Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, reserves for loss payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. Cash and investments (excluding unrealized gains) at December 31, 1998, were $103,713,721 compared to $92,530,294 at December 31, 1997, a 12% increase. Crusader's cash and investments at December 31, 1998, was $97,597,956, or 94% of the total held by the Company compared to $88,456,803 or 96% of the total held by the Company at December 31, 1997.
In addition to the AAC line of credit, Unico has a $2,000,000 line of credit with Union Bank. Interest on this line is referenced to LIBOR and is payable monthly. The agreement contains certain covenants including maintenance of certain financial ratios. This credit line expires September 2, 1999, at which time it is expected to be renewed. As of December 31, 1998 and 1997, no amounts were borrowed.
YEAR 2000 - - --------- The Company has initiated a review of all computer programs to ensure that all computer systems will function properly with respect to dates in the year 2000 and thereafter. The Year 2000 issue is the result of computer programs being written utilizing two digits rather than four digits to define a year. Any computer programs which have date sensitive software utilizing a two digit year would recognize a year of "00" as 1900 rather than 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar activities. The Company has assessed its Year 2000 issues and has made and tested the necessary modifications to its computer system. The project to review and correct all programs was completed and tested at December 31, 1998, prior to any anticipated impact on its operating systems. The costs of the project has been charged to current operations as incurred and did not have a material effect on the Company's results of operations or financial position.
Crusader anticipates that any claims from its policyholders due to Year 2000 events will not be material. Any business interruption losses resulting from Year 2000 events which Crusader policyholders may incur, would not be provided any coverage unless such events also caused physical damage to the insureds property, which the Company believes is not a material exposure.
Results of Operations: General - - ------- The Company had net income after taxes of $8,708,669 for the fiscal year ended December 31, 1998, compared to $7,654,362 for the fiscal year ended December 31, 1997, and $6,849,327 for the twelve month period ended December 31, 1996. Total revenue for the fiscal year ended December 31, 1998, was $47,544,270 compared to $48,290,721 for the fiscal year ended December 31, 1997, and $45,880,272 for the twelve month period ended December 31, 1996.
The effect of inflation on the net income of the Company during the fiscal year ended December 31, 1998, was not significant.
Daily Automobile Rental Insurance Program - - ----------------------------------------- The daily automobile rental insurance program is produced by Bedford. Bedford receives a commission and a claim administration fee from a non-affiliated insurance company based on premium written. Commission and fee income from the daily automobile rental insurance program are as follows:
The daily automobile rental insurance program commission and fee income increase for the current fiscal year was primarily the result of contingent commission income of $49,430. Excluding this contingent commission, revenues increased only $975. This slight increase is due to continued price competition in the daily automobile insurance market. To avoid underwriting losses for the non-affiliated insurance company which Bedford represents, it continues to produce business only at rates which it believes to be adequate. The Company cannot determine how long this "soft market" condition will continue.
Commercial and Personal Automobile Insurance Program - - ---------------------------------------------------- Unifax produced commercial auto policies in California for a non-affiliated insurer and received a commission from them based on premium written. Unifax also received a policy service fee from the insured. In February 1997, management decided to discontinue writing new policies in the Unifax commercial automobile program and only serviced and renewed existing policies until the book of business was sold to an non-affiliated third party in June 1997. As consideration for the sale of this book of business, Unifax will receive a percentage of the commission earned for a two year period on policies which were in force at the time of sale.
Revenue for the fiscal year ended December 31, 1998, represents net commissions received on the sale of the commercial auto program. Revenue for the fiscal year ended December 31, 1997, decreased $130,470 (61%) compared to the twelve month period ended December 31, 1996, due to the discontinuance of the commercial automobile programs.
NIB and AIB market health and life insurance through non-affiliated insurance companies for individuals and groups. Approximately 95% of the health and life commission income in the fiscal year ended December 31, 1998, was from the CIGNA HealthCare medical and dental plan programs compared to approximately 90% in the same period of the prior year. Revenues for the fiscal year ended December 31, 1998, increased $132,664 (6%) compared to the fiscal year ended December 31, 1997. Revenues for the fiscal year ended December 31, 1997, decreased $348,426 (14%) compared the twelve month period ended December 31, 1996.
Group health and life insurance programs - The increase in commission income in the health and life insurance programs is primarily a result of an increase in sales of small business group accounts and to a rate increase implemented by CIGNA in July 1998. The Company has increased the number of CIGNA products available to small groups, including life insurance, vision and dental plans, in order to acquire new accounts and retain existing accounts.
Workers' Compensation Program - - ----------------------------- Unifax produces workers' compensation policies in California and Arizona for non-affiliated insurers and receives a commission from them based on premium written.
