- - Continued benefits from marketplace disruptions due to rating agency downgrades, insolvencies and merger and acquisition activity. These disruptions have resulted in new independent agency relationships, improved premium rates and policy terms and increased market share in certain of the Company's commercial lines segment niche products;
- - The 44.4% growth in the personal lines segment, primarily attributable to the Company's "preferred homeowners" insurance program, which was introduced during 2000 to retirees in gated communities; and
The Company also believes its core strategy of adhering to an underwriting philosophy of sound risk selection and pricing discipline, the mixed marketing platform for its product distribution and creating value added features not typically found in property and casualty products have also contributed to generating premium growth above industry averages, as well as enabling the Company to produce combined ratios (the sum of net loss and loss adjustment expenses and acquisition costs and other underwriting expenses, divided by net earned premiums) well below industry averages. The GAAP combined ratio for the year ended December 31, 2001 was 93.4%, which, once again, was substantially lower than the property and casualty industry as a whole.
As noted above, during the second half of 2000 and through the first nine months of 2001 marketplace disruptions resulted in improving premium rates and policy terms. Additionally, the terrorist attacks of September 11, 2001 caused the property and casualty industry to experience significant losses. As a result, the Company anticipates that the rate increases and improving policy terms, which started to occur in the second half of 2000, will now continue, possibly for an extended period of time. To better position itself to take advantage of these improving conditions the Company issued 3.6 million shares of its common stock through a public offering in the fourth quarter of 2001. The $114.5 million in net proceeds from this offering are primarily being utilized to provide additional capital for the Company's insurance subsidiaries and to fund general corporate purposes.
Investments consist of diversified issuers and issues, and as of December 31, 2001, approximately 88.7% and 4.8% of the total invested assets (total investments plus cash equivalents) on a cost basis consisted of investments in fixed maturity and equity securities, respectively, versus 84.2% and 5.2%, respectively, at December 31, 2000.
During 2001, based upon guidance from the Financial Accounting Standards Board Emerging Issues Task Force (EITF) regarding Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets ("EITF 99-20"), certain of the Company's structured securities were subject to re-evaluation as a result of meeting the recognition for impairment losses in EITF 99-20. This re-evaluation resulted in non-cash realized investment losses of $5.8 million. The Company expects to receive full contract value and recover the writedowns. Any such recovery will be recognized prospectively through net investment income.
Also, during 2001 the relative percentage investment in taxable fixed maturity securities versus tax-exempt fixed maturity securities continued to increase due to the Company taking advantage of the more favorable after-tax yields. At the end of 2001, on a cost basis, investment grade taxable fixed maturity securities represented 73.9% of the total invested assets, compared to 66.5% as of the end of 2000.
The Company performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed to determine whether a decline in fair value below a security's cost basis is other than temporary. If the Company determines a decline in value to be other than temporary, the cost basis of the security is written down to its fair value with the amount of the write down included in earnings as a realized loss in the period the impairment arose.
The Company's impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by EITF 99-20. Under this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent (prior) estimation date. If these criteria are met an impairment charge, the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose.
The respective gross written premium increases for the commercial lines, specialty lines and personal lines segments for the years ended December 31, 2001 vs. December 31, 2000 amount to $76.5 million (31.9%), $11.1 million (16.3%) and $24.1 million (44.4%), respectively. The overall growth in gross written premiums is primarily attributable to the following:
- - Rating downgrades of certain major competitor property and casualty insurance companies have led to their diminished presence in the Company's commercial and specialty lines business segments and continue to result in additional prospects and increased premium writings, most notably for the Company's various commercial package and non-profit D&O product lines.
relationship opportunities for the Company. These relationships have resulted in additional prospects and premium writings for the Company's commercial and specialty lines segments.
Overall premium growth in the specialty lines segment has been offset in part by the Company's decision not to renew certain policies in the professional liability product lines due to inadequate pricing levels being experienced as a result of market conditions and/or loss experience emerging at higher than expected levels.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $21.9 million (29.2%) to $97.0 million for the year ended December 31, 2001 from $75.1 million for the same period of 2000. This increase was due primarily to the 30.3% growth in net earned premiums, offset by relative changes in the Company's product mix and associated distribution channel expense.
