(3) Based on shares of Common Stock outstanding of 28,703,069, 28,703,069, 27,369,736, 27,119,833 and 20,896,563 at the end of 2002, 2001, 2000, 1999 and 1998, respectively. Common Stock outstanding at December 31, 2002, 2001, 2000 and 1999 assumes conversion of the Series A Preferred stock that was issued in the 1999 GMSP transaction. Common Stock outstanding at December 31, 2002 and 2001 assumes conversion of the Series B Preferred Stock that was issued in the transactions with Robert W. Stallings in 2001. See Note (7) of Notes to Consolidated Financial Statements.
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("Statement 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement 142"). Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. Statement 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated
In March 2003, the Financial Accounting Standards Board announced it expects to issue the proposed limited-scope statement "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity", in the second quarter of 2003. This statement would require redeemable preferred stock to be classified as a liability and any related accretion of discount and accrued dividends to be charged to the results of operations. If this statement is adopted as proposed, the Company would record all series of preferred stock as liabilities and would record the related accretion of discount and accrued dividends as charges to Results of Operations. For 2002 the accretion of discount on redeemable preferred stock was $2,657,000 and the dividends accrued were $670,774. Under this proposed statement these amounts would be recorded as charges to Results of Operations, and we anticipate an increase in the deferred tax valuation allowance equal to the related deferred tax benefit.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51." This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities obtained after January 31, 2003. The application of this Interpretation is not expected to have a material effect on the Company's financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34." This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002 and are not expected to have a material effect of the Company's financial statements.
Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement 133"), as amended. Statement 133 establishes accounting and reporting standards for derivative instruments and requires that an entity recognize all derivatives as either assets or liabilities in the financial statements and measure those instruments at fair value with changes in fair value recorded through the income statement. The adoption of Statement 133 had no impact on the consolidated financial statements.
Discontinuance of Commercial Lines. On February 7, 2002, the Company announced its decision to cease writing its primary line of business, commercial insurance, due to continued adverse claims development and unprofitable results. The Company notified all of its commercial lines agents of its intent to cancel their agency contracts and notified all states, where required by statute, of its intent to cease writing commercial lines of insurance in their state. The discontinuance of writing commercial lines will likely result in the Company ceasing to be approved to write insurance in a number of states.
By December 31, 2002, the Company had non-renewed 86% of its in-force policies. The remaining 14% are scheduled to be non-renewed in the first half of 2003 as the applicable policies expire. Concurrently, the Company continued to settle and reduce its inventory of commercial lines claims. At year-end 2002, there were 1,062 claims associated with our overall runoff book outstanding, compared to 1,720 a year earlier. As a result, approximately $68.5 million of unprofitable commercial business premium is being eliminated over the course of 2002 and 2003, with continuing reductions in the cost structure of the Company. Due to the long tail nature of these claims, the Company anticipates it will take a substantial number of years to complete an orderly adjustment and settlement process with regard to existing claims and any additional claims it receives in the future from its past business writings. The Company's commercial lines business segment produced approximately $11,992,000 in gross premiums written in 2002. In the course of reducing its employee count, in the first quarter of 2003 the Company outsourced certain of its information technology operations related to the run-off of its commercial lines to an unaffiliated third party provider with which Richard A. Laabs, a former senior executive of the Company, and three other former employees of the Company are affiliated.
On August 12, 2002, the Company announced its decision to put itself in a position to exit its remaining active insurance business, personal auto, in as orderly and productive a fashion as possible. In June 2002, the Company entered into a letter of intent to sell its Miami, Florida based operation, the Lalande Group, to an unaffiliated party. In September 2002 negotiations in respect of the possible transaction were terminated. In conjunction with this process, the Company evaluated the related goodwill and recorded an impairment of approximately $2.9 million during the second quarter 2002. The remaining goodwill as of December 31, 2002 is $609,000 and is related to the 1998 acquisition of the Lalande Group. Operationally, the Company implemented rate increases and other measures to enhance the profit potential of this business in 2003 and its future strategic direction, which could include the expansion, contraction or disposition of the business.
timing or the nature of the opportunities that may be available at the time capital becomes available. The opportunities may be outside of the insurance business and could be in the financial services business.
On December 2, 2002, the Company completed the sale and transfer of the management contract controlling GAINSCO County Mutual Insurance Company ("GCM") to an affiliate of Liberty Mutual Insurance Company ("Liberty"), for a purchase price of up to $10 million, of which $1 million was paid at closing and the balance is payable in contingent payments through September 2009. The $9 million total of future payments would be payable $3 million in September 2003 and $1 million each year thereafter through September 2009. Each payment is contingent on there being no material adverse change in the regulatory treatment of GCM specifically, or county mutuals generally, from legislative or regulatory administrative actions prior to the applicable payment date. Legislation has been introduced in the current session of the Texas Legislature ending June 2, 2003 which, depending upon whether or in what form it is ultimately adopted, could prejudice the rights of the Company to receive some or all of the future payments from Liberty. Following the closing, the surplus of GCM, which was approximately $3,182,000, remained as a part of the combined statutory policyholders' surplus of the Company. Pursuant to a 100% quota share reinsurance agreement (the "General Agents Reinsurance Agreement") entered into at closing among GCM and GAINSCO's subsidiaries, General Agents Insurance Company of America, Inc. ("General Agents") and MGA Agency, Inc., and certain other arrangements, the Company retained all assets and liabilities associated with GCM's past, present and runoff commercial insurance business. The Company made a number of representations, warranties and covenants in the acquisition agreement and generally indemnifies Liberty for any losses incurred resulting from (i) breaches of representations, warranties or covenants of the Company; (ii) employee benefit plan obligations of GCM relating to pre-closing periods; (iii) tax obligations of GCM relating to pre-closing periods; (iv) all liabilities of GCM, to the extent that they result from conditions or circumstances arising or events occurring before the Closing, subject to certain exceptions; (v) all insurance claims, liabilities and obligations of GCM that are not reinsured pursuant to the General Agents Reinsurance Agreement or certain insurance fronting programs between GCM and Metropolitan Property & Casualty Insurance Company and Omni Insurance Company, respectively; and (vi) any and all insurance claims, liabilities and obligations of General Agents under the General Agents Reinsurance Agreement. GCM did not have any employees or employee benefit plans. The Company made a $500,000 prepayment of outstanding bank debt from the closing proceeds of the transaction.
In August 2002, the Company entered into an office lease for approximately 8,352 square feet of space in Fountain Place, 1445 Ross Avenue, Suite 5300, Dallas, Texas, to house the Company's executive offices. This address is the Company's new registered address. The lease is for a term of four years, although the Company has the right to terminate the lease at its option at the end of 2005 upon payment of a termination fee of approximately $29,000. The annual rental expense is approximately $175,500. The lessor is Crescent Real Estate Funding X, L.P., an affiliate of Crescent Real Estate Equities Company, a Texas real estate investment trust f/k/a Crescent Real Estate Equities, Inc. ("Crescent"). Robert W. Stallings, GAINSCO's Chairman of the Board, became a member of the Board of Trust Managers of Crescent in May 2002, and John C. Goff, a member of GAINSCO's board of directors (the "Board"), is the Chief Executive Officer and Vice Chairman of the Board of Trust Managers of Crescent. Mr. Goff is deemed to be the beneficial owner of 3,630,248 common shares of Crescent, comprising 3.4% of the beneficial ownership of such shares. Mr. Stallings is deemed to be the beneficial owner of 22,000 common shares of Crescent, comprising less than 1% of the beneficial ownership of such shares. The management of the Company believes that the terms of the Company's lease with Crescent are no less favorable to GAINSCO than those offered to other tenants by Crescent or than GAINSCO could obtain for comparable space from unaffiliated parties.
Because of their importance to the Company, in August 2002 the Company entered into executive severance agreements with two senior executives, Richard M. Buxton and Daniel J. Coots. The agreements generally provide that the Company shall pay the executive, upon termination of the employment of the executive by the Company without cause or by the executive with good reason during the term of the agreement, a lump sum severance amount equal to the base annual salary of the executive as of the date that the executive's employment with the Company ends. The current base annual salaries of Mssrs. Buxton and Coots are $170,000 and $155,000, respectively. The executive severance agreements do not supersede the change in control agreements or any other severance agreements the employees may have with the Company. Richard A. Laabs, a former senior executive of the Company, also entered into an executive severance agreement with the Company in August 2002, but did not receive any severance payments pursuant to such agreement when he resigned his employment with the Company in January 2003.
