At December 31, 2001, Vidler owned or had the right to acquire approximately 53,675 acre-feet of transferable ground water in the HARQUAHALA VALLEY, approximately 75 miles northwest of metropolitan Phoenix, Arizona. Vidler owns 39,911 acre-feet, and we have the option to purchase a further 13,764 acre-feet.
On March 1, 2002, Vidler closed the sale, to developers near Scottsdale, of 3,645 acre-feet of water rights and 1,215 acres of land in the Harquahala Valley ground water basin, for approximately $5.3 million, or $1,450 per acre-foot of water. The sale was originally scheduled to close in 2001, but closing was extended until 2002 and the price was increased. This transaction is expected to add $5.3 million to revenues and approximately $2.3 million to segment income in the first quarter of 2002.
There is also demand for the water within the Harquahala Basin. On March 19, 2001, Vidler closed the sale of 6,496.5 acre-feet of water rights and 2,589 acres of land in the Harquahala Valley to a unit of Allegheny Energy, Inc. for approximately $9.1 million. The purchase price equated to $1,400 per acre-foot of water. This transaction added $9.4 million to revenues and $2.3 million to pre-tax income for Vidler in 2001; however, we paid $4.4 million in cash to acquire the assets which were sold, resulting in a $5 million cash surplus. Most of the difference between the $2.3 million pre-tax income on an accounting basis and the $5 million cash surplus was recorded as an increase in book value of the assets when PICO acquired Vidler's ultimate parent company, Global Equity Corporation, in 1998.
Vidler has been increasing its ownership of water rights in northern Nevada through the purchase of ranch properties and entering into joint ventures with parties owning water rights, which they wish to maximize the value of. Nevada is the state experiencing the most rapid population growth in the United States.
Under the Lincoln County Land Act, more than 13,000 acres of publicly owned land in southern Lincoln County will be offered for sale near the fast growing City of Mesquite. Additional water supply will be required if this land is to be developed.
Agreement has been reached to sell an electricity-generating company a minimum of 6,700 acre-feet of water, and a maximum of 9,000 acre-feet of water, at $3,300 per acre-foot. Among other things, the agreement is subject to the water rights being permitted, and the electricity-generating company obtaining permitting and financing for a new power plant. The agreement specifies a closing date of July 2003. Under the terms of the Lincoln County joint venture, when a water sale occurs, Vidler will first recover its costs, and then the remaining revenues will be split on a 50:50 basis.
Big Springs Ranch consists of approximately 37,500 acres of deeded ranch land, located approximately 65 miles east of Elko, Nevada, in the northeastern part of the state. Currently the ranch land is leased to farmers, although parts of the property have the potential for a higher and better use.
In 1999, a land exchange was completed in which approximately 70,500 acres of ranchland at Big Springs Ranch was exchanged with the Bureau of Land Management for several parcels of developable land near West Wendover, Nevada, totaling approximately 6,300 acres. West Wendover is adjacent to the Nevada/Utah border in the Interstate 80 corridor. Governmental officials are considering a proposal to move the state line and then merge the cities of West Wendover, Nevada and Wendover, Utah. West Wendover is approximately 120 miles from Salt Lake City, Utah, and attracts a significant number of drive-in visitors from Utah, a state where gaming is prohibited. The land owned by Vidler will stay in Nevada.
Following the resolution of the partnership dispute, Vidler attained direct management of this land in 2001. The first parcel to be developed is approximately 82 acres of industrial land. Vidler has agreed to sell approximately 7 acres of unimproved land to a user who will then be responsible for installing offsite utilities and access road improvements for an industrial park. The transaction is expected to close later in 2002. We anticipate that these improvements will allow Vidler to sell the remaining 75 acres as higher-value industrial land.
Vidler is examining alternatives for the remaining parcels, including industrial, commercial, hotel/casino, and residential development.
In December 2000, Vidler closed the sale of various water rights and related assets to the City of Golden, Colorado for $1 million, and granted the City options to acquire other water rights. The City exercised an option to acquire water assets for $390,000 in 2001. If the remaining options are exercised, the aggregate purchase price is approximately $1.3 million.
Vidler has agreed to sell its interest in Cline Ranch to Centennial Water and Sanitation District for approximately $2.1 million. This sale requires the approval of the Denver Water Court, which is expected during 2002.
Discussions are continuing to either lease or sell the remaining water rights in Colorado, including the 97 acre-feet of senior water rights which are currently unutilized. Vidler has applied to upgrade these water rights, which would increase their commercial value.
The Southern Nevada Water Authority Water Resource Plan, which can be viewed at www.snwa.com, calls for 1.2 million acre-feet of water to be stored in Arizona in order to meet forecast demand after 2015. The AWBA is currently finalizing agreements to store water on behalf of Nevada. Once these agreements have been concluded, the AWBA can begin to negotiate storage for California. The AWBA will be able to store water at existing publicly owned sites and at the Vidler Arizona Recharge Facility, which is one of the largest water storage facilities. In April 2001, Vidler reached agreement with the Arizona Water Banking Authority concerning the terms under which water can be stored at the facility for the users represented by the Authority -- $45.00 per acre-foot of water recharged in 2001, rising to $46.50 in 2002, and $48.00 in 2003. The agreement concludes on December 31, 2003.
The interest in Semitropic is Vidler's only asset in California, which has proved a difficult state to operate in due to the large number of entities involved in the water industry, each serving different, and sometimes conflicting, constituencies. In the meantime, the strategic value of the guaranteed right to recover an amount of water from Semitropic every year -- even in drought years -- became clear to water agencies, developers, and other parties seeking a reliable water supply. For example, developers of large residential projects in Kern County and Los Angeles County must now be able to demonstrate that they have sufficient back-up supplies of water in the case of a drought year before they are permitted to begin development. Accordingly, during 2001, Vidler took advantage of current demand for water storage capacity with guaranteed recovery, and began to sell its interest in Semitropic.
On May 21, 2001, Vidler closed the sale of 29.7% of its original interest (i.e., approximately 55,000 acre-feet of water storage capacity) to The Newhall Land and Farming Company for $3.3 million, resulting in a pre-tax gain of $1.6 million. This transaction added $1.6 million to revenues and segment income in 2001.
Vidler routinely evaluates the purchase of further water-righted properties in Arizona and, potentially, Nevada. Vidler also continues to be approached by parties who are interested in obtaining a water supply, or discussing joint ventures to commercially develop water assets and/or develop water storage facilities.
In 2002, Vidler's focus will be on: - - generating cash flow from the water rights in Nevada and Arizona through lease agreements or the sale of water rights; - - leasing storage capacity to customers at the Vidler Arizona Recharge Facility; and - - pursuing present and additional water rights applications and partnerships to commercially develop water rights.
The majority of Nevada Land & Resource Company, LLC's revenues come from the sale of land and water rights. In addition, various types of recurring revenue are generated from use of the company's lands, including leasing, easements, and mineral royalties. Nevada Land also generates interest revenue from land sales contracts where the company has provided partial financing, and from temporary investment of the proceeds of land and water rights sales.
In 2001, Nevada Land generated $1.9 million in revenues from the sale of: - - 15,352 acres of former railroad land for $1.7 million. The average sales price of $113 per acre compares to our average basis of $43 per acre in the parcels which were sold, and our average cost of $35 per acre for all of Nevada Land's land, water, and mineral assets; and - - 280 acres of land at Spring Valley Ranches for $178,000, resulting in a gross profit of $70,000. This land was not contiguous with the main property, and was not part of the land exchange transaction we are proposing for the bulk of the land assets at Spring Valley Ranches.
From 1997 until 1999, intense competition in the California market led many insurance companies to lower premiums in an attempt to attract business. In this environment, given that our strategy is to price policies with the objective of earning an underwriting profit, Sequoia declined to write policies which its management felt were inadequately priced, even if this resulted in lower volume overall. Faced with inadequate underwriting returns, during 1999 the focus of many companies in the California market returned to adequate pricing of policies, and some of our competitors began to raise premium rates. Consequently, the rate of decline in Sequoia's premium volume steadily slowed throughout 1999, before turning around to low-single-digit percentage growth from January 2000. Growth in premium volume then accelerated significantly as a result of two developments in the second quarter of 2000.
Direct written premiums in commercial lines increased 17.8% to $39.7 million in 2000. This included 29.1% growth to $21.4 million in the second half of 2000, following the change in Sequoia's A.M. Best rating.
In 2001, direct written premiums rose another 14.9%, to $54.1 million, comprised of $45 million in commercial lines and $9.1 million in personal lines. The growth in premium volume in 2001 was primarily due to growth in the commercial insurance book of business.
During 2001 and 2000, Sequoia's loss ratio, and consequently underwriting results, deteriorated because growth in claims costs (e.g., for construction, medical care, and automobile repair) had outpaced growth in effective premiums in recent years. In 2001, Sequoia introduced a number of initiatives to improve its loss ratio. Sequoia further tightened underwriting standards, for example, by ceasing to provide coverage for certain types of business. In addition, Sequoia increased rates for commercial automobile coverage. Rate increases are planned in most other commercial lines in 2002. While these initiatives have led to an increase in average premiums per policy, the effect on total written premiums was partially offset by a reduction in the number of policies issued. Average direct premiums per policy in commercial lines increased approximately 15% in 2001, but the number of commercial policies written declined by approximately 2.6%. The overall effect on profitability is expected to be positive. Due to the lag between a policy being "written" and the premium being "earned," the full effect of these initiatives will not be reflected in Sequoia's reported results until 2002.
Apart from treasury bonds which are held as deposits and collateral with regulators, and government-sponsored enterprise bonds (i.e., Freddie Mac and FNMA) held for capital purposes, the bond portfolio consists of high quality corporate issues. Our insurance companies do not own any bonds in the telecommunications, technology, utilities, energy, or consumer finance sectors which experienced difficulties in 2001 and the first two months of 2002.
Physicians Insurance Company of Ohio is in "run off." Physicians obtains the funds to pay claims from the maturity of fixed-income securities, the sale of investments, and collections from reinsurance companies (i.e., insurance companies who share in our claims risk). During the "run off," this segment will shrink as the level of claims reserve liabilities and investment assets decrease, as claims are paid with the proceeds of investment maturities and sales. Accordingly, it is anticipated that investment income, and therefore revenue, in this segment will decline over time. We are attempting to minimize segment overhead expenses as much as possible. For example, in 2000 and 2001 we reduced head count and office space. On December 21, 2001, Professionals Insurance Company was merged into Physicians. This will simplify administration and result in cost savings, for example, from the elimination of duplication.
During 2001, our medical professional liability insurance claims reserves, net of reinsurance, decreased from $51.6 million to $34.9 million. Actuarial analysis of Physicians' loss reserves as of September 30, 2001 concluded that Physicians' reserves against claims were significantly greater than the actuary's projections of future claims payments. Accordingly, Physicians reduced its claims reserves by approximately $11.2 million in the fourth quarter, which accounts for 67% of the net decrease in reserves during 2001. It should be noted that such actuarial analyses involves estimation of future trends in many factors which may vary significantly from expectation, which could lead to further reserve adjustments -- either increases or decreases -- in future years.
We manage the Physicians investment portfolio with the objective of having sufficient cash and maturing fixed-income securities to meet the claims payments projected for at least the following twelve months. At December 31, 2001, the duration of the Physicians bond portfolio was 1.6 years.
HyperFeed provides financial market data and data-delivery solutions to the financial services industry.
PICO first invested in HyperFeed in 1995 through the purchase of common stock. We invested further capital in HyperFeed as debt, which was later converted to equity, and received warrants for providing financing. During December 2000 and January 2001, we purchased 245,000 shares of common stock on the open market. In September 2001, the principal and accrued dividends on the HyperFeed Series A and Series B preferred stock held by PICO and its subsidiaries were converted into HyperFeed common shares at a conversion price of $1.03 per share. PICO received 7,462,856 shares on conversion, increasing our voting ownership of HyperFeed from approximately 35% to approximately 42.4%.
At December 31, 2001, PICO and its subsidiaries held the following securities in HyperFeed:
- - 10,077,856 common shares, which had a carrying value of $2.1 million (before taxes), compared to a potential market value of $6.1 million (before taxes) based on the last sale price of $0.61 on December 31, 2001; and - - warrants to buy 4,055,195 shares. The exercise price for the warrants to buy 3,106,163 shares is fixed at $1.575 per share. However, the warrants to buy 949,032 shares are exercisable at the lesser of the stated exercise price, which averages approximately $1.844, or the then market price of the common stock. At December 31, 2001, the warrants were carried at estimated fair value of $527,000 (before taxes).
For full year 2001, HyperFeed generated revenues of $33.3 million, gross margin of $12.9 million, EBITDA (i.e., earnings before depreciation, amortization, interest and tax, a non-GAAP measure which investors frequently use as a proxy for gross cash flow) of $4 million, and a net loss from operations of $1.5 million, excluding non-cash preferred dividends of $927,000. Net cash flow from operating activities was $2.8 million.
We use the equity method to account for the common shares. HyperFeed contributed an equity loss of $1.2 million to the Long Term Holdings segment in 2001.
The HyperFeed warrants are carried in our financial statements at estimated fair value. Following the adoption of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", the change in estimated fair value of warrants during an accounting period is recorded in the Consolidated Statement of Operations for that period. See Note 4 of Notes to Consolidated Financial Statements, "Investments."
On August 31, 2001, Jungfraubahn announced its results for the first six months of 2001. Revenues declined by CHF5.4 million, or 10.6%, year over year to CHF45.7 million, principally due to the absence of revenues from the Raiffeisen promotion. Due to the CHF5.4 million reduction in revenue and a CHF2.1 million increase in operating expenses, EBITDA declined CHF7.5 million to CHF10.3 million, and net income dropped CHF7.6 million to CHF3.3 million, or CHF5.6 per share. In addition, the sale of art contributed an extraordinary profit of CHF1.4 million.
On January 23, 2002, Jungfraubahn issued a press release containing an initial review of 2001 operations. The full text is available on Jungfraubahn's web-site www.jungfraubahn.ch (in the "Shareholders" tab of the "Inside" section).
Jungfraubahn indicated that it expects that the September 11 terrorist attacks in the U.S. will lead to a redistribution in passenger numbers in 2002. Visitors from Japan, the most important inbound market, are expected to be down due to a fear of flying, compounded by the weak Japanese economy, although Jungfraubahn noted "positive signs" suggesting that "a recovery in the travel market may be expected as early as May 2002". Jungfraubahn expects this to be offset, to some extent, by increased visitation from the domestic Swiss market and nearby countries. Jungfraubahn noted that the U.S. is a "relatively small" inbound market.
- - in our income statement for 2001, we recorded a $669,000 dividend received from Jungfraubahn in investment income, and $241,000 of income in the line "Equity Share of Investees' Net Income" for the portion of the year when the equity method was applied; and - - in our balance sheet, we now record the investment at market value. At December 31, 2001, this was approximately $7.4 million less than our previous carrying value because the share price of Jungfraubahn is less than that company's book value per share (i.e., net assets). This caused a net reduction in shareholders' equity of approximately $6.8 million, or $0.55 per PICO share. This is a change in accounting treatment only, and does not reflect any change in the potential value of our investment in Jungfraubahn. See "Significant Accounting Policies" later in this section.
On September 5, 2001, AOG announced that it had returned to profit in the financial year ended June 30, 2001. AOG's revenues increased 86.1% to $A130.1 million ($A1.00 = $US0.5094), and the company reported net income of $A8 million, or $A0.17 per share. Rig utilization improved during the financial year, from 54% in the first half, to 65% in the second half. The increase in utilization during the year appears to have translated into profit growth, with net income for the second half estimated at $A5 million, compared to $A3 million in the first half. In the letter accompanying the results, AOG indicated that rig utilization was "running at over 75%".
On January 17, 2002, AOG announced that it was raising additional capital to purchase a new deep capacity drilling rig and to refit two existing rigs to perform new long term drilling contracts with ExxonMobil Indonesia and Petroleum Development - Oman. In January 2002, PICO provided AOG with a short term $US4 million bridging facility, and was issued 333,333 shares in AOG as a loan establishment fee. AOG is to repay the advance with the proceeds of a rights offering which closes on March 18, 2002. PICO is underwriting part of the offering, and has been issued with another 333,333 shares in AOG as an underwriting fee.
AOG provides its shareholders with half-yearly financial information in accordance with the requirements of the Australian Stock Exchange and Australian securities laws. Given our 20.7% voting ownership at December 31, 2001, and that our Chairman joined AOG's Board of Directors in September 2001, we asked AOG for an on-going commitment to provide timely quarterly financial statements, so that the equity method could potentially be applied to this investment. AOG has declined to provide us with quarterly financial statements and other financial information which is not publicly available to other AOG shareholders. Consequently, we concluded that PICO does not have the ability to exercise significant influence over AOG which is required to apply the equity method of accounting. Instead, the investment is carried at market value, with the unrealized after-tax gain or loss being included in shareholders' equity.
ACCU HOLDING AG PICO owns 8,125 shares in Accu Holding, which represents a voting ownership interest of approximately 28.3% of the company. Since PICO was not able to obtain the necessary financial information, we do not have the ability to exercise significant influence over Accu Holding's activities in 2001, so this investment is not accounted for under the equity method. Instead, the investment is carried at market value, with the unrealized after-tax gain or loss being included in shareholders' equity.
At December 31, 2001, our investment in Accu Holding had a cost basis of $4.6 million, a market value of $4.5 million, and a net carrying value of $4.5 million, after allowing for taxes.
The principal alternative investment is SISCOM, Inc., which is a consolidated subsidiary. SISCOM is a software developer and systems integrator for video-based content management systems for the professional broadcast, sports, and entertainment industries. We are pursuing a number of alternatives to realize the value of this investment, including assisting SISCOM to enter into strategic licensing agreements with companies which have multi-national marketing and distribution channels.
If we determine that the carrying value of an asset cannot be justified by the forecast future cash flows of that asset, the carrying value of the asset is written down, or written off, immediately.
At December 31, 2001, our balance sheet contained capitalized costs of $3 million for two projects at Vidler, which require regulatory approval to proceed.
At December 31, 2001, PICO and its subsidiaries held equities with a carrying value of approximately $56.4 million. These holdings are primarily small-capitalization value stocks in the US, Switzerland, and Australia. Depending on the circumstances, and our judgment about the level of our involvement with the investee company, we apply one of two accounting policies.
In the case of most holdings, we apply Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Under this method, the investment is carried at market value in our balance sheet, with unrealized gains or losses being included in shareholders' equity, and the only income recorded is from dividends.
The application of the equity method (ABP No. 18) to an investment may result in a different outcome in our financial statements than market value accounting (SFAS No. 115). The most significant difference between the two policies is that, under the equity method, we include our proportionate share of the investee's earnings or losses in our statement of operations, and dividends received are used to reduce the carrying value of the investment in our balance sheet. Under market value accounting, the only income recorded is dividends.
The assessment of what constitutes the ability to exercise "significant influence" requires our management to make significant judgments. We look at various factors in making this determination. These include our percentage ownership of voting stock, whether or not we have representation on the investee company's Board of Directors, transactions between us and the investee, the ability to obtain timely quarterly financial information, and whether PICO management can affect the operating and financial policies of the investee company. When we conclude that we have this kind of influence, we adopt the equity method and change all of our previously reported results of the investee to show the investment as if we had applied equity accounting from the date of our first purchase. This adds volatility to our reported results.
For example, our investment in HyperFeed is carried under the equity method of accounting as we have determined that we have the ability to exercise significant influence over HyperFeed. As a result, at December 31, 2001, the carrying value of HyperFeed in our balance sheet is significantly below what it would be if we recorded this investment at market. Also, during 2001 we ceased accounting for our investment in Jungfraubahn Holding under the equity method after we determined that we no longer had the ability to exercise significant influence over Jungfraubahn. When we readopted market value accounting, we recorded a reduction in shareholders' equity because the market value of our investment in Jungfraubahn was significantly below the carrying value under the equity method.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
Total assets at December 31, 2001 were $373.1 million, compared to $395.1 million at December 31, 2000. Most of the $22 million decrease in total assets is attributable to the "run off" of Physicians and Citation, which reduced both insurance liabilities and the corresponding assets. Total liabilities decreased by $22.6 million, primarily due to a $16.7 million reduction in medical professional liability insurance loss reserves during the year.
Detailed information on the performance of each segment is contained later in this report; however, the principal items in the 2001 $7.7 million profit before taxes and minority interest were:
Land and Related Mineral Rights & Water Rights - ---------------------------------------------- - - income of $131,000 from Nevada Land on revenues of $3.2 million, which included $1.9 million in land sales;
Medical Professional Liability Insurance - ---------------------------------------- - - a pre-tax profit of $8.4 million, principally due to an $11.2 million reduction in claims reserves, which was partially offset by a $4 million realized investment loss;
Long Term Holdings - - a $12 million loss before taxes, primarily due to parent company overhead of $4.8 million, a $2.3 million provision against loans to Dominion Capital Pty. Ltd., a $2.5 million SFAS No. 133 decrease in the value of warrants during the year, and our $1.3 million share of the net losses of investments accounted for under the equity method.
Total expenses in 2001 were $60.6 million, unchanged from $60.6 million in 2000, and compared to $73.9 million in 1999. The largest expense item in each of the past 3 years was loss and loss adjustment expense in our insurance businesses (i.e., the cost of making provision to pay claims). In 2001, loss and loss adjustment expense was $18.3 million, compared to $24 million in 2000, and $35.2 million in 1999. Loss and loss adjustment expense for 2001 was reduced by favorable reserve development of $11.2 million in the Medical Professional Liability segment. Due to the greater amount of land and water rights sold in 2001, the cost of land, water rights and water sold was higher than previous years at $7.6 million, compared to $4 million in 2000, and $4.5 million in 1999.
- - the sale of 6,496.5 acre-feet of transferable ground water and 2,589 acres of land in Arizona's Harquahala Valley Irrigation District to a unit of Allegheny Energy, Inc. This transaction added $9.4 million to revenues, comprised of the $9.1 million sales price and a $300,000 option fee earned which is included in Other Revenues, and contributed $2.3 million to segment income; - - the sale of 29.7% of Vidler's original interest in the Semitropic Water Banking and Exchange Program (i.e., approximately 55,000 acre-feet of storage capacity, out of the original 185,000 acre-feet) for $3.3 million. This transaction added $1.6 million to revenues and to segment income; and - - the further sale of 54.1% of Vidler's original interest in the Semitropic Water Banking and Exchange Program (i.e., approximately 100,000 acre-feet of storage capacity) for $6.9 million. This transaction added $4.1 million to revenues and to segment income.
Over the past three years, Vidler has sold water rights, water, and related assets which were not essential to its strategy in Nevada and Arizona. In addition to the Allegheny transaction described in the preceding paragraph, in 2001 Vidler recognized revenues of $390,000 from the sale of water rights to the City of Golden, Colorado. In 2000, Vidler sold 3,691 acre-feet of water which had been "banked" at the Semitropic water storage facility for $509,000, and water rights and the related land and tunnel assets to the City of Golden for $1 million. Due to the potential for significant capital outlays for repairs and maintenance, Vidler disposed of the land and tunnel assets in conjunction with the water rights in 2000, even though this resulted in a loss of $1.2 million being recognized on the sale of the land and tunnel assets. In 1999, Vidler sold 300 acre-feet of priority water rights at Wet Mountain, Colorado for $270,000.
The leasing of agricultural land generated revenues of $795,000 in 2001, $959,000 in 2000, and $477,000 in 1999. Agricultural land lease revenues decreased in 2001 as a result of the sale of farm properties in the Harquahala Valley to Allegheny, as described above. The increase from 1999 to 2000 primarily reflects the purchase of additional Harquahala Valley farm properties during 1999.
Vidler generated revenue of $235,000 in 2001, $188,000 in 2000, and $185,000 in 1999, from leasing some of the company's Colorado water rights. These assets are leased in perpetuity. The lease payments are indexed for inflation, with a minimum annual escalation of 3%.
Other Revenues were $1.5 million in 2001, $467,000 in 2000, and $124,000 in 1999. The most significant items in Other Revenues in 2001 were a $600,000 gain from granting an easement to El Paso Natural Gas Company in the Harquahala Valley, interest revenue of $357,000, and various revenues from properties farmed by Vidler (e.g., sales of hay and cattle). In 2001, Other Revenues were reduced by a $202,000 loss on the condemnation (i.e., compulsory acquisition) of a commercially zoned property in Mesa, Arizona due to freeway construction. This property, which was located in greater metropolitan Phoenix, was not part of Vidler's water business. It was acquired in conjunction with MTB Ranch in 1996, and was being held for sale. Originally, a $442,000 provision for loss on condemnation was recorded in the first quarter of 2001, however this was partially offset by an additional $240,000 payment to be received from a negotiated settlement after Vidler challenged the value at which the property was condemned.
The $348,000 net reduction in segment operating expenses in 2001 from 2000 was primarily attributable to decreases of $301,000 in operations and maintenance expense, $175,000 in interest expense, and $129,000 in other expenses. The decrease in operations and maintenance expense was primarily due to a lower obligation to contribute to operations and maintenance expense at the Semitropic water storage facility, as our interest in the asset reduced. Interest expense declined due to the repayment of the non-recourse debt on the Harquahala Valley farm properties which were sold to Allegheny. These expense reductions were partially offset by a $297,000 increase in depreciation and amortization expense, primarily due to the start of amortization of improvements at the Vidler Arizona Recharge Facility. Since construction of the improvements required to recharge water is complete and the facility is ready for use, on March 1, 2001, Vidler began to amortize the improvements at the facility over 15 years. The annual amortization charge will be approximately $518,000. The amortization charge for 2001 was $421,000.
Segment operating expenses increased $915,000 from 1999 to 2000, due to increases of $398,000 in operations and maintenance, $178,000 in depreciation and amortization, $143,000 in interest, and $196,000 in other expenses. The increase in segment expenses reflected the growth in Vidler's asset base, including the purchase of farm properties and the related water rights in the Harquahala Valley.
The principal causes of the $9.9 million improvement in the segment result from 2000 to 2001 were the contributions to income of $5.7 million from the sale of interests in Semitropic, $2.3 million from the Allegheny transaction, and $600,000 from the easement granted in 2001.
The $907,000 increase in segment loss from 1999 to 2000 was caused by the $1.2 million realized loss on the sale of the land and tunnel assets described above. Excluding this item, the segment loss declined by $296,000, primarily due to a $342,000 gross profit on the sale of the water "banked" at Semitropic and $482,000 higher agricultural lease revenues, which were partially offset by higher charges for depreciation, interest, and other expenses.
Nevada Land generated revenues of $3.2 million in 2001, compared to $5.3 million in 2000, and $7.1 million in 1999.
Nevada Land also generated revenues from a gain on a land exchange transaction in 2000, and the sale of water rights in 2000 and 1999.
After deducting the cost of land sold, the gross margin on land sales was $1.1 million in 2001, $2.2 million in 2000, and $1.5 million in 1999. This represented a gross margin percentage of 59.8% in 2001, 59.2% in 2000, and 28% in 1999.
Operating expenses were little changed over the three-year period, at $1.8 million in 2001, $1.6 million in 2000, and $1.8 million in 1999.
As part of our strategy of increasing our ownership of water rights in northern Nevada, in 1998 Nevada Land and Vidler jointly acquired a controlling interest in Silver State Land, LLC, which had filed applications for approximately 51,000 acre-feet of water rights in various locations that were geographically unrelated to Nevada Land's properties. In 1999, 2000, and 2001, our priority has been to pursue the water rights applications filed by the Vidler/Lincoln County joint venture, and by Nevada Land on its own properties. Accordingly, due to the uncertainty of realizing the value of these applications, in 2001 we reduced the carrying value of Silver State to zero, which resulted in expenses of $541,000 in this segment and $40,000 in the "Water Rights and Water Storage" segment. The Silver State water rights applications were the only water rights applications with a carrying value in our financial statements.
The Property & Casualty Insurance segment generated total revenues of $51.3 million in 2001, compared to $39.3 million in 2000, and $40 million in 1999.
Most revenues in this segment come from earned premiums. When an insurance company writes a policy, the premium charged is referred to as "written" premium. The "written" premium is recognized as revenue, or "earned," evenly over the term of the policy. Therefore, there is a time lag between changes in written premium and the resulting change in earned premium.
Segment investment income increased 8.7% to $5.4 million during 2000. The average income yield on the bond portfolio increased throughout 2000 due to the higher prevailing level of interest rates and the purchase of high quality corporate bonds with 5 years or less to maturity with the proceeds of lower-yielding treasury bills and money market funds. The increase in the income yield was partially offset by the purchase of several small-capitalization value stocks with lower income (i.e., dividend) yields but greater appreciation potential than bonds.
Investment income increased another 11.4% to $6 million in 2001. This reflected a higher average yield to maturity in the bond portfolio, resulting from the purchase of high quality corporate bonds with 5 to 10 years to maturity and the sale of some shorter term securities whose yields had fallen to low levels.
Investment gains of $1.8 million were realized in 2001, primarily due to the sale of bonds with 5 years or less to maturity, compared to realized gains of $172,000 in 2000, and a net realized investment loss of $186,000 in 1999. Given the historic drop in interest rates during 2001, particularly in shorter-term (5 years or less) interest rates, realized gains of this magnitude from bonds are unlikely to be repeated.
The Property and Casualty Insurance segment produced $6.2 million of pre-tax income in 2001, consisting of a $3.3 million pre-tax profit from Sequoia and $2.9 million from Citation. This compares to segment income of $2.5 million in 2000, and a segment pre-tax loss of $3.7 million in 1999.
During 1998 and 1999, Sequoia and Citation "pooled," or shared, most of their premiums and expenses, and all business in California and Nevada was transitioned to Sequoia. From January 1, 2000, the pooling arrangement was terminated, and Citation only wrote a minor amount of premium in Arizona. Citation ceased writing business in December 2000, and went into "run off" in 2001. Citation's last policy expired in December 2001. Due to these factors, as well as the acquisition of the Personal Express book of business, the individual results of Sequoia and Citation for 2001 cannot be directly compared to previous years.
The 1999 $3.7 million segment loss consisted of $2.2 million in income from Sequoia, which was more than offset by a $5.9 million loss from Citation. From 1999 to 2000, the segment result improved by $6.2 million, from a $3.7 million loss in 1999 to a $2.5 million profit in 2000. The 1999 segment loss was caused by a $10.1 million pre-tax charge to strengthen Citation's claims reserves, principally in the artisan/contractors line of business.
SEQUOIA INSURANCE COMPANY In 2001, Sequoia's revenues included earned premiums of $42.3 million, investment income of $3.7 million, and realized gains of $1.5 million. Earned premiums increased 29.2% from the previous year, and consisted of $34.1 million from commercial lines and $8.2 million from personal lines. Earned premiums for 2001 reflected most, but not a full 12 months, of the annualized increase in premium resulting from the acquisition of the Personal Express book of business. For 2001, Sequoia reported a loss from operations (i.e., income before investment income, realized gains, and taxes) of $1.9 million, and income before taxes of $3.3 million. This included an additional expense of $738,000 to recognize adverse development in prior year loss reserves.
In 2000, Sequoia's revenues included $32.7 million in earned premiums, $2.8 million in investment income, and realized gains of $99,000. The earned premiums were composed of $29.6 million from commercial lines and $3.1 million from personal lines, which included some initial revenues from the Personal Express book of business. For 2000, Sequoia reported a loss from operations of $1.5 million, which included an additional expense of $252,000 to recognize adverse development in prior year loss reserves, and income before taxes of $1.3 million.
The higher loss ratio was partially offset by a lower underwriting expense ratio (i.e., operating expenses as a percentage of earned premiums) of 36.3% in 2001, compared to 38.6% in 2000, and 46.3% in 1999. The reduction in the underwriting expense ratio was due to: o economies of scale. Sequoia's earned premiums grew by 29.2% in 2001, following a 93.4% increase in 2000 after the pooling agreement with Citation was terminated. In 2001 and 2000, fixed underwriting expense items (i.e., expenses which do not change with volume) were spread over a larger base of revenue, and therefore reduced as a percentage of revenue; and o earned premiums from the Personal Express book of business. Sequoia does not pay commission on Personal Express business, so commission expense fell as a percentage of revenue in 2001 and 2000.
CITATION INSURANCE COMPANY Citation went into "run off" from January 1, 2001. In future years, this will significantly affect the company's level of revenues and expenses. It is anticipated that the majority of Citation's future revenues will come from investment income, which is expected to decline over time as fixed-income investments mature or are sold to provide the funds to pay down the company's claims reserves. Unless there is adverse development in prior year loss reserves, typically the expenses of an insurance company in "run off" will be lower than the expenses of an insurance company which is actively writing business.
In 2000, Citation's revenues included investment income of $2.7 million, earned premiums of negative $158,000, and negative goodwill amortization of $568,000. Although Citation earned $564,000 in property and casualty premiums in 2000, this was more than offset by a $722,000 reduction in earned premium revenues related to reinsurance. After expenses of $1.9 million, including a partially offsetting $282,000 benefit from favorable development in prior year loss reserves, Citation earned a $1.2 million pre-tax profit for 2000.
From 2000 to 2001, Citation's pre-tax profit increased $1.7 million. While revenues increased $309,000 year over year, underwriting and other expenses declined by $1.4 million after the company went into "run off."
During 1999, Citation was "pooling" most of its revenues and expenses with Sequoia so revenues and expenses were significantly greater than in 2000 and 2001. In 1999, Citation's revenues included earned premiums of $17.5 million, investment income of $2.9 million, and negative goodwill amortization of $568,000. Following expenses of $26.7 million, which included a $10.1 million charge to strengthen loss reserves, Citation reported a pre-tax loss of $5.9 million.
Since Citation is in "run off," its Combined Ratio is no longer meaningful.
Actuarial analysis of Physicians' loss reserves as of September 30, 2001 concluded that Physicians' reserves against future claims were significantly greater than the actuary's projections of future claims payments. This was due to favorable trends in both the "frequency" (number) and "severity" (size) of claims. Accordingly, Physicians took down $11.2 million of excess reserves in the fourth quarter of 2001.
Medical professional liability insurance segment revenues were negative $2.1 million in 2001, compared to $3.4 million in 2000, and $3.1 million in 1999.
Segment total revenues were negative $2.1 million in 2001, due to a $4 million net realized investment loss which exceeded the positive revenue items. The net realized investment loss consisted of a $4.1 million realized loss on the redemption of all units held in the Rydex URSA mutual fund, which was partially offset by $19,000 in realized gains from the sale of bonds. The Rydex URSA Fund is designed to deliver a return which is the inverse of the return on the S&P 500 Index, and was acquired in 1995 when Physicians had greater exposure to listed stocks. In the first four months of 2001, the S&P 500 Index declined sharply. This led to a corresponding increase in the price of the Rydex URSA Fund, and we redeemed the investment. When the loss was realized, there
Investment income was $1.2 million in 2001, $1.5 million in 2000, and $1.2 million in 1999. The principal reason for the variation in investment income from year to year is fluctuation in the amount of fixed-income securities held in the portfolio and the prevailing level of interest rates.
Although Physicians is in "run off" and no longer writing premiums, earned premium does arise, for example, from "swing rated" reinsurance, where the reinsurance premiums we pay are recalculated based on loss experience (i.e., number and size of claims). Under GAAP, reinsurance is recorded in the earned premium line. Earned premiums of $755,000 were recorded in 2001, which primarily reflects a reduction in the amount of reinsurance we need to pay in line with the reduction in our claims reserves during 2001. Similarly, earned premiums of $1.9 million were recorded in both 2000 and 1999.
Underwriting expenses consist of loss and loss adjustment expense and other operating expenses.
In 2001, the segment reported a $10.5 million underwriting recovery, as an $11.2 million reduction in reserves more than offset regular loss and loss adjustment expense and operating expenses for the year. This resulted in segment income of $8.4 million. Excluding the reserve reduction and the net realized investment loss, segment income would have been approximately $1.2 million.
In 2000, a net realized loss of $7.6 million was incurred. This primarily represented a $4.6 million loss on the sale of Conex, a $2.5 million write-down of the loan to MKG Enterprises, and a $526,000 loss when a former employee exercised an option which required PICO to sell existing shares in Vidler for less than current book value. When PICO acquired Vidler in the merger with Global Equity Corporation, call options had already been granted to certain employees over existing shares in Vidler. All of these call options have now been exercised.
Other revenues were $466,000 in 2001, $936,000 in 2000, and $2.1 million in 1999.
The principal expenses recognized in this segment are PICO's corporate overhead and operating expenses from SISCOM and, in 2000 and 1999, Conex. In 2001, segment expenses were $10.1 million, compared to $9.9 million in 2000, and $11.3 million in 1999.
PICO's equity share of investees' income represents our proportionate share of the net income and other events affecting equity in the investments which we carry under the equity method, less any dividends received from those investments. In 2001, an equity share of investees' loss of $1.3 million was recorded, compared to equity income of $1.8 million in 2000, and a $1 million equity share of investees' loss in 1999. Here is a summary of the principal investments which we accounted for under the equity method in each of the past three years:
The Long Term Holdings segment produced a loss before taxes of $12 million in 2001, compared to a $13.9 million loss in 2000 and a $9.2 million loss in 1999.
LIQUIDITY AND CAPITAL RESOURCES -- YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
Vidler's water-related assets began to generate significant cash flow in the first quarter of 2001. As commercial use of these assets increases, we expect that Vidler will start to generate free cash flow as receipts from leasing water or storage and the proceeds from selling land and water rights begin to overtake maintenance capital expenditure, financing costs, and operating expenses. As water lease and storage contracts are signed, we anticipate that Vidler may be able to monetize some of the contractual revenue streams, which could potentially provide another source of funds;
- - Nevada Land & Resource Company, LLC is actively selling land which has reached its highest and best use, and is not part of PICO's long-term utilization plan for the property. Nevada Land's principal sources of cash flow are the proceeds of cash sales, and collections of principal and interest on sales contracts where Nevada Land has provided vendor financing. Since these receipts and other revenues exceed Nevada Land's operating costs, Nevada Land is generating strong positive cash flow which provides funds to finance other group activities;
- - Sequoia Insurance Company is currently generating positive cash flow from increased written premium volume. Shortly after a policy is written, the premium is collected and the funds can be invested for a period of time before they are required to pay claims. Free cash flow generated by Sequoia is being deployed in the company's investment portfolio;
- - Citation Insurance Company has ceased writing business and is "running off" its existing claims reserves. Investment income more than covers Citation's operating expenses. Most of the funds required to pay claims are coming from the maturity of fixed-income investments in the company's investment portfolio and recoveries from reinsurance companies; and
During 2001, Operating Activities used cash of $3.9 million. Operating Activities used cash of $17.3 million in 2000, and $23.5 million in 1999. The most significant cash inflow in 2001 was $9.4 million in total receipts from the sale of water rights and land in the Harquahala Valley. The principal uses of cash were claims payments by our insurance subsidiaries and operating expenses in all three years.
Investing Activities used $55.4 million of cash in 2000. Most of the Investing Activities cash flow represents activity in the investment portfolios of our insurance companies, where the proceeds of cash and cash equivalents and maturing fixed-income securities were reinvested in longer-dated corporate bonds and, to a lesser extent, in small-capitalization value stocks. In addition, Vidler made a $2.3 million payment related to the Semitropic Water Banking and Exchange Program.
Financing Activities used $1.8 million of cash in 2001. Vidler paid off approximately $2.9 million in non-recourse borrowings collateralized by the farm properties in the Harquahala Valley Irrigation District which it sold to Allegheny. Global Equity SA took on an additional $1.9 million of Swiss Franc-denominated borrowings to help finance the acquisition of investments in Swiss public companies, principally Sihl.
PICO is committed to maintaining Sequoia's capital and statutory surplus at a minimum of $7.5 million. At December 31, 2001, Sequoia had approximately $29.3 million in capital and statutory surplus. PICO also aims to maintain Sequoia's A.M. Best rating at or above its present "A-" (Excellent) level. At some time in the future, this may require the injection of additional capital.
See Note 15 of Notes To Consolidated Financial Statements, "Commitments and Contingencies."
In addition to the risks and uncertainties discussed in the preceding sections of "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this document, the following risk factors should be considered carefully in evaluating PICO and its business. The statements contained in this Form 10-K that are not purely historical are forward-looking statements within the meaning of Section 27A of the Exchange Act, including statements regarding our expectations, beliefs, intentions, plans or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date thereof, and we assume no obligation to update any such forward-looking statements.
PICO is a diversified holding company with operations in land and related water rights and mineral rights; water rights and water storage; property and casualty insurance; medical professional liability insurance; and other long-term holdings. Each of these areas is unique, complex in nature, and difficult to understand. In particular, water rights is a developing industry within the western United States with very little historical data, very few experts and a limited following of analysts. Because we are so complex, analysts and investors may not be able to adequately evaluate our operations, and PICO in total. This could cause them to make inaccurate evaluations of our stock, or to overlook PICO, in general. These factors could have a negative impact on the trading volume and price of our stock.
IF WE DO NOT SUCCESSFULLY LOCATE, SELECT AND MANAGE INVESTMENTS AND ACQUISITIONS OR IF OUR INVESTMENTS OR ACQUISITIONS OTHERWISE FAIL OR DECLINE IN VALUE, OUR FINANCIAL CONDITION COULD SUFFER
We will continue to make selective investments, and endeavor to enhance and realize additional value to these acquired companies through our influence and control. This could involve the restructuring of the financing or management of the entities in which we invest and initiating and facilitating mergers and acquisitions. Any acquisition could result in the use of a significant portion of our available cash, significant dilution to you, and significant acquisition-related charges. Acquisitions may also result in the assumption of liabilities, including liabilities that are unknown or not fully known at the time of the acquisition, which could have a material adverse effect on us.
We do not know of any reliable statistical data that would enable us to predict the probability of success or failure of our investments, or to predict the availability of suitable investments at the time we have available cash. You will be relying on the experience and judgment of management to locate, select and develop new acquisition and investment opportunities. Sufficient opportunities may not be found and this business strategy may not be successful. We have made a number of investments in the past that have been highly successful, such as Fairfield Communities, Inc., which we sold in 1996, and Resource America, Inc., which we sold in 1997. We have also made investments that have lost money, such as our approximate $4 million loss from the Korean investments in 1997, an approximate $5 million write-down of investments in 1998, a $3.2 million write-down of an oil and gas investment in 1999, and $7.1 million in investment losses in the third quarter of 2000. We reported net realized investment gains of $441,000 in 1999 and $21.4 million in 1997; however, we reported net realized investment losses of $5.1 million in 2001, $7.5 million in 2000 and $4.4 million for 1998. We reported a net unrealized investment loss of $10.6 million at December 31, 2001, compared to a net unrealized loss of $7 million at December 31, 2000, and a net unrealized gain of $575,000 at December 31, 1999.
Our investments may not achieve acceptable rates of return and we may not realize the value of the funds invested; accordingly, these investments may have to be written down or sold at their then-prevailing market values.
Reserves are provisions that we make to pay insurance claims. We strive to establish a balance between maintaining adequate reserves to pay claims while at the same time using our cash resources to invest in new companies.
Our insurance subsidiaries may not have established reserves adequate to meet the ultimate cost of losses arising from claims. It has been, and will continue to be, necessary for our insurance subsidiaries to review and make appropriate adjustments to reserves for claims and expenses for settling claims. Inadequate reserves could have a material adverse effect on our business, financial condition, and the results of operations and cash flows. Inadequate reserves could cause our financial condition to fluctuate from period to period and cause our financial condition to appear to be better than it actually is for periods in which insurance claims reserves are understated. In subsequent periods when we discover the underestimation and pay the additional claims, our cash needs will be greater than expected and our financial results of operations for that period will be worse than they would have been had our reserves been accurately estimated originally.
- - the length of time in reporting claims; - - the diversity of historical losses among claims; - - the amount of historical information available during the estimation process; - - the degree of impact that changing regulations and legal precedents may have on open claims; and - - the consistency of reinsurance programs over time.
During the past several years, the levels of the reserves for our insurance subsidiaries have been very volatile. We have had to significantly increase and decrease these reserves in the past several years.
STATE REGULATORS COULD REQUIRE CHANGES TO THE OPERATIONS OF OUR INSURANCE SUBSIDIARIES AND/OR TAKE THEM OVER IF WE FAIL TO MAINTAIN ADEQUATE RISK-BASED CAPITAL LEVELS
- - Sequoia Insurance Company A- (Excellent) - - Citation Insurance Company B+ (Very Good) - - Physicians Insurance Company of Ohio NR-3 (rating procedure inapplicable)
POLICY HOLDERS MAY NOT RENEW THEIR POLICIES, WHICH WOULD UNEXPECTEDLY REDUCE OUR REVENUE STREAM
At all times we intend to conduct our business so as to avoid being regulated as an investment company under the Investment Company Act of 1940. However, if we were required to register as an investment company, our ability to use debt would be substantially reduced, and we would be subject to significant additional disclosure obligations and restrictions on our operational activities. Because of the additional requirements imposed on an investment company with regard to the distribution of earnings, operational activities and the use of debt, in addition to increased expenditures due to additional reporting responsibilities, our cash
VARIANCES IN PHYSICAL AVAILABILITY OF WATER, ALONG WITH ENVIRONMENTAL AND LEGAL RESTRICTIONS AND LEGAL IMPEDIMENTS COULD IMPACT PROFITABILITY FROM OUR WATER RIGHTS
The water rights held by us and the transferability of these rights to other uses and places of use are governed by the laws concerning water rights in the states of Arizona, Colorado and Nevada. The volumes of water actually derived from the water rights applications or permitted rights may vary considerably based upon physical availability and may be further limited by applicable legal restrictions. As a result, the amounts of acre-feet anticipated from the water rights applications or permitted rights do not in every case represent a reliable, firm annual yield of water, but in some cases describe the face amount of the water right claims or management's best estimate of such entitlement. Legal impediments exist to the sale or transfer of some of these water rights, which in turn may affect their commercial value. If we were unable to transfer or sell our water rights, we will not be able to make a profit, we will not have enough cash receipts to cover cash needs, and we may lose some or all of our value in our water rights investments.
Water we lease or sell may be subject to regulation as to quality by the United States Environmental Protection Agency acting pursuant to the federal Safe Drinking Water Act. While environmental regulations do not directly affect us, the regulations regarding the quality of water distributed affects our intended customers and may, therefore, depending on the quality of our water, impact the price and terms upon which we may in the future sell our water or water rights.
OUR FUTURE WATER REVENUES ARE UNCERTAIN AND DEPEND ON A NUMBER OF FACTORS, WHICH MAY MAKE OUR REVENUE STREAMS AND PROFITABILITY VOLATILE
Our profitability is significantly affected by changes in the market price of water. In the future, water prices may fluctuate widely as demand is affected by climatic, demographic and technological factors.
OUR WATER SALES MAY MEET WITH POLITICAL OPPOSITION IN CERTAIN LOCATIONS, THEREBY LIMITING OUR GROWTH IN THESE AREAS
- - the need to comply with a wide variety of foreign and U.S. export laws; - - political and economic instability; - - trade restrictions; - - changes in tariffs and taxes; - - volatile interest rates; - - changes in certain commodity prices; - - exchange controls which may limit our ability to withdraw money; - - the greater difficulty of administering business overseas; and - - general economic conditions outside the United States.
Changes in any or all of these factors could result in reduced market values of investments, loss of assets, additional expenses, reduced investment income, reductions in shareholders' equity due to foreign currency fluctuations and a reduction in our global diversification.
Several years or more may elapse between the occurrence of an insured medical professional liability insurance or casualty loss, the reporting of the loss and the final payment of the loss. Loss reserves are estimates of what an insurer expects to pay claimants, legal and investigative costs and claims administrative costs. PICO's insurance subsidiaries are required to maintain reserves for payment of estimated losses and loss adjustment expenses for both reported claims and claims which have occurred but have not yet been reported. Ultimate actual liabilities may be materially more or less than current reserve estimates.
See schedule in Note 12 of Notes to PICO's Consolidated Financial Statements, "Reserves for Unpaid Loss and Loss Adjustment Expenses" for additional information regarding reserve changes.
Physicians' liability for unpaid medical professional liability insurance losses and loss adjustment expenses was discounted through December 31, 1999, to reflect investment income as permitted by the Ohio Department of Insurance. The method of discounting was based upon historical payment patterns and assumed an interest rate at or below Physicians' investment yield, and
Various reinsurance treaties remain in place to limit PICO's exposure levels.
Each decrease or increase amount includes the effects of all changes in amounts during the current year for prior periods. For example, the amount of the redundancy related to losses settled in 1994, but incurred in 1991, will be included in the decrease or increase amount for 1991, 1992 and 1993. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. For example, Physicians commuted reinsurance contracts in several different years that significantly increased the estimate of net reserves for prior years by reducing the recoverable loss and loss adjustment expense reserves for those years. Accordingly, it may not be appropriate to extrapolate future increases or decreases based on this table.
An analysis of changes in the liability for unpaid losses and loss adjustment expenses for 2000, 1999 and 1998 is set forth in Note 12 of Notes to PICO's Consolidated Financial Statements, "Reserves for Unpaid Loss and Loss Adjustment Expenses."
During this period, Citation and Sequoia had the same reinsurance program. For property business, reinsurance provided coverage of $10.4 million excess of $150,000 per occurrence. For casualty business, excluding umbrella coverage, reinsurance provided coverage of $4.9 million excess of $150,000 per occurrence. Umbrella coverages were reinsured $9.9 million excess of $100,000 per occurrence. The catastrophe treaties for 1998 and thereafter provided coverage of 95% of $14 million excess of $1 million per occurrence. Facultative reinsurance was placed with various reinsurers.
See Note 11 of Notes to Consolidated Financial Statements, "Reinsurance", with regard to reinsurance recoverable concentration for all property and casualty lines of business as of December 31, 2001. PICO remains contingently liable with respect to reinsurance contracts in the event that reinsurers are unable to meet their obligations under the reinsurance agreements in force.
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2001 AND 2000 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2001
Independent Auditors' Report................................... 53 Consolidated Balance Sheets as of December 31, 2001 and 2000... 54-55 Consolidated Statements of Operations for the Years Ended December 31, 2001, 2000 and 1999......................... 56 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2001, 2000, and 1999............. 57-59 Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999.......................... 60 Notes to Consolidated Financial Statements..................... 61-88
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PICO Holdings, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 21 to the financial statements, in 2000 the Company changed its method of accounting for medical professional liability claims reserves.
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
PICO was incorporated in 1981 and began operations in 1982. The company was known as Citation Insurance Group until a reverse merger with Physicians Insurance Company of Ohio ("Physicians") on November 20, 1996. Following the reverse merger, the Company changed its name to PICO Holdings, Inc.
Citation Insurance Company ("Citation"). Citation is a California-domiciled insurance company licensed to write commercial property and casualty insurance in Arizona, California, Colorado, Nevada, Hawaii, New Mexico and Utah. Citation ceased writing premiums in December 2000, and is now "running off" the loss reserves from its existing business.
Investments in which the Company owns between 20% to 50% of the voting interest and/or has the ability to exercise significant influence are accounted for under the equity method of accounting. Accordingly, the Company's share of income or losses are included in consolidated results. Currently, the only significant investment the Company classifies as an equity affiliate is HyperFeed Technologies, Inc. ("HyperFeed"). Hyperfeed provides financial market data and data delivery solutions to the financial services industry. PICO owns approximately 42% of the outstanding voting stock of HyperFeed.
The Company invests domestically and abroad. Approximately $36.8 million and $41.2 million of the Company's investments at December 31, 2001 and 2000, respectively, were invested internationally, including equity values of affiliates. The Company's most significant foreign currency exposure is in Swiss francs and Australian dollars.
The Company records all reinsurance assets and liabilities on the gross basis, including amounts due from reinsurers and amounts paid to reinsurers relating to the unexpired portion of reinsured contracts (prepaid reinsurance premiums).
In June 2001, the FASB approved SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 prospectively prohibits the pooling of interest method of accounting for business combinations initiated after June 30, 2001. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. However, as an exception, any goodwill resulting from acquisitions completed after June 30, 2001 will not be amortized. SFAS No. 142 also establishes a new method of testing goodwill for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. At December 31, 2001, PICO's balance sheet included goodwill and intangible assets of $5.8 million, $2.3 million of which is included within the investment balances of the unconsolidated affiliates, and negative goodwill ("excess of fair value of net assets acquired over purchase price") of $2.8 million.
1) The write-off of negative goodwill of $2.8 million; 2) The write-off of goodwill of $1 million.
The net effect of the above of $1.8 million addition to net income or reduction in net loss will be reported as a cumulative effect of a change in accounting principle. The remaining balance of $2.5 million will be classified as an intangible asset with a finite life. Accordingly, it will be amortized over its remaining life of 8 years and tested for impairment at least annually.
is not recoverable and exceeds its fair value." Based on the SFAS No. 121 framework, this statement develops a single accounting model for the disposal of long-lived assets, whether previously held or newly acquired. The statement will be effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with initial application as of the beginning of the fiscal year. Management does not believe this statement will have a material impact on the consolidated financial statements.
Prior to the sale, on November 3, 1999, the Company increased its ownership of Conex from 66% to 83% through the redemption of its remaining preferred shares and conversion of intercompany loans into common stock. On August 2, 1999, the Company increased its ownership of Conex from 32% to 66% through the redemption of preferred shares, the proceeds from which were used to exercise warrants for common shares. The consolidated results of operations for the year ended December 31, 1999 reflect the consolidation of Conex for the period August 3 to December 31. Previous to consolidation, the investment was accounted for using the equity method. Consequently, the results of operations for the year ended December 31, 1999 include 32% of the losses in the unconsolidated affiliate for the period January 1 to August 2, 1999. The reported results in 2000 include Conex as a consolidated subsidiary until September 8, 2000. Conex's primary asset was a 60% sino-foreign joint venture that manufactures wheeled and tracked excavators in The People's Republic of China.
2001 2000 1999 --------------- --------------- --------------- Investment income from: Available for sale: Fixed maturities $ 6,171,014 $ 5,196,831 $ 1,593,052 Equity securities 1,795,248 343,211 252,693 Other 1,871,738 2,884,099 4,809,821 --------------- --------------- --------------- Total investment income 9,838,000 8,424,141 6,655,566 Investment expenses (71,107) (185,845) (268,679) --------------- --------------- --------------- Net investment income $ 9,766,893 $ 8,238,296 $ 6,386,887 =============== =============== ===============
Management determined that use of the equity method was appropriate as we determined we had the ability to exercise significant influence based on the Company's ability to obtain quarterly financial data from Jungfraubahn for inclusion in the Company's consolidated financial statements. PICO also had the expectation of receiving such information for the Company's future financial periods. However, during the second quarter of 2001 and after several discussions between Jungfraubahn and the Company, Jungfraubahn decided that, for various reasons, they would no longer provide quarterly financial data to the Company and that the sole source of financial information available to the Company would be their semi-annual filings provided to the Swiss Stock Exchange. Management believes, based on the guidelines of Accounting Principles Board ("APB") No. 18, that the inability to get quarterly financial information indicates the Company no longer has significant influence, and, accordingly, discontinued use of the equity method of accounting for its investment in Jungfraubahn, at April 1, 2001. At December 31, 2001, the Company accounts for the investment under SFAS No. 115 and, as a result of applying SFAS 115, recorded an unrealized loss net of tax of approximately $6.8 million in other comprehensive loss for the year.
During 2000, the Company purchased 3,472 shares of Jungfraubahn for $493,000. During 1999, the Company purchased 76,600 shares of Jungfraubahn for $11.8 million. The acquisition was financed with $7 million in cash and the remaining balance in debt. At December 31, 2001 and 2000, the Company owns 112,672 shares, or 19.3% of the Jungfraubahn.
At December 31, 2001, the Company's investment in HyperFeed consisted of 10,077,856 shares of common stock, representing 42.4% of the common shares outstanding; and 4,055,195 common stock warrants which on a diluted basis would represent an additional 14.5% voting interest if exercised. The common stock is recorded using the equity method of accounting and has a carrying value of $2.1 million at December 31, 2001. The difference between the carrying value of the investment and the underlying equity in the net assets or liabilities of HyperFeed is considered goodwill and is being amortized over 10 years on a straight-line basis. At December 31, 2001, the common stock warrants are valued at an estimated fair value of $527,000, prior to a $1.2 million deferred tax asset, using the Black Scholes option-pricing model. The warrants are reported as a derivative instrument under the provisions of SFAS 133 and consequently the loss for the 2001 year is reflected in the
caption "Realized Loss on Investments" in the Statement of Operations. The cumulative change in fair value from the date of acquisition to January 1, 2001 was a decline of $1.3 million and is recorded net of a deferred tax benefit on the Statement of Operations.
During the three years ended December 31, 2001, HyperFeed recorded various capital transactions that affected PICO's voting ownership percentage. In 2001, HyperFeed issued 491,000 shares of common stock related to an acquisition which resulted in a dilution gain of $352,000 to PICO. In 2000, HyperFeed issued 164,000 shares of common stock related to conversion of stock options, which resulted in a dilution gain to PICO of approximately $208,000. Deferred taxes are provided on each dilution transaction. In 1999, HyperFeed issued common stock related to the conversion of options and warrants and stock in a private placement. These transactions diluted PICO's ownership percentage approximately 1% to 35% at June of 2001 and through the conversion of preferred shares PICO increased ownership to 42.4% by the end of December 31, 2001.
In September 2001, the Company converted its HyperFeed Series A voting convertible preferred shares, and its Series B voting convertible preferred shares into 7,462,856 newly issued common shares. After the conversion, PICO owned 42.4% of the outstanding voting interest.
The following is the market value of the common shares and preferred shares (preferred shares existed in 2000 only) based on the December 31, 2001 and 2000 closing price of HyperFeed common stock:
2001 2000 --------------- --------------- Agents' balances and unbilled premiums $ 11,081,153 $ 10,008,197 Finance receivables 5,961,567 3,329,670 Trade receivables 49,288 263,400 Other accounts receivable 3,535,157 5,645,636 --------------- --------------- 20,627,165 19,246,903 Allowance for doubtful accounts (2,550,604) (214,300) --------------- --------------- $ 18,076,561 $ 19,032,603 =============== ===============
Other accounts receivable include $2.3 million due from Dominion Capital Pty. Ltd ("Dominion"), which is affiliated with the Company through a mutual ownership in Solpower Corporation. During 2001, an allowance for the total outstanding balance owed by Dominion of $2.3 million was recorded due to the uncertainty surrounding the recovery of the balance. Also included in other accounts receivable is a $187,000 note receivable from the President and CEO of Summit Global Management for the purchase of Summit in January 2000.
The deferred tax asset valuation allowance as of December 31, 2001 and 2000 relates primarily to the net operating loss carryforwards (NOL's) of Global Equity, a Canadian company. Global Equity is subject to rules that limit the ability to utilize their NOL's. Due to these limitations and the uncertainty of future taxable income, a valuation allowance has been recorded for the deferred tax asset that may not be realized. Prior to the enactment, in 1999, of U.S. tax legislation that removed certain limitations on the Company's ability to utilize its U.S. NOL's, the Company carried a valuation allowance on a portion of its U.S. NOL's. As a result of this legislation, in 1999 most of the valuation allowance for U.S. NOL's was removed. Deferred tax assets and liabilities, the recorded valuation allowance, and federal income tax expense in future years can be significantly affected by changes in circumstances that would influence management's conclusions as to the ultimate realization of deferred tax assets.
The difference between income taxes provided at the Company's federal statutory rate and effective tax rate is as follows:
2001 2000 -------------- --------------- Office furniture, fixtures and equipment $ 6,833,972 $ 6,834,381 Building and leasehold improvements 1,135,071 1,192,123 -------------- --------------- 7,969,043 8,026,504 Accumulated depreciation (5,241,112) (5,081,991) -------------- --------------- Property and equipment, net $ 2,727,931 $ 2,944,513 ============== ===============
PICO Holdings 1995 Non-Qualified Stock Option Plan. PICO was authorized to issue 521,030 shares of common stock pursuant to awards granting non-qualified stock options to full-time employees (including officers) and directors. The options granted to employees vest at a rate of 33% upon grant and 33% per year on each of the first two anniversaries of the date of grant. A total of 512,005 options have been issued from this plan. The Company granted stock options in 1996 and 1995 under this plan in the form of incentive stock options and non-qualified stock options. All issued options from this plan are fully vested.
PICO Holdings 1998 Stock Option Agreement. PICO was authorized to issue 100,000 shares of common stock pursuant to awards granted in various forms, including incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended), non-qualified stock options, and other similar stock-based awards. On October 22, 1998, PICO granted 100,000 non-qualified common stock options to an officer of the Company at an exercise price of $15.625 per share. The options granted vest monthly over three years, expiring October 22, 2008. During 1999, 61,111 of these options expired when the officer left the Company. The remaining options expired during 2001. None of these stock options were exercised.
PICO Holdings 1998 Global Equity/PICO Stock Option Plan. As discussed above, PICO assumed 484,967 options to existing Global Equity option holders pursuant to the acquisition of the remaining shares of Global Equity by exchanging PICO options for Global Equity options. The options granted from this plan placed the participants in an economically equivalent position regarding the number of shares, exercise price, and with vesting according to their original terms.
On August 2, 2001, PICO granted 8,777 non-statutory stock options to an employee at an exercise price of $15.00 per share. 2,925 of those stock options vested on August 2, 2001, 2,926 stock options will vest on August 2, 2002, and 2,926 stock options will vest on August 2, 2003. They expire on August 2, 2021.
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in each year: no dividend yield; risk-free interest rates are different for each grant and range from 4.9% to 6.97%; expected lives of options are estimated at 10 years for 2001, 10 years for 2000 and 7 years for 1999; and volatility of 42% for the 2001 grants, 51% for the 2000 grants, and 54% for the 1999 grants.
The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts.
In the normal course of business, the Company's insurance subsidiaries have entered into various reinsurance contracts with unrelated reinsurers. The Company's insurance subsidiaries participate in such agreements for the purpose of limiting their loss exposure and diversifying their risk. Reinsurance contracts do not relieve the Company's insurance subsidiaries from their obligations to policyholders.
In 1994, the Company entered into a retroactive reinsurance arrangement with respect to its MPL business. As a result, Physicians initially recorded a deferred gain on retroactive reinsurance of $3.4 million in 1994. Deferred gains are being amortized into income over the expected payout of the underlying claims using the interest method. The unamortized gain at December 31, 2001 and 2000 was $439,000 and $969,000, respectively.
Physicians prepares its statutory financial statements in accordance with accounting practices prescribed or permitted by the Ohio Department of Insurance ("Ohio Department"). Citation and Sequoia prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the California Department of Insurance. Prescribed statutory accounting practices include guidelines contained in various publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Ohio Department's prescribed accounting practices do not allow for discounting of claim liabilities. However, for years prior to 2000, the Ohio Department permitted Physicians to discount its losses and loss adjustment expenses related to its MPL claims to reflect anticipated investment income. Permission was granted due primarily to the longer claims settlement period related to MPL business as compared to most other types of
property and casualty insurance lines of business. In 2000 the Ohio Department of Insurance withdrew permission to discount MPL claims reserves in Physicians' statutory financial statements. In addition, Physicians no longer discounts MPL reserves in its GAAP financials.
Activity in the reserve for unpaid claims and claim adjustment expenses was as follows for each of the years ended December 31:
PICO maintains a 401(k) Defined Contribution Plan covering substantially all employees of the Company. Matching contributions are based on a percentage of employee compensation. In addition, the Company may make a discretionary contribution at the end of the Plan's fiscal year within limits established by the Employee Retirement Income Securities Act. Total contribution expense incurred by the Company was $855,000 in 2001, $864,000 in 2000, and $862,000 in 1999.
2002 1,450,605 2003 815,851 2004 639,928 2005 586,942 2006 544,928 Thereafter 3,837,728 --------------- Total $7,875,982 ===============
In November 1998, Vidler Water Company, Inc., a PICO subsidiary, entered into an operating lease to acquire 185,000 acre-feet of underground water storage privileges and associated rights to recharge and recover water located near the California Aqueduct, northwest of Bakersfield. The agreement required Vidler to pay a minimum of $2.3 million per year for 10 years beginning October 1998. On October 7, 1998, PICO signed a Limited Guarantee agreement with Semitropic Water Storage District ("Semitropic") that required PICO to guarantee a maximum obligation of $3.2 million, adjusted annually by the engineering price index. In May 2001, Vidler permanently assigned 29.73% of its right, title and interest under the operating lease to Newhall Land and Farming Company. As a result of the permanent assignment by Vidler, PICO entered into an amended Limited Guarantee agreement effective May 21, 2001. Under the amended Limited Guarantee, the maximum obligation of PICO was revised to $2.2 million adjusted annually by the engineering price index. In September 2001, Vidler permanently assigned a further 54.05% of its right, title and interest under the operating lease to Alameda County Water District. Accordingly, PICO entered into a second amendment to the Limited Guarantee effective September 28, 2001. Under the second amendment to the Limited Guarantee, the maximum obligation of PICO was revised to $519,000 adjusted annually by the engineering price index. The guarantee expires October 7, 2008.
On January 10, 1997, Global Equity Corporation ("Global Equity"), a wholly owned PICO subsidiary at December 31, 2001, commenced an action in British Columbia against MKG Enterprises Corp. ("MKG") to enforce repayment of a loan made by Global Equity to MKG. On the same day, the Supreme Court of British Columbia granted an order preventing MKG from disposing of certain assets pending resolution to the action. In March 1999, Global Equity filed an action in the Supreme Court of British Columbia against a third party. This action states the third party had fraudulently entered into loan agreements with MKG. Accordingly, under this action Global Equity is claiming damages from the third party and restraining the third party from further action.
In connection with the sale of their interests in Nevada Land by the former members, a limited partnership agreed to act as consultant to Nevada Land in connection with the maximization of the development, sales, leasing, royalties or other disposition of land, water, mineral and oil and gas rights with respect to the Nevada property. In exchange for these services, the partnership was to receive from Nevada Land a consulting fee calculated as 50% of any net proceeds that Nevada Land actually receives from the sale, leasing or other disposition of all or any portion of the Nevada property or refinancing of the Nevada property provided that Nevada Land has received such net proceeds in a threshold amount equal to the aggregate of: (i) the capital investment by Global Equity and the Company in the Nevada property, (ii) a 20% cumulative return on such capital investment, and (iii) a sum sufficient to pay the United States federal income tax liability, if any, of Nevada Land in connection with such capital investment. Either party could terminate this consulting agreement in April 2002 if the partnership had not received or become entitled to receive by that time any amount of the consulting fee. No payments have been made under this agreement through December 31, 2001. By letter dated March 13, 1998, Nevada Land gave notice of termination of the consulting agreement based on Nevada Land's determination of default by the partnership under the terms of the agreement. In
BSND, Inc. ("BSND"), a wholly-owned subsidiary of Vidler Water Company, has resolved a partnership dispute relating to Big Springs Associates, a partnership which owned real property and water rights in Nevada (the "Partnership"). Under the terms of an agreement resolving the dispute, BSND, Inc. is now the sole owner and manager of all the partnership's assets.
In January 2002, AOG announced that it was raising additional capital to purchase a drilling rig and to refit two existing rigs. PICO subsequently provided AOG with a short term bridge loan of $4 million, and was issued 333,333 shares in AOG as a loan establishment fee. AOG is to repay the loan with the proceeds of a rights offering which is expected to close in March of 2002. PICO has made a commitment to underwrite part of the offering, and was issued another 333,333 shares of AOG in March 2002, as an underwriting fee. The maximum commitment to PICO is just over $4 million.
On March 27, 2000, PICO sold 3,333,333 shares of common stock to PICO Equity Investors, LP ("PEI") in a rights offering. PEI is managed by PICO Equity Investors Management, LLC, which is owned by three of PICO's current directors (including PICO's chairman of the board and PICO's president and chief executive officer). The LLC will exercise all voting and investment decisions with respect to these shares for up to 10 years. There is no monetary compensation for management of the LLC.
Summit Global Management, Inc. is a Registered Investment Advisor providing investment advisory services to managed accounts including the Company's subsidiaries, until June 30, 2000. In January 2000, PICO sold its interest in Summit to its chief executive officer in exchange for a note receivable of $100,000 bearing interest at 7% per annum, and due 2002. In addition, Summit owed PICO approximately $65,000 for operating expenses.
In 1998, the Company entered into an agreement with its president and chief executive officer to defer a portion of his 1998 regular compensation in a deferred compensation Rabbi Trust account held in the name of the Company. The deferrals are included within the Company's consolidated balance sheet. Salary deferrals to the trust amounted to $316,000 for 1998. There were no deferrals into this trust in 1999, 2000 or 2001. During 2001, two other Directors elected to defer their fees into a Rabbi Trust account. Combined deferrals to these two accounts were $17,000 for the year. All PICO stock purchased in the Rabbi Trust accounts is subject to the claims of outside creditors and is reported as treasury stock in the consolidated financial statements.
The Company and its insurance subsidiaries are subject to regulation by the insurance departments of the states of domicile and other states in which the companies are licensed to operate and file financial statements using statutory accounting practices prescribed or permitted by the respective Departments of Insurance. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. Physicians had received written approval from the Ohio Department of Insurance to discount its medical professional liability unpaid loss and loss adjustment expense reserves, including related reinsurance recoverable using a 4% discount rate through December 31, 1999. Effective January 1, 2000, the Ohio Department of Insurance withdrew its permission for Physicians to discount reserves. Statutory practices vary in certain respects from generally accepted accounting principles. The principal variances are as follows:
The Company and its wholly-owned insurance subsidiaries' policyholders' surplus and net income (loss) as of and for the years ended December 31, 2001, 2000 and 1999 on the statutory accounting basis are as follows:
Sequoia Insurance Company is a wholly owned subsidiary of Physicians Insurance Company of Ohio. In the table above, the statutory surplus of Sequoia ($29.3 million in 2001, $23.4 million in 2000, and $25.4 million in 1999) is also reflected in statutory surplus of Physicians.
In this segment, revenues come from premiums earned on policies written and investment income on the assets held by the insurance companies.
Until 1995, Physicians and Professionals wrote medical professional liability insurance, mostly in the state of Ohio. Professionals merged with and into Physicians on December 21, 2001. Physicians has stopped writing new business and is being "run off". This means that it is handling claims arising from historical business, and selling investments when funds are needed to pay claims.
PICO invests in companies, which our management identifies as undervalued based on fundamental analysis. Typically, the stocks will be selling for less than tangible book value or appraised intrinsic value (i.e., what we assess the company to be worth). Often the stocks will also be trading for low ratios of earnings and cash flow, or on high dividend yields. Additionally, the company must have special qualities, such as unique assets, potential catalysts for change, or attractive industry characteristics.
Investments directly related to the insurance operations are included within those segments.
- INVESTMENT IN AFFILIATE: Investments in which the Company owns between 20% and 50%, and/or has the ability to significantly influence the operations and policies of the investee, are carried at equity. The balance of the investment is regularly evaluated for impairment.
At December 31, 2001 and 2000, bank and other borrowings consisted of loans and promissory notes incurred to finance the purchase of land and investment securities. The weighted average interest rate on these borrowings was approximately 7.2% and 7.4% at December 31, 2001 and 2000, respectively with principal and interest due throughout the term.
At December 31, 2001, Global Equity SA has a loan facility with a Swiss bank for a maximum of 15 million CHF based on a margin not higher than 30% of the securities deposited with the bank. The actual amount available is dependent on the value of the collateral held after a safety margin established by the bank. It may be used as an overdraft or for payment obligations arising from securities transactions. At December 31, 2001, CHF 13 million (approximately $7.8 million) is outstanding bearing interest at approximately 6%.
In the fourth quarter of 2000, the Company received notification from the Ohio Department of Insurance that it would no longer permit the Company to discount its MPL reserves for statutory accounting practices. Accordingly, the Company discontinued discounting its MPL reserves in its statutory filing with the Ohio Department of Insurance and financial statements prepared in accordance with US GAAP for the year ended December 31, 2000. The effect of this change was to increase the unpaid losses and loss adjustment expenses reserve by $7.5 million and an cumulative effect of accounting principle of $5 million, or $0.43 per share, net of an income tax benefit of approximately $2.5 million. Had the change been made as of the first day of the earliest period presented, the net loss and loss per share for 1999 and 1998 would have been reduced by $995,000 and $0.11 per share and $643,000, and $0.11 per share, respectively.
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 138, "Accounting for Certain Derivative Instruments and Hedging Activities." As amended, SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position, measure those instruments at fair value and recognize changes in fair value in earnings for the period of change unless the derivative qualifies as an effective hedge that offsets certain exposure. As a result of this adoption, the Company recorded a transition adjustment in the first quarter of 2001 that decreased net income by approximately $1 million, net of a $500,000 tax benefit and increased other comprehensive income by the same amount (no effect on shareholders' equity). These adjustments are reported as a cumulative effect of change in accounting principle in the accompanying consolidated financial statements.