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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 1997 Commission File Number 0-6964
20TH CENTURY INDUSTRIES
- - --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-1935264
- - ------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) number)
Suite 700, 6301 Owensmouth Avenue, Woodland Hills, California 91367
- - -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 704-3700
SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT:
------------------------------------------------------------
COMMON STOCK, WITHOUT PAR VALUE
-------------------------------
(Title of Class)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements,
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
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______
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based on the average high and low prices for shares of the Company's
Common Stock on March 19, 1998 as reported by the New York Stock Exchange, was
approximately $1,167,000,000.
On March 19, 1998, the registrant had outstanding 51,695,379 shares of common
stock, without par value, which is the Company's only class of common stock.
DOCUMENT INCORPORATED BY REFERENCE:
Portions of the definitive proxy statement used in connection with the annual
meeting of shareholders of the registrant, to be held on May 19, 1998, are
incorporated herein by reference into Part III hereof.
1
20TH CENTURY INDUSTRIES
1997 FORM 10-K ANNUAL REPORT
Table of Contents
Part I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . 21
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . 22
Item 4. Submission of Matters to a Vote of
Security Holders. . . . . . . . . . . . . 22
Part II
Item 5. Market for Registrant's Common Stock and
Related Stockholder Matters . . . . . . . 23
Item 6. Selected Financial Data. . . . . . . . . . . . . . 24
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of
Operations. . . . . . . . . . . . . . . . 28
Item 8. Financial Statements and Supplementary
Data. . . . . . . . . . . . . . . . . . . 39
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial
Disclosure. . . . . . . . . . . . . . . . 70
PART III
Item 10. Directors and Executive Officers of the
Registrant . . . . . . . . . . . . . . . 70
Item 11. Executive Compensation . . . . . . . . . . . . . . 70
Item 12. Security Ownership of Certain Beneficial
Owners and Management. . . . . . . . . . 70
Item 13. Certain Relationships and Related
Transactions . . . . . . . . . . . . . . . . . . . 70
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K . . . . . . . . . . 71
Signatures . . . . . . . . . . . . . . . . . . . . 79
2
PART I
ITEM 1. BUSINESS
GENERAL
20th Century Industries is an insurance holding company founded in 1956 and
incorporated in California. The term "Company," unless the context requires
otherwise, refers to 20th Century Industries and its wholly-owned subsidiaries,
20th Century Insurance Company and 21st Century Casualty Company, both of which
are incorporated in California as property and casualty insurance companies and
licensed in California, Nevada, Oregon and Washington. The Common Stock of the
Company is traded on the New York Stock Exchange under the trading symbol "TW."
The Company, through its subsidiaries, directly markets and underwrites
private passenger automobile, homeowners and personal excess liability
insurance. As a direct response writer, the Company has gained a reputation for
excellent customer service and being among the most efficient and low cost
providers of personal insurance in the markets it serves.
Historically, the Company's business has been concentrated in Southern
California, principally the greater Los Angeles and Orange County areas. In the
mid 1980's, however, the Company began expanding into the San Diego area, and in
the early 1990's, the Northern California area. In August 1996, 20th Century
Insurance Company of Arizona ("20th of Arizona") began writing private passenger
automobile insurance in that state. 20th of Arizona is a joint venture between
the Company, which owns a 49% interest, and American International Group, Inc.
("AIG"), which owns a 51% interest. AIG currently owns the largest single
outstanding equity interest in the Company (see Note 17 to the Consolidated
Financial Statements in Item 8 herein). The Company is currently in the process
of completing the regulatory requirements to begin writing private passenger
automobile insurance later in 1998 in Nevada, Oregon and Washington.
The Company began providing homeowners insurance in 1982 and condominium
insurance in 1989. A portion of policies issued or renewed prior to July 23,
1994 included optional earthquake coverage endorsements. In the wake of the
Northridge Earthquake which occurred in the San Fernando Valley area of Southern
California on January 17, 1994, the Company's writings in these lines were
significantly reduced in the period 1994 to 1997. In compliance with an order
3
by the California Department of Insurance in June 1994, the Company immediately
began to non-renew earthquake coverage endorsements and to cease writing new
homeowner and condominium policies. The order also required the Company to begin
non-renewing all homeowner and condominium policies effective July 23, 1996.
In late 1996, the Company obtained permission to renew its remaining
homeowner policies effective February 15, 1997. As of that date, approximately
68,000 homeowner insurance policies remained in force. The condominium program
was fully discontinued as of July 23, 1997. The Company is complying with
California's requirement to offer earthquake coverage to its remaining homeowner
customers through a separate residential earthquake insurance policy
underwritten and issued by American Home Assurance Company, a subsidiary of AIG.
The Company is not currently authorized by the California Insurance Commissioner
to offer homeowner insurance to new or former customers. Although the Company
has initiated discussions to obtain that authorization, it is unable to predict
if or when the California Insurance Commissioner will grant the Company's
request. The Company's reentry into the homeowners market is a strategy
intended to complement its auto business and facilitate growth in that line.
LIMITS OF INSURANCE COVERAGE
The Company offers the following insurance coverages for private passenger
automobiles: bodily injury liability, property damage, medical payments,
uninsured motorist, rental reimbursement, comprehensive and collision.
Policies are written for a six-month term. Various limits of liability are
underwritten with maximum limits of $500,000 per person and $500,000 per
accident. The most frequent bodily injury liability limits purchased are
$100,000 per person and $300,000 per accident.
The homeowners program utilizes an extended replacement cost policy, thereby
limiting loss to 150% of the amount specified in the contract for Coverage A -
Dwelling and Other Building Structures. Underwriting guidelines provide for a
minimum dwelling amount of $50,000 and a maximum dwelling amount of $500,000.
Personal liability coverage limits of $100,000, $200,000 and $300,000 are
available.
4
The personal excess liability policy ("PELP") is written by 20th Century
Insurance Company and provides liability coverage with a limit of $1,000,000 in
excess of the underlying automobile and homeowners liability coverage. Minimum
underlying automobile limits of $100,000 per person and $300,000 per accident
are required while homeowners must have a minimum of $100,000 personal liability
coverage. The underlying automobile coverage must be written by the Company.
MARKETING
The Company markets and writes its policies directly to customers without
utilizing or engaging outside agents or brokers. The Company uses direct mail,
print, radio, television and internet advertising to market its policies.
Quotes may be requested 24 hours a day, 7 days a week through a convenient
toll-free 800 number. Traffic to the Company's internet site
(http://www.20thCenturyInsurance.com) continues to escalate, offering visitors
an additional way to request a rate quotation, amend their policy or obtain
other information about the Company.
Throughout 1997, the Company actively advertised in California's major
metropolitan markets (Los Angeles and Orange Counties, the Inland Empire, the
Bay Area, San Diego and Sacramento) and also expanded its marketing efforts into
the Central Valley areas of Fresno and Bakersfield. Requests for automobile
quotations increased 24% over the prior year while the number of vehicles for
which applications were received increased 45%.
The Company continues to increase penetration in the Sacramento and Bay Area
markets, generating approximately 93% more new business from these two markets
in 1997 than in 1996. Approximately 47% of all new business written in 1997 came
from outside the Los Angeles/Orange County areas.
5
UNDERWRITING AND PRICING
The regulatory system in California requires the prior approval of insurance
rates. Within this regulatory framework, the Company establishes its automobile
and homeowners premium rates based on actuarial analysis of its own historical
premium, loss and expense data. These data are compiled and analyzed to
establish overall rate levels as well as classification differentials. The
Company's rates are established at levels intended to generate underwriting
profits and vary for individual policies based on a number of rating
characteristics. The primary characteristics include driving record, annual
mileage, number of years a driver has been licensed, where the vehicle is
garaged, vehicle usage, value of the automobile and limits and deductibles
selected.
The Company is required to offer insurance to any California prospect who
meets the statutory definition of a "Good Driver." This definition includes all
drivers who have been licensed more than three years and have had no more than
one violation point count under criteria contained in the California Vehicle
Code. These criteria include a variety of moving violations and certain at-
fault accidents.
The Company reviews many of its automobile policies prior to the time of
renewal and as changes occur during the policy period. The customer may contact
the Company to make changes, such as the addition or deletion of drivers or
vehicles, changes in the classification of drivers or usage of vehicles, changes
in garaging location and changes in coverages or limits. Some mid-term changes
may result in premium adjustments and some may result in the policy being
re-underwritten and eventually not renewed because of a substantial increase in
hazard.
With respect to the homeowners renewal program which started on February 15,
1997, underwriting procedures include a review of claims and identification of
changes in circumstances that may warrant premium adjustments or cancellation of
coverage in case of a substantial increase in risk.
6
SERVICING OF BUSINESS
The Company continues to adapt its technological capabilities in keeping
with its business strategies. Computerized systems provide the information
resources, telecommunications and data processing capabilities which support the
business and technical needs of the Company. In addition to providing ongoing
support, the systems provide the strategic capabilities necessary to manage the
Company's business. During 1997, the Company began the process of significantly
upgrading its technology infrastructure and replacing aging information systems
with newer, more flexible capabilities. This transition will take several years
to complete. Upon completion of that transition in early 1999, the Company
believes that all systems requiring modifications will be "Year 2000" compliant,
before any material errors could occur.
CLAIMS
Claims operations include the receipt and analysis of initial loss reports,
assignment of legal counsel and management of the settlement process. Whenever
possible, physical damage claims are handled through the use of Company drive-in
claims facilities, vehicle inspection centers and Direct Repair Program
providers. The claims management staff administers the claims settlement
process and directs the work of the legal and adjuster personnel involved in
that process. Each claim is carefully analyzed to provide for fair loss
payments, to comply with the Company's contractual obligations and to manage
loss adjustment expenses. Liability and property damage claims are handled by
specialists in each area.
The Company utilizes its legal staff to handle most aspects of claims
litigation, including trial, from offices in Brea, Ontario, Long Beach, San
Diego and Woodland Hills. Staff attorneys handle approximately 74% of all
lawsuits. Suits which may involve a conflict of interest are assigned to
outside counsel.
Recognizing the need to provide its customers with convenient, local
service, the Company has established eleven Division Service Offices in Los
Angeles, Orange, San Diego and Ventura Counties and the San Francisco Bay Area.
Each Division Service Office is a full service center,
7
normally staffed with between seventy-five and one hundred employees who
provide complete claims services from initial investigation to final
conclusion.
The Company makes extensive use of its Direct Repair Program ("DRP") to
expedite the repair process. The program involves agreements between the
Company and over 110 independent repair facilities throughout California. The
Company agrees to accept the estimate for damages prepared by the repair
facility without requiring each vehicle to be inspected by staff adjusters. The
facilities selected undergo a screening process before being accepted, and the
Company maintains an aggressive reinspection program to assure quality results;
the Company's reinspection team visits a minimum of 30% of all repair facilities
each month. The customer benefits by getting the repair process started faster,
and the repairs are guaranteed for as long as the customer owns the vehicle.
The Company benefits by not incurring the overhead expense of a larger staff of
appraisers and by negotiating repair rates it believes are beneficial.
Currently, over 30% of all damage repairs are handled using the DRP method.
The Specialty Division is comprised of three vehicle inspection centers
located in Los Angeles and Orange Counties. Each vehicle inspection center is
staffed with between fifteen and twenty employees who handle total losses, total
thefts and vehicles which are not driveable.
The Claims Services Division employs approximately 100 people who are
responsible for subrogation, medical payment claims and workers' compensation
claims arising under the homeowner policy.
The Company also maintains a Special Investigations Unit with approximately
40 personnel who investigate suspected fraudulent claims. The Company believes
its efforts in this area have been responsible for saving several million
dollars annually.
The Homeowners Division processes all homeowner property claims on a
regional basis and is made up of two units of approximately fifteen employees
each. The units are located in Brea and Woodland Hills.
8
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The Company establishes reserves, or liabilities, at each accounting date
for losses and loss adjustment expenses arising from claims, both reported and
unreported, which have been incurred but which remain to be paid. Such reserves
are estimates, as of a particular date, of the amount the Company will
ultimately pay, net of any recoverable salvage and subrogation, for claims
incurred as of the accounting date.
"Case basis" reserves are established for bodily injury liability and
uninsured motorist claims which are either expected to exceed $15,000 or are
older than two years. Such case reserves are based on the specific
circumstances, merits and relevant contractual policy provisions of the claim.
Case reserves for other bodily injury and uninsured motorists claims and for
all other coverages are established at an average case reserve value. These
average values are based on a periodic review of recent claims payments for each
coverage.
The Company supplements the case basis reserve estimates with bulk loss
reserves estimated using actuarial methodologies. These reserves are designed
to provide for claims incurred but not reported to or recorded by the Company as
of the accounting date ("IBNR"), changes over time in case reserve estimates,
and loss adjustment expenses which include estimates of the legal and other
costs of settling claims. The actuarial estimates utilize the Company's own
historical loss experience and are reviewed each quarter. The effects of
inflation are implicitly considered in the actuarial estimates, and the Company
does not discount its reserves to present value for financial reporting
purposes.
Reserve estimates are necessarily subject to the impact of future changes in
economic and social conditions. Management believes that, given the inherent
variability in any such estimates, the aggregate reserves are within a
reasonable and acceptable range of adequacy. The methods of making such
estimates and for establishing the resulting reserves are reviewed and updated
quarterly and any adjustments resulting therefrom are reflected in earnings
currently.
9
A rollforward of loss and loss adjustment expense reserves, including the
effects of reserve changes, loss payments, and reinsurance for each of the three
years in the period ended December 31, 1997, is presented in Note 8 to the
Consolidated Financial Statements.
The following table presents the development of loss and loss adjustment
expense reserves, net of reinsurance, for the years 1987 through 1997. The top
line of the table shows the reserves at the balance sheet date, net of
reinsurance recoverables, for each of the years indicated. The upper portion of
the table indicates the cumulative amounts paid as of subsequent year-ends with
respect to that reserve liability. The lower portion of the table indicates the
re-estimated amount of the previously recorded reserves based on experience as
of the end of each succeeding year, including cumulative payments made since the
end of the respective year. The estimate changes as more information becomes
known about the frequency and severity of claims for individual years. A
redundancy (deficiency) exists when the original reserve estimate is greater
(less) than the re-estimated reserves. The decrease in the redundancy shown in
the 1994 and 1995 columns compared to prior years includes the additional
earthquake losses and loss adjustment expenses recorded subsequent to 1994. The
subsequent increase in the reserve redundancy is due to the lesser impact that
the additional earthquake losses have had on the overall reserves.
Each amount in the following table includes the effects of all changes in
amounts for prior periods. The table does not present accident year or policy
year development data. Conditions and trends that have affected the development
of liabilities in the past may not necessarily occur in the future. Therefore,
it would not be appropriate to extrapolate future deficiencies or redundancies
based on the table.
10
AS OF DECEMBER 31,
(AMOUNTS IN THOUSANDS)
- - ---------------------------------------------------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Reserves for
loss and loss
adjustment expenses,
net of reinsurance $297,853 $391,748 $472,010 $525,220 $547,098 $554,034 $574,619 $755,101 $552,320 $489,033 $388,418
Paid (cumulative)
as of:
One year later 180,516 197,555 242,757 300,707 320,264 327,634 344,876 519,969 351,985 304,714
Two years later 238,947 271,163 328,606 391,970 401,019 403,434 423,713 635,861 485,462
Three years later 272,955 310,757 366,369 420,853 426,412 425,671 443,055 721,445
Four years later 289,901 326,495 377,980 429,791 433,642 432,086 457,430
Five years later 296,310 330,014 381,507 431,791 436,522 434,949
Six years later 297,764 330,879 382,230 432,975 437,365
Seven years later 298,098 331,433 382,108 433,096
Eight years later 298,649 331,344 382,129
Nine years later 298,583 331,421
Ten years later 298,541
Reserves re-
estimated as of:
One year later 294,504 357,220 402,706 473,974 473,209 491,048 490,166 715,637 526,730 424,406
Two years later 302,991 342,365 397,847 449,348 461,343 447,880 465,036 725,098 537,635
Three years later 304,925 340,760 389,559 442,508 440,198 438,726 453,431 751,302
Four years later 302,661 333,432 384,948 433,408 437,350 435,128 460,947
Five years later 298,764 332,100 382,331 432,370 436,929 435,942
Six years later 298,603 331,191 381,996 432,661 437,600
Seven years later 298,319 331,274 381,914 433,050
Eight years later 298,661 331,184 382,126
Nine years later 298,531 331,473
Ten years later 298,640
Redundancy
(Deficiency) $(787) $60,275 $89,884 $92,170 $109,498 $118,092 $113,672 $3,799 $14,685 $64,627
11
In the consolidated balance sheet, the reserves for losses and loss
adjustment expenses are shown "gross," that is, before reduction for
reinsurance. The table which follows presents the development of gross losses
and loss adjustment expense reserves for calendar years 1995 through 1997. As
in the ten-year table presented net of reinsurance, each amount in the following
table includes the effects of all changes in amounts for prior periods. The
table does not present accident year or policy year development data and it
would not be appropriate to extrapolate future development based on this table.
1995 1996 1997
---- ---- ----
(Amounts in thousands)
Gross loss and loss adjustment
expense reserves, December 31 $584,834 $543,529 $437,887
Paid (cumulative) as of:
One year later 375,895 335,386
Two years later 513,514
Gross liability re-estimated as of:
End of year 584,834 543,529 437,887
One year later 559,259 467,473
Two years later 568,048
Gross Cumulative Redundancy 16,786 76,056
OPERATING RATIOS
Combined Ratios
Underwriting profit margins are measured by the extent to which the combined
ratios (loss and loss adjustment expense ("LAE") ratio and underwriting expense
ratio) are less than 100% of premium revenues. Combined ratios are used to
measure the underwriting success of property and casualty insurance companies.
Losses and loss adjustment expenses are stated as a percentage of premiums
earned because losses may occur over the life of a particular insurance policy.
An important indicator of operating efficiency, the underwriting expense ratio
is based on premiums written for statutory accounting purposes ("SAP") and
earned premiums for reporting under generally accepted accounting principles
("GAAP").
12
The loss and LAE ratios, underwriting expense ratios (excluding interest and
fees), and combined ratios for the Company's subsidiaries, on a SAP and GAAP
basis, are shown in the following tables.
YEARS ENDED DECEMBER 31,
--------------------------------------
SAP 1997 1996 1995 1994 1993
- - --- ---- ---- ---- ----- ----
Loss and LAE ratio 77.3% 85.8% 88.7% 173.0% 88.0%
Underwriting Expense ratio 9.4 9.4 8.7 9.9 10.5
---- ---- ---- ----- ----
Combined ratio 86.7% 95.2% 97.4% 182.9% 98.5%
---- ---- ---- ----- ----
---- ---- ---- ----- ----
YEARS ENDED DECEMBER 31,
------------------------------------
GAAP 1997 1996 1995 1994 1993
- - ---- ---- ---- ---- ----- ----
Loss and LAE ratio 77.3% 85.8% 88.4% 176.8% 87.6%
Underwriting Expense ratio 9.4 9.3 9.0 9.7 10.7
---- ---- ---- ----- ----
Combined ratio 86.7% 95.1% 97.4% 186.5% 98.3%
---- ---- ---- ----- ----
---- ---- ---- ----- ----
The Northridge Earthquake contributed 85.1, 2.9, 4.7 and 3.1 percentage
points on both a GAAP and SAP basis to the 1994, 1995, 1996 and 1997 combined
ratios, respectively. In 1997, most of the improvement in the combined ratio is
due to favorable loss trends in the automobile line (discussed in more detail in
Management's Discussion and Analysis, Automobile Underwriting Results).
Premiums to Surplus Ratio
The following table shows, for the periods indicated, the Company's
statutory ratios of net premiums written to policyholders' surplus. Because
each property and casualty insurance company has different capital needs, an
"appropriate" ratio of net premiums written to policyholders' surplus for one
company may not be the same as for another company. While there is no statutory
requirement applicable to the
13
Company, guidelines established by the National Association of Insurance
Commissioners provide that such ratio generally should be no greater than 3
to 1 on a statutory basis.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
SAP 1997 1996 1995 1994 1993
- - --- -------- -------- -------- ---------- ----------
(Amounts in thousands, except ratio)
Net premiums written $788,600 $827,993 $958,614 $1,032,737 $1,021,902
Policyholders' surplus $548,043 $436,367 $358,474 $207,018 $582,176
Ratio 1.4:1 1.9:1 2.7:1 4.9:1 1.8:1
The 1994 and 1995 ratios were high because of the surplus strain caused
by the Northridge Earthquake. Capital infusions in 1994 and a return to
profitable operations in 1995 resulted in improved surplus levels that
reduced the ratio below 3 to 1 in 1995 and below 2 to 1 in 1996 and 1997.
INVESTMENTS AND INVESTMENT RESULTS
The Company's investment guidelines emphasize buying high-quality fixed
income investments. The Investment Committee of the Company's Board of
Directors regularly reviews these guidelines and the performance of the
portfolio. Because of the net operating loss ("NOL") carryforwards available
for tax purposes, the Company's investment strategy has emphasized taxable
securities since 1994 in order to maximize overall cash flow. While the Company
does not invest with a view to achieving realized gains, securities are bought
and sold in order to meet the main objectives of the investment portfolio.
These objectives are to maximize after-tax investment income and total
investment returns while minimizing credit and liquidity risk. The Company
currently has designated all of its portfolio as "available-for-sale."
14
The following table summarizes investment results for the most recent five
years:
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ------------ ---------- -----------
(Amounts in thousands)
Average invested assets (at
cost or amortized cost;
includes cash and cash
equivalents) $1,088,864 $1,111,396 $1,193,202 $1,259,871 $1,384,926
Net investment income:
Before income taxes $ 73,463 $ 73,178 $ 81,658 $ 84,761 $ 97,574
After income taxes $ 49,105 $ 52,038 $ 56,597 $ 68,629 $ 87,915
Average annual return
on investments:
Before income taxes 6.7% 6.6% 6.8% 6.7% 7.0%
After income taxes 4.5% 4.7% 4.7% 5.4% 6.3%
Net realized investment
gains after income taxes $ 2,646 $ 4,736 $ 6,634 $ 40,010 $10,874
Net increase (decrease) in
unrealized gains on
investments after
income taxes $17,478 $(30,688) $73,285 $(134,660) $39,863
The decline in the investment portfolio since 1993 resulted largely from the
need to sell investments to generate cash to cover the severe losses and other
ongoing expenses resulting from the Northridge Earthquake. The declining
after-tax return on investments is a result of the shift to taxable securities
since 1994, the sale, maturity or early redemption of older securities with high
yields and re-investment in securities with significantly lower yields due to
general market conditions. In addition, in 1994 and 1995, a greater portion of
the portfolio was invested in commercial paper for liquidity purposes which
yielded a lower return than the portion invested in bonds.
15
The following table sets forth the composition of the Company's
investments and cash and cash equivalents at the dates indicated.
DECEMBER 31,
---------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Amortized Fair Amortized Fair Amortized Fair
Type of Security Cost Value Cost Value Cost Value
- - ---------------- ---------- ---------- ---------- ---------- ---------- ----------
(Amounts in thousands)
Fixed maturities:
U.S. Treasury secur-
itites and obliga-
tions of U.S. Govern-
ment corporations
and agencies $ 6,735 $ 6,758 $ 11,906 $ 11,885 $ 68,283 $ 69,711
Obligations of
states and politi-
cal subdivisions 36,680 39,523 287,277 292,127 219,026 222,844
Public utilities 171,060 175,174 164,509 163,674 182,828 191,224
Corporate securities 838,500 861,253 596,346 596,017 604,884 641,769
---------- ---------- ---------- ---------- ---------- ----------
Total fixed maturities 1,052,975 1,082,708 1,060,038 1,063,703 1,075,021 1,125,548
Equity securities 250 1,745 250 925 539 1,564
---------- ---------- ---------- ---------- ---------- ----------
Total investments 1,053,225 1,084,453 1,060,288 1,064,628 1,075,560 1,127,112
---------- ---------- ---------- ---------- ---------- ----------
Cash and cash
equivalents 31,268 31,268 18,078 18,078 50,609 50,609
---------- ---------- ---------- ---------- ---------- ----------
Total investments
and cash and cash
equivalents $1,084,493 $1,115,721 $1,078,366 $1,082,706 $1,126,169 $1,177,721
---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ----------
16
COMPETITION
The property and casualty insurance market is highly competitive and is
comprised of a large number of well capitalized companies, many of which
operate in a number of states and offer a wide variety of products. Several
of these competitors are larger and have greater financial resources than the
Company. Based on earned premium, the Company is the fifth largest writer of
private passenger automobile insurance in California.
The Company's main competition comes from other major writers which
concentrate on the good driver market. The Company generally has sought to
avoid, to the extent regulations permit, the "non-standard," "high-risk" and
similar niche market segments.
The Company's marketing and underwriting strategy is to appeal to careful
and responsible drivers who deal directly with the Company in order to save
significant amounts of money on their insurance premiums. By selling its
products directly to the insured, the Company has eliminated agent and broker
commissions. The Company relies heavily on its centralized operations and
its efficient computerized systems to service its policyholders and claimants.
Consequently, the Company consistently operates with one of the lowest
underwriting expense ratios in the industry and is able to maintain its rates
among the lowest in the markets it serves while still providing quality
service to its customers. As a result, the Company has been able to achieve
profitable growth and to maintain policy renewal rates which it believes are
significantly above industry averages.
REINSURANCE
A reinsurance transaction occurs when the Company transfers or cedes a
portion of its exposure from direct business written to a reinsurer which
assumes that exposure for a premium. The reinsurance cession does not
legally discharge the Company from its liability for a covered loss, but
provides for reimbursement from the reinsurer to the Company for the ceded
portion. The Company periodically monitors the continuing appropriateness of
all its reinsurance arrangements to determine that its reinsurers maintain
high A. M. Best ratings and other indicators of ability to meet their
obligations as well as competitive pricing for the risk involved.
17
Each of the Company's insurance subsidiaries have entered into a
five-year quota share reinsurance agreement with an AIG affiliate covering
all ongoing lines of business. Under this contract, which attaches to the
Company's retained risks net of all other reinsurance, 10% of each
subsidiary's premiums earned and losses and loss adjustment expenses incurred
in connection with policies incepted during the period January 1, 1995
through December 31, 1999 are ceded. At the end of the five-year period, the
AIG affiliate may elect to renew the agreement annually for four years at
declining coverage percentages. A ceding commission of 10.8% was earned by
the insurance subsidiaries for 1995 and, thereafter, a commission is paid at
a rate equal to the prior year's gross SAP underwriting expense ratio. The
ceding commission rate was 9.13% and 9.36% for 1996 and 1997, respectively.
Since mid-1996 when the homeowners line began to shrink considerably for
reasons discussed earlier, the Company has found it more economical to
maintain 100% quota share reinsurance arrangements for its homeowners line
rather than purchasing alternative reinsurance coverage for its remaining
exposure to catastrophes such as fire following earthquake. These
reinsurance arrangements are discussed in more detail in Note 10 to the
Consolidated Financial Statements elsewhere herein.
