Physicians leases approximately 1,892 square feet of office space in Columbus, Ohio for its headquarters. Citation leases office space for a claims office in Orange County, California. Vidler and Nevada Land lease office space in Carson City, Nevada. Vidler and Nevada Land hold significant investments in land, water rights and mineral rights in the southwestern United States. We continually evaluate our current and future space capacity in relation to our business needs. We believe that our existing facilities are suitable and adequate to meet our current business requirements. See "Item 1 - Business-Introduction."
The following table presents the Company's selected consolidated financial data. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" in
The consolidated financial statements and other portions of this Annual Report on Form 10-K for the fiscal year ended December 31, 2003, including Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," reflect the effects of:
We believe that continuing trends in Nevada and Arizona indicate strong future demand for Vidler's water rights and water storage assets.
In Arizona, the continued growth of the municipalities surrounding Phoenix in Maricopa County is likely to lead to strong demand for Vidler's water rights in the Harquahala Valley. The Arizona State Demographer estimates that the population of Maricopa County increased 10.6% in the 3.25 years from April 1, 2000 until July 1, 2003, to almost 3.4 million residents. Many municipalities surrounding Phoenix/Scottsdale do not receive allotments of water from the Colorado River, and are therefore forced to find alternative supplies of water.
Due to the low level of Lake Mead, the states of Arizona, California, and Nevada may be required to take no more than their current allotments of water from the Colorado River. This is likely to increase demand for the net recharge credits owned by Vidler, representing water which Vidler has in storage in its Arizona Recharge Facility. We also anticipate demand from developers and other entities to store water for various purposes, including back-up water supply for dry years by developers, and assured water supply for new development projects.
The Central Arizona Water Conservation District ("CAWCD") is a three-county water district servicing the most populous parts of the state, including Maricopa County. A recent CAWCD study predicted that CAWCD will be able to use 9 million acre-feet of water from Arizona's Colorado River supplies in the years from 2004 through 2050, assuming average annual precipitation. The CAWCD also estimated that 8.6 million acre-feet will be required over the same period by the Central Arizona Groundwater Replenishment District, the authority responsible for protecting groundwater supplies in the CAWCD three-county service area. The CAWCD also estimated demand of 3.5 million acre-feet from the Arizona Water Bank for various purposes (e.g., use in Nevada), and a further 4.3 million acre-feet to replenish groundwater reserves. Based on these forecasts, Arizona appears to be faced with a shortfall of 7.4 million acre-feet of water in the period through 2050, which will require CAWCD to purchase additional supplies.
The Southern Nevada Water Authority has released a master water plan (which can be viewed at www.snwa.com) to develop and deliver water supplies to meet regional growth demands. This plan consists of (1) the storage of water, including up to 1.25 million acre-feet in Arizona' combined with (2) the development of further water resources in Nevada. We believe that Vidler's assets are favorably positioned to contribute to the water resource solutions required in the Southwest.
At December 31, 2003, Vidler owned or had the right to acquire approximately 49,559 acre-feet of transferable ground water in the HARQUAHALA VALLEY, approximately 75 miles northwest of metropolitan Phoenix, Arizona. Vidler owns 35,795 acre-feet, and we have the option to purchase a further 13,764 acre-feet. We believe that Vidler's water rights in the Harquahala Valley represent the most practical and competitive source of water to support the growth of greater metropolitan Phoenix, which is one of the fastest growing areas in the nation.
Any new residential development in Arizona must obtain a permit from the Arizona Department of Water Resources certifying a "designated assured water supply" sufficient to sustain the development for at least 100 years. The Harquahala Valley ground water meets the designation of assured water supply. In order for the ground water to be used by municipalities in the heavily populated parts of Arizona, the water must be "wheeled," or transported, from the Harquahala Valley to the end users. The Arizona State Legislature has passed legislation which allows Harquahala Valley ground water to be made available as assured water supply to cities and communities in Arizona through agreements with the Central Arizona Groundwater Replenishment District.
In 2001 and 2002, Vidler completed its first sales of Harquahala Valley ground water for industrial use and municipal use:
- - in March 2002, Vidler sold 3,645 acre-feet of water rights and 1,215 acres of land to golf course developers near Scottsdale, for $5.2 million; and
Vidler is working jointly with Lincoln County to locate and develop water resources in Lincoln County, Nevada. Lincoln County and Vidler have filed applications for more than 100,000 acre-feet of water rights with the intention of supplying water to communities and industrial users. We believe that this is the only known new source of water for Lincoln County. Vidler anticipates that up to 40,000 acre-feet of water rights will ultimately be permitted from these applications, and put to use in Lincoln County.
Under the Lincoln County Land Act, more than 13,000 acres of publicly owned land in southern Lincoln County is to be offered for sale near the fast growing City of Mesquite. The first release of land under the Lincoln County Land Act is expected to occur later in 2004. Additional water will be required if this land is to be developed.
The Lincoln County undertaking is an example of a transaction where Vidler can partner with an entity, in this case a government entity, to provide the necessary capital and skills to commercially develop water assets.
In June 2002, the Nevada State Engineer awarded Vidler 415 acre-feet of water rights near Sandy Valley, Nevada. Vidler has filed another application for 1,000 acre-feet.
The Muddy River is a perennial river fed by the Muddy Springs in Southern Nevada, originating in Nevada and flowing into Lake Mead. Currently, Muddy River water rights are utilized for agriculture and electricity generation; however, in the future, we
At December 31, 2003, Vidler owned approximately 221 acre-feet of Muddy River water rights, and had the right to acquire an additional 45.6 acre-feet.
Vidler is holding discussions with a number of potential users for the Fish Springs water rights, including developers and industrial users. There is strong demand for water in the North Valleys, and few alternative sources of supply. The future demand of the North Valleys area is estimated to exceed 12,000 acre-feet annually. If water from Fish Springs could be supplied to the North Valleys, this would reduce their reliance on Truckee River water which comes through Reno, thereby providing environmental benefits and additional water to support growth in and around Reno, an area which has been experiencing consistent growth.
Vidler is completing the process of monetizing its water rights in Colorado, through sale or lease:
- - during 2002, Vidler closed on the sale of its interest in Cline Ranch for $2.1 million and the sale of 86 acre-feet of water rights for $3.1 million; and
- - in 2003, Vidler closed on the sale of the Wet Mountain water rights for $414,000.
Discussions are continuing to either lease or sell the remaining water rights in Colorado.
We believe that a number of events in recent years have increased the scarcity value of the project's storage capacity. At a public hearing in March 2000, the AWBA disclosed that the Bureau of Reclamation has indicated that, before permits are issued for new facilities to store water for interstate users, extensive environmental impact studies will be required. The AWBA also indicated that the first priority for publicly owned storage capacity in Arizona is to store water for Arizona users. At the same hearing, the states of California and Nevada again confirmed that their demand for storage far exceeds the total amount of storage available at existing facilities in Arizona. Consequently, interstate users will need to rely, at least in part, on privately owned storage capacity.
In addition to the potential demand from the public users represented by the AWBA, demand from private users could potentially utilize up to 100% of the site's storage capacity.
Vidler has not yet stored water for customers at the facility, but the company has been recharging water for its own account since 1998, when the pilot plant was constructed. In 2003, Vidler had "net recharge credits" representing approximately 34,000 acre-feet of water in storage at the facility, and had purchased a further 7,000 acre-feet which was recharged in 2004 as well as ordering an additional 29,000 acre-feet for purchase and recharge in 2004. Vidler purchased the water from the CAP, and intends to resell this water at an appropriate time. Vidler is in discussions with a number of developers and other entities, which could lead to the sale of the water that we have stored on our own account, and to storing additional water.
Vidler anticipates being able to recharge 100,000 acre-feet of water per year at the facility, and to store in excess of 1 million acre-feet of water in the aquifer. Vidler's estimate of the aquifer's storage volume is primarily based on a hydrological report prepared by an independent engineering firm for the Central Arizona Water Conservation District in 1990, which concluded that there is storage capacity of 3.7 million acre-feet.
Vidler routinely evaluates the purchase of further water-righted properties in Arizona and Nevada. Vidler also continues to be approached by parties who are interested in obtaining a water supply, or discussing joint ventures to commercially develop water assets and/or develop water storage facilities in Arizona, Nevada, and other southwestern states. We have the resources and relationships to respond to business opportunities which are consistent with our strategic objectives.
The majority of Nevada Land's revenues come from the sale of land and the related water rights. In addition, various types of recurring revenue are generated from use of the Nevada Land's properties, including leasing, easements, and mineral royalties. Nevada Land also generates interest revenue from land sales contracts where Nevada Land has provided partial financing, and from temporary investment of the proceeds of land sales.
Nevada Land recognizes revenue from land sales, and the resulting gross profit or loss, when transactions close. On closing, the entire sales price is recorded as revenue, and a gross margin is recognized depending on the cost basis attributed to the land which was sold. Since the date of closing determines the accounting period in which the sales revenue and gain are recorded, Nevada Land's reported revenues and income fluctuate from period to period, depending on the dates when specific transactions close.
In 2003, Nevada Land generated $4.1 million in revenues from the sale of 75,131 acres of former railroad land, indicating on-going demand. The average sales price of $55 per acre compares to our average basis of $25 per acre in the parcels which were sold. Included in 2003 land sales were approximately 50,000 acres of desert and mountainous land which biased the average sales price and average basis downwards, but resulted in a gross margin in the typical 50% - 60% range.
In 2003, 89.8% of land sales were settled for cash, and Nevada Land provided partial financing for the remainder. Vendor financing is collateralized by the land conveyed, typically carries a 10% interest rate, and is subject to a minimum 20% down payment.
This section describes the most significant interests in public companies included in this segment during 2003.
Excluding HyperFeed, which became a consolidated subsidiary during the year, we estimate that the common stock interests in public companies reported in this segment generated a total return (i.e., realized and unrealized gains, plus dividends received, in U.S. dollars) of approximately 29% in 2003.
In 2001, 2002, and 2003 until May 15, PICO's investment in HyperFeed common shares was recorded in this segment using the equity method under Accounting Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock." Since May 15, 2003, when HyperFeed became a consolidated subsidiary, its results have been recorded in a separate segment, "HyperFeed Technologies;"; however, PICO's investment in HyperFeed warrants is still recorded in the Business Acquisitions and Financing segment.
In the press release, Jungfraubahn indicated that it expected transport revenues of approximately CHF (Swiss Francs) 86.2 million (US$64.9 million) for 2003, a 2.5% increase year over year. In the first six months of 2003, Jungfraubahn's results were affected by a decrease in group travel, particularly from Japan and the U.S., resulting from a reluctance to travel due to the Iraq war and the respiratory disease SARS. During the summer, the shortfall was partly made up by increased numbers of passengers from Switzerland and other European countries. In the first half of 2003, the number of visitors to Jungfraujoch-Top of Europe declined 16.6% year over year; however, for the full year, passenger numbers were only down 3.4%, illustrating a recovery in the second half of 2003.
In September 2003, Jungfraubahn announced its results for the six months to June 30, 2003. Reported revenues were CHF 54.3 million (US$39.9 million). Net income was CHF 4.4 million (US$3.2 million), or approximately CHF 7.5 per share (US$5.54), a 14.3% increase year over year.
Jungfraubahn announced its results for the 2002 financial year in May 2003, so the 2003 results will not be released until after this 10-K has been filed. Revenues were CHF 110 million (US$71.6 million), and net income was CHF 12.4 million (US$8.1 million), or CHF 21.3 per share (US$13.87). Jungfraubahn's operating activities generated net cash flow of CHF 26.7 million (US$17.4 million).
PICO owns 80,755 shares in Raetie Energie, which is a producer of hydro electricity. At December 31, 2003, our investment in Raetia Energie had a basis of $3.4 million, and a market value of $11.3 million.
Accu Holding manufactures batteries at two plants in Switzerland. Accu is adjusting its production and cost structure following a decline in demand for batteries during the economic slowdown. Accu is also preparing to redevelop the site of a former factory near Zurich, which could have significant value.
We have agreed to support a capital-raising by Accu, which we expect to occur in 2004. Swiss franc funds equivalent to our maximum commitment of US$1.9 million (CHF 2.3 million) are held in a separate bank account.
As more fully explained in the Business Financing and Acquisitions portion of "Results of Operations -- Years Ended December 31, 2003, 2002 and 2001," we regularly review stocks which have declined in price from our cost. If we determine that the decline in market value is other-than-temporary, we record a charge which writes our basis in the investment down from its original cost to current carrying value, which typically is the market price at the balance sheet date when the provision is recorded. It should be noted that charges for other-than-temporary impairments do not affect shareholders' equity or book value per share, since the after-tax decline in the market value of investments carried under SFAS No. 115 is already reflected in shareholders equity in our balance sheet. Also, the carrying (book) value of the holding does not change. If the stock price subsequently recovers, the basis does not change.
Due to the extent and duration of the decline in the market value of SIHL stock, we recorded pre-tax charges for other-than-temporary impairment of our holding in SIHL of $2.1 million in 2001, $1.6 million in 2002, and $293,000 in 2003. At December 31, 2003, the charges for other-than-temporary impairment had reduced our basis in SIHL to $542,000, compared to the carrying (market) value of the holding of $433,000.
Given the very low level of interest rates, we expect to generate limited income and no capital gains from our bond holdings. To maintain liquidity and to guard against capital losses which would be brought on by higher interest rates, we have increased our holdings of bonds maturing in 2 years or less. At December 31, 2003, the duration of Citation's bond portfolio was 1.8 years, and the duration of the Physicians bond portfolio was 2.9 years. The duration of a bond portfolio measures the amount of time it will take for the cash flows from scheduled interest payments and the maturity of bonds to equal the current value of the portfolio. Duration indicates the sensitivity of the market value of a bond portfolio to changes in interest rates. If interest rates increase, the market value of existing bonds will decline. During periods when market interest rates decline, such as 2001, 2002, and 2003, the market value of existing bonds increases. Typically, the longer the duration, the greater the sensitivity of the value of the bond portfolio to changes in interest rates. Duration of less than 3 years is generally regarded as short term.
We hold bonds issued by the U.S. Treasury and government-sponsored enterprises (e.g., Freddie Mac and FNMA) only to the extent required for capital under state insurance codes, or as required for deposits or collateral with state regulators. Otherwise, the bond portfolios consist almost entirely of investment-grade corporate issues with 10 or less years to maturity. As of December 31, 2003, none of our bond holdings had declined significantly from cost. We do not own any municipal bonds, and did not own any corporate bonds in the telecommunications, technology, utilities, energy trading, automotive, and consumer finance sectors, or conglomerates which experienced difficulties in recent years.
Due to the long "tail" (i.e., period of time between the occurrence of the alleged event giving rise to the claim, and the claim being reported to us) in the medical professional liability insurance business, it is difficult to accurately quantify future claims liabilities and establish appropriate loss reserves. Our loss reserves, which are reviewed by management every quarter and are assessed in the fourth quarter of each year, based on independent actuarial analysis of past, current, and projected claims trends in the 12 months ended September 30 of each year.
At December 31, 2003, medical professional liability reserves totaled $19.6 million, net of reinsurance, compared to $30.3 million net of reinsurance at December 31, 2002, and $34.9 million net of reinsurance at December 31, 2001.
