The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin Cheldin, the Company's president, chairman and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties.
Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations ------------- Overview -------- General - ------- Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, health and life insurance through its agency subsidiaries; and through its other subsidiaries provides claim administration services (through December 31, 2003), insurance premium financing, and membership association services.
The Company's net income was $1,068,650 in 2003, a net loss of ($3,224,689) in 2002, and a net loss of ($10,870,018) in 2001.
The primary challenge of the property and casualty insurance company operation is the fact that the Company sells its products before the ultimate costs are actually known. When pricing its products, the Company projects the ultimate claim and loss adjustment cost that it anticipates will be incurred after the policy is sold. In addition, factors such as changes in, among other things, regulations, changes in the legal environment, and inflation can all impact the ultimate cost.
The Company believes that rate adequacy is more important than premium growth and underwriting profit is the Company's primary goal. Management's assessment of trends and underwriting results is a primary factor in its decisions to expand or contract its business. Primarily as a result of losses from liquor and premise liability coverages, much of the Company's business outside of California has not been profitable. In 2002 the Company began placing moratoriums on non-California business on a state-by-state basis. By July 2003, the Company had placed moratoriums on all non-California business. The Company has no short-term plan to expand into additional states or to expand its marketing channels. Instead, the Company intends to allocate its resources toward improving its California business rates, rules, and forms.
The Company incurred underwriting losses in 2000, 2001, and 2002. As a result of these underwriting losses, management analyzed and acted upon various components of its underwriting activity. The Company believes that the implementation of these actions have contributed to improved underwriting results. This is reflected in the decrease in the Company's ratio of losses and loss adjustment expenses to net earned premium from 139% in 2001, to 98% in 2002, and to 85% in 2003.
2003 adverse development of prior year losses was substantially lower than 2002 and the 2003 adverse development was primarily attributable to one claim. That claim was a loss in excess-of-policy-limits, arising from a policy issued in 1993. The claim was resolved on August 1, 2003, for $4,000,000 through binding arbitration. Available reinsurance limits in 1993 were $2,000,000 plus pro-rata loss adjustment expenses. As a result of the binding arbitration decision, in 2003 Crusader incurred adverse development on this claim, net of reinsurance, of approximately $2,000,000 or approximately $1,320,000 net of taxes. To help ensure that such situations do not reoccur, the Company adopted changes in its underwriting and claims adjusting practices, and it bought substantially more reinsurance.
AAC which finances Crusader policies, benefited from Crusader's 22% increase in average policy premiums and resulted in its average loan amount increasing 23% in 2003 compared to 2002.
Investments and Liquidity - ------------------------- The Company generates revenue from its investment portfolio, which consisted of approximately $118.6 million (at amortized cost) at December 31, 2003, compared to $102.7 million (at amortized cost) at December 31, 2002. Although the portfolio increased in 2003, investment income decreased approximately $600,000. The decrease in investment income is primarily the result of a decline in short and long-term yields in the marketplace and a shorter weighted average maturity of the portfolio. Due to the interest rate environment, management believed it was prudent to purchase fixed maturity investments with shorter maturities with minimal credit risk.
Primarily as a result of the Company's growth in premiums in 2003 and 2002, the Company generated positive cash flows from operations, which was approximately $15.5 million in 2003 and $8.0 million in 2002. The increased cash flows from operations contributed to the increase in the Company's investment portfolio.
The cash flow provided by operations in the year ended December 31, 2003, was $15,525,386, an increase in cash flow of $7,512,162 compared to the cash flow for the year ending December 31, 2002. The increase in cash flow from operations in 2003 was primarily the result of Crusader's 2003 growth in written premiums (unearned premium reserves increased $10,293,597). Cash flow provided by operations for the year ended December 31, 2002, was $8,013,224, an increase of $9,302,165 in cash provided compared to the year ended December 31, 2001.
Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, its reserves for loss payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. Cash and investments (excluding net unrealized gains or losses) at December 31, 2003, were $118,592,895 compared to $102,693,616 at December 31, 2002, a 15% increase. Crusader's cash and investments at December 31, 2003, was $116,736,763 or 98% of the total held by the Company, compared to $99,920,299 or 97% of the total held by the Company at December 31, 2002.
The tax-exempt interest income earned (net of bond premium and discount amortization) during the year ended December 31, 2003, was $117,892 compared to $283,856 in the year ended December 31, 2002. In the year ended December 31, 2001, tax-exempt interest income earned totaled $752,189.
On November 15, 2002, the Company borrowed $500,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer, and $250,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. In the quarter ended June 30, 2003, the Company repaid the above-mentioned notes in full.
Crusader's statutory capital and surplus as of December 31, 2003, was $26,103,440, a decrease of $155,012 (0.6%) from December 31, 2002. Crusader's statutory capital and surplus as of December 31, 2002, was $26,258,452, a decrease of $1,261,086, (4.6%) from December 31, 2001.