The Company has a quota share reinsurance treaty for the PELP whereby 60%
of premiums and losses are ceded to the reinsurer. After the effect of the
10% quota share treaty with AIG, the Company effectively retains 36% of the
risk for this line.
REGULATION
An insurance company is subject to regulation and supervision by the
insurance departments of the states in which it does business. These
insurance departments have broad regulatory, supervisory and administative
powers, such as:
- Licensing of insurance companies and agents
- Prior approval of rates, rules and forms
- Standards of solvency
- Nature of, and limitations on, insurance company investments
- Periodic examinations of the affairs of insurers
18
- Annual and other periodic reports of the financial condition and
results of operations of insurers
- Establishment of accounting rules
- Issuance of securities by insurers
- Payment of dividends
State regulations are designed principally for the benefit of
policyholders. Currently, the California Department of Insurance ("CDOI") has
primary regulatory jurisdiction over the Company. In general, the current
regulatory requirements in the other states in which the Company is a
licensed insurer are no more stringent than in California, and in some
respects are significantly less so.
In June 1994, the CDOI ordered the Company to immediately begin
non-renewing earthquake coverage endorsements and to cease writing new
homeowner and condominium policies and, effective July 23, 1996, to begin
non-renewing all its remaining homeowner and condominium policies. On
December 23, 1996, the order was amended, permitting the Company to resume
renewing its remaining homeowner policies effective February 15, 1997, with
the statutorily required offer of earthquake coverage to be made by an
affiliate of AIG. The Company continues to seek approval to resume writing
new homeowner policies, but there is no assurance the CDOI will do so.
Inability to write new homeowner policies hinders the Company's efforts to
sell automobile insurance to certain consumers who prefer the convenience of
having both coverages provided by the same insurer.
The operations of the Company are governed by the laws of the State of
California and by the laws of the other states in which it is a licensed
insurer. Changes in those laws can affect the revenues and expenses of the
Company. In 1997, no new laws were enacted by any such state that are
expected to have a material impact on the auto insurance industry.
Ballot Proposition 213 was approved by an overwhelming majority of
California voters on November 5, 1996. This proposition bars certain drivers
and most uninsured drivers from recovering non-economic damages for injuries
they suffer in vehicle accidents. Two lawsuits challenged the
constitutionality of the proposition, but the appellate courts in 1997 upheld
the proposition's constitutionality. Subsequently, a petition for review was
filed for one of the lawsuits with the California Supreme Court in February
1998,
19
and remains pending at this time. This proposition has had a beneficial
effect on underwriting profit in 1997.
As of this date, there is no legislation or regulatory hearing pending
for 1998 that the Company believes is likely to materially impact its
operations.
The Company is a member of industry organizations which may advocate
legislative and initiative proposals and which provide financial support to
officeholders and candidates for California statewide public offices. The
Company also makes financial contributions to those officeholders and
candidates who, in the opinion of management, have a favorable understanding
of the needs of the property and casualty insurance industry. In 1997, these
contributions were nominal. The Company believes that such contributions are
important to the future of the property and casualty insurance industry in
California and intends to continue to make such contributions as it
determines to be appropriate and comply with applicable law.
HOLDING COMPANY ACT
The Company's subsidiaries are also subject to regulation by the
California Department of Insurance pursuant to the provisions of the
California Insurance Holding Company System Regulatory Act (the "Holding
Company Act"). Certain transactions defined to be of an "extraordinary"
nature may not be effected without the prior approval of the California
Department of Insurance. Such transactions include, but are not limited to,
sales, purchases, exchanges, loans and extensions of credit, and investments
made within the immediately preceding 12 months involving in the net
aggregate, more than the lesser of (i) 3% of the Company's admitted assets or
(ii) 25% of the policyholder's surplus as of the preceding December 31. An
extraordinary transaction also includes a dividend which, together with other
dividends or distributions made within the preceding twelve months, exceeds
the greater of (i) 10% of the insurance company's policyholders' surplus as
of the preceding December 31 or (ii) the insurance company's net income for
the preceding calendar year. The California code further provides that
property and casualty insurers may pay dividends only from earned surplus.
The Holding Company Act generally restricts the ability of any one person to
acquire more than 10% of the Company's voting securities without prior
regulatory approval.
20
NON-VOLUNTARY BUSINESS
Automobile liability insurers in California are required to participate
in the California Automobile Assigned Risk Plan ("CAARP"). Drivers whose
driving records or other relevant characteristics make them difficult to
insure in the voluntary market may be eligible to apply to CAARP for
placement as "assigned risks." The number of assignments for each insurer is
based on the total applications received by the plan and the insurer's market
share. With the passage of AB 650 on January 1, 1997, which requires proof
of financial responsibility for vehicle registration renewals, the number of
drivers applying to CAARP increased, and the Company's share of CAARP
assignments grew commensurately from 6,847 vehicles insured at the end of
1996 to 12,133 vehicles at the end of 1997. The CAARP assignments have
historically produced underwriting losses, although for 1997 this business
registered a statutory combined ratio of less than 100% for the first time.
As of December 31, 1997, this business represented less than 2% of the
Company's total gross premiums written.
Insurers offering homeowners insurance in California are required to
participate in the California Fair Plan ("Fair Plan"). Fair Plan is a state
administered pool of difficult to insure homeowners. Each participating
insurer is allocated a percentage of the total premiums written and losses
incurred by the pool according to its share of total homeowners direct
premiums written in the state. The Company's Fair Plan premiums for 1997
were less than $1 million.
EMPLOYEES
The Company had 2,228 full and part-time employees at December 31, 1997.
The Company provides medical, pension and 401(k) savings plan benefits to
eligible employees according to the provisions of each plan. The Company
believes that its relationship with its employees is excellent, and employee
turnover is generally very low.
ITEM 2. PROPERTIES
The Company leases its Home Office building in Woodland Hills,
California, which contains approximately 234,000 square feet of leasable
office space. The lease was amended in October 1994 to extend its term until
November 1999. The lease may be renewed for two consecutive five-year
periods.
21
The Company also leases office space in 24 other locations
throughout California. The Company anticipates no difficulty in extending
these leases or obtaining comparable office facilities in suitable locations.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is named as a defendant in
lawsuits related to claim issues. Some of the actions request exemplary or
punitive damages. These actions are vigorously defended unless a reasonable
settlement appears appropriate.
Currently included in this class of litigation are certain actions that
arose out of the Northridge Earthquake. It is believed that a majority of
these actions were filed to resolve claims involving disputed damages or to
contest the applicability of the statute of limitations. One lawsuit,
entitled ESTRADA V. 20TH CENTURY INSURANCE COMPANY, was filed in Los Angeles
Superior Court and, as amended in January 1997, seeks to convert an
individual action to a class action. According to the current Amended
Complaint, the potential class involves those insureds whose claims for
damages from the Northridge Earthquake were first reported to the Company on
or after January 18, 1995 and then denied as untimely. The Superior Court
dismissed the request to convert this lawsuit into a class action, but the
plaintiff's attorney has filed Notice of Appeal.
While any litigation has an element of uncertainty, the Company does not
believe that the ultimate outcome of any pending actions will have a material
effect on its consolidated financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
22
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
(a) PRICE RANGE OF COMMON STOCK
The stock is currently traded on the New York Stock Exchange under the
trading symbol "TW." The following table sets forth the high and low bid
prices for the common stock for the indicated periods.
High Low
---- ---
1997
Fourth Quarter 27-3/4 23
Third Quarter 25-15/16 21-1/4
Second Quarter 24 16-1/2
First Quarter 18-1/8 16-3/8
1996
Fourth Quarter 18-5/8 14-5/8
Third Quarter 17-7/8 14-1/2
Second Quarter 17-3/8 15-3/8
First Quarter 20-5/8 15-3/4
(b) HOLDERS OF COMMON STOCK
The approximate number of record holders of common stock on December 31,
1997 was 1,026.
(c) DIVIDENDS
The Company paid cash dividends on its common stock each year since 1973
through the second quarter of 1994. Dividends were resumed in the fourth
quarter of 1996.
The parent company is dependent upon dividends from its subsidiaries to
service debt and pay dividends to its stockholders. Based on 1997 operating
results and earned surplus as of December 31, 1997, the Company believes it
will not require regulatory approval in 1998 for any extraordinary dividends.
23
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented below as of the end
of and for each of the years in the five-year period ended December 31, 1997
are derived from the consolidated financial statements of 20th Century
Industries and its subsidiaries. The consolidated financial statements as of
December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997 are included elsewhere in this Form 10-K. The
earnings per share amounts prior to 1997 have been restated as required to
comply with Statement of Financial Accounting Standards No. 128, EARNINGS PER
SHARE. For further discussion of earnings per share and the impact of
Statement No. 128, see Note 3 to the Consolidated Financial Statements.
24
All dollar amounts set forth in the following tables are in thousands,
except per share data.
YEARS ENDED DECEMBER 31,
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Operations Data:
Net premiums earned $785,989 $856,628 $ 963,797 $1,034,003 $ 989,712
Net investment income 73,463 73,178 81,658 84,761 97,574
Realized investment gains 4,071 7,287 10,207 61,554 16,729
-------- -------- ---------- ---------- ----------
Total Revenues 863,523 937,093 1,055,662 1,180,318 1,104,015
Net losses and loss
adjustment expenses 607,775 734,735 851,602 1,828,346 867,451
Policy acquisition costs 44,851 38,175 38,647 43,409 48,375
Other operating expenses 29,047 41,496 48,311 57,198 57,769
Proposition 103 expense -- -- -- 29,124 3,474
Interest and fees expense 13,722 14,260 15,897 8,348 --
-------- -------- ---------- ---------- ----------
Total Expenses 695,395 828,666 954,457 1,966,425 977,069
-------- -------- ---------- ---------- ----------
Income (loss) before
federal income taxes
and cumulative effect
of change in accounting
for income taxes 168,128 108,427 101,205 (786,107) 126,946
Federal income taxes (benefits) 57,199 34,370 31,575 (288,087) 18,350
Income (loss) before cumulative
effect of change in accounting
for income taxes 110,929 74,057 69,630 (498,020) 108,596
Cumulative effect of change
in accounting for income taxes -- -- -- -- 3,959
-------- -------- ---------- ---------- ----------
Net Income (Loss) $110,929 $74,057 $69,630 $(498,020) $ 112,555
-------- -------- ---------- ---------- ----------
-------- -------- ---------- ---------- ----------
25
YEARS ENDED DECEMBER 31,
--------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Per Share Data:
Basic --
Before cumulative effect
of change in accounting
for income taxes $ 1.76 $ 1.05 $ 0.97 $ (9.69) $ 2.11
Cumulative effect of
change in accounting
for income taxes -- -- -- -- 0.08
------ ------ ------ -------- ------
Net income (loss) $ 1.76 $ 1.05 $ 0.97 $ (9.69) $ 2.19
------ ------ ------ -------- ------
------ ------ ------ -------- ------
Diluted --
Net income (loss) $ 1.37 $ 0.92 $ 0.90 $ (9.69) $ 2.19
------ ------ ------ -------- ------
------ ------ ------ -------- ------
Dividends paid per
common share $ 0.25 $ 0.05 $ -- $ 0.32 $ 0.64
------ ------ ------ -------- ------
------ ------ ------ -------- ------
The Company's financial statements include increases in earthquake
reserves in 1997 of $24.75 million, in 1996 of $40 million and in 1995 of $60
million offset partially by a $32 million reduction in the Proposition 103
liability per an order from the CDOI. In 1994, earthquake-related losses and
expenses were $844.1 million. On an after-tax basis, these additional charges
reduced (increased) basic earnings (loss) per share by $0.31, $0.51, $0.35
and ($10.67) for 1997, 1996, 1995 and 1994, respectively.
26
DECEMBER 31,
----------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Balance Sheet Data:
Total investments $1,084,453 $1,064,628 $1,127,112 $ 942,174 $1,422,555
Total assets 1,482,454 1,513,755 1,608,886 1,702,810 1,644,670
Unpaid losses and loss
adjustment expenses 437,887 543,529 584,834 756,243 577,490
Unearned premiums 33,402 231,141 288,927 298,519 299,941
Bank loan payable 57,500 175,000 175,000 160,000 --
Claims checks payable 35,569 36,445 49,306 70,725 41,535
Stockholders' equity 582,961 487,707 466,585 317,944 655,209
Book value per common share $ 6.93 $ 5.10 $ 4.69 $ 2.29 $ 12.74
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
The Company's financial condition continued to improve in 1997 as shown in
the following table:
1997 1996 1995
---- ---- ----
(Amounts in thousands, except per share data)
Adjusted operating cash flow (1) $ 69,673 $ 931 $ (154,645)
Book value per share $ 6.93 $ 5.10 $ 4.69
Debt to equity ratio (2) 0.28 0.36 0.40
Statutory surplus of
insurance subsidiaries $ 548,043 $ 436,367 $ 358,474
Net written premiums to
surplus ratio 1.4:1 1.9:1 2.7:1
A.M. Best rating A- B+ B-
(1) For 1996, excludes $29.2 million, net of commissions, in homeowner and
condominium unearned premiums ceded to reinsurers in July 1996.
(2) Equity adjusted to exclude unrealized investment gains or losses.
With its strong financial position restored, the Company has positioned
itself for renewed and profitable growth. Additionally, the Company's direct
exposure to future earthquake losses was completely eliminated in 1995. The
Company maintains full insurance protection against its only significant
remaining catastrophe exposure in the homeowner line, primarily relating to
potential wild fires and fire following an earthquake event.
