The Company designs, markets, and underwrites specialty commercial and personal property and casualty insurance products for select target industries or niches. The Company's operations are classified into three reportable business segments which are organized around its three underwriting divisions: The Commercial Lines Underwriting Group which has underwriting responsibility for the Commercial Automobile and Commercial Property and Commercial multi-peril package insurance products; The Specialty Lines Underwriting Group which has underwriting responsibility for the professional liability insurance products; and The Personal Lines Group has responsibility for personal property and casualty insurance products for the Manufactured Housing and Homeowners markets. The company operates solely within the United States through its 12 regional and 24 field offices.
The Company generates its revenues through the sale of commercial property and casualty insurance policies. The insurance policies are sold through the Company's five distribution channels which include direct sales, retail insurance agents/open brokerage, wholesalers, preferred agents and the internet. The Company believes that consistency in its field office representation has created excellent relationships with local insurance agencies across the country.
During 2003, the prior year market trends of premium rate increases and turmoil in the property and casualty insurance market continued. Although further premium rate increases were realized during 2003, the increases moderated from those realized in 2002. The increases have primarily arisen due to the significant property and casualty industry losses as a result of the tragic terrorist attacks of September 11, 2001, lower interest rates, and diminished risk capacity. Rating agency downgrades, insolvencies and consolidations in the industry also continued to be market factors during 2003.
In this environment, the Company continued its strong growth, with gross written premiums increasing 36.5% to $906.0 million. Gross written premium growth was strong across all the Company's business segments with in-force policy counts increasing 22.8% and 39.7% for the commercial and specialty lines segments, respectively, remaining flat for the personal lines segment, and weighted average premium rate increases on renewal business approximating 4.3%, 10.2% and 9.4% for the commercial, specialty and personal lines segments, respectively.
Asset backed, mortgage pass through, and collateralized mortgage obligation securities, on a cost basis, amounted to $183.0 million, $159.2 million and $53.8 million, respectively, as of December 31, 2003 and $202.8 million, $81.3 million and $89.2 million, respectively, as of December 31, 2002. The asset backed, mortgage pass through, and collateralized mortgage obligation investments are amortizing securities possessing favorable prepayment risk and/or extension profiles.
The Company regularly performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed for all securities, except interests in securitized assets, meeting predetermined thresholds to determine whether such decline is other than temporary. If the Company determines a decline in value to be other than temporary, based upon its detailed review, or if a decline in value for an equity investment has persisted continuously for nine months, the cost basis of the security is written down to its fair value. The factors considered in reaching the conclusion that a decline below cost is other than temporary include, but are not limited to, whether: the issuer is in financial distress; the investment is secured; a significant credit rating action has occurred; scheduled interest payments have been delayed or missed; or changes in laws and/or regulations have impacted an issuer or industry. The amount of any write down is included in earnings as a realized loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $1.0 million and $2.1 million for the years ended December 31, 2003 and 2002, respectively. Such non-cash realized investment losses resulted from other than temporary declines in the fair value of certain holdings in the Company's common stock portfolio occurring primarily in the fourth quarter of 2002
Additionally, the Company conducts its impairment evaluation and recognition for interests in securitized assets in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board ("EITF") in EITF 99-20. Under this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent (prior) estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $9.3 million and $1.6 million for the years ended December 31, 2003 and 2002, respectively. These non-cash realized investment losses were primarily due to investments in collateralized bond obligations as a result of the non investment grade default rates which remain higher than historic averages.
The Company's fixed maturity portfolio amounted to $1,081.7 million and $854.5 million, as of December 31, 2003 and December 31, 2002, respectively, of which 98.6% of the portfolio for both years was comprised of investment grade securities. From the fourth quarter of 2001 into early 2003 following the war in Iraq, U.S. investment grade securities experienced varying price and ratings volatility, having been affected by the uncertain economic climate, corporate governance issues, and the subsequent stream of corporate scandals and high profile bankruptcies. More recently certain sectors of the investment grade security market have continued to lag despite a return to a more favorable economic climate. However, the high quality of the Company's overall "AA+" rated fixed maturity portfolio, has mitigated potential volatility. The Company had fixed maturity investments with unrealized losses amounting to $10.6 million and $9.2 million as of December 31, 2003 and December 31, 2002, respectively. Of these amounts, interests in securitized assets had unrealized losses amounting to $9.2 million and $7.3 million as of December 31, 2003 and December 31, 2002, respectively. As discussed above, the Company's impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by the EITF. Investments in aircraft collateralized Enhanced Equipment Trust Certificates (EETCs) had unrealized losses amounting to $0 and $1.3 million as of December 31, 2003 and December 31, 2002, respectively.
The following table identifies the period of time securities with an unrealized loss at December 31, 2003 have continuously been in an unrealized loss position. Included in the amounts displayed in the table are $6.5 million of unrealized losses due to non-investment grade fixed maturity securities having a fair value of $15.6 million. No issuer of securities or industry represents more than 4.4% and 15.5%, respectively, of the total estimated fair value, or 18.1% and 39.7%, respectively, of the total gross unrealized loss included in the table below. As previously discussed, there are certain risks and uncertainties inherent in the Company's impairment methodology, such as the financial condition of specific industry sectors and the resultant effect on underlying security collateral values. Should the Company subsequently determine a decline in the fair value below the cost basis to be other than temporary, the security would be written down to its fair value and the difference would be included in earnings as a realized loss for the period such determination was made.
The Company's financial instruments are subject to the market risk of potential losses from adverse changes in market rates and prices. The primary market risks to the Company are equity price risk associated with investments in equity securities and interest rate risk associated with investments in fixed maturities. The Company has established, among other criteria, duration, asset quality and asset allocation guidelines for managing its investment
portfolio market risk exposure. The Company's investments are held for purposes other than trading and consist of diversified issuers and issues.
The liability for unpaid loss and loss adjustment expenses ($627.1 million and $445.6 million as of December 31, 2003 and 2002, respectively) reflects the Company's best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events. Based upon past experience this estimate has been redundant by as much as 18.5% and deficient by as much as 41.4%. The process of establishing the liability for property and casualty unpaid loss and loss adjustment expenses is a complex and imprecise process, requiring the use of informed estimates and judgments. This liability includes an amount determined on the basis of claim adjusters' evaluations with respect to insured events that have occurred and an amount for losses incurred that have not been reported to the Company. In some cases significant periods of time, up to several years or more, may elapse between the occurrence of an insured loss and the reporting of such to the Company. The method for determining the Company's liability for unpaid loss and loss adjustment expenses includes, but is not limited to, reviewing past loss experience and considering other factors such as legal, social, and economic developments. The methods of making such estimates and establishing the resulting liabilities are regularly reviewed and updated, and any adjustments resulting therefrom are made in the accounting period in which the adjustment arose.
-- The Company increased the estimated gross and net loss for unreported claims incurred and related claim adjustment expenses on residual value polices issued during the years 1998 through 2002 by $38.8 million. As of December 31, 2003 the Company's total liability for gross and net unpaid loss and loss adjustment expenses for these policies is estimated to be $30.3 million. The residual value policies provide coverage guaranteeing the value of a leased automobile at the lease termination which can be up to five years from lease inception. The increase in the estimated gross and net loss was a result of:
- $19.6 million ($13.7 million net of reinsurance recoverables) of development in professional liability products as a result of case reserves developing greater than anticipated from the year-end 2002 ultimate loss estimate; $18.1 million ($11.1 million net of reinsurance recoverables) of development in the automobile and general liability coverages for commercial package products due to losses developing beyond the underlying pricing assumptions; and $5.8 million ($6.0 million net of reinsurance recoverables) of development in the commercial automobile excess liability insurance and GAP commercial automobile products due to losses developing beyond the underlying pricing assumptions.
The method for determining reinsurance recoverables and estimated recoverability are regularly reviewed and adjustments resulting from this review are included in earnings in the period the adjustment arose.
Policy acquisition costs ($56.3 million and $61.3 million as of December 31, 2003 and 2002, respectively) which include commissions (net of ceding commissions), premium taxes, fees, and certain 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. Anticipated investment income is considered in determining whether a premium deficiency exists. The methods of making such estimates and establishing the deferred costs are continually reviewed by the Company, and any adjustments therefrom are made in the accounting period in which the adjustment arose.
