The following selected historical financial data for each of the five years ended December 31, 2000 is derived from the Company's audited consolidated financial statements. The selected data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of
The Company conducts business in two primary categories: fee-for-service operations and traditional insurance operations. Its fee-for-service operations include the activities of INS, its flood operations, and its operations as a servicing carrier for the SC Facility and the SCAAIP. INS provides a variety of claims-related management and adjudication services to the insurance industry, including claims handling, networked glass claims handling and automobile appraisals. The Company's flood unit is a leading provider, and is an original participant, in the NFIP, a flood insurance program administered by the federal government. In this capacity, the Company writes flood insurance for the NFIP in 46 states, and it offers excess flood insurance as a broker for Lloyd's of London. As such, the Company receives commissions and fees from the NFIP and Lloyd's of London, but retains no underwriting risk. The Company's flood operations also offers flood zone determinations and flood compliance tracking services through its subsidiary, AFS. The Company is a servicing carrier for the SC Facility and the SCAAIP. Under both of these pools, the Company issues policies and adjusts claims for a fee. The SC Facility is currently in runoff; however, the Company may continue to cede premiums to the SC Facility through March 1, 2002, at which time final runoff of the SC Facility will commence. The Company is required to continue to adjudicate claims it ceded to the SC Facility during the final runoff, for which it will be paid a fee. The SCAAIP became effective in March 1999 and will survive the SC Facility. Although the SCAAIP offers the Company access to additional fee-based revenue with no underwriting risk, thus far into the runoff of the SC Facility, the Company has not experienced significant activity in the SCAAIP.
The Company's traditional insurance operations include its North Carolina nonstandard automobile subsidiary, UIC, and its commercial lines operations. UIC writes nonstandard automobile insurance primarily in the state of North Carolina. UIC cedes substantially all of its liability premiums to the NC Facility and adjusts the related claims for the NC Facility for a fee. Substantially all of UIC's retained risk operations is on physical damage policies, which are minimum limit policies partially reinsured through a quota share reinsurance agreement. The Company also writes commercial lines insurance, which includes business owner's policies, commercial package policies and commercial automobile policies. These "main street" policies are sold primarily to small businesses. The Company reinsures its commercial lines through quota share, facultative, excess of loss, catastrophe and umbrella reinsurance agreements.
The Company seeks to balance its fee-based operations with selective risk underwriting to increase the Company's value for its shareholders, agents and employees by pursuing maximum growth with limited risk exposure.
Fiscal 2000 was a year of significant change for the Company. Beginning in May 2000, the Company began a comprehensive review of the profitability potential of each of its business segments. As a result of this review, the Company concluded that it would discontinue two of its nonstandard automobile insurance operations. In June 2000, the Company announced the discontinuation of its Nashville operations under its subsidiary, Graward. Of the $16,421 in special items charged to earnings in the second quarter of 2000, $15,678 were non-cash items, including impairment of goodwill associated with the Graward acquisition of $14,915. In July 2000, the Company announced its planned withdrawal from the South Carolina voluntary nonstandard automobile insurance market. Both the Graward and the South Carolina automobile operations had suffered substantial operating losses in 1998 and 1999, with indications that the losses would continue throughout 2000 and that neither operation could become profitable in the foreseeable future. The substantial losses from these two operations and the special items charges associated with discontinuing the Graward operation were the single largest contribution to the Company's consolidated net loss in 2000.
The Company's consolidated net loss in 2000 is primarily related to its nonstandard automobile insurance business. Due to high loss and expense ratios in the Company's Nashville operation, and high loss ratios in its South Carolina voluntary nonstandard automobile business, the Company concluded that these operations could not become profitable in the foreseeable future. Therefore, the Nashville operation was discontinued and the Company began its withdrawal from the South Carolina voluntary nonstandard automobile insurance market. Though the Company's UIC operations were also unprofitable in 2000, the Company believes this operation has profitability potential in the foreseeable future and has implemented profitability initiatives in the fourth quarter of 2000 and the first quarter of 2001 to end the losses. The SC Facility began its three-year run off March 1, 1999. Though the Company may no longer cede premiums to the SC Facility after March 1, 2002, it is required to adjudicate claims it ceded to the SC Facility during the final runoff, for which it will be paid a fee. The Company also issues nonstandard automobile policies and adjusts claims for the SCAAIP, the joint underwriting association formed to replace the SC Facility. The Company is one of two servicing carriers for the SCAAIP. Although the SCAAIP offers the Company access to additional fee-based revenue with no underwriting risk, thus far into the runoff of the SC Facility the Company has not experienced significant activity in the SCAAIP.