Association Operation - - --------------------- Membership and fee income from the association program of AAQHC is as follows:
Premium Finance Program - - ----------------------- Premium finance charges and late fees earned from financing policies are as follows:
AAC, the Company's insurance premium finance subsidiary, provides premium financing to Crusader, and until February 1997 a non-affiliated insurer on commercial auto policies produced by Unifax. In February 1997, the commercial auto program with the non-affiliated insurer was discontinued. The growth of this program is dependent and directly related to the growth of Crusader's written premium and AAC's ability to market its competitive rates and service to finance those policies. AAC finances policies primarily in California.
Investment Income and Net Realized Gains - - ------------------------------------------- Investment income and net realized gains are as follows:
Investment interest and dividends earned (excluding net realized gains) increased $735,642 (15%) in the fiscal year ended December 31, 1998, compared to the fiscal year ended December 31, 1997, primarily as a result of additional invested assets from operating activities. Average invested assets in the fiscal year ended December 31, 1998, (at amortized value) increased $11,294,733 (13%) compared to the fiscal year ended December 31, 1997. Investment income return based on average invested assets was 5.85% for the fiscal year ended December 31, 1998, compared to 5.77% for the fiscal year ended December 31, 1997. The mix of taxable and tax exempt securities in the portfolio affect the above investment income return percentage. Tax exempt securities, which generally carry a lower yield than taxable securities, decreased to $34,144,344 (33% of total investments) at December 31, 1998, compared to $38,361,279 (41% of total investments) at December 31, 1997.
Operating Expenses - - ------------------ Policy Acquisition Costs consist of commissions, premium taxes, inspection fees, and certain other underwriting costs which are related to and vary with the production of Crusader insurance policies. These costs include both Crusader expenses and allocated expenses of other Unico subsidiaries. On certain reinsurance treaties, Crusader receives a ceding commission from its reinsurer which represents a reimbursement of the acquisition costs related to the premium ceded. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premiums are earned. Policy acquisition costs, net of ceding commission, are as follows:
Commissions to Agents/Brokers (not including commissions on Crusader policies which are reflected in policy acquisition costs) are generally related to gross commission income. Commissions to agents and brokers increased $8,087 (1%) for the fiscal year ended December 31, 1998, compared to the fiscal year ended December 31, 1997. An increase of 10% in the commission expense for the daily automobile program and an increase of 3% in commission expense for the health and life programs was offset by a decrease in commission expense as a result of the discontinuance of the commercial auto program. During the fiscal year ended December 31, 1997, commission expense decreased $217,776 (17%) compared to twelve month period ended December 31, 1996. This decrease was primarily related to the 14% decrease in health and life insurance commission income.
Other Operating Expenses generally do not change significantly with changes in production. This is true for both increases and decreases in production. Other operating expenses decreased $218,879 (8%) for the fiscal year ended December 31, 1998, compared to the fiscal year ended December 31, 1997. This decrease was primarily due to a $240,155 reduction in interest expense payable due to a settlement of federal income tax issues for the fiscal years ended March 31, 1990, through March 31, 1994, which were under appeal. Other operating expenses decreased $126,384 (5%) during the fiscal year ended December 31, 1997, compared to the twelve month period ended December 31, 1996. The decrease was primarily due to a decrease in interest expense of $101,425 as a result of the reduction in the Company's bank note payable.
We have audited the accompanying consolidated balance sheets of Unico American Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unico American Corporation and subsidiaries as of December 31, 1998, and 1997, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.
We have audited the accompanying consolidated balance sheets of Unico American Corporation and its subsidiaries as of December 31, 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for the nine months ended December 31, 1996, and the year ended March 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - - --------------------------------------------------- Nature of Business - - ------------------ Unico American Corporation is an insurance holding company. Unico American Corporation and its subsidiaries (the "Company"), all of which are wholly owned provides primarily in California, property, casualty, health and life insurance, and related premium financing.
Use of Estimates - - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosure of certain assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While every effort is made to ensure the integrity of such estimates, actual results could differ from those estimates.
Investments - - ----------- All of the Company's fixed maturity investments are classified as available-for sale and are stated at market value. Although classified as available-for-sale, the Company's investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities are reported as a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses are included in the consolidated statements of operations based on the specific identification method.
Property and Equipment - - ---------------------- Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using accelerated depreciation methods over the estimated useful lives of the related assets.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) - - --------------------------------------------------------------- Fair Value of Financial Instruments - - ----------------------------------- The Company has used the following methods and assumptions in estimating its fair value disclosures:
Earnings Per Share - - ------------------ During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings Per Share," which requires presentation of basic and diluted earnings per share for all publicly traded companies effective for fiscal years ending after December 15, 1997.
Basic earnings per share excludes the impact of common share equivalents and is based upon the weighted average common shares outstanding. Diluted earnings per share utilizes the average market price per share when applying the treasury stock method in determining common share equivalents. Outstanding stock options are treated as common share equivalents for purposes of computing diluted earnings per share and represent the difference between basic and diluted weighted average shares outstanding.
Revenue Recognition - - ------------------- a. General Agency Operations ----------------------------- Commissions and service fees due the Company are recognized as income on the effective date of the insurance policies.
Losses and Loss Adjustment Expenses - - ----------------------------------- The process of establishing loss reserves involves significant judgment. The reserves for unpaid losses and loss adjustment expenses are based on estimates of ultimate claim cost, including claims incurred but not reported. These estimates are reviewed regularly, and as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments are reflected in results of operations in the period in which they become known. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.
Deferred Policy Acquisition Costs - - --------------------------------- Policy acquisition costs consist of direct and indirect costs associated with the production of insurance policies such as commissions, premium taxes, and certain other underwriting expenses which vary with and are primarily related to the production of the insurance policy. Policy acquisition costs are deferred and amortized as the related premiums are earned and are limited to their estimated realizable value based on the related unearned premiums plus investment income less anticipated losses and loss adjustment expenses. Ceding commission applicable to the unexpired terms of policies in force are recorded as unearned ceding commission which is included in deferred policy acquisition costs.
Comprehensive Income - - -------------------- Statement of Financial Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive Income," effective for fiscal years beginning after December 15, 1997, was adopted by the Company in 1998. The Company is reporting comprehensive income for the same periods as presented on the Consolidated Statements of Operations. The implementation of SFAS No. 130 had no effect on the financial position or results of operations of the Company.
Segment Reporting - - ----------------- Statement of Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures about Segments of an Enterprise and Related Information," became effective for fiscal years effective after December 15, 1997. SFAS No. 131 establishes standards for the way information about operating segments is reported in financial statements. The Company has adopted SFAS No. 131 for the fiscal year ended December 31, 1998, and has identified its insurance company operation as its primary reporting segment. Revenues from this segment comprise 85.5% of consolidated revenues. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually insignificant to consolidated revenues.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) - - --------------------------------------------------------------- The insurance company operation is conducted through Crusader, which as of December 31, 1998, is licensed as an admitted insurance carrier in the states of Arizona, California, Montana, Nevada, Oregon and Washington. Crusader is a multiple line property and casualty insurance company which began transacting business on January 1, 1985. As of December 31, 1998, 97% of Crusader's business was commercial multiple peril "business package" insurance policies. This business is written in all of the states in which it is licensed. Commercial multiple peril policies provide a combination of property and liability coverage for businesses and business property. Commercial property coverages insure against loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, hail, water, explosions, severe winter weather and other events such as theft and vandalism, fires and storms and financial loss due to business interruption resulting from covered property damage. Commercial liability coverages insure against third party liability from accidents occurring on the insured's premises or arising out of its operations, such as injuries sustained from products sold. Crusader also writes separate commercial property and commercial liability policies.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) - - -------------------------------------------------------------- Reclassifications - - ----------------- Certain reclassifications have been made to prior year balances to conform to the current year presentation.
Recently Issued Accounting Standards - - ------------------------------------ Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" is effective for financial statements beginning after December 15, 1998. SOP 98-1 requires that the cost of internally developed software be capitalized. The Company will implement this standard during the first quarter of 1999 and is currently evaluating the impact that it will have on the consolidated financial statements.
NOTE 3 - INVESTMENTS - - --------------------- A summary of net investments and related income is as follows:
Certificates of deposit $ 425,000 $ 225,000 Commercial paper 3,425,000 4,750,000 Commercial bank money market accounts 694,834 368,743 U.S. government obligation money market fund 1,290,108 58,032 Short-term U.S. treasury note 735,346 732,216 Savings account 3,574 3,504 --------- --------- Total short-term investments $6,573,862 $6,137,495 ========= =========
NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION) - - ---------------------------------------------------------------- Property and equipment consist of the following:
Bad debt expense for the fiscal year ended December 31, 1998, and the fiscal year ended December 31, 1997, was $25,736 and $28,903, respectively. Premium finance notes receivable represent the balance due to the Company's premium finance subsidiary from policyholders who elect to finance their premiums over the policy term. These notes are net of unearned finance charges.
NOTE 6 - DEFERRED POLICY ACQUISITION COSTS (continued) - - -----------------------------------------------------
NOTE 7 - UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES - - --------------------------------------------------- The following table provides an analysis of the rollforward of Crusader's losses and loss adjustment expenses, including a reconciliation of the ending balance sheet liability for the periods indicated:
(**) In accordance with Financial Accounting Standards Board Statement No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts, reinsurance recoverable on unpaid losses and loss adjustment expenses are reported for generally accepted accounting practices as assets rather than netted against the corresponding liability for such items on the balance sheet.
NOTE 8 - CLAIMS AND LITIGATION - - ------------------------------ The Company, by virtue of the nature of the business conducted by it, becomes involved in numerous legal proceedings as either plaintiff or defendant. The Company is required to resort to legal proceedings from time to time in order to enforce collection of premiums, commissions, or fees for the services rendered to customers or to their agents. These routine items of litigation do not materially affect the Company and are handled on a routine basis by the Company through its general counsel.
Likewise, the Company is sometimes named as a cross-defendant in litigation which is principally directed against that insurer who has issued a policy of insurance directly or indirectly through the Company. Incidental actions are sometimes brought by customers or others which relate to disputes concerning the issuance or non-issuance of individual policies. These items are also handled on a routine basis by the Company's general counsel, and they do not materially affect the operations of the Company. Management is confident that the ultimate outcome of pending litigation should not have an adverse effect on the Company's consolidated operation or financial position.
NOTE 9 - ACCRUED EXPENSES AND OTHER LIABILITIES - - ----------------------------------------------- Accrued expenses and other liabilities consist of the following:
Fiscal Year Ended December 31 ----------------------------- 1998 1997 ---- ---- Note payable - bank $ - $ - ====== =======
NOTE 11 - LEASE COMMITMENT - - -------------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The total rent expense under this lease agreement was $1,025,952 for the fiscal year ended December 31, 1998, $1,025,952 for the fiscal year ended December 31, 1997, and $769,464 for the nine month period ended December 31, 1996.
Crusader has reinsurance agreements with National Reinsurance Corporation and NAC Reinsurance Corporation, both California admitted reinsurers. National Reinsurance Corporation was acquired by General Reinsurance Corporation in 1996. Crusader also has additional catastrophe reinsurance from various other reinsurance companies of which 78% of the participating catastrophe reinsurers are admitted in California. Any catastrophe loss ceded to the reinsurer not admitted in California requires the reinsurer to immediately obtain a non-cancelable (Evergreen) letter of credit covering their ceded outstanding loss including any IBNR. Crusader's retention increased from $150,000 to $250,000 per risk on July 1, 1997. This retention is subject to a maximum dollar amount and to catastrophe and clash covers. The catastrophe and clash covers (subject to a maximum occurrence and annual aggregate amount) help protect the Company from one loss occurrence affecting multiple policies. On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays a commission to Crusader, which includes a reimbursement of the cost of acquiring the portion of the premium that is ceded. Crusader does not currently assume any reinsurance from other insurance companies. The Company intends to continue obtaining reinsurance although the availability and cost may vary from time to time.
NOTE 12 - REINSURANCE (continued) - - -------------------------------- The effect of reinsurance on premiums written, premiums earned, and incurred losses is as follows:
NOTE 14 - STATUTORY CAPITAL AND SURPLUS (continued) - - -------------------------------------------------- In 1998, the National Association of Insurance Commissioners ("NAIC") approved codified accounting practices that changed the definition of what constitutes prescribed statutory accounting practices and will result in changes to the accounting policies that insurance enterprises use to prepare statutory financial statements commencing in 2001. The Company is currently evaluating the impact of these rules. No assurance can be given that future legislation or regulatory changes resulting from such activities will not adversely affect the Company.
As of December 31, 1998 $37,611,089 As of December 31, 1997 $30,899,761
Outstanding at March 31, 1996 680,000 $3.4375 to $4.375 Options granted - Options exercised (114,651) $3.4375 to $3.85 Options terminated (4,650) $3.50 ------- Outstanding at December 31, 1996 560,699 $3.4375 to $4.375 Options granted - Options exercised (186,751) $3.4375 to $3.50 Options terminated - ------- Outstanding at December 31, 1997 373,948 $3.4375 to $4.375
As a California insurance company, Crusader is obligated to pay a premium tax on gross premiums written in the states of Arizona, California, Montana, Nevada, Oregon, and Washington. The premium tax is in lieu of state franchise taxes; thus, the above provision for state taxes does not include the premium tax.
NOTE 17 - EARNINGS PER SHARE - - ---------------------------- A reconciliation of the numerator and denominator used in the basic and diluted earnings per share calculation is presented below: