The Company's operating subsidiaries rent or lease office space in the cities in which they are located. CCS and Qualex lease office space in Tampa, Florida from a company owned by Francis Williams, the Chairman of the Board of the Company, at a monthly rate of $10,885, pursuant to a lease that was executed June 1, 1999 and is effective through May 31, 2009.
Management's Discussion and Analysis of Financial Condition ------ and Results of Operations -------------------------
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In accordance with the Statement of Financial Standards No. 142 Goodwill and Other Liability Assets, the Company assesses goodwill annually for impairment. Upon determination that the carrying value of the asset is impaired, the Company would record an impairment charge or loss. Future adverse changes in market conditions or poor operating results of the underlying investment could result in losses or an inability to recover the carrying value of the investment that may not be reflected therein; and therefore, might require the Company to record an impairment charge in the future.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 ---------------------------------------------------------------------
Premiums -------- During the years ended December 31, 2002 and 2001, earned direct and assumed earned premiums were $17,478,356 and $18,253,687, respectively. Overall earned premiums, net of ceded premiums decreased 2% or $(209,566). The decrease in earned premiums is a result of CCS's focus on a smaller market base in an effort to better control underwriting guidelines. The following table represents the written and earned premium for CCS and the percentage of change for the years ended December 31, 2002 and 2001, respectively.
Written Premiums (000's) Earned Premiums (000's) --------------------------------------------------------------- 2002 2001 % Change 2002 2001 % Change --------------------------------------------------------------- Direct ....... $ 13.849 $ 13,867 (.1)% $ 13,981 $ 14,465 (3.4)% Assumed ...... 2,634 4,194 (37.2)% 3,498 3,788 (7.7)% Ceded ........ (4,139) (4,654) (11.1)% (4,047) (4,612) (12.3)% -------- -------- -------- -------- Total .... $ 12,344 $ 13,407 (7.9)% $ 13,432 $ 13,641 (1.5)% ======== ======== ======== ========
Commission Income ----------------- Commission income represents earnings from subsidiary agencies on bonds sold through insurance carriers that have the capacity for writing bonds not offered by Cumberland Casualty & Surety Company. Inter-company related commission earnings and expenses have been eliminated in preparing the consolidated financial statements. Commission income for the period ended December 31, 2002 increased by $93,690 or 23% when compared to the same period in the prior year.
Other Income ------------ Other income is earned through an affiliate offering claims consulting services to insurance carriers. Primarily, their services include management, administration and completion of jobs defaulted under surety bonds. Other income increased by $194,082 or 13% when compared to the same period in the prior year.
Losses incurred - direct, net .. $3,857,512 $2,313,544 $1,543,968 66.7% Losses incurred - assumed, net . 2,197,521 929,545 1,267,976 136.4% ---------- ---------- ---------- Total ..................... $6,055,033 $3,243,089 $2,811,944 86.7% ========== ========== ==========
Loss adjustment expenses totaled $2,044,046 on direct losses and $453,236 on assumed losses representing an increase over prior year loss adjustment expenses of $1,228,461 or 96.8%. Loss adjustment expenses represent the cost of the internal claims department, outside claims consultants and attorneys in connection with the settlement of claims.
Amortization ------------ During the year ended December 31, 2002 the net amortization of deferred policy acquisition costs were to $3,593,701 as compared to $4,362,721 for the year ended December 31, 2001. The acquisition costs represent 20.6% and 23.9% of the direct and assumed earned premiums for the years ended December 31, 2002 and 2001, respectively.
Premiums -------- During the year ended December 31, 2001 and 2000, earned direct and assumed premium was $18,253,687 and $15,236,814, respectively. Overall earned premiums, net of ceded premiums increased 12.5% or $1,513,363. The increase in earned premiums is a result of CCS's continued growth in the surety bond market. The following table represents the written and earned premium for CCS and the percentage of change for the years ended December 31, 2001 and 2000, respectively.
Written Premiums (000's) Earned Premiums (000's) ------------------------------------------------------------- 2001 2000 % Change 2001 2000 % Change ------------------------------------------------------------- Direct ......... $ 13,867 $ 13,775 .7% $ 14,465 $ 12,756 13.4% Assumed ........ 4,194 2,393 75.3% 3,788 2,481 52.7% Ceded .......... (4,654) (3,510) 32.6% (4,612) (3,109) 48.3% -------- -------- ----- -------- -------- Total ...... $ 13,407 $ 12,658 5.9% $ 13,641 $ 12,128 12.5% ======== ======== ===== ======== ========
Commission Income ----------------- Commission income represents earnings from subsidiary agencies on bonds sold through insurance carriers that have the capacity for writing bonds not offered by CCS. Inter-company related commission earnings and expenses have been eliminated in preparing the consolidated financial statements. Commission income for the year ended December 31, 2001 increased by $27,060 or 7% when compared to the same period in the prior year.
Loss and Loss Adjustment ------------------------ Loss and loss adjustment reserves have been prepared by consulting actuaries in accordance with accepted actuarial standards. The Company writes two lines of business classified as other liability and surety and fidelity bonds. The category of other liability GAAP reporting requirements changed effective January 1, 2001 under SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities and are discussed as a separate item for the reporting year ended December 31, 2001. The following table is a presentation of how the reserves are presented on the Consolidated Balance Sheet for year ended December 31, 2001.
Year Ended December 31, --------------------------- 2001 2000 --------------------------- Loss and loss adjustment reserves ............ $5,284,804 $6,245,818 Derivative instruments ....................... 3,597,782 -- ---------- ---------- Totals ................................... $8,882,586 $6,245,818 ========== ========== Less: Derivative instruments (SFAS No. 133 as of January 1, 2001 formerly included in loss and loss adjustment reserves ..................... 3,237,782 -- Additional amount required under SFAS 133 ................................ 360,000 -- ---------- ---------- Loss and loss adjustment expense reserves ................................ $5,284,804 $6,245,818 ========== ==========
Loss and loss adjustment expenses totaled $4,511,910 and $3,360,358 for the years ended December 31, 2001 and 2000, respectively, representing an increase of $1,151,522 for year 2001. In analyzing losses on direct and assumed business segregated from loss adjustment expenses, losses increased $430,741 (direct business) and $1,053,943 (assumed business) over the prior year. The Company processed 193 claims for payment during 2001 with an average settlement, net of reinsurance amounting to $10,130 on its direct line of business as compared to processing 122 claims for payment during 2000 with an average settlement, net of reinsurance totaling $14,360.
In valuing the reserves on the RIA, the Company had no history other than relying on market fluctuation projections which had a history of supporting the actuarial formulas developed when the policy was initially approved by Consulting Actuaries and Florida regulators. With the implementation of SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities, the impact on how reserves were valued was immediate. At December 31, 2001, the RIA was established using a growth factor, lapse factor and loss projections before applying a present value factor to ultimately determine the liability to the Company. At December 31, 2001 the derivative instrument liability (formerly Loss and loss adjustment expense reserves) for this policy was set at $3,597,782. The charge to earnings for the year ended December 31, 2001 was an additional $360,000. The policies will begin maturing in June of 2002.
Operating Expenses ------------------ During the year ended December 31, 2001, operating expenses and taxes, licenses and fees (excluding income taxes) increased to $6,159,044 from $5,308,516 for the same period in 2000. The increase of $850,600 or 16% is a result of increased salary and related expenses ($307,000); accounting and actuarial fees ($107,000); legal fees ($66,400); credit reports ($48,000); office supplies and related expenses ($178,100) and travel expenses ($93,100) and taxes, license and fees ($51,000). The Company's increase in expenses is related to the Company's direct marketing efforts and continued expansion. The Company reclassified $466,332 and $146,633 attributed to in-house in claims expenses to loss adjustment expenses for the year ended December 31, 2001 and 2000, respectively.
At December 31, 2002, the Company's $29,178,488 of total assets were distributed primarily as follows: 34.2 percent in cash and investments (including accrued investment income), 50.1 percent in receivables and reinsurance recoverables, 7.2 percent in intangibles and deferred policy acquisition costs, 5.1 percent in deferred income tax asset and 3.4 percent in other assets.
Net cash (used in) provided by operating activities was $(3,723,761), $2,753,355 and $191,380 for the years ended December 31, 2002, 2001 and 2000, respectively. In 2002, cash (used in) provided by operating activities is primarily attributed to payment of claims resulting in policy liabilities and reinsurance ceded payable decreasing and reinsurance recoverables increasing. In 2001, cash provided by operating activities was primarily attributed to an increase in policy liabilities and accruals. In 2000, cash provided by operating activities was attributed to policy liabilities which was offset by reinsurance recoverable and policy acquisition costs and amortization.
At December 31, 2002 and 2001, the Company did not have any other commercial commitments, such as guarantees or standby repurchase obligations, or any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
The Company experienced a deficiency of $348,740 for the period ended December 31, 2002. The deficiency is a result of settling claim basis reserves established in prior years for amounts that were more than expected. The Company experienced $936,570 and $1,003,077 in redundancies for losses and loss adjustment expenses in 2001 and 2000, respectively. The redundancies principally result from subrogation received on pooling agreement case base reserves and claims in prior years.
KC and SSI entered into an agreement with an independent contractor, AEC on August 16, 1989 on a construction contract with the United States Navy ("Navy"). At the time the bonds were issued by CCS as surety, KC entered into an indemnification agreement, whereby KC indemnified CCS from any and all losses, costs and expenses incurred related to the bonds. In 1991, the Navy defaulted and terminated AEC on the contract. The contract was subsequently litigated and CCS was unsuccessful in its litigation activities with the Navy. As a result, KC reimbursed CCS $1,500,000 of the total subrogation recoverable of $1,850,877 in November 2001 on the contract. CCS wrote off the remaining $350,877 reinsurance recoverable as a charge to loss and loss adjustment expense and incurred an additional $240,000 in legal fees during 2001.
The following table represents the development of the liability for unpaid losses and LAE, net of reinsurance, for 1992 through 2002 (in thousands).
The consolidated financial statements of the Company required by this Item are listed in Item 15(a)(1) and (2) and are submitted as a separate section of this report.
The following information presents unaudited quarterly operating results for the Company for 2002 and 2001. The data has been prepared by the Company on a basis consistent with the Consolidated Financial Statements included elsewhere in this Form 10-K, and include all adjustments, consisting of normal recurring accruals, that the Company considers necessary for a fair presentation thereof.