The following table sets forth certain selected consolidated financial data and should be read in conjunction with, and is qualified in its entirety by, the Consolidated Financial Statements and the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere herein. This selected consolidated financial data has been derived from the audited Consolidated Financial Statements of the Company and its subsidiaries.
In its Property and Casualty segment, the Company sold its nonstandard automobile business, including Phoenix Indemnity in 1999 and in 2000 reached agreements in principle to transfer its general agency business produced by its Scottsdale office and its transportation business to other carriers. These transactions are part of the Company's strategy in this segment. See "Business-Company Strategy" and " Business-Segments."
Forward-Looking Information Except for the historical information contained in this Annual Report on Form 10-K, matters discussed herein may constitute forward-looking information, within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking information reflects the Company's current best estimates regarding future operations, but, since these are only estimates, actual results may differ materially from such estimates.
The Company's net income decreased from $5.5 million for the year ended December 31, 1998 to a net loss of $36.0 million for the year ended December 31, 1999. The results for 1999 were impacted by a strengthening of the Company's reserves for loss and loss adjustment expense, a reduction in net premiums written in the Company's Property and Casualty segment, an increase in net operating expenses as well as an increase in reinsurance costs in the Company's crop segment, a decline in MPCI profit share, and a decline in investment income. Additionally, certain special and nonrecurring charges affected the comparison of results from 1998 to 1999. Results in 1999 were negatively impacted by charges associated primarily with the divestitures of various lines of property and casualty business. They include severance costs, charges relating to discontinued software development, reduction of certain deferred policy acquisition costs and an increased allowance for doubtful accounts. As part of a retirement agreement, a former employee has the right to put to the Company 274,635 previously issued shares of Common Stock at $15 per share between June 30, 2002 and July 30, 2002. As a result of this redemption feature, the Company has recorded the related redemption amount as temporary equity. Also included in 1999 results are charges associated with the Company's recent and anticipated resolutions of disputes with state regulatory authorities regarding its crop insurance business and the evaluation of strategic and capital alternatives.
Historically, the Company has performed an analysis of its loss and loss adjustment expense reserves quarterly, and has conducted an analysis, in conjunction with its independent actuary, as of September 30 of each year that includes an actuarial study by its independent actuary. This study indicated a significant increase in the number of claims incurred by the Company but not previously reported (IBNR) at September 30, 1999. The increase in previously unreported claims was principally under policies covering the 1990 through 1995 accident years, and primarily were new construction defect claims reported under general liability policies insuring contractors in the state of California. To a lesser extent, the Company also experienced an increase in reported claims for the 1998 year in its commercial automobile lines.
In February 1999, the Company announced a restructuring of its Property and Casualty segment in which approximately one-third of its property and casualty gross written premiums for 1998 were discontinued. As a part of this restructuring, the Company ceded the unearned premium from its discontinued lines, as well as new premiums written during the run-off of the discontinued lines, to an independent reinsurer. Additionally, the Company sold its nonstandard automobile business, including Phoenix Indemnity, in September 1999. Accordingly, during the year ended December 31, 1999, the Company's property and casualty net earned premiums declined by approximately 23% as compared to 1998. While the Company reduced operating expenditures in conjunction with the reduced premium writings, the Company's property and casualty underwriting expense ratio increased from 33.7% in 1998 to 39.7% in 1999. The increase primarily resulted from costs totaling approximately $9.0 million relating primarily to the divestitures of various lines of property and casualty business. The Company expects further reductions in its Property and Casualty segment net written premiums in 2000 as a result of these and other divestitures and premium transfer transactions.
The Company ceded a portion of the profit share related to approximately $35.0 million of its retained premiums under the MPCI program for 1999 to reinsurers participating in its overall crop reinsurance programs. The Company expects to continue to cede portions of its premiums under MPCI program in the future in order to secure the required reinsurance capacity for its crop programs and currently estimates ceding approximately $79 million of such premiums for the 2000 crop year. Additionally, in order to maintain its aggregate retained risk near historic levels, the Company's excess reinsurance costs increased by $8.2 million during 1999 as compared to 1998. The Company expects $7.5 million of these additional excess reinsurance costs to continue each year for up to seven years in the future. The Company has obtained a letter of credit to secure the expected future ceded premiums.
The Company's net income decreased 84.3% from $35.3 million in the year ended December 31, 1997 to $5.5 million in the year ended December 31, 1998. The Company's operating income decreased 69.1% from $57.9 million in the year ended December 31, 1997 to $17.9 million in the year ended December 31, 1998. These deteriorating results occurred due to a decline in the Company's net premiums earned, an increase in the Company's incurred losses and loss adjustment expenses, an increase in the Company's underwriting and general and administrative expenses, an increase in the Company's interest expenses, and a decrease in the Company's net realized capital gains. These negative results were primarily a result of the failure of the Company's property and casualty operations to achieve underwriting profitability, whereas the Company's crop insurance operations were able to meet or exceed profitability expectations for the fifth consecutive year.
For the second year in a row, the Company experienced a decline in net insurance premiums earned from $335.2 million in 1997 to $328.0 million in 1998. While the Company's gross written premiums increased 5.3% from $665.8 million in 1997 to $701.0 million in 1998, an increase in the premiums which the Company ceded to reinsurers resulted in a decrease in net premiums written and net premiums earned. Due to the competitive environment in the property and casualty business, new programs which the Company initiated in 1998 were heavily reinsured in order to diminish the impact on the Company's results until such time as these new programs confirmed their expected level of profitability, and lines of business which were profitable but performing below the Company's return on equity expectations, were more heavily reinsured in order to take advantage of favorable reinsurance terms available in the market. These factors offset growth in profitable lines of business during 1998, as competitive pressures in the property and casualty industry minimized growth in these lines of business.
The Company's charges for general and administrative expenses increased from $2.1 million in 1997 to $3.5 million during 1998. The principal component of this increase was a $1.1 million charge recorded in 1998 related to the valuation of its nonstandard automobile subsidiary that is being held for sale.
Under the American Agrisurance profit sharing agreement, American Agrisurance receives up to 50% of the crop insurance profit after certain expenses and a margin retained by the Insurance Companies based upon a formula established by the Company and approved by the Nebraska Department of Insurance. If the calculated profit share is negative, such negative amounts are carried forward and offset future profit sharing payments. These amounts are distributed from time to time in the form of a dividend to the Company. In 1999 there was no profit sharing distribution.
The principal liquidity needs of the Insurance Companies are to fund losses and loss adjustment expense payments and to pay underwriting expenses, including commissions and other expenses. The available sources to fund these requirements are net premiums received and, to a lesser extent, cash flows from the Company's investment activities, which together have been adequate to meet such requirements on a timely basis. The Company monitors the cash flows of the Insurance Companies and attempts to maintain sufficient cash to meet current operating expenses, and to structure its investment portfolio at a duration which approximates the estimated cash requirements for the payments of loss and loss adjustment expenses.
Inflation The Company does not believe that inflation has had a material impact on its financial condition or the results of operations.
The Company's balance sheet includes a significant amount of assets and liabilities whose fair value are subject to market risk. Market risk is the risk of loss arising from adverse changes in market interest rates or prices. The Company currently has interest rate risk as it relates to its fixed maturity securities and mortgage loans and equity price risk as it relates to its marketable equity securities. In addition, the Company is also subject to interest rate risk at the time of refinancing as it relates to its mandatorily redeemable Preferred Securities. The Company's market risk sensitive instruments are entered into for purposes other than trading.
The Company's Preferred Securities of $94.875 million at December 31, 1999, mature in August 2027 and are redeemable at the Company's option in September 2002. The Company will continue to monitor the interest rate environment and evaluate refinancing opportunities as the redemption and maturity date approaches.
In January 2000, the Company announced an agreement in principle for the sale of Redland to Clarendon. The proposed transaction includes the appointment of other Company subsidiaries as the exclusive producer and administrator of Redland for the business the Company currently writes through Redland. The Company would also reinsure certain portions of the business written by Redland in the future and the Company and Clarendon would jointly develop additional specialty program business. The proposed sale would be a cash transaction based upon the market value of Redland after the divestiture of various assets, including the Redland subsidiaries to The Redland Group, Inc. The Company does not expect to realize a significant gain or loss from the proposed transaction which is expected to close during the second quarter of 2000. The Company may retain an option to repurchase Redland under certain circumstances. Upon closing, Redland is expected to cede most of its business to Clarendon which maintains the rating of A (Excellent) rating from A.M. Best.
The Company is pursuing the proposed transaction as part of its overall strategy to focus its property and casualty operations on core lines of profitable specialty business and to meet the requirements of current and future agents and customers for insurance products issued by an insurance company that is rated A- or better by A.M. Best. The Company and Clarendon have entered into an interim agreement that allows Redland to issue policies with Clarendon endorsements. The Company has no reason to believe that the proposed sale of Redland will not be completed. If, however, the proposed sale is not completed, the Company intends to seek other agreements with Clarendon, similar to the interim agreements, in order to retain the A rating on the policies.
The Company has conducted a comprehensive review of potential claims related to Year 2000 issues which might be submitted in conjunction with policies of insurance underwritten by the Insurance Companies. Although the Company has concluded Year 2000 exposures are not covered under its existing insurance policies, the Company acted to eliminate, reduce or mitigate potential claims for coverage of Year 2000 exposures through the use of exclusionary language, new underwriting procedures and pricing practices, withdrawal from certain classes of business, and establishment of a specialized unit within its claims department to respond to such claims. The Company is not aware of any claims reported to it alleging coverage for losses caused by the advent of year 2000 as of the date of this report.
It is possible, however, that the full impact of the date change has not been fully recognized. For example, it is possible that Year 2000 or similar issues such as leap year-related problems may occur at month, quarterly, or year end. The Company believes that any such problems are likely to be minor and correctable. In addition, the Company could still be negatively affected if its customers or third parties on which the Company relies are adversely affected by the Year 2000 or similar issues. The Company currently is not aware of any significant Year 2000 or similar problems that have arisen for its customers or third parties on which the Company relies.
Prior to December 31, 1999 the Company expensed costs of approximately $2.9 million relating to the Year 2000 issue.
Recent Statement of Financial Accounting Standards In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 (SFAS No. 133), Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company has not completed the process of evaluating the impact of the adoption of SFAS No. 133 on the Company's consolidated financial statements.