Revenues and income before taxes and minority interests from CONTINUING OPERATIONS, by business segment, are shown in the following schedules:
Most of the $29.3 million in 1997 realized investment gains, or approximately $27 million before taxes, resulted from the exercise of the Company's warrants to buy common stock of Resource America and the subsequent sale of that stock. Resource America was a 1994 investment made by Physicians after its change in strategic direction. See "ITEM 1 - BUSINESS-HISTORY OF THE COMPANY." Realized investment gains in 1996, principally from the sale of Physicians' holdings in Fairfield Communities common stock amounted to $26.4 million. This compares to $5.0 million in realized investment gains in 1995.
GEC is an international investment company with offices in Toronto, Ontario, Canada and in La Jolla, California. GEC holds a portfolio of equity securities and convertible instruments in North American, Asian and European companies, as well as a number of interests in land, water and mineral rights in the western United States through Vidler and NLRC. The operations of Vidler and NLRC are reported below in a separate segment entitled "Surface, Water, Geothermal and Mineral Rights," and are excluded from this discussion of GEC's portfolio investments.
Effective November 14, 1995, a wholly-owned subsidiary of GEC acquired all the outstanding common stock of Vidler, a Colorado corporation engaged in the water marketing and transfer business. Vidler's business plan calls for Vidler to identify areas where water supplies are needed in the southwestern United States and then facilitate the transfer from current ownership to Vidler, and subsequently to municipalities, water districts, developers and others. Since its acquisition, Vidler and its immediate parent company have purchased water rights and related assets in Colorado, Nevada and Arizona. On April 23, 1997, GEC acquired 74.77% of the common stock of NLRC and PICO acquired the remaining 25.23%. NLRC owns approximately 1.365 million acres of deeded land located in northern Nevada, together with appurtenant water, geothermal and mineral rights. NLRC is actively engaged in maximizing the property's value in relation to water rights, mineral rights, geothermal resources, and land development.
MPL insurance revenues amounted to $3.9 million during 1997 compared to $12.2 million and $29.0 million during 1996 and 1995, respectively. The decline in MPL earned premiums accounted for most of this variance between years, other than the $6 million in revenues in 1995 from the sale of the Company's MPL business. Investment income also declined during 1997 as compared to 1996 and 1995, principally as a result of the reduced level of MPL claims and the associated reduced level of invested assets allocated to the MPL insurance business segment.
APL has been concentrating its efforts on its unique critical illness product "Survivor Key" during the past several years. This life insurance product combines the benefits of a lump sum cash payout upon the diagnosis of certain critical illnesses with a death benefit. Gross written premiums for Survivor Key continually increased from 1994 through 1997.
The history of the Company is one of change and changing cash requirements. In 1995, Physicians took a significant step in changing its strategic direction by selling its ongoing MPL insurance business and related liability insurance business. During 1995, Physicians reactivated its investment advisory subsidiary, Summit; acquired a California property and casualty insurance company, Sequoia; and purchased 38.2% of GEC, a Canadian corporation active in international investments, surface, water, geothermal and mineral rights, and other businesses. See "ITEM 1 - -BUSINESS--HISTORY OF THE COMPANY." In 1996, Physicians took another large step in the continuing process of changing its strategic direction to maximize shareholder value with the reverse acquisition of Citation. On April 23, 1997, GEC and PICO purchased NLRC, owner of approximately 1,365,000 acres of deeded land in Northern Nevada, for a total purchase price of $48.6 million. During 1997, PICO increased its ownership in GEC to approximately 51.17 %. On June 16, 1997, Physicians announced the signing of a definitive agreement to sell its wholly-owned life and health insurance subsidiary, APL, and its wholly-owned subsidiary. In November and December 1997, GEC sold its investment in its Sri Lankan subsidiaries, providing funds for repayment of debt and additional investments.
As a result of ceasing to write MPL insurance, Physicians' operating cash flows have become, and should continue for the foreseeable future, to be negative. Positive cash flows from other sources within Physicians, primarily reinsurance recoveries, investment income and the sale of invested assets may partially offset such uses of cash. Major cash outflows most likely will include the funding of claims and loss adjustment expenses, investment purchases, dividend distributions, and operating costs. The Company's active insurance P & C subsidiaries, Sequoia and CIC, should provide positive cash flows from premium writings, investment income, and the sale of invested assets. Cash will be used to fund the payment of their own claims and operating expenses, as well as in purchasing investments. Summit should produce positive cash flow in the form of investment management fees in excess of operating costs.
As of December 31, 1995, when Physicians and PRO ceased writing MPL, Physicians and PRO reported discounted unpaid loss and loss adjustment expense reserves of approximately $136.2 million, net of reinsurance. Based upon projections from past actuarial information, more than 75%, or $102 million, of these reserves are expected to be settled by the end of the year 2000. Past experience indicates that funding requirements should be greatest in the first through third years (1996 through 1998), accounting for more than 60% of the total eventual reserve and loss adjustment expense payments. As expected, loss and LAE reserves at December 31, 1996 declined more than 17.1% to $112.9 million after payment of more than $30 million in claims and LAE. During 1997, MPL reserves of approximately $77.5 million at December 31, 1997, decreased an additional $35.4 million, or 31.4%, after payment of more than $38 million in losses and LAE.
At December 31, 1997, Physicians' and PRO's investment portfolios on a stand-alone basis contained invested assets of approximately $120.6 million, plus cash and cash equivalents of $10.8 million. These invested assets are in excess of the present value of expected future payouts of losses and loss adjustment expenses (discounted at 4%) of approximately $77.5 million. Physicians is in the process of selling APL, its life and health insurance subsidiary. When sold, the proceeds from this sale may provide additional available cash.
Unsecured reinsurance risk is concentrated in the companies and amounts shown in the table under Note 12 ("Reinsurance") to the Consolidated Financial Statements as of December 31, 1997. Most companies listed are highly rated companies with significant sources of capital.
CYCLICAL NATURE OF THE P&C INDUSTRY. The P & C insurance industry has been highly cyclical, and the industry has been in a cyclical downturn over the last several years due primarily to premium rate competition, which has resulted in lower profitability. Premium rate levels are related to the availability of insurance coverage, which varies according to the level of surplus in the industry. The level of surplus in the industry varies with returns on invested capital and regulatory barriers to withdrawal of surplus. Increases in surplus have generally been accompanied by increased price competition among P & C insurers. The cyclical trends in the industry and the industry's profitability can also be affected significantly by volatile and unpredictable developments, including natural disasters, fluctuations in interest rates, and other changes in the investment environment which affect market prices of insurance companies' investments and the income from those investments. Inflationary pressures affect the size of losses and judicial decisions affect insurers' liabilities. The demand for P & C insurance can also vary significantly, generally rising as the overall level of economic activity increases and falling as such activity decreases.
- Nevada Land and Resource Company, LLC ("NLRC"). The Company acquired NLRC on April 23, 1997. PICO owns 25.23% of NLRC and Global-Nevada Land Resource Corporation, a wholly-owned subsidiary of GEC owns the remaining 74.77% (Note 3). NLRC owns approximately 1,365,000 acres of deeded land with appurtenant water, geothermal and mineral rights in northern Nevada.
Effective November 14, 1995, a wholly-owned subsidiary of GEC acquired all the outstanding common stock of Vidler Water Company, Inc. ("Vidler"), a Colorado corporation engaged in the water marketing and transfer business. Vidler's business plan calls for Vidler to identify areas where water supplies are needed in the southwestern United States and then facilitate the transfer from current ownership to Vidler, and subsequently to municipalities, water districts, developers and others. Since its acquisition, Vidler and its immediate parent company have purchased water rights and related assets in Colorado, Nevada and Arizona.
NLRC, which is 74.77% owned by GEC and 25.23% by PICO owns approximately 1.365 million acres of deeded land located in northern Nevada, together with appurtenant water, geothermal and mineral rights. NLRC is actively engaged in maximizing the property's value in relation to water rights, mineral rights, geothermal resources, and land development.
As discussed in Note 11, approximately 17.6% of the Company's common stock was owned by Guinness Peat Group plc as of December 31, 1997 and 19% as of December 31, 1996. In addition, GEC and CIC own approximately 13.1% and 1%, respectively, of the Company's common stock as of December 31, 1996 and 1997. The Company's common stock owned by GEC and CIC has been accounted for as treasury stock in the Company's consolidated financial statements.
As discussed in Note 1, on April 23, 1997, GEC and the Company purchased NLRC. The total purchase price was approximately $48.6 million. A wholly-owned subsidiary of GEC owns 74.77% of NLRC. The Company paid approximately $12 million for the remaining interest. GEC financed its portion of the acquisition in part by issuing to the Company a 7% debenture in the principal amount of approximately $25 million. The debenture was subsequently repaid along with accrued interest.
Pre tax net realized gains (losses) on investments were as follows for each of the years ended December 31:
Because APL and its subsidiary represent a major segment of the Company's business, in accordance with Accounting Principles Board Opinion No. 30 "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business," APL's operations for all of 1997 have been classified as discontinued operations. Net income for 1996 and 1995 have also been reclassified for comparative purposes to reflect the discontinued operations. In addition, the net assets of APL have been shown as a single line item in the accompanying 1997 balance sheet as "Net assets of discontinued operations" at December 31, 1997.
No options were granted in 1997. The Company granted stock options in 1996 and 1995 to employees and directors. The stock options granted in 1996 and 1995 have terms of 10 years. The options granted to directors were vested immediately on the grant date. The options granted to employees vest either (i) at the rate of 25%, 33% or 50% per year on each of the first four, three or two year anniversaries of the date of grant, as applicable, or (ii) at a rate of 33% upon grant and 33% per year on each of the first two anniversaries of the date of grant. All options granted under the CIG plan became fully vested upon consummation of the merger.
On March 6, 1996, Charles E. Bancroft, the President and Chief Executive Officer of Sequoia, entered into an incentive agreement with Sequoia after its acquisition by Physicians. Under the terms of this incentive agreement, Mr. Bancroft is to receive a payment equal to ten percent of the increase in Sequoia's value upon his retirement, removal from office for reasons other than cause, or the sale of Sequoia to a third party. For purposes of the incentive agreement, the increase in Sequoia's value is to be measured from August 1, 1995, the date Physicians acquired Sequoia. Mr. Bancroft will not be eligible to receive any incentive payment, and no such incentive payment will be considered to be earned, until Mr. Bancroft had been an employee of Sequoia continuously from August 1, 1995 through August 1, 1998. On March 20, 1998 this incentive agreement was clarified to include the combined increase in value of Sequoia and CIC. The increase in value of CIC will be measured from January 1, 1998. The Company recorded compensation expense of $250,000 during the year ended December 31, 1997 related to this arrangement.