered insurance products for vehicles (including medallion and
radio-controlled livery vehicles), general liability coverage, property coverage
(including mercantile and multi-family residential real estate) and workers'
compensation to commercial accounts and private passenger automobile and
homeowners products to individuals.
During the past several years, the Group experienced poor underwriting results
and adverse reserve development in all of its lines of business. During 2001,
the Group explored its options for developing a new business model and strategy.
After evaluating these options, the Group announced in December 2001 that it had
determined that it was in the best interest of its shareholders and
policyholders to commence an orderly liquidation of all of its operations. The
Group will only accept business that it is obligated to accept by contract or
New York insurance law; it will not engage in any other business activities
except for its claims runoff operations. The voluntary liquidation of its
operations is expected to be substantially complete by 2005. Given the Group's
and the Company's current financial condition, the expected costs to be incurred
during the claims runoff period, and the inherent uncertainty over ultimate
claim settlement values, no assurance can be given that the Company's
shareholders will be able to receive any value at the conclusion of the
voluntary liquidation of its operations.
As of March 8, 2002, the Group was rated "F" (in liquidation) by A.M. Best
Company ("Best") and rated "BB-" (marginal) by Standards & Poors Insurance
Rating Services ("S&P"). Given the Group's decision to commence an orderly
liquidation of all of its operations, the Best and S&P ratings are not expected
to have any impact on the Company's operations. As with all ratings, Best and
S&P ratings are subject to change at any time.
In March 2001, the Group had announced that, effective immediately, it would no
longer issue any new (as compared to renewal) insurance policies in any lines of
business and that it had filed plans of orderly withdrawal with the New York
Insurance Department (the "Department") as required. Commercial lines policies
are being non-renewed or canceled in accordance with New York insurance law or
replaced by Tower Insurance Company of New York or Tower Risk Management
(collectively, "Tower") under the 2001 agreement for the sale of the Group's
renewal rights (the "Tower Agreement"). Starting in the second quarter of 2001,
Tower purchased the renewal rights for substantially all of the Group's
remaining lines of business, excluding private passenger automobile and
commercial automobile/garage, for a fee based on the direct written premium
actually renewed by Tower. The amount of the fee is expected to be approximately
$0.9 million, of which the Company's share would be $0.3 million. Existing
policies of private passenger automobile insurance will be either sold,
non-renewed or cancelled in accordance with New York insurance law. If the
private passenger automobile book of business is not sold, it is expected that
the Group will continue to issue renewal policies over the next several years as
required by applicable insurance law. The Group will continue to be responsible
for the remaining term of its existing policies and all claims incurred prior to
the expiration of these policies. After the expiration of its existing
commercial lines policies, the Group will thereafter have no renewal obligations
for those policies. Under New York insurance law, the Group is obligated to
offer renewals of homeowners, dwelling fire, personal insurance coverage and
personal umbrella for a three-year policy period; however, the Tower Agreement
obligates Tower to offer their own policies as replacements for the Group's
policies. Excluding the remaining terms of existing policies that the Group
intends to either non-renew, cancel or that will be replaced by Tower, as of
December 31, 2001, the Group's in force premium volume totaled $11.1 million. As
indicated above, these policies are primarily personal lines policies whose
volume will continue to decline as the Group exercises its non-renewal rights
under New York insurance law.
- 1 -
For the years ended December 31, 2001, 2000 and 1999 net earned premiums for the
Company were $18.3 million, $30.9 million and $42.4 million, respectively.
Substantially all of the Group's policies are written in New York for a one-year
period, except for its Massachusetts assigned risk servicing carrier business.
The Group is licensed in New York to write most lines of insurance that may be
written by a property and casualty insurer. Empire is also licensed to write
insurance in Connecticut, Massachusetts, Missouri, New Hampshire and New Jersey.
On a quarterly basis, the Group reviews and adjusts its estimated loss reserves
for any changes in trends and actual loss experience. Included in the Company's
results for 2001 was approximately $18.7 million related to losses and loss
adjustment expenses ("LAE") from prior accident years. The Group will continue
to evaluate the adequacy of its loss reserves and record future adjustments to
its loss reserves as appropriate.
POOLING AGREEMENT
All insurance business written by the Company is subject to a pooling agreement
with Empire under which the Company and Empire effectively operate as one
company. The pooling agreement and subsequent amendments were approved by the
New York Insurance Department. The Company operates under the same general
management as Empire and has full use of Empire's personnel, information
technology systems and facilities. As of December 31, 2001, Empire and its
subsidiaries had 157 full and part-time employees. Currently, and for all
periods presented, all premiums, losses, LAE and other underwriting expenses are
shared on the basis of 70% to Empire and 30% to the Company.
Pursuant to the pooling agreement, the Company has a net reinsurance recoverable
from Empire. As of December 31, 2001, the Company's reinsurance recoverable from
Empire is $130.6 million, representing 43% of the Company's total assets. While
this liability is reflected on Empire's stand-alone statutory financial
statements, Empire's statutory surplus (after deducting this liability) is $11.1
million as of December 31, 2001, which is $7.8 million above the minimum
required under New York insurance regulations. The Company currently believes
that its reinsurance recoverable from Empire is fully collectible; however,
further significant deterioration in Empire's surplus could impair Empire's
ability to pay the full amount due to the Company. Further, any adverse
regulatory action taken against Empire in the future could also impair the
Company's ability to fully collect its reinsurance recoverable.
FINANCIAL INFORMATION RELATING TO BUSINESS SEGMENTS
The Group was previously organized into three divisions: the Small Business
Division, the Personal Lines Division and the Mid-Market Division. Each of these
divisions had separate management teams responsible for all underwriting
decisions. As a result of the Group's actions outlined above and a consolidation
of the Group's internal management organization in 2001, the Company's prior
business segments have been eliminated. Accordingly, the separate disclosures
for these prior business segments have been eliminated.
COMBINED RATIOS
Set forth below is certain statistical information for the Company prepared in
accordance with generally accepted accounting principles ("GAAP") and statutory
accounting principles ("SAP"), for the three years ended December 31, 2001. The
Loss Ratio is the ratio of net incurred losses and LAE to net premiums earned.
The Expense Ratio is the ratio of underwriting expenses (policy acquisition
costs, commissions, and a portion of administrative, general and other expenses
attributable to underwriting operations) to net premiums written, if determined
in accordance with SAP, or to net premiums earned, if determined in accordance
with GAAP. A Combined Ratio below 100% indicates an underwriting profit and a
Combined Ratio above 100% indicates an underwriting loss. The Combined Ratio
does not include the effect of investment income. For additional information on
the Company's combined ratios, see Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations," included elsewhere herein.
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YEARS ENDED DECEMBER 31,
2001 2000 1999
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Loss Ratio: (a)
GAAP 199.9% 141.9% 100.2%
SAP 199.9% 141.9% 100.2%
Industry (SAP) (b) N/A 81.2% 78.6%
Expense Ratio:
GAAP 61.8% 51.2% 39.7%
SAP 104.5% 50.4% 45.0%
Industry (SAP) (b) N/A 28.9% 29.2%
Combined Ratio:
GAAP 261.7% 193.1% 139.9%
SAP 304.4% 192.3% 145.2%
Industry (SAP) (b) N/A 110.1% 107.8%
(a) Includes Loss and Loss Adjustment Expenses.
(b) Source: Best's Aggregates & Averages, Property/Casualty, 2001 Edition.
Industry Combined Ratios may not be fully comparable as a result of, among
other things, differences in geographical concentration and in the mix of
property and casualty insurance products.
REINSURANCE
The Group's maximum retained limit for all lines of business was $0.3 million
per occurrence for all three years. Additionally, the Group entered into a
property catastrophe excess of loss treaty to protect against certain losses.
Its retention of lower level losses in this treaty was $7.5 million for each of
the three years. Due to the runoff of the Group's business and resulting reduced
loss exposure, the Group terminated its property catastrophe excess of loss
coverage effective January 1, 2002. In November 2001, the Group received
notification of cancellation of its multiple line reinsurance contract effective
January 1, 2002. The cancellation affects only personal lines policies renewed
on or after January 1, 2002, and would impact the Group for losses only on
policies that provided coverage in excess of its retained reinsurance limit of
$0.3 million. Currently, the Group has approximately 300 policies in force
(which may include multiple insureds and vehicles) that provide such coverage up
to a maximum loss of $0.5 million per occurrence. Under the pooling agreement,
70% of such losses would be assumed by Empire and 30% would be retained by the
Company. After reviewing its options of finding comparable reinsurance coverage,
the Group has decided not to replace this coverage.
Effective January 1, 1997, Empire entered into a quota share reinsurance
agreement with its subsidiary, Centurion. Under this agreement, Empire assumed
50% of the effective period premiums and losses of Centurion up to July 1, 1997
and 75% thereafter and granted Centurion a ceding commission. Under the pooling
agreement, 70% of such business assumed was retained by Empire and 30% was ceded
to the Company. This quota share reinsurance agreement was terminated effective
December 31, 2001 following the merger of Empire and Centurion.
Although reinsurance does not legally discharge an insurer from its primary
liability for the full amount of the policy liability, it does make the assuming
reinsurer liable to the insurer to the extent of the reinsurance ceded. The
Company's reinsurance, excluding the pooling agreement with Empire, generally
has been placed with certain of the largest reinsurance companies, including
(with their respective Best ratings) General Reinsurance Corporation (A++) and
Zurich Reinsurance (NA), Inc. (A+). The Company believes its reinsurers to be
financially capable of meeting their respective obligations. However, to the
extent that any reinsuring company is unable to meet its obligations, the
Company would be liable for the reinsured risks. The Company has established
reserves, which the Company believes are adequate, for any nonrecoverable
reinsurance.
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INVESTMENTS
Investment activities represent a significant part of the Company's total
income. Investments are managed by the Company's investment advisors under the
direction of, and upon consultation with, the Company's investment committee.
The Company has a diversified investment portfolio of securities, 95.0% of which
is rated "investment grade" by established bond rating agencies or issued or
guaranteed by the U.S. Treasury or by governmental agencies. At December 31,
2001, 2000 and 1999, the average yield of the Company's bond portfolio was
approximately 2.4%, 6.4% and 6.5%, respectively, and the average maturity of the
Company's bond portfolio at December 31, 2001, 2000 and 1999 was approximately
0.3 years, 2.2 years and 2.6 years, respectively.
TAX SHARING AGREEMENT
The Company has been included in the consolidated federal income tax returns of
Leucadia since 1993. Under the terms of the tax sharing agreement between
Leucadia and the Company, the Company computes its tax provision on a separate
return basis and is either charged its share of federal income tax resulting
from its taxable income or is credited for tax benefits resulting from its
losses to the extent it could use the losses on a separate return basis.
GOVERNMENT REGULATION
Insurance companies are subject to detailed regulation and supervision in the
states in which they transact business. Such regulation pertains to matters such
as approving policy forms and various premium rates, minimum reserves and loss
ratio requirements, the type and amount of investments, minimum capital and
surplus requirements, granting and revoking licenses to transact business,
levels of operations and regulating trade practices. Insurance companies are
required to file detailed annual reports with the supervising agencies in each
of the states in which they do business, and are subject to examination by such
agencies at any time. Increased regulation of insurance companies at the state
level and new regulation at the federal level is possible, although the Company
cannot predict the nature or extent of any such regulation or what impact it
would have on the Company's operations.
During the third quarter of 2001, the Department informed the Company and Empire
of its examination findings concerning the three-year period ended December 31,
1999. The triennial report was subsequently filed by the Department in November
2001. Among other matters, the Department's report indicated a loss and LAE
reserve deficiency for the Company and Empire. The Company and Empire responded
to the Department's examination findings and concluded that based on subsequent
adverse development recorded by the Company, the Department's reserve estimates
were within a reasonable actuarial range of acceptable estimates. As of
September 30, 2001, the Company's and Empire's reserve levels for losses and LAE
prior to December 31, 1999 were consistent with the Department's findings.
In addition, the triennial report noted that the Group's organizational
structure causes Empire's stand-alone statutory surplus to be reduced by a
statutory limitation on the carrying value of its investment in the Company and
Centurion. Empire submitted to the Department a plan for remedying its
stand-alone surplus deficiency, including the merger of Centurion into Empire,
which was approved by the Department and consummated in 2001. Empire's
stand-alone surplus at December 31, 2001 exceeded the minimum statutory surplus
requirement of $3.3 million by $7.8 million. In the event Empire's stand-alone
statutory surplus declines below the minimum in the future, no assurance can be
given that material adverse regulatory action will not be taken against Empire
or the Company.
The National Association of Insurance Commissioners ("NAIC") has adopted model
laws incorporating the concept of a "risk based capital" ("RBC") requirement for
insurance companies. Generally, the RBC formula is designed to measure the
adequacy of an insurer's statutory capital in relation to the risks inherent in
its business. The RBC formula is used by the states as an early warning tool to
identify weakly capitalized companies for the purpose of initiating regulatory
action. Although New York State has not adopted the RBC requirements for
property and casualty insurance companies, New York does require that property
and casualty insurers file the RBC information with the Department. The NAIC
also has adopted various ratios for insurance companies which, in addition to
the RBC ratio, are designed to serve as a tool to assist state regulators in
screening and analyzing the financial condition of insurance companies operating
in their respective states. The Company and Empire had certain NAIC ratios
outside of the acceptable range of results for the year ended December 31, 2001.
The Group is a member of state insurance funds, which provide certain protection
to policyholders of insolvent insurers doing business in those states. Due to
insolvencies of certain insurers, the Group has been assessed certain amounts
which have not been material and are likely to be assessed additional amounts by
state insurance funds. The Company believes that it has provided for all
anticipated assessments and that any additional assessments will not have a
material adverse effect on the Company's financial condition or results of
operations.
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LOSS AND LOSS ADJUSTMENT EXPENSES
Liabilities for unpaid losses, which are not discounted (except for certain
workers' compensation liabilities), and LAE are determined using case-basis
evaluations, statistical analyses and estimates for salvage and subrogation
recoverable and represent estimates of the ultimate claim costs of all unpaid
losses and LAE. Liabilities include a provision for losses that have occurred
but have not yet been reported. These estimates are subject to the effect of
trends in future claim severity and frequency experience. Adjustments to such
estimates are made from time to time due to changes in such trends as well as
changes in actual loss experience. These adjustments are reflected in current
earnings.
The Company relies upon standard actuarial ultimate loss projection techniques
to obtain estimates of liabilities for losses and LAE. These projections include
the extrapolation of both losses paid and incurred by business line and accident
year and implicitly consider the impact of inflation and claims settlement
patterns upon ultimate claim costs based upon historical patterns. In addition,
methods based upon average loss costs, reported claim counts and pure premiums
are reviewed in order to obtain a range of estimates for setting the reserve
levels. For further input, changes in operations in pertinent areas including
underwriting standards, product mix, claims management and legal climate are
periodically reviewed.
In the following table, the liability for losses and LAE of the Company, is
reconciled for each of the three years ended December 31, 2001. Included therein
are current year data and prior year development.
RECONCILIATION OF LIABILITY FOR LOSSES AND LAE
2001 2000 1999
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(IN THOUSANDS)
Net SAP liability for losses and LAE,
at beginning of the year $ 95,587 $ 113,602 $ 139,771
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Provision for losses and LAE for
claims occurring in the current year 17,747 27,880 36,524
Increase in estimated losses and LAE
for claims occurring in prior years 18,747 15,927 6,014
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Total incurred losses and LAE 36,494 43,807 42,538
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Losses and LAE payments for claims
occurring during:
Current year 5,703 8,920 12,382
Prior years 42,207 52,902 56,325
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47,910 61,822 68,707
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Net SAP liability for losses and LAE,
at end of year 84,171 95,587 113,602
Reinsurance recoverable 159,120 172,919 228,334
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Liability for losses and LAE at the
end of year as reported in the
financial statements (GAAP) $ 243,291 $ 268,506 $ 341,936
=============== ================= ================
The following table presents the development of balance sheet liabilities for
1991 through 2001 for the Company. The liability line at the top of the table
indicates the estimated liability for unpaid losses and LAE recorded at the
balance sheet date for each of the indicated years. The middle section of the
table shows the re-estimated amount of the previously recorded liability based
on experience as of the end of each succeeding year. As more information becomes
available and claims are settled, the estimated liabilities are adjusted upward
or downward with the effect of decreasing or increasing net income at the time
of adjustment. The lower section of the table shows the cumulative amount paid
with respect to the previously recorded liability as of the end of each
succeeding year.
