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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1997 Commission File No. 1-12449
SCPIE HOLDINGS INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4557980
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
9441 West Olympic Boulevard, Beverly Hills, 90212-4015
California
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 551-5900
Securities registered pursuant Name of Exchange on which registered
to Section 12(b) of the Act
Common Stock, par value $0.0001 per share
(Title of Class) New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act
NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss. 229.405 of this chapter) 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]
The aggregate market value of the Registrant's voting stock held by
non-affiliates of the Registrant at March 16, 1998, was approximately
$396,001,337 (based upon the closing sales price of such date, as reported by
the Wall Street Journal).
At March 16, 1998, the Registrant had issued and outstanding an aggregate of
12,776,691 shares of its Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy statement for the Annual Meeting of Stockholders of Registrant to be
held on May 14, 1998 (only portions of which are incorporated by reference).
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PART I
ITEM 1. BUSINESS
SCPIE Holdings Inc. is the parent company of a group of insurance and
insurance-related companies conducting business principally in California. It
began operating as an independent publicly held company on January 29, 1997, as
the result of the merger of Southern California Physicians Insurance Exchange
("SCPIE" or the "Exchange") into SCPIE Indemnity Company, a California domiciled
insurance company and subsidiary of the Company ("SCPIE Indemnity"), and the
issuance of 9,994,652 shares of common stock of the Company to approximately
10,400 members of the Exchange in exchange for their membership interests in
SCPIE and 500,000 shares to SCPIE Indemnity (the "Reorganization"). On January
30, 1997, the Company sold an additional 2,300,000 shares in a public offering
of its common stock (the "Offering"). The common stock is listed on the New York
Stock Exchange ("NYSE") under the trading symbol "SKP."
For purposes of this Form 10-K report, the "Company" refers, at all times
prior to January 29, 1997, the effective date of the Reorganization, to the
Exchange and its subsidiaries, collectively, and at all times on or after such
effective date, to SCPIE Holdings Inc. and its subsidiaries, collectively; the
term "SCPIE Holdings" refers at all times to SCPIE Holdings Inc., excluding its
subsidiaries.
SCPIE Holdings was organized in February 1996, as a Delaware corporation. The
Company principally engages in conducting the business of its predecessor, the
Exchange, through its subsidiaries. The insurance company subsidiaries of SCPIE
Holdings include SCPIE Indemnity, American Healthcare Indemnity Company ("AHI")
and American Healthcare Specialty Insurance Company ("AHSIC"). AHI and AHSIC
were inactive insurance companies acquired by the Company in 1996 to expand the
Company's operations outside California. AHI, domiciled in Delaware, is licensed
to transact insurance in 46 states and the District of Columbia, and AHSIC,
domiciled in Arkansas, is authorized to issue policies as an excess and surplus
line insurer in four states. During 1997, SCPIE Holdings contributed $25.0
million and $23.0 million to the capital and surplus of AHI and AHSIC,
respectively. The other subsidiaries of SCPIE include SCPIE Insurance Services,
Inc., a California licensed insurance agency, and two companies providing
management services. The term "Insurance Subsidiaries" refers to SCPIE
Indemnity, AHI and AHSIC.
OVERVIEW
The Company is a leading provider of medical malpractice insurance in
California. The Company currently insures more than 9,000 California physicians
and oral and maxillofacial surgeons practicing alone or in medical groups or
clinics or other healthcare organizations. The Company also insures a variety of
other healthcare providers, including hospitals, emergency department
facilities, outpatient surgery centers and hemodialysis, clinical and pathology
laboratories.
The Company's total revenues and net income were $183.7 million and $32.2
million, respectively, for the year ended December 31, 1997 and were $173.4
million and $30.2 million, respectively, for the year ended December 31, 1996.
As of December 31, 1997, the Company had $888.4 million of total assets and
$361.1 million of total stockholders' equity.
Medical malpractice insurance, or medical professional liability insurance,
insures the physician, hospital or other healthcare provider against liabilities
arising from the rendering of, or failure to render professional medical
services. Under the typical medical malpractice insurance policy, the insurer
also defends the insured against potentially covered claims. Based on data
compiled by A.M. Best & Co. ("A.M. Best"), in 1996, total medical malpractice
premiums in the United States were approximately $6.0 billion. In California,
the second largest market for medical malpractice insurance based on direct
premiums written, approximately $623.7 million of medical malpractice premiums
were written in 1996. The Company's share of the medical malpractice premiums
written in California in 1996 was approximately 20%. The Company's market share
is substantially higher in Southern California where more than 95% of the
Company's insureds are located.
The Company believes that its considerable market share for medical
malpractice insurance in California is in large part due to the loyalty of its
insured physicians. The Company attributes this loyalty to the high quality,
personalized service it provides and its traditional focus on the California
physician marketplace. Ten county medical associations and several specialty
societies in California have endorsed the medical malpractice insurance offered
by the Company.
The Company believes that the growth in managed healthcare and the emergence of
multi-state integrated healthcare providers and delivery systems will lead to
major changes in the medical malpractice insurance industry. Practice management
organizations,
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hospitals, administrators of large group practices and managed care
organizations have an increasing influence over the purchasing decision for the
medical malpractice insurance coverages of their affiliated physicians. As the
consolidation of healthcare providers continues, the number of physicians
insured through such organizations will increase and the Company believes that
such organizations increasingly will seek well-capitalized medical malpractice
insurers that can provide a full range of products and a high level of service
in each state in which such organizations conduct business.
BUSINESS STRATEGY
To position the Company to compete and grow its business successfully in this
changing environment, the Company has adopted a strategy that includes: (i)
expanding the Company's product offerings, particularly to meet the liability
insurance needs of larger, more diverse healthcare entities; (ii) diversifying
geographically by increasing writings of medical malpractice insurance in states
other than California; (iii) positioning the Company to take advantage of
acquisition and consolidation opportunities relating to medical malpractice
insurance; (iv) maintaining the Company's relationship with its primary
policyholder base of California physician and medical group insureds; and (v)
maintaining sufficient capital to take advantage of future market opportunities
and to retain strong insurance ratings.
While professional liability insurance for physicians is the principal product
offered by the Company, the Company believes that providing insurance to
hospitals and other healthcare entities continues to represent a significant
area for further growth of its insurance business. As a result, the Company has
undertaken to develop other insurance products necessitated by changes in the
healthcare industry and began writing medical malpractice insurance for
hospitals, directors and officers liability insurance for healthcare entities,
and errors and omissions coverage for managed care organizations. The Company
presently intends to continue its efforts to develop insurance products designed
to meet the needs of customers in the healthcare market.
In addition to its traditional direct insurance operations, the Company
assumes reinsurance of medical malpractice insurance and participates in excess
medical malpractice insurance programs. The Company believes that these lines of
business will become an increasingly important aspect of its operations as
healthcare entities become larger and obtain higher policy limits.
To further enable it to grow, the Company has begun to expand its operations
beyond California. As part of this expansion, the Company entered into an
exclusive marketing agreement with a leading hospital malpractice insurance
broker in August 1995. Under the agreement, this insurance broker had the
exclusive right to market the Company's malpractice coverage for hospitals in
all states, and the Company recognized this insurance broker as the exclusive
broker for medical group coverage in all states other than California. In
December 1996, this insurance broker filed for bankruptcy in the United States
Bankruptcy Court, Central District of California, and another insurance company
acquired its assets in September 1997 in a court-approved transaction. Effective
October 1, 1997, the Company and this insurance broker mutually agreed to
terminate their exclusive marketing agreement. The Company now actively markets
its hospital policies under a new program directly and through regional and
local brokers, and must compete with this broker and a number of insurance
companies in the underwriting of hospital malpractice policies. At December 31,
1997, the Company insured 88 hospitals, of which 52 were located in California.
AHI has formed a relationship with Poe & Brown, Inc. ("Poe & Brown"), one of
the nation's top independent insurance agency organizations, to provide
professional liability insurance to physicians commencing January 1, 1998. This
coverage is offered to solo physicians and medical groups in eight states, the
largest being Connecticut, Florida and Georgia. This replaces an existing
program Poe & Brown had established with another insurance company. There is no
assurance, however, that the Company will successfully retain or expand this
business through Poe & Brown or that it will ultimately be profitable. Pending
completion of a definitive agreement with Poe & Brown and the obtaining of
certain regulatory approvals, the Company is providing this coverage through a
reinsurance arrangement with the insurer of the existing program.
AHI has acquired the medical malpractice insurance business of Fremont
Indemnity Company ("Fremont") through a purchase agreement effective January 1,
1998. Simultaneously, a 100% quota-share agreement went into effect, making
SCPIE Indemnity, an affiliate of AHI, the reinsurer for the Fremont policies
pending regulatory approval of AHI to write this business directly. The Fremont
policies are written through brokers in 10 states, with the vast majority in
California and Arizona. At December 31, 1997, Fremont insured approximately
2,000 physicians, chiropractors, podiatrists and other healthcare providers.
There is no assurance that the Company will successfully maintain the Fremont
brokerage relationship or retain the existing insureds under the Fremont
program.
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The Company believes that the medical malpractice insurance industry in
California and other states is currently experiencing a "soft insurance market,"
that is, an insurance market in which the underwriting capacity exceeds current
demand and premium rates are relatively low. The Company believes that its
strategy will position it to expand premium writings and market share when the
market "hardens," that is, when demand coincides more closely with capacity, and
premium rates increase to more appropriate levels.
PRODUCTS
The Company underwrites professional and related liability policy coverages
for physicians (including oral and maxillofacial surgeons), physician medical
groups and clinics, hospitals, managed care organizations and other providers in
the healthcare industry. The following table summarizes, by product, the direct
premiums written by the Company for the periods indicated:
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
-------- -------- --------
Physician and medical group
liability:
Physician and medical group
standard professional
liability ................. $109,393 $117,679 $116,894
Special risk physicians ...... 1,700 1,398 674
Emergency medicine program ... 1,589 628 596
Urgent care centers .......... 277 262 224
-------- -------- --------
Subtotal medical liability 112,959 119,967 118,388
Excess personal liability .... 756 829 877
-------- -------- --------
Subtotal physician and
medical group liability . 113,715 120,796 119,265
Hospital liability ............. 8,475 3,487 2,103
Healthcare provider liability .. 800 792 757
Managed care organization errors
and omissions ................ 668 347 105
Directors and officers
liability .................... 252 213 47
-------- -------- --------
Total ........................ $123,910 $125,635 $122,277
======== ======== ========
Through its insurance agency subsidiary, the Company meets a wide range of
insurance needs of its customers by offering, on a brokerage basis, coverages
not underwritten by the Company, including a comprehensive property protection
program and stop loss insurance related to the provision of managed care
services. The Company intends, in the future, to directly underwrite its own
property lines as part of its overall strategy to meet the principal insurance
needs of healthcare providers.
Physician and Medical Group Liability. The Company offers separate policy
forms for physicians who are sole practitioners and for those who practice as
part of a medical group or clinic. The policy issued to sole practitioners
includes coverage for professional liability that arises in the medical practice
and also for certain other "premises" liabilities that may arise in the
non-professional operations of the medical practice, such as slip and fall
accidents, and a limited defense reimbursement benefit for proceedings by
governmental disciplinary boards. The professional liability insurance for sole
practitioners and for medical groups provides protection against the legal
liability of the insureds for such things as injury caused by or as a result of
the performance of patient treatment, failure to treat and failure to diagnose a
patient.
The policy issued to medical groups and their physician members includes not
only professional liability coverage and defense reimbursement benefits, but
also substantially more comprehensive coverages for commercial general liability
and employee benefit program liability and also provides a small medical payment
benefit to injured persons. The comprehensive general liability coverage
included in the medical group policy does not exclude coverage for certain
employment-related liabilities and for pollution, which are normally excluded
under a standard commercial general liability form. The Company also offers, as
part of its standard policy forms for both sole and group practitioners,
optional excess personal liability for the insured physicians. Excess personal
liability insurance provides coverage to the physician for personal liabilities
in excess of amounts covered under the physician's homeowners and automobile
policies.
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The professional liability coverages are issued primarily on a "claims made and
reported" basis. Coverage is provided for claims reported to the Company during
the policy period arising from incidents that occurred at any time the insured
was covered by the policy. The Company also offers "tail coverage" for claims
reported after the expiration of the policy for occurrences during the coverage
period. The price of the tail coverage is based on the length of time the
insured has been covered under the Company's claims made and reported form. The
Company provides free tail coverage for insured physicians who die or become
disabled during the coverage period of the policy and those who have been
insured by the Company for at least five consecutive years and retire completely
from the practice of medicine. Free tail coverage is automatically provided to
physicians with at least five consecutive years of coverage and who are also at
least 65 years old.
Comprehensive general liability coverage for medical groups and clinics and
the excess personal liability insurance is underwritten on an occurrence basis.
Under occurrence coverage, the coverage is provided for incidents that occur at
any time the policy is in effect, regardless of when the claim is reported. With
occurrence coverage, there is no need to purchase tail coverage.
The Company offers limits of insurance up to $5.0 million per claim or
occurrence, with up to a $10.0 million aggregate policy limit for all claims
reported or occurrences for each calendar year or other 12-month policy period.
The most common limit is $1.0 million per claim or occurrence, subject to a $3.0
million aggregate policy limit. The Company's limit of liability under the
excess personal liability insurance coverage is $1.0 million per occurrence with
no aggregate limit. The defense reimbursement benefit for governmental
disciplinary proceedings is $25,000, and the medical payments benefit for
persons injured in non-professional activities is $10,000.
The following table summarizes the Company's physician and medical group
professional liability direct premiums written for the year ended December 31,
1997:
DIRECT
PREMIUMS PERCENTAGE
GROUP SIZE WRITTEN OF TOTAL
---------- ------- --------
(IN THOUSANDS)
Sole practitioner physicians ............ $ 71,479 62.8%
Group with less than five physicians 17,463 15.4
Group with five through eight
physicians .............................. 9,477 8.3
Group with nine or more physicians ...... 15,340 13.5
-------- -----
Total ......................... $113,759 100.0%
======== =====
Hospital Liability. The Company writes liability insurance on both a claims
made and reported basis and a modified occurrence basis that in effect includes
tail coverage for up to seven years after the policy terminates. The policy
issued to hospitals provides protection for professional liabilities related to
the operation of a hospital and its various staff committees, together with the
same comprehensive general liability, medical payments and employee benefit
program liability coverages included in the policy for large medical groups.
Prior to October 1, 1997, the limits of coverage under the hospital policies
issued by the Company, net of reinsurance, were $500,000 for each claim or
occurrence, with no aggregate limit. Since October 1, 1997, the Company has
offered primary limits of $1.0 million for each claim or occurrence and excess
limits up to $50.0 million with no aggregate limit. The Company reinsures 90%
of the excess limits of coverage.
Healthcare Provider Liability. The Company offers its professional liability
coverage to a variety of specialty provider organizations, including hospital
emergency departments, outpatient surgery centers, medical urgent care
facilities and hemodialysis, clinical and pathology laboratories. These policies
include the standard professional liability coverage provided to physicians and
medical groups, with certain modifications to meet the special needs of these
healthcare providers. The policies are generally issued on a claims made and
reported basis with the limits of liability up to those offered to larger
medical groups. The limits of coverage under the current healthcare provider
policies issued by the Company are between $1.0 million and $5.0 million per
incident, subject to $3.0 million to $10.0 million aggregate policy limits.
The Company plans to extend this coverage to extended care and other
healthcare facilities and to other miscellaneous providers of healthcare and
therapeutic related services.
Managed Care Organization Errors and Omissions. The Company has recently
introduced a policy for managed care organizations that provides coverage for
liability arising from the errors and omissions in managed care operations, for
the vicarious liability of a managed care organization for the acts or omissions
of non-employed physician providers and for liability of directors and officers
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of a managed care organization. These policies are generally issued on a claims
made and reported basis. The annual aggregate limits of coverage under the
current managed care organization policies issued by the Company are between
$1.0 million and $5.0 million.
Directors and Officers Liability. The Company historically has brokered
directors and officers liability coverage through its insurance agency
subsidiary. In 1996, the Company began to directly write renewals of these
policies previously underwritten by other companies, accounting for
approximately $213,000 in direct premiums written in 1996 and $252,000 in 1997.
The directors and officers liability policies are generally issued on a claims
made and reported basis. The limits of coverage on directors and officers
liability policies written by the Company are between $1.0 million and $5.0
million.
MARKETING AND POLICYHOLDER SERVICES
The Company historically marketed its physician professional liability
policies directly to the insured physicians and medical groups and issued
policies only infrequently through brokers to a few large medical group
accounts. The Company actively marketed hospital policies through brokers when
it commenced offering this coverage in 1994, and has recently begun utilizing
brokers for physician and medical group policies in its Poe & Brown and Fremont
arrangements.
The Company's direct marketing organization has approximately 25 employees
providing sales solicitation and communications services. The Company markets to
sole practitioner physicians and other prospective policyholders through its
relationships with medical associations, referrals by existing policyholders,
advertisements in medical journals, the presentation of seminars on timely
topics for physicians, telemarketing and direct mail solicitation to licensed
physicians and members of specialty group organizations. The Company attracts
new physicians through special rates for medical residents and discounts for
physicians just entering medical practice. In addition, the Company participates
as a sponsor and participant in various medical group and hospital
administrators' programs, medical association and specialty society conventions
and similar programs. The Company believes that this personal, comprehensive
approach to marketing is essential to providing professional liability
insurance, where special knowledge and experience is a prerequisite.
The Company maintains marketing offices in Dallas, Texas and Boca Raton,
Florida, principally to solicit hospital accounts both directly and through
brokers, and has one principal brokerage relationship in California that
accounts for 30 of the 52 hospitals insured by the Company in that state.
Ten Southern California county medical associations and the statewide
associations of oral and maxillofacial surgeons and osteopathic physicians
endorse the Company's professional liability program. The Company considers
these endorsements to be helpful in its marketing efforts. The county medical
associations also perform certain limited information verification services for
the Company.
The Company is in the process of finalizing its arrangement with Poe & Brown.
Under that arrangement, Poe & Brown will market the Company's professional
liability policies on an exclusive basis to individual physicians and medical
groups of fewer than 20 physicians, while the Company will have the right to
market these policies directly to larger groups. The exclusive arrangement will
be effective only in designated states, initially Connecticut, Florida, Georgia
and Louisiana. Poe & Brown is a large national brokerage firm, with an
established physicians medical malpractice program in these states that it
offers its customers and through a large network of local and regional brokers.
The arrangement went into effect on January 1, 1998.
The Company also has a policyholder services department that provides account
information to all insureds and maintains relationships with the small medical
groups and sole practitioners insured by the Company. Each of these smaller
insureds has a designated client service representative who can answer most
inquiries and, in other instances, can provide the insured with immediate access
to the person with expertise in a particular department. For hospitals and large
and mid-size medical groups, the Company has an account manager assigned to each
group who heads a service team comprised of underwriting, risk management and
claims management representatives, each of whom may be contacted directly by the
policyholder for prompt response. The Company also provides online computer
access to the large groups and hospitals so that loss and loss adjustment
expense ("LAE") information can be accessed immediately.
The Company provides comprehensive risk management services designed to
heighten its insureds' awareness of situations giving rise to potential loss
exposures, to educate its insureds as to ways to improve their medical practice
procedures, and to assist its insureds in implementing risk modification
measures. The Company maintains a 24-hour hotline to provide immediate access to
its
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risk management personnel. The Company conducts surveys for hospitals and large
medical groups both to review their practice procedures generally and to focus
on specific areas in which there may be some concern. Complete reports that
specify areas of the insured's medical practice that may need attention are
provided to the policyholder. The Company also provides an annual program review
for each of its medical groups. The Company presents periodic seminars and
evening "town hall" meetings at medical societies at which pertinent subjects
are presented. In addition, the Company conducts two seminars annually with its
sponsoring oral and maxillofacial surgeon association that are designed to
educate insureds on loss issues and reduce claims. The Company's risk management
representatives also regularly participate in programs presented by
healthcare-related societies. These educational offerings are designed to
increase risk awareness and the effectiveness of various healthcare
professionals. Additionally, the Company provides risk management and claims
administration services to certain entities on a fee-for-service basis.