28
RESULTS OF OPERATIONS
Units in Force
Units in force for the Company's insurance programs as of December 31
were as follows:
1997 1996 1995
---- ---- ----
Private Passenger Automobile
(Number of vehicles) 1,076,876 1,011,609 1,061,007
Homeowner and Condominium
(Number of policies) 89,010 175,338
Personal Excess Liability ("PELP")
(Number of policies) 11,683 10,223 10,499
--------- --------- ---------
Total 1,149,583 1,110,842 1,246,844
--------- --------- ---------
--------- --------- ---------
Information about recent developments relating to units in force within
each major coverage line follows.
PRIVATE PASSENGER AUTOMOBILE. The 1997 year registered solid and
profitable growth for the Company. In view of the favorable trends in loss
costs and frequency in 1996 and 1997, the Company lowered overall rate levels
approximately 11.5% and 3.2% in 1996 and 1997, respectively, and by an
additional 3.4% in January 1998. These actions, coupled with an aggressive
marketing campaign, have spurred increases in new business production and the
rate of renewals, starting in the fourth quarter of 1996 (for the first time
in nine quarters) and throughout 1997. Vehicles in force grew by 65,267 in
1997, compared to a decline of 49,398 in 1996, a positive swing of 114,665
vehicles. In the fourth quarter of 1997, vehicles in force grew by 10,034
compared to 4,940 for the same period in 1996. In the first two months of
1998, the voluntary vehicles in force grew at an 8.7% annual rate.
Vehicles in force relating to previously uninsured drivers stood at
68,112, 59,013 and 68,256 at December 31, 1997, 1996 and 1995, respectively.
Vehicles in force for the Assigned Risk portion were
29
12,133, 6,847, and 8,204 as of December 31, 1997, 1996 and 1995,
respectively. The overall increase in Assigned Risk units was an expected
response to new legislation.
HOMEOWNER AND CONDOMINIUM. Units in force for the Company's homeowner and
condominium programs declined by 31.4% from December 31, 1996 to December 31,
1997, of which 59% occurred in the first quarter of 1997. This was primarily
due to a requirement by the California Department of Insurance that the Company
non-renew homeowner and condominium policies from July 1, 1996 until February
15, 1997. At that time, the Company began offering renewal of policies for
approximately 68,000 homeowner insurance customers. These renewals were subject
to an overall 6% rate increase on April 1, 1997. As of December 31, 1997, more
than 61,000 policies had been renewed which is 89.7% of those eligible. The
Company continues to seek approval to resume writing new homeowner policies;
however, unless the Company is granted such permission, the impact of this line
on future underwriting results is likely to remain insignificant.
PELP. The penetration of this coverage has averaged about 1% of the
vehicles in force during the three years ended December 31, 1997, which is not
expected to change significantly in 1998.
Underwriting Results
Premium revenue and underwriting results for the Company's insurance
programs follow, presented in conformity with generally accepted accounting
principles ("GAAP"). To facilitate comparability, the effects of the
earthquake and the Proposition 103 settlement have been isolated from the
core business in the table below.
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ------------ -----------
(Amounts in thousands)
Gross Premiums Written
Automobile $871,996 $892,287 $991,969
Homeowner and Condominium - excluding
effects of earthquake and Prop. 103 27,367 34,875 69,468
Personal Excess Liability 2,406 2,114 2,146
----------- ------------ -----------
Subtotal Core Business 901,769 929,276 1,063,583
Earthquake and Prop. 103 - 567 379
----------- ------------ -----------
Total $901,769 $929,843 $1,063,962
----------- ------------ -----------
----------- ------------ -----------
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ------------ -----------
(Amounts in thousands)
Net Premiums Earned
Automobile $781,288 $831,963 $920,560
Homeowner and Condominium - excluding
effects of earthquake and Prop. 103 3,917 23,872 62,890
Personal Excess Liability 784 772 843
----------- ------------ -----------
Subtotal Core Business 785,989 856,607 984,293
Earthquake and Prop. 103 - 21 (20,496)
----------- ------------ -----------
Total $785,989 $856,628 $963,797
----------- ------------ -----------
----------- ------------ -----------
Underwriting Profit (Loss)
Automobile-excluding the
effects of earthquake and Prop. 103 $134,130 $81,010 $73,755
Homeowner and Condominium - excluding
effects of earthquake and Prop. 103 (5,557) (1,394) (438)
Personal Excess Liability - excluding the
effects of earthquake and Prop. 103 493 917 41
----------- ------------ -----------
Subtotal Core Business 129,066 80,533 73,735
Earthquake and Prop 103 (24,750) (38,311) (48,498)
----------- ------------ -----------
Total $104,316 $42,222 $25,237
----------- ------------ -----------
----------- ------------ -----------
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ------------ -----------
CORE BUSINESS - GAAP
Loss and LAE ratio 74.2% 81.3% 83.7%
Underwriting expense ratio 9.4 9.3 8.8
----------- ------------ -----------
Combined ratio 83.6% 90.6% 92.5%
----------- ------------ -----------
----------- ------------ -----------
COMPANY TOTALS - GAAP
Loss and LAE ratio 77.3% 85.8% 88.4%
Underwriting expense ratio 9.4 9.3 9.0
----------- ------------ -----------
Combined ratio 86.7% 95.1% 97.4%
----------- ------------ -----------
----------- ------------ -----------
Automobile
The auto line experienced a record high $134.1 million underwriting profit
in 1997. These results compared favorably to profits in 1996 and 1995 of $81
million and $73.8 million, respectively, as adjusted for the effects of the
earthquake and Proposition 103. The 1997 and 1996 increases in underwriting
profit are primarily the result of favorable loss trends. For 1997, the impact
of relatively dry weather, a continued strong decline in claim frequencies and
severities and the attraction and retention of a higher percentage of more
profitable, preferred customers all contributed to the improvement in
underwriting results.
The 1997 decrease in gross premiums written reflects the 6.5% increase in
insured units coupled with the effect of the 3.2% premium rate reduction
implemented in 1997 and the impact of 1996 rate reductions which were fully felt
in 1997. Gross premiums written in 1996 decreased 10% from 1995 reflective of
the 4.6% reduction in insured units and, to a lesser extent, the effect of the
three premium rate reductions implemented in 1996 (a total reduction of 11.5%).
While a growth in business generally indicates the need for an
increase in incurred but not reported ("IBNR") reserves, favorable development
in older case reserves and the lower frequency and severity of new claims have
resulted in the Company making a smaller provision for IBNR reserves in 1997
than in 1996 and 1995.
The voluntary automobile insurance business written by the Company is
comprised of "Good Drivers" as defined by California statute. While the
majority of this business would have been acceptable to the Company before
Proposition 103, those who had no prior insurance would have been written at a
higher rate level than those who had been insured prior to being written by the
Company. These drivers have produced automobile underwriting losses of
$7,773,000 in 1997 compared to $15,168,000 in 1996 and $26,286,000 in 1995. The
sharp decline in losses in 1997 is reflective primarily of favorable loss
trends, despite the increase in vehicles in force of 14.5% over the previous
year. The 1997 combined ratio for this segment of the business was 116.5%
compared to 129.7% in 1996 and 143.9% in 1995. As part of the new rating plan
that became effective October 1, 1997, changes were implemented that the Company
expects will bring the combined ratio for this class of policyholders more into
line with the rest of the Company's voluntary book of business.
32
Overall automobile underwriting results are also affected by Assigned Risk.
Underwriting losses for Assigned Risk business were $73,000 in 1997, compared to
$102,000 in 1996 and $3,082,000 in 1995. Combined ratios for this business for
the same periods were 100.6%, 101.1% and 126.7%, respectively. The decrease in
underwriting losses in 1997 was reflective of an improved loss ratio despite a
77.2% increase in vehicles in force since 1996, which is believed to have been
fueled by strengthened legal sanctions aimed at reducing the number of uninsured
motorists in California. The decrease in underwriting losses in 1996 was
primarily due to a 16.5% drop in vehicles in force since 1995 coupled with the
effects of a 5.2% rate increase implemented in June 1995. The future effect of
the Assigned Risk plan on the Company cannot be predicted because it depends on
the ability of the state-administered plan to achieve and maintain an adequate
rate level.
Homeowner and Condominium - Excluding Earthquake and Proposition 103 Settlement
Underwriting results for these programs are subject to variability caused
by weather-related claims and by infrequent disasters. In 1997 and 1996, no
significant losses were incurred.
Since July 1, 1996, the Company has maintained reinsurance programs to
provide coverage for its remaining homeowner policies as discussed in Note 10 to
the Consolidated Financial Statements. The Company had previously maintained
separate catastrophe coverage on these lines which expired in June 1996.
Written premiums ceded in 1997 totaled $24.4 million compared to $10.7 million
in 1996 (excluding the $33.3 million portfolio transfer of unearned premium
liabilities under the 100% quota share reinsurance agreement), and $36.3 million
in 1995.
Personal Excess Liability
The personal excess liability program has remained stable over the
three-year period ended December 31, 1997, producing approximately $2 million in
gross written premiums each year. Underwriting profits can vary significantly
with the number of claims which occur infrequently.
33
Earthquake and Proposition 103
Although the Company did not write new or renewal earthquake premiums in
1995 through 1997, the Company assumes a small amount of earthquake premium from
the California Fair Plan, a state administered pool of difficult to insure risks
in which insurers are required to participate in proportion to their share of
direct written homeowners coverage in the state. The negative premiums earned
for the Earthquake and Proposition 103 in 1995 is due to $24 million of
reinsurance purchased to protect the Company until the earthquake endorsements
expired in July 1995.
Policy Acquisition and General Operating Expenses
The Company's policy acquisition and general operating expense ratio
continues to be among the most competitive in the industry. The ratio of
underwriting expenses (excluding interest and fees) to earned premiums was 9.4%
in 1997, 9.3% in 1996 and 9.0% in 1995. The increase in the expense ratios from
1995 to 1997 is mainly due to the decline in premiums earned as well as an
increase in marketing expenses.
Impact of Year 2000
What is commonly referred to in the financial press as the "Year 2000
issue" has arisen because some computer programs were written using two digits
rather than four to define the applicable year. As a result, these systems and
programs may not calculate dates beyond 1999, which may cause errors or systems
failures.
The Company has begun a project to modify the applicable portions of its
software so that its computer systems will properly calculate dates beyond 1999.
The total Year 2000 project cost is estimated to be approximately $6.2 million,
which will be expensed as incurred. In 1997, the Company incurred and expensed
approximately $1.5 million, and substantially all of the remaining costs are
expected to be incurred in 1998. This project is planned for completion in the
first quarter of 1999, which provides sufficient time to avoid any adverse
impact on the Company's operating systems.
34
Investment Income
Net pre-tax investment income was $73,463,000 in 1997 compared to
$73,178,000 in 1996 and $81,658,000 in 1995. Average invested assets decreased
2.0% in 1997, compared to decreases of 6.9% and 5.3% in 1996 and 1995,
respectively. The decline in invested assets resulted from the decline in net
earned premiums and the sale of investments to meet the payment requirements of
both developing earthquake losses and reinsurance premiums. The average annual
pre-tax yield on invested assets was 6.7% in 1997, 6.6% in 1996 and 6.8% in
1995.
Realized capital gains on the sales of investments have declined over the
past three years, as underwriting cashflow has increased and the need to sell
investments to cover claim payments and other operating needs has decreased
commensurately.
As of December 31, 1997, the Company had a pre-tax unrealized gain on fixed
maturity investments of $29,733,000 compared to $3,665,000 in 1996 and
$50,527,000 in 1995. Interest rates fell in 1995 and 1997 which increased the
fair value of the bond portfolio for those years. The decrease in unrealized
gains between 1995 and 1996 resulted largely from a declining bond market
coupled with an overall decline in invested assets.
At December 31, 1997, $17,427,000 of the Company's total investments at
fair value was invested in tax-exempt bonds with the balance representing 98% of
the portfolio, invested in taxable securities.
Liquidity and Capital Resources
Loss and loss adjustment expense payments are the most significant cash
flow requirements of the Company. The Company continually monitors loss
payments to provide projections of future cash requirements. Additional cash
requirements include servicing the bank debt and paying dividends as approved
from time to time by the Company's Board of Directors. With the anticipated
growth of its core auto business and continued settlement of remaining
earthquake losses, the Company expects that future cash flows from operations
will continue to be sufficient to fund future expenditures.
35
The Company has historically written its core business at an underwriting
profit and thus each premium dollar generates a positive cash flow. A
significant part of the decline and subsequent increase in cash flow from
operations in 1996 and 1997, respectively, is due to the fall and rise,
respectively, in the size of the net book of business during these periods.
In 1996 approximately $29.2 million of the $32.5 million net decrease in
cash and cash equivalents was related to the portfolio transfer of unearned
premiums on homeowners business. Cash flows from operations in 1995 were not
sufficient to fund underwriting operations of the Company due to losses from the
Northridge Earthquake. For 1995, funds needed to pay these claims, as well as
Proposition 103 rebates, came from normal operating cash flows, available cash
on deposit, additional loan proceeds of $15 million and preferred stock proceeds
of $20 million.
Funds required by 20th Century Industries to pay dividends and meet its
debt obligations are provided by the insurance subsidiaries. Information
regarding the Company's debt service obligation is included in Note 9 to the
Consolidated Financial Statements. The ability of the insurance subsidiaries to
pay dividends to the holding company is regulated by state law. Based on the
operating results in 1996 and the favorable ratio of premiums to surplus, the
Company was able to resume normal dividends from the insurance subsidiaries in
1996 to service the parent's debt and dividend requirements. Based upon 1997
operating results and earned surplus as of December 31, 1997, the Company
believes it will not require regulatory approval in 1998 for any extraordinary
dividends.