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The "cumulative deficiency" represents the aggregate change in the estimates
over all prior years. For example, the initial 1991 liability estimate indicated
on the table of $84,178,000 has been re-estimated during the course of the
succeeding ten years, resulting in a re-estimated liability at December 31, 2001
of $102,493,000 or a deficiency of $18,315,000. If the re-estimated liability
were less than the liability initially established, a cumulative redundancy
would be indicated.
In evaluating this information it should be noted that each amount shown for
"cumulative deficiency" includes the effects of all changes in amounts for prior
periods. For example, the amount of the deficiency related to losses settled in
1995, but incurred in 1991, will be included in the cumulative deficiency amount
for 1991, 1992, 1993 and 1994. This table is not intended to and does not
present accident or policy year loss and LAE development data. Conditions and
trends that have affected development of the liability in the past may not
necessarily occur in the future. Accordingly, it would not be appropriate to
extrapolate future redundancies or deficiencies based on this table.
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Analysis of Loss and Loss Adjustment Expenses Development
(In thousands)
Year ended December 31,
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1991 1992 1993 1994 1995 1996 1997
Liability for Unpaid Losses and
Loss Adjustment Expense $ 84,178 $ 96,712 $106,115 $ 121,923 $ 142,718 $143,494 $145,260
Liability Re-estimated as of:
One year later $ 83,987 $ 96,516 $103,181 $ 132,189 $ 150,852 $151,798 $158,152
Two years later 83,341 97,208 112,176 140,620 160,686 163,378 163,609
Three years later 85,197 103,592 118,127 150,434 172,650 179,200 176,825
Four years later 88,928 108,430 124,375 160,542 182,318 184,693 188,951
Five years later 92,035 112,988 132,606 167,164 183,482 193,992
Six years later 95,273 118,446 137,669 166,893 190,009
Seven years later 99,467 121,715 137,462 171,364
Eight years later 101,505 121,383 139,982
Nine years later 101,276 122,922
Ten years later 102,493
Cumulative Deficiency $ (18,315)$ (26,210) $(33,867) $ (49,441) $ (47,291) $(50,498) $ (43,691)
========= ========= ========== ========== =========== ========== ===========
Cumulative Amount of Liability Paid Through:
One year later $ 26,852 $ 33,903 $ 35,048 $ 45,789 $ 60,382 $ 56,475 $ 55,875
Two years later 44,989 54,615 59,701 80,911 95,190 94,062 93,714
Three years later 59,336 71,653 81,680 105,977 121,900 122,811 126,295
Four years later 69,955 85,689 97,917 124,645 141,259 146,697 148,482
Five years later 77,965 95,938 109,083 136,791 156,006 162,875
Six years later 83,886 102,416 116,929 146,283 166,814
Seven years later 88,139 107,246 123,022 153,239
Eight years later 91,364 111,097 127,419
Nine years later 93,862 114,205
Ten years later 96,055
Net Liability - End of year $106,115 $ 121,923 $ 142,718 $143,494 $145,260
Reinsurance 184,718 219,676 257,161 262,593 272,266
---------- ---------- ----------- ---------- -----------
Gross Liability - End of year as shown above $290,833 $ 341,599 $ 399,879 $406,087 $417,526
========== ========== =========== ========== ===========
Net Re-Estimated Liability - Latest $139,982 $ 171,364 $ 190,009 $193,992 $188,951
Re-estimated Reinsurance - Latest 277,352 331,866 359,604 370,212 348,402
---------- ---------- ----------- ---------- -----------
Gross Re-estimated Liability - Latest $417,334 $ 503,230 $ 549,613 $564,204 $537,353
========== ========== =========== ========== ===========
Gross Cumulative Deficiency $(126,501) $(161,631) $(149,734) $(158,117) $ (119,827)
========== ========== =========== ========== ===========
Analysis of Loss and Loss Adjustment Expenses Development
(In thousands)
(Continued)
---------------------------------------
1998 1999 2000 2001
Liability for Unpaid Losses and
Loss Adjustment Expense $139,771 $ 113,602 $95,587 $ 84,171
Liability Re-estimated as of:
One year later $145,785 $ 129,529 $114,334 $ -
Two years later 162,692 149,102
Three years later 179,172
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative Deficiency $(39,401) $ (35,500) $ (18,747) $ -
========= =========== ========= ==========
Cumulative Amount of Liability Paid Through:
One year later $ 56,325 $ 52,902 $42,207 $ -
Two years later 97,887 87,448
Three years later 127,198
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Net Liability - End of year $139,771 $ 113,602 $95,587 $ 84,171
Reinsurance 294,461 228,334 172,919 159,120
--------- ----------- --------- ----------
Gross Liability - End of year as shown above $434,232 $ 341,936 $268,506 $243,291
========= =========== ========= ==========
Net Re-Estimated Liability - Latest $179,172 $ 149,102 $114,334
Re-estimated Reinsurance - Latest 328,782 248,894 170,732
--------- ----------- ---------
Gross Re-estimated Liability - Latest $507,954 $ 397,996 $285,066
========= =========== =========
Gross Cumulative Deficiency $(73,722) $ (56,060) $ (16,560)
========= =========== =========
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As reflected in the above table, the Company's reported loss and LAE reserves as
of the end of each calendar year were subsequently determined to be deficient.
This adverse development first became apparent to the Company during the 1995
calendar year, when an increase to prior years' reserves was recorded for the
first time. In each subsequent calendar year, the Company's recalculation of the
reserve balances for prior periods continued to result in higher reserve
estimates. These higher reserve estimates were reflected in the Company's annual
financial statements upon determination.
During the period from 1992 through 2001, the Company recorded in its Statements
of Operations total net adverse reserve development of $77.0 million, as
disclosed in the Reconciliation of Liability for Losses and LAE table for such
years. This adverse development was experienced in substantially all of the
Company's lines of insurance; however, the amount of reserve increases and the
periods in which the reserves were recorded were not the same for all lines of
insurance. On a calendar year basis, the aggregate $77.0 million adverse reserve
development was recorded, as set forth in the table below:
Redundancy/
(Deficiency)
Calendar year recorded (in thousands)
- ---------------------------- --------------
1992 $ 191
1993 196
1994 2,934
1995 (10,266)
1996 (8,134)
1997 (8,304)
1998 (12,891)
1999 (6,014)
2000 (15,927)
2001 (18,747)
----------
Prior year reserve development recorded 1992 to 2001 $(76,962)
This reserve development is reflected in the ten-year Analysis of Loss and Loss
Adjustment Expense Development table above; however, because the deficiency line
in the table is calculated on a cumulative basis, the $77.0 million of actual
adverse reserve development experienced by the Company is reported as
deficiencies in multiple years in the table. An examination of the adverse loss
reserve development recorded during 2001 will illustrate this point. During 2001
the Company recorded $18.7 million of adverse loss reserve development related
to claims incurred in years prior to 2001. This amount is reflected in the 2000
column of the table as a cumulative deficiency. However, since this adverse loss
reserve development related to claims incurred and whose settlement cost was
originally estimated in various periods prior to 2001, the cumulative deficiency
line in years prior to 2001 includes this adverse loss reserve development as
follows: 2000: $18.7 million; 1999: $19.6 million; 1998: $16.5 million; 1997:
$12.1 million; 1996: $9.3 million; 1995: $6.5 million; 1994: $4.5 million; 1993:
$2.5 million; 1992: $1.5 million; and 1991: $1.2 million. Because the cumulative
deficiencies reflected in the ten-year Analysis of Loss and Loss Adjustment
Expense Development table above add up to a much greater number than the actual
adverse development recorded by the Company, an understanding of the Company's
reserve deficiencies during 1991 to 2000 can only be obtained from an analysis
of the adverse reserve development actually recorded by the Company in its
financial statements in each year in the period, beginning in 1995 (the first
year in which adverse reserve development was recorded).
The information below identifies certain of the more significant trends and
events that the Company has experienced in recent years, resulting in the
Company's recognition of the adverse loss reserve development in 1995 and each
subsequent calendar year. As described below, the reserve development recorded
by the Company was caused by many factors, including initial loss ratio
estimates used by the Company that were subsequently found to be too low as a
result of actual loss experience, as well as factors external to the Company
that were not known at the time business was written. In addition, the long
period of time it takes to settle third-party liability claims in the New York
City marketplace further complicates the reserve estimation process. Frequently,
these claims are not received immediately after the accident occurs, and in
fact, a claimant can wait until just before the expiration of the statute of
limitations (three years from the date of the accident) to make a claim. Once
received, a claim may take several years until the claim reaches final
resolution in the New York City courts.
- 8 -
1995
- ----
In 1995, of the $10.3 million of adverse loss reserve development recorded by
the Company, $6.9 million was in the private passenger automobile line of
insurance. In 1994, the Company acquired a large block of assigned risk private
passenger automobile business that nearly doubled the volume previously written
by the Company. In 1995, losses began to develop in this line of insurance that
indicated a higher ultimate loss ratio than the Company had experienced on
similar blocks of assigned risk business from earlier periods, which experience
formed the basis of the Company's original loss estimate. As a result, the
Company increased its estimate for loss reserves for the assigned risk business
acquired in 1994 and earlier years.
1996, 1997 and 1998
- -------------------
For the years ended December 31, 1996, 1997, and 1998, the Company recorded
adverse loss reserve development of $ 8.1 million, $8.3 million and $12.9
million, respectively. For 1996, 1997 and 1998, these amounts included $6.0
million, $2.1 million and $4.2 million, respectively, in the commercial
automobile liability line, and $2.4 million, $3.3 million and $4.2 million,
respectively, in the commercial package liability line. Beginning in 1992, the
Company entered into new market segments of the voluntary commercial business
for automobile and general liability lines, including specialty programs for
sanitation trucks, gas stations, fuel oil deliveries and limousines. Initially,
the Company's loss ratio estimate for these new market segments was based upon
its experience with similar lines of business and standard actuarial ultimate
loss projection techniques, which consider expected loss ratios.
During 1996, claims began to develop unfavorably and the Company used such claim
development to revise the assumptions that had formed the basis of its actuarial
studies; as a consequence reserves were increased. The increase in ultimate loss
estimates did not become apparent prior to 1996, primarily due to the long
period of time it takes to settle claims in these new sub-lines of business. The
Company further increased its loss estimates and increased reserves for these
market segments in 1997 and 1998 as well. Except for the three-year period from
1996 to 1998, there has been no other material development for these market
segments first entered into in 1992.
In addition, during 1998 the Company's claim examiners began recording increases
in the expected settlement costs for 1997 accident year claims in other
sub-lines of the commercial automobile line of insurance in larger amounts than
previously expected. As a result, the 1997 accident year loss ratio for the
commercial automobile line is now currently estimated to be 130%, which is 30
points higher than the current estimate for the 1996 accident year and 50 points
higher than the current estimate for the 1995 accident year. Such a large change
in the loss experience for this book of business from prior experience was not
expected.
1999 and 2000
- -------------
In 1999 and 2000, the Company recorded adverse loss reserve development of $6.0
million and $15.9 million, respectively, of which $5.1 million and $6.1 million,
respectively, related to Personal Injury Protection ("PIP") coverage in all of
its automobile lines of insurance. The majority of the 1999 development resulted
from increased claim cost estimates for the 1998 accident year. It was during
1999 that the Company first began to experience greater severity (the amount
paid to a claimant) in automobile liability claims, which were subsequently
determined to be PIP related. Also during 1999, the Company started to see the
lengthening of the time from the date of loss to the date a claim was first
reported. This change in loss development patterns resulted in more claims being
reported at later dates, which further increased the Company's loss estimates.
In 1999, the Company incorporated this developing trend into its ultimate loss
estimate for PIP related claims and increased its loss reserves accordingly.
During the latter half of 2000, and in particular, the fourth quarter, the
Company experienced further unfavorable development in PIP claims. This
development occurred in all accident years from 1996 through 1999, with further
deterioration in the 1998 accident year being the most significant component.
The Company observed this unfavorable development with respect to both the
frequency and severity of claims. The Company incorporated the results of this
activity with that of developing industry trends into its actuarial valuation
for its PIP coverage and increased its loss reserve estimate.
In the past, the Company has written various commercial package and homeowner
policies that offer liability protection to the insured, and has exposure to
third party liability claims in these lines of insurance. During 2000, the
Company experienced newly reported and reopened liability claims with increased
severity for accident years 1998 and prior. As a result, the Company recognized
$4.5 million of loss reserve development for those accident years. One of the
primary reasons for the reopened claims was that the increase in severity made
certain types of liability claims that previously had lower settlement values
more attractive litigation candidates for plaintiff's attorneys.
- 9 -
Throughout 2000, the Company outsourced a significant portion of its claim
handling responsibilities to outside third party claim administrators. While the
Company anticipates that these administrators will be able to settle these
claims for smaller amounts than the Company was achieving, the LAE reserve
needed to be increased to recognize the fees due to the administrators. Such
fees are higher on a per claim basis than the Company's cost to handle claims
in-house. Accordingly, in 2000 the adverse loss reserve development recorded by
the Company included an increase to the LAE reserve of $3.3 million. The Company
has not recognized any reserve reduction for the potentially lower settlement
amounts that may be achieved by the third party administrators.
2001
- ----
For the year ended December 31, 2001, the Company recorded adverse loss reserve
development of $18.7 million. During 2001, the Company increased its reserve
estimates for its commercial package policies lines of business, primarily due
to increases in severity of liability claims for accident years 1998 and prior.
The Company has exposure for third party liability claims in many of its lines
of insurance. During 2001, there were several settlements and court decisions on
third party liability cases for amounts that are greater than the industry's or
the Company's historical experience for similar claims, which had formed the
basis for the Company's estimated loss reserves. While many of these decisions
are being appealed, these results may signal a change in the judicial
environment in the Company's marketplace. Accordingly, the Company has increased
its loss reserve estimate by $6.9 million due to an estimated increase in
severity for these exposures.
Reserve increases in 2001 also resulted from unfavorable development principally
in automobile lines of business for the 1998 through 2000 accident years,
primarily relating to PIP coverage and in its workers' compensation lines of
insurance. The Company believes that the increased loss estimates for PIP are
consistent with recent trends in the industry, and has increased loss reserves
for all automobile lines by $3.3 million for 2001. In addition, the Company also
increased its reserve for LAE by $7.0 million as a result of the increases to
its loss reserves and an increase in future overhead costs which will be
allocated to settle claims currently incurred.
For additional information, see Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," included elsewhere herein.
ITEM 2. PROPERTIES
- ------ ----------
The Group has entered into a four year lease expiring in 2005 for approximately
16,000 square feet in an office building located at 45 Main Street, Brooklyn,
New York. Under this lease, an additional 9,000 square feet has been leased for
a two year period expiring in 2003.
The Group also leases office space located in Mineola, New York and Boston,
Massachusetts under lease expiring in 2007 and 2003, respectively. The rental
charged to the Company for these facilities is prorated in accordance with the
pooling agreement described in "Pooling Agreement" under Item 1, herein.
ITEM 3. LEGAL PROCEEDINGS
- ------ -----------------
The Company is party to legal proceedings that are considered to be either
ordinary, routine litigation or incidental to its business. Based on discussion
with counsel, the Company does not believe that such litigation will have a
material effect on its financial position, results of operations or cash flows.