Physical damage coverage is retained on voluntary business in North Carolina, as the NC Facility does not reinsure this coverage. Liability coverage, however, is reinsured 100% in the NC Facility. Companies ceding liability coverage to the NC Facility receive an expense allowance for processing the business and a claims allowance for adjusting the claims on that business. Every company that transacts business in North Carolina is a member of the NC Facility. The North Carolina-based UIC operation began the year with favorable loss ratios. However, during the fourth quarter of 2000, the operation began experiencing a deterioration in its loss ratios. The deteriorated loss ratio, coupled with an unfavorable quota share reinsurance agreement, are the primary drivers of the operation's losses in 2000. Under the terms of the quota share reinsurance agreement, the Company must adjust the ceding commission received from the reinsurer on a point-for-point sliding basis as the loss ratio surpasses a defined threshold. When the loss ratio began to deteriorate late in 2000, the Company accrued for the adjustment to the ceding commissions received from the reinsurer. The Company has taken action to mitigate these losses and improve the loss ratio in 2001 through the implementation of various rate increases. The Company continually reevaluates both UIC's insurance rates and its quota share reinsurance contract, which is due to terminate June 30, 2001.
The Company's flood product line includes flood insurance, excess flood insurance, flood zone determinations, claims processing and flood compliance tracking services. The Company's basic flood insurance product is underwritten by the NFIP, a federal government program that sets policy rates, bears risks and pays claims. Working through its independent agents located across the United States, the Company issues policies and processes claims on behalf of the NFIP. The NFIP policies only cover losses up to $250 for residential buildings and $100 for contents. Further, the NFIP commercial coverage is limited to $500 for either buildings or contents. The Company's excess flood insurance product provides a level of protection above the NFIP's limits for residential and commercial properties. The Company, as broker, receives commissions for placing this business. The Company also believes that offering the excess flood product allows it to improve its relationships with its agency force by offering them a broader product portfolio.
The Company, through AFS, offers the additional flood-related services of flood zone determinations and flood zone mapping services to customers located throughout the United States. These services are provided primarily to mortgage originators to determine whether or not homes are located in flood zones and, therefore, require flood insurance. These services allow the Company to offer a more complete flood portfolio to both agents and financial institutions, provide the Company with a stronger presence in the flood market and expand the channels of distribution for the Company's complementary products.
Commercial lines represents an important diversification for the Company, further complementing its product offerings and enabling independent agents to bundle its products for a more complete insurance portfolio. This diversification makes the Company more attractive to agents, enabling them to work with the Company to better serve their customers. The commercial lines operation lost $247 in 2000, primarily due to high expense ratios associated with a lower average premium. As the Company continues to automate the commercial lines operation and look for ways to increase its average premium, the operation is expected to once again become profitable.
INS is an important part of the Company's corporate structure. It has over 50 unaffiliated customers and can accommodate claims services requests from anywhere in the United States. INS claims representatives are differentiated from their counterparts at traditional claims adjusting companies by having an insurance company background, an important characteristic when equitably settling claims.
The Company continues to maintain reserves and pay significant claims with respect to its runoff operations. These operations consist primarily of general liability policies that include contractors' liability and environmental coverages primarily in California and commercial (including workers' compensation) and personal lines policies in the Southeast. The runoff of claims on these policies created substantial losses for the Company over the past 10 years. In addition, the Company's runoff segment contains the management of runoff reserves from prior business in the 1980's and runoff from a nonstandard homeowners MGA book of business in Kentucky and Tennessee entered into in early 1997. The Company discontinued writing new business in this MGA book of business in October of 1998.
The commercial reporting segment accounted for $132 of the overall decrease, posting premiums earned of $3,040 for the year ended December 31, 2000 versus $3,172 for the same period of 1999. Effective March 31, 1999, the Company entered into a 90% quota share reinsurance agreement that remained in place through March 31, 2000. Effective April 1, 2000, the 90% quota share reinsurance agreement was amended to become a 70% quota share reinsurance agreement. The amendment was made to capitalize upon the favorable underwriting results of the commercial book of business. Retaining a larger portion of its commercial book of business had a positive impact on the Company's earned premium for the year ended December 31, 2000. However, more than offsetting this increase in earned premium was the decrease in commercial writings over the last six months of 2000. In accordance with a mandate from the NCDOI, the Company ceased writing new commercial business in the state of North Carolina at the beginning of the third quarter of 2000. The Company may, however, continue renewing existing commercial business at its discretion.
The remaining $25 decrease in premiums earned came from the Company's flood and runoff operations.
Realized losses for the year ended December 31, 2000 consisted of $236 in losses resulting from the liquidation of a portion of the Company's bond portfolio. Partially offsetting these losses were gains of $11 associated with the disposition of certain property and equipment. Furthermore, in December 2000, the Company sold its corporate headquarters with a net book value of $2,589 to its majority shareholder and Chairman of the Board of Directors for $4,500, resulting in a gain of $1,892. Expenses incurred in connection with the sale were $19. Concurrent with this transaction, the Company leased the property back for a fixed period of three years without an option for renewal. The gain resulting from this transaction has been deferred and will be amortized into income evenly over the term of the leaseback.
