The Group has entered into a four year lease expiring in 2005 for approximately 16,000 square feet in an office building located at 45 Main Street, Brooklyn, New York. Under this lease, an additional 9,000 square feet has been leased for a two year period expiring in 2003.
a) Net (loss) income includes net securities gains/(losses) net of applicable tax, as follows (in thousands, except per share amounts):
2001 $ 1,870 $ 0.26 2000 (213) (0.03) 1999 (1,084) 0.15 1998 3,951 0.56 1997 (125) (0.02)
Pursuant to the pooling agreement, the Company has a net reinsurance recoverable from Empire. As of December 31, 2001, the Company's reinsurance recoverable from Empire is $130.6 million, representing 43% of the Company's total assets. While this liability is reflected on Empire's stand-alone statutory financial statements, Empire's statutory surplus (after deducting this liability) is $11.1 million as of December 31, 2001, which is $7.8 million above the minimum required under New York insurance regulations. The Company currently believes that its reinsurance recoverable from Empire is fully collectible; however, further significant deterioration in Empire's surplus could impair Empire's ability to pay the full amount due to the Company. Further, any adverse regulatory action taken against Empire in the future could also impair the Company's ability to fully collect its reinsurance recoverable.
As of March 8, 2002, the Group was rated "F" (in liquidation) by A.M. Best Company ("Best") and rated "BB-" (marginal) by Standards & Poors Insurance Rating Services ("S&P"). Given the Group's decision to commence an orderly liquidation of all of its operations, the Best and S&P ratings are not expected to have any impact on the Company's operations. As with all ratings, Best and S&P ratings are subject to change at any time.
In 2001 and 2000, net cash was used for operations as a result of a decrease in premiums written and the payment of claims and operating expenses. As a result of its decision to conduct an orderly liquidation of all of its operations, the Company expects to report a net use of cash from operations resulting primarily from the payment of claims and other expenses in excess of revenues generated for the foreseeable future. During 2001, the Company replaced a significant portion of its fixed maturities investment portfolio with shorter-term investments in order to shorten its duration to match its cash needs.
The Company maintains cash, short-term and readily marketable securities and anticipates that the cash flow from investment income, maturities and sales of short-term investments and fixed maturities will be sufficient to satisfy its anticipated cash needs. During 2001, the Company realized capital gains of $1.9 million primarily due to the sale of fixed maturities to shorten the duration of the portfolio. During 2000, the Company realized capital losses of $0.2 million principally due to the sale of fixed maturities to satisfy operating cash needs. The Company will continue to sell its investment portfolio and collect its reinsurance receivables to generate the cash that will be required to settle its loss and LAE reserves. At December 31, 2001, these assets totaled $291.0 million as compared to the Company's loss and LAE reserves of $243.0 million. The Company expects to settle approximately 80% of these liabilities within the next three years. Additionally, the Company has not experienced any material default in the payment of reinsurance claims due from its reinsurance providers.
The Company's discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and assumptions that affect the reported amounts in the financial statements and disclosures of contingent assets and liabilities. On an on-going basis, the Company evaluates all of these estimates and assumptions. Actual results could differ from those estimates.
The Company's pre-tax loss was $18.0 million, $17.9 million and $6.3 million for the years ended December 31, 2001, 2000 and 1999, respectively. These amounts were negatively impacted by adverse reserve development of prior years' reserves of $18.7 million, $15.9 million and $6.0 million for 2001, 2000 and 1999, respectively. The more significant trends and events that the Company has experienced in recent years, which resulted in the recognition of the adverse reserve development, are identified below following the Company's combined ratios.
In addition, the triennial report noted that the Group's organizational structure causes Empire's stand-alone statutory surplus to be reduced by a statutory limitation on the carrying value of its investment in the Company and Centurion. Empire submitted to the Department a plan for remedying its stand-alone surplus deficiency, including the merger of Centurion into Empire, which was approved by the Department and consummated in 2001. Empire's stand-alone surplus at December 31, 2001 exceeded the minimum statutory surplus requirement of $3.3 million, by $7.8 million. In the event Empire's stand-alone statutory surplus declines below the minimum in the future, no assurance can be given that material adverse regulatory action will not be taken against Empire or the Company.
The Company's combined ratios as determined under GAAP and SAP were as follows:
The Company's combined ratios increased in 2001 primarily due to lower premium volume coupled with unfavorable loss development from prior accident years and an increase in the reserve for LAE as a result of the increases to its loss reserves and an increase in future overhead costs that will be allocated to settle claims currently incurred. The Company's combined ratios increased in 2000 primarily due to unfavorable loss reserve development from prior accident years, increased LAE for newly outsourced claims and adverse development in LAE. In addition, these ratios increased due to reduced service fees, higher 2000 accident year loss ratios, higher severance costs and overhead costs which, although lower, had not declined commensurate with the reduced premium volume.
Reserve increases in 2001 also resulted from unfavorable development principally in automobile lines of business for the 1998 through 2000 accident years, primarily relating to PIP coverage and in its workers' compensation lines of insurance. The Company believes that the increased loss estimates for PIP are consistent with recent trends in the industry, and has increased loss reserves for all automobile lines by $3.3 million for 2001. In addition, the Company also increased its reserve for LAE by $7.0 million as a result of the increases to its loss reserves and an increase in future overhead costs which will be allocated to settle claims currently incurred.
During 2000, the Company recorded adverse loss reserve development of $15.9 million, principally in the 1996 through 1999 accident years. This development was attributable to an increase in the severity of PIP claims and an increase in the frequency of liability claims in the private passenger automobile line ($2.8 million), an increase in the frequency of liability claims in the commercial automobile line ($1.9 million), an increase in the frequency and severity of PIP claims in the assigned risk automobile line ($1.4 million) and an increase in the severity of certain liability claims in the commercial package policies lines of business ($4.5 million). The increases in severity and frequency of claims in automobile lines of business, particularly with respect to PIP claims, are consistent with emerging industry trends in the New York City marketplace. In addition, the Company increased its estimate for LAE by $3.3 million as a result of the decision to outsource a significant amount of claim handling functions in 2000. Claim files for workers' compensation, automobile no-fault and automobile and other liability claims were outsourced at a cost greater than the reserves previously recorded to handle the claims internally. The Group had outsourced almost two-thirds of its claims. The Group was primarily handling complex claims, first party claims and certain automobile liability and general liability claims internally. Complex claims generally consist of those that have potentially large settlement exposure and are not expected to settle quickly. The Company had also increased its reserve estimate for claims handled internally.
During the period between 1984 and 1995, the Company entered into certain retrospectively rated reinsurance contracts covering substantially all lines of business, except worker's compensation. Under these contracts, the Company paid the reinsurer provisional premiums that are subject to adjustment based on subsequent loss development. Ceded premiums accrued under these contracts reduce both net written and earned premiums during the period the retrospective reinsurance premiums are accrued. If additional unfavorable loss development emerges in future periods, the Company may be required to accrue additional retrospective reinsurance premiums. As a consequence of its reserve increases, the Company reduced premiums and pre-tax profits by $2.4 million, $1.4 million and $1.4 million for the years ended December 31, 2001, 2000 and 1999, respectively, to recognize reinsurance premiums due for 1995 and prior years under retrospectively rated reinsurance agreements.
Net investment income for 2001 was lower than 2000 due to a reduction in investments held as a result of a decrease in premiums written and the payment of claims and operating expenses as well as a reduction in investment yields resulting from lower interest rates and the Company's decision to shorten the duration of its investment portfolio. The reduction in 2000 was primarily as a result of lower invested assets due to claim payments and a decrease in premiums written. During 2001, the Company had realized capital gains of $1.9 million primarily due to the sale of fixed maturities to shorten the duration of the portfolio. During 2000, the Company had realized capital losses of $0.2 million principally due to the sale of fixed maturities to satisfy operating cash needs.
The Company, as well as the property and casualty insurance industry in general, is affected by inflation. With respect to losses, the Company's claim severity is affected by the impact of inflation on the cost of automobile repair parts, medical costs and lost wages. The costs of adjusting claims and other underwriting expenses have also been affected by inflationary pressures on salaries and employee benefits. The Company receives rate increases based in part upon its experience as well as the industry's experience. Accordingly, premium increases generally follow the rate of inflation.
Statements included in this Report may contain forward-looking statements pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may relate, but are not limited, to projections of revenues, income or loss, capital expenditures, fluctuations in insurance reserves, plans for growth and future operations, competition and regulation as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted or quantified. When used in this Report, the words "estimates", "expects", "anticipates", "believes", "plans", "intends" and variations of such words and similar expressions are intended to identify forward-looking statements that involve risks and uncertainties. Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. The factors that could cause actual results to differ materially from those suggested by any such statements include, but are not limited to, those discussed or identified from time to time in the Company's public filings, including general economic and market conditions, changes in domestic laws, regulations and taxes, changes in competition and pricing environments, regional or general changes in asset valuation, the occurrence of significant natural disasters, the inability to reinsure certain risks economically, the adequacy of loss and LAE reserves, prevailing interest rate levels, weather related conditions that may affect the Company's operations, effectiveness of the Tower agreement, the ability to attract and retain key personnel, adverse selection through renewals of the Group's policies, regulatory approval of the Group's proposed actions in response to the findings of the Department, adverse regulatory action against the Group, developments in claims handling, including adverse litigation developments, that could adversely affect the liquidation plan of the Group, the Group's ability to manage the claims runoff, increased loss adjustment expenses resulting from an extended claims run-off period, and changes in composition of the Company's assets and liabilities through acquisitions or divestitures. Undue reliance should not be placed on these forward-looking statements, which are applicable only as of the date hereof. The Company undertakes no obligation to revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this Report or to reflect the occurrence of unanticipated events.