UNDERWRITING
The underwriting department consists of a vice president in charge of
underwriting, three divisional underwriting managers, 14 underwriters and 13
technical and administrative assistants. Certain of these underwriters
specialize in underwriting hospitals, managed care organizations and directors
and officers liability products. The Company's underwriting department is
responsible for the evaluation of applicants for professional liability and
other coverages, the issuance of policies and the establishment and
implementation of underwriting standards for all of the coverages underwritten
by the Company.
The Company follows a strict procedure with respect to the issuance of all
physician professional liability policies. Each applicant or member of an
applicant medical group is required to complete a detailed application that
provides a personal and professional history, the type and nature of the
applicant's professional practice, certain information relating to specific
practice procedures, hospital and professional affiliations and a complete
history of any prior claims and incidents. The application may be forwarded to
the county medical association for verification of educational and professional
information. The Company performs its own independent verification of these
matters and conducts an investigation to determine if there are any lawsuits
that may not have been disclosed in the application.
The Company performs a continuous process of reunderwriting its insured
physicians. Information concerning physicians with large losses, a high
frequency of claims or unusual practice characteristics is developed through
online claims and risk management reports.
The underwriting department submits recommendations for premium surcharges or
non-renewal of physicians or medical groups to the physicians'underwriting
committee of the Company, which is comprised solely of physicians, many of whom
are insureds or retired insureds of the Company, and members of the Board of
Directors. Members of the committee are not employees of the Company, but
receive compensation for their services on the committee. Physicians have the
right to seek reconsideration of surcharges from the committee. The Company has
found that physician interchange with the committee is often helpful in
improving the practice characteristics of the insured.
The Company makes all underwriting and rating decisions on this and all of its
direct business. Except as set forth below, each hospital is required to submit
an application that provides detailed information on operations, financial
position and risk factors. The Company reviews loss experience for at least the
past five years, prior insurance policies and endorsements, financial reports
and reports from the principal accreditation agencies for the hospital industry.
Risk management surveys are performed as needed to supplement this information.
For hospitals that were formerly insured by the Company through its
relationship with a large insurance broker that encountered financial
difficulties, the Company has generally issued its policies utilizing schedules
of coverage, limits, rating factors and other pertinent information supplied to
the Company by the broker. The Company is now developing its own rating
experience with these insureds.
Poe & Brown will perform most of the underwriting functions with respect to
policies issued by AHI under its arrangement with Poe & Brown. Poe & Brown has
an experienced, fully staffed underwriting department that has underwritten the
program for a number of years. The Company has coordinated with Poe & Brown to
provide assurance that the underwriting standards and their application are
consistent.
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RATES
The Company establishes, through its own actuarial staff and independent
actuaries, rates and rating classifications for its physician and medical group
insureds based on the loss and LAE experience it has developed over the past 20
years and upon rates charged by its competitors. The Company has various rating
classifications based on practice, location, medical specialty, limits and other
factors. The Company utilizes various discounts, including discounts for
part-time practice, physicians just entering medical practice and large medical
groups. The Company has developed a special risk program for physicians who have
unfavorable loss history or practice characteristics, but whom the Company
considers insurable. Policies issued in this program have significant
surcharges. The Company has established its premium rates and rating
classifications for hospitals and managed care organizations utilizing data
publicly filed by other insurers. The data for managed care organization errors
and omissions liability is extremely limited, as tort exposures for these
organizations are only recently beginning to develop. The rates for directors'
and officers liability are developed using historical data publicly filed by
other insureds, financial analysis and loss history. All rates for liability
insurance in California are subject to the prior approval of the Insurance
Commissioner.
Between 1993 and 1997, the Company instituted annual overall rate increases
ranging from 4.4% to 9.2% on its physician professional liability policies in
order to improve its underwriting results. These rate increases were higher than
those implemented by most of its competitors. The number of policyholders
insured by the Company has declined by a small percentage in each of these
years, in part due to these rate increases, but the Company has realized a
modest increase in its premium volume and has improved its underwriting results.
The Company partially offset the effect of these rate increases through the
payment of dividends to the members of the Exchange in the form of premium
credits based on the actual results of prior policy years. In 1996, the Board of
Governors of the Exchange declared a final dividend of approximately $9.0
million to members of the Exchange of record on November 5, 1996, which was paid
in the form of premium credits during 1997. The Company has ceased paying such
premium credit dividends to its policyholders, and may find it more difficult to
compete with other insurance companies offering such dividends.
The Company has instituted no rate increases for 1998, which may offset the
elimination of dividends to policyholders and somewhat improve its competitive
position.
CLAIMS
The claims department of the Company is responsible for claims investigation,
establishment of appropriate case reserves for loss and LAE, defense planning
and coordination, control of attorneys engaged by the Company to defend a claim
and negotiation of the settlement or other disposition of a claim. Under most of
the Company's policies, except managed care organization errors and omissions
policies and directors and officers liability policies, the Company is obligated
to defend its insureds, which is in addition to the limit of liability under the
policy. Medical malpractice claims often involve the evaluation of highly
technical medical issues, severe injuries and conflicting expert opinions. In
almost all cases, the person bringing the claim against the physician is already
represented by legal counsel when the Company learns of the potential claim.
The claims department staff includes managers, litigation supervisors,
investigators and other experienced professionals trained in the evaluation and
resolution of medical professional liability and general liability claims. The
claims department staff consists of approximately 55 employees, including
14 clerical personnel. The Company has five unit managers and three branch
managers responsible for specific geographic areas, and additional units for
specialty areas such as hospitals, birth injuries and policy coverage issues.
The Company also occasionally uses independent claims adjusters, primarily to
investigate claims in remote locations. The Company selects legal counsel from
among a group of law firms in the geographic area in which the action is filed.
California has adopted a standard of judicial administration that requires its
trial courts to set goals to dispose of 90% of all cases within 12 months after
filing and 100% of cases within 24 months. The courts in the various counties in
which the Company defends claims have sought to comply with these "fast-track"
standards during the past few years. The effect of this change has been
significant. Before this requirement was implemented, cases in certain counties
did not proceed to trial for many years after filing. The claims department
staff now must make earlier evaluations and reserve estimates, authorize
discovery expenses early in the litigation process and be prepared to settle the
case or proceed to trial within one year.
The Company emphasizes early evaluation and aggressive management of claims.
Claims department professionals complete a full evaluation and reserving of
claims under "fast-track" within six months of the filing of a claim and on all
other cases within 12 months after filing. The Company has established different
levels of authority within the claims department for approval of
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reserves and settlement of claims. The Company has a claims committee comprised
solely of physicians which meets bi-monthly with the vice president in charge of
claims and other claims managers to consider and evaluate cases that have
complex medical issues and subject the Company to large exposures. At December
31, 1997, the Company had 2,837 open claims.
The Company vigorously defends its insureds against claims, but seeks to
resolve expediently cases with high exposure potential. The defense of a medical
professional liability claim requires significant cooperation between the
litigation supervisor or claims department manager responsible for the claim and
the insured physician. California law requires that a medical professional
liability claim cannot be settled for an amount in excess of $30,000 without the
consent of the physician insured. California law further requires that the
insurer report all such settlements to a medical disciplinary board, and Federal
law requires that any claim payment, regardless of amount, be reported to a
national data bank which can be accessed by various state licensing and
disciplinary boards and medical peer evaluation committees. Thus, the physician
is often placed in a difficult position of knowing that a settlement may result
in the initiation of a disciplinary proceeding or some other impediment to the
physician's ability to practice. The claims department supervisor must be able
to fully evaluate considerations of settlement or trial and to communicate
effectively the Company's recommendation to its insured. If the insured will not
consent to a settlement offer, the Company may be exposed to a larger judgment
if the case proceeds to trial.
The claims department staff utilizes structured settlements to resolve certain
large claims. In a structured settlement, the Company will typically purchase an
annuity from another insurance company that will satisfy periodic payments owed
to the claimant as part of the settlement. The Company typically obtains a
release from the claimant for its insured and itself and assigns the annuity to
a third party for payment. The Company purchased annuities during the early
1980s from a life insurance company that subsequently became insolvent and could
not satisfy its obligations. In some instances, the Company has concluded that
it is obligated to satisfy any shortfall in these periodic payments and is
making these shortfall payments. The Company has established a reserve to cover
these expected shortfall obligations. See Note 8 of Notes to Consolidated
Financial Statements.
LOSS AND LAE RESERVES
The determination of loss reserves is a projection of ultimate losses through
an actuarial analysis of the claims history of the Company and other
professional liability insurers, subject to adjustments deemed appropriate by
the Company due to changing circumstances. Included in its claims history are
losses and LAE paid by the Company in prior periods and case reserves for
anticipated losses and LAE developed by the Company's claims department as
claims are reported and investigated. Actuaries rely primarily on such
historical loss experience in determining reserve levels on the assumption that
historical loss experience provides a good indication of future loss experience
despite the uncertainties in loss cost trends and the delays in reporting and
settling claims. As additional information becomes available, the estimates
reflected in earlier loss reserves may be revised. Any increase in the amount of
reserves, including reserves for insured events of prior years, could have an
adverse effect on the Company's results for the period in which the adjustments
are made.
The uncertainties inherent in estimating ultimate losses on the basis of past
experience have grown significantly in recent years principally as a result of
judicial expansion of liability standards and expansive interpretations of
insurance contracts. These uncertainties may be further affected by, among other
factors, changes in the rate of inflation and changes in the propensities of
individuals to file claims. The inherent uncertainty of establishing reserves is
relatively greater for companies writing long-tail casualty insurance, including
medical malpractice insurance, due primarily to the longer-term nature of the
resolution of claims. There can be no assurance that the ultimate liability of
the Company will not exceed the amounts reserved.
The Company utilizes both its internal actuarial staff and independent
actuaries in establishing its reserves. The Company's independent actuaries
review the Company's reserves for losses and LAE at the end of each fiscal year
and prepare a report that includes a recommended level of reserves. The Company
considers this recommendation as well as other factors, such as known,
anticipated or estimated changes in frequency and severity of claims, loss
retention levels and premium rates, in establishing the amount of its reserves
for losses and LAE. The Company continually refines reserve estimates as
experience develops and further claims are reported and settled. The Company
reflects adjustments to reserves in the results of the periods in which such
adjustments are made. Since medical malpractice insurance is a long-tail line of
business for which the initial loss and LAE estimates may be adversely impacted
by events occurring long after the reporting of the claim, such as sudden severe
inflation or adverse judicial or legislative decisions, the Company has
attempted to establish its loss and LAE reserves at the upper end of a
reasonable range of reserve estimates.
9
10
The Company's loss reserve experience is shown in the following table, which
sets forth a reconciliation of beginning and ending reserves for unpaid losses
and LAE for the periods indicated:
DECEMBER 31,
-------------------------------------
1997 1996 1995
--------- --------- ---------
Reserves for losses and LAE at beginning
of year ................................... $ 459,567 $ 466,187 $ 468,743
Less reinsurance recoverables ............. 19,266 19,560 19,177
--------- --------- ---------
Reserves for losses and LAE, net of related
reinsurance recoverable, at
beginning of year ......................... 440,301 446,627 449,566
--------- --------- ---------
Provision for losses and LAE for claims
occurring in the current year, net of
reinsurance ............................... 176,586 168,545 175,856
Decrease in estimated losses and LAE for
claims occurring in prior years, net of
reinsurance ............................... (53,209) (59,748) (57,833)
--------- --------- ---------
Incurred losses during the year, net of
reinsurance ............................... 123,377 108,797 118,023
--------- --------- ---------
Deduct losses and LAE payments for
claims, net of reinsurance, occurring
during:
Current year ............................ 11,814 13,274 11,481
Prior years ............................. 118,424 101,849 109,481
--------- --------- ---------
130,238 115,123 120,962
--------- --------- ---------
Reserve for losses and LAE, net of
related reinsurance recoverable, at
end of year ............................... 433,440 440,301 446,627
Reinsurance recoverable for losses
and LAE, at end of year ................... 21,531 19,266 19,560
--------- --------- ---------
Reserves for losses and LAE, gross
of reinsurance recoverable, at end
of year ................................... $ 454,971 $ 459,567 $ 466,187
========= ========= =========
- ------------
The following table reflects the development of losses and LAE reserves for
the periods indicated at the end of that year and each subsequent year. The line
entitled "Loss and LAE reserves" reflects the reserves, net of reinsurance
recoverables, as originally reported at the end of the stated year. Each
calendar year-end reserve includes the estimated unpaid liabilities for that
report or accident year and for all prior report or accident years. The section
under the caption "Liability reestimated as of" shows the original recorded
reserve as adjusted as of the end of each subsequent year to reflect the
cumulative amounts paid and all other facts and circumstances discovered during
each year. The line "Cumulative redundancy" reflects the difference between the
latest reestimated reserve amount and the reserve amount as originally
established. The section under the caption "Cumulative amount of liability paid
through" shows the cumulative amounts paid related to the reserve as of the end
of each subsequent year.
10
11
In evaluating the information in the table below, it should be noted that each
amount includes the effects of all changes in amounts of prior periods. For
example, if a loss determined in 1993 to be $100,000 was first reserved in 1987
at $150,000, the $50,000 redundancy (original estimate minus actual loss) would
be included in the cumulative redundancy in each of the years 1987
through 1997 shown below. This table presents development data by calendar year
and does not relate the data to the year in which the claim was reported or the
incident actually occurred. Conditions and trends that have affected the
development of these reserves in the past will not necessarily recur in the
future.
YEAR ENDED DECEMBER 31,
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Loss and LAE
reserves .......... $329,369 $389,404 $412,679 $427,049 $439,908 $465,423 $472,129 $449,566 $446,627 $440,301 $433,440
Liability reestimated
as of:
One year later .... 327,627 362,058 375,764 401,878 409,966 421,994 411,915 391,733 386,879 387,092
Two years later ... 312,956 337,901 348,781 368,124 364,105 368,521 363,562 337,441 337,760
Three years later . 295,438 315,718 320,319 324,370 316,220 325,073 315,712 304,063
Four years later .. 278,339 299,308 294,992 284,628 282,291 292,801 293,711
Five years later .. 267,880 284,972 266,649 264,582 261,344 274,304
Six years later ... 260,544 266,423 256,900 251,335 252,077
Seven years later . 249,644 262,642 247,678 245,745
Eight years later . 248,595 257,731 244,863
Nine years later .. 246,267 256,354
Ten years later ... 245,780
Cumulative
redundancy ........ 83,589 133,050 167,816 181,304 187,831 191,119 178,418 145,503 108,867 53,209
Cumulative
amount of
liability paid
through:
One year later .... 78,951 93,607 85,771 103,983 101,001 105,678 121,106 109,481 101,844
Two years later ... 147,865 155,505 162,264 171,327 171,429 184,883 192,519 170,603 170,932
Three years later . 188,038 206,413 204,129 206,499 205,829 219,649 217,484 202,660
Four years later .. 220,575 232,777 221,479 221,654 221,884 232,379 231,794
Five years later .. 233,807 242,140 228,922 230,606 227,692 237,879
Six years later ... 236,809 244,587 234,202 232,410 231,277
Seven years later . 238,105 248,319 235,274 232,912
Eight years later . 239,652 248,993 235,362
Nine years later .. 239,896 249,122
Ten years later ... 239,940
Net reserves--
December 31 ....... $472,129 $449,566 $446,627 $440,301 $433,440
Reinsurance
recoverables ...... 18,644 19,177 19,560 19,266 21,531
-------- -------- -------- -------- --------
Gross reserves ...... $490,773 $468,743 $466,187 $459,567 $454,971
======== ======== ======== ======== ========
The Company has historically experienced favorable loss and LAE reserve
development. The Company believes that the favorable loss and LAE reserve
development since 1987 has resulted from four factors: (i) the Company's
conservative approach to establishing reserves for medical malpractice insurance
losses and LAE; (ii) the continuing benefits from the Medical Injury
Compensation Reform Act ("MICRA"), the California tort reform legislation that
was declared constitutional in a series of decisions by the California Supreme
Court in the mid-1980s; (iii) benefits from California legislation requiring
matters in litigation to proceed more expeditiously to trial; and (iv) improved
results from a restructuring of the Company's internal claims process. See "--
Regulation -- Medical Malpractice Tort Reform" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- General." The
Company believes, based on its analysis of annual statements filed with state
regulatory authorities, that its principal California competitors have
experienced similar favorable loss and LAE reserve development in past years.
General liability losses have been less than 3.2% of medical malpractice
losses in the last five years. The Company does not have material reserves for
pollution claims and the Company's claims experience for pollution coverage has
been negligible.
11
12
While the Company believes that its reserves for losses and LAE are adequate,
there can be no assurance that the Company's ultimate losses and LAE will not
deviate, perhaps substantially, from the estimates reflected in the Company's
financial statements. If the Company's reserves should prove inadequate, the
Company will be required to increase reserves, which could have a material
adverse effect on the Company's financial condition or results of operation.
REINSURANCE
Reinsurance Ceded. The Company follows customary industry practice by
reinsuring a portion of its risks. The Company cedes to reinsurers a portion of
its risks and pays a fee based upon premiums received on all policies subject to
such reinsurance. Insurance is ceded principally to reduce net liability on
individual risks and to provide protection against large losses. Although
reinsurance does not legally discharge the ceding insurer from its primary
liability for the full amount of the policies reinsured, it does make the
reinsurer liable to the insurer to the extent of the reinsurance ceded. The
Company determines how much reinsurance to purchase based upon its evaluation of
the risks it has insured, consultations with its reinsurance brokers and market
conditions, including the availability and pricing of reinsurance. In 1997, the
Company ceded $5.0 million of its earned premiums to reinsurers.
The Company's reinsurance arrangements are generally placed through its
exclusive reinsurance broker, Guy Carpenter & Company, Inc. (formerly Willcox
Incorporated Reinsurance Intermediaries). The Company retains the first $1.0
million of loss incurred per incident for its physician and medical group
policies and has various reinsurance treaties covering losses in excess of $1.0
million up to $20.0 million per incident for physicians. The Company often has
more than one insured named as a defendant in a lawsuit or claim arising from
the same incident, and, therefore, multiple policies and limits of liability may
be involved. The Company retains losses in excess of $20.0 million. The
Company's reinsurance program is purchased in several layers, the limits of
which may be reinstated under certain circumstances at the Company's option
subject to the payment of additional premium. The Company also reinsures a
portion of the reinstatement premiums under a separate treaty, together with
certain other miscellaneous liability exposures, including retroactive liability
for two insurance layers from several past years and aggregate extension
coverage which provides additional aggregate loss limits for the layer $1.0
million excess of $1.0 million, each occurrence, for specified years. The
reinsurers also bear their proportionate share of loss expenses for claims in
which they have an indemnity obligation.
For its hospital policies, the Company retains the first $1.0 million of loss
incurred per incident and has various reinsurance treaties covering 90% of all
losses in excess of $1.0 million up to $50.0 million.
The Company has a separate quota share reinsurance treaty for 1997 with
respect to its managed care organization errors and omissions policies and any
directors and officers liability policies it may write. Under this treaty, the
reinsurers bear 80% of all losses and LAE incurred under these policies. All
losses and LAE incurred greater than $1.0 million but not ceded under the quota
share agreement are subject to ceding under the excess of loss treaties above.
Reinsurance is placed under reinsurance treaties and agreements with a number
of individual companies and syndicates at Lloyd's of London ("Lloyd's") to avoid
concentrations of credit risk. The following table identifies the Company's most
significant reinsurers, their percentage participation in the Company's
aggregate reinsured risk based upon premiums paid by the Company and their
rating as of December 31, 1997. No other single reinsurer's percentage
participation in 1997 exceeded 5% of total reinsurance premiums.
