Management's Discussion and Analysis of Financial Condition and Results of Operations - --------------------------------------------------------------------------------
Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, its reserves for loss payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. Cash and investments (excluding net unrealized gains or losses) at December 31, 2000, were $98,234,157 compared to $105,380,057 at December 31, 1999, a 7% decrease. Crusader's cash and investments at December 31, 2000, was $93,578,918 or 95% of the total held by the Company, compared to $97,452,621or 92% of the total held by the Company at December 31, 1999.
The tax-exempt interest income earned (net of bond premium and discount amortization) during the year ended December 31, 2000, was $1,191,794 compared to $1,473,922 in the year ended December 31, 1999. In the year ended December 31, 1998, tax-exempt interest income earned totaled $1,698,211.
The Company's investment policy limits investments in any one company to $2,000,000. This limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues. The Company's investment guidelines on equity securities limit investments in equity securities to an aggregate maximum of $2,000,000. All of the Company's fixed maturity investments are high-grade investment quality, all state and municipal tax exempt fixed maturity investments are pre-refunded issues, and all certificates of deposit are FDIC insured.
Unico has a $2,000,000 line of credit with Union Bank of California. Interest on this line is referenced to LIBOR and is payable monthly. The agreement contains certain covenants including maintenance of certain financial ratios. This credit line expires September 3, 2002, at which time it is expected to be renewed. Unico did not borrow against its line of credit in 2000 or 1999.
Dividends paid by Crusader to Unico were $1,500,000 in 2000 and $2,000,000 in 1999. These funds were invested in short-term instruments and were ultimately used to help fund the repurchase of shares of the Company's common stock discussed below. As of December 31, 2000, the maximum additional dividend that could have been made by Crusader to Unico without prior of the California Department of Insurance approval was $2,462,626.
Results of Operations: --------------------- General - ------- The Company had net income of $439,797 for the year ended December 31, 2000, compared to $5,131,366 for the year ended December 31, 1999, and $8,708,669 for the year ended December 31, 1998. Total revenue for the year ended December 31, 2000, was $38,367,949 compared to $40,734,257 for the year ended December 31, 1999, and $47,544,270 for the year ended December 31, 1998.
Crusader's primary line of business is commercial multiple peril business package policies. This line of business represented approximately 97% of Crusader's total written premium for both fiscal years ended December 31, 2000 and 1999.
For the year ended December 31, 2000, gross written premium increased by $120,587 compared to the year ended December 31, 1999. The Company believes that the slight growth in written premium in 2000 is the result of a subsidence in the intensity of price-based competition in the property casualty insurance market.
Currently, agents and brokers who call for quotes on policies sold by the Company may also have to call competitors for quotes on products which the Company does not offer. Thus, Crusader competes with not only other insurance companies, but with general agents who produce business for other insurance companies. Many of these general agents offer more products than the Company and thus make it easier for the agents and brokers because they can do more business with fewer telephone calls. To provide better service to the Company's agents and brokers, the Company is currently working on additional non-affiliated insurance company products to be offered by its General Agency operations. In addition to generating additional commission and fee income, the expansion of the General Agency operations may benefit Crusader because agents and brokers may place more of their business with Crusader.
Generally, if the combined ratio is below 100%, an insurance company has an underwriting profit; if it is above 100%, a company has an underwriting loss.
During 1999, as part of the Company's ongoing reserve review process and loss trending analysis, the Company determined that its average claim costs were increasing and claims were settling for amounts greater than had been anticipated. To address this trend, the Company reviewed its open claim files to ensure that its case reserves and IBNR were adequate. The review process took approximately one year and resulted in increased reserves.
1. Higher than anticipated claim cost from business outside of California. 2. The effect on settlements of escalating jury awards 3. Increased development of losses due to the impact of changes in California law that expanded coverage and increased loss exposure, (e.g., Montrose Chemical Corp. v. Admiral Insurance Co.(1994), Montrose Chemical Corp. v. Admiral Insurance Co. (1995), Armstrong World Industries, Inc. v. Aetna Gas & Sur. Co. (1996), James Pepperell, et al., v. Scottsdale Insurance Company (1998), Pardee Construction Company v. Insurance Company of the West et al., (2000), Pershing Park Villas HOA v. United Pacific Ins. Co. (2000), Centex Golden Construction Co. v. Dale Tile Co.(2000)).
Revenues for the year ended December 31, 1999, increased $452,136 (20%) compared the year ended December 31, 1998. This increase was a result of continued increase in sales of small business group accounts for CIGNA, an increase in the number of small business accounts administered by the Company for CIGNA, and a bonus commission of $143,191 received from CIGNA.
Service Fee Income ------------------ Unifax sells and services insurance policies for Crusader. The service fee charged to the policyholder by Unifax is recognized as income in the consolidated financial statements.
Other Commission and Fee Income ------------------------------- Other commission and fee income are as follows: Year ended December 31 ---------------------- 2000 1999 1998 ---- ---- ----
Workers' compensation program commission income $44,816 $81,919 $329,465 Earthquake program commission income $15,993 $22,421 - Commercial liability program commission and fee income $55,828 $22,280 - Commercial and personal auto program commission and fee income - $4,363 $1,843 Miscellaneous fee income $128 $177 $242 ------- ------- -------- Total other commission and fee income $116,767 $131,160 $331,550 ======= ======= =======
Unifax produces workers' compensation policies primarily in California for non-affiliated insurers and receives a commission from them based on premium written. Unifax discontinued writing new business with one of its non-affiliated insurers in 1998 and began placing new business with other non-affiliated insurance companies. The decrease in commission income in 2000 and 1999 was due to underwriting constraints of the new insurance companies that limited the types and classes of business that they would accept.
Unifax produced commercial auto policies in California for a non-affiliated insurer and received a commission from them based on premium written. The Company discontinued that program in February of 1997. Unifax also received a policy service fee from the insured. In February 1997, the Company decided to discontinue writing new policies in the Unifax commercial automobile program and only serviced and renewed existing policies until the book of business was sold to a non-affiliated third party in June 1997. As consideration for the sale of this book of business, Unifax received a percentage of the commission earned for a two-year period on policies which were in force at the time of sale.
AAC provides premium financing primarily to Crusader policies produced by Unifax in California. The growth of this program is dependent and directly related to the growth of Crusader's written premium and AAC's ability to market its competitive rates and service to finance those policies. Due to the intense competition in the market place Unifax has produced only slightly more policies than the previous year. The decrease in revenues and loans in 2000 is primarily due to the fact that fewer policies are being financed. Although AAC finances approximately 80% of all Unifax policies which are financed, the percentage of all Unifax policies which are financed decreased from approximately 54% in 1999 to approximately 50% in 2000.
Investment Income and Net Realized Gains (Losses) - ---------------------------------------------------- Investment income and net realized gains (losses) are as follows:
Investment interest and dividends earned (excluding net realized gains) increased $258,984 (5%) in the year ended December 31, 1999, compared to the year ended December 31, 1998, primarily as a result of additional invested assets from operating activities. Average invested assets in the year ended December 31, 1999, (at
Policy acquisition costs $8,303,917 $8,362,814 $9,497,857 Ratio to net earned premium (GAAP ratio) 32% 30% 27%
Commissions to Agents/Brokers (not including commissions on Crusader policies that are reflected in policy acquisition costs) are generally related to gross commission income from the health and life insurance program, the daily automobile rental insurance program, the earthquake program and the commercial liability program. Commissions to agents and brokers increased $3,971 (0%) for the year ended December 31, 2000, compared to the year ended December 31, 1999. Commissions to agents and brokers increased $261,833 (25%) for the year ended December 31, 1999, compared to the year ended December 31, 1998.
Year ended December 31 ---------------------- 2000 1999 1998 ---- ---- ----
New Accounting Standards - ------------------------ In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). SFAS 133 is effective for fiscal years beginning after June 15, 2000, and establishes standards for the reporting for derivative instruments. It requires changes in the fair value of a derivative instrument and the change in fair value of assets or liabilities hedged by the instrument to be included in income. To the extent that the hedge transaction is effective, income is equally offset by both investments. Currently the changes in fair value of derivative instruments and hedged items are reported in net unrealized gain (loss) on securities. The Company does not participate in derivative instruments or hedging activities. Consequently, the Company's financial statements would not be impacted by the adoption of SFAS 133.
Forward Looking Statements - -------------------------- Certain statements contained herein, including the Sections entitled "Business," "Legal Proceedings" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," that are not historical facts are forward looking. These statements, which may be identified by forward-looking words or phrases such as "anticipate," "appears," "believe," "estimates," "expect," "intend," "may," "should," and "would," involve risks and uncertainties, many of which are beyond the control of the Company. Such risks and uncertainties could cause actual results to differ materially from these forward looking statements. Factors which could cause actual results to differ materially include those described under Item 1 - Business - "Competition," premium rate adequacy relating to competition or regulation, actual versus estimated claim experience, regulatory changes or developments, unforeseen calamities, general market conditions, the Company's ability to introduce new profitable products, and the Company's ability to expand geographically.
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2000, December 31, 1999, and December 31, 1998 30
Consolidated Statements of Cash Flows for the years ended December 31, 2000, December 31,1999, and December 31, 1998 31
We have audited the accompanying consolidated balance sheets of Unico American Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unico American Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
Investments - ----------- All of the Company's fixed maturity investments are classified as available-for sale and are stated at market value. Although classified as available-for-sale, the Company's investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities are reported as accumulated other comprehensive income (loss) which is a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses are included in the consolidated statements of operations based on the specific identification method.
There is a high level of uncertainty inherent in the evaluation of the required loss and loss adjustment expense reserves for the Company. The long-tailed nature of liability claims and the volatility of jury awards exacerbates that uncertainty. Management has selected target loss and loss expense ratios that it believes are reasonable and reflective of anticipated ultimate experience. The ultimate cost of claims is dependent upon future events, the outcomes of which are affected by many factors. Company claim reserving procedures and settlement philosophy, current and perceived social and economic inflation, current and future court rulings and jury attitudes, improvements in medical technology, and many other economic, scientific, legal, political, and social factors all can have significant effects on the ultimate costs of claims. Changes in Company operations and management philosophy also may cause actual developments to vary from the past. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated
Deferred Policy Acquisition Costs - --------------------------------- Policy acquisition costs consist of costs associated with the production of insurance policies such as commissions, premium taxes, and certain other underwriting expenses which vary with and are primarily related to the production of the insurance policy. Policy acquisition costs are deferred and amortized as the related premiums are earned and are limited to their estimated realizable value based on the related unearned premiums plus investment income less anticipated losses and loss adjustment expenses. Ceding commission applicable to the unexpired terms of policies in force is recorded as unearned ceding commission which is included in deferred policy acquisition costs.
(1) Intersegment revenue eliminations reflect commissions paid by Crusader to Unifax. (2) Intersegment asset eliminations reflect the elimination of Crusader receivables and Unifax payables.
NOTE 2 - ADVANCE PREMIUM AND PREMIUM DEPOSITS - --------------------------------------------- Some of the Company's health and life programs require payments of premium prior to the effective date of coverage; and accordingly, invoices are sent out as early as two months prior to the coverage effective date. Insurance premiums received for coverage months effective after the balance sheet date are recorded as advance premiums. Deposit premiums represent funds received from the Company's daily automobile rental program which guarantee the payment of premiums for past coverage months. These deposits are required when information such as gross receipts or number of rental cars is required to compute the actual premium due, but is not available until after the coverage month.
NOTE 3 - INVESTMENTS - -------------------- A summary of net investments and related income is as follows:
Fixed maturities $5,848,248 $5,752,154 $5,463,418 Equity securities - 1,380 8,095 Short-term investments 251,930 238,017 260,725 --------- --------- --------- Total investment income 6,100,178 5,991,551 5,732,238 Less investment expenses 100 664 335 --------- --------- --------- Net investment income $6,100,078 $5,990,887 $5,731,903 ========= ========= =========
Year ended December 31 ---------------------- 2000 1999 ---- ---- Furniture, fixtures, computer, office, and transportation equipment $2,354,072 $2,329,113 Accumulated depreciation 2,239,965 2,180,446 --------- --------- Net property and equipment $ 114,107 $ 148,667 ======= =======
Premiums receivable $1,931,311 $1,615,238 Premium finance notes receivable 3,896,959 3,903,586 --------- --------- Total premiums and notes receivable 5,828,270 5,518,824 Less allowance for doubtful accounts 20,539 21,934 --------- --------- Net premiums and notes receivable $5,807,731 $5,496,890 ========= =========
NOTE 6 - NOTE PAYABLE - BANK - ---------------------------- Unico has a $2,000,000 line of credit with Union Bank of California. Interest on this line is referenced to LIBOR and is payable monthly. The agreement contains certain covenants including maintenance of certain financial ratios. This credit line expires September 3, 2002, at which time it is expected to be renewed. As of December 31, 2000 and 1999, no amounts were borrowed.
NOTE 9 - LEASE COMMITMENT - ------------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The total rent expense under this lease agreement was $1,025,952 for the year ended December 31, 2000; $1,025,952 for the year ended December 31, 1999; and $1,025,952 for the year ended December 31, 1998.
Year ending ----------- December 31, 2001 $1,025,952 December 31, 2002 $1,025,952 December 31, 2003 $1,025,952 December 31, 2004 $1,025,952 December 31, 2005 (through March 31, 2007) $2,308,392 --------- Total minimum payments $6,412,200 =========
Premium payable $6,192,201 $5,208,491 Unearned claim administration income 300,000 300,000 Profit sharing contributions 395,305 406,667 Accrued salaries 475,740 469,721 Security purchases payable (settlement date in 2001) 140,625 - Other 395,308 6,258 --------- --------- Total accrued expenses and other liabilities $7,899,179 $6,391,137 ========= =========
NOTE 11 - CLAIMS AND LITIGATION - ------------------------------- The Company, by virtue of the nature of the business conducted by it, becomes involved in numerous legal proceedings as either plaintiff or defendant. The Company is also required to resort to legal proceedings from time to time in order to enforce collection of premiums, commissions, or fees for the services rendered to customers or to their agents. These routine items of litigation do not materially affect the Company and are handled on a routine basis by the Company through its general counsel.
On September 13, 2000, the City of Los Angeles audited Unico (parent company only) for the years 1997, 1998 and 1999 with respect to its Los Angeles business license gross receipts tax. The audit resulted in an assessment of $97,681 in gross receipts tax, interest of $24,196, and penalties of $39,072, resulting in a total amount due of $160,949. The assessment was based on the city's position that expenses of Unico's subsidiaries that are paid by Unico (parent company) are subject to the gross receipts business tax when those expenses are reimbursed by the subsidiaries to Unico. The Company disagreed with the audit findings and has appealed the matter. As of December 31, 2000, the Company has accrued $25,000 that it estimates will cover the cost of the appeal and an estimate of the gross receipts tax, penalty, and interest that may ultimately become due based on the information currently available.
In 2000, Crusader had its primary reinsurance agreements with Partner Reinsurance Company of the U.S., a California admitted reinsurer. In 1999, Crusader had its primary reinsurance agreements with General Reinsurance Corporation, a California admitted reinsurers. These reinsurance agreements help protect Crusader against liabilities in excess of certain retentions, including major or catastrophic losses that may occur from any one or more of the property and/or casualty risks which Crusader insures. Crusader also has additional catastrophe reinsurance from various other reinsurance companies of which 90% of the premium is ceded to participating catastrophe reinsurers that are admitted in California. Any catastrophe loss ceded to the reinsurer not admitted in California requires the reinsurer to immediately obtain a non-cancelable (Evergreen) letter of credit covering their ceded outstanding loss including any IBNR. On July 1, 1997, Crusader increased its retention from $150,000 to $250,000 per risk. Concurrently, Crusader maintained catastrophe and clash covers (subject to a maximum occurrence and annual aggregate) to help protect the Company from one loss occurrence affecting multiple policies. Beginning January 1, 1998, an annual aggregate deductible of $750,000 commenced on losses ceded to its reinsurance treaty covering losses between $250,000 and $500,000. Beginning January 1, 2000, an annual aggregate deductible of $500,000 commenced on losses ceded to its reinsurance treaty covering losses between $250,000 and $500,000. Prior to January 1, 1998, National Reinsurance Corporation charged a provisional rate on exposures up to $500,000 that was subject to adjustment and was based on the amount of losses ceded, limited by a maximum percentage that could be charged. That provisional rated treaty was cancelled on a runoff basis and replaced by a flat rated treaty on January 1, 1998.
Premiums earned: Direct business $32,743,165 $34,693,113 $40,615,417 Reinsurance assumed - - - Reinsurance ceded (6,843,931) (6,583,752) (5,700,222) ---------- ---------- ---------- Net premiums earned $25,899,234 $28,109,361 $34,915,195 ========== ========== ==========
As of December 31, 2000 $39,626,269 As of December 31, 1999 $40,952,456
Crusader is restricted in the amount of dividends it may pay to its parent in any twelve (12) month period without prior approval of the California Department of Insurance. Presently, without prior approval, Crusader may pay a dividend in any twelve (12) month period to its parent equal to the greater of (a) 10% of Crusader's statutory policyholders' surplus or (b) Crusader's statutory net income for the preceding calendar year. The maximum dividend that may be made without prior approval as of December 31, 2000, is $3,962,626. After taking into account the dividends paid by Crusader to its parent in 2000 of $1,500,000, the remaining dividend which may be made without prior approval as of December 31, 2000, was $2,462,626.
NOTE 15 - STOCK PLANS - --------------------- The Company's 1985 stock option plan provided for the grant of incentive stock options to officers and key employees. The plan covered an aggregate of 1,500,000 shares of the Company's common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.). As of December 31, 2000, there were 71,275 options outstanding, and all are currently exercisable. Options granted under this plan had a life of either 5 or 10 years and had a vesting period from immediate to 9 years. All options were granted at fair market value. There are no additional options available for future grant under the 1985 plan.
The Company's 1999 Omnibus Stock Plan that covers 500,000 shares of the Company's common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.) was approved by shareholders June 4, 1999. On August 26, 1999, the Company granted 135,000 incentive stock options of which 2,500 were terminated and 132,500 were outstanding as of December 31, 2000. These options expire ten years from the date of the grant and were not exercisable prior to September 1, 2000. Options covering 10,000 or less shares become exercisable at the rate of 2,500 shares per year commencing September 1, 2000; and options covering more than 10,000 shares become exercisable at the rate of 5,000 shares per year commencing September 1, 2000. At December 31, 2000, 50,000 options under the 1999 stock option plan were exercisable.
Year ended December 31 ---------------------- 2000 1999 1998 ---- ---- ---- Current provision: Federal $(253,899) $1,668,332 $3,516,390 State 37,409 21,577 179,521 -------- --------- --------- Total federal and state (216,490) 1,689,909 3,695,911 Deferred (29,694) 303,614 350,318 ------- --------- --------- Provision for taxes $(246,184) $1,993,523 $4,046,229 ======= ========= =========
Deferred tax liabilities: Deferred acquisition costs $1,530,051 $1,474,995 Discount on salvage and subrogation 8,027 7,944 Unrealized gain on investments 62,748 - Other 185,810 185,810 --------- --------- Total deferred tax liabilities $1,786,636 $1,668,749 --------- ---------
NOTE 17 - REPURCHASE OF COMMON STOCK - EFFECT ON STOCKHOLDERS' EQUITY - --------------------------------------------------------------------- In April 2000, the Company announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 315,000 shares of the common stock of the Company. On August 8, 2000, the Board of Directors authorized the repurchase of an additional 315,000 shares and on September 6, 2000, the Board of Directors authorized the repurchase of another 315,000 shares of the common stock of the Company in the open market from time to time. This brings the total shares of the Company's common stock authorized to be repurchased and retired to 945,000 shares. As of December 31, 2000, the Company had purchased and retired an aggregate of 628,600 shares of its common stock at a cost of $4,130,068 of which $308,908 was allocated to capital and $3,821,160 was allocated to retained earnings. In addition, the Company has an open commitment to purchase 65,000 shares of the Company's common stock at a price of $6.50 per share. This commitment was completed on February 13, 2001.