The selected consolidated financial data presented below as of the end of and for each of the years in the five-year period ended December 31, 2000, are derived from the Company's consolidated financial statements. The consolidated financial statements as of December 31, 2000 and 1999, and for each of the years in the three-year period ended December 31, 2000, are included elsewhere in this Form 10-K. For further discussion of earnings per share, see Note 3 of the Notes to Consolidated Financial Statements.
2000 1999 1998 -------- -------- -------- (Amounts in thousands, except per share data)
The tables presented in Notes 17 and 18 of the Notes to Consolidated Financial Statements summarize the Company's unaudited quarterly results of operations for each of the two years in the period ended December 31, 2000, and the results of operations by line of business for each of the three years then ended. The following discussion of underwriting results by line of business should be read in conjunction with the information presented in those tables.
Personal Auto. Automobile insurance is the primary line of business written ------------- by the Company and historically has been profitable. The majority of the Company's insured autos are located in Southern California. The Company continues to expand its coverage throughout the West by marketing its business in Northern California, San Diego county, Nevada, Oregon and Washington.
Vehicles in force were 1,166,971, 1,184,797 and 1,130,029 as of December 31, 2000, 1999 and 1998, respectively. The decrease in 2000 resulted from actions taken to improve underwriting results (discussed further below). The increase in vehicles in force in 1999 was mainly from two factors: it was the first full year of operations in Nevada, Oregon and Washington, and California rates were reduced 6.85% early in 1999 in a move that anticipated a continuation of favorable loss trends that failed to materialize. The Company's retention rate was approximately 95% for 2000 and 96% for both 1999 and 1998.
Gross premiums written were $878.2 million in 2000, $853 million in 1999 and $858.3 million in 1998. The increase in 2000 was due to rate increases that more than offset the decline in the number of insured vehicles. The decrease in 1999 was caused mainly by rate decreases of 6.85% effective February 15, 1999 and 3.2% effective January 1, 1998, which more than offset the increase in the number of insured vehicles.
Underwriting results were a loss of $40 million in 2000 compared to underwriting profits of $78.3 million in 1999 and $112.7 million in 1998. The Company had reduced its California rates by more than 25% from 1996 to 1999, and the rate decreases in 1998 and 1999 in particular had anticipated the continuation of favorable loss trends that failed to materialize. The resultant under pricing caused the loss and LAE ratio to grow steadily from 74.9% in 1998 to 90.8% in 2000, with the higher-than-anticipated losses first becoming evident in the third quarter of 1999. Corrective measures taken in 2000 included increasing auto rates by 6.4% in California, 20% in Arizona, 21% in Oregon and 25% in Washington, with a 12.6% rate increase still pending in Nevada. An additional rate increase was filed for in California subsequent to December 31, 2000.
Earthquake. Aside from an insignificant amount of premium assumed from the ---------- California FAIR Plan prior to inception of the California Earthquake Authority in 1998, the Company has not written any earthquake coverage since 1994 but continues to be exposed to possible adverse development stemming from the 1994 Northridge Earthquake. Earthquake losses and expenses totaled $3.5 million in 2000, $2.4 million in 1999 and $40.0 million in 1998. As noted under Item 1 - Business, earthquake losses and loss adjustment expenses may be adversely impacted in 2001 and perhaps future years by SB 1899 and the ultimate resolution of certain earthquake claims currently in litigation.
Net realized losses on the sale of investments were $4.6 million in 2000 and $0.3 million in 1999 compared to net capital gains of $22.6 million for 1998. The 1998 increase in realized gains is primarily due to the Company's decision to begin switching its investment portfolio from taxable to non-taxable securities during 1998 in anticipation of fully utilizing its remaining net operating loss carryforward and selling in a favorable bond market. At December 31, 2000, $831.4 million of the Company's total investments at fair value were invested in tax-exempt bonds with the balance, representing 9.7% of the portfolio, invested in taxable securities compared to 14.4% at December 31, 1999.
