The Company also leases office space for its Assumed Reinsurance division in Summit, New Jersey and claims offices in Reston, Virginia; San Diego, California; Sacramento, California and Tampa, Florida. During 2001, the Company closed marketing offices in Phoenix, Arizona; Addison, Texas and Boca Raton, Florida.
Basic earnings (loss) per share of common stock at December 31, 2001, 2000, 1999 and 1998 are computed using the weighted average number of common shares outstanding during the year of 9,333,425, 9,375,735, 11,383,592 and 12,074,272, respectively. Earnings per share for 1997 gives effect to the merger of the Exchange into a subsidiary of SCPIE Holdings completed on January 29, 1997, including the allocation of approximately 10,000,000 shares of common stock to members of the Exchange in connection therewith. Diluted earnings per share of common stock at December 31, 2001, 2000, 1999 and 1998 are computed using the weighted average number of common shares outstanding during the year of 9,333,425, 9,382,494, 11,403,081 and 12,089,013, respectively. For further discussion of basic earnings per share and diluted earnings per share, see the Notes to Consolidated Financial Statements.
Certain statements in the following discussion that are not historical fact constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements regarding the Company, its business prospects and results of operations are subject to certain risks and uncertainties posed by many factors and events that could cause the Company’s actual business, prospects and results of operations to differ materially from those that may be expressed or implied by such forward-looking statements. Such risks, uncertainties and other factors are discussed in Business-Risk Factors and in periodic filings with the Securities and Exchange Commission.
The Company has been a leading writer of medical malpractice insurance for physicians and healthcare providers in California for many years.
In 1996, the Company began expansion into other professional liability products and into other geographical markets. The principal product expansion was into professional liability insurance for hospitals. From 1997 through 1999, the 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 greater risk nonstandard physicians in a number of states outside California.
end the programs earlier than the termination date, if replacement programs are established by Brown & Brown. The Company is following very strict underwriting standards in these programs and for its nonstandard policies. In addition, significant rate increases during 2001 and 2002 averaging 70% are in place in the states involved. The Company expects a decrease in the number of policyholders in these programs during 2002, but premium volume may decline by a lesser amount, or even increase, due to the rate increases.
The Company has rapidly expanded its assumed reinsurance operations since it formed the division in late 1999. During 2001, assumed reinsurance net premiums written were $112.2 million, an increase of $81.7 million from 2000. Premiums earned in this segment increased 193% in 2001 to $79.5 million, and the Company expects an approximate 76% increase during 2002.
Loss experience in this segment for 2000 was based almost entirely on actuarial estimates, as actual losses were in their early stages of development. In 2001, the unprecedented September 11 terrorist attack materially impacted the results in this segment. At year-end, the Company conducted an examination of its September 11 exposures in conjunction with its outside actuaries to identify to the fullest extent possible the amount of these losses. The Company identified losses of $28.1 million, net of reinsurance benefit. This amount includes a reduction in premiums earned of $8.5 million to reflect estimated losses under a 1996 letter of credit program indexed to a portfolio of worldwide catastrophe excess of loss reinsurance business. Excluding the losses from the terrorist attack, the assumed reinsurance segment would have recorded an underwriting profit of $4.5 million in 2001.
Net investment income increased approximately $1.8 million, or 5.3%, to $35.9 million in 2001 from $34.2 million in 2000. This increase was a result of a 1.1% increase in average invested assets and a shift in investment mix from tax-exempt securities to higher yielding taxable bonds in 2001. The average rate of return on invested assets was 5.1% and 5.2% in 2001 and 2000, respectively. During 2001, the Company realized $5.7 million of investment gains as compared to $0.4 million in realized investment losses in 2000.
Total expenses were $370.6 million in 2001, an increase of 95.2% over total expenses of $189.9 million in 2000. The increased expenses in 2001 reflect significant underwriting losses of $134.7, principally stemming from losses incurred in the Company’s non-California direct healthcare liability insurance programs and September 11 terrorist attack losses incurred in the Company’s assumed reinsurance programs, as well as increased other operating expenses in both programs. During 2001, the company accelerated the recognition of certain deferred acquisition costs in both segments.
The Company realized an income tax benefit of $32.9 million in 2001 as a result of the net loss. In 2000, the Company had federal income tax expense of $5.1 million, at an effective tax rate of 22.9%.
Net loss for 2001 was $58.0 million, or $6.22 basic and diluted earnings per share, compared to net income in 2000 of $17.3 million, or $1.84 basic and diluted earnings per share.
Premiums Earned-Premiums earned in the direct healthcare liability insurance segment increased approximately $7.0 million, or 4.7%, to $156.4 million in 2001 from $149.4 million in 2000.
Premiums earned from other healthcare facilities and providers increased to approximately $7.3 million in 2001 from $6.0 million in 2000. Premiums earned from managed care errors and omissions, directors and officers liability and other miscellaneous coverages totaled slightly more than $2.9 million in 2001, an increase of approximately $0.7 million over 2000.
The Company’s combined ratio for the direct healthcare liability segment in 2001 was 170.1% compared to 108.2% in 2000. The combined ratio is the sum of loss and LAE expenses and other operating expenses to premiums earned. The components are described in the preceding paragraphs.
Premiums Earned-Premiums earned in the assumed reinsurance segment increased to $79.5 million in 2001 from $27.1 million in 2000. Premiums earned during 2001 included approximately $32.3 million under casualty programs, $6.3 million under property programs, $32.1 million under accident and health and workers’ compensation programs and $8.8 million under its marine program. Premiums earned in this segment were reduced by an $8.5 million premium charge under a letter of credit exchange program indexed to the performance of a broad based catastrophe reinsurance portfolio. This portfolio incurred an underwriting loss as the result of the September 11 terrorist attack. See Note 4 to Consolidated Financial Statements.
Other Operating Expenses-Other operating expenses for the assumed reinsurance segment increased $14.7 million to $18.9 million in 2001 from $4.2 million in 2000. The expense ratios for 2001 and 2000 were 23.8% and 15.3%, respectively. The increase was attributable to an overall increase in commission rates, acceleration of recognition of deferred acquisition costs and the decrease in 2001 premiums earned as the result of the September 11 loss in the indexed reinsurance portfolio.
The Company’s combined ratio for the assumed reinsurance segment in 2001 was 129.7% compared to 101.3% in 2000. The combined ratio is the sum of loss and LAE expenses and other operating expenses to premiums earned. The components are described in the preceding paragraphs.
Total revenues were $212.3 million in 2000, an increase of 11.0% over total revenues of $191.3 million in 1999. Premiums earned increased $23.3 million, or 15.2%, in 2000. The increase was principally attributable to assumed reinsurance premiums of $27.1 million earned in 2000 compared to $6.8 million earned in 1999.
The Company had small realized investment losses in both years. Income from affiliates in 2000 of $0.9 million was attributable to a minority equity interest in a small personal lines insurance company.
Federal income tax expense as a percentage of income before federal income taxes varies primarily due to the proportion of tax-exempt investment income arising in the respective periods. The effective tax rate was 22.9% in 2000 compared to 23.7% in 1999, reflecting a small increase in the proportion of tax exempt investment income in 2000.
Hospital medical malpractice premiums remained largely unchanged with approximately $10.0 million in 2000 compared to $9.2 million in 1999. The Company selectively underwrote its hospital business for 2001 and reduced the number of hospitals insured, but at significantly increased premium rates.
Losses and LAE-Losses and LAE in the direct healthcare liability insurance segment increased to $129.3 million, or 86.5% of premiums earned in 2000, from $116.6 million, or 79.6% of premiums earned in 1999. The increase was due to a reduction in 2000 in the favorable loss reserve development experienced by the Company with respect to prior policy years, partially offset by a reduction in the estimated losses incurred in the 2000 policy year as a percentage of premiums earned. The Company experienced a net favorable development in loss and LAE reserves established for prior policy years in 2000 of $42.6 million compared to a favorable development of $61.8 million in 1999.
Losses and LAE-Assumed reinsurance losses and LAE (other than under fronting arrangements) were $23.3 million in 2000, or 86.0% of assumed premiums earned, compared to $6.2 million, or 91.2% of premiums earned, in 1999.
The Company invests its cash flow from operations in both fixed-maturity securities and equity securities. The Company’s current policy is to limit its investment in equity securities and its real estate to no more than 8.0% of the total market value of its investments. Accordingly, the Company’s portfolio of unaffiliated equity securities had a fair value of $29.1 million at December 31, 2001. The Company plans to continue this focus on fixed-maturity securities for the indefinite future.
In October 2001, the Company organized and funded a wholly-owned Cayman Islands subsidiary, which made a $15.0 million investment in a foreign limited partnership, whose financial advisor is Credit Suisse First Boston International. The limited partnership in turn invests principally in a diversified portfolio of offshore hedge funds. The investment return depends on the performance of the portfolio. See Notes 1 and 2 to Consolidated Financial Statements.
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 statutory 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 2002 without prior regulatory approval is approximately $12.4 million.
The Company had borrowings of $9.0 million outstanding at December 31, 2001, under a Credit Agreement with three bank lenders. On February 28, 2002, the Company fully repaid the outstanding balance, and the parties terminated the Credit Agreement. See Note 8 to Consolidated Financial Statements.
At March 15, 2002, SCPIE Holdings held cash and short-terms securities of $2.5 million, after provision for payment of the March 29, 2002, dividend. The Company also holds a minority interest in the capital stock of a small personal lines Florida domiciled insurance company. The stockholders of that Company have entered into an agreement to sell the Company. The sale is scheduled for completion in late May 2002. If the sale is completed, the Company will receive additional cash funds of approximately $4.0 million. Based on historical trends, market conditions and its business plans, the Company believes that its sources of funds (including dividends from the Insurance Subsidiaries) will be sufficient to meet the liquidity needs of SCPIE Holdings over the next 18 months and beyond.
According to regulations governing insurance companies, the Insurance Subsidiaries are required to maintain sufficient statutory capital and surplus to cover the risks associated with the policies they write. Due to losses and strengthening of loss reserves in 2001, the statutory capital and surplus of the Insurance Subsidiaries declined significantly, while premiums
On March 9, 2002, the Job Creation and Worker Assistance Act of 2002 became law. The new law allows tax losses incurred in 2001 and 2002 to be carried back five years instead of the two years allowed under prior law. As a result of this law change, the Company will be able to recoup an additional approximate $8 million of taxes paid in the three years ended December 31, 1998 subsequent to filing its 2001 tax return. The federal income taxes receivable recorded on the December 31, 2001 balance sheet will be increased by approximately $8 million and the deferred tax asset decreased by an identical amount in the financial statements for the quarter ended March 31, 2002.
The Company has certain contractual obligations and commercial commitments principally for issuing letters of credit in connection with its assumed reinsurance segment and for leasing office space for its headquarters and other regional offices. Additionally, the Company has an outstanding bank note that is further described in Liquidity and Capital Resources. The table below presents the contractual payments due by period or expiration period for each obligation or commitment:
The Company invests its assets primarily in fixed-maturity securities, which at December 31, 2001, comprised 79.7% of total investments at market value. U.S. government and tax-exempt bonds represent 53.5% of the market values of 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 4.1% of total investments at market value. The other investment, which is comprised of a mutual fund investment that contains derivative financial instruments, accounts for 2.1% of total investments at market value. 11.9% of the investment portfolio consists of highly liquid short-term money market funds. The remaining 2.2% of investments consists of real estate leased to third parties.
The value of the common stock equity investments is dependent upon general conditions in the securities markets and the business and financial performance of the individual companies in the portfolio. Values are typically based on future economic prospects as perceived by investors in the equity markets.
The estimated fair values at current market rates for financial instruments subject to interest rate risk in the table above are the same as those disclosed in Note 2 to Consolidated Financial Statements. The estimated fair values at the adjusted market rates (assuming a 100-basis-point increase in market interest rates) are calculated using discounted cash flow analysis and duration modeling where appropriate. The estimated values do not consider the effect that changing interest rates could have on prepayment activity (e.g., mortgages underlying mortgage-backed securities).
Endorsements issued by the Company between January 1, 2000 and April 30, 2001 to holders of certain property, workers’ compensation, commercial automobile, general liability and umbrella policies of HIG subsidiaries. The Company received a
Nine agreements under which the Company, together with other assuming reinsurers, has assumed small percentages of business written by HIG subsidiaries, including property, casualty and workers’ compensation coverages. Assumed premium earned under these contracts in 2001 was approximately $673,000.
The Company considers all of the above arrangements to constitute transactions entered into in the ordinary course of its business.
The Company’s Consolidated Financial Statements and related notes, including supplementary data, are set forth in the “Index” on page 46 hereof.