At December 31, 2003, our direct reserves, or reserves before reinsurance, essentially equaled the independent actuary's best estimate. The independent actuary is continually reviewing our claims experience and projected claims trends in order to arrive at the most accurate estimate possible. The independent actuary did not explicitly forecast a range of reserves, but arrived at a best estimate through weighting the results of five different projection methods for each accident year, and in total. Under the different projection methods, the lowest direct reserve calculation was approximately $15.3 million, and the highest direct reserve calculation was $23.1 million. Consequently, our loss reserves could be materially different depending on the particular method of calculation chosen.
Changes in assumptions about future claim trends, and the cost of handling claims, could lead to significant increases and decreases in our loss reserves. When loss reserves are reduced, this is referred to as favorable development. If loss reserves are increased, the development is referred to as adverse or unfavorable.
Over the past 3 years, the trends in open claims and claims paid have been:
PHYSICIANS INSURANCE COMPANY OF OHIO - CHANGE IN LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
As shown in the table above, in 2003 Physicians made $3 million in net indemnity payments to close 7 cases, an average indemnity payment of $435,000 per case. Although total claims payments in 2003 were less than anticipated, the average indemnity payment is higher than in recent years due to the mix of cases closed in 2003. We are projecting a decrease in severity in future years -- at December 31, 2003, the average case reserve per open claim was approximately $115,000.
resulting in a net reduction of approximately $1 million, or 2.9% of reserves at the start of the year. There were no changes in key actuarial assumption in 2002.
There were no changes in key actuarial assumptions during 2001, 2002, and 2003. See "Critical Accounting Policies" and "Risk Factors."
CITATION INSURANCE COMPANY - PROPERTY & CASUALTY INSURANCE LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
CITATION INSURANCE COMPANY - CHANGE IN PROPERTY & CASUALTY INSURANCE LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
During 2003, Citation's property and casualty insurance claims reserves, net of reinsurance, decreased from $14.6 million to $13.3 million. Claims payments for the year were $2.2 million. Following actuarial analysis during 2003, Citation increased loss reserves by $847,000 due to adverse development in the artisans/contractors book of business resulting from an increased frequency of new claims.
During 2001, Citation's property and casualty insurance claims reserves, net of reinsurance, decreased from $23.4 million to $19.2 million. Claims payments for prior years reduced reserves by $4.5 million, and essentially accounted for the net reduction in reserves for the year. This was partially offset by $172,000 in incurred loss and loss adjustment expenses for the 2001 accident year. A $56,000 increase in prior year loss reserves was recorded.
On July 2, 2003, the California Superior Court placed Fremont in liquidation. Since Fremont is in liquidation, it is no longer an admitted reinsurance company under the statutory basis of insurance accounting. Consequently, Citation reversed the reinsurance recoverable from Fremont of approximately $7.5 million in its financial statements prepared on both the statutory basis and GAAP basis in the three months ended June 30, 2003. Citation is pursuing its rights to recover the reinsurance, and to recover deposits reported as held by Fremont for Citation's insureds to utilize against the workers' compensation claims obligations; however, the ultimate outcome cannot be accurately predicted.
At December 31, 2003, Citation had workers' compensation reserves of $22.4 million before reinsurance, and $10.5 million after reinsurance. Citation purchased excess reinsurance to limit its potential losses in this line of business. In general, we have retained the risk on the first $150,000 to $250,000 per claim. The workers' compensation reserves are reinsured with General Reinsurance, a subsidiary of Berkshire Hathaway, Inc.
CITATION INSURANCE COMPANY - WORKERS' COMPENSATION LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
It is difficult to accurately quantify future claims liabilities and establish appropriate loss reserves in the workers' compensation line of business due to:
Our workers' compensation loss reserves were reviewed at September 30, 2003 and December 31, 2003 by an independent actuary who issues an opinion annually, as required by California state law. The independent actuary analyzes past, current, and projected claims trends for all active accident years, using several forecasting methods. The appointed actuary believes this will result in more accurate reserve estimates than using a single method. Our reserves are typically booked at close to the actuary's best estimate. In previous years, we booked the direct reserves and an equal offsetting reinsurance recoverable based on reports provided by Fremont.
Changes in assumptions about future trends in claims and the cost of handling claims can lead to significant increases and decreases in our loss reserves. When the Fremont reinsurance recoverable was reversed after Fremont went into liquidation, our workers' compensation reserves were approximately $7.5 million. Following independent actuarial analysis at September 30, 2003 and December 31, 2003, Citation increased its workers' compensation loss reserves by $3 million, or approximately 39.9% of the initial $7.5 million in reserves. This adverse development was primarily as a result of setting reserves at a more realistic level than Fremont had previously carried them based on management and actuarial review and assessment of claims files after Fremont had been placed in liquidation. There can be no assurance that our workers' compensation reserves will not develop adversely in the future, particularly if medical care costs continue to inflate.
CITATION INSURANCE COMPANY - CHANGE IN WORKERS' COMPENSATION LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
There were no changes in key actuarial assumptions during 2003. It should be noted that such actuarial analyses involves estimation of future trends in many factors which may vary significantly from expectation, which could lead to further reserve adjustments -- either increases or decreases -- in future years. See "Critical Accounting Policies" and "Risk Factors."
At December 31, 2003, Citation's net workers' compensation reserves were carried at $10.5 million, approximately $254,000 below the actuary's best estimate. Approximately $3.8 million of Citation's net workers' compensation reserves (36%) were case reserves, $3.2 million represented provision for IBNR claims (30%), and the unallocated loss adjustment expense reserve was $3.5 million (34%).
- - in November 2003, HyperFeed sold its consolidated market data feed service contracts for $8.5 million. HyperFeed recorded a gain on the sale of $6.6 million in 2003.
Through these disposals, HyperFeed exited two low margin businesses, and replaced the business with revenues from providing products and services to the purchasers. In addition, the sale of the businesses will reduce HyperFeed's operating expenses, and receipt of the sale proceeds has strengthened the balance sheet.
For more detail on HyperFeed's operations, financial condition, and prospects, please refer to HyperFeed's Annual Report on Form 10-K, which will be filed with the SEC on or before March 15, 2004. The contents of HyperFeed's 10-K are not incorporated into this 10-K.
Following is a description of what we believe to be the critical accounting policies affecting PICO, and how we apply these policies.
At December 31, 2003, the loss reserves, net of reinsurance, of our two insurance subsidiaries were:
Our medical professional liability insurance reserves are certified annually by an independent actuary, as required by Ohio insurance law. Actuarial estimates of our future claims obligations have been volatile. In 2003, there was a $6.7 million reduction after independent actuarial studies concluded that Physicians' claims reserves were greater than projected claims payments. In 2002,
The assessment of what constitutes the ability to exercise "significant influence" requires our management to make significant judgments. We look at various factors in making this determination. These include our percentage ownership of voting stock, whether or not we have representation on the investee company's Board of Directors, transactions between us and the investee, the ability to obtain timely quarterly financial information, and whether PICO management can affect the operating and financial policies of the investee company. When we conclude that we have this kind of influence, we adopt the equity method and change all of our previously reported results from the investee to show the investment as if we had applied equity accounting from the date of our first purchase. This adds volatility to our reported results.
(b) the profit is determinable (i.e., the collectability of the sales price is reasonably assured, or any amount that will not be collectable can be estimated);
(c) the earnings process is virtually complete (i.e., we are not obliged to perform significant activities after the sale to earn the profit, meaning we have transferred all risks and rewards to the buyer); and
If any of these conditions are not met, we use the deposit method of accounting. Under the deposit method of accounting, until the conditions to fully recognize a sale are met, payments received from the buyer are recorded as liabilities and no gain is recognized.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
The principal factors leading to the $8.2 million increase in shareholders' equity during 2003 were the net increases of $10.9 million in unrealized appreciation in investments and $570,000 in foreign currency translation. These factors were partially offset by the $3.2 million net loss and a $83,000 increase in treasury stock due to the purchase of PICO shares in deferred compensation plans for directors.
