We lease approximately 111,099 square feet for our home office at 3760 River Run Drive, Birmingham, Alabama under a long-term operating lease from Torchmark Development Corporation, which, until September 25, 1999 was a wholly owned subsidiary of Torchmark Corporation. We lease approximately 8,140 square feet for our Hawaiian operations in Honolulu, Hawaii under a long-term operating lease. We lease approximately 25,000 square feet for our life insurance operations in Phoenix, Arizona, under a long-term operating lease.
We consider the office facilities to be suitable and adequate for our current and anticipated level of operations.
- -------------- * As a result of Vesta's decision in 2000 to discontinue its reinsurance assumed business, and its decision in 1999 to discontinue its commercial lines segment, all periods presented have been reclassified to present operations on a continuing and discontinued basis. (1) Statutory data have been derived from the financial statements of Vesta prepared in accordance with SAP and filed with insurance regulatory authorities.
Our revenues from operations are derived primarily from net premiums earned on risks written by our insurance subsidiaries, investment income and investment gains or losses. Our expenses consist primarily of payments for claims and underwriting expenses, including agents' commissions and operating expenses.
Income available to common shareholders increased by $173.6 million to $32.4 million for the year ended December 31, 1999, from a $141.2 million loss for the year ended December 31, 1998. On a diluted per share basis, income available to common shareholders for 1999 was $1.63 per share versus a loss of $7.61 per share for 1998. The increase in income available to common shareholders is primarily attributable to a $42.6 million after tax loss on goodwill impairment recorded in 1998 and $12.7 million of net income from the our discontinued segments, reinsurance assumed and commercial lines, in 1999 versus a net loss of $63.3 million in 1998. The $12.7 million of net income from our discontinued segments in 1999, was primarily a result of a $15 million pre-tax gain from the sale of a portion of our reinsurance assumed segment.
Net premiums written for standard property-casualty lines decreased by $37 million, or 14.0%, to $227.8 million for the year ended December 31, 1999, from $264.8 million loss for the year ended December 31, 1998. Net premiums earned for standard property-casualty lines increased $1.0 million, or .4% to $248.1 million for the year ended December 31, 1999, from $247.1 million for the year ended December 31, 1998. Net premiums written decreased primarily due to the sale of Vesta County Mutual in early 1999.
Loss and loss adjustment expenses ("LAE") for standard property-casualty lines decreased by $2.4 million, or 1.4%, to $165.0 million for the year ended December 31, 1999, from $167.4 million for the year ended December 31, 1998. The loss and LAE ratio for property-casualty lines for the year ended December 31, 1999 was 66.5% as compared to 67.8% at December 31, 1998. The decrease in loss and LAE incurred is primarily attributable to the decline in earned premium. The changes in losses incurred and the Loss and LAE ratio is due to normal variations in claims from year to year.
Policy acquisition expenses decreased by $12.9 million, or 21.8% to $46.3 million for the year ended December 31, 1999, from $59.2 million for the year ended December 31, 1998 primarily due to the decrease in earned premium. Operating expenses decreased 31.8 million or 52% as we reduced costs in line with reductions in written premium.
The principal uses of funds at the holding company level are to pay operating expenses, principal and interest on outstanding indebtedness and deferrable capital securities and dividends to stockholders if declared by the Board of Directors. During the last three years, our insurance subsidiaries have produced operating results and paid dividends sufficient to fund our needs. Except for the regulatory restrictions described above, we are not aware of any demands or commitments of the insurance subsidiaries that would prevent them from paying dividends sufficient to meet our anticipated needs (including debt service) for at least the next twelve months. See, "Business--Regulation."
