The selected data presented below under the captions "Income Statement Data" and "Balance Sheet Data" as of and for each of the years in the five-year period ended December 31, 2001, are derived from the consolidated financial statements of the Company, which financial statements have been audited by KPMG LLP, independent certified public accountants. The consolidated financial statements as of December 31, 2001 and 2000 and for each of the years in the three-year period ended December 31, 2001, and the report thereon are included elsewhere herein. The information presented below under the caption "Other Data" is unaudited. The selected financial data set forth below should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results
(1)See Note 1 of Notes to Consolidated Financial Statements for a description of the calculation of weighted average shares outstanding and earnings (loss) per share.
(5)Beginning in the fourth quarter of 2001, PAULA Financial began accounting for its investment in PICO using the equity method. Consequently, consolidated operating results of the Company only reflect the result of PICO's operation in the individual income and expense line items for the first nine months of 2001 while the fourth quarter activity is reflected as equity in net loss of PICO. Additionally, PICO's balance sheet amounts are excluded from the consolidated financial statements at year-end. However, the statutory results for PICO include PICO's results of operations for the entire year.
Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates, assumptions and judgments 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 applicable period. On an ongoing basis, management evaluates its estimates, assumptions and
judgments, including those related to revenue recognition, intangible assets, income taxes, financing arrangements and contingencies. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
(1)Beginning in the fourth quarter of 2001, PAULA Financial began accounting for its investment in PICO using the equity method. Consequently, combined ratio activity in the above table only reflects PICO's operations for the first nine months of 2001 and therefore excludes the impact of the $37 million increase in prior year loss reserves posted in the fourth quarter.
Beginning in the fourth quarter of 2001, PAULA Financial began accounting for its investment in PICO using the equity method. Consequently, consolidated operating results of the Company only reflect the result of PICO's operation in the individual income and expense line items for the first nine months of 2001 while the fourth quarter activity is reflected as equity in net loss of PICO.
Commission income. Commission income increased 48.4% to $9.4 million for 2001 from $6.3 million for 2000. Commissions paid by PICO to Pan Am in the first nine months of 2001 are eliminated in consolidation while such commissions are eliminated in consolidation for the full year of 2000. Also contributing to the increase is rate increases on underlying workers' compensation and accident and health policies as well as increased premiums placed with insurance carriers other than PICO.
Net investment income. Net investment income decreased 44.4% to $5.7 million for 2001 from $10.3 million for 2000. The 2001 results only include PICO investment income for the first nine months of 2001 compared to twelve months of activity in 2000. Also contributing to the decline, average invested assets decreased to $75.0 million for 2001 from $146.8 million for 2000. The Company's average yield on its portfolio was 7.4% in 2001 and 7.0% in 2000. The 2001 average yield is skewed by the de-consolidation of PICO in the fourth quarter of 2001. The 2000 average yield is skewed by the increase in the Company's investment portfolio in January 2000. The increase in the portfolio early in the year understated the Company's average total invested assets for 2000. The actual yields in 2001 and 2000 are closer to historical levels.
Service fees. Service fees increased 781.2% to $1.9 million for 2001 from $0.2 million for 2000. The increase is due to the de-consolidation of PICO in the fourth quarter of 2001. Prior to de-consolidation fees paid by PICO to the TPA were eliminated in consolidation.
For the entire year in 2001, PICO experienced an aggregate of approximately $43.1 million in net reserve development compared to $21.2 million in 2000. The continued reserve development on prior accident years relates primarily to the 1998-2000 accident years. The adverse development relates primarily to the California operations. Similar to the claims development experienced by the California workers' compensation insurance industry in general, PICO has seen ongoing expansion in incurred claims values, primarily related to medical inflation and litigation activity. Also contributing to the adverse loss reserve development on the 1999 and 2000 accident years are the Texas operations.
Operating expenses. Operating expenses decreased 38.4% to $21.2 million for 2001 from $34.5 million for 2000. Contributing to the decease is the fact that PICO expense are only included in the consolidated financial statements for the first nine months of 2001 compared to a full year in 2000. Additionally, operating expenses in 2001 include the benefit of $6.3 million in ceding commissions compared to $1.2 million in 2000 received in conjunction with the quota share arrangements. The GAAP expense ratio for 2001 was 28.3% compared to 27.2% for 2000.
