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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, 1998 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.)
1888 Century Park East, Los Angeles, California 90067
(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
Preferred Stock, par value $1.00 per share New York Stock Exchange
Common Stock, par value $0.0001 per share New York Stock Exchange
(Title of Class)
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. [ ]
The aggregate market value of the Registrant's voting stock held by
non-affiliates of the Registrant at March 15, 1999, was approximately
$348,863,840 (based upon the closing sales price of such date, as reported by
the Wall Street Journal).
At March 15, 1999, the Registrant had issued and outstanding an aggregate of
12,300,891 shares of its Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Part II incorporates certain information by reference from the Registrant's
definitive proxy statement for the Annual Meeting of Stockholders of Registrant
to be held on May 13, 1999 (only portions of which are incorporated by
reference).
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PART I
ITEM 1. BUSINESS
SCPIE Holdings Inc. (the "Company") 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 eligible to write policies as an excess and surplus
lines insurer in 24 states and the District of Columbia. 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
SCPIE Holdings is one of the nation's leading providers of medical
malpractice insurance based on direct premiums written in 1998. The Company
currently insures more than 12,500 physicians, other providers and oral and
maxillofacial surgeons practicing alone or in medical groups, clinics or other
healthcare organizations. The Company also insures a variety of healthcare
facilities, including hospitals, emergency departments, outpatient surgery and
hemodialysis centers, and clinical and pathology laboratories.
The Company's total revenues and net income were $210.0 million and $37.0
million, respectively, for the year ended December 31, 1998 and were $183.7
million and $32.2 million, respectively, for the year ended December 31, 1997.
As of December 31, 1998, the Company had total assets of $921.5 million and
total stockholders' equity of $386.5 million.
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 1997, total medical malpractice
premiums in the United States were approximately $5.9 billion. In California,
the second largest market for medical malpractice insurance based on direct
premiums written, approximately $632.3 million of medical malpractice premiums
were written in 1997. The Company's share of the medical malpractice premiums
written in California in 1997 was approximately 19%. 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. Eight county medical associations and several specialty
societies in California have endorsed the medical malpractice insurance offered
by the Company.
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The Company believes that the growth in managed healthcare and the emergence
of multi-state integrated healthcare providers and delivery systems has led to
major changes in the medical malpractice insurance industry. Practice management
organizations, 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.
Furthermore, the Company has begun to expand its operations beyond
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 currently offered to solo physicians and medical groups
in five states, the largest such states being Connecticut, Florida, Georgia and
Louisiana. In 1999, the Company expects to offer this coverage in three
additional states. 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 acquired the medical malpractice insurance business of
Fremont Indemnity Company ("Fremont") effective January 1, 1998 through a 100%
quota-share retroactive reinsurance agreement. Simultaneously, a 100%
quota-share prospective fronting agreement went into effect, making SCPIE
Indemnity the reinsurer for the Fremont policies until AHI obtains the proper
approvals to write this business directly. The Fremont policies are written
through brokers in 10 states, with the vast majority in California and Arizona.
During the fourth quarter of 1998, AHI received regulatory approval to write
this business directly. Upon the policy's renewal date, each policy will be
transferred from a Fremont policy to an AHI policy. There is no assurance,
however, that the Company will successfully retain or expand this business or
that it will ultimately be profitable.
Additionally, the Company 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, 1998, the Company insured 33 hospitals, of
which 18 were located in California.
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 and other states has faced a soft insurance market. 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
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to more appropriate levels. However, 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.
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,
----------------------------------------
1998 1997 1996
-------- -------- --------
Physician and medical group
liability:
Physician and medical group
standard professional
liability ..................... $108,679 $109,393 $117,679
Special risk physicians .......... 1,299 1,700 1,398
Emergency medicine program ....... 2,012 1,589 628
Urgent care centers .............. 325 277 262
-------- -------- --------
Subtotal medical liability .... 112,315 112,959 119,967
Excess personal liability ........ 701 756 829
-------- -------- --------
Subtotal physician and
medical group liability ..... 113,016 113,715 120,796
Hospital liability ................. 10,432 8,475 3,487
Healthcare provider liability ...... 761 800 792
Managed care organization
errors and omissions ............... 740 668 347
Directors and officers'
liability ........................ 264 252 213
-------- -------- --------
Total ............................ $125,213 $123,910 $125,635
======== ======== ========
The Company also wrote physician premium on a fronted basis in connection
with the Poe & Brown and Fremont arrangements. The Company assumed premium from
CNA Insurance Company in connection with the Poe & Brown arrangement and from
Fremont in connection with the Fremont arrangement as an interim measure until
such time as the Company obtained proper approvals to write the business
directly. In 1998 these assumed premiums were $6.0 million and $24.9 million for
the Poe & Brown and Fremont arrangements, respectively.
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 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 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 state licensing boards.
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 business liability coverage included in the
medical group policy includes 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
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physician for personal liabilities in excess of amounts covered under the
physician's homeowners and automobile policies. The Company has developed
nonstandard programs which may exclude business liability coverages for certain
physicians.
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 with the Company and
who are also at least 65 years old.
Business 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,
1998:
DIRECT
PREMIUMS PERCENTAGE
GROUP SIZE WRITTEN OF TOTAL
---------- -------- ----------
(IN THOUSANDS)
Sole practitioner physicians ................ $ 74,129 65.6%
Group with less than five physicians ........ 16,126 14.3
Group with five through eight physicians .... 8,561 7.6
Group with nine or more physicians .......... 14,260 12.5
-------- -------
Total ........................... $113,076 100.0%
======== =======
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 business 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/Healthcare Facilities 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. The Company also offers its professional liability coverage to
healthcare providers such as chiropractors, podiatrists and nurse practitioners.
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.
Managed Care Organization Errors and Omissions. The Company has introduced a
policy for managed care organizations. The policy provides coverage for
liability arising from covered managed care incidents or vicarious liability for
medical services rendered by non-employed physicians. Covered services include
peer review, healthcare expense review, utilization management, utilization
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review and claims and benefit handling in the operation of the managed care
organizations. 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. In 1996, the Company began to directly
write renewals of these policies previously underwritten by other companies,
accounting for approximately $252,000 in direct premiums written in 1997 and
$264,000 in 1998. In August 1998, the California Department of Insurance
approved a new directors and officers' liability policy form that expands the
scope of coverage. 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 marketing organization has approximately 38 employees providing
sales solicitation and communications services. In support of its broker
network, 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 Addison, Texas, Boca Raton,
Florida and Phoenix, Arizona principally to solicit hospital and physician
accounts both directly and through brokers, and has one principal brokerage
relationship in California that accounts for 12 of the 18 hospitals insured by
the Company in that state.
Eight county medical associations and several specialty societies have
endorsed 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.
Effective January 1, 1998, Poe & Brown began marketing 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 one of the nation's top
independent insurance agency organizations, with an established physicians
medical malpractice program in these states offered to customers through a large
network of local and regional brokers.
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 provides a variety of printed materials and newsletters
relating to Risk Management topics. The Company maintains a 24-hour hotline to
provide immediate access to its risk management personnel. The Company conducts
surveys for hospitals and large medical groups both to review their practice
procedures generally and to focus
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on specific areas in which there may be some concern. 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
large and mid-size 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. The company's website also allows insureds to
access various risk management information materials and sources. 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, 15 underwriters and 17
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 may conduct 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
claims and risk management reports or correspondence.
The underwriting department submits recommendations for premium surcharges or
non-renewal of physicians 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 the Company has primarily issued its policies utilizing
schedules of coverage, limits, rating factors and other pertinent information
supplied to the Company by independent brokers. 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 nonstandard programs 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. 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. The Company ceased
paying such premium credit dividends to its policyholders in 1998. The Company
instituted no rate increases for 1998, which may have offset the elimination of
dividends to policyholders and somewhat improved its competitive position.
During 1999, the Company will institute an average rate increase of 3.7% for
California physician insureds. Therefore, the Company may find it more difficult
to compete with other insurance companies offering such dividends.
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 60 employees, including 16
clerical personnel. The Company has 5 unit managers and 4 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 reserves and
settlement of claims. The Company has a claims committee comprised solely of
physicians which meets bi-monthly with the vice
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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, 1998, the Company had 3,488 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.
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.
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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,
---------------------------------------------
1998 1997 1996
--------- --------- ---------
Reserves for losses and LAE at beginning of year .............. $454,971 $ 459,567 $ 466,187
Less reinsurance recoverables ................................. 21,531 19,266 19,560
--------- --------- ---------
Reserves for losses and LAE, net of related
reinsurance recoverable, at beginning of year ................. 433,440 440,301 446,627
--------- --------- ---------
Reserves from purchase of Fremont Indemnity Company ........... 36,972 -- --
Provision for losses and LAE for claims occurring in the
current year, net of reinsurance .............................. 197,870 176,586 168,545
Decrease in estimated losses and LAE for claims occurring in
prior years, net of reinsurance ............................... (65,662) (53,209) (59,748)
--------- --------- ---------
Incurred losses during the year, net of reinsurance ........... 132,208 123,377 108,797
--------- --------- ---------
Deduct losses and LAE payments for claims, net of reinsurance,
occurring during:
Current year ................................................ 14,408 11,814 13,274
Prior years ................................................. 135,480 118,424 101,849
--------- --------- ---------
149,888 130,238 115,123
--------- --------- ---------
Reserves for losses and LAE, net of related reinsurance
recoverable, at end of year ................................... 452,732 433,440 440,301
Reinsurance recoverable for losses and LAE, at end of year .... 24,899 21,531 19,266
--------- --------- ---------
Reserves for losses and LAE, gross of reinsurance recoverable,
at end of year ................................................ $ 477,631 $ 454,971 $ 459,567
========= ========= =========
- ------------
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.
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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 1988
at $150,000, the $50,000 redundancy (original estimate minus actual loss) would
be included in the cumulative redundancy in each of the years 1988 through 1998
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,
---------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995
------- -------- -------- -------- -------- -------- -------- --------
(In thousands)
Loss and LAE
reserves............... 389,404 $412,679 $427,049 $439,908 $465,423 $472,129 $449,566 $446,627
Liability reestimated as of:
One year later......... 362,058 375,764 401,878 409,966 421,994 411,915 391,733 386,879
Two years later........ 337,901 348,781 368,124 364,105 368,521 363,562 337,441 337,760
Three years later ..... 315,718 320,319 324,370 316,220 325,073 315,712 304,063 264,813
Four years later....... 299,308 294,992 284,628 282,291 292,801 293,711 254,004
Five years later....... 284,972 266,649 264,582 261,344 274,304 262,879
Six years later........ 266,423 256,900 251,335 252,077 257,864
Seven years later ..... 262,642 247,678 245,745 243,216
Eight years later ..... 257,731 244,863 241,533
Nine years later....... 256,354 242,973
Ten years later........ 255,709
Cumulative
redundancy............. 133,695 169,706 185,516 196,692 207,559 209,250 195,562 181,814
Cumulative amount of
liability paid through:
One year later......... 93,607 85,771 103,983 101,001 105,678 121,106 109,481 101,844
Two years later........ 155,505 162,264 171,327 171,429 184,883 192,519 170,603 170,932
Three years later ..... 206,413 204,129 206,499 205,829 219,649 217,484 202,660 195,265
Four years later....... 232,777 221,479 221,654 221,884 232,379 231,794 213,431
Five years later....... 242,140 228,922 230,606 227,692 237,879 237,272
Six years later........ 244,587 234,202 232,410 231,277 240,363
Seven years later ..... 248,319 235,274 232,912 232,416
Eight years later ..... 248,993 235,362 233,263
Nine years later....... 249,122 235,621
Ten years later........ 249,213
Net reserves--
December 31............ $472,129 $449,566 $446,627
Reinsurance
recoverables........... 18,644 19,177 19,560
-------- -------- --------
Gross reserves........... $490,773 $468,743 $466,187
======== ======== ========
YEAR ENDED DECEMBER 31,
------------------------------
1996 1997 1998
-------- -------- --------
(In thousands)
Loss and LAE
reserves............... $440,301 $433,440 $452,732
Liability reestimated as of:
One year later......... 387,094 339,672
Two years later........ 301,794
Three years later .....