On January 7, 2000, the Company expanded its personal lines business conducted through the Lalande Group through the acquisition of Tri-State, Ltd. ("Tri-State"), an insurance operation specializing in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. Tri-State owned and operated a managing general agency, a motor vehicle driving records service company and an insurance subsidiary, Midwest Casualty Insurance Company ("MCIC") that had policyholders' surplus of approximately $3,034,000. The purchase price consideration consisted of $6,000,000 in cash at closing plus additional cash payments of $1,200,000 and $1,600,000 paid in July 2000 and January 2001, respectively. On August 31, 2001, the Company sold all of the stock of Tri-State to Herbert A. Hill for a cash price of $935,000. Mr. Hill is the President and a former owner of Tri-State. The Company retained MCIC, which had policyholders' surplus of approximately
The agreement with GMSP in connection with the 2001 GMSP Transaction was conditioned upon the following changes in the securities currently held by GMSP. The exercise prices of the Series A Warrant and the Series B Warrant held by GMSP were amended to $2.25 per share and $2.5875 per share, respectively. Each of these warrants provides for the purchase of 1,550,000 million shares of Common Stock, subject to adjustment. Further, the Company is required to redeem the outstanding shares of its Series A Preferred Stock on January 1, 2006, subject to certain conditions, at a price of $1,000 per share plus accrued and unpaid dividends. Any Series A Preferred Stock unredeemed for any reason after that date would accrue interest, payable quarterly at a rate equal to eight percent per year with any unpaid interest compounded annually. The Series A Preferred Stock is convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share and, should the Company pay dividends on its Common Stock, the Series A Preferred Stock would be entitled to dividends as if converted into Common Stock.
On March 23, 2001, the Company consummated a transaction with Mr. Stallings (the "Stallings Transaction") pursuant to which, among other things, the Company issued shares of its newly created Series B Preferred Stock and a warrant to purchase an aggregate of 1,050,000 shares of Common Stock at $2.25 per share and expiring March 23, 2006 in exchange for an aggregate purchase price of $3 million in cash. The annual dividend provisions and the redemption provisions of the Series B Preferred Stock are the same as those for the Series C Preferred Stock. The Series B Preferred Stock is convertible into Common Stock at $2.25 per share. Subject to adjustment for certain events, the Series B Preferred Stock is convertible into a maximum of 1,333,333 shares of Common Stock. Mr. Stallings also entered into a Consulting Agreement pursuant to which he provides consulting services (including strategic planning advice, analysis of the subsidiaries' performance in various sectors of their respective business and recommendations for growth strategies and opportunities for new markets and products) to the Company's insurance subsidiaries for a period of five (5) years ending on March 22, 2006 for $300,000 per annum. Mr. Stallings was elected non-executive Vice Chairman of the Board and a director of the Company, and on September 6, 2001, he was elected non-executive Chairman of the Board.
Gross premiums written in the 2002 year were 62% below 2001 and the 2001 year was 30% below 2000 year. The Company's decision in the first quarter of 2002 to discontinue writing commercial lines is primarily the reason for the decrease in 2002. The Company's decision in the fourth quarter of 2000 to cease writing certain identified non-profitable commercial trucking business is the primary reason for the decrease in 2001. The following table compares the major product lines between the years for gross premiums written:
PERSONAL LINES decreased 34% in 2002 and 11% in 2001. The decrease in 2002 was primarily related to the Company's decision to discontinue writing nonstandard personal auto outside of Florida and to discontinue writing personal umbrella. Also contributing was the fact that most nonstandard personal auto policies written in 2002 were six month policies, whereas in 2001 a significant amount were twelve month policies, see below. The decrease in 2001 from 2000 was primarily a result of the Florida nonstandard personal auto business. The Company began a transition during 2001 to write a majority of the nonstandard personal auto business on six month policies instead of twelve month policies as had been done in the past. This accounts for a significant portion of the decrease in writings in 2001. This decision gives the Company greater flexibility in managing the business.
For 2002 gross premiums written percentages by significant product line are as follows: personal auto (72%), commercial auto (16%) and general liability (10%) with no other product line comprising 5% or more. Net premiums earned decreased 12% primarily as a result of the decision to discontinue writing commercial lines. The decrease was less than the decrease in written premiums primarily due to the absence of commercial and personal quota share reinsurance in 2002. Net premiums earned decreased 55% in 2001 primarily as a result of the commercial quota share reinsurance agreements and exiting certain commercial trucking business.
The Company recorded net realized capital gains of $2,048,848 and $4,275,192 in 2002 and 2001, respectively, versus net realized capital losses of $1,906,911 in 2000. During 2002, the Company reduced the carrying value of a non-rated commercial mortgage backed security to $0 resulting in a write down of $2,010,670 (recorded as a realized loss in the statement of operations) as a result of a significant increase in the default rate in the underlying commercial mortgage portfolio, which has disrupted the cash flow stream sufficiently to make future cash flows unpredictable. This write-down was offset by net realized gains of $3,604,462 recorded from the sale of various bond securities and other investments in 2002 and the gain of $455,056 recognized from the sale of the home office building. The losses recorded in 2000 were the result of restructuring the portfolio into higher taxable equivalent yields.
Insurance services revenues increased $3,957,583 in 2002 over 2001, primarily as a result of amortization of deferred reinsurance recoveries from claim payments under the reserve reinsurance cover agreement mentioned previously. For 2002, $4,082,469 was recorded which represents the reserve development under the reserve reinsurance cover agreement. In 2001 $1,112,469 was recognized under the reserve reinsurance agreement. Amortization is based upon claims recovered from the reinsurer in relation to the amount of the reinsured layer under the reserve
reinsurance cover agreement. Insurance service revenues decreased $727,443 in 2001 from 2000. The decrease was primarily a result of the decrease in service revenues in the Lalande Group.
Interest expense from the note payable decreased in 2002 and 2001 as a result of principal payments on the note and lower interest rates. The Company paid principal amounts of $7,100,000, $5,200,000 and $2,000,000 in 2002, 2001 and 2000, respectively.
Goodwill impairment in 2002 is a result of the Company positioning itself for an exit from the personal auto business in the second quarter of 2002 and the consideration of a sale of the Lalande Group. A re-evaluation of goodwill for the Lalande Group was made during this period and an additional impairment of $2,859,507 was recorded. This re-evaluation was based upon market indications of value contained in a proposal from a potential acquiror and upon the uncertainty of achieving value levels. Goodwill impairment in 2001 was a result of the Company's decision to no longer pursue a long-term geographic expansion strategy in personal automobile beyond that of its core operation in Florida and to sell its Tri-State agency subsidiary. See "BUSINESS OPERATIONS - Tri-State Acquisition and Sale". Tri-State was acquired by the Company in the first quarter of 2000 and failed to achieve profitability during the Company's ownership. Because of the profitability issues surrounding the Lalande Group, (see below), it was decided in the second quarter of 2001 to sell Tri-State to its former owner so the Company could focus all of the personal auto efforts solely on the Lalande Group. As a result the remaining goodwill associated with the Tri-State acquisition was written off in the second quarter of 2001. In December 2001 the Company recorded an impairment of $13,360,603 on the goodwill associated with the 1998 acquisition of the Lalande Group. The Lalande Group was acquired by the Company in the fourth quarter of 1998, it produced a small profit in 1999, but in 2000 it produced a loss. At the end of 2000 the Company was expecting a significant improvement and profitability from the Lalande Group in 2001. During 2001 the Company continued to implement actions throughout the year to return this business to profitability. While results in 2001 showed improvement, they remained unprofitable. In the fourth quarter of 2001 the Company concluded that the value of this operation was significantly below what the Company had paid and accordingly recorded the impairment against goodwill based upon then current estimated market valuation levels of agencies in the personal auto marketplace.
GAINSCO, INC. ("GNAC") is a holding company that provides administrative and financial services for its wholly owned subsidiaries. GNAC needs cash for: (1) principal and interest on its bank note payable, (2) administrative expenses, and (3) investments. The primary sources of cash to meet these obligations are statutory permitted payments from its insurance subsidiaries, including (1) dividend payments, (2) surplus debenture interest payments, and (3) tax sharing payments. Statutes in Oklahoma and North Dakota restrict the payment of dividends by the insurance company subsidiaries to the available surplus funds. The maximum amount of cash dividends that each subsidiary may declare without regulatory approval in any 12-month period is the greater of net income for the 12-month period ended the
GNAC entered into an amendment dated as of February 27, 2002 to its bank credit agreement which cured GNAC's covenant breaches and provided for additional principal prepayments. Pursuant to the amendment, GNAC prepaid $6,100,000 of the indebtedness outstanding under the credit agreement. Several covenants in the existing credit agreement were eliminated or modified by the amendment and the interest rate was changed to a base rate (which approximates prime) plus 175 basis points. The major financial covenant of the amended credit agreement requires the statutory surplus of General Agents to be at a minimum of three times the unpaid principal balance after December 31, 2002. General Agents' statutory surplus at December 31, 2002 was approximately $38,780,000. GNAC paid $500,000 of the indebtedness outstanding under the credit agreement in December 2002 as a result of the sale of GCM. The credit agreement requires a note prepayment equal to 50% of any dividends from General Agents. On March 24, 2003, GNAC paid $1,939,000 of the indebtedness outstanding under the credit agreement in conjunction with the receipt of $3,878,000 in dividends from General Agents. The remaining $1,761,000 principal balance under the credit agreement is payable in 2003 which GNAC intends to fund with proceeds from short term investments. The credit agreement, among other things, precludes payment of dividends on common or preferred stock and restricts the kinds of investments that GNAC may make.
Subject to bank credit agreement restrictions, GNAC may also obtain cash through the sale of subsidiaries or assets and through the issuance of common or preferred stock. The bank credit agreement generally requires a note prepayment in the event of the sale of GNAC of any subsidiary or assets (except certain ordinary course of business sales), or any issuance of stock (subject to certain exceptions), equal to 50% of the proceeds received.
The Company will be in a lengthy period of transition as it lessens its exposure to the insurance industry. During the transition process, the Company may consider the sale of additional subsidiaries associated with that business. See "BUSINESS OPERATIONS - Discontinuance of Commercial Lines and Redeployment of Capital."
The primary sources of the insurance subsidiaries' liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At December 31, 2002, the insurance subsidiaries held short-term investments and cash that the insurance subsidiaries believe are adequate liquidity for the payment of claims and other short-term commitments.
premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 through December 31, 2001, the Company entered into a quota share reinsurance agreement whereby the Company ceded 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $89,650,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2001. Also in connection with this agreement, the Company was required to maintain assets in a trust fund with a fair value at least equal to the funds held liability. The trust fund was established during the third quarter of 2001 and at December 31, 2001 the assets in the trust had a fair value of $49,553,698. Because the Company's statutory policyholders' surplus fell below certain levels specified in the agreement, the reinsurer had the option to direct the trustee to transfer the assets of the trust to the reinsurer. On March 29, 2002, the reinsurer exercised this option and the trust assets were transferred to the reinsurer. The reinsurer continues to be responsible for reimbursing the Company for claim payments covered under this agreement.
Investments decreased primarily due to a nonaffiliated reinsurer exercising its option, during the first quarter of 2002, to take possession of approximately $44,000,000 in investments, mentioned previously. The remaining decrease is attributable to principal payments on the note payable of $7,100,000 and negative cash flows from operations. At December 31, 2002, 92% of the Company's investments were investment grade with an average duration of approximately 1.4 years, including approximately 45% that were held in short-term investments. On a taxable equivalent basis the return on average investments was 3.9% in 2002, 4.3% in 2001, and 6.5% in 2000. The Company classifies its bond securities as available for sale. In February 2002 GMSP purchased the equity investments and the note receivable, classified as "Other investments", for approximately $2,087,000 which was their carrying value at December 31, 2001. In March 2002, the Company reduced the carrying value of a non-rated security to $0 resulting in a write down of $2,010,670 as a result of a significant increase in the default rate in January and February of 2002 in the underlying collateral, which had disrupted the cash flow stream sufficiently to virtually eliminate future cash flows. The unrealized gain associated with the investment portfolio was $2,400,722 (net of tax effects) at December 31, 2002. The duration of the bonds available for sale approximates the average expected payout of claims.
Reinsurance balances receivable decreased primarily as a result of C & CAE claims paid under the reserve reinsurance cover agreement and the quota share reinsurance agreements for both commercial lines and personal lines business written in 2001. This balance is primarily comprised of ceded unpaid claims and claims adjustment expenses under the reserve reinsurance cover agreement and claims and claim adjustment expenses paid by the Company and due from reinsurers under the Company's various reinsurance agreements. The Company recorded an allowance for doubtful accounts of $1,001,461 in 2002 and of $2,653,597 in 2001 as a result of concern regarding the collectibility of amounts due from specific reinsurers. The decrease in the allowance for doubtful accounts was primarily due to the successful recovery of an amount that had been included in the allowance in 2001. Balances written off in previous years have been immaterial. The Company considers the allowance adequate at the present time.
Current Federal income taxes were received in January 2003. Deferred Federal income taxes have a valuation allowance for its full amount recorded against the asset. This asset is primarily a tax benefit from net operating loss carry forwards which can be used to offset tax expense on future operating earnings or capital gains. See earlier discussion under "RESULTS OF OPERATIONS." A change in ownership of the Company's stock greater than 50% (as specified under Internal Revenue Code Section 382) could severely limit the Company's ability to recover this asset in future periods.
Goodwill decreased as a result of the $2,859,507 impairment recorded in the second quarter of 2002 related to the October 1998 Lalande Group acquisition. The remaining goodwill of $609,000 reflects estimated fair valuation of agencies in the personal automobile marketplace. See "RESULTS OF OPERATIONS." Effective in 2002, goodwill will no longer be amortized but will be subject to an impairment test based on its estimated fair value. Therefore, additional impairment losses could be recorded in future periods.
As of December 31, 2002, in respect of its commercial lines, the Company had $83.664 million in reserves for unpaid claims and claim adjustment expenses. Historically, the Company has experienced significant volatility in its reserve projections for its commercial lines. This volatility has been primarily attributable to its commercial automobile and general liability product lines. See Item 1 "BUSINESS--Unpaid Claims and Claim Adjustment Expenses." On February 7, 2002, the Company announced it had decided to discontinue writing commercial lines insurance due to continued adverse claims development and unprofitable results. Since February 7, 2002, 86% of the Company's commercial policies have been non-renewed and the remainder are scheduled for non-renewal over the course of the first half of 2003. Concurrently, the Company has been settling and reducing its remaining inventory of commercial claims. See "BUSINESS OPERATIONS--Discontinuance of Commercial Lines and Redeployment of Capital." As of December 31, 2002, 1,062 commercial claims remained, compared with 1,720 claims a year earlier. Included in these remaining claims are 82 product liability claims, 32 construction defect type claims, and 1 environmental claim. The Company has no asbestos related claims. The average commercial lines claim at December 31, 2002 was approximately $78,779 per claim.
As of December 31, 2002, in respect of its personal lines, the Company had $12.805 million in unpaid claims and claim adjustment expenses. These personal lines claims generally are shorter tailed than the Company's commercial lines claims. At December 31, 2002, the Company had 1,726 personal auto claims. The average personal auto claim at December 31, 2002 was approximately $7,276 per claim.
Accounts payable decreased primarily because of the decision to net deferred payables on policies not yet written against deferred receivables on these same policies, as mentioned previously. Reinsurance balance payable decreased primarily due to settlements made in 2002 on prior years quota share reinsurance agreements.
Deferred revenues decreased primarily as a result of reinsurance recoveries under the reserve reinsurance cover agreement. This balance is primarily comprised of C & CAE recoveries under this agreement which will be recognized as insurance service revenues in future periods based upon the ratio of actual C & CAE paid to the total of potential C & CAE payable under this reinsurance agreement.
Drafts payable decreased primarily as a result of the Company's decision in the third quarter of 2002 to use checks instead of drafts to pay claims. This balance will continue to decrease in the future.
Note payable decreased due to principal payments of $7,100,000 made during 2002. In the first quarter of 2002, the Company made a scheduled repayment of $500,000 and an unscheduled prepayment of $6,100,000. The unscheduled prepayment was made in conjunction with an amendment to the credit agreement which cured covenant breaches. The Company made a $500,000 principal payment in December 2002 in conjunction with the sale of GCM. On March 24, 2003 the Company made a $1,939,000 principal payment in conjunction with the receipt of a $3,878,000 dividend from General Agents. The remaining $1,761,000 principal balance under the credit agreement is payable in 2003. (see Note (4) of Notes to Consolidated Financial Statements).
Funds held under reinsurance agreements were eliminated due to the reinsurers decision to take possession of investments, which reduced the Company's liability to this reinsurer. See "BUSINESS OPERATIONS - Reinsurance Transaction."
With the reclassification of the Series A Preferred Stock during the first quarter of 2001, preferred stock capital was reduced to $0 and additional paid-in capital was reduced by the discount on the convertible redeemable preferred stock. Common stock warrants decreased for the discount in value of the previously issued Series A and Series B Warrants offset by an increase for the issuance of the warrant in the Stallings Transaction. At December 31, 2002, $10,394,002 has yet to be charged to Retained deficit related to the accretion of the discount on the Series A and Series B Preferred Stock.
Accumulated other comprehensive income of $2,400,722 was recorded at December 31, 2002 as a result of the unrealized gains on bonds available for sale, net of tax. The increase in Retained deficit of $12,088,861 is attributable to the net loss of $8,761,087, the accretion of discount on the Series A and Series B Preferred Stock of $2,657,000 and the accrual of dividends on the Series B and Series C Preferred Stock of $670,774.
The Company is not aware of any current recommendations by regulatory authorities, which if implemented, would have a material effect on the Company's liquidity, capital resources or results of operations. The Company's statutory
capital exceeds the benchmark capital level under the Risk Based Capital formula for its insurance companies that are subject to Risk Based Capital requirements. Risk Based Capital is a method for establishing the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The tragic events of September 11, 2001 did not impact the Company's financial results for 2001 and 2002.
Statements made in this report that are not strictly historical may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that important factors, representing certain risks and uncertainties, could cause actual results to differ materially from those contained in the forward-looking statements. These factors include, but are not limited to, (a) the Company's ability to effect the successful exit from unprofitable lines and businesses that the Company believes cannot be counted on to produce future profit, (b) heightened competition from existing competitors and new competitor entrants into the Company's markets, (c) the extent to which market conditions firm up, the acceptance of higher prices in the market place and the Company's ability to realize and sustain higher rates, (d) contraction of the markets for the Company's business, (e) acceptability of the Company's A.M. Best rating to its end markets, (f) the Company's ability to meet its obligations under its capital and debt agreements, (g) the ongoing level of claims and claims-related expenses and the adequacy of claim reserves, (h) the effectiveness of investment strategies implemented by the Company's investment manager, (i) continued justification of recoverability of goodwill in the future, (j) the availability of reinsurance and the ability to collect reinsurance recoverables, (k) the Company's ability to invest in new endeavors that are successful, (l) the limitation on the Company's ability to use net operating loss carryforwards as a result of constraints caused by ownership changes within the meaning of Internal Revenue Code Section 382, (m) the ability of the Company to realize contingent acquisition payments in connection with its sale of the management contract controlling GCM, which in turn depends upon whether, or in what form, the Texas Legislature passes legislation that has been introduced in the current session of the Texas Legislature ending June 2, 2003 which could prejudice the rights of the Company to receive any of the future payments from Liberty, and (n) general economic conditions, including fluctuations in interest rates. A forward-looking statement is relevant as of the date the statement is made. The commencement of hostilities involving Iraq could produce economic and other reactions that could adversely affect the Company and its ability to effect changes discussed elsewhere in this report. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which the statements are made.
The following consolidated Financial Statements are on pages 53 through 95