PREMIUMS CEDED PERCENTAGE OF TOTAL
FOR YEAR ENDED REINSURANCE
DECEMBER 31, 1997 RATING(1) PREMIUMS
----------------- --------- -------------------
(IN THOUSANDS)
Hannover Ruckversicherungs......... $ 1,435 A+ 29.1
Lloyd's of London Syndicates....... 2,152 NR 43.6
Unionamerica Insurance Co.......... 412 A 8.3
CNA International Reinsurance Co... 309 A 6.3
GIO, Ltd........................... 290 A 5.9
-----
93.2
- ------------
(1) All ratings are assigned by A.M. Best. The Company's minimum requirement
for ratings of its reinsurers is B or better from A.M. Best.
12
13
The Company analyzes the credit quality of its reinsurers and relies on its
brokers and intermediaries to assist it in such analysis. To date, the Company
has not experienced any material difficulties in collecting reinsurance
recoverables. No assurance can be given, however, regarding the future ability
of any of the Company's reinsurers to meet their obligations. Among the
reinsurers to which the Company cedes reinsurance are certain Lloyd's
syndicates. In recent years, Lloyd's has reported substantial aggregate losses
that have had adverse effects on Lloyd's in general and on certain syndicates in
particular. In addition, there has been a decrease in the underwriting capacity
of Lloyd's syndicates in recent years. The substantial losses and other adverse
developments could affect the ability of certain syndicates to continue to trade
and the ability of insureds to continue to place business with particular
syndicates. It is not possible to predict what effects the circumstances
described above may have on Lloyd's and the Company's contractual relationship
with Lloyd's syndicates in future years. The Company understands that Lloyd's
syndicates have created new trust funds to hold reserves for reinsurance
purchased by United States reinsureds gross of outward reinsurance. This
arrangement applies to all purchases on or after August 1, 1995.
Reinsurance and Excess Liability Insurance Assumed. The Company assumes a
small amount of reinsurance covering medical professional liability risks
primarily in the United States. The principal reinsurance treaty, which has been
in effect since 1988, is with a Lloyd's syndicate. Under this surplus share
treaty, the Company assumes 50% of one or more layers of coverage above $1.0
million, which must be retained by the primary insurer. The reinsured receives a
ceding commission and a profit share. The maximum amount of the Company's
liability for any one risk is $500,000, and the Company does not participate as
a reinsurer in any of its own policies. The annual premiums earned under this
treaty have ranged from $160,000 in 1989 to $1.1 million in 1997. In 1997, this
treaty also included reinsurance of excess layers of workers' compensation and
clash casualty liability risks. The Company's liability for any one risk is
limited to $500,000 above a $1.5 million layer assumed by other members of the
syndicate.
The Company also entered into a reinsurance treaty for 1995 and 1996 with
Hannover Ruckversicherungs ("Hannover Re"). The treaty is a quota share treaty,
under which the Company reinsures up to $500,000 for each physician medical
malpractice claim and up to $750,000 for each hospital professional liability
claim on policies or contracts with limits in excess of $2.0 million. The
reinsured receives an override commission and is required to retain not less
than 20% of the risk, subject to a minimum retention of $1.0 million. Premiums
earned under this treaty were approximately $8,000 for 1997.
The Company has an indirect quota share participation in a reinsurance program
of Hannover Re that provides high layer excess of loss property catastrophe
coverage for international risks, other than in the United States and Japan. The
Company has participated in this program since 1994 through the purchase of a
$5.0 million Credit Note issued by a limited liability company organized by
Hannover Re to underwrite a portion of this coverage. The Company purchased this
note through the issuance of a letter of credit, which can be drawn to cover the
Company's proportionate share of losses in this program. Interest on the note is
based upon profits, if any, of the limited liability company. The Company, in
its investment portfolio, holds the outstanding Credit Note, and the amount of
the letter of credit is included in Other Liabilities in the Consolidated
Balance Sheets. See "-- Investment Portfolio."
The Company participates indirectly in another reinsurance program of Hannover
Re similar to the one described above through a swap agreement arranged by
Citibank, N.A. Under the swap agreement, the Company has issued a letter of
credit, which can be drawn to cover the Company's proportionate share of losses
in this program. The Company will share proportionately the underwriting profit
of this program and interest income on premium receipts, and its aggregate
maximum share of losses is $5.0 million.
The Company intends to seek additional assumed reinsurance arrangements in
future years. The Company believes that as more managed care organizations and
integrated healthcare delivery systems retain a larger part of their own
exposure directly or through captive insurance arrangements, they will need to
obtain excess insurance or reinsurance for the potentially larger losses.
INVESTMENT PORTFOLIO
An important component of the Company's operating results has been the return
on its invested assets. Investments of the Company are made by investment
managers under policies established and supervised by the Board. The Company's
investment policy has placed primary emphasis on investment grade, fixed
maturity securities and maximization of after-tax yields. The investment manager
since 1978 for the portfolio of fixed maturity securities is Brown Brothers
Harriman & Co., and the investment manager for the equity securities portion of
the portfolio is Hotchkis & Wiley.
13
14
All of the fixed maturity securities are classified as available-for-sale and
carried at estimated fair value. For these securities, temporary unrealized
gains and losses, net of tax, are reported directly through stockholders'
equity, and have no effect on net income. The following table sets forth the
composition of the investment portfolio of the Company at the dates indicated.
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
--------------------- --------------------- ---------------------
COST OR COST OR COST OR
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Fixed maturity securities:
Bonds:
U.S. Government and
Agencies ................. $290,028 $298,073 $272,315 $276,929 $304,091 $319,119
State, municipalities and
political subdivisions ... 327,273 335,156 300,347 303,461 149,693 155,118
Mortgage-backed securities,
U.S. Government .......... 68,161 68,290 83,031 82,850 80,279 81,898
Corporate .................. 7,256 7,248 5,027 5,027 46,951 48,889
Other ...................... 93 93 100 100 105 105
-------- -------- -------- -------- -------- --------
Total bonds ........... 692,811 708,860 660,820 668,367 581,119 605,129
Redeemable preferred stock ... -- -- -- -- 996 1,026
-------- -------- -------- -------- -------- --------
Total fixed maturity
securities .......... 692,811 708,860 660,820 668,367 582,115 606,155
-------- -------- -------- -------- -------- --------
Equity securities:
Common stock ................. 17,052 23,523 15,555 19,977 49,396 61,083
-------- -------- -------- -------- -------- --------
Total equity securities 17,052 23,523 15,555 19,977 49,396 61,083
-------- -------- -------- -------- -------- --------
Total .......................... $709,863 $732,383 $676,375 $688,344 $631,511 $667,238
======== ======== ======== ======== ======== ========
The Company's current policy is to limit its investment in equity securities
and real estate to no more than 8% of the total market value of its investments.
Accordingly, the Company's portfolio of unaffiliated equity securities was
reduced from $61.1 million at December 31, 1995 to $23.5 million at December 31,
1997.
The Company's investment portfolio of fixed maturity securities consists
primarily of intermediate-term, investment-grade securities. The Company's
investment policy provides that fixed maturity investments are limited to
purchases of investment-grade securities or unrated securities which, in the
opinion of a national investment advisor, should qualify for such rating. The
table below contains additional information concerning the investment ratings of
the Company's fixed maturity investments at December 31, 1997:
AMORTIZED FAIR PERCENTAGE OF
TYPE/RATING OF INVESTMENT(1) COST VALUE FAIR VALUE
---------------------------- --------- ----- -------------
(IN THOUSANDS)
AAA (including U.S. Government and
Agencies)..................... $ 491,538 $ 503,187 71.0%
AA.............................. 145,763 148,774 21.0
A............................... 50,417 51,806 7.3
Non rated(2).................... 5,093 5,093 0.7
--------- --------- -----
$ 692,811 $ 708,860 100.0%
========= ========= =====
- ------------
(1) The ratings set forth above are based on the ratings, if any, assigned by
Standard & Poor's Corporation ("S&P"). If S&P's ratings were unavailable,
the equivalent ratings supplied by Moody's Investors Services, Inc. were
used.
(2) Includes a credit note received from a catastrophe reinsurance limited
liability company controlled by Hannover Re with an amortized cost and fair
value of $5.0 million. See "--Reinsurance."
14
15
The following table sets forth certain information concerning the maturities
of fixed maturity securities in the Company's investment portfolio as of
December 31, 1997:
AMORTIZED FAIR PERCENTAGE OF
COST VALUE FAIR VALUE
--------- ----- -------------
(IN THOUSANDS)
Years to maturity:
One or less........... $ 2,349 $ 2,341 0.3%
After one through five 89,663 91,519 12.9
After five through ten 241,715 249,699 35.3
After ten............. 290,923 297,011 41.9
Mortgage-backed securities 68,161 68,290 9.6
--------- --------- -----
Totals $ 692,811 $ 708,860 100.0%
========= ========= =====
The average maturity of the securities in the Company's fixed maturity
portfolio as of December 31, 1997 was 5.6 years. The average duration of the
Company's fixed maturity portfolio as of December 31, 1997 was 4.6 years.
The Company also maintains cash and highly liquid short-term investments,
which at December 31, 1997 totaled $66.5 million.
The following table summarizes the Company's investment results for the three
years ended December 31:
AS OF OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
FIXED MATURITY SECURITIES:
Average invested assets (includes short-
term cash investments)(1) ............ $ 718,239 $ 650,090 $ 614,492
Net investment income:
Before income taxes .................. 39,926 40,594 36,987
After income taxes ................... 30,731 29,706 26,481
Average annual return on investments:
Before income taxes .................. 5.56% 6.24% 6.02%
After income taxes ................... 4.28% 4.57% 4.31%
Net realized investment gains after
income tax ........................... $ 1,909 $ 351 $ 2,202
Net increase (decrease) in unrealized
gains on all fixed maturity
investments after income taxes ....... 5,526 (10,720) 34,366
EQUITY SECURITIES:
Average invested assets(2) ............. $ 21,750 $ 37,695 $ 50,927
Net investment income:
Before income taxes .................. 840 994 1,627
After income taxes ................... 777 854 1,189
Average annual return on investments:
Before income taxes .................. 3.86% 2.64% 3.19%
After income taxes ................... 3.57% 2.27% 2.33%
Net realized investment gains after
income tax ........................... $ 2,382 $ 7,279 $ 2,965
Net increase (decrease) in unrealized
gains on all equity investments after
income taxes ......................... 1,333 (4,742) 5,548
- ------------
(1) Fixed maturity securities at cost.
(2) Equities at market.
15
16
COMPETITION
The physician professional liability insurance market in California is highly
competitive. The Company competes principally with three physician-owned mutual
or reciprocal insurance companies, Norcal Mutual Insurance Company, The Doctors'
Company and Medical Insurance Exchange of California, with several commercial
insurers, including CNA Insurance Companies, and also with a physicians' mutual
protection trust. The physician-owned insurance companies were organized at
approximately the same time as the Company and all of these companies have
expanded their operations in California. Each of these companies is actively
engaged in soliciting insureds in Southern California, the Company's primary
area of operations, and each has offered assessments or premiums at very
competitive rates during the past few years. The Company believes that the
principal competitive factors, in addition to pricing, include dividend policy,
financial stability, breadth and flexibility of coverage and the quality and
level of services provided. In addition, commercial insurance companies such as
Farmers Group, Inc. and MMI Companies, Inc. now actively compete for larger
medical groups in the California market, and companies endorsed by specialty
medical societies are also entering the market.
The hospital professional liability insurance market is also extremely
competitive. Most of the Company's principal insurance company competitors for
physicians and medical groups, as well as a hospital industry sponsored captive
insurance company, actively compete in the hospital professional liability
insurance market. The largest writer of malpractice insurance for hospitals in
California is an affiliate of Farmers Group, Inc. The Company actively markets
its hospital policies through brokers and directly under a new program and
competes not only with Farmers Group, Inc. affiliates but also with MMI
Companies, Inc., Executive Risk Inc. and a number of other insurance companies
in the underwriting of hospital malpractice policies.
The Company expects to encounter similar competition from local doctor-owned
insurance companies and commercial companies in other states as it carries out
its expansion plans. The Company plans to compete in other states principally
through independent agents and brokers, such as its relationship with Poe &
Brown, and by offering superior policyholder services. The Company also intends
to expand its business through business combinations with medical professional
liability insurers, such as its purchase of the medical malpractice insurance
business of Fremont. All markets in which the Company now writes insurance and
in which it expects to enter have certain competitors with pre-existing
relationships with prospective customers, name recognition in those states and
in many cases greater financial and operating resources than the Company.
Marketing efforts in states other than California will take substantial time and
resources in order for prospective customers to become familiar with the Company
and its insurance products.
REGULATION
General. Insurance companies are regulated by government agencies in states in
which they transact insurance. The extent of regulation varies by state, but
such regulation usually includes: (i) regulating premium rates and policy forms;
(ii) setting minimum capital and surplus requirements; (iii) regulating guaranty
fund assessments; (iv) licensing companies and agents; (v) approving accounting
methods and methods of setting statutory loss and expense reserves; (vi) setting
requirements for and limiting the types and amounts of investments; (vii)
establishing requirements for the filing of annual statements and other
financial reports; (viii) conducting periodic statutory examinations of the
affairs of insurance companies; (ix) approving proposed changes of control; and
(x) limiting the amounts of dividends that may be paid without prior regulatory
approval. Such regulation and supervision are primarily for the benefit and
protection of policyholders and not for the benefit of investors.
Most of the Company's policies are written in California where SCPIE Indemnity
is domiciled. California laws and regulations, including the tort liability
laws, and laws relating to professional liability exposures and reports, have
the most significant impact on the Company and its operations.
Insurance Guaranty Associations. Most states, including California, require
admitted property and casualty insurers to become members of insolvency funds or
associations that generally protect policyholders against the insolvency of such
insurers. Members of the fund or association must contribute to the payment of
certain claims made against insolvent insurers. Maximum contributions required
by law in any one year vary by state, and California permits a maximum
assessment of 1% of annual premiums written by a member in that state during the
preceding year. The largest assessment paid by the Company was $697,000 in 1994.
However, such payments are recoverable through policy surcharges.
Holding Company Regulation. SCPIE Holdings is subject to the California
Insurance Holding Company System Regulatory Act (the "Holding Company Act"). The
Holding Company Act requires the Company periodically to file information with
the California
16
17
Department and other state regulatory authorities, including information
relating to its capital structure, ownership, financial condition and general
business operations. Certain transactions between an insurance company and its
affiliates, including sales, loans or investments which in any twelve-month
period aggregate at least 3% of its admitted assets or 25% of its statutory
capital and surplus, whichever is less, also are subject to prior approval by
the California Department. Recently, legislation was adopted in California,
which requires 30 days advance notice to the California Department of a material
transaction, rather than prior approval, and increases the types of transactions
subject to the notice requirement.
The Holding Company Act also provides that the acquisition or change of
"control" of a California insurance company or of any person or entity that
controls such an insurance company cannot be consummated without the prior
approval of the California insurance commissioner. In general, a presumption of
"control" arises from the ownership of voting securities and securities that are
convertible into voting securities, which in the aggregate constitute 10% or
more of the voting securities of a California insurance company or of a person
or entity that controls a California insurance company, such as SCPIE Holdings.
A person or entity seeking to acquire "control," directly or indirectly, of the
Company is generally required to file with the Insurance Commissioner an
application for change of control containing certain information required by
statute and published regulations and provide a copy of the application to the
Company. The Holding Company Act also effectively restricts the Company from
consummating certain reorganizations or mergers without prior regulatory
approval.
The Company will also be subject to insurance holding company laws in other
states that contain similar provisions and restrictions.
Regulation of Dividends from Insurance Subsidiaries. The Holding Company Act
also limits the ability of SCPIE Indemnity to pay dividends to the Company.
Without prior notice to and approval of the Insurance Commissioner, SCPIE
Indemnity may not declare or pay an extraordinary dividend, which is defined as
any dividend or distribution of cash or other property whose fair market value
together with other dividends or distributions made within the preceding twelve
months exceeds the greater of such subsidiary's statutory net income of the
preceding calendar year or 10% of statutory surplus as of the preceding December
31. Applicable regulations further require that an insurer's statutory surplus
following a dividend or other distribution be reasonable in relation to its
outstanding liabilities and adequate to meet its financial needs, and permit the
payment of dividends only out of statutory earned (unassigned) surplus unless
the payment out of other funds is approved by the Insurance Commissioner. In
addition, an insurance company is required to give the California Department of
Insurance notice of any dividend after declaration, but prior to payment.
The other Insurance Subsidiaries are subject to similar provisions and
restrictions under the insurance holding company laws of other states.
Risk-Based Capital. The National Association of Insurance Commissioners
("NAIC") has developed a new methodology for assessing the adequacy of statutory
surplus of property and casualty insurers which includes a risk-based capital
("RBC") formula that attempts to measure statutory capital and surplus needs
based on the risks in a company's mix of products and investment portfolio. The
formula is designed to allow state insurance regulators to identify potentially
under-capitalized companies. Under the formula, a company determines its RBC by
taking into account certain risks related to the insurer's assets (including
risks related to its investment portfolio and ceded reinsurance) and the
insurer's liabilities (including underwriting risks related to the nature and
experience of its insurance business). The RBC rules provide for different
levels of regulatory attention depending on the ratio of a company's total
adjusted capital to its "authorized control level" of RBC. At December 31, 1997,
each of the Insurance Subsidiaries' RBC exceeded the threshold requiring the
least regulatory attention.
Regulation of Investments. The Insurance Subsidiaries are subject to state
laws and regulations that require diversification of their investment portfolios
and limit the amount of investments in certain investment categories such as
below investment grade fixed income securities, real estate and equity
investments. Failure to comply with these laws and regulations would cause
investments exceeding regulatory limitations to be treated as nonadmitted assets
for purposes of measuring statutory surplus and, in some instances, would
require divestiture of such non-qualifying investments over specified time
periods unless otherwise permitted by the state insurance authority under
certain conditions.
Prior Approval of Rates and Policies. Pursuant to the California Insurance
Code, the Company must submit rating plans, rates, policies and endorsements to
the Insurance Commissioner for prior approval. The possibility exists that the
Company may be unable to implement desired rates, policies, endorsements, forms
or manuals if the Insurance Commissioner does not approve such items. In the
past, all of the Company's rate applications have been approved in the normal
course of review. AHI and AHSIC are similarly
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required to make certain policy form and rate filings in most of the other
states to permit the Company to write medical malpractice insurance in these
states.
Medical Malpractice Tort Reform. MICRA, enacted in 1975, has been one of the
most comprehensive medical malpractice tort reform measures in the United
States. MICRA currently provides for limitations on damages for pain and
suffering of $250,000, limitations on fees for plaintiffs' attorneys according
to a specified formula, periodic payment of medical malpractice judgments and
the introduction of evidence of collateral source benefits payable to the
injured plaintiff. The Company believes that this legislation has brought
stability to the medical malpractice insurance marketplace in California by
making it more feasible for insurers to assess the risks involved in
underwriting this line of business.
The constitutionality of the various provisions of MICRA was judicially
challenged soon after its enactment, and California trial courts and
intermediate appellate courts reached conflicting decisions. The California
Supreme Court, in a series of decisions rendered during 1984 and 1985, upheld
the constitutionality of MICRA. Bills have been introduced in the California
Legislature from time to time to modify or limit certain of the tort reform
benefits provided to physicians and other healthcare providers by MICRA. In
1987, the principal proponents and opponents of MICRA signed an agreement under
which the parties agreed to a five-year moratorium on amendments to MICRA,
except for an increase in the limits on plaintiffs' attorneys' fees, which was
enacted at the time of this agreement. This moratorium expired by its terms on
December 31, 1992. Neither the proponents nor opponents have been able to enact
significant changes since that time. The Company cannot predict what changes, if
any, to MICRA may be enacted during the next few years or what effect such
changes might have on the Company's medical malpractice insurance operations.