Policy acquisition costs decreased $8,718 for the year ended December 31, 2000 compared to 1999, or 25.9%. Fluctuations in policy acquisition costs are directly correlated to fluctuations in direct written premium. Direct written premium for the year ended December 31, 2000 amounted to $125,018, a $43,588, or 25.9%, decrease from the $168,606 written during the same period in 1999. See PREMIUMS EARNED for discussion concerning the decrease in premium volume for the year ended December 31, 2000 versus the same period of 1999.
Commission and service income for the year ended December 31, 1999 decreased $3,646, or 7.4%, to $45,652 from $49,298 for the year ended December 31, 1998. The automobile and commercial segments experienced declines of $5,657 and $814, respectively, related to the runoff of the SC Facility. Offsetting these decreases were increases in the flood and adjusting services segments of $2,812 resulting from increased storm-related activities and services.
Property and casualty premiums earned for the year ended December 31, 1999 increased $30,582, or 134.4%, to $53,344 from $22,762 for the year ended December 31, 1998. This increase is due to a $31,647 increase in nonstandard automobile premiums offset by a $804 decrease in commercial multi-peril premiums. The increase in nonstandard automobile earned premiums is a result of the Company's continued emphasis on premium growth during 1999 in addition to an entire year of sustained premium growth from Graward, which was acquired in May 1998, versus only seven comparable months during 1998. The decrease in commercial multi-peril earned premiums is a result of the unearned premium portfolio transfer associated with its 90% quota share reinsurance agreement effective March 1999. The remaining change in property and casualty premiums earned is attributable to a $322 decrease in earned premium in the Company's runoff operation.
There were no credit life premiums earned for the year ended December 31, 1999 as this operation was nearing completion of its runoff.
Net investment and other interest income for the year ended December 31, 1999 decreased 9.1%, or $425, to $4,220 from $4,645 for the year ended December 31, 1998. This decrease is due to a $4.6 million reduction in the Company's total cash and investments to fund operations and service its debt. Furthermore, the Company's average investment yield decreased to 4.7% in 1999 from 5.6% for
1998 due primarily to the Company's conservative investment portfolio consisting of significant investments in obligations of the U.S. Government and government agencies and authorities.
Property and casualty losses and loss adjustment expenses for the year ending December 31, 1999 increased $20,741, or 82.1%, to $46,010 from $25,269 for the year ended December 31, 1998. This increase is due to the Company's higher than expected losses on the increased premiums earned in 1999.
Other operating costs and expenses for the year ended December 31, 1999 decreased $11,938 or, 25.5%, to $34,885 from $46,823 for the year ended December 31, 1998. This decrease is due to significant one-time charges incurred and expensed in 1998, including approximately $1,000 associated with Year 2000 remediation and legal expenses; as well as approximately $2,000 in various other items. In addition, cost control measures designed to reduce the Company's operating expense ratios were implemented in the third quarter of 1999.
The liability for losses on direct business is determined using case-basis evaluations and statistical projections. The liabilities determined under these procedures are reduced, for GAAP reporting purposes, by an estimated amount to be received through salvage and subrogation. The resulting liabilities represent the Company's estimate of the net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates may be affected by the frequency and/or severity
of future claims. These estimates are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as necessary.
The ceded reinsurance recoverable on paid and unpaid losses and LAE, classified as an asset, includes $46,160, $66,371 and $94,440 at December 31, 2000, 1999 and 1998, respectively, of balances recoverable from the SC Facility, the NC Facility and the NFIP.
The difference between the year-end net liability for losses and LAE reported in the accompanying consolidated financial statements in accordance with GAAP and that in accordance with SAP was as follows for the years ended December 31:
The claims involve four Superfund sites, seven asbestos or toxic claims, two underground storage tanks and twenty-seven miscellaneous clean-up sites. For this direct business there are usually several different insurers participating in the defense and settlement of claims made against the insured. Costs and settlements are pro-rated by either time on the risk or policy limits.
In estimating the liability for reported and estimated losses and LAE related to environmental and construction defect claims, management considers facts currently known along with current laws and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy and management can reasonably estimate its liability. In exposures on both known and unasserted claims, estimates of the liabilities are reviewed and updated continually. The potential development of losses is restricted by policy limits.
Because only forty claims remain open as of December 31, 2000, the exposure to significant additional development is less than when the claims were less mature. In addition, the likelihood of new claims being asserted for construction liability is lessened by the expiration of statutes of limitations since the last policy expired over ten years ago.
Liquidity relates to the Company's ability to produce sufficient cash to fulfill contractual obligations, primarily to policyholders. Sources of liquidity include service fee income, premium collections, policy fees, investment income and sales and maturities of investments. The principal uses of cash are payments of claims, principal and interest payments on debt, payments for operating
The most significant source of cash flows from operating activities resulted from the net collection of $4,497 of reinsurance recoverable on paid losses and LAE. As of December 31, 1999, the Company reinsured 90% of its commercial operations. Effective April 1, 2000, the agreement was amended to reduce the reinsured percentage to 70% in an effort to capitalize on the profitability of this business. The reduction in the quota share reinsurance accounted for $2,246 of the net collection of reinsurance recoverable on paid losses. The remaining $2,251 net collection of reinsurance recoverable on paid losses is attributable to substantial collections under various old reinsurance treaties nearing completion of runoff. An additional source of cash flows from operating activities was the Company's net collection of premiums and agent's balances receivable. During the second and third quarters of 2000, the Company's Nashville and South Carolina automobile operations, respectively, were placed into runoff due to the unprofitable nature of the operations. The substantial decrease in direct written premium over the last six months of 2000, coupled with the Company's increased collections efforts to reduce bad debts expected from the runoff of the operations, resulted in net collections of premiums and agent's balances receivable of $6,519.
Investing activities in 2000 used cash in the amount of $222. In December 2000, the Company sold its corporate headquarters to its majority shareholder and Chairman of the Board of Directors, providing cash of $4,500 less $19 of expenses incurred in connection with the sale. Concurrent with this transaction, the Company leased the property back for a fixed period of three years without an option for renewal. The Company received $11 from the sale of other property and equipment and used $212 for the purchase of additional property and equipment. More than offsetting the cash provided by these transactions was net cash used in the purchase of debt and equity securities of $4,502. Effective
January 21, 2000, three of the Company's insurance subsidiaries collectively acquired a 30.625% equity ownership interest in QualSure Holding Corporation, the holding company parent of QualSure, a homeowners take-out insurance company domiciled in the state of Florida, for $4,900. In connection with this investment, INS entered into a Claims Administration Services Agreement with QualSure to adjudicate all of its claims for a fee based upon subject earned premium. Approximately $398 of cash was provided through net liquidations and maturities of the Company's debt securities portfolio.
The Company is a legal entity separate and distinct from its subsidiaries. As a holding company, the primary sources of cash needed to meet its obligations, including principal and interest payments on outstanding debt, are dividends and other permitted payments, including management fees, from its subsidiaries and affiliates.
South Carolina and North Carolina insurance laws and regulations require a domestic insurer to report any action authorizing distributions to shareholders and material payments from subsidiaries and affiliates at least 30 days prior to distribution or payment except in limited circumstances. Additionally, those laws and regulations provide the Department of Insurance with the right to disapprove and prohibit distributions meeting the definition of an "Extraordinary Dividend" under applicable statutes and regulations.
companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy, and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that are potentially inadequately capitalized. Compliance is determined by the ratio of the Company's regulatory total adjusted capital to its company action level RBC (as defined by the NAIC). Companies which fall below the company action level RBC are required to disclose plans to remedy the situation. As of December 31, 2000, all of the insurance subsidiaries have ratios in excess of the level that would prompt regulatory action.
- the effects and impact of laws, rules and regulations which apply to insurance companies;
- geographic concentrations of loss exposure, causing revenues and profitability to be subject to prevailing regulatory, demographic and other conditions in the area in which the Company operates;
- the availability of reinsurance and the ability of the Company's reinsurance arrangements to balance the geographical concentrations of the Company's risks;
- the ability to successfully implement the restructuring plan and the risk that current initiatives may not be successful;
- the outcome of certain litigation and administrative proceedings involving the Company;
- control of the Company by a principal shareholder, which shareholder has the ability to exert significant influence over the policies and affairs of the Company;
Accordingly, there can be no assurance that the actual results will conform to the forward-looking statements discussed or incorporated by reference in this annual report on Form 10-K.
The Company receives fee-based income from its catastrophe, property and casualty and automobile claims adjusting services and liability runoff management services. The Company's premium concentration in the catastrophe-heavy Southeast led to the creation of a catastrophe adjusting
The net losses experienced in 2000 and 1999 are primarily related to the Company's automobile segment, which includes its Nashville and North Carolina operations, South Carolina voluntary automobile operations, the SC Facility and the NC Facility. The overall automobile segment incurred net losses of $15,245 and $12,761 in 2000 and 1999, respectively. Within the overall automobile segment, the Nashville and South Carolina automobile operations accounted for the most significant portion of the losses, losing approximately $13,325 and $2,076, respectively, in 2000 and approximately $4,235 and $4,845, respectively, in 1999.
The Company began 2000 with a variety of challenges. The nonstandard automobile market remained intensely competitive, keeping downward pressure on insurance rates and significantly impacting the ability of the Company's risk-bearing insurance operations, most notably the Nashville and South Carolina automobile operations, to become profitable. In addition, the SC Facility would continue its runoff and have an adverse affect on the Company's commission and service income opportunities. From a regulatory compliance standpoint, the Company's primary insurance subsidiary, SCIC, remained subject to a minimum statutory capital and surplus requirement placed by the South Carolina Department of Insurance (the "SCDOI") which was in excess of statutorily required minimums. Finally, the Company's credit facility stipulated that the Company demonstrate compliance with a number of affirmative and negative covenants on a quarterly basis. Significant financial covenants include minimum statutory capital and surplus levels, ratios of debt to total capitalization and cash flow coverage.
