Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, its reserves for loss payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. Cash and investments (excluding net unrealized gains or losses) at December 31, 2002, were $102,693,616 compared to $94,720,698 at December 31, 2001, an 8% increase. Crusader's cash and investments at December 31, 2002, was $99,920,299 or 97% of the total held by the Company, compared to $92,790,350 or 98% of the total held by the Company at December 31, 2001.
The Company's investment policy limits investments in any one company to $2,000,000 and any one U.S. government agency to $3,000,000. This limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues. The Company's investment guidelines on equity securities limit investments in equity securities to an aggregate maximum of $2,000,000. As of December 31, 2002, all but one of the Company's fixed maturity investments were investment grade, the Company held no non-traded fixed maturity or equity securities, all state and municipal tax exempt fixed maturity investments were pre-refunded issues, and all certificates of deposit are FDIC insured. The one fixed maturity investment rated below investment grade has a par value $1,500,000, a maturity date of March 1, 2004, a Moody's rating of B3, and a temporary unrealized loss at December 31, 2002, and February 28, 2003, of $32,620 and $27,468, respectively.
The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company (see Note 18 of Notes to Consolidated Financial Statements). During the year ended December 31, 2002, the Company did not repurchase any shares of the Company's common stock. As of December 31, 2002, the Company has purchased and retired under the Board of Directors authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.
Although material capital expenditures may also be funded through borrowings, the Company believes that its cash and short-term investments at year end, net of trust restriction of $1,114,403, statutory deposits of $2,725,000, and dividend restriction between Crusader and Unico (see Item 1 - Business - Insurance Company Operation - Holding Company Act) plus the cash to be generated from operations, should be sufficient to meet its operating requirements during the next twelve months without the necessity of borrowing funds.
The Company has certain obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2002, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
For the year ended December 31, 2001, the Company had a loss before taxes of $16,723,109 compared to income before taxes of $193,613 in the year ended December 31, 2000, a decrease of $16,916,722. The decrease in pre-tax income was primarily due to a decrease of $16,396,612 in the underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader. The Company had a net loss for the year ended December 31, 2001, of $10,870,018 compared to net income of $439,797 for the year ended December 31, 2000, a decrease in net income of $11,309,815.
The effect of inflation on the net income of the Company during the years ended December 31, 2002 and 2001 was not significant.
Crusader's primary line of business is commercial multiple peril business package policies. This line of business represented approximately 97% of Crusader's total written premium for the year ended December 31, 2002, 96% for the year ended December 31, 2001, and 97% for the year ended December 31, 2000.
Premiums written outside of California in 2002 decreased $2,231,433 (42%) as described below under the discussion of losses.
For the year ended December 31, 2001, gross written premium increased by $4,377,448 (13%) compared to the year ended December 31, 2000. In 2001, approximately 86% of the Company's premium was written in the state of California, which accounted for 88% of the increase in gross written premium. The growth in written premium in 2001 was primarily the result of the subsidence in the intensity of price-based competition in the property and casualty insurance market that has resulted in the Company's products becoming more competitive. The number of policies issued by the Company in 2001 increased approximately 4% while gross written premium increased 13%.
Year Ended Gross Written Policies Average December 31 Premium Issued Premium ----------- ------- ------ -------
2002 $45,622,280 18,603 $2,452 2001 $37,637,396 18,114 $2,078 2000 $33,259,948 17,351 $1,917
The Company continues to believe that it can compete effectively and profitably by offering better service and by marketing its policies through its current independent agents and brokers. In pursuing its growth plan, the Company adopted a geographic expansion strategy several years ago. The Company is currently reevaluating this strategy of expanding geographically and has placed a moratorium on a substantial amount of business written outside of California. The Company has no short-term plan to expand into additional states, nor to expand its marketing channels. Instead, the Company intends to allocate its resources toward improving its California business rates, rules and forms.
The Company writes annual policies and, therefore, earns written premium daily over the one-year policy term. Premium earned before reinsurance increased $5,159,671 (15%) in the year ended December 31, 2002, compared to the year ended December 31, 2001, and increased $2,666,009 (8%) in the year ended December 31, 2001, compared to the year ended December 31, 2000. The increase in earned premium before reinsurance in 2002 and 2001 was directly related to the increase in written premium in 2002 and 2001.
