The Company owns a 3.28 acre tract of land in Fort Worth, Texas and all improvements located thereon, including two office buildings with approximately 12,500 square feet of combined space. The Company currently has this property available for sale or lease.
The selected consolidated financial data presented in the following tables for, and as of the end of each of the years ended December 31, have been derived from the consolidated financial statements of the Company which have been audited by KPMG LLP, independent certified public accountants. The consolidated balance sheets as of December 31, 2002 and 2001, and the consolidated statements of operations, shareholders' equity and comprehensive loss and cash flows for each of the years in the three-year period ended December 31, 2002, and the independent auditors report thereon are included elsewhere in this document. The information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," consolidated financial statements and the notes thereto, and the other financial information included herein.
(1) Excludes premiums of $1,727,000 in 2002, $16,627,000 in 2001, $26,973,000 in 2000, $58,137,000 in 1999, and $47,588,000 in 1998 from the Company's fronting arrangements, the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania under which the Company was a servicing carrier and the reinsurance arrangement in Florida whereby MGAI premiums are ceded to a non-affiliated reinsurer and assumed by General Agents.
(2) Includes after tax net realized gains (losses) from securities transactions of $1,352,000, $2,822,000, $(1,258,000), $400,000, and $457,000 for 2002, 2001, 2000, 1999, and 1998, respectively.
(4) Based on 21,169,736 shares of Common Stock outstanding at the end of 2002, 2001 and 2000 and 20,919,833 shares at the end of 1999. See Note (7) of Consolidated Financial Statements.
The discussion and analysis of the Company's financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates under different assumptions or conditions.
Bonds available for sale and other investments are stated at fair value with changes in fair value recorded as a component of comprehensive income. Short-term investments are stated at cost. The "specific identification" method is used to determine costs of investments sold. Provisions for possible losses are recorded only when the values have experienced impairment considered "other than temporary" by a charge to realized losses resulting in a new cost basis of the investment. The Company's policy is to review investments on a regular basis to evaluate whether or not each investment has experienced an "other than temporary" impairment.
residual values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("Statement 121").
The remaining $609,000 of goodwill is associated with the 1998 acquisition of the Lalande Group and reflects a value no less than the estimated fair valuation levels of combined agency and claims handling operations of this type in the personal automobile marketplace.
Claims and claim adjustment expenses, less related reinsurance, are provided for as claims are incurred. The provision for unpaid claims and claim adjustment expenses includes: (1) the accumulation of individual case estimates for claims and claim adjustment expenses reported prior to the close of the accounting period; (2) estimates for unreported claims based on past experience modified for current trends; and (3) estimates of expenses for investigating and adjusting claims based on past experience.
Ultimate liability may be greater or lower than current reserves. Reserves are monitored by the Company using new information on reported claims and a variety of statistical techniques. The reserves are reviewed annually by an outside actuarial firm. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. Beginning in the third quarter of 2002 and for each quarter thereafter, the Company set reserves equal to the selected reserve estimate as established by an outside actuarial firm. Formerly management set reserves based upon its actuarial analysis.
In assessing the realization of its deferred tax assets, management considers whether it is more likely than not that a portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon management's consideration of expected reversal of deferred tax liabilities and projected future taxable income, management believes it is more likely than not that the Company will not realize the benefits of these deferred tax assets in the near future.
In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("Statement 146"). The provisions of Statement 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of Statement 146 is not expected to have a material effect on the Company's consolidated financial position or result of operations.
In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("Statement 144"), establishing financial accounting and reporting for the impairment or disposal of long-lived assets. Statement 144 is effective for fiscal years beginning after December 15, 2001. Pursuant to Statement 144 the discontinuance of commercial lines was not reported as discontinued operations. The Company believes that the adoption of Statement 144 will have no other effect on the Company's financial position or results of operation.
