The Company leases its Home Office building in Woodland Hills, Califor- nia, which contains approximately 234,000 square feet of leasable office space. The lease was amended in October 1994 which extended the lease term until November 1999. The lease may be renewed for two consecutive five-year periods.
The property and casualty insurance business has a history of fluctuat- ing results and underwriting profitability and has tended to vary in cycles. Insurer profitability is influenced by many factors, including price competi- tion, claim frequency and severity, crime rates, natural disasters, economic conditions, interest rates, state regulations and laws, changes in the legal system and court decisions. Insurance industry price levels tend to change with underwriting results. As companies experience underwriting losses, and therefore reduced surplus levels, prices tend to increase and competition decreases. As underwriting results improve, and surplus levels increase, prices tend to decrease and competition increases. One of the challenging and unique features of the property and casualty insurance business is that its products must be priced before costs are fully known because premiums are charged before claims are incurred.
The Northridge, California Earthquake which occurred on January 17, 1994 ("Northridge Earthquake") resulted in unprecedented losses for the Company. In order to reduce future earthquake exposure, the Company ceased writing new homeowner and condominium insurance and renewing earthquake insurance in accordance with an order received from the California Department of Insurance ("DOI") in June 1994. The last earthquake coverages were terminated in July 1995. In accordance with the order, the Company will continue to renew existing homeowner and condominium policies (without earthquake coverage) until June 1996. The last homeowners and condominium coverages will be term- inated in July 1997.
In June 1994, the Company obtained a bank loan of $175 million and in December 1994 entered into an Investment and Strategic Alliance Agreement ("Investment Agreement") with American International Group, Inc. ("AIG"). Under the terms of the Investment Agreement, AIG provided the Company with a total of $216 million of equity capital in exchange for 200,000 shares of convertible preferred stock and certain preferential stock warrants. As a part of the agreement, each of the Company's insurance subsidiaries and an AIG affiliate have entered into a five-year quota share reinsurance agree- ment for 10% of each subsidiaries' policies incepting on and after January 1, 1995. After the initial term, the AIG affiliate may renew the agreement annually for four years at declining rates of coverage. In addition, the Company and AIG have formed a joint venture to market personal automobile in- surance in Arizona which is expected to become operational in the second quar- ter of 1996.
Units in force for the Company's insurance programs as of December 31 were as follows: 1995 1994 1993 ---- ---- ---- Units in Force Private Passenger Automobile (number of vehicles) 1,056,028 1,132,605 1,130,446 Homeowner and Condominium (number of policies) 174,968 206,167 233,436 Personal Excess Liability (number of policies) 10,400 11,072 11,350 --------- --------- --------- Total 1,241,396 1,349,844 1,375,232 ========= ========= =========
Automobile insurance is the primary line of business written by the Com- pany and has been consistently profitable. Excluding earthquake-related claims and expenses, the earthquake reinsurance reinstatement premium and the Proposition 103 rollback, the Company would have realized an automobile underwriting profit of $73.8 million in 1995 and $10.1 million in 1994. Because of the cessation of advertising in 1994 and some loss of auto business from not offering new homeowner business or earthquake coverage, total automobile units in force for 1995 decreased from 1994 by 6.8% compared to a slight increase of .2% in 1994. Gross written premiums in 1995 remained level despite the decrease in units in force, primarily as a result of the rate increases effective during the year. Net earned premiums decreased 6.2% in 1995 compared to an increase of 8.1% in 1994, reflecting the impact of the quota share treaty with an AIG affiliate effective January 1, 1995 which ceded 10% of premiums and losses on a net written basis.
As ordered by the DOI, the Company no longer writes new homeowners or condominium policies or earthquake coverage endorsements. Additionally, the Company will continue to renew existing homeowner and condominium policies
first $ 10,000,000 $ 7,750,000 $ 2,250,000 next $ 90,000,000 $ 4,500,000 $ 85,500,000
The Company will maintain a catastrophe reinsurance program in place until the homeowner and condominium program expires. It is expected that the cost will decline as the exposures decline.
The personal excess liability program has remained stable over the three-year period ended December 31, 1995 producing approximately $2 million in gross written premiums each year. Underwriting profits can vary sig- nificantly with the number of claims which occur infrequently.
Net pre-tax investment income was $81,658,000 in 1995, $84,761,000 in 1994 and $97,574,000 in 1993. Average invested assets decreased 5.3% and 9.0% in 1995 from 1994 and 1994 from 1993, respectively. Average annual pre-tax yield on invested assets declined from 7.1% in 1993 to 6.7% in 1994 and increased slightly to 6.8% in 1995. The overall decline in investment income and yields from 1993 levels is the result of lower rates available on fixed maturity investments purchased since 1993, the sale of relatively higher yielding bonds in 1994 to generate cash for paying earthquake claims in 1994 and the decline in business in 1995.
Realized capital gains on the sales of investments increased from $16,729,000 in 1993 to $61,554,000 in 1994 and then decreased to $10,207,000 in 1995.
Of the Company's total investments, $195,609,000 at fair value was invested in tax-exempt state and municipal bonds and the balance was invested in taxable government, corporate and municipal securities. At December 31, 1995, the portfolio contained 83% taxable instruments compared to 76% a year earlier.
The Company's investment guidelines currently emphasize buying high- quality, fixed income, taxable securities because of the Company's substantial net operating loss carryforward. While the Company's policy is generally to hold these investments until maturity, its ongoing monitoring and evaluation of investment holdings and market conditions may, from time to time, result in selected sales of investments prior to maturity. The Company has designated its portfolio as "available-for-sale" and it is carried at fair value as of December 31, 1995 and 1994 in accordance with the standards set forth in Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". For a more complete description of this standard, see Note 1 of the Notes to Consolidated Financial State- ments, "Investments".
Loss and loss expense payments are the most significant cash flow requirements of the Company. The Company continually monitors loss payments to provide projections of future cash requirements.
Prior to 1994, the Company's most significant capital requirement resulted from its need to maintain an acceptable ratio of net premiums written to policyholders' surplus. In 1994, the losses from the Northridge Earthquake were so severe that the Company obtained a bank loan for its subsidiaries and equity financing from AIG to meet its obligation to pay earthquake claims and strengthen surplus. See Notes 7 and 14 of the Notes to Consolidated Financial Statements.
The Company leases its Home Office building in Woodland Hills, Califor- nia, which contains approximately 234,000 square feet of leasable office space. The current lease comes up for renewal in November 1999 and may be renewed for two consecutive five-year periods.
We have audited the accompanying consolidated balance sheets of 20th Century Industries and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 based on our audits.
Unpaid losses and loss adjustment expenses - Note 6 $ 584,834 $ 756,243 Unearned premiums 288,927 298,519 Bank loan payable - Note 7 175,000 160,000 Claims checks payable 49,306 70,725 Reinsurance payable 23,176 296 Proposition 103 payable - Note 12 - 78,307 Other liabilities - Note 5 21,058 20,776 ---------- ---------- Total liabilities 1,142,301 1,384,866 ---------- ----------
Commitments - Note 9 and Contingencies - Note 11 Stockholders' equity - Note 10 Capital Stock Preferred stock, par value $1.00 per share; authorized 500,000 shares, none issued Series A convertible preferred stock, stated value $1,000 per share, authorized 376,126 shares, outstanding 224,950 in 1995 and 200,000 in 1994 224,950 200,000 Common stock without par value; authorized 110,000,000 shares, outstanding 51,493,406 in 1995 and 51,472,471 in 1994 69,805 69,340 Common stock warrants 16,000 16,000 Unrealized investment gains (losses), net - Note 2 33,508 (39,777) Retained earnings 122,322 72,381 ---------- ---------- Total stockholders' equity 466,585 317,944 ---------- ---------- $1,608,886 $1,702,810 ========== ==========
The Company has classified its investments as available-for-sale in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities". SFAS No. 115, which was adopted January 1, 1994, requires that fixed maturity securities are to be classified as either held-to-maturity, available-for- sale, or trading. Held-to-maturity debt securities are to be reported at amortized cost; trading securities are to be reported at fair value, with unrealized gains or losses included in earnings; and available-for-sale securities are to be reported at fair value, with unrealized gains or losses excluded from earnings and reported in a separate component of stockholders' equity.
In the normal course of business, the Company seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Reinsurance premiums and reserves on reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Amounts applicable to ceded unearned premiums and ceded claim liabilities are reported as assets in the accompanying balance sheets.
Income taxes have been provided using the liability method in accordance with SFAS No. 109, "Accounting for Income Taxes". Under that method, deferred tax assets and liabilities are determined based on the differences between their financial reporting and their tax bases and are measured using the enacted tax rates.
Earnings (losses) per common share are computed using the weighted average number of common shares outstanding during the respective periods. The primary weighted average number of shares was 57,223,839 for the year ended December 31, 1995, 51,387,120 for 1994 and 51,411,968 for 1993. The fully diluted weighted average number of shares was 79,325,308 for the year ended December 31, 1995, and were the same as primary for 1994. Primary earnings per share amounts for 1993 reflect a simple capital structure in which there were no securities in existence allowing common stock to be acquired as a result of exercising the conversion rights of such securities. The 1994 and 1995 primary and fully diluted loss per share amounts reflect a complex capital structure in which securities exist that allow for the acquisition of additional common stock through the exercise of conversion rights in these securities. Primary and fully diluted loss per share amounts for 1994 are the same since there was a net loss for the year, as including the convertible securities in the computation of the loss per share would be antidilutive.
The carrying amounts of financial instruments, other than investment securities, approximate their fair values. For investment securities, fair values are based on quoted market prices. The carrying amounts and fair values for all investment securities are disclosed in Note 2.
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting and Disclosure of Stock-Based Compensation", became effective with fiscal years beginning after December 15, 1995. Stock-based compensation is accounted for presently in accordance with the requirements set forth in APB Opinion No. 25, "Accounting for Stock Issued to Employees". At this time, the Company is evaluating the provisions of SFAS No. 123 and has not yet determined whether it will adopt the Statement for expense recognition purposes.
The maturity distribution of the Company's fixed maturity investments at December 31, 1995 was as follows: (Amounts in thousands)
Available-for-Sale --------------------------- Amortized Fair Fixed maturities due: Cost Value - - --------------------- ---------- --------
Under normal operations, the Company's principal deferred tax assets arise from the discounting of loss reserves for tax purposes which delays a portion of the loss deduction, and from the acceleration of 20% of the unearned premium reserve into taxable income before it is earned. The Company as of December 31, 1995 has a net operating loss carryforward of approximately $518,000,000 for regular tax purposes and $373,000,000 for alternative minimum tax purposes expiring in the year 2009 and an alternative minimum tax credit carryforward of $8,778,000.
The Company is required to establish a "valuation allowance" for any portion of the deferred tax asset that management believes will not be realized. In order to utilize the deferred tax asset, the Company must have the ability to generate sufficient future taxable income to realize the tax benefits. The Company has available the following tax-planning strategies to generate additional taxable income in the future above historical levels:
Cash paid for income taxes was $65,000, $-0- and $26,026,000 for the years ended December 31, 1995, 1994 and 1993, respectively.
The Company has voluntary qualified contributory savings and security plans for eligible employees which incorporate Section 401(k) of the Internal Revenue Code to permit certain pre-tax contributions by participants. Under the plans, the Company matches 75% of all employee contributions up to a limit of 6% of each participating employee's compensation. Contributions charged against operations were $2,376,000, $2,210,000 and $1,943,000 in 1995, 1994 and 1993, respectively.
As of December 31, 1995, the Company's outstanding advances against the Facility totalled $175 million for which loan origination fees totaling $9.8 million were incurred. Loan fees are being amortized over the life of the Facility. Interest is charged at a variable rate based, at the option of the Company, on either (1) the contractually defined Alternate Base Rate (ABR) plus a margin of 0.25% or (2) the Eurodollar Rate plus a margin of 1.00%. Margins will be adjusted in relation to certain financial and operational levels of the Company. The ABR is defined as a daily rate which is the higher of (a) the prime rate for such day or (b) the Federal Funds Effective Rate for such day plus 1/2% per annum. Interest is payable at the end of each interest period. The stock of the Company's insurance subsidiaries is pledged as collateral under the loan agreement. At December 31, 1995, the annual interest rate for the specified interest period was approximately 6.9%. Interest paid was $12,636,000 in 1995 and $7,277,000 in 1994.
Loss and loss adjustment expenses have been reduced by reinsurance ceded as follows (amounts in thousands): 1995 1994 1993 -------- ---------- -------- Gross losses and loss adjustment expenses incurred $921,104 $1,905,161 $871,151 Ceded losses and loss adjustment expenses (69,502) (76,815) (3,700) -------- ---------- -------- Net losses and loss adjustment expenses incurred $851,602 $1,828,346 $867,451 ======== ========== ========
In connection with an investment agreement formed in 1995 with American International Group, Inc. ("AIG") (see Note 14), each of the Company's insurance subsidiaries entered into a five-year quota share reinsurance agreement with an AIG affiliate to provide coverage for all ongoing lines of business. Under this contract, 10% of each subsidiary's premiums earned and losses incurred in connection with policies incepted during the period January 1, 1995 through December 31, 1999 are ceded. Substantially all of the Company's reinsurance receivables are due from the AIG affiliate. At the end of the five-year period, the AIG affiliate may elect to renew the agreement annually at declining coverage percentages. A ceding commission of 10.8% was earned by the insurance subsidiaries for 1995 and, thereafter, is paid a ceding commission at a rate equal to their actual underwriting expense ratio.
The Company's insurance subsidiaries have restrictions affecting the amount of stockholder dividends which may be paid to the parent company within any one year without the approval of the California Department of Insurance. The California Insurance Code provides that amounts may be paid as dividends from earned surplus on an annual, noncumulative basis, without prior approval by the California Department of Insurance, up to the greater of (1) net income for the preceding year, or (2) 10 percent of statutory surplus as regards policyholders as of the preceding December 31.
COMMON MARKET PRICE PER SHARES SHARE ON DATE OF GRANT ------ ----------------------
Granted in 1995 35,813 $11.17 Vested in 1995 40,224 Cancelled or forfeited 14,878 ------- Outstanding, December 31, 1995 43,883 =======
On January 27, 1995, the Company announced a settlement of rebate liabilities associated with Proposition 103, which was passed by California voters on November 8, 1988, for $78 million.
The Company's estimate of gross losses and allocated loss adjustment expenses for this catastrophe as of December 31, 1995 is $1 billion, of which $60 million was recorded in 1995. In accordance with the terms of the settlement with the California Department of Insurance, the Company offset the increase in earthquake losses with approximately $32 million in funds previously set aside for potential Proposition 103 rebates.
On December 16, 1994, the Company received $216 million of equity capital from AIG and in exchange, issued (i) 200,000 shares of Series A 9% Convertible Preferred Stock, par value $1.00 per share, at a price and liquidation value of $1,000 per share and convertible into common shares at a conversion price of $11.33 per share, and (ii) 16,000,000 Series A Warrants to purchase an aggregate 16,000,000 shares of the Company's Common Stock at $13.50 per share (collectively, the "Investment Agreement"). In 1995, an additional 20,000 shares of preferred stock were issued to AIG in exchange for $20,000,000 of equity capital. The Series A Preferred Stock ranks senior to the Common Stock in respect to dividend and liquidation rights. Cash dividends of $14,622,750 were paid on the preferred stock. Preferred stock dividends in kind of $4,950,000, representing 4,950 additional shares, were issued on June 26, 1995. Per the Investment Agreement, the exercise price of the Series A Warrants is reduced $.08 per share for each million dollars of gross losses and allocated loss adjustment expenses in excess of $945 million with respect to the Northridge Earthquake through December 31, 1995. As the Company's estimate of the gross losses and loss adjustment expenses for the Northridge Earthquake rose to $1 billion at December 31, 1995, the exercise price of the Series A Warrants declined to $9.10 per share. The Common Stock Warrants are generally exercisable from February 1998 to February 2007.
The net income (loss) for all four quarters of 1994 reflects the impact of the January 17 Northridge Earthquake, which were as follows: first quarter, $551.3 million; second quarter, $76.5 million; third quarter, $129.8
million; and fourth quarter, $126.2 million. The second quarter 1994 net income reflects approximately $50 million in realized capital gains from the sale of investments. The third quarter 1994 net loss reflects additional deferred revenue of $43.6 million and interest expense of $28 million related to the Proposition 103 order directing the Company to issue refunds totaling approximately $78.3 million, plus interest at 10% per annum from May 8, 1989 to September 30, 1994. The fourth quarter 1994 net loss reflects the reversal of all Proposition 103 interest accrued of approximately $44 million in accordance with a settlement with the California Department of Insurance.
In 1995, the Homeowner and Condominium line experienced an underwriting loss primarily as a result of first quarter weather-related losses of $14.2 million, earthquake-related catastrophe reinsurance premiums of $24 million, Northridge Earthquake-related losses of $60 million, and an overall decline in homeowner and
In 1993 , the Homeowner and Condominium line experienced an underwriting loss primarily as a result of first quarter weather-related losses of approximately $4.6 million, and the third quarter Southern California fires with related net losses incurred of approximately $4.3 million and $2.6 million in assessments for the Company's share of California Fair Plan losses. The underwriting loss also included losses of approximately $1 million related to the 1991 Oakland, California fire.