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Delaware		13-3994449
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
5701 Stirling Road, Davie, Florida		33314
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code:
(954) 316-5200

 

 

 

 

 

BRISTOL WEST HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
		(Unaudited)
		September 30,			December 31,
		2004			2003
		(in thousands, except share data)
Assets:
Investments:
Fixed maturities available-for-sale (amortized cost $261,862--2004, and $136,065--2003)		$	263,564		$	139,502
Equity securities (cost $2,171--2004, $1,782--2003)			2,173			1,783
Total investments			265,737			141,285
Cash and cash equivalents			39,556			9,256
Accrued investment income			2,525			1,627
Premiums receivable			222,037			142,229
Reinsurance recoverables on paid and unpaid losses & loss adjustment expenses			152,061			149,486
Prepaid reinsurance			123,784			95,037
Ceding commission receivable			128,281			90,513
Deferred policy acquisition costs			33,304			22,423
Property, equipment and leasehold improvements - net			16,662			13,082
Goodwill			101,677			101,677
Other assets			9,516			11,261
Total assets		$	1,095,140		$	777,876
Liabilities and Stockholders' Equity:
Liabilities:
Policy liabilities:
Reserve for losses and loss adjustment expenses		$	214,959		$	202,296
Drafts outstanding			1,851			2,154
Unearned premiums			244,004			157,178
Total policy liabilities			460,814			361,628
Reinsurance payables			183,323			159,598
Accounts payable and other liabilities			63,557			40,782
Deferred income taxes			5,887			5,633
Long-term debt			73,925			71,500
Total liabilities			787,506			639,141
Commitments and contingent liabilities (Note 7)
Stockholders' equity:
Preferred stock, $0.01 par value (15,000,000 shares authorized; 0 shares
outstanding as of September 30, 2004 and December 31, 2003, respectively)			-			-
Common stock, $0.01 par value (200,000,000 shares authorized; 32,461,882 and
24,506,485 shares issued as of September 30, 2004 and December 31, 2003, respectively)			324			245
Additional paid-in capital			230,185			97,810
Retained earnings			83,950			41,504
Deferred compensation on restricted stock			(4,694	)		-
Treasury stock at cost (683,036 and 662,330 shares held as of
September 30, 2004 and December 31, 2003, respectively)			(2,965	)		(2,563	)
Stock subscription receivable			(154	)		(393	)
Accumulated other comprehensive income			988			2,132
Total stockholders' equity			307,634			138,735
Total liabilities and stockholders' equity		$	1,095,140		$	777,876
The accompanying notes are an integral part of the consolidated financial statements.

 

 

    Bristol West Holdings, Inc. (the "Company") is a holding company engaged in the distribution and underwriting of private passenger automobile insurance through its subsidiaries. The Company conducts its business as a single segment, given that the product, the regulatory framework, the type of customer and the method of distribution vary little from state to state. As of September 30, 2004, the Company was licensed in 37 states and the District of Columbia. The Company consists of a holding company, four property and liability insurance companies (Bristol West Casualty Insurance Company, Bristol West Insurance Company, Security National Insurance Company and Coast National Insurance Company), agencies and claims servicing companies.

 

 2.    Basis of Presentation

 

    The unaudited consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three months and nine months ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. These unaudited consolidated financial statements and the notes thereto should be read in conjunction with the Company’s audited financial s tatements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

    On February 12, 2004, the Company declared a 130.38-for-one split of its outstanding common stock (see Note 4). All references to number of shares, per share amounts and stock option data have been restated to reflect the stock split. The authorized number of shares of common stock has been increased to 200,000,000. In addition, 15,000,000 shares of preferred stock, par value $0.01 per share, are authorized.

 

 3.    Debt

 

    On February 18, 2004, the Company completed a refinancing of its secured credit facility. This bank agreement ("Bank Agreement") consists of: (1) a $50,000 Secured Revolving Credit Facility, which includes up to $15,000 of letters of credit and matures in 2009, (2) a $35,000 Term A Loan, which matures in 2010 and (3) a $40,000 Term B Loan, which matures in 2011. The Company’s interest rate on borrowings under the Bank Agreement is London Interbank Offered Rate (LIBOR) plus a margin (1% to 2.25%), which is determined based on the Company’s consolidated total debt to consolidated total capitalization ratio. The Company also pays certain commitment fees. The Bank Agreement is secured by a pledge of stock of certain of the Company’s subsidiaries. The refinancing extended the maturity of the Company’s debt coming due in 2005 through 2007. In connection w ith the refinancing, the Company recorded a charge of $1,613 related primarily to the write-off of deferred financing fees. The amount outstanding at September 30, 2004 was $73,925.  The Company had no borrowings on the revolving credit line at September 30, 2004.

 

 

     On February 12, 2004, an initial public offering of 17,250,000 shares of the Company’s common stock (after effect of a 130.38-for-one stock split (see Note 2)) was completed. The Company sold 6,250,000 shares resulting in net proceeds to the Company (after deducting issuance costs) of approximately $113,407.  The Company contributed $110,000 of the proceeds to its insurance subsidiaries, which increased their statutory surplus.  The additional capital will permit the Company to reduce its reinsurance purchases and to retain more gross premiums written over time. The Company used the remaining $3,407 for general corporate purposes at the holding company level. Additionally, selling shareholders sold 11,000,000 shares of common stock in connection with the initial public offering, which included the exercise of the underwriters’ over-allotment of 2,2 50,000 shares.  Although the Company did not receive any proceeds for the sale of stock by the selling shareholders, the Company did receive net proceeds of approximately $6,936, including the related tax benefit, from the selling shareholders’ exercise of stock options and warrants of 750,751.