Medical Malpractice Reports. The Company has been required to report detailed
information with regard to settlements or judgments against its California
physician insureds in excess of $30,000 to the Medical Board of California,
which has responsibility for investigations and initiation of proceedings
relating to professional medical conduct in California. Since January 1, 1998,
all judgments, regardless of amount, must be reported to the Medical Board,
which now publishes on the Internet all judgments reported after January 1,
1993. In addition, all payments must also be reported to the Federal National
Practitioners' Data Bank and such reports are accessible by state licensing and
disciplinary authorities, hospital and other peer review committees and other
providers of medical care. A California statute also requires that defendant
physicians must consent to all medical professional liability settlements in
excess of $30,000, unless the physician waives this requirement. The Company
policy provides the physician with the right to consent to any such settlement,
regardless of the amount, but that either party may submit the matter of consent
to a county medical review board. In virtually all instances, the Company must
obtain the consent of the insured physician prior to any settlement.
A.M. BEST RATING
A.M. Best, which rates insurance companies based on factors of concern to
policyholders, currently assigns the Company an "A (Excellent)" rating. Such
rating is the third highest rating of 15 ratings that A.M. Best assigns to
insurance companies, which currently range from "A++ (Superior)" to "F (In
Liquidation)." Publications of A.M. Best indicate that the A rating is assigned
to those companies that in A.M. Best's opinion have a strong ability to meet
their obligations to policyholders over a long period of time. In evaluating a
company's financial and operating performance, A.M. Best reviews the company's
profitability, leverage and liquidity, as well as its book of business, the
adequacy and soundness of its reinsurance, the quality and estimated market
value of its assets, the adequacy of its loss reserves, the adequacy of its
surplus, its capital structure, the experience and competence of its management
and its market presence. A.M. Best's ratings reflect its opinion of an insurance
company's financial strength, operating performance and ability to meet its
obligations to policyholders and are not evaluations directed to purchasers of
an insurance company's securities.
The Insurance Subsidiaries have entered into a pooling arrangement and each of
the Insurance Subsidiaries has been assigned the same "pooled" "A (Excellent)"
A.M. Best rating based on their consolidated performance.
EMPLOYEES
As of December 31, 1997, the Company employed 188 persons. None of the employees
is covered by a collective bargaining agreement. The Company believes that its
employee relations are good.
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EXECUTIVE OFFICERS
The Executive Officers of the Company and their ages as of March 17, 1998 are
as follows:
Name Age Position
---- --- --------
Donald J. Zuk 61 President, Chief Executive Officer and
Director
Patrick S. Grant 55 Senior Vice President, Marketing
Joseph P. Henkes 48 Secretary and Senior Vice President,
Operations and Actuarial Services
Patrick T. Lo 45 Vice President and Chief Financial Officer
Donald J. Zuk has been President and Chief Executive Officer of SCPIE
Management Company since 1989. Prior to joining SCPIE Management Company, he
served 22 years with Johnson & Higgins, insurance brokers. His last position
there was Senior Vice President in charge of its Los Angeles Healthcare
operations, which included the operations of SCPIE under a contract that then
existed with SCPIE Management Company.
Patrick S. Grant has been with SCPIE since 1990 serving initially as Vice
President, Marketing. He was named Senior Vice President, Marketing in 1992.
Prior to that time, he spent almost 20 years with the insurance brokerage firm
of Johnson & Higgins. His last position there was Vice President, Professional
Liability. Mr. Grant has worked on the Company operations since 1976.
Joseph P. Henkes has been with the Company since 1990 serving initially as
Vice President, Operations and Actuarial Services. He was named Senior Vice
President, Operations and Actuarial Services in 1992. Prior to that time he
spent almost five years with Johnson & Higgins, where his services were devoted
primarily to the Company. He has been an Associate of the Casualty Actuarial
Society since 1975 and a member of the American Academy of Actuaries since 1980.
Patrick T. Lo has been Vice President and Chief Financial Officer of the
Company since 1993. From 1990 to 1993 he served as Vice President and Controller
of the Company. Prior to that time, he spent nine years as Assistant Controller,
Assistant Vice President and Vice President at The Doctors' Company, a
California medical malpractice insurance company.
RISK FACTORS
Certain statements in this Form 10-K that are not historical fact constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results of the Company to be materially different from historical results or
from any results expressed or implied by such forward-looking statements. Such
risks, uncertainties and other factors include, but are not limited to, the
following risks:
CONCENTRATION OF BUSINESS
Substantially all of the Company's premiums written are generated from medical
malpractice insurance policies issued to physicians and medical groups. As a
result, negative developments in the economic, competitive or regulatory
conditions affecting the medical malpractice insurance industry, particularly as
such developments might affect medical malpractice insurance for physicians,
could have a material adverse effect on the Company's results of operations.
Substantially all of the Company's direct premiums written are generated in
Southern California. The revenues and profitability of the Company are therefore
subject to prevailing regulatory, economic and other conditions in Southern
California. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Results of Operations."
The Company's strategy includes expanding and diversifying its insurance
products and geographic operations. There can be no assurance that the Company
will be successful in implementing this strategy. See "-- Entry into New
Markets"
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INDUSTRY FACTORS
Many factors influence the financial results of the medical malpractice
insurance industry, several of which are beyond the control of the Company.
These factors include, among other things: changes in severity and frequency of
claims; changes in applicable law and regulatory reform; changes in judicial
attitudes toward liability claims; and changes in inflation, interest rates and
general economic conditions.
The availability of medical malpractice insurance, or the industry's
underwriting capacity, is determined principally by the industry's level of
capitalization, historical underwriting results, returns on investment and
perceived premium rate adequacy. Historically, the financial performance of the
medical malpractice industry has tended to fluctuate in cyclical patterns
characterized by periods of greater competition in pricing and underwriting
terms and conditions (a "soft insurance market") followed by periods of capital
shortage and lesser competition (a "hard insurance market"). In a soft insurance
market, competitive conditions could result in premium rates and underwriting
terms and conditions which may be below profitable levels. For a number of
years, the medical malpractice insurance industry in California and nationally
has faced a soft insurance market. There can be no assurance as to whether or
when industry conditions will improve or the extent to which any improvement in
industry conditions may improve the Company's results of operations.
COMPETITION
The Company competes with numerous insurance companies in the California
market. The Company's principal competitors for physicians and medical groups
consist of three physician-owned mutual or reciprocal insurance companies,
several commercial companies and a physicians' mutual protection trust, which
levies assessments primarily on a "claims paid" basis. In addition, commercial
insurance companies such as Farmers Group, Inc., Executive Risk Inc. and MMI
Companies, Inc. compete for the medical malpractice insurance business of larger
medical groups, hospitals and other healthcare providers. Several of these
competitors have greater financial resources than the Company. Between 1993 and
1997, the Company has increased premium rates, while most of its competitors
have maintained their rates or instituted smaller increases. The Company has
lost some of its policyholders, in part due to its rate increases, but has
realized a modest increase in its premium volume and improved its underwriting
results. See "Business - Rates."
In addition to pricing, competitive factors may include dividend policy,
financial stability, breadth and flexibility of coverage and the quality and
level of services provided. The Company paid dividends to its members of $9.0
million and $9.9 million in 1997 and 1996, respectively. Such dividends were
paid primarily to insureds who were members of the Exchange in 1990 and prior
policy years and were based primarily on underwriting results in such years. The
Company has ceased paying dividends and may find it more difficult to compete
with other insurance companies offering such dividends.
The Company has instituted no rate increases for 1998, which may offset the
elimination of dividends to policyholders and somewhat improve its competitive
position.
The competitive environment could also result in lower premium rates and fees,
reduced profitability and loss of market share. As the Company expands into new
product lines and new geographic markets, it will need to compete with
established companies in such markets, many of which will have existing
relationships with the doctors and medical groups that the Company will be
seeking to insure. See "Business -- Competition."
LOSS AND LAE RESERVES
The reserves for losses and loss adjustment expenses established by the
Company are estimates of amounts needed to pay reported and unreported claims
and related LAE. The estimates are based on assumptions related to the ultimate
cost of settling such claims based on facts and interpretation of circumstances
then known, predictions of future events, estimates of future trends in claims
frequency and severity and judicial theories of liability, legislative activity
and other factors. However, establishment of appropriate reserves is an
inherently uncertain process involving estimates of future losses and there can
be no assurance that currently established reserves will prove adequate in light
of subsequent actual experience. The inherent uncertainty is greater for certain
types of insurance, such as medical malpractice, where a longer period may
elapse before a definite determination of ultimate liability is made, and where
the judicial, political and regulatory climates are changing. Medical
malpractice claims and expenses may be paid over a period of 10 or more years,
which is longer than most property and casualty claims. Trends in losses on
long-tail lines of business such as medical malpractice may be slow to appear,
and accordingly, the Company's reaction in terms of modifying underwriting
practices and changing premium rates may lag underlying loss trends. In
addition, emerging changes in the practice of medicine, such
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as the emergence of new, larger medical groups that do not have an established
claims history and additional claims resulting from restrictions on treatment by
managed care organizations, may require the Company to adjust its underwriting
and reserving practices. See "-- Changes in Healthcare." While the Company
believes that its reserves for losses and LAE are adequate, there can be no
assurance that the Company's ultimate losses and LAE will not deviate, perhaps
substantially, from the estimates reflected in the Company's financial
statements. If the Company's reserves should prove inadequate, the Company will
be required to increase reserves, which could have a material adverse effect on
the Company's financial condition or results of operations.
The Company believes it has been conservative in establishing loss and LAE
reserves. In recent years, the Company has revised estimates of loss severity
and determined that certain of its reserves were redundant. Redundant reserves,
which have been released in every year since 1985, contributed significantly to
reported earnings in 1997, 1996 and 1995. The Company reduced reserves for prior
years by $53.2 million, $59.7 million and $57.8 million in the years ending
December 31, 1997, 1996 and 1995, respectively. See Note 3 of Notes to
Consolidated Financial Statements. The Company cannot predict whether similar
redundancies will be experienced in future years. The Company continues to
establish its loss and LAE reserves at what it believes is the upper end of a
reasonable range of reserve estimates, but there is no assurance that such
reserves will ultimately prove to be redundant. If reserves ultimately prove
redundant, then the redundant amount will become income in the period such
amount is released from reserves and will be included in stockholders' equity.
If such redundancies do not occur or loss and LAE experience does not improve,
the Company's net income could be significantly reduced or a net loss could
occur. To the extent that reserves prove to be inadequate in the future, the
Company would have to increase such reserves and incur a charge to earnings in
the period that such reserves are increased, which could have a material adverse
effect on the Company's results of operations and financial condition. See
"Business - Loss and LAE Reserves."
CHANGES IN HEALTHCARE
Significant attention has recently been focused on reforming the healthcare
system at both the Federal and state levels. A broad range of healthcare reform
measures has been suggested, and public discussion of such measures will likely
continue in the future. Proposals have included, among others, spending limits,
price controls, limits on increases in insurance premiums, limits on the
liability of doctors and hospitals for tort claims and changes in the healthcare
insurance system. The Company cannot predict which, if any, reform proposals
will be adopted, when they may be adopted or what impact they may have on the
Company. While some of these proposals could be beneficial to the Company, the
adoption of others could have a material adverse effect on the Company's
financial condition or results of operations.
In addition to regulatory and legislative efforts, there have been significant
market driven changes in the healthcare environment. In recent years, a number
of factors related to the emergence of "managed care" have negatively impacted
or threatened to impact the medical practice and economic independence of
physicians. Physicians have found it more difficult to conduct a traditional fee
for service practice and many have been driven to join or contractually
affiliate with managed care organizations, healthcare delivery systems or
practice management organizations. This consolidation could result in the
elimination or significant decrease in the role of the physician and the medical
group from the medical professional liability purchasing decision. In addition,
the consolidation could reduce primary medical malpractice insurance premiums
paid by healthcare systems, as larger healthcare systems generally retain more
risk by accepting higher deductibles and self-insured retentions or form their
own captive insurance companies.
ENTRY INTO NEW MARKETS
The Company's strategy is to expand and diversify its products and operations
to meet the insurance needs of large healthcare organizations, while maintaining
its traditional personalized service for physicians and medical groups, both
large and small. The Company has recently introduced policies providing hospital
professional liability, managed care organization errors and omissions and
directors and officers liability insurance for healthcare organizations. The
Company has also participated in recent years as a reinsurer in the excess
medical professional liability market. There is no assurance, however, that this
diversification will be successful.
In August 1995, SCPIE entered into a marketing agreement with a leading
healthcare insurance broker in the Western United States. Under the agreement,
the broker had the exclusive right to market SCPIE's malpractice coverage for
hospitals in all states, and the Company recognizes the broker as the exclusive
broker for medical group coverage in all states other than California. In
December 1996, the broker filed for bankruptcy, and another insurance company
acquired its assets in September 1997 in a court-approved transaction. Effective
October 1, 1997, the Company and this insurance broker mutually agreed to
terminate their exclusive
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marketing agreement. The Company now actively markets its hospital policies
under a new program directly and through regional and local brokers, and must
compete with that broker and a number of insurance companies in the underwriting
of hospital malpractice policies.
AHI has formed a relationship with Poe & Brown, one of the nation's top
independent insurance agency organizations, to provide professional liability
insurance to physicians commencing January 1, 1998. This program replaces an
existing program Poe & Brown had established with another insurance company. The
contracts for this program are being finalized. There is no assurance, however,
that the Company will successfully retain or expand this business through Poe &
Brown or that it will ultimately be profitable.
AHI acquired the medical malpractice insurance business of Fremont effective
January 1, 1998. The Fremont insureds include chiropractors, podiatrist and
other healthcare providers that have not been regularly insured by the Company
in the past and include a number of insureds, particularly outside California,
who do not qualify for the Company's standard risk program. In addition, the
Fremont business is written almost entirely through brokers, not only in
California but also in a number of other states in which the Company does not
have prior operating experience. There is no assurance that the Company will be
able to retain this business or the broker relationships or that the business
will be profitable.
PHYSICIAN AND MEDICAL ASSOCIATION RELATIONSHIPS
The Exchange was organized in 1976 by physicians, received the exclusive
endorsement and active support of a number of local county medical associations
in building its physician and medical group policyholder base and, as a
reciprocal insurance company, has been wholly owned and governed by its members.
The Exchange has relied on its relationship with physicians and medical
associations in marketing its policies in competition with commercial insurance
companies and other physician-owned companies. The Company will endeavor to
maintain its medical association endorsements and to continue its close
relationship with physicians and medical groups through personalized service.
There can be no assurance that the Company will be able to maintain these
relationships.
IMPORTANCE OF RATINGS
Ratings have become an increasingly important factor in establishing the
competitive position of insurance companies. The Company is rated "A
(Excellent)" by A.M. Best, the third highest rating of 15 ratings assigned to
insurance companies, which currently range from "A++ (Superior)" to "F (In
Liquidation)." A.M. Best's ratings reflect its opinion of an insurance company's
financial strength, operating performance and ability to meet its obligations to
policyholders and are not evaluations directed to purchasers of an insurance
company's securities. In June 1996, A.M. Best reduced the Company's rating from
"A+ (Superior)," citing significant uncertainty in the medical malpractice
marketplace, caused, in part, by evolving managed care issues, the Company's
narrow product line and geographic concentration, and intense competition and
weakening premium rates in the medical malpractice industry. A.M. Best similarly
reduced the ratings of three other medical malpractice insurance companies
domiciled in California and several other medical malpractice companies
domiciled in states other than California. The Company's ability to maintain or
improve its rating by A.M. Best may depend on its ability to implement
successfully its business strategy. See "Business -- A.M. Best Rating." If A.M.
Best materially reduces the Company's rating from its current level, the
Company's results of operations could be adversely affected. The Insurance
Subsidiaries have entered into a reinsurance pooling arrangement and each of the
Insurance Subsidiaries has been assigned the same "pooled" "A (Excellent)" A.M.
Best rating based on their consolidated performance.
REINSURANCE
The amount and cost of reinsurance available to companies specializing in
medical professional liability insurance are subject, in large part, to
prevailing market conditions beyond the control of the Company. The Company's
ability to provide professional liability insurance at competitive premium rates
and coverage limits on a continuing basis will depend in part upon its ability
to secure adequate reinsurance in amounts and at rates that are commercially
reasonable. Although the Company anticipates that it will continue to be able to
obtain such reinsurance, there can be no assurance that this will be the case.
Further, the Company is subject to a credit risk with respect to its reinsurers
because reinsurance does not relieve the Company of liability to its insureds
for the risks ceded to reinsurers. Although the Company places its reinsurance
with reinsurers it believes to be financially stable, a significant reinsurer's
inability to make payment under the terms of a reinsurance treaty could have a
material adverse effect on the Company. See "Business -- Reinsurance."
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HOLDING COMPANY STRUCTURE; LIMITATION ON DIVIDENDS
SCPIE Holdings is an insurance holding company whose assets consist of all of
the outstanding capital stock of the Insurance Subsidiaries and, following the
Offering, will include a portion of the net proceeds of the Offering. As an
insurance holding company, SCPIE Holdings' ability to meet its obligations and
to pay dividends, if any, may depend upon the receipt of sufficient funds from
its subsidiaries. The payment of dividends to SCPIE Holdings by the Insurance
Subsidiaries is subject to general limitations imposed by applicable insurance
laws. See "Business -- Regulation -- Regulation of Dividends from Insurance
Subsidiaries."
ANTI-TAKEOVER PROVISIONS
SCPIE Holdings' amended and restated certificate of incorporation (the
"Restated Certificate") and amended and restated bylaws (the "Bylaws") include
provisions that may be deemed to have anti-takeover effects and may delay, defer
or prevent a takeover attempt that stockholders may consider to be in their best
interests. These provisions include: a Board of Directors consisting of three
classes; authorization to issue up to 5,000,000 shares of preferred stock, par
value $1.00 per share (the "Preferred Stock"), in one or more series with such
rights, obligations, powers and preferences as the Board of Directors of SCPIE
Holdings (the "SCPIE Holdings Board") may provide; a limitation which permits
only the SCPIE Holdings Board, or the Chairman or the President of SCPIE
Holdings to call a special meeting of stockholders; a prohibition against
stockholders acting by written consent; provisions which provide that directors
may be removed only for cause and only by the affirmative vote of holders of
two-thirds (66 2/3%) of the outstanding shares of voting securities; provisions
which provide that the SCPIE Holdings Board may increase the size of the Board
and may fill vacancies and newly created directorships; and certain advance
notice procedures for nominating candidates for election to the SCPIE Holdings
Board and for proposing business before a meeting of stockholders. In addition,
state insurance holding company laws applicable to the Company in general
provide that no person may acquire control of SCPIE Holdings without the prior
approval of appropriate insurance regulatory authorities. See "Business --
Regulation -- Holding Company Regulation."
REGULATORY AND RELATED MATTERS
Insurance companies are subject to supervision and regulation by the state
insurance authority in each state in which they transact business. Such
supervision and regulation relate to numerous aspects of an insurance company's
business and financial condition, including limitations on lines of business,
underwriting limitations, the setting of premium rates, the establishment of
standards of solvency, statutory surplus requirements, the licensing of insurers
and agents, concentration of investments, levels of reserves, the payment of
dividends, transactions with affiliates, changes of control and the approval of
policy forms. Such regulation is concerned primarily with the protection of
policyholders' interests rather than stockholders' interests. See "Business --
Regulation."
