The Company also leases office space for a claims office in San Diego, California, a sales office in Sacramento, California and marketing offices in Dallas, Texas and Boca Raton, Florida.
The following table sets forth selected financial and operating data for the Company.
SELECTED FINANCIAL AND OPERATING DATA (In thousands, except per share data)
(1) Financial data as of and for the years ended December 31, 1995, 1994 and 1993 are derived from the combined financial statements of the Southern California Physicians Insurance Exchange (the Exchange) and an affiliated non-profit corporation that was liquidated into the Exchange on July 12, 1996. Financial data as of and for the year ended December 31, 1996 are derived from the consolidated financial statements of the Exchange and its wholly-owned subsidiaries. Financial data as of and for the year ended December 31, 1997 are derived from the financial statements of SCPIE Holdings Inc. and its wholly-owned subsidiaries.
(3) Basic earnings per share of common stock at December 31, 1997 is computed using the weighted average number of common shares outstanding during the year of 12,108,330. All other periods give effect to the Reorganization completed on January 29, 1997, including the allocation of approximately 10,000,000 shares of common stock to members of the Exchange in connection therewith. The adoption of Statement of Financial Accounting Standards No. 128 (Statement 128), "Earnings per Share" had no impact on the calculation of basic earnings per share amounts. For further discussion of basic earnings per share and Statement 128 see the notes to the consolidated financial statements beginning on page 42.
Certain statements in the following discussion that are not historical in fact constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements regarding the Company, its business, prospects and results of operations are subject to certain risks and uncertainties posed by many factors and events that could cause the Company's actual business, prospects and results of operations to differ materially from those that may be expressed or implied by such forward-looking statements. Such risks, uncertainties and other factors are discussed below and under "Business--Risk Factors" and in periodic filings with the Securities and Exchange Commission.
COMPETITIVE ENVIRONMENT The California medical malpractice insurance market for medical groups and physicians, in which the company principally operates, has become extremely competitive in recent years. The Company's principal competitors are three physician-owned companies and a physicians' mutual protection trust. In addition, commercial insurance companies have recently returned to the California market to insure medical groups and physicians.
In the late 1980s, many medical malpractice insurance companies began to experience significantly improved claims cost trends and attempted to attract medical groups and physicians insured by other companies by reducing premium rates. Beginning in 1990, the Company implemented annual rate decreases aggregating more than 25% during the next three years, which resulted in a reduction in premium volume to approximately $107.1 million in 1992, and a deterioration of underwriting results. Between 1993 and 1997, however, SCPIE instituted annual overall rate increases ranging from 4.4% to 9.2% in order to improve its underwriting results. These rate increases were higher than those implemented by most of its competitors. As a result, the Company has lost some of its policyholders, in part due to these rate increases, but realized a modest increase in its premium volume and has improved its underwriting results.
The Company partially offset the effect of these rate increases through the payment of dividends to the members of the Exchange in the form of premium credits based on the actual results of prior policy years.
In 1996, the Board of Governors of the Exchange declared a final dividend to members of the Exchange of record on November 5, 1996, which was paid in the form of premium credits in 1997. This dividend of approximately $9.0 million (offset by a $0.6 million credit for forfeited dividends declared in 1995) was reflected as an expense in the year ended December 31, 1996. The Company has ceased paying such premium credit dividends to its policyholders. Therefore, the Company may find it more difficult to compete with other insurance companies offering such dividends.
estimates. The Company believes that it has been particularly difficult to make such estimates for medical malpractice claims in California because of the uncertain benefits of tort reform measures and more recently a change in the judicial process.
PREMIUMS EARNED Premiums earned increased approximately $13.4 million, or 11.1%, to $133.9 million in 1997 from $120.5 million in 1996. The increase was due to a $5.7 million increase in hospital medical malpractice premiums and an increase of $9.1 million in assumed reinsurance. Medical malpractice premiums from physicians and medical groups were approximately $111.4 million in 1997 compared to $112.7 million in 1996. An average 5.0% increase in premium rates in effect during 1997 was offset by a 4.1% decrease in the average number of policies in force during 1997 as compared to 1996. Hospital medical malpractice premiums were approximately $8.0 million in 1997 compared to $2.3 million in 1996. Assumed reinsurance premiums were approximately $13.6 million, which includes $6.5 million of assumed hospital premiums in 1997 compared to less than $4.5 million in 1996.
NET INVESTMENT INCOME Net investment income increased approximately $1.9 million, or 4.8%, to $42.7 million in 1997 from $40.8 million in 1996. Invested assets increased $67.8 million to $785.7 million in 1997 from $717.9 million at December 31, 1996. The average pretax yield on the investment portfolio decreased to 5.6% in 1997 compared to 6.1% in 1996 primarily due to lower-yielding, tax-exempt bonds.
OTHER OPERATING EXPENSES Other operating expenses increased $3.7 million, or 26.0%, to $18.0 million in 1997 from $14.3 million in 1996. This increase was principally attributable to increases in policy acquisition expenses, payroll/benefit expenses, and legal and consultation fees of $1.1 million, $0.7 million, and $1.2 million, respectively. The ratio of other operating expenses to premiums earned is referred to as the expense ratio, which was 13.4% in 1997 and 11.8% in 1996.
YEAR ENDED DECEMBER 31, 1996, COMPARED TO YEAR ENDED DECEMBER 31, 1995
REALIZED INVESTMENT GAINS AND OTHER REVENUE Realized investment gains were approximately $11.7 million in 1996 compared to $8.0 million in 1995. Approximately $11.2 million of the gains from 1996 resulted from the sale of equity securities in connection with the Company's decision in the first quarter of 1996 to increase the focus of its investment portfolio on fixed-maturity securities. The remainder was attributable to sales made in the fixed-maturity portion of the investment portfolio to take advantage of more favorable yields or to reposition the maturity of the portfolio.
POLICYHOLDER DIVIDENDS A final dividend to members of the Exchange of $9.0 million (offset by a $0.6 million credit for forfeited dividends declared in 1995) was reflected as an expense for the year ended December 31, 1996. Dividends declared in prior years have been accrued as an expense for the period in which the related premiums were earned and not the year paid or declared. Accordingly, there is no expense reflected in 1995.
FEDERAL INCOME TAXES Federal income taxes increased $1.6 million, or 16.0%, to $11.7 million in 1996 from $10.1 million in 1995. The effective tax rate decreased to 27.9% in 1996 from 29.2% in 1995, due primarily to an increase in tax-exempt interest in 1996.
The Company invests its positive cash flow from operations in both fixed-maturity securities and equity securities. The Company's current policy is to limit its investment in equity securities and real estate to no more than 8.0% of the total market value of its investments. Accordingly, the Company's portfolio of unaffiliated equity securities was reduced from $61.1 million at December 31, 1995, to $23.5 million at December 31, 1997. The Company plans to continue this focus on fixed-maturity securities for the indefinite future. The Company has made limited investments in real estate, which has been used almost entirely in the Company's operating activities, with the remainder leased to third parties.
The Company maintains a portion of its investment portfolio in high-quality, short-term securities to meet short-term operating liquidity requirements, including the payment of losses and LAE. Short-term investments totaled $53.3 million, or 6.8% of invested assets, at December 31, 1997. The Company believes that all of its short-term and fixed-maturity securities are readily marketable.
SCPIE Holdings is an insurance holding company whose assets primarily consist of all of the capital stock of its insurance company subsidiaries and approximately $36.4 million of net proceeds from a January 1997 common stock offering. In 1997, along with the net proceeds from the common stock offering, and dividends from its insurance subsidiaries, SCPIE has contributed $25.0 million to American Healthcare Specialty Insurance Company and another $23.0 million to AHI. Its principal sources of funds are dividends from its subsidiaries and proceeds from the issuance of debt and equity securities. The insurance company subsidiaries are restricted by state regulation in the amount of dividends they can pay in relation to earnings or surplus, without the consent of the applicable state regulatory authority, principally the California Department of Insurance. SCPIE Holdings' principal insurance company subsidiary may pay dividends to SCPIE Holdings in any year, without regulatory approval, to the extent such dividends do not exceed the greater of (i) 10% of its statutory surplus at the end of the preceding year or (ii) its net income for the preceding year. Applicable regulations further require that an insurer's statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs, and permit the payment of dividends only out of statutory earned (unassigned) surplus unless the payment out of other funds receives regulatory approval. The amount of dividends that the insurance company subsidiaries are able to pay to SCPIE Holdings during 1998 without prior regulatory approval is approximately $27.5 million. Dividends of $20.0 million were paid during 1997.
Based on our assessments in prior years, the Company has determined modification of significant portions of its software were required so that its computer systems would function properly with respect to dates in the year 2000 and thereafter. The Company has utilized internal resources to reprogram, or replace and test, the software for Year 2000 modifications. The Company estimates that approximately 85% of the most important changes have been made and anticipates completing the entire project by December 31, 1998. The total cost of the Year 2000 project since its inception in 1995 is estimated at $1.8 million, of which approximately $734,000 was incurred through December 31, 1997. There can be no assurance, however, that there will not be a delay in or increased costs associated with the completion and implementation of such changes, and the Company's inability to implement such changes could have an adverse effect on future results of operations.
The Company's Consolidated Financial Statements and related notes, including supplementary data, are set forth in the "Index" on page 37 hereof.