Vesta writes insurance on selected personal lines risks only. Our Standard- Property Casualty writings are balanced between risks of property damage (faster determination of ultimate loss but is highly unpredictable) and casualty exposure (more predictable but takes longer to determine the ultimate loss). We also write life and annuity business, and in 2001 will write accident and health insurance business. Additionally, we are actively involved in the writing of insurance on our policies for the benefit of reinsurance companies, commonly referred to as servicing carrier or fronting, which generates fee-for-service income.
Policy acquisition expenses increased by $6.1 million, or 13.2 % to $52.4 million for the year ended December 31, 2000, from $46.3 million for the year ended December 31, 1999 primarily due to an increase in contingent commissions owed on profitable business and the additional premium earned on our Property Plus book of business, which pays a higher commission than our other books of business. Operating expenses decreased by $2.2 million or 7.6% to $26.6 million as we continued our efforts to control costs.
On June 30, 2000, we entered the life and annuity business through a 71% investment in American Founders Financial Corporation , a holding company for two life insurance companies domiciled in Texas. American Founders has approximately $1.8 billion (face value) of life products in force and approximately $339 million of annuity deposits as of December 31, 2000. Premiums and policy fees were $5.3 million for the year ended December 31, 2000 compared to zero for the comparable prior period due to the acquisition of American Founders on June 30, 2000. American Founders has approximately $2.1 billion face amount of life insurance and annuities in force at December 31, 2000.
Net investment income decreased by $.7 million, or 2.6%, to $25.9 million for the year ended December 31, 1999, from $26.6 million for the year ended December 31, 1998. The weighted average yield on invested assets (excluding realized and unrealized gains) was 6.5% for the year ended December 31, 1999, compared with 5.8% for the year ended December 31, 1998.
Vesta is a holding company whose principal asset is its investment in the capital stock of the companies constituting the Vesta Insurance Group, a group of wholly owned property and casualty insurance companies including Vesta Fire and a majority ownership in a life insurance holding company which includes American Founders Life Insurance Company. The insurance subsidiaries comprising the Vesta Group are individually supervised by various state insurance regulators. Vesta Fire and American Founders are our principal operating subsidiaries.
. an additional $7.5 million line, secured by a pledge of the management contract between our wholly owned management company, J. Gordon Gaines, Inc., and our operating insurance subsidiaries, which carries interest at First Commercial's prime rate.
Subsequent to December 31, 2000, the holders of the Series A convertible preferred stock converted their holding to common stock, and we repurchased the 5.9 million converted shares for $47.2 million. We also completed an additional debt for equity swap in January 2001, exchanging 380 thousand shares of common stock for $3.5 million face amount of deferrable capital securities.
On a consolidated basis, net cash used in operations for the years ended December 31, 2000 and 1999, was $59.0 million and $103.3 million, respectively. Of those amounts, for the years ended December 31, 2000 and 1999, approximately, $ 47.9 million and $117.3 million, respectively represented the cash outflows from our reinsurance assumed and commercial lines, funded with the liquidation of their corresponding invested assets. Net cash provided by investing activities was $128.7 million and $136.4 million for the years ended December 31, 2000 and 1999, respectively as we funded the discontinuance of the reinsurance assumed and commercial lines of business. We also utilized the excess cash generated by our investing activities to retire debt and other financing activities. Net cash used in financing activities was $73.9 million and $40.8 million for the years ending December 31, 2000 and 1999, respectively as we aggressively repurchased outstanding debt.
Vesta Insurance Group, Inc. Consolidated Statements of Operations and Comprehensive Income (Loss) (amounts in thousands, except share data) Statements of Operations
Vesta Insurance Group, Inc Consolidated Statements of Cash Flows (amounts in thousands)
Nature of Operations: Vesta Insurance Group, Inc. and subsidiaries is a holding company for a group of insurance companies that offers financial services through the production, distribution, and administration of property- casualty and life insurance products. The lead insurers in the Vesta Group are Vesta Fire Insurance Corporation and American Founders Life Insurance Company. In 1999 and 2000, we discontinued commercial line of business and its reinsurance assumed line of business, respectively. See Note Q.
For investment contracts without mortality risk (such as deferred annuities and immediate annuities with benefits paid for a certain period), premium deposits and benefit payments are recorded as increases or decreases in a liability account, rather than as revenue and expense. We record as revenue any amounts charged against the liability account for the cost of insurance, policy administration, and surrender penalties. Any interest credited to the liability account and any benefit payments which exceed the contract liability account balance are recorded as expenses. As of December 31, 2000, approximately $72.5 million (34%) of Vesta's annuity reserves are subject to discretionary withdrawal without surrender charges or other adjustments.
Deferred Acquisition Costs: Commissions and other costs that vary with and are primarily related to the production of new and renewal business are deferred and amortized over the terms of the policies to which they relate. Anticipated investment income is considered in determining recoverability of deferred acquisition costs.
The costs to acquire blocks of life insurance representing the present value of future profits from such blocks of insurance is also included in deferred acquisition costs. We amortize the present value of future profits over the premium payment period. The unamortized present value of future profits was approximately $17.9 million at December 31, 2000. During 2000, $19.2 million of present value of future profits was capitalized (relating to acquisitions made during the year) and $1.3 million was amortized.
Depreciation expense on property and equipment used in the business was $3.3 million, $4.3 million, and $4.2 million for the years ended December 31, 2000, 1999, and 1998, respectively.
2000 1999 ------- ------- Goodwill $20,516 $ 7,339 Accumulated amortization (2,719) (1,724) ------- ------- $17,797 $ 5,615 ======= =======
Liabilities acquired: Future policy benefits $690,206 FHLB notes payable 143,123 Other liabilities 52,496 -------- Total liabilities $885,825
Pro forma consolidated results of operations are as follows for the years ending December 31 (in thousands except per share amount, unaudited):
The following is a summary of selected statutory financial information for our primary insurance subsidiaries at December 31, 2000 and 1999 (in thousands):
An analysis of gains (losses) from investments is as follows (in thousands):
We maintain a mortgage loan portfolio consisting of first-lien residential and commercial mortgages. At December 31, 2000, our residential mortgages had carrying values of approximately $3.9 million and commercial mortgages had carrying values of approximately $22.8 million. Collateral loans totaled $36.4 million and were collateralized by the stock of 5 separate Mexican companies.
Subsequent to the filing of its quarterly report on Form 10-Q for the period ended March 31, 1998 with the Securities and Exchange Commission, we commenced an internal investigation to determine the exact scope and amount of certain reductions of reserves and overstatement of premium income in Vesta's reinsurance assumed business that had been recorded in the fourth quarter of 1997 and the first quarter of 1998. This investigation concluded that inappropriate amounts had, in fact, been recorded and we determined that we should restate our previously issued 1997 financial statements and first quarter 1998 Form 10-Q. Additionally, during our internal investigation we re-evaluated the accounting methodology being utilized to recognize earned premium income in our reinsurance business. We had historically reported certain assumed reinsurance premiums as earned in the year in which the related reinsurance contracts were entered even though the terms of those contracts frequently bridged two years. We determined that reinsurance premiums should be recognized as earned over the contract period and corrected the error in our accounting methodology by restating previously issued financial statements. We issued press releases, which were filed with the Securities and Exchange Commission, on June 1, 1998 and June 29, 1998 announcing our intention to restate our historical financial statements.
Commencing in June 1998, Vesta and several of its current and former officers and directors were named in several purported class action lawsuits in the United States District Court for the Northern District of Alabama. Several of Vesta's officers and directors also have been named in a derivative action lawsuit in the Circuit Court of Jefferson County, Alabama, in which Vesta is a nominal defendant.
As discussed above, we corrected our accounting for assumed reinsurance business through restatement of our previously issued financial statements. Similar corrections were made on a statutory accounting basis through recording cumulative adjustments in Vesta Fire's 1997 statutory financial statements. The impact of this correction has been reflected in amounts ceded under our 20 percent whole account quota share treaty which was terminated on June 30, 1998 on a run-off basis. We believe such treatment is appropriate under the terms of this treaty and have calculated the quarterly reinsurance billings presented to the three treaty participants accordingly. The aggregate amount included herein as recoverable from such reinsurers totaled $55.2 million at December 31, 2000. We have previously collected approximately $48.5 million from the drawdown of collateral on hand.
NRMA, one of the participants in the 20 percent whole account quota share treaty, filed a lawsuit in the United States District Court for the Northern District of Alabama contesting the Vesta's claim and the validity of the treaty, and seeking return of the $34.5 million of drawn down collateral. Vesta filed a demand for arbitration as provided for the treaty and filed a motion to compel arbitration which was granted in the United States District Court action. Vesta filed for arbitration against the other two participants on the treaty and all those arbitrations are in their early stages. While management believes its interpretation of the treaty's terms and computations based thereon are correct, these matters are in their early stages and their ultimate outcome cannot be determined at this time.
During 1999, F&G Re (on behalf of USF&G), filed for arbitration under two aggregate stop loss reinsurance treaties whereby F&G Re assumed certain risk from the Vesta. F&G Re is seeking to cancel the treaties and avoid its obligation. Based on the terms of the two treaties, Vesta will be entitled to recoveries of approximately $28.2 million as losses from prior accident years mature. Vesta has recorded a reinsurance recoverable of $28.2 million at December 31, 2000 and 1999 related to these two treaties. While management believes that the treaties with F&G Re are valid and legal treaties, this arbitration is in its early stage and the ultimate outcome cannot be determined at this time.
quarter, the treaty was terminated on a cut-off basis. Vesta is seeking recoupment of all improper claims payments and excessive expense allocations and charges from CIGNA. This arbitration is in its early stages and the ultimate outcome cannot be determined at this time.
Under insurance guaranty fund laws, in most states, insurance companies doing business therein can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies. We do not believe such assessments will be materially different from amounts already provided for in the financial statements.
Leases: We lease office space for our home office and subsidiary offices under operating lease arrangements. Rental expense for operating leases was $3.0 million, $2.1 million, and $1.8 million for the years ending December 31, 2000, 1999 and 1998 respectively. Future minimum rental commitments required under these leases are approximately $3.2 million per year.
Year Ended December 31, 2000 1999 1998 ------- ------- ------- Interest paid $23,275 $10,174 $11,193 Income taxes paid 1,901 -- --
Year Ended December 31, 2000 1999 1998 ------- -------- -------- (amounts in thousands) Premiums assumed $38,240 $116,678 $341,956 Losses, policy benefits, and LAE assumed 31,746 69,348 230,497
Year Ended December 31, 2000 1999 1998 ------- ------- -------- Reinsurance ceded: (in thousands) Premiums ceded $43,413 $91,759 $310,652 Losses and LAE recovered and recoverable $40,316 $97,758 $199,026
The amounts of reserves for unpaid losses and loss adjustment expenses and unearned premiums that Vesta would remain liable for should reinsuring companies be unable to meet their obligations are as follows:
Year Ended December 31, 2000 1999 -------- -------- (in thousands) Losses and loss adjustment expense $170,050 $186,559 Policy liabilities 170,766 -- Retroactive Reinsurance Receivable 599 3,275 Unearned premiums 12,534 3,511 -------- -------- $353,949 $193,345 ======== ========
Year Ended December 31, 2000 1999 1998 ------ ------ ------ Statutory federal income tax rate 35.0 % 35.0 % 35.0 % Increases (reductions) in tax resulting from: Tax exempt investment income (4.0) (5.0) 2.0 Goodwill 1.0 0.4 (8.0) Other 1.9 0.6 -- ---- ---- ---- 33.9 % 31.0 % 29.0 % ==== ==== ====
2000 1999 ------- ------- (in thousands) Deferred tax assets: Unearned and advance premiums $ 6,160 $ 9,122 Discounted unpaid losses 6,443 8,217 Net operating loss/AMT credit carryforward 15,468 20,077 Policy liabilities 4,204 -- Goodwill 9,653 7,140 Other 11,107 1,841 ------- ------- Total deferred tax assets 53,035 46,397
Deferred tax liabilities: Deferred acquisition costs 18,433 $20,565 Contingent commissions -- 2,002 Unrealized gains (losses) 2,330 (1,779) Fixed assets 1,874 2,889 Other 7,941 9,231 ------- ------- Total deferred tax liabilities 30,578 $32,908 ------- -------
Deferred tax assets are to be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. Vesta has determined that the benefits of its deferred tax assets are realizable and accordingly, no valuation allowance has been recorded at December 31, 2000 and 1999. Net operating loss carryforwards expire in 2019.
Vesta has 2,950,000 shares of Series A Convertible Preferred Stock outstanding at December 31, 2000 and 1999. Each share of the preferred stock is convertible into two shares of Vesta's common stock. Dividends are cumulative at a 9% rate compounded semi-annually. The preferred stock will automatically be converted into shares of common stock of Vesta at the date the common stock achieves an average closing price of $8.00 per share for twenty consecutive trading days. The preferred stock can also be converted at any time at the election of the preferred stockholders and must be converted at the end of fifteen years. The preferred stockholders have liquidation preference senior to common stock, have voting rights of 5.9 million shares of common stock, and have the right to elect 3 members of the Board of Directors. On January 26, 2001, pursuant to the original terms, the preferred stockholders converted their preferred stock into 5.9 million shares of common stock.
In the fourth quarter of 2000, Vesta established the Agent Stock Incentive Plan Trust to satisfy future obligations of Vesta to its Agents under the terms of the Agent's Stock Incentive Plan. Vesta issued 750,000 shares to the Trust in December 2000. At December 31, 2000, 750,000 shares were held by the trust and are included in the Unearned stock caption on the Balance Sheet as contra equity.
During 2000, we engaged in a number of purchases and sales of our common stock. In two separate transactions, we repurchased 5.1 million shares of stock from our former parent, Torchmark Corporation. We disposed of the acquired stock in a number of private placements, two debt
Unearned stock consists of shares of common stock issued by Vesta that remain subject to certain future restrictions, and therefore are shown as a reduction to stockholders' equity. Unearned stock compensation is composed of the following at December 31, 2000, and 1999, respectively (in thousands):
2000 1999 ------ ------ Unamortized restricted stock awards $1,804 $1,121 Receivable from issuance of restricted stock 438 681 Agent's trust 4,725 -- ------ ------ $6,967 $1,802 ====== ======
In 2000, we changed our segments to reflect our entering new lines of business, and exiting old lines of business. We operate several segments, which are distinguishable by their product offerings. The accounting policies of the operating segments are described in Note A. Segment pre-tax income is generally income before income tax, and minority interest. Premiums, policy fees, other income, loss and benefit expenses, and amortization of deferred acquisition costs are attributed directly to each operating segment. Operating expenses are allocated to the segments in a manner which most appropriately reflects the operations of that segment. Net investment income and interest expense are allocated only to those segments for which such amounts are considered an integral part of the financial results for that segment.
The standard property-casualty segment primarily consists of the marketing and distribution of personal lines products including Homeowners and Personal Auto coverages. Vesta's products are distributed primarily through approximately 1,600 independent agencies in 24 states. Our personal auto line targets drivers over age thirty-five with above average driving records and our homeowners products cover the full range of homes.
In 2000, we began utilizing our licences to write business for the benefit of reinsurance companies. In this segment, we enter into arrangements whereby we write targeted property-casualty insurance coverages and reinsure substantially all of the risks to reinsurers in exchange for fees. This business takes advantage of our certificates of authority granting us license to write insurance in many states. Income in this segment is generated on a fee-for- service basis primarily.
Long-term debt and Deferrable Capital Securities at December 31, 2000 and 1999 consists of the following (in thousands):
8.75% Senior Debentures, due July 15, 2025 $86,820 $100,000 12.5% Senior Notes, due December 30, 2006 -- 44,082 Less: debt issue cost (401) (2,206) ------- -------- Long-term debt $86,419 $141,876 ======= ========
8.525% Deferrable Capital Securities, issued by Vesta Capital Trust I, due January 15, 2027 $33,225 $ 41,225 ======= ========
We are required to maintain a collateral deposit with FHLB. At December 31, 2000, investments having a market value of approximately $153.9 million were pledged to FHLB. Interest expense was approximately $9.6 million for the year ended December 31, 2000.
During 1995, the Financial Accounting Standards Board issued Financial Accounting Statement No. 123, Accounting for Stock-Based Compensation ("SFAS 123"). The Statement defines a fair value based method of accounting for an employee stock option. It also allows an entity to continue using the intrinsic value based accounting method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Vesta has continued to use this method to account for its stock options. However, SFAS 123 requires entities electing to remain with the intrinsic method of accounting to provide pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied as well as other disclosures about Vesta's stock-based employee compensation plans. Information about Vesta's stock option plans and the related required disclosures follow.
Weighted- Average Expiration Number of Exercise Options Date Shares Price Exercisable ---------- --------- ---------- ----------- 2003 155,501 $16.33 155,501 2004 19,500 15.05 19,500 2005 98,061 21.87 98,061 2006 9,000 35.38 9,000 2007 15,000 31.00 15,000 2008 15,000 59.19 15,000 2009 383,500 4.51 138,500 2010 130,000 4.89 35,000
. Equity Securities - The carrying value of unaffiliated common stock, except for stock of FHLB, approximates fair value. Because FHLB shares are not publicly traded, the market value of the stock was considered to be equivalent to cost due to the fact that FHLB has historically redeemed the shares at the original cost.
. Other Invested Assets, Including Collateral Loans - The carrying value of certain other invested assets approximates fair value because existing rates of return approximates the current rates of return required on similar investments. The carrying amount of collateral loans approximates fair value as effective yields approximate current rates.
. Annuity Account Balances - Annuity account balances include single premium and flexible premium deferred and immediate annuity contracts, supplementary contracts not having significant mortality risk, policyholder dividend accumulations, and separate account liabilities. Cash surrender value is used in determining the fair value of single premium and flexible premium deferred annuity contracts. Carrying amounts approximated fair value for immediate annuities, supplementary contracts, policyholder dividend accumulations, and separate account liabilities.
In 1999, we elected to exit the assumed reinsurance business and ceased accepting new contracts. We sold the majority of our reinsurance assumed operations, including most renewal rights to Hartford Fire Insurance Company in the first quarter of 1999 for $15 million. In the fourth
2000 1999 -------- -------- Investments and other assets $128,794 $133,000 Deferred acquisition costs - 8,995 Reserves for loss, LAE and unearned premium 128,794 141,995
On January 30, 2000, we exchanged approximately 380,000 shares of common stock for $3.5 million face amount of Deferrable Capital Securities, resulting in a pre-tax gain of approximately $.9 million.