State regulatory oversight and various proposals at the Federal level may in
the future adversely affect the Company's results of operations. In recent
years, the state insurance regulatory framework has come under increased Federal
scrutiny, and certain state legislatures have considered or enacted laws that
alter and, in many cases, increase state authority to regulate insurance
companies and insurance holding company systems. Further, the NAIC and state
insurance regulators are reexamining existing laws and regulations, which in
many states has resulted in the adoption of certain laws that specifically focus
on insurance company investments, issues relating to the solvency of insurance
companies, RBC guidelines, interpretations of existing laws, the development of
new laws and the definition of extraordinary dividends. See "Business --
Regulation -- Regulation of Dividends from Insurance Subsidiaries," "--
Risk-Based Capital" and "-- Regulation of Investments."
ITEM 2. PROPERTIES
The Company is the owner of two office buildings, both located in Beverly
Hills, California. One building contains approximately 25,000 square feet of
office space and is used by the Company as a home office. The other office
building contains approximately 24,000 square feet, of which the Company
occupies approximately 17,000 square feet and the remaining 7,000 square feet of
space in this office building is leased to unaffiliated persons. Both office
buildings are currently unencumbered.
The Company is in the process of seeking leased space to replace its existing
facilities. The Company has no commitments for such space to date.
The Company also leases office space for a claims office in San Diego,
California, a sales office in Sacramento, California and marketing offices in
Dallas, Texas and Boca Raton, Florida.
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ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in an action brought by the bankruptcy estate of an
uninsured physician. The bankruptcy estate alleged that the Company had an
undisclosed conflict of interest when it provided the physician with a free
courtesy defense by an attorney who had represented the interests of the
Company's insureds in other cases. The jury awarded compensatory damages of
$4.2 million and punitive damages were reduced to $14.0 million by the trial
judge. The Company believes that the action is entirely without merit and plans
to aggressively pursue its rights on appeal. However, the ultimate resolution of
this matter cannot be determined at this time and could result in a loss to the
Company.
The Company is named as defendant in various legal actions primarily arising
from claims made under insurance policies and contracts. These actions are
considered by the Company in estimating the loss and loss adjustment expense
reserves. The Company's management believes that the resolution of these actions
will not have a material adverse effect on the Company's financial position or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Company did not have an established public trading market for its Common
Stock during fiscal year 1996. The Company's Common Stock became publicly
tradable on the NYSE on January 30, 1997 under the symbol "SKP." The following
table shows the price ranges per share in each quarter since that date:
HIGH Low
---- ---
1997
First quarter (since January 30) 24.63 19.50
Second quarter 27.81 19.25
Third quarter 31.56 24.50
Fourth quarter 32.00 26.94
1998
First quarter (January 1 - March 16) 31.63 27.31
On March 16, 1998, the closing price of the Company's common stock was $31.13.
STOCKHOLDERS OF RECORD
The approximate number of stockholders of record of the Company's Common Stock
as of March 16, 1998 was 8,110. Approximately 114 of such stockholders' of
record held the Company's common stock for an additional 2,301 beneficial
holders according to ChaseMellon Shareholder Services, the Company's transfer
agent.
DIVIDENDS
The SCPIE Holdings' Board of Directors (the "Board") declared a cash dividend
of $0.05 per share on its common stock each quarter of 1997. On February 25,
1998, the Board declared a $0.06 quarterly dividend payable on March 31, 1998,
to stockholders of record on March 16, 1998. The Company expects to continue the
payment of quarterly dividends to its stockholders. The continued payment and
amount of cash dividends will depend upon, among other factors, the Company's
operating results, overall financial condition, capital requirements and general
business conditions.
As a holding company, SCPIE Holdings is largely dependent upon dividends from
its subsidiaries to pay dividends to its stockholders. These subsidiaries are
subject to state laws that restrict their ability to distribute dividends. State
law permits payment of dividends and advances within any twelve month period
without any prior regulatory approval in an amount up to the greater of 10% of
statutory earned surplus at the preceding December 31 or net income for the
calendar year preceding the date the dividend is paid. Under these restrictions,
the principal insurance subsidiary of the Company is entitled to pay dividends
to SCPIE Holdings during 1998 up to approximately $27.5 million. See Note 6 of
the Notes to Consolidated Financial Statements and "Business Regulation --
Regulation of Dividends from Insurance Subsidiaries."
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ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
The following table sets forth selected financial and operating data for the
Company.
SELECTED FINANCIAL AND OPERATING DATA
(In thousands, except per share data)
AS OF OR FOR THE YEAR ENDED DECEMBER 31, 1997 1996 1995 1994 1993
- ---------------------------------------- -------- -------- -------- -------- --------
INCOME STATEMENT DATA(1):
Direct premiums written ................... $123,910 $125,635 $122,277 $120,024 $112,459
======== ======== ======== ======== ========
Premiums earned ........................... $133,866 $120,484 $116,354 $111,659 $113,194
Net investment income ..................... 42,716 40,769 40,424 39,663 39,738
Realized investment gains
and other revenue ....................... 7,153 12,113 8,231 755 16,254
-------- -------- -------- -------- --------
Total revenues ........................ 183,735 173,366 165,009 152,077 169,186
-------- -------- -------- -------- --------
Losses and loss adjustment
expenses ................................ 123,377 108,797 118,023 108,720 125,354
Other operating expenses .................. 17,987 14,276 12,561 11,844 9,734
-------- -------- -------- -------- --------
Total expenses ........................ 141,364 123,073 130,584 120,564 135,088
-------- -------- -------- -------- --------
Income before policyholder
dividends and
federal income taxes .................... 42,371 50,293 34,425 31,513 34,098
Policyholder dividends(2) ................. -- 8,436 -- -- --
Federal income taxes ...................... 10,195 11,665 10,056 9,212 8,618
-------- -------- -------- -------- --------
Net income .............................. $ 32,176 $ 30,192 $ 24,369 $ 22,301 $ 25,480
======== ======== ======== ======== ========
BALANCE SHEET DATA(1):
Total investments ......................... $785,664 $717,910 $695,021 $636,909 $679,257
Total assets .............................. 888,449 805,155 781,358 751,605 775,667
Total liabilities ......................... 527,334 516,588 507,539 542,069 548,268
Total stockholders' equity ................ 361,115 288,567 273,819 209,536 227,399
ADDITIONAL DATA(1):
Basic earnings per share of common stock(3) $ 2.66 $ 3.02 $ 2.44 $ 2.23 $ 2.55
Dividends per share of common stock ....... 0.20 -- -- -- --
Book value per share(3) ................... 29.41 28.86 27.38 20.95 22.74
GAAP ratios:
Loss ratio .............................. 92.2% 90.3% 101.4% 97.4% 110.7%
Expense ratio ........................... 13.4 11.8 10.8 10.6 8.6
Combined ratio .......................... 105.6 102.1 112.2 108.0 119.3
Statutory capital and surplus ............. $321,289 $251,958 $235,352 $187,299 $171,589
(1) Financial data as of and for the years ended December 31, 1995, 1994 and
1993 are derived from the combined financial statements of the Southern
California Physicians Insurance Exchange (the Exchange) and an affiliated
non-profit corporation that was liquidated into the Exchange on July 12,
1996. Financial data as of and for the year ended December 31, 1996 are
derived from the consolidated financial statements of the Exchange and its
wholly-owned subsidiaries. Financial data as of and for the year ended
December 31, 1997 are derived from the financial statements of SCPIE
Holdings Inc. and its wholly-owned subsidiaries.
(2) In the second quarter of 1996, the Company estimated an additional $9.0
million of policyholder dividends (offset by a $0.6 million credit for
forfeited dividends declared in 1995) would be paid due to favorable loss
experience related to policy years 1987 through 1992. This policyholder
dividend was paid to members of the Exchange in the form of premium credits
during 1997. The Company has ceased paying such dividends to its
policyholders.
(3) Basic earnings per share of common stock at December 31, 1997 is computed
using the weighted average number of common shares outstanding during the
year of 12,108,330. All other periods give effect to the Reorganization
completed on January 29, 1997, including the allocation of approximately
10,000,000 shares of common stock to members of the Exchange in connection
therewith. The adoption of Statement of Financial Accounting Standards No.
128 (Statement 128), "Earnings per Share" had no impact on the calculation
of basic earnings per share amounts. For further discussion of basic
earnings per share and Statement 128 see the notes to the consolidated
financial statements beginning on page 42.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and the related notes thereto appearing elsewhere in this Form 10-K.
The financial statements for 1997 include the accounts and operations of SCPIE
Holdings Inc. and its wholly-owned subsidiaries. The financial statements for
1996 and prior years include the accounts and operations of the Southern
California Physicians Insurance Exchange (the Exchange) and its wholly-owned
subsidiaries and certain affiliates.
For purposes of this Form 10-K, the terms "SCPIE" and the "Company" refer, at
all times prior to January 29, 1997, to the Exchange and its subsidiaries,
collectively, and at all times on or after such date, to SCPIE Holdings Inc. and
its subsidiaries, collectively; and the term "SCPIE Holdings" refers at all
times to SCPIE Holdings Inc., excluding its subsidiaries.
GENERAL
On January 29, 1997, SCPIE consummated its reorganization from a reciprocal
insurance company to a stock insurance company by merging with and into SCPIE
Indemnity Company (the Reorganization). In connection with the Reorganization,
9,994,652 shares of the Company's common stock were issued to members of the
Exchange in exchange for their membership interests in SCPIE, and 500,000 shares
of common stock were issued to SCPIE Indemnity.
On January 30, 1997, the Company made an initial public offering of 2,300,000
shares of its common stock. The net proceeds of approximately $36.4 million of
the common stock offering were used to capitalize the Company's insurance
company subsidiaries, to facilitate geographic expansion, and for general
corporate purposes.
Certain statements in the following discussion that are not historical in fact
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements regarding
the Company, its business, prospects and results of operations are subject to
certain risks and uncertainties posed by many factors and events that could
cause the Company's actual business, prospects and results of operations to
differ materially from those that may be expressed or implied by such
forward-looking statements. Such risks, uncertainties and other factors are
discussed below and under "Business--Risk Factors" and in periodic filings with
the Securities and Exchange Commission.
CYCLICAL NATURE OF MEDICAL MALPRACTICE INSURANCE INDUSTRY Many factors
influence the financial results of the medical malpractice insurance industry,
several of which are beyond the control of the Company. These factors include,
among other things, changes in severity and frequency of claims; changes in
applicable law and regulatory reform; changes in judicial attitudes toward
liability claims; and changes in inflation, interest rates and general economic
conditions.
The availability of medical malpractice insurance, or the industry's
underwriting capacity, is determined principally by the industry's level of
capitalization, historical underwriting results, returns on investment and
perceived premium rate adequacy. Historically, the financial performance of the
medical malpractice industry has tended to fluctuate between a soft insurance
market and a hard insurance market. In a soft insurance market, competitive
conditions could result in premium rates and underwriting terms and conditions
that may be below profitable levels. For a number of years, the medical
malpractice insurance industry in California has faced a soft insurance market.
There can be no assurance as to whether or when industry conditions will improve
or the extent to which any improvement in industry conditions may improve the
Company's financial condition and results of operations.
CHANGING NATURE OF THE BUSINESS The vast majority of the Company's business is
professional liability insurance for physicians written on a claims made and
reported basis. The Company believes that the integration of healthcare delivery
in recent years, particularly in California, will result in the growing
importance of large medical groups and other healthcare entities, and a
corresponding change in the entities that make professional liability purchasing
decisions. The Company believes that these changes have created a need for the
Company to further diversify. As a result, the Company has adopted a strategy
for growth that includes expanding the type of products offered by the Company
and diversifying geographically by offering products in states other than
California. The Company began to implement its strategy in 1994 by offering
professional liability insurance to hospitals in California and, in 1995, began
offering errors and omissions coverage for managed care organizations.
In August 1995, the Company entered into a marketing arrangement with Sullivan,
Kelly & Associates (SKA) to expand its business to other states. Under the
agreement, SKA had the exclusive right to market the Company's malpractice
coverage for
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hospitals in all states, and the Company recognized SKA as the exclusive broker
for medical group coverage in all states other than California. In December
1996, SKA filed for bankruptcy in the United States Bankruptcy Court, Central
District of California, and its assets were acquired by another insurance
company in September 1997 in a court-approved transaction. Effective October 1,
1997, the Company and SKA mutually agreed to terminate their exclusive marketing
agreement. The Company now actively markets its hospital policies under a new
program directly and through regional and local brokers, and must compete with
SKA and a number of insurance companies in the underwriting of hospital
malpractice policies.
American Healthcare Indemnity Company (AHI), a subsidiary of SCPIE Holdings,
has formed a relationship with Poe & Brown, Inc. (Poe & Brown) one of the
nation's top independent insurance agency organizations, to provide professional
liability insurance to physicians commencing January 1, 1998. This coverage is
offered to solo physicians and medical groups in eight states, the largest being
Connecticut, Florida and Georgia. This replaces an existing program Poe & Brown
had established with another insurance company. There is no assurance, however,
that the Company will successfully retain or expand this business through Poe &
Brown or that it will ultimately be profitable.
In addition, AHI has acquired the medical malpractice insurance business of
Fremont Indemnity Company (Fremont) through a purchase agreement effective
January 1, 1998. Simultaneously, a 100% quota-share reinsurance agreement went
into effect, making SCPIE Indemnity the reinsurer for the Fremont policies
pending regulatory approval of AHI to write this business directly. The Fremont
policies are written through brokers in 10 states the vast majority in
California and Arizona.
COMPETITIVE ENVIRONMENT The California medical malpractice insurance market for
medical groups and physicians, in which the company principally operates, has
become extremely competitive in recent years. The Company's principal
competitors are three physician-owned companies and a physicians' mutual
protection trust. In addition, commercial insurance companies have recently
returned to the California market to insure medical groups and physicians.
In the late 1980s, many medical malpractice insurance companies began to
experience significantly improved claims cost trends and attempted to attract
medical groups and physicians insured by other companies by reducing premium
rates. Beginning in 1990, the Company implemented annual rate decreases
aggregating more than 25% during the next three years, which resulted in a
reduction in premium volume to approximately $107.1 million in 1992, and a
deterioration of underwriting results. Between 1993 and 1997, however, SCPIE
instituted annual overall rate increases ranging from 4.4% to 9.2% in order to
improve its underwriting results. These rate increases were higher than those
implemented by most of its competitors. As a result, the Company has lost some
of its policyholders, in part due to these rate increases, but realized a modest
increase in its premium volume and has improved its underwriting results.
The Company partially offset the effect of these rate increases through the
payment of dividends to the members of the Exchange in the form of premium
credits based on the actual results of prior policy years.
In 1996, the Board of Governors of the Exchange declared a final dividend to
members of the Exchange of record on November 5, 1996, which was paid in the
form of premium credits in 1997. This dividend of approximately $9.0 million
(offset by a $0.6 million credit for forfeited dividends declared in 1995) was
reflected as an expense in the year ended December 31, 1996. The Company has
ceased paying such premium credit dividends to its policyholders. Therefore, the
Company may find it more difficult to compete with other insurance companies
offering such dividends.
The Company has instituted no rate increases for 1998, which may offset the
elimination of dividends to policyholders and somewhat improve its competitive
position.
LOSS AND LAE RESERVES Medical malpractice and other property and casualty loss
and loss adjustment expense (LAE) reserves are established based on known facts
and interpretation of circumstances, including the Company's experience with
similar cases and historical trends involving claim payment patterns, loss
payments and pending levels of unpaid claims, as well as court decisions and
economic conditions. The effects of inflation are considered in the reserving
process. Establishment of appropriate reserves is an inherently uncertain
process, and there can be no assurance that currently established reserves will
prove adequate in light of subsequent actual experience. The Company follows a
practice of conservatively estimating its future liabilities relating to
losses already incurred and has attempted to establish its loss and LAE reserves
at the upper end of a reasonable range of reserve
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estimates. The Company believes that it has been particularly difficult to make
such estimates for medical malpractice claims in California because of the
uncertain benefits of tort reform measures and more recently a change in the
judicial process.
The Company believes that a combination of these and other factors have
contributed to the recent redundancies in reserves established by SCPIE for
prior years. The original reserves were established without full knowledge of
the effect of these factors. Redundant reserves, which have been released in
every year since 1985, have contributed significantly to reported earnings in
recent years. The Company reduced reserves for prior years by $53.2 million,
$59.7 million, and $57.8 million in the years ended December 31, 1997, 1996 and
1995, respectively. The Company cannot predict whether similar redundancies will
be experienced in future years. The Company continues to establish its loss and
LAE reserves at what it believes is the upper end of a reasonable range of
reserve estimates, but there is no assurance that such reserves will ultimately
prove to be redundant. The Company believes that some reduction in the amount of
the redundancies recently experienced is reasonably likely. If such redundancies
do not occur or loss and LAE experience does not improve, the Company's net
income could be significantly reduced or a net loss could occur.
OPERATING EXPENSES With its continued expansion into other states and markets,
the Company has experienced an increase in its operating expense levels to
achieve and service this expansion. Commissions for policies that are sold
through agents and brokers typically range from 7.5% to 17.5% of premiums,
whereas the Company does not incur commissions on products sold directly.
Hospital and other healthcare provider policies are typically sold through
brokers, as are physicians and medical group policies sold through Poe & Brown
and in the program acquired from Fremont. To the extent that these policies
represent an increased percentage of the Company's business in the future,
expense ratios will increase.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997, COMPARED TO YEAR ENDED DECEMBER 31, 1996
PREMIUMS EARNED Premiums earned increased approximately $13.4 million, or 11.1%,
to $133.9 million in 1997 from $120.5 million in 1996. The increase was due to a
$5.7 million increase in hospital medical malpractice premiums and an increase
of $9.1 million in assumed reinsurance. Medical malpractice premiums from
physicians and medical groups were approximately $111.4 million in 1997 compared
to $112.7 million in 1996. An average 5.0% increase in premium rates in effect
during 1997 was offset by a 4.1% decrease in the average number of policies in
force during 1997 as compared to 1996. Hospital medical malpractice premiums
were approximately $8.0 million in 1997 compared to $2.3 million in 1996.
Assumed reinsurance premiums were approximately $13.6 million, which includes
$6.5 million of assumed hospital premiums in 1997 compared to less than $4.5
million in 1996.
NET INVESTMENT INCOME Net investment income increased approximately $1.9
million, or 4.8%, to $42.7 million in 1997 from $40.8 million in 1996. Invested
assets increased $67.8 million to $785.7 million in 1997 from $717.9 million at
December 31, 1996. The average pretax yield on the investment portfolio
decreased to 5.6% in 1997 compared to 6.1% in 1996 primarily due to
lower-yielding, tax-exempt bonds.
REALIZED INVESTMENT GAINS AND OTHER REVENUE Realized investment gains were
approximately $6.6 million in 1997 compared to $11.7 million in 1996.
Approximately $11.2 million of the gains from 1996 resulted from the sale of
equity securities in connection with the Company's decision in the first quarter
of 1996 to increase the focus of its investment portfolio on fixed-maturity
securities. In 1997 sales were made in the fixed-maturity portion of the
investment portfolio to reposition the portfolio by increasing the percentage of
tax-exempt securities.
LOSSES AND LAE Losses and LAE increased $14.6 million, or 13.4%, to $123.4
million in 1997 from $108.8 million in 1996. As a percentage of premiums earned,
losses and LAE increased to 92.2% in 1997 from 90.3% for the same period in
1996. For 1997, the Company reduced loss and LAE reserves incurred in prior
policy years approximately $53.2 million as compared to a reserve reduction of
$59.7 million for 1996 for claims incurred in prior policy years.
OTHER OPERATING EXPENSES Other operating expenses increased $3.7 million, or
26.0%, to $18.0 million in 1997 from $14.3 million in 1996. This increase was
principally attributable to increases in policy acquisition expenses,
payroll/benefit expenses, and legal and consultation fees of $1.1 million, $0.7
million, and $1.2 million, respectively. The ratio of other operating expenses
to premiums earned is referred to as the expense ratio, which was 13.4% in 1997
and 11.8% in 1996.
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POLICYHOLDER DIVIDENDS The governing board of the Exchange declared a final
dividend to members of the Exchange of record on November 5, 1996, who were also
members of the Exchange during policy years 1987 through 1992. Such dividend was
paid in the form of premium credits during 1997. This dividend of $9.0 million
(offset by a $0.6 million credit for forfeited dividends declared in 1995) was
reflected as an expense for the year ended December 31, 1996.
FEDERAL INCOME TAXES Federal income taxes decreased $1.5 million, or 12.6%, to
$10.2 million in 1997 from $11.7 million in 1996. The effective tax rate
decreased to 24.1% in 1997 from 27.9% in 1996, due primarily to an increase in
tax-exempt interest in 1997.
YEAR ENDED DECEMBER 31, 1996, COMPARED TO YEAR ENDED DECEMBER 31, 1995
PREMIUMS EARNED Premiums earned increased approximately $4.1 million, or 3.5%,
to $120.5 million in 1996 from $116.4 million in 1995. The increase was
principally due to a $3.5 million increase in assumed reinsurance premiums.
Medical malpractice premiums from physicians and medical groups were
approximately $112.7 million in 1996 compared to $113.3 million in 1995. An
average 4.4% increase in premium rates in effect during 1996 was offset by a
4.2% decrease in the average number of policies in force during 1996 as compared
to 1995. Hospital medical malpractice premiums were approximately $2.3 million
in 1996 compared to $1.3 million in 1995. Assumed reinsurance premiums were
approximately $4.5 million in 1996 compared to less than $1.0 million in 1995.
NET INVESTMENT INCOME Net investment income, after a $0.4 million interest
expense accrual for a federal income tax settlement, increased approximately
$0.4 million, or 1.0%, to $40.8 million in 1996 from $40.4 million in 1995.
Invested assets increased $22.9 million to $717.9 million in 1996 from $695.0
million at December 31, 1995. The average pretax yield on the investment
portfolio increased to 6.1% in 1996 compared to 5.9% in 1995.
REALIZED INVESTMENT GAINS AND OTHER REVENUE Realized investment gains were
approximately $11.7 million in 1996 compared to $8.0 million in 1995.
Approximately $11.2 million of the gains from 1996 resulted from the sale of
equity securities in connection with the Company's decision in the first quarter
of 1996 to increase the focus of its investment portfolio on fixed-maturity
securities. The remainder was attributable to sales made in the fixed-maturity
portion of the investment portfolio to take advantage of more favorable yields
or to reposition the maturity of the portfolio.
LOSSES AND LAE Losses and LAE decreased $9.2 million, or 7.8%, to $108.8 million
in 1996 from $118.0 million in 1995. As a percentage of premiums earned, losses
and LAE decreased to 90.3% in 1996 from 101.4% for the same period in 1995. For
1996, the Company reduced loss and LAE reserves incurred in prior policy years
approximately $59.7 million as compared to a reserve reduction of $81.7 million
for 1995 for claims incurred in prior policy years. This reserve reduction of
$81.7 million was offset by a $23.9 million reserve increase for free tail
coverage to be provided by the Company to currently insured physicians at the
time of their death, disability or retirement. This increase was the result of a
refinement in the actuarial methodology used to calculate this reserve.
OTHER OPERATING EXPENSES Other operating expenses increased $1.7 million, or
13.7%, to $14.3 million in 1996 from $12.6 million in 1995. This increase was
principally attributable to increases in policy acquisition expenses and
payroll/benefit expenses of $0.6 million and $1.3 million, respectively, offset
partially by lower legal fees of $0.7 million. The expense ratio was 11.8% in
1996 and 10.8% in 1995.
POLICYHOLDER DIVIDENDS A final dividend to members of the Exchange of $9.0
million (offset by a $0.6 million credit for forfeited dividends declared in
1995) was reflected as an expense for the year ended December 31, 1996.
Dividends declared in prior years have been accrued as an expense for the period
in which the related premiums were earned and not the year paid or declared.
Accordingly, there is no expense reflected in 1995.
FEDERAL INCOME TAXES Federal income taxes increased $1.6 million, or 16.0%, to
$11.7 million in 1996 from $10.1 million in 1995. The effective tax rate
decreased to 27.9% in 1996 from 29.2% in 1995, due primarily to an increase in
tax-exempt interest in 1996.
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LIQUIDITY AND CAPITAL RESOURCES
The primary sources of the Company's liquidity are insurance premiums, net
investment income, recoveries from reinsurers and proceeds from the maturity or
sale of invested assets. Funds are used to pay losses, LAE, operating expenses,
reinsurance premiums and taxes. The Company has also paid significant dividends,
in the form of premium credits, to its members in each year since 1980. The
Company paid $9.0 million and $9.9 million of such dividends during the years
ended December 31, 1997 and 1996, respectively. The Company has now ceased
paying such premium credit dividends to its policyholders.
SCPIE has consistently experienced positive cash flow from operations. Because
of uncertainty related to the timing of the payment of claims, cash from
operations for a property and casualty insurance company can vary substantially
from year to year. Cash provided by operating activities for SCPIE, before the
payment of dividends to policyholders, was $13.5 million in 1997 compared to
$39.8 million in 1996. The higher amount of cash flow from operations in 1996
was due to a refund of federal income tax and interest of $25.9 million in
settlement of a tax dispute for the 1985 through 1988 tax years.
The Company invests its positive cash flow from operations in both
fixed-maturity securities and equity securities. The Company's current policy is
to limit its investment in equity securities and real estate to no more than
8.0% of the total market value of its investments. Accordingly, the Company's
portfolio of unaffiliated equity securities was reduced from $61.1 million at
December 31, 1995, to $23.5 million at December 31, 1997. The Company plans to
continue this focus on fixed-maturity securities for the indefinite future. The
Company has made limited investments in real estate, which has been used almost
entirely in the Company's operating activities, with the remainder leased to
third parties.
The Company maintains a portion of its investment portfolio in high-quality,
short-term securities to meet short-term operating liquidity requirements,
including the payment of losses and LAE. Short-term investments totaled $53.3
million, or 6.8% of invested assets, at December 31, 1997. The Company believes
that all of its short-term and fixed-maturity securities are readily marketable.
SCPIE Holdings is an insurance holding company whose assets primarily consist
of all of the capital stock of its insurance company subsidiaries and
approximately $36.4 million of net proceeds from a January 1997 common stock
offering. In 1997, along with the net proceeds from the common stock offering,
and dividends from its insurance subsidiaries, SCPIE has contributed $25.0
million to American Healthcare Specialty Insurance Company and another $23.0
million to AHI. Its principal sources of funds are dividends from its
subsidiaries and proceeds from the issuance of debt and equity securities. The
insurance company subsidiaries are restricted by state regulation in the amount
of dividends they can pay in relation to earnings or surplus, without the
consent of the applicable state regulatory authority, principally the California
Department of Insurance. SCPIE Holdings' principal insurance company subsidiary
may pay dividends to SCPIE Holdings in any year, without regulatory approval, to
the extent such dividends do not exceed the greater of (i) 10% of its statutory
surplus at the end of the preceding year or (ii) its net income for the
preceding year. Applicable regulations further require that an insurer's
statutory surplus following a dividend or other distribution be reasonable in
relation to its outstanding liabilities and adequate to meet its financial
needs, and permit the payment of dividends only out of statutory earned
(unassigned) surplus unless the payment out of other funds receives regulatory
approval. The amount of dividends that the insurance company subsidiaries are
able to pay to SCPIE Holdings during 1998 without prior regulatory approval is
approximately $27.5 million. Dividends of $20.0 million were paid during 1997.
Common stock dividends paid to stockholders were $0.20 per share in 1997.
These dividends are funded through dividends from the Company's insurance
subsidiaries. The Company expects to pay dividends in the future. However,
payment of dividends is subject to Board approval, earnings and the financial
condition of the Company.
The Company has received a commitment from a large lender for a bank facility
in the amount of $50.0 million. The commitment is subject to certain terms and
conditions as well as negotiation and completion of all documentation. The
Company expects to use this facility for general corporate purposes.
Based on historical trends, market conditions and its business plans, the
Company believes that its sources of funds will be sufficient to meet its
liquidity needs over the next 18 months and beyond. However, because economic,
market and regulatory conditions may change, there can be no assurance that the
Company's sources of funds will be sufficient to meet these liquidity needs. The
short- and long-term liquidity requirements of the Company may vary because of
the uncertainties regarding the settlement dates for unpaid claims.
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The Company is in the process of seeking leased space for its operations. The
Company has not entered into any commitments to date. The Company expects to use
its cash flow from current operations to pay for any additional space and
capital equipment.
During May 1997, the Board of Directors authorized the repurchase of up to
1,000,000 shares of its common stock in the open market. The repurchase may
begin at any time and continue until May 1998. During 1997, 15,400 shares were
repurchased. Subsequent to December 31, 1997, an additional 55,800 shares were
repurchased.
IMPACT OF YEAR 2000
Based on our assessments in prior years, the Company has determined
modification of significant portions of its software were required so that its
computer systems would function properly with respect to dates in the year 2000
and thereafter. The Company has utilized internal resources to reprogram, or
replace and test, the software for Year 2000 modifications. The Company
estimates that approximately 85% of the most important changes have been made
and anticipates completing the entire project by December 31, 1998. The total
cost of the Year 2000 project since its inception in 1995 is estimated at $1.8
million, of which approximately $734,000 was incurred through December 31, 1997.
There can be no assurance, however, that there will not be a delay in or
increased costs associated with the completion and implementation of such
changes, and the Company's inability to implement such changes could have an
adverse effect on future results of operations.
The Company has initiated formal communications with its significant suppliers
to determine the extent to which the Company's interface systems are vulnerable
to those third parties' failure to remediate their own Year 2000 issues.
However, there can be no assurance that the systems of other companies on which
the Company's systems rely will be timely converted and would not have an
adverse effect on the Company's systems.
EFFECT OF INFLATION
The primary effect of inflation on the Company is considered in pricing and
estimating reserves for unpaid losses and LAE for claims in which there is a
long period between reporting and settlement, such as medical malpractice
claims. The actual effect of inflation on the Company's results cannot be
accurately known until claims are ultimately settled. Based on actual results to
date, the Company believes that loss and LAE reserve levels and the Company's
ratemaking process adequately incorporate the effects of inflation.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements and related notes, including
supplementary data, are set forth in the "Index" on page 37 hereof.
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
Information regarding Directors of the Company is incorporated by reference to
the section entitled "Election of Directors" in the Company's definitive proxy
statement to be filed with the SEC in connection with the Annual Meeting of
Stockholders to be held on May 14, 1998 (the "Proxy Statement"). Information
regarding Executive Officers is set forth in Item 1 of Part I of this Form 10-K
report under the caption "Executive Officers."
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ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Stock Ownership of Directors and Executive
Officers."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Certain Relationships and Related
Transactions."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a)(1) and (a)(2) and (d) FINANCIAL STATEMENTS AND SCHEDULE. Reference is
made to the "Index--Financial Statements and
Financial Statement Schedule--Annual Report on Form
10-K" filed on page 37 of this Form 10-K report.
(a) (3) Exhibits:
NUMBER DOCUMENT
------ --------
2. Amended and Restated Plan and Agreement of Merger by
and among SCPIE Holdings Inc., SCPIE Indemnity Company and Southern
California Physicians Insurance Exchange dated August 8, 1996, as
amended December 19, 1996.**
3.1 Amended and Restated Certificate of Incorporation.**
3.2 Amended and Restated Bylaws.**
10.1 Amended and Restated Employment Agreement dated
January 2, 1998, between SCPIE Management Company and
Donald J. Zuk.
10.2 Letter of Credit Agreement dated February 11, 1998 between Union
Bank of California, N.A. and American Healthcare Indemnity Company
in the amount of $7,674,561.
10.3 Letter of Credit Agreement dated February 11, 1998 between Union
Bank of California, N.A. and American Healthcare Indemnity Company
in the amount of $1,000,000.
10.4 Letter of Credit Agreement dated January 11, 1995 between First
Interstate Bank and Southern California Physicians Insurance
Exchange in the amount of $27,368,087.**
10.5 Letter of Credit Agreement dated January 26, 1995 between
First Interstate Bank and Southern California Physicians
Insurance Exchange for a $5,000,000 Secured Standby
Letter of Credit Facility.**
33
34
NUMBER DOCUMENT
------ --------
10.6 First Excess of Loss Treaty No. 01-95-0020 with various
subscribing reinsurers.**
10.7 Second Excess of Loss Treaty No. 01-95-0021 with various
subscribing reinsurers.**
10.8 Third Excess of Loss Treaty No. 01-95-0022 with various
subscribing reinsurers.**
10.9 Fourth Excess of Loss Treaty No. 01-95-0599 with various
subscribing reinsurers.**
10.10 Per Policy Excess of Loss Treaty No. 01-94-0365 with
various subscribing reinsurers.**
10.11 Reinstatement/Retroactive/Aggregate Extension Excess of
Loss Treaty No. 01-95-0879 with various subscribing
reinsurers.**
10.12 Medical Malpractice Surplus Reinsurance Treaty between SCPIE and
Lloyd's Syndicate No. 1010 and Syndicates Comprising 1007 Group
underwritten for by CW Spreckley, Esq. and others, effective date
January 1, 1996, Treaty No.
01-95-0374.**
10.13 Physician Medical Malpractice/Hospital Professional Liability Quota
Share Reinsurance Agreement between Hannover Ruckversicherungs,
Aktiengesellschaft/Eisen Und Stahl
Ruckversicherungs-Aktiengesellschaft, Hannover, Germany, and
various subscribing reinsurers, effective date January 1, 1995,
Treaty No. 01-95-0694.**
10.14 First Excess of Loss Treaty No. 01-96-0020 with various
subscribing reinsurers.**
10.15 Second Excess of Loss Treaty No. 01-96-0021 with various
subscribing reinsurers.**
10.16 Third Excess of Loss Treaty No. 01-96-0022 with various
subscribing reinsurers.**
10.17 Fourth Excess of Loss Treaty No. 01-96-0599 with various
subscribing reinsurers.**
10.18 Per Policy Excess of Loss Treaty No. 01-96-0365 with
various subscribing reinsurers, reference is made to Exhibit
10.9.**
10.19 Addendum No. 1 to the
Reinstatement/Retroactive/Aggregate Extension Excess of
Loss Treaty No. 01-96-0879 with various subscribing
reinsurers, reference is made to Exhibit 10.11.**
10.20 Quota Share Reinsurance Agreement Treaty No. 01-96-
0922.**
34
35
NUMBER DOCUMENT
------ --------
10.21 First Excess of Loss Treaty No. 01-97-0020 with various
subscribing reinsurers.
10.22 Second Excess of Loss Treaty No. 01-97-0021 with various
subscribing reinsurers.
10.23 Third Excess of Loss Treaty No. 01-97-0022 with various
subscribing reinsurers.
10.24 Fourth Excess of Loss Treaty No. 01-97-0599 with various
subscribing reinsurers.
10.25 Per Policy Excess of Loss Treaty No. 01-97-0365 with
various subscribing reinsurers.
10.26 Addendum No. 2 to the
Reinstatement/Retroactive/Aggregate Extension Excess of
Loss Treaty No. 01-97-0879 with various subscribing
reinsurers, reference is made to Exhibit 10.11.
10.27 Quota Share Reinsurance Treaty No. 1-97-0922.
10.28 Allocated Loss Adjustment Expense Excess of Loss Treaty
No. 01-97-1154 with various subscribing reinsurers.
10.29 Cover Note for First Excess of Loss Reinsurance Treaty No.
01-97-1134 with various subscribing reinsurers.
10.30 Cover Note for Second Excess of Loss Reinsurance Treaty
No. 01-97-1135 with various subscribing reinsurers.
10.31 Cover Note for First Excess of Loss Reinsurance Treaty No.
01-98-0020 with various subscribing reinsurers.
10.32 Cover Note for Second Excess of Loss Reinsurance Treaty
No. 01-98-0021 with various subscribing reinsurers.
10.33 Cover Note for Third Excess of Loss Reinsurance Treaty No.
01-98-0022 with various subscribing reinsurers.
10.34 Cover Note for Fourth Excess of Loss Reinsurance Treaty
No. 01-98-0023 with various subscribing reinsurers.
10.35 Cover Note for Quota Share Reinsurance Treaty No. 1-98-
0922.
10.36 SCPIE Management Company Retirement Income Plan, as amended and
restated, effective January 1, 1989.**
10.37 Supplemental Employee Retirement Plan for Selected
Employees of SCPIE Management Company dated January
1, 1995.**
10.38 Retirement Plan for Outside Governors and Affiliated
Directors, effective January 1, 1994 as amended.**
35
36
NUMBER DOCUMENT
------ --------
10.39 The SMC Cash Accumulation Plan, dated July 1, 1991, as
amended.**
10.40 Inter-Company Pooling Agreement effective January 1,
1997.
10.41 SCPIE Holdings Inc. and subsidiaries Consolidated Federal
Income Tax Liability Allocation Agreement effective
January 1, 1996.
10.42 The 1997 Equity Participation Plan of SCPIE Holdings Inc.
10.43 Form of Indemnification Agreement.**
11.1 Statement re: computation of per share earnings.
21.1 Subsidiaries of the registrant.
27.1 Financial Data Schedule.
- ------------
(**) Previously filed as Exhibits to the Company's Registration Statement on
Form S-1 (No. 33-4450), declared effective by the SEC on January 29, 1997
and incorporated herein by this reference.
(b) Reports on Form 8-K:
None.
36
37
SCPIE HOLDINGS INC.
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
ANNUAL REPORT ON FORM 10-K
---------------
INDEX
PAGES
-----
Report of Independent Auditors...................................... 38
Financial Statements:
Consolidated Balance Sheets as of December 31, 1997 and 1996 39
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995................................ 40
Statements of Changes in Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995................................ 40
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995................................ 41
Notes to Consolidated Financial Statements 42
Schedule II - Condensed Financial Information of Registrant 53
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
37
38
Report of Independent Auditors
Board of Directors
SCPIE Holdings Inc.
We have audited the accompanying consolidated balance sheets of SCPIE Holdings
Inc. and subsidiaries as of December 31, 1997 and 1996 and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1997. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of SCPIE Holdings
Inc. and subsidiaries at December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
ERNST & YOUNG LLP
Los Angeles, California
February 23, 1998
38
39
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, 1997 1996
- ------------ -------- --------
ASSETS
Securities available for sale (Note 2):
Fixed-maturity investments, at fair value
(amortized cost: 1997 - $692,811; 1996 - $660,820) $ 708,860 $ 668,367
Equity investments, at fair value
(cost: 1997 - $17,052; 1996 - $15,555) 23,523 19,977
--------- ---------
Total securities available for sale 732,383 688,344
Short-term investments 53,281 29,566
--------- ---------
Total investments 785,664 717,910
Cash 13,252 4,212
Accrued investment income 12,202 11,198
Reinsurance recoverable (Note 4) 21,531 19,266
Deferred federal income taxes (Note 5) 16,158 20,221
Deferred acquisition costs 520 591
Property and equipment, net 19,534 19,084
Other assets 19,588 12,673
--------- ---------
Total assets $ 888,449 $ 805,155
========= =========
LIABILITIES
Reserves:
Losses and loss adjustment expenses (Note 3) $ 454,971 $ 459,567
Unearned premiums 22,072 25,297
--------- ---------
Total reserves 477,043 484,864
Policyholders' dividends payable -- 7,723
Other liabilities 50,291 24,001
--------- ---------
Total liabilities 527,334 516,588
Commitments and contingencies (Note 8)
STOCKHOLDERS' EQUITY
Preferred stock - par value $0.0001, 5,000,000 shares
authorized, no shares issued or outstanding -- --
Common stock - par value $0.0001, 30,000,000 shares
authorized 12,792,091 shares issued,
12,276,691 shares outstanding 1 --
Additional paid-in capital 36,386 --
Retained earnings 310,506 280,788
Treasury stock, at cost (15,400 shares) (416) --
Net unrealized appreciation on securities
available for sale, net of deferred taxes 14,638 7,779
--------- ---------
Total stockholders' equity 361,115 288,567
--------- ---------
Total liabilities and stockholders' equity $ 888,449 $ 805,155
========= =========
See accompanying notes.
39
40
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEAR ENDED DECEMBER 31, 1997 1996 1995
- ------------------------------- --------- --------- ---------
REVENUES
Premiums earned (Note 4) $ 133,866 $ 120,484 $ 116,354
Net investment income (Note 2) 42,716 40,769 40,424
Realized investment gains (Note 2) 6,602 11,738 7,950
Other revenue 551 375 281
--------- --------- ---------
Total revenues 183,735 173,366 165,009
EXPENSES
Losses and loss adjustment expenses (Note 3) 123,377 108,797 118,023
Other operating expenses 17,987 14,276 12,561
--------- --------- ---------
Total expenses 141,364 123,073 130,584
--------- --------- ---------
Income before policyholder dividends
and federal income taxes 42,371 50,293 34,425
Policyholder dividends -- 8,436 --
Federal income taxes (Note 5) 10,195 11,665 10,056
--------- --------- ---------
Net income $ 32,176 $ 30,192 $ 24,369
========= ========= =========
Basic earnings per share of common stock (Note 1) $ 2.66 $ 3.02 $ 2.44
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
UNREALIZED
APPRECIATION
ADDITIONAL (DEPRECIATION) TOTAL
PREFERRED COMMON PAID-IN RETAINED TREASURY ON SECURITIES, STOCKHOLDERS'
STOCK STOCK CAPITAL EARNINGS STOCK NET EQUITY
--------- ------- ---------- --------- --------- -------------- -------------
Balance at January 1, 1995 .. $ -- $ -- $ -- $ 226,227 $ -- ($ 16,691) $ 209,536
Net income ................ -- -- -- 24,369 -- -- 24,369
Net unrealized appreciation -- -- -- -- -- 39,914 39,914
------ ------- --------- --------- -------- --------- ---------
Balance at December 31, 1995 -- -- -- 250,596 -- 23,223 273,819
Net income ................ -- -- -- 30,192 -- -- 30,192
Net unrealized depreciation -- -- -- -- -- (15,444) (15,444)
------ ------- --------- --------- -------- --------- ---------
Balance at December 31, 1996 -- -- -- 280,788 -- 7,779 288,567
Net income ................ -- -- -- 32,176 -- -- 32,176
Issuance of common stock .. -- 1 36,386 -- -- -- 36,387
Purchase of treasury stock -- -- -- -- (416) -- (416)
Cash dividends ............ -- -- -- (2,458) -- -- (2,458)
Net unrealized appreciation -- -- -- -- -- 6,859 6,859
------ ------- --------- --------- -------- --------- ---------
Balance at December 31, 1997 $ -- $ 1 $ 36,386 $ 310,506 $ (416) $ 14,638 $ 361,115
====== ======= ========= ========= ======== ========= =========
See accompanying notes.
40
41
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 31, 1997 1996 1995
- ------------------------------- --------- --------- ---------
OPERATING ACTIVITIES
Net income ..................................... $ 32,176 $ 30,192 $ 24,369
Adjustments to reconcile net income to net
cash provided by operating activities:
Unpaid losses and loss adjustment expenses,
and reinsurance recoverables ............. (12,950) (6,301) (2,796)
Accrued investment income .................. (1,004) (1,363) 1,301
Provision for deferred federal income taxes 370 80 158
Unearned premiums .......................... (3,225) 5,381 (2,012)
Policyholders' dividends payable ........... (7,723) (923) (9,501)
Realized investment gains .................. (6,602) (11,738) (7,950)
Provisions for amortization and depreciation 4,938 2,837 4,504
Changes in other liabilities ............... 579 11,212 430
Changes in other assets .................... (755) 9,468 3,029
--------- --------- ---------
Net cash provided by operating activities ...... 5,804 38,845 11,532
INVESTING ACTIVITIES
Purchases - fixed maturities ................... (410,381) (480,401) (269,149)
Sales - fixed maturities ....................... 335,210 375,877 235,332
Maturities - fixed maturities .................. 38,073 23,571 15,909
Purchases - equities ........................... (7,692) (5,445) (37,033)
Sales - equities ............................... 10,312 50,495 37,510
Change in short-term investments, net .......... 4,201 (1,783) 3,772
--------- --------- ---------
Net cash used in investing activities .......... (30,277) (37,686) (13,659)
FINANCING ACTIVITIES
Issuance of common stock, net of expenses ...... 36,387 -- --
Purchase of treasury stock .................... (416) -- --
Cash dividends ................................. (2,458) -- --
--------- --------- ---------
Net cash provided by financing activities ...... 33,513 -- --
Increase (decrease) in cash .................... 9,040 1,159 (2,127)
Cash at beginning of year ...................... 4,212 3,053 5,180
--------- --------- ---------
Cash at end of year ............................ $ 13,252 $ 4,212 $ 3,053
========= ========= =========
See accompanying notes.
41
42
SCPIE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying 1997 financial statements include the accounts and operations,
after intercompany eliminations, of SCPIE Holdings Inc. (SCPIE Holdings) and its
wholly-owned subsidiaries, principally SCPIE Indemnity Company (SCPIE
Indemnity), American Healthcare Indemnity Company (AHI), American Healthcare
Specialty Insurance Company (AHSIC) and SCPIE Management Company (SMC),
collectively, the Company.
On January 29, 1997, the Southern California Physicians Insurance Exchange
(the Exchange) consummated its plan and agreement of merger (the Merger
Agreement) whereby the Exchange reorganized from a reciprocal insurer to a stock
insurance company and became a wholly-owned subsidiary of SCPIE Holdings (the
Reorganization). Pursuant to the Reorganization, the Exchange merged with and
into SCPIE Indemnity, a California stock insurance company and a wholly-owned
subsidiary of SCPIE Holdings, the surviving corporation of the Reorganization.
The assets and liabilities of the Exchange that were merged into SCPIE Indemnity
were accounted for at historical cost in a manner similar to that in a pooling
of interests.
The principal purpose of the Reorganization was to improve SCPIE's access to
the capital markets and to raise capital to permit the growth of existing
business and develop new business opportunities in the professional liability
insurance industry. The Reorganization also provided members of the Exchange
with shares of common stock in SCPIE Holdings.
Concurrent with the Reorganization, SCPIE Holdings completed an initial public
offering, which generated net proceeds to SCPIE Holdings of approximately $36.4
million.
SCPIE Holdings acquired the outstanding stock of AHI (formerly FG Insurance
Corporation) and AHSIC (formerly FG Casualty Company), both inactive
property/casualty insurance companies for $12.5 million in March 1996. The
transaction was accounted for as a purchase and the excess of the purchase price
over the net book value ($5.9 million) was recorded as goodwill and amortized
over a period of 10 years. SCPIE Holdings has utilized these companies to enter
geographic markets outside California.
The accompanying 1996 financial statements include the accounts and
operations, after intercompany eliminations, of the Exchange and its
wholly-owned subsidiaries, principally SCPIE Holdings, SCPIE Indemnity, AHI,
AHSIC, and SMC.
The 1995 financial statements have been combined using the consolidated
balance sheets and results of operations of the Exchange and the Organization of
Southern California Physicians (OSCAP). OSCAP was the holding company of SMC,
the Exchange's attorney-in-fact. All transactions between the Exchange and OSCAP
have been eliminated in the preparation of the combined financial statements. On
July 12, 1996, OSCAP was liquidated into the Exchange, and SMC and its
subsidiaries became subsidiaries of the Exchange.
The Company principally writes professional liability insurance for
physicians, oral and maxillofacial surgeons, hospitals and other healthcare
providers. Substantially all of the Company's coverage is written on a "claims
made and reported" basis. Generally, coverage is provided only for claims that
are first reported to the Company during the insured's coverage period and which
arise from occurrences during the insured's coverage period. The Company also
makes "tail" coverage available for purchase by policyholders in order to cover
claims that arise from occurrences during the insured's coverage period, but
which are first reported to the Company after the insured's coverage period and
during the term of the applicable tail coverage.
The preparation of financial statements of insurance companies requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Such estimates and assumptions
could change in the future as more information becomes known that could impact
the amounts reported and disclosed herein.
42
43
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles which differ from statutory accounting
practices prescribed or permitted by regulatory authorities. The significant
accounting policies followed by the Company that materially affect financial
reporting are summarized below:
INVESTMENTS
Recognizing the need for the ability to respond to changes in market conditions
and in tax positions, the Company has designated its entire investment portfolio
as available-for-sale. The Company has no securities classified as "trading" or
"held-to-maturity." Transfers between categories are severely restricted.
Changes in fair values of available-for-sale securities, after adjustment of
deferred income taxes, are reported as unrealized appreciation or depreciation
directly in stockholders' equity and, accordingly, have no effect on net income.
For the mortgage-backed bond portion of the fixed-maturity securities
portfolio, the Company recognizes income using a constant effective yield based
on anticipated prepayments and the estimated economic life of securities. When
actual prepayments differ significantly from anticipated prepayments, the
effective yield is recalculated to reflect actual payments to date and
anticipated future payments. The net investment in the security is adjusted to
the amount that would have existed had the new effective yield been applied
since the acquisition of the security. That adjustment is included in net
investment income.
Premiums and discounts on investments are amortized to investment income using
the interest method over the contractual lives of the investments. Short-term
investments are carried at cost, which approximates fair value. Realized
investment gains and losses are included as a component of revenues based on
specific identification of the investment sold.
DEFERRED ACQUISITION COSTS
Premium taxes are capitalized and amortized as premiums are earned over the
terms of the related policies. The deferred acquisition costs are amortized over
the effective period of the related policies.
PREMIUMS
Premiums are recognized as earned on a pro rata basis over the terms of the
respective policies.
UNEARNED PREMIUMS
Unearned premiums are calculated using the monthly pro rata basis over the terms
of the respective policies.
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Reserves for losses and loss adjustment expenses (LAE) represent the estimated
liability for reported claims plus those incurred but not yet reported and the
related estimated adjustment expenses. The reserve for unpaid claims and related
adjustment expenses is determined using case-basis evaluations and statistical
analysis and represents estimates of the ultimate cost of all unpaid losses
incurred through December 31 of each year. Although considerable variability is
inherent in such estimates, management believes that the reserve for unpaid
losses and related LAE is adequate. The estimates are continually reviewed and
adjusted as necessary; such adjustments are included in current operations and
are accounted for as changes in estimates.
REINSURANCE
Reinsurance premiums, losses and loss adjustment expenses are accounted for on
bases consistent with those used in accounting for the original policies issued
and the terms of the reinsurance contracts.
DIVIDENDS TO POLICYHOLDERS
Dividends to policyholders are accrued during the period in which the related
premiums are earned. Estimates of policyholder dividends are reviewed and
adjusted as necessary; such adjustments are included in current operations and
accounted for as changes in
43
44
estimates. In the second quarter of 1996, the Company estimated an additional
$9.0 million of policyholder dividends would be paid due to favorable loss
experience related to policy years 1987 through 1992. Except for this final
dividend, after the Reorganization, the Company has ceased paying such dividends
to its policyholders.
PROPERTY AND EQUIPMENT
Property and equipment, principally the Company's home office building, are
recorded at cost and depreciated principally under the straight-line method over
the useful life of the assets.
CREDIT RISK
Financial instruments, that potentially subject the Company to concentrations of
credit risk consist principally of temporary cash investments and fixed
maturities. The Company places its temporary cash investments with high-credit
quality financial institutions and limits the amounts of credit exposure to any
one financial institution. Concentrations of credit risk with respect to fixed
maturities are limited due to the large number of such investments and their
distributions across many different industries and geographics.
Reinsurance is placed with a number of individual companies and syndicates at
Lloyd's of London to avoid concentration of credit risk. For the year ended
December 31, 1997, approximately 62% of total reinsurance premiums ceded were
placed with reinsurance companies with an A.M. Best or Insurance Solvency
International rating of A or better, including 38% with Hannover
Ruickversicherungs, and between 2% to 8% primarily among five other reinsurers.
Of the remaining reinsurance companies, Lloyds of London syndicates'
participation is 34%.
CREDIT FACILITY
The Company has received a commitment from a large lender for a bank facility in
the amount of $50.0 million. The commitment is subject to certain terms and
conditions as well as negotiations and completion of all documentation.
NEW ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement No. 128, "Earnings Per Share" (FASB 128) which is effective for
quarters ending after December 15, 1997. Under FASB 128, primary earnings per
share will be replaced by basic earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Fully diluted earnings per share would not
change significantly but would be renamed diluted earnings per share. All
previously recorded earnings per share amounts require restatement to conform to
the new standard. The adoption of FASB 128 did not have an impact on any of the
Company's earnings per share calculations as it only has common stock
outstanding.
In June 1997, FASB issued Statement No. 130 "Reporting Comprehensive Income"
(FASB 130). FASB 130 establishes new rules for the reporting and display of
comprehensive income and its components. However, adoption in the first quarter
of 1998 will have no impact on the Company's net income or stockholders' equity.
FASB 130 requires unrealized gains or losses on the Company's available-for sale
securities, which are currently reported in stockholders' equity to be included
in other comprehensive income and the disclosure of total comprehensive income.
SEGMENT INFORMATION
The Company operates in the United States of America and in only one reportable
industry segment, that provides professional liability insurance for physicians,
oral and maxillofacial surgeons, hospitals and other healthcare providers
principally in California.
EARNINGS PER SHARE OF COMMON STOCK
Basic earnings per share of common stock for the year ended December 31, 1997 is
computed using the weighted average number of common shares outstanding during
the year of 12,108,330. Basic earnings per share of common stock for the years
ended December 31, 1996 and 1995 gives effect to the Reorganization and the
allocation of 10,000,000 shares of common stock to eligible members of the
Exchange.
44
45
NOTE 2. INVESTMENTS
The Company's investments in available-for-sale securities are summarized as
follows:
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
(IN THOUSANDS) COST GAINS LOSSES VALUE
- --------------- -------- ---------- ---------- --------
December 31, 1997
Fixed-maturity securities:
Bonds:
U.S. Government and Agencies $290,028 $ 8,182 $ 137 $298,073
State, municipalities and
political subdivisions ... 327,273 8,003 120 335,156
Mortgage-backed securities,
U.S. Government .......... 68,161 574 445 68,290
Corporate .................. 7,256 -- 8 7,248
Other ...................... 93 -- -- 93
-------- -------- -------- --------
Total fixed-maturity securities 692,811 16,759 710 708,860
Common stocks .................. 17,052 6,759 288 23,523
-------- -------- -------- --------
Total .......................... $709,863 $ 23,518 $ 998 $732,383
======== ======== ======== ========
December 31, 1996
Fixed-maturity securities:
Bonds:
U.S. Government and Agencies $272,315 $ 6,576 $ 1,962 $276,929
State, municipalities and
political subdivisions ... 300,347 4,788 1,674 303,461
Mortgage-backed securities,
U.S. Government .......... 83,031 593 774 82,850
Corporate .................. 5,027 -- -- 5,027
Other ...................... 100 -- -- 100
-------- -------- -------- --------
Total fixed-maturity securities 660,820 11,957 4,410 668,367
Common stocks .................. 15,555 4,864 442 19,977
-------- -------- -------- --------
Total .......................... $676,375 $ 16,821 $ 4,852 $688,344
======== ======== ======== ========
The fair values for fixed-maturity securities are based on quoted market prices,
where available. For fixed-maturity securities not actively traded, fair values
are estimated using values obtained from independent pricing services. The fair
values for equity securities are based on quoted market prices.
The amortized cost and fair value of the Company's investments in
fixed-maturity securities at December 31, 1997, are summarized by stated
maturities as follows:
AMORTIZED FAIR
(IN THOUSANDS) COST VALUE
- -------------- ---------- ---------
Years to maturity:
One or less $ 2,349 $ 2,341
After one through five 89,663 91,519
After five through ten 241,715 249,699
After ten 290,923 297,011
Mortgage-backed securities 68,161 68,290
---------- ----------
Totals $ 692,811 $ 708,860
========= ==========
The foregoing data is based on the stated maturities of the securities. Actual
maturities will differ for some securities because borrowers may have the right
to call or prepay obligations.
45
46
The ratings of the Company's fixed-maturity securities at December 31, 1997,
using Moody's and Standard & Poor's rating services, are summarized as follows:
AAA 71.0%
AA 21.0%
A 7.3%
Not rated 0.7%
------
100.0%
======
Major categories of the Company's investment income are summarized as follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1997 1996 1995
- -------------------------------------------------- -------- -------- --------
Fixed-maturity investments $ 39,926 $ 40,594 $ 36,987
Equity investments 840 994 1,627
Other 4,329 1,213 4,250
-------- -------- --------
Total investment income 45,095 42,801 42,864
Investment expenses 2,379 2,032 2,440
-------- -------- --------
Net investment income $ 42,716 $ 40,769 $ 40,424
======== ======== ========
Realized gains and losses from sales of investments are summarized as follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1997 1996 1995
- -------------------------------------------------- -------- -------- --------
Fixed-maturity investments:
Gross realized gains $ 4,959 $ 6,419 $ 4,946
Gross realized losses 2,022 5,880 1,558
-------- -------- --------
Net realized gains $ 2,937 $ 539 $ 3,388
======== ======== ========
Equity investments:
Gross realized gains $ 3,854 $ 13,028 $ 6,649
Gross realized losses 189 1,829 2,087
-------- -------- --------
Net realized gains $ 3,665 $ 11,199 $ 4,562
======== ======== ========
The change in the Company's unrealized appreciation (depreciation) on
fixed-maturity securities was $8.5 million, ($16.5 million) and $52.9 million
for the years ended December 31, 1997, 1996 and 1995, respectively; the
corresponding amounts for equity securities were $2.0 million, ($7.3 million),
and $8.5 million.
At December 31, 1997, the Company's investments in fixed-maturity securities
with a carrying amount of $22.0 million were on deposit with state insurance
departments to satisfy regulatory requirements.
No investment in any person or its affiliates exceeded 10% of the Company's
stockholders' equity at December 31, 1997.
46
47
NOTE 3. LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
reserve balances, net of reinsurance recoverable, for 1997, 1996 and 1995.
(IN THOUSANDS) 1997 1996 1995
- -------------- --------- --------- ---------
Reserve for losses and LAE, net of related
reinsurance recoverable, at beginning of year $ 440,301 $ 446,627 $ 449,566
Provision for losses and LAE for claims occurring
in the current year, net of reinsurance 176,586 168,545 175,856
Decrease in estimated losses and LAE for claims
occurring in prior years, net of reinsurance (53,209) (59,748) (57,833)
--------- --------- ---------
Incurred losses during the year, net of reinsurance 123,377 108,797 118,023
Deduct losses and LAE payments for claims,
net of reinsurance, occurring during:
Current year 11,814 13,274 11,481
Prior years 118,424 101,849 109,481
--------- --------- ---------
130,238 115,123 120,962
Reserve for losses and LAE, net of related
reinsurance recoverable, at end of year 433,440 440,301 446,627
Reinsurance recoverable for losses and LAE,
at end of year 21,531 19,266 19,560
--------- --------- ---------
Reserves for losses and LAE, gross of
reinsurance recoverable, at end of year $ 454,971 $ 459,567 $ 466,187
========= ========= =========
The Company's reserves for unpaid losses and LAE, net of related reinsurance
recoverable, at December 31, 1996, 1995 and 1994, were decreased in the
following year by $53.2 million, $59.7million, and $57.8 million, respectively,
for claims that had occurred on or prior to those balance sheet dates. Those
redundancies resulted primarily from settling case-basis reserves established in
prior years for amounts that were less than expected. The 1995 redundancies were
offset, in part, by a $23.9 million increase in the loss reserves carried for
physicians who receive free tail coverage in the event of death, disability or
retirement from the medical profession. The increase was the result of a
refinement in the actuarial methodology used to calculate the reserve for this
tail coverage.
The anticipated effect of inflation is implicitly considered when estimating
liabilities for losses and LAE. While anticipated price increases due to
inflation are considered in estimating the ultimate claim costs, the increase in
average severities of claims is caused by a number of factors that vary with the
individual type of insurance written. Future average severities are projected
based on historical trends adjusted for implemented changes in underwriting
standards, policy provisions, and general economic trends. Those anticipated
trends are monitored based on actual development and are modified if necessary.
47
48
NOTE 4. REINSURANCE
Certain premiums and benefits are ceded to other insurance companies under
various reinsurance agreements. These reinsurance agreements provide the Company
with increased capacity to write additional risks and maintain its exposure to
loss within its capital resources. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liability associated with the
reinsured policy. Some of these agreements include terms whereby the Company
earns a profit sharing commission if the reinsurer's experience is favorable.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. The failure of reinsurers to honor their obligations could result
in losses to the Company; consequently, allowances are established for amounts
deemed uncollectible. The Company evaluates the financial condition and economic
characteristics of its reinsurers to minimize its exposure to significant losses
from reinsurer insolvencies.
The effect of assumed and ceded reinsurance on premiums is summarized in the
following table.
(IN THOUSANDS) 1997 1996 1995
--------------------- --------------------- ---------------------
YEAR ENDED DECEMBER 31, WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
- ----------------------- -------- -------- -------- -------- -------- --------
Direct $123,910 $125,289 $125,289 $124,281 $124,281 $124,118
Assumed 11,673 13,603 8,922 4,497 780 780
Ceded 4,941 5,026 8,239 8,294 8,544 8,544
-------- -------- -------- -------- -------- --------
Net premiums $130,642 $133,866 $126,318 $120,484 $114,513 $116,354
======== ======== ======== ======== ======== ========
Reinsurance ceded reduced losses and loss adjustment expenses incurred by $5.4
million, $0.9 million and $1.4 million in 1997, 1996 and 1995, respectively.
The Company retains the first $1.0 million of losses incurred per incident and
has various reinsurance up to $20.0 million per incident for its physician
coverage and up to $45.0 million for its hospital coverage. The Company assumes
a small amount of reinsurance covering medical professional liability risks,
primarily in the United States, as well as participating in high-layer excess of
loss property catastrophe reinsurance for U.S. and international risks.
In November 1996, the Company entered into a six-year agreement with a third
party whereby the Company provided a $5.5 million letter of credit in exchange
for future gains or losses based on the underwriting index of a reinsurance
portfolio. The portfolio is composed of worldwide geographically dispersed
catastrophe excess of loss treaty reinsurance business. The Company will also
receive semiannual payments based on its notional amount ($5.0 million) at a
rate determined annually. On an annual basis, if the combined ratio of the
portfolio is below a stipulated underwriting index amount, the Company will
recognize a gain; if the combined ratio is between two stipulated underwriting
index amounts, the Company will not recognize a gain or loss; and, if the
combined ratio is greater than a stipulated underwriting index amount, the
Company will recognize a loss limited to its notional value plus any interest
earned during the agreement. At December 31, 1997, the amounts recorded in the
financial statements related to this agreement are not material.
The Company has acquired the medical malpractice insurance business of Fremont
Indemnity Company (Fremont) effective January 1, 1998 for $14.0 million. As part
of this transaction, the Company will assume $42.0 million in loss and LAE
reserves outstanding, and other net liabilities. In December 1997, the Company
received $28.0 million in investments related to this transaction, which has
been reflected in short-term investments and other liabilities at December 31,
1997. The Company entered into a 100% quota-share reinsurance agreement, making
SCPIE Indemnity the reinsurer for the Fremont policies pending regulatory
approval to write them directly. The Fremont policies are written in 10 states,
with the vast majority in California and Arizona.
48
49
NOTE 5. FEDERAL INCOME TAXES
The components of the federal income tax provision in the accompanying
consolidated statements of income are summarized as follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1997 1996 1995
- -------------------------------------------- ------- ------- -------
Current $ 9,825 $11,585 $ 9,898
Deferred 370 80 158
------- ------- -------
Total $10,195 $11,665 $10,056
======= ======= =======
A reconciliation of income tax computed at the federal statutory tax rate to
total income tax expense is as follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1997 1996 1995
- -------------------------------------------- ------- ------- -------
Federal income tax at 35% $14,830 $14,650 $12,049
Increase (decrease) in taxes resulting from:
Tax-exempt interest (4,775) (3,124) 2,125)
Dividends received deduction (136) (139) (216)
Goodwill 220 148 --
Other 56 130 348
------- ------- -------
Total federal income tax expense $10,195 $11,665 $10,056
======= ======= =======
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are summarized as follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1997 1996
- -------------------------------------------- ------- -------
Deferred tax assets:
Discounting of loss reserves $22,122 $22,306
Unearned premium 1,545 1,771
Other 557 540
-------- -------
Total deferred tax assets 24,224 24,617
Deferred tax liabilities:
Deferred policy acquisition costs 182 207
Unrealized investment gains 7,882 4,189
Other 2 --
-------- --------
Total deferred tax liabilities 8,066 4,396
-------- --------
Net deferred tax assets $16,158 $20,221
======== =======
Federal income taxes paid during 1997, 1996, and 1995 were $11.0 million,
$14.8 million and $9.9 million, respectively.
49
50
NOTE 6. STATUTORY ACCOUNTING PRACTICES
SCPIE Indemnity, AHI and AHSIC are domiciled in California, Delaware and
Arkansas, respectively, and prepare their statutory- basis financial statements
in accordance with accounting practices prescribed or permitted by the
respective insurance departments. Currently, "prescribed" statutory accounting
practices include state laws, regulations, and general administrative rules, as
well as a variety of publications of the National Association of Insurance
Commissioners (NAIC). "Permitted" statutory accounting practices encompass all
accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. The NAIC is in the process of codifying statutory
accounting practices ("Codification"). Codification would likely change, to some
extent, prescribed statutory accounting practices and may result in changes to
the accounting practices that the Companies' insurance subsidiaries use to
prepare their statutory-basis financial statements. Codification, which is
expected to be approved by the NAIC in 1998, will require adoption by the
various states before it becomes the prescribed statutory basis of accounting
for insurance companies domesticated within those states. At this time, it is
unclear whether the states of California, Delaware and Arkansas will adopt
Codification. However, based on current draft guidance, management believes that
the impact of Codification will not be material to the statutory basis financial
statements of SCPIE Indemnity, AHI and AHSIC. Policyholders' surplus and net
income, as reported to the domiciliary state insurance department in accordance
with its prescribed or permitted statutory accounting practices, for the
insurance subsidiaries are summarized as follows:
(IN THOUSANDS) 1997 1996 1995
- -------------- ---------- ----------- -----------
Statutory net income for the year $ 32,239 $ 32,703 $ 24,393
Statutory capital and surplus at year end 321,289 254,679 235,352
SCPIE Indemnity offers its insureds free tail coverage in the event of death,
total and permanent disability, and complete and permanent retirement. In 1993,
the NAIC published guidelines for establishing a reserve for future free tail
policies when the claims- made policy includes a provision for waiving a premium
charge in the event of death, disability or retirement of the insured. Based on
the NAIC guidelines, this reserve should be recorded as an unearned premium
reserve. Alternatively, it can be considered an unpaid loss with the permission
of the insurance entity's state insurance department. In 1997, SCPIE Indemnity
received written approval from the California Department of Insurance to record
this reserve as an unpaid loss. SCPIE Indemnity's statutory surplus would be
unaffected if the California Department of Insurance were to rescind its
permission for this treatment.
The maximum amount of dividends that may be paid by property/casualty
insurance companies without prior approval of the California Insurance
Commissioner is subject to restrictions relating to statutory surplus and net
income. In 1998, dividends of $27.5 million may be distributed from SCPIE
Indemnity to SCPIE Holdings without prior approval of the California Insurance
Commissioner.
50
51
NOTE 7. BENEFIT PLANS
The Company has a 401(k) defined contribution plan and a noncontributory defined
benefit plan, which provide retirement benefits to all its employees. Under the
401(k) plan, the Company presently matches the employee's contribution. The
contribution expense for the 401(k) plan was $479,000, $418,000 and $389,000 for
the years ended December 31, 1997, 1996 and 1995, respectively. An additional
defined contribution plan that no longer accepts contributions will remain with
the trustee as funded at December 31, 1989, until retirement or termination of
all employees vested in the plan.
The Company also maintains a defined benefit pension plan whose benefits are
based on years of service and salary levels. The Company's policy is to fund the
pension plan up to the maximum deductible contributions the federal laws and
regulations permit.
Plan assets consist of investment funds and cash held in a bank money market
account.
Net pension expense consists of the following components:
(IN THOUSANDS) YEAR ENDED DECEMBER 31 1997 1996 1995
- ---------------------------------------------- ------ ------ ------
Service cost-benefits earned during the year $ 323 $ 291 $ 223
Interest on projected benefit obligation 161 123 73
Actual return on plan assets (527) (240) (282)
Net amortization and deferral 352 115 201
------ ------ ------
Net pension expense $ 309 $ 289 $ 215
====== ====== ======
The following table sets forth the funding status of the plan:
(IN THOUSANDS) DECEMBER 31 1997 1996
- ------------------------------------------------------ -------- --------
Actuarial present value of benefit obligations:
Accumulated benefit obligations, including vested
benefits of $1,559,000 in 1997 and $988,000 in 1996 $(2,000) $(1,378)
======= =======
Projected benefit obligation $(2,501) $(1,764)
Plan assets 2,758 1,966
------- -------
Plan assets in excess of
projected benefit obligations 257 202
Unrecognized net loss from past experience
different from that assumed (27) (31)
Unrecognized past service cost (12) (13)
Unrecognized net asset at January 1 (159) (76)
------- -------
Prepaid pension expense $ 59 $ 82
======= =======
The projected benefit obligation for 1997, 1996 and 1995 was determined using an
assumed discount rate of 7%, 7.25% and 7%, respectively, and an assumed rate of
compensation increase of 5% for 1997, 1996 and 1995. The expected long-term rate
of return on plan assets was 8% in 1997, 1996 and 1995.
The Company also has enacted a nonqualified supplemental employee retirement
agreement for selected employees which provides benefits retroactively from
January 1, 1990. At December 31, 1996 and 1995, the projected benefit obligation
for this unfunded plan was $2.7 million and $2.1 million, respectively, of which
the accumulated benefit obligation of $1.8 million and $1.2 million,
respectively, is accrued as a liability in the consolidated balance sheets.
Pension expense for this plan was approximately $394,000, $349,000 and $258,000
in 1997, 1996 and 1995, respectively.
51
52
NOTE 8. COMMITMENTS AND CONTINGENCIES
The Company is a defendant in an action brought by the bankruptcy estate of an
uninsured physician. The bankruptcy estate alleged that the Company had an
undisclosed conflict of interest when it provided the physician with a free
courtesy defense by an attorney who had represented the interests of the
Company's insureds in other cases. The jury awarded compensatory damages of $4.2
million, and punitive damages were reduced to $14.0 million by the trial judge.
The Company believes that the action is entirely without merit and plans to
aggressively pursue its rights on appeal. However, the ultimate resolution of
this matter cannot be determined at this time and could result in a loss to the
Company.
Since 1981, the Company has purchased annuities from life insurance companies
to fund obligations under structured settlement agreements with certain medical
malpractice claimants. Annuities having an aggregate purchase price of
approximately $12.3 million were purchased from Executive Life Insurance Company
(ELIC), which was placed in conservatorship during 1991 the California Insurance
Commissioner. Substantially all of the assets of ELIC have been transferred to
another insurer, which has assumed the restructured annuities and is obligated
to pay varying percentages of the original annuity benefits as they become due.
The Company has determined that it is contractually obligated for the shortfall
amounts under certain of these annuities. At December 31, 1997, a reserve of
$4.0 million (net of expected reinsurance recoveries of $3.0 million) was
recorded to cover these expected shortfall payments. The Company believes that
the amount of its obligations in excess of the existing reserves, if any, is not
material to its financial positions or results of operations.
The Company is named as defendant in various legal actions primarily arising
from claims made under insurance policies and contracts. These actions are
considered by the Company in estimating the loss and loss adjustment expense
reserves. The Company's management believes that the resolution of these actions
will not have a material adverse effect on the Company's financial position or
results of operations.
NOTE 9. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The unaudited quarterly results of operations for 1997 and 1996 are summarized
as follows:
1997 1996
----------------------------------------- ------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
- ------------------------------------- -------- -------- -------- -------- -------- -------- -------- --------
Premiums earned and other revenues $ 36,563 $ 32,837 $ 33,126 $ 31,891 $ 31,505 $ 29,714 $ 29,071 $ 30,569
Net investment income 10,572 10,637 10,798 10,709 10,561 10,409 10,245 9,554
Realized investment gains (losses) 1,212 1,975 989 2,426 12,804 (1,308) 58 184
Net income 8,121 8,004 7,320 8,731 13,744 333 5,772 10,343
Basic earnings per share of common stock (1) $ 0.70 $ 0.65 $ 0.60 $ 0.71 $ 1.38 $ 0.03 $ 0.58 $ 1.03
(1) Gives effect in all periods to the Reorganization and the allocation of
10,000,000 shares of common stock to eligible members of the Exchange.
52
53
Schedule II - Condensed Financial Information of Registrant
SCPIE Holdings Inc.
Condensed Balance Sheets
(in thousands)
DECEMBER 31 1997 1996
--------- ---------
ASSETS
Investments
Available for sale fixed maturity investments,
at fair value (amortized cost: 1997 - $3,004) $ 2,994 $ --
Short-term investments 272 --
Investment in subsidiaries 356,179 13,489
--------- ---------
Total investments 359,445 13,489
Cash 227 417
Due from subsidiaries 74 --
Other 1,241 433
--------- ---------
Total assets $ 360,987 $ 14,339
========= =========
LIABILITIES
Due to affiliates $ -- $ 403
Other (128) 6
--------- ---------
Total liabilities (128) 409
Stockholders' equity:
Preferred stock - par value $0.0001,
5,000,000 shares authorized,
no shares issued or outstanding -- --
Common stock par value $0.0001,
30,000,000 shares authorized, 12,792,091
shares issued, 12,276,691 shares outstanding 1 --
Additional paid-in capital 36,386 13,999
Retained earnings (deficit) 310,506 (69)
Treasury stock, at cost (15,400 shares) (416) --
Net unrealized appreciation on securities
available for sale, net of deferred taxes 14,638 --
--------- ---------
Total stockholders' equity 361,115 13,930
--------- ---------
Total liabilities and stockholders' equity $ 360,987 $ 14,339
========= =========
See accompanying notes.
53
54
Schedule II - Condensed Financial Information of Registrant (continued)
SCPIE Holdings Inc.
Condensed Statements of Operations
(in thousands)
TWELVE
MONTHS TEN MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
Dividend from subsidiary $ 20,000 $ --
Net investment income 804 16
Realized investment losses (10) --
Other expenses (1,287) (1)
-------- --------
Earnings before federal income taxes and
equity in income (loss) of subsidiaries 19,507 15
Federal income taxes 37 (5)
-------- --------
Earnings before equity in income (loss) of
subsidiaries 19,470 10
Equity in income (loss) of subsidiaries 12,706 (79)
-------- --------
Net income (loss) $ 32,176 $ (69)
======== ========
Condensed Statements of Cash Flows
(in thousands)
TWELVE MONTHS TEN MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
1997 1996
-------- --------
OPERATING ACTIVITIES
Net income (loss) $ 32,176 $ (69)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Realized investment losses 10 --
Due to affiliates -- 403
Due from subsidiaries (74) --
Changes in other assets and liabilities (1,345) (427)
Equity in undistributed (income) loss of subsidiaries (12,706) 79
-------- --------
Net cash provided by (used in) operating activities 18,061 (14)
INVESTING ACTIVITIES
Purchase of subsidiaries -- (12,119)
Purchases - fixed maturities (22,881) --
Sales - fixed maturities 19,389 --
Change in short-term investments (272) --
Capital contribution to subsidiaries (48,000) (1,050)
-------- --------
Cash used in investing activities (51,764) (13,169)
FINANCING ACTIVITIES
Issuance of common stock, net of expenses 36,387 --
Purchase of treasury stock (416) --
Cash dividends (2,458) --
Capital contribution from parent -- 13,000
-------- --------
Cash provided by financing activities 33,513 13,000
Decrease in cash (190) (183)
Cash at beginning of period 417 600
-------- --------
Cash at end of period $ 227 $ 417
======== ========
See accompanying notes.
54
55
Schedule II - Condensed Financial Information of Registrant (continued)
SCPIE Holdings Inc.
Notes to Condensed Financial Statements
December 31, 1997
1. REORGANIZATION
On January 29, 1997, the Exchange consummated its plan and agreement of merger
whereby the Exchange reorganized from a reciprocal insurer to a stock insurance
company and became a wholly owned subsidiary of SCPIE Holdings (the
Reorganization). SCPIE Holdings has no historic operations and was organized in
February 1996, as part of the Exchange's plan to reorganize its corporate
structure. Pursuant to the Reorganization, the Exchange merged with and into
SCPIE Indemnity, a California stock insurance company and a wholly owned
subsidiary of SCPIE Holdings, the surviving corporation of the Reorganization.
2. BASIS OF PRESENTATION
In the SCPIE Holdings' financial statements, investment in subsidiaries is
stated at cost plus equity in undistributed earnings of subsidiaries since date
of acquisition. The SCPIE Holdings' financial statements should be read in
conjunction with the consolidated financial statements.
56
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.
SCPIE HOLDINGS, INC.,
By /s/ DONALD J. ZUK
-------------------------------------
Donald J. Zuk
President and Chief Executive Officer
March 31, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report to be signed on its behalf of the Registrant and in the capacities
and on the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ DONALD J. ZUK President, Chief Executive Officer
- ----------------------------- and Director (Principal Executive
Donald J. Zuk Officer) March 31, 1998
/s/ PATRICK T. LO Vice President, Chief Financial
- ----------------------------- Officer and Chief Accounting
Patrick T. Lo Officer (Principal Financial
Officer and Principal Accounting
Officer) March 31, 1998
/s/ MITCHELL S. KARLAN, M.D. Chairman of the Board and
- ----------------------------- Director
Mitchell S. Karlan, M.D. March 31, 1998
/s/ JACK E. McCLEARY, M.D. Director and Treasurer March 31, 1998
- -----------------------------
Jack E. McCleary, M.D.
/s/ ALLAN K. BRINEY, M.D. Director March 31, 1998
- -----------------------------
Allan K. Briney, M.D.
/s/ WILLIS T. KING, JR. Director March 31, 1998
- -----------------------------
Willis T. King, Jr.
/s/ CHARLES B. McELWEE, M.D. Director March 31, 1998
- -----------------------------
Charles B. McElwee, M.D.
/s/ WENDELL L. MOSELEY, M.D. Director March 31, 1998
- -----------------------------
Wendell L. Moseley, M.D.
/s/ DONALD P. NEWELL Director March 31, 1998
- -----------------------------
Donald P. Newell
/s/ HARRIET M. OPFELL, M.D. Director March 31, 1998
- -----------------------------
Harriet M. Opfell
/s/ WILLIAM A. RENERT, M.D. Director March 31, 1998
- -----------------------------
William A. Renert, M.D.
/s/ HENRY L STOUTZ, M.D. Director March 31, 1998
- -----------------------------
Henry L Stoutz, M.D.
/s/ REINHOLD A. ULLRICH, M.D. Director March 31, 1998
- -----------------------------
Reinhold A. Ullrich, M.D.