The Company owns several properties in Rock Hill, New York, consisting of a three-story office building in which its executive offices and the insurance operations of Frontier are located and three one-story buildings used for the corporate day care center, a facilities and maintenance building and a building used for off site storage. The Company also owns a two-story office building in Monticello, New York, and a hanger at a local airport.
The Company leases office space at 23 locations in 12 states at an aggregate monthly rental, net of sublease income of approximately $235,250.
(1) For purposes of calculating the GAAP Combined Ratio, underwriting and other operating expenses include amortization of policy acquisition costs, underwriting and other expenses, restructuring related charges and other corporate expenses.
For the year 2000, the Company reported a net loss of $295 million as compared to a net loss of $174 million in 1999.
All segments combined reported a loss, exclusive of net expenses not allocated to segments, of $295 million for 2000 as compared to a combined segment loss of $231 million in 1999. Of the 2000 total segment loss $148 million is attributable to the Specialty Programs segment as compared to a loss of $98 million in 1999 for that segment. The Professional Liability segment that showed a 1999 loss of $108 million improved to a 2000 loss of $46 million. The remaining four segments account for a combined loss of $101 million in 2000 as compared to a loss of $25 million in 1999.
The $76 million or 13.4% decrease in net premiums earned during 2000 compared to 1999 is primarily attributable to the effects of sales of certain subsidiaries and renewal rights during 2000 and the termination of several programs. In addition, rating agency downgrades impaired the Company's ability to write new and renewal business in certain segments. Because the last downgrade occurred in July 2000, the full effect of these downgrades has not been reflected in net earned premiums for 2000. This impact is more apparent in the decrease in net written premiums during 2000 compared to 1999 of $306 million or 45.3%. To the extent the Company was able to continue to write premiums in segments less sensitive to insurance company ratings, those premiums reflected as being earned over the related policy periods, most of which end by the middle of 2001.
Effective March 2001, the Company voluntarily agreed with the State of New York that Frontier will not write any new or renewal business until such time as the State of New York gives written notification that it may resume such writings. During 2000, Frontier represented 74.4% of the Company's net earned premiums.
The $21 million or 102.7% increase in net premiums earned for the Alternative Risk Division was primarily attributable to the reversal of ceded premiums due to the rescission of two ceding reinsurance agreements, which took place during the year 2000. An approximate $10.3 million increase resulted from the rescission of a reinsurance agreement with Reliance Insurance Company related to certain workers' compensation programs placed through Unicover Managers. An additional $12.2 million increase resulted from the rescission of a reinsurance agreement with Terramar Insurance Company related to inland marine and ocean marine business placed through Terramar General Agency.
Net premiums earned for the Professional Liability Division decreased 9.4% from $104 million during 1999 to $94 million for the year 2000. Although rating agency downgrades had a significant negative effect on this segment, physician medical malpractice business tends to be less rating sensitive and the Company had some limited success in retaining this business, including implementation of rate increases. The rate increases contributed approximately $12 million to net premiums earned during 2000.
The $3 million 3.6% decrease in net premiums earned in the Surety Division is primarily due to the loss of Frontier and Frontier Pacific's Treasury Listings in July 2000, combined with the sale of renewal rights to a large book of business effective during the third quarter of 2000. (See Note E - Sale of Renewal Rights of the Notes to the Consolidated Financial Statements).
Also during the third quarter of 2000, the Company realized a net capital loss of approximately $12 million, primarily the result of the liquidation of portfolio securities in connection with the purchase of the aggregate stop loss reinsurance treaty.
The adverse loss and LAE development of $17 million recorded in the Professional Liability Division related primarily to losses incurred by Western Indemnity. These charges included approximately $14 million medical practice, both direct and assumed, and workers compensation business written by Western prior to 1999. During the third quarter of 2000, the Company filed a plan of withdrawal for Western with the Texas Department of Insurance under which Western will longer write any new or renewal business (see Note U of the Notes to the Consolidated Financial Statements-Statutory Financial and Other Information).
The adverse loss and LAE development of $59 million recorded in the Specialty Division related to deterioration in its commercial auto liability and general liability programs. During 2000, the commercial auto liability reserves were increased approximately $25 million primarily due to three discontinued programs, which included a short-term auto rental program, an ambulette program and a truckers program. Additionally, general liability reserves increased by approximately $30 million. Approximately $15 million of this increase was due to deterioration related to discontinued programs for large crane operators, landlords of low and moderate-income housing and a worker's compensation program written in California. Also contributing to this increase was a program for municipalities in New Jersey. The remainder of this increase related to a variety of programs, none of which were individually significant.