- 10 -
ITEM 10. EXECUTIVE OFFICERS OF REGISTRANT
- ------- --------------------------------
All executive officers of the Company are elected at a meeting of the Board of
Directors of the Company and serve at the pleasure of the Board of Directors. As
of March 14, 2002, the executive officers of the Company, their ages, the
positions held by them and the periods during which they have served in such
positions were as follows:
Name Age Position with Company Office Held Since
---- --- --------------------- -----------------
H.E. Scruggs, Jr. 45 President and Chief September 2000
Executive Officer
Rocco J. Nittoli 43 Chief Operating Officer February 2001
Edward A. Hayes 50 Senior Vice President November 1999
Christopher J. Gruttemeyer 36 Vice President December 2000
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
- ------ -----------------------------------------------------------------
MATTERS
-------
(A) MARKET INFORMATION
Effective February 25, 2002, the Company's common shares were delisted from the
Nasdaq Stock Market, Inc. ("Nasdaq") National Market System because of the
Company's failure to hold an annual shareholders' meeting in 2001 and to
otherwise meet Nasdaq's proxy solicitation requirements for the fiscal year
ended December 31, 2001, as required by Nasdaq's Marketplace Rules 4350(e) and
4350(g), respectively. The Company was also advised by Nasdaq that it had failed
to meet the minimum market value of publicly held shares and the minimum bid
price per share as required by Nasdaq's Marketplace Rules 4450(a)(2) and
4450(a)(5). The Company's common shares began trading over-the-counter on
February 25, 2002 under the same symbol, "ALCI." The following table sets forth,
for the calendar quarters indicated, the high and low closing trade price per
common share as reported by the Bloomberg Professional Service provided by
Bloomberg L.P. (for 2002) and as reported by the National Association of
Securities Dealers, Inc (for 2001 and 2000).
High Low
------ ------
1st Quarter 2002 $0.890 $0.310
(through March 14, 2002)
1st Quarter 2001 7.625 4.875
2nd " " 4.950 1.800
3rd " " 2.000 1.000
4th " " 1.500 0.200
1st Quarter 2000 9.750 5.875
2nd " " 9.250 6.875
3rd " " 11.500 8.000
4th " " 8.000 6.000
(B) HOLDERS
The number of shareholders of record of common shares at December 31, 2001 was
458.
(C) DIVIDENDS
The Company has paid no dividends on its common shares since 1975. The New York
Insurance Law prohibits New York domiciled property and casualty companies from
paying dividends except out of earned surplus. Without the approval of the
Department, no New York domestic property/ casualty insurer may declare or
distribute any dividend to shareholders which, together with any dividends
declared or distributed by it during the preceding twelve months, exceeds the
lesser of (1) 10% of statutory surplus to policyholders as shown in its last
statutory annual statement or (2) 100% of adjusted net investment income during
such period. Based on the above criteria, at December 31, 2001, $2.2 million was
available for distribution of dividends.
- 11 -
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data have been summarized from the Company's
consolidated financial statements and are qualified in their entirety by
reference to, and should be read in conjunction with, such consolidated
financial statements and Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" of this Report:
YEAR ENDED DECEMBER 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total Revenues $ 29,728 $ 42,303 $55,662 $ 92,070 $102,624
Net (Loss)/Income (a) $(18,048) $(30,800) $(3,731) $ 504 $ (83)
Basic and Diluted (Loss)/Earnings
Per share:
(Loss)/Income(a) $ (2.55) $ (4.35) $ (0.53) $ 0.07 $ (0.01)
a) Net (loss) income includes net securities gains/(losses) net of applicable
tax, as follows (in thousands, except per share amounts):
GAINS/(LOSSES) PER SHARE
-------------- ---------
2001 $ 1,870 $ 0.26
2000 (213) (0.03)
1999 (1,084) 0.15
1998 3,951 0.56
1997 (125) (0.02)
AT DECEMBER31,
-------------------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(IN THOUSANDS)
Total assets $ 302,240 $372,284 $490,520 $605,704 $640,249
Invested assets 129,639 163,873 205,246 234,039 271,736
Surplus note:
Face value 7,000 7,000 7,000 7,000 7,000
Accrued interest (a) 114 9,486 8,851 8,300 7,710
Common shareholders'
equity (b) 25,904 43,791 71,716 78,200 78,164
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
GAAP Combined Ratio(c) 261.7% 193.1% 139.9% 129.4% 119.3%
SAP Combined Ratio (c) 304.4% 192.3% 145.2% 134.4% 118.6%
Industry SAP Combined
Ratio (d) N/A 110.1% 107.8% 106.0% 101.6%
Premium to Surplus
Ratio (e) 0.3x 0.5x 0.5x 0.8x 1.1x
(a) Effective January 1, 1980, the Company issued a surplus note to Empire in
the principal amount of $7.0 million. During 2001, with the approval of the
Superintendent of Insurance of the State of New York (the
"Superintendent"), the Company paid Empire $9.9 million of interest that
had been accrued on the surplus note through September 30, 2001. For
further information on the surplus note, see Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations,
Liquidity and Capital Resources" elsewhere in this Report.
(b) Includes unrealized appreciation of approximately $0.7 million in 2001,
$0.6 million in 2000, $0.5 million in 1998 and $0.9 million in 1997 and
unrealized depreciation of approximately $2.3 million in 1999, all net of
tax, on investments classified as available for sale.
(c) For all years presented, the difference between the GAAP Combined Ratio and
the SAP Combined Ratio is affected by the accounting for certain costs,
which are treated differently under SAP and GAAP. In 2001, this difference
was more pronounced to the decline in the Company's net premiums written at
a rate faster than the decline in earned premiums. For 1998, the difference
in the accounting treatment for curtailment gains relating to the defined
benefit pension plans was the principal reason for the difference between
the GAAP Combined Ratio and the SAP Combined Ratio. For further information
about the Company's Combined Ratios, see Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations" elsewhere in
this Report.
(d) Source: Best's Aggregates & Averages, Property/Casualty, 2001 Edition.
Industry Combined Ratios may not be fully comparable as a result of, among
other things, differences in geographical concentration and in the mix of
property and casualty insurance products.
(e) Premium to Surplus Ratio was calculated by dividing annual statutory net
premiums written by statutory surplus at the end of the year.
- 12 -
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- ------ -----------------------------------------------------------------------
OF OPERATIONS
-------------
The purpose of this section is to discuss and analyze the Company's financial
condition, liquidity and capital resources and results of operations. This
analysis should be read in conjunction with the financial statements and related
notes which appear elsewhere in this Report.
VOLUNTARY LIQUIDATION (RUN-OFF OF COMPANY'S OPERATIONS)
During the past several years, the Group experienced poor underwriting results
and adverse reserve development in all of its lines of business. During 2001,
the Group explored its options for developing a new business model and strategy.
After evaluating these options, the Group announced in December 2001 that it had
determined that it was in the best interest of its shareholders and
policyholders to commence an orderly liquidation of all of its operations. The
Group will only accept business that it is obligated to accept by contract or
New York insurance law; it will not engage in any other business activities
except for its claims runoff operations. The voluntary liquidation of its
operations is expected to be substantially complete by 2005. Given the Group's
and the Company's current financial condition, the expected costs to be incurred
during the claims runoff period, and the inherent uncertainty over ultimate
claim settlement values, no assurance can be given that the Company's
shareholders will be able to receive any value at the conclusion of the
voluntary liquidation of its operations.
Pursuant to the pooling agreement, the Company has a net reinsurance recoverable
from Empire. As of December 31, 2001, the Company's reinsurance recoverable from
Empire is $130.6 million, representing 43% of the Company's total assets. While
this liability is reflected on Empire's stand-alone statutory financial
statements, Empire's statutory surplus (after deducting this liability) is $11.1
million as of December 31, 2001, which is $7.8 million above the minimum
required under New York insurance regulations. The Company currently believes
that its reinsurance recoverable from Empire is fully collectible; however,
further significant deterioration in Empire's surplus could impair Empire's
ability to pay the full amount due to the Company. Further, any adverse
regulatory action taken against Empire in the future could also impair the
Company's ability to fully collect its reinsurance recoverable.
As of March 8, 2002, the Group was rated "F" (in liquidation) by A.M. Best
Company ("Best") and rated "BB-" (marginal) by Standards & Poors Insurance
Rating Services ("S&P"). Given the Group's decision to commence an orderly
liquidation of all of its operations, the Best and S&P ratings are not expected
to have any impact on the Company's operations. As with all ratings, Best and
S&P ratings are subject to change at any time.
LIQUIDITY AND CAPITAL RESOURCES
In 2001 and 2000, net cash was used for operations as a result of a decrease in
premiums written and the payment of claims and operating expenses. As a result
of its decision to conduct an orderly liquidation of all of its operations, the
Company expects to report a net use of cash from operations resulting primarily
from the payment of claims and other expenses in excess of revenues generated
for the foreseeable future. During 2001, the Company replaced a significant
portion of its fixed maturities investment portfolio with shorter-term
investments in order to shorten its duration to match its cash needs.
- 13 -
At December 31, 2001 and 2000, the yield of the Company's fixed maturities
portfolio was 2.4% and 6.4%, respectively, with an average maturity of 0.3 years
and 2.2 years, respectively. Additionally, the Company has a diversified
investment portfolio of securities, 95.0% of which is rated "investment grade"
by established bond rating agencies or issued or guaranteed by the U.S. Treasury
or by governmental agencies. During 2001, $34.5 million of the Company's
investment in a limited partnership was liquidated and distributed to the
Company. The distribution proceeds were reinvested in short-term fixed
maturities. The Company's remaining balance in the limited partnership at
December 31, 2001 of $6.1 million consisted of short-term investments and cash
equivalents.
The Company maintains cash, short-term and readily marketable securities and
anticipates that the cash flow from investment income, maturities and sales of
short-term investments and fixed maturities will be sufficient to satisfy its
anticipated cash needs. During 2001, the Company realized capital gains of $1.9
million primarily due to the sale of fixed maturities to shorten the duration of
the portfolio. During 2000, the Company realized capital losses of $0.2 million
principally due to the sale of fixed maturities to satisfy operating cash needs.
The Company will continue to sell its investment portfolio and collect its
reinsurance receivables to generate the cash that will be required to settle its
loss and LAE reserves. At December 31, 2001, these assets totaled $291.0 million
as compared to the Company's loss and LAE reserves of $243.0 million. The
Company expects to settle approximately 80% of these liabilities within the next
three years. Additionally, the Company has not experienced any material default
in the payment of reinsurance claims due from its reinsurance providers.
At December 31, 2001, the Group's contractual cash obligations under its
operating leases total $4.0 million of which $1.0 million is due in less than 1
year, $1.8 million is due in 1 to 3 years, $1.0 million is due in 4 to 5 years
and $0.2 million is due after 5 years.
Effective January 1, 1980, the Company issued a surplus note to Empire in the
principal amount of $7.0 million. The surplus note provides, among other things,
for interest to be accrued on the principal of the note based on a bank's prime
rate at the end of the current calendar quarter. Neither the principal amount of
the surplus note nor the accrued interest may be paid, in whole or in part,
without the consent of the Superintendent and must be repaid, in whole or in
part, when so ordered by the Superintendent. During 2001, with the approval of
the Superintendent, the Company paid Empire $9.9 million of interest that had
been accrued on the surplus note through September 30, 2001.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles. The
preparation of these financial statements requires the Company to make estimates
and assumptions that affect the reported amounts in the financial statements and
disclosures of contingent assets and liabilities. On an on-going basis, the
Company evaluates all of these estimates and assumptions. Actual results could
differ from those estimates.
Liabilities for unpaid losses, which are not discounted (except for certain
workers' compensation liabilities), and LAE are determined using case-basis
evaluations, statistical analyses for losses incurred but not reported and
estimates for salvage and subrogation recoverable and represent estimates of the
ultimate claim costs of all unpaid losses and LAE. Liabilities include a
provision for losses that have occurred but have not yet been reported. These
estimates are subject to the effect of trends in future claim severity and
frequency experience. The Company relies upon standard actuarial ultimate loss
projection techniques to obtain estimates of liabilities for losses and LAE.
These projections include the extrapolation of both losses paid and incurred by
business line and accident year and implicitly consider the impact of inflation
and claims settlement patterns upon ultimate claim costs based upon historical
patterns. In addition, methods based upon average loss costs, reported claim
counts and pure premiums are reviewed in order to obtain a range of estimates
for setting the reserve levels. For further input, changes in operations in
pertinent areas including underwriting standards, product mix, claims management
and legal climate are periodically reviewed. Adjustments to such estimates are
made from time to time due to changes in such trends as well as changes in
actual loss experience. These adjustments are reflected in current earnings. The
liability for losses and LAE are based on estimates and assumptions and the
ultimate loss may differ.
- 14 -
The Company uses the liability method in providing for income taxes. Under the
liability method, deferred income taxes are provided at the enacted tax rates
for differences between the financial statement carrying amounts and tax bases
of assets and liabilities and for net operating loss carryforwards. The Company
records a valuation allowance to reduce its deferred taxes to the amount that is
more likely than not to be realized. If the Company were to determine that it
would be able to realize its deferred tax assets in the future in excess of its
net recorded amount, an adjustment would increase income in such period.
Similarly, if the Company were to determine that it would not be able to realize
all or part of its net deferred taxes in the future, an adjustment would be
charged to income in such period.
RESULTS OF OPERATIONS
The Company's pre-tax loss was $18.0 million, $17.9 million and $6.3 million for
the years ended December 31, 2001, 2000 and 1999, respectively. These amounts
were negatively impacted by adverse reserve development of prior years' reserves
of $18.7 million, $15.9 million and $6.0 million for 2001, 2000 and 1999,
respectively. The more significant trends and events that the Company has
experienced in recent years, which resulted in the recognition of the adverse
reserve development, are identified below following the Company's combined
ratios.
Net earned premium revenues of the Company were $18.3 million, $30.9 million and
$42.4 million for the years ended December 31, 2001, 2000 and 1999,
respectively. The Company's earned premiums declined in all lines of business
during 2001 as a result of actions announced during late 2000 and the first
quarter of 2001. During the fourth quarter of 2000, the Group announced that it
would no longer accept any new private passenger automobile policies. Existing
policies of private passenger automobile insurance will be either sold,
non-renewed or cancelled in accordance with New York insurance law. If the
private passenger automobile book of business is not sold, it is expected that
the Group will continue to issue renewal policies over the next several years as
required by applicable insurance law. In March 2001, the Group announced that,
effective immediately, it would no longer issue any new (as compared to renewal)
insurance policies and that it had filed plans of orderly withdrawal with the
New York Insurance Department as required. Commercial lines policies will be
non-renewed or canceled in accordance with New York insurance law or replaced by
Tower under the 2001 Tower Agreement for the sale of the Group's renewal rights.
Starting in the second quarter of 2001, Tower purchased the renewal rights for
substantially all of the Group's remaining lines of business, excluding private
passenger automobile and commercial automobile/garage, for a fee based on the
direct written premium actually renewed by Tower. The amount of the fee is
expected to be approximately $0.9 million of which the Company's share would be
$0.3 million. Existing policies of private passenger automobile insurance will
be either sold, non-renewed or cancelled in accordance with New York insurance
law. If the private passenger automobile book of business is not sold, it is
expected that the Group will continue to issue renewal policies over the next
several years as required by applicable insurance law. The Group will continue
to be responsible for the remaining term of its existing policies and all claims
incurred prior to the expiration of these policies. After the expiration of its
existing commercial lines policies, the Group will thereafter have no renewal
obligations for those policies. Under New York insurance law, the Group is
obligated to offer renewals of homeowners, dwelling fire, personal insurance
coverage and personal umbrella for a three-year policy period; however, the
Tower Agreement obligated Tower to offer their own policies as replacements for
the Group's policies. Excluding the remaining terms of existing policies that
the Group intends to either non-renew, cancel or that will be replaced by Tower,
as of December 31, 2001, the Group's in force premium volume totaled $11.1
million. As indicated above, these policies are primarily personal lines
policies whose volume will continue to decline as the Group exercises its
non-renewal rights under New York insurance law.
