(1) 1996, 1995, and 1994 restated to reflect a two-for-one split of the Company's common stock distributed in November 1997.
1998 marked the fifth anniversary for the Company as a publicly traded entity. During this five-year period, gross written premiums increased from $57.1 million to $197.4 million, the GAAP basis combined ratio (the sum of the net loss and loss adjustment expenses and acquisition costs and other underwriting expenses divided by net earned premiums) averaged 86.4%, and the net operating income compound annual growth rate was 42.1%. The Company believes these achievements are primarily due to its continued focus on generating underwriting profits through conservative underwriting and pricing discipline, its differentiation in the marketplace through development of value-added coverage and service enhancements, and its multiple channels of distribution.
The Company's insurance subsidiaries are rated "A+" (Superior) by A.M. Best Company and have been assigned an "A" claims paying ability rating by Standard & Poors'.
The Company increased its existing portfolio of fixed maturity securities by predominately investing in investment grade taxable fixed maturity securities during 1998 due to the more favorable after-tax yields as compared to tax-exempt fixed maturity securities. At the end of 1998, investment grade taxable fixed maturity securities represented 51.5% of the total invested assets, compared to 35.7% as of the end of 1997. The Company has also continued to invest in common stock of quality growth-oriented mid-and large-cap companies seeking to achieve diversification and capital appreciation in its invested assets. At December 31, 1998, common stocks comprised 18.8% of invested assets, compared to 20.9% as of the end of 1997.
Premiums: Gross written premiums grew $22.2 million (16.2%) to $159.1 million in 1997 from $136.9 million in 1996; gross earned premiums grew $28.3 million (23.2%) to $150.1 million in 1997 from $121.8 million in 1996; net written premiums increased $27.8 million (33.1%) to $111.8 million in 1997 from $84.0 million in 1996; and net earned premiums
grew $28.5 million (39.5%) to $100.6 million in 1997 from $72.1 million in 1996. The overall growth in premiums and the varying growth rates for gross written premiums, gross earned premiums, net written premiums and net earned premiums are attributable to a number of factors including:
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $9.1 million (41.0%), to $31.3 million in 1997 from $22.2 million in 1996. This increase was due primarily to the 39.5% growth in net earned premiums.
The attainment of profitable new business continues to be a primary focus of the Company. During the fourth quarter of 1998, the Company added a new Specialty Property and Inland Marine underwriting organization which specializes in large property risks and all classes of inland marine insurance. The Company also anticipates growing its Preferred Agent Program, thereby further increasing the distribution of the Company's niche products. In addition, the Company has grown its field organization during 1998 to 160 professionals, including production underwriters and customer service representatives, and plans to further expand this organization in 1999, thereby further strengthening its resources to prospect the Company's existing niches for profitable new business. The Company also seeks acquisition opportunities to purchase programs or books of business which complement its niche markets or parallel its conservative underwriting and pricing discipline. The Company is exploring opportunities in this regard.
Overall, due to the abundance of capital in the insurance industry, the current business climate remains very competitive from a solicitation and pricing standpoint. In the context of the current environment, the Company will not sacrifice underwriting standards or pricing guidelines solely for premium volume and will "walk away", if necessary, from writing business that does not meet established underwriting standards and pricing guidelines, as has occurred in the commercial auto niche over the past three years and in the Company's nursing home commercial package product during the fourth quarter of 1998. Management believes, though, that the Company's mixed marketing strategy is a strength in this market environment, in that it provides the flexibility to quickly deploy the marketing efforts of the Company's direct production underwriters from soft market segments to market segments with emerging opportunities. Additionally, through the mixed marketing strategy, the
Philadelphia Consolidated Holding Corp. (PCHC) is a holding company whose principal assets currently consist of 100% of the capital stock of the Insurance Subsidiaries (Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company), Maguire Insurance Agency, Inc., and PCHC Investment Corp. Its primary sources of funds are dividends from its subsidiaries and payments to it pursuant to tax allocation agreements with the Insurance Subsidiaries. For the year ended December 31, 1998, payments to PCHC pursuant to such tax allocation agreements totaled $9.3 million. The payment of dividends to PCHC from the Insurance Subsidiaries is subject to certain limitations imposed by the insurance laws of the Commonwealth of Pennsylvania. Accumulated statutory profits of the Insurance Subsidiaries from which dividends may be paid totaled $80.5 million at December 31, 1998. Of this amount, the Insurance Subsidiaries are entitled to pay a total of approximately $17.7 million of dividends in 1999 without obtaining prior approval from the Insurance Commissioner of the Commonwealth of Pennsylvania. During the fourth quarter of 1998, for surplus allocation purposes, Philadelphia Insurance Company paid a $5.5 million dividend to PCHC which PCHC subsequently contributed to Philadelphia Indemnity Insurance Company.
The Company has produced net cash from operations of $49.8 million in 1998, $38.0 million in 1997 and $37.6 million in 1996. Management believes that the Company has adequate liquidity to pay all claims and meet all other cash needs.
Risk-based capital is designed to measure the acceptable amount of capital and surplus an insurer should have, based on the inherent specific risks of each insurer. Insurers failing to meet this benchmark level may be subject to scrutiny by the insurer's domiciliary insurance department and ultimately rehabilitation or liquidation. Based on the standards currently contained in the applicable Pennsylvania Insurance Company statutes, the Insurance Subsidiaries' capital and surplus is in excess of the prescribed risk-based capital requirements.
In the past, many computer software programs were written utilizing two digits rather than four in defining a year in the date field. As a result, date-sensitive computer software and embedded technology may recognize the year "00" in the date field as the year 1900 rather than 2000. This inability of computer hardware, software, and other technology to distinguish between the year 1900 and 2000 is generally referred to as the Year 2000 issue. If this situation occurs, the potential exists for computer systems and equipment failures or erroneous calculations by computer programs and embedded technology in the year 2000.
Phase 5 Executing the project plan, which includes repairing, replacing or upgrading of such items;
With respect to the "IT Systems" and "Non-IT Systems" sections, Phases 1 - 5 have been completed and Phase 6 is currently in process. The Company expects to have substantially all "IT Systems" and "Non-IT Systems" Year 2000 issues mitigated by March 31, 1999. With respect to the "Third Parties" section, the Company has identified and prioritized its critical vendors, suppliers and customers and communicated with them about their plans in addressing the Year 2000 problem. Evaluations of certain of the most critical vendors are in process and the "Third Party" section is expected to be completed by June 30, 1999.
The estimated cost of the Company's Year 2000 efforts and the dates on which the Company believes it will complete the various phases referred to above are based on management's best estimates using various assumptions regarding future events, including the continued availability of certain resources, third-party remediation plans and other matters. There can be no assurance that these estimates will prove to be accurate, and actual results could differ from those currently anticipated. Specific factors that could cause such differences include the availability and costs of personnel trained in Year 2000 issues, the ability to identify, assess, remediate, and test all relevant computer codes and embedded technology, the risk that reasonable testing will not uncover all Year 2000 problems and similar uncertainties.
The Company utilizes computer systems in virtually all aspects of its business. The Company also maintains relationships with a number of vendors, suppliers, and customers whose own state of readiness with regard to the Year 2000 issue could potentially impact the Company. These parties include software, hardware, and telecommunication providers; banks and investment brokers; reinsurers and reinsurance intermediaries; certain agents; and utilities. The failure to correct a material Year 2000 issue by the Company or a material "Third Party" could materially and adversely impact the Company's statement of operations, liquidity; and financial position. Due to the uncertainty inherent in the Year 2000 issue, the Company is unable to determine whether the consequences of Year 2000 failures will have a material impact on the Company's statement of operations, liquidity, or financial position. However, the Company believes with its completion of its Year 2000 project significant interruptions of operations should be reduced.
However, it is not possible to predict whether or to what extent coverage could ultimately be found to exist by the courts and the effect thereof on the Company. Additionally, the Company could incur expense to contest the assertion of Year 2000 coverage claims, even if the Company prevails in its position. As a result, it is impossible to predict what, if any, exposure insurance companies may ultimately have for Year 2000 claims whether coverage for the issue is specifically excluded or included.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is effective for all fiscal years beginning after June 15, 1999. SFAS No. 133 requires that an entity shall recognize all derivative instruments in the statement of financial position as either assets or liabilities depending on the rights or obligations under the instrument. Furthermore, derivative instruments shall be measured at fair value. SFAS No. 133 also provides guidance for accounting for changes in the fair value (that is, gains or losses) of a derivative instrument. The Company will adopt the provisions of SFAS No. 133 as of January 1, 2000. At December 31, 1998 the Company held no derivative financial instruments.
Certain information included in this report and other statements or materials published or to be published by the Company are not historical facts but are forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new and existing products, expectations for market segment and growth, the impact of Year 2000 issues, and similar matters. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary remarks regarding important factors which, among others, could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, results of the Company's business, and the other matters referred to above include, but are not limited to: (i) changes in the business environment in which the Company operates, including inflation and interest rates; (ii) changes in taxes, governmental laws, and regulations; (iii) competitive product and pricing activity; (iv) difficulties of managing growth profitably; and (v) the impact of Year 2000 issues, including the matters referred to above under "Risk Factors".
(1) 1996 share information restated to reflect a two-for-one split of the Company's common stock distributed in November 1997, see Note 11.
Investments in fixed maturities are adjusted for amortization of premiums and accretion of discounts to maturity date, except for collateralized mortgage and asset backed securities which are adjusted for amortization of premiums and accretion of discounts over their estimated lives. Certain collateralized mortgage and asset backed securities repayment patterns will change based on interest rate movements and, accordingly, could impact future investment income if the reinvestment of the repayment amounts are at lower interest rates than the underlying securities. Collateralized mortgage and asset backed securities amounted to $42,820,000 and $46,394,000, respectively, at December 31, 1998 and $7,329,000 and $11,302,000, respectively, at December 31, 1997. The collateralized mortgage and asset back securities held as of December 31, 1998 and 1997 are short tranche securities possessing favorable prepayment risk profiles.
Policy acquisition costs, which include commissions, premium taxes, fees, and other costs of underwriting policies, are deferred and amortized over the same period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable after providing for losses and expenses that are expected to be incurred, based upon historical and current experience. Amortization of policy acquisition costs in the accompanying consolidated statements of operations was $30,034,000, $25,034,000 and $17,739,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the respective assets. Costs incurred in developing information systems technology are capitalized and included in property and equipment. These costs are amortized over their useful lives from the dates the systems technology became operational. Upon disposal of assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in earnings.
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share", specifying the computation, presentation, and disclosure requirements for earnings per share for entities with publicly held common stock. Under SFAS No. 128, basic and diluted per share amounts shall be presented for net income on the face of the statement of operations. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared
Accounting Principles: The Philadelphia Indemnity Insurance Company ("PIIC") and the Philadelphia Insurance Company ("PIC") are domiciled in the Commonwealth of Pennsylvania. PIIC and PIC are required to report to certain regulatory agencies on the basis of Statutory Accounting Practices ("SAP"). The statutory financial statements are prepared in accordance with accounting practices prescribed or permitted by the Insurance Department of the Commonwealth of Pennsylvania. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as Commonwealth laws, regulations, and general administrative rules. Permitted Statutory Accounting Practices encompass all accounting practices not so prescribed.
- Under SAP, investments in debt securities are carried at amortized cost, while under GAAP, investments in debt securities classified as Available for Sale are carried at fair value.
Financial Information: The statutory capital and surplus of PIIC as of December 31, 1998 and 1997 was $113,659,000 and $75,894,000, respectively. Statutory net income of PIIC for the years ended December 31, 1998, 1997, and 1996 was $9,785,000, $8,839,000 and $5,626,000, respectively. Capital contributions to PIIC for the years ended December 31, 1998 and 1997 were $19,500,000 and $0, respectively.
Dividend Restrictions: The Insurance Subsidiaries are subject to various regulatory restrictions which limit the maximum amount of annual shareholder dividends allowed to be paid. The maximum dividend which PIIC may pay to Philadelphia Insurance during 1999 without prior approval is $11,366,000 and the maximum dividend which PIC may pay to Philadelphia Insurance during 1999 without prior approval is $6,339,000.
(2) Estimated market values have been based on quoted market prices.
The cost and estimated market value of fixed maturity securities at December 31, 1998, by remaining contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The sources of net investment income for the years ended December 31, 1998, 1997, and 1996 are as follows (in thousands):
There are no investments in fixed maturity securities that were non-income producing during the years ended December 31, 1998, 1997, and 1996. Investment expense includes $189,000, $164,000 and $60,000, in advisory fees paid to a related party in 1998, 1997, and 1996, respectively.
PIIC and PIC have investments, principally U.S. Treasury securities, on deposit with the various states in which they are licensed insurers. At December 31, 1998 and 1997 the carrying value on deposit totaled $11,032,000 and $10,912,000, respectively.
The Company also maintains investments in trust accounts under current reinsurance agreements with unrelated insurance companies. These investments collateralize the Company's obligations under the reinsurance agreements. The Company possesses sole responsibility for investment and reinvestment of the trust account assets. All dividends, interest and other income, resulting from investment of these assets are owned by the Company, and are distributed on a monthly basis. At December 31, 1998 and 1997 the carrying value of these trust fund investments were $8,886,000 and $12,205,000, respectively.
The following table summarizes property and equipment at December 31, 1998 and 1997 (dollars in thousands):
As a result of changes in estimates of insured events of prior years, the Company reduced losses and loss adjustment expenses incurred by $3,170,000, $1,716,000 and $965,000 in 1998, 1997, and 1996, respectively. Such favorable development was due to losses emerging at a lesser rate than had been originally anticipated when the initial reserves for the applicable accident years were estimated.
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 1998 and 1997 are as follows (in thousands):
9. Minority Interest in Consolidated Subsidiaries: Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Debentures of Company
On May 5, 1998, the Company issued 10.350 million FELINE PRIDES(SM) at $10.00 per security and PCHC Financing I, the Company's business trust subsidiary, issued 1,000,000 7.0% Trust Originated Preferred Securities with a stated liquidation amount per trust preferred security equal to $10.00. The 10.350 million FELINE PRIDES(SM) consisted of 9.350 million units referred to as Income Prides and 1.000 million units referred to as Growth Prides. Each Income Prides consists of a unit comprised of (a) a purchase contract under which the holder will purchase a number of shares of Philadelphia Consolidated Holding Corp. common stock no later than May 16, 2001 (ranging from .3858 to .4706 shares per FELINE PRIDES(SM)) under the terms specified in the stock purchase contract and (b) beneficial ownership of a 7.0% Trust Originated Preferred Security issued by PCHC Financing I and representing an undivided beneficial ownership in the assets of PCHC Financing I. Each holder will receive aggregate cumulative cash distributions at the annual rate of 7.00% of the $10.00 stated amount for the security, payable quarterly in arrears. Each Growth Prides consists of a unit with a face amount of $10.00 comprised of (a) a purchase contract under which (i) the holder will purchase a number of shares of Philadelphia Consolidated Holding Corp. common stock no later than May 16, 2001 (ranging from .3858 to .4706 shares per FELINE PRIDES(SM)) under the terms specified in the stock purchase contract and (ii) the Company will pay the holder contract adjustment payments at the rate of .50% of the stated amount per annum and (b) a 1/100 undivided beneficial ownership interest in a treasury security having a principal amount at maturity equal to $1,000 and maturing on May 15, 2001. The applicable distribution rate on the trust originated securities that remain outstanding during the period May 16, 2001 through May 16, 2003, will be reset so that the market value of the Trust Originated Preferred Securities will be equal to 100.5 percent of the stated amount. The Company may limit the reset rate to be no higher than the rate on the two-year benchmark treasury plus 255 basis points. The guarantee by the Company is a full and unconditional guarantee on a subordinated unsecured basis with respect to the Trust
Originated Preferred Securities, but will not apply to any payment of distributions except to the extent the Trust shall have funds available therefor.
Proceeds from the offering were approximately $99.0 million (after underwriting and associated costs). The proceeds from the sale of the Growth Prides were used to purchase the underlying securities to be transferred to the holders of the Growth Prides pursuant to the terms thereof. All the proceeds from the sale of the Trust Preferred Securities that were not components of the Income Prides and all of the proceeds from the sale of the Income Prides were invested by PCHC Financing I in debentures of the Company. The debentures account for substantially all the assets of PCHC Financing I. The debentures, whose principal amount is $106.7 million, mature on May 16, 2003 and pay interest initially at the rate of 7.0% per annum until May 15, 2001 and at the reset rate thereafter. The Company utilized $33.1 million of the net proceeds to make contributions to its subsidiaries, of which $20.0 million was contributed to the Insurance Subsidiaries. Additionally, $3.1 million was utilized by the Company to buy back its common stock under its stock buy-back program. The Company anticipates utilizing the remaining proceeds for general corporate purposes which may include acquisitions, capital expenditures, and the repurchase by the Company of its common stock.
(2) Restated to reflect a two-for-one split of the Company's common stock distributed in November 1997, see Note 11.
On October 16, 1997, the Board of Directors approved a two-for-one split of the Company's common stock payable to shareholders of record on October 27, 1997 for distribution on November 5, 1997. Weighted-average common shares outstanding, common stock equivalents, and earnings per share have been restated to reflect this stock split.
The loss and loss adjustment expense reserves ceded under such arrangements were $16,120,000 and $13,502,000 at December 31, 1998 and 1997, respectively. The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The percentage of ceded reinsurance reserves that are with companies rated "A" (Excellent) or better by A.M. Best Company is 100% as of December 31, 1998 and 1997, respectively. Additionally, approximately 1%, 2%, and 4% of the Company's net written premiums for the years ended December 31, 1998, 1997, and 1996, respectively, were assumed from an unrelated reinsurance company.
The Company has a defined contribution Profit Sharing Plan, which includes a 401K feature, covering substantially all employees. Under the plan, employees may contribute up to an annual maximum of the lesser of 15% of eligible compensation or the applicable Internal Revenue Code limit in a calendar year. The Company makes a matching contribution in an amount equal to 50% of the participant's pre-tax contribution, subject to a maximum of 6% of the participant's eligible compensation. The Company may also make annual discretionary profit sharing contributions at each plan year end. Participants are fully vested in the Company's contribution upon completion of seven years of service. The Company's contributions to the plan were $423,000 $474,300 and $322,400, in 1998, 1997, and 1996, respectively.