The Company expects to have very small cash outlays for income taxes,
specifically alternative minimum tax, for the next two to three years. Until
the net operating losses caused by the Northridge Earthquake are fully utilized,
the Company expects that cash outlays for income taxes will be less than income
tax expense recorded in accordance with generally accepted accounting
principles. The net operating loss carryforwards will expire in the year 2009.
The Company in 1997 embarked on a major project to upgrade its
technological infrastructure and to conform certain of its procedures to
"industry best practices." Although the ultimate cost of this project is not
yet determinable, management believes cash flow from operations as well as
expected improvements in operational efficiencies will be more than adequate to
fund the project's implementation which is expected to take place over the next
several years.
36
Risk-Based Capital
The National Association of Insurance Commissioners requires property and
casualty insurance companies to calculate and report information under a
Risk-Based Capital ("RBC") formula in their annual statements. The RBC
requirements are intended to assist regulators in identifying inadequately
capitalized companies. The RBC calculation is based on the type and mix of
risks inherent in the Company's business and includes components for
underwriting, asset, interest rate and other risks. The Company's insurance
subsidiaries exceeded their RBC statutory surplus standards by a considerable
margin as of December 31, 1997. To the extent that a subsidiary would fall
below prescribed levels of surplus, it would be the parent company's intention
to infuse necessary capital to support that entity.
Home Office Lease
The Company leases its Home Office building in Woodland Hills, California,
which contains approximately 234,000 square feet of leasable office space. The
current lease comes up for renewal in November 1999 and may be renewed for two
consecutive five-year periods.
Forward-Looking Statements
The Company's management has made in this report, and from time
to time may make in its public filings and press releases as well as in oral
presentations and discussions, forward-looking statements concerning the
Company's operations, economic performance and financial condition.
Forward-looking statements include, among other things, discussions concerning
the Company's potential expectations, beliefs, estimates, forecasts, projections
and assumptions. Forward-looking statements are subject to risks and
uncertainties. Actual results could differ materially from those anticipated by
forward-looking statements due to a number of important factors including those
discussed elsewhere in this report and in the Company's other public filings,
press releases, oral presentations and discussions and the following: (a) the
intensity of competition from other companies in the insurance industry; (b) the
Company's experience with respect to persistency and claims experience; (c) the
Company's ability to distribute and administer competitive services in a timely,
cost-effective manner; (d) the Company's visibility in the market place and its
financial and claims paying ratings; (e) the effect of changes in laws and
regulations affecting the Company's business, including changes in tax laws
affecting insurance products; (f) market risks related to
37
interest rates; (g) the Company's ability to develop information technology
and management information systems to support strategic goals while
continuing to control costs and expenses; (h) the costs of defending
litigation and the risk of unanticipated material adverse outcomes in such
litigation; (i) changes in accounting and reporting practices and (j) the
Company's access to adequate financing to support its future business.
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors
20th Century Industries
We have audited the accompanying consolidated balance sheets of 20th
Century Industries and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1997. Our audits
also included the financial statement schedule listed in the Index at Item
14(a). These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
20th Century Industries and subsidiaries at December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
Ernst & Young LLP
Los Angeles, California
January 30, 1998
39
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
----------------------
1997 1996
---- ----
(Amounts in thousands)
Investments, available-for-sale, at fair value:
Fixed maturities $1,082,708 $1,063,703
Equity securities 1,745 925
--------- ----------
Total investments - Note 4 1,084,453 1,064,628
Cash and cash equivalents 31,268 18,078
Accrued investment income 20,008 18,549
Premiums receivable 71,494 71,308
Reinsurance receivables and recoverables 70,050 79,183
Prepaid reinsurance premiums 32,154 33,020
Deferred income taxes - Note 5 126,877 190,857
Deferred policy acquisition costs - Note 6 11,510 9,127
Other assets 34,640 29,005
---------- ---------
$1,482,454 $1,513,755
---------- ---------
---------- ---------
See accompanying notes to financial statements.
40
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITY AND STOCKHOLDERS' EQUITY
DECEMBER 31,
-------------------------
1997 1996
------ -----
(Amounts in thousands, except share data)
Unpaid losses and loss adjustment expenses - Note 8 $ 437,887 $ 543,529
Unearned premiums 233,402 231,141
Bank loan payable - Note 9 157,500 175,000
Claims checks payable 35,569 36,445
Reinsurance payable 19,347 19,730
Other liabilities 15,788 20,203
-------- ---------
Total liabilities 899,493 1,026,048
Commitments and contingencies - Notes 11 and 14
Stockholders' equity - Notes 12 and 17
Capital Stock
Preferred stock, par value $1.00 per share;
authorized 500,000 shares, none issued
Series A convertible preferred stock, par value
$1.00 per share, stated value $1,000 per share;
authorized 376,126 shares, outstanding
224,950 shares - Note 17 224,950 224,950
Common stock, without par value; authorized
110,000,000 shares, outstanding 51,636,361
in 1997 and 51,520,006 in 1996 71,230 70,263
Common stock warrants - Note 17 16,000 16,000
Unrealized investment gains, net - Note 4 20,298 2,820
Retained earnings 250,483 173,674
---------- -----------
Total stockholders' equity 582,961 487,707
---------- -----------
$1,482,454 $1,513,755
---------- -----------
---------- -----------
See accompanying notes to financial statements.
41
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
----- ----- -----
(Amounts in thousands, except per share data)
REVENUES
Net premiums earned - Note 10 $785,989 $856,628 $ 963,797
Net investment income - Note 4 73,463 73,178 81,658
Realized investment gains - Note 4 4,071 7,287 10,207
-------- --------- ----------
863,523 937,093 1,055,662
LOSSES AND EXPENSES
Net losses and loss adjustment
expenses - Note 8 607,775 734,735 851,602
Policy acquisition costs - Note 6 44,851 38,175 38,647
Other operating expenses 29,047 41,496 48,311
Interest and fees expense - Note 9 13,722 14,260 15,897
-------- --------- ----------
695,395 828,666 954,457
-------- --------- ----------
Income before federal
income taxes 168,128 108,427 101,205
Federal income taxes - Note 5 57,199 34,370 31,575
-------- --------- ----------
NET INCOME $110,929 $ 74,057 $ 69,630
-------- --------- -----------
-------- --------- -----------
BASIC EARNINGS PER COMMON
SHARE - Note 3 $ 1.76 $ 1.05 $ 0.97
-------- --------- -----------
-------- --------- -----------
DILUTED EARNINGS PER COMMON
SHARE - Note 3 $ 1.37 $ 0.92 $ 0.90
-------- --------- -----------
-------- --------- -----------
See accompanying notes to financial statements.
42
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Amounts in thousands, except per share data)
Convertible
Preferred Stock Common Stock Unrealized
$1 Par Value Without Common Investment
Per Share Par Value Stock Gains Retained
Amount Amount Warrants (Losses) Earnings
--------------- ------------- ----------- ------------ -------------
Balance at January 1, 1995 $200,000 $69,340 $16,000 $(39,777) $ 72,381
Net income for the year 69,630
Issuance of Series A
Preferred Stock - Note 17 24,950 (4,950)
Cash dividends paid on
preferred stock (14,623)
Other 465 73,285 (116)
---------------- ------------- ----------- ------------ -------------
Balance at December 31, 1995 224,950 69,805 16,000 33,508 122,322
Net income for the year 74,057
Cash dividends paid on common
stock ($.05 per share) (2,576)
Cash dividends paid on
preferred stock (20,245)
Other 458 (30,688) 116
---------------- ------------- ----------- ------------- ------------
Balance at December 31, 1996 224,950 70,263 16,000 2,820 173,674
Net income for the year 110,929
Cash dividends paid on common
stock ($.25 per share) (12,906)
Cash dividends paid on
preferred stock (20,245)
Other 967 17,478 (968)
--------------- -------------- ------------ ------------- -------------
Balance at December 31, 1997 $224,950 $71,230 $16,000 $20,298 $250,483
--------------- -------------- ------------ ------------- -------------
--------------- -------------- ------------ ------------- ------------
See accompanying notes to financial statements.
43
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
-------- -------- --------
(Amounts in thousands)
OPERATING ACTIVITIES:
Net income $ 110,929 $ 74,057 $ 69,630
Adjustments to reconcile net income
to net cash provided by (used in) operating
activities:
Provision for depreciation and amortization 5,598 4,679 6,555
Provision for deferred income taxes 54,569 31,835 30,856
Realized gains on sale of investments (4,071) (7,287) (10,207)
Federal income taxes 502 (1,430) 74,718
Reinsurance balances 9,616 (38,512) (73,163)
Unpaid losses and loss adjustment expenses (105,642) (41,305) (171,409)
Unearned premiums 2,261 (57,786) (9,592)
Claims checks payable (876) (12,861) (21,419)
Proposition 103 payable - - (78,307)
Other (3,213) 20,361 27,693
-------- -------- --------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES 69,673 (28,249) (154,645)
44
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
YEARS ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
-------- -------- --------
(Amounts in thousands)
INVESTING ACTIVITIES:
Investments available-for-sale:
Purchases $(660,903) $(631,428) $(666,203)
Called or matured 6,981 17,190 33,308
Sales 664,675 636,419 570,443
Net purchases of property and
equipment (16,585) (3,642) (2,505)
-------- -------- --------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES (5,832) 18,539 (64,957)
FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock - - 20,000
Proceeds from (repayments of) bank loan (17,500) - 15,000
Dividends paid (33,151) (22,821) (14,623)
-------- -------- --------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (50,651) (22,821) 20,377
-------- -------- --------
Net increase (decrease) in cash 13,190 (32,531) (199,225)
Cash and cash equivalents, beginning of year 18,078 50,609 249,834
-------- -------- --------
Cash and cash equivalents, end of year $31,268 $18,078 $50,609
-------- -------- --------
-------- -------- --------
See accompanying notes to financial statements.
45
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1. DESCRIPTION OF BUSINESS
20th Century Industries, through its wholly-owned subsidiaries, 20th Century
Insurance Company and 21st Century Casualty Company (collectively, the
"Company"), is engaged in the sale of private passenger automobile, homeowners
and personal excess liability insurance policies in the state of California. In
accordance with an order from state insurance regulators, no new homeowner and
condominium policies have been written since July 23, 1994 and beginning July
24, 1996, the Company was required to begin non-renewing these policies. On
February 15, 1997, pursuant to regulatory approval granted in December 1996, the
Company resumed renewing its approximately 68,000 remaining homeowner policies.
All condominium policies expired in July 1997.
NOTE 2. SUMMARY OF ACCOUNTING POLICIES
Basis of Consolidation and Presentation
The accompanying consolidated financial statements include the accounts and
operations of 20th Century Industries and its wholly-owned subsidiaries. All
material intercompany accounts and transactions have been eliminated. The
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles which differ from statutory accounting
practices ("SAP") prescribed or permitted by insurance regulatory authorities.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements.
Actual results could differ from these estimates.
Investments
The Company classifies its investment portfolio as available-for-sale and
carries it at fair value with unrealized gains and losses, net of any tax
effect, reported as a separate component of stockholders' equity.
46
Fair values for fixed maturity and equity securities are based on quoted
market prices. When investment securities are sold, the cost used to determine
any realized gain or loss is based on specific identification.
The Company's 49% interest in 20th Century Insurance Company of Arizona,
which is a joint venture between the Company and American International Group,
Inc. ("AIG") and which began operations in August 1996, has a carrying value of
$2,559,000 at December 31, 1997, and is included in other assets in the
consolidated balance sheet. The Company's equity in the 1997 net loss of this
venture amounted to $656,000 and is included in investment income in the
consolidated statement of income.
Cash and Cash Equivalents
Cash and cash equivalents include cash and short-term investments in demand
deposits having a maturity of three months or less at the date of purchase.
Recognition of Revenues
Insurance premiums are recognized as revenue pro rata over the terms of the
policies. The unearned portion is included in the balance sheet as a liability
for unearned premiums.
Losses and Loss Adjustment Expenses
The estimated liabilities for losses and loss adjustment expenses include
the accumulation of estimates of losses for claims reported prior to the balance
sheet dates, estimates (based upon actuarial analysis of historical data) of
losses for claims incurred but not reported and estimates of expenses for
investigating and adjusting all incurred and unadjusted claims. Amounts
reported are estimates of the ultimate costs of settlement, net of estimated
salvage and subrogation, which are necessarily subject to the impact of future
changes in economic and social conditions. Management believes that, given the
inherent variability in any such estimates, the aggregate reserves are within a
reasonable and acceptable range of adequacy. The methods of making such
estimates and for establishing the resulting reserves are reviewed and updated
quarterly and any adjustments resulting therefrom are reflected in current
earnings.
47
Reinsurance
In the normal course of business, the Company seeks to reduce the loss that
may arise from catastrophes and to reduce its overall risk levels by reinsuring
certain areas of exposure with other insurance enterprises or reinsurers.
Reinsurance premiums and reserves on reinsured business are accounted for on a
basis consistent with those used in accounting for the original policies issued
and the terms of the reinsurance contracts. Amounts applicable to ceded
unearned premiums and ceded claim liabilities are reported as assets in the
accompanying balance sheets. The Company believes that the fair value of its
reinsurance recoverables approximates their carrying amounts.
Policy Acquisition Costs
Policy acquisition costs, principally direct and indirect costs related to
production of business, are deferred and amortized to expense as the related
premiums are earned.
Income Taxes
Deferred income tax assets and liabilities are determined based on the
differences between the financial reporting and the tax bases of assets and
liabilities and are measured using the enacted tax rates and laws.
New Accounting Standards
Statement of Financial Accounting Standards ("SFAS") No. 128, EARNINGS PER
SHARE, became effective for periods ending after December 15, 1997. SFAS No.
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of common stock
equivalents and other dilutive securities (i.e. options, warrants and
convertible securities). Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share in that it includes the
effects of all dilutive instruments meeting certain requirements. All earnings
per share amounts for all prior periods have been restated to conform to the
SFAS No. 128 requirements. Additional financial statement disclosures required
by SFAS No. 128 are included in Note 3.
48
In 1997, the Financial Accounting Standards Board also issued SFAS No. 130,
REPORTING COMPREHENSIVE INCOME, and No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. The Company plans to adopt these statements
effective March 31, 1998 and December 31, 1998, respectively. The Company
believes that neither of these statements will require disclosure of any
significant information beyond that already provided in the Company's financial
statements.
49
NOTE 3. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
---------- ---------- -----------
(Amounts in thousands, except per share data)
Numerator:
Net income $110,929 $74,057 $69,630
Preferred stock dividends (20,245) (20,245) (19,573)
---------- ---------- -----------
Numerator for basic earnings per share -
income available to common stockholders $90,684 $53,812 $50,057
Effect of dilutive securities:
Dividends on convertible preferred stock * 20,245 - -
---------- ---------- -----------
Numerator for diluted earnings per share -
income available to common stockholders
after assumed conversions $110,929 $53,812 $50,057
---------- ---------- -----------
Denominator:
Denominator for basic earnings per share -
weighted-average shares outstanding 51,500 51,465 51,450
Effect of dilutive securities:
Restricted stock grants 121 49 44
Employee stock options 171 42 17
Warrants 9,079 7,092 3,884
Convertible preferred stock * 19,854 - -
---------- ---------- -----------
Dilutive potential common shares 29,225 7,183 3,945
Denominator for diluted earnings per share -
adjusted weighted-average shares outstanding 80,725 58,648 55,395
---------- ---------- -----------
Basic earnings per share $1.76 $1.05 $0.97
---------- ---------- -----------
Diluted earnings per share $1.37 $0.92 $0.90
---------- ---------- -----------
* For 1996 and 1995, the effect of the convertible preferred stock would be
anti-dilutive and, therefore, it is not included in the calculation of diluted
earnings per share for those periods.
50
NOTE 4. INVESTMENTS
A summary of net investment income is as follows:
YEARS ENDED DECEMBER 31,
---------------------------
1997 1996 1995
-------- -------- -------
(Amounts in thousands)
Interest on fixed maturities $72,140 $71,996 $74,286
Interest on cash equivalents 2,333 2,170 8,049
Other (654) (183) 109
------- ------- -------
Total investment income 73,819 73,983 82,444
Investment expense 356 805 786
------- ------- -------
Net investment income $73,463 $73,178 $81,658
------- ------- -------
------- ------- -------
A summary of realized investment gains and losses before income taxes is as
follows:
YEARS ENDED DECEMBER 31,
---------------------------
1997 1996 1995
-------- -------- -------
(Amounts in thousands)
Fixed maturities available-for-sale:
Gross realized gains $ 6,958 $ 9,608 $12,080
Gross realized losses (2,887) (2,321) (2,321)
-------- -------- -------
Net realized investment gains $ 4,071 $ 7,287 $10,207
-------- -------- -------
-------- -------- -------
51
The amortized cost, gross unrealized gains and losses, and fair values of
investments as of December 31, 1997 and 1996, respectively, are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
1997 Cost Gains Losses Value
- - ---- ---------- ---------- ---------- -----------
(Amounts in thousands)
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 6,735 $ 45 $ 22 $ 6,758
Obligations of states and
political subdivisions 36,680 2,843 - 39,523
Public utilities 171,060 4,347 233 175,174
Corporate securities 838,500 23,688 935 861,253
---------- ------- ------ ----------
Total fixed maturities 1,052,975 30,923 1,190 1,082,708
Equity securities 250 1,495 - 1,745
---------- ------- ------ ----------
Total investments $1,053,225 $32,413 $1,190 $1,084,453
---------- ------- ------ ----------
---------- ------- ------ ----------
1996
- - ----
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 11,906 $ 57 $ 78 $ 11,885
Obligations of states and
political subdivisions 287,277 5,776 926 292,127
Public utilities 164,509 1,330 2,165 163,674
Corporate securities 596,346 6,002 6,331 596,017
---------- ------- ------ ----------
Total fixed maturities 1,060,038 13,165 9,500 1,063,703
Equity securities 250 675 - 925
---------- ------- ------ ----------
Total investments $1,062,088 $13,840 $9,500 $1,064,628
---------- ------- ------ ----------
---------- ------- ------ ----------
52
The amortized cost and fair value of the Company's fixed maturity
investments at December 31, 1997 are summarized, by contractual maturity, as
follows:
(Amounts in thousands) Available-for-sale
------------------
Amortized Fair
Fixed maturities due: Cost Value
- - --------------------- --------- ------
1998 $ 3,099 $ 3,125
1999 - 2002 42,202 43,297
2003 - 2007 778,885 798,052
2008 - 2017 228,378 237,800
2018 and after 411 434
---------- ----------
Total $1,052,975 $1,082,708
---------- ----------
---------- ----------
Expected maturities of the Company's investments may differ from contractual
maturities because certain borrowers have the right to call or prepayment
obligations with or without call or prepayment penalties.
The changes in unrealized gains (losses) on investments available-for-sale
for 1997, 1996 and 1995 total $17,478,000, $(30,688,000) and $73,285,000, net of
deferred income taxes (benefits) of $9,411,000, $(16,524,000) and $39,461,000,
respectively.
53
NOTE 5. FEDERAL INCOME TAXES
Federal income tax expense consists of:
YEARS ENDED DECEMBER 31,
--------------------------
1997 1996 1995
---- ---- ----
(Amounts in thousands)
Current tax expense $ 2,630 $ 2,535 $ 719
Deferred tax expense 54,569 31,835 30,856
------- ------- -------
$57,199 $34,370 $31,575
------- ------- -------
------- ------- -------
The Company's net deferred income tax asset is comprised of:
YEARS ENDED DECEMBER 31,
------------------------
1997 1996
---- ----
(Amounts in thousands)
Deferred tax assets:
Net operating loss carryforward $ 94,981 $142,422
Unearned premiums 14,087 16,180
Unpaid losses and loss adjustment expenses 9,811 13,170
Alternative minimum tax credit 13,927 11,200
Salvage and subrogation 3,322 7,506
Non-qualified retirement plans 3,291 3,063
Other 2,416 2,058
-------- --------
141,835 195,599
-------- --------
-------- --------
Deferred tax liabilities:
Deferred policy acquisition costs 4,028 3,223
Unrealized investment gains 10,930 1,519
-------- --------
14,958 4,742
-------- --------
Net deferred tax asset $126,877 $190,857
-------- --------
-------- --------
54
Ordinarily, the Company's principal deferred tax assets arise from the
discounting of loss reserves for tax purposes, which delays a portion of the
loss deduction, and from the acceleration of 20% of the unearned premium reserve
into taxable income before it is earned. As of December 31, 1997, the Company
has a net operating loss carryforward of approximately $271,000,000 for regular
tax purposes and $141,000,000 for alternative minimum tax purposes expiring in
the year 2009 and an alternative minimum tax credit carryforward of $13,927,000.
Alternative minimum tax credits may be carried forward indefinitely to offset
future regular tax liabilities.
The Company is required to establish a "valuation allowance" for any
portion of the deferred tax asset that management believes will not be realized.
In order to realize the net deferred tax asset, the Company must have the
ability to generate sufficient future taxable income to realize the tax
benefits. Taxable income for 1997, 1996 and 1995 totaled $273.5 million, and
except for the losses arising from the Northridge Earthquake in 1994, the
Company has been profitable for each of the past 10 years. Over the last five
years, the Company's combined ratio has been approximately 96% excluding the
Northridge Earthquake, and net investment income has averaged approximately $82
million a year over the same five year period. Historically, the Company has
generated almost all of its profits from its automobile line of business. The
Company exited the earthquake line of business in 1995, which substantially
eliminated the Company's exposure to future earthquake catastrophes.
The Company believes that because of its historically strong earnings
performance, and the tax planning strategies available, it is more likely than
not that the Company will realize the benefit of the deferred tax asset, and
therefore, no valuation allowance has been established.
55
A reconciliation of income tax computed at the federal statutory tax rate,
which was 35% for 1995 through 1997, to total income tax expense follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
(Amounts in thousands)
Federal income taxes at
statutory rate............................ $58,845 $37,949 $35,422
Decrease due to:
Tax-exempt income, net.................... (1,354) (4,472) (3,520)
Other.................................... (292) 893 (327)
--------------- --------------- ---------------
Federal taxes on income...................... $57,199 $34,370 $31,575
--------------- --------------- ---------------
--------------- --------------- ---------------
Payments for income taxes were $3,150,000, $2,367,500 and $65,000 for
the years ended December 31, 1997, 1996 and 1995, respectively.
NOTE 6. POLICY ACQUISITION COSTS
Following is a summary of policy acquisition costs deferred for
amortization against future income and the related amortization charged to
income from operations:
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
(Amounts in thousands)
Deferred policy acquisition costs
at beginning of year....................... $ 9,127 $10,481 $14,776
Acquisition costs deferred.................... 47,234 36,821 34,352
--------------- --------------- ---------------
56,361 47,302 49,128
Acquisition costs amortized and
charged to income during the year.......... 44,851 38,175 38,647
--------------- --------------- ---------------
Deferred policy acquisition costs
at end of year............................. $11,510 $ 9,127 $10,481
--------------- --------------- ---------------
--------------- --------------- ---------------
56
NOTE 7. EMPLOYEE BENEFITS
Pension Plan and Supplemental Executive Retirement Plan
The Company sponsors a non-contributory defined benefit pension plan
which covers essentially all employees who have completed at least one year
of service. The benefits are based on employees' compensation during all
years of service. The Company's funding policy is to make annual
contributions as required by applicable regulations. The pension plan's
assets consist of high-grade fixed income securities and cash equivalents.
The Company also sponsors an unfunded supplemental executive retirement
plan which covers certain key employees designated by the Board of Directors.
The supplemental plan benefits are based on years of service and compensation
during the last three years of employment, and are reduced by the benefit
payable from the pension plan.
The net periodic pension cost for these plans was $4,012,000, $3,925,000
and $3,147,000 in 1997, 1996 and 1995, respectively. Accrued pension costs
included in the consolidated balance sheets at December 31, 1997 and 1996 are
$2,521,000 and $4,073,000, respectively.
Savings and Security Plan
The Company sponsors a contributory savings and security plan for
eligible employees. The Company provides matching contributions equal to 75%
of the lesser of 6% of an employee's compensation or the amount contributed
by the employee. Contributions charged against operations were $2,697,000,
$2,556,000 and $2,376,000 in 1997, 1996 and 1995, respectively.
57
NOTE 8. LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
liability for unpaid losses and loss adjustment expenses ("LAE"):
1997 1996 1995
--------------- --------------- ---------------
(Amounts in thousands)
Reserves for losses and LAE, net of reinsurance
recoverables, at beginning of year...................... $489,033 $552,320 $ 755,101
Add:
Provision for unpaid losses and LAE for claims
occurring, in the current year,
net of reinsurance.................................. 672,402 760,325 891,066
Decrease in provision for insured
events of prior years, net of reinsurance........... (64,627) (25,590) (39,464)
--------------- --------------- ---------------
Total incurred losses and loss adjustment
expenses, net of reinsurance........................ 607,775 734,735 851,602
Deduct losses and LAE payments for claims,
net of reinsurance, occurring during:
The current year...................................... 403,676 446,037 534,414
Prior years........................................... 304,714 351,985 519,969
--------------- --------------- ---------------
Total payments, net of reinsurance...................... 708,390 798,022 1,054,383
--------------- --------------- ---------------
Reserve for unpaid losses and LAE, net of
reinsurance recoverables, at year end................... 388,418 489,033 552,320
Reinsurance recoverables on unpaid
losses, at year end..................................... 49,469 54,496 32,514
--------------- --------------- ---------------
Reserves for losses and LAE, gross of
reinsurance recoverables on unpaid losses,
at year end............................................. $437,887 $543,529 $ 584,834
--------------- --------------- ---------------
--------------- --------------- ---------------
As a result of changes in estimates of insured events in prior years,
the provision for losses and loss adjustment expenses decreased by
$64,627,000, $25,590,000 and $39,464,000 in 1997, 1996 and 1995,
respectively, due to a combination of improvements in the claims handling
process and unanticipated decreases in frequency and severity. The 1997, 1996
and 1995 decreases in provisions
58
for insured events of prior years is offset by increases in losses related to
the Northridge Earthquake of $24.75 million, $40 million and $60 million,
respectively.
NOTE 9. BANK LOAN PAYABLE
The Company has entered into a revolving credit facility ("the Facility")
that provides an aggregate commitment of $157.5 million at December 31, 1997.
The commitment decreases by $11.25 million on the first day of each quarter
until April 1, 2001. Principal repayments are required when total outstanding
advances exceed the aggregate commitment. The Company may prepay principal
amounts of the advances, as well as voluntarily cause the aggregate commitment
to be reduced at any time during the term of the Facility.
As of December 31, 1997, the Company's outstanding advances against the
Facility totaled $157.5 million, which approximates its fair value. Interest is
charged at a variable rate based, at the option of the Company, on either (1)
the contractually defined Alternate Base Rate ("ABR") plus a margin of 0.25% or
(2) the Eurodollar Rate plus a margin of 1.00%. Margins are adjusted in
relation to certain financial and operational levels of the Company. The ABR is
defined as a daily rate which is the higher of (a) the prime rate for such day
or (b) the Federal Funds Effective Rate for such day plus .5% per annum.
Interest is payable at the end of each interest period. The stock of the
Company's insurance subsidiaries is pledged as collateral under the Facility.
At December 31, 1997, the annual interest rate for the specified interest period
was approximately 6.7%. Interest paid was $12,758,000 in 1997, $9,813,000 in
1996 and $12,636,000 in 1995.
NOTE 10. REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. The Company periodically reviews the financial condition of its
reinsurers to minimize its exposure to losses from reinsurer insolvencies. It
is the Company's policy to hold collateral under related reinsurance agreements
in the form of letters of credit for unpaid losses for all reinsurers not
licensed to do business in the Company's state of domicile.
59
The effect of reinsurance on premiums written and earned is as follows
(amounts in thousands):
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------- -----------------------------
Written Earned Written Earned Written Earned
------------ ------------ ------------ ------------ -------------- --------------
Gross......... $901,769 $899,506 $929,843 $987,628 $1,063,962 $1,073,556
Ceded......... (113,169) (113,517) (101,850) (131,000) (137,345) (109,759)
------------ ------------ ------------ ------------ -------------- --------------
Net........... $788,600 $785,989 $827,993 $856,628 $926,617 $963,797
------------ ------------ ------------ ------------ -------------- --------------
------------ ------------ ------------ ------------ -------------- --------------
Losses and loss adjustment expenses have been reduced by reinsurance ceded
as follows (amounts in thousands):
YEARS ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
Gross losses and loss
adjustment expenses incurred $688,436 $839,146 $921,104
Ceded losses and loss
adjustment expenses incurred (80,661) (104,411) (69,502)
------------ ------------ ------------
Net losses and loss
adjustment expenses incurred $607,775 $734,735 $851,602
------------ ------------ ------------
------------ ------------ ------------
In connection with an investment agreement executed in 1994 with
AIG (see Note 17), each of the Company's insurance subsidiaries entered into
a five-year quota share reinsurance agreement with an AIG affiliate to
provide coverage for all ongoing lines of business. Under this contract,
which attaches to the Company's retained risks net of all other reinsurance,
10% of each subsidiary's premiums earned and losses incurred in connection
with policies incepted during the period January 1, 1995 through December 31,
1999 are ceded. The majority of the Company's reinsurance receivables are due
from the AIG affiliate. At the end of the five-year period, the AIG
affiliate may elect to renew the agreement annually at declining coverage
percentages. Ceding commissions of 9.36%, 9.13% and 10.8% were earned by the
insurance subsidiaries for 1997, 1996 and 1995,
60
respectively. The ceding commission is adjusted annually to equal the prior
year's gross SAP underwriting expense ratio.
In 1996, the Company's insurance subsidiaries entered into a 100% quota
share reinsurance agreement with F&G Re and Risk Capital Re covering the
homeowner and condominium lines of business. This agreement covers, for a
one-year policy term, all business in force as of July 1, 1996 plus renewal
business attaching between July 1, 1996 and July 23, 1996, effectively
terminating with the expiration of the underlying, one-year policies. Under
this contract, 100% of each subsidiary's homeowner and condominium unearned
premium reserves as of June 30, 1996 were ceded 50/50 to F&G Re and Risk
Capital Re, a total of $33.3 million. Additionally, 100% of written premiums
and incurred losses and allocated loss adjustment expenses subsequent to June
30, 1996, on covered policies, are ceded under this contract. The Company's
insurance subsidiaries earn a commission on ceded premiums based on a sliding
scale dependent on the incurred loss ratio. In both 1997 and 1996, the
Company earned commissions at a rate of 12.5% on this treaty. Homeowner
policies renewed February 15, 1997 and subsequent are covered in full by
quota share reinsurance agreements with three reinsurers, as follows:
National Union Fire Insurance Co. of Pittsburgh, PA (50%), a subsidiary of
AIG, F&G Re (25%) and Risk Capital Re Company (25%). The Company's insurance
subsidiaries earn a commission on ceded premiums based on a sliding scale
dependent on the incurred loss ratio. In 1997, the Company earned
commissions at a rate of 14% on this treaty.
The Company has a quota share treaty for its Personal Excess Liability
Policy line whereby it cedes 60% of premiums and losses. After the effect of
the 10% quota share treaty with AIG discussed earlier, the Company
effectively retains 36% of the risk for this line.
NOTE 11. LEASE COMMITMENTS
The Company leases office space in a building in Woodland Hills,
California. The lease was amended in October 1994, extending the lease term
until November 1999. The lease may be renewed for two consecutive five-year
periods. The Company also leases office space in several other locations
throughout California, primarily for claims servicing.
61
Minimum rental commitments under the Company's lease obligations are
as follows:
1998........................ $11,394,868
1999........................ $10,698,643
2000........................ $ 4,424,956
2001........................ $ 3,110,794
2002........................ $ 2,083,928
Thereafter.................. $ 609,259
Rental expense charged to operations for the years ended December
31, 1997, 1996 and 1995 were $11,969,000, $11,243,000, and $12,062,000,
respectively.
NOTE 12. STOCKHOLDERS' EQUITY
The Company's insurance subsidiaries are subject to restriction as
to the amount of dividends which may be paid to the parent company within any
one year without the approval of the California Department of Insurance
("DOI"). The California Insurance Code provides that amounts may be paid as
dividends from earned surplus on an annual, noncumulative basis, without
prior approval by the DOI, up to the greater of (1) net income for the
preceding year, or (2) 10% of statutory surplus as regards policyholders as
of the preceding December 31. Earned surplus available for dividends as of
December 31, 1997 was approximately $175 million.
Surplus of the insurance subsidiaries on a statutory basis at
December 31, 1997 and 1996 was $548,043,000 and $436,367,000, respectively.
Statutory net income for the insurance subsidiaries was $178,727,000,
$121,780,000, and $118,562,000 for the years ended December 31, 1997, 1996
and 1995, respectively.
NOTE 13. STOCK-BASED COMPENSATION
The Company has two separate stock compensation plans: the 1995
Stock Option Plan, which provides for grants of stock options to key
employees and non-employee directors of the Company, and the Restricted
Shares Plan, which provides for stock grants to key employees.
62
The Company has elected to follow Accounting Principles Board Opinion 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. Under APB 25, the fair value of stock grants made under
the Restricted Shares Plan is amortized to expense over the vesting periods of
the grants. SFAS 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.
1995 Stock Option Plan
The aggregate number of common shares issued and issuable under the Plan
currently is limited to 4,000,000. All options granted have ten year terms
and vest over various future periods.
Exercise prices for options outstanding at December 31, 1997 ranged from
$12.50 to $22. The weighted average remaining contractual life of those
options is 8.7 years.
A summary of the Company's stock option activity and related information
follows:
Weighted-Average
Number of Exercise
Options Price
---------- -----------------
Options outstanding January 1, 1995 -
Granted in 1995 180,000 $12.56
---------
Options outstanding December 31, 1995 180,000 $12.56
Granted in 1996 396,500 $19.64
Exercised in 1996 (8,000) $12.50
Forfeited in 1996 (27,000) $19.33
---------
Options outstanding December 31, 1996 541,500 $17.41
Granted in 1997 649,750 $19.81
Exercised in 1997 (27,000) $17.14
Forfeited in 1997 (12,500) $17.68
---------
Options outstanding December 31, 1997 1,151,750 $18.76
---------
---------
63
The Company's pro forma information using the Black-Scholes valuation model
follows:
1997 1996 1995
----------- ---------- ----------
Estimated weighted average of
the fair value of options granted $ 7.90 $ 10.70 $ 6.27
Pro forma net income (in 000's) $ 108,541 $ 70,522 $ 69,211
Pro forma earnings per share - Basic $ 1.71 $ 0.98 $ 0.96
- Diluted $ 1.34 $ 0.86 $ 0.90
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 of 6.5% for 1997 and 1996
and 6.6% for 1995; dividend yields ranging from 1.14% to 1.44% in 1997, from
1.0% to 1.3% in 1996 and from 1.5% to 1.6% in 1995; volatility factors of the
expected market price of the Company's common stock of .27, .39 and .43 for
1997, 1996 and 1995, respectively; and a weighted average expected life of the
options of 8 years in 1997 and 10 years in 1996 and 1995.
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.
Restricted Shares Plan
The Restricted Shares Plan currently provides for grants of up to 921,920
shares of common stock to be made available to key employees as determined by
the Key Employee Incentive Committee of the Board of Directors. The common
shares are restricted for five years retroactive to the first day of the year of
grant. Restrictions are removed on 20% of the shares of each employee on
January 1 of each of the five years following the year of grant. At December
31, 1997, 205,519 common shares remain available for future grants. Upon
issuance of grants of common shares under the plan, unearned compensation
equivalent to the market value on the date of grant is charged to
64
common stock and subsequently amortized in equal monthly installments over
the five-year vesting period of the grant. Amortization of the unearned
compensation was $534,900, $365,500 and $550,000 in 1997, 1996 and 1995,
respectively. This accounting treatment results in compensation expense
being recorded in a manner consistent with that required under Statement 123
and, therefore, pro forma net income and earnings per share amounts would be
unchanged from those reported in the financial statements.
A summary of grants under the plan from 1995 through 1997 follows:
Common Market Price Per
Shares Share on Date of Grant
---------- ----------------------
Outstanding, January 1, 1995 63,172
Granted in 1995 35,813 $11.17
Vested in 1995 (40,224)
Canceled or forfeited (14,878)
----------
Outstanding, December 31, 1995 43,883
Granted in 1996 18,600 $19.63
Vested in 1996 (13,800)
Canceled or forfeited -
----------
Outstanding, December 31, 1996 48,683
Granted in 1997 89,355 $16.50-$17.50
Vested in 1997 (18,444)
Canceled or forfeited -
----------
Outstanding, December 31, 1997 119,594
----------
----------
NOTE 14. LITIGATION
Lawsuits arising from claims under insurance contracts are provided for
through loss and loss adjustment expense reserves established on an ongoing
basis. From time to time, the Company has been named as a defendant in lawsuits
incident to its business. Some of these actions assert claims for exemplary or
punitive damages which are not insurable under California judicial decisions.
The Company vigorously defends these actions unless a reasonable settlement
appears appropriate. While any litigation has an element of uncertainty, the
Company believes that the ultimate outcome of pending actions will not have a
material adverse effect on its consolidated financial condition or results of
operations.
65
NOTE 15. PROPOSITION 103
In accordance with a settlement with the DOI in 1995 regarding rebate
liabilities associated with Proposition 103, the Company offset a portion of the
1995 increase in earthquake losses associated with the 1994 Northridge
Earthquake (see Note 16) with $32 million in funds previously set aside for
potential Proposition 103 rebates. In addition, as part of the settlement, the
Company contributed $30 million to the surplus of the insurance subsidiaries
with funds obtained from the existing bank credit facility and from the issuance
of 20,000 additional shares of preferred stock to AIG (see Notes 9 and 17,
respectively).
NOTE 16. NORTHRIDGE EARTHQUAKE
The Northridge Earthquake, which occurred on January 17, 1994,
significantly affected the operating results and the financial position of the
Company. The Company has recorded additional losses related to the 1994 event
of $24.75 million, $40 million and $60 million in 1997, 1996, and 1995,
respectively. In accordance with the terms of a settlement with the California
Department of Insurance, the Company offset a portion of the 1995 increase in
earthquake losses with $32 million in funds previously set aside for potential
Proposition 103 rebates (see Note 15).
NOTE 17. CAPITAL TRANSACTIONS
On December 16, 1994, the Company received $216 million of equity capital
from AIG and, in exchange, issued (i) 200,000 shares of Series A 9% Convertible
Preferred Stock, par value $1.00 per share, at a price and liquidation value of
$1,000 per share and convertible into common shares at a conversion price of
$11.33 per share, and (ii) 16,000,000 Series A Warrants to purchase an aggregate
16,000,000 shares of the Company's Common Stock, initially at $13.50 per share
subject to a formula that resulted in a permanent reduction to $9.10 per share.
In 1995, an additional 20,000 shares of preferred stock were issued to AIG in
exchange for $20,000,000 of equity capital. In addition, preferred stock
dividends in kind of $4,950,000, representing 4,950 additional shares, were
issued on June 26, 1995. The Common Stock Warrants are generally exercisable
from February
66
1998 to February 2007. There are no restrictions on the redemption of the
Convertible Preferred Stock shares.
NOTE 18. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The summarized unaudited quarterly results of operations were as follows:
QUARTER ENDED
-----------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------ ------------ ------------- ---------------
(Amounts in thousands, except per share data)
1997
- - ----
Net premiums earned $ 194,969 $ 195,107 $ 197,676 $ 198,237
Investment income $ 17,835 $ 18,400 $ 18,612 $ 18,616
Realized gains $ 1,072 $ 471 $ 1,452 $ 1,076
Net income $ 26,872 $ 31,507 $ 33,218 $ 19,332
Basic earnings
per common share $ 0.42 $ 0.51 $ 0.55 $ 0.28
Diluted earnings
per common share $ 0.34 $ 0.39 $ 0.41 $ 0.23
1996
- - ----
Net premiums earned $ 232,628 $ 225,068 $ 204,755 $ 194,177
Investment income $ 18,689 $ 18,776 $ 17,770 $ 17,943
Realized gains $ 2,588 $ 1,310 $ 2,642 $ 747
Net income (loss) $ 25,583 $ 31,928 $ 24,345 $ (7,799)
Basic earnings (loss)
per common share $ 0.40 $ 0.52 $ 0.37 $ (0.25)
Diluted earnings (loss)
per common share $ 0.32 $ 0.41 $ 0.31 $ (0.25)
The quarterly earnings per share amounts do not necessarily add to annual
amounts due to the changing dilutive effect of common stock equivalents as the
price of the common stock fluctuates.
67
The 1996 and first three quarters of 1997 earnings per share amounts have
been restated to comply with SFAS No. 128 (see Note 3).
The second and fourth quarters of 1997 were impacted by pre-tax charges
of $6.75 million and $18 million, respectively, in additional reserves
related to the 1994 Northridge Earthquake.
The fourth quarter of 1996 was impacted by pre-tax charges of $40 million
in additional reserves related to the 1994 Northridge Earthquake. It was also
adversely affected by weather-related claims amounting to approximately $8
million.
NOTE 19. RESULTS OF OPERATIONS BY LINE OF BUSINESS
The following table presents premium revenue and underwriting profit
(loss) for the Company's insurance lines on a GAAP basis for the years ended
December 31.
1997
------
Homeowner Personal
(Amounts in thousands) Auto and Condominium Excess Liability
---------- --------------- ----------------
Gross premiums written $ 871,996 $ 27,367 $ 2,406
---------- ---------- ----------
---------- ---------- ----------
Premiums earned $ 781,288 $ 3,917 $ 784
---------- ---------- ----------
---------- ---------- ----------
Underwriting profit (loss) $ 134,130 $ (30,307) $ 493
---------- ---------- ----------
---------- ---------- ----------
1996
------
Homeowner Personal
(Amounts in thousands) Auto and Condominium Excess Liability
---------- --------------- ----------------
Gross premiums written $ 892,287 $ 35,442 $ 2,114
---------- ---------- ----------
---------- ---------- ----------
Premiums earned $ 831,963 $ 23,893 $ 772
---------- ---------- ----------
---------- ---------- ----------
Underwriting profit (loss) $ 81,010 $ (39,705) $ 917
---------- ---------- ----------
---------- ---------- ----------
1995
------
Homeowner Personal
(Amounts in thousands) Auto and Condominium Excess Liability
---------- --------------- ----------------
Gross premiums written $ 991,969 $ 69,847 $ 2,146
---------- ---------- ----------
---------- ---------- ----------
Premiums earned $ 920,560 $ 42,394 $ 843
---------- ---------- ----------
---------- ---------- ----------
Underwriting profit (loss) $ 103,744 $ (78,976) $ 469
---------- ---------- ----------
---------- ---------- ----------
68
AUTO. The $53.1 million increase in underwriting profit in 1997 compared to
1996 was largely the result of growth in the number of vehicles in force,
relatively dry weather, and a continued strong decline in claim frequencies
and severities. The $22.7 million decline in underwriting profit for the auto
lines in 1996 compared to 1995 was caused principally by a $30 million
benefit in 1995 from the reversal of amounts previously set aside for
Proposition 103 rebates (see Note 15), and 1996 weather-related claims of
approximately $8 million. In 1995, excluding earthquake-related claims and
expenses, earthquake reinsurance reinstatements and Proposition 103 rebate
adjustments, the underwriting profit for the auto lines would have been $73.8
million.
HOMEOWNER AND CONDOMINIUM. The 1997, 1996 and 1995 underwriting losses in
these lines included respective provisions for additional earthquake reserves
of $24.75 million, $40 million and $60 million, the latter of which was
partially offset by a $2 million reduction in Proposition 103 rebates. Also
affecting the three years was an overall decline in premium volume resulting
from an order from the DOI. In addition, 1995 was impacted by first quarter
weather-related losses of $14.2 million and earthquake-related catastrophe
reinsurance premiums of $24 million.
69
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no disagreements with the Company's independent auditors on
any matters of accounting principles or practices, financial statement
disclosure or auditing scope or procedure, or any reportable events.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information in response to Item 10 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's
1998 Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to Item 11 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's
1998 Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to Item 12 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's
1998 Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to Item 13 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's
1998 Annual Meeting of Shareholders pursuant to
70
Instruction G(3) of Form 10-K. There were no relationships or related party
transactions which require disclosure.
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED WITH THIS REPORT PAGE
----
(1) FINANCIAL STATEMENTS
The following consolidated financial statements of the Company are filed as a part
of this report:
(i) Report of independent auditors; ................................................ 39
(i) Consolidated balance sheets - December 31, 1997 and 1996; ...................... 40
(i) Consolidated statements of income - Years ended December 31 1997,
1996, and 1995; ................................................ ..................... 42
(i) Consolidated statements of stockholders' equity--Years ended
December 31, 1997, 1996 and 1995; ................................................... 43
(i) Consolidated statements of cash flows - Years ended December 31, 1997,
1996 and 1995; ...................................................................... 44
(i) Notes to consolidated financial statements ..................................... 46
(2) SCHEDULES
The following financial statement schedule required to be filed by Item
8 and by paragraph (d) of Item 14 of Form 10-K is submitted as a
separate section of this report.
Schedule II - Condensed Financial Information of Registrant ......................... 75
Schedules I, III, IV, and VI have been omitted as all required data is
included in the Notes to Consolidated Financial Statements.
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore
have been omitted.
71
(3) EXHIBITS REQUIRED
The following exhibits required by Item 601 of Regulation S-K and by
paragraph (c) of Item 14 of Form 10-K are listed by number corresponding
to the Exhibit Table of Item 601 of Regulation S-K and are incorporated
by reference as indicated below.
3(a) Articles of Incorporation, as amended, incorporated
herein by reference from the Registrant's Form 10-K for
the year ended December 31, 1994
3(b) By Laws, as amended, incorporated herein by reference
from the Registrant's Form 10-K for the year ended
December 31, 1996
The following contract is incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1985:
10(a) Life Insurance Agreement for key officers
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1987:
10(b) Amendment to 20th Century Industries Restricted Shares
Plan
10(c) Split Dollar Insurance Agreement between the Company and
Stanley M. Burke, as trustee of the 1983 Foster Insurance
Trust
The following contract is incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1988:
10(d) Amendment to 20th Century Industries Supplemental
Executive Retirement Plan
72
The following contracts are incorporated herein by reference from the
Registrant's Form 8-K dated October 5, 1994:
10(e) Letter of intent between the Company and American
International Group, Inc.
10(f) Stock Option Agreement between the Company and American
International Group, Inc.
The following contract is incorporated herein by reference from the
Registrant's Form 10-Q dated November 13, 1994:
10(g) Investment and Strategic Alliance Agreement between the
Company and American International Group, Inc.
The following contract is incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1994:
10(h) Amendment No. 1 to Investment and Strategic Alliance
Agreement between the Company and American International
Group, Inc.
The following contract is incorporated herein by reference from the
Registrant's Form S-8 dated July 26, 1995:
10(i) 20th Century Industries Stock Option Plan for eligible
employees and non- employee directors
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1995:
10(j) Amended and Restated Credit Agreement among the Company,
Union Bank, The First National Bank of Chicago, et. al.
10(k) Quota Share Reinsurance Agreement between the Company and
American International Group, Inc., as amended
73
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1996:
10(l) Forms of Stock Option Agreements
10(m) Form of Restricted Shares Agreement
10(n) 20th Century Industries Supplemental Executive Retirement
Plan, as amended
10(o) 20th Century Industries Pension Plan, 1994 Amendment and
Restatement
10(p) Amendment No. 1 to 20th Century Industries Pension Plan
The following exhibits are incorporated by reference or filed herewith
as indicated:
21 Subsidiaries of the Registrant, incorporated herein by
reference from "Item 1. Business" in the Registrant's
Form 10-K for the year ended December 31, 1997
23 Consent of Independent Auditors, filed herewith
(a) REPORTS ON FORM 8-K.
There were no reports on Form 8-K filed for the three months ended
December 31, 1997.
74
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
ASSETS
DECEMBER 31,
1997 1996
---------- ----------
(Amounts in thousands,
except share data)
Cash $ 15,264 $ 14,802
Prepaid loan fees 4,204 5,999
Other current assets 2,251 1,224
Accounts receivable from subsidiaries and affiliates,
net of payables - 3,610
Investment in non-consolidated insurance
subsidiaries and affiliates at equity 717,439 641,261
Other assets 16,247 12,594
---------- ----------
$ 755,405 $ 679,490
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 12,550 $ 16,783
Accounts payable to subsidiaries and affiliates,
net of receivables 2,394 -
Bank loan payable 157,500 175,000
---------- ----------
Total liabilities 172,444 191,783
---------- ----------
Stockholders' equity:
Capital Stock
Preferred stock, par value $ 1.00 per share;
authorized 500,000 shares, none issued
Series A convertible preferred stock, par value
$ 1.00 per share, stated value $ 1,000 per share;
authorized 376,126 shares, outstanding
224,950 in 1997 and 1996 224,950 224,950
Common stock, without par value; authorized
110,000,000 shares, outstanding 51,636,361
in 1997 and 51,520,006 in 1996 71,230 70,263
Common stock warrants 16,000 16,000
Unrealized investment gains of
insurance subsidiaries - net 20,298 2,820
Retained earnings 250,483 173,674
---------- ----------
Total stockholders' equity 582,961 487,707
---------- ----------
$ 755,405 $ 679,490
---------- ----------
---------- ----------
See note to condensed financial statements.
75
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ---------- ----------
(Amounts in thousands, except
per share data)
REVENUES
Dividends received from subsidiaries $ 69,000 $ 43,000 $ -
Interest (94) 339 1,390
Other - - 1,269
----------- ---------- ----------
Total 68,906 43,339 2,659
EXPENSES
Loan interest and fees 12,942 14,260 15,897
General and administrative 991 621 544
----------- ---------- ----------
Total 13,933 14,881 16,441
Income (loss) before income tax refund 54,973 28,458 (13,782)
Refund of income taxes (31) (7) (4,994)
----------- ---------- ----------
Net income (loss) before equity in
undistributed income of subsidiaries 55,004 28,465 (8,788)
Equity in undistributed income of
subsidiaries 55,925 45,592 78,418
----------- ---------- ----------
NET INCOME $ 110,929 $ 74,057 $ 69,630
----------- ---------- ----------
----------- ---------- ----------
EARNINGS PER COMMON SHARE
Basic $ 1.76 $ 1.05 $ 0.97
----------- ---------- ----------
----------- ---------- ----------
Diluted $ 1.37 $ 0.92 $ 0.90
----------- ---------- ----------
----------- ---------- ----------
See note to condensed financial statements.
76
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
-------- -------- --------
(Amounts in thousands)
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES $62,990 $31,749 $(11,795)
INVESTING ACTIVITIES:
Capital contributed to 21st Century
Casualty Company $(2,000) $- $-
Capital contributed to 20th Century
Insurance Company - - (30,000)
Capital contributed to 20th Century Insurance
Company of Arizona (1,430) (1,970) -
Purchase of equipment (8,576) (1,126) (1,472)
Proceeds from sale of equipment 275 271 306
-------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES (11,731) (2,825) (31,166)
FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock - - 20,000
Proceeds from (repayment of ) bank loan (17,500) - 15,000
Dividends paid (33,151) (22,821) (14,623)
-------- -------- --------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (50,651) (22,821) 20,377
-------- -------- --------
Net increase (decrease) in cash 462 6,103 (22,584)
Cash, beginning of year 14,802 8,699 31,283
-------- -------- --------
Cash, end of year $ 15,264 $ 14,802 $ 8,699
-------- -------- --------
-------- -------- --------
See note to condensed financial statements.
77
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
NOTE TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements should be read in
conjunction with the consolidated financial statements and notes thereto of 20th
Century Industries and Subsidiaries.
NOTE 1 - DEBT AND OTHER DISCLOSURES
The Company's outstanding advances against its revolving credit
facility ("the Facility") totaled $157.5 million at December 31, 1997.
Refer to Note 9 of the Notes to Consolidated Financial Statements for a more
detailed explanation of the Facility.
78
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.
20TH CENTURY INDUSTRIES
(Registrant)
Date: March 19, 1998 By: /s/ William L. Mellick
----------------------------------
William L. Mellick
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated on the 19th of
March, 1998.
SIGNATURE TITLE
President and Chief Executive Officer
/s/ William L. Mellick (Principal Executive Officer)
- - -----------------------------------
William L. Mellick
Senior Vice President
and Chief Financial Officer
/s/ Robert B. Tschudy (Principal Financial Officer)
- - -----------------------------------
Robert B. Tschudy
Controller
/s/ John M. Lorentz (Principal Accounting Officer)
- - -----------------------------------
John M. Lorentz
79
SIGNATURE TITLE
/s/ John B. De Nault Chairman of the Board
- - -----------------------------------
John B. De Nault
/s/ William H. Braddock Director
- - -----------------------------------
William H. Braddock
/s/ Stanley M. Burke Director
- - -----------------------------------
Stanley M. Burke
/s/ John B. De Nault, III Director
- - -----------------------------------
John B. De Nault, III
/s/ R. Scott Foster, M.D Director
- - -----------------------------------
R. Scott Foster, M.D
/s/ Rachford Harris Director
- - -----------------------------------
Rachford Harris
/s/ William L. Mellick Chief Executive Officer and Director
- - -----------------------------------
William L. Mellick
/s/ Robert M. Sandler Vice Chairman of the Board
- - -----------------------------------
Robert M. Sandler
/s/ Gregory M. Shepard Director
- - -----------------------------------
Gregory M. Shepard
/s/ Howard I. Smith Director
- - -----------------------------------
Howard I. Smith
/s/ Arthur H. Voss Director
- - -----------------------------------
Arthur H. Voss
80