Equity in net loss of PICO. Beginning in the fourth quarter of 2001, PAULA Financial began accounting for its investment in PICO using the equity method. Consequently, the equity in net loss of PICO in 2001 represents PICO's results for the fourth quarter of 2001. As of December 31, 2001, PAULA Financial was carrying its investment in PICO at $-0-.
Income taxes. Income tax benefit for 2001 was $6.8 million compared to $3.4 million for 2000. The effective combined income tax rates for 2001 and 2000 were (18.0%) and (15.1%), respectively. The 2001 and 2000 effective tax rates are impacted by a change in valuation allowance of $6.2 million and $4.6 million, respectively. The recoverability of the net deferred tax asset is dependent on Pan Am's anticipated future operating results and various tax planning strategies.
Net realized investment gains and losses. The Company had net realized investment losses of $5.6 million for 2000 compared to $1.5 million for 1999. In 2000, the Company recorded an impairment loss of $3.3 million related to its investment in Montlake. In 1999 the Company realized an "other than temporary" decline of $1.6 million on a non-performing investment.
In March 1997, PAULA Financial entered into a Credit Agreement with a commercial bank providing PAULA Financial with a revolving credit facility of $15.0 million until December 31, 1999. On December 31, 1999, PAULA Financial elected to convert all of the borrowings into a term loan maturing on December 31, 2001. At the date of conversion, the line of credit had an outstanding balance of $15.0 million and an interest rate of 8.5%. The use of the credit facility was for repurchase of the Company's common stock and investments in new ventures.
On January 30, 2001, the Company and the lender completed negotiations and signed the first Amendment to the Credit Agreement (the "First Amendment"). Under the terms of the First Amendment, the Company was scheduled to make principal payments of $6.9 million with the $4.4 million balance due on December 31, 2001. The Company made principal payments totaling $7.2 million in 2001.
On December 31, 2001, the Company and the lender completed negotiations and signed the second Amendment to the Credit Agreement (the "Second Amendment"). Under the terms of the Second Amendment, the Company will make principal payments totaling $1.3 million during 2002 with the remaining principal balance of $2.8 million due on January 1, 2003. Balances outstanding under the term loan bear interest at the lender's reference rate plus 2.0%. As of March 15, 2002, the interest rate is 6.75%.
Management believes that funds currently available and expected to be generated by agency operations will be sufficient to meet the required principal and interest payments on the term loan in 2002. The Company has plans to refinance the January 1, 2003 payment. Management believes that such financing is available and can be obtained under appropriate and reasonable terms.
In 2001, Pan Am placed 16% of its total insurance premiums with PICO. In 2002 Pan Am will focus on the transition initiated by PICO and its exit from workers' compensation underwriting. Pan Am has successfully moved PICO business to alternative markets over several years and management believes that completing this process does not pose a material problem to customer retention or total commissions. (It was PICO's practice to pay a market based commission, so Pan Am should not suffer any reduction of commission to rotate business formerly underwritten by its affiliate.)
California workers' compensation insurance companies are required to maintain some of their investments on deposit with the California DOI for the protection of policyholders. The deposit requirements are generally determined annually based on loss and LAE reserve levels and are designed to insure that funds are available for the future payment of claim obligations. Other states in which PICO is licensed have also required PICO to post deposits for the protection of those states' policyholders. In October 2001, PICO applied for and received the early release of $15.0 million in investment securities held on deposit by the California DOI. In 2001, PICO made claim payments for prior accident years totaling $83.1 million. In December 2000, PICO applied for and received the early release of $13.4 million in investment securities held on deposit by the California DOI. In 2000, PICO made claim payments for prior accident years totaling $85.9 million. As these obligations were paid, there was a corresponding reduction in the deposit requirement. However, in practice the deposit requirement calculations are only performed annually based on year-end balances. The release of deposits in late 2001 and 2000 represents an acceleration in the timing of the release of funds and not an exception to the deposit requirement. Pursuant to applicable state laws, PICO had, as of December 31, 2001, securities with a book value of $89.7 million held by authorized depositories pursuant to these deposit requirements.
Since 1999, the Company's agency operations have outsourced certain backroom functions to a service center operation. Additionally, the agency which operates the service center placed business with PICO. In 2001, a partial owner of this agency was elected to the Company's board of directors. Fees paid by the Company's agency to the service center were $1.1 million, $1.0 million and $0.9 million for the years ended December 31, 2001, 2000 and 1999, respectively. Commissions paid by PICO to this agency were $0.6 million, $0.8 million and $0.8 million for the years ended December 31, 2001, 2000 and 1999, respectively. Additionally, the Company has a $0.7 million minority investment in the agency.
In 2001, the shareholders elected to the Company's board of directors a director who also has a significant ownership interest in an agency that placed business with PICO. Commissions and other fees paid by PICO to this agency were $0.1 million, $0.1 million and $0.2 million for the years ended December 31, 2001, 2000 and 1999, respectively.
In connection with, and because it desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers to recognize the existence of certain forward-looking statements in this Form 10-K and in any other statement made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Some forward-looking statements may be identified by the use of terms such as "expects," "believes," "anticipates," "intends," or "judgment." Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties, many of which are beyond the Company's control and many of which, with respect to future business decisions, are subject to change. Examples of such uncertainties and contingencies include, among other important factors, those affecting the insurance industry in general, such as the economic and interest rate environment, legislative and regulatory developments and market pricing and competitive trends, and those relating specifically to the Company and its businesses, such as the level of commission revenue and fee income, and acquisitions of companies or blocks of business. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. The Company disclaims any obligation to update forward-looking statements.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PAULA Financial and subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.
Additionally, in 2001, PAULA Financial liquidated its investment in PAULA Assurance Company ("PACO") and surrendered its insurance license to the state of California.
In 2001, approximately 89% of the Company's agency commission revenue was generated in the state of California while approximately 52% of commission revenue was derived from the workers' compensation line of business.
Beginning in the fourth quarter of 2001, the Company began accounting for its investment in PICO using the equity method. Consequently, PICO's balance sheet amounts are excluded from the consolidated financial statements at year-end and the consolidated operating results of the Company only reflect the result of PICO's operation in the individual income and expense line items for the first nine months of 2001 while the fourth quarter activity is reflected as equity in net loss of PICO. As of December 31, 2001, PAULA Financial is carrying its investment in PICO at $-0-.
assets and liabilities as of the date of the consolidated financial statements and revenues and expenses for the period. Actual results could differ significantly from those estimates.
The entire investment portfolio was classified as available-for-sale and was reflected at estimated fair value with unrealized gains and losses recorded as a separate component of stockholders' equity, net of related deferred income taxes. The premium and discount on fixed maturities and collateralized mortgage obligations were amortized using the interest method. Amortization and accretion of premiums and discounts on collateralized mortgage obligations were adjusted for principal paydowns and changes in expected maturities. Investments in which the decline in market value is deemed other than temporary are reduced to the estimated realizable value through a charge to income.
Commission income is recorded on the effective date of the policy or the billing date, whichever is later. Premiums are earned by the insurance subsidiaries on a monthly pro rata basis over the terms of the policies.
Leasehold improvements are depreciated on a straight-line basis over the term of the lease or the estimated useful life of the improvement if less than the lease term.
In early 1999, the Company made an investment in Montlake Insurance Holdings, LLC ("Montlake"), the parent company of Montlake Casualty Company, Ltd., a specialty workers' compensation insurance company. The Company made an initial investment of $5,500 for a 21% equity position and has the option to acquire additional equity. The Company is accounting for its investment
As of December 31, 2000, Montlake had total assets of $26,268 and net deficiency of $(3,157). For the year ended December 31, 2000, Montlake had a net loss of $6,493. Based on Montlake's unfavorable 2000 operating results, specifically adverse loss development at its Bermuda captive, which is in run-off, the Company has recorded an impairment loss of $3,273 to reduce the carrying value of its investment in Montlake to $-0- as of December 31, 2000.
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," modifies the accounting for goodwill and identifiable intangible assets. As of January 1, 2002, all goodwill and indefinite-lived intangible assets must be tested for impairment annually, or more frequently if circumstances indicate potential impairment. The Company has completed an analysis of the impact of the adoption of SFAS No. 142 and does not believe the adoption will have a material impact on the Company's consolidated financial statements.
Participating workers' compensation policies represented approximately 25%, 25%, and 18% of net written premium for the years ended December 31, 2001, 2000 and 1999, respectively. Dividends are
The EPS calculations for the years ended December 31, 2001, 2000 and 1999 were based upon the weighted average number of shares of common stock outstanding. The EPS-assuming dilution calculations were based upon the weighted average number of shares of common stock outstanding adjusted for the effect of convertible securities, and options and warrants considered common stock equivalents. Stock options and warrants are considered to be common stock equivalents, except when their effect is antidilutive.
The following table reflects the weighted average shares of common stock outstanding used in the EPS calculation as well as the EPS-assuming dilution calculation. (In loss periods options are
The NAIC has adopted a RBC formula for both property and casualty and life insurance companies. The formula calculates a minimum level of capital and surplus which should be maintained by each insurer. The formula is designed to allow state regulators to identify potentially under-capitalized companies. Under the formula, a company determines its RBC by taking into account certain risks related to the insurer's assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer's liabilities (including underwriting risks related to the nature and experience of its insurance business). The RBC rules provide for different levels of regulatory attention depending upon the ratio of the company's total adjusted capital to its "authorized control level" of RBC.
In addition to above, insurer is subject to examination, analysis and specific corrective action
In addition to both of the above, insurance commissioner may place insurer under regulatory control
The amortized cost and estimated fair value of investments in fixed maturities classified as available for sale at December 31, 2001 are as follows:
As of December 31, 2001 PICO held equity investments with a carrying value of $1,041. Gross unrealized investment losses on preferred stock at December 31, 2001 was $123. Gross unrealized investment losses on common stock at December 31, 2001 was $240.
As of December 31, 2001, PICO had $60,517 in short-term investments.
Fixed maturities and invested cash with a book value of $89,668 were on deposit with various regulatory authorities as of December 31, 2001 as required.
On a statutory basis, PICO reported a net loss of $(38,588) and capital and surplus of $(22,028) as of and for the year ended December 31, 2001.
The amortized cost and estimated fair value of investments in fixed maturities classified as available for sale at December 31, 2000 are as follows:
At December 31, 2000 the gross unrealized investment loss on preferred stock is $130.
Until August 2000, an affiliate of a significant holder of the Company's stock also acted as one of the Company's investment advisors. Fees paid for such investment services totaled $212 and $264 in 2000 and 1999 respectively.
The unfavorable incurred development for prior periods in 2000 in the liability for unpaid losses and loss adjustment expenses is principally due to reserve development on the 1998 accident year. The continued development on the 1998 accident year was largely attributable to extended claim durations
for the California book of business. To a lesser extent, the 1999 accident year also had adverse reserve development, principally related to experience in Texas.
At December 31, 2000 the Company had outstanding a note payable in the amount of $1,629. The unsecured note bore interest at 7.5% and matured in 2001.
On January 30, 2001, the Company and the lender completed negotiations and signed an Amendment to the Credit Agreement (the "First Amendment"). Under the terms of the First Amendment, the Company was scheduled to make principal payments totaling $6,874 during 2001. The remaining principal balance of $4,376 was due on December 31, 2001.
On December 31, 2001, the Company and the lender completed negotiations and signed a second Amendment to the Credit Agreement (the "Second Amendment"). Under the terms of the Second Amendment, the Company will make principal payments totaling $1,300 during 2002 with the remaining principal balance of $2,751 due on January 1, 2003. Balances outstanding under the term loan bear interest at the lender's reference rate plus 2.0%. As of March 15, 2002, the interest rate was 6.75%.
Each of the Company's non-insurance subsidiaries has guaranteed all obligations of PAULA Financial under the Credit Agreement. Additionally, under the terms of the First Amendment, the Company has pledged as collateral its stock in PICO.
Total interest paid by the Company on all notes during the years ended December 31, 2001, 2000 and 1999 was $675, $1,536 and $758, respectively.
The net operating loss carry forward includes losses generated by PICO in the fourth quarter of 2001 which are available to offset future taxable income of the Company. As of December 31, 2001 and 2000, the Company has established a $25,106 and $4,610, respectively, valuation allowance related to the net operating loss carry forward.
The Company received Federal income tax refunds of $672 and $326 during the years ended December 31, 2001 and 2000, respectively. The Company received Federal income tax refunds of $955 and made Federal income tax payments of $326 during the year ended December 31, 1999. As of December 31, 2001, the Company had state taxes payable of $25.
At December 31, 2001, the Company had a tax net operating loss carry forward of $88,547 that begins to expire in 2018.
A large portion of the reinsurance is effected under reinsurance contracts known as treaties. PICO maintains excess of loss and catastrophic reinsurance arrangements to protect it against losses above its retention on workers' compensation policies. Additionally, PICO has also chosen from time to time to quota-share a portion of its retained claims exposure. In a quota share reinsurance contract, the company and the reinsurer share premiums, losses and loss adjustment expenses on a proportional basis based on each party's interest in the quota-shared risk.
The maximum retention for each loss occurrence on workers' compensation policies is $250 subject to $2,000 in annual aggregate losses on the $250 excess $250 layer. In July 2000, PICO modified the terms of the deductible from a fixed $2,000 to 2.0% of earned premium.
In July 1998, PICO entered into an assumption agreement with the New Mexico Retail Association Self-Insured Group ("the SIG"). The agreement provides for the complete assumption by PICO of the SIG reserves outstanding as of July 1, 1998 as well as a 100% quota-share participation on policies in-force as of that date. The prospective piece of the treaty was accounted for as reinsurance. Premiums assumed under the prospective piece of this agreement were $-0-, $37 and $326 while loss incurred were $91, $237 and $13 for the years ended December 31, 2001, 2000 and 1999, respectively. The portion of the contract related to the loss portfolio transfer does not meet risk transfer requirements and has therefore been accounted for using the deposit method of accounting. At December 31, 2000, the related liability of $1,021 was included in accounts payable and accrued expenses in the accompanying consolidated financial statements.
In 1994, the Company adopted a stock incentive plan, reserving 550,000 shares of common stock, which provides for granting of stock options and restricted stock bonuses to officers and directors and key employees of the Company. Options and restricted stock are granted at the discretion of the Executive Compensation Committee of the Board of Directors. Prior to the initial public offering, options were granted at fair value as determined by the Executive Compensation Committee of the Board of Directors. At December 31, 2001, 3,100 shares of common stock were available for issuance under the 1994 plan.
In 1997, the Company adopted its 1997 Stock Incentive Plan, reserving 200,000 shares of common stock. In 2001, shares authorized under the 1997 plan were increased to 900,000 shares. At December 31, 2001, 577,536 shares of common stock were available for issuance under the 1997 plan.
Changes in the status of options granted under the 1994 plan are summarized as follows:
Association of Insurance Commissioners ("NAIC") as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state and may change in the future.
The Company leases buildings for its home office and certain other premises under long-term operating leases that expire in various years to 2005. Certain of these leases contain renewal provisions. Rent expense was $1,577, $2,087 and $1,950 for the years ended December 31, 2001, 2000 and 1999, respectively.
In the ordinary course of business, the Company's subsidiaries are defendants in various lawsuits. Management believes that the ultimate disposition of the litigation will not result in a material impact to the financial position or operating results of the Company.
Since 1999, the Company's agency operations have outsourced certain backroom functions to a service center operation. Additionally, the agency which operates the service center placed business with PICO. In 2001, a partial owner of this agency was elected to the Company's board of directors. Fees paid by the Company's agency to the service center were $1,123, $1,042 and $891 for the years ended December 31, 2001, 2000 and 1999, respectively. Commissions paid by PICO to this agency were $603, $814 and $752 for the years ended December 31, 2001, 2000 and 1999, respectively. Additionally, the Company has a $703 minority investment in the agency.
In 2001, the shareholders elected to the Company's board of directors a director who also has a significant ownership interest in an agency that placed business with PICO. Commissions paid by PICO
to this agency were $98, $89 and $193 for the years ended December 31, 2001, 2000 and 1999, respectively.