The Company leases its Home Office building in Woodland Hills, California, which contains approximately 234,000 square feet of leasable office space. The lease was amended in October 1994 which expanded the lease term until November 1999. The lease may be renewed for two consecutive five- year periods.
The Company also leases office space in nineteen other locations throughout Southern California. The Company anticipates no difficulty in extending these leases or obtaining comparable office facilities in comparable locations.
The property and casualty insurance business has a history of fluctuating results, and underwriting profitability has tended to vary in cycles. Insurer profitability is influenced by many factors, including price competition, claim frequency and severity, crime rates, natural disasters, economic conditions, interest rates, state regulations and laws and changes in the legal system and court decisions. One of the challenging and unique features of the property and casualty insurance business is that its products must be priced before costs are fully known because premiums are charged before claims are incurred.
Insurance industry price levels tend to change with underwriting results. As companies experience underwriting losses, prices tend to increase and competition decreases. As underwriting results improve, prices tend to decrease and competition increases.
The Company engages in private passenger automobile, homeowners, condominium, earthquake and personal excess liability insurance primarily in Southern California. The Northridge Earthquake on January 17, 1994 resulted in unprecedented losses for the Company. In order to reduce future earthquake exposure, the Company ceased writing new homeowner and condominium insurance in accordance with an order received from the California Department of Insurance in June 1994. However, the Company continues to renew existing homeowner and condominium policies for two more annual renewal periods, excluding earthquake coverage. All earthquake coverages will be terminated by July 23, 1995, and all homeowners and condominium coverage will be terminated by July 23, 1997.
from one period to another depending on weather during the periods. Results for the first and fourth quarters of the year are particularly vulnerable to weather patterns. Quarterly loss and loss adjustment expense ratios for the most recent three years are as follows:
YEAR 1Q 2Q 3Q 4Q ---- ----- ----- ----- ----- 1992 88.0 81.6 82.9 88.5 1993 90.3 83.9 86.5 89.9 1994 312.1 116.9 143.1 142.4
While the quarterly loss and loss adjustment expense ratios generally exhibit the pattern expected to be caused by weather influences, they also show the variability caused by the fortuitous events which are the basic subject of the insurance process. More specifically, the effect of the Southern California fires in October 1993 and the Northridge Earthquake in January 1994 can be seen in the ratios for the fourth quarter of 1993 and all of 1994, respectively. The Northridge Earthquake contributed 215.0%, 28.7%, 51.3%, and 49.2% to the loss ratios for each of the four quarters in 1994, respectively. Excluding the Northridge Earthquake, the loss ratios follow the expected pattern caused by weather influences in the first and fourth quarters. Refer to Management's Discussion and Analysis - Financial Condition for a further discussion of the earthquake impact.
Because the Company does not write property or liability insurance for commercial risks, its exposure to losses caused by exposure to radon or caused by environmental pollution is insignificant. The Company has received no such claims under the homeowners policy and believes the probability of a success-
This reinsurance program was renewed for the period from July 1, 1994 through June 30, 1995, with amended terms, for a total annual premium of approximately $28 million. Coverage under these treaties is provided by a number of domestic, foreign and London market companies in layers as follows:
first $ 10,000,000 $10,000,000 $ 0 next $ 90,000,000 $ 7,200,000 $ 82,800,000 next $100,000,000 $ 5,000,000 $ 95,000,000
of each month beginning March 1, 1995 through May 1, 1995. The treaty expires May 15, 1995.
The resulting losses from the earthquake continue to place pressure on the Company and its financial condition. The Company experienced a reduction in its historical pattern of growth, ceased all advertising and marketing for new policies, and suspended its quarterly dividend for the third and fourth quarters of fiscal 1994. As of December 31, 1994, total estimated gross losses and allocated loss adjustment expenses from the Northridge Earthquake reached $940 million.