Premiums and investment income represent the Company's major sources of cash, while loss and loss adjustment expense payments are the most significant cash out-flows. The Company continually monitors loss payments to provide projections of future cash requirements. Additional cash requirements include the cost of investing in new technology, dividends to stockholders and, in 2000, the payoff of the bank loan of $67.5 million. Funds required by the Company to pay dividends are provided by the insurance subsidiaries. The ability of the insurance subsidiaries to pay dividends to the parent company is regulated by state law. Based upon 2000 operating results and earned surplus as of December 31, 2000, the Company believes it will not require regulatory approval in 2001 for any extraordinary dividends.
In 1997, the Company embarked on a major project to upgrade its technological infrastructure and to conform certain of its operational procedures to "industry best practices." Although the ultimate cost of this project is expected to be about $100 million to be paid through the end of 2001, management believes cash flow from operations as well as expected improvements in operational efficiencies will be more than adequate to fund the project's implementation which is expected to be completed over the next several years.
We have audited the accompanying consolidated balance sheets of 21st Century Insurance Group and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of 21st Century Insurance Group and subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
21ST CENTURY INSURANCE GROUP CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, ----------------------- 2000 1999 ---------- ----------- (Amounts in thousands, except share data)
Unpaid losses and loss adjustment expenses - Note 9 $ 298,436 $ 276,248 Unearned premiums 236,519 232,702 Bank loan payable - Note 10 - 67,500 Claims checks payable 35,982 31,912 Reinsurance payable 15,989 22,311 Other liabilities 30,588 27,822 ---------- ----------- Total liabilities 617,514 658,495
Series A convertible preferred stock, par value $1.00 per share, stated value $1,000 per share; authorized 376,126 shares, none outstanding - -
Net premiums earned - Note 11 $825,486 $770,423 $772,864 Net investment income - Note 4 49,286 62,668 75,146 Realized investment gains (losses) - Note 4 (5,010) (410) 22,640 --------- --------- -------- 869,762 832,681 870,650
21ST CENTURY INSURANCE GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000
The accompanying consolidated financial statements include the accounts and operations of the Company. All material intercompany accounts and transactions have been eliminated. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States ("GAAP") which differ from statutory accounting practices ("SAP") prescribed or permitted by insurance regulatory authorities. The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from these estimates.
The Company classifies its investment portfolio as available-for-sale and carries it at fair value with unrealized gains and losses, net of any tax effect, reported as accumulated other comprehensive income (loss) as a separate component of stockholders' equity.
The Company's 49% interest in 21st Century Insurance Company of Arizona ("21st of Arizona"), which is a joint venture between the Company and AIG and which began operations in August 1996, has a carrying value of $4,604,000 at December 31, 2000, and is included in other assets in the consolidated balance sheet. The Company's equity in the net loss of this venture amounted to $1,060,000, $451,000 and $373,000 in 2000, 1999 and 1998, respectively, and is included in investment income in the consolidated statements of income. See Note 4 of Notes to Consolidated Financial Statements.
The estimated liabilities for losses and loss adjustment expenses include the accumulation of estimates of losses for claims reported prior to the balance sheet dates, estimates (based upon actuarial analysis of historical data) of losses for claims incurred but not reported and estimates of expenses for investigating and adjusting all incurred and unadjusted claims. Amounts reported are estimates of the ultimate costs of settlement, net of estimated salvage and subrogation, which are necessarily subject to the outcome of future events including the effects of changes in economic and social conditions. Management believes that, given the inherent variability in any such estimates, the aggregate reserves are within a reasonable and acceptable range of adequacy. The methods of making such estimates and for establishing the resulting reserves are reviewed and updated quarterly and any adjustments resulting therefrom are reflected in current earnings.
The following table sets forth the computation of basic and diluted earnings per common share:
The amortized cost, gross unrealized gains and losses and fair values of investments as of December 31, 2000 and 1999, are as follows:
The amortized cost and fair value of the Company's fixed maturity investments at December 31, 2000, are summarized by contractual maturity as follows:
Details follow concerning the changes in the after-tax items included in "Other Comprehensive Income" in the Consolidated Statements of Stockholders Equity for 2000, 1999 and 1998.
YEARS ENDED DECEMBER 31, --------------------------- 2000 1999 1998 --------- ------- ------- (Amounts in thousands) Current tax expense (benefit) $(10,077) $16,101 $ 3,414 Deferred tax expense (benefit) (3,961) 17,598 50,884 --------- ------- ------- $(14,038) $33,699 $54,298 ========= ======= =======
During 2000, the Company had a net operating loss of approximately $82 million. As of December 31, 2000, the Company has a net operating loss carryforward of approximately $177 million for regular tax purposes of which approximately $95 million expires in the year 2009 and $82 million expires in the year 2020, a charitable contribution carryforward expires in 2006 and an alternative minimum tax credit carryforward of $23 million. Alternative minimum tax credits may be carried forward indefinitely to offset future regular tax liabilities.
The Company is required to establish a "valuation allowance" for any portion of the deferred tax asset that management believes will not be realized. The Company believes that because of its historically strong earnings performance and tax planning strategies available, it is more likely than not that the Company will realize the full benefit of the deferred tax asset; therefore, no valuation allowance has been established.
A reconciliation of income tax computed at the federal statutory tax rate of 35% for 1998 through 2000 to total income tax expense follows:
There were no income tax payments required for the year ended December 31, 2000. Payments for income taxes were $19,500,000 and $13,661,000 for the years ended December 31, 1999 and 1998, respectively.
A summary of property and equipment follows as of December 31,
Furniture and office equipment $ 47,288 $ 36,034 Automobiles 3,575 3,164 Leasehold improvements 14,153 8,282 Software currently in service 44,504 35,040 Software development projects in progress 74,442 31,970 --------- --------- Subtotal 183,962 114,490 Less accumulated depreciation (45,900) (30,035) --------- --------- $138,062 $ 84,455 ========= =========
The Company also sponsors an unfunded supplemental executive retirement plan that covers certain key employees designated by the Board of Directors. The supplemental plan benefits are based on years of service and compensation during the last three years of employment and are reduced by the benefit payable from the pension plan.
The Company sponsors a contributory savings and security plan for eligible employees. The Company provides matching contributions equal to 75% of the lesser of 6% of an employee's compensation or the amount contributed by the employee. Contributions charged against operations were $3,089,000, $2,963,000 and $2,728,000 in 2000, 1999 and 1998, respectively.
In September 2000, the Company exercised its option to prepay the then-remaining balance of $33.75 million, which resulted in a pre-tax charge of $286,000 from the write-off of previously unamortized debt issuance costs. This charge has been included in third quarter interest expense for financial reporting purposes. Interest paid was $2,204,000 in 2000, $5,306,000 in 1999 and $8,660,000 in 1998.
The effect of reinsurance on premiums written and earned is as follows (amounts in thousands):
Gross $910,720 $906,903 $ 880,534 $ 881,523 $ 885,617 $ 885,332 Ceded (78,593) (81,417) (111,721) (111,100) (111,903) (112,468) --------- --------- ---------- ---------- ---------- ---------- Net $832,127 $825,486 $ 768,813 $ 770,423 $ 773,714 $ 772,864 ========= ========= ========== ========== ========== ==========
YEARS ENDED DECEMBER 31, ------------------------------- 2000 1999 1998 --------- --------- --------- (Amounts in thousands)
Beginning January 1, 2000, a multilevel catastrophe reinsurance program provides for recoveries of homeowner losses of up to $65 million in excess of $10 million retention per occurrence. Because the Company's homeowner policies do not include any earthquake coverage, its principle catastrophe exposure relates to the potential for fire following an earthquake. In 2000, the company ceded 10.64% of the direct premium earned on homeowners policies related to property coverage in the amount of $2.6 million.
The Company has a quota share treaty for its Personal Umbrella Policy line of business whereby it cedes 60% of premiums and losses. After the effect of the 10% quota share treaty with AIG discussed earlier, the Company effectively retains 36% of the risk for this line of business from 1995 through 1999. For 2000, the quota share treaty percent is 8% and the retention is 36.8%.
2001 $ 14,579 2002 14,389 2003 12,994 2004 12,032 2005 12,059 Thereafter 108,959
State insurance laws and regulations of the California Department of Insurance (CDOI) prescribe accounting practices, which differ from GAAP, for determining statutory net income and policyholders' surplus for insurance companies. The statutory-basis policyholders' surplus of the Company's insurance subsidiaries was $475.6 million and $581.4 million as of December 31, 2000 and 1999, respectively. The statutory-basis net income was $11.1 million, $100.1 million and $154.9 million for the years ended December 31, 2000, 1999 and 1998, respectively.
The maximum amount of dividends which can be paid by California insurance companies without prior approval of the CDOI is limited to the greater of 10% of policyholders' surplus as of the preceding December 31 or net income for the preceding year. Statutory regulations also require that dividends be paid from earned surplus. At December 31, 2000, the amount of dividends available to the Company from its insurance subsidiaries during 2001 not limited by such restrictions is approximately $46.7 million.
The National Association of Insurance Commissioners developed a revised Accounting Practices and Procedures Manual (the "Codification") that became effective for California-domiciled insurance companies on January 1, 2001. To some extent, the new Codification prescribes changes to the statutory accounting practices that the Company and its insurance subsidiaries will use to prepare their statutory-basis financial statements for periods ending after December 31, 2000. Management believes the impact of these changes to the Company and its insurance subsidiaries' statutory-basis capital and surplus as of January 1, 2001, will not be significant.
Exercise prices for options outstanding at December 31, 2000, ranged from $12.50 to $29.25. The weighted-average remaining contractual life of those options is 7.8 years.
For pro forma disclosure purposes, the fair value of stock options was estimated at each date of grant using a Black-Scholes option pricing model using the following assumptions: risk-free interest rates ranging from 5.93% to 6.82% for 2000, 5.48% for 1999 and 5.02% to 5.65% for 1998; dividend yields of 2.50% for 2000, 3.59% in 1999 and ranging from 1.98% to 2.33% in 1998; volatility factors
of the expected market price of the Company's common stock ranging from 0.20 to 0.32 for 2000 and 0.23 for both 1999 and 1998; and a weighted-average expected life of the options of 8 years in 2000, 1999 and 1998.
The Restricted Shares Plan currently provides for grants of up to 1,421,920 shares of common stock to be made available to key employees as determined by the Key Employee Incentive Committee of the Board of Directors. Restrictions are removed on 20% of the shares of each employee on January 1 of each of the five years following the year of grant. Upon issuance of grants of common shares under the plan, unearned compensation equivalent to the market value on the date of grant is charged to common stock and subsequently amortized in equal monthly installments over the five-year vesting period of the grant. As a consequence of AIG's acquiring a controlling interest in the Company, the previously unamortized balance of $2,280,000 as of July 27, 1998, was recognized as a charge to income. Total amortization expense relating to the Restricted Shares Plan was $178,000 and $2,698,900 in 2000 and 1998, respectively. There was no amortization expense in 1999. The Board of Directors decided in November 2000 to discontinue this plan as a major component of its long-term incentive program. In the future, restricted share awards are intended be used on a selective basis to reward key contributions, recruit new executives or key personnel or for similar purposes.
Other Personal Lines. An underwriting profit was generated in 2000 as ---------------------- policies-in-force increased. The $9.8 million underwriting loss in 1999 was primarily due to a $6.75 million charge taken in the second quarter in connection with a settlement reached in April 1998 with the CDOI. The settlement enabled the Company to resume sales of new homeowner policies in 1999. The 1998 underwriting loss is primarily due to the Company's not being able to write new business.