The Company leases certain office space in Bala Cynwyd, PA which serves as its headquarters location and also leases 40 field offices for its field marketing organization. The Company sold its previous headquarters building in Wynnewood, PA for proceeds of approximately $2.0 million during 1998.
(2) 1996, 1995, and 1994 earnings per share amounts restated in accordance with the provisions of SFAS No. 128 adopted as of December 31, 1997.
1998 was a year in which the Company not only continued to realize profitable growth, but also built upon its existing franchise foundation. For 1998, the Company reported net income of $20.0 million, an 18.3% increase over its net income of $16.9 for 1997. This increase was principally due to a 24.1% increase in gross written premiums, a 58.8% increase in net investment income and profitable underwriting which resulted in an 85.4% GAAP basis combined ratio, which, once again, is substantially lower than the commercial property and casualty insurance industry as a whole.
The Company's gross written premium growth during the year was attributable to a number of factors, including: the continued growth and strengthening of the Company's field marketing organization from 100 professionals at year end 1997 to 160 at year end 1998 and the addition of two new field offices; the addition of a Specialty Property and Inland Marine underwriting organization which brings a new line of business to the Company; increased product distribution through the Preferred Agent Program by the addition of 18 new Preferred Agent relationships; and new product offerings. Additionally, the 58.8% growth in net investment income was due to the 63.8% increase in total investments during 1998. This growth in total investments was primarily due to investing the proceeds of the Company's FELINE PRIDES(SM) security offering.
The Company's investment objective continues to be the realization of relatively high levels of investment income while generating competitive after-tax total rates of return within a prudent level of risk and within the constraints of maintaining adequate securities in amount and duration to meet cash requirements of current operations and long-term liabilities, as well as maintaining and improving the Company's A.M. Best and Standard & Poors' ratings. The Company utilizes professional investment managers for its fixed maturity and equity investments. These investments consist of diversified issuers and issues, and as of December 31, 1998 approximately 73% of the total invested assets (total investments plus cash equivalents) consisted of investments in fixed maturity securities.
The Company increased its existing portfolio of collateralized mortgage and asset backed securities during 1998 in order to realize more favorable after-tax yields. Collateralized mortgage and asset backed securities amounted to $42.8 million and $46.4 million, respectively, as of December 31, 1998 and $7.3 and $11.3, respectively, as of December 31 1997. These securities are short tranche securities possessing favorable prepayment risk profiles. The Company had no derivative financial instruments.
- - Expansion of marketing efforts relating to commercial auto, commercial package, and specialty lines products through the increase in the Company's field organization to a total of 160 professionals.
- - The continued development and growth of the Company's Preferred Agent Program (18 new preferred relationships formed in 1998), initiated in 1996, wherein business relationships are formed with brokers specializing in certain of the Company's business niches, thereby increasing the distribution of the Company's niche products.
- - The addition of a new Specialty Property and Inland Marine underwriting organization during the fourth quarter of 1998 as well as several other new programs during the year.
Net Investment Income: Net investment income approximated $15.4 million in 1998 and $9.7 million in 1997. Total investments grew to $356.5 million at December 31, 1998 from $217.7 million at December 31, 1997, primarily due to investing the proceeds from the Company's FELINE PRIDES(SM) security offering and cash flows provided from operating activities.
- - Overall premium growth is primarily attributable to: continued marketing efforts relating to commercial auto, commercial package, and specialty lines products, along with the continued development of the Company's Preferred Agent Program, initiated in 1996, wherein business relationships are formed with brokers specializing in certain of the Company's business niches, thereby increasing the distribution of the Company's niche products; the increase of the Company's proprietary field organization to a total of 100 professionals, production underwriters and customer service representatives.
- - Net written and net earned premiums grew at higher rates than gross written and gross earned premiums, primarily due to the renegotiation of the Company's reinsurance program effective January 1, 1997, whereby more favorable reinsurance rates were realized while substantially the same retentions and coverages were maintained.
Company's production underwriters have established relationships with approximately 4,000 brokers, thus facilitating a regular flow of submissions.
On May 4, 1998, the consolidated capitalization of the Company increased by approximately $99.0 million from the sale of FELINE PRIDES(SM) and Trust Preferred securities. The sales of FELINE PRIDES(SM) consisted of 9,350,000 units of Income Prides with a stated amount of $10.00, 1,000,000 units of Growth Prides with a face amount equal to the stated amount, and 1,000,000 units of separate Trust Preferred securities with a stated amount of $10.00. $33.1 million from the sale of these securities was contributed to the Company's subsidiaries, of which, $20.0 million was contributed to the Insurance Subsidiaries. Additionally, $3.1 million was utilized by the Company to buy back its common stock under its stock buy-back program. The Company anticipates using the remaining proceeds for general corporate purposes, which may include acquisitions (including, without limitation, acquisitions of programs or books of business), capital expenditures, additional capital contributions to its subsidiaries and the repurchase by the Company of its common stock. The Company is obligated to make cash distributions, commencing May 4, 1998 through May 15, 2001, at a rate of 7.0% of the stated amount per annum for the Income Prides and the separate Trust Preferred securities and contract adjustment payments at the rate of .50% per annum of the $10.00 stated amount to the holders of the Growth Prides.
The Insurance Subsidiaries, which operate under a pooling agreement, must have certain levels of policyholders' surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners (the "NAIC") suggest that a property and casualty insurer's ratio of annual statutory net premium written to policyholders' surplus should not exceed 3-to-1. The ratio of combined annual statutory net premium written by the Insurance Subsidiaries to their combined policyholders' surplus was 1.0-to-1.0 for 1998 and 1997. Management believes that the policyholders' surplus, which was $152.3 million at December 31, 1998, will be sufficient to support current and anticipated premium writings.
The Company has established a Year 2000 oversight committee comprised of certain senior officers and internal audit personnel to develop a comprehensive approach with regard to the Company's assessment and mitigation of the Year 2000 issue. To date, this approach has included the establishment of a Year 2000 task force comprised principally of various information technology personnel under the direction of the Company's Information Technology Vice President. The task force has been meeting on a regularly scheduled basis to assess the Company's readiness with regard to the Year 2000 issue. The task force has divided the Year 2000 project into three main sections: "IT Systems", which encompasses the Company's hardware and software (operating and application); "Non-IT Systems", which encompasses embedded technology and microprocessors contained in telecommunications and facilities management systems and other equipment; and "Third Parties", which encompasses the Company's major vendors, suppliers and customers.
Phase 4 Creating a project plan to address material items that are determined not to be Year 2000 compliant;
The total cost associated with required modifications to become Year 2000 compliant is not expected to have a material effect on the Company's operations or financial condition. The estimated total cost to the Company of the Year 2000 project is approximately $125,000. The total amount expended on the project through December 31, 1998 was approximately $115,000, which related primarily to the "IT Systems" and "Non-IT Systems" section. This amount came from the Company's operating funds.
Additionally, the Company issues professional liability, including Directors & Officers liability, and commercial multi-peril insurance policies. Coverage under certain of these policies may cover losses suffered by insureds as a result of Year 2000 issues. The Company's professional liability policies are written on a "claims made and reported" basis, and since early 1997 approximately 50% of such policies have included a Year 2000 exclusion endorsement. The Company is including a Year 2000 exclusion endorsement on virtually all new or renewing professional liability policies providing coverage effective January 1, 1999 and thereafter. On occasion, for qualifying accounts, underwriters may remove the exclusion after satisfactory receipt and review of a supplemental application (which includes a warranty statement) and other underwriting information. With respect to its commercial multi-peril policies the Company believes claims against the comprehensive general liability coverage under these policies should fail based upon the doctrine of fortuity.
The Company has not established contingency plans for non-compliance of its "IT Systems" or "Non-IT Systems" since the Company anticipates that the "IT Systems" and "Non-IT Systems" sections will be Year 2000 compliant by March 31, 1999. The Company's review of the "Third Parties" section will be completed by June 30, 1999. Presently, the Company is not aware of any major "Third Party" problem. The Company is on schedule with its expected completion dates for all sections. To the extent that the Company is aware of a non-compliant material "Third Party" a contingency plan would be developed which would potentially include replacing non-compliant material "Third Party" vendors and suppliers.
In December 1997, the Accounting Standards Executive Committee of the American Institute of Certified Public Accounts issued Statement of Position (SOP) 97-3 "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," specifying the preferable accounting treatment for entities that are subject to guaranty-fund and other insurance-related assessments. The Company will adopt the provisions of SOP 97-3 in the first quarter of 1999 and does not expect a material impact on the Company's financial statements.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income, changes in shareholders' equity and cash flows present fairly, in all material respects, the financial position of Philadelphia Consolidated Holding Corp. and Subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. 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 conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Philadelphia Consolidated Holding Corp. ("Philadelphia Insurance"), and its subsidiaries (collectively the "Company") doing business as Philadelphia Insurance Companies, include two Pennsylvania domiciled property and casualty insurance companies, Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company ("Insurance Subsidiaries"); an underwriting manager Maguire Insurance Agency, Inc.; and an investment subsidiary, PCHC Investment Corp. The Company designs, markets, and underwrites specialty commercial property and casualty insurance products for select target industries or niches including, among others, the rent-a-car industry; automobile leasing industry; nonprofit organizations; the health, fitness and wellness industry; and selected classes of professional liability. All marketing, underwriting, claims management, investment, and general administration is provided by the underwriting manager. The Company manages one operating segment comprised of all its property and casualty insurance business.
The consolidated financial statements include the accounts of the Company prepared in conformity with generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements requires making estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain prior years' amounts have been reclassified for comparative purposes.
In the normal course of business, the Company seeks to reduce the loss that may arise from events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the reinsured policy. Amounts for reinsurance assets and liabilities are reported gross.
Earnings per share and common stock equivalents outstanding have been retroactively restated to reflect the increased number of common shares resulting from a two-for-one stock split that was announced in October 1997 and distributed to shareholders on November 5, 1997. A total of 6,119,716 additional shares were issued as a result of the stock split. The par value of the Company's stock remained unchanged.
in the earnings of the entity. The Company adopted the provisions of SFAS No. 128 as of December 31, 1997 and restated all prior period earnings per share data to conform with the provisions of this Statement.
Generally accepted accounting principles ("GAAP") differ in certain respects from SAP prescribed or permitted by the Insurance Department of the Commonwealth of Pennsylvania. The principal differences between SAP and GAAP are as follows:
The statutory capital and surplus of PIC as of December 31, 1998 and 1997 was $38,677,000 and $30,091,000, respectively. Statutory net income of PIC for the years ended December 31, 1998, 1997, and 1996 was $6,339,000, $5,494,000 and $3,629,000, respectively. Capital contributions to PIC for the years ended December 31, 1998 and 1997 were $6,000,000 and $0, respectively.
Risk-Based Capital: Risk-based capital is designed to measure the acceptable amount of capital an insurer should have based on the inherent specific risks of each insurer. Insurers failing to meet this benchmark capital level may be subject to scrutiny by the insurer's domiciliary insurance department, and ultimately, rehabilitation or liquidation. Based on the standards, PIIC's and PIC's capital and surplus at December 31, 1998 is in excess of the prescribed risk-based capital requirements.
The Company invests primarily in investment grade fixed maturities, the majority of which are rated "A-" or better by Standard and Poors'. The cost, gross unrealized gains and losses, estimated market value and carrying value of investments as of December 31, 1998 and 1997 are as follows (in thousands):
Realized pre-tax gains (losses) on the sale of investments for the years ended December 31, 1998, 1997, and 1996 are as follows (in thousands):
The Company is required to maintain certain investments in trust accounts under reinsurance agreements with unrelated insurance companies that cede insurance risks to the Company. At December 31, 1998 and 1997, the Company had investments with a carrying value of $2,326,000 and $2,403,000, respectively, in trust accounts pursuant to a terminated quota share reinsurance agreement. Under the terms of this agreement, net premiums received by the Company were invested and held in a trust account to pay future claims. Interest income on these investments is distributed to the parties to the quota share agreement on a quarterly basis. The Company receives its interest in net trust investments in accordance with a formula that specifies certain percentages of funds to be released over a five-year period as losses are settled.
Included in property and equipment are costs incurred in developing or purchasing information systems technology of $2,716,500 and $2,516,500 in 1998 and 1997, respectively. Amortization of these costs was $195,300, $180,200 and $100,100 for the years ended December 31, 1998, 1997, and 1996, respectively. Depreciation expense, excluding amortization of capitalized information systems technology costs, was $1,169,700, $858,200 and $530,000, for the years ended December 31, 1998, 1997, and 1996, respectively.
As of December 31, 1998, the Company has approximately $0.6 million in net operating loss carryforwards, which expire in 2000 and 2001, available to offset future taxable income. Utilization of the loss carryfowards is limited to an annual amount of $336,000. For financial reporting purposes, the tax benefit of any utilization of these operating loss carryfowards is applied to reduce goodwill ($118,000 in 1998) and does not reduce income tax expense.
Under the Company's stock option plan, stock options may be granted for the purchase of common stock at a price not less than the fair market value on the date of grant. Options outstanding as of December 31, 1994 are exercisable over a four-to-five-year vesting period. Options issued in 1998, 1997, 1996, and 1995 are exercisable after the expiration of five years following the grant date. Under this plan, the Company has reserved 2,475,000 shares of common stock for issuance pursuant to options granted under the plan.
SFAS No. 123, "Accounting for Stock-Based Compensation", encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at a fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for the Company's compensation instruments is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock.
The Company has established a non-qualified Employee Stock Purchase Plan (the "Stock Purchase Plan"). The aggregate maximum number of shares that may be issued pursuant to the Stock Purchase Plan is 500,000. Shares may be purchased under the Stock Purchase Plan by eligible employees during designated one-month offering periods established by the Compensation Committee of the Board of Directors at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. The purchase price of shares may be paid by the employee over six years pursuant to the execution of a promissory note. The promissory note(s) are collateralized by such shares purchased under the Stock Purchase Plan and are interest free. Under the Stock Purchase Plan, the Company issued 51,794 and 78,569 shares in 1998 and 1997, respectively. The weighted-average fair value of those purchase rights granted in 1998 and 1997 was $2.70 and $1.94, respectively.
(1) Per share information restated to reflect a two-for-one split of the Company's common stock distributed in November 1997, see Note 11.
On August 3, 1998, the Company's Board of Directors authorized the Company to repurchase up to $10.0 million of its common stock. As of December 31, 1998, the Company had repurchased 159,100 shares for approximately $3.1 million under this authorization.
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 1998 and 1997 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown (in thousands, except share and per share data):