The following table sets forth certain selected consolidated financial data and should be read in conjunction with, and is qualified in its entirety by, the Consolidated Financial Statements and the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere herein. This selected consolidated financial data has been derived from the audited Consolidated Financial Statements of the Company and its subsidiaries.
(1) For a discussion of the Company’s discontinued business, see “Business-Business Segments” and for a discussion of the accounting treatment of the Company’s MPCI business, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-General.”
(2) Statutory data has been derived from the separate financial statements of the Company’s insurance companies prepared in accordance with SAP. The statutory deficit at December 31, 2003 and 2002 relates only to AIC, the Company’s only consolidated insurance company. The statutory deficit at December 31, 2003 and 2002 was significantly impacted by the non-admission of pledged investments under statutory accounting principles totaling approximately $57.5 million and $89.9 million, respectively.
Acceptance Insurance Companies Inc.’s (“AICI”) tangible assets are comprised of approximately $2.7 million in cash and cash equivalents and $1.5 million of restricted cash equivalents. Additionally, AICI has an investment in its subsidiary, Acceptance Insurance Company (“AIC”). AICI may also benefit from proceeds, if any, related to its complaint against the United States of America (See Item 3. “Legal Proceedings”) and proceeds, if any, related to the sale of any of its shell subsidiaries. AICI’s short-term strategy is to reduce expenses and maintain adequate short-term liquidity while preserving and, if possible, enhancing assets. There is significant uncertainty as to whether or not AICI will be able to achieve the objectives under its short-term strategy. If AICI is unable to achieve these objectives, the Company will decide to take the course of action that is in the best interests of the Company based upon all relevant factors, which action may include filing bankruptcy.
The Company’s short-term strategy related to AIC is to minimize payments of losses and loss adjustment expenses, effectively manage the collection of reinsurance balances, maintain adequate short-term liquidity and reduce expenses. There is significant uncertainty as to whether or not the AIC will be able to achieve the objectives under its short-term strategy. If AIC is unable to achieve these objectives, the Company believes that the Director may increase regulatory control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of Liquidation. Even if AIC achieves these objectives, the Director currently has the authority to increase regulatory control of AIC. The Company believes that an Order of Rehabilitation would have a significant negative impact on the Company and that an Order of Liquidation would have a material adverse effect on the Company.
Subsequent to the issuance of the Company’s December 31, 2002 consolidated financial statements, the Company determined that SFAS No. 144 was not properly applied to the 2002 consolidated
financial statement presentation. The accounting policy the Company previously used classified the Company’s property and casualty operations as discontinued operations due to its inability to write new business under the Order of Supervision.
The Company historically has been an agricultural risk management company providing comprehensive insurance products (“Agricultural Segment”) and a provider of property and casualty insurance (“Property and Casualty Segment”). American Growers Insurance Company (“AGIC”), the Company’s wholly owned crop insurance subsidiary, was placed into rehabilitation by the District Court of
Lancaster County, Nebraska on December 20, 2002. Effective as of December 20, 2002, AGIC and its subsidiaries ceased to be under the control of the Company and are not included as consolidated subsidiaries of the Company. Additionally, AGIC and its supporting crop operations (the “Agricultural Segment”) have been presented as discontinued operations. Operating results for previous periods of the Agricultural Segment were reclassified to discontinued operations.
The principal lines of the Company’s Agricultural Segment were MPCI, supplemental coverages, and named peril insurance. MPCI is a federally subsidized risk management program designed to encourage agricultural producers to manage their risk through the purchase of insurance policies. MPCI provides the agricultural producers with yield coverage for crop damage from substantially all natural perils. CRC is an extension of the MPCI program that provides a producer of crops with varying levels of insurance protection against loss of revenues caused by changes in crop prices, low yields, or a combination of the two. As used herein, the term MPCI includes CRC, unless the context indicates otherwise.
On November 18, 2002 the Company announced that it signed a Non-Binding Letter of Intent setting forth the preliminary terms for the Company’s potential sale of certain crop insurance assets to Rain and Hail L.L.C. (“Rain and Hail”). On November 25, 2002 Rain and Hail announced “termination of further negotiations under the previously announced Non-Binding Letter of Intent because RMA (USDA Risk Management Agency) would not allow the transaction as set forth in the terms of the Non-Binding Letter of Intent.” As a result the Company filed a complaint against the United States of America on December 9, 2003 (See Item 3. “Legal Proceedings”).
The Company announced several strategic decisions over the last several years which have significantly impacted the Property and Casualty Segment. During 1999, the Company ceased or reduced its underwriting in several product lines of the Property and Casualty Segment business. In September 1999, the Company sold its nonstandard automobile business, including Phoenix Indemnity Insurance Company. In the first quarter of 2000 the Company transferred the renewal rights to all business previously produced and serviced by the Company’s Scottsdale, Arizona office and its “long haul” trucking business. During 2001 the Company ceased writing or sold all remaining Property and Casualty Segment business. Additionally, as part of its strategy to exit the Property and Casualty Segment business, in 2001 the Company sold Acceptance Indemnity Insurance Company (“AIIC”) and Acceptance Casualty Insurance Company (“ACIC”).
As of December 31, 2003 and 2002 the only remaining consolidated insurance company of AICI is AIC. The Director entered an administrative Order of Supervision with respect to AIC on December 20, 2002 and AIC currently is operating pursuant to that Order. Under the Order of Supervision, AIC is required to pay all costs incurred by the Supervisor, AIC may not accept or renew any insurance business and may not perform any activities beyond those that are routine in the day-to-day conduct of its runoff business without prior approval of the Director or Supervisor. The Director currently has the authority to increase regulatory control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of
Liquidation, with or without a change in the financial condition of AIC. The Company believes that an Order of Rehabilitation would have a significant negative impact on the Company and that an Order of Liquidation would have a material adverse effect on the Company.
Critical accounting policies are those that are important to the presentation of the Company’s financial condition and results of operations and require the Company’s management to make significant estimates or exercise significant judgment.
Reinsurance recoverables on unpaid losses and loss adjustment expenses are similarly subject to change of estimations. In addition to factors noted above, estimates of reinsurance recoveries may prove uncollectible if the reinsurer is unable or unwilling to meet its responsibilities under the reinsurance contracts. Reinsurance contracts do not relieve the Company of its obligations to indemnify its own policyholders.
Under reinsurance agreements with previously owned insurance subsidiaries, the Company assumed business, after cessions to outside reinsurers. While the amounts recoverable from these outside reinsurers are not assets of the Company, the Company is contingently liable for any uncollectible amounts due from outside reinsurers related to this business. The Company analyzes this contingent liability as part of its review of reinsurance recoverable exposures. Any differences that arise between previously accrued amounts and actual unrecoverable amounts are reflected in the statement of operations in the period such information becomes known.
The Company has recorded an allowance for doubtful accounts for the estimated amount of reinsurance recoverables on a case by case and overall basis. These estimates are subject to significant judgment and may vary significantly depending upon the reinsurers continued willingness and ability to pay amounts due. Any future changes in estimates will be recorded as insurance expenses in the period such information becomes known.
discussed herein may constitute forward-looking information within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking information reflects the Company’s current best estimates regarding future operations, but, as these are only estimates, actual results may differ materially from such estimates.
A variety of factors, most of which are outside the control of the Company, cannot be accurately predicted and may materially impact estimates of future operations. Important among such factors are changes in state and federal regulations, decisions by regulators including any increased regulatory control over Acceptance Insurance Company as discussed below, changes in the reinsurance market, including the ability and willingness of reinsurers to pay claims, financial market performance, changes in federal policies or court decisions affecting coverages, changes in the rate of inflation, interest rates and general economic conditions.
The Company’s consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the consolidated financial statements, during the years ended December 31, 2003, 2002 and 2001, the Company incurred a net loss of approximately $43.3 million, $209.7 million and $9.1 million, respectively and as of December 31, 2003 and 2002, the Company had a stockholders’ deficit of approximately $97.4 million and $53.9 million, respectively. Additionally, the National Association of Insurance Commissioners has established risk-based capital (“RBC”) standards to measure the acceptable level of capital an insurer should maintain. As of December 31, 2003 and 2002, AIC, the Company’s only remaining insurance subsidiary, had negative statutory surplus resulting in risk based capital at a mandatory control level and is under an administrative Order of Supervision by the NEDOI. AIC is no longer authorized to write new or renewal business and may not perform other activities beyond the routine conduct of its runoff business. These factors among others indicate that there is substantial doubt about the Company’s ability to continue as a going concern.
The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, the attainment of management’s plans as discussed below and no further regulatory action by the NEDOI.