While earned premiums declined in almost all lines of business, the most
significant reductions in earned premiums during 2000 were in assigned risk
automobile ($4.4 million) and voluntary private passenger automobile ($4.4
million). Effective January 1, 2000, all policy renewal obligations for assigned
risk contracts were assigned to another insurance company. However, the Company
remains liable for the claim settlement costs for assigned risk claims that
occurred during the policy term. The decline in voluntary private passenger
automobile resulted from tighter underwriting standards, increased competition
and the Company's decision in 1999 to no longer accept new policies from those
agents who historically have had poor underwriting results. The Company's
termination of certain unprofitable agents also adversely affected premium
volume in other lines of business.
During the remaining term of the Company's policies that are being sold or
non-renewed at the expiration of the policy term, and for other policies which
may have to be renewed under New York insurance law, the Company's estimate of
losses for those policies will be based on its accumulated loss experience in
those lines of insurance as well as industry trends. The Company anticipates
that its accident year loss ratios for certain of these policies, in particular
private passenger automobile, will remain high reflecting the poor loss
experience that the Company and the insurance industry has experienced in the
past.
- 15 -
The NAIC has adopted model laws incorporating the concept of a "risk based
capital" ("RBC") requirement for insurance companies. Generally, the RBC formula
is designed to measure the adequacy of an insurer's statutory capital in
relation to the risks inherent in its business. The RBC formula is used by the
states as an early warning tool to identify weakly capitalized companies for the
purpose of initiating regulatory action. Although New York State has not adopted
the RBC requirements for property and casualty insurance companies, New York
does require that property and casualty insurers file the RBC information with
the Department. The NAIC also has adopted various ratios for insurance companies
which, in addition to the RBC ratio, are designed to serve as a tool to assist
state regulators in screening and analyzing the financial condition of insurance
companies operating in their respective states. The Company and Empire had
certain NAIC ratios outside of the acceptable range of results for the year
ended December 31, 2001.
During the third quarter of 2001, the Department informed the Company and Empire
of its examination findings concerning the three-year period ended December 31,
1999. The triennial report was subsequently filed by the Department in November
2001. Among other matters, the Department's report indicated a loss and LAE
reserve deficiency for the Company and Empire. The Company and Empire responded
to the Department's examination findings and concluded that based on subsequent
adverse development recorded by the Company, the Department's reserve estimates
were within a reasonable actuarial range of acceptable estimates. As of
September 30, 2001, the Company's and Empire's reserve levels for losses and LAE
prior to December 31, 1999 were consistent with the Department's findings.
In addition, the triennial report noted that the Group's organizational
structure causes Empire's stand-alone statutory surplus to be reduced by a
statutory limitation on the carrying value of its investment in the Company and
Centurion. Empire submitted to the Department a plan for remedying its
stand-alone surplus deficiency, including the merger of Centurion into Empire,
which was approved by the Department and consummated in 2001. Empire's
stand-alone surplus at December 31, 2001 exceeded the minimum statutory surplus
requirement of $3.3 million, by $7.8 million. In the event Empire's stand-alone
statutory surplus declines below the minimum in the future, no assurance can be
given that material adverse regulatory action will not be taken against Empire
or the Company.
The Company's combined ratios as determined under GAAP and SAP were as follows:
YEARS ENDED DECEMBER 31,
------------------------
2001 2000 1999
---- ---- ----
GAAP 261.7% 193.1% 139.9%
SAP 304.4% 192.3% 145.2%
The Company's combined ratios increased in 2001 primarily due to lower premium
volume coupled with unfavorable loss development from prior accident years and
an increase in the reserve for LAE as a result of the increases to its loss
reserves and an increase in future overhead costs that will be allocated to
settle claims currently incurred. The Company's combined ratios increased in
2000 primarily due to unfavorable loss reserve development from prior accident
years, increased LAE for newly outsourced claims and adverse development in LAE.
In addition, these ratios increased due to reduced service fees, higher 2000
accident year loss ratios, higher severance costs and overhead costs which,
although lower, had not declined commensurate with the reduced premium volume.
During 2001, the Company recorded adverse loss reserve development of $18.7
million. During 2001, the Company increased its reserve estimates for its
commercial package policies lines of business, primarily due to increases in
severity of liability claims for accident years 1998 and prior. The Company has
exposure for third party liability claims in many of its lines of insurance.
During 2001, there were several settlements and court decisions on third party
liability cases for amounts that are greater than the industry's or the
Company's historical experience for similar claims, which had formed the basis
for the Company's estimated loss reserves. While many of these decisions are
being appealed, these results may signal a change in the judicial environment in
the Company's marketplace. Accordingly, the Company has increased its loss
reserve estimate by $6.9 million due to an estimated increase in severity for
these exposures.
Reserve increases in 2001 also resulted from unfavorable development principally
in automobile lines of business for the 1998 through 2000 accident years,
primarily relating to PIP coverage and in its workers' compensation lines of
insurance. The Company believes that the increased loss estimates for PIP are
consistent with recent trends in the industry, and has increased loss reserves
for all automobile lines by $3.3 million for 2001. In addition, the Company also
increased its reserve for LAE by $7.0 million as a result of the increases to
its loss reserves and an increase in future overhead costs which will be
allocated to settle claims currently incurred.
- 16 -
As a result of the terrorist attacks on September 11, 2001 at the World Trade
Center, the Company recorded estimated incurred losses and LAE of $0.8 million,
primarily relating to business interruption coverage. Due to the recency and
nature of this event, the loss estimate is likely to be revised.
During 2000, the Company recorded adverse loss reserve development of $15.9
million, principally in the 1996 through 1999 accident years. This development
was attributable to an increase in the severity of PIP claims and an increase in
the frequency of liability claims in the private passenger automobile line ($2.8
million), an increase in the frequency of liability claims in the commercial
automobile line ($1.9 million), an increase in the frequency and severity of PIP
claims in the assigned risk automobile line ($1.4 million) and an increase in
the severity of certain liability claims in the commercial package policies
lines of business ($4.5 million). The increases in severity and frequency of
claims in automobile lines of business, particularly with respect to PIP claims,
are consistent with emerging industry trends in the New York City marketplace.
In addition, the Company increased its estimate for LAE by $3.3 million as a
result of the decision to outsource a significant amount of claim handling
functions in 2000. Claim files for workers' compensation, automobile no-fault
and automobile and other liability claims were outsourced at a cost greater than
the reserves previously recorded to handle the claims internally. The Group had
outsourced almost two-thirds of its claims. The Group was primarily handling
complex claims, first party claims and certain automobile liability and general
liability claims internally. Complex claims generally consist of those that have
potentially large settlement exposure and are not expected to settle quickly.
The Company had also increased its reserve estimate for claims handled
internally.
During 1999, the Company recorded adverse loss reserve development of $6
million, principally due to an increase in severity of 1998 accident year losses
in the assigned risk automobile and voluntary private passenger automobile
lines, and 1996 accident year losses in certain classes of the commercial
automobile line. As a result, the Company increased its reserves by $2.2 million
for assigned risk automobile, $1.5 million for voluntary private passenger
automobile and $1.4 million for commercial automobile lines.
During the period between 1984 and 1995, the Company entered into certain
retrospectively rated reinsurance contracts covering substantially all lines of
business, except worker's compensation. Under these contracts, the Company paid
the reinsurer provisional premiums that are subject to adjustment based on
subsequent loss development. Ceded premiums accrued under these contracts reduce
both net written and earned premiums during the period the retrospective
reinsurance premiums are accrued. If additional unfavorable loss development
emerges in future periods, the Company may be required to accrue additional
retrospective reinsurance premiums. As a consequence of its reserve increases,
the Company reduced premiums and pre-tax profits by $2.4 million, $1.4 million
and $1.4 million for the years ended December 31, 2001, 2000 and 1999,
respectively, to recognize reinsurance premiums due for 1995 and prior years
under retrospectively rated reinsurance agreements.
For all lines of property and casualty insurance business, the Company employs a
variety of standard actuarial ultimate loss projection techniques, statistical
analyses and case-basis evaluations to estimate its liability for unpaid losses.
The actuarial projections include an extrapolation of both losses paid and
incurred by business line and accident year and implicitly consider the impact
of inflation and claims settlement patterns upon ultimate claim costs based upon
historical patterns. These estimates are performed quarterly and consider any
changes in trends and actual loss experience. Any resulting change in the
estimate of the liability for unpaid losses, including those discussed above, is
reflected in current year earnings during the quarter the change in estimate is
identified.
The reserving process relies on the basic assumption that past experience is an
appropriate basis for predicting future events. The probable effects of current
developments, trends and other relevant matters are also considered. Since the
establishment of loss reserves is affected by many factors, some of which are
outside the Company's control or are affected by future conditions, reserving
for property and casualty claims is a complex and uncertain process requiring
the use of informed estimates and judgments. As additional experience and other
data become available and are reviewed, the Company's estimates and judgments
may be revised. Any negative changes in estimates could be material to future
results of operations and result in the surplus of the Company or Empire being
below the minimum required level.
In management's judgment, information currently available has been appropriately
considered in estimating the Company's loss reserves. The Company will continue
to evaluate the adequacy of its loss reserves on a quarterly basis,
incorporating any future changes in trends and actual loss experience, and
record adjustments to its loss reserves as appropriate.
- 17 -
Net investment income for 2001 was lower than 2000 due to a reduction in
investments held as a result of a decrease in premiums written and the payment
of claims and operating expenses as well as a reduction in investment yields
resulting from lower interest rates and the Company's decision to shorten the
duration of its investment portfolio. The reduction in 2000 was primarily as a
result of lower invested assets due to claim payments and a decrease in premiums
written. During 2001, the Company had realized capital gains of $1.9 million
primarily due to the sale of fixed maturities to shorten the duration of the
portfolio. During 2000, the Company had realized capital losses of $0.2 million
principally due to the sale of fixed maturities to satisfy operating cash needs.
The combination of other underwriting expenses incurred and the amortization of
deferred policy acquisition costs reflected a decrease of $5.1 million or 32.0%
in 2001 and approximately $3.1 million or 16.4% in 2000. The decrease in both
2001 and 2000 primarily related to the decline in premium revenue coupled with a
reduction in operating expenses. In addition, during 2001, the Company expensed
$2.6 million of deferred policy acquisition costs as their recoverability from
premiums and related investment income was no longer anticipated.
Due to the uncertainty of future taxable income necessary for realization of the
deferred tax asset, a valuation allowance has been provided as of December 31,
2001 and 2000 on the total amount of the deferred tax asset. Current income
taxes for 2000 reflect a benefit of $0.4 million for a change in the Company's
estimated prior year's federal tax liability.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"),
which is effective for all business combinations after June 30, 2001, Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"), which is effective for fiscal years beginning after
December 15, 2001, and Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations" ("SFAS 143"), which is effective
for fiscal years beginning after June 15, 2002. In August 2001, the FASB issued
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which is effective
for fiscal years beginning after December 15, 2001. SFAS 141 requires that
companies use the purchase method of accounting for all business combinations
initiated after June 30, 2001 and addresses the initial recognition and
measurement of goodwill and other intangible assets acquired in a business
combination. SFAS 142 addresses the initial recognition and measurement of
intangible assets acquired outside a business combination and the recognition
and measurement of goodwill and other intangible assets subsequent to
acquisition. SFAS 143 requires recognition of the fair value of liabilities
associated with the retirement of long-lived assets when a legal obligation to
incur such costs arises as a result of the acquisition, construction,
development and/or the normal operation of a long-lived asset. Upon recognition
of the liability, a corresponding asset is recorded and depreciated over the
remaining life of the long-lived asset. SFAS 144 requires that one accounting
model be used for the long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and broadens the presentation of
discontinued operations to include more disposal transactions and resolves
implementation issues. The Company has reviewed the impact of the implementation
of these pronouncements, and does not expect them to have a material effect on
the Company's financial position or results of operations.
IMPACT OF INFLATION
The Company, as well as the property and casualty insurance industry in general,
is affected by inflation. With respect to losses, the Company's claim severity
is affected by the impact of inflation on the cost of automobile repair parts,
medical costs and lost wages. The costs of adjusting claims and other
underwriting expenses have also been affected by inflationary pressures on
salaries and employee benefits. The Company receives rate increases based in
part upon its experience as well as the industry's experience. Accordingly,
premium increases generally follow the rate of inflation.
- 18 -
CAUTIONARY STATEMENT FOR FORWARD-LOOKING INFORMATION
Statements included in this Report may contain forward-looking statements
pursuant to the safe-harbor provisions of the Private Securities Litigation
Reform Act of 1995. Such forward-looking statements may relate, but are not
limited, to projections of revenues, income or loss, capital expenditures,
fluctuations in insurance reserves, plans for growth and future operations,
competition and regulation as well as assumptions relating to the foregoing.
Forward-looking statements are inherently subject to risks and uncertainties,
many of which cannot be predicted or quantified. When used in this Report, the
words "estimates", "expects", "anticipates", "believes", "plans", "intends" and
variations of such words and similar expressions are intended to identify
forward-looking statements that involve risks and uncertainties. Future events
and actual results could differ materially from those set forth in, contemplated
by or underlying the forward-looking statements. The factors that could cause
actual results to differ materially from those suggested by any such statements
include, but are not limited to, those discussed or identified from time to time
in the Company's public filings, including general economic and market
conditions, changes in domestic laws, regulations and taxes, changes in
competition and pricing environments, regional or general changes in asset
valuation, the occurrence of significant natural disasters, the inability to
reinsure certain risks economically, the adequacy of loss and LAE reserves,
prevailing interest rate levels, weather related conditions that may affect the
Company's operations, effectiveness of the Tower agreement, the ability to
attract and retain key personnel, adverse selection through renewals of the
Group's policies, regulatory approval of the Group's proposed actions in
response to the findings of the Department, adverse regulatory action against
the Group, developments in claims handling, including adverse litigation
developments, that could adversely affect the liquidation plan of the Group, the
Group's ability to manage the claims runoff, increased loss adjustment expenses
resulting from an extended claims run-off period, and changes in composition of
the Company's assets and liabilities through acquisitions or divestitures. Undue
reliance should not be placed on these forward-looking statements, which are
applicable only as of the date hereof. The Company undertakes no obligation to
revise or update these forward-looking statements to reflect events or
circumstances that arise after the date of this Report or to reflect the
occurrence of unanticipated events.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------- ----------------------------------------------------------
The following includes "forward-looking statements" that involve risks and
uncertainties. Actual results could differ materially from those projected in
the forward-looking statements.
The Company's market risk arises principally from interest rate risk related to
its investment portfolio. The Company does not enter into material derivative
financial instrument transactions.
The Company's investment portfolio is primarily classified as available for
sale, and consequently, is recorded on the balance sheet at fair value with
unrealized gains and losses reflected in shareholders' equity. Included in the
Company's investment portfolio are fixed income securities, which comprised
approximately 95.0% of the Company's total investment portfolio at December 31,
2001. These fixed income securities are primarily rated "investment grade" or
are U.S. governmental agency issued or guaranteed obligations, although limited
investments in "non-rated" or rated less than investment grade securities have
been made from time to time. The estimated weighted average remaining life of
these fixed income securities was approximately 0.3 years at December 31, 2001.
The Company's fixed income securities, like all fixed income instruments, are
subject to interest rate risk and will fall in value if market interest rates
increase. At December 31, 2000, fixed income securities comprised approximately
77.1% of the Company's investment portfolio and had an estimated weighted
average remaining life of 2.2 years. Expected maturities will differ from
contractual maturities because the borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties. The Company
currently manages the investment portfolio to maintain liquidity, maintain a
high level of quality, comply with applicable insurance industry regulations and
achieve an acceptable rate of return.
- 19 -
The following table provides information about the Company's fixed income
securities. The table presents principal cash flows by expected maturity dates.
EXPECTED MATURITY DATE
----------------------
2002 2003 2004 2005 2006 THEREAFTER TOTAL FAIR VALUE
---- ---- ---- ---- ---- ---------- ----- ----------
(DOLLARS IN THOUSANDS)
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities:
U.S. Government $94,961 $6,199 $6,192 - - $4,495 $111, 847 $111,847
Weighted Average Interest Rate 2.65% 4.94% 4.94% - - 7.07% - -
Other Fixed Maturities:
Rated Investment Grade $5,287 $3,895 $50 $25 - $1,538 $ 10,795 $ 10,795
Weighted Average Interest Rate 7.20% 7.75% 5.50% 5.50% - 7.13% - -
Held to Maturity Fixed Income
Securities:
U.S. Government $480 - - - - - $480 $489
Weighted Average Interest Rate 6.38% - - - - - - -
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------ -------------------------------------------
Financial Statements and supplementary data required by this Item 8 are set
forth at the pages indicated in Item 14(a) below.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------ ---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------- --------------------------------------------------
The information to be included under the caption "Nominees for Election as
Directors" in the Company's definitive proxy statement to be filed with the
Commission pursuant to Regulation 14 of the 1934 Act in connection with the 2002
Annual Meeting of Shareholders of the Company (the "Proxy Statement") is
incorporated herein by reference. In addition, reference is made to Item 10 in
Part I of this Report.
ITEM 11. EXECUTIVE COMPENSATION
- -------- ----------------------
The information to be included under the caption "Executive Compensation" in the
Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------
The information to be included under the caption "Security Ownership of certain
Beneficial Owners" in the Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------
The information to be included under the caption "Certain Relationships and
Related Transactions" in the Proxy Statement is incorporated herein by
reference.
- 20 -
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- -------- ----------------------------------------------------------------
(A) FINANCIAL STATEMENTS AND SCHEDULE.
1. The following Financial Statements of Allcity Insurance Company are
included in Item 8:
Report of Independent Accountants ................................ F2
Financial Statements:
Consolidated Balance Sheets as of December 31, 2001 and 2000 ........ F3
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999 ................................. F4
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 2001, 2000 and 1999 ............. F5
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 ................................. F6
Notes to Consolidated Financial Statements .......................... F7
Financial Statement Schedule:
Schedule VI - Supplemental Information Concerning
Property/Casualty Insurance Operations ........................... F27
2. The information for Schedules I, IV and V required to be filed pursuant to
Regulation S-X, Article 7 is contained in the Notes to Consolidated
Financial Statements and, therefore, these schedules have been omitted.
Schedule VI - Supplemental Information Concerning Property/Casualty
Insurance Operations has been included herein. All other required schedules
are not applicable.
(B) REPORTS ON FORM 8-K.
The Company filed current reports on Form 8-K dated March 1, 2001 and December
28, 2001 which set forth information under Item 5. "Other Events" and Item 7.
"Financial Statements and Exhibits."
(C) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K.
See attached Exhibit Index.
(D) FINANCIAL STATEMENTS REQUIRED BY REGULATION S-X.
See Item 14(a).
- 21 -
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.
ALLCITY INSURANCE COMPANY
April 1, 2002 By: /s/ Rocco J. Nittoli
-----------------------------------
Rocco J. Nittoli
Director, Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated and on the date set forth above.
/s/ H. E. Scruggs, Jr. /s/ Rocco J. Nittoli
- ------------------------------ ----------------------------------
H. E. Scruggs, Jr. Rocco J. Nittoli
Director, President and Chief Director, Chief Operating Officer
Executive Officer
/s/ Joseph S. Steinberg /s/ Martin B. Bernstein
- ------------------------------ ----------------------------------
Joseph S. Steinberg Martin B. Bernstein
Director, Chairman of the Board Director
/s/ Louis V. Siracusano /s/ Harry H. Wise
- ------------------------------ ----------------------------------
Louis V. Siracusano Harry H. Wise
Director Director
/s/ Daniel G. Stewart /s/ Thomas E. Mara
- ------------------------------ ----------------------------------
Daniel G. Stewart Thomas E. Mara
Director Director
/s/ Ian M. Cumming /s/ James E. Jordan
- ------------------------------ ----------------------------------
Ian M. Cumming James E. Jordan
Director Director
/s/ Lucius Theus /s/ Christopher J. Gruttemeyer
- ------------------------------ ----------------------------------
Lucius Theus Christopher J. Gruttemeyer
Director Director, Vice President
/s/ Joseph A. Orlando
- ------------------------------
Joseph A. Orlando
Director
- 22 -
EXHIBIT INDEX
- -------------
The following designated exhibits, as indicated below, are either filed
herewith (if indicated by an asterisk) or have heretofore been filed with the
Securities and Exchange Commission under the Securities Act of 1933 or the
Securities Exchange Act of 1934 and are incorporated herein by reference to such
filings.
Exhibit Number Description of Document
-------------- -----------------------
3 Corporate charter, as amended, and by-laws, as amended, of
the Company (incorporated by reference to Exhibit 3 of the
Company's Annual Report on Form 10-K for the year ended
December 31, 1994).
10(a) Pooling Agreement, as amended through March 31, 1992 between
Empire and the Company (incorporated by reference to Exhibit
10(a)-20 of the Company's Form 8 Amendment No. 1 of its
Annual Report on Form 10-K for the year ended December 31,
1981).
10(b) Centurion Agreement, made effective as of August 21, 1987 by
and between Empire and the Company, and Centurion
(incorporated by reference to Exhibit 10(e) of the Company's
Annual Report on Form 10-K for the year ended December 31,
1987).
- 23 -
Exhibit Number Description of Document
-------------- -----------------------
10(c) Tax Allocation Agreement dated February 28, 1989 among the
Company, PHLCORP, Inc., Empire, Centurion, Empire Livery
Services, Inc., Executroll Services Corporation, and Empall
Agency Incorporated (incorporated by reference to Exhibit
10(m) of the Company's Annual Report on Form 10-K for the
year ended December 31, 1988).
10(d) Quota Share Reinsurance Agreement between Empire Insurance
Company and Centurion Insurance Company (incorporated by
reference to Exhibit 10(i) of the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
10(e) Lease agreement dated June 27, 1996 between Empire Insurance
Company and Brooklyn Renaissance Plaza L.L.C., as Landlord,
BRPII L.L.C as sub-landlord (incorporated by reference to
Exhibit 10(a) of the Company's quarterly report on Form 10-Q
for the quarter ended March 31, 1997).
10(f) Sublease agreement dated November 9, 2000 between Empire
Insurance Company and The New York City School Construction
Authority (incorporated by reference to Exhibit 10(i) of the
Company's Annual Report on Form 10-K for the year ended
December 31, 2000).
10(g) Transfer Agreement dated February 28, 2001 between Empire
Insurance Company, Allcity Insurance Company, Centurion
Insurance Company and Tower Risk Management Corporation and
Tower Insurance Company of New York (incorporated by
reference to Exhibit 10(j) of the Company's Annual Report on
Form 10-K for the year ended December 31, 2000).
10(h) Lease agreement dated October 3, 2001 between Empire
Insurance Company and the Washington Group, LLC.*
10(i) Merger agreement dated October 5, 2001 between Empire
Insurance Company and Centurion Insurance Company.*
- 24 -
ITEM 8. Financial Statements and Supplementary Data
- ------ --------------------------------------------
PAGE
----
The following financial information is submitted herein:
Report of Independent Accountants F2
Consolidated Balance Sheets as of December 31, 2001 and 2000 F3
Consolidated Statements of Operations for the years
ended December 31, 2001, 2000 and 1999 F4
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 2001, 2000 and 1999 F5
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 F6
Notes to Consolidated Financial Statements F7
Financial Statement Schedule:
Schedule VI- Supplemental Insurance Information Concerning
Property/Casualty Insurance Operations for the years
ended December 31, 2001, 2000 and 1999 F27
-F1-
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Allcity Insurance Company:
In our opinion, the consolidated financial statements listed in the index
appearing under item 14(a)(1) of this Form 10-K present fairly, in all material
respects, the financial position of Allcity Insurance Company and its subsidiary
(a substantially owned subsidiary of Empire Insurance Company which is a wholly
owned subsidiary of Leucadia National Corporation) at December 31, 2001 and
2000, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 14(a)(1) of this Form 10-K presents fairly, in all material respects,
the information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and the financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and the
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the financial statements, the Company has decided to
limit its operations to paying existing obligations and accepting only business
that it is obligated to accept by contract or New York insurance law. As also
discussed in Note 1, the Company's majority shareholder and primary reinsurer
through a Pooling Arrangement, Empire Insurance Company, has reported limited
statutory surplus in its December 31, 2001 statutory financial statements and
further decreases in its statutory surplus may allow the New York Insurance
Department the ability to take material adverse regulatory actions against
Empire and the Company.
PricewaterhouseCoopers LLP
New York, New York
March 1, 2002
-F2-
CONSOLIDATED BALANCE SHEETS
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
(In thousands, except share and per share amounts)
DECEMBER 31,
--------------------
ASSETS 2001 2000
-------- -------
Investments:
Fixed maturities
Available for sale (amortized cost of
$23,872 in 2001 and $118,833 in 2000) $ 24,175 $119,029
Held to maturity (fair value
of $489 in 2001 and $483 in 2000) 480 486
Equity securities available for sale 429 375
Short-term 98,467 6,834
Other invested assets 6,088 37,149
-------- -------
TOTAL INVESTMENTS 129,639 163,873
Cash 36 77
Agents' balances, less allowance for
doubtful accounts ($837 in 2001 and
$1,770 in 2000) 2,873 5,773
Accrued investment income 464 2,329
Reinsurance balances receivable 160,713 174,629
Prepaid reinsurance premiums 3,785 17,748
Deferred policy acquisition costs -- 3,035
Other assets 4,730 4,820
-------- -------
TOTAL ASSETS $302,240 $372,284
======== =======
LIABILITIES
Unpaid losses $211,254 $239,051
Unpaid loss adjustment expenses 32,037 29,455
Unearned premiums 7,215 32,622
Due to affiliates 9,713 649
Reinsurance balances payable 949 1,505
Other liabilities 8,054 8,725
Surplus note 7,114 16,486
-------- -------
TOTAL LIABILITIES 276,336 328,493
-------- -------
SHAREHOLDERS' EQUITY
Common stock, $1 par value: 7,368,420
shares authorized; 7,078,625 shares issued
and outstanding in 2001 and 2000 7,079 7,079
Additional paid-in capital 9,331 9,331
Accumulated other comprehensive income 732 571
Retained earnings 8,762 26,810
-------- -------
TOTAL SHAREHOLDERS' EQUITY 25,904 43,791
-------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $302,240 $372,284
======== =======
See Notes to Consolidated Financial Statements.
-F3-
CONSOLIDATED STATEMENTS OF OPERATIONS
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
(In thousands, except shareand per share amounts)
YEARS ENDED DECEMBER 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
REVENUES
Premiums earned $ 18,258 $ 30,855 $ 42,448
Net investment income 9,159 11,443 12,466
Service fee income -- -- 2,032
Net securities gains/(losses) 1,870 (213) (1,668)
Other income 441 218 384
----------- ----------- -----------
29,728 42,303 55,662
----------- ----------- -----------
LOSSES AND EXPENSES
Losses 24,575 31,760 33,597
Loss adjustment expenses 11,919 12,047 8,941
Other underwriting expenses, less
deferrals of $1,783 in 2001, $7,413
in 2000 and $7,398 in 1999 5,925 8,009 9,547
Amortization of deferred policy
acquisition costs 4,818 7,793 9,348
Interest on surplus note 538 634 551
----------- ----------- -----------
47,775 60,243 61,984
----------- ----------- -----------
LOSS BEFORE FEDERAL INCOME TAXES (18,047) (17,940) (6,322)
FEDERAL INCOME TAXES
Current expense/(benefit) 1 (338) (49)
Deferred expense /(benefit) -- 13,198 (2,542)
----------- ----------- -----------
1 12,860 (2,591)
----------- ----------- -----------
NET LOSS $(18,048) $(30,800) $ (3,731)
=========== =========== ===========
Per share data, based on 7,078,625
average shares outstanding in 2001,
2000 and 1999
BASIC AND DILUTED LOSS PER SHARE $ (2.55) $ (4.35) $ (0.53)
=========== =========== ===========
See Notes to Consolidated Financial Statements.
-F4-
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(In thousands)
SHAREHOLDERS'EQUITY
- --------------------------------------------------------------------------------------------------------
ACCUMULATED TOTAL
ADDITIONAL OTHER SHARE-
COMMON STOCK PAID-IN COMPREHENSIVE RETAINED HOLDERS'
SHARES AMOUNT CAPITAL INCOME/(LOSS) EARNINGS EQUITY
------ ------ ------- ------------- -------- ------
Balance as of January 1, 1999 7,079 $7,079 $9,331 $449 $61,341 $78,200
--------
Comprehensive Loss:
Net loss for the year (3,731) (3,731)
Unrealized holding losses arising during
the period (net of deferred tax benefit
of $1,803) (3,349) (3,349)
Less reclassification of net securities
losses included in net loss (net of
deferred tax benefit of $321) 596 596
--------
Comprehensive Loss (6,484)
------ ------ ------- ------------- -------- ------
Balance as of December 31, 1999 7,079 7,079 9,331 (2,304) 57,610 71,716
--------
Comprehensive Loss:
Net loss for the year (30,800) (30,800)
Unrealized holding gains arising during
the period (net of deferred tax expense
of $1,240) 1,776 1,776
Less reclassification of net securities
losses included in net loss (net of
deferred tax of $0) 1,099 1,099
--------
Comprehensive Loss (27,925)
------ ------ ------- ------------- -------- ------
Balance as of December 31, 2000 7,079 7,079 9,331 571 26,810 43,791
Comprehensive Loss:
Net loss for the year (18,048) (18,048)
Unrealized holding gains arising during
the period (net of deferred tax
of $0) 272 272
Less reclassification of net securities
gains included in net loss (net of
deferred tax of $0) (111) (111)
--------
Comprehensive Loss (17,887)
------ ------ ------- ------------- -------- ------
Balance as of December 31, 2001 7,079 $7,079 $9,331 $ 732 $8,762 $25,904
====== ====== ======= ============= ======== =======
See Notes to Consolidated Financial Statements
-F5-
CONSOLIDATED STATEMENTS OF CASH FLOWS
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
(In thousands)
YEARS ENDED DECEMBER 31,
--------------------------------------------
2001 2000 1999
NET CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (18,048) $ (30,800) $ (3,731)
Adjustments to reconcile net loss
to net cash used for operating
activities:
Provision for deferred tax expense
(benefit) -- 13,198 (2,542)
Amortization of deferred policy
acquisition costs 4,818 7,793 9,348
Provision for doubtful accounts (933) (42) (5)
Net securities (gains)/losses (1,870) 213 1,668
Policy acquisition costs incurred
and deferred (1,783) (7,413) (7,398)
Net change in:
Agents' balances 3,833 384 3,905
Reinsurance balances receivable 13,916 55,564 65,801
Prepaid reinsurance premiums 13,963 4,534 15,409
Unpaid losses and loss adjustment
expenses (25,215) (73,430) (92,296)
Unearned premiums (25,407) (6,305) (25,045)
Due to(from)affiliates 9,064 (11,327) 15,674
Reinsurance balances payable (556) 788 (168)
Other, net 2,028 1,755 (2,000)
---------- ----------- -----------
NET CASH USED FOR OPERATING ACTIVITIES (26,190) (45,088) (21,380)
---------- ----------- -----------
NET CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of fixed maturities (28,380) (23,245) (186,831)
Net change in other invested assets 31,061 (3,274) (2,429)
Proceeds from sale of fixed maturities 33,256 67,560 181,863
Proceeds from maturities of fixed
maturities 91,755 3,185 15,974
Net change in short-term investments (91,633) 295 13,057
---------- ----------- -----------
NET CASH PROVIDED BY INVESTING ACTIVITIES 36,059 44,521 21,634
---------- ----------- -----------
NET CASH FLOWS FROM FINANCING ACTIVITIES
Interest on Surplus Note (9,910) -- --
---------- ----------- -----------
NET CASH USED FOR FINANCING ACTIVITIES (9,910) -- --
---------- ----------- -----------
NET (DECREASE)/INCREASE IN CASH (41) (567) 254
Cash at beginning of year 77 644 390
---------- ----------- -----------
Cash at the end of year $ 36 $ 77 $ 644
---------- ----------- -----------
Cash paid for federal income taxes $ - $ 1,583 $ 2,872
---------- ----------- -----------
See Notes to Consolidated Financial Statements.
-F6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 1-ORGANIZATION
Allcity Insurance Company ("Allcity" or the "Company") is a property and
casualty insurer and includes the results of its subsidiary, Empall Agency, Inc.
("Empall"). Empire Insurance Company ("Empire"), a property and casualty insurer
owns approximately 84.6% of the outstanding common shares of the Company. Empire
also owned 100% of the common shares of Centurion Insurance Company which merged
with Empire, effective December 31, 2001. Empire's common shares are 100% owned
and controlled, through subsidiaries, by Leucadia National Corporation
("Leucadia"). Additionally, Leucadia indirectly owns an additional 6.7% of the
outstanding common shares of the Company. The Company and Empire are sometimes
hereinafter collectively referred to as the Group.
The property and casualty insurance business written by Empire and Allcity is
subject to a pooling agreement under which premiums, losses, loss adjustment
expenses and other underwriting expenses, net of reinsurance, are shared on the
basis of 70% to Empire and 30% to Allcity. The pooling percentages have been
changed from time to time and may be changed in the future subject to New York
Insurance Department approval. Allcity has no employees of its own. Empire
provides administrative services and 30% of the related expenses are allocated
to Allcity.
Historically, the Group specialized in commercial and personal property and
casualty insurance business primarily in the New York metropolitan area. The
Group offered insurance products for vehicles (including medallion and
radio-controlled livery vehicles), general liability coverage, property coverage
(including mercantile and multi-family residential real estate) and workers'
compensation to commercial accounts and private passenger automobile and
homeowners products to individuals.
During the past several years, the Group experienced poor underwriting results
and adverse reserve development in all of its lines of business. During 2001,
the Group explored its options for developing a new business model and strategy.
After evaluating these options, the Group announced in December 2001 that it had
determined that it was in the best interest of its shareholders and
policyholders to commence an orderly liquidation of all of its operations. The
Group will only accept business that it is obligated to accept by contract or
New York insurance law; it will not engage in any other business activities
except for its claims runoff operations. The voluntary liquidation of its
operations is expected to be substantially complete by 2005.
During the third quarter of 2001, the Department informed the Company and Empire
of its examination findings concerning the three-year period ended December 31,
1999. The triennial report was subsequently filed by the Department in November
2001. Among other matters, the Department's report indicated a loss and loss
adjustment expenses ("LAE") reserve deficiency for the Company and Empire. The
Company and Empire responded to the Department's examination findings and
concluded that based on subsequent adverse development recorded by the Company,
the Department's reserve estimates were within a reasonable actuarial range of
acceptable estimates. As of September 30, 2001, the Company's and Empire's
reserve levels for losses and LAE prior to December 31, 1999 were consistent
with the Department's findings.
-F7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 1-ORGANIZATION--CONTINUED
In addition, the triennial report noted that the Group's organizational
structure causes Empire's stand-alone statutory surplus to be reduced by a
statutory limitation on the carrying value of its investment in the Company and
Centurion. Empire submitted to the New York Insurance Department (the
"Department") a plan for remedying its stand-alone surplus deficiency, including
the merger of Centurion into Empire, which was approved by the Department and
consummated in 2001. Empire's stand-alone surplus at December 31, 2001 exceeded
the minimum statutory surplus requirement of $3,300,000 by $7,771,000. In the
event Empire's stand-alone statutory surplus declines below the minimum in the
future, no assurance can be given that material adverse regulatory action will
not be taken against Empire or the Company.
In March 2001, the Group had announced that, effective immediately, it would no
longer issue any new (as compared to renewal) insurance policies in any lines of
business and that it had filed plans of orderly withdrawal with the Department
as required. Commercial lines policies are being non-renewed or canceled in
accordance with New York insurance law or replaced by Tower Insurance Company of
New York or Tower Risk Management (collectively, "Tower") under the 2001
agreement for the sale of the Group's renewal rights (the "Tower Agreement").
Starting in the second quarter of 2001, Tower purchased the renewal rights for
substantially all of the Group's remaining lines of business, excluding private
passenger automobile and commercial automobile/garage, for a fee based on the
direct written premiusm actually renewed by Tower. The amount of the fee is
expected to be approximately $900,000, of which the Company's share would be
$270,000. Existing policies of private passenger automobile insurance will be
either sold, non-renewed or cancelled in accordance with New York insurance law.
If the private passenger automobile book of business is not sold, it is expected
that the Group will continue to issue renewal policies over the next several
years as required by applicable insurance law. The Group will continue to be
responsible for the remaining term of its existing policies and all claims
incurred prior to the expiration of these policies. After the expiration of its
existing commercial lines policies, the Group will thereafter have no renewal
obligations for those policies. Under New York insurance law, the Group is
obligated to offer renewals of homeowners, dwelling fire, personal insurance
coverage and personal umbrella for a three-year policy period; however, the
Tower Agreement obligates Tower to offer their own policies as replacements for
the Group's policies. Excluding the remaining terms of existing policies that
the Group intends to either non-renew, cancel or that will be replaced by Tower,
as of December 31, 2001, the Group's in force premium volume totaled
$11,100,000. As indicated above, these policies are primarily personal lines
policies whose volume will continue to decline as the Group exercises its
non-renewal rights under New York insurance law.
-F8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 1-ORGANIZATION--CONTINUED
The National Association of Insurance Commissioners ("NAIC") has adopted model
laws incorporating the concept of a "risk based capital" ("RBC") requirement for
insurance companies. Generally, the RBC formula is designed to measure the
adequacy of an insurer's statutory capital in relation to the risks inherent in
its business. The RBC formula is used by the states as an early warning tool to
identify weakly capitalized companies for the purpose of initiating regulatory
action. Although New York State has not adopted the RBC requirements for
property and casualty insurance companies, New York does require that property
and casualty insurers file the RBC information with the Department. The NAIC
also has adopted various ratios for insurance companies which, in addition to
the RBC ratio, are designed to serve as a tool to assist state regulators in
screening and analyzing the financial condition of insurance companies operating
in their respective states. The Company and Empire had certain NAIC ratios
outside of the acceptable range of results for the year ended December 31, 2001.
The Company and Empire are licensed to transact insurance in the State of New
York with Empire being additionally licensed in Connecticut, Massachusetts,
Missouri, New Hampshire and New Jersey.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Empall.
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Critical Accounting Policies and Estimates: The preparation of financial
- ----------------------------------------------
statements in conformity with generally accepted accounting principles ("GAAP")
requires the Company to make estimates and assumptions that affect the reported
amounts in the financial statements and disclosures of contingent assets and
liabilities. On an ongoing basis, the Company evaluates all of these estimates
and assumptions. Actual results could differ from those estimates.
Liabilities for unpaid losses, which are not discounted (except for certain
workers' compensation liabilities), and LAE are determined using case-basis
evaluations, statistical analyses for losses incurred but not reported and
estimates for salvage and subrogation recoverable and represent estimates of the
ultimate claim costs of all unpaid losses and LAE. Liabilities include a
provision for losses that have occurred but have not yet been reported. These
estimates are subject to the effect of trends in future claim severity and
frequency experience. The Company relies upon standard actuarial ultimate loss
projection techniques to obtain estimates of liabilities for losses and LAE.
These projections include the extrapolation of both losses paid and incurred by
business line and accident year and implicitly consider the impact of inflation
and claims settlement patterns upon ultimate claim costs based upon historical
patterns. In addition, methods based upon average loss costs, reported claim
counts and pure premiums are reviewed in order to obtain a range of estimates
for setting the reserve levels. For further input, changes in operations in
pertinent areas including underwriting standards, product mix, claims management
and legal climate are periodically reviewed. Adjustments to such estimates are
made from time to time due to changes in such trends as well as changes in
actual loss experience. These adjustments are reflected in current earnings. The
liability for losses and LAE are based on estimates and assumptions and the
ultimate loss may differ.
-F9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-CONTINUED
The Company uses the liability method in providing for income taxes. Under the
liability method, deferred income taxes are provided at the enacted tax rates
for differences between the financial statement carrying amounts and tax bases
of assets and liabilities and for net operating loss carryforwards. The Company
records a valuation allowance to reduce its deferred taxes to the amount that is
more likely than not to be realized. If the Company were to determine that it
would be able to realize its deferred tax assets in the future in excess of its
net recorded amount, an adjustment would increase income in such period.
Similarly, if the Company were to determine that it would not be able to realize
all or part of its net deferred taxes in the future, an adjustment would be
charged to income in such period.
Investments: At acquisition, marketable debt and equity securities are
- -----------
designated as either (i) "held to maturity" and carried at amortized cost, (ii)
"trading" and carried at estimated fair value with differences between cost and
estimated fair value reflected in results of operations or (iii) "available for
sale" and carried at estimated fair value, with differences between cost and
estimated fair value being reflected as a separate component of shareholders'
equity, net of taxes. Other invested assets, which are designated as trading
securities, represent an investment in a limited partnership which invested
principally in convertible preferred stocks, convertible long-term debt
securities, limited partnerships, and common stocks sold, but not yet purchased.
At December 31, 2001, all of the underlying securities held by the limited
partnership were liquidated and a substantial portion of the proceeds were
distributed to the Company and reinvested in short-term fixed income securities.
The undistributed proceeds held by the limited partnership at December 31, 2001
were invested in short-term investments and cash equivalents. Short-term
investments are carried at cost which approximates fair value. Estimated fair
values are principally based on quoted market prices.
At December 31, 2001 and 2000, investments in fixed maturities on deposit with
the Department, which the Company has the intent and ability to hold to
maturity, are classified as "Investments held to maturity".
Investment income is reported when earned. Net securities gains or losses on the
sales of investments are determined on a specific identification basis.
Investments with an impairment in value considered to be other than temporary
are written down to estimated net realizable values.
Unearned Premiums: Unearned premiums have been calculated predominantly using
- -----------------
the daily pro rata method.
Reinsurance: Unpaid losses, unpaid LAE and unearned premiums are stated gross of
- -----------
reinsurance ceded. Premiums written and earned, losses and LAE paid and
incurred, and other underwriting expenses are stated net of reinsurance ceded.
Pension Cost: Empire funds actuarially determined pension costs as currently
- ------------
accrued; 30% of such pension costs are allocated to the Company.
-F10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-CONTINUED
Policy Acquisition Costs: Policy acquisition costs, which consisted of
- ---------------------------
commissions, premium taxes and certain other underwriting expenses (net of
reinsurance allowances), were deferred and amortized ratably over the terms of
the related policies. Deferred policy acquisition costs were limited to their
net realizable value after consideration of investment income on the related
premium. If recoverability of such costs from future premiums and related
investment income was not anticipated, the amounts not considered recoverable
were charged to operations. During 2001, the Company expensed $2,600,000 of
deferred policy acquisition costs as their recoverability from premiums and
related investment income was no longer anticipated.
Participating Policies: Participating business on workers' compensation lines
- -----------------------
constitutes approximately 1.4% of the Company's net premiums written for the
year ended December 31, 2001. Amounts transferred to the participating
policyholders' funds are determined by means of specific identification based
upon premium volume and loss experience. The amount of dividends to be paid to
participating policyholders is approved quarterly by the Board of Directors. The
amount of policyholders' dividends paid on participating policies was $35,000,
$59,000 and $133,000 in 2001, 2000 and 1999 respectively. Unpaid dividends to
participating policyholders are included as a liability in the consolidated
balance sheets.
Servicing Arrangements: Service fee income from assigned risk business acquired
- ----------------------
through contractual arrangements with other insurance companies was recognized
as revenue and earned over the life of the covered policies on a monthly
pro-rata method.
Service fee income for the administrative services, including underwriting,
policy issuance, premium collection and claims services, provided to the New
York Public Auto Pool (the "NYPAP") was recorded as a reduction to other
underwriting and loss adjustment expenses and was earned over the life of the
policies issued. The premiums and losses processed by the Company on behalf of
the NYPAP, which are not reflected in the consolidated financial statements for
the years ended December 31, are as follows (in thousands):
2001 2000 1999
------- ------- --------
Premiums Earned $ - $ - $ -
Losses Incurred (1,127) 231 (12,972)
Unpaid Losses 13,534 21,781 32,250
The premiums, losses and expenses of the business for which the Company provides
administrative services are reflected on the financial statements of those
insurance companies, including the Company, in New York State which are required
to participate in the NYPAP. In its role as a servicing carrier, the Company is
liable only for the LAE which are incurred to adjust and settle the claims
processed on behalf of the NYPAP. Liabilities for this LAE are determined using
case basis evaluations and statistical analyses.
Earnings Per Share: Earnings per share ("EPS") are based on the weighted average
- ------------------
number of common shares outstanding. There were no outstanding common stock
equivalents during 2001, 2000 and 1999 and therefore, basic and diluted EPS are
the same.
-F11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-CONTINUED
New Pronouncements: In June 2001, the Financial Accounting Standards Board
- -------------------
("FASB") issued Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("SFAS 141"), which is effective for all business combinations
after June 30, 2001, Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), which is effective for
fiscal years beginning after December 15, 2001, and Statement of Financial
Accounting Standards No. 143, "Accounting for Asset Retirement Obligations"
("SFAS 143"), which is effective for fiscal years beginning after June 15, 2002.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"), which is effective for fiscal years beginning after December 15, 2001.
SFAS 141 requires that companies use the purchase method of accounting for all
business combinations initiated after June 30, 2001 and addresses the initial
recognition and measurement of goodwill and other intangible assets acquired in
a business combination. SFAS 142 addresses the initial recognition and
measurement of intangible assets acquired outside a business combination and the
recognition and measurement of goodwill and other intangible assets subsequent
to acquisition. SFAS 143 requires recognition of the fair value of liabilities
associated with the retirement of long lived assets when a legal obligation to
incur such costs arises as a result of the acquisition, construction,
development and/or the normal operation of a long-lived asset. Upon recognition
of the liability, a corresponding asset is recorded and depreciated over the
remaining life of the long-lived asset. SFAS 144 requires that one accounting
model be used for the long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and broadens the presentation of
discontinued operations to include more disposal transactions and resolves
implementation issues. The Company has reviewed the impact of the implementation
of these pronouncements, and does not expect them to have a material effect on
the Company's financial position or results of operations.
NOTE 3-SURPLUS NOTE
Effective January 1, 1980, the Company issued a surplus note to Empire in the
principal amount of $7,000,000. Accrued but unpaid interest of $114,000 and
$9,486,000 as of December 31, 2001 and 2000, respectively, is included in the
balance due under the surplus note. The surplus note provides, among other
things, for interest to be accrued on the principal of the note based on a
bank's prime rate at the end of the current calendar quarter. Neither the
principal amount of the surplus note nor the accrued interest may be paid, in
whole or in part, without the consent of the Superintendent of Insurance of the
State of New York ("Superintendent") and must be repaid, in whole or in part,
when so ordered by the Superintendent. During 2001, with the approval of the
Superintendent, the Company paid Empire $9,910,000 of interest that had been
accrued on the surplus note through September 30, 2001.
