The Company is the owner of two office buildings, that were previously occupied by the Company's headquarters, both located in Beverly Hills, California. One building contains approximately 25,000 square feet of office space and the other office building contains approximately 24,000 square feet. Both office buildings are currently unencumbered.
Brown & Brown Relationship. Geographic expansion has been accomplished -------------------------- principally through an arrangement with Brown & Brown, Inc. ("Brown & Brown"), one of the nation's top independent insurance agency organizations. American Healthcare Indemnity Company ("AHI"), a subsidiary of SCPIE Holdings, entered into an agreement with Brown & Brown to market professional liability insurance to physicians and small medical groups in selected states commencing January 1, 1998. The program now has been expanded to encompass eight states, the largest in terms of premium volume being Connecticut, Florida and Georgia. Continued expansion of this relationship with Brown & Brown is an important element of the Company's strategy for diversification into states outside California. AHI has also expanded its operations outside California through sales of professional liability policies to physicians who do not meet the normal underwriting criteria of the Company. These policies are sold through various brokers typically at a higher premium. The broker relationships were developed from the medical malpractice insurance businesses AHI acquired from Fremont Indemnity Company (Fremont) and a small midwestern insurance company in 1998 and 1999, respectively. In 1999, the Company derived approximately 20% of its physician and medical group premium volume from policies issued outside the state of California. This expansion is in its initial stages. There is no assurance, however, that the Company will successfully retain or continue to expand this business or that it will ultimately be profitable.
Hospital Policies. The Company initially expanded its insurance products in ----------------- 1994 by offering professional liability insurance to hospitals in California. The Company greatly extended its presence in the hospital market in late 1996 through a marketing agreement with a leading healthcare insurance broker. Under this arrangement, the broker placed a coverage with the Company for approximately 75 hospitals, healthcare providers and other organizations in seven states. The broker encountered financial difficulties, and the Company now underwrites its business through a regional broker headquartered in California and through various brokers in other states. The Company has been unable to expand its hospital business because of the severe competitive conditions in this market, and
In the late 1980s, many medical malpractice insurance companies began to experience significantly improved claims cost trends and attempted to attract medical groups and physicians insured by other companies by reducing premium rates. Beginning in 1990, the Company implemented annual rate decreases aggregating more than 25% during the next three years, which resulted in a significant reduction in premium volume and a deterioration of underwriting results. Between 1993 and 1999, however, the Company instituted annual overall rate increases ranging from 3.7% to 9.2% on its physician professional liability policies in order to improve its underwriting results. These rate increases were higher than those implemented by most of its competitors. As a result, the Company has lost some of its policyholders, in part due to these rate increases, but realized a modest increase in its premium volume through 1998 and has improved its underwriting results. In 1999, the Company actually experienced a small decrease in premium volume as a result of its 3.7% rate increase. The Company has instituted no rate increase for 2000. It appears that the Company's competitors are also foregoing rate increases for the current year, and the current competitive conditions will continue to persist.
Medical malpractice and other property and casualty loss and loss adjustment expense (LAE) reserves are established based on known facts and interpretation of circumstances, including the Company's experience with similar cases and historical trends involving claim payment patterns, loss payments and pending levels of unpaid claims, as well as court decisions and economic conditions. The effects of inflation are considered in the reserving process. Establishment of appropriate reserves is an inherently uncertain process, and there can be no assurance that currently established reserves will prove adequate in light of subsequent actual experience. The Company follows a practice of conservatively estimating its future liabilities relating to losses already incurred and has attempted to establish its loss and LAE reserves at the upper end of a reasonable range of reserve estimates. The Company believes that it has been
particularly difficult to make such estimates for medical malpractice claims in California because of the uncertain benefits of tort reform measures and more recently a change in the judicial process.
During 1999, the Company experienced a number of paid losses under its physician and medical group policies that were in excess of the limits of insurance retained by the Company and thus borne by its reinsurers. In addition, the Company established significant reserves for such excess losses for certain claims reported under its hospital policies. The Company has experienced a similar period in the past in which a number of excess losses were incurred in a relatively short period of time. However, if such excess losses continue, the Company may encounter difficulty in obtaining reinsurance on reasonable terms.
its Common Stock from its public stockholders in November 1999. The investment portfolio also contained a larger percentage of higher-yielding bonds during 1999 than in 1998.
OTHER OPERATING EXPENSES Other operating expenses increased $1.1 million, or 3.9%, to $29.3 million in 1999 from $28.2 million in 1998. The ratio of other operating expenses to premiums earned is referred to as the expense ratio, which increased to 19.1% in 1999 from 17.9% in 1998. This increase reflected a decrease in premiums earned and higher commission expenses associated with the greater proportion of broker-produced premiums in 1999 compared to 1998.
FEDERAL INCOME TAXES Federal income taxes decreased $3.3 million, or 26.2%, to $9.3 million in 1999 from $12.6 million in 1998. The effective tax rate decreased to 23.7% in 1999 from 25.4% in 1998, due primarily to lower realized gains in 1999.
FEDERAL INCOME TAXES Federal income taxes increased $2.4 million, or 23.3%, to $12.6 million in 1998 from $10.2 million in 1997. The effective tax rate increased to 25.4% in 1998 from 24.1% in 1997, due primarily to higher realized gains in 1998.
SCPIE Holdings is an insurance holding company whose assets primarily consist of all of the capital stock of its insurance company subsidiaries. Its principal sources of funds are dividends from its subsidiaries and proceeds from the issuance of debt and equity securities. The insurance company subsidiaries are restricted by state regulation in the amount of dividends they can pay in relation to earnings or surplus, without the consent of the applicable state regulatory authority, principally the California Department of Insurance. SCPIE Holdings' principal insurance company subsidiary may pay dividends to SCPIE Holdings in any 12-month period, without regulatory approval, to the extent such dividends do not exceed the greater of (i) 10% of its statutory surplus at the end of the preceding year or (ii) its net income for the preceding year. Applicable regulations further require that an insurer's statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs, and permit the payment of dividends only out of statutory earned (unassigned) surplus unless the payment out of other funds receives regulatory approval. The amount of dividends that the insurance company subsidiaries are able to pay to SCPIE Holdings during 2000 without prior regulatory approval is approximately $30.6 million.
On August 31, 1999, the California Insurance Commissioner approved a special dividend of $80.0 million from SCPIE Indemnity Company to SCPIE Holdings, which was distributed on November 9, 1999. The proceeds from this dividend were used by the Company to purchase 2,023,973 shares of its common stock at $35 per share through a procedure referred to as a "Dutch Auction." Including the special dividend, total dividends of $106.0 million were paid to SCPIE Holdings in 1999. Because of the large amount of these dividends paid to SCPIE Holdings on November 9, 1999, additional dividends in 2000 in any material amount effectively may not be paid to SCPIE Holdings, without regulatory approval, until 12 months after that date. The Company believes that SCPIE Holdings has sufficient liquid assets and other resources of cash that no dividends will be required until after November 9, 2000.
During May 1999, the Board of Directors authorized the repurchase of up to 1,000,000 shares of its common stock on the open market. This authorization replaced the company's prior program that expired in May 1999. Since 1997, 900,100 shares were repurchased under these programs.
The Company invests its assets primarily in fixed-maturity securities, which at December 31, 1999, comprised 84% of total investments at market value. U.S. government and tax-exempt bonds represent 70% of the fixed-maturity investments, with the remainder consisting almost entirely of mortgage-backed securities and corporate bonds. Equity securities, consisting primarily of common stocks, account for 5% of total investment at market value. The remaining 11% of the investment portfolio consists of highly liquid short-term money market funds.
The value of the fixed-maturity portfolio is subject to interest rate risk. As market interest rates decrease, the value of the portfolio goes up with the opposite holding true in rising interest rate environments. A common measure of the interest sensitivity of fixed-maturity assets is modified duration, a calculation that takes maturity, coupon rate, yield and call terms to calculate an average, age of the expected cash flows. The longer the duration, the more sensitive the asset is to market interest rate fluctuations.
The first two columns of the following table show the financial statement carrying values and related estimated fair values of the fixed-maturity securities and equity investments held by the Company at December 31, 1999 and 1998, respectively. The third column shows the effect on current estimated fair values assuming a 100 basis point increase in market interest rates and a 10% decline in equity prices (sensitivity analysis). This sensitivity analysis is required by the Securities and Exchange Commission rules issued in 1997.
* Adjusted interest rates assume a 100 basis point increase in market rates **Adjusted equity prices assume a 10% decline in market values
This sensitivity analysis provides only a limited, point-in-time view of the market risk sensitivity of certain of the Company's financial instruments. The actual impact of market interest rate and price changes on the financial instruments may differ significantly from those shown in the sensitivity analysis. The sensitivity analysis is further limited as it does not consider any actions the Company could take in response to actual and/or anticipated changes in interest rates and equity prices.
The Year 2000 issue is the result of many computer programs being written using two digits rather than four digits to define the applicable year. To date, all of the Company's systems have continued to operate without any disruption related to the Year 2000. Year 2000 costs incurred were $101,000, $1,018,000 and $734,000 in 1999, 1998 and 1997, respectively, for a total of $1,853,000. The Company does not expect to incur any further Year 2000 related costs.