Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operation ------------ In December 1996, the Company changed its fiscal year end from March 31 to December 31, effective December 31, 1996. As a result of this change, the Company's fiscal year ended December 31, 1996, consisted of nine months. For that reason, management's discussion and analysis includes many comparisons of the Company's fiscal year ended December 31, 1997, which consists of twelve months, to the comparable twelve month period of the prior year. The financial information for the unaudited twelve month period ended December 31, 1996, is included in this discussion for comparisons.
Liquidity and Capital Resources: -------------------------------- Due to the nature of the Company's business (insurance and insurance services) and whereas Company growth does not normally require material reinvestments of profits into property or equipment, the cash flow generated from operations usually results in improved liquidity for the Company.
The Company's investment policy limits investments in any one company. This limit was raised from $1,000,000 to $1,500,000 in 1997. This limitation excludes bond premiums paid in excess of par value and U.S. Government or U.S. Government guaranteed issues.
All of the Company's investments are high-grade investment quality; all state and municipal tax exempt fixed maturity investments are pre-refunded issues, and all certificates of deposit are FDIC insured.
Maximum bank note payable $750,001 $2,000,001 Average bank note payable $296,576 $1,387,038 Weighted average interest rate 7.3% 7.2%
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 $2,668,472, statutory deposits of $2,725,000, and dividend restriction between Crusader and Unico (as discussed under "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 (excluding AAC's credit line discussed above).
Dividends paid by Crusader to Unico were $1,500,000 in 1997 and $1,000,000 in 1996. Unico invested $1,000,000 of the 1997 dividend it received from Crusader in a two year U.S. treasury note.
Crusader's statutory capital and surplus as of December 31, 1997, was $30,899,761, an increase of $5,151,004 over December 31, 1996. Crusader's statutory capital and surplus as of December 31, 1996, was $25,748,757, an increase of $3,858,981 over December 31, 1995.
For the fiscal year ended December 31, 1997, income before taxes increased by $1,212,956 (12%) and net income increased by $805,035 (12%) compared to the twelve month period ended December 31, 1996. The increase in pre-tax income was primarily due to an increase of $499,418 (8%) in the underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader and an increase in investment income of $762,891 (18%) (excluding realized investment gains).
In the fiscal year ended December 31, 1997, gross written premium increased by $848,275 (2%) compared to the twelve month period ended December 31, 1996. The increase in gross written premium was primarily attributable to an increase in Crusader's Commercial Package business of $1,419,864 (4%) to $40,881,943. This increase was partially offset by a decrease in Crusader's Commercial
In the twelve month period ended December 31, 1996, gross written premium increased $3,794,358 (10%) compared to the fiscal year ended March 31, 1996. This increase was primarily the result of an increase in Crusader's Commercial Package business of $2,501,146 (7%) and an increase in Commercial Property and Other Liability business of $1,293,212 (193%). For the twelve month period ended December 31, 1996, the Commercial Package premium accounted for 95% of the Crusader's total written premium. Premium written in California increased $2,106,603 (7%) while premium written outside of California increased $1,687,755 (23%).
In the fiscal year ended December 31, 1997, Crusader's direct earned premium increased $4,053,656 (10%) and net premium earned increased $2,046,778 (6%) over the twelve month period ended December 31, 1996. For the twelve month period ended December 31, 1996, Crusader's direct earned premium increased $1,112,736 (3%) and net premium earned increased $2,802,689 (9%) over the fiscal year ended March 31, 1996. The percentage of earned ceded premium to gross premium earned was 15% for the fiscal year ended December 31, 1997, 11% for the twelve month period ended December 31, 1996, and 16% for the fiscal year ended March 31, 1996.
The Company's future writings and growth are dependent on market conditions, competition, the Company's ability to introduce new profitable products, and its ability to expand geographically. As of December 31, 1997, Crusader was licensed as an admitted insurance company in the states of California, Arizona, Nevada, Oregon, and Washington and is approved as a non-admitted surplus lines writer in several other states. Crusader's written premium by state is as follows:
The daily automobile rental insurance program continues to experience decreased commission and fee income due to decreased premium written. This decrease is due to continued price competition. To avoid underwriting losses for the non-affiliated insurance company which Bedford represents, it continues to produce business only at rates which it believes to be adequate. The Company cannot determine how long this "soft market" condition will continue.
Revenue for the fiscal year ended December 31, 1997, decreased $130,470 (61%) compared to the twelve month period ended December 31, 1996, due to the discontinuance of the programs. Revenue for the twelve months ended December 31, 1996, increased $29,390 (16%) compared to the fiscal year ended March 31, 1996.
New legislation - --------------- The Health Insurance Portability and Accountability Act of 1996 ("HIPPA"), which became effective January 1, 1998, requires that individual health plans accept consumers moving from group plans on a guarantee-issue basis if certain specified criteria is met. Rates charged for individual and group accounts are expected to increase in order to cover the increased costs related to the guarantee-issue policy.
Also effective January 1, 1998, is the implementation of Cal COBRA, a new law that pertains to small groups with 2 to 19 eligible employees. Cal COBRA allows departing employees of small firms to continue their health insurance coverage for at least 18 months at a cost of 110% of the rate charged for group members.
The Company has not determined the effect on health insurance sales resulting from the implementation of the above new legislation.
Workers' Compensation Program - ----------------------------- Unifax produces workers' compensation policies in California and Arizona for a non-affiliated insurer and receives a commission from them based on premium written.
Association Operation - --------------------- Membership and fee income from the Association program of AAQHC is as follows:
American Acceptance Corporation, the Company's insurance premium finance subsidiary, provides premium financing to Crusader, and until February 1997 a non-affiliated insurer on commercial auto policies produced by Unifax. In February 1997, the commercial auto program with the non-affiliated insurer was discontinued. The growth of this program is dependent and directly related to the growth of Crusader's written premium and AAC's ability to market its competitive rates and service to finance those policies. AAC finances policies primarily in California.
Investment interest and dividends earned (excluding net realized gains) increased $762,891 (18%) in the fiscal year ended December 31, 1997, compared to the twelve month period ended December 31, 1996. This increase was primarily due to an increase in invested assets (at amortized value) of $11,627,815 (14%) at December 31, 1997, compared to December 31, 1996, and to the mix of taxable and tax exempt securities in the portfolio. The Company's investments at December 31, 1997 are comprised of $38,361,279 (41%) of tax exempt investments compared to $39,634,159 (49%) of tax exempt investments at December 31, 1996.
For the twelve month period ended December 31, 1996, investment interest and dividends earned (excluding net realized gains) increased $369,637 (10%) compared to the fiscal year ended March 31, 1996. This increase was primarily due to an increase in invested assets (at amortized value) of $8,300,066 (11%) at December 31, 1996, compared to March 31, 1996. The Company's investments at December 31, 1996, were comprised of $39,634,159 (49% of total investments) tax exempt investments and $38,126,835 (53% of total investments) of tax exempt investments at March 31, 1996.
Additional information regarding investments and investment income is described in the "Management Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources."
Salaries and Employee Benefits decreased $5,707 for the fiscal year ended December 31, 1997, compared to the twelve month period ended December 31, 1996. Salaries and employee benefits increased $78,677 (2%) in the twelve month period ended December 31, 1996, compared to the fiscal year ended March 31, 1996.
Forward Looking Statements - -------------------------- Certain statements contained herein that are not historical facts are forward looking. These statements 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, regulatory changes or developments, unforeseen calamities, general market conditions, the Company's ability to introduce new profitable products, and the Company's ability to expand geographically.
Use of Estimates - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosure of certain assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While every effort is made to ensure the integrity of such estimates, actual results could differ from those estimates.
Investments - ----------- All of the Company's fixed maturity investments are classified as available-for sale and are stated at market value. Although classified as available-for-sale, the Company's investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities are reported as a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses are included in the consolidated statements of operations based on the specific identification method.
The Company had net unrealized investment gains of $1,222,095 as of December 31, 1997, and net unrealized investment gains of $742,004 as of December 31, 1996.
Income Taxes - ------------ The provision for federal income taxes is computed on the basis of income as reported for financial reporting purposes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and are measured using the enacted tax rates and laws expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted.
Earnings Per Share - ------------------ Basic earnings per share excludes the impact of common share equivalents and is based upon the weighted average common shares outstanding. Diluted earnings per share utilizes the average market price per share when applying the treasury stock method in determining common share equivalents. Outstanding stock options are treated as common share equivalents for purposes of computing diluted earnings per share and represent the difference between basic and diluted weighted average shares outstanding.
Deferred Policy Acquisition Costs - --------------------------------- Policy acquisition costs consist of direct and indirect costs associated with the production of insurance policies such as commissions, premium taxes, and certain other underwriting expenses which vary with and are primarily related to the production of the insurance policy. Policy acquisition costs are deferred and amortized as the related premiums are earned and are limited to their estimated realizable value based on the related unearned premiums plus investment income less anticipated losses and loss adjustment expenses. Ceding commission applicable to the unexpired terms of policies in force are recorded as unearned ceding commission which is included in deferred policy acquisition costs.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) - -------------------------------------------------------------- Recently Issued Accounting Standards - ------------------------------------ In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings per Share." SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share excludes the impact of common share equivalents and is based upon the weighted average common shares outstanding. Diluted earnings per share utilizes the average market price per share when applying the treasury stock method in determining common share equivalents. The Company adopted the provisions of SFAS No. 128 in the December 31, 1997, financial statements, including the earnings per share for all prior periods. Outstanding stock options are treated as common share equivalents for purposes of computing diluted earnings per share and represent the difference between basic and diluted weighted average shares outstanding.
The amortized cost and estimated market value of fixed maturity investments at December 31, 1997, 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.
Estimated Amortized Market Cost Value ---- ----- Due in one year or less $11,073,532 $ 11,108,518 Due after one year through five years 46,081,678 47,126,488 Due after five years through ten years 28,951,361 29,730,584 ---------- ---------- Total fixed maturities $86,106,571 $87,965,590 ========== ==========
NOTE 5 - PREMIUMS AND NOTES RECEIVABLE, NET - ------------------------------------------- Premiums and notes receivable are substantially secured by unearned premiums and funds held as security for performance. Fiscal Year Ended December 31 ----------------------------- 1997 1996 ---- ---- Premiums receivable $2,525,588 $3,171,706 Premium finance notes receivable 4,902,269 5,751,709 --------- --------- Total premiums and notes receivable 7,427,857 8,923,415 Less allowance for doubtful accounts 23,251 24,576 --------- --------- Net premiums and notes receivable $7,404,606 $8,898,839 ========= =========
Bad debt expense for the fiscal year ended December 31, 1997, and the nine month fiscal year ended December 31, 1996, was $28,903 and $22,387, respectively. Premium finance notes receivable represent the balance due to the Company's premium finance subsidiary from policyholders who elect to finance their premiums over the policy term. These notes are net of unearned finance charges.
NOTE 6 - DEFERRED POLICY ACQUISITION COSTS - ------------------------------------------ Deferred policy acquisition costs, net of ceding commission, consist of commissions, premium taxes, inspection fees, and certain other underwriting costs which are related to and vary with the production of Crusader Insurance Company policies. These costs are incurred by Crusader and include allocated expenses of other Unico subsidiaries. Policy acquisition costs are deferred and amortized as the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income, including investment income.
NOTE 7 - CLAIMS AND LITIGATION - ------------------------------ The Company, by virtue of the nature of the business conducted by it, becomes involved in numerous legal proceedings as either plaintiff or defendant. The Company is required to resort to legal proceedings from time-to-time in order to enforce collection of premiums, commissions, or fees for the services rendered to customers or to their agents. These routine items of litigation do not materially affect the Company and are handled on a routine basis by the Company through its general counsel.
Likewise, the Company is sometimes named as a cross-defendant in litigation which is principally directed against that insurer who has issued a policy of insurance directly or indirectly through the Company. Incidental actions are sometimes brought by customers or other agents which relate to disputes concerning the issuance or non-issuance of individual policies. These items are also handled on a routine basis by the Company's general counsel, and they do not materially affect the operations of the Company. Management is confident that the ultimate outcome of pending litigation should not have an adverse effect on the Company's consolidated operation or financial position.
NOTE 8 - UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES - --------------------------------------------------- The following table sets forth a reconciliation of the liabilities for losses and loss adjustment expenses for the periods shown:
(1) Decreases in incurred losses and loss adjustment expenses related to the indicated prior years reflect favorable loss experience during these years attributable to a number of combined factors which have produced favorable frequency and severity trends in recent years. In addition, actuarial assumptions based on historical trends have proven to be conservative.
NOTE 10 - ACCRUED EXPENSES AND OTHER LIABILITIES - ------------------------------------------------ Accrued expenses and other liabilities consist of the following:
NOTE 11 - NOTE PAYABLE - BANK - ----------------------------- American Acceptance Corporation ("AAC"), the Company's premium finance subsidiary, has a line of credit with Union Bank which can be used only to fund its premium finance operation. At the Company's request, this line of credit was decreased from $4,000,000 to $2,000,000 in September 1997. Interest on the note is referenced to the London Interbank Offered Rate ("LIBOR"). The note amount is collateralized by the assets of AAC and is guaranteed by the Company. The loan agreement contains certain covenants including restrictions on certain transactions between AAC and the Company and the maintenance of certain financial ratios. The note was paid in full on July 3, 1997. The credit line matures September 2, 1998, and is expected to be renewed.
Fiscal Year Ending ------------------ December 31, 1998 $1,025,952 December 31, 1999 $1,025,952 December 31, 2000 $1,025,952 December 31, 2001 $1,025,952 December 31, 2002 $1,025,952 December 31, 2003 (through March 31, 2007) $4,360,296 --------- Total minimum payments $9,490,056
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 unaffiliated third parties. The Company utilizes for its own operations 100% of the space it leases.
NOTE 13 - REINSURANCE - --------------------- A reinsurance transaction occurs when an insurance company transfers (cedes) a portion of its exposure on business written by it to a reinsurer which assumes that risk for a premium (ceded premium). Reinsurance does not legally discharge the company from primary liability under its policies; and if the reinsurer fails to meet the obligations, the company must nonetheless pay its policy obligations. The Company continually monitors and evaluates the liquidity and financial strength of its reinsurers to determine their ability to fulfill obligations assumed under the reinsurance contracts.
NOTE 15 - 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.
Fiscal year ended December 31, 1997 $545,906 Fiscal year ended December 31, 1996 (nine months) $364,226 Fiscal year ended March 31, 1996 $484,715
NOTE 16 - STATUTORY CAPITAL AND SURPLUS - --------------------------------------- Crusader is required to file an annual statement with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities ("statutory"). Statutory accounting practices differ in certain respects from generally accepted accounting principles. The more significant of these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) all bonds are recorded at amortized cost, regardless of trading activity; (c) non-admitted assets are charged directly against surplus; (d) loss reserves and unearned premium reserves are stated net of reinsurance; and (e) federal income taxes are recorded when payable. Additionally, the cash flow presentation is not consistent with generally accepted accounting principles and a reconciliation from net income to funds provided by operations is not presented.
Crusader Insurance Company statutory net income is as follows: Fiscal year ended December 31, 1997 $6,658,352 Fiscal year ended December 31, 1996 (nine months) $3,526,515 Fiscal year ended March 31, 1996 $4,639,537
NOTE 18 - TAXES ON INCOME - ------------------------- The provision for taxes on income consists of the following:
Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. The amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.
As a California insurance company, Crusader is obligated to pay a premium tax on gross premiums written in the states of Arizona, California, Nevada, Oregon, and Washington. The premium tax is in lieu of state franchise taxes; thus, the above provision for state taxes does not include the premium tax.