-F12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 4-INVESTMENTS
Investment income by source is summarized as follows:
YEARS ENDED DECEMBER 31,
--------------------------
2001 2000 1999
---- ---- ----
(In thousands)
Investment income:
Fixed maturities $3,666 $ 8,077 $ 9,214
Other invested assets 3,440 3,273 2,430
Short-term investments 2,255 329 1,025
------- -------- --------
9,361 11,679 12,669
Less: Investment expenses 202 236 203
------- -------- --------
NET INVESTMENT INCOME $9,159 $11,443 $12,466
======= ======== ========
Investments at December 31, 2001 are summarized as follows:
GROSS UNREALIZED ESTIMATED
----------------
AMORTIZED APPRE- DEPRE- FAIR
COST CIATION CIATION VALUE
--------- ------ ------ ---------
(In thousands)
Available for sale:
U.S. Treasury securities
and obligations of U.S.
government agencies $12,349 $ 41 $ - $ 12,390
Mortgage-backed
securities 4,338 157 - 4,495
Foreign governments 75 - - 75
All other corporate bonds 7,110 105 - 7,215
--------- ------ ------ ---------
Total fixed maturities 23,872 303 - 24,175
--------- ------ ------ ---------
Equity securities - 429 - 429
--------- ------ ------ ---------
TOTAL INVESTMENTS
AVAILABLE FOR SALE 23,872 732 - 24,604
--------- ------ ------ ---------
Held to maturity:
U.S. Treasury securities 480 9 - 489
--------- ------ ------ ---------
TOTAL INVESTMENTS
HELD TO MATURITY 480 9 - 489
--------- ------ ------ ---------
Short-term 98,467 - - 98,467
Other invested assets 6,088 - - 6,088
--------- ------ ------ ---------
TOTAL INVESTMENTS $128,907 $ 741 $ - $129,648
========= ====== ====== =========
-F13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 4-INVESTMENTS-CONTINUED
Investments at December 31, 2000 are summarized as follows:
GROSS UNREALIZED ESTIMATED
----------------
AMORTIZED APPRE- DEPRE- FAIR
COST CIATION CIATION VALUE
--------- ------ ------ ---------
(In thousands)
Available for sale:
U.S. Treasury securities
and obligations of U.S.
government agencies $69,432 $ 142 $ 268 $ 69,306
Mortgage-backed
securities 9,310 66 3 9,373
Foreign governments 3,696 66 - 3,762
All other corporate bonds 36,395 370 177 36,588
--------- ------ ------ ---------
Total fixed maturities 118,833 644 448 119,029
--------- ------ ------ ---------
Equity securities - 375 - 375
--------- ------ ------ ---------
TOTAL INVESTMENTS
AVAILABLE FOR SALE 118,833 1,019 448 119,404
--------- ------ ------ ---------
Held to maturity:
U.S. Treasury securities 486 - 3 483
--------- ------ ------ ---------
TOTAL INVESTMENTS
HELD TO MATURITY 486 - 3 483
--------- ------ ------ ---------
Short-term 6,834 - - 6,834
Other invested assets 37,149 - - 37,149
--------- ------ ------ ---------
TOTAL INVESTMENTS $163,302 $1,019 $451 $163,870
========= ====== ====== =========
The amortized cost and estimated fair values of fixed maturities (including
short-term securities) at December 31, 2001 are shown as follows (in thousands):
AMORTIZED FAIR
COST VALUE
--------- ---------
Investments available for sale:
Due in one year or less $100,236 $100,248
Due after one year through five years 16,245 16,361
Due after five years through ten years - -
Thereafter 1,520 1,538
--------- ---------
Sub total 118,001 118,147
Mortgage-backed securities 4,338 4,495
--------- ---------
Sub total 122,339 122,642
Investments held to maturity:
Due after one year through five years 480 489
--------- ---------
TOTAL $122,819 $123,131
========= =========
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
The Company sold certain fixed maturities classified as available for sale
during 2001, 2000 and 1999 and realized gross pre-tax capital gains of
$1,891,000, $661,000 and $148,000, respectively, and gross pre-tax capital
losses of $21,000, $874,000 and $1,820,000, respectively.
-F14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 4-INVESTMENTS-CONTINUED
The changes in unrealized appreciation/(depreciation) on investments available
for sale were $161,000 and $4,115,000 before taxes for the years ended December
31, 2001 and 2000, respectively.
As of December 31, 2001 and 2000, a security with an amortized cost of
approximately $480,000 and $486,000 respectively, was on deposit with the
Department.
NOTE 5-STATUTORY INFORMATION
The following is a reconciliation of net loss and surplus as reported on a
statutory basis ("SAP") to net loss and shareholders' equity as determined in
conformity with GAAP (in thousands):
YEARS ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
Statutory net loss $(25,171) $(16,694) $(4,174)
Add (deduct):
Change in deferred policy acquisition
costs (3,035) (380) (1,950)
Change in allowances for doubtful
accounts 1,200 42 5
Policyholders' dividends 30 36 234
Sublease real estate commission 487 416 -
Capitalized systems development costs (1,100) (696) 582
Other postretirement benefits (46) (41) 253
Current tax benefit (expense) (1) 338 (688)
Deferred tax (expense) benefit - (13,198) 2,542
Interest on surplus note 9,372 (634) (551)
Other 216 11 16
-------- -------- -------
GAAP $(18,048) $(30,800) $(3,731)
======== ======== =======
DECEMBER 31,
--------------------------
2001 2000
------ ------
Statutory Shareholders' Equity and Surplus $ 29,013 $53,707
Add (deduct):
Deferred policy acquisition costs - 3,035
Non-admitted premiums receiavble,
less allowance for doubtful accounts 588 250
Sublease real estate commission 903 416
Capitalized systems development costs 825 1,926
Provision for unauthorized reinsurance 110 110
Policyholders' dividends - (30)
Other postretirement benefits (91) (45)
Net unrealized appreciation on investments 303 196
Surplus note (7,114) (16,486)
Other non-admitted assets 1,367 712
------ ------
GAAP $25,904 $43,791
====== ======
-F15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 5-STATUTORY INFORMATION--CONTINUED
The Company has paid no dividends on its common shares since 1975. The New York
Insurance Law prohibits New York domiciled property and casualty companies from
paying dividends except out of earned surplus. Without the approval of the
Department, no New York domestic property/casualty insurer may declare or
distribute any dividend to shareholders which, together with any dividends
declared or distributed by it during the preceding twelve months, exceeds the
lesser of (1) 10% of statutory surplus to policyholders as shown in its last
statutory annual statement or (2) 100% of adjusted net investment income during
such period. Based on the above criteria, at December 31, 2001, $2,201,000 was
available for distribution of dividends.
In 1998 the NAIC adopted the Codification of Statutory Accounting Principles
("Codification"), which replaces the current Accounting Practices and Procedures
manual as the NAIC's primary guidance on statutory accounting as of January 1,
2001. The Codification provides guidance for areas where statutory accounting
has been silent and changes current statutory accounting in some areas. The
Department adopted the Codification guidance (Regulation 172), effective January
1, 2001, but did not adopt several key provisions of the guidance. The Company
recorded a reduction to surplus of $267,000 representing the cumulative effect
of adoption of the Codification guidance in its statutory financial statements
for the quarter ended March 31, 2001 filed with the Department.
The NAIC has adopted model laws incorporating the concept of a "risk based
capital" ("RBC") requirement for insurance companies. Generally, the RBC formula
is designed to measure the adequacy of an insurer's statutory capital in
relation to the risks inherent in its business. The RBC formula is used by the
states as an early warning tool to identify weakly capitalized companies for the
purpose of initiating regulatory action. Although New York State has not adopted
the RBC requirements for property and casualty insurance companies, New York
does require that property and casualty insurers file the RBC information with
the Department. The NAIC also has adopted various ratios for insurance companies
which, in addition to the RBC ratio, are designed to serve as a tool to assist
state regulators in screening and analyzing the financial condition of insurance
companies operating in their respective states. The Company and Empire had
certain NAIC ratios outside of the acceptable range of results for the year
ended December 31, 2001.
For additional information on the Department's triennial examination of the
Company's statutory-basis financial statements as of December 31, 1999, See Note
1.
-F16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 6-AGENTS' BALANCES
Activity affecting the allowance for uncollectible agents' balances for the
years ended December 31, 2001, 2000 and 1999 is summarized as follows (in
thousands):
Balance at January 1, 1999 $1,817
Provision 1,130
Charge-offs, net of recoveries (1,135)
-----
Balance at December 31, 1999 1,812
Provision 386
Charge-offs, net of recoveries (428)
-----
Balance at December 31, 2000 1,770
Provision (516)
Charge-offs, net of recoveries (417)
-----
Balance at December 31, 2001 $ 837
=====
NOTE 7-UNPAID LOSSES AND LAE
In the following table, the liability for losses and LAE are reconciled for the
three years ended December 31, 2001, 2000 and 1999. Included therein are current
year data and prior year development.
RECONCILIATION OF LIABILITY FOR LOSSES AND LAE
2001 2000 1999
------- ------- -------
(In thousands)
Net SAP liability for losses and LAE,
net of reinsurance, at beginning of year $95,587 $113,602 $139,771
Provision for losses and LAE for claims
occurring in the current year 17,747 27,880 36,524
Increase in estimated losses and LAE
for claims occurring in prior years 18,747 15,927 6,014
------- ------- -------
Total incurred losses and LAE 36,494 43,807 42,538
------- ------- -------
Loss and LAE payments for claims
occurring during:
Current year 5,703 8,920 12,382
Prior years 42,207 52,902 56,325
------- ------- -------
47,910 61,822 68,707
------- ------- -------
Net SAP liability for losses and LAE,
at end of year 84,171 95,587 113,602
Reinsurance recoverable 159,120 172,919 228,334
------- ------- -------
Liability for losses and LAE
at end of year as reported in
financial statements (GAAP) $243,291 $268,506 $341,936
======= ======= =======
-F17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 7-UNPAID LOSSES AND LAE-CONTINUED
During 2001, the Company recorded adverse loss reserve development of
$18,747,000. During 2001, the Company increased its reserve estimates for its
commercial package policies lines of business, primarily due to increases in
severity of liability claims for accident years 1998 and prior. The Company has
exposure for third party liability claims in many of its lines of insurance.
During 2001, there were several settlements and court decisions on third party
liability cases for amounts that are greater than the industry's or the
Company's historical experience for similar claims, which had formed the basis
for the Company's estimated loss reserves. While many of these decisions are
being appealed, these results may signal a change in the judicial environment in
the Company's marketplace. Accordingly, the Company has increased its loss
reserve estimate by $6,900,000 due to an estimated increase in severity for
these exposures.
Reserve increases in 2001 also resulted from unfavorable development principally
in automobile lines of business for the 1998 through 2000 accident years,
primarily relating to personal injury protection coverage ("PIP") and in its
workers' compensation lines of insurance. The Company believes that the
increased loss estimates for PIP are consistent with recent trends in the
industry, and has increased loss reserves for all automobile lines by $3,300,000
for 2001. In addition, the Company also increased its reserve for LAE by
$7,000,000 as a result of the increases to its loss reserves and an increase in
future overhead costs which will be allocated to settle claims currently
incurred.
As a result of the terrorist attacks on September 11, 2001 at the World Trade
Center, the Company recorded estimated incurred losses and LAE of $800,000,
primarily relating to business interruption coverage. Due to the recency and
nature of this event, the loss estimate is likely to be revised.
During 2000, the Company recorded adverse loss reserve development of
$15,927,000, principally in the 1996 through 1999 accident years. This
development was attributable to an increase in the severity of PIP claims and an
increase in the frequency of liability claims in the private passenger
automobile line ($2,800,000), an increase in the frequency of liability claims
in the commercial automobile line ($1,900,000), an increase in the frequency and
severity of PIP claims in the assigned risk automobile line ($1,400,000) and an
increase in the severity of certain liability claims in the commercial package
policies lines of business ($4,500,000). The increases in severity and frequency
of claims in automobile lines of business, particularly with respect to PIP
claims, are consistent with emerging industry trends in the New York City
marketplace. In addition, the Company increased its estimate for LAE by
$3,300,000 as a result of the decision to outsource a significant amount of
claim handling functions in 2000. Claim files for workers' compensation,
automobile no-fault and automobile and other liability claims were outsourced at
a cost greater than the reserves previously recorded to handle the claims
internally. The Group had outsourced almost two-thirds of its claims. The Group
was primarily handling complex claims, first party claims and certain automobile
liability and general liability claims internally. Complex claims generally
consist of those that have potentially large settlement exposure and are not
expected to settle quickly. The Company had also increased its reserve estimate
for claims handled internally.
-F18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 7-UNPAID LOSSES AND LAE-CONTINUED
During 1999, the Company recorded adverse loss reserve development of
$6,014,000, principally due to an increase in severity of 1998 accident year
losses in the assigned risk automobile and voluntary private passenger
automobile lines, and 1996 accident year losses in certain classes of the
commercial automobile line. As a result, the Company increased its reserves by
$2,200,000 for assigned risk automobile, $1,500,000 for voluntary private
passenger automobile and $1,400,000 for commercial automobile lines.
The Company has purchased annuities with various life insurance companies for a
number of settled claims. The claimants have been designated as payees; however,
the Company has a contingent liability of approximately $6,800,000 which
represents the aggregate amount of settlements with the claimants, in the event
of the failure of the various life insurance companies to perform.
NOTE 8-REINSURANCE
The Group has obtained reinsurance coverage to reduce its risk of and exposure
to large insurance claims and catastrophes. For all three years, the Group's
maximum retained limit for all lines of business was $300,000 per occurrence.
Additionally, the Group entered into a property catastrophe excess of loss
treaty to protect against certain losses. Its retention of lower level losses
under this treaty was $7,500,000 for each of the three years. Due to the
geographic concentration of its business, the Group believes hurricanes,
windstorms and civil disturbances are its most significant exposures to
catastrophic losses. Computer modeling programs provided by independent
consultants are used to estimate exposure to such losses. Due to the runoff of
the Group's business and resulting reduced loss exposure, the Group terminated
its property catastrophe excess of loss coverage effective January 1, 2002. In
November 2001, the Group received notification of cancellation of its multiple
line reinsurance contract effective January 1, 2002. The cancellation affects
only personal lines policies renewed on or after January 1, 2002, and would
impact the Group for losses only on policies that provided coverage in excess of
its retained reinsurance limit of $300,000. Currently, the Group has
approximately 300 policies in force (which may include multiple insureds and
vehicles) that provide such coverage up to a maximum loss of $500,000 per
occurrence. Under the pooling agreement, 70% of such losses would be assumed by
Empire and 30% would be retained by the Company. After reviewing its options of
finding comparable reinsurance coverage, the Group has decided not to replace
this coverage.
Although reinsurance does not legally discharge an insurer from its primary
liability for the full amount of the policy liability, it does make the assuming
reinsurer liable to the insurer to the extent of the reinsurance ceded. The
Company's reinsurance, excluding the pooling agreement with Empire, generally
has been placed with certain of the largest reinsurance companies, including
(with their respective A.M Best & Co. ratings) General Reinsurance Corporation
(A++) and Zurich Reinsurance (NA), Inc. (A+). The Company believes its
reinsurers to be financially capable of meeting their respective obligations.
However, to the extent that any reinsuring company is unable to meet its
obligations, the Company would be liable for the reinsured risks. The Company
has established reserves, which the Company believes are adequate, for any
nonrecoverable reinsurance.
-F19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 8-REINSURANCE-CONTINUED
Effective January 1, 1997 Empire entered into a quota share reinsurance
agreement with its subsidiary, Centurion. Under this agreement, Empire assumed
50% up to July 1, 1997 and 75% thereafter of the effective period premiums and
losses of Centurion and granted Centurion a ceding commission. Under the pooling
agreement, 70% of such business assumed was retained by Empire and 30% was ceded
to the Company. This quota share reinsurance agreement was terminated effective
December 31, 2001 following the merger of Empire and Centurion.
Pursuant to the pooling agreement, the Company has a net reinsurance recoverable
from Empire. As of December 31, 2001, the Company's reinsurance recoverable from
Empire was $130,631,000, representing 43% of the Company's total assets. While
that liability is reflected on Empire's stand-alone statutory financial
statements, Empire's statutory surplus (after deducting this liability) is
$11,071,000 as of December 31, 2001, which is $7,771,000 above the minimum
required under New York insurance regulations. The Company currently believes
that its reinsurance recoverable from Empire is fully collectible; however,
further significant deterioration in Empire's surplus could impair Empire's
ability to pay the full amount due to the Company. Further, any adverse
regulatory action taken against Empire in the future could also impair the
Company's ability to fully collect its reinsurance recoverable.
Reinsurance receivable balances at December 31, 2001 and 2000 (including
$130,631,000 and $167,699,000, respectively, of reinsured amounts arising from
the intercompany pooling agreement with Empire) are as follows (in thousands):
CEDED TO
------------------------------
EMPIRE OTHERS TOTAL
------ ------ -----
As of December 31, 2001
Prepaid reinsurance premiums $ 3,752 $ 33 $ 3,785
Reinsurance balances receivable
on:
Paid losses - 1,593 1,593
Unpaid losses 108,033 32,241 140,274
Unpaid loss adjustment expenses 18,846 - 18,846
CEDED TO
------------------------------
EMPIRE OTHERS TOTAL
------ ------ -----
As of December 31, 2000
Prepaid reinsurance premiums $ 17,452 $ 296 $ 17,748
Reinsurance balances receivable
on:
Paid losses - 1,710 1,710
Unpaid losses 132,143 22,672 154,815
Unpaid loss adjustment expenses 18,104 - 18,104
-F20-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 8-REINSURANCE-CONTINUED
An analysis of reinsurance premiums, losses, LAE and commissions for the years
ended December 31, 2001, 2000 and 1999 are summarized as follows (in thousands):
DIRECT ASSUMED CEDED NET
-------- ---------------- ---------------- -------
EMPIRE OTHERS EMPIRE OTHERS
------ ------ ------ ------
2001
- ----
Premiums earned $ 38,593 $ 18,258 $305 $ 36,156 $2,742 $18,258
Losses incurred 61,224 24,575 275 45,547 15,952 24,575
LAE incurred 12,774 11,918 64 12,380 457 11,919
Commissions incurred 2,986 1,332 25 2,369 642 1,332
Premiums written 18,709 6,813 356 16,586 2,479 6,813
Losses paid 85,860 37,831 512 79,989 6,383 37,831
LAE Paid 11,714 10,076 67 11,321 457 10,079
Unearned premiums(a) 5,323 3,429 71 5,361 32 3,430
Unpaid losses (a) 186,191 70,980 383 154,333 32,241 70,980
Unpaid LAE (a) 26,922 13,192 - 26,923 - 13,191
2000
- ----
Premiums earned $ 56,407 $ 30,855 $(13) $ 52,868 $3,526 $30,855
Losses incurred 46,825 31,760 (303) 48,238 (1,716) 31,760
LAE incurred 9,453 12,047 (83) 13,296 (3,926) 12,047
Commissions incurred 8,317 5,175 (3) 7,512 802 5,175
Premiums written 49,893 29,084 (13) 46,268 3,612 29,084
Losses paid 112,872 49,604 80 102,405 10,547 49,604
LAE Paid 14,959 12,218 34 14,590 403 12,218
Unearned premiums(a) 25,207 14,874 20 24,931 296 14,874
Unpaid losses (a) 210,828 84,236 620 188,776 22,672 84,236
Unpaid LAE (a) 25,863 11,351 - 25,863 - 11,351
1999
- ----
Premiums earned $ 87,793 $ 42,448 $485 $ 81,528 $ 6,750 $42,448
Losses incurred 58,022 33,597 659 56,088 2,593 33,597
LAE incurred (6,302) 8,941 223 (6,316) 237 8,941
Commissions incurred 10,111 5,051 34 9,300 845 5,051
Premiums written 65,794 32,812 473 59,520 6,747 32,812
Losses paid 130,845 56,034 958 124,513 7,290 56,034
LAE Paid 13,289 12,673 107 12,853 543 12,673
(a) Amounts as reflected in the consolidated balance sheets can be derived by
adding together amounts for direct and assumed and subtracting from this sum 30%
of the amount ceded to Empire. The Company remains primarily liable for amounts
ceded to reinsurers for unpaid losses, LAE and unearned premiums to the extent
that the assuming reinsuring companies are unable to meet their obligations.
-F21-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 8-REINSURANCE-CONTINUED
PERCENTAGE
ASSUMED CEDED OF AMOUNT
DIRECT FROM TO NET ASSUMED
AMOUNT EMPIRE(a) EMPIRE(b) AMOUNT TO NET
-------- ---------- --------- -------- --------
Premiums written:
2001 $18,709 $ 7,169 $19,065 $ 6,813 105.2%
2000 $49,893 $29,071 $49,880 $29,084 100.0%
1999 $65,794 $33,285 $66,267 $32,812 101.4%
(a) Includes $356, $(13) and $473 assumed from non-affiliates in 2001,
2000 and 1999, respectively, before the effects of the pooling
agreement described in Note 1.
(b) Includes $2,479, $3,612 and $6,747 ceded to non-affiliates in 2001,
2000 and 1999, respectively, before the effects of the pooling
agreement described in Note 1.
NOTE 9-FEDERAL INCOME TAXES
The Company has been included in the consolidated federal income tax returns of
Leucadia since 1993. Under the terms of the tax sharing agreement between
Leucadia and the Company, the Company computes its tax provision on a separate
return basis and is either charged its share of federal income tax resulting
from its taxable income or is credited for tax benefits resulting from its
losses to the extent it could use the losses on a separate return basis.
The principal components of the deferred tax benefit at December 31, 2001 and
2000 were as follows (in thousands):
2001 2000
---- ----
Unpaid loss and loss adjustment
expense reserves $4,537 $4,014
Unearned premiums 240 1,041
Employee benefits and compensation 584 574
Interest accrued on surplus note 40 3,320
Allowance for doubtful accounts 200 620
Deferred policy acquisition costs - (1,062)
Sublease real estate commission (316) (146)
Pension plan curtailment gain (368) (344)
Unrealized appreciation on investments (256) (200)
Investment in a limited partnership - 476
Unamortized deferred income 637 681
Capitalized systems development costs (289) (674)
Tax loss carryforwards 20,282 10,068
Other, net (155) (183)
Deferred tax benefit 25,136 18,185
Valuation allowance (25,136) (18,185)
Total $ - $ -
------ ------
-F22-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 9-FEDERAL INCOME TAXES-CONTINUED
Due to the Company's uncertainty as to having future taxable income necessary
for realization of the deferred tax asset, a valuation allowance has been
provided as of December 31, 2001 and 2000 for the total amount of the deferred
tax asset.
For the years 2001, 2000 and 1999, the difference between the "expected"
statutory federal income tax and the actual income tax expense is as follows (in
thousands):
2001 2000 1999
Expected federal income tax (benefit)/expense $(6,316) $(6,279) $(2,213)
Establishment of deferred tax valuation allowance 6,951 18,185 -
Other (634) 954 (378)
------- ------- -------
Actual federal income tax expense /(benefit) $ 1 $12,860 $(2,591)
======= ======= =======
NOTE 10-PENSION PLAN AND POSTRETIREMENT BENEFITS
Effective January 1, 1999 Empire adopted a non-contributory defined contribution
plan. The contributions, ranging from 2% - 16% of employees' current pension
eligible compensation, are based on age and service life of the employee. These
contributions accumulate for participants on a tax-deferred basis. Participants
direct the investment of the contributions to their accounts. In accordance with
the pooling agreement, the Company shared 30% of the amount contributed by the
Group to the Plan ($624,000 and $682,000 in 2001 and 2000, respectively).
Empire provides certain health care and life insurance benefits for retired
employees. During 1996, Empire amended the eligibility requirement to only those
employees who had at least ten years of service and were at least 50 years of
age as of October 1, 1996. Prior to this amendment, substantially all of
Empire's employees were eligible for such benefits if they reached normal or
early retirement age while still working for Empire. As a result of this
amendment, the accumulated postretirement benefit obligation was reduced by
approximately $7,602,000 which has been amortized over three years. Those
benefits are provided through an insurance company whose premiums are based on
the cost of benefits paid during the year.
-F23-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 10-PENSION PLAN AND POSTRETIREMENT BENEFITS-CONTINUED
The following table sets forth certain information, before the effects of the
pooling arrangement, relating to Empire's unfunded substantive plan for
postretirement benefits (in thousands):
2001 2000
---- ----
Accumulated postretirement obligation
at beginning of year $4,934 $4,606
Service cost 35 33
Interest cost 351 355
Actuarial loss 104 239
Participant contributions 183 161
Benefits paid (479) (460)
----- -----
Accumulated postretirement obligation at
end of year 5,128 4,934
Unrecognized net gain from past
experience different from that assumed
and effects of changes in assumptions 433 541
----- -----
ACCRUED POSTRETIREMENT BENEFITS COST $5,561 $5,475
===== =====
COMPONENTS OF NET POSTRETIREMENT BENEFITS
2001 2000 1999
----- ----- ------
Service cost--benefits earned during the period $ 35 $ 33 $ 32
Interest cost on projected benefit obligation 351 355 363
Amortization of curtailment gain - - (1,900)
Net amortization and deferral (4) (19) -
----- ----- ------
PERIODIC POSTRETIREMENT BENEFITS COST/(INCOME) $ 382 $ 369 $(1,505)
===== ===== ======
In accordance with the pooling agreement, the Company's share of accrued
postretirement benefit cost and net periodic postretirement benefit income is
30% of the amounts reflected above and is included in other liabilities. In
determining the accumulated postretirement benefit obligation at December 31,
2001 and 2000, Empire utilized discount rates of 7.0% and 7.5%, respectively.
The assumed health care cost trend rates used in measuring the accumulated
postretirement benefit obligation were 9.5% for 2001 declining to an ultimate
rate of 5% by 2010. If the health care cost trend rates were increased by 1%,
the accumulated postretirement benefit obligation as of December 31, 2001 would
have increased by approximately $459,000 before the effects of the pooling
agreement. If the health care cost trend rates were decreased by 1%, the
accumulated postretirement benefit obligation as of December 31, 2001 would have
decreased by approximately $397,000 before the effects of the pooling agreement.
The effect of a 1% increase or decrease on the estimated aggregate of service
and interest cost for 2001, 2000 and 1999 would be immaterial.
Empire sponsors an Employees' Savings Plan (the "Savings Plan"), under which
each eligible employee may defer a portion of their annual compensation, subject
to certain limits. Empire matches contributions equal to 50% of the employee's
contributions up to a maximum of 3% of the employee's salary. A participant may
also contribute, from after-tax dollars, an amount, not to exceed 10% of annual
compensation. Empire's contributions to the Savings Plan were $299,000, $294,000
and $452,000 in 2001, 2000 and 1999, respectively. Under the pooling agreement,
the Company is obligated to provide 30% of Empire's contributions to the Savings
Plan.
-F24-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 11-LEASES
The Group has entered into a four year lease expiring in 2005 for approximately
16,000 square feet in an office building located at 45 Main Street, Brooklyn,
New York. Under this lease, an additional 9,000 square feet has been leased for
a two year period expiring in 2003. The Group also leases office space located
in Mineola, New York and Boston, Massachusetts under leases expiring in 2007 and
2003, respectively.
Future minimum rentals for the Group, which exclude escalation amounts, on
non-cancelable leases in the aggregate for each of the next five years and
thereafter are as follows (in thousands). The amounts below exclude future
minimum rentals and sublease amounts from the former corporate headquarters of
the Group. The Company is not an obligor under that lease agreement and it is
not subject to the pooling agreement as it is not an operating asset of the
Group commencing January 1, 2002.
2002 $ 968
2003 995
2004 847
2005 873
2006 196
Thereafter 163
------
Total $ 4,042
======
Rental expense for the Group for the years 2001, 2000 and 1999, (net of sublease
income), was $1,500,000, $3,800,000 and $3,300,000, respectively. The Company is
obligated to pay 30% of these rental charges in accordance with the pooling
agreement.
NOTE 12-BUSINESS SEGMENTS
As a result of the Company's underwriting actions described in Note 1 and a
consolidation of Empire Group's internal management organization in 2001, the
Company's prior business segments of Small Business Division, Mid-Market
Division and Personal Lines Division have been eliminated. Accordingly, the
disclosures for these prior business segments have been eliminated.
NOTE 13-FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's only material financial instruments are investments for which the
fair values are disclosed in Note 4 and the surplus note and short-term
investments, for which the carrying amounts approximate fair value.
NOTE 14-LITIGATION
The Company is a party to legal proceedings that are considered to be either
ordinary, routine litigation or incidental to its business. Based on discussions
with counsel, the Company does not believe that such litigation will have a
material effect on its financial position, results of operations or cash flows.
-F25-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
ALLCITY INSURANCE COMPANY AND SUBSIDIARY
NOTE 15-RELATED PARTIES
See Notes 1, 2, 3, 8, 9, 10 and 11 regarding Allcity's relationships with the
Group and Leucadia.
NOTE 16-SUMMARY OF UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of unaudited quarterly results of operations for 2001
and 2000 (in thousands, except per share amounts):
2001
------------------------------------
1ST 2ND 3RD 4TH
------ ------ ------ ------
Total Revenues $10,314 $ 7,715 $ 5,625 $ 6,074
Net (Loss)/Income (14,277) (780) (3,856) 865
Basic and Diluted Earnings/
(Loss)/Gain Per Share (2.02) (0.11) (0.54) 0.12
2000
------------------------------------
1ST 2ND 3RD 4TH
------ ------ ------ ------
Total Revenues $11,299 $10,907 $ 10,925 $ 9,172
Net Income/(Loss) 287 (564) (3,120) (27,403)
Basic and Diluted Earnings/
Gain/(Loss) Per Share 0.04 (0.08) (0.44) (3.87)
See Notes 1, 7 and 9 for certain additional information concerning results of
operations for 2001 and 2000.
-F26-
ALLCITY INSURANCE COMPANY
SCHEDULE VI - SUPPLEMENTAL INSURANCE INFORMATION
CONCERNING PROPERTY/ CASUALTY INSURANCE OPERATIONS
(Thousands of dollars)
- ---------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E COL. F COL. G COL. H
- ---------------------------------------------------------------------------------------------------------------
RESERVES CLAIMS AND CLAIM
FOR UNPAID ADJUSTMENT EXPENSES
DEFERRED CLAIMS DISCOUNT INCURRED RELATED TO
POLICY AND CLAIM IF ANY NET (1) (2)
ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT CURRENT PRIOR
COSTS EXPENSES COLUMN C (a) PREMIUMS PREMIUMS INCOME YEAR YEARS
- ---------------------------------------------------------------------------------------------------------------
Year ended 12/31/01 $ - $ 243,291 $ 621 $ 7,215 $ 18,258 $ 9,159 $ 17,747 $ 18,747
Year ended 12/31/00 3,035 268,506 239 32,622 30,855 11,443 27,880 15,927
Year ended 12/31/99 3,415 341,936 250 38,927 42,448 12,466 36,524 6,014
ALLCITY INSURANCE COMPANY
SCHEDULE VI - SUPPLEMENTAL INSURANCE INFORMATION
CONCERNING PROPERTY/ CASUALTY INSURANCE OPERATIONS
(Thousands of dollars)
(Continued)
- --------------------------------------------------------------------
COL. A COL. I COL. J COL. K COL. L
- --------------------------------------------------------------------
AMORTIZATION PAID
OF DEFERRED CLAIMS
POLICY OTHER AND CLAIM
ACQUISITION OPERATING PREMIUMS ADJUSTMENT
COSTS EXPENSES (b) WRITTEN EXPENSES
- --------------------------------------------------------------------
Year ended 12/31/01 $ 4,818 $ 5,925 $ 6,813 $47,910
Year ended 12/31/00 7,793 8,009 29,084 61,822
Year ended 12/31/99 9,348 7,515 32,812 68,707
(a) Liabilities for losses for certain long - term disability payments under
workers' compensation insurance are discounted at a maximum of 6%. The
liabilities discounted are deemed insignificant and do not have a material
effect on reported income.
(b) Other Operating Expenses are reflected net of service fee income and
exclude other income and interest on surplus note.
-F27-