Financial Statements and Supplementary Data Page The following financial information is submitted herein:
To the Board of Directors and Shareholders Of Allcity Insurance Company:
In our opinion, the consolidated financial statements listed in the index appearing under item 14(a)(1) of this Form 10-K present fairly, in all material respects, the financial position of Allcity Insurance Company and its subsidiary at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 14(a)(2) of this Form 10-K presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America 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 our opinion.
NOTE 1-ORGANIZATION-CONTINUED The National Association of Insurance Commissioners ("NAIC") has adopted model laws incorporating the concept of a "risk based capital" ("RBC") requirement for insurance companies. Generally, the RBC formula is designed to measure the adequacy of an insurer's statutory capital in relation to the risks inherent in its business. The RBC formula is used by the states as an early warning tool to identify weakly capitalized companies for the purpose of initiating regulatory action. Although New York State has not adopted the RBC requirements for property and casualty insurance companies, New York does require that property and casualty insurers file the RBC information with the New York Insurance Department ("the Department"). The NAIC also has adopted various ratios for insurance companies which, in addition to the RBC ratio, are designed to serve as a tool to assist state regulators in screening and analyzing the financial condition of insurance companies operating in their respective states. The Company and its parent had certain NAIC ratios outside of the acceptable range of results for the year ended December 31, 2000.
In 2001, the Department completed its fieldwork for its triennial examination of the statutory-basis financial statements of the Company and its parent as of December 31, 1999 but has not as yet issued its report. However, the Department has verbally informed the Company that its estimate of the Company's required loss and loss adjustment expense reserves as of December 31, 1999 was higher than the amount recorded by the Company. The Department's estimate of loss and loss adjustment expense reserves for accident years 1999 and prior is approximately $15,000,000 higher than the Company's recorded reserves for such accident years as of December 31, 2000. The Company and its parent are currently discussing the results of the Department's reserve study with them, and are working to reconcile the differences between the two estimates. Based on the Company's and its parent's recent discussions with the Department, and their decision to file plans of orderly withdrawal from all lines of business, as previously described, the Company believes that no material adverse action will be taken by the Department at this time. However, no assurance can be given that the Company and its parent will not be required to increase their reserves or that the Department will not take materially adverse regulatory action in the future.
The Group is currently exploring its options for the future. The Group may commence new property and casualty insurance operations if a new business model with an acceptable expense structure can be developed, enter into a joint venture with another property and casualty insurance operation, explore entering the claim services business or commence a liquidation. There may be other options that the Company will explore, but no assurance can be given at this time as to what the ultimate plan will be.
NOTE 1-ORGANIZATION-CONTINUED The Company and Empire distributed their products through seven general agents, one of which was an Empire subsidiary, and independent agents and brokers. Effective October 3, 2000, Empire's wholly owned general agent sold its book of business to an unrelated party. Empire's wholly-owned general agent was its largest producer and generated approximately 8%, 12% and 12% of its total earned premium volume for the years ended December 31, 2000, 1999 and 1998, respectively.
Investments: At acquisition, marketable debt and equity securities are designated as either (i) "held to maturity" and carried at amortized cost, (ii) "trading" and carried at estimated fair value with differences between cost and estimated fair value reflected in results of operations or (iii) "available for sale" and carried at estimated fair value, with differences between cost and estimated fair value being reflected as a separate component of shareholders' equity, net of taxes. Other invested assets, which are designated as trading securities, represent an investment in a limited partnership which invests principally in convertible preferred stocks, convertible long-term debt securities, limited partnerships, and common stocks sold, but not yet purchased. Short-term investments are carried at cost which approximates fair value. Estimated fair values are principally based on quoted market prices.
Unearned Premiums: Unearned premiums have been calculated predominantly using the daily pro rata method.
Unpaid Losses and Loss Adjustment Expenses: Liabilities for unpaid losses, which are not discounted (except for certain workers' compensation liabilities), and loss adjustment expenses ("LAE") are determined using case-basis evaluations, statistical analyses for losses incurred but not reported and estimates for salvage and subrogation recoverable and represent estimates of the ultimate claim costs of all unpaid losses and LAE. Liabilities include a provision for losses that have occurred but have not yet been reported. These estimates are subject to the effect of trends in future claim severity and frequency experience. Adjustments to such estimates are made from time to time due to changes in such trends as well as changes in actual loss experience. These adjustments are reflected in current earnings.
Pension Cost: Empire funds actuarially determined pension costs as currently accrued; 30% of such pension costs are allocated to the Company.
Servicing Arrangements: Service fee income from assigned risk business acquired through contractual arrangements with other insurance companies was recognized as revenue and earned over the life of the covered policies on a monthly pro-rata method.
Federal Income Taxes: The Company uses the liability method in providing for income taxes. Under the liability method, deferred income taxes are provided at the enacted tax rates for differences between the financial statement carrying amounts and tax bases of assets and liabilities and for net operating loss carryforwards. A valuation allowance is provided if tax loss carryforwards and deferred tax benefits are not considered more likely than not to be realized.
Presentation: Certain prior year amounts have been reclassified to conform with the 2000 presentation.
The amortized cost and estimated fair values of fixed maturities (including short-term securities) at December 31, 2000 are shown as follows (in thousands): Amortized Fair Cost Value Investments available for sale: Due in one year or less $ 34,088 $ 34,060 Due after one year through five years 75,194 75,357 Due after five years through ten years 5,568 5,574 Thereafter 1,507 1,499 Sub total 116,357 116,490 Mortgage-backed securities 9,310 9,373 Sub total $125,667 $125,863 Investments held to maturity: Due after one year through five years 486 483 TOTAL $126,153 $126,346
During 1999 and 1998, the Company sold call options on certain U.S. Treasury Notes and recognized investment gains and losses of $4,000 and ($57,000), respectively.
The following is a reconciliation of net loss and surplus as reported on a statutory basis ("SAP") to net (loss)/income and shareholders' equity as determined in conformity with GAAP (in thousands):
The Company has paid no dividends on its common shares since 1975. The New York Insurance Law prohibits New York domiciled property and casualty companies from paying dividends except out of earned surplus. Without the approval of the New York Insurance Department, no New York domestic property/casualty insurer may declare or distribute any dividend to shareholders which, together with any dividends declared or distributed by it during the preceding twelve months, exceeds the lesser of (1) 10% of surplus to policyholders as shown by its last statutory annual statement or (2) one hundred percent of adjusted net investment income during such period. At December 31, 2000, $4,670,000 was available for distribution of dividends. The Company does not presently anticipate paying dividends in the near future.
In the following table, the liability for losses and LAE are reconciled for the three years ended December 31, 2000, 1999 and 1998. Included therein are current year data and prior year development.
During 1999, the Company experienced unfavorable development due to an increase in severity of 1998 accident year losses in the assigned risk automobile and voluntary private passenger automobile lines, and 1996 accident year losses in certain classes of the commercial automobile line. As a result, the Company increased its reserves by $2.2 million for assigned risk automobile, $1.5 million for voluntary private passenger automobile and $1.4 million for commercial automobile lines.
During 1998, the Company reviewed the adequacy of the reserves carried for its open claims' files, focusing on workers' compensation, commercial auto and other commercial liability lines of business. As part of the review, substantially all open workers' compensation claim files were reviewed for every accident year up to and including 1998. Additionally, during 1998, the Group reorganized the commercial auto claims department. As part of this realignment, more complex claims files were reviewed by the most experienced claims examiners and assumptions regarding average claims severity and probable ultimate losses were revised. Accordingly, reserves were strengthened by $3.9 million for workers' compensation, $4.2 million for commercial automobile and $4.2 million for other commercial liability lines of business.
NOTE 8-REINSURANCE The Company has purchased annuities with various life insurance companies for a number of settled claims. The claimants have been designated as payees; however, the Company has a contingent liability of approximately $5.0 million which represents the aggregate amount of settlements with the claimants, in the event of the failure of the various life insurance companies to perform.
The Company has obtained reinsurance coverage to reduce its risk of and exposure to large insurance claims and catastrophes. The Company's maximum retained limit for all lines of business was $0.3 million for 2000 and 1999. The Company's maximum retained limit for 1998 was $0.5 million for workers' compensation and $0.3 million for other property and casualty lines of business. Additionally, the Company has entered into a property catastrophe excess of loss treaty to protect against certain losses. Its retention of lower level losses under this treaty is $7.5 million for 2001, and was $7.5 million for 2000, 1999 and 1998. Due to the geographic concentration of its business, the Company believes hurricanes, windstorms and civil disturbances are its most significant exposures to catastrophic losses. Computer modeling programs provided by independent consultants are used to estimate exposure to such losses.
Assets and insurance reserves at December 31, 2000 and 1999 (including $192.4 million and $252.5 million, respectively, of reinsured amounts principally arising from the intercompany pooling agreement with Empire) are as follows (in thousands):
Unearned premiums(a) 31,722 16,645 20 31,531 211 16,645 Unpaid losses (a) 276,875 102,080 1,003 242,942 34,936 102,080 Unpaid LAE (a) 31,369 11,522 116 27,156 4,329 11,522
Premiums written 117,449 58,059 48 111,135 6,362 58,059 Losses paid 146,208 62,323 655 135,539 11,324 62,323 LAE Paid 15,576 12,755 74 15,157 493 12,755
(b)Includes $3,612, $6,747 and $6,362 ceded to non-affiliates in 2000, 1999 and 1998, respectively, before the effects of the pooling agreement described in Note 1.
The Company has been included in the consolidated federal income tax returns of Leucadia since 1993. Under the terms of the tax sharing agreement between Leucadia and the Company, the Company computes its tax provision on a separate return basis and is either charged its share of federal income tax resulting from its taxable income or is credited for tax benefits resulting from its losses to the extent it could use the losses on a separate return basis.
The principal components of the deferred tax benefit at December 31, 2000 and 1999 were as follows (in thousands):
Due to the Company's recent announcement that it will no longer accept any applications for new insurance policies and its having entered into an agreement to sell its renewal rights, there is uncertainty as to having future taxable income necessary for realization of the deferred tax asset. Accordingly, a valuation allowance was provided as of December 31, 2000 for the total amount of the deferred tax asset.
Effective January 1, 1999, Empire adopted a non-contributory defined contribution plan. The contributions, ranging from 2% - 16% of employees' current pension eligible compensation, are based on age and service life of the employee. These contributions accumulate for participants on a tax-deferred basis. Participants direct the investment of the contributions to their accounts. In accordance with the pooling agreement, the Company shared 30% of the amount contributed by the Group to the Plan ($682,000 and $1,145,000 in 2000 and 1999, respectively).
Prior to January 1, 1999, Empire had a trusteed non-contributory defined benefit pension plan ("prior pension plan") covering substantially all employees. The benefits were based on years of credited service and the employees' highest compensation during any five consecutive plan or calendar years before retirement. Empire's policy was to fund pension costs on a current basis using an aggregate method.
Components of net pension cost: Service cost-benefits earned during the period $1,794 Interest cost on projected benefit obligation 1,906 Actual return on plan assets (1,637) Deferred (loss) on plan assets (124) Net amortization and deferral 145
Empire provides certain health care and life insurance benefits for retired employees. During 1996, Empire amended the eligibility requirement to only those employees who had at least ten years of service and were at least 50 years of age as of October 1, 1996. Prior to this amendment, substantially all of Empire's employees were eligible for such benefits if they reached normal or early retirement age while still working for Empire. As a result of this amendment, the accumulated postretirement benefit obligation was reduced by approximately $7,602,000 which has been amortized over three years. Those benefits are provided through an insurance company whose premiums are based on the cost of benefits paid during the year.
In accordance with the pooling agreement, the Company's share of accrued postretirement benefit cost and net periodic postretirement benefit income is 30% of the amounts reflected above and is included in other liabilities. In determining the accumulated postretirement benefit obligation at December 31, 2000 and 1999, Empire utilized discount rates of 7.5% and 8%, respectively. The assumed health care cost trend rates used in measuring the accumulated postretirement benefit obligation were 10% for 2000 declining to an ultimate rate of 5% by 2010. If the health care cost trend rates were increased by 1%, the accumulated postretirement benefit obligation as of December 31, 2000 would have increased by approximately $442,000 before the effects of the pooling agreement. If the health care cost trend rates were decreased by 1%, the accumulated postretirement benefit obligation as of December 31, 2000 would have decreased by approximately $382,000 before the effects of the pooling agreement. The effect of a 1% increase or decrease on the estimated aggregate of service and interest cost for 2000, 1999 and 1998 would be immaterial.
Empire sponsors an Employees' Savings Plan (the "Savings Plan"), under which each eligible employee may defer a portion of their annual compensation, subject to certain limits. Empire matches contributions equal to 50% of the employee's contributions up to a maximum of 3% of the employee's salary. A participant may also contribute, from after-tax dollars, an amount, not to exceed 10% of annual compensation. Empire's contributions to the Savings Plan were $294,000, $452,000 and $420,000 in 2000, 1999 and 1998, respectively. Under the pooling agreement, the Company is obligated to provide 30% of Empire's contributions to the Savings Plan.
The Group has entered into a twenty year lease agreement which expires in 2018, consisting of 286,510 square feet, in an office building located at 335 Adams Street in Brooklyn, New York, in which Leucadia has an equity interest. The Group received certain incentives from both the City and State of New York in connection with this lease, which will be recognized over the term of the lease.
Empire guaranteed the payment of lease rentals by a wholly-owned subsidiary which relocated its offices in 1998 to the new office building with Empire. In accordance with the guarantee, in 1998, $2.0 million of a $2.3 million liability for lease abandonment costs established by Empire in 1997 was reversed upon release by the landlord from its obligation. The remainder was paid in 1999. Under the pooling agreement, the Company was obligated for 30% of this transaction.
Future minimum rentals, which exclude escalation amounts, on non-cancelable leases in the aggregate for each of the next five years and thereafter are as follows (in thousands):
Rental expense for the Group for the years 2000, 1999 and 1998 was $3.8 million, $3.3 million and $3.3 million, respectively. The Company is obligated to pay 30% of these rental charges in accordance with the pooling agreement.
Seven general agents produced approximately 30%, 33%, and 32% of Allcity's premiums for the years ended December 31, 2000, 1999 and 1998, respectively. All of Allcity's business is conducted in the State of New York.
See Notes 1, 7 and 9 for certain additional information concerning results of operations for 2000.
(b) Allocations of Net Investment Income and Other Operating Expenses are based on a number of assumptions and estimates and results would change if different methods were applied. Other Operating Expenses are reflected net of service fee income excluding other income and interest on surplus note.
* Information required by Schedule III - Supplementary Insurance Information has been incorporated within this schedule.