Of the $157 million of adverse development charges recorded during 2000, approximately $95.8 million is recoverable under the National Indemnity retroactive reinsurance treaty (see Note N of the Notes to the Consolidated Financial Statements-Reinsurance). The expected recoveries under the treaty must be deferred and recognized as a reduction to losses and LAE incurred in future periods as the underlying claims are settled. Incurred losses and LAE in 2000 are offset by $12.5 million of amortization of deferred gain on the retroactive reinsurance treaty.
For the year ended December 31, 2000, amortization of policy acquisition costs represented 25.7% of net premiums earned compared to 25.1% (25.3% excluding Lyndon) for the comparable 1999 period. This increase, excluding Lyndon, was primarily due to the Company's increased use of its cut-through reinsurance agreements. As a result of rating agency downgrades, effective December 1, 1999, the Company entered into a cut-through reinsurance agreements with an "A" rated insurance company. This cut-through arrangement effectively provides assurance to the Company's policyholders that the "A" rated companies will pay claims in the event of the Company's insolvency. For the year 2000, the Company incurred cut-through fees of approximately $6 million as compared to $3 million in 1999.
Underwriting and other expenses as a percentage of net premiums earned increased from 21.0% (20.8% excluding Lyndon) during the 1999 year to 21.5% for the comparable 2000 period. Although the 2000 expense ratio approximates the 1999 ratio, both 2000 and 1999 operating results were negatively impacted by significant asset write downs and valuation adjustments.
As a result of the Company's weakened financial condition and its inability to generate positive cash flows from operations, the Company determined that the future undiscounted cash flows related to its home office building and certain furniture and equipment were not sufficient to support the carrying value of the related assets. Accordingly, during 2000, the Company recorded charges to operations of $9.8 million and $1.5 million related to its home office and certain furniture and equipment, respectively, to estimated fair value. (See Note B of the Notes to the Consolidated Financial Statements - Significant Accounting Policies - Property, Furniture, Equipment and Software).
During 2000, the Company increased its allowance for doubtful reinsurance recoverables within its Professional Liability, Alternative Risk and Specialty Programs Divisions of approximately $1.1 million, $8.7 million and $0.2 million, respectively. The Company determines the allowance based on its best estimate of ultimate amounts expected to be collected from reinsurers after giving consideration to collateral provided by the reinsurers in the form of letters of credit, trust accounts and funds held. Additionally, such analysis includes the overall financial condition of the reinsurer and the aging and related disputed balances of reinsurance recoverables.
During the 2000, the Company also increased it allowance for uncollectible premiums and agents' balances receivable by approximately $15.1 million. Of this amount, $3.7 million, $5.6 million, $5.2 million and $0.6 million related to the Surety, Specialty Programs, Alternative Risk and Environmental Excess and Surplus Divisions.
During 2000, the Company wrote off approximately $2.7 million and $7.4 million of intangible assets related to previously acquired insurance agencies and renewal rights in the Environmental, Excess and Surplus Lines and Surety Divisions, respectively (see Note F of the Notes to the Consolidated Financial Statements - Impairment of Intangibles).
As part of the Company's Corrective Action Plan implemented during the first quarter of 2000, the Company recorded approximately $18 million of restructuring related charges for the year ended December 31, 2000. For additional disclosure regarding the restructuring related charges see Note G of the Notes to the Consolidated Financial Statements - Restructuring Related Charges.
Other corporate expenses include certain expenses of the parent company not attributable to segments and expenses of directly owned non-insurance subsidiaries, reduced by other miscellaneous income. During the year 2000, other corporate expenses increased approximately $16 million from $5 million in 1999 to $21 million for the year 2000.
Additionally, the years ended December 2000 and 1999 included losses of approximately $1.8 million and $1.5 million, respectively, related to Metro Partners, Inc. ("Metro Partners"). The 2000 results included a write down of goodwill of approximately $0.8 million. On June 15, 2000, desiring to terminate its common stock ownership interest in Metro Partners; the Company exchanged its common stock ownership for non-voting, non-convertible, 8%, cumulative preferred stock (see Note Q of the Notes to the Consolidated Financial Statements - Related Party Transactions). During 2000, the Company wrote down its investment in Metro Partners to $0, a decrease of $0.5 million, as Management believes the value of that investment to be permanently impaired as Metro Partners has continued operating losses and has been unable to secure additional capital.
During September 1999, the Company entered into a definitive agreement to purchase ManagedComp Holdings, Inc. ("ManagedComp"), a managed care workers' compensation service company. On February 10, 2000, the Company announced that it had terminated the agreement to purchase ManagedComp. Under the terms of the termination agreement, the Company agreed to pay a fee of $4.5 million.
The increase in minority interest in income of consolidated subsidiary trust for the year ended December 31, 2000 reflects the effects of approximately $2.6 million in non-cash inducement charges related to the exchange of common stock for TOPrS (see Note P of the Notes to the Consolidated Financial Statements - Guaranteed Preferred Beneficial Interest in Company's Convertible Subordinated Debentures).
Although the amount of interest expense in the year 2000 approximates that of the comparable 1999 period, the 2000 amount reflected increased interest rates charged under the Deutsche Bank Credit Facility. Such increase was largely offset by the reduced principal amount outstanding as a result of a $75 million repayment on January 21, 2000.
During 2000, the tax benefit that would have resulted from the increase in net deferred tax assets, primarily relating to loss carryforwards, was substantially offset by an increase in the deferred tax asset valuation allowance of $79 million to $203 million. Because the Company has experienced recurring operating losses, management does not currently believe that it is more likely than not that these tax benefits will be realized in the near future. Accordingly the Company has established a valuation allowance fully offsetting the deferred tax asset.
The $78 million or 15.8% increase in net premiums earned during 1999 compared to 1998 was primarily attributable to continued growth in certain core and new programs within the Surety, Specialty Programs and Environmental, Excess and Surplus Lines Divisions. The growth in these divisions was offset by planned decreases in unprofitable programs within the Professional Liability and Personal and Credit Related Divisions and, to a lesser extent, a decline in business in the Alternative Risk Division due to a discontinued earthquake program and competitive conditions in the excess workers' compensation market.
The increase in net premiums earned for the Environmental Excess and Surplus Lines Division was primarily driven by growth in the California contractors' liability and environmental and pollution liability programs, which had increases of $10 million and $7 million, respectively, in 1999 compared to 1998.
The remaining increase in net premiums earned for the year 2000 over 1999 was attributable to the termination, effective December 31, 1998, of a stop loss reinsurance agreement between the company and Zurich N.A. The company ceded $47 million of premiums to Zurich N.A. in 1999.
Since the second quarter of 1998, the Company increased its personnel count by approximately 260 employees, including several members of senior management and the formation of several underwriting units, resulting in increased salary expenses of approximately $16 million in 1999.
The Company periodically evaluates the recoverability of its intangible assets. During 1999, the Company determined that the undiscounted cash flows related to Western (included in the Professional Liability Division) and Regency (included in the Personal and Credit Related Division) were not sufficient to support the related goodwill. Accordingly, goodwill for Western and Regency of approximately $13.6 million and $1.5 million, respectively, was charged to operations during 1999.
During the third quarter of 1999, the Company recorded a $5.3 million adjustment resulting from a reallocation of certain corporate overhead and administrative expenses which were previously included in LAE allocated to the Company's underwriting departments. This reallocation was based on a recently completed time study performed in connection with the Company's third quarter reserve analysis and related claim study, which concluded that certain corporate and administrative personnel were not spending as much time adjusting losses as they previously had. When the allocations being used were updated, the result was a decrease in LAE and a corresponding increase in underwriting and other expenses.
Other corporate expenses include certain expenses of the parent company not attributable to the segments and directly owned non-insurance subsidiaries, reduced by other miscellaneous income. During 1999, other corporate expenses amounted to approximately $5.0 million compared to $13.7 million in 1998.
At December 31, 2000 and 1999, the Company's fixed maturity investments included mortgage-backed securities of $1588 million and $369 million, respectively, which are subject to risks associated with variable prepayments of the underlying mortgage loans that differ from typical fixed maturities. Securities that have an amortized cost greater than par value that are backed by mortgages that prepay faster than expected will incur a reduction in yield, while securities that have an amortized cost less than par value that are backed by mortgages that prepay faster than expected will generated an increase in yield. The degree to which a security is susceptible to either gains or losses is influenced by the difference between amortized cost and par value, the relative sensitivity to prepayment risk of the underlying mortgages backing the assets and the repayment priority of the securities in the overall structure of a securitization.
The Company treats the partnership interests as available for sale and limits recognition of income and capital gains to that which is realized by the individual partnerships. At December 31, 2000, the partnership investments had net unrealized gains of $7 million. In addition, the Company had unfunded commitments to limited partnerships of approximately $4 million to be funded over the next several years. Internal investment personnel monitor all partnership investments.
Funds borrowed under the credit facility during 1999 amounted to approximately $50.8 million and were primarily used to purchase treasury stock and several small insurance agencies. As a result of the significant reserve charge during the third quarter of 1999, Deutsche Bank suspended any further loans to the Company under the facility until certain credit terms could be renegotiated. In January 2000, terms of the credit agreement were amended and the commitment under the facility was permanently reduced to $67.8 million and, pursuant to the terms of an amendment to the credit facility, the Company applied $75 million of the net proceeds from the sale of Lyndon to repay outstanding loans under the facility. In addition, the common stock of Frontier and Western and other ownership interests in certain noninsurance subsidiaries were pledged by the Company as collateral for amounts outstanding under the credit facility.
Under the revised terms of the credit facility, the Company is subject to certain financial and nonfinancial covenants, some of which restrict its ability to dispose of assets, incur additional indebtedness and require the maintenance of a minimum level of consolidated shareholders' equity. At December 31, 2000, the Company, violated certain covenants, including failure to make required interest payments. Such violations allow the bank to accelerate repayment of the amounts outstanding under the credit facility and exercise their rights with respect to the stock and ownership interests pledged as collateral. On March 15, 2001, the Company received notification with respect to the bank debt that repayment of principal and interest amounts outstanding were being accelerated. The Company does not have sufficient liquid assets to satisfy this obligation. The Company is currently in discussions with the bank regarding the restructuring and repayment of its debt.
The liquidity needs of the Company's insurance subsidiaries are generally met through cash provided by operating activities. However, during 1998 and in January of 2000, additional funds of approximately $62.6 million and $80 million were contributed to the Company's insurance subsidiaries in order to maintain certain minimum surplus levels after significant reserve charges in 1998 and 1999. The $62.6 million capital contribution was funded through the Company's credit facility and the $80 million capital contribution was funded by the net proceeds received from the sale of Lyndon.
At December 31, 2000 insurance subsidiary invested assets with a carrying value of $205 million are in a trust account as collateral pursuant to a reinsurance agreement (see Note M of the Notes to the Consolidated Financial Statements-Prospective Reinsurance). These assets and investment income thereon may not available for current operating purposes. Additionally insurance subsidiary invested assets with an amortized cost of $52 million are on deposit with various states as required by laws or regulations and are not available for current operating purposes.
At December 31, 2000, all of the Company's insurance subsidiaries, with the exception of Frontier, met the RBC requirements (exceeded authorized control level RBC ratio). Frontier, the Company's largest insurance subsidiary, is domiciled in New York State. The Department utilizes its own methodology for computing capital adequacy and does not follow the NAIC RBC guidelines. However, many of the other states in which Frontier writes business have adopted the NAIC RBC guidelines. In accordance with the NAIC RBC guidelines, at December 31, 2000, Frontier was at the Mandatory Control Level. The Mandatory Control Level authorizes the commissioner of a state insurance department to take whatever regulatory actions it considers necessary to protect the best interest of the policyholders and creditors of an insurer, which could include placing Frontier under regulatory control (i.e., rehabilitation or liquidation). In addition, failure to meet capital requirements and other requirements, which may be imposed by the insurance departments, or further unfavorable operating results in future periods, could expose Frontier to regulatory sanctions that may include restrictions on operations and growth and/or mandatory asset dispositions.
While the Company intends to improve the current RBC ratio level of its insurance subsidiaries, it cannot predict all events that could cause this ratio to decrease to the point of increased oversight by the Department or by other departments of the states in which the Company's subsidiaries are domiciled.
In 1998, the NAIC adopted codified SAP ("Codification"). Codification will change, to some extent, prescribed SAP and may result in changes to the accounting practices that the Company's insurance subsidiaries use to prepare their statutory-basis financial statements. Codification requires adoption by the various states before it becomes the prescribed statutory basis of accounting for insurance companies domesticated within those states. Accordingly, before Codification becomes effective for the Company's insurance subsidiaries, their respective states of domicile must adopt Codification as the prescribed basis of accounting for domestic insurers to report their statutory-basis results to the insurance department. As of December 31, 2000, all of the states of domicile for the Company's insurance subsidiaries had adopted Codification, in whole or in part, with an effective date of January 1, 2001.
Effective January 1, 1998, the Company entered into a stop loss reinsurance agreement with Zurich N.A. for the 1998 and 1999 accident years. The new agreement included selected programs underwritten by United Capitol, Western, and selected core programs of Frontier and Frontier Pacific, which were not part of the original 1995-1997 reinsurance agreement. Under the terms of the new agreement, Zurich, N.A. provided reinsurance protection within certain contract aggregate dollar limits for losses and LAE in excess of a predetermined ratio of these expenses to earned premiums for a given accident year for the covered insurance programs. In addition there are line of business specific aggregate limits for medical malpractice and excess workers' compensation. As of December 31, 1998, the Company had exceeded these aggregates.
Over the past decade, the Company has been engaged in litigation with the State of New York as to whether physician medical school faculty members at the State University of New York ("SUNY") engaged in the clinical practice of medicine at a SUNY medical school facility, corollary to such physician's faculty activities, were within the scope of their employment by SUNY, and thereby protected against malpractice claims arising out of such activity by the State, or by the Company under its medical malpractice policies insuring the SUNY physicians. As a result of favorable judicial
In December 1999, on a procedural motion in the Court of Claims, the Court linked the 1997 adverse decision on the duty to defend litigation to the Company's right to reimbursement and ruled that the Supreme Court decision would govern the future outcome of any cases in the Court of Claims. Although the Company is continuing to seek recovery from the State in the Court of Claims, the December 1999 ruling may have a significant adverse impact on the Company's ability to recover amounts paid by the Company on behalf of SUNY physicians. At December 31, 2000 the amount of subrogation recoverables recorded by the Company related to the SUNY litigation was approximately $ 1million.
The Company, through its subsidiary United Capitol, in the ordinary course of business, writes insurance on accounts, which have hazardous, unique or unusual risk characteristics. Since United Capitol's organization in 1986, its liability policies have included an absolute pollution coverage exclusion, except for policies specifically designed and underwritten to cover environmental exposures. In addition, United Capitol's product liability and other primary general liability policies contain exclusions for coverage of claims for bodily injury or property damage caused by exposure to asbestos, other than for the policies providing coverage to asbestos abatement contractors for third party claims alleging bodily injury or property damage as a result of exposure to asbestos. Employees of the insured contractor and others required to be in the abatement are excluded from coverage.
class certification motion practice and discovery. In November 1995, plaintiffs served a consolidated amended complaint alleging violations by the Company of section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)(5) there under, seeking to impose controlling person liability on certain of the Company's officers and directors, and further alleging insider sales all premised on negative financial information that should have been publicly disclosed earlier. Plaintiffs seek an unspecified amount in damages to be proven at trial, reasonable attorney fees' and expert witness costs. In April 1997, the Court certified the class. Plaintiffs have subpoenaed documents and deposed outside auditors and analysts. Plaintiffs have also taken depositions from current or former officers, directors and employees of the Company.
In June 1999, plaintiffs were granted permission to amend their complaint and to reopen discovery to take additional depositions and request additional documents. The additional depositions have been taken. In February 2000, the plaintiffs made an additional motion to amend their complaint wherein they seek to have the class period, which presently runs from February 10, 1994 through November 8, 1994, extended to November 15, 1999. The motion also seeks to add an additional plaintiff and defendant. Plaintiffs also seek to allege that increases in reserves taken by the Company in various reporting periods subsequent to November 1994 evidence an ongoing fraud. The court has not ruled on this motion.
In July 2000, the Company was served with a purported securities class action complaint. Subsequently, six nearly identical complaints were filed. The complaints allege that the Company and certain of its officers and directors violated certain securities laws by making false and misleading statements about the Company's business and prospects during the period from August 5, 1997 to April 14, 2000. The actions are purportedly brought on behalf of all persons who purchased the Company's stock during that period. The plaintiffs' damages are not specified.
In November 2000, the Court granted the plaintiffs' motion to consolidate these actions and for appointment of lead plaintiffs and lead plaintiffs' counsel. On February 5, 2001, plaintiffs filed a Corrected Consolidated Amended Class Action Complaint.
The Company believes the suits are without merit and has retained special legal counsel to contest the suits vigorously. It is not currently possible to determine the probability of a favorable outcome. Further, it is not possible to estimate the amount of a potential loss. However, an adverse judgment in the litigation in excess of available insurance would have a material adverse effect on the Company's financial condition and results of operations.