Four years later.......
Five years later.......
Six years later........
Seven years later .....
Eight years later .....
Nine years later.......
Ten years later........
Cumulative
redundancy............. 138,507 93,768
Cumulative amount of
liability paid through:
One year later......... 118,307 107,748
Two years later........ 181,116
Three years later .....
Four years later.......
Five years later.......
Six years later........
Seven years later .....
Eight years later .....
Nine years later.......
Ten years later........
Net reserves--
December 31............ $440,301 $433,440 $452,732
Reinsurance
recoverables........... 19,266 21,531 24,899
-------- -------- --------
Gross reserves........... $459,567 $454,971 $477,631
======== ======== ========
The Company has historically experienced favorable loss and LAE reserve
development. The Company believes that the favorable loss and LAE reserve
development since 1988 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 1.5% 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.
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
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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 1998, the
Company ceded $8.2 million of its earned premiums to reinsurers.
The Company's reinsurance arrangements are generally placed through its
exclusive reinsurance broker, Guy Carpenter & Company, Inc. 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 1998 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, 1998. No other single reinsurer's percentage
participation in 1998 exceeded 3.1% of total reinsurance premiums.
PREMIUMS CEDED PERCENTAGE OF TOTAL
FOR YEAR ENDED REINSURANCE
DECEMBER 31, 1998 RATING(1) PREMIUMS CEDED
----------------- --------- -------------------
(IN THOUSANDS)
Lloyd's of London NR Syndicates . $5,165 NR 31.3
Hannover Ruckversicherungs ...... 4,535 A+ 27.5
American Re ..................... 2,836 A 17.2
GIO, Ltd. ....................... 625 A 5.3
CNA International Reinsurance Co. 611 A 5.1
- -------------
(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.
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
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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 $100,000 in 1998. In 1998, 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 $57,000 for 1998.
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.
Effective October 1, 1997, the Company assumed 50% of a 50% quota share of
Odyssey Reinsurance Corporation's Regional Companies Program. Maximum 100%
limits vary from $500,000 on proportional programs up to $5,000,000 on any one
non-proportional program. Participation in this Treaty allows access to a wide
geographic distribution of small to medium sized companies writing personal and
commercial property and casualty business. This facility targets Mutual and
Stock Insurance Companies with a subject premium base of less than $100,000,000,
operating in no more than ten states. Premiums earned for 1998 were $742,952.
The Company has a small participation of the Catastrophe First Aggregate
Excess Reinsurance Contract for the California Earthquake Authority (CEA)
through a fronting relationship with X.L. Global Reinsurance Company. This
program is in excess of an aggregate incurred loss equal to CEA's claims-paying
capacity less a minimum capital requirement of $350,000,000. Premiums earned for
1998 were $512,007.
The Company participates as a co-reinsurer with Zurich Insurance Company,
Zurich, Switzerland on an adverse loss development contract protecting a
specific portfolio of non-U.S. medical malpractice business. Premiums earned for
1998 were $1,660,000.
The Company also wrote physician premium on a fronted basis in connection
with the Poe & Brown and Fremont arrangements. The Company also assumed premium
from CNA Insurance Company in connection with the Poe & Brown arrangement and
from Fremont in connection with the Fremont arrangement through 100% quota share
reinsurance agreements as an interim measure until
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14
such time as the Company obtained proper approvals to write the business
directly. In 1998 these assumed premiums were $6.0 million and $24.9 million for
the Poe & Brown and Fremont arrangements, respectively.
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.
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, 1998 DECEMBER 31, 1997
---------------------- -----------------------
COST OR COST OR
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
-------- -------- -------- --------
(IN THOUSANDS)
Fixed maturity securities:
U.S. Government and
Agencies ................................. $237,290 $252,800 $290,028 $298,073
State, municipalities and
political subdivisions ................... 348,161 355,402 327,273 335,156
Mortgage-backed securities,
U.S. Government . ........................ 68,542 68,938 68,161 68,290
Corporate ................................ 44,881 44,959 7,256 7,248
Other .................................... 97 97 93 93
-------- -------- -------- --------
Total fixed maturity securities ............ 698,971 722,196 692,811 708,860
Common stocks .................................. 31,493 37,015 17,052 23,523
-------- -------- -------- --------
Total .......................................... $730,464 $759,211 $709,863 $732,383
======== ======== ======== ========
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 $37.0
million at December 31, 1998.
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, 1998:
AMORTIZED FAIR PERCENTAGE OF
TYPE/RATING OF INVESTMENT(1) COST VALUE FAIR VALUE
- ---------------------------- -------- -------- -------------
(IN THOUSANDS)
AAA (including U.S.
Government and Agencies) ... $442,461 $457,315 63.3%
AA ........................... 186,494 192,591 26.7
A ............................ 62,329 64,511 8.9
BBB .......................... 2,591 2,682 0.4
Non rated (2) ................ 5,097 5,097 0.7
-------- -------- -------
$698,972 $722,196 100.0%
======== ======== =======
- ------------
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(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."
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16
The following table sets forth certain information concerning the maturities
of fixed maturity securities in the Company's investment portfolio as of
December 31, 1998:
AMORTIZED FAIR PERCENTAGE OF
COST VALUE FAIR VALUE
--------- -------- -------------
(IN THOUSANDS)
Years to maturity:
One or less ...................... $ 3,205 $ 3,216 0.5%
After one through five ........... 88,083 90,539 12.5
After five through ten ........... 226,817 240,097 33.3
After ten ........................ 312,324 319,406 44.2
Mortgage-backed securities ......... 68,542 68,938 9.5
-------- -------- -----
Totals ................... $698,971 $722,196 100.0%
======== ======== =====
The average weighted maturity of the securities in the Company's fixed
maturity portfolio as of December 31, 1998 was 6.63 years. The average duration
of the Company's fixed maturity portfolio as of December 31, 1998 was 5.71
years.
The Company also maintains cash and highly liquid short-term investments,
which at December 31, 1998 totaled $46.7 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,
-------------------------------------------------------
1998 1997 1996
--------- ---------- ------------
(IN THOUSANDS)
FIXED MATURITY SECURITIES:
Average invested assets
(includes short-term cash investments)(1) .... $739,734 $718,239 $650,090
Net investment income:
Before income taxes ........................... 39,654 39,926 40,594
After income taxes ............................ 30,733 30,731 29,706
Average annual return on investments:
Before income taxes ........................... 5.36% 5.56% 6.24%
After income taxes ............................ 4.15% 4.28% 4.57%
Net realized investment gains after
income tax .................................... $ 5,804 $ 1,909 $ 351
Net increase (decrease) in
unrealized gains on all fixed maturity
investments after income taxes . .............. 4,664 5,526 (10,720)
EQUITY SECURITIES:
Average invested assets(2) ...................... $ 30,269 $ 21,750 $ 37,695
Net investment income:
Before income taxes ........................... 713 840 994
After income taxes ........................... 564 777 854
Average annual return on investments:
Before income taxes ........................... 2.36% 3.86% 2.64%
After income taxes ............................ 1.86% 3.57% 2.27%
Net realized investment gains after
income tax .................................... $ 1,430 $ 2,382 $ 7,279
Net increase (decrease) in
unrealized gains on all equity
investments after income taxes .................. (617) 1,333 (4,742)
- ------------
(1) Fixed maturity securities at cost.
(2) Equities at market.
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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 policyholder
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").
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Pursuant to the Holding Company Act, the California Department of Insurance
may examine the affairs of each company at any time. The Holding Company Act
requires disclosure of any material transactions by or among an insurance
company and its affiliates. Certain transactions and dividends defined to be of
an "extraordinary" type may not be effected if the California Department of
Insurance disapproves the transaction within 30 days after notice. Such
transactions include, but are not limited to, sales, purchases, exchanges, loans
and extensions of credit, and investments, in the net aggregate, involving more
than the lesser of 3% of the Company's admitted assets or 25% of surplus as to
policyholders, as of the preceding December 31. An extraordinary dividend is a
dividend which, together with other dividends or distributions made within the
preceding 12 months, exceeds the greater of 10% of the insurance company's
policyholders' surplus as of the preceding December 31 or the insurance
company's net income for the preceding calendar year. An insurance company is
also required to notify the California Department of Insurance of any dividend
after declaration, but prior to payment.
The Holding Company Act also provides that the acquisition or change of
"control" of a California 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 12
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 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, 1998,
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,
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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 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 expects that concentrated
efforts will be undertaken by opponents of MICRA in 1999 to weaken its
provisions. 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.
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EMPLOYEES
As of December 31, 1998, the Company employed 233 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, 1999 are
as follows:
NAME AGE POSITION
---- --- --------
Donald J. Zuk 62 President, Chief Executive Officer
and Director
Patrick S. Grant 56 Senior Vice President, Marketing
Joseph P. Henkes 49 Secretary and Senior Vice President,
Operations and Actuarial Services
Patrick T. Lo 46 Senior 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 was named Senior Vice President in 1999 and has been 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 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 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 financial condition and 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 instituted overall rate increases 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 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 partially offset the effect of its 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. The
Company ceased paying such premium credit dividends to its policyholders in
1998. The Company instituted no rate increases for 1998, which may have offset
the elimination of dividends to policyholders and somewhat improved its
competitive position. During 1999, the Company will institute an average rate
increase of 3.7% for California physician insureds. Therefore, the Company may
find it more difficult to compete with other insurance companies offering such
dividends.
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 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.
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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 1998, 1997 and 1996. The Company reduced reserves for prior
years by $ 93.8 million, $53.2 million and $59.7 million in the years ending
December 31, 1998, 1997 and 1996, respectively. The redundancies recognized in
1998 were offset, in part, by a $28.1 million increase in the loss and LAE
reserves for the medical malpractice insurance business assumed from Fremont in
January 1998. The strengthening of the Fremont reserves was made in order to
bring those reserves in line with the Company's more conservative reserving
policy. 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. The Company
believes that some reduction in the amount of redundancies recently experienced
is reasonably likely. 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 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.