On June 30, 1994, the Company obtained a $175 million bank line (the "Bank Credit Agreement") through The First National Bank of Chicago and Union Bank (the "Lenders") of which $160 million has been borrowed and is outstanding at December 31, 1994. Loan proceeds of $120 million were used to increase
the statutory surplus of the Insurance Subsidiaries to minimum levels mandated by the DOI. The five-and-one-half year reducing-revolver loan features interest-only payments for the first 18 months. Beginning January 1, 1996, the aggregate commitment will be automatically reduced $35 million and $8.75 million thereafter on the first day of each quarter through the facility's maturity date of January 1, 2000. Principal repayments are required when total outstanding advances exceed the aggregate commitment. Under the terms of the Bank Credit Agreement, all of the outstanding shares of capital stock of the Insurance Subsidiaries have been pledged as collateral.
In order to provide reinsurance coverage for the declining earthquake exposure, the Company also purchased from National Indemnity Company additional reinsurance in excess of the underlying $200 million. An additional layer beginning at $400 million effective June 16, 1994 and decreasing by $50 million each month through February 15, 1995 was purchased for a total premium of approximately $21.8 million.
On September 8, 1994, the Company notified the Lenders that the Company was in default under the Bank Credit Agreement and, on September 12, 1994, the Lenders imposed the default rate of interest on outstanding loans and notified the Company that no additional loans would be available while any default was continuing. The Lenders also requested prompt information concerning the steps the Company was taking to restore the capital of its Insurance Subsidiaries and to cure the default. On September 20, 1994, the Lenders requested that the Company deposit $25 million in a cash collateral account with one of the agent banks to secure its obligations under the Bank Credit Agreement. The Lenders also presented the Company with a series of capital investment alternatives and required the Company to select and take action to raise the required capital.
At a special shareholder meeting held on December 15, 1994, (the "Closing Date"), the Investment Agreement was approved. Subsequently, Holders of the Series A Preferred Stock, voting separately as a class, elected two of the Company's eleven directors. Holders of Common Stock were not entitled to vote in the election of such two directors. Since the Company's gross losses and allocated loss adjustment expenses related to the Northridge Earthquake have exceeded $850 million, AIG shall, if requested by the Company, contribute up to an additional $70 million to the Company in exchange for shares of Series A Preferred Stock having an aggregate liquidation value equal to the contributed amount plus an additional liquidation amount based on a formula designed to compensate AIG for its proportional share of the Company's after- tax loss resulting from the gross losses and allocated loss adjustment expenses relating to the Northridge Earthquake in excess of $850 million. The Company may determine not to obtain some or all of the additional capital from AIG in light of certain rules under the Internal Revenue Code governing the Company's ability to utilize its net operating losses to offset taxable income in future years. The Series A Preferred Stock will be entitled to a per annum cumulative dividend equal to 9% payable quarterly. At the option of the Company, during the next three years, dividends may be paid in cash or in kind (whereby, a holder receives, in lieu of cash, shares of Series A Preferred Stock having a liquidation value equal to the dividends declared).
The Investment Agreement also provides that the Company and AIG use their respective best efforts to negotiate and mutually agree upon a joint venture agreement whereby the Company and AIG will form a new subsidiary or subsidiaries to engage in the Company's automobile insurance business in states outside California.
On August 18, 1994, the California Supreme Court issued a decision (the "Proposition 103 Ruling") reversing a lower court ruling that had upheld the Company's challenge to the constitutionality of certain regulations and an administrative order issued by the Commissioner pursuant to California Proposition 103. The effect of the Proposition 103 Ruling was to reinstate the Commissioner's order directing that the Company issue refunds totaling approximately $78.3 million, plus interest at 10% per annum from May 8, 1989, to policyholders who purchased insurance from the Insurance Subsidiaries between November 8, 1988 and November 8, 1989.
Barring action by the U.S. Supreme Court to reverse the Proposition 103 Ruling, the Commissioner's refund order obligated the Company to pay approximately $122 million, which included accrued interest through December 31, 1994. Prior to the Supreme Court ruling, the Company had $51 million accrued, and recorded an additional $71 million in September of 1994.
On January 27, 1995, the Company announced a settlement of rebate liabilities associated with Proposition 103. As a result, the Company allocated $78 million for customer refunds, consistent with the Company's liability established through a DOI administrative hearing during 1992. Interest on the liability established through the original refund order will not be assessed.
Initially, the Company will refund $46 million to customers specified in the agreement as soon as practicable, representing an average payment per household of $80.00, approximately 7.5 percent of premiums paid between November 8, 1988 and November 7, 1989. The remaining $32 million will be set aside for additional customer refunds conditioned on the ultimate level of claim costs associated with the 1994 Northridge Earthquake.
Prior to this settlement, the Company had accrued approximately $122 million with respect to its possible Proposition 103 liability. Therefore, as of December, 1994, the Company reduced its accrual $44 million.
Another condition of this agreement required the Company to obtain new capital of $50 million and contribute the funds to the surplus of the Insurance Subsidiaries. Of the $50 million, $30 million must be obtained by March 31, 1995. Available to the Company were an additional $15 million under the existing bank credit facility and up to $70 million in "Earthquake Preferred" stock which could be issued to AIG.
The Northridge Earthquake has resulted in substantial losses. Since the event occurred, the Company and other members of the property and casualty insurance industry have revised their estimates of claim costs and related expenses several times. Because of the unusual nature of the ground motion during the earthquake, the earthquake produced significant damage to structures beyond normal expectations. Delayed discovery of the severity of damages has caused claims to be reevaluated as the additional damage becomes known and has made the estimation process extremely difficult. The Company estimates total gross losses and allocated loss adjustment expenses for this catastrophe to be $940 million at December 31, 1994. Unallocated loss adjustment, FAIR Plan assessments and other earthquake related expenses are estimated to be an additional $20 million. By mid-July, the Company had received all of the $76.3 million in catastrophe and per-risk reinsurance recoverables due to this event. As of December 31, 1994, the Company has received 35,327 homeowners and condominium claims and 10,139 automobile claims. Because of the difficulties of estimation noted above, it is possible that the Company's Northridge Earthquake loss estimates will increase. Should
On a pre-tax basis, net incurred claims and expenses, including reinsurance reinstatement costs, total $883.8 million. The net after-tax charge against year-to-date earnings for all costs for this event is $574.5 million, or $11.18 per share.
As of December 31, 1994, the Company had paid approximately $785 million in gross losses and allocated loss adjustment expenses related to the Northridge Earthquake. Funds to make payments came from normal operating cash flows of $226 million, reinsurance proceeds of $76.3 million, and the sale or maturity of approximately $483 million in investments. The funds needed to pay remaining earthquake related losses and expenses will come from normal positive operating cash flows, from loan proceeds and from the proceeds of the capital transaction with AIG.
Operations Excluding the Effects of the Northridge Earthquake and Proposition ------------------------------------------------------------------------------ 103 Rollback ------------
1993, compared to an 11.0% increase in 1993 over 1992. Earned premiums grew 8.1% in 1994 compared to 10.4% in 1993. Automobile underwriting profits have declined over the last three years due to the increase in losses from Assigned Risk business and no rate increases during this period of time.
Overall automobile underwriting results are also affected by assigned risk policies in force. Such policies remained level between 1992 and 1993 and then increased in 1994. Underwriting losses for assigned risk business were $3,800,000 in 1994, compared to $3,031,000 in 1993 and $1,862,000 in 1992.
The Company was granted an overall increase in automobile rates of 6%, which took effect on October 7, 1994. Prior to this increase, the Company had not revised its automobile rates since 1988.
these lines was $(21,514,000) in 1994, $(11,598,000) in 1993 and $1,714,000 in 1992. Results in 1994 include approximately $35,000,000 of catastrophe reinsurance premiums related to the additional reinsurance coverage. Results in 1993 were influenced by $4.6 million in claims due to rainy weather in the first quarter of the year; and by claims of approximately $4.3 million, after reinsurance, plus a $2.6 million assessment for the Company's share of California Fair Plan losses, due to the Southern California fires in the fourth quarter of the year. Results in 1992 included rainy weather in the first and fourth quarters of the year.
The Company's policy acquisition and general operating expense ratio continues to be one of the lowest in the industry. The ratio of underwriting expenses (excluding interest) to earned premiums was 10.1% in 1994, 10.7% in 1993 and 10.0% in 1992. The Company's efficiency, as reflected in its expense advantage over its competitors, enables the Company to maintain its price leadership and provide for future growth and profitability.
The Company's investment guidelines currently emphasize buying high- quality, fixed income, taxable securities because of the Company's substantial net operating loss carryforward. While the Company's policy is generally to hold these investments until maturity, its ongoing monitoring and evaluation of investment holdings and market conditions may, from time to time, result in selected sales of investments prior to maturity. The Company has designated its portfolio as "available-for-sale," and it is carried at fair value as of December 31, 1994 in accordance with the standards set forth in Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company implemented this new standard January 1, 1994. For a more complete description of this new standard, see Note 1 of the Notes to Consolidated Financial Statements, "Investments".
In 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", which requires the recognition of deferred tax liabilities and tax assets for the expected future tax consequences of temporary differences between the carrying amount and the tax bases of assets and liabilities. For further discussion, refer to Note 4 of the Notes to Consolidated Financial Statements.
Statutory regulations require the majority of the Company's investments to be made in high-grade securities to provide ample protection for policyholders. The Company primarily invests in long-term fixed maturity investments such as bonds.
Loss and loss expense payments are the most significant cash flow requirements of the Company. The Company continually monitors the loss payments to provide projections of future cash requirements. The Company generally generates enough cash flow to allow for monthly investments in the Cash Management Fund which is the source for purchasing long-term investments such as bonds. In order to help pay for the earthquake losses in 1994, the Company capitalized on the substantial unrealized gain in its bond portfolio by selling off bonds with higher market values. This resulted in capital gains of $61,554,000.
In prior years, the Company's most significant capital requirement resulted from its need to maintain an acceptable ratio of net premiums written to policyholders' surplus. In 1994, the losses from the Northridge Earthquake were so severe that the Company obtained a $160 million bank loan for its subsidiaries and equity financing from American International Group, Inc. (AIG). See Notes 7 and 14 of the Notes to Consolidated Financial Statements.
In March 1995, the Company issued an additional $20 million of preferred stock and borrowed another $10 million against the existing bank credit facility in order to increase the surplus of its Insurance Subsidiaries pursuant to an order by the California Department of Insurance. Dividends required in June 1995 and subsequent quarters will be $4,950,000. Interest for the credit facility will be approximately $3,700,000 for the second quarter of 1995.
For years prior to 1994, the Company's cash outlays for income taxes generally exceeded income tax expense recorded in accordance with generally accepted accounting principles. This resulted primarily because of the reduction of the unearned premium deduction and the discounting of unpaid loss reserve mandated by the Tax Reform Act of 1986.
expects to have very small cash outlays for income taxes, specifically alternative minimum tax. Until the net operating losses are fully utilized, the Company expects that cash outlays for income taxes will be less than income tax expense recorded in accordance with generally accepted accounting principles. The net operating loss carryforwards will expire in the year 2009.
We have audited the accompanying consolidated balance sheets of 20th Century Industries and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of 20th Century Industries and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As described in Note 1, 20th Century Industries and subsidiaries adopted in 1994 the provisions of Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities". As described in Note 4, 20th Century Industries and subsidiaries adopted in 1993 the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes".
Unpaid losses and loss adjustment expenses - Note 6 $ 756,243 $ 577,490 Unearned premiums 298,519 299,941 Bank loan payable - Note 7 160,000 - Claims checks payable 70,725 41,535 Proposition 103 payable - Note 12 78,307 49,185 Other liabilities - Note 5 21,072 21,310 ---------- ---------- Total liabilities 1,384,866 989,461 ---------- ----------
The accompanying financial statements include the accounts of 20th Century Industries and its wholly-owned subsidiaries, 20th Century Insurance Company and 21st Century Casualty Company. All material intercompany accounts and transactions have been eliminated. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles which differ in some respects from those followed in reports to insurance regulatory authorities.
Prior to the adoption in 1994 of Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities", the Company adhered to less stringent requirements and management believed that it had the ability to hold its investments to maturity and intended to do so. However, the Company also recognized that it could be appropriate to sell a security prior to maturity in response to unforeseen changes in circumstances. Recognizing the need for the ability to respond to changes in tax position and in market conditions, the Company had designated a portion of its investment portfolio as "available-for-sale". These fixed income securities were valued in the aggregate at the lower of amortized cost or fair value. The remainder of the Company's portfolio was designated as "held-for-investment" and valued at amortized cost.
The Company adopted SFAS 115 at January 1, 1994. SFAS 115 requires that fixed maturity securities are to be classified as either held-to-maturity, available-for-sale, or trading. Held-to-maturity debt securities are to be reported at amortized cost; trading securities are to be reported at fair value, with unrealized gains or losses included in earnings; and available- for-sale securities are to be reported at fair value, with unrealized gains or losses excluded from earnings and reported in a separate component of shareholders' equity.
Because these rules are more stringent than in prior years, the Company during 1994 has reclassified its portfolio into the available-for-sale category. (See Note 2).
Fair values for fixed maturity and equity securities are based on quoted market prices. Unrealized investment gains and losses on available-for-sale securities are credited or charged directly to stockholders' equity, net of any tax effect. When investment securities are sold, the cost used to determine any realized gain or loss is based on specific identification.
The accompanying 1992 and 1993 financial statements have been reclassified to conform with the 1994 presentation.
( see Note 13 ), reclassified the balance of its investment portfolio as available-for-sale, increasing stockholders' equity by $19,719,000 (net of deferred income taxes of $10,618,000). In the nine-month period ended December 31, 1994, net unrealized holding gains on the Company's bond portfolio decreased from $40,925,000 (net of deferred income taxes of $22,036,000) at March 31, 1994 to a net unrealized loss of $39,926,000 (net of deferred income taxes of $21,499,000) at December 31, 1994 or a decrease of $80,851,000 (net of deferred income taxes of $43,535,000). The aggregate of the changes in unrealized gains (losses) for 1994 as discussed above totals $76,683,000, which is reflected in the Consolidated Statement of Stockholders' Equity.
Expected maturities of the Company's investment portfolios differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
In 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes". The adoption of SFAS 109 changes the Company's method of accounting for income taxes from the deferred method to the liability method. The liability method requires the recognition of deferred tax liabilities and tax assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. The adjustments to the January 1, 1993 balance sheet to adopt SFAS 109 totaled $3,959,000, which is reflected in the 1993 statement of income as the effect of a change in accounting principle.
The Company is required to establish a "valuation allowance" for any portion of the deferred tax asset that management believes will not be realized. In order to utilize the deferred tax assets, the Company must have the ability to generate sufficient future taxable income to realize the tax benefits. The Company has available the following tax-planning strategies to generate additional taxable income in the future above historical levels:
The Company has a strong record of profitable operations. Except for the losses arising from the Northridge Earthquake, the Company has been profitable for each of the past 10 years. Over the last five years, the Company's combined ratio on a GAAP basis has been approximately 97% and investment earnings have averaged approximately $95 million a year over the same five year period. Historically, the Company has generated almost all of its profits from its automobile line of business. In accordance with the order by the California Department of Insurance, the Company is withdrawing from the homeowners and earthquake lines of business. The Company cannot renew any homeowner policies which include earthquake coverage with effective dates on or after July 23, 1994 and thus will be completely out of the earthquake line of business by July 23,
The Company's estimates of future taxable income are based on its historical profitable operations and the equity financing received from American International Group ("AIG") to replace diminished statutory capital (See Note 14). The Company believes the AIG transaction will provide sufficient statutory capital to allow the Company, in combination with its significantly reduced exposure to catastrophic losses, to return to its historical levels of profitability. The Company believes that the capital transaction with AIG does not create any limitations on the ability of the Company to utilize the net operating loss carryforward. The Company believes that because of its historically strong earnings performance and the tax planning strategies available, it is more likely than not that the Company will realize the benefit of the deferred tax assets, and therefore, no valuation allowance has been established.
In 1988, the Company adopted a non-contributory defined benefit pension plan (Pension Plan) which covers essentially all employees who have completed at least one year of service. The benefits are based on employees' compensation during all years of service. The Company's funding policy is to make annual contributions as required by applicable regulations. The Pension Plan's assets consist of high-grade fixed income securities and cash equivalents.
The net periodic pension cost for these plans reflected in the 1994, 1993 and 1992 Consolidated Statements of Operations is $3,722,000, $2,998,000 and $2,398,000, respectively. Accrued pension costs reflected in the Consolidated Balance Sheets at December 31, 1994 and 1993 are $4,713,000 and $6,811,000, respectively.
Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows: 1994 1993 ---- ---- (AMOUNTS IN THOUSANDS) Reserves for losses and loss adjustment expenses, net of reinsurance recover- ables on unpaid losses, at beginning of year $ 574,619 $554,034 Incurred losses and loss adjustment expenses, net of reinsurance: Provision for insured events of the current year, non-earthquake related, net of reinsurance 1,028,983 930,437 Provision for insured events of the current year, earthquake related, net of reinsurance 868,407 - Decrease in provision for insured events of prior years, net of reinsurance (84,453) (62,986) ---------- -------- Total incurred losses and loss adjustment expenses, net of reinsurance 1,812,937 867,451 ---------- -------- Payments, net of reinsurance: Losses and loss adjustment expenses attributable to insured events of the current year, earthquake related, net of reinsurance 708,981 - Losses and loss adjustment expenses attributable to insured events of the current year, non-earthquake re- lated, net of reinsurance 578,598 519,232 Losses and loss adjustment expenses attributable to insured events of prior years, net of reinsurance 344,876 327,634 ---------- -------- Total payments, net of reinsurance 1,632,455 846,866 ---------- -------- Reserves for losses and loss adjustment expenses, net of reinsurance recover- ables on unpaid losses, at year end 755,101 574,619 Reinsurance recoverables on unpaid losses, at year end 1,142 2,871 ---------- -------- Reserves for losses and loss adjust- ment expenses, gross of reinsurance recoverables on unpaid losses, at year end $ 756,243 $577,490 ========== ========
As a result of changes in estimates of insured events in prior years, the provision of losses and loss adjustment expenses (net of reinsurance recoveries of $400,000 and $(366,000) in 1993 and 1994, respectively) decreased by $62,986,000 and $84,453,000 in 1993 and 1994, respectively, due to a combination of improvements in the claims handling process, unanticipated decreases in frequency and random fluctuations in severity.
Effective June 30, 1994, the Company secured a five and one-half year reducing-revolver credit facility (the Facility), with an aggregate commitment of $175 million through The First National Bank of Chicago and Union Bank (the Agents).
Beginning January 1, 1996, the aggregate commitment will be automatically reduced $35 million, and $8.75 million thereafter on the first day of each quarter through the Facility's maturity date of January 1, 2000. Principal repayments are required when total outstanding advances exceed the aggregate commitment. The Company may prepay principal amounts of the advances, as well as voluntarily cause the aggregate commitment to be reduced at any time during the term of the Facility.
With the increase in Northridge Earthquake losses and resulting decline in equity, the Company was in default of certain financial covenants of the Facility. The Company deposited $25 million in a cash collateral account with one of the agent banks to secure its obligations under the Bank Credit Agreement. The Company and the Agents and Lenders agreed to amendments to the loan agreement to waive the events of default in order to facilitate the capital transaction with American International Group (AIG). (See Note 14). Upon the closing of the capital transaction, the default condition was cured.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company periodically reviews the financial condition of its
reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. It is the Company's policy to hold collateral under related reinsurance agreements in the form of letters of credit for unpaid losses for all reinsurers not licensed to do business in the Company's state of domicile. At December 31, 1994, there were no insurance agreements in force with any such unauthorized reinsurers.
The Company has a quota share treaty for its Personal Excess Liability Policy business with Underwriters Reinsurance Company and others. Effective January 1, 1993, the Company cedes 60% of its business; prior to 1993, 90% was ceded under this treaty.
The Company leases office space in a building in Woodland Hills, California. The lease was amended in October 1994, extending the lease term until November 1999. The lease may be renewed for two consecutive 5 year periods.
The plan provides for grants of common shares not to exceed 921,920 shares to be made to key employees as determined by the Key Employee Incentive Committee of the Board of Directors. At December 31, 1994, 334,409 common shares remain available for future grants. Upon issuance of grants of common shares under the plan, unearned compensation equivalent to the market value on the date of grant is charged to common stock and subsequently amortized in equal monthly installments over the 5-year period of the grant. Amortization of unearned compensation was $431,000, $320,000 and $255,000 in 1994, 1993 and 1992, respectively. At December 31, 1994 and 1993, unearned compensation, net of amortization, was $1,153,000 and $915,000, respectively. The common shares are restricted for 5 years retroactive to the first day of the year of grant. Restrictions are removed on 20% of the shares of each employee on January 1 of each of the 5 years following the year of grant. A summary of grants outstanding under the plan from 1992 through 1994 is as follows:
Granted in 1993 21,225 $28.13 Vested in 1993 19,460 Cancelled or forfeited - ------- Outstanding, December 31, 1993 56,715
Lawsuits arising from claims under insurance contracts are provided for through loss and loss adjustment expense reserves established on an ongoing basis. From time to time, the Company has been named as a defendant in lawsuits incident to its business. Some of these actions assert claims for exemplary or punitive damages which are not insurable under California judicial decisions. The Company vigorously defends these actions unless a reasonable settlement appears appropriate. While any litigation has an element of uncertainty, the Company is confident that the ultimate outcome of pending actions will not have a material adverse effect on its consolidated financial condition or results of operations.
This settlement required the Company to withdraw its request for a hearing with the United States Supreme Court to appeal the California Supreme Court decision in the Proposition 103 test case "20th Century vs. Garamendi" and abide by the terms of Commissioner Quackenbush's order. Upon announcement of the settlement, a consumer group objected to the settlement terms, and threatened legal action. The Company is advised by counsel, and believes that any challenge to the settlement will be unsuccessful.
Another condition of this agreement required the Company to obtain new capital of $50 million and contribute the funds to the surplus of the Insurance Subsidiaries, consisting of $30 million by March 31, 1995 and $20 million by Decem-
The Northridge, California Earthquake, which occurred on January 17, 1994, significantly affected the operating results and the financial position of the Company for 1994. The earthquake occurred in an area in which the Company's homeowners and earthquake coverages were concentrated. Since the event occurred, the Company and other members of the property and casualty insurance industry have revised their estimates of claim costs and related expenses several times. Because of the unusual nature of the ground motion during the earthquake, the earthquake produced significant damage to structures beyond normal expectations. Delayed discovery of the severity of damages has caused claims to be reevaluated as the additional damage becomes known and has made the estimation process extremely difficult. The Company currently estimates total gross losses and allocated loss adjustment expenses for this catastrophe to be $940 million. Unallocated loss adjustment expense, FAIR plan assessments and other earthquake related expenses are estimated to be an additional $20 million. The charge for the year against pre-tax earnings, after reduction for $76.3 million of reinsurance, was $883.8 million.
As a result of the earthquake losses discussed in Note 13, the Company found it necessary to obtain additional capital to increase the combined statutory surplus of the Insurance Subsidiaries.
The Company received aggregate consideration of $200,000,000 for the shares of the Preferred Stock and $16,000,000 for the Warrants (collectively, the "Investment Agreement").
The Investment Agreement also provides for a 10% quota share reinsurance agreement applicable to the Company's entire book of business, thereby improving the Company's ability to sustain growth.
An amendment to the Company's Articles of Incorporation to increase the number of authorized shares of Common Stock without par value from 80,000,000 to 110,000,000 shares was also approved by shareholders. This proposed amendment was necessary in order to permit the full exercise of conversion privileges under the Investment Agreement.
The fourth quarter 1993 net income was impacted by approximately $4.3 million in net losses and $2.6 million in assessments for the Company's share of California Fair Plan losses as a result of the Southern California fires.
Direct premiums written $ 932,497 $ 101,398 ========= ========= Premiums earned $ 908,522 $ 81,190 ========= ========= Underwriting profit (loss) $ 25,064 $ (11,598) ========= =========
Direct premiums written $ 841,610 $ 85,098 ========= ========= Premiums earned $ 823,680 $ 72,673 ========= ========= Underwriting profit $ 36,890 $ 1,714 ========= =========
In 1993, the Homeowners line experienced an underwriting loss primarily as a result of first quarter weather-related losses of approximately $4.6 million, and the third quarter Southern California fires with related net losses incurred of approximately $4.3 million and $2.6 million in assessments for the Company's share of California Fair Plan losses. The underwriting loss also included losses of approximately $1.0 million related to the 1991 Oakland, California fire.