The NEDOI Director (“Director”) currently has the authority to increase regulatory control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of Liquidation, with or without a change in the financial condition of AIC. The Company believes that an Order of Rehabilitation would have a significant negative impact on the Company and that an Order of Liquidation would have a material adverse effect on the Company. If the NEDOI seeks and obtains an Order of Rehabilitation or Order of Liquidation, the Company will decide to take the course of action that is in the best interests of the Company based on all relevant factors. The Company believes that its possible options will range from no action to filing bankruptcy depending on what type of order, if any, is sought and obtained by the NEDOI, what actions the NEDOI takes pursuant to any such order and all other factors relevant to taking the actions that are in the best interests of the Company. The filing of a bankruptcy proceeding would constitute an event of default under the trust agreement for the Trust Preferred Securities.
There is also significant uncertainty as to whether Acceptance Insurance Companies Inc. (“AICI”) will be able to meet its cash flow needs. AICI has deferred interest payments on its Junior Subordinated Debentures, which in turn deferred the interest on the Trust Preferred Securities issued by AICI Capital Trust, as permitted by the trust agreement and indenture, and AICI has disputed or denied payments of certain other liabilities and commitments. Based upon current estimates management of the Company believes AICI would likely have the ability to meet its cash flow needs through December 31, 2004 assuming the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with respect to AIC. There can be no assurances considering the significant uncertainties that exist, that AICI will have the ability to meet its cash flow needs through December 31, 2004. It is unlikely that AICI will be able to meet its long-term cash flow needs if either its short-term or long-term strategies are unsuccessful. If AICI is not able to meet its cash flow needs in the future, the Company will decide to take the course of action that is in the best interests of the Company based upon all relevant factors, which action may include filing bankruptcy. Additionally, if the NEDOI obtains an Order of Rehabilitation or Order of Liquidation with respect to AIC, the Company believes that it is unlikely that AICI would be able to meet its cash flow needs.
Management has not adopted or contemplated to adopt a plan of liquidation. Management’s current short-term business plan can be summarized as follows:
Unless these current short-term strategies are successful, the Company will not have the ability to implement any longer term strategies. The total focus continues to be on successfully accomplishing the above short-term strategies. If the Company is able to meet these short-term objectives, management may consider several strategies. These strategies may include commutation of reinsurance treaties, loss portfolio transfers, unwinding of trust balances and related items, sale of active and/or shell subsidiaries and other options that may be available. The Company may be required to accomplish certain of these strategies to meet its short-term or long-term objectives. At this time, management is unable to determine if any of these strategies will be available and if so, under acceptable terms to both the Company and the NEDOI. As such, it is uncertain if the Company can achieve either its short-term or long-term objectives.
The loss from discontinued operations, net of tax, was $152.9 million for the year ended December 31, 2002. The Company was not materially impacted during 2003 and does not expect to be impacted by the discontinued operations of the Agricultural Segment in the future.
The Company’s net loss was approximately $209.7 million, or $14.65 loss per share, for the
year ended December 31, 2002 as compared to a net loss of approximately $9.1 million, or $0.63 loss per share, for the year ended December 31, 2001. The increase in net loss was comprised of a $39.8 million increase in loss from continuing operations and a $160.9 million increase in loss from discontinued operations, net of tax.
The Company’s net investment income declined from approximately $1.9 million for the year ended December 31, 2001 to approximately $587,000 for the year ended December 31, 2002. The Company’s net investment income for its insurance operations declined from approximately $12.7 million for the year ended December 31, 2001 to approximately $5.7 million for the year ended December 31, 2002. These decreases in investment income were primarily a result of lower interest yields due to the lower interest rate environment coupled with a decline in the size of the investment portfolio. The Company’s net realized capital gains for its insurance operations were approximately $2.8 million for the year ended December 31, 2001 as compared to total net realized capital losses of approximately $1.5 million for the year ended December 31, 2002. During the year ended December 31, 2002, net realized losses were impacted by approximately $1.5 million of other than temporary impairments of common stock securities.
Additionally, the loss from continuing operations was impacted by the change in valuation allowance for deferred taxes. During the year ended December 31, 2002, the Company’s ability to generate sufficient taxable income in future periods was significantly impacted by the discontinuance of the Agricultural Segment and the only remaining insurance subsidiary of the Company being placed under supervision by the NEDOI. Management concluded it is unlikely that the deferred tax asset will be realized and recorded a valuation allowance related to continuing operations of $36.1 million as of December 31, 2002.
The underwriting loss from the Company’s discontinued Agricultural Segment was approximately $87.3 million for the year ended December 31, 2002 compared to underwriting earnings of approximately $10.1 million for the year ended December 31, 2001.
For the year ended December 31, 2002, the amount of direct and allocated expenses in excess of MPCI reimbursements from the FCIC totaled approximately $61.5 million and non-competition expense totaled approximately $2.5 million. Additionally, the Company expensed its current and future obligations under a multi-year reinsurance agreement totaling $27.5 million as no future benefit will inure to the Company. During 2002, the Company determined that the intangible asset related to non-competition agreements, approximately $5.7 million, and the goodwill carried on the books of the Company at approximately $30.0 million were impaired and were written down to zero.
On November 18, 2002 the Company announced that it signed a Non-Binding Letter of Intent setting forth the preliminary terms for the Company’s potential sale of certain crop insurance assets to Rain and Hail L.L.C. (“Rain and Hail”). On November 25, 2002 Rain and Hail announced “termination of further negotiations under the previously announced Non-Binding Letter of Intent because RMA (USDA Risk Management Agency) would not allow the transaction as set forth in the terms of the Non-Binding Letter of Intent.”
For the year ended December 31, 2001 the amount of direct and allocated expenses in excess of MPCI reimbursements from the FCIC totaled approximately $37.6 million. Additionally, non-competition and goodwill amortization costs for the year ended December 31, 2001 totaled $2.7 million. The MPCI underwriting earnings for 2001 included approximately $1.9 million from partial reimbursement of research and development costs previously associated with the development of the CRC product. This one-time reimbursement from the FCIC was recorded as a reduction to expenses. The Agricultural Segment’s underwriting earnings for the year ended December 31, 2001 also included negative adjustments of approximately $1.6 million related to 2000 crop year results. These adjustments included a decrease in the estimated 2000 year MPCI profit share of approximately $4.8 million partially offset by approximately $3.2 million in lower operating costs primarily comprised of a decrease in related reinsurance costs and agency contingent commissions.
At December 31, 2003 the Company has $2.7 million in cash and cash equivalents and $1.5 million of restricted cash equivalents. The Company also holds a surplus note for $20 million issued by AIC, bearing interest at the rate of 9% per annum payable quarterly. The Company does not expect to have access to any surplus note interest payments or dividend payments from AIC, as these payments would require NEDOI approval as AIC is currently under the supervision of the NEDOI.
During the first quarter of 2003, the Company sold its office building and certain contents in Council Bluffs, Iowa. The proceeds included approximately $204,000 of cash and a note receivable with a fair value of approximately $1.3 million and the sale resulted in a gain of approximately $334,000. During the fourth quarter of 2003, the Company sold the note receivable for approximately $1.2 million and the sale resulted in a loss of approximately $83,000.
In order to induce employees of AIC to remain in the employment of AIC, AICI has agreed to pay each employee a retention bonus in the event AIC would be unable to meet this obligation. Additionally, AICI has agreed to guarantee certain amounts due under employment agreements with the Chief Executive Officer and Chief Financial Officer. During the second quarter of 2003, AICI agreed to guarantee these obligations by establishing an appropriate trust with a bank whereby the amount of such guarantees, totaling approximately $1.1 million, have been deposited in such trust account. The amounts held in the trust account at December 31, 2003, totaling approximately $1.1 million, are presented as restricted cash equivalents on the Company’s consolidated balance sheets.
In August 1997, AICI Capital Trust, a Delaware business trust organized by the Company (the “Issuer Trust”) issued 3.795 million shares or $94.875 million aggregate liquidation amount of its 9% Preferred Securities (liquidation amount $25 per Preferred Security). The Company owns all of the common securities (the “Common Securities”) of the Issuer Trust. The Preferred Securities represent preferred undivided beneficial interests in the Issuer Trust’s assets. The assets of the Issuer Trust consist solely of the Company’s 9% Junior Subordinated Debentures due in 2027, which were issued in August 1997 in an amount equal to the total of the Preferred Securities and the Common Securities. The issue costs on the Preferred Securities and Junior Subordinated Debentures are being amortized over the term of the debt.
Distributions on the Preferred Securities and Junior Subordinated Debentures are cumulative, accrue from the date of issuance and are payable quarterly in arrears. The Junior Subordinated Debentures are subordinate and junior in right of payment to all senior indebtedness of the Company and are subject to certain
events of default and can be called at par value after September 30, 2002, all as described in the Junior Debenture Indenture. At December 31, 2003 and 2002, the Company had Preferred Securities of $94.875 million outstanding at a weighted average interest cost of 9.1% and 9.2%, respectively.
The Company’s only consolidated insurance subsidiary at December 31, 2003 is AIC. The principal liquidity needs of AIC are to fund losses and loss adjustment expense payments and operating expenses related to the run-off of its property and casualty operations. The available sources to fund these requirements are cash flows from the Company’s investment activities, of which at December 31, 2003 approximately 76% and 32% of AIC’s fixed maturity securities and cash and cash equivalents, respectively, are pledged to states and to acquirers of former Company affiliates.
that exist that AIC will have the ability to meet its cash flow needs through December 31, 2004. Based upon current agreements that are in place, primarily related to amounts pledged under the trust agreements, it is unlikely that AIC will be able to meet its long term cash flow needs without changes to existing agreements, commutation of reinsurance agreements or other strategies, if available.
Cash used by operating activities was approximately $77.1 million during the year ended December 31, 2002 compared to approximately $38.1 million for the year ended December 31, 2003. The Company expects negative cash flows from operating activities as the Company runs off its property and casualty operations. See “The Parent - Company Only” and “Acceptance Insurance Company” regarding uncertainties of the Company to meet its ongoing cash flow needs.
At December 31, 2003 and 2002 the Company had $74.3 million and $114.7 million, respectively, of fixed maturity investments that were subject to market risk. At December 31, 2003 and 2002 the Company had $1.1 million and $7.3 million, respectively, of marketable equity securities that were subject to market risk. The Company’s investment strategy is to manage the duration of the portfolio relative to the duration of the liabilities while managing interest rate risk.
In March 2003, the Company and Clarendon agreed to a Master Collateral Agreement (“MCA”) which supercedes previous agreements with respect to the minimum pledged assets to be included in the trust, the methodology for releasing these pledged assets from the trust and use of the trust account for collateral for the issuance of letter of credits to the California Department of Insurance.
At December 31, 2003, Gerling Global Reinsurance Corp. (“Gerling”) accounts for approximately 1.3% of the Company’s Off-Balance Sheet Obligations. Gerling had its financial strength rating lowered by A.M. Best from A- (Excellent) to B- (Fair) during the fourth quarter of 2002. In January 2003, in response to a request from Gerling’s parent to withdraw from the rating process, A.M. Best withdrew its financial strength rating of B- and assigned Gerling and its parent an NR-3 rating (Rating Procedure Inapplicable). Gerling continues to make regular payments to the Company for reinsurance billings and accordingly, no specific liability has been established for these balances.
The Company is obligated under noncancelable operating leases, expiring on various dates through 2007 for office space. Future aggregate minimum obligations under these noncancelable operating leases are approximately $386,000 in 2004, $391,000 in 2005, $391,000 in 2006 and $98,000 in 2007.
financial statements at January 1, 2002. With the adoption of SFAS No. 142 on January 1, 2002 goodwill is no longer amortized and in accordance with SFAS No. 142 the goodwill is tested for impairment annually and between annual tests if an event occurs that would more likely than not reduce the fair value of the reporting unit. As a result of the significant operating losses and the discontinuance of the Agricultural Segment in 2002, the Company reevaluated the recoverability of the goodwill and intangible assets during the third and fourth quarters of 2002. Based upon the results of such reviews, it was determined that the intangible asset related to non-competition agreements, approximately $5.7 million, and the goodwill carried on the books of the Company of approximately $30.0 million were impaired and were written down to zero during 2002.
A reconciliation of the Company’s net loss and loss per share for the years ended December 31, 2003, 2002 and 2001 to amounts adjusted for the exclusion of goodwill amortization is as follows:
Upon adoption of FIN No. 46R, effective January 1, 2004, prior periods will be restated for comparability. The effect of adoption will be to increase the Company’s long-term debt by approximately $2.9 million with a corresponding increase in an asset of equal amount. In addition, investment income and interest expense will be increased by approximately $279,000, $264,000 and $264,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
The Emerging Issues Task Force (“EITF”) is currently deliberating Issue No. 03-01, which addresses the definition of other-than-temporary impairment and its application to investment securities accounted for under both Statement of Financial Accounting Standards No. 115 (“SFAS No. 115”), Accounting for Certain Investments in Debt and Equity Securities and Accounting Principles Board Opinion No. 18 (“APB No. 18”), The Equity Method of Accounting for Investments in Common Stock. The current issue summary proposes that if, at the evaluation date, the fair value of an investment security is less than its carrying value then an impairment exists for which a determination must be made as to whether the impairment is other-than-temporary. If it is determined that an impairment is other-than-temporary, then an impairment loss should be recognized equal to the difference between the investment’s carrying value and its fair value at the reporting date. In November 2003, the EITF reached a consensus with respect to certain disclosures effective for fiscal years ending after December 15, 2003. The Company has included those disclosures at December 31, 2003.