The Company's principal executive offices, comprised of approximately 35,000 square feet of office space leased through April 2000, are located in Pasadena, California. The Company is currently evaluating various alternatives for its headquarters office after its current lease expires. In addition, the Company maintains 22 branch offices in various locations in the western United States and Florida in leased facilities with various lease terms. Management believes that the Company's facilities are suitable and adequate for their intended uses.
(1) See Note 1 of Notes to Consolidated Financial Statements for a description of the calculation of weighted average shares outstanding and earnings (loss) per share. (2) As of December 31, 1994, a portion of the portfolio was classified as held to maturity and was therefore reflected at amortized cost and the remaining portfolio was shown at market value. Investments as of December 31, 1995, 1996, 1997 and 1998 are reflected at market value. (3) "PICO Estimated Annual Premium" means, as of any date, the estimated total annualized premiums for all policies written by PICO in force on that date, whether earned prior to or after such date.
The Company's revenues have been seasonal, and have tended to be highest in the second and third quarters of each year. This is due primarily to the seasonality of the size of the workforce employed by the Company's agribusiness clients.
OTHER INCOME. Other income decreased $0.2 million to $0.8 million for 1998 from $1.0 million for 1997.
OPERATING EXPENSES. Operating expenses increased 22.4% to $37.6 million for 1998 from $30.7 million for 1997 due in part to a net $4.7 million increase in variable expenses, principally commissions paid to unaffiliated agencies and a $1.8 million increase in personnel costs related to the growth in the Company's insurance operations. Variable expenses include the benefit of $3.0 million in ceding commissions received in the fourth quarter of 1998 in conjunction with the Reliance reinsurance arrangement.
COMMISSION INCOME. Commission income decreased 18.5% to $3.4 million for 1997 from $4.2 million for 1996. The decrease was primarily the result of decreased premiums placed with carriers other than PICO and PACO, a result of the Company's decision to focus on writing PICO workers' compensation insurance. Commission income is earned on premiums placed with carriers other than PICO and PACO. Commission income paid by PICO and PACO to Pan Am is eliminated in consolidation.
In March 1997, PAULA Financial entered into the Credit Agreement with a commercial bank providing PAULA Financial with a revolving credit facility of $15.0 million until December 31, 1999. As of March 15, 1999, $8.1 million was outstanding under this facility. The use of the credit facility was for repurchase of the Company's common stock and investments in new ventures. On December 31, 1999, PAULA Financial may elect to convert all or a portion of the borrowings then outstanding under such facility into a term loan payable in quarterly installments and maturing on December 31, 2001. The Company is currently in discussions with the bank to renew and extend the Credit Agreement at the end of its initial term in December 1999. Borrowings under the Credit Agreement bear interest at variable interest rates. The Credit Agreement limits the Company's ability to (i) enter new lines of business; (ii) incur or assume debt; (iii) pay dividends and repurchase or retire capital stock upon a default or event of default; and (iv) make acquisitions, investments and capital expenditures. The Credit Agreement contains financial covenants with respect to minimum stockholders' equity, minimum statutory surplus, a ratio of debt to stockholders' equity, a ratio of PICO's premiums written to statutory surplus and excess statutory reserves, a debt service coverage ratio, A.M. Best rating and risk-based capital levels. Each of PAULA Financial's non-insurance subsidiaries has guaranteed all obligations of PAULA Financial under the Credit Agreement. As of December 31, 1998, the Company was in compliance with its debt covenants.
On August 12, 1998, the Company announced the approval of the Board of Directors of a 500,000 share stock repurchase program. On October 29, 1998, the Board authorized an additional 500,000 shares bringing the total authorization under the program to 1,000,000 shares. The shares are expected to be repurchased over the next 30 months through open market and/or privately negotiated purchases. As of December 31, 1998, the Company had repurchased 409,800 shares at an average price of $7.84 per share.
In March 1999, the Company announced that Pan Am had agreed to purchase the insurance agency assets of the Sacramento and Stockton, California offices of CAPAX for approximately $3.2 million. The Company will fund the transaction with $2.1 million in cash plus $1.1 million in CAPAX securities which the Company currently holds. The transaction is expected to close in April, subject to certain conditions.
California workers' compensation insurance companies are required to maintain some of their investments on deposit with the California DOI for the protection of policyholders. Other states in which PICO is licensed have also required PICO to post deposits for the protection of those states' policyholders. Pursuant to applicable state laws, PICO had, as of December 31, 1998, securities with a book value of $83.3 million held by authorized depositories pursuant to these deposit requirements. In addition to the deposits, the insurance company operating subsidiaries must maintain capital and surplus levels related to premiums written and the risks retained by the subsidiaries.
The Company believes that it has identified substantially all of its own information technology systems ("IT Systems") and non-information technology (embedded technology) systems ("Non-IT Systems") which require modification in order to become Year 2000 compliant. In addition, the Company believes that it has identified those third parties whose inability to handle date-sensitive processing could materially and adversely impact the Company if corrective action is not taken in a timely manner.
The Company has identified five major internal IT Systems which require attention as part of the Project: General Ledger ("GL"), Agency Operations ("Agency"), Underwriting, which includes policy issuance, maintenance of policy records, billing and auditing ("Underwriting"), Claims Adjudication ("Claims") and Third Party Administration, which includes life insurance and accident and health insurance policy issuance, maintenance and billing operations ("TPA"). The Company's approach to each of these systems differs based on the Company's use of the system and whether the system was purchased from a third party or developed in-house.
The Company has purchased a software tool to perform the windowing project and has retained several consultants familiar with the software tool to perform the project. The consultants will work under the supervision of the Company's information services staff. The Company has identified the programs to be modified, prioritized those programs based on their earliest expected date of failure and has begun using the software tool to perform the correction to the programs. The Company has prepared a testing environment to perform the corrective procedures and to test the results in a realistic data environment.
CLAIMS SYSTEM. The Company's Claims system is licensed from a third party vendor. The Claims system uses two distinct products, one for claims telephonic reporting and one for claims adjudication. The Company has added custom features to the standard version of each of the products provided by the vendor. The Company's current version of these two system products are not Year 2000 compliant.
The Company has received delivery of a standard upgrade to its Claims adjudication system which is Year 2000 compliant, according to the vendor, which is currently being tested by the Company. The Company and the vendor have identified customized features which must be added to the upgraded Claims adjudication system and the vendor has agreed to perform the customization. The Company expects the customization to be completed during June 1999 and final installation, testing and training to be complete by early in the third quarter of 1999. This represents a delay of approximately 45 days from the Company's prior disclosures.
The Company's Claims telephonic reporting system will not be made Year 2000 compliant by the vendor. As scheduled, the Company has modified its Claims telephonic reporting system to properly process claims during 1999, but this modification will not allow claims processing in 2000. The Company has chosen to move to a vendor maintained, Year 2000 compliant, mainframe-based telephonic reporting system. This is expected to be effective during the middle of the second quarter of 1999, a delay of approximately 45 days from the Company's prior disclosures.
TPA SYSTEM. The Company has licensed a third party claims administration software product that the Company uses for all TPA functions. The Company has received from the vendor a Year 2000 upgrade to the version used by the Company which will be installed and tested by the end of the first quarter 1999, on schedule.
COSTS. The total cost associated with required program modifications, software upgrades and equipment purchases to become Year 2000 compliant is not expected to be material to the Company's financial position, results of operations or cash flows. The Company's total budget for its Year 2000 compliance program, which began in 1997, is $875,000. This estimate does not include the Company's potential share of Year 2000 costs that may be incurred by the Company's trading partners which the Company may choose to bear to increase the likelihood of their timely Year 2000 compliance.
Of the total budget amount, $80,000 was spent in 1997, $300,000 was spent in 1998, and $495,000 will be spent during 1999. The costs associated with the Company's new Underwriting System are not included in the Year 2000 budget. The Company is utilizing cash flow from operations to fund its Year 2000 budget needs.
CONTINGENCIES. The Company continues to review its alternatives in the event that it is not able to complete its Year 2000 compliance plans in a timely manner. These alternatives include, without limitation, purchasing third party insurance company software packages, acceleration of the construction of the Company's new Underwriting system and outsourcing the non-compliant Company functions to third parties. Each of these alternatives is less advantageous to the Company than its current Year 2000 compliance plan and, if required, could have an adverse effect on the Company's financial position, results of operations or cash flows.
Also, during the first quarter of 1998, the Company adopted the provisions of FASB Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information: ("SFAS 131"). This statement specifies revised guidelines for determination of an entity's operating segments and the type and level of financial information to be disclosed. Based on the guidance included in SFAS 131, the Company has determined that it operates in a single segment: the production, underwriting and servicing of workers' compensation and accident and health insurance.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for fiscal years beginning after June 15, 1999 and establishes standards for the reporting for derivative instruments. It requires changes in the fair value of a derivative instrument and the changes in fair value of assets or liabilities hedged by that instrument to be included in income. To the extent that the hedge transaction is effective, income is equally offset by both investments. Currently the changes in fair value of
We have audited the accompanying consolidated balance sheets of PAULA Financial and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of operations, comprehensive income (loss), stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In 1998, the Company adopted the provisions of Financial Accounting Standards Board ("FASB") Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information ("SFAS 131"). Based on guidance included in SFAS 131, the Company has determined that it operates in a single segment: the production, underwriting and servicing of workers' compensation and accident and health insurance.
Where necessary, prior years' information has been reclassified to conform to the 1998 presentation.
The amortized cost and estimated fair value of fixed maturities classified as available for sale at December 31, 1998 by the earlier of the pre-escrowed date or contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Fixed maturities with a book value of $83,995 were on deposit with various regulatory authorities as of December 31, 1998 as required.
Unrealized investment gains (losses) on common stock at December 31, 1998 and 1997 are as follows:
The unfavorable incurred development for prior periods in 1998 in the liability for unpaid losses and loss adjustment expenses is due to reserve development on the 1997 accident year for the California book of business in excess of what was anticipated given prior year reserving trends.
A summary of notes payable at December 31, 1998 and 1997 is as follows:
Total interest paid by the Company on all notes during the years ended December 31, 1998, 1997 and 1996 was $61, $1,014 and $1,300, respectively.
On March 31, 1997, the Company entered into a $15,000 unsecured line of credit with a commercial bank. The line of credit requires no principal payments during its term and matures December 31, 1999 and, at the Company's option, converts to a two-year term note. The interest rate on the line of credit is based on various indices. The weighted average interest rate on balances outstanding at December 31, 1998 was 6.5%. The line of credit imposes certain financial covenants. At December 31, 1998, the Company's available line of credit was $12,400.
The Company and its subsidiaries file a consolidated Federal income tax return. Income tax expense (benefit) for the years ended December 31, 1998, 1997 and 1996 is shown as follows:
The recoverability of the net deferred tax asset is demonstrated by taxes paid in prior years and available tax planning strategies. Management believes that it is more likely than not that the results of future operations and various tax planning strategies will generate sufficient taxable income in the periods necessary to realize the net deferred tax asset.
The Company received Federal income tax refunds of $1,552 and made Federal income tax payments of $65 during the year ended December 31, 1998 and paid $2,300 and $1,400 of Federal income taxes during the years ended December 31, 1997 and 1996, respectively.
In July 1998, the Company entered into an assumption agreement with the New Mexico Retail Association Self-Insured Group ("the SIG"). The agreement provides for the complete assumption by PICO of the SIG reserves outstanding as of July 1, 1998 as well as a 100% quota-share participation on policies in-force as of that date. The prospective piece of the treaty has been accounted for as reinsurance in the accompanying consolidated financial statements. Premiums assumed under the prospective piece of this agreement were $1,647 while loss incurred were $1,031 for the year ended December 31, 1998. The portion of the contract related to the loss portfolio transfer does not meet risk transfer requirements and has therefore been accounted for using the deposit method of accounting. At December 31, 1998, the related liability of $1,962 is included in accounts payable and accrued expenses in the accompanying consolidated financial statements.
The Company maintains a defined contribution employee stock ownership plan ("ESOP") covering all full-time employees, excluding hourly employees. The ESOP has assets principally comprised of 827,223 and 1,094,126 shares of the Company's common stock at December 31, 1998 and 1997, respectively. The Company can make annual contributions to the ESOP in cash or shares of the Company's common stock in amounts determined by the Company's Board of Directors, except that such contributions must be in cash to the extent the ESOP requires liquid funds to meet its obligations. The Company expensed cash contributions of $125 and $150 in the years ended December 31, 1997 and 1996, respectively. No contributions were made in 1998.
In 1998, the Company implemented a key employee/consultant loan program which provides funds exclusively for the borrowers' purchase of Company stock. The Company has authorized loans of up to $1,000. The loans are full recourse, bear interest at the rate of 8.5% per annum, payable quarterly, have a three year maturity and are secured by the stock purchased. The loan program was reviewed and approved by the Compensation Committee of the Board of Directors. As of December 31, 1998, the Company had extended loans in the amount of $505,000. Such amounts are included in other receivables in the accompanying consolidated financial statements.
determined by the Executive Compensation Committee of the Board of Directors. At December 31, 1998, 1,250 shares of common stock were available for issuance under the 1994 plan.
In 1997, the Company adopted its 1997 Stock Incentive Plan, reserving 200,000 shares of common stock. Stock awards totaling 1,000 shares were granted in 1998 and at December 31, 1998, 199,000 shares of common stock were available for issuance under the 1997 plan. Stock options vest either immediately or over periods not to exceed five years and carry an exercise price equal to or in excess of the fair market value of the common stock on the date of grant. The stock options are generally exercisable for a ten-year term.
Pursuant to the plan, the Company granted 28,700 shares at $9.03 per share and 22,500 shares at $7.88 per share of restricted common stock in 1995 and 1996, respectively. The per share price for these awards was based on an annual independent appraisal. The restrictions lapse pursuant to various vesting schedules. Holders of restricted stock are entitled to vote such shares and receive dividends, which are not subject to restrictions. As of December 31, 1998, the restrictions on an aggregate of 13,900 shares of restricted stock have lapsed; 450, 1,150 and 1,400 shares in 1998, 1997, and 1996, respectively, were forfeited based upon voluntary termination. No restricted stock was granted in the years ended December 31, 1998 and 1997.
In addition, in 1996, the Company issued options to purchase an aggregate of 316,000 shares of common stock to officers and directors of the Company outside the Plan. The options carry an exercise price of $9.50 per share. Also, outstanding is an option to purchase an aggregate of 60,000 shares of common stock to an officer of the Company outside of the plan granted at $8.50 per share in 1994. The options were granted at fair value as determined by the Executive Compensation Committee of the Board of Directors. Such options have the same terms as options granted under the plans. Options to purchase 84,000 shares of common stock were immediately exercisable with the remaining options vesting over a period of three years. In 1998 options to purchase 8,000 shares at $9.50 per share were exercised. Options to purchase 368,000 shares of common stock issued outside the plans remain outstanding as of December 31, 1998.
The insurance subsidiaries are required to file statutory financial statements with state insurance regulatory authorities. Accounting practices used to prepare these statutory financial statements differ from generally accepted accounting principles ("GAAP"). Such differences include the following: (1) reserves for losses and loss adjustment expenses must meet certain minimum requirements, (2) reserves for policyholder dividends are recorded as a restriction on surplus until declared, (3) Federal income taxes are recorded when payable, (4) fixed maturities are carried at admitted values, (5) certain assets are non-admitted and (6) acquisition expenses are expensed when incurred. Amounts reported to regulatory authorities as compared to amounts included in the accompanying consolidated financial statements on a GAAP basis for the years ended December 31, 1998, 1997 and 1996 follow:
Insurance regulatory authorities impose various restrictions on the payment of dividends and advances by insurance companies. As of December 31, 1998, the maximum dividend and advance payments that may be made during 1999 by the insurance subsidiaries to PAULA Financial without prior approval of the regulatory authorities are limited to the greater of net income for the preceding year or 10% of policyholder surplus as of the preceding December 31 and approximate $5,415.
Approximate aggregate minimum rental commitments under operating leases at December 31, 1998 are as follows:
In early 1999, the Company made an investment in the recently formed Altus Insurance Holdings, LLC, the parent company of Altus Casualty Company Ltd. ("Altus"), a specialty workers' compensation insurance company. The Company made a capital contribution of $5,500 and has the option to acquire additional equity and provide quota-share reinsurance to Altus through PICO. The Company will use the equity method to account for its investment in Altus.