As a holding company with no other business operations, we rely primarily on fees generated by our management agreement with our insurance subsidiaries and dividend payments from Vesta Fire to meet our cash requirements (including our debt service) and to pay dividends to our stockholders. Transactions between Vesta and its insurance subsidiaries, including the payment of dividends and management fees to Vesta by such subsidiaries, are subject to certain limitations under the insurance laws of those subsidiaries' domiciliary states. The insurance laws of the state of Illinois, where Vesta Fire is domiciled, permit the payment of dividends in any year which, together with other dividends or distributions made within the preceding 12 months, do not exceed the greater of 10% of statutory surplus as of the end of the preceding year or the net income for the preceding year, with larger dividends payable only after receipt of prior regulatory approval.
Each of these newly established credit facilities mature on December 31, 2002. In addition, the credit agreements related to these facilities contain typical financial covenants which require us to maintain certain financial standards. As of December 31, 2000, $10 million of the credit facility is available.
We extinguished $13.1 million of our 8.75% Senior Debentures for approximately $9.8 million plus accrued interest and all $44.1 million of our 12.5% Senior Notes for approximately $38.2 million, plus accrued interest. In December 2000, we completed two debt for equity swaps in which we exchanged 1.2 million shares of common stock for $8.0 million face amount of deferrable capital securities. We recognized a total after-tax gain of $6.6 million from these transactions. In the fourth quarter of 2000, Vesta redeemed preferred stock of a subsidiary with a stated value of $21 million and a carrying value of $18 million for $7.0 million. We recognized an after-tax gain of $7.9 million, net of minority interest, on this transaction.
Annual distribution obligations for our long term debt, deferrable capital securities and preferred stock outstanding at December 31, 2000 were as follows:
The principal sources of funds for our insurance subsidiaries are premiums, investment income and proceeds from the sale or maturity of invested assets. Such funds are used principally for the payment of claims, operating expenses, commissions and the purchase of investments. As is typical in the insurance industry, we collect cash in the form of premiums and invest that cash until claims are paid. Cash collected from
premiums and cash paid for claims is included in cash flow from operations, while the cash impact from our investing activities is included in cash flow from investing activities. In periods such as 1999 and 2000, where we are exiting certain lines of business such as commercial lines and reinsurance assumed lines we are funding the payout of commercial and reinsurance assumed claims through the liquidation of invested assets, consistent with the historical insurance business model. However, this generates cash outflows from operations that can be misleading.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) present fairly, in all material respects, the financial position of Vesta Insurance Group, Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles and estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Recognition of Premium Revenue: Earned premiums on property-casualty business are generally recognized as revenue on a pro rata basis over the policy term. For traditional life insurance contracts, premiums are recognized as income when due.
Losses and Loss Adjustment Expenses: The liability for losses and loss adjustment expenses ("LAE") includes an amount determined from loss reports and individual cases. It also includes an amount for losses incurred but not reported ("IBNR") which is based on historical experience. Such liabilities are necessarily based on estimates and, while management believes that the amount is adequate, the ultimate liability may be in excess of or less than the amounts provided. The methods for making such estimates and for establishing the resulting liabilities are continually reviewed, and any adjustments are reflected in earnings currently. These reserves are established on an undiscounted basis and are reduced for estimates of salvage and subrogation.
Policy liabilites: Reserves for investment-type contracts are based either on the contract account balance (if future benefit payments in excess of the account balance are not guaranteed) or on the present value of future benefit payments (if such payments are guaranteed). Additions to insurance liabilities are made if it is determined that future cash flows (including investment income) are insufficient to cover future benefits and expenses.
Reinsurance: We report assets and liabilities related to insurance contracts before the effects of reinsurance. Reinsurance receivables and prepaid reinsurance premiums (including amounts related to insurance liabilities) are reported as assets. Estimated reinsurance receivables are recognized in a manner consistent with the liabilities related to the underlying reinsured contracts.
Minority Interest: Minority interest in consolidated subsidiaries totaled $20.5 million at December 31, 2000. $7.6 million of this amount represents mandatorily redeemable preferred stocks.
Property and Equipment: Property and equipment is reported at cost less allowances for depreciation. Depreciation is recorded primarily on the straight line method over the estimated useful lives of these assets which range from 1 to 15 years. Ordinary maintenance and repairs are charged to income as incurred.
Goodwill: Goodwill is amortized on a straight-line basis over a period of 15 years. Goodwill at December 31 is as follows (in thousands):
Reclassification: Certain amounts in the financial statements presented have been reclassified from amounts previously reported in order to be comparable between years. These reclassifications, other than as discussed in Note Q, have no effect on previously reported total assets, total liabilities, stockholders' equity or net income during the period involved.
In accordance with Accounting Principles Board Opinion (APB) No. 17, "Intangible Assets," the recoverability of goodwill not identified with assets subject to an impairment loss is reviewed for impairment, on an acquisition by acquisition basis, whenever events or changes in circumstances indicate that it may not be recoverable. If such an event occurred, we would prepare projections of future discounted cash flows for the applicable acquisition. The projections are for the remaining term of the goodwill using a discount rate and terminal value that would be customary for evaluating insurance company transactions. We believe that this discounted cash flow approach approximates fair market value.
New Accounting Standard. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 and subsequent amendments standardize the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, by requiring that an entity recognize those items as assets or liabilities in the financial statements and measure them at fair value. Management has evaluated our activities and has determined that Vesta does not currently have any material derivative exposures and that the adoption of the SFAS No. 133 on January 1, 2001 will not have a material impact on the financial statements.
On June 30, 2000, we completed the acquisition of a 71% controlling interest in American Founders Financial Corporation for $25 million. American Founders is a life insurance holding company with approximately $1.8 billion (face value) of life products in force and approximately $339 million of annuity deposits as of December 31, 2000. American Founders is currently rated B+ by A.M. Best and operates in 40 states and the District of Columbia. The transaction has been accounted for as a purchase. Summarized below is an allocation of assets and liabilities acquired and the consolidated results of operations for the year ended December 31, 2000 and 1999 on an unaudited pro forma basis as if the acquisition had occurred as of January 1, 1999. The pro forma information is based on our consolidated results of operations for the year ended December 31, 2000 and 1999 and on data provided by the acquired company, after giving effect to certain pro forma adjustments. The pro forma financial information does not purport to be indicative of results of operations that would have occurred had the transactions occurred on the basis assumed above nor are they indicative of results of the future operations of the combined enterprises.
Insurance subsidiaries of Vesta are required to file statutory financial statements with state insurance regulatory authorities. Accounting principles used to prepare these statutory financial statements differ from accounting principles generally accepted in the United States of America. The most significant differences between GAAP and statutory accounting principles are as follows: (a) acquisition costs of obtaining new business are deferred and amortized over the policy period rather than charged to operations as incurred; (b) deferred income taxes are provided for temporary differences between financial and currently taxable earnings; (c) certain items are reported as assets (property and equipment, agents' balances, prepaid expenses) rather than being charged directly to surplus as nonadmitted items; (d) statutory accounting disallows reserve credits for reinsurance in certain circumstances; (e) bonds are recorded at their market values instead of amortized costs; (f) benefit liabilities are computed using a net level method and are based on realistic estimates of expected mortality, interest, and withdrawals as adjusted to provide for possible unfavorable deviation from such assumptions; (g) the Asset Valuation Reserve and Interest Maintenance Reserve are restored to shareholders' equity.
Statutory net income: Vesta Fire Insurance Corporation $ 41,611 $ 55,226 American Founders Life $ 12,444 --
Restrictions on Dividends to Stockholders: Our insurance subsidiaries are subject to various state statutory and regulatory restrictions, generally applicable to each insurance company in its state of domicile, which limit the amount of dividends or distributions by an insurance company to its stockholders. The payment of dividends by Vesta Fire is subject to certain limitations imposed by the insurance laws of the State of Illinois. The restrictions are generally based on certain levels of surplus, investment income and operating income, as determined under statutory accounting practices. Illinois permits dividends in any year which together with other dividends or distributions made within the preceding 12 months, do not
A summary of fixed maturities and equity securities by amortized cost and estimated fair value at December 31, 2000 and 1999 is as follows (in thousands)
A schedule of fixed maturities held for investment by contractual maturity at December 31, 2000 is shown below on an amortized cost basis and on a fair value basis. Actual maturities could differ from contractual maturities due to call or prepayment provisions.
Proceeds from the sale of equity securities were $.5 million, $22 million, and $4 million in 2000, 1999, and 1998, respectively. Gross gains (losses) realized on those sales were $(.6) million, $8.2 million and $3.1 million in 2000, 1999 and 1998, respectively. Proceeds from sales, maturities and calls of fixed maturities were $157.7 million in 2000, $294 million in 1999 and $156 million in 1998. Gross gains realized on those sales were $1.4 million in 2000, $1.7 million in 1999 and $.2 million in 1998. Gross losses on those sales were $1.8 million in 2000, $2 million in 1999 and $.02 million in 1998.
The class actions filed in the United States District Court for the Northern District of Alabama have been consolidated into a single action in that district and the derivative case has been placed on the administrative docket. The class representatives in that action filed (a) a consolidated amended complaint alleging that the defendants violated the federal securities laws and (b) a motion for class certification, which was granted in 1999. The consolidated amended complaint also added as defendants Torchmark Corporation and our predecessor auditors, KPMG Peat Marwick, LLP. The consolidated amended complaint alleges various violations of the federal securities law and seeks unspecified but potentially significant damages. Our motion to dismiss the consolidated amended complaint was denied in October 2000. The case was recently assigned to another judge to explore settlement possibilities, but there is no assurance that any compromise of the securities litigation is feasible or will be achieved.
We have notified our directors and officers liability insurance companies of these lawsuits and the consolidated amended complaint. The securities litigation is presently in the discovery stage. We intend to vigorously defend this litigation and intend to explore all available rights and remedies it may have under the circumstances. In related litigation, in September, 1998, Cincinnati Insurance Company ("Cincinnati"), one of Vesta's directors and officers liability insurance carriers, filed a lawsuit in the United States District Court for the Northern District of Alabama seeking to avoid coverage under its directors and officers liability and other policies. We filed a motion to dismiss Cincinnati's complaint on jurisdictional grounds in federal court (which was granted), and filed a lawsuit against Cincinnati in the Circuit Court of Jefferson County, Alabama seeking damages arising out of Cincinnati's actions. Cincinnati has filed an answer and counterclaim in that case again seeking to avoid coverage. This litigation is in the discovery stage.
Subsequent to the initiation of the class actions described above, we secured additional excess D&O insurance providing coverage for losses in excess of $50 million up to $110 million, or additional excess coverage of $60 million for the class action securities litigation. We paid for this additional coverage in full in 1998.
These matters are in their early stages and their ultimate outcome cannot be determined. Accordingly, we have not currently set aside any financial reserves relating to any of the above-referenced actions. Of course, we cannot predict the outcome of any of these matters. See Exhibit 99.1.
A dispute has also arisen with CIGNA Property and Casualty Insurance Company (now ACE USA) under a personal lines insurance quota share reinsurance agreement, whereby we assumed certain risks from CIGNA. During September 2000, CIGNA filed for arbitration under the reinsurance agreement, seeking payment of the balances that CIGNA claims are due under the terms of the treaty. In addition, during the fourth
On September 23, 1999, Torchmark Corporation, formerly Vesta's largest common stockholder, filed a lawsuit in the Circuit Court of Jefferson County, Alabama against Vesta asserting breach of contract, conversion and breach of duty in connection with the Company's preparation and filing of a registration statement covering its shares in accordance with certain registration rights claimed by Torchmark. This claim seeks an injunction requiring a registration statement to be filed, as well as compensatory and punitive damages. During the course of this litigation, Vesta repurchased its stock from Torchmark which was the subject of such registration rights. This litigation is in its early stages, and management is unable to assess the damages that may be awarded, if any. However, management does not believe that such damages, if any, would materially and adversely affect the Company's financial position or result of operation.
On June 23, 1999, a subsidiary of Torchmark filed suit in the Circuit Court of Jefferson County, Alabama against two subsidiaries of Vesta. The lawsuit claims that the Vesta's subsidiaries have failed to pay certain sums due under a marketing and administrative services agreement between the parties. The suit also seeks payment of certain commissions and administrative expenses. Management does not believe that such damages awarded as a result of this litigation, if any, would materially and adversely affect our financial position or results of operation.
The following table summarizes amounts recorded for interest and income taxes paid (in thousands).
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2000 and 1999 are presented below:
On June 30, 2000, we entered the life and annuity business through a 71% investment in American Founders Financial Corporation, a holding company for two life insurance companies domiciled in Texas. American Founders has approximately $1.8 billion (face value) of life products in force and approximately $339 million of annuity deposits as of December 31, 2000. American Founders markets traditional life products, universal life products, fixed-rate annuities, pension contracts and related products thru independent agents throughout the majority of the United States.
The Senior debentures are unsecured and rank on parity with all other unsecured and unsubordinated indebtedness. The debentures contain certain restrictions on the ability of Vesta to issue, sell, or otherwise dispose of any restricted subsidiary or to pledge the capital stock of any subsidiary.
During the year ended December 31, 2000, we extinguished $13.1 million of our 8.75% Senior Debentures for approximately $9.8 million plus accrued interest and all $44.1 million of its 12.5% Senior Notes for approximately $38.2 million plus accrued interest. We recorded extraordinary gains, net of tax and related debt issue costs of $5.3 million, ($.22 per diluted share), as a result of the early redemption of this long term debt. The redemptions were funded with internally generated cash. The warrants attached to the 12.5% Senior Notes have been cancelled.
Vesta's short-term debt outstanding at December 31, 2000 and 1999 is as follows (in thousands):
As of December 31, 2000, Vesta's credit facilities consisted of a $7.5 million unsecured line of credit which carries an interest rate of the bank's prime rate plus 1/4%, and an additional $7.5 million line of credit, secured by a pledge of the management contract between our wholly owned management company, J. Gordon Gaines, Inc., and our operating insurance subsidiaries which carries an interest rate of the bank's prime rate. The prime rate at December 31, 2000 was 9.5%. Each of these credit facilities mature on December 31, 2002. In addition, the credit agreements related to these facilities contain typical financial covenants which require Vesta to maintain certain financial standards.
In 1997, our single purpose finance subsidiary, Vesta Capital Trust I, issued $100 million principal amount of its 8.525% Deferrable Capital Securities. We have unconditionally guaranteed Vesta Capital Trust's obligation to make semi- annual distributions on these capital securities, and we have issued a debenture in a like amount to Vesta Capital Trust which requires us to make interest payments in the same amounts and at the same times as the distributions which are payable on these capital securities. These securities and the related distributions are treated in a manner similar to minority interest in the financial statements. The terms of the capital securities and the underlying debenture permit us to defer interest payments on the debentures, and, therefore, distributions on the capital securities, for up to ten years. We exercised this right of deferral with respect to the semi-annual payment originally due July 15, 1999. While we have elected to resume payment on these capital securities effective January 15, 2000, including all accrued amounts due since July 15, 1999, we may elect to defer payments again in the future. In the event we elect to defer such payments again in the future, we will not be permitted to pay any dividends on our common stock or other equity securities. In December, 1999, we exchanged $44.1 million of 12.5% senior notes, due 2006 for $58.8 million of the Deferrable Capital Securities. The resulting after-tax gain of $9.5 million was recorded directly to retained earnings in accordance with EITF 86-32 "Early Extinguishment of a Subsidiary's Mandatorily Redeemable Preferred Stock." In December, 2000, we exchanged 1,200,066 shares of common stock for $8 million face amount of Deferrable Capital Securities. The resulting after-tax gain of $1.3 million was recorded directly to retained earnings in accordance with EITF 86-32. The after tax gains from these transactions have been included in the respective computations of income available to common shareholders and related earnings per share computations in accordance with EITF Topic No. D-42, "The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock."
As of December 31, 2000, approximately $33.2 million of these capital securities remained outstanding and carried a semi-annual distribution obligation of approximately $1.4 million.
Advances from FHLB as of December 31, 2000 are as follows (in thousands):
Short-term advances, bearing interest at 6.62% for 2000 $75,000 Amortizing advances with balloon payments, bearing interest at rates from 6.41% to 7.3%, maturing from 2016 to 2024 68,107 Fully amortizing advances, bearing interest at rates ranging From 6.19% to 7.48%, maturing from 2010 to 2016 7,584 -------- $150,691 ========
Annual maturities of borrowings from FHLB as of December 31, 2000 are as follows (in thousands):
2001 $77,177 2002 2,301 2003 2,437 2004 2,585 2005 2,808 Thereafter 63,383 -------- $150,691 ========
Pro forma information regarding net income and earnings per share is required by FAS 123, and has been determined as if Vesta had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2000, 1999 and 1998, respectively: risk-free interest rates of 6.50%, 6.22% and 5.16%; dividend yields of 1.0%, 1.67% and 0.44% percent; volatility factor of the expected market price of Vesta's common stock of 78.39, 67.02 and 44.70; and a weighted- average expected life of the options of ten years for all years.
Of the 825,562 outstanding options at December 31, 2000, 485,562 were exercisable.
At December 31, 2000, Vesta had issued 488,318 shares of restricted stock. 74,307 shares have been issued to officers of Vesta in exchange for promissory notes. The common stock is being held by Vesta as security for the repayment of the notes. The balance of the unamortized restricted stock and unpaid note receivable at December 31, 2000 and 1999, was $2.2 million and $1.8 million, respectively, and are shown as reductions to stockholders' equity. The restrictions on the remaining 414,011 shares expire in 2002 - 2004.
The carrying amounts and estimated fair values of Vesta's financial instruments, none of which were held for trading purposes, were as follows (in thousands):
The fair values presented represent management's best estimates and may not be substantiated by comparisons to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all nonfinancial instruments are not required to be disclosed; therefore, the aggregate fair value amounts presented do not purport to represent the underlying fair value of Vesta. Except as noted below, fair values were estimated using quoted market prices.
. Mortgage Loans - The fair value of mortgage loans is calculated by discounting scheduled cash flows through the estimated maturity using the current rates at which similar loans would be made to borrowers with similar credit and interest rate risks. Approximately $66,000 of the loans were in the process of foreclosure.
. Borrowings - Fair values for the advances from FHLB were calculated using interest rates in effect as of each year end with the other terms of the advances unchanged. Carrying values of the convertible debentures and notes payable approximate fair value as effective rates approximate current rates.
It is not practical to estimate the fair value of policy loans as they have no stated maturity and their rates are set at a spread related to policy liability amounts.
In 1999, we elected to exit all commercial lines programs by not accepting new commercial policy applications and non renewing existing in-force policies at their renewal dates. In November of 1999 we received final regulatory approval to non renew our commercial lines policies from all of the states in which we wrote commercial lines. Such approval represented the measurement date for treatment of the commercial segment as a discontinued operation under APB 30. Therefore, the commercial operations have been segregated from continuing operations herein for all periods presented. We will continue to earn premium and incur losses on policies which were in-force through November 1999.
On January 26, 2001, we effectively retired 2,950,000 shares of Series A Convertible Preferred Stock, eliminating $2.25 million in annual dividend payments. The preferred stock holders converted the preferred stock pursuant to their original conversion terms and then we repurchased the 5,900,000 shares of common stock issued upon conversion for $15 million cash and a $32.2 million note. The common stock was resold in privately negotiated transactions and the Note was repaid in full on March 14, 2001.