Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations --------------
The Company's investment policy limits investments in any one issuer. This limit was raised from $1,500,000 to $2,000,000 in 1999. This limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues.
Dividends paid by Crusader to Unico were $2,000,000 in 1999 and $1,500,000 in 1998. These funds were invested by Unico in U.S. treasury notes and high grade commercial paper.
Crusader's statutory capital and surplus as of December 31, 1999, was $40,952,456, an increase of $3,341,367 (9%) over December 31, 1998. Crusader's statutory capital and surplus as of December 31, 1998, was $37,611,253, an increase of $6,711,328 (22%) over December 31, 1997.
YEAR 2000 - --------- Subsequent to December 31, 1999, the Company has not experienced adverse effects as a result of Year 2000 issues from either internal or external sources. However, due to the unusual nature of the problem and lack of historical experience with Year 2000 issues, it is difficult to predict with certainty if there may be other computer or infrastructure problems which may occur and affect the Company and its' customers or suppliers.
General - ------- The Company had net income of $5,131,366 for the year ended December 31, 1999, compared to $8,708,669 for the year ended December 31, 1998, and $7,654,362 for the year ended December 31, 1997. Total revenue for the year ended December 31, 1999, was $40,734,257 compared to $47,544,270 for the year ended December 31, 1998, and $48,290,721 for the year ended December 31, 1997.
For the year ended December 31, 1999, income before taxes decreased by $5,630,009 (44%) and net income decreased by $3,577,303 (41%) compared to the year ended December 31, 1998. The decrease in pre-tax income was primarily due to a decrease of $5,104,399 (65%) in the underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader.
For the year ended December 31, 1998, income before taxes increased by $1,765,865 (16%) and net income increased by $1,054,307 (14%) compared to the year ended December 31, 1997. The increase in pre-tax income was primarily due to an increase of $1,347,619 (21%) in the underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader and an increase in investment income of $735,642 (15%) (excluding realized investment gains).
The effect of inflation on the net income of the Company during the year ended December 31, 1999, was not significant.
The Company's future writings and growth are dependent on market conditions, competition, the Company's ability to introduce new profitable products, and its ability to expand geographically. As of December 31, 1999, Crusader was licensed as an admitted insurance company in the states of Arizona, California, Colorado, Montana, Nevada, Oregon, and Washington and is approved as a non-admitted surplus lines writer in several other states.
Health and Life Insurance Program - --------------------------------- Commission income from the health and life insurance sales of NIB and AIB is as follows: Year ended December 31 ---------------------- 1999 1998 1997 ---- ---- ---- Commission income $2,668,582 $2,216,446 $2,083,782
Group health and life insurance programs - The increase in commission income in the health and life insurance programs is primarily a result of an increase in sales of small business group accounts for CIGNA, an increase in the number of small business accounts administered by the Company for CIGNA, and a bonus commission of $143,191 received from CIGNA. The Company has increased the number of CIGNA products available to small groups, including life insurance and dental plans, in order to acquire new accounts and retain existing accounts.
Service Fee Income - ------------------ Unifax sells and services insurance policies for Crusader. The service fee charged to the policyholder by Unifax is recognized as income in the consolidated financial statements. The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected in commission income or commission expense.
The daily automobile rental insurance program commission and fee income (excluding contingent commission) decreased in 1999 primarily due to continued price competition in the daily automobile insurance market. To avoid underwriting losses for the non-affiliated insurance company that Bedford represents, it continues to produce business only at rates which it believes to be adequate. The Company cannot determine how long this "soft market" condition will continue.
Association Operation - --------------------- Membership and fee income from the association program of AAQHC is as follows:
Other Commission and Fee Income - ------------------------------- Unifax produced commercial auto policies in California for a non-affiliated insurer and received a commission from them based on premium written. Unifax also received a policy service fee from the insured. In February 1997, management decided to discontinue writing new policies in the Unifax commercial automobile program and only serviced and renewed existing policies until the book of business was sold to a non-affiliated third party in June 1997. As consideration for the sale of this book of business, Unifax received a percentage of the commission earned for a two-year period on policies which were in force at the time of sale. Revenue for the years ended December 31, 1999 and December 31, 1998, represents net commissions received on the sale of the commercial auto program.
Premium Finance Program - ----------------------- Premium finance charges and late fees earned from financing policies are as follows: Year ended December 31 ---------------------- 1999 1998 1997 ---- ---- ---- Premium finance charges and late fees earned $915,940 $1,033,479 $1,191,503 New loans 7,597 8,092 8,615
AAC provides premium financing primarily to Crusader policies produced by Unifax in California. The growth of this program is dependent and directly related to the growth of Crusader's written premium and AAC's ability to market its competitive rates and service to finance those policies. Due to the intense competition in the market place Unifax has produced fewer policies which has resulted in fewer policies being financed by AAC.
Premium finance charges and late fees earned on loans decreased $117,539 (11%) in the year ended December 31, 1999, compared to the year ended December 31, 1998. The decrease was primarily a result of fewer policies being financed due to a decrease in policies being written by Crusader and an overall decrease in the number of policyholders financing policies. For the year ended December 31, 1998, premium finance charges and late fees earned on loans decreased $158,024 (13%) compared to the year ended December 31, 1997, also as a result of fewer policies being written by Crusader.
Year ended December 31 ---------------------- 1999 1998 1997 ---- ---- ---- Interest and dividend income Insurance company operations $5,706,945 $5,497,323 $4,855,580 Other operations 283,942 234,580 140,681 --------- --------- -------- Total interest and dividend income 5,990,887 5,731,903 4,996,261 Net realized investment gains 64,793 247,931 25,093 --------- -------- -------- Total investment income and realized gains $6,055,680 $5,979,834 $5,021,354 ========= ========= =========
Investment interest and dividends earned (excluding net realized gains) increased $258,984 (5%) in the year ended December 31, 1999, compared to the year ended December 31, 1998, primarily as a result of additional invested assets from operating activities. Average invested assets in the year ended December 31, 1999, (at amortized value) increased $6,400,046 (7%) compared to the year ended December 31, 1998. Investment income return based on average invested assets was 5.74% for the year ended December 31, 1999, compared to 5.85% for the year ended December 31, 1998. The mix of taxable and tax-exempt securities in the portfolio affect the above investment income return percentage. Tax-exempt securities, which generally carry a lower yield than taxable securities, decreased to $28,078,605 (27% of total investments) at December 31, 1999, compared to $34,144,344 (33% of total investments) at December 31, 1998.
Investment interest and dividends earned (excluding net realized gains) increased $735,642 (15%) in the year ended December 31, 1998, compared to the year ended December 31, 1997, primarily as a result of additional invested assets from operating activities. Average invested assets in the year ended December 31, 1998, (at amortized value) increased $11,294,733 (13%) compared to the year ended December 31, 1997. Investment income return based on average invested assets was 5.85% for the year ended December 31, 1998, compared to 5.77% for the year ended December 31, 1997. Tax-exempt securities decreased to $34,144,344 (33% of total investments) at December 31, 1998, compared to $38,361,279 (41% of total investments) at December 31, 1997.
Salaries and Employee Benefits increased $135,797 (3%) for the year ended December 31, 1999, compared to the year ended December 31, 1998. Salaries and employee benefits increased $457,794 (12%) in the year ended December 31, 1998, compared to the year ended December 31, 1997.
Consolidated Statements of Comprehensive Income for the years ended December 31, 1999, December 31, 1998, and December 31, 1997 27
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1999, December 31, 1998 and December 31, 1997 28
Consolidated Statements of Cash Flows for the years ended December 31, 1999, December 31, 1998, and December 31, 1997 29
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31
Nature of Business - ------------------ Unico American Corporation is an insurance holding company. Unico American Corporation and its subsidiaries (the "Company"), all of which are wholly owned, provides primarily in California, property, casualty, health and life insurance, and related premium financing.
Cash and Short-Term Investments - The carrying amounts reported in the balance sheet for these instruments approximate their fair values.
Year ended December 31 ---------------------- 1999 1998 ---- ---- Restricted Funds: Premium trust funds (1) $3,071,696 $2,867,099 Assigned to state agencies (2) 2,725,000 2,725,000 --------- --------- Total restricted funds $5,796,696 $5,592,099 ========= =========
Deferred Policy Acquisition Costs - --------------------------------- Policy acquisition costs consist of costs associated with the production of insurance policies such as commissions, premium taxes, and certain other underwriting expenses which vary with and are primarily related to the production of the insurance policy. Policy acquisition costs are deferred and amortized as the related premiums are earned and are limited to their estimated realizable value based on the related unearned premiums plus investment income less anticipated losses and loss adjustment expenses. Ceding commission applicable to the unexpired terms of policies in force are recorded as unearned ceding commission which is included in deferred policy acquisition costs.
Segment Reporting - ----------------- Statement of Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures about Segments of an Enterprise and Related Information," became effective for fiscal years effective after December 15, 1997. SFAS No. 131 establishes standards for the way information about operating segments is reported in financial statements. The Company has adopted SFAS No. 131 for the fiscal year ended December 31, 1998, and has identified its insurance company operation as its primary reporting segment. Revenues from this segment comprise 83.2% of consolidated revenues. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually insignificant to consolidated revenues.
The insurance company operation is conducted through Crusader, which as of December 31, 1999, is licensed as an admitted insurance carrier in the states of Arizona, California, Colorado, Montana, Nevada, Oregon and Washington. Crusader is a multiple line property and casualty insurance company which began transacting business on January 1, 1985. As of December 31, 1999, 97% of Crusader's business was commercial multiple peril business package insurance policies. Commercial multiple peril policies provide a combination of property and liability coverage for businesses and business property. Commercial property coverages insure against loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, hail,
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) - --------------------------------------------------------------- water, explosions, severe winter weather and other events such as theft and vandalism, fires and storms and financial loss due to business interruption resulting from covered property damage. Commercial liability coverages insure against third party liability from accidents occurring on the insured's premises or arising out of its operations, such as injuries sustained from products sold. Crusader also writes separate commercial property and commercial liability policies.
Deposit premiums represent funds received from the Company's daily automobile rental program which guarantee the payment of premiums for past coverage months. These deposits are required when information such as gross receipts or number of rental cars is required to compute the actual premium due, but is not available until after the coverage month.
Year ended December 31 ---------------------- 1999 1998 1997 ---- ---- ---- Fixed maturities $5,752,154 $5,463,418 $4,694,838 Equity securities 1,380 8,095 48,960 Short-term investments 238,017 260,725 253,053 --------- --------- --------- Total investment income 5,991,551 5,732,238 4,996,851 Less investment expenses 664 335 590 --------- --------- --------- Net investment income $5,990,887 $5,731,903 $4,996,261 ========= ========= =========
NOTE 3 - INVESTMENTS (continued) - -------------------------------- A summary of the unrealized appreciation (depreciation) on investments carried at market and the applicable deferred federal income taxes is shown below:
Amortized Estimated Cost Market Value ---- ------------ Due in one year or less $ 11,794,279 $11,830,167 Due after one year through five years 73,087,609 72,137,455 Due after five years through ten years 14,260,387 13,626,512 ---------- ---------- Total fixed maturities $99,142,275 $97,594,134 ========== ==========
Year ended December 31 ---------------------- 1999 1998 ---- ---- Certificates of deposit 425,000 $ 425,000 Commercial paper 2,675,000 3,425,000 Commercial bank money market accounts 2,055,254 694,834 U.S. government obligation money market fund 78,799 1,290,108 Short-term U.S. treasury note 731,281 735,346 Savings account 2,839 3,574 --------- --------- Total short-term investments $5,968,173 $6,573,862 ========= =========
Bad debt expense for the fiscal year ended December 31, 1999, and the fiscal year ended December 31, 1998, was $20,736 and $25,736, respectively. Premium finance notes receivable represent the balance due to the Company's premium finance subsidiary from policyholders who elect to finance their premiums over the policy term. These notes are net of unearned finance charges.
NOTE 6 - DEFERRED POLICY ACQUISITION COSTS - ------------------------------------------ Deferred policy acquisition costs consist of commissions (net of ceding commission), premium taxes, inspection fees, and certain other underwriting costs which are related to and vary with the production of Crusader Insurance Company policies. These costs are incurred by Crusader and include allocated expenses of other Unico subsidiaries. Policy acquisition costs are deferred and amortized as the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income, including investment income.
NOTE 7 - UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES - --------------------------------------------------- The following table provides an analysis of the rollforward of Crusader's losses and loss adjustment expenses, including a reconciliation of the ending balance sheet liability for the periods indicated:
(*) Decreases in incurred losses and loss adjustment expenses related to the indicated prior years reflect favorable loss experience during these years attributable to a number of combined factors which have produced favorable frequency and severity trends in recent years. In addition, actuarial assumptions based on historical trends have proven to be conservative. The above table shows favorable loss development decreased to $1,241,520 in 1999 from $4,860,647 in 1998. The decrease was primarily due to an increase in prior years losses incurred in 1999, which was greater than the prior years losses experienced in 1998. The methodology used by the Company in determining 1999 case reserves and IBNR is consistent with prior years.
NOTE 8 - CLAIMS AND LITIGATION - ------------------------------ The Company, by virtue of the nature of the business conducted by it, becomes involved in numerous legal proceedings as either plaintiff or defendant. The Company is also required to resort to legal proceedings from time to time in order to enforce collection of premiums, commissions, or fees for the services rendered to customers or to their agents. These routine items of litigation do not materially affect the Company and are handled on a routine basis by the Company through its general counsel.
NOTE 11 - LEASE COMMITMENT - -------------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The total rent expense under this lease agreement was $1,025,952 for the year ended December 31, 1999; $1,025,952 for the year ended December 31, 1998; and $1,025,952 for the year ended December 31, 1997.
In 1999, Crusader had reinsurance agreements with General Reinsurance Corporation, a California admitted reinsurer. In 1998, Crusader had reinsurance agreements with National Reinsurance Corporation (acquired by General Reinsurance Corporation in 1996) and NAC Reinsurance Corporation, both California admitted reinsurers. These reinsurance agreements help protect Crusader against liabilities in excess of certain retentions, including major or catastrophic losses that may occur from any one or more of the property and/or casualty risks which Crusader insures. Crusader also has additional catastrophe reinsurance from various other reinsurance companies of which 79% of the premium is ceded to participating catastrophe reinsurers that are admitted in California. Any catastrophe loss ceded to the reinsurer not admitted in California requires the reinsurer to immediately obtain a non-cancelable (Evergreen) letter of credit covering their ceded outstanding loss including any IBNR. Crusader's retention increased from $150,000 to $250,000 per risk on July 1, 1997. This retention is subject to a maximum dollar amount and to catastrophe and clash covers. The catastrophe and clash covers (subject to a maximum occurrence and annual aggregate amount) help protect the Company from one loss occurrence affecting multiple policies. Prior to January 1, 1998, National Reinsurance Corporation charged a provisional rate on exposures up to $500,000 that is subject to adjustment and is based on the amount of losses ceded, limited by a maximum percentage that could be charged. That provisional rated treaty was canceled and replaced by a flat rated treaty on January 1, 1998.
Premiums earned: Direct business $34,693,113 $40,615,417 $42,721,222 Reinsurance assumed - - - Reinsurance ceded $(6,583,752) $(5,700,222) $(6,394,328)
Year ended December 31, 1999 $653,389 Year ended December 31, 1998 $563,160 Year ended December 31, 1997 $545,906
As of December 31, 1999 $40,952,456 As of December 31, 1998 $37,611,089
NOTE 15 - INCENTIVE STOCK PLANS - ------------------------------- The Company's 1985 stock option plan provided for the grant of incentive stock options to officers and key employees. The plan covered an aggregate of 1,500,000 shares of the Company's common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.). As of December 31, 1999, there were 101,415 options outstanding, and all are currently exercisable. Options granted under this plan had a life of either 5 or 10 years and had a vesting period of from immediate to 9 years. All options were granted at fair market value. There are no additional options available for future grant under the 1985 plan.
The Company's 1999 Omnibus Stock Plan that covers 500,000 shares of the Company's common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.) was approved by shareholders June 4, 1999. On August 26, 1999, the Company granted 135,000 options which are all outstanding as of December 31, 1999. These options expire ten years from the date of the grant and are not exercisable prior to September 1, 2000. Options covering 10,000 or less shares become exercisable at the rate of 2,500 share per year commencing September 1, 2000; and options covering more than 10,000 shares become exercisable at the rate of 5,000 share per year commencing September 1, 2000. None of the 135,000 options outstanding under the 1999 stock option plan are currently exercisable.
As explained in Note 1, the Company applies APB Opinion No. 25 in accounting for its incentive stock option plan. Accordingly, no compensation cost has been recognized in the statements of operations. Had compensation cost for the Company Plans been determined based on the fair value at the grant dates consistent with the method of SFAS No. 123, the Company's 1999 net income would have been reduced by $135,453. Net income for 1998 and 1997 were not affected. In addition, 1999 earnings per share (basic and diluted) would have been reduced by $0.02. Calculations of the fair value under the method prescribed by SFAS No. 123 were made using the Black-Scholes option-price model with the following weighted average assumptions used for the 1999 grant: dividend yield 2.46%, expected volatility of 43%, expected lives of 10 years, and risk-free interest rates of 6.09%.
NOTE 15 - INCENTIVE STOCK PLANS (continued) - ------------------------------------------- The following table summarizes information regarding the stock options outstanding at December 31, 1999:
Weighted Weighted Weighted Average Average Average Remaining Exercise Exercise Number of Contractual Price of Number of Price of Exercise Options Life Options Options Options Price Outstanding (Years) Outstanding Exercisable Exercisable ----- ----------- ----- ----------- ----------- ----------- $3.50 101,415 1.46 $3.50 101,415 $3.50 $9.25 135,000 9.65 $9.25 - -
Year ended December 31 ---------------------- 1999 1998 1997 ---- ---- ---- Current provision: Federal $1,668,332 $3,516,390 $2,900,181 State 21,577 179,521 184,020 --------- --------- --------- Total federal and state 1,689,909 3,695,911 3,084,201 Deferred 303,614 350,318 250,470 --------- --------- --------- Provision for taxes $1,993,523 $4,046,229 $3,334,671 ========= ========= =========
The income tax provision reflected in the consolidated statements of operations is less than the expected federal income tax on income as shown in the table below: Year ended December 31 ----------------------- 1999 1998 1997 ---- ---- ---- Computed tax expense $2,422,462 $4,336,665 $3,736,270 Tax effect of: Tax exempt income (425,963) (490,783) (522,813) Dividend exclusion (279) (1,638) (9,905) Other (23,334) 23,525 (54,971) State income tax expense 20,637 178,460 186,090 --------- --------- --------- Tax per financial statement $1,993,523 $4,046,229 $3,334,671 ========= ========= =========