(b) Includes unrealized appreciation of approximately $0.7 million in 2002, $0.7 million in 2001, $0.6 million in 2000 and $0.5 million in 1998 and unrealized depreciation of approximately $2.3 million in 1999, all net of tax, on investments classified as available for sale.
(d) Source: Best's Aggregates & Averages, Property/Casualty, 2002 Edition. Industry Combined Ratios may not be comparable as a result of, among other things, differences in the Company's geographic concentration and limited mix of property and casualty insurance products.
(e) Premium to Surplus Ratio was calculated by dividing annual statutory net premiums written by statutory surplus at the end of the year.
During the past several years, the Group experienced poor underwriting results and adverse reserve development in all of its lines of business. During 2001, the Group explored its options for developing a new business model and strategy. After evaluating these options, the Group announced in December 2001 that it had determined that it was in the best interest of its shareholders and policyholders to commence an orderly voluntary liquidation of all of its operations. The Group will only accept business that it is obligated to accept by contract or New York insurance law; it does not engage in any other business activities except for its claims runoff operations. The voluntary liquidation of its operations is expected to be substantially complete by 2005. Given the Group's and the Company's current financial condition, the expected costs to be incurred during the claims runoff period, and the inherent uncertainty over ultimate claim settlement values, no assurance can be given that the Company's shareholders will be able to receive any value at the conclusion of the voluntary liquidation of its operations.
Pursuant to the pooling agreement, the Company has a net reinsurance recoverable from Empire. As of December 31, 2002, the Company's reinsurance recoverable from Empire is $91.7 million, representing 44% of the Company's total assets. After deducting this liability,, Empire's stand alone statutory surplus was approximately $5.3 million as of December 31, 2002, which is approximately $2.0 million above the minimum required under New York insurance regulations. The Company currently believes that its reinsurance recoverable from Empire is fully collectible; however, further reductions in Empire's statutory surplus, resulting from operating results, the contingencies discussed below or from other matters, could impair Empire's ability to pay the full amount due to the Company. Further, any adverse regulatory action taken against Empire in the future could also impair the Company's ability to fully collect its reinsurance recoverable and could result in adverse regulatory action against the Company. No assurance can be given that adverse regulatory action will not be taken against Empire or the Company. Empire's management continues to investigate transactions which could increase its stand alone surplus level, in order to remain above minimum requirements. During 2003, Empire believes that it will obtain a release from any obligation to the City of New York concerning its former headquarters building, which if successful would result in a $8.5 million increase in Empire's stand alone statutory surplus. However, no assurance can be given that Empire will be successful in this or any other transaction to increase its stand alone statutory surplus.
The Company maintains cash, short-term and readily marketable securities and anticipates that the cash flow from investment income, maturities and sales of short-term investments and fixed maturities will be sufficient to satisfy its anticipated cash needs. During 2002, the Company realized capital gains of $1.4 million primarily due to the sale of an equity security for operating cash flow needs. During 2001, the Company realized capital gains of $1.9 million primarily due to the sale of fixed maturities to shorten the duration of the portfolio. The Company will continue to sell its investment portfolio and collect its reinsurance receivables to generate the cash that will be required to settle its loss and LAE reserves. At December 31, 2002, these assets totaled $200.7 million as compared to the Company's loss and LAE reserves of $175.6 million. The Company expects to settle approximately 65% of these liabilities within the next three years. Additionally, the Company has not experienced any material default in the payment of reinsurance claims due from its reinsurance providers.
At December 31, 2002, the Group's contractual cash obligations under its operating leases total $2.6 million, of which $1.0 million is due in less than 1 year, $1.2 million is due in 1 to 3 years, $0.4 million is due in 4 to 5 years and none is due after 5 years. Effective January 1, 1980, the Company issued a surplus note to Empire in the principal amount of $7.0 million. The surplus note provides, among other things, for interest to be accrued on the principal of the note based on a bank's prime rate at the end of the then current calendar quarter. Neither the principal amount of the surplus note nor the accrued interest may be paid, in whole or in part, without the consent of the Superintendent and must be repaid, in whole or in part, when so ordered by the Superintendent. During 2002 and 2001, with the approval of the Superintendent, the Company paid Empire $0.2 million and $9.9 million of interest that had been accrued on the surplus note through March 31, 2002 and September 30, 2001, respectively.
Empire is obligated to pay certain severance and retention benefits to its employees, and has fully accrued this obligation as of December 31, 2002. Pursuant to the pooling agreement, the Company has accrued its 30% share of such benefits. In January 2003, to enhance its ability to retain employees during its voluntary liquidation, Empire established a trust for the benefit of certain of its employees and transferred $3.7 million of its cash to the trust. These funds in the trust may be used to pay Empire's severance and retention obligations to those employees, if not paid by Empire when due. Empire retains the residual interest in the trust after satisfaction or release of the employees' severance and retention benefit claims, and the establishment of the trust does not in any way eliminate Empire's obligations. Under the pooling agreement, the Company will pay Empire its share of the benefits when they are paid by either Empire or the trust.
Empire and the Company have a financial dispute with a company that previously acted as a third party claims administrator for the Group ("Former Claims Administrator"). The Group received a $1.7 million claim for unpaid services from the Former Claims Administrator that the Group believes it is not obligated to pay because the services provided by the Former Claims Administrator were deficient and resulted in damages to the Group in excess of the $1.7 million claim. The Group is currently evaluating its options to resolve this dispute, including possibly litigating the matter. The Group does not believe it is probable that it will have to pay the $1.7 million to the Former Claims Administrator, however, if the Group does not prevail in this matter, the Company's share of this payment, which has not been accrued, would be $0.5 million pursuant to the terms of the pooling agreement.
The Company's combined ratios increased in 2002 and 2001 primarily due to higher expense ratios due to lower premium volume and the reasons discussed below.
During 2002, the Company recorded adverse loss reserve development of $3.1 million. During 2002, the Company increased its reserve estimates in the workers' compensation line by $3.1 million, primarily for accident years 1999 and prior which reflects the Company's current analysis of its and the industry's recent experience. The Company also increased its loss reserve estimate for older accident years by approximately $2.5 million, principally in the general liability, commercial package policies and homeowners lines of businesses which reflects the Company's recent claim experience. Partially offsetting this was a decrease in the Company's reserve estimates in the automobile lines of business for the 1998 through 2001 accident years by $3.1 million, primarily relating to PIP. This decrease was principally due to favorable reported loss development during 2002 that the Company believes is primarily due to improved claims handling, which resulted in improved severity.
During 2000, the Company recorded adverse loss reserve development of $15.9 million, principally in the 1996 through 1999 accident years. This development was attributable to an increase in the severity of PIP claims and an increase in the frequency of liability claims in the private passenger automobile line ($2.8 million), an increase in the frequency of liability claims in the commercial automobile line ($1.9 million), an increase in the frequency and severity of PIP claims in the assigned risk automobile line ($1.4 million) and an increase in the severity of certain liability claims in the commercial package policies lines of business ($4.5 million). The increases in severity and frequency of claims in automobile lines of business, particularly with respect to PIP claims, was consistent with emerging industry trends in the New York City marketplace. In addition, the Company increased its estimate for LAE by $3.3 million as a result of the decision to outsource a significant amount of claim handling functions in 2000. Claim files for workers' compensation, automobile no-fault and automobile and other liability claims were outsourced at a cost greater than the reserves previously recorded to handle the claims internally. The Group had outsourced almost two-thirds of its claims. The Group was primarily handling complex claims, first party claims and certain automobile liability and general liability claims internally. Complex claims generally consist of those that have potentially large settlement exposure and are not expected to settle quickly. The Company had also increased its reserve estimate for claims handled internally.
During the period between 1984 and 1995, the Company entered into certain retrospectively rated reinsurance contracts covering substantially all lines of business, except worker's compensation. Under these contracts, the Company paid the reinsurer provisional premiums that are subject to adjustment based on subsequent loss development. Ceded premiums accrued under these contracts reduce both net written and earned premiums during the period the retrospective reinsurance premiums are accrued. If additional unfavorable loss development emerges in future periods, the Company may be required to accrue additional retrospective reinsurance premiums. As a consequence of its reserve increases, the Company reduced premiums and pre-tax profits by $0.3 million, $2.4 million and $1.4 million for the years ended December 31, 2002, 2001 and 2000, respectively, to recognize reinsurance premiums due for 1995 and prior years under retrospectively rated reinsurance agreements.
For all lines of property and casualty insurance business, the Company employs a variety of standard actuarial ultimate loss projection techniques, statistical analyses and case-basis evaluations to estimate its liability for unpaid losses. The actuarial projections include an extrapolation of both losses paid and incurred by business line and accident year and implicitly consider the impact of inflation and claims settlement patterns upon ultimate claim costs based upon historical patterns. These estimates are performed quarterly and consider any changes in trends and actual loss experience. Any resulting change in the estimate of the liability for unpaid losses, including those discussed above, is reflected in current year earnings during the quarter the change in estimate is identified.
The Company, as well as the property and casualty insurance industry in general, is affected by inflation. With respect to losses, the Company's claim severity is affected by the impact of inflation on the cost of automobile repair parts, medical costs and lost wages. The costs of adjusting claims and other underwriting expenses have also been affected by inflationary pressures on salaries and employee benefits. The Company receives rate increases based in part upon its experience as well as the industry's experience. Accordingly, premium increases generally follow the rate of inflation. However, the Company's ability to raise premium rates is subject to approval by the Department.
o general economic and market conditions or prevailing interest rate levels;
o changes in composition of the Company's assets and liabilities through acquisitions or divestitures;
o Consummation of the proposed Leucadia tender offer for the Company's common shares and the merger of the Company and Empire.