In 2002 the Company recorded a net loss of $8,761,087, or $0.57 per share (basic), primarily due to unfavorable claims experience and goodwill impairment. The Company continues to proceed in an orderly fashion with its exit from commercial lines. The loss of $75,607,047, or $3.68 per share (basic) recorded in 2001 was primarily a result of unfavorable claims experience, goodwill impairment and a valuation allowance for deferred Federal income taxes. On February 7, 2002, the Company announced its plans to discontinue writing commercial lines insurance due to continued adverse claims development and unprofitable results. In 2000 the Company recorded a net loss of $19,551,365, or $.97 per share (basic), primarily as a result of significant unfavorable claims experience in the commercial auto liability line of business. The Company materially increased the ultimate estimated liabilities for the line and entered into a reinsurance agreement, effective December 31, 2000, that provides significant additional protection in the event of further adverse reserve development. Additionally, the Company has reinsured the run-off of this business in 2001. The Company recorded U.S. GAAP combined ratios of 125.9% in 2002, 172.6% in 2001 and 126.3% in 2000.
The Company sold the office building at 500 Commerce Street in Fort Worth, Texas, where the Company's principal executive offices and commercial insurance operations were located, to an unaffiliated third party for $5 million on August 30, 2002. The Company recorded a gain of $455,056 from this transaction. As a result, the Company leased new office space to house its principal executive offices and commercial insurance operations.
In July 2002 the Company also entered an office lease with an unaffiliated third party for 10,577 square feet of space at 5400 Airport Freeway, Suite A, Fort Worth, Texas, to house the Company's commercial insurance operations. The lease is for a term of five years, although the Company may terminate the lease at its option after the expiration of three years. The annual base rental expense is $105,770.
The Company entered into retention incentive agreements with sixteen of its employees, three of whom are officers of the Company. Each of the retention incentive agreements generally requires that the Company pay the applicable employee an amount based upon the employee's annual base salary, less amounts owed by the Company to the employee pursuant to any change in control or severance agreements the employee may have with the Company. The Company's obligation to make payments under each retention incentive agreement is conditioned upon the employee remaining in the employ of the Company through a specified date, unless terminated earlier by the Company without cause or by the employee with good reason. The Company could be obligated to make up to an aggregate of approximately $793,000 in payments under the retention incentive agreements. Other than Jackiben N. Wisdom (who was not one of the five most highly compensated employees of the Company at the time he entered into his retention incentive agreement), none of the five most highly compensated employees of the Company are parties to the retention incentive agreements.
In December 2002, McRae B. Johnston, the President - Personal Lines Division of the Company, resigned his employment with the Company and each of its subsidiaries other than MGA Insurance Company, Inc. ("MGAI"), where Mr. Johnston remained employed until March 1, 2003. The Company and Mr. Johnston entered into separation agreements and releases (the "Release Agreements") pursuant to which the Company and Mr. Johnston each mutually released the other from obligations under the stock purchase agreement and employment contract between the Company and Mr. Johnston and generally from any and all other claims that each otherwise may have had against the other. The Company paid Mr. Johnston an aggregate of $400,000 pursuant to the Release Agreements. Mr. Johnston also entered into a one-year Consulting Agreement with MGAI effective after the conclusion of his employment with MGAI on March 1, 2003 pursuant to which MGAI will pay Mr. Johnston an aggregate of $200,000 to be made in four equal payments of $50,000 each in March, June, September and December of 2003.
$2,965,000 at December 31, 2002 and $3,078,000 at December 31, 2001. MCIC is to be liquidated on March 31, 2003 and all of its assets, liabilities and equity are to be transferred to General Agents.
1999 GMSP Transaction. On October 4, 1999, the Company sold to Goff Moore Strategic Partners, L.P. ("GMSP"), for an aggregate purchase price of $31,620,000, (i) 31,620 shares of Series A Preferred Stock, which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share (subject to adjustment for certain events), (ii) the Series A Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and expiring October 4, 2004 and (iii) the Series B Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share and expiring October 4, 2006. At closing the Company and its insurance company subsidiaries entered into Investment Management Agreements with GMSP, pursuant to which GMSP manages their respective investment portfolios. Completion of these transactions (the "1999 GMSP Transaction") concluded the strategic alternatives review process that the Company initiated in 1998. Proceeds from the 1999 GMSP Transaction were available for acquisitions, investments and other corporate purposes.
2002 Amendment to Investment Management Agreements. In August 2002, the Company entered into an amendment to its Investment Management Agreements with GMSP. See "Transactions with Goff Moore Strategic Partners, L.P. - 1999 GMSP Transaction." The amendment reduces, effective as of October 1, 2002, the minimum aggregate monthly payment owed by the Company to GMSP from $75,000 to $63,195 (with respect to each calendar month from October 2002 through September 2003), $53,750 (with respect to each calendar month from October 2003 through September 2004), and $45,417 (with respect to each calendar month after September 2004). The amendment also changes the date upon which either party to each of the investment management agreements can terminate such agreements at its sole option from October 4, 2002 to September 30, 2005.
Effective December 31, 2000, the Company entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 through December 31, 2001, the Company entered into a quota share reinsurance agreement whereby the Company ceded 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $89,650,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2001. Also in connection with this agreement, the Company was required to maintain assets in a trust fund with a fair value at least equal to the funds held liability. The trust fund was established during the third quarter of 2001 and at December 31, 2001 the assets in the trust had a fair value of $49,553,698. Because the Company's statutory policyholders' surplus fell below certain levels specified in the agreement, the reinsurer had the option to direct the trustee to transfer the assets of the trust to the reinsurer. On March 29, 2002, the reinsurer exercised this option and the trust assets were transferred to the reinsurer. As a result, investments and funds held under reinsurance agreements were reduced by approximately $44,000,000. The Company recorded a realized gain of approximately $486,000 as a result of the transfer. The reinsurer continues to be responsible for reimbursing the Company for claim payments covered under this agreement.
The discussion below primarily relates to the Company's insurance operations, although the selected consolidated financial data appearing elsewhere is on a consolidated basis. The expense Item "Underwriting and operating expenses" includes the operating expenses of GNAC.
COMMERCIAL LINES decreased 82% in 2002 and 40% in 2001. The Company's decision to discontinue writing commercial lines insurance due to continued adverse claims development and unprofitable results in the first quarter of 2002 is the reason for the decrease in 2002. In 2001 commercial auto contributed 30 points to the decrease for the reason mentioned previously and general liability line contributed 6 points to the decrease.
Net investment income decreased 47% and 43% in 2002 and 2001, respectively. The decrease in 2002 was primarily attributed to the decline in investments, short-term investments comprising a significantly greater portion of investments and the decline in interest rates. For 2001, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement required the Company to maintain a funds held liability and to increase this liability at an annual interest rate of 7.5%. This resulted in a charge to investment income of $3,650,417 during 2001.
The ratio of commissions and the change in deferred policy acquisition costs and deferred ceding commission income to net premiums earned is 18% in 2002, 21% in 2001 and 22% in 2000. The progressive decrease in this ratio is primarily due to the shift in the mix of business to nonstandard personal auto which has lower acquisition expenses than commercial lines.
Change in deferred policy acquisition costs ("DPAC") and deferred ceding commission income ("DCCI") represents the change during the period in the asset "Deferred policy acquisition cost". This asset item is comprised of commission expenses, premium taxes and certain marketing and underwriting expenses which are deferred, offset by commission income received from reinsurers, which is also deferred. This net asset DPAC is amortized into the results of operations through "Change in deferred policy acquisition costs and deferred ceding commission income", as the underlying gross premiums written and ceded premiums written are earned. Change in DPAC and DCCI resulted in a charge in 2002 of $1,513,880, a credit in 2001 of $886,282 and a charge in 2000 of $12,638,482. The charge in 2002 is primarily attributable to the amortization of previous DPAC and DCCI exceeding DPAC and DCCI incurred for 2002 as a result of the decision to discontinue writing commercial lines in 2002. The credit in 2001 is primarily the result of the DPAC and DCCI incurred in 2001 exceeding the amortization of previous DPAC and DCCI. The amortization of previous DPAC and DCCI included a significant amount of DCCI from the 2000 year (see below). The charge in 2000 is primarily the result of a significant amount of DCCI received in 2000 from a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums.
There is no amortization expense in 2002 due to the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (see Note 1(h) of Notes to Consolidated Financial Statements). Amortization of goodwill decreased in 2001 as a result of the sale of Tri-State and the second quarter 2001 write-off of its goodwill.
The Company recognized a current tax benefit of $2,607,796 during the third quarter of 2002 as a result of a carry back of alternative minimum tax losses. A change in the tax law during 2002 extended the carry back period for losses to offset income in earlier periods. As a result, the Company was entitled to a tax refund which it received in October 2002. The Company recorded deferred tax expense during the first quarter of 2002 due to an increase in the deferred tax asset valuation allowance, as a result of excluding the effects of unrealized gains in the deferred tax asset. The Federal income tax expense for 2001 is a result of the Company recording a valuation allowance of $31,534,712 against its deferred Federal income tax asset offset by the income tax benefit generated by the net loss from operations. Establishing the valuation allowance was necessary because of the uncertainty of future profitability levels. The Company does not lose the right to utilization of its net operating loss carry forwards for Federal income tax purposes in the future. For 2000 the Company generated a current tax benefit, with an effective tax benefit rate of 37%, as a result of a net loss from operations. While the Company produced a loss in 2000, at the end of 2000 the Company projected earnings in 2001 with subsequent increases each year thereafter. During 2001 the Company continued to implement actions to return to profitability, both in commercial lines and the personal lines. However, earnings in 2001 did not materialize and in the first quarter of 2002 the Company announced it was discontinuing the writing of its largest line of business, commercial lines, due to continued adverse claims development and unprofitable results. At that time the prospects for significant profits in personal lines, its only remaining line of business, were unclear. Because the Company had no near-term expectation of profitable results, it was necessary to fully reserve the deferred
tax asset due to uncertainty of future profitable results which could utilize this asset. In 2002 the Company continued to record unprofitable results and has no expectation of significant profits at this time. A reconciliation between income taxes computed at the Federal statutory rates and the provision for income taxes is included in Note (6) of Notes to Consolidated Financial Statements.
previous December 31 or ten percent (10%) of policyholders' surplus as of the previous December 31. In December 2002 MCIC (the North Dakota subsidiary) declared and paid dividends to GNAC of $300,000. On March 20, 2003, General Agents (the Oklahoma subsidiary) paid dividends to GNAC of $3,878,000, based on its surplus amounts at December 31, 2002. GNAC believes the cash dividends from its insurance subsidiaries should be sufficient to meet its expected obligations for 2003.
The Company had Federal income tax net operating loss carry forward tax benefits at December 31, 2002 of $23,017,524 that could be applied against any future tax expense of the Company, subject to certain limitations. Thus, the Company does not currently require funds to satisfy Federal income tax obligations.
With regard to long term liquidity, the average duration of the investment portfolio is approximately 1.4 years. The fair value of the fixed maturity portfolio at December 31, 2002 was $3,637,456 above amortized cost, before taxes. With regard to the availability of funds to the holding company, see Note (7) of Notes to Consolidated Financial Statements for restrictions on the payment of dividends by the insurance companies. Various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 2002 and 2001, the balance on deposit for the benefit of such policyholders totaled $13,731,408 and $15,398,298, respectively.
Net cash used for operating activities was $62,050,686 for 2002 versus $61,384,654 in 2001. The significant usage in 2001 was primarily related to the decrease in premium writings and the ongoing payment of claims and claim adjustment expense.
Premiums receivable decreased primarily as a result of the decrease in writings caused primarily by the decision to discontinue writing commercial lines during 2002 and the decision to net deferred payables on policies not yet written against deferred receivables on these same policies. This balance is comprised primarily of premiums due from insureds for nonstandard personal auto. The nonstandard personal auto premiums are written with a down payment of 34% and monthly payment terms of up to four months. The Company has recorded an allowance for doubtful accounts of $275,000 which it considers adequate at the present time.
represents unpaid claims and claim adjustment expenses which have been ceded to reinsurers under the Company's various reinsurance agreements, other than the reserve reinsurance cover agreement. These amounts are not currently due from the reinsurers but are expected to become due in the future when the Company pays the claim and requests reimbursement from the reinsurers.
Ceded unearned premiums decreased primarily as a result of the decision to discontinue writing commercial lines in 2002. This balance represents the portion of premiums ceded to reinsurers which are applicable to the unexpired terms of policies in force under the applicable reinsurance agreement. In the event the Company cancels policies, the reinsurer is required to return the premium to the Company. This type of action, on a material scale, is not expected to occur.
Deferred policy acquisition costs decreased primarily as a result of the decision to discontinue writing commercial lines. This balance represents commissions, premium taxes and certain marketing and underwriting expenses which are deferred and charged to operations over periods in which the related premiums are earned. Ceding commission income, which is realized on a written basis, is deferred and recognized over periods in which the related premiums are earned. Deferred ceding commission income is netted against deferred policy acquisition costs. The change in the resulting deferred asset is charged (credited) to operations. The Company recorded impairments on its deferred policy acquisition costs at December 31, 2002 of $28,386 and at December 31, 2001 of $2,487,009 related to the property and commercial auto lines of business.
Property and equipment decreased primarily as a result of the sale of the former home office building during the third quarter of 2002. A gain of $455,056 was recorded on this sale. The Company adjusted accumulated depreciation to reflect fully depreciated property and equipment that has been disposed. This balance is comprised primarily of computer hardware, computer software, furniture and an office building the Company previously occupied which is under lease until May 2003, and which the Company has listed as available for sale or lease.
The management contract controlling GCM was sold on December 2, 2002 to an unaffiliated third party. See "BUSINESS OPERATIONS - Sale of GAINSCO County Mutual."
Other assets increased primarily as a result of funds placed on deposit with a reinsurer in the second quarter of 2002 to collateralize commissions payable balances due the reinsurer. Other assets are comprised primarily of funds held by reinsurers as collateral for the reinsurers and prepaid expenses.
Unpaid claims and claim adjustment expenses decreased primarily as a result of the run-off of commercial lines. As of December 31, 2002, the Company had $96.469 million in unpaid claims and claim adjustment expenses. This amount represents management's best estimate, as derived from the actuarial analysis and was set equal to the selected reserve estimate as established by our outside actuary. The reserve estimates considered by our outside actuaries ranged from $83.1 million to $104.1 million. The actuary's range of reserves was developed by applying various methods considered appropriate for each line of coverage written. The actuary selected an estimate for each line of coverage written by accident year based on the results of the various methods applied, along with judgement. Management has reviewed and discussed the results of the actuarial analysis with the actuary and believes the reserve estimate selected by the actuary to be the best estimate of reserves at this time.
The Company considers the unpaid claims and claim adjustment expenses to be adequate; they are set to equal the selected reserve estimate determined by an outside actuarial firm.
Deferred Federal income taxes is comprised of the taxes on the unrealized gains of the bonds available for sale. The unrealized gains have been recorded net of taxes in "Accumulated other comprehensive income."
As a result of the 2001 GMSP Transaction and the Stallings Transaction, the Company has three series of redeemable Preferred Stock, which are classified as mezzanine financing. The Series A Preferred Stock was previously classified in shareholders' equity because it was not subject to mandatory redemption. The Company is required to redeem the Series A Preferred Stock on January 1, 2006 at a price of $31,620,000 plus unpaid dividends, if any. As of December 31, 2002, there were no accrued but unpaid dividends in respect of the Series A Preferred Stock. The Series B and Series C Preferred Stock are redeemable at the Company's option in March 2006 and at the option of the majority holders in March 2007 at a price of $3,000,000 each plus accrued dividends. The Series B and the Series C Preferred Stock each include accrued dividends in the amount of $556,059 as of December 31, 2002.
At December 31, 2002, total assets less total liabilities of the Company was $42,605,214 and there were outstanding three series of preferred stock with an aggregate liquidation value of $38,752,118 ($37,620,000 stated value plus accrued dividends of $1,132,118). Based on the forgoing, the Shareholders' Equity assuming the redemption of all series of the Preferred Stock at December 31, 2002, would be $3,853,096 ($0.18 per common share). The amount ultimately available to the shareholders would vary with changes in the assets and liabilities of the Company.
The following Consolidated Financial Statements Schedules are on pages 96 through 107