Premiums: Premium information relating to the Company's business segments is as follows (in millions):
- - The displacement of certain competitor property and casualty insurance companies and their independent agency relationships continues to result in new agency relationship opportunities for the Company. These relationship opportunities have resulted in additional policyholders and premium writings for the Company's commercial and specialty lines segments.
The differing percentage changes in net written premiums versus gross written premiums for the commercial lines, specialty lines and personal lines segments during the year results from:
- - Relatively lower reinsurance costs (ceded premiums) as a result of increasing the Company's loss retention from $0.5 million to $2.0 million on its commercial lines per-risk property reinsurance treaty and from $0.9 million to $1.0 million on its excess liability reinsurance treaty, effective January 1, 2003.
Net Investment Income Net investment income approximated $38.8 in 2003 and $37.5 million in 2002. Total investments grew to $1,172.1 million at December 31, 2003 from $908.9 million at December 31, 2002. The growth in investment income is due to investing net cash flows provided from operating activities. The Company's average duration of its fixed income portfolio increased to approximately 4.0 years at December 31, 2003, compared to 3.2 years at December 31, 2002 as a result of investing in overall "AAA" rated intermediate to longer tax exempt fixed income securities due to their perceived relative value to taxable alternatives. The Company's taxable equivalent book yield on its fixed income holdings declined to 4.9% at December 31, 2003, from 5.2% at December 31, 2002, as a result of investing strong cash inflows due to premium increases at relatively low interest rates during the Federal Reserve's latest easing cycle. Net investment income was reduced by $2.3 million due to the interest credit on the Funds Held Account balance pursuant to the Company's quota share reinsurance agreement (see Premiums).
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $33.0 million (25.4%) to $162.9 million for the year ended December 31, 2003 from $129.9 million for the same period of 2002. This increase was due primarily to the 35.7% growth in net earned premiums and in part to the Company establishing a $1.4 million allowance for doubtful reinsurance receivables based upon its review of collectibility from its reinsurers. During the year the Company ceded $109.3 million of net earned premium and earned $46.7 million in ceding commission under the quota share reinsurance agreement (see Premiums).
Income Tax Expense: The Company's effective tax rate for the years ended December 31, 2003 and 2002 was 30.5% and 31.4%, respectively. The effective rates differed from the 35% statutory rate principally due to investments in tax-exempt securities and the relative proportion of tax exempt income to total income before tax.
The total return, which includes the effect of realized and unrealized gains and losses, of the Company's fixed income portfolio was 9.09% and 7.30% for the years ended December 31, 2002 and 2001, respectively versus the Lehman Brothers US Aggregate Bond Index ("the Index") total return of 9.51% and 8.67% for the same periods, respectively. While the performance during 2002 and 2001 was similar to the total return of the Index, performance differed from the Index due primarily to the following factors:
- - the Company maintains a higher level of credit quality in the portfolio versus the Index; and
Other Income: Other income approximated $0.9 million for the year ended December 31, 2002 and $0.6 million for the same period of 2001. Other income primarily consists of commissions earned on brokered personal lines business, and to
During 2003 PCHC repurchased 10,000 shares of its common stock for approximately $0.3 million under the stock repurchase authorization. At December 31, 2003 the remaining stock repurchase authorization is $24.7 million.
The Company produced net cash from operations of $298.5 million in 2003, $205.0 million in 2002 and $115.1 million in 2001. Sources of operating funds consist primarily of net premiums written and investment income. Funds are used primarily to pay claims and operating expenses and for the purchase of investments. Cash from operations in 2003 was primarily generated from strong premium growth during such year due to increases in the number of policies written and price increases realized on renewal business. Net loss and loss expense payments were $237.4 million in 2003, $157.9 million in 2002, and $125.0 million in 2001. Net cash from operations also included cash provided from tax savings as a result of the exercise of employee stock options amounting to $0.9 million, $1.3 million and $25.8 million for 2003, 2002 and 2001, respectively. Management believes that the Company has adequate liquidity to pay all claims and meet all other cash needs.
Under certain reinsurance agreements, the Company is required to maintain investments in trust accounts to secure its reinsurance obligations (primarily the payment of losses and loss adjustment expenses on business it does not write directly). At December 31, 2003, the investment and cash balances in such trust accounts totaled approximately $1.7 million. In addition, various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 2003, the balance on deposit for the benefit of such policyholders totaled approximately $15.5 million.
The Insurance Subsidiaries, which operate under an intercompany reinsurance pooling agreement, must have certain levels of surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners (the "NAIC") suggest that a property and casualty insurer's ratio of annual statutory net premium written to policyholders' surplus should not exceed 3-to-1. The ratio of combined annual statutory net premium written by the insurance subsidiaries to their combined policyholders' surplus was 1.5-to-1.0 and 1.7-to-1.0 for 2003 and 2002, respectively.
(2) Represents 12 month collateralized borrowings from the Federal Home Loan Bank of Pittsburgh.
(3) Represents open commitments under certain limited partnership and information technology development agreements.
severity of natural disasters and other catastrophe losses; (vii) adequacy of reinsurance coverage which may be obtained by the Company; (viii) ability and willingness of our reinsurers to pay; and (ix) future terrorist attacks.
Philadelphia Consolidated Holding Corp. ("Philadelphia Insurance"), and its subsidiaries (collectively the "Company") doing business as Philadelphia Insurance Companies, include four property and casualty insurance companies, Philadelphia Indemnity Insurance Company ("PIIC") and Philadelphia Insurance Company ("PIC"), which are domiciled in Pennsylvania; and Mobile USA Insurance Company ("MUSA") and Liberty American Insurance Company ("LAIC"), which are domiciled in Florida (collectively the "Insurance Subsidiaries"); an underwriting manager, Maguire Insurance Agency, Inc.; a managing general agency, Mobile Homeowners Insurance Agencies, Inc; a premium finance company Liberty American Premium Finance Company; and an investment subsidiary, PCHC Investment Corp. The Company designs, markets, and underwrites specialty commercial and personal property and casualty insurance products for select target industries or niches including, among others, nonprofit organizations; the health, fitness and wellness industry; select classes of professional liability; the rental car industry; automobile leasing industry; and personal property and casualty insurance products for the manufactured housing and homeowners markets. All marketing, underwriting, claims management, investment, and general administration is provided by the underwriting manager and managing general agency.
Investments in fixed maturities are adjusted for amortization of premiums and accretion of discounts to maturity date, except for asset backed, mortgage pass-through and collateralized mortgage obligation securities which are adjusted for amortization of premiums and accretion of discounts over their estimated lives. Certain asset backed, mortgage pass-through and collateralized mortgage obligation security 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. Asset backed, mortgage pass-through and collateralized mortgage obligation securities amounted to $177.7 million, $162.5 million and $53.5 million, respectively, at December 31, 2003 and $200.0 million, $86.1 million and $90.7 million, respectively, at December 31, 2002. The asset backed, mortgage pass-through and collateralized mortgage obligation securities held as of December 31, 2003 and 2002 are shorter tranche securities possessing favorable prepayment risk profiles.
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 becomes 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. The carrying value of property and equipment is reviewed for recoverability including an evaluation of the estimated useful lives of such assets.
The Company adopted the provisions of Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets" on January 1, 2002. SFAS No. 142 eliminates the practice of amortizing goodwill through periodic charges to earnings and establishes a two-step impairment test to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). As a result of the impairment analysis, no change in the carrying amount of goodwill, which arose from the purchase of Liberty, was recorded by the Company for the years ended December 31, 2003 and December 31, 2002, respectively. Goodwill amortization was $1.5 million for the year ended December 31, 2001.
The liability for unpaid loss and loss adjustment expenses reflects the Company's best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events. The process of establishing the ultimate claims
In the normal course of business, the Company seeks to reduce the loss that may arise from events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the reinsured policy. At December 31, 2003 and 2002 the allowance for uncollectible reinsurance amounted to $1.2 million and $0, respectively. Amounts for reinsurance assets and liabilities are reported gross.
The Insurance Subsidiaries are subject to state guaranty fund assessments, which provide for the payment of covered claims or meet other insurance obligations from insurance company insolvencies, and other assessments related to its insurance activities. Each state has enacted legislation establishing guaranty funds and other insurance activity related assessments resulting in a variety of assessment methodologies. Expense for guaranty fund and insurance activity related assessments are recognized when it is probable that an assessment will be imposed, the obligatory event has occurred and the amount of the assessment is reasonably estimatable. As of December 31, 2003 and 2002, included in Other Liabilities in the Consolidated Balance Sheets were $10.3 million and $6.1 million, respectively, of liabilities for state guarantee fund and other assessments. As of December 31, 2003 and 2002, included in other assets were $0.1 million and $1.8 million, respectively, of related assets for premium tax offsets or policy surcharges. The related asset is limited to the amount that is determined based upon future premium collections or policy surcharges from policies in force.
Components of comprehensive income, as detailed in the Consolidated Statements of Operations and Comprehensive Income, are net of tax. The related tax effect of Holding Gains (Losses) arising during the year was $0.6 million, $3.0 million and ($1.5) million in 2003, 2002 and 2001, respectively. The related tax effect of Reclassification Adjustments was $0.3 million, ($1.2) million, and $1.2 million in 2003, 2002 and 2001, respectively.
Financial Information: The combined statutory capital and surplus of the Insurance Subsidiaries as of December 31, 2003 and 2002 was $415.9 million and $312.6 million, respectively. Combined statutory net income for the years ended December 31, 2003, 2002 and 2001 was $49.9 million, $14.5 million, and $28.3 million, respectively. The Company made capital contributions of $47.0 million and $20.0 million to the Insurance Subsidiaries for the years ended December 31, 2003 and 2002, 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 the Insurance Subsidiaries may pay to Philadelphia Insurance during 2004 without prior approval is $50.7 million. Dividends paid for the years ended December 31, 2003 and 2002 were $4.0 million and $5.1 million, respectively.
The Company invests primarily in investment grade fixed maturities which possessed an average quality rating of AA+ at December 31, 2003. The cost, gross unrealized gains and losses and estimated market value of investments as of December 31, 2003 and 2002 are as follows (in thousands):
(1) Original cost of equity securities; original cost of fixed maturities adjusted for amortization of premiums and accretion of discounts. All amounts are shown net of impairment losses.
The Company had no debt or equity investments in a single issuer totaling in excess of 10% of shareholders' equity at December 31, 2003.
(2) Estimated market values have been based on quoted market prices or quotes from third party broker-dealers.
The sources of net investment income for the years ended December 31, 2003, 2002, and 2001 are as follows (in thousands):
Realized pre-tax gains (losses) on the sale of investments for the years ended December 31, 2003, 2002, and 2001 are as follows (in thousands):
The Insurance Subsidiaries have investments, principally U.S. Treasury securities, on deposit with the various states in which they are licensed insurers. At December 31, 2003 and 2002, the carrying value of the securities on deposit totaled $15.5 million.
Included in property and equipment are costs incurred in developing or purchasing information systems technology of $13.3 million and $8.2 million in 2003 and 2002, respectively. At December 31, 2003, costs incurred for Property and Equipment not yet placed in service was $4.0 million. Amortization of these costs was $1.1 million, $1.0 million and $0.8 million for the years ended December 31, 2003, 2002 and 2001, respectively. Depreciation expense, excluding amortization of capitalized information systems technology costs, was $1.6 million, $1.5 million and $1.4 million, for the years ended December 31, 2003, 2002, and 2001, respectively.
- Adverse trends further deteriorating in both claims frequency and severity for leases expiring in 2003. During the second quarter of 2003, the Company engaged a consulting firm to aid in evaluating the ultimate potential loss exposure under these policies. Based upon the study and subsequent evaluation by the Company the Company changed its assumptions relating to future frequency and severity of losses, and increased the estimate for unpaid loss and loss adjustment expenses by $33.0 million. The Company primarily attributes this deterioration to the following factors that led to a softening of prices in the used car market subsequent to the September 11, 2001 terrorist attacks: prolonged 0% new car financing rates and other incentives which increased new car sales and the volume of trade-ins, daily rental units being sold into the market earlier and in greater numbers than expected, further adding to the over supply of used cars and the overall uncertain economic conditions.
-- The Company increased its estimate for unpaid loss and loss adjustment expenses for non residual value policies by $43.5 million ($30.8 million net of reinsurance recoverables) primarily for accident years 1999 to 2001 and decreased its estimate of the unpaid loss and loss adjustment expenses by $30.6 million ($25.0 million net of reinsurance recoverables) for the 2002 accident year. The increase in accident years 1999 to 2001 is principally attributable to:
commercial automobile excess liability insurance and GAP commercial automobile products due to losses developing beyond the underlying pricing assumptions.
During 2002, the Company increased the estimated loss for unreported claims incurred and related claim adjustment expenses on residual value polices issued during the years 1998 through 2001 by $30.2 million ($20.7 million net of reinsurance). As of December 31, 2001 the Company had estimated a total liability for unpaid loss and loss adjustment expenses for these policies of $14.5 million ($8.7 million net of reinsurance recoverables). During 2002 adverse trends further deteriorated in both frequency and severity on leases expiring in 2002. As part of the Company's monitoring and evaluation process, consulting firms were engaged during the third quarter of 2002 to aid in evaluating this deterioration and the ultimate potential loss exposure under these policies. As a result of the indications and subsequent evaluation by the Company and changes in the Company's assumptions relating to future frequency and severity of losses, the estimate for unpaid loss and loss adjustment expenses was increased. The Company primarily attributes this deterioration to the following factors that led to a softening of prices in the used car market subsequent to the September 11, 2001 terrorist attacks: prolonged 0% new car financing rates and other incentives which increased new car sales and the volume of trade-ins, daily rental units being sold into the market earlier and in greater numbers than expected further adding to the over supply of used cars; and the overall uncertain economic conditions.
Effective April 1, 2003, the Company entered into a quota share reinsurance agreement covering all of the Company's lines of business. Under this agreement, the Company cedes 22% of its net written premium (including 22% of net unearned premium reserves at April 1, 2003) and loss and loss adjustment expenses. The Company also receives a provisional commission of 33.0% adjusted pro-rata based upon the ratio of losses incurred to premiums earned. Pursuant to this reinsurance agreement the Company withholds the reinsurance premium due the reinsurers reduced by the reinsurers' expense allowance, and the Company's ceding commission allowance in a Funds Held Payable to Reinsurer account. This Funds Held Payable to Reinsurer account is also reduced by ceded paid losses and loss adjustment expenses under this agreement, and increased by an interest credit. The interest credit (expense), which is included in net investment income, was $2.3 million for the year ended December 31, 2003.
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2003 and 2002 are as follows (in thousands):
On May 16, 2001, the Company issued 4.0 million common shares to satisfy the stock purchase contract obligation from the Company's 1998 FELINE PRIDES(SM) offering. The issuance of such shares resulted in a $98.9 million increase in Shareholders' Equity and a corresponding decrease in the Minority Interest In Consolidated Subsidiaries balance.
The number of weighted share equivalents not included in the weighted-average share equivalents outstanding calculation amounted to 2,730, 9,620 and 122 for the years ended December 31, 2003, 2002 and 2001, respectively.
During the fourth quarter of 2001, the Company closed on its public offering of an aggregate of 3.6 million shares of its common stock. Proceeds from the offering amounted to $114.5 million (after underwriting and associated costs). The Company contributed $70.0 million of the net proceeds to its subsidiaries in 2001, of which $60.0 million was contributed to the Insurance Subsidiaries. The remaining proceeds are presently being held for general corporate purposes.
Under the Company's stock option plan, stock options may be granted for the purchase of common stock at a price not less than the fair market value on the date of grant. Options are primarily exercisable after the expiration of five years following the grant date. Under this plan, as amended, the Company has reserved 3,500,000 shares of common stock for issuance pursuant to options granted under the plan. As of December 31, 2003, 119,725 shares of common stock remain reserved for future issuance pursuant to options granted under this plan.
In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure ("SFAS No. 148") which amends SFAS Statement No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). The objective of SFAS No. 148 is to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 does not change the provisions of SFAS No. 123 that permit entities to continue to apply the intrinsic value method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"). In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company continues to maintain its accounting for stock-based compensation in accordance with APB No. 25, but has adopted the disclosure provisions of SFAS No. 148.
Employee Stock Purchase Plan (the "Stock Purchase Plan"): The aggregate maximum number of shares that may be issued pursuant to the Stock Purchase Plan as amended is 1,000,000. Shares may be purchased under the Stock Purchase Plan by eligible employees during designated one-month offering periods established by the Compensation Committee of the Board of Directors at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. The purchase price of shares may be paid by the employee over six years pursuant to the execution of a promissory note. The promissory note(s) are collateralized by such shares purchased under the Stock Purchase Plan and are interest free. Under the Stock Purchase Plan, the Company issued 36,265 and 77,730 shares in 2003 and 2002, respectively. The weighted-average fair value of those purchase rights granted in 2003 and 2002 was $6.00 and $4.47, respectively.
The Nonqualified Employee Stock Purchase Plan (the "Nonqualified Stock Plan"): The aggregate maximum number of shares that may be issued pursuant to the Nonqualified Stock Plan is 1,000,000. Shares may be purchased under the Nonqualified Stock Plan by eligible employees during designated one-month offering periods established by the Compensation Committee of the Board of Directors at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. The purchase price of shares may be paid by the employee over nine years pursuant to the execution of a promissory note. The promissory note(s) are collateralized by such shares purchased under the Nonqualified Stock Plan and are interest free. Under the Nonqualified Stock Plan, the Company issued 5,939 and 242,444 shares in 2003 and 2002, respectively. The weighted-average fair value of those purchase rights granted in 2003 and 2002 was $6.00 and $4.47, respectively.
Preferred Agents Stock Purchase Plan ("Preferred Agents Plan"): The Preferred Agents Plan has been established for the benefit of eligible Preferred Agents. The aggregate maximum number of shares that may be issued pursuant to the Preferred Agents Plan is 200,000. Eligible Preferred Agents during designated offering periods may either remit cash or have the Company withhold from commissions or other compensation amounts to be used for the purchase of shares under the terms of the Preferred Agents Plan at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. Under the Preferred Agents Plan, the Company issued 7,056 and 10,966 shares in 2003 and 2002, respectively. The weighted-average fair value of those purchase rights granted in 2003 and 2002 was $6.00 and $6.07, respectively.
During the three years ended December 31, 2003, the Company repurchased 0.1 million shares for approximately $2.5 million under its stock repurchase authorization. At December 31, 2003, $24.7 million remains under a $55.0 million stock purchase authorization.
The loss and loss adjustment expense reserves ceded under such arrangements were $145.6 million and $85.8 million at December 31, 2003 and 2002, 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 (excluding reserves ceded to voluntary and mandatory pool mechanisms) that are with companies rated "A" (Excellent) or better by A.M. Best Company is 99.3% and 97.0% as of December 31, 2003 and 2002, respectively. Additionally, approximately 1%, 1% and 3% of the Company's net written premiums for the years ended December 31, 2003, 2002, and 2001, respectively, were assumed from an unrelated reinsurance company.
The Company also sponsors an unfunded nonqualified executive deferred compensation plan. Under the plan deferred compensation benefits are provided by the Company through deferrals of base salary and bonus compensation for management and highly compensated executives designated by the Board of Directors. Each participant is permitted to specify an investment or investments from among permissible investments which shall be the basis for determining the gain or loss adjustment applicable to such participant's plan deferral account. A participant's benefit under the plan is the amount of such participant's plan deferral amount. The Company had a deferred compensation obligation pursuant to the plan amounting to $0.8 million and $0.5 million as of December 31, 2003 and 2002, respectively.
The Company currently leases office space to serve as its headquarters location and 36 field offices for its production underwriters. In addition, the Company leases certain computer equipment. Rental expense for these operating leases was $3.5 million, $3.1 million and $2.6 million for the years ended December 31, 2003, 2002, and 2001, respectively.
(2) During the three months ended December 31, 2003, the Company recorded a benefit pursuant to the 2003 accident year quota share reinsurance agreement. Consequently, net earned premiums and net income increased by $7.5 million and $4.9 million, respectively.