Infinity's insurance subsidiaries lease approximately 680,000 square feet of office space in numerous cities throughout the United States. Most of these leases expire within 8 years. The most significant leased office spaces are located in suburban Atlanta, Birmingham (Infinity's principal office), Cincinnati, Windsor (Connecticut) and Los Angeles. An Infinity subsidiary also owns a 46,000 square foot office building in Dallas.
Through a reinsurance transaction effective January 1, 2003, Infinity acquired the Assumed Agency Business consisting of the personal lines business written through independent agents by AFG's principal property and casualty subsidiary, GAI. The Assumed Agency Business had net earned premiums of $107 million in 2002 consisting primarily of standard and preferred private passenger automobile insurance. The Assumed Agency Business is not included in Infinity's historical financial statements.
SOURCES OF FUNDS Infinity is organized as a holding company with all of its operations being conducted by its insurance subsidiaries. Accordingly, Infinity will have continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Funds to meet these obligations will come primarily from dividend and tax payments from Infinity's insurance subsidiaries.
Following the completion of the public offering in February of 2003, Infinity plans to file consolidated federal income tax returns including all 80%-owned U.S. subsidiaries. Under tax allocation agreements with Infinity, its eligible subsidiaries will compute tax provisions as if filing separate returns based on book taxable income computed in accordance with generally accepted accounting principles. The resulting provision (or credit) will be currently payable to (or receivable from) Infinity.
Infinity's insurance subsidiaries generate liquidity primarily by collecting and investing premiums in advance of paying claims. Infinity had positive cash flow from operations of approximately $45 million in 2002, $33 million in 2001 and $25 million in 2000.
INVESTMENTS Infinity's investment portfolio at December 31, 2002, contained $956 million in fixed maturity securities and $18 million in equity securities, all carried at market value with unrealized gains and losses reported as a separate component of shareholder's equity on an after-tax basis. At December 31, 2002, Infinity had a pretax net unrealized gain of $38.5 million on fixed maturities and a pretax unrealized loss of $1.5 million on equity securities.
Investments in mortgage-backed securities ("MBSs") represented approximately one-seventh of Infinity's fixed maturities at December 31, 2002. MBSs are subject to significant prepayment risk due to the fact that, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of lower rates. Due to the significant decline in the general level of interest rates in 2002, Infinity has experienced an increase in the level of prepayments on its MBSs; these prepayments have not been reinvested at interest rates comparable to the rates earned on the prepaid MBSs. Approximately 95% of Infinity's MBSs are rated "AAA" and all are investment grade.
Summarized information for securities with unrealized gains and losses in Infinity's balance sheet at December 31, 2002 is shown in the following table (dollars in millions). Approximately $1.6 million of "Fixed Maturities" and $883,000 of "Equity Securities" had no unrealized gains or losses at December 31, 2002.
Infinity realized aggregate losses of $5.9 million during 2002 on $34 million in sales of fixed maturity securities (12 issues; 9 issuers) that had individual unrealized losses greater than $100,000 at December 31, 2001. The market value of four of the securities did not change from December 31, 2001 to the sale date. Market values of three of the securities increased an aggregate of $1.4 million from December 31, 2001 to date of sale. One of the securities was a Qwest Communications bond that decreased in value by $2.2 million from December 31, 2001 to the date of sale due to the decline in Qwest's financial condition. Market values of the remaining four securities decreased an aggregate of $694,000 from December 31, 2001 to the sale date.
When a decline in the value of a specific investment is considered to be "other than temporary", a provision for impairment is charged to earnings (accounted for as a realized loss) and the cost basis of that investment is reduced. The determination of whether unrealized losses are "other than temporary" requires judgment based on subjective as well as objective factors. Factors considered and resources used by management include:
- the extent to which market value is less than cost basis,
Underwriting profitability is measured by the combined ratio which is a sum of the ratios of losses, loss adjustment expenses ("LAE") and underwriting expenses to earned premiums. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, other income or federal income taxes.
Since early 2000, Infinity's insurance subsidiaries have been increasing their premium rates with a goal of achieving underwriting profits, even if it entails foregoing volume. Management expects rate increases to continue during 2003 but at a reduced pace and level. As with all property and casualty companies, the beneficial impact of these price increases is reflected in Infinity's financial results over time. Infinity implements price increases on its in-force policies as they are renewed, which generally takes between six and twelve months for the entire book of business. Infinity recognizes increased premiums on particular policies as the premiums are earned, generally over the course of the six to twelve months after the policy is effective.
(a) Under a reinsurance agreement entered into with GAI, Infinity's insurance subsidiaries assumed net written premiums from GAI. Accordingly, gross written premiums and net written premiums are the same.
2002 COMPARED TO 2001 Infinity's net earned premiums decreased $271 million (30%) during 2002 due primarily to the Inter-Ocean reinsurance agreement, effective April 1, 2001, under which Infinity ceded 90% of the personal automobile physical damage business written by its insurance subsidiaries during 2002. Excluding the effect of this agreement, net earned premiums declined approximately 9%, reflecting lower business volume partially offset by the impact of rate increases. Policies in force declined 16% from approximately 734,000 on December 31, 2001 to 616,000 on December 31, 2002. The decline in policy counts is due to rate increases and actions taken to reduce business in certain non-focus or non-profitable states as well as decisions by insureds not to renew. During 2002, Infinity increased personal auto rates about 12% over rates in effect at year end 2001. Underwriting expenses in 2002 include the effect of $130.4 million in ceding commissions earned under the Inter-Ocean reinsurance agreement. Commissions earned under this agreement generally vary directly with the loss and LAE ratio on the business ceded. Accordingly, Infinity's expense ratio reflects the benefit of strong underwriting results in the business ceded to Inter-Ocean. Overall, Infinity's combined ratio improved 10.2 points over 2001 due primarily to recent rate increases. Excluding the effect of the Inter-Ocean agreement, Infinity's combined ratio for 2002 was 95.9% compared to 103.7% in 2001.
The $21 million (16%) increase in net earned premiums for the Assumed Agency Business was due primarily to volume growth across numerous states stemming from a 10% increase in new agents. The increase in the combined ratio resulted from insufficient pricing on new business. The Assumed Agency Business' underwriting expenses increased $3.6 million (9%) in 2001 primarily due to increased commissions on higher premiums.
INVESTMENT INCOME Changes in investment income reflect fluctuations in market rates and changes in average invested assets. Fluctuations in average invested assets reflect primarily the timing of dividends and capital contributions as capital requirements and the cash needs of Infinity change.
2002 COMPARED TO 2001 Net investment income decreased $14.0 million in 2002 compared to 2001 due primarily to (i) a $4.6 million increase in interest expense (included in net investment income) on funds held from the aforementioned automobile reinsurance agreement (ii) a decrease in interest rates and (iii) an 8% decrease in average invested assets. Average invested assets decreased due primarily to dividends paid in the fourth quarter of 2001 and the last three quarters of 2002.
2002 COMPARED TO 2001 Other operating and general expenses for 2001 include goodwill amortization of $2.2 million. Under SFAS No. 142, which was implemented January 1, 2002, goodwill is no longer amortized. Excluding 2001 goodwill amortization, other operating and general expenses increased $9.2 million due primarily to a $5.3 million litigation settlement.
"Selected Quarterly Financial Data" has been included in Note I to the Consolidated Financial Statements of Infinity Property and Casualty Corporation and Note D to the Financial Statements of the Personal Lines Agency Business of Great American Insurance Company.