Properties - ------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin Cheldin, the Company's president, chairman and principal stockholder, is the owner of the
building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties.
The tax-exempt interest income earned (net of bond premium and discount amortization) during the year ended December 31, 2002, was $283,856 compared to $752,189 in the year ended December 31, 2001. In the year ended December 31, 2000, tax-exempt interest income earned totaled $1,191,794.
On November 15, 2002, the Company borrowed $500,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer, and $250,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. The notes are due and payable upon demand of lender (on no less than fourteen days' notice) and, if no demand is made, then the notes are payable in full on November 15, 2006. The notes may be prepaid at any time without penalty. The notes are
unsecured and bear interest at 8% per annum, with interest payable monthly. Proceeds of the notes and available cash from the Company's other operations were used by Unico to make a capital contribution of $1,500,000 to its Crusader subsidiary. This contribution was made to ensure that Crusader's capital remained above $25,000,000.
Crusader's statutory capital and surplus as of December 31, 2002, was $26,258,452, a decrease of $1,261,086 (5%) from December 31, 2001. Crusader's statutory capital and surplus as of December 31, 2001, was $27,519,538, a decrease of $12,106,731, (31%) from December 31, 2000.
There were no dividends paid by Crusader to Unico in 2002 or 2001. Crusader paid dividends of $1,500,000 to Unico in 2000. The dividends paid in 2000 were invested in short-term instruments and were ultimately used to help fund the repurchase of shares of the Company's common stock discussed below. As of December 31, 2002, the maximum dividend that could have been made by Crusader to Unico without the prior approval of the California Department of Insurance was $2,625,845.
Unico had a $2,000,000 line of credit with Union Bank of California. As of December 31, 2001, no amounts were borrowed and the Company did not utilize its credit line during the remainder of its current term that expired in November of 2002. The credit line was not renewed at expiration.
In 2002, the Company initiated an upgrade and replacement of its printing and forms generation systems. As of the date of this report, the project has been completed at a total cost of approximately $95,000. There are no other material commitments for capital expenditures as of the date of this report.
In a recent court ruling that affects the tax years 1997 through 2002, a statute that allowed Unico American a tax deduction for the dividends received from its wholly-owned insurance subsidiary was held unconstitutional on the grounds that it discriminated against out-of-state insurance holding companies. Based on the court ruling, the California Franchise Tax Board ("FTB") is taking the position that the discriminatory sections of the statute are not severable and the entire statute is invalid. As a result, the FTB is disallowing dividend-received deductions for all insurance holding companies, regardless of domicile, for tax years ending on or after December 1, 1997. The Company received dividends from its insurance subsidiary of $5 million for the 1998 through 2000 tax years. As of the date of this report, the FTB has not proposed any assessments to the Company for additional tax as a result of the dividends received deduction that the Company utilized for those periods. This ruling by the court has confused certain long standing aspects of the California tax law and has already resulted in legislative proposals for relief which, if approved, would reduce or eliminate the amount of the Company's exposure. In addition, without such legislation, years of future litigation may be required to determine the ultimate outcome. Consequently, the ultimate amount that the Company may be required to pay is impossible to predict at the
present time and the Company has not recorded a provision for additional state income tax liabilities related to this matter.
For the year ended December 31, 2002, the Company had a loss before taxes of $4,814,059 compared to a loss before taxes of $16,723,109 in the year ended December 31, 2001, a decrease in loss before taxes of $11,909,050. The decrease in pre-tax loss was primarily due to a decrease of $11,836,195 in the underwriting loss (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader. The Company had a net loss for the year ended December 31, 2002, of $3,224,689 compared to a net loss of $10,870,018 for the year ended December 31, 2001, a decrease in net loss of $7,645,329.
Due to more selective underwriting by the Company, the number of policies issued in 2002 increased only 3% over 2001, and the number of policies issued in 2001 increased only 4% over 2000. Although the Company attempts to be competitive on price, it believes that maintaining adequate rates on the insurance policies it sells is a better business strategy than increasing total written premium by selling more policies at inadequate rates.
Crusader's net reinsurance cost is anticipated to approximately double in 2003 as a result of rate increases primarily due to the Company's ceded loss experience and a hardening in the reinsurance marketplace. Without taking into account premium growth, this rate increase, net of ceding commission, is estimated to cost approximately $4,000,000 in 2003. The Company's regularly planned premium increases are expected to help offset this added cost of reinsurance. In 2003, the annual aggregate deductible on Crusader's primary excess of loss treaty will decrease from $675,000 in 2002 to $500,000. Crusader's 2003 primary excess of loss treaty provides for a contingent commission equal to 45% of the net profit, if any, accruing to the reinsurer.
In 2002, the Company's reinsurance coverage for terrorism, mold and cyber risk was significantly reduced. To the extent allowed by regulators, the Company intends to address this change in its reinsurance coverage by modifying the coverage provided to its policyholders.
The combined ratio is the sum of (1) the net ratio of losses and loss adjustment expenses incurred (including a provision for incurred-but-not-reported losses "IBNR") to net premiums earned ("loss ratio") and (2) the ratio of policy acquisition and general operating costs to net premiums earned ("expense ratio"). The following table shows the loss ratios, expense ratios, and combined ratios of Crusader as derived from data prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). As shown on the table below, the loss ratio decreased to 98.1% in 2002 from 139.4% in 2001 and increased from 83.7% in 2000. This increase in the loss ratio since 2000 was primarily due to an increase in prior years' incurred losses.
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ----
Loss ratio 98.1% 139.4% 83.7% Expense ratio 27.8% 29.1% 32.1% ----- ----- ----- Combined ratio 125.9% 168.5% 115.8% ===== ===== =====
structures. Apartment house habitability claims arise from uninhabitable conditions related to dilapidated structures and insect and vermin infestation.
The following table provides an analysis of the roll forward of Crusader's losses and loss adjustment expenses, including a reconciliation of the ending balance sheet liability for the periods indicated:
(*) In accordance with Financial Accounting Standards Board Statement No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts, reinsurance recoverable on unpaid losses and loss adjustment expenses are reported for GAAP as assets rather than netted against the corresponding liability for such items on the balance sheet.
1. Higher than anticipated claim cost from business outside of California. 2. The effect on settlements of escalating jury awards. 3. The effect on settlements in apartment house habitability claims due to a statute that provides for payment of plaintiff attorney fees without regard to policy limits. 4. Increased development of losses due to the impact of changes in California law that expanded coverage and increased loss exposure primarily on construction defect claims for losses incurred prior to the Company's revision in its policy form in 1995. For example:
Montrose Chemical Corp. v. Admiral Insurance Co. (1994), ----------------------------------------------- Montrose Chemical Corp. v. Admiral Insurance Co. (1995), ----------------------------------------------- Armstrong World Industries, Inc. v. Aetna Gas & Sur. Co. (1996) --------------------------------------------------------- and James Pepperell, et al., v. Scottsdale Insurance Company (1998). -------------------------------------------------------------- These four cases state that all insurance companies with completed operations property damage coverage in force during a period of continuing damage or property deterioration must provide coverage for construction defect losses regardless as to whether or not the damage first manifested during their policy period.
Centex Golden Construction Co. v. Dale Tile Co. (2000) ---------------------------------------------- This case states that indemnity agreements in construction contracts requires the subcontractor to defend the general contractor even though the subcontractor's liability has not been established.
Estimates for ultimate loss reserves are inherently difficult to determine because they are attempts to quantify future results based on current trends. The effort to predict the Company's ultimate losses and loss adjustment expenses was made more difficult in 2000 and 2001 because of the following:
1. The Company had written liquor liability outside of California since 1992. The time allowed by statute to report a claim in these states ranges from 2 years to 3 years. Prior to 1998, the frequency and severity of the claims seemed reasonably predictable. Before the statute of limitations expired, claims occurring in 1998 that were reported to the Company in 2000 were significantly higher than anticipated based on the Company's loss experience for all prior years in which these coverages were offered. The Company could not identify any reason for this change and was unable to tell whether it was an aberration or a new trend. Although the Company increased its reserves, they were not enough to cover the claims reported in 2001 for losses occurring in 1999. In 2001, the Company created a separate analysis of its non-California CMP liabililty business to provide for better data analysis in arriving at its best estimate for its CMP line of business. In addition, the analysis provided the Company a better understanding of the appropriate underwriting actions that should be taken, and in 2001, the Company responded to the change in development in 2001 and 2000 by either substantially increasing rates or reducing coverages offered on this business.
1. Business Underwritten Outside of California 2. Habitability Exposure 3. Construction Defect Exposure 4. Rate Inadequacy Within Special Risk Class of Business 5. Increased Cost of Settling Claims, Indemnity and Expense 6. Increased Cost of Reinsurance 7. Mold Exposure 8. Terrorism Exposure 9. Market Conditions and Competition
PENNSYLVANIA: The Company discontinued offering all types of insurance in Pennsylvania on August 1, 2002, and the Company is issuing non-renewal notices on all remaining Pennsylvania business. Total premium written by the Company in Pennsylvania in 2001 was $614,317, compared to $372,748 in 2002.
OREGON: The Company discontinued offering all types of insurance for new business in Oregon on August 1, 2002, and the Company started issuing non-renewal of all remaining policies later that year. Total premium written by the Company in Oregon in 2001 was $401,960, which compares to $340,336 in 2002.
WASHINGTON: The Company discontinued offering all types of insurance in Washington on August 1, 2002, and the Company started issuing non-renewal of all remaining policies later that year. Total premium written in Washington in 2001 was $721,071, which compares to $278,279 in 2002.
IDAHO: The Company stopped offering insurance in Idaho on November 1, 2002. The Company began to non-renew all of its Idaho policies in February of 2003. Total premium written by the Company in Idaho in 2001 was $32,769, which compares to $36,495 in 2002.
KENTUCKY: In the year 2000 the Company stopped offering insurance in Kentucky, and in May of 2001 the Company started to non-renew all of its policies in that state. Total premium written by the Company in Kentucky in 2001 was $24,293, which compares to $0 in 2002.
NEVADA: The Company believes that it has no adverse exposure in Nevada. Although the Company's sales in Nevada are small, there are no plans to change operations in that state. Total premium written by the Company in Nevada in 2001 was $380,835, which compares to $210,244 in 2002.
2. HABITABILITY EXPOSURE: In October 2000, the Company significantly changed its underwriting practice with respect to the type of apartment buildings thought to cause these claims, and additional changes are planned. These changes are:
a. In September 2000, the Company identified a subcategory of apartment building risk, referred to as the "Big and Old" group. The Company believes that members of this group pose a greater-than-average probability of habitability loss.
b. On September 28, 2000, the Company imposed more stringent underwriting restrictions and requirements upon members of the "Big and Old" group, including the adoption of more restrictive coverage forms and use of maintenance warranties for members of this group.
4. RATE INADEQUACY WITHIN SPECIAL RISK CLASS OF BUSINESS: In November 2000 after a change of program management, the Company reviewed those policies underwritten by its Special Risks program. That review resulted in the cancellation of a significant number of policies, those thought to be generating most of the losses. The Company plans to make rate filings so as to be able to re-underwrite those types of policy that were cancelled. Meanwhile, it continues with its culling of marginal policies. The Company expects to receive regulatory approval of the revised filings by the end of year 2003. Total premium written by the Company's Special Risks program in the year 2001 was approximately $2,300,000, compared to $1,793,000 in the
7. MOLD EXPOSURE: The Company gained regulatory approval of a "Mold Exclusion" form, which it began endorsing to all policies effective after January 29, 2003. That exclusion applies to both first and third party claims. Policies issued prior to that time contained absolute pollution exclusions and exclusions for deterioration, which historically acted to minimize the Company's exposure to "mold" claims.
Health and Life Insurance Program --------------------------------- Commission income from the health and life insurance sales of NIB and AIB is as follows:
NIB and AIB market health and life insurance through non-affiliated insurance companies for individuals and groups. In 2002 and 2001 approximately 94% of the health and life commission income was from the CIGNA HealthCare medical and dental plan programs. Revenues for the year ended December 31, 2002, increased $159,382 (6%) compared to the year ended December 31, 2001. The increase in commissions is due to an
Revenues for the year ended December 31, 2001, decreased $42,903 (2%) compared to the year ended December 31, 2000. The decrease in commission income in the health and life insurance programs is primarily due to a decrease in premiums written in the CIGNA HealthCare programs as a result of increased competition in the individual and group healthcare market.
Service fee income increased $515,072 (30%) in the year ended December 31, 2002, compared to the year ended December 31, 2001. The increase in service fee is primarily due to an increase in the fee from $100 to $165 per policy written in California. This increase was approved by California regulatory authorities on June 21, 2002, and was implemented for policies effective on and after the latter part of August 2002. The increase in service fee income is also related to the number of policies written by Unifax. Policies issued increased by 489 (3%) in the year ended December 31, 2002, compared to the year ended December 31, 2001. Service fee income increased $72,076 (4%) and policies issued increased by 763 (4%) in the year ended December 31, 2001, compared to the year ended December 31, 2000.
Daily Automobile Rental Insurance Program ----------------------------------------- The daily automobile rental insurance program is produced by Bedford. Bedford receives a commission and a claim administration fee from a non-affiliated insurance Company based on premium written. Commission and fee income from the daily automobile rental insurance program are as follows:
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Daily auto rental program commission and claim administration fee $722,536 $657,273 $741,662 Contingent commission 66,947 10,145 69,979 ------- ------- ------ Total commission and fee income $789,483 $667,418 $811,641 ======= ======= =======
The insurance claim administration operation generates all its business from insurance policies effective on or prior to December 31, 2002, that were produced by its sister company Bedford for a non-affiliated insurance company. Approximately 10% of Bedford's commission from the non-affiliated insurance company was charged and applied to the claim administration operation. This amount will cease for insurance policies effective in 2003 and the non-affiliated insurance company will assume the claim administration of these policies. The unearned claim administration income of $300,000 as of December 31, 2002, is anticipated to be sufficient to cover the cost to complete the claim administration on policies effective on or prior to December 31, 2002.
In October 2003, CIGNA will discontinue its Individual and Family health insurance programs to all policyholders in the state of California. Due to this change, AAQHC members who have these coverages will no longer be members of the association and AAQHC's membership and fee income is expected to decrease by approximately 70%. However, this decrease in AAQHC income is expected to be substantially offset with higher commission/ override income earned by AIB from non-CIGNA companies.
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Earthquake program commission income $51,576 $51,029 $15,993 Workers' compensation program commission income $12,258 $19,730 $44,818 Commercial liability program commission and fee income $(741) $62,839 $55,828 Miscellaneous fee income $109 $161 $128 ------ ------- ------ Total other commission and fee income $63,202 $133,759 $116,767 ====== ======= =======
Unifax produced workers' compensation policies primarily in California for non-affiliated insurers and received a commission from them based on premium written. Unifax discontinued its sales of workers' compensation insurance policies for non-affiliated insurers in 2002. The Company continues to receive commissions on policies
Unifax began producing commercial liability insurance policies in California for non-affiliated insurance companies in 1999. Unifax received a commission from the insurance company based on premium written and a service fee from the policyholder. Effective December 2001 the Company discontinued the program. The Company took this action in order to better utilize its resources and focus on those markets that offer the greatest potential for 2002 and beyond. Commission and fee income on the commercial liability program decreased $63,580 in the year ended December 31, 2002, compared to the prior year as a result of the discontinuance of the program.
Premium Finance Program ----------------------- Premium finance charges and late fees earned from financing policies are as follows: Year ended December 31 ---------------------- 2002 2001 2000 ----- ----- ---- Premium finance charges and late fees earned $878,316 $868,496 $837,902 New loans 6,340 7,148 7,166
AAC provides premium financing primarily to Crusader policies produced by Unifax in California. The growth of this program is dependent and directly related to the growth of Crusader's written premium and AAC's ability to market its competitive rates and service to finance those policies. Revenue increased $9,820 (1%) in the year ended December 31, 2002, compared to the prior year although there were 808 (11%) fewer loans financed in the current year. The increase in revenue in 2002 is primarily due an increase of approximately 22% in the amount of the average loan financed. Although AAC finances approximately 77% of all Unifax policies financed, the percentage of all Unifax policies that are financed decreased from approximately 49% in 2001 to approximately 44% in 2002.
Revenue for the year ended December 31, 2001, increased $30,594 (4%) compared to the year ended December 31, 2000. The number of new loans decreased by 18 in the year ending December 31, 2001 compared to the prior year. The increase in revenues despite the decrease in the number of new loans in 2001 is primarily due to the fact that the average policy loan being financed is approximately 6% greater than the prior year. Although AAC finances approximately 80% of all Unifax policies which are financed, the percentage of all Unifax policies which are financed decreased from approximately 54% in 1999 to approximately 50% in 2000.
Investment Income and Net Realized Gains (Losses) Investment income and net realized gains (losses) are as follows:
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Interest income Insurance Company operations $5,401,870 $5,647,026 $5,764,094 Other operations 56,176 156,387 335,984 --------- --------- --------- Total interest income 5,458,046 5,803,413 6,100,078 On investments Net realized investment gains (losses 3,690 9,572 (135,389) --------- --------- --------- Total investment income and realized gains (losses) $5,461,736 $5,812,985 $5,964,689 ========= ========= =========
Investment interest earned (excluding net realized gains) decreased $296,665 (5%) in the year ended December 31, 2001, compared to the year ended December 31, 2000, primarily as a result of a decrease in the average invested assets in the Company's investment portfolio. In the year ended December 31, 2001, the Company's average invested assets (at amortized value) decreased $5,299,460 (5%) compared to the year ended December 31, 2000. The decrease in average invested assets primarily resulted from the cash used from operations and from the sale of U.S. treasury securities and other short-term investments to fund the repurchase of the Company's common stock. There were no losses on the sale of these securities. As of December 31, 2001 the cost of the stock repurchase plan has been $5,517,465 (see Note 18 of Notes to Consolidated Financial Statements). The Investment income return based on average invested assets was 6.02% for the year ended December 31, 2001, compared to 6.00% for the year ended December 31, 2000. The mix of taxable and tax-exempt securities in the portfolio affect the investment income return percentage. Tax-exempt securities generally carry a lower yield than taxable securities. These securities (at amortized value) decreased to $8,213,141 (9% of total investments) at December 31, 2001, compared to $19,789,675 (20% of total investments) December 31, 2000.
Within 1 year $20,347 $20,786 Beyond 1 year but within 5 years 62,614 66,266 Beyond 5 years but within 10 years 10,689 11,321 ------ ------ Total $93,650 $98,373 ====== ======
The Company sold one bond in the year ending December 31, 2002, and recognized a short-term capital gain of $3,906. The single bond was sold in order to maintain conformity with the Company's investment guidelines. In the year ending December 31, 2001, the Company sold three bonds and recognized a capital gain on each sale aggregating $35,276. Two of these bonds were sold to maintain conformity with the Company's investment guidelines, and one bond was sold to fund the repurchase of the Company's common stock.
SALARIES AND EMPLOYEE BENEFITS increased $52,241 (1%) for the year ended December 31, 2002, compared to the year ended December 31, 2001. Salaries and employee benefits increased $80,520 (2%) for the year ended December 31, 2001, compared to the year ended December 31, 2000. Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Salaries and employee benefits $4,373,878 $4,321,637 $4,241,117
COMMISSIONS TO AGENTS/BROKERS (not including commissions on Crusader policies that are reflected in policy acquisition costs) are generally related to gross commission income from the health and life insurance program, the daily automobile rental insurance program, the earthquake program and the commercial liability program. Commissions to agents and brokers decreased $40,749 (3%) for the year ended December 31, 2002, compared to the year ended December 31, 2001. Commissions to agents and brokers decreased $49,431 (4%) for the year ended December 31, 2001, compared to the year ended December 31, 2000.
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Other operating expenses $3,248,227 $2,886,266 $2,642,897
Income Taxes - ------------ The income tax benefit for the year ended December 31, 2002, was $1,589,370 compared to an income tax benefit of $5,853,091 for the year ended December 31, 2001. The effective combined income tax rates for 2002 and 2001 were (33%) and (35%), respectively. The pre-tax loss decreased $11,909,050 for the year ended December 31, 2002, compared to the year ended December 31, 2001, which resulted in a decreased income tax benefit in 2002. The income tax benefit for the year ended December 31, 2001, was $5,853,091 compared to an income tax benefit of $246,184 for the year ended December 31, 2000. The effective combined income tax rates for 2001 and 2000 were (35%) and (127.2%), respectively. The pre-tax loss was significantly higher in 2001 compared to 2000 which resulted in the difference in the effective tax rates between 2001 and 2000. The income tax benefit for 2002 and 2001 arises primarily from the Company's ability to recover prior income taxes paid due to the carryback of current period net operating losses (see Note 17 of Notes to Consolidated Financial Statements).
In June 2002 the FASB issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Terminations Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred as opposed to the date of an entity's commitment to an exit plan as required under EITF 94-3. SFAS No. 146 also requires that measurement of the liability associated with exit or disposal activities be at fair value. SFAS No. 146 is effective for the Company for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 is not expected to have a material impact on the Company's financial statements.
In October 2002 the FASB issued SFAS No. 147, "Acquisition of Certain Financial Institutions" ("SFAS No. 147"), which addresses the financial accounting and reporting for the acquisition of all or a part of a financial institution, except for transactions between two or more mutual enterprises. Under SFAS No. 147, the acquisition of all or part of a financial institution that meets the definition of a business combination shall be accounted for by the purchase method in accordance with SFAS No. 141, Business Combinations. SFAS No. 147 also provides guidance on accounting for the impairment or disposal of acquired long-term customer-relationship intangible assets, including those acquired in transactions between two or more mutual enterprises. SFAS No. 147 is effective for acquisitions for which the date of acquisition is on or after October 1, 2002. The provisions related to accounting for the impairment or disposal of acquired long-term customer-relationship intangible assets, including those acquired in transactions between two or more mutual enterprises are effective on October 1, 2002. Management of the Company anticipates that the adoption of SFAS No. 147 is not expected to have a material impact on the Company's financial statements.
of interim and annual reporting periods ending after December 15, 2002. The provisions related to the recognition of a liability and initial measurement shall be applied prospectively to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year end. Management of the Company anticipates that the adoption of this interpretation is not expected to have a material impact on the Company's financial statements.
Losses and Loss Adjustment Expenses ----------------------------------- The preparation of the Company's financial statements requires judgments and estimates. The most significant is the estimate of loss reserves as required by Statement of Financial Accounting Standards No 60 ("SFAS No. 60"), "Accounting and Reporting by Insurance enterprises" and Statement of Financial Accounting Standards No. 5 ("SFAS No. 5"), "Accounting for Contingencies". Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the
operating results of the periods in which they are made. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.
Investments ----------- In accordance with Statement of Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company is required to classify its investments in debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading securities. Although all of the Company's investments are classified as available-for-sale and although the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities are reported as accumulated other comprehensive income (loss) which is a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses are included in the consolidated statements of operations based on the specific identification method.
Consolidated Balance Sheets as of December 31, 2002, and December 31, 2001 37
Consolidated Statements of Operations for the years ended December 31, 2002, December 31, 2001, and December 31, 2000 38
Consolidated Statements of Comprehensive Income for the years ended December 31, 2002, December 31, 2001, and December 31, 2000 39
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 and 2000
Principles of Consolidation - --------------------------- The consolidated financial statements include the accounts of Unico American Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Basis of Presentation - --------------------- The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). As described in Note 15, the Company's insurance subsidiary also files financial statements with regulatory agencies prepared on a statutory basis of accounting that differs from GAAP.
Income Taxes - ------------ The provision for federal income taxes is computed on the basis of income as reported for financial reporting purposes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and are measured using the enacted tax rates and laws expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted.
Earnings Per Share - ------------------ Basic earnings per share excludes the impact of common share equivalents and are based upon the weighted average common shares outstanding. Diluted earnings per share utilizes the average market price per share when applying the treasury stock method in determining common share dilution. When dilutive, outstanding stock options are treated as common share equivalents for purposes of computing diluted earnings per share and represent the difference between basic and diluted weighted average shares outstanding.
Losses and Loss Adjustment Expenses - ----------------------------------- The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses.
procedures and settlement philosophy, current and perceived social and economic inflation, current and future court rulings and jury attitudes, improvements in medical technology, and many other economic, scientific, legal, political, and social factors all can have significant effects on the ultimate costs of claims. Changes in Company operations and management philosophy also may cause actual developments to vary from the past. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.
Restricted Funds - ---------------- Restricted funds are as follows: Year ended December 31 ---------------------- 2002 2001 ---- ---- Restricted Funds: Premium trust funds (1) $1,114,403 $1,529,996 Assigned to state agencies (2) 2,725,000 2,725,000 --------- --------- Total restricted funds $3,839,403 $4,254,996 ========= =========
Stock-Based Compensation - ------------------------ The Company applies APB Opinion No. 25 in accounting for its incentive stock option plans. Accordingly, no compensation cost has been recognized in the accompanying statements of operations. Had compensation cost for the Company's stock-based compensation plan been reflected in the accompanying consolidated financial statements based on the fair value at the grant dates for option awards consistent with the method of SFAS 123, the Company's net income would have been reduced to the pro forma amounts indicated below:
Recently Issued Accounting Standards - ------------------------------------ In June 2001 the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs; and it applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. Under SFAS No. 143, a company is required to (1) record an existing legal obligation associated with the retirement of a tangible long-lived asset as a liability when incurred and the amount of the liability be initially measured at fair value, (2) recognize subsequent changes in the liability that result from (a) the passage of time and (b) revisions in either the timing or amount of estimated cash flows and (3) upon initially recognizing a liability for an asset retirement obligation, an entity shall capitalize the cost by recognizing an increase in the carrying amount of the related long-lived asset. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002, with earlier application encouraged. The adoption of SFAS No. 143 will not have a material impact on the financial statements.
In April 2002 the FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS No. 145"). The objectives of SFAS No. 145 are to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of SFAS No. 145 related to the rescission of Statement 4 are applicable to fiscal years beginning after May 15, 2002. The provisions related to Statement 13 are applicable to transactions occurring after May 15, 2002. All other provisions of SFAS No. 145 are applicable to financial statements issued on or after May 15, 2002. Management of the Company anticipates that the adoption of SFAS No. 145 will not have a material effect on the Company's earnings or financial position.
those acquired in transactions between two or more mutual enterprises are effective on October 1, 2002. Management of the Company anticipates that the adoption of SFAS No. 147 is not expected to have a material impact on the Company's financial statements.
Investment income is summarized as follows: Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Fixed maturities $5,354,707 $5,628,698 $5,848,248 Short-term investments 103,339 174,720 251,930 --------- --------- --------- Total investment income 5,458,046 5,803,418 6,100,178 Less investment expenses - 5 100 --------- --------- --------- Net investment income $5,458,046 $5,803,413 $6,100,078 ========= ========= =========
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Gross realized gains on fixed maturities: $3,906 $35,276 $ 2,861 Gross realized (losses) on equity securities: (216) (25,704) (138,250) --- ------ ------- Net realized investment gains (losses) $3,690 $ 9,572 $(135,389) ===== ===== =======
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Gross unrealized appreciation of fixed maturities: $4,828,956 $3,030,903 $936,589 Gross unrealized (depreciation) of fixed maturities: (105,074) (214,480) (752,036) --------- --------- ------- Net unrealized appreciation on investments 4,723,882 2,816,423 184,553 Deferred federal tax (expense) (1,606,120) (957,584) (62,748) --------- --------- ------- Net unrealized appreciation, net of deferred income taxes $3,117,762 $1,858,839 $121,805 ========= ========= =======
Premiums receivable $2,364,150 $2,268,702 Premium finance notes receivable 4,350,685 4,002,347 --------- --------- Total premiums and notes receivable 6,714,835 6,271,049 Less allowance for doubtful accounts 14,926 22,722 --------- --------- Net premiums and notes receivable $6,699,909 $6,248,327 ========= =========
Bad debt expense for the fiscal year ended December 31, 2002, and the fiscal year ended December 31, 2001, was $25,857 and $27,759, respectively. Premium finance notes receivable represent the balance due to the Company's premium finance subsidiary from policyholders who elect to finance their premiums over the policy term. These notes are net of unearned finance charges.
NOTE 7 - NOTES PAYABLE - RELATED PARTIES - ---------------------------------------- On November 15, 2002 the Company borrowed $500,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer and $250,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. The notes are due and payable upon demand of lender (on no less than fourteen days' notice) and, if no demand is made, then the notes are payable in full on November 15, 2006. The notes may be prepaid at any time without penalty. The notes are unsecured and bear interest at 8% per annum with interest payable monthly.
In the years ended December 31, 2001 and 2000, the Company increased its estimates of ultimate losses for both reported and unreported claims primarily occurring from 1998 through 2000 and from 1993 through 1995 (the years most impacted by construction defect claims). Adverse development of prior years' losses of $19,326,349 as of December 31, 2001, and $4,270,631 as of December 31, 2000, was primarily the result of an increase in the Company's estimate of ultimate reported and unreported claims for construction defect claims, non-California liquor liability claims and apartment house habitational type of claims.
The increase in incurred losses and loss adjustment expenses recognized in 2001 and 2000 was primarily due to the following:
1. Higher than anticipated claim cost from business outside of California. 2. The effect on settlements of escalating jury awards. 3. The effect on settlements in apartment house habitability claims due to a statute that provides for payment of plaintiff attorney fees without regard to policy limits. 4. Increased development of losses due to the impact of changes in California law that expanded coverage and increased loss exposure primarily on construction defect claims for losses incurred prior to the Company's revision in its policy form in 1995.
Year ended December 31 ---------------------- 2002 2001 ---- ---- Premium payable $4,708,648 $5,487,753 Unearned claim administration income 300,000 300,000 Profit sharing contributions 291,144 292,900 Accrued salaries 451,347 469,690 Security purchases payable (settlement date in 2003) 2,000,000 - Other 882,337 706,114 --------- --------- Total accrued expenses and other liabilities $8,633,476 $7,256,457 ========= =========
NOTE 12 - COMMITMENT AND CONTINGENCIES - -------------------------------------- The Company, by virtue of the nature of the business conducted by it, becomes involved in numerous legal proceedings as either plaintiff or defendant. The Company is also required to resort to legal proceedings from time to time in order to enforce collection of premiums, commissions, or fees for the services rendered to customers or to their agents. These routine items of litigation do not materially affect the Company and are handled on a routine basis by the Company through its general counsel.
NOTE 13 - REINSURANCE - --------------------- A reinsurance transaction occurs when an insurance company transfers ("cedes") a portion of its exposure on business written by it to a reinsurer which assumes that risk for a premium ("ceded premium"). Reinsurance does not legally discharge the Company from primary liability under its policies. If the reinsurer fails to meet its obligations, the Company must nonetheless pay its policy obligations. The Company's reinsurance agreements help protect Crusader against liabilities in excess of certain retentions, including major or catastrophic losses which may occur from any one or more of the property and/or casualty risks which Crusader insures. The Company continually monitors and evaluates the liquidity and financial strength of its reinsurers to determine their ability to fulfill obligations assumed under the reinsurance contracts. The Company has no reinsurance recoverable balances in dispute.
A reinsurance transaction occurs when an insurance company transfers ("cedes") a portion of its exposure on business written by it to a reinsurer that assumes that risk for a premium ("ceded premium"). Reinsurance does not legally discharge the Company from primary liability under its policies. If the reinsurer fails to meet its obligations, the Company must nonetheless pay its policy obligations. In 2003, Crusader's primary excess of loss reinsurance agreements are with QBE Reinsurance Corporation (A.M. Best Rating A), St. Paul Fire & Marine Insurance Co. (A.M. Best Rating A), Hannover Ruckversicherungs (A.M. Best Rating A+), Mapfre Reinsurance Corporation (A.M. Best Rating A), and Chubb Re, Inc. (A.M. Best Rating A++). From 2000 to 2002, Crusader has had its primary excess of loss reinsurance agreements with Partners Reinsurance Company of the U.S., a California admitted reinsurer rated A+ by the A.M. Best Company. In 1999, Crusader had its primary excess of loss reinsurance agreements with General Reinsurance Corporation, a California admitted reinsurer rated A++ by the A.M. Best Company. Crusader also has catastrophe reinsurance from various highly rated California admitted and Bermuda reinsurance companies. These reinsurance agreements help protect Crusader against liabilities in excess of certain retentions, including major or catastrophic losses that may occur from any one or more of the property and/or casualty risks which Crusader insures. . The Company has no reinsurance recoverable balances in dispute.
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Premiums written: Direct business $45,622,280 $37,637,396 $33,259,948 Reinsurance assumed - - - Reinsurance ceded (7,259,079) (5,531,221) (6,853,383) ---------- ---------- ---------- Net premiums written $38,363,201 $32,106,175 $26,406,565 ========== ========== ==========
Premiums earned: Direct business $40,568,845 $35,409,174 $32,743,165 Reinsurance assumed - - - Reinsurance ceded (7,209,573) (5,515,330) (6,843,931) ---------- ---------- ---------- Net premiums earned $33,359,272 $29,893,844 $25,899,234 ========== ========== ==========
Incurred losses and loss adjustment expenses: Direct $54,352,403 $52,939,238 $34,225,322 Assumed - - - Ceded (21,625,380) (11,262,222) (12,548,407) ---------- ---------- ---------- Net incurred losses and loss adjustment expenses $32,727,023 $41,677,016 $21,676,915 ========== ========== ==========
Employer contributions to the plan were as follows: Year ended December 31, 2002 $434,789 Year ended December 31, 2001 $554,111 Year ended December 31, 2000 $624,388
NOTE 15 - STATUTORY CAPITAL AND SURPLUS - --------------------------------------- Crusader is required to file an annual statement with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities ("statutory"). Statutory accounting practices differ in certain respects from GAAP. The more significant of these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) fixed maturity securities are reported at amortized cost, or the lower of amortized cost or market value, depending on the quality of the security as specified by the NAIC; (c) equity securities are valued by the NAIC as required by Statutory Accounting Principles d) non-admitted assets are charged directly against surplus; (e) loss reserves and unearned premium reserves are stated net of reinsurance; and (f) federal income taxes are recorded when payable and deferred taxes, subject to limitations, are recognized but only to the extent that they do not exceed 10% of statutory surplus; changes in deferred taxes are recorded
directly to surplus as regards policyholders. Additionally, the cash flow presentation is not consistent with GAAP and a reconciliation from net income to cash provided by operations is not presented. Comprehensive income is not presented under statutory accounting.
Year ended December 31, 2002 $(5,331,777) Year ended December 31, 2001 $(12,110,967) Year ended December 31, 2000 $214,787
The California Department of Insurance has completed its financial examination of Crusader's December 31, 2001, statutory financial statements. The report on the examination is pending finalization by the insurance department. The Company does not expect any material adjustments to Crusaders statutory financial statements.
In 2002, the Company was outside the usual values of 4 of the 12 IRIS ratio tests, primarily as a result of adverse losses and loss adjustment expenses development. The IRIS ratio test outside the usual values were the Two Year Overall Operating Ratio, One Year Reserve Development to Surplus, Two Year Reserve Development to Surplus, and Estimated Current Reserve Deficiency to Surplus.
NOTE 16 - STOCK PLANS - --------------------- The Company's 1985 stock option plan provided for the grant of incentive stock options to officers and key employees. The plan covered an aggregate of 1,500,000 shares of the Company's common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.). As of December 31, 2002, all of the options under this plan were exercised or terminated. Options granted under this plan had a life of either 5 or 10 years and had a vesting period from immediate to 9 years. All options were granted at fair market value. There are no additional options available for future grant under the 1985 plan.
On December 18, 2002, the Company granted an additional 182,000 incentive stock options under the Company's 1999 Omnibus Stock Plan. All of these options were outstanding as of December 31, 2002. These options expire 10 years from the date of the grant and are not exercisable prior to January 1, 2004. Options become exercisable as follows:
Date Exercisable Number of ---------------------------------------------------------- Options January 1, January 1, January 1, January 1, Granted 2004 2005 2006 2007 ------- ---- ---- ---- ---- 2,500 2,500 5,000 2,500 2,500 7,500 2,500 2,500 2,500 10,000 2,500 2,500 2,500 2,500 12,500 2,500 2,500 2,500 5,000 15,000 5,000 5,000 5,000 20,000 5,000 5,000 5,000 5,000 35,000 5,000 10,000 10,000 10,000
NOTE 17 - TAXES ON INCOME - ------------------------- The provision for taxes on income consists of the following:
Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Current provision: Federal $(1,599,760) $(5,375,381) $(253,899) State 160,626 24,935 37,409 --------- --------- ------- Total federal and state (1,439,134) (5,350,446) (216,490) Deferred (150,236) (502,645) (29,694) --------- --------- -------- Provision for taxes $(1,589,370) $(5,853,091) $(246,184) ========= ========= =======
The income tax provision reflected in the consolidated statements of operations is less than the expected federal income tax on income as shown in the table below: Year ended December 31 ---------------------- 2002 2001 2000 ---- ---- ---- Computed tax expense (benefit) $(1,636,780) $(5,685,857) $65,828 Tax effect of: Tax exempt income (82,034) (217,383) (344,428) Other (41,236) 19,220 (5,910) State income tax expense 170,680 30,929 38,326 --------- -------- ------- Tax per financial statements $(1,589,370) $(5,853,091) $(246,184) ========= ========= =======
Tax year ended Amount Applied - -------------- -------------- December 31, 1998 $(1,548,427) --------- Total Federal income tax carryback (1,548,427) Adjustment to prior year tax provision (51,333) --------- Current Federal income tax provision $(1,599,760) =========
The Company and its wholly owned subsidiaries file consolidated Federal and combined California income tax returns. Pursuant to the a tax allocation agreement, Crusader and American Acceptance Corporation are allocated taxes or (in the case of losses) tax credits at current corporate rates based on their own taxable income or loss.
This ruling by the court has confused certain longstanding aspects of the California tax law and has already resulted in legislative proposals for relief which, if approved, would reduce or eliminate the amount of the Company's exposure. In addition, without such legislation, years of future litigation may be required to determine the ultimate outcome. Consequently, the ultimate amount that the Company may be required to pay is impossible to predict at the present time and the Company has not recorded a provision for additional state income tax liabilities related to this matter.
NOTE 20 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - ------------------------------------------------------ Summarized unaudited quarterly financial data for each of the calendar years 2002 and 2001 is set forth below: