Physicians owns a facility with approximately 56,000 square feet in Pickerington, Ohio. APL leases office space in Indianapolis, Indiana for its sales office located there. APL's Cleveland Regional Sales Director leases office space in Cleveland; APL is a party to the lease and reimburses the Regional Sales Director for all of the lease costs. Sequoia leases office space for its headquarters in Monterey, California and for its regional claims and underwriting offices in Modesto, Monterey, Rancho Cordova, Ventura, Visalia, Oceanside, Orange, Pleasanton, and San Jose, California, as well as Reno, Nevada. CLM's only office space consists of a leased facility in Monterey, California. GEC owns a commercial office building in Toronto, Ontario, Canada and also shares office space with PICO in La Jolla, California. Vidler and NLRC lease office space in Ft. Collins, Colorado, and Reno, Nevada, respectively. Vidler and NLRC hold significant investments in land, water and mineral rights in the western United States. See "ITEM 1 - BUSINESS-INTRODUCTION."
The following table presents selected consolidated financial data of the Company. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" in
Readers of Citation Insurance Group's prior financial statements will find that these financial statements differ greatly from those presented for periods prior to December 31, 1996. Whereas Citation Insurance Group was previously engaged predominantly in property and casualty operations, PICO Holdings, Inc. specializes in portfolio investing, property and casualty insurance, investment management, surface, water, geothermal and mineral rights and other services.
Prior to July 16, 1995, the effective date of Physicians and PRO's 100% quota share reinsurance of their MPL businesses with Mutual and the subsequent sale of the rights to these MPL books of business, effective January 1, 1996, the Physicians group of affiliated companies consisted primarily of two property and casualty insurance companies writing MPL insurance (Physicians and PRO) and one life and health insurance company, APL. For various reasons, in November 1994, the respective boards of directors of Physicians and PRO determined that it was in the best interests of Physicians and PRO and their respective shareholders to sell their MPL insurance businesses. This sale was part of an overall shift in the strategic direction of Physicians and PRO.
In addition to the operation of its subsidiaries, the Company's objective is to use its resources and those of its subsidiaries and affiliates to increase shareholder value through investments in businesses that the Company believes are undervalued. The Company's acquisition philosophy is to make selective investments, predominantly in public companies, for the purpose of enhancing and realizing additional value by means of appropriate levels of shareholder influence and control. This could involve the restructuring of the financing or management of the companies in which the Company invests. It may also encompass initiating and facilitating mergers and acquisitions within the relevant industry to achieve constructive rationalization. This business strategy was adopted in late 1994, but was not fully implemented until 1996. Therefore, the results of this business strategy are not fully reflected in the historical financial statements. There can be no assurance that sufficient opportunities will be found or that this business strategy will be successful. This strategy may negatively impact the business and financial condition and results of the Company.
See the Notes to Consolidated Financial Statements for additional information regarding events affecting PICO subsequent to the date of these financial statements.
During 1997, the Company's assets decreased approximately $60.1 million to $430.3 million. Reclassification of APL as discontinued operations reduced assets by $53.4 million.
For a number of reasons, including the existence of an experienced claims adjustment staff and Physicians' success in managing invested assets, it was decided that it would be more advantageous to manage the assets remaining at the cessation of writing MPL business than to sell off or fully reinsure the reserves. As a result, assets are managed for the maximum overall return, within prudent safety guidelines. Assets are not designated on an individual security basis as either MPL or portfolio investing. As a result, Physicians' invested assets produce income in both MPL and portfolio investing segments.
Revenues and income or losses generated by PICO through its own portfolio are assigned entirely to portfolio investing. GEC's portfolio investing operations exclude the results of Vidler and NLRC which are assigned to surface, water, geothermal and mineral rights segment.
Net of expenses, but before taxes, portfolio investing operations, excluding those of GEC, contributed $27.9 million to pre-tax operating income in 1997 compared to $23.3 million during 1996 and $5.3 million in 1995. Realized investment gains, as discussed above, accounted for nearly $29.3 million, $26.4 million and $5.0 million of this pre-tax income in 1997, 1996 and 1995, respectively. While past results are very encouraging, future results cannot and should not be predicted based upon past performance alone.
Equity in unconsolidated subsidiaries represents the Company's share of GEC's net income prior to its consolidation with PICO. GEC's financial results are consolidated with those of the Company for 1997.
Following is a breakdown of GEC's portfolio investing revenues and loss:
Physicians initially acquired approximately 38.2% of GEC on September 5, 1995. PICO and its wholly-owned subsidiaries acquired additional shares of GEC in July and August 1997, bringing the Company's holdings up to approximately 51.17% as of August 19, 1997. As a result of the increased ownership of GEC, GEC's results have been consolidated with those of the Company beginning August 19, 1997. Appropriate provisions have been made in these financial statements to reflect the interests of other GEC shareholders, where applicable.
Since CIC and CNIC became part of the group in November 1996, their activities are not included in the Company's financial results prior to that date. Sequoia has been part of the group since August 1, 1995. Therefore, Sequoia's financial results are not included with those of the Company prior to August 1, 1995. Sequoia and CIC are continually seeking ways to realize savings and synergies and to combine operations, wherever possible. In evidence of this, Sequoia and CIC consolidated their home office operations in Monterey, California in July 1997. Both companies are in the process of subleasing their former office spaces in Pleasanton and San Jose, California.