 

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    The following table sets forth the computation of basic and diluted earnings (loss) per share:

 

 

 

          In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results. The Company has elected to continue to apply APB No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for stock options.

 

The following table illustrates the effect on net income (loss) and net income (loss) per share if the Company had applied SFAS No. 123 to stock-based compensation.

 

 

 

    In the course of pursuing its normal business activities, the Company is involved in various legal proceedings and claims. Management does not expect that amounts, if any, which may be required to be paid by reason of such proceedings or claims will have a material effect on the Company’s financial position or results of operations.

 

 

    On October 26, 2004, the Company exercised its right to terminate and commute the 2002 to 2004 quota share reinsurance agreement effective January 1, 2005 on a cut-off basis. The contractual right to terminate and commute was at the Company’s sole option. Effective January 1, 2005, the termination and commutation will result in the reinsurers being released as of that date from any future liability on the contract in return for them paying to the Company, within 45 business days of January 1, 2005 all balances due the Company, including ceded loss and loss adjustment expense reserves less any payable due the reinsurers. If the termination and commutation had been effective as of September 30, 2004, the monies due the Company would have been $214.7 million. The termination and commutation will have no immediate impact to earnings per share or book value. In future pe riods, the Company will save the 3% margin the reinsurers would have earned on the ceded unearned premiums and will earn investment income on the net cash balances collected from the reinsurers.

 

 

 

 

     The following discussion and analysis of the results of operations for the three months and nine months ended September 30, 2004, and three months and nine months ended September 30, 2003, respectively, provides commentary relating to, and should be read in conjunction with, the consolidated financial statements included elsewhere in this document.

 

 

     We provide non-standard private passenger automobile insurance and related services in 19 states. Non-standard automobile insurance affords coverage to drivers who find it difficult to purchase standard automobile insurance as a result of a number of factors, including their driving record, vehicle, age or claims history, or because they have limited financial resources. Many of these drivers purchase state-mandated minimum limits of coverage to comply with financial responsibility laws. Premium rates for non-standard automobile insurance policies are generally higher than standard or preferred automobile insurance policies for comparable coverage.

 

    The non-standard automobile insurance business is highly competitive and we compete with both large national insurance providers and smaller regional companies. Some of our competitors have more capital, higher ratings and greater resources than we have, and may offer a broader range of products and lower prices and down payments than we offer.

 

    The operating results of property and casualty insurance companies are subject to fluctuations from quarter-to-quarter and year-to-year due to a number of factors, including but not limited to general economic conditions, the regulatory climate in states where an insurer operates, state regulation of premium rates, changes in pricing and underwriting practices of the insurer and its competitors, the frequency and severity of losses, natural disasters and other factors. Historically, results of property and casualty insurance companies have been cyclical, with periods of high premium rates and strong profitability followed by periods of price competition, falling premium rates and reduced profitability.

 

    We continue to direct our operations in view of the market conditions and anticipated changes to those conditions we encounter in each state in which we operate. One facet of our strategy is to be a long-term, stable market for our producers and insureds. We possess licenses, systems and professional staff to service the markets in each state in which we operate.

 

    We provide systems and processes to help our agents and producers improve customer retention, such as our online point-of-sale application systems, OneStep™™and OneStep-Raptor™, electronic funds transfer bill plans, check by phone and BWProducers.com, which web enables a producer’s customer management.  We continue to target profitable areas within the states in which we operate, and we continuously add new producers to increase new business production.

 

 

    In certain states in which we operate, most notably California, we believe that market conditions are becoming generally more competitive.  We are seeing few rate filings where companies are raising rates, and in several states, companies with which we compete have filed rate decreases.  In addition, some companies with which we compete have relaxed underwriting standards and/or lowered rates in an effort to attract more business.

 

    Most companies, Bristol West included, are operating profitably at current rate levels, so there does not appear to be a need for large rate increases for market participants to earn a profit.  This contrasts with market conditions during 2001, 2002 and even into 2003 when most market participants were seeking rate increases.

 

    We monitor the rate and underwriting activity of the other market participants in each state in which we do business.  During the quarter, we observed 58 rate revisions by companies that we monitor in the states in which we do business.  Four of these filed changes were rate increases, 36 were rate reductions, 7 were revenue neutral and 11 were introductions of new products.