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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 coverage will be
offered to solo physicians and medical groups in eight states, the largest being
Connecticut, Florida, Georgia and Louisiana. 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 acquired the medical malpractice insurance business of
Fremont effective January 1, 1998 through a 100% quota-share retroactive
reinsurance agreement. Simultaneously, a 100% quota-share prospective fronting
reinsurance agreement went into effect, making SCPIE Indemnity the reinsurer for
the Fremont policies until AHI obtains the proper approvals to write this
business directly. The Fremont policies are written through brokers in 10
states, with the vast majority in California and Arizona. During the fourth
quarter of 1998, AHI received regulatory approval to write this business
directly. Upon the policy's renewal date, each policy will be transferred from a
Fremont policy to an AHI policy. There is no assurance, however, that the
Company will successfully retain or expand this business or that it will
ultimately 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 in part on its relationship with eight county physician
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. Two other county associations recently switched their endorsements
to another insurance company. There can be no assurance that the Company will be
able to maintain its remaining 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. 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."
In May 1997, the Board of Directors of the Company adopted a stockholder
rights plan (the "Rights Plan") to deter any attempted takeover of the Company
on terms not approved by the Board of Directors. Pursuant to the Rights
Agreement, dated May 13, 1997, with ChaseMellon Shareholder Services, LLC (the
"Rights Agreement"), the Company declared a dividend of one preferred share
purchase right (a "Right") for each share of Company common stock, $.0001 par
value (the "Common Shares"), of the Company outstanding at the close of business
on June 3, 1997 (the "Record Date"). One Right attaches to each share of common
stock, and, when exercisable, each Right will entitle the registered holder to
purchase from the Company one one-hundredth of a share of Series A Junior
Participating Preferred Stock, $1.00 par value per share (the "Preferred
Shares"), at a price of $80.00 per one one-hundredth of a Preferred Share,
subject to adjustment (the "Purchase Price"). Because of the nature of the
Preferred Share's dividend, liquidation and voting rights, the value of one
one-hundredth of a Preferred Share purchasable upon exercise of each Right
should approximate the value of one Common Share.
The Rights Plan operates by diluting the ownership of any person who
acquires a number of Common Shares above the 20% threshold defined in the Rights
Agreement (an "Acquiring Person") or any person or group who commences or
announces an intention to commence a tender or exchange offer that would result
in beneficial ownership of 20% or more of the Common Shares. In the event that a
person becomes an Acquiring Person or if the Company were the surviving
corporation in a merger with an Acquiring Person or any affiliate or associate
of an Acquiring Person and the Common Shares were not changed or exchanged, each
holder of a Right, other than Rights that are or were acquired or beneficially
owned by the 20% stockholder (which Rights will thereafter be void), will
thereafter have the right to receive upon exercise that number of Common Shares
having a market value of two times the then current Purchase Price of the Right.
In the event that, after a person has become an Acquiring Person, the Company
were acquired in a merger or other business combination transaction or more than
50% of its assets or earning power were sold, proper provision shall be made so
that each holder of a Right shall thereafter have the right to receive, upon the
exercise thereof at the then current Purchase Price of the Right, that number of
shares of common stock of the acquiring company which at the time of such
transaction would have a market value of two times the then current Purchase
Price of the Right.
The Rights will expire on May 12, 2007, subject to the Company's right
to extend such date, unless earlier redeemed or exchanged by the Company or
terminated. The Rights may be redeemed in whole, but not in part, at a price of
$.01 per Right by the Board of Directors at any time prior to the time a person
becomes an Acquiring Person. The Rights may also be exchanged at any time after
a person becomes an Acquiring Person and prior to the acquisition of 50% or more
of the then-outstanding Common Shares (except for the Rights of the Acquiring
Person) for that number of Common Shares having an aggregate value equal to the
Spread (the excess of the value of the Common Shares issuable upon exercise of a
Right after a Person becomes an Acquiring Person over the Purchase Price) per
Right (subject to adjustment).
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Any of the provisions of the Rights Agreement may be amended by the Board of
Directors of the Company prior to the Distribution Date as defined in the Rights
Agreement. After the Distribution Date, the Company and the Rights Agent may
amend or supplement the Rights Agreement without the approval of any holders of
Right Certificates under certain circumstances provided that the interests of
the holders of Right Certificates (other than an Acquiring Person or an
affiliate or associate of an Acquiring Person) are not adversely affected
thereby.
As the result of a recent Delaware court case, the Board of Directors
recently approved an amendment to the Rights Agreement which eliminated certain
"Continuing Director" provisions from the Rights Agreement to bring the Rights
Agreement squarely within the type of plan previously held to be valid by the
Delaware Supreme Court. The Company does not believe this amendment dilutes the
effectiveness of the Company's Rights Plan or reduces the ability of the
Company's directors, in response to any likely set of circumstances, to redeem
the Rights if required to properly exercise their fiduciary duties.
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."
YEAR 2000
The Company relies heavily on information technology ("IT") systems and
other systems and facilities such as telephones, building access control systems
and heating and ventilation equipment ("embedded systems") to conduct its
business. The Company also has business relationships with health care
providers, financial institutions, financial intermediaries, public utilities
and other critical vendors as well as regulators and customers who are
themselves reliant on IT and embedded systems to conduct their businesses.
Worldwide concerns have arisen over the ability of IT and embedded systems to
function properly on and after January 1, 2000 ("Year 2000") generally because
many computer programs are written using two digits rather than four digits to
define the applicable year, and thus may not properly recognize "00" as the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices or engage in similar normal business
operations. As set forth below in "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Year 2000," the Company believes
it has taken adequate steps to prepare its IT, embedded systems, and external
relationships for the Year 2000. There can be no assurance, however, that the
Company or its external relationships have adequately prepared their computer
systems for the Year 2000.
ITEM 2. PROPERTIES
The Company is the owner of two office buildings, both located in Beverly
Hills, California, which were occupied by the Company's headquarters until March
1999. One building contains approximately 25,000 square feet of office space and
the other office building contains approximately 24,000 square feet. Both office
buildings are currently unencumbered. The Company intends to lease all of the
space in both buildings to third parties.
In July 1998, the Company entered into a lease covering approximately 95,000
square feet of office space for new Company headquarters. The lease is for a
term of 10 years and the Company moved its headquarters and principal operations
to this space in early March 1999. The Company
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expended $4.7 million for leasehold improvements and equipment in the fourth
quarter of 1998, and estimates that a total of $6.9 million will be incurred.
The Company also leases office space for claims offices in San Diego,
California; Fresno, California and Tampa, Florida, a sales office in Sacramento,
California and Phoenix, Arizona and marketing offices in Addison, Texas and Boca
Raton, Florida.
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in a California 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. In 1995, a jury made a damage award against
the Company of $4.2 million in compensatory damages, and punitive damages which
were reduced to $14.0 million by the trial judge. The Company appealed these
awards to the California district court of appeal. On May 8, 1998, the appellate
court reversed the judgment against the Company in its entirety. The bankruptcy
estate may attempt to obtain a new trial in the California Superior Court in
which the judgment was originally entered. The Company believes that the
bankruptcy estate is not entitled to any additional trial under applicable
California appellate court decisions and will aggressively oppose any such
attempt. The Company believes that the action is entirely without merit and will
continue to aggressively pursue its rights.
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 1998.
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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 31.63 27.31
Second quarter 38.38 30.25
Third quarter 35.38 28.50
Fourth quarter 32.25 27.94
1999
First quarter (January 1 - March 15) 30.13 28.13
----- -----
On March 15, 1999, the closing price of the Company's common stock was
$29.56.
STOCKHOLDERS OF RECORD
The approximate number of stockholders of record of the Company's Common
Stock as of March 15, 1999 was 7,326.
DIVIDENDS
The SCPIE Holdings' Board of Directors (the "Board") declared cash dividends
per share on its common stock of $0.20 per share in 1997 and $0.24 per share in
1998. On February 24, 1999, the Board declared an $0.08 quarterly dividend
payable on March 31, 1999, to stockholders of record on March 15, 1999. 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 1999 up to approximately $41.1 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 CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table sets forth selected consolidated 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, 1998 1997 1996 1995 1994
- ------------------------------------------- -------- -------- -------- -------- --------
INCOME STATEMENT DATA(1):
Direct premiums written $125,213 $123,910 $125,635 $122,277 $120,024
======== ======== ======== ======== ========
Premiums earned $157,976 $133,866 $120,484 $116,354 $111,659
Net investment income 40,367 42,716 40,769 40,424 39,663
Realized investment gains
and other revenue 11,618 7,153 12,113 8,231 755
-------- -------- -------- -------- --------
Total revenues 209,961 183,735 173,366 165,009 152,077
-------- -------- -------- -------- --------
Losses and loss adjustment
expenses 132,208 123,377 108,797 118,023 108,720
Other operating expenses 28,211 17,987 14,276 12,561 11,844
-------- -------- -------- -------- --------
Total expenses 160,419 141,364 123,073 130,584 120,564
-------- -------- -------- -------- --------
Income before policyholder
dividends and
federal income taxes 49,542 42,371 50,293 34,425 31,513
Policyholder dividends (2) -- -- 8,436 -- --
Federal income taxes 12,566 10,195 11,665 10,056 9,212
-------- -------- -------- -------- --------
Net income $ 36,976 $ 32,176 $ 30,192 $ 24,369 $ 22,301
======== ======== ======== ======== ========
BALANCE SHEET DATA(1):
Total investments $793,616 $785,664 $717,910 $695,021 $636,909
Total assets 921,469 888,449 805,155 781,358 751,605
Total liabilities 534,951 527,334 516,588 507,539 542,069
Total stockholders' equity 386,518 361,115 288,567 273,819 209,536
ADDITIONAL DATA(1):
Basic earnings per share of common stock(3) $ 3.06 $ 2.66 $ 3.02 $ 2.44 $ 2.23
Diluted earnings per share of common
stock(3) 3.06 -- -- -- --
Dividends per share of common stock
0.24 0.20 -- -- --
Book value per share(3) 32.54 29.41 28.86 27.38 20.95
GAAP ratios:
Loss ratio 83.7% 92.2% 90.3% 101.4% 97.4%
Expense ratio 17.9 13.4 11.8 10.8 10.6
Combined ratio 101.6 105.6 102.1 112.2 108.0
Statutory capital and surplus $343,330 $321,289 $251,958 $235,352 $187,299
(1) Financial data as of and for the years ended December 31, 1995 and 1994 are
derived from the combined financial statements of 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 years ended
December 31, 1998 and 1997 are derived from the consolidated 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, 1998 and 1997 is
computed using the weighted average number of common shares outstanding
during the year of 12,074,272 and 12,108,330, respectively. All other
periods give effect to the Reorganization completed on January 29, 1997,
including the allocation of 9,994,652 shares of common stock to members of
the Exchange in connection therewith. Diluted earnings per share of common
stock at December 31, 1998 is computed using the weighted average number of
common shares outstanding during the year of 12,089,013. The adoption of
Statement of Financial Accounting Standards No. 128 (Statement 128),
"Earnings per Share" had no impact on the calculation of earnings per share
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amounts. For further discussion of earnings per share and Statement 128 see
the notes to consolidated financial statements beginning on page 54.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the consolidated
financial statements and the related notes thereto appearing elsewhere in this
Form 10-K. The consolidated financial statements for 1998 and 1997 include the
accounts and operations of SCPIE Holdings Inc. and its wholly-owned
subsidiaries. The financial statements for 1996 include the 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 Company ("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 in "Year 2000" disclosure, and in periodic filings with the
Securities and Exchange Commission ("SEC").
