The accounting treatment for MPCI is different than the more traditional property and casualty insurance lines. For income statement purposes, gross premiums written consist of the aggregate amount of MPCI premiums paid by farmers, and does not include any related federal premium subsidies. The Company's profit or loss from its MPCI business is determined after the crop season ends on the basis of a profit sharing formula established by law and the RMA. For income statement purposes, any such profit share earned by the Company, net of the cost of third party reinsurance, is shown as net premiums written, which equals net premiums earned for MPCI business; whereas, any share of losses payable by the Company is charged to losses and loss adjustment expenses. Due to various factors, including timing and severity of losses from storms and other natural perils and crop production cycles, the profit or loss on MPCI premiums was primarily recognized in the second half of the calendar year for 1999 and prior years. Due to the nature of the CRC product whereby results are influenced by changes in the market prices of various commodities in the fourth quarter and the increasing significance of CRC as a percentage of MPCI, the Company recorded its initial estimate of the profit or loss for the 2000 crop results in the fourth quarter of 2000. The Company relies on loss information from the field to determine (utilizing a formula established by the RMA) the level of losses that should be considered in estimating the profit or loss during this period.
Certain characteristics of the Company's crop business may affect comparisons, including: (i) the seasonal nature of the business whereby profits or losses are generally recognized predominately in the fourth quarter of the year; (ii) the nature of crop business whereby losses are known within a one year period; and (iii) the limited amount of investment income associated with crop business. In addition, cash flows from such business differ from cash flows from certain more traditional lines. See "Liquidity and Capital Resources" below. With the Company's increased emphasis on the crop segment, the seasonal and short term nature of the Company's crop business, as well as the impact on the crop business of weather and other natural perils, may produce more volatility in the Company's operating results on a quarter to quarter or year to year basis than has historically been the case.
The Company's results are significantly impacted by its crop business, particularly its MPCI line. Initial estimated results from the crop lines are not generally recorded until the fourth quarter of the year, after crops are harvested and final market prices are established. Crop segment results are particularly dependent on events beyond the Company's control, notably weather conditions during the crop growing seasons in the states where the Company writes a substantial amount of its crop insurance, the market price of grains on various commodity exchanges and overall worldwide supply and demand, the continuing globalization of the crop industry and its effect on the export of crops to other countries and the volatility of crop prices resulting from domestic and foreign policy decisions. Additionally, federal regulations governing aspects of crop insurance are frequently modified, and any such changes may impact crop insurance results.
Forward-looking information set forth herein does not take into account any impact from any adverse weather conditions during the 2001 crop season, or the various other factors noted above which may affect crop and noncrop operation results. See "Business-Uncertainties Affecting the Insurance Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations-General" above for additional information regarding these events and factors.
Year ended December 31, 2000 Compared to Year Ended December 31, 1999
The underwriting loss from the Company's crop segment increased from $3.7 million in 1999 to $22.6 million in 2000. The MPCI premium volume increased from $365 million in 1999 to $375 million in 2000. The Company's core markets areas increased by approximately $35 million while a reduction of $25 million was achieved in less profitable areas. During 2000 the Company earned a profit share of $40.0 million on its MPCI retained pool of approximately $232.0 million while in 1999 the Company earned a profit share of $40.1 million on approximately $246.1 million retained premium pool. In 2000 and 1999, the Company recorded additional profit share relating to previous years of approximately $11.0 million and $.8 million, respectively. As a percent of premium, the Company experienced a reduction in the 2000 crop year profit share due to drought conditions, particularly in Nebraska and Iowa. The Company utilizes both the FCIC reinsurance program and third party reinsurance in order to manage volatility in loss exposure. During 2000 the Company increased its utilization of the FCIC reinsurance program and increased third party reinsurance protection. The Company ceded a portion of the profit share related to approximately $66 million and $35 million of its retained premium under the MPCI program for 2000 and 1999, respectively, to reinsurers participating in its overall crop reinsurance programs which resulted in an additional cost to the Company of $5.1 million in 2000 as compared to 1999. The Company expects to continue to cede portions of its premiums under MPCI programs in the future in order to secure the required reinsurance capacity for its crop programs. Additionally, the Company expects $7.5 million of the reinsurance costs to continue each year for up to six years in the future. The Company has obtained a letter of credit to secure the expected future ceded premiums.
The Company's property and casualty segment was impacted in 2000 by the sale of its nonstandard automobile business in the third quarter of 1999 and by the transfer in the first quarter of 2000 of the renewal rights for all business previously produced and serviced by the Company's Scottsdale, Arizona office and for its "long haul" trucking business. Accordingly, gross written premiums and net earned premiums decreased by approximately 45% and 38%, respectively, during 2000 compared to 1999. The Company expects further reductions in property and casualty segment premiums due to 74% of the net earned premiums for 2000 being from lines of business discontinued during the past three years or included the Company's sale of property and casualty lines announced in March 2001. The Company is exploring opportunities to reduce the remaining property and casualty business.
As a result of the sale of a significant portion of its property and casualty business and based upon estimated future discounted cash flows, the Company concluded that the excess of cost over acquired net assets was partially impaired by approximately $9.9 million. As such, the Company recorded a $9.9 million charge for the write-off of cost over acquired net assets in the fourth quarter of 2000.
The underwriting loss for the property and casualty segment decreased from $74.9 million in 1999 to $21.2 million in 2000. This was primarily related to the $44.0 million reserve strengthening that was recorded in 1999 related to losses for 1998 and prior years compared to approximately $2.4 million of reserve strengthening recorded in 2000 for years 1999 and prior. The reserve increase recorded in 1999 resulted from a significant unexpected increase in the number of claims reported, principally under policies covering the 1990 through 1995 accident years, and primarily related to construction defect claims under general liability policies insuring contractors in the State of California. To a lessor extent, the Company also experienced an increase in the IBNR claims for the 1998 year in its commercial automobile lines. Additionally, results for 1999 were negatively impacted by costs totaling approximately $9.0 million related primarily to the divestitures of various lines of property and casualty business.
The Company's net investment income declined from approximately $25.1 million in 1999 to $24.7 million in 2000. This decrease in investment income was primarily affected by a decline in the size of the average outstanding portfolio of the Company from approximately $473 million in 1999 to $414 million in 2000. Partially offsetting this was an increase in the yield on the portfolio to 6.0% for 2000 compared to 5.3% for 1999. During the fourth quarter of 2000 and continuing into 2001 the Company has liquidated a substantial portion of the municipal securities. The Company anticipates that the municipal security holdings will represent less than 5% of the portfolio.
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 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. 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 decrease in operating profits from $33.9 million in 1998 to $0.8 million in 1999 was primarily attributable to the decrease in reimbursement rate, increase in reinsurance costs, the higher operating costs and less profit share.
The Company has included a discussion of the liquidity and capital resources requirement of the Company and the Company's insurance subsidiaries.
As an insurance holding company, the Company's assets consist primarily of the capital stock of its subsidiaries, surplus notes issued by two of its insurance company subsidiaries and investments held at the holding company level. The Company's primary sources of liquidity are receipts from interest payments on the surplus notes, payments from the profit sharing agreement with American Agrisurance, the Company's wholly owned subsidiary which operates as the general agent for the Company's crop insurance programs, tax sharing payments from its subsidiaries, investment income from, and proceeds from the sale of, holding company investments, and dividends and other distributions from subsidiaries of the Company. The Company's liquidity needs are primarily to service debt, pay operating expenses and taxes and make investments in subsidiaries.
In 1997, AICI Capital Trust, a Delaware business trust organized by the Company (the "Issuer Trust") issued 3.795 million shares or $94.875 million aggregate liquidation amount of its 9% Preferred Securities (liquidation amount $25 per Preferred Security). The Company owns all of the common securities (the "Common Securities") of the Issuer Trust. The Preferred Securities represent preferred undivided beneficial interests in the Issuer Trust's assets. The assets of the Issuer Trust consist solely of the Company's 9% Junior Subordinated Debentures due 2027 which were issued in 1997 in an amount equal to the Preferred Securities and the Common Securities. Distributions on the Preferred Securities and Junior Subordinated Debentures are cumulative, accrue from the date of issuance and are payable quarterly in arrears. The Junior Subordinated Debentures are subordinate and junior in right of payment to all senior indebtedness of the Company and are subject to certain events of default and redemptive provisions, all described in the Junior Debenture Indenture. At December 31, 2000, the Company had $94.875 million outstanding at a weighted average interest cost of 9.1%.
At December 31, 1999, the Company had a Revolving Credit Facility for $31.4 million. The entire facility was reserved for an outstanding letter of credit and, accordingly, no borrowings were permitted under such facility. During the first quarter of 2000, the Company replaced this facility with a Security and Letter Loan Agreement ("Loan") for the same amount. As with the previous facility, the entire amount of the Loan was used as security for an existing outstanding letter of credit. Under this Loan, the Company was not required to pledge stock of Redland Insurance Company and Acceptance Insurance Company, restrict payments of dividends, or maintain certain financial covenants, all of which were required by the Revolving Credit Facility. In December 2000, the Loan and related outstanding letter of credit were increased to $33.1 million.
Cash used by operating activities was $85.9 million for the year ended December 31, 2000 compared to cash used from operations for the same period in 1999 of $20.9 million. This decrease in cash flow from period to period is primarily related to the decline in operations under the Company's property and casualty segment. The Company expects negative cash flow from its property and casualty segment due to a decline in new business and the settlement of losses and loss adjustment expense reserves. The Company has positioned its portfolio to be able to meet these liquidity needs.
The Company does not believe that inflation has had a material impact on its financial condition or the results of operations.
At December 31, 2000 and 1999, the Company had $234.9 million and $259.3 million, respectively, of fixed maturity investments and mortgage loans and $17.6 million and $25.1 million, respectively, of marketable equity securities that were subject to market risk. The Company's investment strategy is to manage the duration of the portfolio relative to the duration of the liabilities while managing interest rate risk. In addition, the Company has the ability to hold its fixed maturity investments until maturity and therefore would not expect to realize a material adverse impact on income or cash flows.
As a result of the sale of a significant portion of its property and casualty business and based upon estimated future discounted cash flows, the Company concluded that the excess of cost over acquired net assets was partially impaired by approximately $9.9 million. As such, the Company recorded a $9.9 million charge for the write-off of excess of cost over acquired net assets in the fourth quarter of 2000.
Statement of Financial Accounting Standards No. 133 (SFAS No. 133), "Accounting for Derivative Instruments and for Hedging Activities," requires companies to recognize all derivatives as either assets or liabilities in the statement of financial condition and to measure all derivatives at fair value. SFAS No. 133 requires that changes in fair value of a derivative be recognized currently in earnings unless specific hedge accounting criteria are met. Upon implementation of SFAS No. 133, hedging relationships may be redesignated, and securities held to maturity may be transferred to available-for-sale or trading. SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133," deferred the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" amended the accounting and reporting standards of SFAS No. 133 for certain derivative instruments, hedging activities, and decisions made by the Derivatives Implementation Group. The impact on the Company's financial statements related to the adoption of SFAS No. 133, SFAS No. 137 and SFAS No. 138 will not be significant.
See Item 14 hereof and the Consolidated Financial Statements attached hereto.