 

    The table below shows our direct written premium by state.  In the aggregate, our direct written premium grew by 46% in the third quarter of 2004 compared to the third quarter of 2003 and by 28% for the first nine months of 2004 compared to the comparable period of 2003. Included in these figures is a change in the provision for expected policy cancellations that increased gross written premiums by 21% and 2% for the three months ended September 30, 2004 and 2003, respectively. The purpose of the provision is to reduce the balance of

 

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installment premiums due from policyholders to the amount the Company expects to ultimately collect. Likewise, the Company’s liability for unearned premiums related to the installment premiums is reduced to reflect expected policy cancellations related to such non-payments. The provision was reduced (which increases both premiums receivable and unearned premiums) to reflect an underlying improvement in the Company’s cancellation experience throughout 2004, as well as more precise measurement of the expected dollar amount of future cancellations. The change in estimate increases unearned premiums and premiums receivable by $46.8 million and lowers net income by delaying earned fee income recognition of just under $0.5 million in the quarter, after taxes. The Company believes the reduction in policy cancellations emanates from several factors: point of sale underwriting resulting in fewer up-rates, increased use of electronic funds transfer, the ability to receive telephone and web payments from policyholders and less shopping by consumers.

 

    Exclusive of the change in the provision for cancellations, gross written premiums increased by 17% for the third quarter of 2004 to $175.7 million compared to $149.8 million for the third quarter of 2003 and increased by 14% for the nine months ended September 30, 2004 to $556.3 million compared to $489.9 million for the comparable period of 2003. Average policies in force increased 14% and 12% for the three months and nine months ended September 30, 2004 compared to the corresponding periods of 2003.

DIRECT WRITTEN PREMIUM PRODUCTION BY STATE
($ in millions)
		Three months ended September 30,						%			Nine months ended September 30,						%
		2004			2003			Change			2004			2003			Change
State
California		$	90.1		$	90.3			-0.2	%	$	320.9		$	314.4			2.1	%
Florida			30.9			16.5			87.3	%		78.2			52.7			48.4	%
Michigan			18.7			12.7			47.2	%		52.9			34.1			55.1	%
South Carolina			5.0			3.4			47.1	%		13.2			9.8			34.7	%
Pennsylvania			3.7			4.6			-19.6	%		11.9			11.2			6.3	%
Texas			4.7			2.9			62.1	%		11.2			7.9			41.8	%
Maine			3.5			3.2			9.4	%		10.1			8.8			14.8	%
New Hampshire			3.0			1.6			87.5	%		9.5			4.9			93.9	%
Virginia			2.7			2.3			17.4	%		9.1			6.1			49.2	%
Georgia			2.6			5.6			-53.6	%		8.6			17.1			-49.7	%
All Other			10.8			6.7			61.2	%		30.7			22.9			34.1	%
Total		$	175.7		$	149.8			17.3	%	$	556.3		$	489.9			13.6	%
Change in expected policy cancellation provision			46.8			2.9			n/m			47.1			(17.0	)		n/m
Total, net of change in expected policy cancellation provision		$	222.5		$	152.7			45.7	%	$	603.4		$	472.9			27.6	%

 

    One important aspect of our growth strategy is to increase the number of producers with which we do business. We attempt to target producers in geographic areas where we are under-represented and where we believe we can write profitable business.  During the first nine months of 2004, we increased our total number of producers to 6,200 and our total number of producer locations to 8,060. 

 

    California continues to be our largest state, and California, Florida and Michigan accounted for 80% of our volume for the third quarter.       Growth rates, as enumerated above, vary significantly by state and are dependent upon a variety of factors, including competitive conditions and regulatory environments within those states, our strategies with respect to product pricing and the number and location of producers.

 

    Most of our growth, in the aggregate, emanates from increasing the number of policies in force.  At the end of the third quarter of 2004, our in force policy count had increased to 503,000 from 445,000 at December 31, 2003, an increase of 13%.  The related annualized premiums in force increased by 17% compared to December 31, 2003. 

 

    Exclusive of the change in the provision for cancellations, we had no growth in California for the quarter ended September 30, 2004 and 2% growth for the nine months ended September 30, 2004 relative to the comparable periods of 2003. While our competitors’ rates remain stable, some have relaxed underwriting standards by not verifying mileage bands

 

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and other underwriting information, such as driving experience.  This behavior results in lower policy premium for some drivers, making it more difficult for companies not engaging in such practices to attract new customers or retain those that see alternate quotes at renewal.  We have not relaxed our underwriting standards and do not intend to in the future.

 

    Our new business application volume in California is down by 11% from 2003, but customer retention has improved, resulting in a 4% increase in policies in force. The year to date decline in new business applications is due to the first nine months of 2004 being a less active market for new business than the comparable period of 2003.  During the first nine months of 2003, many companies were implementing rate increases, which precipitated increased shopping by consumers.

 

    We have increased the number of producers in California to 870 at September 30, 2004 from 520 at December 31, 2003, an increase of 67%.  Producer locations in California have increased to 1,550 as of September 30, 2004. Our strategy of increasing the number of producers, without over-saturating the market, is contributing to our overall premium volume, as smaller and newer producers have grown more rapidly than our largest producers.  We closely monitor the behavior of our new producers to ensure adherence to our underwriting standards.

 

    In Florida, our second largest state, gross written premium for the third quarter of 2004 grew by 87% as compared to the third quarter of 2003.  In April, we introduced a new product design, with a rating structure that utilizes a larger number of rating variables than did its predecessor. This product has been well received in the market, and we are pleased with the increase in new business volume. Our producer count has increased by 430 producers, or 70%, in Florida since the beginning of 2004.  The market remains stable in Florida.

 

    We have experienced very strong growth in Michigan where our premium volume for the third quarter of 2004 increased 47% as compared to the third quarter of 2003.  Our strategy in Michigan and elsewhere is to grow by increasing the number of producers in profitable geographic areas where we are under-represented.

 

    The Company’s premiums continued to decrease in Georgia, and for the nine months ended September 30, 2004, decreased by approximately 50% to $8.6 million, as compared to $17.1 million for the comparable period of 2003. The Georgia legislature approved the use of credit score as a rating variable, effective July 2003. The Company made a rate filing using credit score as a rating variable in June 2003. The Georgia Department of Insurance has taken no action on the filing. Consequently, we have curtailed our writings in Georgia to those risks we believe we can write profitably without employing credit as a rating variable.

 

 

    We continue to stress productivity gains, and staff count has increased by 2% since December 31, 2003, while policy count has grown by 13% and direct written premiums have grown by 14% over the same period. We continue to monitor our staffing levels in relation to volume in our claims and policyholder services operations.  In addition, we use a number of metrics to track performance, and, generally, performance is meeting or exceeding our internal benchmarks.

 

    We have modified rates 23 times this year.  Only one such modification was a decrease.  This was in Wisconsin, a state we entered in mid-2003, where we were too conservative in setting rates initially.  We plan to continue to seek rate increases in states where necessary to stay ahead of loss cost trends. In addition, we believe we can continue to improve our product structure by filing class plan changes that, through segmentation, are designed to attract certain risks that we have found to be superior versus the overall market in a given state.

 

    In the aggregate, we utilized point of sale underwriting on 54% of new business applications in the third quarter of 2004 and 70% in the month of October 2004.  Policy issuance has gone on average from 5 days to a half a day in the states where point of sale underwriting technology, OneStep or OneStep-Raptor, has been deployed.

 

    In the third quarter of 2004, we continued to roll out OneStep in California.  As of the end of October 2004, it was deployed in over 1,200 brokerage locations in California, representing approximately 67% of our new business applications in the state. The roll-out to the remainder of the states should take 24 to 36 months to achieve full functionality.

 

    OneStep-Raptor was introduced in Colorado, Ohio, New Hampshire, Tennessee and Texas during the third quarter of 2004. We now have point-of-sale underwriting systems deployed in 9 states, which constituted 90% of our production during the three months ended September 30, 2004.

 

 

    On August 12, 2004, the Company entered into a new quota share reinsurance agreement effective January 1, 2005 with National Union Fire Insurance Company of Pittsburgh, PA, a subsidiary of AIG. The agreement permits the Company to cede from 5% to 30% of its business written for 2005 with an option for 2006 subject to certain performance criteria being met. The ceding percentage will be 10% of business written during the 2005 underwriting year. This contrasts with a ceding percentage of 50% of business written in the 2004 underwriting year.

 

    On October 26, 2004, the Company exercised its right to terminate and commute the 2002 to 2004 quota share reinsurance agreement effective January 1, 2005 on a cut-off basis. The contractual right to terminate and commute was at the Company’s sole option. Effective January 1, 2005, the termination and commutation will result in the reinsurers being released as of that date from any future liability on the contract in return for them paying to the Company, within 45 business days of January 1, 2005, all balances due the Company, including ceded loss and loss adjustment expense reserves less any payable due the reinsurers. If the termination and commutation had been effective as of September 30, 2004, the monies due the Company would have been $214.7 million. The termination and commutation will have no immediate impact to earnings per share or book value. In future p eriods, the Company will save the 3% margin the reinsurers would have earned on the ceded unearned premiums and will earn investment income on the net cash balances collected from the reinsurers.

 

 

     The table below displays certain measures we use in monitoring and evaluating our operations.

Overview of Operating Results 

 

    Net income for the three months ended September 30, 2004 was $15.4 million compared to a net loss of $0.5 million for the three months ended September 30, 2003.  Net income for the quarter ended September 30, 2004 included after-tax losses associated with Hurricanes Charley, Frances, Ivan, and Jeanne of $0.6 million. Net income for the quarter ended September 30, 2003 included after-tax litigation expenses of $10.7 million associated with class action lawsuits. Net income for the three months ended September 30, 2004 grew 57% excluding the items noted above compared to the corresponding period of 2003.

 

    Net income for the nine months ended September 30, 2004 grew to $45.6 million compared to $22.8 million for the nine months ended September 30, 2003, or by 100%.  Net income for the nine months ended September 30, 2004 included after-tax losses associated with Hurricanes Charley, Frances, Ivan, and Jeanne of $0.6 million, charges related to the refinancing of the Company’s credit facilities of $1.0 million and the cost of stock awards to employees in connection with the Company’s initial public offering in February 2004 of $0.6 million. Net income for the nine months ended September 30, 2003 included after-tax litigation expenses associated with class action lawsuits of $10.7 million. Net income for the nine months ended September 30, 2004 grew 43% excluding the items noted above compared to the corresponding period of 2003.

 

    The increase in net income in 2004 as compared to the same periods in 2003 is primarily attributable to growth in net earned premium and fee revenue and a reduction in the loss and loss adjustment expense ratio.  The Company’s loss and loss adjustment expense ratio improved to 55.2% and 54.6% for the three months and nine months ended September 30, 2004, respectively, from 59.7% and 58.4% for the three months and nine months ended September 30, 2003.  The improvement in the loss and loss adjustment expense ratio is due to the reduction in the impact of adverse development on prior years’ reserves for losses and loss adjustment expenses. The Company’s expense ratio improved to 21.5% for the nine months ended September 30, 2004 from 22.3% for the nine months ended September 30, 2003 as a result of increased ceding commissions ea rned resulting from an improved loss and loss adjustment expense ratio on the business ceded and productivity gains resulting in lower company expenses per dollar of premium written.

 

 

    Gross Written Premium. Gross written premium increased to $222.5 million and $603.3 million for the three months and nine months ended September 30, 2004, or by 46% and 28%, respectively, compared to $152.7 million and $472.9 million for the same periods in 2003.  Exclusive of the change in the provision for cancellations, gross written premium increased by 17% for the third quarter of 2004 to $175.7 million compared to $149.8 million for the third quarter of 2003 and increased by 14% for the first nine months of 2004 to $556.3 million compared to $489.9 million for the comparable period of 2003. Average policies in force increased by 14% and 12% for the three months and nine months ended September 30, 2004, respectively, compared to the corresponding periods of 2003. 

 

    In California, our largest market, exclusive of the effect of the change in the provision for cancellations, gross written premium remained steady at $90.1 million for the three months ended September 30, 2004 compared to $90.3 million for the comparable period of 2003. Gross written premium increased by 2% to $320.9 million for the nine months ended September 30, 2004 from $314.4 million for the nine months ended September 30, 2003, primarily as a result of the improved retention rate. 

 

    In Florida, our second largest market, exclusive of the effect of the change in the provision for cancellations, gross written premium increased by 87% to $30.9 million for the three months ended September 30, 2004 compared to $16.5 million for the three months ended September 30, 2003. Gross written premium increased 48% to $78.2 million for the nine months ended September 30, 2004 compared to $52.7 million for the comparable period of 2003. In April 2004, we introduced additional segmentation into our rating structures, which rendered our products more broadly competitive. We have increased the number of producers in Florida by 70% since the beginning of 2004.

 

    In Michigan, our third largest market, exclusive of the effect of the change in the provision for cancellations, gross written premium increased by 47% to $18.7 million for the three months ended September 30, 2004 from $12.7 million for the three months ended September 30, 2003.  Gross written premium increased by 55% to $52.9 million for the nine months ended September 30, 2004 from $34.1 million for the nine months ended September 30, 2003. This growth is attributable to increasing the number of producers in Michigan by 22% since the beginning of 2004, as well as the strength of our competitive position.

 

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    Net Written Premium. Net written premium for the three months and nine months ended September 30, 2004 was $109.8 million and $295.3 million, respectively, compared to $62.0 million and $195.5 million for the same periods in 2003, representing increases of 77% and 51%, respectively.  Exclusive of the effect of the change in the provision for expected policy cancellations, net written premium grew by $27.5 million, or 46%, for the three months ended September 30, 2004 as compared to the three months ended September 30, 2003, and by $104.5 million, or 59%, for the nine months ended September 30, 2004 as compared to the same period of 2003. The increase in net written premium exceeded the increase in gross written premium as a result of changes in the Company’s underlying reinsurance programs.  The percentage of premiums ceded under our quota share reinsurance treaty was reduced from 60% for policies written in 2003 to 50% for those written in 2004. Afte r the impact of the cessions, net written premium retained by the Company was 49% for the three months and nine months ended September 30, 2004, as compared to 41% for the three months and nine months ended September 30, 2003. 

 

    Net Earned Premium. Net earned premium for the three months and nine months ended September 30, 2004 was $86.5 million and $237.2 million, respectively, compared to $65.3 million and $210.1 million for the same periods in 2003, representing increases of 32% and 13%, respectively.  The following table shows the gross and ceded amounts of written and earned premium for the three months and nine months ended September 30, 2004 and 2003.

 

    Policy Service Fee Revenues. Policy service fee revenues for the three months and nine months ended September 30, 2004 were $18.7 million and $55.0 million, respectively, compared to $16.9 million and $52.4 million for the same periods in 2003.  Absent changes in the mix of business by state, policy service fee revenues would be expected to change from period to period commensurate with the change in gross earned premium.  However, during the first nine months of 2004, the Company’s premium volume has been growing comparatively faster in states other than California.  Our policy service fees are lower in relation to premium in these other states.  Hence, policy service fee revenues have grown slower than gross earned premium for the three months and nine months ended September 30, 2004 when compared to the corresponding periods of 2003. Also contributing to the slower growth of policy service fee revenues is the change in the provision for expected policy cancellations, which delayed the recognition of earned policy service fee revenues by approximately $0.7 million in the quarter ended September 30, 2004.

 

 

    Losses and Loss Adjustment Expenses.  Loss and loss adjustment expenses incurred for the three months and nine months ended September 30, 2004 were $58.4 million and $160.6 million, respectively, compared to $49.4 million and $154.1 million for the same periods in 2003.  The loss and loss adjustment expense ratios were 55.2% and 54.6% for the three months and nine months ended September 30, 2004, respectively, compared to 59.7% and 58.4% for the same periods in 2003.  The improvement in the loss and loss adjustment expense ratio principally is due to the relative absence of adverse loss development in the third quarter and first nine months of 2004 when compared to the similar periods of 2003.  The following table displays the Company’s incurred loss and loss adjustment expenses ("LAE") as related to the current accident year (los ses and LAE occurring in the current fiscal year) and prior accident years (losses and LAE recognized in the current fiscal year related to accidents which took place in a prior fiscal year).

    Adverse loss development occurs when loss and loss adjustment expense reserves established for accidents that took place in years prior to the current year prove to be inadequate, and management increases those loss and loss adjustment expense reserves to reflect the revised estimate of the ultimate losses and loss adjustment expenses related to such accidents.  Such increases result in a charge to loss and loss adjustment expenses in the current year.

 

    Commissions and Other Underwriting Expenses. Commissions and other underwriting expenses for the three months ended September 30, 2004 were $16.0 million compared to $11.9 million for the same period in 2003, representing an increase of 34%. The increase is consistent with the 33% increase in net earned premium over the same period. Commissions and other underwriting expenses for the nine months ended September 30, 2004 were $39.3 million compared to $39.9 million for the nine months ended September 30, 2003. Ceding commissions earned under our quota share reinsurance contracts increased in the nine months ended 2004 compared to the similar period of 2003, as a result of the improvement in the underlying combined ratio on the business ceded. This mitigated the increase in commissions and other underwriting expenses for the nine months ended September 30, 20 04 as compared to the respective period of 2003.

 

    Other Operating and General Expenses. Other operating and general expenses for the three months and nine months ended September 30, 2004 were $8.6 million and $24.0 million, respectively, compared to $6.6 million and $18.9 million for the same periods in 2003, representing an increase of 30% and 27%, respectively.  The increase was due to the increase in gross written premium and the related increase in expenses that are variable, such as telephone and bank service charges associated with the lock box facilities used for collecting payments from policyholders.  The growth in operating and general expenses was greater than the growth in gross written premium.  The Company estimates that it incurred additional expenses of $0.5 million and $2.1 million for the three months and nine months ended September 30, 2004, respectively, related to b eing a publicly traded company.  Such expenses included increased Directors and Officers liability insurance premiums, increased audit fees and other costs associated with being a public company.

 

    Interest Expense.  Interest expense for the three months and nine months ended September 30, 2004 were $0.7 million and $2.1 million, respectively, compared to $0.8 million and $2.5 million for the same periods in 2003.  As of September 30, 2004, the Company had $73.9 million of outstanding debt as compared to $81.5 million at September 30, 2003. The aggregate weighted average interest rate was 3.1% and 3.0% during the three months and nine months ended September 30, 2004, respectively.

 

17

 

    Ratios. Our combined ratio was 78.4% and 76.1% for the three months and nine months ended September 30, 2004, respectively, compared to 82.1% and 80.7% for the same periods in 2003, an improvement of 3.7 and 4.6 percentage points, respectively.  The improvement relates to the aforementioned improvements in both our loss and loss adjustment expense ratio and expense ratio.  For the nine months ended September 30, 2003, the Company’s combined ratio was impacted negatively by 3 percentage points due to adverse development on loss and loss adjustment expense reserves recorded at the previous year-end.

 

    Income Taxes.  Income taxes for the three months and nine months ended September 30, 2004 were $8.8 million and $26.2 million, respectively, representing effective tax rates of approximately 36.5%.  The effective rates are comprised of 34.0% for federal income taxes and 2.5% for state income taxes.

 

 

 

    We are organized as a holding company with all of our operations being conducted by our subsidiaries.  Our insurance subsidiaries underwrite the risks associated with our insurance policies. Our non-insurance subsidiaries provide our policyholders and our insurance subsidiaries services related to the insurance policies. We have continuing cash needs for the payment of principal and interest on borrowings, dividends, taxes and administrative expenses. These ongoing obligations are funded with dividends from our non-insurance subsidiaries and taxes paid by each subsidiary through an inter-company tax allocation agreement. 

 

    In February 2004, we completed an initial public offering of 17,250,000 shares of the Company’s common stock. The Company sold 6,250,000 shares providing net proceeds to the Company, after deducting issuance costs, of approximately $113.4 million. The Company contributed $110.0 million of the proceeds to its principal insurance subsidiary, which increased its statutory surplus. The Company used the $3.4 million not contributed to its insurance subsidiary for general corporate purposes at the holding company. The additional capital has provided the Company with the ability to reduce its reinsurance purchases and retain more of its written premium. For 2005 written premium, the Company will reduce its quota share cession percentage to 10% from 50% for 2004.

 

    In February 2004, the Company completed a refinancing of its secured credit facility. This bank agreement (the "Bank Agreement") consists of: (1) a $50.0 million Secured Revolving Credit Facility, which includes up to $15.0 million of letters of credit, (2) a $35.0 million Term A Loan and (3) a $40.0 million Term B Loan. The Company’s interest rate on borrowings under the Bank Agreement is LIBOR plus a margin ranging from 1.0% to 2.25%, which is determined based on the Company’s consolidated total debt to consolidated total capitalization ratio. The Company also pays certain commitment fees. The Bank Agreement is secured by a pledge of stock of certain of the Company’s subsidiaries.

 

    There are no restrictions on the payment of dividends by our non-insurance subsidiaries other than customary state corporation laws regarding solvency. Dividends from our insurance subsidiaries are subject to restrictions relating to statutory surplus and earnings.  As of December 31, 2003, our insurance subsidiaries could pay dividends of $1.1 million without seeking regulatory approval.  Our insurance subsidiaries have not paid any dividends since 1999, which has not impacted our ability to meet our obligations. We do not anticipate that our insurance subsidiaries will pay dividends in the foreseeable future because we wish to reduce our reinsurance purchases in order to retain more of the premium we generate and seek stronger financial strength ratings for our insurance subsidiaries, both of which require that the surplus of our insurance subsidiar ies be increased. Because our non-insurance subsidiaries generate revenues, profits and net cash flows that are generally unrestricted as to their availability for the payment of dividends, we expect to use those funds to service all of our corporate financial obligations, such as debt service and stockholder dividends.

 

    Our insurance subsidiaries’ primary sources of funds are premiums received, investment income and proceeds from the sale and redemption of investment securities. Our non-insurance subsidiaries’ primary sources of funds are policy service fee revenues and commission income received from our insurance subsidiaries. These subsidiaries use these funds to pay claims and operating expenses, make payments under the tax allocation agreement, purchase investments and pay dividends to us.

 

    On August 3, 2004, the Board of Directors declared a dividend of $0.05 per common share resulting in a total payout of approximately $1.6 million from Bristol West Holdings, Inc.  The dividend was paid on August 31, 2004 to shareholders of record on August 17, 2004.

 

18

 

    Net cash provided by operating activities was $39.6 million for the nine months ended September 30, 2004, as compared to $28.8 million for the same period in 2003.  The increase from the prior year relates primarily to the increase in net income year over year, net of changes in various balance sheet accounts, primarily ceding commission receivable. 

 

    Net cash used in investment activities amounted to $132.8 million and $22.9 million for the nine months ended September 30, 2004 and 2003, respectively, and was primarily used to purchase fixed income securities.  The increase in investment purchases was due to the investment of proceeds from the Company’s IPO that was completed in February 2004.

 

    Net cash provided by financing activities was $123.5 million for the nine months ended September 30, 2004 as compared to $10.0 million for the same period in 2003.  As mentioned above, the increase in cash from financing activities is primarily attributable to the Company’s IPO.

 

 

    We had total cash, cash equivalents and invested assets of $305.3 million as of September 30, 2004. The following table summarizes our cash, cash equivalents and invested assets.

 

    Investment Portfolio.  Our investment portfolio consists primarily of debt securities, all of which are classified as available for sale, and are carried at fair value with unrealized gains and losses reported in our financial statements as a separate component of stockholders’ equity on an after-tax basis. As of September 30, 2004, the fair value of our investment portfolio of $265.7 million included $1.7 million in pre-tax net unrealized gains.  We had a de minimus amount of realized pre-tax net gains for the nine months ended September 30, 2004.  The weighted average pre-tax equivalent book yield of the portfolio was 4.03% at September 30, 2004.

 

    Our investment objective is to maximize book income, while maintaining strong credit quality and satisfactory liquidity. Our portfolio at September 30, 2004 had an average Standard & Poor’s rating of "AA+".

    The following table presents the composition of our investment portfolio by type of investment as of September 30, 2004 (in millions):

 

    The following table presents the composition, by type of security, including the amortized cost, gross unrealized gains, gross unrealized losses and fair value of debt securities available for sale in our investment portfolio as of September 30, 2004.

 

The quality distribution of our fixed maturity portfolio as of September 30, 2004 was as follows:

     Based upon our analysis, we believe that we will recover all contractual principal and interest payments related to those securities that currently reflect unrealized losses and that we have the ability and intent to hold these securities until they mature or recover in value. Should either of these beliefs change with regard to a particular security, a charge for impairment would likely be required. In the last three and one-half years, we have not needed to record any impairment charges. We believe that it is not likely that future impairment charges will have a significant effect on our liquidity.

 

    As of September 30, 2004, investments carried at a fair value of $11.9 million and approximately $0.3 million of cash were on deposit with state insurance regulatory authorities.

 

    This report includes various forward-looking statements regarding the Company that are subject to risks and uncertainties including, without limitation, the factors set forth below and under the caption "Risk Factors" in the prospectus filed with the United States Securities and Exchange Commission on February 11, 2004, pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended, in connection with the Company’s Registration Statement on Form S-1 (File No. 333-111259). Forward-looking statements include, but are not limited to, discussions regarding our operating strategy, growth strategy, acquisition strategy, cost savings initiatives, industry, economic conditions, financial condition, liquidity and capital resources and results of operations. Such statements include, but are not limited to, statements preceded by, followed by or that ot herwise include the words "believes," "expects," "anticipates," "intends," "estimates" or similar expressions. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

    Certain important factors, which are discussed elsewhere in this document and in our Registration Statement on Form S-1 described above, could affect our future financial results and could cause actual results to differ materially from those expressed in forward-looking statements contained or incorporated by reference in this document.

 

    We believe that we are principally exposed to two types of market risk: interest rate risk and credit risk.

 

 

     Investments. Our investment portfolio consists primarily of debt securities, all of which are classified as available for sale. Accordingly, the primary market risk exposure to our debt securities portfolio is interest rate risk, which we strive to limit by managing duration to a defined range of three to four years and laddering or utilizing an even distribution in the maturities of the securities we purchase to achieve our duration target. Interest rate risk includes the risk from movements in the underlying market rate and in the credit spread of the respective sectors of the debt securities held in our portfolio. The fair value of our fixed maturity portfolio is impacted directly by changes in market interest rates. As interest rates rise, the market value of our fixed-income portfolio falls, and the converse is also true. We expect to manage interest rat e risk by selecting investments with characteristics such as duration, yield and liquidity tailored to the anticipated cash outflow characteristics of our liabilities. The effective duration of the portfolio as of September 30, 2004 was 3.63 years. Should market interest rates increase 1.0%, our fixed income portfolio would be expected to decline in market value by approximately $11.2 million, or 3.7%. Conversely, a 1.0% decline in interest rates would result in approximately $10.8 million, or 3.6%, appreciation in the market value of our fixed income portfolio. These market value changes are a result of the effective duration of the portfolio, as well as the slightly negative convexity of the portfolio.

 

     Credit Facility. Our exposure to market risk for changes in interest rates also relates to the interest expense of variable rate debt under a bank credit agreement that we entered into on February 18, 2004. The credit agreement is a floating rate borrowing facility and the interest rate we pay increases or decreases with the changes in interest rates, specifically LIBOR. Based on our borrowings under the floating rate credit agreement at September 30, 2004, a 10% increase in market interest rates would increase our annual net interest expense by approximately $141,000.

 

 

     Investments. An additional exposure to our debt securities portfolio is credit risk. We attempt to manage our credit risk through issuer and industry diversification. We regularly monitor our overall investment results and review compliance with our investment objectives and guidelines. Our investment guidelines include limitations on the minimum rating of debt securities in our investment portfolio, as well as restrictions on investments in debt securities of a single issuer.

 

    Reinsurance.  We are subject to credit risks with respect to our reinsurers. Although our reinsurers are liable to us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have reinsured. As a result, reinsurance agreements do not limit our ultimate obligations to pay claims to policyholders and we may not recover claims made to our reinsurers. A.M. Best rates our reinsurers from "A-" to "A++".

 

    Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this quarterly report. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures provide reasonable assurance that material information relating to us and our consolidated subsidiaries is made known to such officers by others within these entities, particularly during the period this quarterly report was prepared, in order to allow timely decisions regarding required disclosure. There have not been any changes in our internal control over financial reporting during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

22

 

Item 1.  Legal Proceedings  

 

    The Company is named as a defendant in a number of class action and individual lawsuits, the outcomes of which are uncertain at this time.  These cases include those plaintiffs who are seeking restitution, damages and other remedies as a result of the Company’s alleged failure to timely return unearned premium, the Company’s use of allegedly improper rates and discounts and other cases challenging various aspects of the Company’s claims and marketing practices and business operations.  The Company plans to contest the outstanding suits vigorously. Based upon currently available information, the Company believes that its reserves for these lawsuits are reasonable.  However, if any one or more of theses lawsuits results in a judgment against or settlement by the Company in an amount that is significantly in excess of the reserve established fo r such lawsuit (if any), the resulting liability could have a material adverse impact on the Company’s financial condition, cash flows and results of operations.

 

    For a further discussion on the Company’s pending litigation, see Item 3 - Legal Proceedings in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

 

    None

 

 

    None

 

 

    None

 

 

    Pursuant to the Company's Non-Employee Directors' Deferred Compensation and Stock Award Plan, seven directors have elected to defer some or all of their director fees, beginning with the third quarter of 2004.

 

    On August 12, 2004, the Company entered into a new quota share reinsurance agreement effective January 1, 2005 with National Union Fire Insurance Company of Pittsburgh, PA, a subsidiary of AIG. The agreement permits the Company to cede from 5% to 30% of its business written for 2005 with an option for 2006 subject to certain performance criteria being met. The ceding percentage will be 10% of business written during the 2005 underwriting year. This contrasts with a ceding percentage of 50% of business written in the 2004 underwriting year.

 

    On October 26, 2004, the Company exercised its right to terminate and commute the 2002 to 2004 quota share reinsurance agreement effective January 1, 2005 on a cut-off basis. The contractual right to terminate and commute was at the Company’s sole option. Effective January 1, 2005, the termination and commutation will result in the reinsurers being released as of that date from any future liability on the contract in return for them paying to the Company, within 45 business days of January 1, 2005, all balances due the Company, including ceded loss and loss adjustment expense reserves less any payable due the reinsurers. If the termination and commutation had been effective as of September 30, 2004, the monies due the Company would have been $214.7 million. The termination and commutation will have no immediate impact to earnings per share or book value. In future p eriods, the Company will save the 3% margin the reinsurers would have earned on the ceded unearned premiums and will earn investment income on the net cash balances collected from the reinsurers.

 

Item 6. Exhibits 

 

List of exhibits:

  

 

 

* Pursuant to Commission Release No. 33-8212, this certification will be treated as "accompanying" this Quarterly Report on Form 10-Q and not "filed" as part of such report for purposes of Section 18 of Exchange Act, or otherwise subject to the liability of Section 18 of the Exchange Act and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

 

Pursuant to the requirements 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.