- - The consolidation of certain competitor property and casualty insurance companies has led to the displacement of certain of its independent agency relationships which continues to result in new agency relationships for the Company which have been bringing additional prospects and premium writings for the Company's commercial and specialty lines segments.
The respective net written premium increases for the commercial lines, specialty lines and personal lines segments for the years ended December 31, 2000 vs. December 31, 1999 amount to $34.4 million (26.6%), $26.9 million (65.8%) and $18.1 million (128.6%) respectively. The higher percentage increase in net written premiums versus gross written premiums for the period is primarily due to the Company, effective January 2000, increasing its liability retention on each occurrence from $250,000 to $1.0 million for all specialty lines segment business, thus reducing its reinsurance cost (ceded written premiums) and increasing its retained premiums (net written premiums).
Net Realized Investment Gain: Net realized investment gains were $11.7 million for 2000 and $5.7 million for 1999. The Company realized net investment gains of $15.1 million from the sales of common stock equity securities offset by $3.4 million of realized net investment losses from sales of certain fixed maturity securities during the year ended December 2000. The proceeds from these common stock sales were reinvested in fixed maturity securities to increase current investment income, lessen the Company's holdings in certain common stock positions, and decrease the overall percentage of investments in common stock securities. The proceeds realized from the fixed maturity sales were reinvested in fixed maturity securities with higher relative book yields than the fixed income securities sold. The net realized investment gains of $5.7 million for the year ended December 31, 1999 were due to the sales of certain fixed maturity and equity investments. A portion of the proceeds from these sales were utilized for the cash purchase price and repayment of certain obligations of the Liberty acquisition. The remaining proceeds were repositioned within the fixed maturity portfolio.
- - Losses emerging during 2000 at a higher rate than had been originally anticipated for certain products in the commercial lines segment when the initial reserves were estimated.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $21.3 million (39.6%), to $75.1 million in 2000 from $53.8 million in 1999. This increase was due primarily to the 37.8% growth in net earned premiums and to relative changes in the Company's product mix and associated distribution expense.
The Company believes that it can continue its premium growth due to: its national presence via 36 production underwriting offices located across the United States from which the production underwriting organization markets the Company's products and services directly to its customers, as well as coordinating the efforts of the Company's external producers; the evaluation and development of new product opportunities and differentiation of policy and service features; the disruption in the marketplace as a result of consolidation activity and certain distressed situations along with the improving fundamentals (premium rates and policy terms) in the property and casualty industry; and expansion of its personal lines business into new states in addition to seeking premium growth in its current markets. The Company also anticipates cross selling opportunities to arise between its personal and commercial lines business niches as well as cross selling opportunities within its preferred agency base for its portfolio of commercial niche insurance products.
Overall future premium growth may be offset in part due to the continuing adverse affects the September 11th terrorist attacks have had on the Company's rental car customers offering its excess liability (SLI) insurance coverage to the business and leisure traveler. This product is sold at the rental car counters through arrangements with a number of the largest rent-a-car companies and protects rent-a-car customers against liability for bodily injury and property damage excess of the statutory coverage provided with the rental vehicle. The SLI product represented approximately 8.0% of the 2001 commercial lines segment total net written premium.
On November 27, 2001 the Company closed on its public offering of an aggregate of 3.6 million shares of its common stock. Proceeds from the offering were $114.5 million (after underwriting and associated costs). The Company contributed $70.0 million of the net proceeds to its subsidiaries in 2001, of which $60.0 million was contributed to the Insurance Subsidiaries. The remaining proceeds are presently being held for general corporate purposes.
On September 14, 2001, the Company's Board of Directors authorized the repurchase of an additional $15.0 million of the Company's common stock. This authorization is in addition to the previously announced $40.0 million common stock buyback authorization, bringing the total current remaining authorization to $30.1 million. Purchases are made from time to time in the open market or through privately negotiated transactions.
In the normal course of business, the Company has entered into various reinsurance contracts with unrelated reinsurers. The Company participates in such agreements for the purpose of limiting loss exposure and diversifying business. Reinsurance contracts do not relieve the Company from its obligations to policyholders. To minimize the potential for a write off of amounts due from reinsurers, the Company: evaluates the financial condition of its reinsurers; principally contracts with large reinsurers that are rated at least "A-" (Excellent) by A.M. Best Company; regularly monitors its reinsurance receivables; and collects the obligations of its reinsurers on a timely basis.
The insurance subsidiaries, which operate under an intercompany reinsurance pooling agreement, must have certain levels of surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners (the "NAIC") suggest that a property and casualty insurer's ratio of annual statutory net premium written to policyholders' surplus should not exceed 3-to-1. The ratio of combined annual statutory net premium written by the insurance subsidiaries to their combined policyholders' surplus was 1.2-to-1.0 and 1.4-to-1.0 for 2001 and 2000, respectively. Management believes that the policyholders' surplus, which was $281.0 million at December 31, 2001, will be sufficient to support current and anticipated premium writings.
(1) Represents 12 month collateralized borrowings from the Federal Home Loan Bank of Pittsburgh, the proceeds from which are invested to achieve a positive spread between the investment and borrowing interest rates. (2) Represents open commitments under certain limited partnership agreements.
Property and casualty insurance premiums are established before the amount of losses and loss adjusted expenses, or the extent to which inflation may affect such amounts, is known. The Company attempts to anticipate the potential impact of inflation in establishing its premiums and reserves. Substantial future increases in inflation could result in future increases in interest rates, which, in turn, are likely to result in a decline in the market value of the Company's investment portfolio and resulting unrealized losses and/or reductions in shareholders' equity.
Certain information included in this report and other statements or materials published or to be published by the Company are not historical facts but are forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new and existing products, expectations for market segment and growth, and similar matters. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary remarks regarding important factors which, among others, could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, results of the Company's business, and the other matters referred to above include, but are not limited to: (i) changes in the business environment in which the Company operates, including inflation and interest rates; (ii) changes in taxes, governmental laws, and regulations; (iii) competitive product and pricing activity; (iv) difficulties of managing growth profitably; (v) catastrophe losses; and (vi) the amount of time and extent of business interruptions and other losses resulting from any future terrorist attacks.
Philadelphia Consolidated Holding Corp. ("Philadelphia Insurance"), and its subsidiaries (collectively the "Company") doing business as Philadelphia Insurance Companies, include four property and casualty insurance companies, Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company, which are domiciled in Pennsylvania; and Mobile USA Insurance Company and Liberty American Insurance Company, which are domiciled in Florida (collectively the "Insurance Subsidiaries"); an underwriting manager, Maguire Insurance Agency, Inc.; a managing general agency, Mobile Homeowners Insurance Agencies, Inc; a premium finance company Liberty American Premium Finance Company; and an investment subsidiary, PCHC Investment Corp. The Company designs, markets, and underwrites specialty commercial and personal property and casualty insurance products for select target industries or niches including, among others, nonprofit organizations; the health, fitness and wellness industry; select classes of professional liability; the rental car industry; automobile leasing industry; and personal property and casualty insurance products for the manufactured housing and homeowners markets. All marketing, underwriting, claims management, investment, and general administration is provided by the underwriting manager and managing general agency.
Investments in fixed maturities are adjusted for amortization of premiums and accretion of discounts to maturity date, except for collateralized mortgage and asset backed securities which are adjusted for amortization of premiums and accretion of discounts over their estimated lives. Certain collateralized mortgage and asset backed securities repayment patterns will change based on interest rate movements and, accordingly, could impact future investment income if the reinvestment of the repayment amounts are at lower interest rates than the underlying securities. Collateralized mortgage and asset backed securities amounted to $70.9 million and $273.3 million, respectively, at December 31, 2001 and $66.8 million and $103.9 million, respectively, at December 31, 2000. The collateralized mortgage and asset backed securities held as of December 31, 2001 and 2000 are shorter tranche securities possessing favorable prepayment risk profiles.
Investments are considered impaired when the Company determines a decline in value to be other than temporary. Accordingly, such a decline is recorded as a charge to income in the period this determination is made.
relationship exists. Changes in the fair value of derivatives that are not designated as hedges or that do not meet the hedge accounting criteria in SFAS 133 are required to be reported in income. The Company held no derivative financial instruments, nor embedded financial derivatives, as of December 31, 2001 and 2000.
Policy acquisition costs, which include commissions, premium taxes, fees, and certain other costs of underwriting policies, are deferred and amortized over the same period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable after providing for losses and expenses that are expected to be incurred, based upon historical and current experience. Anticipated investment income is considered in determining whether a premium deficiency exists. Amortization of policy acquisition costs in the accompanying consolidated statements of operations and comprehensive income was $80.2 million, $60.4 million, and $46.5 million for the years ended December 31, 2001, 2000, and 1999, respectively.
On July 16, 1999, Philadelphia Insurance closed on its acquisition of Liberty (Mobile USA Insurance Company, Liberty American Insurance Company, Mobile Homeowners Insurance Agencies, Inc., and Liberty American Premium Finance Company) for a purchase price of $45.0 million, and a contingent additional amount of up to $5.0 million based upon the earnings for the acquired business. Of the purchase price, $20.0 million was paid in cash and the balance in 1,037,772 shares of common stock of the Company. Based on the Company's current estimate, no additional future amount will be paid. The acquisition was accounted for using the purchase method of accounting. Goodwill resulting from the acquisition amounted to $32.7 million. This amount represents the excess of acquisition costs over the fair value of net assets acquired.
Accounting Principles: In December 1998, the National Association of Insurance Commissioners ("NAIC") adopted the Codification of Statutory Accounting Principles guidance, which replaces the Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting as of January 1, 2001. The Codification of Statutory Accounting Principles provides guidance for areas where statutory accounting was previously silent and changed previous statutory accounting in some areas (e.g., deferred income taxes, electronic data processing equipment and software, and uncollected
premiums). The Insurance Departments of Pennsylvania and Florida adopted the Codification guidance, effective January 1, 2001. The effect of adoption of the Codification of Statutory Accounting Principles, recorded as a direct increase to the Company's combined statutory unassigned surplus of it's subsidiaries, was $15.7 million.
- - Under SAP, investments in debt securities are carried at amortized cost, while under GAAP, investments in debt securities classified as Available for Sale are carried at fair value.
- - Under SAP, net deferred income tax assets are admitted following the application of certain criteria, with the resulting admitted deferred tax amount being credited directly to policyholder surplus.
Financial Information: The statutory capital and surplus of the Insurance Subsidiaries as of December 31, 2001 and 2000 was $281.0 million and $193.3 million, respectively. Statutory net income for the years ended December 31, 2001, 2000 and 1999 was $28.3 million, $26.2 million, and $19.2 million, respectively. Capital contributions for the years ended December 31, 2001 and 2000 were $73.0 and $0 million, respectively.
The Company invests primarily in investment grade fixed maturities which possessed an average quality rating of AA at December 31, 2001. The cost, gross unrealized gains and losses and estimated market value of investments as of December 31, 2001 and 2000 are as follows (in thousands):
(1) Original cost of equity securities; original cost of fixed maturities adjusted for amortization of premiums and accretion of discounts. (2) Estimated market values have been based on quoted market prices.
The Company had no debt or equity investments in a single issuer totaling in excess of 10% of shareholders' equity at December 31, 2001.
The cost and estimated market value of fixed maturity securities at December 31, 2001, by remaining contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The sources of net investment income for the years ended December 31, 2001, 2000, and 1999 are as follows (in thousands):
Realized pre-tax gains (losses) on the sale of investments for the years ended December 31, 2001, 2000, and 1999 are as follows (in thousands):
Additionally, the Insurance Subsidiaries have investments, principally asset backed securities, which collateralize the borrowings from the Federal Home Loan Bank of Pittsburgh, see Note 9. The carrying value of these investments was $33.9 million and $0 million as of December 31, 2001 and 2000, respectively.
The Company maintains investments in trust accounts under reinsurance agreements with unrelated insurance companies. These investments collateralize the Company's obligations under the reinsurance agreements. The Company possesses sole responsibility for investment and reinvestment of the trust account assets. All dividends, interest and other income, resulting from investment of these assets are distributed to the Company on a monthly basis. At December 31, 2001 and 2000 the carrying value of these trust fund investments were $11.9 million and $10.9 million, respectively.
The following table summarizes property and equipment at December 31, 2001 and 2000 (dollars in thousands):
The Company had aggregate borrowings of $31.3 million and $0 million as of December 31, 2001 and 2000, respectively, from the Federal Home Loan Bank of Pittsburgh. These borrowings bear interest at adjusted LIBOR and mature twelve months from inception. The proceeds from these borrowings were invested in asset backed securities and collateralized mortgage obligations to achieve a positive spread between the rate of interest on these securities and the borrowing rates. The weighted-average interest rate on borrowings outstanding as of December 31, 2001 was 2.07%.
The following table summarizes the differences between the Company's effective tax rate for financial statement purposes and the federal statutory rate (dollars in thousands):
During 1998, the Company issued 10.350 million FELINE PRIDESSM at $10.00 per security and PCHC Financing I, the Company's business trust subsidiary, issued 1,000,000 7.0% Trust Originated Preferred Securities with a stated liquidation amount per trust preferred security equal to $10.00. The 10.350 million FELINE PRIDESSM consisted of 9.350 million units referred to as Income Prides and 1.000 million units referred to as Growth Prides. Each Income Prides consisted of a unit comprised of (a) a purchase contract under which the holder purchased a number of shares of Philadelphia Consolidated Holding Corp. common stock on May 16, 2001 (equal to .3858 shares per FELINE PRIDESSM) under the terms specified in
the stock purchase contract and (b) beneficial ownership of a 7.0% Trust Originated Preferred Security issued by PCHC Financing I and representing an undivided beneficial ownership in the assets of PCHC Financing I. Each holder received aggregate cumulative cash distributions at the annual rate of 7.00% of the $10.00 stated amount for the security, payable quarterly in arrears. Each Growth Prides consisted of a unit with a face amount of $10.00 comprised of (a) a purchase contract under which (i) the holder purchased a number of shares of Philadelphia Consolidated Holding Corp. common stock on May 16, 2001 (equal to .3858 shares per FELINE PRIDESSM) under the terms specified in the stock purchase contract and (ii) the Company paid the holder contract adjustment payments at the rate of .50% of the stated amount per annum and (b) a 1/100 undivided beneficial ownership interest in a treasury security having a principal amount at maturity equal to $1,000 and maturing on May 15, 2001.
The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for the Company's compensation instruments is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock.
The following is a summary of the Company's option activity, including weighted-average option information:
Preferred Agents Stock Purchase Plan ("Preferred Agents Plan"): The Preferred Agents Plan has been established for the benefit of eligible Preferred Agents. The aggregate maximum number of shares that may be issued pursuant to the Preferred Agents Plan is 200,000. Eligible Preferred Agents during designated offering periods may either remit cash or have the Company withhold from commissions or other compensation amounts to be used for the purchase of shares under the terms of the Preferred Agents Plan at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. Under the Preferred Agents Plan, the Company issued 0 and
On September 14, 2001, the Company's Board of Directors increased the authorization for the Company to repurchase up to a total of $55.0 million of its common stock. For the three year period ended December 31, 2001, the Company repurchased 1.6 million shares for approximately $24.9 million under this authorization.
The Company currently leases office space to serve as its headquarters location and 36 field offices for its production underwriters. In addition, the Company leases certain computer equipment. Rental expense for these operating leases was $2.6 million, $2.2 million and $1.7 million for the years ended December 31, 2001, 2000, and 1999, respectively.
At December 31, 2001 the Company has open commitments of $1.1 million under certain limited partnership agreements. The future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2001 were as follows (in thousands):