There were no dividends paid by Crusader to Unico in 2003, 2002 or 2001. Based on Crusader's statutory surplus as regards policyholders as of December 31, 2003, the maximum dividend that can be made by Crusader to Unico without prior regulatory approval in 2004 is $2,610,344.
Although material capital expenditures may also be funded through borrowings, the Company believes that its cash and short-term investments at year end, net of trust restriction of $939,491, statutory deposits of $2,825,000, cash deposited (with Superior courts) in lieu of bond of $752,659 and dividend restriction between Crusader and Unico (see Item 1 - Business - Insurance Company Operation - Holding Company Act) plus the cash to be generated from operations, should be sufficient to meet its operating requirements during the next twelve months without the necessity of borrowing funds. There are no material commitments for capital expenditures as of the date of this report.
A recent court ruling in Ceridian vs. Franchise Tax Board held that the California statute permitting the tax deductibility of dividends received from a wholly owned insurance subsidiary was unconstitutional because it discriminated against out-of-state holding companies and thus was in violation of the interstate commerce clause of the United States Constitution. The ruling concluded that the discriminatory sections of the statute are not severable and the entire statute is invalid and unenforceable. California law provides that the proper remedy in such circumstances is to disallow the deduction to those taxpayers that benefited from the deduction. As a result of the court ruling, in February 2003, the Franchise Tax Board (FTB) notified the Company that it would issue a Notice of Proposed Assessment (NPA) for the tax years 1999 and 2000 of approximately $287,000 representing California state franchise taxes plus related interest of approximately $80,000.
The Company has certain obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2003, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
Results of Operations: --------------------- General - ------- The Company had a net income of $1,068,650 for the year ended December 31, 2003, compared to a net loss of $3,224,689 for the year ended December 31, 2002, and net loss of $10,870,018 for the year ended December 31, 2001. Total revenue for the year ended December 31, 2003, was $51,130,439 compared to $46,028,642 for the year ended December 31, 2002, and $42,116,906 for the year ended December 31, 2001.
For the year ended December 31, 2003, the Company had income before taxes of $2,149,371 compared to a loss before taxes of $4,814,059 in the year ended December 31, 2002, an increase in income before taxes of $6,963,430. The increase in pre-tax income was primarily due to a decrease of $6,086,381 in the underwriting loss (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader. The Company had a net earnings for the year ended December 31, 2003, of $1,068,650 compared to a net loss of $3,224,689 for the year ended December 31, 2002, an increase in net earnings of $4,293,339.
The effect of inflation on the net income of the Company during the years ended December 31, 2003, 2002, and 2001 was not significant.
For the year ended December 31, 2003, gross written premium increased by $18,425,437 (40%) compared to the year ended December 31, 2002.
The above-mentioned growth in written premium was due to an increase in written premium in the state of California. The increase in written premium in the state of California in 2003 was primarily the result of the continued subsidence in priced-based competition in the property casualty insurance market that has resulted in the Company's products becoming more competitive. In addition, the Company has increased rates on some of its California products, is in the process of filing for rate increases on some of its California products, and is waiting for regulatory approval of rate increases on some of its products that have already been filed with California regulatory authorities. The Company believes that a "hard market" cycle exists in California. Industry-wide underwriting losses, decreases in investment yield, and increases in reinsurance cost have all contributed to the change from the "soft market" to the "hard market." The Company is also benefiting from the fact that some of its competitors have gone out of business and others have recently raised rates or adopted more restrictive rules. The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change. The Company's future writings and growth are dependent on market conditions, competition, and the Company's ability to introduce new and profitable products.
Premiums written outside of California in 2003 decreased $3,013,382 (99%). Primarily as a result of losses from liquor and premise liability coverages, much of the Company's business outside of California has not been profitable. In 2002 the Company began placing moratoriums on non-California business on a state-by-state basis. By July 2003, the Company had placed moratoriums on all non-California business. As a result of these moratoriums, written premium outside California decreased significantly to $18,224 for the year ended December 31, 2003, as compared to $3,031,606 for the year ended December 31, 2002, and $5,263,039 for the year ended December 31, 2001. There were no premiums written outside the state of California in the quarter ended December 31, 2003. The Company has no short-term plan to expand into additional states, or to expand its marketing channels. Instead, the Company intends to allocate its resources toward improving its California business rates, rules, and forms.
Year Ended Direct Written Policies Average December 31 Premium Issued Premium ----------- ------- ------ -------
The Company writes annual policies and, therefore, earns written premium daily over the one-year policy term. Premium earned before reinsurance increased $13,185,274 (33%) in the year ended December 31, 2003, compared to the year ended December 31, 2002, and increased $5,159,671 (15%) in the year ended December 31, 2002, compared to the year ended December 31, 2001. The increase in earned premium before reinsurance in 2003 and 2002 was directly related to the increase in written premium in 2003 and 2002.