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 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 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
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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.
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 currently offered to solo physicians and medical groups in five
states, the largest such states being Connecticut, Florida, Georgia and
Louisiana. In 1999, the Company expects to offer this coverage in three
additional states. 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 acquired the medical malpractice insurance business of
Fremont Indemnity Company ("Fremont") effective January 1, 1998 through a 100%
quota-share retroactive reinsurance agreement. Simultaneously, a 100%
quota-share prospective fronting reinsurance agreement went into effect, making
SCPIE Indemnity the reinsurer for the Fremont policies until AHI obtains the
proper approvals to write this business directly. The Fremont policies are
written through brokers in 10 states, with the vast majority in California and
Arizona. During the fourth quarter of 1998, AHI received regulatory approval to
write this business directly. Upon the policy's renewal date, each policy will
be transferred from a Fremont policy to an AHI policy. There is no assurance,
however, that the Company will successfully retain or expand this business or
that it will ultimately be profitable.
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 1998, however, 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. 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. The Company ceased
paying such premium credit dividends to its policyholders in 1998. The Company
instituted no rate increases for 1998, which may have offset the elimination of
dividends to policyholders and somewhat improved its competitive position.
During 1999, the Company will institute an average rate increase of 3.7% for
California physician insureds. Therefore, the Company may find it more difficult
to compete with other insurance companies offering such dividends.
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 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 changes
in the judicial process.
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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 $93.8 million,
$53.2 million, and $59.7 million in the years ended December 31, 1998, 1997 and
1996, respectively. The redundancies recognized in 1998 were offset, in part, by
a $28.1 million increase in the loss and LAE reserves for the medical
malpractice insurance business assumed from Fremont in January 1998. The
strengthening of the Fremont reserves was made in order to bring those reserves
in line with the Company's more conservative reserving policy. 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 7.0% 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 physician 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, 1998, COMPARED TO YEAR ENDED DECEMBER 31, 1997
PREMIUMS EARNED Premiums earned increased approximately $24.1 million, or 18%,
to $158.0 million in 1998 from $133.9 million in 1997. The increase was
principally due to a $30.0 million increase in physician and medical group
medical malpractice insurance premiums to approximately $143.2 million in 1998
from $113.2 million in 1997. This increase was a result of the Company's
acquisition of the medical malpractice book of business of Fremont on January 1,
1998 and premiums attributable to an agency relationship with Poe & Brown which
commenced on January 1, 1998. Hospital medical malpractice premiums were
approximately $8.8 million in 1998 compared to $14.6 million in 1997. This
decrease in 1998 hospital premiums is due principally to the loss of one large
integrated hospital account in Florida in late 1997. Assumed reinsurance
premiums, other than those received in the Fremont and Poe and Brown
arrangements, increased slightly in 1998.
NET INVESTMENT INCOME Net investment income decreased approximately $2.3
million, or 5.5%, to $40.4 million in 1998 from $42.7 million in 1997. Invested
assets increased $7.9 million to $793.6 million in 1998 from $785.7 million at
December 31, 1997. The average pretax yield on the investment portfolio
decreased to 5.2% in 1998 compared to 5.6% in 1997 due to a general decline in
interest rates and a greater proportion of lower-yielding, tax-exempt securities
in the portfolio.
REALIZED INVESTMENT GAINS AND OTHER REVENUE Realized investment gains were
approximately $11.1 million in 1998 compared to $6.6 million in 1997. In
December 1998 sales were made in the fixed-maturity portion of the investment
portfolio to reposition the portfolio by increasing the percentage of corporate
securities.
LOSSES AND LAE Losses and LAE increased $8.8 million, or 7.2%, to $132.2 million
in 1998 from $123.4 million in 1997. As a percentage of premiums earned, losses
and LAE decreased to 83.7% in 1998 from 92.2% for the same period in 1997. For
1998, the Company reduced loss and LAE reserves incurred in prior policy years
approximately $93.8 million as compared to a reserve reduction of $53.2 million
for 1997 for claims incurred in prior policy years. The redundancies recognized
in 1998 were offset, in part, by a $28.1 million increase in the loss and LAE
reserves for the medical malpractice insurance business assumed from Fremont in
January 1998. The strengthening of those reserves was made in order to bring
those reserves in line with the Company's more conservative reserving policy.
OTHER OPERATING EXPENSES Other operating expenses increased $10.2 million, or
56.8%, to $28.2 million in 1998 from $18.0 million in 1997. The ratio of other
operating expenses to premiums earned is referred to as the expense ratio, which
increased to 17.9%
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in 1998 from 13.4% in 1997. This increase is due primarily to certain one-time
charges and the amortization of non-recurring costs related to the acquisition
of the Fremont business. Additionally, other operating expenses include higher
commission expenses associated with the greater percentage of business written
through brokers in 1998 and general personnel increases necessary to produce and
service the higher 1998 premium volume.
FEDERAL INCOME TAXES Federal income taxes increased $2.4 million, or 23.3%, to
$12.6 million in 1998 from $10.2 million in 1997. The effective tax rate
increased to 25.4% in 1998 from 24.1% in 1997, due primarily to higher realized
gains in 1998.
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
principally due to a $5.7 million increase in hospital medical malpractice
premiums and an increase of $9.1 million increase in assumed reinsurance
premiums. 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 in 1997, which includes $6.5 million of assumed
hospital premiums compared to $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 expense ratio was 13.4% in 1997 and
11.8% in 1996.
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.
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 the years 1980 through
33
34
1997. 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 paid no
policyholder dividends in 1998, and has ceased paying such dividends to its
policyholders.
The Company 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 the Company was
$9.2 million in 1998 compared to $13.5 million in 1997. The cash provided by
operating activities in 1997 was before the payment of policyholder dividends.
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 $37.0 million at December 31,
1998. The Company plans to continue this focus on fixed-maturity securities for
the indefinite future.
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 $34.4
million, or 4.3% of invested assets, at December 31, 1998. The Company believes
that all of its short-term and fixed-maturity securities are readily marketable.
The Company has made limited investments in real estate, which have been used
almost entirely in the Company's operating activities, with the remainder leased
to third parties. In July 1998, the Company entered into a lease covering
approximately 95,000 square feet of office space for new Company headquarters.
The lease is for a term of 10 years and the Company moved its headquarters and
principal operations to this space in early March 1999. The Company intends to
lease its former headquarters to third parties. The Company expended $4.7
million for leasehold improvements and equipment in the fourth quarter of 1998,
and estimates a total of $6.9 million will be incurred.
SCPIE Holdings is an insurance holding company whose assets primarily consist
of all of the capital stock of its insurance company subsidiaries. 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 1999
without prior regulatory approval is approximately $41.1 million. Dividends of
$25 million were paid to SCPIE Holdings during 1998.
Common stock dividends paid to stockholders were $0.24 per share in 1998.
These dividends were 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 $75.0 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.
During May 1997, the Board of Directors authorized the repurchase of up to
1,000,000 shares of the Company's common stock in the open market. The
repurchases may be made from time to time and continue until May 1999. Since
1997, 413,300 shares were repurchased. Subsequent to December 31, 1998, an
additional 77,900 shares were repurchased. The Board of Directors may further
extend the program's expiration date.
34
35
YEAR 2000
The Company relies heavily on information technology ("IT") systems and other
systems and facilities such as telephones, building access control systems and
heating and ventilation equipment ("embedded systems") to conduct its business.
The Company also has business relationships with health care providers,
financial institutions, financial intermediaries, public utilities and other
critical vendors as well as regulators and customers who are themselves reliant
on IT and embedded systems to conduct their businesses.
Worldwide concerns have arisen over the ability of IT and embedded systems
to function properly on and after January 1, 2000 ("Year 2000"). The Year 2000
concern is the result of many computer programs being written using two digits
rather than four digits to define the applicable year. Systems that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000, or as no date. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business operations.
State of Readiness
In 1995, the Company organized a multi-disciplinary Year 2000 Project Team.
The Year 2000 Project Team has developed and is currently executing a
comprehensive plan designed to make the Company's mission critical IT systems
and embedded systems Year 2000 ready. Outside consultants have reviewed the
Company's overall process, plan and progress to date. The Company's plan for IT
systems consists of four phases: (1) inventory - identifying all IT systems and
risk rating each according to its potential business impact; (2) assessment
identifying IT systems that use date functions and assessing them for Year 2000
functionality; (3) remediation - reprogramming, or replacing where necessary,
inventoried items to ensure they are Year 2000 ready; and (4) testing and
certification - testing the code modifications and new inventory with other
associated systems, including extensive date testing and performing quality
assurance testing to ensure successful operation in the post-1999 environment.
The Company completed the remediation of substantially all of its mission
critical IT systems by year-end 1998.
The Company believes that its Year 2000 project is on schedule.
External Relationships
The Company also faces the risk that one or more of its critical suppliers or
customers ("external relationships") will not be able to interact with the
Company due to the third party's inability to resolve its own Year 2000 issues,
including those associated with its own external relationships. The Company has
completed its inventory of external relationships and risk rated each external
relationship based upon the potential business impact, available alternatives
and cost of substitution. The Company is attempting to determine the overall
Year 2000 readiness of its external relationships. In the case of mission
critical suppliers such as banks, financial intermediaries (such as stock
exchanges), telecommunications providers and other utilities, IT vendors,
financial market data providers, major physician groups and major hospitals, the
Company is engaged in discussions with the third parties and is attempting to
obtain detailed information as to those parties' Year 2000 plans and state of
readiness. The Company, however, does not have sufficient information at the
current time to predict whether its external relationships will be Year 2000
ready.
Year 2000 Costs
Year 2000 costs incurred were $1,018,000 and $734,000 in 1998 and 1997,
respectively and are currently estimated to be $101,000 in 1999 for a total of
$1,853,000. A large majority of these costs are expected to be incremental
expenses that will not recur in the Year 2000 or thereafter. The Company
expenses these costs as incurred and funds these costs through operating cash
flows.
Risks and Contingency/Recovery Planning
If the Company's Year 2000 issues were unresolved, potential consequences
would include, among other possibilities, the inability to accurately and timely
process claims, update policyholders' accounts, process financial transactions,
bill policyholders, assess exposure to risks, determine liquidity requirements
or report accurate data to management, stockholders, policyholders, regulators
and others as well as business interruptions or shutdowns, financial losses,
reputational harm, increased scrutiny by regulators and litigation related to
Year 2000 issues. The Company is attempting to limit the potential impact of the
Year 2000 by monitoring the progress of its
35
36
own Year 2000 project and those of its critical external relationships and by
developing contingency/recovery plans. The Company cannot guarantee that it will
be able to resolve all of its Year 2000 issues. Any critical unresolved Year
2000 issues at the Company or with its external relationships, however, could
have a material adverse effect on the Company's results of operations, liquidity
or financial condition.
The Company has begun to develop contingency/recovery plans aimed at ensuring
the continuity of critical business functions before and after December 31,
1999. As part of that process, the Company has begun to develop reasonably
likely failure scenarios for its critical IT systems and external relationships
and the embedded systems in its critical facilities. Once these scenarios are
identified, the Company will develop plans that are designed to reduce the
impact on the Company, and provide methods of returning to normal operations, if
one or more of those scenarios occur. The Company expects contingency/recovery
planning to be substantially complete by March 31, 1999.
Other Factors Affecting the Company's Businesses
Any critical unresolved Year 2000 issues at the Company or with its external
relationships could have a material adverse effect on the Company's results of
operations, liquidity or financial condition. In addition, the Company's
expectations about the future costs and timely and successful completion of its
Year 2000 program are subject to uncertainties that could cause actual results
to differ materially from what has been discussed above under "Year 2000."
Factors that could influence the amount of future costs and the completion dates
and effectiveness of remediation, testing and certification and contingency
planning efforts include the Company's success in identifying IT systems and
embedded systems that contain two-digit year codes, the nature and amount of
required reprogramming, testing and certification, the rate and magnitude of
related labor and consulting costs, the availability of qualified personnel and
the success of the Company's external relationships in addressing their own Year
2000 issues.
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 7a: QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to various market risk exposures, including
interest rate risk and equity price risk.
The Company invests its assets primarily in fixed-maturity securities,
which at December 31, 1998 comprised 91% of total investments at market value.
U.S. government and tax-exempt bonds represent 84% of the fixed-maturity
investments, with the remainder consisting almost entirely of mortgage-backed
securities and corporate bonds. Equity securities, consisting primarily of
common stocks, account for 5% of total investment at market value. The remaining
4% of the investment portfolio consists of highly liquid short-term investments,
which are primarily overnight bank repurchase agreements and short-term money
market funds.
The value of the fixed-maturity portfolio is subject to interest rate
risk. As market interest rates decrease, the value of the portfolio goes up with
the opposite holding true in rising interest rate environments. A common measure
of the interest sensitivity of fixed-maturity assets is modified duration, a
calculation that takes maturity, coupon rate, yield and call terms to calculate
an average age of the expected cash flows. The longer the duration, the more
sensitive the asset is to market interest rate fluctuations.
The value of the common stock equity investments is dependent upon
general conditions in the securities markets and the business and financial
performance of the individual companies in the portfolio. Values are typically
based on future economic prospects as perceived by investors in the equity
markets.
36
37
The first two columns of the following table show the financial
statement carrying values and related estimated fair values of certain of the
Company's financial instruments as of December 31, 1998. The third column shows
the effect on current estimated fair values assuming a 100-- basis point
increase in market interest rates and a 10% decline in equity price (sensitivity
analysis).
Estimated Fair Vale
Estimated Fair Vale At Adjusted
(In thousands) at Current Market Market Rates/Prices
Carrying Value Rates/Prices as Indicated Below
-------------------------- ----------------- --------------- -----------------
Interest rate risk*
Fixed-maturity securities
available-for-sale $ 722,196 $ 722,196 $ 662,312
Equity price risk**
Common stocks $ 37,015 $ 37,015 $ 33,314
* Adjusted interest rates assume a 100-basis point increase in
market rates at December 31, 1998
** Adjusted equity prices assume a 10 percent decline in values at
December 31, 1998
For all its financial assets and liabilities, the Company seeks to maintain
reasonable average durations, consistent with the maximization of income without
sacrificing investment quality and providing for liquidity and diversification.
The estimated fair values at current market rates for financial instruments
subject to interest rate risk in the table above are the same as those disclosed
in Note 2 (Investments) to the consolidated financial statements. The estimated
fair values at the adjusted market rates (assuming a 100-basis point increase
in market interest rates) are calculated using discounted cash flow analysis and
duration modeling where appropriate. The estimated values do not consider the
effect that changing interest rates could have on prepayment activity.
This sensitivity analysis provides only a limited, point-in-time view of the
market risk sensitivity of certain of the Company's financial instruments. The
actual impact of market interest rate and price changes on the financial
instruments may differ significantly from those shown in the sensitivity
analysis. The sensitivity analysis is further limited as it does not consider
any actions the Company could take in response to actual and/or anticipated
changes in interest rates and equity prices.
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 48 hereof.
37
38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
38
39
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 13, 1999 (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."
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 and Certain Beneficial Owners."
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."
39
40
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 48
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.**
3.3 First Amendment to the Bylaws
10.1 Amended and Restated Employment Agreement dated
January 4, 1999, 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.**
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.**
40
41
NUMBER DOCUMENT
------ --------
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.**
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
41
42
NUMBER DOCUMENT
------ --------
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 First Excess of Loss Reinsurance Treaty No.
01-97-1134 with various subscribing
reinsurers.
10.30 Second Excess of Loss Reinsurance Treaty No.
01-97-1135 with various subscribing
reinsurers.
10.31 First Excess of Loss Treaty No. 01-98-0020 with
various subscribing reinsurers.
10.32 Second Excess of Loss Treaty No. 01-98-0021 with
various subscribing reinsurers
10.33 Third Excess of Loss Treaty No. 01-98-0022 with
various subscribing reinsurers.
10.34 Fourth Excess of Loss Treaty No. 01-98-0599 with
various subscribing reinsurers.
10.35 Quota Share Reinsurance Treaty No. 1-98-0922.
10.36 Cover Note for Allocated Loss Adjustment Expense
Excess of Loss Treaty No. 01-99-1154 with
various subscribing reinsurers.
10.37 Cover Note for First Excess of Loss Reinsurance
Treaty No. 01-98-1134 with various subscribing
reinsurers.
10.38 Cover Note for Second Excess of Loss Reinsurance
Treaty No. 01-98-1135 with various subscribing
reinsurers.
10.39 Cover Note for First Excess of Loss Reinsurance
Treaty No. 01-99-0020 with various subscribing
reinsurers.
10.40 Cover Note for Second Excess of Loss Reinsurance
Treaty No. 01-99-0021 with various subscribing
10.44 reinsurers.
10.41 Cover Note for Third Excess of Loss Reinsurance
Treaty No. 01-99-0022 with various subscribing
reinsurers.
42
43
NUMBER DOCUMENT
------ --------
10.42 Cover Note for Fourth Excess of Loss Reinsurance
Treaty No. 01-99-0599 with various subscribing
reinsurers
10.43 Cover Note for Quota Share Reinsurance Treaty
No. 1-99-0922.
10.44 SCPIE Management Company Retirement Income Plan,
as amended and restated, effective January 1,
1989.**
10.45 Supplemental Employee Retirement Plan for
Selected Employees of SCPIE Management Company
dated January 1, 1995.**
10.46 Retirement Plan for Outside Governors and
Affiliated Directors, effective January 1, 1994
as amended.**
10.47 The SMC Cash Accumulation Plan, dated July 1,
1991, as amended.**
10.48 Inter-Company Pooling Agreement effective
January 1, 1997.**
10.49 SCPIE Holdings Inc. and Subsidiaries
Consolidated Federal Income Tax Liability
Allocation Agreement effective January 1, 1996.
**
10.50 The 1997 Equity Participation Plan of SCPIE
Holdings Inc.**
10.51 Form of Indemnification Agreement.**
10.52 Lease between Wh/WSA Realty, L.L.C., a Delaware
limited liability company and SCPIE Holdings
Inc., a Delaware corporation dated July 31, 1998.
10.53 Quota Share Reinsurance Agreement between
Fremont Indemnity Company and SCPIE Indemnity
Company, effective January 1, 1998.
10.54 Assumption Reinsurance Agreement between Fremont
Indemnity Company and American Healthcare Indemnity
Company, effective January 1, 1998.
11.1 Statement re: computation of per share earnings.**
21.1 Subsidiaries of the registrant.**
27.1 Financial Data Schedule.
- ------------
43
44
(**) 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 or as Exhibits to the Company's Annual Report on Form 10-K, dated
March 31, 1998, and incorporated herein by this reference.
(b) Reports on Form 8-K:
None.
44
45
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 29, 1999
45
46
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ DONALD J. ZUK President
- ---------------------------- Chief Executive Officer
Donald J. Zuk and Director
(Principal Executive
Officer) March 29, 1999
/s/ PATRICK T. LO Vice President
- ---------------------------- Chief Financial Officer
Patrick T. Lo and Chief Accounting
Officer
(Principal Financial
Officer and
Principal Accounting
Officer) March 29, 1999
/s/ MITCHELL S. KARLAN, M.D.
- ---------------------------- Chairman of the Board
Mitchell S. Karlan, M.D. and Director March 29, 1999
/s/ JACK E. MCCLEARY, M.D.
- ---------------------------- Director and Treasurer March 29, 1999
Jack E. McCleary, M.D.
46
47
/s/ ALLAN K. BRINEY, M.D. Director March 29, 1999
- ----------------------------
Allan K. Briney, M.D.
/s/ WILLIS T. KING, JR. Director March 29, 1999
- ----------------------------
Willis T. King, Jr.
/s/ CHARLES B. MCELWEE, M.D. Director March 29, 1999
- ----------------------------
Charles B. McElwee, M.D.
/s/ WENDELL L. MOSELEY, M.D. Director March 29, 1999
- ----------------------------
Wendell L. Moseley, M.D.
/s/ DONALD P. NEWELL Director March 29, 1999
- ----------------------------
Donald P. Newell
/s/ HARRIET M. OPFELL, M.D. Director March 29, 1999
- ----------------------------
Harriet M. Opfell, M.D.
/s/ WILLIAM A. RENERT, M.D. Director March 29, 1999
- ----------------------------
William A. Renert, M.D.
/s/ HENRY L. STOUTZ, M.D. Director March 29, 1999
- ----------------------------
Henry L. Stoutz, M.D.
/s/ REINHOLD A. ULRICH, M.D. Director March 29, 1999
- ----------------------------
Reinhold A. Ulrich, M.D.
47
48
SCPIE HOLDINGS INC.
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
ANNUAL REPORT ON FORM 10-K
---------------
INDEX
PAGES
-----
Report of Independent Auditors .......................................... 49
Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and 1997 ........... 50
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996 ..................................... 51
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996.......................... 52
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996...................................... 53
Notes to Consolidated Financial Statements.............................. 54
Schedule II - Condensed Financial Information of Registrant .............. 70
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.
48
49
Report of Independent Auditors
Board of Directors and Shareholders
SCPIE Holdings Inc.
We have audited the accompanying consolidated balance sheets of SCPIE Holdings
Inc. and subsidiaries as of December 31, 1998 and 1997 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, 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.
/s/ Ernst & Young LLP
Los Angeles, California
February 22, 1999
49
50
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, 1998 1997
- ------------ -------- ------
ASSETS
Securities available for sale (Note 2):
Fixed-maturity investments, at fair value
(amortized cost: 1998 - $698,971; 1997 -
$ 692,811) $ 722,196 $ 708,860
Equity investments, at fair value
(cost: 1998 - $31,493; 1997 - $17,052) 37,015 23,523
--------- ---------
Total securities available for sale 759,211 732,383
Short-term investments 34,405 53,281
--------- ---------
Total investments 793,616 785,664
Cash 12,305 13,252
Accrued investment income 11,440 12,202
Reinsurance recoverable (Note 4) 24,899 21,531
Deferred federal income taxes (Note 5) 12,163 16,158
Costs in excess of net assets acquired 7,811 4,641
Property and equipment, net 19,706 19,534
Other assets 39,529 15,467
--------- ---------
Total assets $ 921,469 $ 888,449
========= =========
LIABILITIES
Reserves:
Losses and loss adjustment expenses (Note 3) $477,631 $ 454,971
Unearned premiums 24,591 22,072
--------- ---------
Total reserves 502,222 477,043
Other liabilities 32,729 50,291
--------- ---------
Total liabilities 534,951 527,334
Commitments and contingencies (Note 8)
STOCKHOLDERS' EQUITY
Preferred stock - par value $1.00; 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,
1998 - 11,878,791 shares outstanding
1997 - 12,276,691 shares outstanding 1 1
Additional paid-in capital 36,386 36,386
Retained earnings 344,587 310,506
Treasury stock, at cost
(1998 - 413,300 shares; 1997 - 15,400 shares) (13,141) (416)
Accumulated other comprehensive income 18,685 14,638
--------- ---------
Total stockholders' equity 386,518 361,115
--------- ---------
Total liabilities and stockholders' equity $ 921,469 $ 888,449
========= =========
See accompanying notes.
50
51
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------- -------- -------- ------
REVENUES
Premiums earned (Note 4) $157,976 $133,866 $120,484
Net investment income (Note 2) 40,367 42,716 40,769
Realized investment gains (Note 2) 11,129 6,602 11,738
Other revenue 489 551 375
-------- -------- --------
Total revenues 209,961 183,735 173,366
EXPENSES
Losses and loss adjustment expenses (Note 3) 132,208 123,377 108,797
Other operating expenses 28,211 17,987 14,276
-------- -------- --------
Total expenses 160,419 141,364 123,073
-------- -------- --------
Income before policyholder dividends
and federal income taxes 49,542 42,371 50,293
Policyholder dividends -- -- 8,436
Federal income taxes (Note 5) 12,566 10,195 11,665
-------- -------- --------
Net income $ 36,976 $ 32,176 $ 30,192
======== ======== ========
Basic earnings per share of common stock (Note 10) $ 3.06 $ 2.66 $ 3.02
Diluted earnings per share of common stock (Note 10) $ 3.06 N/A N/A
See accompanying notes.
51
52
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
ADDITIONAL
PREFERRED COMMON PAID-IN RETAINED
STOCK STOCK CAPITAL EARNINGS
--------- --------- --------- ---------
Balance at January 1, 1996 $ -- $ -- $ -- $ 250,596
Net income -- -- -- 30,192
Comprehensive income for
unrealized losses on securities
sold, net of reclassification
adjustments of $13,743 for
gains included in net income -- -- -- --
Comprehensive Income
--------- --------- --------- ---------
Balance at December 31, 1996 -- -- -- 280,788
Net income -- -- -- 32,176
Comprehensive income for
unrealized gains on securities
sold, net of reclassification
adjustments of $4,534 for
gains included in net income -- -- -- --
--------- --------- --------- ---------
Comprehensive Income
Issuance of common stock -- 1 36,386 --
Purchase of treasury stock -- -- -- --
Cash dividends -- -- -- (2,458)
--------- --------- --------- ---------
Balance at December 31, 1997 -- 1 36,386 310,506
Net income -- -- -- 36,976
Comprehensive income for
unrealized gains on securities
sold, net of reclassification
adjustments of $1,863 for
gains included in net income -- -- -- --
--------- --------- --------- ---------
Comprehensive Income
Purchase of treasury stock -- -- -- --
Cash dividends -- -- -- (2,895)
--------- --------- --------- ---------
Balance at December 31, 1998 $ $ 1 $ 36,386 $ 344,587
========= ========= ========= =========
ACCUMULATED OTHER TOTAL
TREASURY COMPREHENSIVE STOCKHOLDERS'
STOCK INCOME EQUITY
--------- --------- ---------
<
Balance at January 1, 1996 $ -- $ 23,223 $ 273,819
Net income -- -- 30,192
Comprehensive income for
unrealized losses on securities
sold, net of reclassification
adjustments of $13,743 for
gains included in net income -- (15,444) (15,444)
---------
Comprehensive Income 14,748
--------- --------- ---------
Balance at December 31, 1996 -- 7,779 288,567
Net income -- -- 32,176
Comprehensive income for
unrealized gains on securities
sold, net of reclassification
adjustments of $4,534 for
gains included in net income -- 6,859 6,859
--------- --------- ---------
Comprehensive Income 39,035
---------
Issuance of common stock -- -- 36,387
Purchase of treasury stock (416) -- (416)
Cash dividends -- -- (2,458)
--------- --------- ---------
Balance at December 31, 1997 (416) 14,638 361,115
Net income -- -- 36,976
Comprehensive income for
unrealized gains on securities
sold, net of reclassification
adjustments of $1,863 for
gains included in net income -- 4,047 4,047
--------- --------- ---------
Comprehensive Income 41,023
---------
Purchase of treasury stock (12,725) -- (12,725)
Cash dividends -- -- (2,895)
--------- --------- ---------
Balance at December 31, 1998 $ (13,141) $ 18,685 $ 386,518
========= ========= =========
See accompanying notes.
52
53
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 31, 1998 1997 1996
--------- --------- ---------
OPERATING ACTIVITIES
Net income $ 36,976 $ 32,176 $ 30,192
Adjustments to reconcile net income to net cash provided by operating
activities:
Unpaid losses and loss adjustment expenses,
and reinsurance recoverables 19,292 (12,950) (6,301)
Accrued investment income 762 (1,004) (1,363)
Provision for deferred federal income taxes 1,815 370 80
Unearned premiums 2,519 (3,225) 5,381
Policyholders' dividends payable -- (7,723) (923)
Realized investment gains (11,129) (6,602) (11,738)
Provisions for amortization and depreciation 5,061 4,938 2,837
Changes in other liabilities (18,905) 579 11,212
Changes in other assets (27,232) (755) 9,468
--------- --------- ---------
Net cash provided by operating activities 9,159 5,804 38,845
INVESTING ACTIVITIES
Purchases - fixed maturities (300,916) (410,381) (480,401)
Sales - fixed maturities 263,293 335,210 375,877
Maturities - fixed maturities 36,501 38,073 23,571
Purchases - equities (19,219) (7,692) (5,445)
Sales - equities 6,979 10,312 50,495
Change in short-term investments, net 18,876 4,201 (1,783)
--------- --------- ---------
Net cash provided by (used in) investing activities 5,514 (30,277) (37,686)
FINANCING ACTIVITIES
Issuance of common stock, net of expenses -- 36,387 --
Purchase of treasury stock (12,725) (416) --
Cash dividends (2,895) (2,458) --
--------- --------- ---------
Net cash provided by (used in) financing activities (15,620) 33,513 --
--------- --------- ---------
Increase (decrease) in cash (947) 9,040 1,159
Cash at beginning of year 13,252 4,212 3,053
--------- --------- ---------
Cash at end of year $ 12,305 $ 13,252 $ 4,212
========= ========= =========
See accompanying notes.
53
54
SCPIE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying 1998 and 1997 consolidated 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 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 the Company'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 exchange for their membership interests
in the Exchange.
Concurrent with the Reorganization, SCPIE Holdings completed an initial
public offering, which generated net proceeds to SCPIE Holdings of approximately
$36.4 million.
In March 1996, SCPIE Holdings acquired the outstanding stock of AHI and
AHSIC, both inactive property/casualty insurance companies for $12.5 million.
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 is
being 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 operations, after
intercompany eliminations, of the Exchange and its wholly-owned subsidiaries,
principally SCPIE Holdings, SCPIE Indemnity, AHI, AHSIC, and SMC.
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.
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:
54
55
INVESTMENTS
The Company has designated its entire investment portfolio as
available-for-sale. The Company has no securities classified as "trading" or
"held-to-maturity." Available-for-sale securities are stated at fair value with
the unrealized gains and losses, net of tax, reported in other comprehensive
income. Realized investment gains and losses are included as a component of
revenues based on specific identification of the investment sold. Interest and
dividends on securities classified as available-for-sale are included in
investment 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.
DEFERRED ACQUISITION COSTS
Deferred acquisition costs are capitalized and amortized as premiums are
earned over the terms of the related policies.
(IN THOUSANDS) 1998 1997 1996
- -------------- -------- ------- --------
Balance at beginning of year $ 520 $ 591 $ 468
Costs deferred 12,871 2,944 2,920
Costs amortized 5,340 3,015 2,797
-------- ------- --------
Balance at end of year $ 8,051 $ 520 $ 591
======== ======= ========
As the Company has expanded its operations in other states during 1998
through brokerage relationships, the corresponding commissions and fronting fee
arrangements have resulted in an overall increase in acquisition costs.
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 method 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
Prospective 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.
55
56
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 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 buildings, are
recorded at cost and depreciated principally under the straight-line method over
the useful life of the assets.
INCOME TAXES
Income taxes have been provided using the liability method in accordance with
Financial Accounting Standards Board (FASB) Statement No. 109, Accounting for
Income Taxes.
CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash investments,
fixed maturities and reinsurance recoverables. 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
geographic areas.
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, 1998, approximately 64% 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 28% with Hannover
Ruickversicherungs, 17% with American Re and between 2% to 5% primarily among
five other reinsurers. Of the remaining reinsurance companies, Lloyd's of London
syndicates' participation is 31%.
STOCK-BASED COMPENSATION
The Company grants stock options for a fixed number of shares to employees
and non-employee directors with an exercise price equal to the fair value of the
shares at the date of grant. The Company accounts for stock option grants in
accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25) and related Interpretations because the Company
believes the alternative fair value accounting provided for under FASB Statement
No. 123, Accounting for Stock-Based Compensation, requires the use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, because the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the dates of
grant, no compensation expense is recognized.
EARNING PER SHARE
Basic and diluted earnings per share are calculated in accordance with FASB
Statement No. 128, Earnings Per Share. All earnings per-share amounts for all
periods have been presented and where appropriate restated to conform to the
requirements of FASB Statement No. 128.
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.
56
57
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD
As of January 1, 1998, the Company adopted FASB No. 130, Reporting
Comprehensive Income (FASB 130). FASB 130 establishes new rules for the
reporting and display of comprehensive income and its components; however, the
adoption had 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 prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income.
RECLASSIFICATIONS
The accompanying 1997 and 1996 financial statements have been reclassified to
conform with the 1998 presentation.
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, 1998
Fixed-maturity securities:
Bonds:
U.S. Government and Agencies $ 237,290 $ 15,874 $ 364 $ 252,800
State, municipalities and
political subdivisions 348,161 8,080 839 355,402
Mortgage-backed securities,
U.S. Government 68,542 602 206 68,938
Corporate 44,881 254 176 44,959
Other 97 -- -- 97
------------ ----------- --------- -----------
Total fixed-maturity securities 698,971 24,810 1,585 722,196
Common stocks 31,493 6,930 1,408 37,015
------------ ----------- --------- -----------
Total $ 730,464 $ 31,740 $ 2,993 $ 759,211
============ =========== ========= ===========
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
============ =========== ========= ===========
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, 1998, are summarized by stated
maturities as follows:
AMORTIZED FAIR
(IN THOUSANDS) COST VALUE
- ------------- -------- --------
Years to maturity:
One or less $ 3,205 $ 3,216
After one through five 88,083 90,539
After five through ten 226,817 240,097
After ten 312,324 319,406
Mortgage-backed securities 68,542 68,938
-------- --------
Totals $698,971 $722,196
======== ========
57
58
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.
58
59
Major categories of the Company's investment income are summarized as
follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1998 1997 1996
- -------------------------------------------- ------- ------- ------
Fixed-maturity investments $39,670 $39,926 $40,594
Equity investments 812 840 994
Other 2,396 4,329 1,213
------- ------- -------
Total investment income 42,878 45,095 42,801
Investment expenses 2,511 2,379 2,032
------- ------- -------
Net investment income $40,367 $42,716 $40,769
======= ======= =======
Realized gains and losses from sales of investments are summarized as
follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------ ------- ------- -----
Fixed-maturity investments:
Gross realized gains $ 9,060 $ 4,959 $6,419
Gross realized losses 131 2,022 5,880
------- ------- ------
Net realized gains on fixed-maturity
investments 8,929 2,937 539
Equity investments:
Gross realized gains 2,506 3,854 13,028
Gross realized losses 306 189 1,829
------- ------- ------
Net realized gains on equity investments 2,200 3,665 11,199
------- ------- ------
Total net realized gains $11,129 $ 6,602 $11,738
======= ======= =======
The change in the Company's unrealized appreciation (depreciation) on
fixed-maturity securities was $7.2 million, $8.5 million and ($16.5 million) for
the years ended December 31, 1998, 1997 and 1996, respectively; the
corresponding amounts for equity securities were ($1.0 million), $2.0 million
and ($7.3 million).
At December 31, 1998, the Company's investments in fixed-maturity securities
with a carrying amount of $50.5 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, 1998.
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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 1998, 1997 and 1996.
(IN THOUSANDS) 1998 1997 1996
- -------------- --------- --------- ---------
Reserves for losses and LAE, net of related
reinsurance recoverable, at beginning of year $ 433,440 $ 440,301 $ 446,627
Reserves assumed under the retroactive reinsurance agreement
(Note 4) 36,972 -- --
Provision for losses and LAE for claims occurring
in the current year, net of reinsurance 197,870 176,586 168,545
Decrease in estimated losses and LAE for claims
occurring in prior years, net of reinsurance (65,662) (53,209) (59,748)
--------- --------- ---------
Incurred losses during the year, net of reinsurance 132,208 123,377 108,797
Deduct losses and LAE payments for claims,
net of reinsurance, occurring during:
Current year 14,408 11,814 13,274
Prior years 135,480 118,424 101,849
--------- --------- ---------
149,888 130,238 115,123
Reserves for losses and LAE, net of related
reinsurance recoverable, at end of year 452,732 433,440 440,301
Reinsurance recoverable for losses and LAE,
at end of year 24,899 21,531 19,266
--------- --------- ---------
Reserves for losses and LAE, gross of
reinsurance recoverable, at end of year $ 477,631 $ 454,971 $ 459,567
========= ========= =========
The Company's reserves for unpaid losses and LAE, net of related reinsurance
recoverable, at December 31, 1997, 1996 and 1995, were decreased in the
following year by $93.8 million, $53.2 million, and $59.7 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 redundancies
recognized in 1998 were offset, in part, by a $28.1 million increase in the loss
and LAE reserves for the medical malpractice insurance business assumed from
Fremont in January 1998. The strengthening of the Fremont book of business was
made in order to bring those reserves in line with the Company's more
conservative reserving policy.
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.
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 Company generally does not require collateral
from its reinsurers.
The effect of reinsurance on premiums written and earned are as follows:
60
61
(IN THOUSANDS) 1998 1997 1996
--------------------- ---------------------- --------------------
YEAR ENDED DECEMBER 31, WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
----------------------- ------- ------ ------- ------ ------- ------
Direct $125,213 $124,077 $123,910 $125,289 $125,635 $124,281
Assumed 39,297 42,080 11,673 13,603 8,922 4,497
Ceded 8,187 8,181 4,941 5,026 8,239 8,294
-------- -------- -------- ------- -------- --------
Net premiums $156,323 $157,976 $130,642 $133,866 $126,318 $120,484
======== ======== ======== ======= ======== ========
Reinsurance ceded reduced losses and loss adjustment expenses incurred by
$2.6 million, $5.4 million and $0.9 million in 1998, 1997 and 1996,
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 90% of all losses up to $50.0 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.
The Company acquired the medical malpractice insurance business of Fremont
effective January 1, 1998 for $14.0 million. As part of this transaction, the
Company assumed $42.0 million in loss and LAE reserves outstanding, and other
net liabilities through a 100% quota-share retroactive reinsurance agreement and
received $28.0 million in investments, which has been reflected in short-term
investments and other liabilities, respectively, at December 31, 1997. The
difference between the loss and LAE reserves assumed and their estimated
discounted basis ($10.0 million) was charged to operations in 1998 and the
balance of the purchase price is reflected as goodwill in the accompanying
consolidated balance sheet and is being amortized over a period of 10 years. The
Company concurrently entered into a 100% quota-share prospective fronting
agreement, making SCPIE Indemnity the reinsurer for the Fremont policies until
AHI obtains the necessary licenses to write them directly. The Fremont policies
are written in 10 states, with the vast majority in California and Arizona.
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, 1998, the amounts recorded in the
financial statements related to this agreement are not material.
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, 1998 1997 1996
- ----------------------------------------------- ------- ------- -------
Current $10,751 $ 9,825 $11,585
Deferred 1,815 370 80
------- ------- -------
Total $12,566 $10,195 $11,665
======= ======= =======
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, 1998 1997 1996
- ------------------------------------------------- -------- -------- --------
Federal income tax at 35% $ 17,339 $ 14,830 $ 14,650
Increase (decrease) in taxes resulting from:
Tax-exempt interest (4,964) (4,775) (3,124)
Dividends received deduction (158) (136) (139)
Goodwill 210 220 148
Other 139 56 130
-------- -------- --------
Total federal income tax expense $ 12,566 $ 10,195 $ 11,665
======== ======== ========
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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) DECEMBER 31, 1998 1997
- ----------------------------------- ------- ------
Deferred tax assets:
Discounting of loss reserves $23,107 $22,122
Unearned premium 1,721 1,545
Other 214 557
------- -------
Total deferred tax assets 25,042 24,224
Deferred tax liabilities:
Deferred policy acquisition costs 2,818 182
Unrealized investment gains 10,061 7,882
Other -- 2
------- -------
Total deferred tax liabilities 12,879 8,066
Net deferred tax assets $12,163 $16,158
======= =======
Federal income taxes paid during 1998, 1997 and 1996 were $8.7 million, $11.0
million and $14.8 million, respectively.
The Internal Revenue Service (IRS) has proposed adjustments to increase
the Company's tax liability for 1993 through 1995 as a result of its
examinations. The Company's management disagrees with the adjustments proposed
by the IRS and has decided to contest the deficiencies proposed by the IRS for
these years. The 1993 through 1995 taxable years have been assigned to the IRS
Appeals Office.
The Company's management will take all necessary steps to contest the
IRS' position. The Company's management believes that resolution of this matter
will not have a material adverse effect on the Company's financial position or
results of operations. However, the ultimate outcome cannot be predicted at this
time.
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 are interspersed throughout the state insurance law and regulations,
the National Association of Insurance Commissioner's (NAIC) Accounting Practices
and Procedures Manual and a variety of other NAIC publications. "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.
In 1998, the NAIC adopted codified statutory accounting principles
("Codification"). Codification will likely change, to some extent, prescribed
statutory accounting practices and may result in changes to the accounting
practices that the Company's insurance subsidiaries use to prepare their
statutory-basis financial statements. Codification will require adoption by the
various states before it becomes the prescribed statutory basis of accounting
for insurance companies domesticated within those states. Accordingly, before
Codification becomes effective for each of the Company's insurance subsidiaries,
the respective state of domicile must adopt Codification as the prescribed basis
of accounting on which domestic insurers must report their statutory-basis
results to the Insurance Departments. 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) 1998 1997 1996
- -------------- ---- ---- ----
Statutory net income for the year $ 35,936 $ 32,239 $ 32,703
Statutory capital and surplus at year end $343,330 $321,289 $254,679
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
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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 1998, 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 1999, dividends of $41.1 million may be distributed from SCPIE
Indemnity to SCPIE Holdings without prior approval of the California Insurance
Commissioner.
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 $661,000,
$479,000 and $418,000 for the years ended December 31, 1998, 1997 and 1996,
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 and a non-qualified
supplemental plan of which the net pension expense consists of the following
components:
QUALIFIED PLAN SUPPLEMENTAL PLAN
--------------------------- ----------------------------
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1998 1997 1996 1998 1997 1996
-------------------------------------- -------- -------- -------- -------- -------- ------
Service cost $ 344 $ 323 $ 291 $ 184 $ 139 $ 115
Interest cost 195 161 123 212 164 143
Actual return on plan assets (220) (170) (120) -- -- --
Amortization of:
Transition obligation (asset) (4) (4) (4) 7 7 7
Prior service cost (1) (1) (1) 84 84 84
Actuarial loss -- -- -- 26 -- --
----- ----- ----- ----- ----- -----
Net pension expense $ 314 $ 309 $ 289 $ 513 $ 394 $ 349
===== ===== ===== ===== ===== =====
The following table sets forth the funding status of the plan:
QUALIFIED PLAN SUPPLEMENTAL PLAN
--------------------- --------------------
(IN THOUSANDS) DECEMBER 31, 1998 1997 1998 1997
- ----------------------------------------------- ------- ------- ------- -------
Change in Benefit Obligation
Net benefit obligation at beginning of year 2,501 1,764 2,724 2,079
Service cost 344 323 184 139
Interest cost 195 161 212 164
Actuarial loss 182 275 187 342
Gross benefits paid (8) (22) -- --
------- ------- ------- -------
Net benefit obligation at end of year 3,214 2,501 3,307 2,724
------- ------- ------- -------
Change in Plan Assets
Fair value of plan assets at beginning of year 2,758 1,966 -- --
Actual return on plan assets 452 527 -- --
Employer contributions -- 287 -- --
Gross benefits paid (8) (22) -- --
------- ------- ------- -------
Fair value of plan assets at end of year 3,202 2,758 -- --
------- ------- ------- -------
Funded status (underfunded) (12) 257 (3,307) (2,724)
Unrecognized actuarial (gain) loss (209) (159) 524 364
Unrecognized prior service cost (11) (12) 940 1,024
Unrecognized net transition obligation (asset) (23) (27) -- 7
------- ------- ------- -------
Prepaid (accrued) pension expense $ (255) $ 59 $(1,843) $(1,329)
======= ======= ======= =======
Amounts recognized in the statement of
financial position consists of
Prepaid benefit cost $ -- $ 59 $ -- $ --
Accrued benefit liability (255) -- (2,040) (1,816)
Intangible asset -- -- 197 487
------- ------- ------- -------
Prepaid (accrued) pension expense $ (255) $ 59 $(1,843) $(1,329)
======= ======= ======= =======
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QUALIFIED PLAN SUPPLEMENTAL PLAN
--------------------------- -------------------------
DECEMBER 31, 1998 1997 1996 1998 1997 1996
----------------------- -------- -------- -------- -------- -------- ------
Weighted-average assumptions
Discount rate 6.75% 7.00% 7.25% 6.75% 7.00% 7.25%
Expected return on plan assets 8.00% 8.00% 8.00% -- -- --
Rate of compensation increase 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
NOTE 8. COMMITMENTS AND CONTINGENCIES
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.
The Company is a defendant in a California 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. In 1995, a jury made a damage award against
the Company of $4.2 million in compensatory damages, and punitive damages which
were reduced to $14.0 million by the trial judge. The Company appealed these
awards to the California district court of appeal. On May 8, 1998, the appellate
court reversed the judgment against the Company in its entirety. The bankruptcy
estate may attempt to obtain a new trial in the California Superior Court in
which the judgment was originally entered. The Company believes that the
bankruptcy estate is not entitled to any additional trial under applicable
California appellate court decisions and will aggressively oppose any such
attempt. The Company believes that the action is entirely without merit and
plans to aggressively pursue its rights.
In July 1998, the Company entered a lease covering approximately 95,000
square feet of office space for new Company headquarters. The lease has
escalating payments over a term of 10 years and the Company expects to occupy
this space in early March 1999. The Company estimates that expenditures of
approximately $6.9 million in capital improvements, equipment and relocation
costs will be incurred in connection with this relocation.
Future minimum payments under noncancelable operating leases with initial
terms of one year or more consist of the following at December 31, 1998 (in
thousands).
1999 $ 2,407
2000 2,637
2001 2,732
2002 2,718
2003 2,754
Thereafter 14,833
----------
$28,081
NOTE 9. STOCK BASED COMPENSATION
The Company has a stock compensation plan, the 1997 Equity Participation
Plan of SCPIE Holdings Inc. (the Plan), which provides for grants of stock
options to key employees and non-employee directors of the Company.
The company has elected to follow APB No. 25, "Accounting for Stock
Issued to Employees" (APB 25) and related Interpretations in accounting for its
stock-based compensation. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized. FASB No. 123
requires disclosure of the pro forma net income and earnings per share as if the
Company had accounted for its employee stock compensation under the fair value
method of that Statement.
The aggregate number of options for common shares issued and issuable
under the Plan currently is limited to 1,250,000. All options granted have ten
year terms and vest over various future periods.
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Exercise prices for options outstanding at December 31, 1998 ranged from
$29.19 to $36.50. The weighted average remaining contractual life of those
options is 9 years.
A summary of the Company's stock option activity and related information
follows:
Number of Weighted-Average
Options Exercise Price
--------- ----------------
Options outstanding at December 31, 1997 -- $ --
Granted in 1998 262,590 30.76
Exercised in 1998 -- --
Forfeited in 1998 5,800 30.76
--------
Options outstanding at December 31, 1998 256,790 30.76
========
The Company's pro forma information using the Black-Scholes valuation
model follows:
1998
----
Estimated weighted average of the fair value of options granted $ 10.72
Pro forma net income (in thousands) $ 35,869
Pro forma earnings per share - Basic $ 2.97
- Diluted $ 2.97
For pro forma disclosure purposes, the fair value of stock options was
estimated at each date of grant using a Black-Scholes option pricing model using
the following assumptions: Risk-free interest rates ranging from 5.5% to 5.6%;
dividend yields ranging from 0.66% to 0.75%; volatility factors of the expected
market price of the Company's common stock ranging from .283 to .358; and a
weighted average expected life of the options ranging from 3 to 5 years.
In management's opinion, existing stock option valuation models do not
provide an entirely reliable measure of the fair value of non-transferable
employee stock options with vesting restrictions.
NOTE 10. EARNINGS PER SHARE OF COMMON STOCK
The following table sets forth the computation of basic and diluted earnings
per share as of and for the year ended:
DECEMBER 31,
-----------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1998 1997 1996
------------ ----------- --------
Numerator:
Net income $36,976 $32,176 $30,192
Numerator for:
Basic earnings per share of common stock $36,976 $32,176 $30,192
Diluted earnings per share of common stock $36,976 $32,176 $30,192
Denominator:
Denominator for basic earnings per share of common
stock - weighted-average shares outstanding 12,074 12,108 9,995
Effect of dilutive securities:
Stock options 15 -- --
-------
Denominator for diluted earnings per share of common
stock adjusted - weighted-average shares outstanding 12,089 -- --
=======
Basic earnings per share of common stock $ 3.06 $ 2.66 $ 3.02
======= ======= =======
Diluted earnings per share of common stock $ 3.06 -- --
=======
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Basic earnings per share of common stock for the year ended December 31, 1996
gives effect to the Reorganization and the allocation of 9,994,652 shares of
common stock to eligible members of the Exchange.
NOTE 11. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The unaudited quarterly results of operations for 1998 and 1997 are
summarized as follows:
1998 1997
------------------------------------- ----------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
------- ------- ------- ------- ------- ------- ------- -------
Premiums earned and other revenues $39,724 $40,026 $38,447 $40,268 $36,563 $32,837 $33,126 $31,891
Net investment income 10,503 10,123 9,768 9,973 10,572 10,637 10,798 10,709
Realized investment gains 2,320 1,741 3,269 3,799 1,212 1,975 989 2,426
Net income 9,024 8,393 9,412 10,147 8,121 8,004 7,320 8,731
Basic earnings per share of common stock $ 0.74 $ 0.69 $ 0.79 $ 0.85 $ 0.70 $ 0.65 $0.60 $ 0.71
Diluted earnings per share of common stock $ 0.74 $ 0.69 $ 0.78 $ 0.85 -- -- -- --
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Schedule II - Condensed Financial Information of Registrant
SCPIE Holdings Inc.
Condensed Balance Sheets
(in thousands, except share data)
DECEMBER 31 1998 1997
--------- ---------
ASSETS
Investments
Available for sale fixed maturity investments,
at fair value (amortized cost: 1998 - $43, $ 43 $ 2,994
1997 - 3,004)
Investments - Equity 2,000 --
Short-term investments 1,210 272
Investment in subsidiaries 383,555 356,179
--------- ---------
Total investments 386,808 359,445
Cash 72 227
Due from subsidiaries -- 74
Other 652 1,369
--------- ---------
Total assets $ 387,532 $ 361,115
========= =========
LIABILITIES
Due to affiliates $ 1,014 $ --
Other --
--------- ---------
Total liabilities 1,014
Stockholders' equity:
Preferred stock - $1 par value;
5,000,000 shares authorized;
no shares issued or outstanding -- --
Common stock - $0.0001 par value;
30,000,000 shares authorized; 1 1
1998 - 11,878,791 shares outstanding; 1997 -
12,276,691 shares outstanding
Additional paid-in capital 36,386 36,386
Retained earnings 344,587 310,506
Treasury stock, at cost 1998 - (13,141) (416)
413,300 shares; 1997 - 15,400 shares 18,685 14,638
--------- ---------
Accumulated other comprehensive income
Total stockholders' equity 386,518 361,115
--------- ---------
Total liabilities and stockholders' equity $ 387,532 $ 360,987
========= =========
See accompanying notes.
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Schedule II - Condensed Financial Information of Registrant (continued)
SCPIE Holdings Inc.
Condensed Statements of Operations
(in thousands)
YEAR ENDED
------------------------
DECEMBER 31, DECEMBER 31,
1998 1997
-------- --------
Dividend from subsidiary $ 25,000 $ 20,000
Net investment income 142 804
Realized investment gains (losses) 2 (10)
Other expenses (1,956) (1,287)
-------- --------
Earnings before federal income taxes and
equity in income of subsidiaries 23,188 19,507
Federal income taxes (28) (37)
-------- --------
Earnings before equity in income of
subsidiaries 23,160 19,470
Equity in income of subsidiaries 13,816 12,706
-------- --------
Net income $ 36,976 $ 32,176
======== ========
See accompanying notes.
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Condensed Statements of Cash Flows
(in thousands)
YEAR ENDED
----------------------------
DECEMBER 31, DECEMBER 31,
1998 1997
---------- ----------
OPERATING ACTIVITIES
Net income $ 36,976 $ 32,176
Adjustments to reconcile net loss to net cash
provided by operating activities:
Provision for amortization 601 --
Realized investment gains (losses) (2) 10
Change in due from subsidiaries 1,088 (74)
Changes in other assets and liabilities 591 (1,345)
Equity in undistributed income of subsidiaries (13,816) (12,706)
-------- --------
Net cash provided by operating activities 25,438 18,061
INVESTING ACTIVITIES
Purchases - fixed maturities -- (22,881)
Sales - fixed maturities 2,965 19,389
Purchase-securities (2,000) --
Change in short-term investments (938) (272)
Capital contribution to subsidiaries (10,000) (48,000)
-------- --------
Cash used in investing activities (9,973) (51,764)
FINANCING ACTIVITIES
Issuance of common stock, net of expenses -- 36,387
Purchase of treasury stock (12,725) (416)
Cash dividends (2,895) (2,458)
-------- --------
Cash provided by financing activities (15,620) 33,513
Decrease in cash (155) (190)
Cash at beginning of period 227 417
-------- --------
Cash at end of period $ 72 $ 227
======== ========
See accompanying notes.
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Schedule II - Condensed Financial Information of Registrant (continued)
SCPIE Holdings, Inc.
Notes to Condensed Financial Statements
December 31, 1998
I. REORGANIZATION
On January 29, 1997, the Southern California Physicians Insurance Exchange (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,
Inc. (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 Company, a California stock insurance company and a wholly owned
subsidiary of SCPIE Holdings, the surviving corporation of the Reorganization.
II. 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.
III. RECLASSIFICATIONS
The accompanying 1997 financial statements have been reclassified to conform
with the 1998 presentation.
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