In July 1998, the Company entered into a lease covering approximately 95,000 square feet of office space for its Company headquarters. The lease is for a term of 10 years ending in 2009 and the Company has options to renew the lease for an additional 10 years. The Company moved its headquarters and principal operations to these offices in March 1999.
Certain statements in this report on Form 10-K that are not historical in fact constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors based on the Company’s estimates and expectations concerning future events that may cause the actual results of the Company to be materially different from historical results or from any results expressed or implied by such forward-looking statements. These risks and uncertainties, as well as the Company’s critical accounting policies, are discussed in more detail under “Business-Risk Factors,” “Management’s Discussion and Analysis-Overview,” and “Management’s Discussion and Analysis-Critical Accounting Policies” and in periodic filings with the Securities and Exchange Commission.
The Company’s insurance business is organized into two reportable business segments: direct healthcare liability insurance and assumed reinsurance operations. Primarily due to significant losses on medical malpractice insurance outside of the state of California and assumed reinsurance business losses arising out of the September 11, 2001 World Trade Center terrorist attack, the Company has incurred losses since 2001. The resulting reductions in surplus and corresponding decrease in capital adequacy ratios under both the A.M. Best Company (A.M. Best) and National Association of Insurance Commissioners (NAIC) capital adequacy models required the Company to take actions to improve its long-term capital adequacy position. The primary actions taken by the Company were to effect an orderly withdrawal from healthcare liability insurance markets outside of California and Delaware and from the assumed reinsurance market in its entirety. At December 31, 2003, the Company had only 379 healthcare liability insurance policies remaining in force in these other markets, all of which expired during the first quarter of 2004. In December 2002, the Company entered into a 100% quota share reinsurance agreement to retrocede to another insurer the majority of reinsurance business written in 2002 and 2001. During 2003, the Company participated in only one ongoing reinsurance syndicate and had no ongoing reinsurance participation in 2004. The Company continues to settle and pay claims incurred in the non-core healthcare and assumed reinsurance operations.
A decline in the fair value of an available-for-sale security below cost that is judged to be other than temporary is realized as a loss in the current period and reduces the cost basis of the security.
The Company believes it is more likely than not that the deferred income tax assets will be realized through its future earnings. As a result, the Company has not recorded a valuation allowance. The Company’s core operations have historically been profitable on both a GAAP and tax basis. The losses incurred in 2001 to 2004 have been primarily caused by losses in the non-core healthcare and assumed reinsurance businesses. Since the core healthcare liability operation has remained strong and improved over the past years and the non-core healthcare liability and assumed operations are now in run-off, the Company believes it should return to a position of taxable income, thus enabling it to utilize the net operating loss carryforward.
During 2005, the Company will continue to concentrate its efforts on its core physician and medical group business in California and Delaware and settling outstanding claims in the non-core business. The Company does not expect to initiate any significant new programs outside California during 2005.
Ultimate loss experience in this segment is based primarily on reports received by the Company from the underlying ceding insurers. Actual losses may take several years to be reported through the system. In 2001, the unprecedented September 11, 2001, terrorist attack materially impacted the results in this segment. The Company identified losses of $19.6 million, net of reinsurance benefit as of December 31, 2001, and an additional $15.4 million, $7.2 million, and $1.1 million in losses have been recorded in 2002, 2003, and 2004, respectively.
GoshawK, the parent of Rosemont, suffered serious underwriting losses in late 2003. As a result, the Company incurred significant losses attributable to its participation in the GoshawK underwriting syndicate and a $9.6 million loss in its holdings of GoshawK capital stock. The losses suffered by GoshawK did not materially affect the financial condition of Rosemont Re.
The Company made good progress in 2004 in settling claims related to the non-core healthcare liability business in run-off. Total net reserves declined from $145.3 million at December 31, 2003 to $97.4 million at December 31, 2004 and outstanding claims fell from 739 at December 31, 2003 to 431 at December 31, 2004. In total only 78 new claims were reported in 2004 compared to 244 in 2003.
The Assumed Reinsurance Segment premiums written declined 84% in 2003 from 2002 as the full impact of the retrocession to Rosemont Re took effect. Premiums written in 2004 relate to the one remaining syndicate supported in 2003. Premiums earned decreased to $14.6 in 2004, from $32.4 million in 2003 and from $122.5 million in 2002 because of reduction in treaty programs to one account and the cession of premiums written to Rosemont Re.
Net loss reserves related to the assumed reinsurance segment declined from $106.3 million at December 31, 2003 to $87.8 million at December 31, 2004 as reserves were settled and 2001 underwriting years for the London syndicates closed and settlements were made in 2004.
The retroactive accounting treatment required under FASB 113 requires that a charge to income be recorded to the extent premiums ceded under the contract are in excess of the estimated losses and expenses ceded under the contract.
Rosemont Re has an A- rating from A.M. Best and the cession of business to Rosemont Re is on a funds withheld basis whereby premiums ceded under the contract are kept in trust to collateralize Rosemont Re’s obligations to the Company.
Net investment income decreased to $20.7 million for 2004 from $22.2 million in 2003 and $32.2 million in 2002. The decrease in net investment income is primarily related to the decline in average invested assets resulting from lower premiums and loss payments related to the non-core healthcare liability and assumed reinsurance businesses. In addition, the net investment income in 2003 was impacted by a lower rate of return after tax on invested assets due to the significant realized gains recognized in the latter half of 2002. The lower rate reflected the rates available for reinvestment at the time as the quality of the portfolio was maintained.
The Company currently has a net deferred tax asset of $48.5 million as of December 31, 2004, of which $24.3 million relates to a net operating loss carryforward which expires in 2021. The Company will be able to utilize this carryforward to reduce taxes in future periods. The losses in recent years which gave rise to the operating loss carryforward were primarily generated by underwriting losses in the non-core direct healthcare liability and assumed reinsurance businesses. Since these operations are now in run-off and the core business has historically been profitable on both a GAAP and tax basis after consideration of investment income, the Company’s projections indicate that it is more likely than not that the net operating carryforward will be fully utilized within the carryforward period.
Because of uncertainty related to the timing of the payment of claims, cash from operations for a property and casualty insurance company can vary substantially from period to period. During 2004, 2003 and 2002, the Company had negative cash flow from operations of $63.3 million, $46.8 million and $24.5 million, respectively. The negative cash flow during this period is primarily related to the declining premium receipts and the increasing claims payments associated with the non-core physician and assumed reinsurance programs, which are now in run-off. As the Company continues to pay-off non-core healthcare liability and assumed reinsurance reserves generated by prior years written premiums, the Company may continue to have negative cash flow from operations.
SCPIE Holdings is an insurance holding company whose assets primarily consist of all of the capital stock of its Insurance Subsidiaries. Its principal sources of funds are dividends from its subsidiaries and proceeds from the issuance of debt and equity securities. The Insurance Subsidiaries are restricted by state regulation in the amount of dividends they can pay in relation to earnings or surplus, without the consent of the applicable state regulatory authority, principally the California Department of Insurance. SCPIE Holdings’ principal insurance company subsidiary, SCPIE Indemnity, may pay dividends to SCPIE Holdings in any 12-month period, without regulatory approval, to the extent such dividends do not exceed the greater of (i) 10% of its statutory surplus at the end of the preceding year or (ii) its statutory net income for the preceding year. Applicable regulations further require that an insurer’s statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs, and permit the payment of dividends only out of statutory earned (unassigned) surplus unless the payment out of other funds receives regulatory approval. The amount of dividends that SCPIE Indemnity is able to pay to SCPIE Holdings during 2005 without prior regulatory approval is approximately $13.7 million.
Common stock dividends paid to stockholders were $0.40 per share in 2003. These dividends were funded through dividends received from the Insurance Subsidiaries in prior years. In March 2004, the Board of Directors suspended the Company’s quarterly dividends. The payment
The Company has certain contractual obligations and commercial commitments principally for providing letters of credit in connection with its assumed reinsurance segment and operating leases for office space for its headquarters and other regional offices. The table below presents the contractual payments due by period or expiration period for each obligation or commitment:
In November 2001, the Company arranged a letter of credit facility in the amount of $50 million with Barclays Bank PLC. Letters of credit issued under the facility fulfill the requirements of Lloyd’s and guarantee loss reserves under reinsurance contracts. As of December 31, 2004, letter of credit issuance under the facility was approximately $45.4 million. Securities of $52.1 million are pledged as collateral under the facility.
The Company’s Consolidated Financial Statements and related notes, including supplementary data, are set forth in the “Index” on page 49 hereof.