Earned ceded premiums increased in 2002 and 2003 primarily as a result of rate increases by the Company's reinsurers effective January 1, 2002, and on January 1, 2003, and the related increase in direct earned premium on which these rates are based. The rate increases are primarily due to the Company's ceded loss experience and the hardening of the reinsurance marketplace. Ceding commissions increased in 2003 from 25% to 35%. Ceding commission is a component of policy acquisition costs. The annual aggregate deductible on Crusader's primary excess of loss treaty was $500,000 in 2001, $675,000 in 2002, and $500,000 in 2003. In 2003 Crusader retained a participation in its excess of loss reinsurance treaties of 5% in its 1st layer ($750,000 in excess of $250,000) 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property clash treaty. Premium ceded under the provisionally rated contract, which was canceled on a runoff basis effective December 31, 1997, is subject to adjustment based on the amount of losses ceded, limited by a maximum percentage that can be charged by the reinsurer. Crusader's 2003 1st layer primary excess of loss treaty provides for a contingent commission equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the combined accident years 2003 through 2005, and therefore no contingent commission has been accrued.
The remaining adverse development in 2003 was attributable to continued losses due to the impact of changes in California case law that expanded coverage and increased loss exposure primarily on construction defect claims for claims occurring on or prior to the Company's revision of its policy forms in 1995.
The Company believed that it had adequately addressed its estimate of ultimate losses and loss adjustment expenses as of December 31, 2001, and anticipated that underwriting changes in problematic business such as reducing coverages, modifying policy forms, more restrictive underwriting, reductions in non-California business, and increasing rates would be reflected in the 2002 development. However, continued adverse development in 2002 indicated that the underwriting changes implemented through December 31, 2001, were not sufficient to fully address the losses primarily occurring on accident years 1999 through 2001 on the Company's business outside of California (primarily liquor and premises liability), and on the Company's special risk class of business. Liquor liability claims arise from the liability of tavern owners related to the sale of alcoholic beverages. The Company's special risk class of business represents risks written within current underwriting programs that have a higher degree of exposure and require special pricing and underwriting. Based on the development in 2002 primarily on the business discussed above, the Company increased its estimate of ultimate losses for accident years 1999 and subsequent. The adverse development in 2002 for accident years 1998 and prior was primarily due to higher than anticipated cost of construction defect and apartment house habitability claims. Construction defect claims arise from the liability of contractors for their defective work in the construction of habitation structures (such as apartments, condominiums and single-family dwellings) or commercial type structures. Apartment house habitability claims arise from uninhabitable conditions related to dilapidated structures and insect and vermin infestation.
Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.
The following is a discussion of the above items. Crusader believes that except for one aberrational claim previously discussed under the 2003 adverse development, the implementation of the above items have contributed to improved operating results.
Non-California Non-California Accident Direct Written Direct Earned Year Premium Premium ---- ------- ------- 1997 $9,464,473 $9,287,644 1998 5,813,949 8,085,720 1999 4,429,266 4,783,426 2000 4,746,126 4,473,864 2001 5,263,039 5,112,715 2002 3,031,606 4,431,289 2003 $18,224 $1,198,006
Starting in October 2000, the Company significantly changed its underwriting practice with respect to the type of apartment buildings thought to cause these claims. These changes included:
D. In September 2003, the Company adopted an 80% liability rate increase for all of its apartment risks.
Special Risk Special Risk Special Risk Direct Written Direct Earned Policies Year Premium Premium In Force ---- ------- ------- --------
1998 $2,734,635 $3,380,747 259 as of 12/31/98 1999 2,595,032 2,636,451 235 as of 12/31/99 2000 2,851,194 2,731,012 250 as of 12/31/00 2001 2,922,257 2,925,365 201 as of 12/31/01 2002 2,329,771 2,582,673 131 as of 12/31/02 2003 $1,804,249 $2,222,707 115 as of 12/31/03
5. Increased Cost of Settling Claims: In 2002 the Company noticed a trend of increasing costs but does not believe that the trend reflects operational changes. The Company believes that the trend is most likely attributable to several changes in the law, including an increased propensity for trial courts to award large plaintiff verdicts. However, several favorable decisions were recently published, including the Federal Supreme Court's limitation on punitive damages (see Campbell vs. State Farm, 2003), and the California Supreme Court's limitation on public policy reformations (see Rosen vs. State Farm, 2003). It is difficult to quantify and predict the continuation of this trend. In 2003, an outside actuary was engaged to assist the Company in reviewing the premium rate adequacy of certain key Crusader programs and to assist in the regulatory rate filings. Crusader raises its premium rates whenever the adequacy is in doubt.
Primarily as a result of the underwriting losses in 2000 and 2001, the A.M. Best Company lowered Crusader's rating from A (Excellent) to A- (Excellent) effective March 26, 2002, based on financial information as of December 31, 2001. At the time the rating was lowered, A.M. Best remained concerned with the potential for further adverse loss reserve development and the negative impact it would have on the Company's operating performance and overall capitalization and viewed the rating outlook as negative. Due to the continued adverse development in the six months ended June 30, 2002, on October 3, 2002, A.M. Best Company lowered Crusader's rating to B+ (Very Good) and continues to view its rating outlook as negative. The lowering of Crusader's rating to B+ did not have a material adverse effect on the Company.
Year ended December 31 ---------------------- 2003 2002 2001 ---- ---- ---- Commission income $3,312,715 $2,741,672 $2,582,290
In 2003 and 2002 approximately 93% and 94% of the health and life commission income accordingly was from the CIGNA HealthCare medical and dental plan programs. Revenues for the year ended December 31, 2003, increased $571,043 (21%) compared to the year ended December 31, 2002. The increase in health and life insurance program commission and fee income is primarily due to an increase in premium written. This increase in health and life insurance income is primarily due to both increased marketing efforts and the fact that in November 2002 CIGNA terminated their contract with another administrator and approximately 2,000 affected members were transitioned into the Company's health and life insurance program effective January 1, 2003. Approximately 65% were enrolled in the CIGNA individual health and family program and 35% were enrolled in CIGNA's small group program.
Beginning in April 2003, CIGNA discontinued its individual and family health insurance program to new policyholders in the state of California. On November 1, 2003, CIGNA began terminating approximately 2,200 individual and family policyholders on a runoff basis. The termination of policyholders will continue through October 1, 2004. Beginning April 2003, AIB began assisting affected policyholders with the purchase of new health coverage through other insurance carriers. AIB has secured both commission and override commission relationships with other carriers including Health Net, Nationwide (formerly CalFarm), and PacifiCare, and is continuing its efforts to diversify and offer a wider variety of products to its customers. Overall, the commissions/overrides from other carriers are generally higher than the commission structure paid by CIGNA.
The discontinuance of CIGNA's individual and family health insurance program does not affect the CIGNA small group program. Due to intense competition in both rates and benefits offered, CIGNA small group program membership decreased in 2003. As of December 31, 2003, CIGNA small group program membership is comprised of 1,935 subscribers and 1,149 dependents compared to 2,368 subscribers and 1,475 dependents as of December 31, 2002.
Service fee income increased $1,216,676 (54%) in the year ended December 31, 2003, compared to the year ended December 31, 2002. The increase in service fee is primarily due to an increase in the fee from $100 to
$165 per policy written in California. This increase was approved by California regulatory authorities on June 21, 2002, and was implemented for policies effective on and after the latter part of August 2002. The increase in service fee income is also related to the number of policies written by Unifax. Policies issued increased by 2,822 (15%) in the year ended December 31, 2003, compared to the year ended December 31, 2002. Service fee income increased $515,072 (30%) and policies issued increased by 489 (3%) in the year ended December 31, 2002, compared to the year ended December 31, 2001.
Year ended December 31 ---------------------- 2003 2002 2001 ---- ---- ---- Rental program commission $574,197 $642,005 $585,252 Claim administration fee 241,428 80,531 72,021 Contingent commission - 66,947 10,145 ------- ------- ------- Total commission and fee income $815,625 $789,483 $667,418 ======= ======= =======
The daily automobile rental insurance program commission income (excluding contingent commission) decreased $67,808 (11%) in 2003 compared to 2002. The daily automobile rental insurance program commission income (excluding contingent commission) increased $56,753 (10%) in 2002 compared to 2001. Premium written in 2003 decreased 11% compared to prior year, and premium written in 2002 increased 7% compared to premium written in 2001. The decrease in written premium in 2003 is primarily due to the continued intense price competition in the daily automobile rental insurance program, which is causing these fluctuations in the Company's written premium and related commission income. To avoid underwriting losses for the non-affiliated insurance Company that it represents, Bedford continues to produce business only at rates that it believes to be adequate. The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change.
The increase in claim administration fee income in 2003 is primarily due to the recognition of $200,000 of claim administration fees that were unearned as of December 31, 2002. The Company is responsible for all claim administration cost arising from losses covered by premiums for which it received a claim administration fee. These costs may be incurred by the Company or the non-affiliated insurer should it assume the claim administration responsibility. The Company maintains an unearned claim administration reserve to cover these future costs. On January 1, 2003, the non-affiliated insurer assumed the claim administration for all new policies effective in 2003. The Company did not receive any claim administration fees on those policies. As of December 31, 2003, the non-affiliated insurer assumed the claim administration for the remaining outstanding and IBNR claims. The Company will no longer receive any claim administration fees and will not incur any future internal claim administration costs. The unearned claim administration reserve as of December 31, 2003 reflects the estimated costs to complete the claim administration by the non-affiliated insurer. The non-affiliated insurer will bill the Company for these costs as they are incurred.
Year ended December 31 ---------------------- 2003 2002 2001 ---- ---- ---- Membership and fee income $481,366 $424,784 $398,677
and approximately 2,000 affected members were transitioned into the Company's health and life insurance program effective January 1, 2003. However, beginning in April 2003, CIGNA discontinued its individual and family health insurance program to new policyholders in the State of California. On November 1, 2003, CIGNA began terminating approximately 2,200 individual and family policyholders on a runoff basis. The termination of policyholders will continue through October 1, 2004. Due to the discontinuance of CIGNA's individual and family health insurance program, membership and fee income is expected to decrease as these terminated members will no longer be members of the association.
Unifax began producing commercial earthquake insurance policies in California for non-affiliated insurance companies in 1999. Unifax receives a commission from these insurance companies based on premium written. Commission income on the earthquake program for the year ended December 31, 2003, decreased $11,561 (22%) compared to the prior year. The 22% decrease in commission income on earthquake policies in the year ended December 31, 2003, is directly related to a 23% decrease in written premium in 2003 compared to 2002.
Unifax produced workers' compensation policies primarily in California for non-affiliated insurers and received a commission from them based on premium written. Unifax discontinued its sales of workers' compensation insurance policies for non-affiliated insurers in 2002. The Company continues to receive commissions on policies, which were renewed in 2002. The Company's decision to discontinue selling this business was due to underwriting constraints of the non-affiliated insurance companies that limited the types and classes of business that they would accept. These constraints resulted in the decrease in commission income for the years ended December 31, 2003 and 2002.
Unifax began producing commercial liability insurance policies in California for non-affiliated insurance companies in 1999. Unifax received a commission from the insurance company based on premium written and a service fee from the policyholder. Effective December 2001 the Company discontinued the program. The Company took this action in order to better utilize its resources and focus on those markets that offer a greater potential. As such, Unifax had no commission and fee income on the commercial liability program in the year ended December 31, 2003.
Net realized investment gains - 3,690 9,572 --------- --------- --------- Total investment income and realized gains $4,848,143 $5,461,736 $5,812,985 ========= ========= =========
In the year ended December 31, 2002, while the Company's average invested assets (at amortized value) increased $2,247,249 (2%) compared to the year ended December 31, 2001, investment income earned (excluding net realized gains) decreased $345,367 (6%) compared to the year ended December 31, 2001. The decrease in investment income is primarily the result of a decline in the average return on invested assets in the Company's investment portfolio due to both a general decline in short and long-term yield in the marketplace and a shorter weighted average maturity of the portfolio. Due to the interest rate environment, management believed it was prudent to purchase fixed maturity investments with shorter maturities and therefore, the weighted average maturity of the Company's fixed maturity investments has decreased from 2.8 years as of December 31, 2001, to 2.4 years as of December 31, 2002. In the year ended December 31, 2002, the Company's average yield on invested assets (at amortized value) was 5.53% compared to 6.02% at the year ended December 31, 2001. The Company's average invested assets increased in the year ending December 31, 2002, primarily as a result of increased cash flows from operations. The mix of taxable and tax-exempt securities in the portfolio affects the investment income return percentage. Tax-exempt securities generally carry a lower yield than taxable securities. These securities (at amortized value) decreased to $2,731,060 (3% of total investments) at December 31, 2002, compared to $8,213,141 (9% of total investments) at December 31, 2001.
(Amounts in Thousands) As of December 31, 2003 ----------------------- Amortized Market Fixed maturities due Cost Value -------------------- ---- ----- Within 1 year $26,151 $26,525 Beyond 1 year but within 5 years 77,963 80,292 Beyond 5 years but within 10 years 7,212 7,707 ------- ------- Total $111,326 $114,524 ======= =======
The Company did not sell any bonds in the year ending December 31, 2003. The Company sold one bond in the year ending December 31, 2002, and recognized a short-term capital gain of $3,906. The single bond was sold in order to maintain conformity with the Company's investment guidelines. In the year ending December 31, 2001, the Company sold three bonds and recognized capital gains aggregating $35,276. Two of these bonds were sold to maintain conformity with the Company's investment guidelines, and one bond was sold to fund the repurchase of the Company's common stock.
Salaries and Employee Benefits increased $586,888 (13%) for the year ended December 31, 2003, compared to the year ended December 31, 2002. Factors that affected the increase include the hiring of higher-level employees, general salary increases (less than 6%), increases in employee benefits costs, and the composition of employees whose salaries and employee benefits are capitalized to policy acquisition cost versus those being directly expensed. Salaries and employee benefits increased $52,241 (1%) for the year ended December 31, 2002, compared to the year ended December 31, 2001.
Year ended December 31 ---------------------- 2003 2002 2001 ---- ---- ---- Salaries and employee benefits $4,960,766 $4,373,878 $4,321,637
Year ended December 31 ---------------------- 2003 2002 2001 ---- ---- ---- Commission to agents/brokers $1,460,684 $1,219,310 $1,260,059
ruling concluded that the discriminatory sections of the statute are not severable and the entire statute is invalid and unenforceable. California law provides that the proper remedy in such circumstances is to disallow the deduction to those taxpayers that benefited from the deduction. As a result of the court ruling, in February 2003, the Franchise Tax Board (FTB) notified the Company that it would issue a Notice of Proposed Assessment (NPA) for tax years 1999 and 2000 of approximately $287,000 representing California state franchise taxes plus related interest of approximately $80,000. The income tax benefit for the year ended December 31, 2002, was $1,589,370 compared to an income tax benefit of $5,853,091 for the year ended December 31, 2001. The effective combined income tax rates for 2002 and 2001 were 33% and 35%, respectively. The pre-tax loss was significantly lower in 2002 compared to 2001, which resulted in the difference in the effective tax rates between 2002 and 2001. The income tax benefit for 2002 and 2001 arises primarily from the Company's ability to recover prior income taxes paid due to the carryback of those years net operating losses (see Note 16 of Notes to Consolidated Financial Statements).
In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150). SFAS No. 150 addresses certain financial instruments that, under previous guidelines, could be accounted for as equity, but now must be classified as liabilities in the statement of financial position. These financial instruments include: 1) mandatory redeemable financial instruments, 2) obligations to repurchase the issuer's equity shares by transferring assets, and 3) obligations to issue a variable number of shares. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The implementation of SFAS No. 150 did not have an impact on the Company's consolidated financial statements.
Investments ----------- In accordance with Statement of Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company is required to classify its investments in debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading securities. Although all of the Company's investments are classified as available-for-sale and although the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities are reported as accumulated other comprehensive income (loss), which is a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses are included in the consolidated statements of operations based on the specific identification method.
Consolidated Statements of Comprehensive Income for the years ended December 31, 2003, December 31, 2002, and December 31, 2001 39
Consolidated Statements of Cash Flows for the years ended December 31, 2003, December 31, 2002, and December 31, 2001 41
We have audited the accompanying consolidated balance sheets of Unico American Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
Basis of Presentation - --------------------- The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). As described in Note 14, the Company's insurance subsidiary also files financial statements with regulatory agencies prepared on a statutory basis of accounting that differs from GAAP.
The Company had net unrealized investment gains, net of deferred taxes, of $2,110,979 as of December 31, 2003, and $3,117,762 as of December 31, 2002.
Segment Reporting - ----------------- Statement of Financial Accounting Standards No. 131 (SFAS No. 131), Disclosures about Segments of an Enterprise and Related Information, became effective for fiscal years effective after December 15, 1997. SFAS No. 131 establishes standards for the way information about operating segments is reported in financial statements. The Company has identified its insurance company operation as its primary reporting segment. Revenues from this segment comprised 82.2% of consolidated revenues in the year ended December 31, 2003, 84.3% of consolidated revenues in the year ended December 31, 2002, and 84.4% for the year ended December 31, 2001. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually insignificant to consolidated revenues.
A.M. Best Amount Name of Reinsurer Rating Recoverable - ----------------- ------ ----------- General Reinsurance Corporation A++ $ 3,774,936 Partners Reinsurance of the U.S A+ 10,103,257 Platinum Reinsurance A 3,158,000 QBE Reinsurance Corporation A 947,000 Hannover Ruckversicherungs A+ 1,895,000 ---------- Total $19,878,193 ==========
Recently Issued Accounting Standards - ------------------------------------ In April 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS No. 149). SFAS No. 149 amends and clarifies accounting for derivative instruments and improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. The amendments to SFAS No. 133 fall principally into three categories: amendments related to SFAS No. 133 implementation issues, amendments clarifying the definition of a derivative instrument, and amendments relating to the definition of expected cash flows contained in FASB Concepts Statement No. 7 Using Cash Flow Information and Present Value in Accounting Measurements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. SFAS No. 149 does not alter current valuation or disclosures. The implementation of SFAS No. 149 did not have an impact on the Company's consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150). SFAS No. 150 addresses certain financial instruments that, under previous guidelines, could be accounted for as equity, but now must be classified as liabilities in the statement of financial position. These financial instruments include: 1) mandatory
In December 2003, FASB Statement No. 132 (revised), Employers' Disclosures about Pensions and Other Postretirement Benefits, was issued. Statement 132 (revised) prescribes employers' disclosures about pension plans and other postretirement benefit plans; it does not change the measurement or recognition of those plans. The Statement retains and revises the disclosure about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. The Statement generally is effective for fiscal years ending after December 15, 2003. The Company's disclosures in Note 13 incorporate the requirements of Statement 132 (revised).
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46. Consolidation of Variable Interest Entities, which was issued in January 2003. The implementation of FASB Interpretation No. 46 did not have an impact on the Company's consolidated financial statements.
NOTE 3 - INVESTMENTS - --------------------- The Company manages its own investment portfolio. A summary of net investments and related income is as follows:
The amortized cost and estimated market value of fixed maturity investments at December 31, 2003, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
Amortized Estimated Cost Market Value ---- ------------ Due in one year or less $26,150,904 $26,524,679 Due after one year through five years 77,962,487 80,292,227 Due after five years through ten years 7,212,201 7,707,140 ----------- ----------- Total fixed maturities $111,325,592 $114,524,046 =========== ===========
Certificates of deposit $425,000 $225,000 Cash deposited in lieu of bond * 752,659 - Commercial paper 2,000,000 1,525,000 U.S. treasury bills 2,998,850 - Commercial bank money market accounts 902,517 724,842 U.S. government obligation money market fund 147,666 6,546,602 Savings account 2,623 2,938 --------- --------- Total short-term investments $7,229,315 $9,024,382 ========= =========
Year ended December 31 ---------------------- 2003 2002 ---- ---- Furniture, fixtures, computer, office, and transportation equipment $1,570,716 $1,768,856 Accumulated depreciation 1,247,626 1,414,662 --------- --------- Net property and equipment $323,090 $354,194 ======= =======
NOTE 5 - PREMIUMS AND NOTES RECEIVABLE, NET - ------------------------------------------- Premiums and notes receivable are substantially secured by unearned premiums and funds held as security for performance. Year ended December 31 ---------------------- 2003 2002 ---- ---- Premiums receivable $2,851,189 $2,364,150 Premium finance notes receivable 5,457,797 4,350,685 --------- --------- Total premiums and notes receivable 8,308,986 6,714,835 Less allowance for doubtful accounts 18,817 14,926 --------- --------- Net premiums and notes receivable $8,290,169 $6,699,909 ========= =========
Bad debt expense for the fiscal year ended December 31, 2003, and the fiscal year ended December 31, 2002, was $23,895 and $25,857, respectively. Premium finance notes receivable represent the balance due to the Company's premium finance subsidiary from policyholders who elect to finance their premiums over the policy term. These notes are net of unearned finance charges.
NOTE 6 - NOTES PAYABLE - RELATED PARTIES - ---------------------------------------- On November 15, 2002, the Company borrowed $500,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer, and $250,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. In the quarter ended June 30, 2003, the Company repaid the above-mentioned notes in full.
Adverse development of prior years' losses of $19,326,349 as of December 31, 2001, was primarily the result of an increase in the Company's estimate of ultimate reported and unreported claims for construction defect claims, non-California liquor liability claims and apartment house habitational type of claims. In the year ended December 31, 2001, the Company increased its estimates of ultimate losses for both reported and unreported claims primarily occurring from 1998 through 2000 and from 1993 through 1995 (the years most impacted by construction defect claims).
Policy acquisition costs are deferred and amortized as the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income, including investment income.
Year ending ----------- December 31, 2004 $1,025,952 December 31, 2005 1,025,952 December 31, 2006 1,025,952 December 31, 2007 (through March 31, 2007) 256,488 --------- Total minimum payments $3,334,344 =========
NOTE 11 - COMMITMENT AND CONTINGENCIES - -------------------------------------- The Company, by virtue of the nature of the business conducted by it, becomes involved in numerous legal proceedings as either plaintiff or defendant. The Company is also required to resort to legal proceedings from time to time in order to enforce collection of premiums, commissions, or fees for the services rendered to customers or to their agents. These routine items of litigation do not materially affect the Company and are handled on a routine basis by the Company through its general counsel.
Likewise, the Company is sometimes named as a cross-defendant in litigation, which is principally directed against that insurer who was issued a policy of insurance directly or indirectly through the Company. Incidental actions are sometimes brought by customers or others, which relate to disputes concerning the issuance or non-issuance of individual policies. These items are also handled on a routine basis by the Company's general counsel, and they do not materially affect the operations of the Company. Management is confident that the ultimate outcome of pending litigation should not have an adverse effect on the Company's consolidated operation or financial position.
NOTE 14 - STATUTORY CAPITAL AND SURPLUS - --------------------------------------- Crusader is required to file an annual statement with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory). Statutory accounting practices differ in certain respects from GAAP. The more significant of these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) ) fixed maturity securities are reported at amortized cost, or the lower of amortized cost or market value, depending on the quality of the security as specified by the NAIC; (c) equity securities are valued by the NAIC as required by Statutory Accounting Principles; d) non-admitted assets are charged directly against surplus; (e) loss reserves and unearned premium reserves are stated net of reinsurance; and (f) federal income taxes are recorded when payable and deferred taxes, subject to limitations, are recognized but only to the extent that they do not exceed 10% of statutory surplus; changes in deferred taxes are recorded directly to surplus as regards policyholders. Additionally, the cash flow presentation is not consistent with generally accepted accounting principles and reconciliation from net income to cash provided by operations is not presented. Comprehensive income is not presented under statutory accounting.
As of December 31, 2003 $26,103,440 As of December 31, 2002 $26,258,452
Year ended December 31, 2003 $(3,106,103) Year ended December 31, 2002 $(5,331,777) Year ended December 31, 2001 $(12,110,967)
Insurance Regulatory Information System (IRIS) was developed by a committee of state insurance regulators primarily to assist state insurance departments in executing their statutory mandate to oversee the financial condition of insurance companies. IRIS helps those companies that merit highest priority in the allocation of the regulators' resources on the basis of 12 financial ratios that are calculated annually. The analytical phase is a review of annual statements and the financial ratios. The ratios and trends are valuable in pointing to companies likely to experience financial difficulties, but are not themselves indicative of adverse financial condition. The ratio and benchmark comparisons are mechanically produced and are not intended to replace the state insurance departments' own in-depth financial analysis or on-site examinations.
An unusual range of ratio results has been established from studies of the ratios of companies that have become insolvent or have experienced financial difficulties. In the analytical phase, companies that receive four or more financial ratio values outside the usual range are analyzed in order to identify those companies that appear to require immediate regulatory action. Subsequently, a more comprehensive review of the ratio results and an insurer's annual statement are performed to confirm that an insurer's situation calls for increased or close regulatory attention.
In 2003, the Company was outside the usual values on 4 of the 12 IRIS ratio tests, primarily as a result of adverse loss and loss adjustment expense development and investment yield. The IRIS tests outside the usual values related to adverse loss and loss adjustment expenses were the Two Year Overall Operating Ratio, Two Year Reserve Development to Surplus, and Estimated Current Reserve Deficiency to Surplus. A usual value for the IRIS test for investment yield is a range greater than 4.5% and less than 10%. Crusader's 2003 statutory investment yield of 4.5% was, therefore, also outside the usual value.
Date Exercisable ------------------------------------------------- Number of January 1, January 1, January 1, January 1, Options Granted 2004 2005 2006 2007 - --------------- ---- ---- ---- ---- 2,500 2,500 5,000 2,500 2,500 7,500 2,500 2,500 2,500 10,000 2,500 2,500 2,500 2,500 12,500 2,500 2,500 2,500 5,000 15,000 5,000 5,000 5,000 20,000 5,000 5,000 5,000 5,000 35,000 5,000 10,000 10,000 10,000
Weighted Average Options Exercise Price ------- -------------- Outstanding at December 31, 2000 203,775 $7.239 Options granted - - Options exercised (59,860) $3.500 Options terminated (27,500) $9.250 ------- Outstanding at December 31, 2001 116,415 $8.686 Options granted 182,000 $3.110 Options exercised (8,245) $3.500 Options terminated (3,170) $3.500 ------- Outstanding at December 31, 2002 287,000 $5.356 Options granted - - Options exercised - - Options terminated (10,000) $9.250 ------- Outstanding at December 31, 2003 277,000 $5.216 =======
Year ended December 31 ---------------------- 2003 2002 ---- ---- Deferred tax assets: Discount on loss reserves $2,246,793 $2,111,565 Unearned premiums 2,351,751 1,650,395 AMT credit 203,340 - Other 210,777 131,141 --------- --------- Total deferred tax assets $5,012,661 $3,893,101 --------- --------- Deferred tax liabilities: Deferred acquisition costs $2,738,484 $2,021,984 Discount on salvage and subrogation 5,802 6,992 Unrealized gain on investments 1,087,474 1,606,120 Other 205,200 200,054 --------- --------- Total deferred tax liabilities $4,036,960 $3,835,150 --------- ---------
The Company is following the progress of current legislation that would address the unconstitutionality of the California statue by restructuring the rate at which California taxes dividends for in and out of state insurance holding companies. The legislation would also resolve the issue regarding the retroactive assessments due to the disallowance of the deduction. If the legislation were enacted, it would result in the Company paying a relatively small amount of California franchise taxes on dividends received from its insurance company subsidiary. Without a legislative solution, the Company anticipates the ultimate outcome of the dividend received deduction will settled by future litigation.
NOTE 17 - REPURCHASE OF COMMON STOCK - EFFECT ON STOCKHOLDERS' EQUITY - --------------------------------------------------------------------- The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company. During the year ended December 31, 2003, the Company did not purchase any shares of the Company's common stock. As of December 31, 2003, the Company had purchased and retired under the Board of Directors authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.
NOTE 18 - EARNINGS PER SHARE - ---------------------------- A reconciliation of the numerator and denominator used in the basic and diluted earnings per share calculation is presented below:
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - ------------------------------------------------------ Summarized unaudited quarterly financial data for each of the calendar years 2003 and 2002 is set forth below: