* Fully diluted earnings per share are not presented as the results would be antidilutive.
The Company's financial condition continued to improve in 1996 as shown in the following table:
As indicated in the Notes to Consolidated Financial Statements, the 1994 Northridge Earthquake had a significant adverse effect which required a variety of measures to be taken to improve the Company's financial condition. In particular, the statutory surplus strain caused by the earthquake was alleviated by capital infusions funded through borrowings and the issuance of equity securities (see Notes 8 and 16 of Notes to Consolidated Financial Statements), and by suspending dividends from the insurance subsidiaries to the parent and from the parent to common shareholders. Additionally, the Company's direct exposure to future earthquake coverage losses was completely eliminated in 1995. The Company's only significant remaining catastrophe exposure is in the homeowner and condominium lines, primarily relating to potential wild fires and fire following an earthquake event, which remained adequately protected by reinsurance.
Units in force for the Company's insurance programs as of December 31 were as follows:
The Company maintained average annual unit growth of over 10% during the ten years prior to 1994. That growth trend was interrupted for nine quarters starting with the third quarter of 1994, when the surplus strain created by the Northridge Earthquake caused the Company to reduce its insured exposures. This was accomplished by a combination of: cessation of advertising and marketing for new policies in the first quarter of 1994; cessation of writing new homeowner and condominium policies in June 1994; the non-renewal of all existing earthquake coverages in July 1994; and, rate increases of 17% in the homeowner line effective August 1, 1994 and 6% and 3.7% in the automobile line effective October 7, 1994 and June 15, 1995, respectively. Information about more recent developments relating to units in force within each major coverage line follows.
Premium revenue and underwriting results for the Company's insurance programs follow. To facilitate comparability, the effects of the earthquake coverage and the Proposition 103 settlement have been isolated from the core business in the table below.
The auto line experienced an $81 million underwriting profit in 1996, which included an $8 million pre-tax charge for weather-related claims in the fourth quarter. These results compared favorably to profits in 1995 and 1994 of $73.8 million and $10.1 million, respectively, as adjusted for the effects of the earthquake and Proposition 103. The 1996 increase in underwriting profit primarily reflects favorable loss trends while the 1995 increase was mainly due to the 6% rate increase implemented in October 1994 and the 3.7% increase implemented in June 1995.
The voluntary automobile insurance business written by the Company is comprised of "Good Drivers" as defined by California statute. While the majority of this business would have been acceptable to the Company before Proposition 103, those who had no prior insurance would have been written at a higher rate level than those who had been insured prior to being written by the Company. These drivers have produced automobile underwriting losses of $15,168,000 in 1996 compared to $26,286,000 in 1995 and $31,134,000 in 1994. The sharp decline in losses in 1996 is reflective of the continuing effect of the implementation of 1995 premium rate increases as well as an overall decline in the number of these vehicles insured. The 1996 combined ratio for this segment of the business was 129.7%. compared to 143.9% in 1995 and 155.3% in 1994.
Overall automobile underwriting results are also affected by Assigned Risk. Underwriting losses for Assigned Risk business were $102,000 in 1996, compared to $3,082,000 in 1995 and $3,800,000 in 1994. Combined ratios for this business for the same periods were 101.1%, 126.7% and 137.6%, respectively. The decrease in underwriting losses in 1996 was primarily due to a 16.5% drop in vehicles in force since 1995 coupled with the effects of a 5.2% rate increase implemented in June 1995. The future effect of the Assigned Risk plan on the Company cannot be predicted because it depends on the ability of the state-administered plan to achieve and maintain an adequate rate level.
underwriting loss for this line included first quarter weather-related losses of $14.2 million and an overall decline in homeowner and condominium premium volume.
The 100% quota share agreement covers all written exposures on homeowner policies renewing on or before July 23, 1996 through the end of their one-year policy term. These policies do not cover earthquake losses, and the Company's exposure to fire following an earthquake on these policies is covered by the agreement. For homeowner policies renewing on and after February 15, 1997, the Company has no exposure to earthquake losses. As the number of homeowner policy renewals increase after February 15, 1997, the Company intends to reduce its exposure to other losses on this line, as appropriate, through reinsurance. The Company had maintained separate catastrophe coverage on these lines which expired in June, 1996. Written premiums ceded for these lines in 1996 totaled $10.7 million (excluding the $33.3 million portfolio transfer of unearned premium liabilities under the 100% quota share reinsurance agreement), compared to $36.3 million in 1995 and $56.5 million in 1994.
Although the Company did not write new or renewal earthquake premiums in 1995 or 1996, the Company assumes a small amount of earthquake premium from the California Fair Plan, a state administered pool of difficult to insure risks in which insurers are required to participate in proportion to their share of direct written homeowners coverage in the state. The negative premiums earned for the Earthquake and Proposition 103 in 1995 and 1994 are due to the large amounts of reinsurance purchased, primarily in 1994, to protect the Company until the earthquake endorsements expired in July 1995.
The Company's policy acquisition and general operating expense ratio continues to be among the most competitive in the industry. The ratio of underwriting expenses (excluding loan interest and fees) to earned premiums was 9.3% in 1996, 9.0% in 1995 and 9.7% in 1994. The decline in the ratio from 1994 to 1996 reflects the impact of the ceding commission earned on the quota share agreements with an affiliate of AIG and, in 1996, with F&G Re and Risk Capital Re. Additionally, there was a reduction in general operating expenses due to the decline in business as well as cost efficiencies. The Company believes that its ability to write and administer its business in a cost efficient manner will enable it to regain and maintain price leadership in the industry and provide for future growth and profitability.
Net pre-tax investment income was $73,178,000 in 1996 compared to $81,658,000 in 1995 and $84,761,000 in 1994. Average invested assets decreased 6.9% in 1996, compared to decreases of 5.3% and 9.0% in 1995 and 1994, respectively. The decline in invested assets is the result of the Company's sale of these investments to meet the payment requirements of both developing earthquake losses and reinsurance premiums. The average annual pre-tax yield on invested assets has remained relatively stable over the past three years; the average yield was 6.6% in 1996, 6.8% in 1995 and 6.7% in 1994.
Of the Company's total investments, $265,163,000 at fair value was invested in tax-exempt state and municipal bonds and the balance was invested in taxable government, corporate and municipal securities at December 31, 1996, and the portfolio contained approximately 75% taxable instruments.
Loss and loss adjustment expense payments are the most significant cash flow requirements of the Company. The Company continually monitors loss payments to provide projections of future cash requirements. Additional cash requirements include servicing the bank debt and paying the quarterly dividend on preferred shares of $5,061,500. With the anticipated growth of its core auto business and continued settlement of remaining earthquake losses, the Company expects that future cash flows from operations will be sufficient to fund future expenditures. The Company has historically written its core businesses at an underwriting profit and thus each premium dollar produces positive cash flow. A significant part of the decline in cash flow from operations in 1995 and 1996 is due to the decline in the size of the net book of business during those periods. This
In addition, in 1996 approximately $29.2 million of the $32.5 million net decrease in cash and cash equivalents was related to the portfolio transfer of unearned premiums on homeowners business. Cash flows from operations in 1995 and 1994 were not sufficient to fund underwriting operations of the Company due to losses from the Northridge Earthquake. In 1994, the Company paid for these losses with cash flow from operations, investment sales, loan proceeds and equity financing. For 1995, funds needed to pay these claims as well as Proposition 103 rebates came from normal operating cash flows, available cash on deposit, additional loan proceeds of $15 million and preferred stock proceeds of $20 million.
Funds required by 20th Century Industries to pay dividends and meet its debt obligations are provided by the insurance subsidiaries. Information regarding the Company's debt service obligation is included in Note 8 to the Notes to Consolidated Financial Statements. The ability of the insurance subsidiaries to pay dividends to the holding company is regulated by state law. Based on the operating results in 1995 and the favorable ratio of premiums to surplus, the Company was able to resume normal dividends from the insurance subsidiaries in 1996 to service the parent's debt and preferred dividend requirements. Based upon 1996 operating results and earned surplus as of December 31, 1996, the Company believes dividends in 1997 will not require extraordinary regulatory approval.
The National Association of Insurance Commissioners requires property and casualty insurance companies to calculate and report information under a Risk-Based Capital ("RBC")
formula in their annual statements. The RBC requirements are intended to assist regulators in identifying inadequately capitalized companies. The RBC calculation is based on the type and mix of risks inherent in the Company's business and includes components for underwriting, asset, interest rate and other risks. The Company's insurance subsidiaries exceeded their RBC statutory surplus standards by considerable margin as of December 31, 1996. To the extent that the subsidiaries would fall below prescribed levels of surplus, it would be the parent company's intention to infuse necessary capital to support that entity.
We have audited the accompanying consolidated balance sheets of 20th Century Industries and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
20TH CENTURY INDUSTRIES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
20th Century Industries, through its wholly-owned subsidiaries, 20th Century Insurance Company and 21st Century Casualty Company (collectively, the "Company"), is engaged in the sale of private passenger automobile, homeowners and personal excess liability insurance policies in the State of California. In accordance with an order from state insurance regulators, no new homeowner and condominium policies have been written since July 23, 1994 and, beginning July 24, 1996, the Company was required to begin non-renewing these policies. In December 1996, the Company was granted approval to resume offering renewals effective February 15, 1997 on existing homeowner policies. Condominium policies are still in run-off and all policies will expire in July 1997.
The accompanying consolidated financial statements include the accounts and operations of 20th Century Industries and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles which differ from statutory accounting practices prescribed or permitted by insurance regulatory authorities. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from these estimates.
Effective January 1, 1994, in accordance with a required accounting change, the Company classified its investment portfolio as available-for-sale and carries it at fair value with unrealized gains and losses, net of any tax effect, reported as a separate component of stockholders' equity. The effect of this change was to increase stockholders equity as of January 1, 1994 by approximately $36.8 million, net of deferred income taxes of $19.8 million; the change had no effect on net income.
Earnings (loss) per common share are computed using the weighted average number of common share equivalents outstanding during the respective periods utilizing the modified treasury stock method. The primary weighted average number of common share equivalents was 58,694,730 for 1996, 57,223,839 for 1995 and 51,387,120 for 1994. The fully diluted weighted average number of common share equivalents was 78,737,410 for 1996, 79,325,308 for 1995 and 52,122,630 for 1994. The primary and fully diluted earnings (loss) per share amounts reflect a complex capital structure in which securities exist that allow for the acquisition of additional common stock through the exercise of conversion rights in these securities. Fully diluted earnings (loss) per share amounts for 1994, 1995 and 1996 are not presented as the effect would be antidilutive.
The accompanying 1994 and 1995 financial statements have been reclassified to conform with the 1996 presentations.
The changes in unrealized gains (losses) on investments available-for-sale for 1996, 1995 and 1994 total $(30,688,000), $73,285,000 and $(76,534,000), net of deferred income taxes (benefits) of $(16,524,000), $39,461,000 and $(41,211,000) respectively.
Under normal operations, the Company's principal deferred tax assets arise from the discounting of loss reserves for tax purposes which delays a portion of the loss deduction, and from the acceleration of 20% of the unearned premium reserve into taxable income before it is earned. As of December 31, 1996, the Company has a net operating loss carryforward of approximately $407,000,000 for regular tax purposes and $263,000,000 for alternative minimum tax purposes expiring in the year 2009 and an alternative minimum tax credit carryforward of $11,200,000. Alternative minimum tax credits may be carried forward indefinitely to offset future regular tax liabilities.
The net periodic pension cost for these plans reflected in the 1996, 1995 and 1994 consolidated statements of operations is $3,925,000, $3,147,000 and $3,722,000, respectively. Accrued pension
The Company sponsors contributory savings and security plans for eligible employees that permit participants to make pre-tax contributions. The Company provides matching contributions equal to 75% of the lesser of 6% of an employee's compensation or the amount contributed by the employee. Contributions charged against operations were $2,556,000, $2,376,000 and $2,210,000 in 1996, 1995 and 1994, respectively.
As a result of changes in estimates of insured events in prior years, the provision for losses and loss adjustment expenses decreased by $25,590,000, $39,464,000 and $84,453,000 in 1996, 1995 and 1994, respectively, due to a combination of improvements in the claims handling process, unanticipated decreases in frequency and random fluctuations in severity. The 1996 and 1995
decreases in provisions for insured events of prior years is affected by increases in losses related to the Northridge Earthquake of $40 million and $60 million, respectively.
1997 $10,571,538 1998 $ 9,244,447 1999 $ 8,312,720 2000 $ 2,312,556 2001 $ 1,253,591 Thereafter $ 705,788
The Company's insurance subsidiaries are subject to restriction as to the amount of dividends which may be paid to the parent company within any one year without the approval of the California Department of Insurance ("DOI"). The California Insurance Code provides that amounts may be paid as dividends from earned surplus on an annual, noncumulative basis, without prior approval by the California Department of Insurance, up to the greater of (1) net income for the preceding year, or (2) 10% of statutory surplus as regards policyholders as of the preceding December 31. Earned surplus available for dividends as of December 31, 1996 was $67.3 million.
At December 31, 1996, 116,000 options were exercisable at an average exercise price of $12.59. No options were exercisable or forfeited in 1995. Exercise prices for options outstanding at December 31, 1996 ranged from $12.50 to $19.88. The weighted average remaining contractual life of those options is 8.9 years.
The Restricted Shares Plan currently provides for grants of up to 921,920 shares of common stock to be made available to key employees as determined by the Key Employee Incentive Committee of the Board of Directors. At December 31, 1996, 294,874 common shares remain available for future grants. Upon issuance of grants of common shares under the plan, unearned compensation equivalent to the market value on the date of grant is charged to common stock and subsequently amortized in equal monthly installments over the five-year period of the grant. Amortization of the unearned compensation was $365,500, $550,000 and $431,000 in 1996, 1995 and 1994, respectively. The common shares are restricted for five years retroactive to the first day of the year of grant. Restrictions are removed on 20% of the shares of each employee on January 1 of each of the five years following the year of grant.
Lawsuits arising from claims under insurance contracts are provided for through loss and loss adjustment expense reserves established on an ongoing basis. From time to time, the Company has been named as a defendant in lawsuits incident to its business. Some of these actions assert claims for exemplary or punitive damages which are not insurable under California judicial decisions. The Company vigorously defends these actions unless a reasonable settlement appears appropriate. While any litigation has an element of uncertainty, the Company believes that the ultimate outcome of pending actions will not have a material adverse effect on its consolidated financial condition or results of operations.
On January 27, 1995, the Company announced it had reached a settlement with the DOI regarding rebate liabilities associated with Proposition 103, which was passed by California voters on November 8, 1988, for $78 million. By the second quarter of 1995, the Company had refunded $46 million to customers specified in the settlement, which represented an average payment per household of $80.00, or approximately 7.5% of premiums paid between November 8, 1988 and November 7, 1989. In accordance with the settlement, the Company offset a portion of the 1995 increase in earthquake losses associated with the 1994 Northridge Earthquake (see Note 15) with $32 million in funds previously set aside for potential Proposition 103 rebates. In addition, as part of the settlement, the Company contributed $30 million to the surplus of the insurance subsidiaries with funds obtained from the existing bank credit facility and from the issuance of 20,000 additional shares of preferred stock to AIG (see Notes 8 and 16, respectively).
The Company's estimate of gross losses and loss adjustment expenses for this catastrophe as of December 31, 1996 is $1.04 billion, of which $40 million and $60 million were recorded in 1996 and 1995, respectively. In accordance with the terms of a settlement with the California Department of Insurance, the Company offset a portion of the 1995 increase in earthquake losses with $32 million in funds previously set aside for potential Proposition 103 rebates (see Note 14).
QUARTER ENDED --------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ---------- ----------- ------------ ----------- (Amounts in thousands, except per share data) - - ---- Net premiums earned $ 232,628 $ 225,068 $ 204,755 $ 194,177
Net income (loss) $ 25,583 $ 31,928 $ 24,345 $ (7,799)
Fully diluted earnings per common share $ .32 $ .41 $ .31 *
- - ---- Net premiums earned $ 248,737 $ 240,085 $ 237,588 $ 237,387
Net income (loss) $ (1,418) $ 14,611 $ 30,132 $ 26,305
---- Homeowner Personal Auto Lines and Condominium Excess Liability --------------- ----------------- ------------------ Gross premiums written $ 991,969 $ 69,847 $ 2,146 --------------- ----------------- ------------------ --------------- ----------------- ------------------ Premiums earned $ 920,560 $ 42,394 $ 843 --------------- ----------------- ------------------ --------------- ----------------- ------------------ Underwriting profit (loss) $ 103,744 $ (78,976) $ 469 --------------- ----------------- ------------------ --------------- ----------------- ------------------
---- Homeowner Personal Auto Lines and Condominium Excess Liability --------------- ----------------- ------------------ Gross premiums written $ 991,268 $ 85,088 $ 2,307 --------------- ----------------- ------------------ --------------- ----------------- ------------------ Premiums earned $ 981,893 $ 51,166 $ 944 --------------- ----------------- ------------------ --------------- ----------------- ------------------ Underwriting profit (loss) $ (45,850) $ (879,221) $ 997 --------------- ----------------- ------------------ --------------- ----------------- ------------------
HOMEOWNERS AND CONDOMINIUM. The 1996 and 1995 underwriting losses in these lines included respective provisions for additional earthquake reserves of $40 million and $60 million, which was partially offset by a $32 million reduction in Proposition 103 rebates. Also affecting 1995 were first quarter weather-related losses of $14.2 million, earthquake-related catastrophe reinsurance premiums of $24 million and an overall decline in premium volume resulting from the DOI's order to discontinue writing new policies. The significant underwriting loss in 1994 was caused by the Northridge Earthquake.