During the first and second quarters of 2000, in an attempt to mitigate the losses experienced during 1999, the Company intensified its cost control and profitability measures originally introduced in the third and fourth quarters of 1999. These measures were primarily directed at the Nashville and South Carolina automobile operations in an attempt to turn the operations profitable. Despite these efforts, however, both operations remained unprofitable. During the second quarter of 2000, management concluded that all available actions and cost control measures that could reasonably be taken in relation to the Nashville operations had been taken and that it would not generate profits. That operation was then discontinued (see SPECIAL ITEMS). Similarly, during the third quarter of 2000, it was concluded that the South Carolina automobile operations also would not generate profits. As a result, the Company began its withdrawal from the voluntary nonstandard automobile market in South Carolina. With these actions, management believes it has effectively addressed the major causes of its operating losses in 2000 and has positioned the Company for profitability in 2001.
From a debt compliance standpoint, after obtaining waivers of noncompliance for minimum statutory capital and surplus levels and the ratio of debt to total capitalization, the Company was in compliance with credit facility covenants as of December 31, 2000. Additionally, the restrictive minimum statutory capital and surplus requirement placed by the SCDOI on SCIC, which was in excess of statutorily required minimums and related to premium writings on retained business, was no longer restrictive once the Company announced the discontinuation of its Nashville operations and its withdrawal from the nonstandard voluntary automobile market in South Carolina. These actions removed SCIC from the majority of its voluntary automobile risk-bearing market.
The Company continues with many of the same challenges. The SC Facility will continue its runoff and have an adverse affect on the Company's commission and service income opportunities. With regard to the Company's credit facility, it must still demonstrate compliance with a number of affirmative and negative covenants on a quarterly basis, including minimum statutory capital and surplus levels, ratios of debt to total capitalization and cash flow coverage. While the Company indeed continues to face considerable challenges in 2001, it now operates without the significant losses generated by the unprofitable Nashville and South Carolina automobile operations. Furthermore, INS continued its growth in 2000 and is expecting additional growth in 2001 to partially offset the Company's expected decrease in commission and service income. In addition, UIC is under new management and is planning on significantly increasing its business ceded to the NCRF, thereby increasing the Company's commission and service income with no underwriting risk. The Company is also actively seeking other fee-based opportunities in the insurance marketplace. Finally, in 2001 SCIC is subject to the normal capital and surplus requirements enforced by the SCDOI and it is management's opinion that the Company's amended affirmative and negative covenants under its credit facility allow for the Company to be in compliance within its 2001 Business Plan. Management is of the opinion that the Company's operations will be profitable in 2001 and that it will be able to maintain compliance with existing capital and surplus and debt requirements.
Investments in debt and equity securities are classified as either held-to-maturity, available-for-sale or trading. The Company currently holds all securities as available-for-sale, and reports them at fair value, with subsequent changes in value reflected as unrealized investment gains and losses credited or charged directly to accumulated other comprehensive income included in shareholders' equity.
The fair values of debt securities and equity securities were determined from nationally quoted market rates. The fair market value of certain municipal bonds is assumed to be equal to amortized cost where no market quotations exist.
Cash and short-term investments consists of cash on hand, time deposits and commercial paper. Short-term investments have an original maturity of three months or less and are considered to be cash equivalents.
The Company offers premium financing arrangements that require a down payment and payment of the remaining balance in equal installments over the policy term.
The Company routinely evaluates the collectability of receivables and has established an allowance for uncollectable accounts for agents' balances and direct billed balances receivable and premium notes receivable in the amount of approximately $5,180 and $4,640 at December 31, 2000 and 1999, respectively.
Intangible assets consist primarily of goodwill and deferred loan costs. Goodwill is the excess of the amount paid to acquire a company over the fair value of its net assets, reduced by amortization and any subsequent valuation adjustments. The Company amortizes goodwill using the straight-line method over a period not to exceed 40 years. Deferred loan costs are the costs associated with issuing long term debt. The costs are amortized over the life of the debt. Intangible assets are continually evaluated to determine if any portion of the remaining balance may not be recoverable. If circumstances suggest that their value may be impaired and the write-down would be material, an assessment of recoverability is performed and any impairment is recorded through a valuation allowance with a corresponding charge recorded in the statements of operations. During 2000, the Company concluded that the goodwill associated with the acquisition of Graward General Companies, Inc. ("Graward") was fully impaired (see SPECIAL ITEMS).
(3) Estimates of allocated, as well as unallocated, loss adjustment expense liabilities determined by applying percentage factors to the unpaid loss reserves, with such factors determined on a by-line basis based on past results of paid loss expenses to paid losses.
Commission and service income is predominately derived from servicing carrier and managing general agent activities. The commission income related to producing and underwriting the business is recognized in the period in which the business is written. Service income and policy fees related to claims processing are recognized on an accrual basis as earned.
Property and casualty premiums are reflected in income when earned as computed on a monthly pro-rata basis. Written premiums and earned premiums have been reduced by reinsurance placed with other companies, including amounts related to business produced as a servicing carrier.
Policy acquisition costs attributable to property and casualty operations represent that portion of the cost of writing business that varies with, and is primarily related to, the production of business. Such costs are deferred and charged against income as the premiums are earned. The deferral of policy acquisition costs is subject to the application of recoverability tests to each primary line or source of business based on past and anticipated underwriting results. The deferred policy acquisition costs that are not recoverable from future policy revenues, if any, are expensed. The Company considers anticipated investment income in determining whether premium deficiencies exist.
In June 2000, the Company's Board of Directors approved and the Company announced a restructuring plan (the "Restructuring Plan") centering on the discontinuation of its Nashville operations. The Restructuring Plan will be substantially completed by December 31, 2001 and includes approximately $16,421 in special charges related primarily to the impairment of long-lived assets associated with the operation, employee severance, and the cancellation of contractual commitments. The cash requirements of the Restructuring Plan were estimated to be approximately $743 and will be substantially expended by March 31, 2001. Restructuring costs include all costs directly related to the Restructuring Plan. Employee termination costs were recognized when benefit arrangements were communicated to affected employees in sufficient detail to enable the employees to determine the amount of benefits to be received upon termination. Other exit costs resulting from the exit plan that were not associated with and that did not benefit continued activities were recognized at the date of commitment to the exit plan. Other costs directly related to the discontinuation of the Nashville operations that were not eligible for recognition at the commitment date, such as relocation costs and estimated operating costs to be incurred during the runoff period, are being expensed as incurred.
On November 29, 2000, the Company reached a settlement with the sellers of Graward related to certain purchase price adjustments. In the settlement, the sellers of Graward agreed to cancel four
All charges associated with the Restructuring Plan were determined based on the formal plans of management, and approved by the Board of Directors, using the best information available. The amounts ultimately incurred could change as the operations are run off over 2001.
Comprehensive income is a measure of all non-owner changes in equity of an entity and includes net loss plus changes in certain assets and liabilities that are reported directly through equity.
Unrealized gains and losses on debt and equity securities are credited or charged directly to accumulated other comprehensive income and included in shareholders' equity. Realized gains and losses on investments included in the results of operations are determined using the "identified
Excluding investments in the U.S. Government, government agencies and authorities, the only investments exceeding 10% of shareholders' equity at December 31, 2000 were the Company's equity investments in Sunshine State Holding Corporation and QualSure Holding Corporation totaling $6,307.
The equity securities consist of investments in Sunshine State Holding Corporation and QualSure Holding Corporation. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties. The amortized cost and estimated market value of debt securities at December 31, 2000, by contractual maturity, are as follows:
Depreciation expense charged to operations was $1,451 in 2000, $1,800 in 1999 and $1,654 in 1998.
In December 2000, the Company sold its corporate headquarters with a net book value of $2,589 to its majority shareholder and Chairman of the Board of Directors for $4,500, resulting in a gain of $1,892. Expenses incurred in connection with the sale were $19. Concurrent with this transaction, the Company leased the property back for a fixed period of three years without an option for renewal (see Note 15). The gain resulting from this transaction has been deferred and will be amortized into income evenly over the term of the leaseback.
Policy acquisition costs incurred and amortized to income on property and casualty business were as follows:
Effective March 31, 1998 the Company entered into a $15,000,000 credit facility (the "Facility") with a major lending institution for the purpose of financing its acquisitions activity and other general corporate purposes. Security for the Facility includes substantially all of the Company's assets. Principal payments are due quarterly beginning March 1999 with a final payment of all remaining principal and accrued interest due in June 2004. Accrued interest is payable monthly on the outstanding balance under the Facility and is calculated, at the Company's discretion, using a pre-determined spread over LIBOR or the prime interest rate of the lending institution. The effective interest rate was 9.44% on December 31, 2000 and 8.94% on December 31, 1999. The Facility is secured by a lien on the assets of the Company.
NOTE 5 DEBT (CONTINUED) Effective November 29, 2000, in connection with the settlement of liabilities the Company assumed upon the acquisition of Graward, the holders of the subordinated convertible notes payable released and discharged the Company from liability under the notes and the Company issued warrants to purchase 25,000 shares of common stock at $3.00 per share and an additional 25,000 shares of common stock at $7.00 per share (see Notes 8 and 15). The Company recorded a special items gain of $2,700 in connection with this transaction.
The Company uses the liability method in accounting for income taxes. A reconciliation of the income tax provision (benefit) to that computed by applying the statutory federal income tax rate to loss before income taxes is as follows:
The Company has unused tax operating loss carryforwards and capital loss carryforwards of $104,857 for income tax purposes. However, due to "change in ownership" events that occurred in June 1998, January 1997, and January 1995, the Company's use of the net operating loss carryforwards are subject to maximum limitations in future years of approximately $2,200 per year. Net operating loss carryforwards available for use in 2001 are approximately $10,900 due to losses incurred in 1998, 1999 and 2000 after the change in ownership event occurred and carryover of previous years' unused limitations.
NOTE 7 PROPERTY AND CASUALTY UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
A part of the Company's reserve for losses and loss adjustment expenses ("LAE") is set aside for environmental, pollution, and toxic tort claims. These claims relate to business written by the Company's previously owned West Coast operation prior to 1986. On June 7, 1994, the Company settled a dispute related to approximately 400 of these claims. Any future liability on these claims is limited to 50% of the direct loss and LAE paid. The Company's obligation does not begin until the other company involved in the settled dispute pays, subsequent to the settlement date, a total of $20 million in losses and LAE. As of December 31, 2000 and 1999, $14.3 million and $13.8 million, respectively, of claims payments have been made by the other company since the settlement date.
NOTE 8 SALE, MERGERS AND ACQUISITIONS (CONTINUED) policies from the Florida Windstorm Underwriting Association and approximately 40,000 homeowners policies from the Florida Residential Property & Casualty Joint Underwriting Association. In connection with this investment, INS entered into a Claims Administration Services Agreement with QualSure to adjudicate all of its claims for a fee based upon subject earned premium.
Effective May 1, 1998, the Company acquired all of the issued and outstanding shares of common stock of Graward. Consideration in the transaction included cash of $7,500 and Subordinated Convertible Notes (the "Notes") with a principal amount of $2,700. The Company accounted for the transaction as a purchase. The excess purchase price over the fair value of the assets was $16,245 (see Note 1 "SPECIAL ITEMS").
Effective March 31, 1998, the Company acquired all of the issued and outstanding shares of common stock of Americas Flood Services, Inc. ("AFS"). Consideration in the transaction included cash of $2,100 and 50,000 shares of the Company's $0.625 Cumulative, Convertible, Redeemable, Nonvoting Special Preferred Stock ("$0.625 Special Stock") (see Note 9). The Company accounted for the transaction as a purchase. The excess purchase price over the fair value of the assets was $2,237.
The results of operations in the Company's consolidated financial statements include a full year's operations of Graward and AFS in 2000 and 1999, and eight (Graward) and nine (AFS) month's worth of operations in 1998. The following pro forma unaudited consolidated results of operation for 1998 give affect to the acquisitions as though they had occurred at the beginning of the year. The dividends on the preferred stock and interest of the notes have been considered.
On December 1, 1997, the Company issued 220,000 shares of Cumulative, Convertible, Redeemable, Nonvoting Special Preferred Stock ("Special Stock") in connection with an acquisition. The Company determined the value of the Special Stock at the issuance date to be $2,200. The Special Stock pays quarterly dividends at an annual rate of $0.62 per share. The Company paid $137 in special stock dividends in 2000 and 1999. On or after August 15, 2000, but prior to August 15, 2002, the Company, at its option, may redeem in whole or in part the Special Stock at a price of $15.00 per share. On August 15, 2002, the Company must redeem any remaining shares at a rate of $10.00 per share. On or after August 15, 2000, but prior to August 15, 2002, holders of the shares have the right to convert each share of the Special Stock into 1.25 shares, or a total of 275,000 shares, of the Company's common stock.
The South Carolina Insurance Holding Company Regulatory Act provides that, without prior approval of the Commissioner of Insurance of the State of South Carolina, dividends within any 12-month period may not exceed the greater of (i) 10% of a domestic insurer's surplus as regarding policyholders as shown in the insurer's most recent annual statement or (ii) a domestic insurer's net income, not including realized capital gains or losses as shown in the insurer's most recent annual statement. Furthermore, dividends may only be paid out of positive earned surplus unless approved by the Commissioner. As of December 31, 2000, SCIC had an accumulated deficit.
At December 31, 2000, 1999 and 1998, all common stock equivalents were anti-dilutive.
NOTE 11 STATUTORY REPORTING (CONTINUED) Significant changes to the Company's statutory accounting and reporting resulting from Codification include the following:
- The Codification requires the recognition of deferred tax balances, as defined by the Codification;
- Electronic data processing equipment and software are considered admitted assets with depreciable lives not to exceed 3 years;
Management has evaluated the impact of the Codification and does not believe it will have a material effect on the financial statements of the Company's statutory subsidiaries.
The 1996 Stock Option Plan for Employees (the "Employee Plan") became effective on November 1, 1995. The Employee Plan reserved 2,500,000 shares of the Company's common stock for
NOTE 12 BENEFIT AND STOCK OPTION PLANS (CONTINUED) issuance under the plan as options and incentive stock to employees and consultants of the Company. Activity in the Employee Plan is summarized as follows:
All grants made under the Employee Plan have exercise prices no lower than the market price at the date of grant. At December 31, 2000, 1,636,869 shares of the Company's common stock have been reserved for future grants. Following is a summary of options outstanding and exercisable by price range as of December 31, 2000:
The 1995 Stock Option Plan for Non-Employee Directors (the "Director Plan") became effective June 15, 1995, with 250,000 shares of the Company's common stock reserved for grants. Under the Directors Plan, all non-employee directors holding office on June 15 of each year are granted 1,250 options to purchase the Company's common stock. The exercise price of the options is the market value on the date of grant. On June 15, 1998, 1999 and 2000, 12,500, 12,500 and 8,750 shares were granted, respectively, at exercise prices of $7.00, $4.75 and $1.09, respectively.
Options granted during 1998, 1999, and 2000 were granted at average exercise prices of $6.97, $4.68, and $1.83, respectively. At December 31, 2000, 120,451 shares of the Company's common stock have been reserved for future grants.
The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for its three stock option plans. Had compensation costs for the Company's stock option plans been determined based on the fair value at the grant date for awards in 2000, 1999 and 1998 consistent with the provisions of SFAS No. 123, the Company's net loss and loss per share would have been as indicated below:
The Company sponsors the South Carolina Insurance Company Employees' Profit-Sharing and Savings Plan (the "Plan"), which provides both a profit-sharing and a 401(k) element for the employees of the Company, its subsidiaries and affiliates. As of December 31, 2000, the amount of assets available in the Plan, based on information currently available, was $11,155.
The Company currently provides certain health care and life insurance benefits for certain retired employees. The projected future cost of providing post-retirement benefits is reflected as an expense as employees render services instead of when the benefits are paid. The net transition obligation is being recorded as a charge against income on a prospective basis as part of the future annual benefit cost. Post-retirement benefit expense was approximately $100 in 2000, $115 in 1999, and $90 in 1998.
NOTE 12 BENEFIT AND STOCK OPTION PLANS (CONTINUED) The weighted-average annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) was 5.5% for 2000, 6% for 1999, and 7% for 1998 and is assumed to decrease to a 5% ultimate trend (5% in 1999 and 1998) with a duration to ultimate trend of one year (two years in 1999 and three years in 1998). The health care cost trend rate assumption has an effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point each year would increase the post-retirement benefit obligation as of December 31, 2000 by $2.
NOTE 13 SEGMENT REPORTING (CONTINUED) each reportable segment's total net loss and LAE and unearned premium reserves. The results of the reportable segments are included in the following table:
The Company's property and casualty insurance operations include a retained risk component and a servicing carrier component. A significant percentage of the risk business is ceded through several reinsurance programs including pro-rata and excess of loss. In its servicing carrier operation, premiums
NOTE 14 REINSURANCE (CONTINUED) are ceded entirely to the applicable state's reinsurance facility or to the NFIP. A reconciliation of direct to net premiums, on both a written and an earned basis is as follows:
NOTE 14 REINSURANCE (CONTINUED) A summary of the Company's reinsurance recoverable on paid and unpaid losses and LAE, as well as its prepaid reinsurance premiums at December 31, 2000 is as follows:
NOTE 15 COMMITMENTS AND CONTINGENCIES (CONTINUED) into income evenly over the term of the leaseback. Lease expense incurred under this related party lease amounted to $13 in 2000. Approximate minimum future lease payments are as follows:
NOTE 15 COMMITMENTS AND CONTINGENCIES (CONTINUED) (e) On March 1, 2000, the Company received a demand from Generali-U.S. Branch ("Generali") for arbitration of claims arising under the April 1995 Agency Agreement between Generali and Graward. Effective February 19, 2001, the Company resolved these arbitration claims. As a result of the settlement, the remaining liabilities assumed upon the acquisition of Graward recorded in the amount of $6,527 were discharged in exchange for $1,000 in cash and the issuance of warrants to purchase 75,000 shares of the Company's common stock at $1.00 per share and an additional 75,000 shares of the Company's common stock at $2.00 per share (see Note 1). The resolution and ultimate quantification of these preacquisition liabilities resulted in a special items gain of $5,527.
(g) The Company and its subsidiaries are parties to various other lawsuits generally arising in the normal course of their insurance and ancillary businesses. The Company does not believe that the eventual outcome of such suits will have a material effect on the financial condition or results of operations of the Company.
On December 21, 2000, the Company sold its corporate headquarters to its majority shareholder and Chairman of the Board of Directors (see Note 3). Concurrent with this transaction, the Company leased the property back for a fixed period of three years without an option for renewal.
During the years ended December 31, 2000 and 1999, the Company paid a total of $110 and $2 to FHI, Inc. ("FHI"), respectively, for services related to the settlement of certain outstanding litigation. Kenneth W. Pavia, a member of the Company's Board of Directors and member of the Board of Director's Compensation Committee, is the owner of FHI.
NOTE 16 RELATED PARTY TRANSACTIONS (CONTINUED) Company leased the property back for a fixed period of three years without an option for renewal. The entire gain resulting from this transaction has been deferred and excluded from the 2000 statements of operations and will be amortized into income evenly over the term of the leaseback.
NOTE 16 RELATED PARTY TRANSACTIONS (CONTINUED) share (see Note 15). The resolution and ultimate quantification of these preacquisition liabilities resulted in a special items gain of $5,527 recorded in the fourth quarter of 2000.