Total assets at December 31, 2003 were $330.9 million, compared to $396.2 million at December 31, 2002. During 2003, total assets decreased by $65.3 million and total liabilities decreased by $76.2 million, primarily due to the sale of Sequoia during 2003. At December 31, 2002, our balance sheet included $130.6 million in assets and $93.2 million of liabilities related to Sequoia.
and Citation Insurance Group (now known as PICO Holdings, Inc.) over the write-off of goodwill items which were determined to be impaired. See Note 20 of Notes to Consolidated Financial Statements, "Cumulative Effect of Changes in Accounting Principle."
The $6.1 million in net income before a change in accounting principle was comprised of:
In accordance with Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," PICO reports comprehensive income as well as net income from the Consolidated Statement of Operations. Comprehensive income measures changes in shareholders' equity, and includes unrealized items which are not recorded in the Consolidated Statement of Operations, for example, foreign currency translation and the change in investment gains and losses on available-for-sale securities.
- - comprehensive income of $8.2 million in 2003, primarily consisting of net increases of $10.9 million in net unrealized appreciation in investments and $570,000 in foreign currency translation, which were partially offset by the $3.2 million net loss;
In 2003, total revenues were $32.9 million, compared to $29.3 million in 2002, and $23.6 million in 2001. Revenues increased by $3.6 million year over year in 2003, and by $5.7 million year over year in 2002.
Total expenses in 2003 were $46.2 million, compared to $24.4 million in 2002, and $16.2 million in 2001. The largest expense item in each of the past three years was the cost of land and water rights sold -- $12.6 million in 2003, compared to $9.7 million in 2002, and $7.6 million in 2001. As detailed in the following individual segment analyses, the increase in expenses in 2003 from 2002 is primarily attributable to the reserve increases at Citation, the adoption of the PICO Holdings, Inc. 2003 SAR Program, and the consolidation of HyperFeed.
- - a $4.3 million loss from the continuing operations of HyperFeed.
In 2003, Vidler generated $15.4 million in revenues from the sale of water rights and land. This primarily represented two transactions, which generated $14.8 million in revenues:
- - the sale of approximately 6,500 acres of land and the related water rights near West Wendover, Nevada. This transaction added $12 million to revenues and $4.1 million to gross margin; and
In 2002, Vidler generated $12.1 million in revenues from the sale of water rights and land. This primarily represented four transactions, which generated $11.4 million in revenues:
- - the sale of 480 acre-feet of water rights and 240 acres of land in the HVID to a unit of Allegheny Energy, Inc., which added $1 million to revenues and $556,000 to gross margin; and
- - two sales of water rights in Colorado -- Cline Ranch to Centennial Water and Sanitation District, which added $2.1 million to revenues and $119,000 in gross margin, and 85 acre-feet of water rights to the City of East Dillon, which added $3.1 million to revenues and $401,000 to gross margin.
In 2001, Vidler's results were dominated by three transactions, which generated $15.1 million in revenues:
- - the sale of 6,496.5 acre-feet of transferable ground water and 2,589 acres of land in Arizona's Harquahala Valley Irrigation District to a unit of Allegheny Energy, Inc. This transaction added $9.4 million to revenues and $2.3 million to gross margin;
- - another sale of 54.1% of Vidler's original interest in the Semitropic Water Banking and Exchange Program (i.e., approximately 100,000 acre-feet of storage capacity) for $6.9 million. This transaction added $4.1 million to revenues and to gross margin.
In 2003, segment operating expenses were $383,000 higher than in 2002, principally due to a $381,000 increase in operations, maintenance, and other expenses.
In 2002, segment operating expenses were $68,000 higher than in 2001. Decreases of $150,000 in interest expense and $332,000 in depreciation and amortization charges were offset by a $550,000 increase in operations, maintenance, and other expenses.
Vidler recorded a segment loss of $543,000 in 2003, compared to a segment loss of $897,000 in 2002, and segment income of $5 million in 2001.
The segment result decreased $5.9 million from 2001 to 2002, primarily due to the $5.7 million in gains from the sale of interests in Semitropic recorded in 2001, which did not recur in 2002.
Nevada Land generated revenues of $5.9 million in 2003, compared to $4.4 million in 2002, and $3.2 million in 2001.
Segment operating expenses were $1.9 million in 2003, $2.7 million in 2002, and $2.3 million in 2001. Segment operating expenses returned to more typical levels in 2003, after being unusually high in 2002 due to approximately $900,000 in legal and related expenses related to land development issues.
In 2003, a net realized gain of $2.2 million was recorded. This primarily represented $1.7 million in realized gains on the sale of two unrelated foreign stocks. In addition, as explained in the following paragraphs, a $1.1 million realized gain on the sale of most of our holding in MC Shipping, Inc. was offset by $1.1 million in charges for other-than-temporary impairment of our holdings in Accu Holding AG and SIHL during 2003. Finally, Statement of Financial Accounting Standards No. 133, "Accounting For Derivative Instruments and Hedging Activities" income was $461,000, primarily representing an increase in the estimated fair value of HyperFeed warrants.
- - the carrying (book) value of the holding does not change. The impairment simply reclassifies the decline from an unrealized decrease in shareholders' equity to a realized loss in the Statement of Operations.
The written-down value becomes our new basis in the investment. In future accounting periods, unrealized gains or losses from that level will be recorded in shareholders' equity, and when the investment is sold a realized gain or loss from that level will be recorded in the statement of operations.
During 2003, we sold the majority of our holding in MC Shipping, Inc. Although this resulted in a $1.1 million realized gain under GAAP, the gain only recovered part of a charge for other-than-temporary impairment of this holding recorded in 1998. The gain on MC Shipping was offset by charges of $1.1 million for other-than-temporary impairment of our holdings in Accu Holding and SIHL, which reflected a decline in the market value of those securities during 2003.
- - a $312,000 charge for other-than-temporary impairment of our investment in Solpower Corporation.
Segment expenses were $13.1 million in 2003, $7.4 million in 2002, and $10.1 million in 2001. The principal expenses recognized in this segment are PICO's corporate overhead, the U.S. dollar change in value of a Swiss franc inter-company loan, and operating expenses from SISCOM.
The Business Acquisitions And Financing segment produced pre-tax losses of $8.1 million in 2003, $1.2 million in 2002, and $15.3 million in 2001.
SISCOM expenses. Segment expenses were reduced by a $2.3 million resulting from the effect of appreciation in the Swiss Franc on an inter-company loan during 2003.
During 2003, the Company's shareholders approved the PICO Holdings, Inc. 2003 SAR program, which replaced the stock option and call option programs previously in place. The change in the "in the money" amount (i.e., the difference between the market value of PICO stock and the exercise price of the SAR) of SAR outstanding during each accounting period is recorded through the consolidated statements of operations. An increase in the "in the money" amount of SAR (i.e., if the price of PICO stock rises during the accounting period) is recorded as an expense, and a decrease in the "in the money" amount of SAR (if the price of PICO stock declines) will be recorded as a reduction in expenses. See "Equity Compensation Plan Information" in Item 5, "Market for Registrant's Common Equity and Related Stockholder Matters."
For 2003, a total expense of $6 million before taxes for SAR was recorded. This consists of a $3.5 million charge on the initial adoption of the SAR program on July 17, 2003, and a $2.5 million expense to record the increase in the "in the money" amount of SAR during the period from July 17, 2003 through the end of 2003.
The 2001 segment loss includes investment income and other revenues totaling $2.3 million, which were more than offset by the $3 million in provisions for other-than-temporary impairment in investments, the $2.5 million SFAS No. 133 loss, the $500,000 MKG realized loss, the $1.5 million equity share of investees' losses, and segment expenses of $10.1 million. Segment expenses include parent company overhead of $4.8 million, SISCOM expenses of $1.7 million, and a $270,000 expense related to the Swiss Franc loan to Global Equity SA discussed in a previous paragraph. In 2001, segment expenses also included a $2.3 million provision against loans to Dominion Capital Pty. Ltd. See Item 3, "Legal Proceedings."