Earned premium ceded increased $1,694,243 (31%) to $7,209,573 or 18% of earned premium before reinsurance in the year ended December 31, 2002, compared to $5,515,330 or 16% of earned premium before reinsurance for the year ended December 31, 2001. Earned premium ceded decreased $1,328,601 (19%) to $5,515,330 or 16% of earned premium before reinsurance in the year ended December 31, 2001, compared to $6,843,931 or 21% of earned premium before reinsurance for the year ended December 31, 2000. Ceded premiums increased in the year ended December 31, 2002, primarily as a result of rate increases effective January 1, 2002, of approximately 56% on the Company's primary excess of loss treaties and approximately 11% on the Company's catastrophe treaties, and the related increase in earned premium on which these rates are based. There was also a decrease in premium ceded under the Company's provisionally rated reinsurance contract in the year ended December 31, 2002, compared to the prior year. Ceded premiums decreased in the year ended December 31, 2001, primarily as a result of a decrease in premium ceded under the Company's provisionally rated reinsurance contract. Premium ceded under the Company's provisionally rated reinsurance contract, which was canceled on a runoff basis effective December 31, 1997, is subject to adjustments based on the amount of losses ceded, limited by a maximum percentage that can be charged by the reinsurer. This decrease in ceded premiums was partially offset by an increase in premium ceded to the Company's primary reinsurance contract as a result of the related increase in earned premiums.
Reserves for losses and loss adjustment expenses before reinsurance were $74,905,284 at December 31, 2002, compared to $60,534,295 at December 31, 2001, and to $45,217,369 at December 31, 2000. The increase in reserves at December 31, 2002 and 2001 reflect both an increase in claim severities and adverse development of prior years in the Company's Commercial Multiple Peril ("CMP") and Other Liability lines of business.
Pardee Construction Company v. Insurance Company of the West et al. (2000) ------------------------------------------------------------------ This case states that an additional insured endorsement includes completed operations property damage coverage even for projects that were completed before the inception date of the endorsement.
2. Prior to 1995, the Company was writing a wide variety of general contractors and subcontractors in California. In 1995, California law relating to contractors changed significantly as a consequence of various California legal decisions. The effect of these changes was to expand coverages and increase loss exposure. Although the Company modified its policy forms and underwriting standards relating to its contractor business in 1995, it could not change the exposure on the policies already written. Although the Company increased its reserves in 2000, construction defect claims on its contractor business for 1995 and prior continued to be reported in 2001 in amounts greater than the Company anticipated. In 2001, the Company created a separate analysis of its contractor CMP business to provide for better data analysis in arriving at its best estimate for its CMP line of business.
3. In 2000 and 2001, the Company began experiencing adverse development on its apartment house business due to the effect of settlements on habitability claims. Those settlements were substantially influenced by a statute that provides for the payment of plaintiff attorney fees without regard to policy limits and the Montrose Chemical Corp. v. Admiral Insurance Company decision of 1995. In 2000, the Company modified its underwriting criteria to address this adverse development and on September 7, 2002, the Company changed its coverage forms so as to limit the "costs taxed against the insured" clause of the "Supplementary Provisions" coverage grant, from unlimited to $100,000.
As of result of substantial underwriting losses during 2002 and 2001, Crusader's management analyzed and acted upon the following components of its underwriting activity:
1. BUSINESS UNDERWRITTEN OUTSIDE OF CALIFORNIA: Collectively, the insurance underwritten by the Company outside of California has been very unprofitable, particularly with respect to the Liquor and Premises types of liability coverage. The Company adopted substantial (e.g., 300%) rate increases and coverage restrictions beginning in June of 2001 for all Liquor Liability written outside of California and Nevada. The rate increases caused a dramatic decline in sales, causing the Company to be concerned about adverse selection. Therefore, the Company took further steps, described below. In these states, the Company's liquor liability exposure during the 2002 year was only approximately 24% of what it was in the year 2000.
TEXAS: The Company discontinued offering all types of insurance in Texas in March 2002, and the Company is issuing non-renewal notices on all remaining Texas business. Total premium written in Texas by the Company in 2001 was $303,393, compared to $23,962 in 2002.
OHIO: The Company discontinued offering Liquor Liability to new applicants in Ohio on August 1, 2002, and it started issuing non-renewal of all remaining policies later that year. Total premium written by the Company in Ohio in 2001 was $1,269,026, which compares to $743,010 in 2002.
ARIZONA: The Company discontinued offering Liquor Liability to new applicants in Arizona on August 1, 2002. The Company started deleting Liquor Liability coverage from all renewal policies in Arizona on November 1, 2002. The Company expects that this change will improve profitability but that it will also significantly reduce sales in Arizona. Total premium written by the Company in Arizona in 2001 was $1,001,640, which compares to $632,566 in 2002. The Company is considering complete withdrawal from Arizona.
3. CONSTRUCTION DEFECT EXPOSURE: The Company continuously modifies its underwriting practice with respect to subcontractors in an effort to improve loss experience. For example, subcontractors performing "waterproofing, weather-coating, or decking" were deemed ineligible by the Company in 1995; and, to minimize the adverse effects of the Montrose decision of 1995, the Company changed its coverage forms in 1996; and, the Company adopted numerous, program-specific questions to its applications, inspections, and survey forms. Although the Company believes that the ultimate results of its post-1996 underwriting of this class of business will prove to be profitable, the results will not be known until the 10 year statute runs. Therefore, on April 18, 2002, the Company sought regulatory approval for a change in or discontinuation of its experience rating plan. When the regulator disapproved that filing, the Company imposed a moratorium on all new offers of artisan contractors' insurance on June 18, 2002. The Company since gained regulatory approval to discontinue its experience rating plan, which will result in a rate increase of approximately 21% for all policies renewing after April 1, 2003. The Company also plans to implement another rate increase before the end of 2003 along with further underwriting restrictions.
year. During the same time average "in force" policy count changed from 201 in year 2001, to 134 in year 2002. Other rate increases are described in paragraph 5, below.
5. INCREASED COST OF SETTLING CLAIMS: The Company loss and loss adjustment expense costs have increased. Nonetheless, the Company's overall California business continues to develop favorably in relationship to the risks underwritten and to the premiums earned. The Company continues to monitor and adjust its premium rates to assure that they are adequate. However, certain California classes of business and types of coverage have been identified as needing adjustment. For example, on December 19, 2002, the Company filed for a 126% rate increase for casualty risk assumed under its Bar/Tavern program policies, and on January 30, 2003, the Company filed for a 132% rate increase for casualty risk assumed under its Apartments program policies. These rate filings may or may not be approved by the insurance department.
6. INCREASED COST OF REINSURANCE: On January 1, 2002 and 2003, the Company's reinsurers raised their prices. The Company's regularly planned premium increases are expected to help offset the added cost of reinsurance. To help assure that the Company's reinsured exposures are underwritten at adequate prices, it maintains its Increased Limits Factors ("ILF's") at levels that are virtually the same as those of the Insurance Services Office ("ISO"). The ISO was formed in 1971 through consolidation of six national insurance rating or service organizations. Also, the Company plans to study its ILF's during 2003 and to make adjustments where deemed necessary.
8. TERRORISM EXPOSURE: The Company implemented use of a Terrorism Exclusion form in all of its California policies effective after October 11, 2002. Also, the Company complies with the 2002 Federal Terrorist Act by offering the coverage availed by that law, and it charges a premium to customers electing that coverage.
9. MARKET CONDITIONS: The Company believes that market conditions have changed during the past 24 months, becoming highly conducive for the achievement of underwriting profits. The Company believes that it currently enjoys less competition than it has since it began underwriting policies in 1985.
Primarily as a result of the underwriting losses in 2000 and 2001, the A.M. Best Company lowered Crusader's rating from A (Excellent) to A- (Excellent) effective March 26, 2002, based on financial information as of December 31, 2001. At the time the rating was lowered, A.M. Best remained concerned with the potential for further adverse loss reserve development and the negative impact it would have on the Company's operating performance and overall capitalization, and viewed the rating outlook as negative. Due to the continued adverse development in the six months ended June 30, 2002, on October 3, 2002, A.M. Best Company lowered Crusader's rating to B+ (Very Good) and continues to view its rating outlook as negative. The Company does not believe that the lowering of Crusader's rating from A- to B+ will have a material adverse effect on the Company.
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Commission income $2,741,672 $2,582,290 $2,625,193
increase in premiums written in the CIGNA HealthCare programs as a result of increased marketing efforts by AAQHC, which has increased membership of individuals and groups.
In October 2003, CIGNA plans to discontinue its Individual and Family health insurance programs to all policyholders in the state of California. Over the next six months, AIB and AAQHC will assist this membership with the purchase of new health coverage through another insurance carrier. AIB and AAQHC have secured both commission and override commission relationships with other carriers including Health Net and Nationwide (formerly CalFarm) and will continue to diversify and offer a wider variety of products to its customers. Overall, the commissions/overrides from other carriers are generally higher than the commission structure paid by CIGNA.
Commission and fee income during the year ended December 31, 2002, were $789,483, an increase of $122,065 (18%) compared to the same period of the prior year. Revenue for the year ended December 31, 2001, decreased by $144,223 (18%) compared to the year ended December 31, 2000.
program which is causing these fluctuations in the Company's written premium and related commission income. To avoid underwriting losses for the non-affiliated insurance Company that it represents, Bedford continues to produce business only at rates which it believes to be adequate. The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change.
Revenue for 2001 and 2000 were relatively unchanged, as the membership base remained constant.
which were renewed in 2002. The Company's decision to discontinue selling this business was due to underwriting constraints of the non-affiliated insurance companies that limited the types and classes of business that they would accept. These constraints resulted in the decrease in commission income in the years ended December 31, 2002 and 2001.
The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected in commission income or commission expense.
In the year ended December 31, 2002, while the Company's average invested assets (at amortized value) increased $2,247,249 (2%) compared to the year ended December 31, 2001, investment income earned (excluding net realized gains) decreased $345,367 (6%) in the year ended December 31, 2002, compared to the year ended December 31, 2001. The decrease in investment income is primarily the result of a decline in the
average return on invested assets in the Company's investment portfolio due to both a general decline in short and long-term yield in the marketplace and a shorter weighted average maturity of the portfolio. Due to the current interest rate environment, management believes it prudent to purchase fixed maturity investments with shorter maturities and therefore, the weighted average maturity of the Company's fixed maturity investments has decreased from 2.8 years as of December 31, 2001, to 2.4 years as of December 31, 2002. In the year ended December 31, 2002, the Company's average yield on invested assets (at amortized value) was 5.53% compared to 6.02% at the year ended December 31, 2001. The Company's average invested assets increased in the year ending December 31, 2002, primarily as a result of increased cash flows from operations. The mix of taxable and tax-exempt securities in the portfolio affect the investment income return percentage. Tax-exempt securities generally carry a lower yield than taxable securities. These securities (at amortized value) decreased to $2,731,060 (3% of total investments) at December 31, 2001, compared to $8,213,141 (9% of total investments) at December 31, 2001.
The amortized cost and estimated market value of fixed maturity investments at December 31, 2002, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
(Amounts in Thousands) As of December 31, 2002 ----------------------- Amortized Market Fixed maturities due Cost Value
At December 31, 2002, the Company held securities with unrealized appreciation of $4,828,956 and securities with unrealized depreciation of $105,074. The securities with unrealized depreciation consisted of four fixed maturity investments with a total par value of $4,015,000. The Company does not deem the unrealized depreciation to be significant or indicative of an other-than-temporary decline, either individually, or in the aggregate. As of February 28, 2003, only three of these securities had unrealized depreciation which aggregated $49,929. Only one of these securities is rated below investment grade and was in a loss position at December 31, 2001. This security has a par value of $1,500,000, a maturity date of March 1, 2004, a Moody's rating of B3, and a temporary unrealized loss at December 31, 2002, and February 28, 2003, of $32,620 and $27,468, respectively. This security is a secured bond with respect to which the Company does not expect to realize a loss.
The Company continually evaluates the recoverability of its investment holdings. All securities held by the Company are rated. When a decline in value of fixed maturities or equity securities is considered other than temporary, a loss is recognized in the consolidated statement of operations. During 2002, the Company realized a loss of $216 on one equity security where a decline in market value was considered other than temporary. The Company had recognized a loss on this equity security in 2001 of $25,704 and $138,250 in 2000. No securities were sold at a loss during 2002, 2001 or 2000.
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Commission to agents/brokers $1,219,310 $1,260,059 $1,309,490
OTHER OPERATING EXPENSES generally do not change significantly with changes in production. This is true for both increases and decreases in production. Operating expenses increased $361,961 (13%) for the year ended December 31, 2002, compared to the year ended December 31, 2001. The increase is primarily the result of an increase in fees of $163,511 primarily associated with the California Department of Insurance financial examination of Crusader and increased legal expenses for general corporate purposes of $108,616.
In August 2001 the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). The objectives of SFAS No. 144 are to address significant issues relating to the implementation of SFAS Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS No. 121") and to develop a single accounting model based on the framework established in SFAS No. 121 for long-lived assets to be disposed of by sale whether previously held and used or newly acquired. Even though SFAS No. 144 supersedes SFAS No. 121,
it retains the fundamental provisions of SFAS No. 121 for (1) the recognition and measurement of the impairment of long-lived assets to be held and used and (2) the measurement of long-lived assets to be disposed of by sale. SFAS No. 144 supersedes the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB No. 30") for segments of a business to be disposed of. However, SFAS No. 144 retains the requirement of APB No. 30 that entities report discontinued operations separately from continuing operations and extends that reporting requirement to "a component of an entity" that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as "held for sale." SFAS No. 144 also amends the guidance of Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to eliminate the exception to consolidation for a temporarily controlled subsidiary. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The adoption of SFAS No. 144 did not have a material effect on the Company's earnings or financial position.
In December 2002 the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure" ("SFAS No. 148") which amends SFAS Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). The objective of SFAS No. 148 is to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 does not change the provisions of SFAS No. 123 that permit entities to continue to apply the intrinsic value method of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company continues to maintain its accounting for stock-based compensation in accordance with APB No. 25, but has adopted the disclosure provisions of SFAS No. 148 (see Note 16 of Notes to Consolidated Financial Statements).
In January 2003 the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51" ("FIN No. 46"). FIN No. 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. FIN No. 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN No. 46 applies to public enterprises as of the beginning of the applicable interim or annual period. FIN No. 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The implementation of FIN No. 46 is not expected to have a material impact on the Company's financial statements.
Related Party Transactions - -------------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin Cheldin, the Company's president, chairman and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations 100% of the space it leases.
On November 15, 2002, the Company borrowed $500,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer, and $250,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. The notes are due and payable upon demand of lender (on no less than fourteen days' notice) and, if no demand is made, then the notes are payable in full on November 15, 2006. The notes may be prepaid at any time without penalty. The notes are unsecured and bear interest at 8% per annum, with interest payable monthly. Proceeds of the notes and available cash from the Company's other operations were used by Unico to make a capital contribution of $1,500,000 to its Crusader subsidiary. This contribution was made to insure that Crusader's capital remained above $25,000,000.
Forward Looking Statements - -------------------------- Certain statements contained herein, including the Sections entitled "Business," "Legal Proceedings" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," that are not historical facts are forward looking. These statements, which may be identified by forward looking words or phrases such as "anticipate," "appears," "believe," "estimates," "expect," "intend," "may," "should," and "would," involve risks and uncertainties, many of which are beyond the control of the Company. Such risks and uncertainties could cause actual results to differ materially from these forward looking statements. Factors which could cause actual results to differ materially include those described under Item 1 - Business - "Competition"; premium rate adequacy relating to competition or regulation; actual versus estimated claim experience; success of the Company's underwriting and pricing actions that it believes addresses the adverse development on its construction defect, apartment house habitability, special risk class of business, and non-California liquor liability claims; the outcome of existing and planned filings with regulatory authorities seeking rate increases; acceptance by insureds of rate increases; adequacy of rate increases; possible reductions in Crusader's A.M. Best rating; regulatory changes or developments; the outcome of regulatory proceedings; unforeseen calamities; general market conditions; and the Company's ability to introduce new profitable products.
Consolidated Statements of Cash Flows for the years ended December 31, 2002, December 31, 2001, and December 31, 2000 41
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unico American Corporation and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
Nature of Business - ------------------ Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, health and life insurance through its agency subsidiaries; and provides insurance premium financing, claim administration services, and membership association services through its other subsidiaries. Unico American Corporation is referred to herein as the "Company" or "Unico" and such references include both the corporation and its subsidiaries, all of which are wholly owned, unless otherwise indicated. Unico was incorporated under the laws of Nevada in 1969.
Investments - ----------- All of the Company's fixed maturity investments are classified as available-for-sale and are stated at market value. Although all of the Company's investments are classified as available-for-sale and the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities are reported as accumulated other comprehensive income (loss) which is a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses are included in the consolidated statements of operations based on the specific identification method.
The Company had net unrealized investment gains of $3,117,762 as of December 31, 2002, and net unrealized investment gains of $1,858,839 as of December 31, 2001. These amounts are net of deferred taxes.
d. Insurance Claim Administration Operation -------------------------------------------- Claim administration income is based on premium written for non-affiliated insurers by the Company's wholly owned subsidiary Bedford Insurance Services, Inc. Income is recognized on the effective date of the insurance policies and a liability is recognized for the estimated cost of completing the administration of all current and future claims that are covered by these policies.
Deferred Policy Acquisition Costs - --------------------------------- Policy acquisition costs consist of costs associated with the production of insurance policies such as commissions, premium taxes, and certain other underwriting expenses which vary with and are primarily related to the production of the insurance policy. Policy acquisition costs are deferred and amortized as the related premiums are earned and are limited to their estimated realizable value based on the related unearned premiums plus investment income less anticipated losses and loss adjustment expenses. Ceding commission applicable to the unexpired terms of policies in force is recorded as unearned ceding commission, which is included in deferred policy acquisition costs.
Segment Reporting - ----------------- Statement of Financial Accounting Standards No. 131 ("SFAS No. 131"), Disclosures about Segments of an Enterprise and Related Information, became effective for fiscal years effective after December 15, 1997. SFAS No. 131 establishes standards for the way information about operating segments is reported in financial statements. The Company has identified its insurance company operation as its primary reporting segment. Revenues from this segment comprised 84.3% of consolidated revenues in the year ended December 31, 2002, 84.4% of consolidated revenues in the year ended December 31, 2001, and 82.3% for the year ended December 31, 2000. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually insignificant to consolidated revenues.
Concentration of Risks - ---------------------- In 2002 approximately 93% of Crusader's gross premium written was derived from California. In 2002, approximately 94% of the $2,714,672 commission income from the Company's health and life insurance program was from CIGNA HealthCare medical and dental plan programs. At December 31, 2002, the Company's reinsurance recoverable on paid and unpaid losses and loss adjustment expenses of $24,113,387 were from Partners Reinsurance of the U.S. and General Reinsurance Corporation, both California admitted companies rated A+ and A++ respectively by A.M. Best Company.
In August 2001 the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). The objectives of SFAS No. 144 are to address significant issues relating to the implementation of SFAS Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS No. 121") and to develop a single accounting model based on the framework established in SFAS No. 121 for long-lived assets to be disposed of by sale whether previously held and used or newly acquired. Even though SFAS No. 144 supersedes SFAS No. 121, it retains the fundamental provisions of SFAS No. 121 for (1) the recognition and measurement of the impairment of long-lived assets to be held and used and (2) the measurement of long-lived assets to be disposed of by sale. SFAS No. 144 supersedes the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB No. 30") for segments of a business to be disposed of. However, SFAS No. 144 retains the requirement of APB No. 30 that entities report discontinued operations separately from continuing operations and extends that reporting requirement to "a component of an entity" that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as "held for sale." SFAS No. 144 also amends the guidance of Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to eliminate the exception to consolidation for a temporarily controlled subsidiary. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The adoption of SFAS No. 144 did not have a material effect on the Company's earnings or financial position.
In October 2002 the FASB issued SFAS No. 147, "Acquisition of Certain Financial Institutions" ("SFAS No. 147"), which addresses the financial accounting and reporting for the acquisition of all or a part of a financial institution, except for transactions between two or more mutual enterprises. Under SFAS No. 147, the acquisition of all or part of a financial institution that meets the definition of a business combination shall be accounted for by the purchase method in accordance with SFAS No. 141, Business Combinations. SFAS No. 147 also provides guidance on accounting for the impairment or disposal of acquired long-term customer-relationship intangible assets, including those acquired in transactions between two or more mutual enterprises. SFAS No. 147 is effective for acquisitions for which the date of acquisition is on or after October 1, 2002. The provisions related to accounting for the impairment or disposal of acquired long-term customer-relationship intangible assets, including
In November 2002 the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," which addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. This interpretation also clarifies the requirements related to the recognition of a liability by a guarantor at the inception of a guarantee for the obligations the guarantor has undertaken in issuing that guarantee. The provisions related to the disclosure requirements to be made by a guarantor are effective for financial statements of interim and annual reporting periods ending after December 15, 2002. The provisions related to the recognition of a liability and initial measurement shall be applied prospectively to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year end. Management of the Company anticipates that the adoption of this interpretation is not expected to have a material impact on the Company's financial statements.
Amortized Estimated Cost Market Value ---- ------------ Due in one year or less $20,346,601 $20,786,476 Due after one year through five years 62,614,363 66,265,536 Due after five years through ten years 10,688,504 11,321,338 ---------- ---------- Total fixed maturities $93,649,468 $98,373,350 ========== ==========
Short-term investments have an initial maturity of one year or less and consist of the following: Year ended December 31 ---------------------- 2002 2001 ---- ---- Certificates of deposit $ 225,000 $ 225,000 Commercial paper 1,525,000 - Commercial bank money market accounts 724,842 2,050,006 U.S. government obligation money market fund 6,546,602 585,699 Savings account 2,938 2,917 --------- --------- Total short-term investments $9,024,382 $2,863,622 ========= =========
NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION) - ---------------------------------------------------------------- Property and equipment consist of the following: Year ended December 31 ---------------------- 2002 2001 ---- ---- Furniture, fixtures, computer, office, and transportation equipment $1,768,856 $1,779,293 Accumulated depreciation 1,414,662 1,511,867 --------- --------- Net property and equipment $ 354,194 $ 267,426 ======= =======
NOTE 5 - PREMIUMS AND NOTES RECEIVABLE, NET - ------------------------------------------- Premiums and notes receivable are substantially secured by unearned premiums and funds held as security for performance. Year ended December 31 ---------------------- 2002 2001 ---- ----
NOTE 6 - NOTE PAYABLE - BANK - ---------------------------- Unico had a $2,000,000 line of credit with Union Bank of California. Interest on this line was referenced as the Bank's LIBOR rate plus 1.75% per annum and is payable monthly. The agreement contained certain covenants including maintenance of certain financial ratios. As of December 31, 2001, the Company did not meet the covenant requiring a tangible net worth of at least $45,000,000. The Company did not utilize this credit line in 2002 or 2001. This credit line expired on November 4, 2002. Although the bank amended the agreement on July 8, 2002 to reduce the tangible net worth requirement to $35,000,000, the Company did not renew the line.
Year ended December 31 ---------------------- 2002 2001 ---- ---- Note payable - Erwin Cheldin $500,000 $- Note payable - The Cary and Danielle Cheldin Family Trust 250,000 - ------- - Notes payable - related parties $750,000 $- ======= =
NOTE 8 - UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES - --------------------------------------------------- The following table provides an analysis of the roll forward of Crusader's losses and loss adjustment expenses, including a reconciliation of the ending balance sheet liability for the periods indicated:
The Company`s consolidated financial statements include estimated reserves for unpaid losses and related claim settlement or loss adjustment expenses of our insurance company operation. Crusader sets loss and loss adjustment expense reserves at each balance sheet date at management's best estimate of the ultimate payments that it anticipates will be made to settle all losses incurred and related expenses incurred as of that date for both reported and unreported losses. The process of estimating loss and loss adjustment reserves involves significant judgment and is complex and imprecise due to the number of variables and assumptions inherent in the estimating process. Crusader establishes reserves for reported losses based on historical experience, upon case-by-case evaluation of facts surrounding each known loss, and the related policy provisions. The amount of reserves for unreported losses is estimated by analysis of historical and statistical information. Reserves are monitored and adjusted when appropriate and reflected in the statement of operations in the period of adjustment.
The Company believed that it had adequately addressed its estimate of ultimate losses as of December 31, 2001, and anticipated that underwriting changes in problematic business such as reducing coverages, modifying policy forms, more restrictive underwriting, reductions in non-California business, and increasing rates would be reflected in the 2002 development. However, continued adverse development in 2002 indicated that the underwriting changes implemented through December 31, 2001, were not sufficient to fully address the losses primarily occurring on accident years 1999 through 2001 on the Company's business outside of California (primarily liquor and premises liability), and on the Company's special risk class of business. Liquor liability claims arise from the liability of tavern owners related to the sale of alcoholic beverages. The Company's special risk class of business represents risks written within current underwriting programs that have a higher degree of exposure and require special pricing and underwriting. Based on the development in 2002 primarily on the business discussed above, the Company increased its estimate of ultimate losses for accident years 1999 and subsequent. The adverse development in 2002 for accident years 1998 and prior was primarily due to higher than anticipated cost of construction defect and apartment house habitability claims. Construction defect claims arise from the liability of contractors for their defective work in the construction of habitation structures (such as apartments, condominiums and single-family dwellings) or commercial type structures. Apartment house habitability claims arise from uninhabitable conditions related to dilapidated structures and insect and vermin infestation.
Adverse (favorable) development of prior years losses in 2002 by line of business are as follows:
NOTE 10 - LEASE COMMITMENT TO RELATED PARTY - ------------------------------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The total rent expense under this lease agreement was $1,025,952 for the year ended December 31, 2002; $1,025,952 for the year ended December 31, 2001; and $1,025,952 for the year ended December 31, 2000.
Year ending ----------- December 31, 2003 $1,025,952 December 31, 2004 $1,025,952 December 31, 2005 $1,025,952 December 31, 2006 $1,025,952 December 31, 2007 (through March 31, 2007) $ 256,488 --------- Total minimum payments $4,360,296 =========
Erwin Cheldin, the Company's president, chairman, and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations 100% of the space it leases.
NOTE 11 - ACCRUED EXPENSES AND OTHER LIABILITIES - ------------------------------------------------ Accrued expenses and other liabilities consist of the following:
Due to a recent California court ruling that affects the tax years 1997 through 2002, the Company may be assessed for additional tax by the California Franchise Tax Board as a result of the dividends received deduction that the Company utilized for those periods. See Note 17.
NOTE 14 - PROFIT SHARING PLAN - ----------------------------- During the fiscal year ended March 31, 1986, the Company adopted the Unico American Corporation Profit Sharing Plan. Employees who are at least 21 years of age and have been employed by the Company for at least two years are participants in the Plan. Pursuant to the terms of the Plan, the Company annually contributes to the account of each participant an amount equal to a percentage of the participant's eligible compensation as determined by the Board of Directors. Participants are entitled to receive benefits under the plan upon the later of the following: the date 60 days after the end of the plan year in which the participant's retirement occurs or one year and 60 days after the end of the plan year following the participant's termination with the Company. However, the participant's interest must be distributed in its entirety no later than April 1 of the calendar year following the calendar year in which the participant attains age 70 1/2 or otherwise in accordance with the Treasury Regulations promulgated under the Internal Revenue Code of 1954 as amended.
In December 1993, the National Association of Insurance Commissioners ("NAIC") adopted a Risk-Based Capital ("RBC") Model Law for property and casualty companies. The RBC Model Law is intended to provide standards for calculating a variable regulatory capital requirement related to a company's current operations and its risk exposures (asset risk, underwriting risk, credit risk and off-balance sheet risk). These standards are intended to serve as a diagnostic solvency tool for regulators that establishes uniform capital levels and specific authority levels for regulatory intervention when an insurer falls below minimum capital levels. The RBC Model Law specifies four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer if its RBC is equal to or less than 200% of its computed authorized control level RBC. A company's RBC is required to be disclosed in its statutory annual statement. The RBC is not intended to be used as a rating or ranking tool nor is it to be used in premium rate making or approval. Crusader's adjusted capital at December 31, 2002, was 370% of authorized control level risk-based capital.
Weighted Average Options Exercise Price ------- -------------- Outstanding at December 31, 1999 236,415 $6.780 Options granted - - Options exercised (30,140) $3.500 Options terminated (2,500) $9.250 ------- Outstanding at December 31, 2000 203,775 $7.239 Options granted - Options exercised (59,860) $3.500 Options terminated (27,500) $9.250 ------- Outstanding at December 31, 2001 116,415 $8.686 Options granted 182,000 $3.110 Options exercised (8,245) $3.500 Options terminated (3,170) $3.500 ------- Outstanding at December 31, 2002 287,000 $5.356 =======
Options exercisable were 92,500 at December 31, 2002, at a weighted average exercise price of $9.25; 81,145 at December 31, 2001, at a weighted average exercise price of $8.44; 121,275 at December 31, 2000, at a weighted average exercise price of $5.87.
Year ended December 31 ---------------------- 2002 2001 ---- ---- Deferred tax assets: Discount on loss reserves $2,111,565 $1,950,452 Unearned premiums 1,650,395 1,310,128 Other 131,141 169,793 --------- --------- Total deferred tax assets $3,893,101 $3,430,373 --------- ---------
Deferred tax liabilities: Deferred acquisition costs $2,021,984 $1,727,043 Discount on salvage and subrogation 6,992 8,400 Unrealized gain on investments 1,606,120 957,584 Other 200,054 181,095 --------- --------- Total deferred tax liabilities $3,835,150 $2,874,122 --------- ---------
In a recent court ruling that affects the tax years 1997 through 2002, a statute that allowed Unico American a tax deduction for the dividends received from its wholly-owned insurance subsidiary was held unconstitutional on the grounds that it discriminated against out-of-state insurance holding companies. Based on the court ruling, the
California Franchise Tax Board ("FTB") is taking the position that the discriminatory sections of the statute are not severable and the entire statute is invalid. As a result, the FTB is disallowing dividend-received deductions for all insurance holding companies, regardless of domicile, for tax years ending on or after December 1, 1997. The Company received dividends from its insurance subsdiary of $5 million for the 1998 through 2000 tax years. The FTB has not proposed any assessments to the Company for additional tax as a result of the dividends received deduction that the Company utilized for those periods.
As a California insurance company, Crusader is obligated to pay a premium tax on gross premiums written in the states of Arizona, California, Colorado, Idaho, Montana, Nevada, Ohio, Oregon, and Washington. The premium tax is in lieu of state franchise taxes; thus, the above provision for state taxes does not include the premium tax.