In July 1998, the Company entered into a lease covering approximately 95,000 square feet of office space for its Company headquarters. The lease is for a term of 10 years ending in 2009 and the Company has options to renew the lease for an additional 10 years. The Company moved its headquarters and principal operations to these offices in March 1999. The Company also leases office space for its claims offices in Reston, Virginia, and San Diego, California.
The Company had a growing volume of assumed reinsurance between 1999 and 2002. Assumed reinsurance is a line of business with inherent volatility. Ultimate loss experience for the assumed reinsurance operation is based primarily on reports received by the Company from the underlying ceding insurers. Many losses take several years to be reported through the system. Ceding entities, representing over 61.5% of the reinsurance assumed business for the 1999 to 2003 underwriting years (based on gross written premiums), submit reports to the Company containing ultimate incurred loss estimates reviewed by independent or internal actuaries of the ceding entities. These reported ultimate incurred losses are the primary basis for the Company’s reserving estimates. In other cases, the Company relies on its own internal estimates determined primarily by experience to date, individual knowledge of the specific reinsurance contract, industry experience and other actuarial techniques to determine reserve requirements.
for the Core Healthcare Business, the primary decline in pure loss cost trend over the past several years has been driven primarily by decreases in the frequency of claims. Since the decrease in claim frequency is not attributable to any specific cause, this trend is not readily predictable and the Company considers a 2 percentage point movement either up or down reasonably possible.
successful in defense of the claim, less than current reserves. The Company believes there is a reasonable possibility further uncertainties of settlement could cause the average settlement value to increase or decrease 10%.
The following table shows the progress the Company has achieved in the disposition of the non-core healthcare claims.
As the individual cases mature and more information becomes available for evaluating individual cases, there is a declining need for Bulk and IBNR reserves. While the Company believes its reserves are adequate, several jurisdictions where the
The Company holds net reserves (including retrospective reserves ceded under the Rosemont Re treaty of $6.4 million) of $49.0 million as of December 31, 2006. The net reserves consist of the following (in thousands):
Additional net liabilities of $3.6 million representing payment requests made to the Company are included in other liabilities on the Company’s balance sheet. These net liabilities are being contested in pending arbitrations. (See “Legal Proceedings-Bail and Immigration Bond Proceedings.”)
The Occupational Accident reserves are provided to the Company by the internal actuary for the managing general agent in charge of the programs. The Company and its independent actuaries periodically review the resulting estimates of the managing general agent’s actuary for concurrence with his estimates. The remaining reserves involve approximately 40 separate contracts primarily involving high level excess of loss contracts, both property and casualty. These contracts are subject to periodic review by the Company’s internal and independent actuaries.
based on the Company’s assumptions related to the underlying policies written, including the lives of the underlying policies, future investment income, and level of expenses necessary to maintain the policies over their entire lives. Deferred policy acquisition costs are amortized over the period in which the related premiums are earned.
The Company considers its fixed maturity and equity securities as available-for-sale securities. Available-for-sale securities are sold in response to a number of issues, including the Company’s liquidity needs, the Company’s statutory surplus requirements and tax management strategies, among others. During the fourth quarters of 2002 and 2003, the Company sold significant amounts of its available-for-sale securities to increase surplus for statutory accounting purposes. In late 2001 and 2002, the Company began to shift the character of its investment income to fully taxable in recognition of the Company’s current tax position. Available-for-sale securities are recorded at fair value. The related unrealized gains and losses, net of income tax effects, are excluded from net income and reported as a component of stockholders’ equity.
The current unrealized losses in fixed maturity securities are considered to be interest rate related. All fixed maturity securities held by the Company have paid all scheduled contractual obligations and the Company believes that each issuer has the ability to meet their remaining contractual obligations related to the security. The Company has the ability and intent to hold these securities to maturity.
The Company believes it is more likely than not that the deferred income tax assets will be realized through its future earnings. As a result, the Company has not recorded a valuation allowance. The Company’s core operations have historically been profitable on both a GAAP and tax basis. The losses incurred in 2001 to 2004 were primarily caused by losses in the non-core healthcare and assumed reinsurance businesses. Since the core healthcare liability operation has remained strong and improved over the past years and the non-core healthcare liability and assumed operations are now in run-off, the Company has returned to a position of taxable income, thus enabling it to begin utilizing the net operating loss carryforward.
Company added more than 75 hospitals to its program. These policies were written through national and regional brokers and covered facilities in four states outside California. At approximately the same time, the Company undertook a major geographic expansion in the physician and small medical group market through an arrangement with Brown & Brown, a leading publicly held insurance broker. This arrangement commenced in 1998, eventually encompassed nine states and in 2000 was expanded to include dentists in two states. During the same period, the Company also expanded into underwriting nonstandard physicians in a number of states outside California.
In 2001, the Company recognized that the Brown & Brown and non-standard physician programs were seriously underpriced and implemented significant premium increases in its principal non-California markets. The Company also instituted more stringent underwriting and pricing guidelines in these states. Despite the significant price increases and more stringent underwriting guidelines, the non-California programs produced significant underwriting losses in 2002, 2003 and 2004.
The underwriting expense ratio (expenses related to premiums earned) remained relatively unchanged at 20.7% in 2006 compared to 20.3% and 20.9% in 2005 and 2004.
No adjustments were made to overall reserve levels in 2006 because experience related to new claims and average settlement amounts was consistent with actuarial expectations.
The underwriting gain in 2005 was the result of reductions in reserves for prior losses. The experience related to new claims and average settlement costs was less than what had been expected when 2004 reserve levels were set. The underwriting loss incurred in 2004 is primarily due to two adverse litigation decisions, reserve increases attributable to older years on dentists coverage and a general reserve increase of $3.0 million in the fourth quarter 2004.
The Company has made significant progress in 2006 and 2005 in settling claims related to non-core healthcare liability business in run-off. Total net reserves declined from $97.3 million at December 31, 2004 to $60.6 million at December 31, 2005, to $37.7 million at December 31, 2006. Outstanding claims decreased from 431 at December 31, 2004 to 229 at December 31, 2005, and to 136 at December 31, 2006. Eleven new claims were reported in 2006 compared to 16 in 2005 and 78 in 2004.
As a result of the Company’s decline in capital and surplus from the World Trade Center losses and losses incurred in healthcare insurance outside California, A. M. Best reduced the Insurance Subsidiaries ratings below the A- (Excellent) rating. Most ceding companies and companies in assumed reinsurance syndicates are reluctant to deal with insurers whose ratings are below A-. This fact made it difficult for the Company to remain in the assumed reinsurance market.
As a result, in December 2002 the Company entered into a quota share reinsurance transaction with Rosemont Reinsurance Ltd. (Rosemont Re) (formerly known as GoshawK Reinsurance Limited), a Bermuda reinsurance subsidiary of GoshawK Insurance Holdings plc, a publicly held London-based Lloyd’s underwriter (GoshawK), under which the Company ceded to Rosemont Re almost all of its unearned assumed reinsurance premiums as of June 30, 2002, together with written reinsurance premiums after that date, in each case related to the assumed reinsurance business for the 2001 and 2002 underwriting years. The Company retained certain losses related to the assumed reinsurance business, including those related to the World Trade Center, and the Company continued to participate in one Lloyd’s syndicate for the 2003 underwriting year. The Rosemont Re treaty relieved the Company of underwriting leverage and improved the Company’s risk-based capital adequacy ratios under both the A.M. Best and NAIC models.
Assets approximately equal to Rosemont Re’s estimated liabilities under its reinsurance agreement with the Company are currently held in trust to satisfy the liabilities under the agreement. If the estimated recoveries were to increase in the future, the Company would have to rely on Rosemont Re’s continuing ability to fund these amounts. As of June 30, 2006 Rosemont Re had $66.1 million of capital.
The underwriting loss in 2005 was primarily attributable to (i) adjustments made to amounts ceded to Rosemont Re following a review by the parties in the third quarter, which resolved interpretative issues relating to the wording of the reinsurance contract, (ii) additional costs incurred with closing the last syndicate at Lloyd’s for which the Company provided capital, a decision which was made in the fourth quarter and significantly improved the Company’s capital adequacy ratios under the A.M. Best capital adequacy model, and (iii) unexpected upward development on London-based business, including Lloyd’s syndicates.
The Rosemont Re reinsurance treaty has both prospective and retroactive elements as defined in Financial Accounting Standards Board Statement (FASB) No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. As such, any gains under the contract will be deferred and amortized to income based upon the expected recovery. No gains are anticipated currently. Losses related to future earned premium ceded, as well as development on losses related to existing earned premium ceded after June 30, 2002, will ultimately determine whether a gain will be recorded under the contract. The retroactive accounting treatment required under FASB 113 requires that a charge to income be recorded to the extent premiums ceded under the contract are in excess of the estimated losses and expenses ceded under the contract.
The Company had an income tax expense in 2006, 2005 and 2004. During the third quarter 2004, the Company settled with the California Franchise Tax Board (FTB) for $4.0 million, an assessment received in 2002. Legislation enacted in California during
the third quarter of 2004 restored 80% of a deduction provision under which insurance holding companies had for many years deducted all dividends received from their insurance company subsidiaries. The $4.0 million settlement was included in income taxes and offsets a federal tax benefit for the year of $3.9 million.
Because of uncertainty related to the timing of the payment of claims, cash from operations for a property and casualty insurance company can vary substantially from period to period. The Company had positive cash flow from operations of $7.6 million in 2006 compared to 2005 and 2004, when the Company had negative cash flow from operations of $30.2 million and $63.1 million, respectively. The positive cash flow during 2006 is primarily related to core premium receipts and the decreasing claims payments associated with the non-core healthcare liability and assumed reinsurance programs, which are now in run-off. As the Company continues to pay-off non-core healthcare liability and assumed reinsurance reserves generated by prior years written premiums, the Company may again have negative cash flow from operations.
The Company maintains a significant portion of its investment portfolio in high-quality, short-term securities and cash to meet short-term operating liquidity requirements, including the payment of losses and LAE. Cash and cash equivalents totaled $145.8 million, or 27.1% of invested assets, at December 31, 2006. The Company believes that all of its short-term and fixed-maturity securities are readily marketable and have scheduled maturities in line with projected cash needs. In addition, available current investment yields have caused the Company to build up its short-term investments.
The Company invests its cash flow from operations principally in taxable fixed-maturity securities. The Company’s current policy is to limit its investment in unaffiliated equity securities and mortgage loans to no more than 8.0% of the total market value of its investments. The market value of the Company’s portfolio of unaffiliated equity securities was $2.0 million at both December 31, 2006 and 2005. The Company plans to continue its emphasis on fixed-maturity securities investments.
The Company leases approximately 95,000 square feet of office space for its headquarters. The lease is for a term of 10 years ending in 2009, and the Company has two options to renew the lease for a period of five years each.
In March 2004, the Board of Directors suspended the Company’s quarterly dividends. The payment and amount of cash dividends will depend upon, among other factors, the Company’s operating results, overall financial condition, capital requirements and general business conditions. As of December 31, 2006, SCPIE Holdings held cash and short-term securities of $5.6 million. Based on historical trends, market conditions and its business plans, the Company believes that its sources of funds
The Company’s capital adequacy position was weakened in the past by the losses in the non-core businesses. The Company’s current rating from A.M. Best is B+ (Good), with a stable outlook. A.M. Best assigns this rating to companies that have, in its opinion, a good ability to meet their current obligations to policyholders. The Company believes that it has strengthened its capital adequacy position at December 31, 2006, under the methodology followed by A.M. Best, but does not know whether this will result in a further rating change. The NAIC has developed a different methodology for measuring the adequacy of an insurer’s surplus which includes a risk-based capital (RBC) formula designed to measure state statutory capital and surplus needs. The RBC rules provide for different levels of regulatory attention based on four thresholds determined under the formula. At December 31, 2006, the RBC level of each Insurance Subsidiary exceeded the threshold requiring the least regulatory attention. At December 31, 2006, SCPIE Indemnity’s adjusted surplus level of $164.5 million was 340% of this threshold.
The Company believes that it has the ability to fund its continuing operations from its premiums written and investment income. The Company plans to continue its focus on the efficient operation of its core business, while at the same time continuing to adjudicate and settle claims incurred in its discontinued non-core business. As the Company continues to run-off the non-core loss and LAE reserves, its capital adequacy position should improve.
date, the Company believes that loss and LAE reserve levels and the Company’s rate making process adequately incorporate the effects of inflation.