The financial results of insurance companies in run off can be volatile if there is favorable or unfavorable development in the loss reserves. Physicians recorded significant income from favorable reserve development in 2001 and 2003; however, Citation recorded a significant loss in 2003, principally due to the reversal of the $7.5 million Fremont reinsurance recoverable and $3.9 million in reserve increases in the property and casualty insurance and workers' compensation loss reserves. See the Citation section of the "Company Summary, Recent Developments, and Future Outlook" portion of Item 7.
The Insurance Operations in Run Off segment incurred a $2.9 million loss in 2003, consisting of a $7.3 million profit from Physicians, which was more than offset by a $10.2 million loss from Citation. In 2002, the segment generated income of $4.3 million, consisting of $2.1 million from Physicians and $2.2 million from Citation. In 2001, segment income was $16 million, consisting of income of $13.1 million from Physicians, and $2.9 million from Citation.
Physicians' total revenues were $1.4 million in 2003, compared to $1.1 million in 2002 and $2.6 million in 2001.
The $750,000 net realized investment gain recorded in 2001 was primarily due to a $731,000 gain on the redemption of all units held in the Rydex URSA mutual fund.
In 2002, Physicians recorded a $1.1 million underwriting recovery. The $1 million net reduction in reserves and a $439,000 benefit related to reinsurance more than offset regular loss and loss adjustment expense and operating expenses of $395,000 for the year.
In 2001, the segment reported a $10.5 million underwriting recovery, primarily due to a $10.6 million reduction in reserves which was partially offset by on-going operating expenses.
In 2002, Citation generated total revenues of $1.6 million. Revenues primarily consisted of $1.6 million in investment income and realized gains of $391,000, which were partially offset by a reduction in earned premiums of $424,000 related to reinsurance. Citation recorded approximately $889,000 of favorable development in prior year loss reserves, which more than offset operating expenses of approximately $277,000, resulting in a net underwriting recovery of $612,000. As a result of these factors, Citation generated income of $2.2 million before taxes for 2002.
The $12.4 million year over year deterioration in Citation's pre-tax result was primarily due to the reinsurance reversal and reserve increases recorded in 2003.
From 2001 to 2002, Citation's pre-tax profit declined by $683,000. A $1.2 million year over year improvement in underwriting performance was more than offset by a $676,000 decrease in investment income, a $649,000 decrease in earned premium, and the absence in 2002 of negative goodwill which added $568,000 to income in 2001.
In 2002, Sequoia generated income of $2.8 million after-tax, compared to income of $2.3 million after-tax in 2001.
During the period from May 15, 2003 until their sale, the discontinued operations of HyperFeed generated income of $659,000 after-tax, which is included in the "Income from discontinued operations, net of tax" line in the Consolidated Statement of Operations for 2003.
HyperFeed also recorded a $7 million after-tax gain from the sale of the discontinued operations in 2003, which forms part of the "Gain on disposal of discontinued operations, net" line in the Consolidated Statement of Operations for 2003.
PICO's assets primarily consist of our operating subsidiaries, holdings in other public companies, marketable securities, and cash and cash equivalents. On a consolidated basis, the Company had $24.3 million in cash and cash equivalents at December 31, 2003, compared to $22.1 million at December 31, 2002.
In addition to the $24.3 million in consolidated cash and cash equivalents as defined by GAAP, at December 31, 2003, the parent company held fixed-income securities, mostly investment-grade corporate bonds maturing in 2004, with a market value of $8.8 million.
- - As its "run off" progresses, Physicians is obtaining funds to pay operating expenses and claims from the maturity of fixed-income securities, the realization of investments, and recoveries from reinsurance companies; and
The Departments of Insurance in Ohio and California prescribe minimum levels of capital and surplus for insurance companies, and set guidelines for insurance company investments. Typically, PICO's insurance subsidiaries structure the maturity of fixed-income securities to match the projected pattern of claims payments. When interest rates are at very low levels, to insulate the capital value of the bond portfolios against a decline in value which could be brought on by a future increase in interest rates, the bond portfolios may have a shorter duration than the projected pattern of claims payments. It is possible that fixed-income and equity securities may occasionally need to be sold at unfavorable times when the bond market, the stock market, or prices of individual securities are depressed.
In 2002, Investing Activities used cash of $1.1 million. This primarily represented the sale of our holding in AOG for $21.1 million and the subsequent reinvestment of the proceeds in marketable fixed-income and equity securities, and regular activity in the investment portfolios of our insurance companies.
Financing Activities used $617,000 of cash in 2003, primarily due to the repayment of $534,000 in non-recourse borrowings collateralized by farm properties owned by Vidler. In addition, during 2003 Global Equity S.A. repaid borrowings to a Swiss bank of $9.1 million (CHF 12.1 million) and took out new borrowings of an equivalent amount with another Swiss bank.
Financing Activities used $1.8 million of cash in 2001. Vidler paid off approximately $2.9 million in non-recourse borrowings collateralized by the farm properties in the Harquahala Valley Irrigation District which it sold during the year. Global Equity S.A. took on an additional $1.9 million of Swiss Franc-denominated borrowings to help finance the acquisition of investments in Swiss public companies.
At December 31, 2003, PICO had no significant commitments for future capital expenditures.
As of December 31, 2003, no stock had been repurchased under this authorization.
Global Equity S.A. has agreed to support a capital raising by Accu Holding AG, which we expect to occur in 2004 (see the Business Acquisitions and Financing segment in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations"). Swiss franc funds of CHF 2.3 million (US$ 1.9 million), equivalent to our maximum commitment, are held in a separate bank account.
Several years or more may elapse between the occurrence of an insured medical professional liability insurance or casualty loss or workers' compensation claim, the reporting of the loss and the final payment of the loss. Loss reserves are estimates of what an insurer expects to pay claimants, legal and investigative costs and claims administrative costs. PICO's insurance subsidiaries are required to maintain reserves for payment of estimated losses and loss adjustment expenses for both reported claims and claims which have occurred but have not yet been reported. Ultimate actual liabilities may be materially more or less than current reserve estimates.
The liabilities for unpaid losses and loss adjustment expenses of Physicians and Citation were $60.9 million at December 31, 2003, $52.7 million at December 31, 2002, and $61.5 million at December 31, 2001 before reinsurance reserves, which reduce net unpaid losses and loss adjustment expenses. Of those amounts, the liabilities for unpaid loss and loss adjustment expenses of prior years increased by $4.7 million in 2003, and decreased by $2.3 million in 2002, and $11.1 million in 2001. These changes to prior years' reserves were due to the following:
An analysis of changes in the liability for unpaid losses and loss adjustment expenses for 2003, 2002, and 2001 is set forth in Note 11 of Notes to PICO's Consolidated Financial Statements, "Reserves for Unpaid Loss and Loss Adjustment Expenses."
Effective January 1, 1998, Sequoia and Citation entered into an inter-company reinsurance pooling agreement for business in force as of January 1, 1998 and business written thereafter. Per the agreement, Citation ceded 100% of its net premium and losses to Sequoia and Sequoia then ceded 50% of its net premiums and losses to Citation. Sequoia and Citation shared equally in the underwriting expenses. This arrangement was terminated effective January 1, 2000.
During this period, Citation and Sequoia had the same reinsurance program. For property business, reinsurance provided coverage of $10.4 million excess of $150,000 per occurrence. For casualty business, excluding umbrella coverage, reinsurance provided coverage of $4.9 million excess of $150,000 per occurrence. Umbrella coverage's were reinsured $9.9 million excess of $100,000 per occurrence. The catastrophe treaties for 1998 and thereafter provided coverage of 95% of $14 million excess of $1 million per occurrence. Facultative reinsurance was placed with various reinsurers.
Citation does not require reinsurance from 2002 onwards, as its last policy expired in December 2001.
Claims and Liabilities Related to the Insolvency of Fremont Indemnity Company
In 1997, pursuant to a Quota Share Reinsurance Agreement (the "Reinsurance Agreement"), Citation ceded its California workers' compensation insurance liabilities to Citation National Insurance Company ("CNIC") and transferred all administrative services relating to these liabilities to Fremont. The Reinsurance Agreement became effective upon Fremont's acquisition, with approval from the California Department of Insurance (the "Department"), of CNIC on or about June 30, 1997. Thereafter, on or about December 31, 1997, CNIC merged, with Department approval, with and into Fremont. Accordingly, since January 1, 1998, Fremont has been both the reinsurer and the administrator of the California workers' compensation business ceded by Citation.
Concurrent with Fremont's posting of the Citation Allocated Deposit, Citation reduced its own workers' compensation insurance reserves by the amount of the Citation Allocated Deposit. Prior to the commencement of Fremont's liquidation case, the Department had never questioned, let alone disputed, Citation's right to reduce its workers' compensation insurance reserves by the amount of the Citation Allocated Deposit posted by Fremont for Citation's benefit.
According to an A.M. Best Company report dated June 6, 2003, Fremont executed a letter of oversight with the Department on November 27, 2000, which provided the Department with certain oversight privileges in return for allowing Fremont to discount its workers' compensation loss and allocated loss adjustment expense reserves related to 1999 and prior accident years. Under a permitted accounting practice, a discount rate of 4.25% was applied to the loss and allocated loss adjustment expense reserves as of June 30, 2000. On December 31, 2001, the Department revised the permitted accounting practice to allow Fremont to discount its workers' compensation loss and loss adjustment expense reserves for accidents occurring in 2001 and earlier using a 5.5% discount rate.
reduction of the Citation Allocated Deposit or otherwise increase its own deposit. Although the exact impact of the reserve discount adjustment upon Citation is unclear, the Department of Insurance allowed a full reinsurance offset to Citation in the amount of the Citation Allocation Deposit for 2001 and 2002.
On June 4, 2003, the Superior Court of the State of California for the County of Los Angeles (the "Liquidation Court") entered an Order of Conservation over Fremont and appointed the California Department of Insurance Commissioner (the "Commissioner") as the conservator. Pursuant to such order, the Commissioner was granted authority to take possession of all of Fremont's assets, including its rights in the Citation Allocated Deposit. Shortly thereafter, on July 2, 2003, the Liquidation Court entered an Order appointing the Commissioner as the liquidator of Fremont's Estate (hereafter, the "Liquidator"). The July 2, 2003 Order further provides, in relevant part, that (i) "the rights and liabilities of claimants, creditors, shareholders, policyholders, escrow holders and all other persons interested in the assets of [Fremont], including the State of California, are fixed as of the date of the entry of this order;" and (ii) "any and all claims against [Fremont] . . . , including those which in any way affect or seek to affect any of the assets of [Fremont], wherever and however such assets may be owned or held, must be filed by no later than June 30, 2004 (the `Claims Bar Date') . . . and any claim not filed by the Claims Bar Date is conclusively deemed forever waived."
As of the date hereof, the Commissioner has refused to comply with Citation's request; instead, the Commissioner indicated that he intended to transfer the Citation Allocated Deposit to the California Insurance Guarantee Association ("CIGA"). At present, it is unknown whether the Commissioner is still in possession of the Citation Allocated Deposit. Thus, the Department appears to have (i) refused to acknowledge that the Citation Allocated Deposit assets are required to have been held in trust for Citation and its policyholders, and (ii) maintained its belief that Citation holds nothing more than a general unsecured claim that falls near the bottom of the statutory distribution scheme.
In light of the foregoing, it appears that Citation must litigate its claim to the Citation Allocated Deposit assets. As of the date hereof, Citation has not filed a claim seeking the benefit of the Citation Allocated Deposit. However, unless the situation is amicably resolved, Citation intends to bring legal action to enforce its rights prior to the June 30, 2004 Claims Bar Date. In the event that Citation asserts, but fails to prevail on such a claim, it is unlikely to receive any distribution from the Fremont Estate or any credit for the Citation Allocated Deposit. If, however, Citation prevails on such a claim, it may obtain the benefit, directly or indirectly, of the Citation Allocated Deposit, as well as other relief.
Citation feels very strongly in the validity of its claim. However, the results of litigation are difficult to predict. Moreover, this dispute, involving the interpretation of workers' compensation laws enacted in 2002, appears to present an issue of first impression. Accordingly, Citation is presently unable to predict the outcome of this dispute with a reasonable degree of certainty
In addition to the reinsurance agreements with Fremont noted above, Citation's workers' compensation insurance liabilities from policy years 1986 to 1997 retain additional reinsurance coverage with General Reinsurance, a wholly owned subsidiary of Berkshire Hathaway, Inc. (Standard & Poors rating of AAA.) Policy years 1986 and 1987 have a Company retention of $150,000; policy years 1988 and 1989 have a Company retention of $200,000 and policy years 1990 through to 1997 have a Company retention of $250,000.
PICO's financial statements as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003 and the independent auditors' report is included in this report as listed in the index.
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2003 AND 2002 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2003
We have audited the accompanying consolidated balance sheets of PICO Holdings, Inc. and subsidiaries (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Hyperfeed Technologies, Inc. (a 51% owned consolidated subsidiary), which statements reflect total assets of $9,714,258 as of December 31, 2003, and net income of $1,600,818 for the year then ended. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Hyperfeed Technologies, Inc., is based solely on the report of the other auditors.
In our opinion, based on our audits and the report of other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the Consolidated Financial Statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets", on January 1, 2002.
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
PICO Holdings, Inc. and subsidiaries (collectively, "PICO" or "the Company") is a diversified holding company.
The Company's primary operating subsidiaries as of December 31, 2003 are as follows:
Nevada Land & Resource Company, LLC ("Nevada Land"). Nevada Land is a Delaware Limited Liability Company, which owns approximately 1.1 million acres of land in northern Nevada. Nevada Land's business includes selling land and water rights, and leasing property.
Citation Insurance Company ("Citation"). Citation is a California-domiciled insurance company licensed to write commercial property and casualty insurance in Arizona, California, Colorado, Nevada, Hawaii, New Mexico and Utah. Citation ceased writing premiums in December 2000, and is now "running off" the loss reserves from its existing business. This means that it is handling claims arising from historical business, and selling investments when funds are needed to pay claims.
HyperFeed Technologies, Inc. ("HyperFeed"). HyperFeed is a developer and provider of software, ticker plant technologies and managed services to the financial markets industry. PICO owns approximately 51% of the outstanding voting stock of HyperFeed.
SISCOM Corporation ("SISCOM"). SISCOM is a Delaware corporation that is a software developer for video-based digital asset management systems for the professional broadcast, sports, and entertainment industries.
Investments in which the Company owns at least 20% but not more than 50% of the voting interest and, or has the ability to exercise significant influence are generally accounted for under the equity method of accounting. Accordingly, the Company's share of the income or loss of the affiliate is included in PICO's consolidated results. Currently, there is no significant investment the Company classifies as an equity affiliate.
Revenue on the sale of land, water, and water rights is recognized in full when (a) there is a legally binding sale contract; (b) the profit is determinable (i.e., the collectibility of the sales price is reasonably assured, or any amount that will not be collectible can be estimated); (c) the earnings process is virtually complete (i.e., the Company is not obligated to perform significant activities after the sale to earn the profit, meaning the Company has transferred all risks and rewards to the buyer); and (d) the buyer's initial and continuing investment are adequate to demonstrate a commitment to pay for the property. If these conditions are not met, the Company records the cash received as a deposit until the conditions to recognize full profit are met.
The Company applies the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company classifies all investments as available for sale. Unrealized investment gains or losses on securities available for sale are recorded directly to shareholders' equity as accumulated other comprehensive income, or loss, net of applicable tax effects. The Company also applies the provisions of Accounting Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock," for investments where management determines the Company has the ability to exercise significant influence over the operating and financial policies of the investee. The Company's share of the income or loss of the investee is included in the consolidated statement of operations and any dividends are recorded as a reduction in the carrying value of the investment.
The Company regularly and methodically reviews the carrying value of its investments for impairment. When there is a decline in value of an investment to below cost, that is deemed other-than-temporary, a loss is recorded within net realized gains or losses in the consolidated statement of operations and the security is written down to its fair value. Impairment charges of $1.1 million, $4.1 million, and $3 million are included in realized losses for the years ended December 31, 2003, 2002 and 2001, respectively, related to various securities where the unrealized losses had been deemed other-than-temporary. If a security is impaired and continues to decline in value, additional impairment charges are recorded in the period of the decline if
deemed other-than-temporary. Subsequent recoveries of such securities are reported as an unrealized gain and part of other comprehensive results in future periods. Realized gains on impaired securities are recorded only when sold.
Net investment income includes amortization of premium and accretion of discount on the level yield method relating to bonds acquired at other than par value. Realized investment gains and losses are included in revenues, are determined on an average basis and recorded on the trade date.
Property and equipment are carried at cost, net of accumulated depreciation. Depreciation is computed on the straight-line method over the estimated lives of the assets. Buildings and leasehold improvements are depreciated over 15-20 years, office furniture and fixtures are generally depreciated over seven years, and computer equipment is depreciated over 3 years. Maintenance and repairs are charged to expense as incurred, while significant improvements are capitalized. Gains or losses on the sale of property and equipment are included in other revenues.
difference between the carrying amount and the fair value of such assets determined using the estimated future discounted cash flows, excluding interest charges, generated from the use and ultimate disposition of the respective long-lived asset.
Basic earnings per share are computed by dividing net earnings by the weighted average shares outstanding during the period. Diluted earnings per share are computed similar to basic earnings per share except the weighted average shares outstanding are increased to include additional shares from the assumed exercise of stock options using the treasury method, if dilutive. The number of additional shares is calculated by assuming that the outstanding options and warrants were exercised, and that the proceeds were used to acquire shares of common stock at the average market price during the period.
The following table summarizes the SARs outstanding at December 31, 2003:
In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for those entities that elect to voluntarily adopt the fair value accounting provision of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148 also requires more prominent disclosures of the pro forma effect of using the fair value method of accounting for stock based employee compensation as well as pro forma disclosure of the effect in interim financial statements. The transition and annual disclosure provision of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure requirements are effective for the first interim period ending after December 15, 2002. PICO has not elected to adopt the fair value accounting provisions of SFAS No. 123, but rather has elected to continue accounting for stock-based compensation under the intrinsic value method of APB No. 25, "Accounting for Stock Issued to Employees."
The fair value of each SAR granted in 2003 and stock option granted in previous years is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: no dividend yield; risk-free interest rate of 1% for grants in 2003 and 6.97% for grants in 2001; expected life of a SAR is estimated at 5 years, expected life of a stock option is generally estimated at 10 years; and volatility of 36% for the 2003 grants and 42% for the 2001 grants. No stock options were granted in 2002.
Financial statements of foreign operations are translated into U.S. dollars using average rates of exchange in effect during the year for revenues, expenses, gains and losses, and the exchange rate in effect at the balance sheet date for assets and liabilities. Unrealized exchange gains and losses arising on translation are reflected within accumulated other comprehensive income or loss.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." FIN 46 requires the consolidation of certain variable interest entities by the primary beneficiary of the entity if the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or if the equity investors lack the characteristics of a controlling financial interest. FIN 46 is effective for variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied in the first interim or annual period beginning after December 15, 2003. Management does not expect the adoption of FIN 46 will have a material effect on the Company's results of operations and financial position.
In April 2003, the FASB approved Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement is effective for contracts entered into or modified after June 30, 2003, except as stated, and for hedging relationships designated after June 30, 2003. In addition, except as stated, all provisions of this Statement should be applied prospectively. SFAS 149 amends Statement 133 for certain decisions made as
part of the Derivatives Implementation Group (DIG) process. The adoption of this statement did not have a material effect on the Company's results of operations and financial position.
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31 (THREE MONTHS ENDED MARCH 31 FOR 2003):
Pre-tax net realized gain or loss on investments is as follows for each of the years ended December 31:
At December 31, 2003, the Company owns 130,577 shares of Jungfraubahn, which represents approximately 22.4% of the outstanding shares of Jungfraubahn. At December 31, 2003, the market value of the investment was $26.7 million and had an unrealized gain of $3 million, net of tax. During 2002, the Company acquired 17,505 shares for approximately $2.8 million, and became the largest shareholder in Jungfraubahn. Despite the increase in our shareholding to more than 20%, the Company continues to account for this investment under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." At this time, the Company does not believe that it has the requisite ability to exercise "significant influence" over the financial and operating policies of Jungfraubahn, and therefore does not apply the equity method of accounting.
The following are the unaudited pro forma results of PICO for the years ended December 31, 2003, 2002 and 2001 assuming the acquisition had taken effect at the beginning of the period:
In the third quarter of 2003, HyperFeed completed a 1 for 10 reverse split of its common stock. Consequently, the following share amounts have been adjusted from amounts previously reported.
The Black-Scholes pricing model incorporates assumptions in calculating an estimated fair value. The following assumptions were used in the computations in each of the three years ended December 31, 2003: no dividend yield for all years; a risk-free interest rate ranging from 1% - 2%; a one year expected life; and a historical cumulative volatility ranging from 109% to 139%.
At December 31, 2002, the Company's investment in HyperFeed consisted of 1.1 million shares of common stock, representing 44% of the common shares outstanding; and 310,616 common stock warrants which on a diluted basis would represent an additional 6% voting interest if exercised. During 2002, PICO exercised 94,903 common stock warrants in HyperFeed for $305,000. The common stock was recorded using the equity method of accounting. At December 31, 2002, the carrying value of the investment in common stock was $498,000 after recording losses of $2 million before tax and the common stock warrants are valued at an estimated fair value of $65,000, using the Black-Scholes option-pricing model. The warrants are reported as a derivative instrument under the provisions of SFAS No. 133 and consequently gains and losses for each period are reflected in the caption "Net Realized Loss on Investments" in the Statement of Operations. The difference between the carrying value of the investment and the underlying equity in the net assets or liabilities of HyperFeed is considered goodwill, which is no longer being amortized beginning January 1, 2002. For the year ended December 31, 2002, no goodwill was amortized given the provisions of SFAS No. 142.
During the three years ended December 31, 2003, HyperFeed recorded various capital transactions that affected PICO's voting ownership percentage. During 2002, our voting percentage declined slightly due to the issue of new shares for option exercises, and increased by approximately 2% upon PICO's exercise of 94,903 common stock purchase warrants. In 2001, HyperFeed issued 49,100 shares of common stock related to an acquisition which resulted in a dilution gain of $352,000 to PICO. Deferred taxes were recorded on each dilution transaction. These transactions diluted PICO's ownership percentage approximately 1% to 35% at June of 2001 and through the conversion of preferred shares and exercise of warrants, PICO increased its voting ownership to 42.4% by December 31, 2001, and to 44% by December 31, 2002. In 2003, PICO increased its ownership to 51%.
The market value of the common shares at December 31, 2003 and 2002 based on the closing price of HyperFeed common stock is $9.5 million and $3.3 million, respectively.
The Company and its U.S. subsidiaries (excluding HyperFeed) file a consolidated federal income tax return. Non-U.S. subsidiaries file tax returns in various foreign countries. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
In March 2000, an investment partnership registered as PICO Equity Investors, L.P. acquired 3,333,333 shares of PICO stock for approximately $50 million. PICO Equity Investors, an entity managed by PICO Equity Investors Management, LLC, which is owned by three of PICO's current directors (including PICO's chairman of the board and PICO's president and chief
executive officer), will exercise all voting and investment decisions with respect to these shares for up to 10 years. There is no monetary compensation for the management of either partnership. PICO used the $49.8 million net proceeds to develop existing water and water storage assets, acquire additional water assets, acquire investments, and for general working capital needs.
In the normal course of business, the Company's insurance subsidiaries have entered into various reinsurance contracts with unrelated reinsurers. The Company's insurance subsidiaries participate in such agreements for the purpose of limiting their loss exposure and diversifying risk. Reinsurance contracts do not relieve the Company's insurance subsidiaries from their obligations to policyholders. All reinsurance assets and liabilities are shown on a gross basis in the accompanying consolidated financial statements. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Such amounts are included in "reinsurance receivables" in the consolidated balance sheets at December 31 as follows:
In 1997, Citation ceded its workers' compensation business to Fremont Indemnity Company ("Fremont"). On July 2, 2003 Fremont was placed in liquidation and as a result Citation recorded a provision of $7.5 million of reinsurance recoverable from Fremont, which is included in incurred loss and loss adjustment expenses for the year ended December 31, 2003. In addition, during the year, Citation also recorded adverse development in its property and casualty business of $3.9 million. The $11.4 million in negative development in Citation is offset by $6.7 million of positive development within Physicians' medical professional liability loss reserves, reduced after actuarial analysis concluded that Physicians' reserves against claims were significantly greater than the actuary's projections of future claims payments. During 2001, medical professional liability insurance claims reserves, net of reinsurance, decreased from $51.6 million to $34.9 million and during 2002 decreased from $34.9 million to $30.3 million. Actuarial analysis of Physicians' loss reserves concluded that Physicians' reserves against claims were significantly greater than the actuary's projections of future claims payments. Accordingly, Physicians reduced its claims reserves by approximately $11.2 million in 2001.
The regulations of the Departments of Insurance in the states where the Company's insurance subsidiaries are domiciled generally restrict the ability of insurance companies to pay dividends or make other distributions. Based upon statutory financial statements filed with the insurance departments as of December 31, 2003, $7.7 million was available for distribution by the Company's wholly-owned insurance subsidiaries to the parent company without the prior approval of the Department of Insurance in the states in which the Company's insurance subsidiaries are domiciled.
Vidler is party to a lease to acquire 30,000 acre-feet of underground water storage privileges and associated rights to recharge and recover water located near the California Aqueduct, northwest of Bakersfield. The agreement requires a minimum payment of $378,000 per year adjusted annually by the engineering price index until 2007. PICO signed a Limited Guarantee agreement with Semitropic Water Storage District ("Semitropic") that requires PICO to guarantee Vidler's annual obligation up to $519,000, adjusted annually by the engineering price index.
Future minimum payments under all leases for the years ending December 31, are as follows:
In 1997, pursuant to a Quota Share Reinsurance Agreement, Citation ceded its workers' compensation insurance business to Fremont Indemnity Company ("Fremont"). Fremont maintained a security deposit for the benefit of claimants under workers' compensation insurance policies issued, or assumed, by Fremont. A portion of that deposit was specifically allocated for the benefit of Citation. Consequently, Citation reduced its own workers' compensation insurance reserves by the amount of the deposit. On June 4, 2003, the Superior Court of the State of California for the County of Los Angeles entered an Order of Conservation over Fremont and appointed the California Department of Insurance Commissioner as the conservator. Pursuant to such order, the Commissioner was granted authority to take possession of all of Fremont's assets, including the Citation deposit. On July 2, 2003, the Liquidation Court entered an Order appointing the Commissioner as liquidator of Fremont.
The employment agreements entered into with Ronald Langley and John R. Hart in 1997 and renewed for 4 years on January 1, 2002 provide for annual base salaries of $800,000 subject to annual adjustment in January of each year in the same percentage applicable to PICO's other staff members in an amount deemed adequate to provide for inflation, cost of living, and merit increases based on the CPI and major compensation studies. Each is also entitled to an incentive award based on the growth of the Company's book value per share in excess of a threshold that is calculated as 80% of the previous five year average total return for the S&P 500. The growth in book value per share exceeded the threshold in 2003 and 2002 and an award was accrued in the accompanying consolidated financial statements of $935,000 and $1.5 million, respectively. No award was accrued during 2001 under this program.
Trusts of $1.5 million, of which $537,000 represents PICO stock, is included within the Company's consolidated balance sheets (John Hart 19,940 PICO shares, Dr. Richard Ruppert 2,272 PICO shares, John Weil 5,227 PICO shares, Robert Broadbent 5,266 PICO shares, and Carlos Campbell 1,557 PICO shares). The trustee for the accounts is Huntington National Bank. Each account contains various assets, including PICO stock. The accounts are subject to the claims of outside creditors, and any PICO stock held in the accounts is reported as treasury stock in the consolidated financial statements.
The Company and its insurance subsidiaries are subject to regulation by the insurance departments of the states of domicile and other states in which the companies are licensed to operate and file financial statements using statutory accounting practices prescribed or permitted by the respective Departments of Insurance. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. Statutory practices vary in certain respects from generally accepted accounting principles. The principal variances are as follows:
PICO is engaged in land and related mineral rights and water rights operations through its subsidiary Nevada Land. Nevada Land owns approximately 1.1 million acres of land and related mineral and water rights in northern Nevada. Revenue is generated by land sales, land exchanges and leasing for grazing, agricultural and other uses. Revenue is also generated from the development of water rights and mineral rights in the form of outright sales and royalty agreements.
- BANK AND OTHER BORROWINGS: Carrying amounts for these items approximate fair value because current interest rates and, therefore, discounted future cash flows for the terms and amounts of loans disclosed in Note 19, are not significantly different from the original terms.
At December 31, 2003 and 2002, bank and other borrowings consisted of loans and promissory notes incurred to finance the purchase of land and equity securities. The weighted average interest rate on these borrowings was approximately 5.1% and 5.4% at December 31, 2003, and 2002, respectively, with principal and interest due throughout the term.
Global Equity SA has a loan facility with a Swiss bank which matures by May 2006, for a maximum of $10.1 million (12.5 million CHF) based on a margin not higher than 30% of the securities deposited with the bank. It is anticipated the Company will refinance the loan facility when it becomes due. The actual amount available is dependent on the value of the collateral held after a safety margin established by the bank. It may be used as an overdraft or for payment obligations arising from securities transactions. At December 31, 2003 and 2002, $10.1 million bearing interest at 3.27% and $8.8 million bearing interest at 3.33% is outstanding. Subsequent to year end, the Company established an additional line of credit to borrow a further $2.4 million bearing interest at 3.32% (3 million CHF).
At December 31, 2003 and 2002, $5.2 million and $5.8 million, respectively, of the total outstanding borrowings was reported within Vidler, primarily incurred to finance the acquisition of lands in the Harquahala Valley in Arizona. The weighted average interest rate of these notes is 8.5% and is collateralized by the purchased properties.
Effective July 1, 2001 the Company adopted SFAS No. 141, "Business Combinations," and effective January 1, 2002, SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 prospectively prohibits the pooling of interests method of accounting for business combinations initiated after June 30, 2001. SFAS No. 142 establishes a new method of testing goodwill for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The adoption of SFAS No. 142 is reflected in Company's consolidated financial statements as a cumulative effect of change in accounting principle. The cumulative adjustment of $2 million is comprised of a gain from recognizing negative goodwill of $2.8 million offset by write-offs of goodwill of $800,000. Had the Company ceased amortizing goodwill as of the first day of the earliest period presented, net income or loss for each of the years ended December 31, would be as follows: