* As a result of Vesta’s decision to discontinue its health insurance and consulting business in 2002, its reinsurance assumed business in 2000 and its commercial business in 1999, all periods presented have been reclassified to present operations on a continuing and discontinued basis.
Vesta conducts business in three areas of the personal insurance industry: (1) standard property and casualty insurance; (2) non-standard automobile insurance; and (3) life insurance. Our consolidated revenue is derived principally from risk-bearing premiums, commissions and fees, investment income and investment gains and losses. Our consolidated expenses consist primarily of payments for claims and expenses associated with underwriting activities, agents’ commissions and operations.
Since 2000, we have pursued a strategy to diversify into various segments of the personal insurance markets. While we have experienced significant and profitable growth in various personal lines business since 2000, we have also experienced significant declines in our property and casualty subsidiaries’ statutory capital and surplus during the same period. These declines in capital and surplus are primarily attributable to lower than expected arbitration awards and changes in estimates of disputed reinsurance recoverable balances, reserve strengthening in our discontinued commercial and assumed reinsurance segments and increased policy acquisitions costs associated with significant premium growth. This decline is statutory surplus coupled with significant growth in premium written is the primary reason that A.M. Best Company recently adjusted the financial strength ratings of our property and casualty insurance subsidiaries from B+ (Very Good) to B (Fair). Management is unable to quantify the impact that this adjustment will have on our business; however, this adjustment could lead to significant deterioration in selected portions of our standard property and casualty premium volume and adversely impact the financial results of this segment going forward. In an effort to strengthen our statutory capital position, we have undertaken an evaluation of a possible sale or divestiture of a portion of our property and casualty business.
Subject to competitive and market trends and regulatory approval, premium rates are generally within our control, and we continuously monitor and seek to adjust rates as appropriate. During 2002, we implemented 21 rate increases in our standard automobile business line, which represented an average premium increase of approximately 11.6%. In 2002, we also implemented 23 rate increases in our standard residential property line, which represented an average premium increase of approximately 13.5%. With respect to volume, our ability to increase written premium in our property-casualty underwriting activities is largely dependent upon our surplus leverage ratio, which reflects our underwriting operations’ net written premiums relative to statutory surplus at the end of a period. As of December 31, 2002, our surplus leverage ratio did not indicate capacity for significant growth in our net premiums written, and, in March of 2003, we commenced an evaluation of a possible sale or divestiture of a portion of our property and casualty business in an effort to maximize shareholder value and strengthen our statutory capital position.
The costs we incur to adjust and pay claims, known as loss and loss adjustment expenses, are largely beyond our control and depend primarily upon the frequency and/or severity of claims made by our policyholders. One measure of performance in the insurance industry is the “loss ratio,” which is the ratio of (i) the sum of loss and loss adjustment expenses; to (ii) the sum of earned premiums and policy fees. Our loss ratio will generally increase or decrease according to the frequency and/or severity of claims made by our policyholders.
• SFAS No. 145, “Rescission of FASB Statement No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.”
For a discussion of the accounting pronouncements that we have recently adopted, please refer to Note A to our consolidated financial statements on page 50 of this report.
At December 31, 2002, we had recorded $79.3 million as amounts recoverable from reinsurers on losses we had paid for valid claims. The amounts recorded have been estimated based upon management’s interpretation of each reinsurer’s obligations pursuant to individual reinsurance contracts between Vesta and each reinsurer. In establishing the balance for reinsurance recoverable, we have made judgments in assessing the financial viability and credit quality of each reinsurer as well as the ability of each reinsurer to pay amounts owed to us. In evaluating the credit and financial quality of each reinsurer, we rely upon our management’s experience and industry knowledge, as well as financial statements, credit reports and other publicly available information applicable to each reinsurer.
On an ongoing basis, management reviews the components of deferred acquisition costs we have established and assesses their recoverability. Changes in our assumptions, estimates and judgments with respect to establishing deferred acquisition costs including any change in our estimated future loss ratios, could materially impact our financial statements and financial condition.
In order to record deferred tax assets, GAAP requires management to justify that realization of the asset is more likely than not. A valuation allowance against deferred taxes is recorded if it is more likely than not that all or some portion of the benefits related to the deferred tax assets will not be realized. Valuation allowances are based upon estimates of taxable income and the period over which the deferred tax assets will be recovered. In the event that actual results differ from these estimates or these estimates are adjusted in future periods, we may need to establish a valuation allowance, which would impact our financial position and results of operations. To date, no such valuation allowance has been established, as we believe it is more likely than not that our deferred tax assets will be fully realized.
The recoverability of deferred tax assets is determined based upon management’s assumptions and judgments as to our future financial performance. With respect to future financial performance, we have projected that we will generate earnings sufficient to utilize, prior to their respective expiration periods, all net operating losses that comprise deferred tax assets. There can be no assurance that our actual financial results in the future will not vary materially from the estimates we have used in our assessment of the recoverability of deferred taxes. Material differences between expected results and actual performance would adversely impact our financial results and financial condition. In addition, there can be no assurance that there will not be changes in the accounting rules or tax laws regarding treatment of deferred tax assets.
Effective January 1, 2002, in accordance with the provisions of SFAS No. 142, we no longer amortize goodwill on a periodic basis in our financial statements. Rather, on at least an annual basis, we conduct an evaluation to assess whether the fair value of our reporting units exceeds each reporting units’ carrying value. We evaluate impairment of three reporting units: homeowners’ insurance operations; life insurance companies; and non-standard agency operations. For purposes of applying the provisions of SFAS No. 142, we compare the aggregate fair value and carrying value of each reporting unit to determine if there is any impairment. As long as the aggregate fair value exceeds the aggregate carrying value for each reporting unit, no impairment is recognized in our financial statements, even if an individual component of a reporting unit would be impaired on a stand-alone basis.
For the year ended December 31, 2002, we have recorded goodwill and other intangible assets for each reporting unit as follows: homeowners’ insurance operations -$56.5 million; life insurance companies - $10.8 million; and nonstandard auto insurance operations - $67.6 million. In connection with our evaluation of goodwill, we engaged a third party regularly involved in the valuation of insurance companies to perform a valuation analysis of our reporting units. Based upon (a) the historical financial performance of each unit; (b) the most recent financial performance of each unit; (c) management’s financial forecast for each reporting unit; (d) information regarding publicly available financial terms of recent transactions in the insurance industry; (e) current and historical market prices of the common stock of comparable companies in the insurance industry; and (f) other publicly available information, management concluded that there was no impairment of goodwill with respect to any of our reporting units.
In accordance with guidelines established by our Board of Directors, our investment portfolio consists primarily of investment grade, fixed income securities. At December 31, 2002, our cash and investment portfolio was approximately $1.2 billion, with only 2.4% consisting of investments in equity securities. Because of the nature of our investments, the fair value of our portfolio is not typically volatile, and the market values of our investments have generally been greater than or equal to their costs.
We maintain property-casualty loss reserves to cover the estimated ultimate unpaid liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred. Reserves do not represent an exact calculation of the ultimate liability, but rather utilize actuarial projection techniques commonly used in the insurance industry to develop estimates. Reserve estimates represent managements’ expectations of what the ultimate settlement and administration of claims will cost based upon (1) an assessment of facts and circumstances then known; (2) a review of historical settlement
For purposes of establishing reserves on risks insured during the most recent year, including interim periods for which there is minimum experience to date, we have used forecasted loss ratios that have been applied to earned premiums during the interim periods. The determination of such forecasted loss ratios involved significant judgments by management, taking into account the results of the most recent actuarial studies performed, current pricing and underwriting, expected loss and loss adjustment expense trends and other pertinent considerations. In addition, we monitored and analyzed key loss and loss adjustment expense indicators and trends throughout the year. These included, but were not limited to, paid losses, newly reported claims and incidents, closed claim activity and other metrics.
Our consolidated revenue is derived principally from premiums, commissions, fees, investment income and investment gains and losses. Premium income, the largest component of our revenue is generally recognized on a pro-rata basis over the respective period of each property-casualty insurance policy. Premium receivables are recorded net of an estimated allowance for uncollectible amounts. Agency commission income is recognized at the later of the billing or effective date of the related insurance policies, net of an allowance for estimated policy cancellations. At that date, the earnings process has been completed and we can reliably estimate the impact of policy cancellations for refunds and establish reserves accordingly. Premiums on life insurance contracts are recognized as income as they become due.
Changes in assumptions, estimates and judgments we have made concerning the ultimate realization of profit sharing commissions, as well as differences in the frequency and severity of claims by policyholders, would adversely impact our financial results and financial condition.
We are subject to proceedings, arbitrations, lawsuits and other claims, including proceedings under laws and government regulations related to securities, labor, insurance contracts and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is based upon a careful analysis of each individual issue with the assistance of outside legal counsel. We have not established any amounts for reserves for litigation or arbitration risks in our financial statements. Our judgments as to any reserves required in connection with these matters may change in the future because of new developments in each situation or changes in our approach in addressing these matters such as a change in settlement strategy. For more information concerning litigation and arbitration matters to which we are a party, please refer to “Item 3. Legal Proceedings” beginning on page 22 of this report and Note G to our financial statements on page 63 of this report.
For the year ended December 31, 2002, we reported a net loss available to common shareholders of $31.7 million ($.94 diluted per share), compared with a net loss available to shareholders of $22.4 million ($.84 diluted per share) reported for the previous year.
In our standard property-casualty segment, we underwrite or sell personal automobile and residential property insurance through approximately 2,475 independent insurance sales agencies. In 2002, the standard property-casualty segment generated approximately $332 million in revenue, or approximately 52% of consolidated revenue. For the year ended December 31, 2002, net premiums written in our standard property-casualty lines increased by $96 million (up 36.3%), to $360 million from $264 million in the prior year. Net premiums earned for standard property-casualty lines increased by $79.9 million in 2002, up 32.5%, to $326.0 million from $246.1 million in 2001. The increase in both net premiums written and net premiums earned was primarily attributable to increased writings in Texas of $130.4 million compared with $16.4 million in the prior year. The growth in premiums was partially offset by decreased writings in the Midwest and Mid-Atlantic regions in connection with our decision to terminate agents and withdraw from certain states. Effective December 1, 2002, we ceded 50% of the premiums and losses on our Texas residential property business to third party reinsurers pursuant to a quota share reinsurance contract. As a result, we expect our total standard property-casualty net written premiums will decrease in 2003.
Loss and loss adjustment expenses for standard property casualty lines for the year ended December 31, 2002 increased by $64.6 million (up 38.6%) to $224.0 million from $161.6 million in the prior year. The increase in loss and loss adjustment expenses incurred was primarily attributable to our growth in business in Texas. Loss and loss adjustment expenses in Texas were $57.2 million in 2002, compared with $1.7 million in the prior year.
Our non-standard agency segment does not engage in underwriting activities. Rather, the primary focus of our agency segment is the distribution of non-standard auto insurance products for various insurance carriers in exchange for commissions and fees. Since our entry into the non-standard auto business in late 2000, revenue for our agency segment has
For the year ended December 31, 2002, fees and commissions in our agency segment increased by $144.7 million from the prior year as a result of the acquisitions of InsureOne and American Agencies in January 2002 and A-Affordable and SpaceCoast Underwriters, in November and October 2001, respectively. As a result of these acquisitions, our agency segment improved its financial performance in 2002, achieving pre-tax income from continuing operations of approximately $11.8 million compared with a pre-tax operating loss of $3.0 million in 2001.
Since entering the non-standard auto business in late 2000, our revenue has increased significantly. In 2002, our non-standard underwriting segment generated approximately $178 million of revenue, representing approximately 28% of consolidated revenue.
Consistent with the corresponding increase in earned premium, policy acquisition expenses for the year ended December 31, 2002 increased by $43.8 million from the same period of the prior year. In 2002, we paid a slightly higher commission rate of 26.8% compared with 22.8% in the prior year because of increased contingent, or profit sharing, commissions earned on improved underwriting results.
In 2002, our life insurance segment generated approximately $52 million in revenue, or 8% of consolidated revenue, excluding realized gains and losses. Realized losses in 2002 consist primarily of a write-off of approximately $27 million of collateral loans (see discussion below).
For the year ended December 31, 2002, net investment income related to our property-casualty underwriting operations decreased by $1.7 million to $18.4 million from $20.1 million in 2001. The weighted average yield on invested assets for 2002 (excluding realized and unrealized gains) was 4.97%, compared with 6.5% for the year ended December 31, 2001. The decrease in investment income was primarily attributable to a decline in overall market interest rates.
In 2002, operating expenses increased by $10.6 million from the prior year primarily because of a severance payment to our former Chairman of approximately $4.2 million in connection with his voluntary resignation in December, 2002. As part of that severance, the former Chairman forfeited 595,000 shares of restricted stock and repaid $2.6 million of loans plus accrued interest.
In the fourth quarter of 2002, we made the decision to exit the health insurance and consulting business lines. Accordingly, our health insurance and consulting lines results for 2002 have been reclassified in our financial statements as part of discontinued operations and are classified as operations held for sale. For the year ended December 31, 2002, we recorded a
pre-tax loss of $9.9 million for our health operations and $1.8 million for our consulting business. These results include write downs in the fourth quarter of $7.9 million and $1.2 million, representing the previously recorded goodwill for the health insurance and consulting lines, respectively.
With respect to the discontinued assumed reinsurance line, we increased reserves because of negative trend development relating primarily to certain homeowner coverages. We believe these types of claims should fully develop over a relatively short period of time. With respect to the discontinued commercial lines, the increase in expected losses related primarily to our participation in mandatory pools. These types of claims may take many years to fully develop and we must continue to monitor trends in their ultimate developments.
Based upon available information, we believe the recorded reserves for discontinued operations at December 31, 2002 is adequate. However, we will continue to monitor these reserves and their related claims activity and experience. Further adjustments to our estimates could be necessary as we continue to run off the remaining outstanding claims.
For the year ended December 31, 2002, we recorded an income tax benefit of $5.8 million, compared with an income tax benefit of $4.4 million recorded in the prior year. Our effective tax rate of 35% in 2002 was consistent with our effective tax rate in the prior year.
Loss and loss adjustment expenses for standard property casualty lines for the year ended December 31, 2001 increased by $36.8 million (up 29.5%) to $161.6 million from $124.8 million in the prior year. The loss ratio for property-casualty lines at December 31, 2001 was 64.7%, compared with 58.6% at December 31, 2000. The increase in loss and loss adjusted expenses incurred was primarily attributable to corresponding increases in earned premium. The increase in the loss ratio was primarily attributable to deterioration in our homeowners book of business, uninsured motorist coverage in Pennsylvania and a $1.4 million net loss we incurred in connection with Tropical Storm Gabrielle.
For the year ended December 31, 2001, the principal operating subsidiary of our non-standard agency segment was Instant Auto. The principal revenue stream for Instant Auto is agents’ fees and commissions. In the fourth quarter of 2001, Instant Auto completed the acquisition of A-Affordable Insurance Agency and Spacecoast Agency. In connection with these acquisitions and their related activity in the fourth quarter of 2001, we increased our fees and commissions for this segment by $5.9 million compared with the year ended December 31, 2000. Partially as a result of these acquisitions, our agency segment improved its financial performance, achieving approximately breakeven results in the fourth quarter of 2001, compared with a pre-tax loss of approximately $1.0 million per quarter in the first nine months.
For the year ended December 31, 2001, net premiums written for non-standard lines increased by $9.6 million, to $11.8 million from $2.2 million in 2000. For the same period, net premiums earned for non-standard lines increased by $9.1 million to $10.2 million from $1.1 million. The increase in net premiums written and net premiums earned was primarily attributable to inclusion of a full year of activity for this segment in our financial statements for 2001 compared with four months of activity in 2000. In addition, in 2001 we increased our retained risk on premium produced by unaffiliated agencies by ceding less premiums to third party reinsurers.
For the year ended December 31, 2001, we earned “issuing carrier” or “fronting” fees of approximately $4.2 million, up from $1.0 million in 2000. The increase in fronting fees was primarily attributable to the inclusion of a full year of activity for this segment in our 2001 financial statements compared with four months of activity in 2000.
Policy acquisition expenses for the year ended December 31, 2001 increased by $2.1 million from the same period of the prior year in accordance with the corresponding increase in earned premium.
In 2001, life insurance premiums and policy fees increased to $13.8 million from $5.3 million in the prior year primarily because of the inclusion in our financial statements of a full year of results for American Founders in 2001 versus six months in 2000.
At the time we made the decision to exit these business lines, we estimated the reserves required to fulfill our expected future obligations with respect to these discontinued operations. On an ongoing basis, we monitor these estimates with respect to ultimate settlement. During 2001, we experienced an unexpected increase in the severity and volume of reported claims associated with both our discontinued assumed reinsurance and commercial lines and increased payments on claim reserves. As a result, we recorded an after-tax charge of $19.5 million in our financial statements for the year ended December 31, 2001 to increase the reserves in order to revise our estimated reserves to reflect expected losses from these discontinued lines.
For the year ended December 31, 2001, we recorded an income tax benefit of $4.5 million, down $13.0 million from income tax expense of $8.5 million recorded for the prior year. Compared with the prior year, our effective rate on pre-tax income in 2001 increased to 35% from 33.9%, primarily because of reduced tax-exempt investment income and an increase in state income taxes.
statutorily required annual statement. Our lead insurance subsidiary, Vesta Fire, reported negative “unassigned funds” on its annual statement for 2002, and is expected to continue to report negative unassigned funds for the foreseeable future. Accordingly, we may not be able to declare and pay a dividend from our lead insurance company subsidiary for the foreseeable future without prior approval. There can be no assurance that Vesta Fire will be able to obtain the requisite regulatory approval for the payment of dividends.
J. Gordon Gaines, Inc. provides administrative services to all of our property - casualty insurance subsidiaries in exchange for fees pursuant to an administrative services agreement and, with respect to our Texas Select Lloyds Insurance Company, an attorney-in-fact agreement. These management agreements are subject to certain regulatory standards which generally require their terms and fees to be fair and reasonable. The Illinois or Texas Departments of Insurance may review these agreements from time to time to insure the reasonableness of their terms and fees, and it is possible that such terms and fees could be modified to reduce the amounts available to our holding company. Assuming these management agreements are not modified in a material respect, we believe that J. Gordon Gaines, Inc. will be able to pay dividends to our holding company, or otherwise fund the obligations of our holding company on its behalf, sufficient to fund our anticipated needs (including debt service) for at least the next twelve months.
During the transition to the new credit facility, we were required to be in compliance with covenants pertaining to the ratio of consolidated debt to capital, consolidated GAAP net worth and risk-based capital. As of December 31, 2002, we were in compliance with all required covenants.
The following table sets forth the principal maturities of our material contractual obligations owing to third parties at December 31, 2002 (in thousands):
As discussed above, our subsidiary operations are also involved in ongoing reinsurance recoverable disputes that could result in an obligation to repay certain amounts to reinsurers from whom we have collected funds. In connection with these disputes, our principal operating subsidiary, Vesta Fire, has obtained letters of credit for the benefit of reinsurers for which it is contingently liable. At December 31, 2002, Vesta Fire was contingently liable for $33.7 million under the terms of letters of credit obtained in connection with these reinsurance disputes.
As is typical in the insurance industry, we collect cash in the form of premiums and invest that cash until claims are paid. Cash collected from premiums and cash paid for claims are included in cash flow from operations, while the cash impact from our investing activities is included in cash flow from investing activities. In periods such as 2001 and 2000, when we were exiting certain lines of business such as commercial lines and reinsurance assumed lines, we funded the payout of commercial and reinsurance assumed claims through the liquidation of invested assets, consistent with the historical insurance business model. However, this generates cash outflows from operations that can be misleading.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations.” SFAS No. 141 address financial accounting and reporting for business combinations and supersedes Accounting Principles Board Opinion No. 16, “Business Combinations,” and SFAS No. 38 “Accounting for Preacquisition Contingencies of Purchased Enterprises.” The standard eliminates the pooling of interests method of accounting for business combinations except for qualifying business combinations initiated prior to July 1, 2001 and requires that all intangible assets be accounted for separately from goodwill, for acquisitions after July 1, 2001. Vesta has applied the requirements of SFAS No. 141 to all acquisitions after July 1, 2001 and will account for future acquisitions in accordance with the new guidance.
• The carrying amount of intangible assets by major category; and
Effective January 1, 2002, Vesta adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which had been issued by the FASB in October 2001. SFAS No. 144 provides a single model for treatment of the disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121 “Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions.” Adoption of SFAS No. 144 is not expected to have a material impact on Vesta’s financial position, results of operations or cash flows other than the classification of certain items in our statements of financial position, results of operations and cash flows.
In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities” which clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” This Interpretation provides guidance on the identification and consolidation of variable interest entities (“VIEs”), whereby control is achieved through means other than through voting rights. Management is currently evaluating the impact of FIN 46.
Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2002
Investments: Investment securities are classified as available for sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders’ equity. Mortgage loans, policy loans, and collateral loans are stated at the aggregate unpaid principal balances, less any unamortized premium or discount and less allowance for possible losses and permanent impairments, if required.
• Agency commission income is recognized at the later of the billing or effective date of the related insurance policies, net of an allowance for estimated policy cancellations.
• Premiums for accident and health policies are recognized in proportion to the insurance protection provided over the period covered by the policies.
Policy Liabilities: Reserves for investment-type contracts are based either on the contract account balance (if future benefit payments in excess of the account balance are not guaranteed) or on the present value of future benefit payments (if such payments are guaranteed). Additions to insurance liabilities are made if it is determined that future cash flows (including investment income) are insufficient to cover future benefits and expenses.
For investment contracts without mortality risk (such as deferred annuities and immediate annuities with benefits paid for a certain period), premium deposits and benefit payments are recorded as increases or decreases in a liability account, rather than as revenue and expense. We record as revenue any amounts charged against the liability account for the cost of insurance, policy administration, and surrender penalties. Any interest credited to the liability account and any benefit payments which exceed the contract liability account balance are recorded as expenses. As of December 31, 2002 and 2001, approximately $112.5 million and $95.7 million, respectively, of Vesta’s annuity reserves are subject to discretionary withdrawal without surrender charges or other adjustments.
Deferred Policy Acquisition Costs: Commissions and other costs that vary with and are primarily related to the production of new and renewal business are deferred and amortized over the terms of the policies to which they relate. Anticipated investment income is considered in determining recoverability of deferred acquisition costs.
The costs to acquire blocks of life insurance representing the present value of future profits from such blocks of insurance is also included in deferred policy acquisition costs. We amortize the present value of future profits over the premium payment period. The unamortized present value of future profits was approximately $13.9 million and $20.9 million at December 31, 2002 and 2001, respectively. During 2002, we reduced value of business acquired (“VOBA”) by approximately $6.0 million and recorded deferred revenue of $8.8 million in relation to an increase in our ceded reinsurance with Employers Reinsurance Corporation (“ERC”) from 35% to 62.5%. In 2002, we amortized $.3 million of deferred revenue, and the balance at December 31, 2002 was $8.5 million. During 2001, $4.5 million of present value of future profits was capitalized (relating to acquisitions made during the year). During the years ending December 31, 2002 and 2001, we recognized amortization expenses associated with future profits of $1.8 million and $1.5 million, respectively. Estimated amortization expense for each of the next five years is as follows (in thousands):
A summary of property and equipment used in the business at December 31, 2002 and 2001 is as follows (in thousands):
Reclassification: Certain amounts in the financial statements presented have been reclassified from amounts previously reported in order to be comparable between years. These reclassifications have no effect on previously reported total assets, total liabilities, stockholders’ equity or net income during the periods involved.
* In 2002 and 2001, 184 thousand and 1.2 million shares, respectively, had an anti-dilutive effect and were excluded in accordance with SFAS No. 128
Pro forma information regarding net income and earnings per share is required by SFAS No. 123 and has been determined as if Vesta had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2002, 2001 and 2000, respectively: risk-free interest rates of 4.03%, 5.13% and 6.50%; dividend yields of 2.36%, 1.0% and 1.0%; volatility factor of the expected market price of Vesta’s common stock of 79.10, 88.97, and 78.39; and a weighted-average expected life of the options of ten years.
New Accounting Standards: In June 2001, the FASB issued SFAS No. 141, “Business Combinations.” SFAS No. 141 address financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, “Business Combinations,” and SFAS No. 38 “Accounting for Preacquisition Contingencies of Purchased Enterprises.” The standard eliminates the pooling of interests method of accounting for business combinations except for qualifying business combinations initiated prior to July 1, 2001 and requires that all intangible assets be accounted for separately from goodwill, for acquisitions after July 1, 2001. Vesta has applied the requirements of SFAS No. 141 to all acquisitions after July 1, 2001 and will account for future acquisitions in accordance with the new guidance.
Effective January 1, 2002, Vesta adopted SFAS No. 142 “Goodwill and Other Intangible Assets”, which had been issued by the FASB in June 2001. SFAS No. 142 addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. The statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements.
Effective January 1, 2002, Vesta adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which had been issued by the FASB in October 2001. SFAS No. 144 provides a single model for treatment of the disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121 “Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” Adoption of SFAS No. 144 is not expected to have a material impact on Vesta’s financial position, results of operations or cash flows other than the classification of certain items in our statements of financial position, results of operations and cash flow.
Effective July 1, 2002, Vesta adopted SFAS No. 145, “Rescission of FASB Statement No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections”, which had been issued by the FASB in April 2002. SFAS No. 145 rescinds SFAS No. 4, which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion No. 30, will now be used to classify those gains and losses. SFAS No. 64 amended SFAS No. 4, and is no longer necessary because SFAS No. 4 has been rescinded. SFAS No. 44 and the amended sections of SFAS No. 13 are not applicable to Vesta and, therefore, have no effect on our financial statements. In connection with our adopting SFAS No. 145 on July 1, 2002, we reclassified gains on the extinguishment of debt from extraordinary gain on debt
extinguishment to other expense in our third quarter financial statements. These reclassifications decreased other expense by $9.5 million, $1.4 million and $8.1 million for the years ending December 31, 2002, 2001 and 2000, respectively.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure”. This statement is effective for 2003 and amends SFAS No. 123, “Accounting for Stock-Based Compensation” by providing alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 requires additional disclosures related to the effect of stock-based compensation on reported results. Vesta has adopted the disclosure provisions of SFAS No. 148 and is currently reviewing its treatment of stock-based compensation as well as the impact of this pronouncement.
In May 2002, the Derivatives Implementation group of the FASB exposed for comment issue No. B36, “Bifurcation of Embedded Credit Derivatives” (“DIG B36”). DIG B36 would require the bifurcation of potential embedded derivatives within modified coninsurance and funds withheld coinsurance arrangements in which the terms require the future payment of a principal amount plus a return based on a specified proportion of the ceding company’s return on either its general account assets or a specified block of those assets. The proposed effective date of the implementation guidance in DIG B36 is for the first fiscal quarter beginning after June 15, 2003 and would be applied on a prospective basis. The Company is currently evaluating the impact of this pronouncement.
Effective April 1, 2001, we acquired Florida Select Insurance Holdings Inc., the parent company of Florida Select Insurance Company for cash of approximately $66.4 million. Florida Select is the eighth largest residential homeowners insurer in the state of Florida with approximately $137.7 million of assets and $60.0 million of annual gross written premium. The transaction has been accounted for as a purchase. Summarized below is an allocation of assets and liabilities acquired (in thousands and unaudited):
Summarized below are the consolidated results of operations for the years ended December 31, 2002 and 2001 on an unaudited pro forma basis as if the acquisitions had occurred as of the beginning of each period presented. The pro forma information is based on our consolidated results of operations for the years ended December 31, 2002 and 2001 and on data provided by the acquired companies, after giving effect to certain pro forma adjustments. The pro forma financial information does not purport to be indicative of results of operations that would have occurred had the transactions occurred on the basis assumed above nor are they indicative of results of the future operations of the combined enterprises (in thousands, except per share amounts and unaudited):
In June, 2001, the FASB issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets,” having a required effective date for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and other intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to at least annual impairment testing as prescribed by the new Statements. Other intangible assets will continue to be amortized over their useful lives. We adopted SFAS No. 142 effective January 1, 2002.
At December 31, 2002, we have recorded goodwill and other intangible assets for each reporting unit as follows: (a) homeowners’ insurance operations - $56.5 million; (b) life insurance operations - $10.8 million; and (c) non-standard automobile agency operations - $67.6 million. With respect to our continuing operations reporting units, we have concluded that there was no goodwill impairment as of December 31, 2002.
The changes in the carrying amount of goodwill and other intangible assets for the years ended December 31, 2002 and 2001 are as follows (in thousands):
Restrictions on Dividends to Stockholder and Transactions between Affiliates: Transactions between Vesta and its insurance subsidiaries, including the payment of dividends and management fees to Vesta by such subsidiaries, are subject to certain limitations under the insurance laws of those subsidiaries’ domiciliary states. The insurance laws of the state of Illinois, where Vesta Fire is domiciled, permit the payment of dividends out of unassigned surplus in any year which, together with other dividends or distributions made within the preceding 12 months, such dividends do not exceed the greater of 10% of statutory surplus as of the end of the preceding year or the net income for the preceding year, with larger dividends payable only after receipt of prior regulatory approval. On October 29, 2001, the Illinois Insurance Department published a Company Bulletin that indicates that the Department interprets these dividend limitations to prohibit the payment of dividends if the insurer has negative or zero “unassigned funds” at the end of the prior year, as reported on its statutorily required annual statement. Our lead insurance subsidiary, Vesta Fire, reported negative “unassigned funds” in its annual statement for 2002. Accordingly, we may not be able to declare and pay a dividend from our lead insurance company subsidiary for the foreseeable future without prior approval.
regulatory attention depending on the ratio of a company’s total adjusted capital to its “authorized control level” of RBC.
Based upon calculations by Vesta, the RBC levels of our primary insurance subsidiaries do not trigger regulatory attention. The RBC levels of each of our other insurance subsidiaries also do not trigger regulatory attention except for Texas Select Lloyds Insurance Company (“TSLIC”). TSLIC has $3.5 million in total adjusted capital, but is required to have more than $4.4 million in order to avoid regulatory action. This situation is due primarily to how RBC is impacted by TSLIC’s 50% quota share reinsurance agreement, entered into in December 2002, with unaffiliated insurance companies that have received ratings of A and A+ by A.M. Best. In addition to the “Excellent” and “Superior” A.M. Best ratings, the reinsurers have provided to TSLIC letters of credit in amounts equal to reserve and unearned premiums assumed by them. Notwithstanding the financial strength of the reinsurers and the letters of credit held by TSLIC, Vesta is taking steps to increase the surplus of TSLIC to a level that satisfies appropriate regulators.
During 2002, we actively pursued collection of approximately $27 million in loans held as assets by American Founders, including the filing of civil lawsuits seeking to collect these loans and cooperation
As part of a modified coinsurance agreement with Employers Reinsurance Corporation, our life insurance subsidiary is holding $170.0 million of invested assets for the benefit of Employers Re. Additionally, we have pledged investments having a market value of $183.6 million to the Federal Home Loan Bank.
We maintain a mortgage loan portfolio consisting of first-lien residential and commercial mortgages. At December 31, 2002, our residential mortgages had carrying values of approximately $28.0 million and commercial mortgages had carrying values of approximately $9.3 million. In the fourth quarter of 2002, we wrote off approximately $27 million of impaired collateralized loans held as investments by our life insurance subsidiary.
Bonds with a fair value of $71.2 million and $76.1 million were on deposit with certain states in accordance with their insurance regulations at December 31, 2002 and 2001, respectively.
In 2002, Vesta received two arbitration cases rulings with USF&G and NRMA. Both companies reinsured Vesta companies, and Vesta fully expected to recover all unpaid liabilities. However, as disclosed during the year, the impact of these cases resulted in adverse development to Vesta of $13.6 million and $23.6 million, respectively. Therefore, the total adverse development recognized in 2002 was $35.5 million for the cumulative prior years. In 2001, the $34.3 million in adverse development of prior years is primarily due
Vesta discontinued its commercial and assumed reinsurance lines of business in 1999 and 2000, respectively. The variability in reserves is largely due to the ultimate disposition of individual claims. The absence of other risk factors from this listing does not imply that additional factors will not be identified in the future that will have a significant influence on our reserves.
In 2001, Vesta settled a securities class action that had been pending since 1998. In connection with that settlement, we advanced approximately $5.4 million due from two issuers of directors and officers insurance policies and recorded a receivable for that amount due from those insurers. We collected that $5.4 million in cash during 2002.
On December 30, 2002, States General provided the contractually required notice of termination of its exclusive agency contract with Jimmy Walker, Sr., and that contract will expire in accordance with its terms on June 30, 2003. At the same time, another of our affiliates ceased loaning money to Mr. Walker and exercised its right to receive certain commissions earnings on the policies placed in force by Mr. Walker, which Mr. Walker had assigned to us as collateral for his indebtedness to us. At December 31, 2002, the outstanding balance owed by Mr. Walker was approximately $2.5 million. Mr. Walker contended that these actions constituted a premature termination of his agency contracts and threatened litigation. In the interest of resolving this issue expeditiously, we filed a lawsuit in Jefferson County, Alabama seeking a declaratory judgment that our receipt of these assigned commissions is in accordance with an enforceable collateral assignment of commissions document and otherwise lawful. We also filed for arbitration seeking a declaration that our actions were in accordance with our agency contracts with Mr. Walker and otherwise lawful. In the opinion of management, resolution of the lawsuit is not expected to have a material adverse effect on our financial position.
Our subsidiary, American Founders, is a defendant in a lawsuit brought by a judgment creditor of IFS Holdings, Inc. - the former holder of American Founders’ series A and C preferred stock - alleging that
Pursuant to Delaware law and our by-laws, we are obligated to indemnify our current and former officers and directors for certain liabilities arising from their employment with or services to Vesta, provided that their conduct complied with certain requirements. Pursuant to these obligations, we have been advancing costs of defense and other expenses on behalf of certain current and former officers and directors, subject to an undertaking from such individuals to repay any amounts advanced in the event a court determines that they are not entitled to indemnification.
NRMA Insurance Ltd. (“NRMA”), one of the participants in the 20 percent whole account quota share treaty, filed a lawsuit in the United States District Court for the Northern District of Alabama contesting our billings. NRMA sought rescission of the treaty and a temporary restraining order preventing us from drawing down approximately $34.5 million of collateral. We filed a demand for arbitration as provided for in the treaty and also filed a motion to compel arbitration which was granted in the United States District action. Vesta reached an agreement with NRMA to collect the $34.5 million of collateral in exchange for posting a $25 million letter of credit in favor of NRMA to fund any amounts NRMA may recover as a result of the arbitration. We also filed for arbitration against Alfa Mutual Insurance Company and Dorinco Reinsurance Company, the other two participants on the treaty. All those arbitrations are in the discovery stages. Additionally, Alfa filed a Motion for Declaratory Judgment asking the arbitration panel to order that there is no enforceable agreement between Alfa and Vesta or alternatively, that there is no coverage for developmental losses under the treaty. After a hearing in June 2002, the arbitration panel denied Alfa’s motion. The hearing on the merits of the arbitration with Alfa is scheduled for May 2003. On December 16, 2002, Dorinco filed a motion for an order that the treaty does not cover developmental losses. A decision on that motion is pending. On June 19, 2002, the panel in the NRMA arbitration issued an order to bifurcate the arbitration, and scheduled a hearing for the week of October 28, 2002 to decide the issue of coverage for developmental losses under the treaty. On September 6, 2002, the panel notified the parties that it would make such determination on this specific issue on the papers and filings submitted by the parties without the necessity of a live hearing. On November 6, 2002 the Company was recently notified by the panel that it ruled that the treaty does not apply to loss occurrences prior to July 1, 1997. As a result, Vesta recorded a $23.6 million pre-tax non-operating charge as a revision of our estimated reinsurance recoverable in the third quarter of 2002. This ruling does not set a binding precedent regarding Vesta’s other arbitrations and, accordingly, we have not recorded any change in our estimate of our recoverable from the other treaty participants as a result of this ruling. In February 2003, Vesta filed a petition to vacate the NRMA panel ruling in the U.S. District Court for the Northern District of Alabama. There has been no decision on this petition. While management continues to believe its interpretation of the treaty’s terms and computations based thereon are correct, these matters are in arbitration and their ultimate outcome cannot be determined at this time. If rescission on all three treaties was awarded by three separate arbitration panels, we would incur a charge of approximately $57.0 million.
We are in arbitration with CIGNA Property and Casualty Insurance Company (now ACE USA) under a personal lines insurance quota share reinsurance agreement, whereby we assumed certain risks from CIGNA. During September 2000, CIGNA filed for arbitration under the reinsurance agreement, seeking payment of the balances that CIGNA claims are due under the terms of the treaty. At that time, the treaty was terminated on a cut-off basis. In the pending arbitration Vesta is seeking, among other things, recoupment of all believed improper claims payments and excessive expense allocations and charges from CIGNA. The arbitration was bifurcated into two phases with Phase I concentrating on the interpretation of the intent of the parties related to the expense reimbursement provisions of the treaty at the time it was entered. Phase II, which is ongoing, relates to any remaining issues between the parties, including those that exist with regard to an audit of expenses ceded to the treaty which Vesta intends to conduct. The Phase I hearing was held in February 2002 and the panel ruled that (i) the Company is responsible for the payment of ceding commissions provided for in the treaty and should pay any outstanding billings for commissions and paid claims, plus interest; (ii) the Company may proceed with an audit of expenses ceded to the treaty; and (iii) the parties should identify any further issues to be brought before the arbitration panel for phase two of the hearing. The Phase II hearing has not yet been scheduled.
If the amounts recoverable under the relevant treaties are ultimately determined to be materially less than the amounts that we have reported as recoverable, we may incur a significant, material, and adverse impact on our financial condition and results of operations.
During 1999, F&G Re (on behalf of USF&G), filed for arbitration under two aggregate stop loss reinsurance treaties whereby F&G Re assumed certain risks from Vesta. F&G Re is seeking to cancel the treaties and avoid its obligation. Based on the terms of the two treaties, Vesta was entitled to recoveries of approximately $30.0 million as losses from prior accident years mature and had recorded a reinsurance recoverable of $30.0 million at December 31, 2001. The hearing in this arbitration began on February 11, 2002. The hearing was adjourned on February 15, 2002 and resumed on June 11, 2002, and the panel awarded Vesta $15 million, plus interest of $1.4 million. Accordingly, we recorded a pre-tax charge of approximately $13.6 million in the second quarter of 2002. The charge related to this award was recorded in our Assumed Reinsurance segment, which is reflected herein as a discontinued operation, consistent with the manner in which premiums and losses under these contracts were originally recorded.
Third party auditors hired by Vesta have identified coverage issues that cast doubt on the validity of a number of claims. In addition, there is no actual retrocessional agreement that evidences the terms and conditions of Pool III which involves 71% or more of the incurred losses at issue. Although there are other tangential documents that the Liquidator may attempt to rely on to prove liability under Pool III, we believe that the Liquidator will not be able to establish liability for any portion of the Pool III claims. We also believe that a number of the losses allegedly incurred in connection with Pool I may be avoided on specific coverage grounds. We are defending this matter vigorously and are reasonably optimistic regarding the ultimate outcome, although an adverse ruling in this case could have a material effect on our financial condition.
Nichols vs. Vesta Fire Insurance Corporation is a lawsuit brought by the Liquidator of Delta America Re Insurance Company in Kentucky state court to recover losses alleged under reinsurance contracts entered into in the 1970’s. Vesta removed the action to federal court and successfully moved to compel arbitration. Each party has selected a party arbitrator but as yet there is no neutral umpire. There has been no discovery as yet and no organizational meeting of the panel. Given the preliminary nature of these proceedings, it is too early to evaluate the likelihood of a favorable or unfavorable outcome.
New Cap Re challenged Vesta’s earlier draw on a Letter of Credit for $7.5 million which was held in connection with one of the two contracts. Shortly after the arbitration commenced, New Cap Re became the subject of insolvency proceedings in Australia and an ancillary proceeding in the U.S. Bankruptcy Court in New York. The Bankruptcy Court stayed all pending litigation and arbitration against New Cap Re, and we appealed that ruling to the Southern District of New York, and ultimately to the U.S. Court of Appeals for the Second Circuit which recently affirmed the Bankruptcy Court’s stay of the arbitration against New Cap Re. Hence, our efforts to recover losses as well as New Cap Re’s efforts to challenge the earlier draw on the $7.5 million Letter of Credit by us are stayed.
On September 5, 2002, New Cap Re served us with an Application pursuant to Section 588FF of the Australian Corporations Act seeking an order directing us to pay New Cap Re and its liquidator $1.0 million that Vesta allegedly received as an “unfair preference” and/or arising out of an “uncommercial transaction,” as those terms are defined by the Corporations Act. We filed a Notice of Appearance on October 31, 2002. While management intends to vigorously defend this matter, given the preliminary nature of these proceedings, it is too early to evaluate the likelihood of success.
As part of its ongoing reinsurance recoverable arbitrations, we have obtained letters of credit for the benefit of certain parties. Our principal operating subsidiary, Vesta Fire is contingently liable under the terms of these letters of credit. For our reinsurance arbitrations, we have obtained letters of credit totaling $33.7 million for which we are contingently liable. Additionally, as part of our specialty lines underwriting retained, we have pledges of securities totaling $7.7 million securing our obligations under various reinsurance agreements. As part of our Federal Home Loan Bank Program, as more fully described in Note N, we have pledged securities with a market value of $183.6 million securing our obligation thereunder.
Future payments for operating lease obligations at December 31, 2002 are as follows (in thousands):
The effect on premiums earned and losses and loss adjustment expenses of all ceded and assumed reinsurance transactions are as follows (in thousands):
As further discussed in Note R, we exited the assumed reinsurance line of business in 1999. The premiums disclosed here as assumed premiums represent life insurance premiums that were acquired through reinsurance agreements and residential property and non-standard automobile premiums which were fronted for Vesta by another carrier. However, in these situations, we control the underwriting, and claims functions and therefore it is considered to be direct premiums and included in either the standard property-casualty or non-standard underwriting segments.
Vesta has a Shareholders’ Rights Plan that provides for the payment of a dividend of one preferred stock purchase right to be attached for each outstanding share of common stock. Each Right, if and when it becomes exercisable, will entitle the registered holder to purchase from Vesta one one-hundreth (1/100) of a share of Vesta’s Series B Junior participating Preferred Stock at a price of $30.00 per one one-hundreth of a share. The Rights will be excercisable only if a person or group acquires a beneficial ownership of 10%
In 2002, we purchased 218 thousand shares of treasury stock on the open market for approximately $1.4 million. In the first quarter, we issued 57 thousand shares of treasury stock in exchange for 328 thousand shares of Instant Insurance Holdings, Inc. held by four minority shareholders. As of December 31, 2002, the Board of Directors has authorized the Company to acquire up to 5.0 million shares of treasury stock.
In 2001, we redeemed $10.0 million face amount of Deferrable Capital Securities in exchange for approximately 965 thousand shares of common stock. We also redeemed the preferred stock of a subsidiary with a stated value of $9.0 million and a carrying value of $8.4 million for approximately $5.2 million. Additionally, we were not required to pay the contingent amount recorded in 2000 as discussed below. The resulting after-tax gain from these transactions of $7.1 million was recorded directly to equity in accordance with EITF 86-32 “Early Extinguishment of a Subsidiary’s Mandatorily Redeemable Preferred Stock.” Also, we redeemed $7.0 million face amount of our Senior Debentures in exchange for approximately 568 thousand shares of common stock, resulting in a pretax gain of $1.4 million.
On December 31, 2001, we issued 1.5 million shares of common stock in exchange for 9.2 million shares of Instant Insurance Holdings, Inc. held by a minority shareholder.
In the fourth quarter of 2000, Vesta established the Agent Stock Incentive Plan Trust to satisfy future obligations of Vesta to its Agents under the terms of the Agent’s Stock Incentive Plan. Vesta issued 750 thousand shares to the Trust in December 2000. Effective December 31, 2002, the Agent’s Stock Incentive Plan was terminated, and the trustees returned 730 thousand shares to Vesta, which we have included as treasury stock. At December 31, 2001, 745 thousand shares were held by the trust and included in the unearned stock caption on the consolidated balance sheet as contra equity.
During 2000, we engaged in a number of purchases and sales of our common stock. In two separate transactions, we repurchased 5.1 million shares of stock from our former parent, Torchmark Corporation. We disposed of the acquired stock in a number of private placements, two debt for equity exchanges, the acquisitions of Aegis Financial Corporation and Instant Insurance Holdings, and the establishment of the Agent Stock Incentive Plan Trust.
We report financial results according to five business segments, which are distinguished by their product offerings or business activities. The accounting policies of the operating segments are described in Note A. Segment pre-tax income is generally income before income tax and minority interest. Premiums, policy fees, other income, loss and benefit expenses, operating expenses and policy acquisition expenses are attributed directly to each operating segment. Net investment income and interest expense are allocated only to those segments for which such amounts are considered an integral part of the financial results for that segment.
The standard property-casualty segment consists of two principal lines of business: (1) underwriting only residential property insurance in capacity constrained states; and (2) underwriting residential property and automobile insurance in states where we can profitably offer both products through independent agents. Vesta’s insurance products are distributed primarily through approximately 2,475 independent agencies in 24 states. Our residential property lines target families (1) with multiple insurance policies; (2) who own more than one automobile; and (3) who live in a home valued between $100,000 and $250,000. Our standard personal auto line targets drivers over age thirty-five with above average driving records.
With respect to fronting arrangements, we write property-casualty insurance coverages and reinsure substantially all of the risks to reinsurers in exchange for fees. This business takes advantage of our certificates of authority granting us license to write insurance in many states. Income from fronting arrangements is primarily generated on a fee-for-service basis. For the premium written through our non-standard auto agencies, we determine, based upon market conditions and the prospective results of the underlying business, whether to keep 100% of the underwriting risk or reinsure this risk to various reinsurers. Our decision on how much underwriting risk to retain is dependent on the current rating environment and the amount of commissions offered by the reinsurers.
We provide a variety of life insurance products through American Founders Financial Corporation, a holding company for two life insurance companies domiciled in Texas. In 2000, we purchased a 72% interest in American Founders. On February 18, 2003, we purchased the remaining shares held by minority holders and now own 100% of American Founders. At December 31, 2002, American Founders had in force approximately $2.5 billion (face value) of life and annuity products. American Founders markets traditional life products, universal life products, fixed-rate annuities, pension contracts and related products through independent agents located throughout the U.S. In the fourth quarter of 2002, we decided to exit the health insurance business line, which was previously included in the life insurance segment. The results for the health insurance line have been reclassified to discontinued operations for all periods presented in this report.
Our corporate and other segment consists primarily of (1) net income earned on investments; (2) interest expenses associated with all debt; (3) financial results for a small life insurance agency; and (4) overhead expenses not directly associated with any other business segment.
Long-term debt and Deferrable Capital Securities at December 31, 2002 and 2001 consists of the following (in thousands):
During the year ended December 31, 2002, we extinguished $23.9 million of our Senior Debentures for 1.1 million shares of common stock and approximately $9.4 million plus accrued interest. As a result of the early redemption of this long term debt, we recorded a pre-tax gain of $9.5 million. During the year ended December 31, 2001, we extinguished $7.0 million of our Senior Debentures for 569 thousand shares of common stock. As a result of the early redemption of this long term debt, we recorded a pretax gain of $1.4 million. During the year ended December 31, 2000, we extinguished $13.1 million of our Senior Debentures for approximately $9.8 million plus accrued interest and all $44.1 million of our 12.5% Senior Notes for approximately $38.2 million plus accrued interest. We recorded pretax gains, net of related debt issue costs, of $8.1 million as a result of the early redemption of this long term debt. The redemptions were funded with internally generated cash.
This new credit agreement contains covenants which require us to maintain (i) consolidated GAAP net income (excluding realized gains and losses) of at least $15 million for any calendar year beginning in 2003, (ii) Consolidated debt to capital ratio of no more than 39%, (iii) an A.M. Best rating of “B” or better, (iv) consolidated GAAP net worth of at least $208 million, (v) an interest coverage ratio of not less than 1.5 to 1 and (vi) risk-based capital of not less than 150% of the NAIC’s authorized control level.
Annual maturities of borrowings from FHLB as of December 31, 2002 are as follows (in thousands):
Prior to completion of our initial public offering, our stockholders approved the Vesta Insurance Group, Inc. Long Term Incentive Plan (“Plan”), which provided for grants to our executive officers of restricted stock, stock options, stock appreciation rights, and deferred stock awards, and in certain instances grants of options to directors. Our stockholders approved certain amendments to the Plan effective August 27, 1999 and May 16, 1995, including an amendment to increase the shares of common stock available for awards to 2,221,998 shares and an amendment to delete the provision for the grant of options to non-employee directors. On May 7, 2001, stockholders approved the 2001 Incentive Compensation Plan (“Incentive Compensation Plan”) as a means of continuing our ability to attract, retain and motivate directors and employees through equity based compensatory awards. Under the Incentive Compensation Plan, the Compensation Committee has the discretion to issue stock options, restricted stock awards, and unrestricted stock awards in recognition of past services or other valid consideration. The aggregate number of shares of Vesta common stock that may be issued under the Incentive Compensation Plan may not exceed 2,000,000; provided, however, that no more than 750,000 shares may be awarded under the Incentive Compensation Plan in the form of awards other than options. The maximum number of shares with respect to which awards may be granted to any individual in any one-year under the Incentive Compensation Plan is 350,000. The stockholders also approved the Vesta Insurance Group, Inc. Non-Employee Director Stock Plan (“Director Plan”) effective May 16, 1995, which provides for grants to Vesta’s non-employee directors of stock options and restricted stock.
The following table shows expiration dates and weighted average exercise price for all outstanding options and options currently exercisable at December 31, 2002.
The following is a summary of selected quarterly information (in thousands, except for per share data):
The carrying amounts and estimated fair values of Vesta’s financial instruments, none of which were held for trading purposes, at December 31, 2002 and 2001 are as follows (in thousands):
• Borrowings - Fair values for the advances from FHLB were calculated using interest rates in effect as of each year end with the other terms of the advances unchanged. Carrying values of short-term debt approximate fair value as effective rates approximate current rates. Fair values of long-term debt and deferrable capital securities, were determined based on recent transactions involving the applicable securities.
In 1999, we elected to exit all commercial lines programs by not accepting new commercial policy applications and non renewing existing in-force policies at their renewal dates. In November of 1999, we received final regulatory approval to non renew our commercial lines policies from all of the states in which we wrote commercial lines. Such approval represented the measurement date for treatment of the commercial segment as a discontinued operation under APB Opinion No. 30. Therefore, the commercial operations have been segregated from continuing operations herein for all periods presented. We will continue to earn premium and incur losses on policies that were in-force through November 1999.
Assets and liabilities of the commercial and reinsurance assumed segments are primarily comprised of the following at December 31, 2002 and 2001 (in thousands):