The Company is the owner of two office buildings, both located in Beverly Hills, California, which were occupied by the Company's headquarters until March 1999. One building contains approximately 25,000 square feet of office space and the other office building contains approximately 24,000 square feet. Both office buildings are currently unencumbered. The Company intends to lease all of the space in both buildings to third parties.
In July 1998, the Company entered into a lease covering approximately 95,000 square feet of office space for new Company headquarters. The lease is for a term of 10 years and the Company moved its headquarters and principal operations to this space in early March 1999. The Company
(1) Financial data as of and for the years ended December 31, 1995 and 1994 are derived from the combined financial statements of the Exchange and an affiliated non-profit corporation that was liquidated into the Exchange on July 12, 1996. Financial data as of and for the year ended December 31, 1996 are derived from the consolidated financial statements of the Exchange and its wholly-owned subsidiaries. Financial data as of and for the years ended December 31, 1998 and 1997 are derived from the consolidated financial statements of SCPIE Holdings Inc. and its wholly-owned subsidiaries.
(3) Basic earnings per share of common stock at December 31, 1998 and 1997 is computed using the weighted average number of common shares outstanding during the year of 12,074,272 and 12,108,330, respectively. All other periods give effect to the Reorganization completed on January 29, 1997, including the allocation of 9,994,652 shares of common stock to members of the Exchange in connection therewith. Diluted earnings per share of common stock at December 31, 1998 is computed using the weighted average number of common shares outstanding during the year of 12,089,013. The adoption of Statement of Financial Accounting Standards No. 128 (Statement 128), "Earnings per Share" had no impact on the calculation of earnings per share
On January 29, 1997, SCPIE consummated its reorganization from a reciprocal insurance company to a stock insurance company by merging with and into SCPIE Indemnity Company (the "Reorganization"). In connection with the Reorganization, 9,994,652 shares of the Company's common stock were issued to members of the Exchange in exchange for their membership interests in SCPIE, and 500,000 shares of common stock were issued to SCPIE Indemnity Company ("SCPIE Indemnity").
On January 30, 1997, the Company made an initial public offering of 2,300,000 shares of its common stock. The net proceeds of approximately $36.4 million of the common stock offering were used to capitalize the Company's insurance company subsidiaries, to facilitate geographic expansion, and for general corporate purposes.
Many factors influence the financial results of the medical malpractice insurance industry, several of which are beyond the control of the Company. These factors include, among other things, changes in severity and frequency of claims; changes in applicable law and regulatory reform; changes in judicial attitudes toward liability claims; and changes in inflation, interest rates and general economic conditions.
The vast majority of the Company's business is professional liability insurance for physicians written on a claims made and reported basis. The Company believes that the integration of healthcare delivery in recent years, particularly in California, will result in the growing importance of large medical groups and other healthcare entities, and a corresponding change in the entities that make professional liability purchasing decisions. The Company believes that these changes have created a need for the Company to further diversify. As a result, the Company has adopted a strategy for growth that includes expanding the type of products offered by the
Company and diversifying geographically by offering products in states other than California. The Company began to implement its strategy in 1994 by offering professional liability insurance to hospitals in California and, in 1995, began offering errors and omissions coverage for managed care organizations.
In addition, AHI acquired the medical malpractice insurance business of Fremont Indemnity Company ("Fremont") effective January 1, 1998 through a 100% quota-share retroactive reinsurance agreement. Simultaneously, a 100% quota-share prospective fronting reinsurance agreement went into effect, making SCPIE Indemnity the reinsurer for the Fremont policies until AHI obtains the proper approvals to write this business directly. The Fremont policies are written through brokers in 10 states, with the vast majority in California and Arizona. During the fourth quarter of 1998, AHI received regulatory approval to write this business directly. Upon the policy's renewal date, each policy will be transferred from a Fremont policy to an AHI policy. There is no assurance, however, that the Company will successfully retain or expand this business or that it will ultimately be profitable.
The Company believes that a combination of these and other factors have contributed to the recent redundancies in reserves established by SCPIE for prior years. The original reserves were established without full knowledge of the effect of these factors. Redundant reserves, which have been released in every year since 1985, have contributed significantly to reported earnings in recent years. The Company reduced reserves for prior years by $93.8 million, $53.2 million, and $59.7 million in the years ended December 31, 1998, 1997 and 1996, respectively. The redundancies recognized in 1998 were offset, in part, by a $28.1 million increase in the loss and LAE reserves for the medical malpractice insurance business assumed from Fremont in January 1998. The strengthening of the Fremont reserves was made in order to bring those reserves in line with the Company's more conservative reserving policy. The Company cannot predict whether similar redundancies will be experienced in future years. The Company continues to establish its loss and LAE reserves at what it believes is the upper end of a reasonable range of reserve estimates, but there is no assurance that such reserves will ultimately prove to be redundant. The Company believes that some reduction in the amount of the redundancies recently experienced is reasonably likely. If such redundancies do not occur or loss and LAE experience does not improve, the Company's net income could be significantly reduced or a net loss could occur.
PREMIUMS EARNED Premiums earned increased approximately $24.1 million, or 18%, to $158.0 million in 1998 from $133.9 million in 1997. The increase was principally due to a $30.0 million increase in physician and medical group medical malpractice insurance premiums to approximately $143.2 million in 1998 from $113.2 million in 1997. This increase was a result of the Company's acquisition of the medical malpractice book of business of Fremont on January 1, 1998 and premiums attributable to an agency relationship with Poe & Brown which commenced on January 1, 1998. Hospital medical malpractice premiums were approximately $8.8 million in 1998 compared to $14.6 million in 1997. This decrease in 1998 hospital premiums is due principally to the loss of one large integrated hospital account in Florida in late 1997. Assumed reinsurance premiums, other than those received in the Fremont and Poe and Brown arrangements, increased slightly in 1998.
REALIZED INVESTMENT GAINS AND OTHER REVENUE Realized investment gains were approximately $11.1 million in 1998 compared to $6.6 million in 1997. In December 1998 sales were made in the fixed-maturity portion of the investment portfolio to reposition the portfolio by increasing the percentage of corporate securities.
OTHER OPERATING EXPENSES Other operating expenses increased $10.2 million, or 56.8%, to $28.2 million in 1998 from $18.0 million in 1997. The ratio of other operating expenses to premiums earned is referred to as the expense ratio, which increased to 17.9%
YEAR ENDED DECEMBER 31, 1997, COMPARED TO YEAR ENDED DECEMBER 31, 1996
PREMIUMS EARNED Premiums earned increased approximately $13.4 million, or 11.1%, to $133.9 million in 1997 from $120.5 million in 1996. The increase was principally due to a $5.7 million increase in hospital medical malpractice premiums and an increase of $9.1 million increase in assumed reinsurance premiums. Medical malpractice premiums from physicians and medical groups were approximately $111.4 million in 1997 compared to $112.7 million in 1996. An average 5.0% increase in premium rates in effect during 1997 was offset by a 4.1% decrease in the average number of policies in force during 1997 as compared to 1996. Hospital medical malpractice premiums were approximately $8.0 million in 1997 compared to $2.3 million in 1996. Assumed reinsurance premiums were approximately $13.6 million in 1997, which includes $6.5 million of assumed hospital premiums compared to $4.5 million in 1996.
REALIZED INVESTMENT GAINS AND OTHER REVENUE Realized investment gains were approximately $6.6 million in 1997 compared to $11.7 million in 1996. Approximately $11.2 million of the gains from 1996 resulted from the sale of equity securities in connection with the Company's decision in the first quarter of 1996 to increase the focus of its investment portfolio on fixed-maturity securities. In 1997, sales were made in the fixed-maturity portion of the investment portfolio to reposition the portfolio by increasing the percentage of tax-exempt securities.
The Company maintains a portion of its investment portfolio in high-quality, short-term securities to meet short-term operating liquidity requirements, including the payment of losses and LAE. Short-term investments totaled $34.4 million, or 4.3% of invested assets, at December 31, 1998. The Company believes that all of its short-term and fixed-maturity securities are readily marketable.
SCPIE Holdings is an insurance holding company whose assets primarily consist of all of the capital stock of its insurance company subsidiaries. Its principal sources of funds are dividends from its subsidiaries and proceeds from the issuance of debt and equity securities. The insurance company subsidiaries are restricted by state regulation in the amount of dividends they can pay in relation to earnings or surplus, without the consent of the applicable state regulatory authority, principally the California Department of Insurance. SCPIE Holdings' principal insurance company subsidiary may pay dividends to SCPIE Holdings in any year, without regulatory approval, to the extent such dividends do not exceed the greater of (i) 10% of its statutory surplus at the end of the preceding year or (ii) its net income for the preceding year. Applicable regulations further require that an insurer's statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs, and permit the payment of dividends only out of statutory earned (unassigned) surplus unless the payment out of other funds receives regulatory approval. The amount of dividends that the insurance company subsidiaries are able to pay to SCPIE Holdings during 1999 without prior regulatory approval is approximately $41.1 million. Dividends of $25 million were paid to SCPIE Holdings during 1998.
The Company has received a commitment from a large lender for a bank facility in the amount of $75.0 million. The commitment is subject to certain terms and conditions as well as negotiation and completion of all documentation. The Company expects to use this facility for general corporate purposes.
During May 1997, the Board of Directors authorized the repurchase of up to 1,000,000 shares of the Company's common stock in the open market. The repurchases may be made from time to time and continue until May 1999. Since 1997, 413,300 shares were repurchased. Subsequent to December 31, 1998, an additional 77,900 shares were repurchased. The Board of Directors may further extend the program's expiration date.
The Company relies heavily on information technology ("IT") systems and other systems and facilities such as telephones, building access control systems and heating and ventilation equipment ("embedded systems") to conduct its business. The Company also has business relationships with health care providers, financial institutions, financial intermediaries, public utilities and other critical vendors as well as regulators and customers who are themselves reliant on IT and embedded systems to conduct their businesses.
Worldwide concerns have arisen over the ability of IT and embedded systems to function properly on and after January 1, 2000 ("Year 2000"). The Year 2000 concern is the result of many computer programs being written using two digits rather than four digits to define the applicable year. Systems that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000, or as no date. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business operations.
The Company also faces the risk that one or more of its critical suppliers or customers ("external relationships") will not be able to interact with the Company due to the third party's inability to resolve its own Year 2000 issues, including those associated with its own external relationships. The Company has completed its inventory of external relationships and risk rated each external relationship based upon the potential business impact, available alternatives and cost of substitution. The Company is attempting to determine the overall Year 2000 readiness of its external relationships. In the case of mission critical suppliers such as banks, financial intermediaries (such as stock exchanges), telecommunications providers and other utilities, IT vendors, financial market data providers, major physician groups and major hospitals, the Company is engaged in discussions with the third parties and is attempting to obtain detailed information as to those parties' Year 2000 plans and state of readiness. The Company, however, does not have sufficient information at the current time to predict whether its external relationships will be Year 2000 ready.
own Year 2000 project and those of its critical external relationships and by developing contingency/recovery plans. The Company cannot guarantee that it will be able to resolve all of its Year 2000 issues. Any critical unresolved Year 2000 issues at the Company or with its external relationships, however, could have a material adverse effect on the Company's results of operations, liquidity or financial condition.
The Company's Consolidated Financial Statements and related notes, including supplementary data, are set forth in the "Index" on page 48 hereof.