Total P&C revenues for 1997 of $57.0 million surpassed those of 1996 by $21.7 million and 1995 by $54.5 million. Of these amounts, CIC added $21.0 million to the 1997 revenues and $6.5 million to 1996 following the merger. Sequoia's 1997 revenues were $35.4 million, up $6.7 million from 1996 and $33.0 million from the five-month period of the Company's ownership in 1995. Included in these amounts, investment income and realized investment gains from P&C operations rose to $5.8 million in 1997, up $2.5 million from 1996 and $5.6 million over 1995. Sequoia's earned premiums increased $6.5 million, or 24.7%, as compared to 1996 and $30.4 million compared to the partial year of inclusion in 1995.
Industry ratios as determined on the basis of generally accepted accounting principles ("GAAP") for Citation are shown in the following chart:
Loss and LAE Ratios, Underwriting Expense Ratios and Combined Ratios are calculated using net earned premiums as a denominator. Theoretically, a combined ratio of less than 100% indicates that the insurance company is making a profit on its base insurance business before consideration of investment income, realized investment gains or losses, extraordinary items, taxes and other non-insurance items. Sequoia's loss experience improved considerably in 1997 from a GAAP loss ratio of 62.9% in 1996 to 57.3% in 1997. Sequoia's reduced loss ratios reflect Sequoia's improved loss experience principally resulting from management's efforts to reduce exposure to risk through re-underwriting existing business during 1995 and 1996, tighter underwriting and careful selection of risks.
The management of Sequoia and CIC estimate that storm losses incurred by the companies as a result of the recent El Nino phenomenon is less than $1.0 million for the first quarter of 1998.
The marked decline in direct written premiums prior to 1996 is indicative of the increasing competitive pressures within Ohio which, among other factors, led Physicians and PRO to increase premium rates, to be more selective in underwriting and, ultimately, to withdraw from the MPL line of business.
MPL premiums continued to be earned during 1996 based upon premiums written prior to July 16, 1995, the effective date of the 100 percent quota share treaty with Mutual. Investment income revenues will continue to accrue to the MPL runoff.
Physicians' claims department staff continues to process the runoff of the remaining MPL loss and loss adjustment expense claims which is progressing routinely. At December 31, 1997, MPL reserves totaled $ 77.5 million, net of reinsurance and discount. This compares to $112.9 million and $136.2 million at December 31, 1996 and 1995, respectively. MPL loss and LAE reserves continue to decline as a result the disposition of claims.
Investment management revenues and operating income from Summit, before elimination of intercompany transactions, increased over 1996 and 1995. In 1997 Summit's revenues before intercompany eliminations were $1.1 million compared to approximately $762,000 in 1996 and $209,000 in 1995. Summit now has more than $700 million in assets under management, up approximately 75% over a year ago. Summit's revenues have increased due to the addition of additional clients and increased intercompany portfolio management fees.
Under the category of "Other," Stonebridge Partners AG ("Stonebridge"), a Swiss corporation wholly-owned by Physicians which brokered annuities and other insurance products within Europe, produced a pre-tax operating loss of approximately $386,000 in 1997 and a $1 million loss for 1996. The pre-tax loss for 1995 was $234,000. Stonebridge began operations in late 1995, resulting in significant start-up costs in 1995 which continued into 1996. For various reasons, Stonebridge has been unsuccessful in marketing their brokerage business, as well as in collecting accounts which they believe are due them from clients. Stonebridge was deactivated in 1997.
Discontinued operations consists of the operations of APL, the Company's life and health insurance subsidiary and GEC's former Sri Lankan subsidiaries which engaged in various activities including stock and commodity brokerage and agricultural services.
The net assets of the discontinued operations of APL have been shown as one line on the 1997 balance sheet as net assets of discontinued operations totaling $15.9 million.
LIQUIDITY AND CAPITAL RESOURCES -- YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
PICO Holdings, Inc. is a holding company whose assets principally consist of the stock of its subsidiaries. PICO continually evaluates the operations of its existing operations and searches for new opportunities in order to maximize shareholder value. Because of this business strategy, PICO's cash needs and those of its subsidiaries vary considerably from period to period. At times cash may not be readily available when an opportunity arises requiring the liquidation of securities, advances from subsidiaries, direct purchases of investments by subsidiaries, or the borrowing of funds. It may also become necessary and/or advantageous for PICO to offer stock or debt through public offerings from time to time. At times PICO may come to possess cash balances in excess of cash needs. Such cash is invested to provide maximum returns within the constraint of remaining liquid enough to meet expected future cash requirements. PICO, the parent company, had a minimal cash and cash equivalent balance at year-end 1997 compared to a $13.1 million balance at the end of 1996. The year-end 1996 balance reflected the receipt of a $13.2 million cash dividend from Physicians.
Insurance has always been and continues to be a major source of funds for the Company. Physicians initially provided virtually all the funding necessary for the Company to execute its revised business strategy. Since the acquisition of Sequoia in 1995, management has made significant strides in improving Sequoia's operating performance. Sequoia made a profit of approximately $2.8 million in 1997 and produced positive cash flows of $9.3 million from operations. Management has taken a number of steps to improve CIC's profitability and cash flow since its acquisition in November 1996, including the sale of its workers' compensation business and its subsidiary, CNIC, in June 1997. CIC used nearly $13.7 million in cash in operating activities during 1997. Much of CIC's negative operating cash flow relates to its unusually high GAAP combined industry ratio of 117.7% for 1997. SEE MANAGEMENT'S DISCUSSION AND ANALYSIS-PROPERTY AND CASUALTY INSURANCE. Physicians' cash flows have had the greatest impact on the consolidated group during the past three years and should continue to do so for the foreseeable future, due to the wind down of the MPL business. Physicians, Sequoia and Citation had cash and cash equivalent balances at December 31, 1997 of $9.3 million, $38.3 million, and a deficit of $1.1 million, respectively. This compares to $12.5 million, $19.1 million, and $843,000, respectively, at the end of 1996. A large portion of Sequoia's and Citation's investments is kept in the form of cash and cash equivalents to pay claims and expenses due to the relatively short lag period between the receipt of premiums and payment of claims in the commercial property and casualty insurance business lines written by those companies.
The Company's insurance subsidiaries attempt to structure the duration of their invested assets to match the cash flows required to settle the related unpaid claims liabilities. Their invested assets provide adequate liquidity to fund projected claims and LAE payments for the coming years. The Ohio and California Insurance Departments monitor and set guidelines for the insurance companies' investments. The Ohio and California Insurance Departments also set minimum levels of policyholder capital and surplus and monitor these levels through various vehicles such as RBC. All the Company's insurance subsidiaries have more than adequate, if not strong, RBC levels as of December 31, 1997.
Cash used for financing activities increased to $14.3 million, compared to cash provided of $69,000 and $439,000 in 1996 and 1995, respectively. The approximate $14 million decrease in funds provided by financing activities reflects repayments of debt incurred by GEC.
GEC financed acquisitions in its investment portfolio of more than $75 million during 1997. This was accomplished through a mixture of equity, borrowings, minority interests, operating cash flow and disposition of non-core assets. GEC held approximately $11.1 in cash and cash equivalents at December 31, 1997.
At December 31, 1997, the Company had no significant commitment for future capital expenditures, other than in the ordinary course of business and as discussed herein. The Company has also committed to maintain Sequoia's capital and statutory policyholder surplus level at a minimum of $7.5 million. Sequoia was well above this level as of December 31, 1997. The Company has also committed to make every attempt to maintain Sequoia's Best rating at or above the "B++" (Very Good) level, which may at some time in the future require additional capital infusions into Sequoia by the Company. During 1997 Physicians contributed an additional $5.5 million in paid-in capital to Sequoia.
CHANGE IN STRATEGIC DIRECTION. In late 1994, Physicians began the process of changing its strategic direction from the operation of an MPL insurance business to investing in businesses which PICO believes are undervalued or will benefit from additional capital, restructuring of operations or management or improved competitiveness through operational efficiencies with existing PICO operations. Accordingly, in January 1995, Physicians reactivated its investment advisory subsidiary, Summit; in August 1995 Physicians acquired Sequoia and entered new lines of property and casualty insurance; in August 1995 Physicians sold its MPL insurance business; in September 1995 Physicians purchased 38.2% of GEC, a Canadian corporation active in international investments, agricultural services, water rights, and other businesses; in November 1996 Physicians acquired control of Citation Insurance Group ("CIG") pursuant to the Merger; in April 1997 PICO acquired 25.23% ownership of Nevada Land and Resource Company which owns approximately 1,365,000 acres of deeded land in northern Nevada; in June 1997 PICO sold its workers' compensation business; and in July and August 1997, PICO increased its ownership in GEC to 51.17%. Due to the Company's limited experience in the operation of the businesses of each of these subsidiaries, which currently constitute a substantial portion of the Company's operations, there can be no assurance as to the future operating results of the Company or the recently acquired businesses of the Company.
The Company will continue to make selective investments for the purpose of enhancing and realizing additional value by means of appropriate levels of shareholder influence and control. This could involve the restructuring of the financing or management of the entities in which the Company invests and initiating and facilitating mergers and acquisitions. This business strategy has only recently been implemented, however, and it is not fully reflected in prior years' financial statements, nor are the financial statements indicative of possible results of this new business strategy in the future. Shareholders are relying on the experience and judgment of the Company's management to locate, select and develop new acquisition and investment opportunities. There can be no assurance that sufficient opportunities will be found or that this business strategy will be successful. Failure to successfully implement this strategy may negatively impact the business and financial condition and results of operations of the Company.
Cash flow needed to fund the day-to-day operations and the payment of claims and claims expenses will be provided by investment income, lease income, and proceeds from the sale or maturity of securities. Physicians and PRO have established reserves to cover losses and loss adjustment expense ("LAE") on claims incurred under the MPL policies issued or renewed to date. The amounts established and to be established by Physicians and PRO for loss and LAE reserves are estimates of future costs based on various assumptions and, in accordance with Ohio law, have been discounted (adjusted to reflect the time value of money). These estimates are based on actual and industry experience and assumptions and projections as to claims frequency, severity and inflationary trends and settlement payments. In accordance with Ohio law, Physicians and PRO annually obtain a certification that their respective reserves for losses and LAE are adequate from an independent actuary. Physicians and PRO also obtain a concurring actuarial opinion. Physicians' and PRO's reserves for losses and LAE for prior years developed favorably in 1994, and these reserves were decreased by $12.7 million in 1994. Reserves also developed favorably in 1995; however, accretion of reserve discount exceeded the amount of favorable development and retroactive reinsurance, resulting in a $3.2 million increase in liabilities for prior years' claims. As a result of continued favorable claims experience, reserves for prior years' claims were further reduced in the first and fourth quarters of 1996. However, based upon actuarial indications from data through June 30, 1997, Physicians' MPL claims reserves were increased by $2 million during the third quarter of 1997 due to somewhat deteriorated claims experience during the first six months of 1997. At the same time, favorable development of Physicians' and PRO's discontinued personal lines reserves (automobile, homeowner, etc.) allowed reserve reductions of $750,000 during the third quarter of 1997. Management believes that the reserving methods and assumptions are reasonable and prudent and that Physicians' and PRO's reserves for losses and LAE are adequate. Due to the inherent uncertainties in the reserving process there is a risk, however, that Physicians' and PRO's reserves for losses and LAE could prove to be inadequate which could result in a decrease in earnings and shareholders' equity. Adverse reserve development can reduce statutory surplus or otherwise limit the growth of such surplus
LOSS RESERVE EXPERIENCE. The inherent uncertainties in estimating loss reserves are greater for some insurance products than for others, and are dependent on the length of the reporting tail associated with a given product, the diversity of historical development patterns among various aggregations of claims, the amount of historical information available during the estimation process, the degree of impact that changing regulations and legal precedents may have on open claims, and the consistency of reinsurance programs over time, among other things. Because MPL and commercial casualty claims may not be fully paid for several years or more, estimating reserves for such claims can be more uncertain than estimating reserves in other lines of insurance. As a result, precise reserve estimates cannot be made for several years following a current accident year for which reserves are initially established.
There can be no assurance that the insurance subsidiaries in the group have established reserves adequate to meet the ultimate cost of losses arising from such claims. It has been necessary, and will over time continue to be necessary, for the insurance companies to review and make appropriate adjustment to reserves for estimated ultimate losses, LAE, future policy benefits, claims payables, and annuity and other policyholder funds. To the extent reserves prove to be inadequate, the insurance companies would have to adjust their reserves and incur a charge to earnings, which could have a material adverse effect on the financial results of the Company.
REINSURANCE RISKS. Prior to the June 30, 1997 sale of CNIC, all of CNIC's existing insurance risks and claims liabilities, except for those insuring workers' compensation, were transferred to CIC through reinsurance treaties in order to effect the sale of CNIC and the Company's workers' compensation business. As with other P & C insurers, CIC's and Sequoia's operating results and financial condition can be adversely affected by volatile and unpredictable natural and man-made disasters, such as hurricanes, windstorms, earthquakes, fires, and explosions. CIC and Sequoia generally seek to reduce their exposure to such events through individual risk selection and the purchase of reinsurance. CIC's and Sequoia's estimates of their exposures depend on their views of the possibility of a catastrophic event in a given area and on the probable maximum loss to the insurance companies should such an event occur. While CIC and Sequoia attempt to limit their exposure to acceptable levels, it is possible that an actual catastrophic event or multiple catastrophic events could significantly exceed the probable maximum loss previously assumed, resulting in a material adverse effect on the financial condition and results of operations of the Company.
COMPETITION. There are several hundred P & C insurers licensed in California, many of which are larger and have greater financial resources than CIC, and Sequoia; offer more diversified types of insurance coverage; have greater financial resources and have greater distribution capabilities than the insurance companies of the group.
INSURANCE COMPANY CAPITAL AND SURPLUS TESTING. In the past few years, the NAIC has developed risk-based capital ("RBC") measurements for both property and casualty and life and health insurers. The measures provide the various state regulators with varying levels of authority based on the adequacy of an insurer's RBC. At December 31, 1997, the PICO, PRO, APL, CIC and Sequoia annual statements reported more than adequate RBC levels.
Summarized unaudited quarterly financial data (in thousands, except share and per share amounts) for 1997 and 1996 are shown below. In management's opinion, the interim financial data contains all adjustments, consisting of only normal recurring accruals, necessary for a fair presentation of results for such interim periods. Prior period amounts have been adjusted to conform with the current period presentation, including reclassification for discontinued operations and adjustment to shares and net income (loss) per share values due to the Merger.
AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1997 AND 1996 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Independent Auditors' Reports.................................. 46-46.2 Consolidated Balance Sheets as of December 31, 1997 and 1996... 47-48 Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995................... 49 Consolidated Statement of Changes in Shareholders' Equity for the Years Ended December 31, 1997, 1996, and 1995.... 50-51 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995................... 52 Notes to Consolidated Financial Statements..................... 53-80
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PICO Holdings, Inc. and subsidiaries as of December 31, 1996 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY, CONTINUED FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- Physicians Insurance Company of Ohio ("Physicians"), which owns the following subsidiaries:
- Physicians Investment Company ("PIC"), which owns American Physicians Life Insurance Company ("APL"), which owns Living Benefit Administrators Agency, Inc.
Investments in entities in which the Company owns between 20% to 50% of the voting interest and has the ability to exercise significant influence and which are made for long term operating purposes, are accounted for on the equity method of accounting. The Company had no investment of this type at December 31, 1997 (Note 5).
Prior to selling its book of medical malpractice business in 1995, Physicians engaged in providing medical professional liability coverage to physicians, surgeons, dentists and nurses, primarily in the state of Ohio. On August 28, 1995, Physicians entered into an agreement with Mutual Assurance, Inc. ("Mutual") pursuant to which Physicians sold its recurring medical professional liability insurance ("MPL") business and that of its wholly owned subsidiary, PRO, to Mutual. Physicians and PRO still hold MPL unpaid losses and loss adjustment expense liabilities that are being settled.
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles.
The Company applies the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Under SFAS No. 115, investments in available for sale securities are recorded at estimated fair value. Unrealized holding gains and losses on investments classified as available-for-sale, net of the adjustment to deferred policy acquisition costs and deferred income taxes, are excluded from earnings and are reported as a separate component of shareholders' equity. The Company's entire portfolio of debt and equity securities has been designated as available-for-sale.
The Company and its subsidiaries consider highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Maintenance, repairs and minor renewals are charged to expense as incurred, while significant renewals and betterments are capitalized.
Certain costs of acquiring new insurance business, net of reinsurance ceding commissions, are deferred and amortized over the terms of the policy for property and liability insurance and over the average lives of investment and universal life-type contracts, based on the present value of the estimated gross profit amounts expected to be realized over the lives of the contracts, and over the premium paying periods of ordinary and group life insurance contracts. Future investment income has been taken into consideration in determining the recoverability of such costs.
Goodwill represents the difference between the purchase price and the fair value of the net assets (including tax attributes) of companies acquired in purchase transactions. Both positive and negative goodwill are amortized on a straight-line basis over a period of 10 years. There was negative goodwill (i.e., excess of fair value of assets acquired over purchase price) as of December 31, 1996 resulting from the acquisition of Citation Insurance Group in November 1996 (Note 3). Positive goodwill is included in "Other Assets" in the accompanying consolidated balance sheets.
As more fully described in Note 13, reserves for MPL and property and casualty unpaid losses and loss adjustment expenses include amounts determined on the basis of actuarial estimates of ultimate claim settlements, which include estimates of individual reported claims and estimates of incurred but not reported claims. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and updated based on current circumstances, and any adjustments resulting therefrom are reflected in current operations. Reserves for MPL unpaid losses and loss adjustment expenses for medical professional liability claims have been adjusted to reflect the time value of money (discounting).
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128, "Earnings Per Share," effective for financial statements issued after December 15, 1997. SFAS No. 128 requires dual presentation of "Basic" and "Diluted" earnings per share ("EPS") by entities with complex capital structures, replacing "Primary" and "Fully Diluted" EPS under Accounting Principles Board ("APB") Opinion No. 15. Basic EPS excludes dilution from common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from common stock equivalents, similar to fully diluted EPS, but uses only the average stock price during the period as part of the computation. The Company adopted the new method of reporting EPS for the year ended December 31, 1997, and the 1996 and 1995 financial statements have been restated to reflect the change.
The weighted average number of shares outstanding for the year ended December 31, 1995 used in the calculation of earnings per share have been recomputed to give effect to the stock exchange ratio utilized in connection with the reverse acquisition of Citation Insurance Group consummated on November 20, 1996 (Note 3). Stock options of 1,382,715, 1,696,092 and 2,580,098 for 1997, 1996 and 1995, respectively, were not included in the calculation of weighted average shares because the impacts of such options were anti-dilutive.
Separate account assets and liabilities represent contract-holders' funds that have been segregated into accounts with specific investment objectives and are recorded at estimated fair market value based upon quoted market prices. The investment income and gains or losses of these accounts accrue directly to the contract-holders. The activity of the separate accounts is not reflected in the consolidated statements of income and cash flows, except for the fees that the Company receives for administrative services.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", SFAS No. 130 establishes requirements for disclosure of comprehensive income and becomes effective for the Company for the year ending December 31, 1998. Comprehensive income includes such items as foreign currency translation adjustments, unrealized holding gains and losses on available for sale securities, and equity changes of investee company that are currently being presented by the Company as a component of stockholders' equity.
The allocation of the purchase price of CIG was as follows:
The excess of the fair value of the net assets acquired over the purchase price of such net assets (negative goodwill) is being amortized over a 10 year period using the straight-line method. As discussed in Note 1, the Company entered into a Letter of Intent in January 1997 and, effective June 30, 1997, sold CNIC and the net assets related to CIC's workers' compensation operations.
On August 1, 1995, the Company acquired from Sydney Reinsurance Corporation ("SRC") all the outstanding stock of SRC's wholly owned subsidiary, Sequoia, a property and casualty insurance company. The acquisition price of $1,350,000 was paid in cash August 1, 1995. Approximately $350,000 was paid to acquire Sequoia's fixed assets, while the remaining $1,000,000 was used in the purchase of intangible assets and goodwill. These intangible assets are being amortized over a 10-year period using the straight-line method. The Company used available working capital to make the purchase. All policy and claims liabilities of Sequoia prior to closing are the responsibility of SRC and have been unconditionally and irrevocably guaranteed by QBE Insurance Group Limited ("QBE"), a publicly-held corporation based in Sydney, Australia, of which SRC indirectly is a wholly-owned subsidiary. Sequoia's operating results are included in the consolidated statements of income for the years ended December 31, 1997 and 1996 and for the period August 1, 1995 to December 31, 1995.
The Company is required to maintain a minimum surplus in Sequoia of $7.5 million and, through a management agreement, will supervise the run-off of SRC's liabilities. As part of the management agreement, Sequoia will be reimbursed $4.8 million in management fees by the seller for processing the run off of claims and policy receivables and servicing the business existing prior to closing. This management fee is to be received from SRC over a three-year period and is recognized based on the percentage of completion method based on total anticipated claims. Approximately $1.0 million, $1.7 million and $1.6 million have been recognized as management fee income for the years ended December 31, 1997 and 1996 and for the period August 1, 1995 through December 31, 1995, respectively.
The following unaudited pro forma information presents (i) a summary of consolidated results of operations of the Company and CIG and its subsidiaries for the years ended December 31, 1996 and 1995 as if the acquisition of CIG and its subsidiaries occurred at the beginning of 1995, with proforma adjustments to give effect to the amortization of goodwill and the accounting for CIC's workers' compensation line of business held for sale in accordance with EITF 87-11, as discussed above (in thousands, except per share data) and (ii) a summary of consolidated results of operations of the Company and Sequoia for the year ended December 31, 1995 as if the acquisition of Sequoia had occurred at the beginning of 1995, with pro forma adjustments to give effect to the amortization of goodwill and related income tax effects (in thousands, except per share data):
These unaudited pro forma results have been prepared for comparative purposes and do not purport to be indicative of the results of operations which actually would have resulted had the combinations been in effect on January 1, 1995 or of future results of operations of the consolidated entities.
On September 5, 1995, Physicians purchased 38.2% of the outstanding common shares of GEC for $34.4 million. Approximately $33.5 million was paid to acquire the net assets, while the remaining $887,000 was allocated to goodwill. The goodwill is being amortized over a 10-year period using the straight-line method. Physicians used available working capital to make the purchase. On July 30, 1997, Physicians, PRO, Sequoia, and CIC purchased from Mackenzie Financial Corporation 6,616,218 additional shares of GEC at a total cost of $11,406,435 increasing the Company's ownership of GEC to approximately 49.9%. On August 19, 1997, PICO and Physicians acquired through a public offering 13,586,143 additional shares of GEC at a cost of $25,270,266, increasing PICO's ownership in GEC to approximately 51.17%.
GEC is included in the consolidated results of the Company for 1997. The following unaudited information presents a summary of the stand alone results of operations of GEC for 1997 and the pro forma consolidated results of operations of the Company and GEC for 1996 as if the acquisition of a majority interest in GEC occurred at the beginning of 1996:
In connection with the sale of their interests in NLRC by the former members, a limited partnership agreed to act as consultant to NLRC in connection with the maximization of the development, sales, leasing, royalties or other disposition of land, water, mineral and oil and gas rights with respect to the Nevada property. In exchange for these services, the partnership will receive from NLRC a consulting fee calculated as 50% of any net proceeds that NLRC actually receives from the sale, leasing or other disposition of all or any portion of the Nevada property or refinancing of the Nevada property provided that NLRC has received such net proceeds in a threshold amount equal to the aggregate of: (i) the capital investment by GEC and the Company in the Nevada property (ii) a 20% cumulative return on such capital investment, and (iii) a sum sufficient to pay the United States federal income tax liability, if any, of NLRC in connection with such capital investment. Either party may terminate this consulting agreement in April 2002 if the partnership has not received or become entitled to receive by that time any amount of the consulting fee. No payments have been made under this agreement through December 31, 1997. By letter dated March 13, 1998, NLRC gave notice of termination of the consulting agreement based on NLRC's determination of a default by the partnership under the terms of the agreement. The partnership has yet to formally respond to NLRC regarding the notice of termination.
At December 31, the cost (amortized cost for fixed maturities) and estimated fair value of available for sale investments are as follows:
Excluded from above are fixed maturity and equity securities investments with estimated fair values of $18,186,963 and $5,503,877, respectively, that have been classified as net assets of discontinued operations on the consolidated balance sheet as of December 31, 1997.
Investment income is summarized as follows for each of the years ended December 31:
Investments in entities which the Company owns between 20% to 50% of the voting interest and has the ability to exercise significant influence and which are made for long term operating purposes, are accounted for on the equity method of accounting. The financial statements of all affiliates of the Company have been consolidated with those of the Company for 1997 as a result of the increase in the Company's ownership in GEC to approximately 51.17%. However, the following information presents a summary of the financial position of GEC as of December 31, 1996 along with the results of operations for the year ended December 31, 1996 and the three- month period ended December 31, 1995.
On June 16, 1997, Physicians announced the signing of a definitive agreement to sell its indirectly wholly-owned life and health insurance subsidiary, American Physicians Life Insurance Company ("APL") and its wholly-owned subsidiary, Living Benefit Administrators Agency, Inc. to IFS Insurance Holdings Corporation. The closing is subject to certain closing conditions, including regulatory approval which is still pending. The expected purchase price is approximately $17 million and is expected to be paid in cash.
On August 21, 1997, GEC announced the signing of a definitive agreement to sell its Sri Lankan subsidiaries. The closings occurred on November 19 and December 22, 1997. The purchase price was approximately $25 million paid in cash of $17.3 million and marketable securities of $7.7 million. A gain of approximately $3.5 million was realized on the sale before taxes.
Following is an unaudited summary of these Sri Lankan companies stand alone financial results for the period included as discontinued operations in the accompanying financial statements:
The Company and its U.S. subsidiaries file a consolidated life/non-life federal income tax return. Non-U.S. subsidiaries file tax returns in various foreign countries.
The deferred tax asset valuation allowances as of December 31, 1997 and 1996 relate to the net operating loss carryforwards (NOL's) of CIC, PICO and Sequoia. Such NOL's are subject to the separate return limitation year rules and, therefore, can only be used to offset the respective future taxable income generated by CIC, PICO and Sequoia. Given management's uncertainty as to the ability of CIC, PICO and Sequoia to generate sufficient future taxable income to utilize such NOL's, they do not currently believe that it is more likely than not that the deferred tax asset related to such NOL's will be realized. Net deferred tax assets, the recorded valuation allowance and federal income tax expense in future years can be significantly affected by changes in enacted tax rates or by changes in circumstances that would influence management's conclusions as to the ultimate realizability of deferred tax assets.
The aggregate NOL's of approximately $25,009,452 expire between 1999 and 2012. There is an annual limitation on the NOL's of approximately $1,400,000.
On May 9, 1996, the Company, Guinness Peat Group plc ("GPG"), and GEC entered into an agreement whereby GPG agreed to sell 4,258,415 common shares (adjusted for the merger exchange rate) of the Company's common stock to GEC in two blocks, subject to regulatory approval, at an average price of approximately $3.60 per share. GPG agreed to sell the shares to GEC at a discount to market due to their status as restricted stock and in consideration of the quantity of shares to be purchased. On May 13, and June 4, 1996 GEC purchased the shares. Prior to these transactions, GPG owned approximately 40% of the Company's common stock. Following these transactions, GPG and GEC owned approximately 23% and 16% of the Company's common stock, respectively. GPG and GEC owned approximately 19% and 13.1%, respectively, of the Company's common stock subsequent to the merger with CIG in November 1996. The shares of the Company owned by GEC have been accounted for as treasury shares in the Company's consolidated financial statements. GPG sold 324,000 shares of PICO in May 1997 pursuant to Securities Exchange Commission Rule 144 on the open market to an unrelated party or parties, decreasing its ownership of the Company as of December 31, 1997 to approximately 17.6%.
In connection with the merger, the PICO Board of Directors adopted a Stockholders' Rights Plan and, pursuant to such Plan, declared a dividend on its common stock of one right (a "Right") for each share of common stock outstanding. Upon the occurrence of certain events, each Right becomes exercisable to purchase 1/100 of a share of Series A Junior Participating Cumulative Preferred Stock at an initial price of $35.00. The Rights expire on July 22, 2001 and prior to the occurrence of certain events, may be redeemed at a price of $.01 per Right. Of the Company's 2,000,000 authorized shares of preferred stock, 1,000,000 shares have been designated as Series A Junior Participating Cumulative Preferred Stock. Each share of Series A Junior Participating Cumulative Preferred Stock shall entitle the holder thereof to 100 votes on all matters submitted to a vote of the stockholders of the Company.
In connection with the merger, CIG's existing Employee Stock Ownership Plan ("ESOP") continued in effect. Pursuant to direction by the Board of Directors in the last quarter of 1997, management is in the process of terminating the CIG ESOP. Such plan covers substantially all of the employees of the Company and its subsidiaries. Contributions are made to the plan at the discretion of the Board of Directors. No contributions were made to the plan in 1996 or 1997.
Under the Plans, Physicians is authorized to issue 2,572,029 shares of Common Stock pursuant to awards granted in various forms, including incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended), non-qualified stock options, and other similar stock-based awards to full-time employees (including officers) and directors. The total options available for future grants as of December 31, 1997 were 25,050. The Company granted stock options in 1996 and 1995 under the Plans in the form of incentive stock options and non-qualified stock options. In conjunction with the Merger, the Company assumed all of Physicians' options outstanding. The exercise price of all options granted was equal to the fair market value of the Company's common stock at the date of grant.
The Company entered into a reinsurance treaty in 1995 with Mutual in connection with the sale of Physicians' MPL business to Mutual. This treaty is a 100% quota share treaty covering all claims arising from policies issued or renewed with an effective date after July 15, 1995. At the same time, Physicians terminated two treaties entered into in 1994 and renewed in 1995. The first of these was a claims-made agreement under which Physicians' retention was $200,000, for both occurrence and claims-made insurance policies. Claims are covered up to $1 million. The second treaty reinsured claims above $1 million up to policy limits of $5 million on a true occurrence and claims-made basis, depending on the underlying insurance policy.
In 1994, the Company entered into a retrospective reinsurance arrangement with respect to its MPL business. As a result, Physicians initially recorded a deferred gain on retroactive reinsurance of $3,445,123 in 1994. Deferred gains are being amortized into income over the expected payout of the underlying claims using the interest method. The unamortized gain as of December 31, 1997 and 1996 was $2,168,393 and $2,874,128, respectively.
Physicians and PRO prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the Ohio Department of Insurance ("Ohio Department"). CIC, CNIC and Sequoia prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the California Department of Insurance. Prescribed statutory accounting practices include guidelines contained in various publications of the National Association of Insurance Commissioners, as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Ohio Department's prescribed accounting practices do not allow for discounting of claim liabilities. However, for the years ended December 31, 1997, 1996, and 1995, the Ohio Department permitted Physicians to discount its losses and loss adjustment expenses related to its MPL claims to reflect investment income. Such permission was granted due primarily to the longer claims settlement period related to MPL business as compared to most other types of property and casualty insurance lines of business. Property and casualty insurance companies are permitted to discount claims liabilities under generally accepted accounting principles to the extent that the discounting of claims liabilities by such entities is prescribed or permitted by statutory accounting principles.
PICO maintains a 401(k) Defined Contribution Plan (the "Plan") covering substantially all employees of PICO, Physicians, Sequoia, APL, Summit, Vidler, NLRC, and Forbes & Walker. Matching contributions to the Plan are based on a percentage of employee compensation, as well as amounts contributed by employees. In addition, the Company may make a discretionary contribution at the end of the Plan's fiscal year within limits established by ERISA. During 1997, 1996, and 1995, expenses for contributions made to the Plan were $365,000, $334,000, and $133,000, respectively.
In 1994, the Company entered into a consulting agreement for a combined annual fee of $200,000 with two of its directors for consulting services related to the Company's investment activities, investment banking services and analysis of operations. Effective January 1, 1995, the Company revised the agreement with these directors to a combined annual fee of $300,000. Effective September 11, 1995, the previous agreements were terminated and the Company entered into consulting arrangements with the same two Directors for a three-year period at a combined fee of $300,000 annually for their services as officers of the Company related to analysis of the Company's operations, investment banking activities, and analysis and recommendation on the Company's investment portfolio. The Company paid a combined fee of $300,000 and $305,000 to each of these two Directors for 1996 and 1995, respectively. In addition, the aforementioned directors were awarded a bonus of $450,000 each in 1996. These contracts were superceded by the January 1997 contracts described below.
In January 1997, the consulting arrangements described above between two of the Company's directors and the Company, SGM, and GEC were terminated and were replaced with a single consulting arrangement between each of the directors, a wholly-owned subsidiary of GEC and PICO. Under the new consulting arrangement, the Company's Board of Directors increased the annual base consulting fees for the two directors who perform consulting services related to investment activities, investment banking services and analysis of operations to $800,000 each beginning January 1, 1997. In addition, each is entitled to an incentive award based on the growth of the Company's book value during 1997, above a threshold rate of return. PICO will be responsible for two-thirds of the consulting fee and a wholly-owned subsidiary of GEC will be responsible for one-third. Effective December 31, 1997, these two directors became employees of the Company and a subsidiary of GEC; the terms of employment were similar to the consultant arrangements described above. The employment agreements entered into by the two directors, effective December 31, 1997, superceded and replaced the prior consulting agreements.
Certain of the Company's subsidiaries have stock option arrangements with officers and other employees for stock of the respective subsidiary. Options are granted under these arrangements at the fair value of the subsidiary's stock. Therefore, no compensation has been recorded by the Company related to these arrangements.
In November 1996, Physicians purchased a $2.5 million convertible debenture from PC Quote, Inc. Physicians currently owns approximately 16.8% of PC Quote, Inc. On May 5, 1997, PICO agreed to provide a line of credit to PC Quote, Inc. The initial credit was for $1 million with repayment due September 30, 1997. The credit has since been increased to $2,250,000 with repayment due April 30, 1998. The Company received warrants to purchase common shares of PC Quote, Inc. in connection with these transactions. The value of such warrants is not material to the Company's financial position or results of operations.
5) Fixed maturity securities classified as available for sale are carried at amortized cost.
(A) Portfolio investing identifiable assets include certain investments held by one of the Company's regulated insurance subsidiaries which is no longer writing new business. Management believes that this component of the insurance subsidiary's assets is in excess of the amount of the subsidiary's assets that will be required to settle its claims liabilities. The amount of the insurance subsidiary's assets included in the portfolio investing segment were approximately $6 million, $56 million and $58 million as of December 31, 1997, 1996, and 1995, respectively. Investment income revenue thereon was approximately $2 million, $27 million and $8 million, for the years ended December 31, 1997, 1996, and 1995, respectively.
(B) The life and health insurance segment was discontinued in 1997. Included in "Other" are amounts of identifiable assets of approximately $68,000 for both 1996 and 1995. Income statement amounts for 1997, 1996 and 1995 are classified as discontinued operations.
- INVESTMENT IN AFFILIATE: Estimated fair value of GEC for 1996 is based upon its quoted market price on the Toronto Stock Exchange translated at the exchange rates in effect at the balance sheet date.