The Company leases certain office space in Bala Cynwyd, PA which serves as its headquarters location, and also leases 36 offices for its field marketing organization.
- - Continued rating agency downgrades and insolvencies in the industry; and
In this environment, the Company continued its strong growth, with gross written premiums increasing 40.1% to $663.7 million. The Company also believes its core strategy of adhering to an underwriting philosophy of sound risk selection and pricing discipline, the mixed marketing platform for its product distribution and creating value added features not typically found in property and casualty products have also contributed to generating premium growth above industry averages, as well as enabling the Company to produce combined ratios (the sum of net loss and loss adjustment expenses and acquisition costs and other underwriting expenses, divided by net earned premiums) well below industry averages. The GAAP combined ratio for the year ended December 31, 2002 was 94.3%, which, once again, was substantially lower than the property and casualty industry as a whole.
During 2002 the relative percentage investment in tax-exempt fixed maturity securities versus taxable fixed maturity securities increased due to the Company taking advantage of the more favorable after-tax yields. At the end of 2002, on a cost basis, investment grade tax-exempt fixed maturity securities represented 30.3% of the total invested assets, compared to 14.8% as of the end of 2001.
Collateralized mortgage and asset backed securities, on a cost basis, amounted to $89.2 million and $284.1 million, respectively, as of December 31, 2002 and $70.4 and $272.7, respectively, as of December 31 2001. The collateralized mortgage and asset backed investments are shorter tranche securities possessing favorable prepayment risk profiles.
The Company regularly performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed for all securities, except interests in securitized assets, meeting predetermined thresholds, to determine whether such decline is other than temporary. If the Company determines a decline in value to be other than temporary, based upon its detailed review, or if a decline in value for an equity investment has persisted continuously for nine months the cost basis of the security is written down to its fair value. The factors considered in reaching the conclusion that a decline below cost is other-than-temporary include, but are not limited to, whether: the issuer is in financial distress; the investment is secured; a significant credit rating action has occurred; scheduled interest payments have been delayed or missed; or changes in laws and/or regulations have impacted an issuer or industry. The amount of any
The Company's fixed maturity portfolio amounted to $854.5 million and $628.6 million, as of December 31, 2002 and 2001, respectively, of which 98.6% of the portfolio for both years was comprised of investment grade securities. Since the fourth quarter of 2001, U.S. investment grade securities have experienced varying price and ratings volatility, having been affected by the uncertain economic climate following the September 11, 2001 terrorist attacks, the corporate governance issues following the Enron scandal and the subsequent stream of corporate problems and high profile bankruptcies. While these circumstances have the potential to impact investment grade securities, the high quality of the Company's overall "AA+" rated fixed maturity portfolio and the decline in interest rates have mitigated potential volatility. As of December 31, 2002 the Company had fixed maturity investments with unrealized losses amounting to $9.2 million. Of this amount, interests in securitized assets had unrealized losses amounting to $7.3 million and investments in aircraft collateralized Enhanced Equipment Trust Certificates (EETCs) had unrealized losses amounting to $1.3 million. As discussed above, the Company's impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by the EITF. With respect to the EETCs, these investments are current on interest and sinking fund payments, and are subjected to a quarterly impairment review which includes performing a liquidation collateral analysis that incorporates various stress scenarios impacting the security's implied loan-to-value levels.
The carrying amount for the Company's investments approximates their estimated fair value. The Company measures the fair value of investments based upon quoted market prices or by obtaining quotes from third party broker-dealers. The Company's total investments include $22.4 million in securities for which there is no readily available independent market price. The estimated fair value of such securities is determined by independent third party broker-dealers. Material assumptions and factors utilized by such broker-dealers in pricing these securities include: future cash flows, constant default rates, recovery rates and any market clearing activity that may have occurred since the prior month-end pricing period.
The Company regularly performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed for all securities, meeting predetermined thresholds, to determine whether such decline is other than temporary. If the Company determines a decline in value to be other than temporary, based
-- The Company also increased the liability for unpaid loss and loss adjustment expenses on the Commercial Automobile Excess Liability Insurance ("Excess Liability") product sold to rental car companies (Commercial Lines Underwriting Segment) primarily for the 2000 and 2001 accident years by $6.9 million ($4.9 million net of reinsurance). As of December 31, 2001 the Company had estimated a total liability for unpaid loss and loss adjustment expenses for the Excess Liability policies issued in these years of $23.0 million ($21.6 million net of reinsurance). Excess Liability provides automobile liability coverage in excess of the state mandated limits which are provided by the rental car company. During the third quarter of 2002, pursuant to a routine underwriting review focusing on price adequacy and loss experience, the Company non-renewed a significant Excess Liability customer as a result of an unacceptable underwriting risk profile (see Results of Operations (2002 versus 2001)). This adverse loss development was primarily due to pricing inadequacy and the adverse loss experience of this customer. Additionally, the Company has experienced a delay in both the reporting of claims and the claim litigation discovery process as a result of this policyholder and another Excess Liability policyholder filing for Chapter 11 during the third quarter 2002 and fourth quarter 2001, respectively.
Policy acquisition costs ($61.3 million and $41.5 million as of December 31, 2002 and 2001, respectively) which include commissions, premium taxes, fees, and certain other costs of underwriting policies, are deferred and amortized over the same period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable after providing for losses and expenses that are expected to be incurred, based upon historical and current experience. Anticipated investment income is considered in determining whether a premium deficiency exists. The methods of making such estimates and establishing the deferred costs are continually reviewed by the Company, and any adjustments therefrom are made in the accounting period in which the adjustment arose.
- - the Company's fixed income portfolio is overweighted in the spread sectors, versus the Index, to capture the incremental spread available in non-Treasury securities consistent with its investment objective of achieving the highest after-tax risk adjusted yields;
- - the Company maintains a shorter portfolio duration versus the Index.
Other Income: Other income approximated $0.9 million for the year ended December 31, 2002 and $0.6 million for the same period of 2001. Other income primarily consists of commissions earned on brokered personal lines business, and to a lesser extent brokered commercial lines business. The Company is seeking to increase brokering activities in its personal lines segment, as it is restricting new business and not renewing certain policies in designated areas of Florida as a result of its property exposures in these areas and the related catastrophe loss considerations.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased $87.7 million (48.8%) to $267.4 million for the year ended December 31, 2002 from $179.7 million for the same period of 2001 and the loss ratio increased to 63.5% in 2002 from 60.7% in 2001. This increase in net loss and loss adjustment expenses was due principally to the 42.2% growth in net earned premiums, and in part to the Company increasing loss and loss adjustment expenses incurred as a result of changes in estimates of insured events in prior years by: $27.6 million ($68.0 million gross of reinsurance) due to deterioration in frequency and severity trends on automobile leases currently expiring on residual value policies issued during the years 1998 through 2001 (see Certain Critical Accounting Estimates and Judgments - Liability for Unpaid Loss and Loss Adjustment Expense); and by $4.9 million ($6.9 million gross of reinsurance) due to adverse loss experience on the Commercial Automobile Excess Liability Insurance product (see Certain Critical Accounting Estimates and Judgments - Liability for Unpaid Loss and Loss Adjustment Expense). The Company also commuted a 2001 accident year aggregate stop loss reinsurance program in the second quarter of 2002, resulting in net written and net earned premium increasing by $3.6 million. The Company had not ceded any losses to the 2001 accident year aggregate stop loss reinsurance program. The year ended December 31, 2001 included a $4.0 million increase to unpaid loss and loss adjustment expenses arising from business interruption, business personal property, business property and workers' compensation exposures relating to the September 11, 2001 terrorist attacks. The Company has entered into various reinsurance agreements for the purpose of limiting its loss exposure. Net reinsurance recoveries as a percentage of loss and loss adjustment expenses may vary considerably from period to period based upon the number and/or severity of our individual losses in excess of the amount retained under the Company's reinsurance agreements in any one period.
Premiums: Gross written premiums grew $111.7 million (30.9%) to $473.6 million in 2001 from $361.9 million in 2000; gross earned premiums grew $92.7 million (28.2%) to $421.1 million in 2001 from $328.4 million in 2000; net written premiums increased $70.4 million (26.7%) to $333.8 million in 2001 from $263.4 in 2000; and net earned premiums grew $68.8 million (30.3%) to $296.1 million in 2001 from $227.3 million in 2000.
- - The consolidation of certain competitor property and casualty insurance companies has led to the displacement of certain of their independent agency relationships. This consolidation continues to result in new agency relationship opportunities for the Company. These relationships have resulted in additional prospects and premium writings for the Company's commercial and specialty lines segments.
- - Continued expansion of marketing efforts relating to commercial lines and specialty lines products through the Company's field organization and preferred agents.
- - Losses emerging at a higher rate on automobile leases expiring in 2001 on residual value policies underwritten in prior years than had been originally anticipated when the initial reserves were estimated.
January 1, 2002 due to the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
Philadelphia Consolidated Holding Corp. (PCHC) is a holding company whose principal assets currently consist of 100% of the capital stock of its subsidiaries. The Company's primary sources of funds are dividends from its subsidiaries and payments received pursuant to tax allocation agreements with the insurance subsidiaries. For the year ended December 31, 2002, payments to PCHC pursuant to such tax allocation agreements totaled $20.1 million. The payment of dividends to PCHC from the insurance subsidiaries is subject to certain limitations imposed by the insurance laws of the Commonwealth of Pennsylvania and State of Florida. Accumulated statutory profits or policyholders' surplus of the insurance subsidiaries from which dividends may be paid totaled $123.0 million at December 31, 2002. Of this amount, the insurance subsidiaries are entitled to pay a total of approximately $31.7 million of dividends in 2003 without obtaining prior approval from the Insurance Commissioner of the Commonwealth of Pennsylvania or State of Florida. During 2002 the insurance subsidiaries paid dividends of $5.1 million to Liberty American Insurance Group, Inc., a subsidiary of PCHC. Also, during 2002 the Company repurchased 75,000 shares of the Company's common stock for approximately $2.0 million under the stock repurchase authorization. At December 31, 2002 the remaining stock repurchase authorization is $25.0 million.
The Company produced net cash from operations of $205.0 million in 2002, $115.1 million in 2001 and $47.0 million in 2000. Sources of operating funds consist primarily of net premiums written and investment income. Funds are used primarily to pay claims and operating expenses and for the purchase of investments. The source of cash from operations in 2002 was primarily generated from strong premium growth during the current year due to increases in the number of policies written and price increases realized on renewal business. Net loss and loss expense payments were $157.9 million in 2002, $125.0 million in 2001, and $97.2 million in 2000. Net cash from operations also included cash provided from tax savings as a result of the exercise of employee stock options amounting to $1.3 million, $25.8 million and $0.1 million for 2002, 2001 and 2000, respectively. Management believes that the Company has adequate liquidity to pay all claims and meet all other cash needs.
Two of the Company's Insurance Subsidiaries are members of the Federal Home Loan Bank of Pittsburgh ("FHLB"). A primary advantage of FHLB membership is the ability of members to access credit products from a reliable capital markets provider. The availability of any one member's access to credit is based upon its FHLB eligible collateral. At December 31, 2002 the Insurance Subsidiaries borrowing capacity with the FHLB was $85.1 million. The Insurance Subsidiaries have utilized a portion of its borrowing capacity to purchase a diversified portfolio in investment grade floating rate securities. These purchases were funded by floating rate FHLB borrowings to achieve a positive spread between the rate of interest on these securities and borrowing rates. The remaining borrowing capacity provides an immediately available line of credit. Borrowings aggregated $39.1 million at December 31, 2002, bear interest at adjusted LIBOR and mature twelve months from inception. The weighted-average interest rate on borrowings outstanding as of December 31, 2002 was 1.54% per annum. These borrowings are collateralized by investment securities, principally asset backed securities, with a carrying value of $49.2 million.
The insurance subsidiaries, which operate under an intercompany reinsurance pooling agreement, must have certain levels of surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners (the "NAIC") suggest that a property and casualty insurer's ratio of annual statutory net premium written to policyholders' surplus should not exceed 3-to-1. The ratio of combined annual statutory net premium written by the insurance subsidiaries to their combined policyholders' surplus was 1.7-to-1.0 and 1.2-to-1.0 for 2002 and 2001, respectively.
123 that permit entities to continue to apply the intrinsic value method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"). In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company continues to maintain its accounting for stock-based compensation in accordance with APB No. 25, but has adopted the disclosure provisions of SFAS No. 148 (See Note 12 in Notes to Consolidated Financial Statements).
Certain information included in this report and other statements or materials published or to be published by the Company are not historical facts but are forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new and existing products, expectations for market segment and growth, and similar matters. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary remarks regarding important factors which, among others, could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, results of the Company's business, and the other matters referred to above include, but are not limited to: (i) changes in the business environment in which the Company operates, including inflation and interest rates; (ii) changes in taxes, governmental laws, and regulations; (iii) competitive product and pricing activity; (iv) difficulties of managing growth profitably; (v) claims development and the adequacy of our liability for unpaid loss and loss adjustment expenses; (vi) severity of natural disasters and other catastrophes; (vii) adequacy of reinsurance coverage which may be obtained by the Company; (viii) ability and willingness of our reinsurers to pay; and (ix) future terrorist attacks.
As discussed in Note 1 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill to conform with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
The consolidated financial statements include the accounts of the Company prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). All significant intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements requires making estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain prior years' amounts have been reclassified for comparative purposes.
The Company regularly performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed for all securities, except interests in securitized assets, meeting predetermined thresholds, to determine whether such decline is other than temporary. If the Company determines a decline in value to be other than temporary, the cost basis of the security is written down to its fair value with the amount of the write down included in earnings as a realized loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $2.1 million for the year ended December 31, 2002. No impairment losses were recorded for the years ended December 31, 2001 and 2000, respectively.
Additionally, the Company's impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. Under this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent (prior) estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. This re-evaluation resulted in non-cash realized investment losses of $1.6 million, $5.8 and $0 million for the years ended December 31, 2002, 2001 and 2000, respectively.
The provisions of Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities" require, among other things, that all derivatives be recognized in the consolidated balance sheets as either assets or liabilities and measured at fair value. The corresponding derivative gains and losses should be reported based upon the hedge relationship, if such a relationship exists. Changes in the fair value of derivatives that are not designated as hedges or that do not meet the hedge accounting criteria in SFAS 133 are required to be reported in income. The Company held no derivative financial instruments, nor embedded financial derivatives, as of December 31, 2002 and 2001.
Policy acquisition costs, which include commissions, premium taxes, fees, and certain other costs of underwriting policies, are deferred and amortized over the same period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable from future income, including anticipated investment income, after providing for losses and expenses included in future income that are expected to be incurred, based upon historical and current experience. If such costs are estimated to be unrecoverable, they are expensed.
The Company adopted the provisions of Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets" on January 1, 2002. SFAS No. 142 eliminates the practice of amortizing goodwill through periodic charges to earnings and establishes a two-step impairment test to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). As a result of the impairment analysis, no change in the carrying amount of goodwill was recorded by the Company for the year ended December 31, 2002. Goodwill amortization was $1.5 million for the years ended December 31, 2001 and 2000, respectively.
Premiums are generally earned on a pro rata basis over the terms of the policies. Premiums applicable to the unexpired terms of the policies in-force are reported as unearned premiums. The Company records an allowance for doubtful accounts for premiums receivable balances estimated to be uncollectible. At December 31, 2002 and 2001 the allowance for doubtful accounts amounted to $1.7 million and $1.0 million, respectively.
Accounting Principles: The Codification of Statutory Accounting Principles provides guidance for areas where statutory accounting was previously silent and changed previous statutory accounting in some areas (e.g., deferred income taxes,
electronic data processing equipment and software, and uncollected premiums). The Insurance Departments of Pennsylvania and Florida adopted the Codification guidance, effective January 1, 2001. The effect of adoption of the Codification of Statutory Accounting Principles, recorded as a direct increase to the Company's combined statutory unassigned surplus of it's subsidiaries, was $15.7 million.
- - Under SAP, premiums receivable are considered nonadmitted if determined to be uncollected based upon aging criteria as defined in SAP.
- - Under SAP, the costs and related recoverables for guaranty funds and other assessments are recorded based on management's estimate of the ultimate liability and related recoverable settlement, while under GAAP, such costs are accrued when the liability is probable and reasonably estimatable and the related recoverable amount is based on future premium collections or policy surcharges from in-force policies.
Financial Information: The combined statutory capital and surplus of the Insurance Subsidiaries as of December 31, 2002 and 2001 was $312.6 million and $281.0 million, respectively. Combined statutory net income for the years ended December 31, 2002, 2001 and 2000 was $14.5 million, $28.3 million, and $26.2 million, respectively. The Company made capital contributions of $20.0 million and $73.0 million to the Insurance Subsidiaries for the years ended December 31, 2002 and 2001, respectively.
Dividend Restrictions: The Insurance Subsidiaries are subject to various regulatory restrictions which limit the maximum amount of annual shareholder dividends allowed to be paid. The maximum dividend which the Insurance Subsidiaries may pay to Philadelphia Insurance during 2003 without prior approval is $31.7 million. Dividends paid for the years ended December 31, 2002 and 2001 were $5.1 million and $16.8 million, respectively.
The Company invests primarily in investment grade fixed maturities which possessed an average quality rating of AA+ at December 31, 2002. The cost, gross unrealized gains and losses and estimated market value of investments as of December 31, 2002 and 2001 are as follows (in thousands):
The Company had no debt or equity investments in a single issuer totaling in excess of 10% of shareholders' equity at December 31, 2002.
The cost and estimated market value of fixed maturity securities at December 31, 2002, by remaining contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The sources of net investment income for the years ended December 31, 2002, 2001, and 2000 are as follows (in thousands):
The following table summarizes property and equipment at December 31, 2002 and 2001 (dollars in thousands):
Included in property and equipment are costs incurred in developing or purchasing information systems technology of $8.2 million and $6.3 million in 2002 and 2001, respectively. Amortization of these costs was $1.0 million, $0.8 million and $0.6 million for the years ended December 31, 2002, 2001 and 2000, respectively. Depreciation expense, excluding amortization of capitalized information systems technology costs, was $1.5 million, $1.4 million and $1.4 million, for the years ended December 31, 2002, 2001, and 2000, respectively.
During 2001, as a result of changes in estimates of insured events in prior years, the Company increased losses and loss adjustment expenses incurred by $13.4 million. Such development was primarily due to losses emerging at a higher rate on automobile leases expiring in 2001 on residual value policies underwritten in prior years than had been originally anticipated when the initial reserves were estimated.
The Company had aggregate borrowings of $39.1 million and $31.3 million as of December 31, 2002 and 2001, respectively, from the Federal Home Loan Bank of Pittsburgh. These borrowings bear interest at adjusted LIBOR and mature twelve months from inception. The proceeds from these borrowings were invested in asset backed securities and collateralized mortgage obligations to achieve a positive spread between the rate of interest on these securities and the borrowing rates. The weighted-average interest rate on borrowings outstanding as of December 31, 2002 was 1.54%.
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2002 and 2001 are as follows (in thousands):
The number of weighted share equivalents not included in the weighted-average share equivalents outstanding calculation amounted to 9,620, 122 and 20,291 for the years ended December 31, 2002, 2001 and 2000, respectively.
The following table is presented in accordance with SFAS No. 148. The Company uses the Black-Scholes pricing model; to calculate the fair value of the options awarded as of the date of grant.
Preferred Agents Stock Purchase Plan ("Preferred Agents Plan"): The Preferred Agents Plan has been established for the benefit of eligible Preferred Agents. The aggregate maximum number of shares that may be issued pursuant to the Preferred Agents Plan is 200,000. Eligible Preferred Agents during designated offering periods may either remit cash or have the Company withhold from commissions or other compensation amounts to be used for the purchase of shares under the terms of the Preferred Agents Plan at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. Under the Preferred Agents Plan, the Company issued 10,966 and 0 shares in 2002 and 2001, respectively. The weighted-average fair value of those purchase rights granted in 2002 was $6.07.
The following represents pro forma information as if the Company recorded compensation costs using the fair value of the issued compensation instruments (the results may not be indicative of the actual effect on net income in future years) (in thousands, except per average common share data):
During the three years ended December 31, 2002, the Company repurchased 0.9 million shares for approximately $15.0 million under its stock repurchase authorization. At December 31, 2002, $25.0 million remains under a $55.0 million stock purchase authorization.
The Company has a defined contribution Profit Sharing Plan, which includes a 401K feature, covering substantially all employees. Under the plan, employees may contribute up to an annual maximum of the lesser of 15% of eligible compensation or the applicable Internal Revenue Code limit in a calendar year. The Company makes a matching contribution in an amount equal to 75% of the participant's pre-tax contribution, subject to a maximum of 6% of the participant's eligible compensation. The Company may also make annual discretionary profit sharing contributions at each plan year end. Participants are fully vested in the Company's contribution upon completion of four years of service. The Company's total contributions to the plan were $0.8 million, $0.6 million and $0.6 million in 2002, 2001, and 2000, respectively.
At December 31, 2002 the Company has open commitments of $4.5 million under certain limited partnership and information technology development agreements. The future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2002 were as follows (in thousands):
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 2002 and 2001 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown (in thousands, except share and per share data):
(3) Net Realized Investment Gain (Loss) for the three months ended June 30, 2001 and December 31, 2001 includes non-cash realized losses of $4.3 million and $1.5 million, respectively, as a result of impairment evaluations.