The following selected historical financial data for each of the five years ended December 31, 2001 is derived from the Company's audited consolidated financial statements. The selected data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 7) and the consolidated financial statements and accompanying notes (Item 8) included elsewhere herein.
reasonable under the circumstances, the results of which form the basis for making judgements about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management has identified the following policies as critical in understanding and evaluating the Company's reported financial results:
Policy acquisition costs attributable to property and casualty operations represent the portion of the cost of writing business that varies with, and is primarily related to, the production of business. Such costs are deferred and charged against income as the premiums are earned. The deferral of policy acquisition costs is subject to the application of recoverability tests to each primary line or source of business based on past and anticipated underwriting results. The deferred policy acquisition costs that are not recoverable from future policy revenues, if any, are expensed. The Company considers anticipated investment income in determining whether premium deficiencies exist.
The liability for property and casualty unpaid losses and LAE includes:
(1)An accumulation of case estimates for losses reported prior to the close of the accounting period.
(2)Estimates of incurred-but-not-reported losses based upon past experience and current circumstances.
(4)The deduction of estimated amounts recoverable from salvage, subrogation, and second injury funds.
The Company routinely evaluates the collectability of its premiums and agents' balances receivable and its premium notes receivable based upon past experience and known economic trends or conditions and establishes reserves for estimated uncollectable accounts. The Company believes its current estimated allowances for doubtful accounts are adequate. However, it is possible that the accuracy of the estimation process could be materially impacted as current economic trends or conditions change or develop.
Over the last 10 to 15 years the Company has generated substantial net operating losses, which have resulted in a sizeable federal tax operating loss carryforwards and capital loss carryforwards of $103,921. In addition, the Company has experienced three "change in ownership" events since June 1998, which limit the Company's ability to fully utilize the benefit of these carryforwards. Due to its history of unprofitable operations and uncertainties surrounding its current operations, the Company has placed a full valuation reserve against its net deferred tax asset at December 31, 2001. Subsequent revisions to the net realizeable value of the net deferred tax asset could cause the Company's provision for income taxes to vary significantly from period to period, although its cash tax payments would remain unaffected until the benefit of the federal net operating loss carryforward expires or is utilized.
The above listing is not intended to be a comprehensive list of all of the Company's accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States with no need for management's judgement in their application. There are also areas in which management's judgement in selecting any available alternative would not produce a materially different result. See Item 8 for the Company's audited consolidated financial statements and notes thereto which contain accounting policies and other disclosures required by accounting principles generally accepted in the United States.
The Company conducts business in two primary categories: fee-for-service operations and traditional insurance operations. Its fee-for-service operations include the activities of INS, its flood operations, and its operations as a servicing carrier for the SC Facility and the SCAAIP. INS provides a variety of claims-related management and adjudication services to the insurance industry, including claims handling, networked glass claims handling and automobile appraisals. The Company's flood unit is a leading provider, and is an original participant, in the NFIP, a flood insurance program administered by the federal government. In this capacity, the Company writes flood insurance for the NFIP in 46 states, and offers excess flood insurance through Lloyd's of London. As such, the Company receives commissions and fees from the NFIP and Lloyd's of London, but retains no underwriting risk. The Company's flood operations also offers flood zone determinations and flood compliance tracking services through its subsidiary, AFS. The Company is a servicing carrier for the SC Facility and the SCAAIP. Under both of these pools, the Company issues policies and adjusts claims for a fee. The SC Facility is currently in runoff; however, the Company was permitted to cede premiums to the SC Facility through March 1, 2002, at which time final runoff of the SC Facility commenced. The Company is required to continue to adjudicate claims it ceded to the SC Facility during the final runoff, for which it will be paid a fee. The SCAAIP became effective in March 1999 and will survive the SC Facility. Although the SCAAIP offers the Company access to additional fee-based revenue with no underwriting risk, thus far into the runoff of the SC Facility, the Company has not experienced significant activity in the SCAAIP.
The Company's traditional insurance operations include its North Carolina nonstandard automobile subsidiary, UIC, and its commercial lines operations. UIC writes nonstandard automobile insurance primarily in the state of North Carolina. UIC cedes substantially all of its liability premiums to the NC Facility and adjusts the related claims for the NC Facility for a fee. Substantially all of UIC's retained risk operations is on physical damage policies, which are minimum limit policies partially reinsured through a quota share reinsurance agreement. The Company also writes commercial lines insurance, which includes business owner's policies, commercial package policies and commercial automobile policies. These "main street" policies are sold primarily to small businesses. The Company reinsures the retained risk operations of UIC and its commercial lines operations through quota share, facultative, excess of loss, catastrophe and umbrella reinsurance agreements.
The Company's net income (loss) by business segment for 2001 and 2000 is as follows:
*2000 includes a net special items charge of $8,138 related to the discontinuation of the Company's Nashville operations and the settlement of related preacquisition liabilities.
The following table sets forth the sources of the Company's direct and net written premiums for the years ended December 31, 2001 and 2000:
During 2000, the Company discontinued its Nashville operations and placed all of this business into runoff. Due to high loss ratios and an extremely high expense structure, this operation had suffered substantial operating losses in 1998 and 1999, with indications that the losses would continue throughout 2000 without expectation that it could become profitable in the foreseeable future. In the second quarter of 2000, the Company took a special items charge to earnings of $16,421, $15,678 of which were non-cash items, including impairment of goodwill associated with the Graward acquisition of $14,915. Other special items charges associated with exiting the operation included the write-down of certain fixed and operating assets, accrual of closure costs and accrual of severance and other personnel-related costs. On August 1, 2000, the Company moved all remaining business of the operation to its South Carolina headquarters to complete the runoff of this book of business. In the fourth quarter of 2000, the Company recorded special items gains totaling $8,283 resulting from the settlement of purchase price disputes and the settlement of assumed liabilities, both of which were associated with the acquisition of Graward. Direct written premiums associated with the Nashville operations during 2001 were insignificant; however, earned premiums associated with Graward as a result of running off the unearned premiums existing at December 31, 2000 amounted to approximately $1,026. Further, the operation experienced insignificant incurred losses during 2001 primarily as a result of effective reserving practices at December 31, 2000 and the minimal claims activity experienced during 2001. Finally, as the Nashville operations were in runoff for the full year of 2001, the operating costs and expenses experienced substantial reductions over 2000. As a result of these factors, the Nashville operations posted net income of $1,616 in 2001.
insurance product is ceded entirely to the NFIP, a federal government program that establishes premium rates and coverage limits, bears all risk of loss and pays claims. Working through its independent agents located across the United States, the Company issues policies and processes claims on behalf of the NFIP. In this capacity, the Company receives commissions for the policies it processes and the related claims it services of 31% of direct premiums written and 3.3% of direct incurred losses, respectively. NFIP policies only cover losses up to $250 for residential buildings and $100 for contents. Further, the NFIP commercial coverage is limited to $500 for both buildings and contents. The Company's excess flood insurance product provides a level of protection above the NFIP's limits for residential and commercial properties. The Company, as broker, receives commissions for placing this business. The Company also believes that offering the excess flood product allows it to improve its relationships with its agency force by offering them a broader product portfolio. During 2001, the Company's NFIP written premium once again increased at a rate that surpassed that of the total NFIP, due primarily to obtaining several large books of flood business from independent insurance agents across the United States. This was facilitated by expanding the Company's product offering to independent agents and the introduction of new technology to its agency force, including internet-based policy rating and flood zone determination services. The Company's NFIP written premium amounted to approximately $44,724 in 2001, an increase of $6,413 (16.7%) over 2000. As a result of its premium growth and the retention of its NFIP book of business, the Company received a marketing bonus from the NFIP of $553 in March 2001. Such bonuses are unpredictable and are not guaranteed.
Claims processing for the NFIP has been a substantial source of revenues and earnings for the Company over the past several years and is a weather-dependent component of its flood operations. Whereas most property and casualty insurance companies suffer losses during hurricanes and floods, the Company benefits strongly as a fee-based processor of claims for the NFIP. Due to the relatively quiet 2000 and 2001 hurricane seasons, the revenue generated from flood claims handling is down significantly from prior years. AFS provides the Company a presence for flood claims processing on both coasts, an important element of diversification and scale for weather-dependent operations.
The Company reentered the risk-bearing commercial lines market in February 1998 when it converted a substantial amount of premiums written in an MGA capacity for another insurance carrier to retained risk premiums. Since that time, the Company has capitalized on the long-standing relationships of its commercial lines agents and benefited from the experience of its qualified underwriters. The Company's commercial lines have historically been reinsured primarily through quota share reinsurance agreements. From April 1, 1999 through March 31, 2000 the Company's commercial lines were subject to a 90% quota share reinsurance agreement. Effective April 1, 2000, the 90% quota share reinsurance agreement was amended to become a 70% quota share reinsurance agreement, and the amended agreement was terminated at the Company's request effective April 1, 2001. The Company's commercial lines are presently reinsured through facultative, excess of loss, catastrophe and umbrella coverages. Retaining a larger portion of its book of business had a positive impact on the operation's earnings in 2001 and was the primary reason for its turnaround over 2000. Further
enhancing the results of the Company's commercial operations in 2001 was the introduction of a new technology initiative. This initiative centered on a web-based rating and underwriting system that allows the Company's agents to provide real time quotes on commercial business owners' policies, store those quotes and then submit the policy over the internet. During 2002, the Company looks to expand the use of this technology to other lines of its commercial operations.
The Company's premium concentration in the catastrophe-heavy Southeast led to the 1996 creation of INS to manage the Company's internal claims. INS currently offers a wide array of services: automobile appraisals, automobile liability claims handling, catastrophe claims handling, claims administration, direct reporting, general liability claims handling, glass claims handling, property claims handling, subrogation and recovery and total loss claims handling. These services expand the Company's business opportunities by allowing it to offer services to other insurance companies. The Company's experience in processing flood claims led to the award of two statewide Wind and Hail Association contracts, a strong indication of its growing presence in the catastrophe claims handling market. INS is an important part of the Company's corporate structure. It has over 50 unaffiliated customers and can accommodate claims services requests from anywhere in the United States. INS claims representatives are differentiated from their counterparts at traditional claims adjusting companies by having an insurance company background, an important characteristic when equitably settling claims.
Though still profitable in 2001, the adjusting services segment experienced a significant decline in profitablity over 2000. The two most significant components of the segment's revenues are its Claims Administration Services Agreement with QualSure and the loss adjusting services provided in connection with the SC Facility. Commission and service income earned by INS under its Claims Administration Services Agreement with QualSure amounted to $3,915 and $3,458 in 2001 and 2000, respectively. QualSure experienced a full twelve months of operations during 2001 as compared to approximately eleven months of operations in 2000. Commission and service income generated by the adjusting services segment through the SC Facility was approximately $1,065 and $2,277 in 2001 and 2000, respectively. The SC Facility began its planned runoff effective March 1, 1999, at which time no new business was accepted into the SC Facility. Effective October 1, 1999, voluntary renewals were no longer accepted by the SC Facility. However, servicing carriers were able to cede renewals to the SC Facility until March 1, 2002, at which time final runoff of the SC Facility commenced. Commission and service income from these two components of the adjusting services segment represent approximately 54% and 62% of the segment's total commission and service income in 2001 and 2000, respectively. The decline in profitability experienced by the adjusting services segment in 2001 is a direct result of the net decrease in revenues generated through QualSure and the SC Facility.
March 1, 2002. Commission and service income generated through the SC Facility and the SCAAIP amounted to $3,146 for the year ended December 31, 2001 and $4,019 for the year ended December 31, 2000, a decrease of $873. The operations of the Company's North Carolina domiciled subsidiary, UIC, accounted for another $220 decrease in commission and service income, resulting entirely from business ceded to the NC Facility. Though the Company experienced an increase in premium writings within the NC Facility during the year ended December 31, 2001 versus the same period of 2000, claims commissions earned from the NC Facility actually decreased. This is attributable to a reduction in losses ceded to the NC Facility resulting from much lower weather-related claims activities during 2001 as compared to 2000. The remaining $12 decrease in commission and service income came from the Company's Nashville and South Carolina nonstandard automobile operations, which began runoff in the second and third quarters of 2000, respectively.
Commission and service income for the adjusting services segment was $8,435 for the year ended December 31, 2001, versus $9,249 for the same period of 2000, a decrease of $814. The overall decrease is substantially attributable to the net effect of two factors. First and foremost, commission and service income generated from the SC Facility amounted to $1,065 and $2,284 for the years ended December 31, 2001 and 2000, respectively, a decrease of $1,219. The SC Facility has been in runoff since March 1, 1999 and entered the final stage of runoff effective March 1, 2002. Second, in connection with the Company's $4,900 investment in QualSure Holding, INS entered into a Claims Administration Services Agreement with QualSure to adjudicate all of its claims for a fee based upon subject earned premium. Commission and service income earned under this agreement amounted to $3,915 and $3,458 for the years ended December 31, 2001 and 2000, respectively, an increase of $457. The remaining decrease of $52 came from the other activities of the adjusting services segment.
The remaining $113 decrease in premiums earned came from all other operations.
Net realized losses amounted to $211 for the year ended December 31, 2001 due to $301 of losses realized on the sale of certain automobiles no longer required for operations and the disposal of certain obsolete data processing equipment and software partially offset by $90 in gains realized on the liquidation of a portion of the Company's bond portfolio to fund its operations. Sales of fully depreciated property and equipment during the year ended December 31, 2000 resulted in realized gains of $11, while realized losses on the sale of investments amounted to $236 and resulted from the liquidation of a portion of the Company's investment portfolio to fund its operations and investment in QualSure Holding.
Also contributing to the overall decrease in policy fees and other income was the Company's net $615 decrease in equity in earnings of its unconsolidated subsidiaries, Sunshine State Holding Corporation and QualSure Holding from income of $129 for the year ended December 31, 2000 to a loss of $486 for the same period in 2001. The Company invested $854 and $4,900 in Sunshine State Holding Corporation and QualSure Holding, respectively, for ownership interests of 21.49% and 30.625%, respectively. As each of these investments exceeds 20% of the equity of each respective company, the Company's equity in the undistributed earnings of the unconsolidated affiliates, using a computed equity method, are included in current earnings.
In December 2000, the Company sold its corporate headquarters to its majority shareholder and Chairman of the Board of Directors for a gain of $1,892. Concurrent with this transaction, the
Losses and LAE decreased $16,705, or 68.3%, to $7,740 for the year ended December 31, 2001 from $24,445 for the year ended December 31, 2000. The automobile segment accounted for $18,255 of the overall decrease, posting incurred losses and LAE of $2,928 for the year ended December 31, 2001 versus $21,183 for the same period of 2000. The largest component of this decrease is the $15,737 combined decrease resulting from the aforementioned discontinuation of the Company's Nashville operations and its withdrawal from the voluntary nonstandard automobile market in South Carolina. Further, as previously mentioned, UIC's year ended December 31, 2000 included certain risk-bearing business that was not subject to its 75% quota share reinsurance agreement while all risk-bearing business during the year ended December 31, 2001 was subject to its 75% quota share reinsurance agreement. This situation largely accounted for the $1,739 decrease in losses and LAE incurred by UIC for the year ended December 31, 2001 versus the same period of 2000. Finally, the Company experienced a $779 reduction in losses and LAE related to business the Company is required to assume from the SC Facility, which has been in runoff since March 1, 1999 and entered the final stage of runoff effective March 1, 2002.
Partially offsetting the overall decrease in losses and LAE was the $1,472 increase posted by the commercial segment. As previously discussed, the Company's commercial lines have been reinsured primarily through quota share reinsurance agreements since December 31, 1999. For the year ended December 31, 2000, the Company's commercial lines were subject to a 90% quota share reinsurance agreement. Effective April 1, 2000, the 90% quota share reinsurance agreement was amended to become a 70% quota share reinsurance agreement, and the amended agreement was terminated at the Company's request effective April 1, 2001. By retaining a larger portion of its commercial book of business, the Company's commercial operations experienced an increase in losses and LAE for the year ended December 31, 2001 over the same period of 2000. However, somewhat offsetting this increase was the impact of a decrease in commercial writings for the year ended December 31, 2001 over the same period of 2000. In accordance with a mandate from the NCDOI, the Company ceased writing new risk-bearing commercial business in the state of North Carolina at the beginning of the third quarter of 2000. The Company may, however, continue renewing existing risk-bearing commercial business at its discretion.
The remaining net increase of $78 came from all other operations.
Interest expense was $728 and $1,436 for the years ended December 31, 2001 and 2000, respectively, a decrease of $708. The Company's Credit Facility bears interest at a pre-determined spread over LIBOR or the prime interest rate of the lending institution, at the Company's discretion. The decrease in interest expense for the year ended December 31, 2001 as compared to the same period of 2000 is due to lower average interest rates in 2001 versus 2000, coupled with interest saved through the pay down of debt. The average interest rate of the Company's debt was 6.89% between December 31, 2000 and December 31, 2001 versus 9.24% between December 31, 1999 and December 31, 2000. Further, at December 31, 2001, the outstanding balance of the Credit Facility was $7,721, a $2,438 decrease over the balance existing at December 31, 2000.
Offsetting these decreases in commission and service income was the $5,010 increase posted by the adjusting services reporting segment. Over the last fifteen months, the adjusting services reporting segment has focussed on attracting and retaining external customers and, as a result, now boasts more than 50 unaffiliated customers. In addition, concurrent with the Company's January 21, 2000 investment in QualSure Holding Corporation, the Company's adjusting services reporting segment entered into a Claims Administration Services Agreement with QualSure to adjudicate all of its claims for a fee-based upon subject earned premium. Revenues, net of deferrals, under this arrangement amounted to $3,458 for the year ended December 31, 2000.
The remaining $238 decrease in commission and service income came from the Company's flood and runoff operations.
Net investment and other interest income for the year ended December 31, 2000 increased $407, or 9.6%, to $4,627 from $4,220 for the year ended December 31, 1999. During the fourth quarter of 2000, the Company received approximately $800 from the SC Facility related to the time value of money consideration on recoupment premiums the Company writes for the SC Facility. This activity is calculated by the SC Facility and communicated to its servicing carriers on an irregular basis. The Company records all normal interest income on a monthly basis from the SC Facility. Partially offsetting this increase in net investment and other interest income was lower investment income earned on the Company's cash and investments. Total cash and investments decreased $10,907 from December 31, 1999 to December 31, 2000, primarily to fund the acquisition of QualSure, to settle liabilities created through the 75% quota share reinsurance agreement for the Company's automobile
operations, and to fund the Company's operations. However, substantially all of the overall decrease in total cash and investments came from the lower yielding cash and short-term investments rather than from the higher yielding bond portfolio. Therefore, the impact on net investment and other interest income from the sharp decrease in total cash and investments was somewhat mitigated.
Policy acquisition costs decreased $8,718 for the year ended December 31, 2000 compared to 1999, or 25.9%. Fluctuations in policy acquisition costs are directly correlated to fluctuations in direct written premium. Direct written premium for the year ended December 31, 2000 amounted to $125,018, a $43,588, or 25.9%, decrease from the $168,606 written during the same period in 1999. See Premiums Earned for discussion concerning the decrease in premium volume for the year ended December 31, 2000 versus the same period of 1999.
The Company's results of operations for the year ended December 31, 2000 include $8,138 in special items charges associated with the discontinuation of its Nashville operations and the resolution
On November 29, 2000, the Company reached a settlement with the sellers of Graward related to certain purchase price adjustments. In the settlement, the sellers of Graward agreed to cancel four Subordinated Purchase Notes dated May 1, 1998 in the aggregate face amount of $2,700. The Company in turn agreed to dismiss a pending motion and an arbitration demand. Additionally, the Company agreed to issue to the sellers of Graward warrants to purchase 25,000 shares of its common stock at a price of $3.00 per share and an additional 25,000 shares of its common stock at a price of $7.00 per share. The settlement of these purchase price disputes resulted in a special items gain of $2,700.
Effective February 19, 2001, the Company reached a settlement with respect to liabilities assumed upon the acquisition of Graward recorded in the amount of $6,527 which were discharged in exchange for $1,000 in cash and the issuance of warrants to purchase 75,000 shares of the Company's common stock at $1.00 per share and an additional 75,000 shares of the Company's common stock at $2.00 per share (see Note 15). The resolution and ultimate quantification of these preacquisition liabilities resulted in a special items gain of $5,527.
The difference between the year-end net liability for losses and LAE reported in the accompanying consolidated financial statements in accordance with GAAP and that reported in accordance with Statutory Accounting Principles ("SAP") was as follows for the years ended December 31:
The following table reflects the loss and LAE balances and development for 2001 and 2000 on a GAAP basis:
A part of the Company's reserve for losses and LAE is set aside for environmental, pollution, and toxic tort claims. These claims relate to business written by the Company's previously owned West Coast operation prior to 1986. On June 7, 1994, the Company settled a dispute related to approximately 400 of these claims. Any future liability on these claims is limited to 50% of the direct loss and LAE paid. The Company's obligation does not begin until the other company involved in the settled dispute pays, subsequent to the settlement date, a total of $20 million in losses and LAE. As of December 31, 2001 and 2000, $15.0 million and $14.3 million, respectively, of claims payments have been made by the other company since the settlement date.
The Company's principal sources of liquidity include the collection of commission and service fees, including substantial amounts received from the NFIP, NC Facility, SC Facility and QualSure; premium collections on insurance policies issued; the collection of policy fees and interest income on insurance policies financed; collections of balances due from its reinsurers; and the collection of net investment income and proceeds received from the sale or maturity of investments. The SC Facility began its planned runoff effective March 1, 1999, at which time no new business was accepted into the SC Facility. Effective October 1, 1999, voluntary renewals were no longer accepted by the SC Facility. However, servicing carriers were able to cede renewals to the SC Facility until March 1, 2002, at which time final runoff of the SC Facility commenced. Though the Company may no longer cede premiums to the SC Facility after March 1, 2002, it is required to adjudicate claims ceded to the SC Facility during the final runoff. The Company's cash outflows can vary greatly because of the uncertainties regarding settlement dates for liabilities for unpaid losses and LAE and because of the potential for large losses. Accordingly, the Company maintains investment and reinsurance programs generally intended to avoid the forced sale of investments to meet claims obligations.
The Company is a legal entity separate and distinct from its subsidiaries. As a holding company, the primary sources of cash needed to meet its obligations, including the redemption of its special stock and principal and interest payments on its outstanding debt, are dividends and other permitted payments, including management fees, from its subsidiaries and affiliates.
Net cash used in operations was $90 for 2001, compared to net cash used of $13,797 in 2000. Net income for the year ended December 31, 2001 amounted to $4,366 (see "Results of Operations"). Other significant sources of cash include the net collection of reinsurance recoverable on paid and unpaid losses and LAE of $12,965 and the $4,449 reduction in reinsurance premiums prepaid to the Company's reinsurers. As previously discussed, in the second and third quarters of 2000, respectively, the Company announced the discontinuation of its Nashville operations and its withdrawal from the voluntary nonstandard automobile market in South Carolina. As this business continued its runoff during the year ended December 31, 2001, collections on reinsurance recoverable on paid and unpaid losses and LAE outstanding at December 31, 2000 surpassed new recoverables being generated through this business. Similarly, with substantially less business being subjected to reinsurance, the Company experienced a reduction in the level of reinsurance premiums it had to prepay to the reinsurers. Further, effective April 1, 2001, the 70% quota share reinsurance agreement for the Company's commercial lines operations was cancelled at the Company's request. With no quota share reinsurance agreement in place for the entire second quarter of 2001, the Company experienced a net collection of
reinsurance recoverable on paid and unpaid losses and LAE and a reduction of reinsurance premiums prepaid under the agreement.
Another significant source of cash was the $1,592 net decrease in premium notes receivable. As a result of PBP's operating losses and reassessments of its core competencies, the Company entered into a management contract with an unaffiliated company effective June 1, 2001 to manage the operations of PBP. In December 2001, UIC introduced an installment billing program to its insureds and PBP was placed into runoff.
Another significant use of cash was the $1,220 net decrease in balances due other insurance companies. Effective February 19, 2001, the Company resolved certain arbitration claims with Generali-U.S. Branch relating to the Company's acquisition of its Nashville operations. As a result of the settlement, preacquisition liabilities assumed by the Company in the acquisition were discharged in exchange for $1,000 in cash and the issuance of warrants to purchase 75,000 shares of the Company's common stock at $1.00 per share and an additional 75,000 shares of the Company's common stock at $2.00 per share. The resolution and ultimate quantification of these preacquisition liabilities resulted in a special items gain of $5,527, which was recorded in the fourth quarter of 2000.
In its investment strategy, the Company attempts to match the average duration of its investment portfolio with the approximate duration of its liabilities. Total cash and investments at December 31, 2001 and 2000 were $45,874 and $48,707, respectively. All debt securities are considered available for sale and are carried at market value as of December 31, 2001 and 2000. The weighted-average maturity of the fixed income investments as of December 31, 2001 was approximately 2.17 years. Average net investment yields on the Company's cash and investments were 5.2% in 2001 and 5.6% in 2000.
Except in limited circumstances, South Carolina and North Carolina insurance laws and regulations require a domestic insurer to report any action authorizing distributions to shareholders and material payments from subsidiaries and affiliates at least 30 days prior to distribution or payment. Additionally, those laws and regulations provide the SCDOI and the NCDOI the right to disapprove and prohibit distributions meeting the definition of an "Extraordinary Dividend" under applicable statutes and regulations.
Effective January 21, 2000, three of the Company's insurance subsidiaries made a combined investment totaling $4,900 in the common stock of QualSure Holding, representing a combined ownership interest of 30.625%. QualSure Holding owns 100% of the issued and outstanding stock of QualSure, a homeowners take out insurance company domiciled in the state of Florida, and QualSure Underwriting Agencies, Inc., an MGA for QualSure. QualSure was formed to take out approximately 44,000 homeowners policies from the Florida Windstorm Underwriting Association and approximately 40,000 homeowners policies from the Florida Residential Property & Casualty Joint Underwriting Association. In connection with this investment, INS entered into a Claims Administration Services Agreement with QualSure to adjudicate all of its claims for a fee based upon subject earned premium. During the fiscal years ended December 31, 2001 and 2000, INS recorded commission and service income of $3,915 and $3,458, respectively, in connection with its Claims Administration Services Agreement with QualSure.
The Company's majority shareholder and Chairman of the Board of Directors is an owner and operator of SADISCO Corporation ("SADISCO"), a provider of salvage and disposal services for the Company. During the fiscal years ended December 31, 2001, 2000 and 1999, the Company paid a total of $242, $225 and $350, respectively, to SADISCO.
In December 2000, the Company sold its corporate headquarters to its majority shareholder and Chairman of the Board of Directors for a gain of $1,892. Concurrent with this transaction, the Company leased the property back for a fixed period of three years without an option for renewal. The gain resulting from this transaction was deferred and is being amortized into income evenly over the term of the related leaseback. Included in policy fees and other income for the year ended December 31, 2001 is $631 of amortized gain. Lease expense incurred under this related party lease amounted to $458 and $13 in 2001 and 2000, respectively.
•the availability of new or additional sources of financing on acceptable terms to replace existing facilities and satisfy maturing obligations related to the Company's Special Stock;
•the ability to secure and maintain long-term relationships with customers and agents;
•the effects of economic conditions and conditions which affect the market for property and casualty insurance, including, but not limited to, interest rate fluctuations and flood zone determination services;
•the effects and impact of laws, rules and regulations which apply to insurance companies;
•the effects if estimated reserves for losses and LAE established by the Company are deficient;
•geographic concentrations of loss exposure, causing revenues and profitability to be subject to prevailing regulatory, demographic and other conditions in the area in which the Company operates;
•the availability of reinsurance and the ability of the Company's reinsurance arrangements to balance the geographical concentrations of the Company's risks;
•the continuing impact of the decisions to exit the Nashville and South Carolina nonstandard automobile operations;
•the uncertainty associated with estimating loss reserves, and the adequacy of such reserves, capital resources and other financial items;
•control of the Company by a principal shareholder, which shareholder has the ability to exert significant influence over the policies and affairs of the Company;
We have audited the accompanying consolidated balance sheets of The Seibels Bruce Group, Inc. (the Parent Company-a South Carolina corporation) and subsidiaries (collectively the "Company") as of December 31, 2001 and 2000, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
(Dollars and weighted average shares outstanding shown in thousands, except per share amounts)
The accompanying consolidated financial statements include the accounts of The Seibels Bruce Group, Inc. (the "Company") and its wholly-owned subsidiaries and have been prepared in conformity with accounting principles generally accepted in the United States ("GAAP") pursuant to the rules and regulations of the Securities and Exchange Commission. All significant intercompany balances and transactions have been eliminated in consolidation.
Through its subsidiaries, SCIC and Catawba, the Company continues to be a leading provider, and is an original participant, in the NFIP, a flood insurance program administered by the federal government. In this capacity, the Company receives commissions and fees from the NFIP, but retains no underwriting risk.
The Company receives fee-based income from its catastrophe, property and casualty and automobile claims adjusting services and liability runoff management services. The Company's premium concentration in the catastrophe-heavy Southeast led to the creation of a catastrophe adjusting business, Insurance Network Services, Inc. ("INS"), to manage the Company's internal claims volume. INS has since extended its services to third party affiliated and unaffiliated customers and currently offers three services: catastrophe claims handling for hurricanes, tornadoes, hailstorms, earthquakes and floods; catastrophe claims supervision; and ordinary claims adjusting.
One of the Company's subsidiaries, America's Flood Services, Inc. ("AFS"), located in Rancho Cordova, California, offers fee-based flood zone determinations and compliance tracking services to a variety of customers and institutions located throughout the United States.
After enduring its results of operations for the years ended December 31, 1999 and 2000, the Company began 2001 with a variety of challenges. First, the Company would have to continue the runoff of its Nashville and South Carolina automobile operations. Further, the SC Facility would continue its runoff and have an adverse affect on the Company's commission and service income opportunities. Finally, the Company's Credit Facility stipulates that the Company demonstrate compliance with a number of amended affirmative and negative covenants on a quarterly basis. Significant financial covenants include minimum statutory capital and surplus levels, ratios of debt to total capitalization and cash flow coverage.
During 2001, the results of the Company's runoff Nashville and South Carolina automobile operations developed more favorably than expected and, therefore, did not exhibit a significant strain on its earnings. Further, commission and service income actually increased during the year ended December 31, 2001, despite the continued runoff of the SC Facility, as the Company continued its emphasis on fee-based revenue growth through the NC Facility and the NFIP. Additionally, INS' Claims Administration Services Agreement with QualSure Insurance Corporation (see Note 8) continued to provide substantial fee-based income for the Company. Finally, the Company was in compliance with all amended Credit Facility covenants for each quarter of 2001. On March 28, 2002, the Company issued 800,000 shares of $10 par value Adjustable Rate Cumulative Nonvoting Preferred Special Stock to its majority shareholder and Chairman of the Board of Directors for an aggregate purchase price of $8,000. The proceeds from the transaction were used to repay the outstanding balance of the Credit Facility (see Notes 5 and 17).
The fair values of the Company's cash and short-term investments approximate carrying values due to the short-term nature of those instruments.
The Company routinely evaluates the collectability of receivables and has established an allowance for uncollectable accounts for premiums and agents' balances receivable and premium notes receivable in the amount of approximately $3,763 and $5,180 at December 31, 2001 and 2000, respectively.
Intangible assets consist primarily of goodwill and deferred loan costs. Goodwill is the excess of the amount paid to acquire a company over the fair value of its net assets, reduced by amortization and any subsequent valuation adjustments. Through December 31, 2001, the Company amortized its goodwill using the straight-line method over a period of 40 years. Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" (see Recent Accounting Pronouncements) . Deferred loan costs are the costs associated with issuing the Company's Credit Facility and are amortized over the life of the debt. Intangible assets are continually evaluated to determine if any portion of the remaining balance may not be recoverable. If circumstances suggest that their value may be impaired and the write-down would be material, an assessment of recoverability is performed and any impairment is recorded through a valuation allowance with a corresponding charge recorded in the statements of operations. During 2000, the Company concluded that the goodwill associated with the acquisition of Graward General Companies, Inc. ("Graward") was fully impaired (see Special Items).
The liability for property and casualty unpaid losses and loss adjustment expenses ("LAE") includes:
Commission and service income is predominately derived from servicing carrier, managing general agent and claims processing activities. The commission income related to producing and underwriting the business is recognized in the period in which the business is written. Service income and fees related to claims processing are recognized on an accrual basis as earned.
Property and casualty premiums are reflected in income when earned as computed on a monthly pro-rata basis. Written premiums and earned premiums have been reduced by reinsurance placed with other companies, including amounts related to business produced through the NC Facility, the SC Facility and the NFIP.
are not recoverable from future policy revenues, if any, are expensed. The Company considers anticipated investment income in determining whether premium deficiencies exist.
Of the $16,421 total restructuring charge, approximately $15,678 related to the impairment of long-lived assets, including $14,915 of goodwill, $580 of fixed assets directly associated with the Nashville operation and $183 of deferred financing costs. The Company evaluated the recoverability of long-lived assets by determining the recoverability of long-lived assets not held for sale. Management measured the carrying amount of the assets against the estimated undiscounted future cash flows associated with them. The recoverability of long-lived assets held for sale was then compared to the asset's carrying amount less estimated selling costs.
Effective February 19, 2001, the Company reached a settlement with respect to liabilities assumed upon the acquisition of Graward recorded in the amount of $6,527 which were discharged in exchange for $1,000 in cash and the issuance of warrants to purchase 75,000 shares of the Company's common stock at $1.00 per share and an additional 75,000 shares of the Company's common stock at $2.00 per share (see Note 15). The resolution and ultimate quantification of these preacquisition liabilities resulted in a special items gain of $5,527 recorded in the fourth quarter of 2000.
Following is a summary of the special items charge included in the consolidated statements of operations for the year ended December 31, 2000:
Following is a summary of the restructuring plan charge included in the consolidated balance sheet at December 31, 2000 and 2001:
Comprehensive income is a measure of all non-owner changes in equity of an entity and includes net income (loss) plus changes in certain assets and liabilities that are reported directly through equity.
In accordance with SFAS No. 128, "Earnings Per Share", the Company measures earnings per share at two levels: basic earnings per share and diluted earnings per share. Basic per share data is calculated by dividing income (loss) allocable to common stockholders by the weighted average number of shares outstanding during the year. Diluted per share data is calculated by dividing income (loss) allocable to common stockholders by the weighted average number of shares outstanding during the
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. This statement could increase volatility in earnings and other comprehensive income. The effective date of this statement was amended by SFAS Nos. 137 and 138 and, as amended, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company adopted SFAS No. 133 effective January 1, 2001 and the statement had no material impact on its financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires the recognition, as a component of asset cost, the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. Under this statement, the liability is discounted and accretion expense is recognized using the credit-adjusted risk-free interest rate in effect when the liability was initially recognized. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company is in the process of evaluating the impact that the adoption of SFAS No. 143 will have on its consolidated financial position and results of operations.
Net accretion of bond discount and amortization of bond premium charged to income for the years ended December 31, 2001, 2000 and 1999 was not significant.
Net investment income as of December 31 consists of the following:
In December 2000, the Company sold its corporate headquarters with a net book value of $2,589 to its majority shareholder and Chairman of the Board of Directors for $4,500, resulting in a gain of $1,892. Expenses incurred in connection with the sale were $19. Concurrent with this transaction, the Company leased the property back for a fixed period of three years without an option for renewal (see Notes 15 and 16). The gain resulting from this transaction has been deferred and is being amortized into income evenly over the term of the leaseback.
The Company files a consolidated federal income tax return that includes all subsidiaries. A formal tax-sharing agreement has been established by the Company with its subsidiaries.
A part of the Company's reserve for losses and LAE is set aside for environmental, pollution, and toxic tort claims. These claims relate to business written by the Company's previously owned West Coast operation prior to 1986. On June 7, 1994, the Company settled a dispute related to approximately 400 of these claims. Any future liability on these claims is limited to 50% of the direct loss and LAE paid. The Company's obligation does not begin until the other company involved in the settled dispute pays, subsequent to the settlement date, a total of $20,000 in losses and LAE. As of December 31, 2001 and 2000, approximately $15,000 and $14,300, respectively, of claims payments have been made by the other company since the settlement date.
The claims involve four Superfund sites, eight asbestos or toxic claims, four underground storage tanks and twenty-two miscellaneous clean-up sites. For this direct business there are usually several different insurers participating in the defense and settlement of claims made against the insured. Costs and settlements are pro-rated by either time on the risk or policy limits.
A reconciliation between GAAP shareholders' equity and surplus as regards policyholders, at December 31, is as follows:
Since before the Company's acquisition of UIC in 1997, UIC has operated, and continues to operate, under the Regulatory Action Division ("RAD") of the North Carolina Department of Insurance ("NCDOI"). Under the requirements of the RAD, UIC is required to submit monthly financial statements to the NCDOI.
Effective January 1, 2001, both the North and South Carolina Departments of Insurance adopted the Codification of Statutory Accounting Principles ("Codification") as the prescribed basis of accounting for insurance companies domiciled in their respective states. Accordingly, all of the
Company's statutory subsidiaries adopted Codification effective January 1, 2001. Significant changes to the Company's statutory accounting and reporting resulting from Codification include the following:
•Amounts received on deposit-type contracts are recorded as policy reserves and not as income; and
•Codification requires the recording of premium revenue beginning with the effective date of coverage, except for workers compensation, and the recognition of a premium deficiency reserve, if necessary.
Adoption of Codification did not have a material effect on the financial statements of any of the Company's statutory subsidiaries.
The Company currently has three plans under which stock options and incentive stock may be granted to employees, non-employee directors, consultants and active independent agents of the Company. The options expire ten years from the date of grant. Each plan is administered by a committee appointed by the Board of Directors.
reserved for future grants. Following is a summary of options outstanding and exercisable by price range as of December 31, 2001:
The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for its three stock option plans. Had compensation costs for the Company's stock option plans been determined based on the fair value at the grant date for awards in 2001, 2000 and 1999 consistent with the provisions of
SFAS No. 123, the Company's net income (loss) and income (loss) per share would have been as follows:
The Company sponsors the South Carolina Insurance Company Employees' Profit-Sharing and Savings Plan (the "Plan"), which provides both a profit-sharing and a 401(k) element for the employees of the Company, its subsidiaries and affiliates. As of December 31, 2001, the amount of assets available in the Plan, based on information currently available, was $10,568. The profit-sharing element of the Plan covers all full-time employees who have met minimum eligibility requirements. There were no contributions to this part of the Plan in 2001, 2000 or 1999. Under the 401(k) element of the Plan, employees may elect to have a portion of their salary withheld from pre-tax wages for investment in the Plan, subject to limitations imposed by IRS regulations. The Company matches 50% of the first 6% of
The Company currently provides certain health care and life insurance benefits for certain retired employees. The projected future cost of providing post-retirement benefits is reflected as an expense as employees render services instead of when the benefits are paid. The net transition obligation is being recorded as a charge against income on a prospective basis as part of the future annual benefit cost. Post-retirement benefit expense was approximately $70 in 2001, $110 in 2000, and $115 in 1999.
Reportable segments are determined based on management's internal reporting approach, which is based on product line and complementary coverages. The reportable segments are comprised of Automobile, Flood, Commercial, Adjusting Services and All Other. The Automobile segment includes UIC's retained risk nonstandard automobile and premium finance operations, the runoff of the Nashville and South Carolina automobile operations, and the fee-based NC Facility, SC Facility and SCAAIP operations. The Flood segment contains all flood operations including the National Flood Insurance Program, flood zone determinations, excess flood and flood compliance tracking, as well as the runoff of the complementary homeowners product line. The Commercial segment includes all commercial operations, as well as the commercial automobile activity for the NC Facility and SC Facility. The Adjusting Services segment contains the catastrophe insurance claims handling for hurricanes, tornadoes, hailstorms, earthquakes and floods; catastrophe claims supervision; and ordinary claims adjusting for both the Company and external insurance companies. The All Other segment contains other runoff operations of the Company, including worker's compensation, environmental and general liability. While the majority of revenues and expenses are captured directly by each reportable segment, the Company does have shared other income and other expenses. Shared other income comprised approximately 35%, 35% and 36% of total other income in fiscal 2001, 2000 and 1999, respectively, and shared other expenses comprised approximately 2%, 2% and 8% of total other expenses in fiscal 2001, 2000 and 1999, respectively. These shared amounts were allocated on a basis proportionate with each reportable segment's total net loss and LAE and unearned premium reserves. The results of the reportable segments are included in the following tables:
The Company and its subsidiaries lease various other office space, computer equipment and automobiles under several operating leases that expire at various times. Lease expense amounted to $1,027, $1,320, and $1,451 in 2001, 2000, and 1999 respectively. Approximate minimum future lease payments under these operating leases at December 31, 2001 are as follows:
In or about June 2001, SCIC, Catawba, and CAIC entered into negotiations to sell their investments in QualSure Holding to an unrelated third party. On November 2, 2001, the plaintiffs initiated the litigation against SCIC, Catawba, and CAIC by filing a Complaint, a motion for a preliminary injunction, and a motion for expedited discovery. Plaintiffs filed their First Amended Complaint on December 13, 2001; the allegations in the First Amended Complaint are substantially similar to the allegations in the original Complaint. The First Amended Complaint alleges that SCIC, Catawba and CAIC improperly divulged confidential information belonging to QualSure Holding in their negotiations with the third party. Plaintiffs generally allege that defendants' dissemination of certain information regarding QualSure Holding's policyholders and QualSure Holding's calculations of "Probable Maximum Loss" injured QualSure Holding in its efforts to obtain reinsurance for 2002. The First Amended Complaint alleges claims for breach of contract (based on a confidentiality provision in the Stockholders' Agreement), breach of fiduciary duties (for defendants' alleged dissemination of the confidential information), and misappropriation of confidential and proprietary information and trade secrets (under Florida's Uniform Trade Secrets Act). Plaintiffs seek compensatory damages in excess of $75, punitive damages, and preliminary and permanent injunctive relief.
Defendants filed a motion to disqualify plaintiffs' lead law firm, which was representing the Company in certain matters at the time the plaintiffs initiated the litigation. The Court granted the motion on December 13, 2001. In addition, defendants filed a motion to dismiss the First Amended Complaint on December 14, 2001, on the ground that the First Amended Complaint fails to state claims against SCIC, Catawba, and CAIC upon which relief may be granted. That motion is now fully briefed and is pending a decision. Meanwhile, each side has propounded and responded to written discovery requests. SCIC, Catawba and CAIC have not as yet filed their answers to the First Amended Complaint, nor have they filed their response to plaintiffs' motion for a preliminary injunction.
Management believes SCIC, Catawba and CAIC have meritorious defenses to the foregoing action and it will be vigorously contested.
realizable assets. Effective July 31, 2001, the Company reached a settlement with Wells Fargo Financial Resources, Inc. ("Wells Fargo") (formerly known as Norwest Financial Resources, Inc.) in which Wells Fargo agreed to dismiss the pending lawsuit. The Company in turn agreed to pay Wells Fargo $100.
During the fiscal years ended December 31, 2001, 2000 and 1999, the Company paid a total of $242, $225 and $350, respectively, to SADISCO Corporation ("SADISCO") for salvage and disposal
In February 2002, the Company sold previously nonmarketable equity securities back to the issuer of the securities for a gain of $2,117.
states in which the Company's insurance subsidiaries are licensed. The Company's participation in each of these pools and associations is calculated by and communicated to the Company on a quarterly basis by a centralized statistical processing agency. Similar to the unusual fourth quarter fluctuation of other interest income in 2000, the second and third quarter fluctuations in 2001 are directly related to the time value of money consideration on recoupment premiums the Company writes for the SC Facility. The tendency for large fluctuations in this activity is heightened as the SC Facility is nearing the end stages of runoff. Excluding the effects of the mandatory residual market pools and associations, other interest income is substantially comprised of interest income on premium notes receivable earned by the Company's premium finance subsidiary, PBP. For a variety of reasons, including PBP's continuing operating losses and reassessments of the Company's strategic direction, PBP was placed into runoff in mid December 2001. Other interest income earned by PBP for the first through fourth quarters of 2001 was $266, $251, $348 and $266, respectively.
Net realized losses of $211 for the year ended December 31, 2001 resulted from the sale of certain automobiles no longer required for operations and the disposal of certain obsolete data processing equipment and software partially offset by gains realized on the liquidation of a portion of the Company's bond portfolio to fund its operations.
was completed by September 30, 2001, and included a final downward adjustment to the original estimated cost of $156.
Other interest income increased in the fourth quarter of 2000 as a result of the Company's mandatory participation in the numerous residual market pools and associations of the 46 states in which the Company's insurance subsidiaries are licensed. The Company's participation in each of these pools and associations is calculated by and communicated to the Company on a quarterly basis by a centralized statistical processing agency. During the fourth quarter of 2000, the Company recorded approximately $800 from the SC Facility related to the time value of money consideration on recoupment premiums the Company writes for the SC Facility.
In June 2000, the Company's Board of Directors approved and the Company announced the Restructuring Plan centering on the discontinuation of its Nashville operations. The Restructuring Plan, which was completed by September 30, 2001, included approximately $16,421 in special charges related primarily to the impairment of long-lived assets associated with the operation, employee severance, and the cancellation of contractual commitments. The cash requirements of the Restructuring Plan were estimated to be approximately $743. In December 2000, the estimated cost of the restructuring plan was adjusted downward by $56.