We lease approximately 115,000 square feet for our home office at 3760 River Run Drive, Birmingham, Alabama under a long-term operating lease. For our life insurance businesses, we lease approximately 25,000 square feet in Phoenix, Arizona. In our non standard auto insurance operations, we lease approximately 400,000 square feet of office space for our agencies, insurance companies and retail stores in various locations throughout the United States.
Vesta conducts business in three areas of the personal insurance industry: (1) standard property and casualty insurance; (2) non-standard automobile insurance; and (3) life insurance. Our consolidated revenue is derived principally from risk-bearing premiums, policy fees, commissions and fees, investment income and investment gains and losses. Our consolidated expenses consist primarily of payments for claims and expenses associated with underwriting activities, agents’ commissions and operations.
Since 2000, we have pursued a strategy (1) to grow our market share in certain capacity restrained niche markets in the standard property-casualty business, (2) to exit certain states in which current results and projected future results do not fit our overall profitability strategy and (3) to participate in profitable opportunities in other industry segments such as the non-standard automobile business and the life insurance business. While we have experienced significant and profitable growth in various personal lines business since 2000, we have also experienced significant declines in our property and casualty subsidiaries’ statutory capital and surplus during the same period. These declines in capital and surplus are primarily attributable to lower than expected arbitration awards and changes in estimates of disputed reinsurance recoverable balances, reserve strengthening in our discontinued commercial and assumed reinsurance segments and increased policy acquisitions costs associated with significant premium growth. This decline in statutory surplus coupled with significant growth in premium written is the primary reason that A.M. Best Company adjusted the financial strength ratings of our property and casualty insurance subsidiaries from B+ (Very Good) to B (Fair) in March of 2003. Since the A.M. Best rating action, we have not experienced a significant negative impact from our operations. However, the adjustment could lead to significant deterioration in selected portions of our standard property and casualty premium volume and adversely impact the financial results of this segment going forward, the degree to which management is unable to quantify.
In an effort to strengthen our capital position, we began a capital evaluation in March of 2003. The capital evaluation included an analysis of the possible divestiture of certain of our businesses, including our life and health operations and elements of our property-casualty operations. The capital evaluation resulted in the following significant events affecting our results of operation and financial condition during 2003:
• The increased utilization of quota share reinsurance for our standard property-casualty operations during 2003;
The financial results of our property-casualty underwriting activities (including our standard property-casualty segment and the non-standard underwriting segment) primarily depend upon three variables: (1) the amount of premiums and policy fees we collect, which is dependent upon rates and volume; (2) the costs we incur to adjust and pay claims submitted by individuals we have insured; and (3) the expenses we incur for policy acquisition and to operate our insurance companies.
The degree to which the Company is able to realize the positive impact from these rate increases is contingent upon the degree to which we can sustain current net written premium levels. Decreased written premium levels due to our surplus constraints, competition, or further increases in our utilization of reinsurance would reduce the impact of these rate increases. Furthermore, the impact of these rate increases may be reduced through future rate reductions enacted by state regulatory agencies.
Our property and casualty insurance companies also earn investment income by collecting and investing premiums in advance of paying claims. In addition to investing operating cash flow, these insurance companies invest funds and earn investment income related to the required statutory surplus that we maintain in our insurance companies to support the premium that we underwrite. We report the investment income and realized investment security gains or losses generated from these activities of our property and casualty insurance companies in our corporate and other segment.
Our underwriting agencies predominantly design, distribute and service policies issued by our insurance companies. During 2003, our underwriting agencies also administered the policies of one unaffiliated non-standard personal automobile insurance company. In the future, these underwriting agencies may provide services to additional unaffiliated insurance companies in order to ensure continuity and sufficient underwriting product and capacity for our distribution channels regardless of hard or soft cycles.
The financial results of our life insurance operations primarily depend upon (1) the amount we collect as premium; (2) the amount of investment income earned on invested premium; and (3) the benefits we pay to insureds upon their death. Unlike the standard property-casualty segment, we typically hold the premium collected on our life products for many years and invest such premium over a long period of time, making investment income a significant component of revenue that we report in the life segment. The greatest variable in our revenue in the life segment is the amount of income we can earn on invested assets, which is dependent upon general interest rates and market conditions. The greatest variable in our expense from period to period is the mortality rate of our insureds, as mortality rates in excess of our actuarially predicted levels will adversely impact financial results in any given period.
In addition to the above-mentioned factors, our financial results may also be impacted by weather-related events such as hurricanes and tornadoes. Also, our ability to effectively compete in the insurance markets we serve is influenced by the financial strength ratings assigned to our companies by A.M. Best.
Our consolidated financial statements are based upon the selection and application of accounting policies that require management to make significant estimates and assumptions. Our financial results would be directly impacted by changes in assumptions and judgments used to apply our accounting policies, particularly in certain critical areas. We believe the following are some of the more critical judgment areas in the application of our accounting policies that affect our financial condition and results of operations.
• Recoverability of assets, including reinsurance receivables, deferred policy acquisition costs, deferred tax assets and other intangible assets;
• FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees”;
• SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”.
• Emerging Issues Task Force Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”
Our financial statements include as assets amounts we either (i) expect to collect from third parties, particularly reinsurance recoverables, or (ii) expect to benefit from in future periods, particularly deferred acquisition costs and deferred tax assets. In establishing these amounts, we have made significant judgments and estimates regarding the ultimate realization of each asset. Specifically, we have made critical assumptions and judgments in establishing assets for reinsurance recoverables on
The Company has ceded reserves of $26.5 million to Lumbermens Mutual Casualty Company, a member of the Kemper Insurance Companies, primarily related to long-term care obligations under personal injury protection auto policies of the Shelby insurance companies originating prior to their acquisition in 1997. Lumbermens and other members of the Kemper Insurance Companies, which operate under a business pooling arrangement, were assigned an A. M. Best’s rating of “D” (Poor) on June 30, 2003. The Company is closely monitoring the financial condition of Lumbermens, which has entered into a voluntary run-off plan with the Illinois Department of Insurance. As of December 31, 2003, no valuation allowance has been recorded related to the ceded reserve receivables from Lumbermens.
It is possible that the amounts we recover under reinsurance contracts could be materially less than the amounts we have recorded, which may result in a material adverse impact on our financial condition and results of operations. Some reinsurers may dispute our claims under reinsurance contracts, including our calculation of amounts recoverable and may pursue arbitration or litigation over these matters. During the years 2002 and 2003, we have recorded changes in our estimated reinsurance recoverables of approximately $106.3 million primarily related to several reinsurance arbitrations including NRMA Insurance Ltd., Alfa Mutual Insurance Company and Dorinco Reinsurance Company related to our 1997 20% whole account quota share, F&G Re (on behalf of USF&G), CIGNA Property and Casualty Insurance Company, Hartford Reinsurance, and Delta Re.
Changes in our assumptions, estimates and judgments with respect to establishing assets for reinsurance recoverables on paid losses and reinsurance balances receivable would materially impact our financial results and financial condition. For more discussion of reinsurance recoverables and other amounts subject to estimation due to arbitrations with our reinsurers, please refer to Notes G and I to our consolidated financial statements.
A reduction in recorded deferred policy acquisition costs shall be recognized if the sum of the expected loss and loss adjustment expenses, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums and anticipated investment income. On an ongoing basis, management reviews the components of deferred acquisition costs we have established and assesses their recoverability. At December 31, 2003, we determined that there was no premium deficiency. Changes in our assumptions, estimates and judgments with respect to establishing deferred acquisition costs could materially impact our financial statements and financial condition. Such changes assessed by management that could negatively impact the recoverability of deferred acquisition costs on an ongoing basis include changes in estimated future loss ratios, changes in projected investment income, reduction of premium rates due to competitive factors or regulatory actions, or changes in our overall expense levels.
In our financial statements, we have recorded $143.8 million of goodwill and other intangible assets with indefinite lives, which represents the amount by which the price we paid to acquire net assets exceeds the fair value of tangible assets and identified intangibles with definite lives acquired less the fair value of the liabilities assumed. The determination of whether these assets are impaired involves significant judgments based upon management’s short and long-term projections of future performance for each of our business lines. Certain of these forecasts reflect assumptions regarding our ability to sustain or increase activities in our various business lines. Changes in strategy and/or market conditions may result in changes to recorded asset balances.
Effective January 1, 2002, in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangibles”, we no longer amortize goodwill on a periodic basis in our consolidated financial statements. Rather, on at least an annual basis, we conduct an evaluation to assess whether the fair value of our reporting units exceeds each reporting units’ carrying value. Our annual evaluation is performed as of September 30th. Upon the occurrence of significant events, which could impact the assumptions we use to project future profitability, we update our evaluation of our reporting units. We evaluate impairment of three reporting units: homeowners’ insurance operations; life insurance companies; and non-standard agency operations. For purposes of applying the provisions of SFAS No. 142, we compare the aggregate fair value and carrying value of each reporting unit to determine if there is any impairment. As long as the aggregate fair value exceeds the aggregate carrying value for each reporting unit, no impairment is recognized in our financial statements, even if an individual component of a reporting unit would be impaired on a stand-alone basis.
For the year ended December 31, 2003, we have recorded goodwill and other intangible assets with indefinite lives for each reporting unit as follows: homeowners’ insurance operations -$57.7 million; life insurance companies - $10.8 million; and non-standard auto insurance operations - $75.3 million. We assess the valuation of goodwill and other indefinite intangibles based upon (a) the historical financial performance of each unit; (b) the most recent financial performance of each unit; (c) management’s financial forecast for each reporting unit; (d) information regarding publicly available financial terms of recent transactions in the insurance industry; and (e) other publicly available information.
In accordance with guidelines established by our Board of Directors, our investment portfolio consists primarily of investment grade, fixed income securities. At December 31, 2003, our cash and investment portfolio was approximately $1.1 billion, with 2.8% consisting of investments in equity securities. Because of the nature of our investments, the fair value of our portfolio is not typically volatile, and the market values of our investments have generally been greater than or equal to their costs.
Our investments are recorded at fair value based upon quoted prices, if available. If quoted prices are not available, fair value is primarily determined based upon management’s assessment of the market value of comparable investments. Our determination of fair value also considers various factors including time value and volatility issues, credit quality of the counterparty and existing conditions in the overall financial markets. From time-to-time, the carrying values of our investments may be temporarily impaired because of such factors. We do not adjust the carrying value of any investment unless management determines that its value is other than temporarily impaired. Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic concerns warrant such an evaluation. Factors considered by management in determining whether an impairment of an investment security is other than temporary includes the credit quality of the security, the severity of the decrease between the security’s cost and market value, the length of time of the security’s impairment and the likelihood that the impairment will reverse in the future. In the event that management determined that a reduction in an investment security’s fair value below its costs basis is other than temporary, the security’s cost basis is reduced to its fair value and a corresponding realized loss is recorded in our consolidated income statement. For the years ended December 31, 2003 and 2002, we recorded $3.1 million and $8.0 million, respectively, of realized losses for other than temporary impairments of investment securities.
The determination of whether other than temporary impairment has occurred involves significant assumptions, estimates and judgments by management. Changing economic conditions - global, regional or related to industries of specific issuers - could adversely affect these values.
At December 31, 2003, included in securities available-for-sale are the following investments with unrealized losses classified according to the term of the unrealized loss of less than twelve months or twelve months or longer:
For those securities identified as having temporary impairments of twelve months or more, approximately 48% of these unrealized losses occurred in federal agency mortgage-backed securities. Management does not view these losses as being related to credit quality as these bonds are guaranteed by the issuing agency and, with respect to certain securities, by the U.S. Government. It is not expected that the securities would be settled at a price less than the amortized cost of the investment.
The remaining potential losses over one year are split between investment and non-investment grade securities. A majority of these losses represent securities that are secured by collateral mitigating any impairment risk. It is not expected that the securities will be settled at a price less than the amortized cost of the investment.
We maintain property-casualty loss reserves to cover the estimated ultimate unpaid liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred. Reserves do not represent an exact calculation of the ultimate liability, but rather utilize actuarial projection techniques commonly used in the insurance industry to develop estimates. Reserve estimates represent managements’ expectations of what the ultimate settlement and administration of claims will cost based upon, among other factors, (1) an assessment of facts and circumstances then known; (2) a review of historical settlement patterns; (3) estimates of trends in claims severity and frequency; and (4) estimates of salvage and subrogation.
At December 31, 2003, we had recorded liabilities for loss and loss adjustment expenses of $355.6 million. Our loss and loss adjustment expense reserves comprise the largest liability and most significant estimate or compilation of estimates in our consolidated financial statements. Furthermore, our loss and loss adjustment expense reserves are subject to significant inherent uncertainties and so there can be no assurance as to whether the actual results will be higher or lower than these estimates. Any adjustments or changes for such differences may be material, especially to our operating results for a period. As our loss and loss adjustment expense reserves are re-estimated, changes to those estimates, if any, are recognized through a charge to income in the most recent period presented.
Our consolidated revenue is derived principally from premiums, commissions, fees, investment income and investment gains and losses. Premium income, the largest component of our consolidated revenue, is generally recognized on a pro-rata basis over the respective period of each property-casualty insurance policy. Premium receivables are recorded net of an estimated allowance for uncollectible amounts. Agency commission income is recognized at the later of the billing or effective date of the related insurance policies, net of an allowance for estimated policy cancellations. At that date, the earnings process has been completed and we can reliably estimate the impact of policy cancellations for refunds based on an analysis of our historical policy cancellation data and establish reserves accordingly. Premiums on life insurance contracts are recognized as income as they become due.
Changes in assumptions, estimates and judgments we have made concerning the ultimate realization of profit sharing commissions, as well as differences in the frequency and severity of claims by policyholders, could adversely impact our financial results and financial condition.
• The recognition of a deferred tax asset valuation charge of $75.4 million.
• Charges to discontinued operations of $15.9 million, net of tax, related to the divestiture of our health operations, increases to our commercial and assumed reinsurance reserves, and the write-off of certain assumed reinsurance receivable balances.
For a depiction of the various components of revenue, expense and financial results for each of our business segments for the years ending December 31, 2003 please refer to Note L of our consolidated financial statements.
The impact of the 2003 50% Quota Share and the 2002 50% Quota Share on the standard property-casualty net premiums written and net premiums earned and policy fees in fiscal year 2003 was a reduction of $104.3 million and $97.7 million, respectively. Additionally, the continuation of management’s initiative to exit certain states (Georgia, Arkansas, Illinois, Indiana, Maryland, North Carolina, New Mexico, Nevada, Ohio and Virgina), our Discontinued States, further decreased net written and net premiums earned in 2003 by $28.7 million and $15.8 million respectively.
Loss and loss adjustment expenses for standard property-casualty lines for the year ended December 31, 2003 decreased by $13.8 million, or 6.2%, to $207.8 million from $221.6 million in the prior year. The decrease in loss and loss adjustment expenses incurred was primarily attributable to a $9.0 million impact resulting from the effects of the 2003 50% Quota Share and improved underwriting results, offset by increases in catastrophe losses, including the $18.3 million in loss and loss adjustment expenses resulting from a series of hail storms in Texas and the Southeastern United States.
For the year ended December 31, 2003, policy acquisition expenses decreased by $8.6 million, or 11.9%, to $63.6 million from $72.2 million for the same period of the prior year. Policy acquisition expenses as a percentage of net premiums earned decreased to 22.1% in 2003 from 22.5% in 2002, reflecting the effects of the 2003 Quota Share and a shifting of business concentration to states with lower agent commissions and other policy acquisition expenses. The 2003 Quota Share treaty include a provisional ceding commission that is 11% higher than that of the 2002 50% Quota Share agreement.
Operating expenses increased by $4.6 million, or 11.5%, to $44.5 million from $39.9 million. The increase in operating expenses is primarily attributed to a $2 million increase in expenses related to Texas and a $2 million increase in expenses related to California. The increase in Texas is a direct result of the significant increase in that book of business throughout 2002 and the maintaining of this premium level throughout 2003. The increase in California relates to start-up costs as we began to write standard homeowner’s business in California in 2003.
Policy service fee income for the year ended December 31, 2003 was $39.0 million, an increase of $1.8 million or 4.8% as compared to policy service fee income of $37.2 million for the prior year. The increase in policy service fees during 2003 as compared to 2002 was principally due to increased installment billing fees in our affiliated underwriting agencies in Texas.
We provided a variety of life insurance products through our holdings in American Founders Financial Corporation, a holding company for two life insurance companies domiciled in Texas. American Founders’ business is currently driven by the acquisitions of closed blocks of life insurance policies and, by marketing and distributing its single premium annuity
In 2003, our life insurance segment generated approximately $42.3 million in revenue, or 6.9% of consolidated revenue, excluding realized gains and losses. Segment pre-tax income from continuing operations for our life insurance segment improved from a loss of $18.6 million in 2002 to income of $7.4 million in 2003.
Life insurance premiums and policy fees decreased to $11.1 million from $14.0 million in the prior year as a result of normal declines on closed blocks and increased reinsurance. Investment income decreased from $36.0 million the prior year to $28.3 million in the current year. The decrease in investment income is attributed to several factors. First, average invested assets decreased, excluding policy loans from $590.6 million in 2002 to $561.7 million in 2003. Compounding the impact on investment income from the decrease in the overall size of the investment portfolio was higher levels of mortgage-backed security paydowns and decreases in overall interest rates in 2003. The weighted average annual yield (excluding realized and unrealized gains and losses) on invested assets for the year ended December 31, 2003 was 5.0% compared to 6.2% in the prior year.
Our life insurance segment reflects realized gains of $2.4 million in 2003 compared to realized losses of $28.2 million in the priory year. The realized losses in 2002 were primarily related to the write-off of approximately $27 million of loans held as assets by American Founders. During 2002, we actively sought collection of these loans, including the filing of civil lawsuits seeking to collect these loans and cooperation with the Mexican Attorney General in a criminal investigation related to the conduct of some of the individuals responsible for these loans. As of December 31, 2002, we had seen no indications that these individuals would voluntarily perform on these loans, and we expected to engage in protracted civil litigation regarding this matter. Accordingly, we concluded that these loans were impaired and recorded an estimated loss on these loans equal to their entire balance. This write-off reduced American Founders’ statutory surplus significantly.
In an effort to restore American Founders’ surplus to an acceptable level, we increased a third party reinsurer’s coinsurance participation in substantially all of American Founders’ business from 35% to 62.5%, effective October 1, 2002. At December 31, 2003, American Founders had improved its statutory capital to $35.7 million from $30.6 million at December 31, 2002, reflecting a full year’s impact of the our increased use of coinsurance and continued profitability.
For the year ended December 31, 2003, net investment income related to our property-casualty underwriting operations decreased by $6.0 million to $12.4 million from $18.4 million in 2002. The decrease in interest income is attributed to several factors. First, average invested assets decreased from $409.7 million in 2002 to $407.4 million in 2003. Compounding the impact on investment income from the decrease in the overall size of the investment portfolio was higher levels of mortgage-backed security paydowns and decreases in overall interest rates in 2003. The weighted average annual yield (excluding realized and unrealized gains and losses) on invested assets for the year ended December 31, 2003 was 3.1% compared to 4.0% in the prior year.
• $6.8 million related to settlement of the CIGNA arbitration and the Nichols lawsuit.
• $3.8 million in development of our commercial and assumed reinsurance loss reserves.
Based upon available information, we believe the recorded reserves for discontinued operations at December 31, 2003 are adequate. However, we will continue to monitor these reserves and their related claims activity and experience. Further adjustments to our estimates could be necessary as we continue to run off the remaining outstanding claims.
The Company’s prior results have been reclassified to reflect the historical results from discontinued operations.
For the year ended December 31, 2003, we recorded an income tax expense of $62.1 million, compared with an income tax benefit of $6.0 million recorded in the prior year. During the fourth quarter of 2003, we recorded a deferred tax asset valuation expense of $75.4 million, which is reflected as a component on income tax expense.
The primary factors that impacted our financial results in 2002 were as follows:
• The writedown of $27 million of non-performing collateral loans held as investments in our life insurance segment;
• The recognition of a pre-tax charge of $9.9 million related to our decision to exit the health insurance business, including $7.9 million to recognize goodwill impairment on the health insurance business line;
• Significant growth in our non-standard agency and non-standard underwriting business lines as a result of the acquisitions of InsureOne (January 2002), American Agencies (January 2002), A-Affordable Insurance (November 2001) and SpaceCoast Underwriters (October 2001); and
Loss and loss adjustment expenses for standard property casualty lines for the year ended December 31, 2002 increased by $59.9 million (up 37.1%) to $221.5 million from $161.6 million in the prior year. The increase in loss and loss adjustment expenses incurred was primarily attributable to our growth in business in Texas. Loss and loss adjustment expenses in Texas were $57.2 million in 2002, compared with $1.7 million in the prior year.
For the year ended December 31, 2002, the loss ratio for standard property-casualty segment was 68.1% compared with 64.7% at December 31, 2001. The increase in the loss ratio was primarily attributable to deteriorating results in the first half of 2002 in Pennsylvania, West Virginia and certain other states that deteriorated because of increased severity and frequency. The loss ratio for these states, and the entire segment, returned to more normal levels in the second half of 2002.
Total expenses for the year ended December 31, 2002 were $118.4 million, an increase of $109.3 million as compared to total expenses of $9.1 million for the prior year. The increase in total expenses in 2002, as compared to 2001, was principally due to the acquisitions of six retail and/or underwriting agencies in 2001 and 2002, as mentioned above.
Total policy acquisition and operating expenses for the year ended December 31, 2002 were $67.1 million, an increase of $64.5 million as compared to policy acquisition and operating expenses of $2.6 million in the prior year. The increase in policy acquisition and operating expenses was consistent with the corresponding increase in earned premium which was primarily attributable to the increase in earned premium produced by affiliated underwriting agency operations. The expense ratio for the year ended December 31, 2002 was 37.7%, as compared to an expense ratio of 18.1% for the prior year.
During 2002, we actively pursued collection of approximately $27 million in loans held as assets by American Founders, including the filing of civil lawsuits seeking to collect these loans and cooperation with the Mexican Attorney General in a criminal investigation related to the conduct of some of the individuals responsible for these loans. We believed that these collection efforts would yield in a short time period positive indications that the individuals responsible for repaying these loans would acknowledge their obligations and voluntarily perform. As of December 31, 2002, we had seen no indications that these individuals would perform on the loans. Accordingly, we concluded that these loans were impaired and recorded an estimated loss on these loans equal to their entire balance. This write-off reduced American Founders’ statutory surplus significantly.
For the year ended December 31, 2002, net investment income related to our property-casualty underwriting operations decreased by $1.7 million to $18.4 million from $20.1 million in 2001. The weighted average yield on invested assets for 2002 (excluding realized and unrealized gains) was 4.97% compared with 6.5% for the year ended December 31, 2001. The decrease in investment income was primarily attributable to a decline in overall market interest rates.
Our overall interest expense includes interest payable on our 8.75% senior debentures due in 2025, interest on certain Federal Home Loan Bank borrowings and our commercial credit borrowings. Although we repurchased approximately $24.7 million face amount of our long-term debentures and capital securities during 2002, overall interest expense decreased only slightly compared with 2001, as the interest savings arising from the repurchases of these securities was substantially offset by higher average commercial credit borrowings and higher borrowing from the Federal Home Loan Bank.
In the fourth quarter of 2002, we made the decision to exit the health insurance and consulting business lines. Accordingly, our health insurance and consulting lines results for 2002 have been reclassified in our financial statements as part of discontinued operations and are classified as operations held for sale. For the year ended December 31, 2002, we recorded a pre-tax loss of $9.9 million for our health operations and $1.8 million for our consulting business. These results include writedowns in the fourth quarter of $7.9 million and $1.2 million, representing the previously recorded goodwill for the health insurance and consulting lines, respectively.
Previously, in 2000 and 1999, we exited the reinsurance assumed and commercial lines businesses, respectively. As a result, the reporting for these business lines is included in discontinued operations in our financial statements. At the time we made the decision to exit each of these business lines, we estimated the reserves required to fulfill our expected future obligations with respect to these discontinued operations. However, we continue to monitor our recorded estimates with respect to ultimate settlement on an ongoing basis.
During 2002, we experienced an unexpected increase in the severity and volume of reported claims associated with both our discontinued assumed reinsurance and commercial lines and increased payments on claim reserves. Additionally, in the second quarter of 2002, we received an award of $16.4 million from our arbitration with F&G Re related to two loss ratio contracts covering accident years 1996 and 1997. In our financial statements, we recorded a charge of $13.6 million to reflect the difference between our recorded recoverable of $30 million and the award amount. The charge was recorded in our Assumed Reinsurance segment which is included in discontinued operations, consistent with the manner in which premiums and losses were originally recorded. As a result of these items, we recorded a pre-tax charge of $22.9 million in our financial statements for the year ended December 31, 2002.
For the year ended December 31, 2002, we recorded an income tax benefit of $6.0 million, compared with an income tax benefit of $4.4 million recorded in the prior year. Our effective tax rate of 35% in 2002 was consistent with our effective tax rate in the prior year.
modified in a material respect, we believe that J. Gordon Gaines, Inc. will be able to pay dividends to our holding company, or otherwise fund the obligations of our holding company on its behalf, sufficient to fund our anticipated needs (including debt service) for at least the next twelve months. During 2003, J. Gordon Gaines and Texas Select Lloyds paid $18.6 million in dividends to our holding company. Management believes that the forecasted dividends that will be available from J. Gordon Gaines and Texas Select Lloyds will be sufficient to allow our holding company to meet all of its scheduled debt payment and operating expenses in 2004.
This credit agreement contains covenants which require us to maintain (i) consolidated GAAP net income (excluding realized gains and losses) of at least $15 million for any calendar year, (ii) consolidated debt to capital ratio of no more than 39%, measured on a quarterly basis, (iii) an A.M. Best rating of “B” or better, measured continuously, (iv) consolidated GAAP net worth of at least $208 million, measured quarterly, (v) an interest coverage ratio of not less than 1.5 to 1 for any calendar year and (vi) risk-based capital of not less than 150% of the NAIC’s authorized control level, measured continuously. As of December 31, 2003, the Company was in non-compliance with its consolidated GAAP net income, interest coverage ratio, consolidated debt to capital ratio, and GAAP net worth covenants. First Commercial has waived compliance with these covenants through December 31, 2004.
The principal sources of funds for our insurance subsidiaries are premiums, investment income and proceeds from the sale or maturity of invested assets. The principal uses of funds in our subsidiary operations are the payment of claims, operating expenses, commissions and the purchase of investments. Our subsidiaries also borrow funds from the Federal Home Loan Bank from time to time and invest the proceeds at higher interest rates, and we have a need to repay these funds to the FHLB as indicated in the table illustrating our overall contractual obligations presented below.
The following table sets forth the principal maturities of our material contractual obligations owing to third parties at December 31, 2003 (in thousands):
(1) As part of the Federal Home Loan Bank program, as more fully described in Note N to our financial statements, we have pledged securities with a market value of approximately $178.8 million to secure our obligation of $158.8 million. We intend to renew all Federal Home Loan Bank advances maturing in the current year, however in the unlikely event we elect not to renew all maturing advances, we could liquidate the pledged investments to satisfy the obligation.
Additionally, we regularly obtain letters of credit or otherwise pledge securities for the benefit of ceding insurers in our nonstandard underwriting segment pursuant to reinsurance contracts. As of December 31, 2003, we had pledged approximately $16.4 million in securities pursuant to these reinsurance contracts.
statements. As of December 31, 2003, our insurance company subsidiaries held $13.2 million face amount of our 8.75% Senior Debentures due 2025 and $44.1 million face amount of our 12.5% Senior Notes due in December of 2005. Our holding company paid these subsidiaries approximately $6.7 million in interest payments in 2003 which was eliminated in consolidation.
In November 2002, the FASB issued FASB Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosures Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 clarifies the requirements of SFAS No. 5, “Accounting for Contingencies,” related to a guarantors accounting for, and disclosures of, the issuance of certain types of guarantees. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 15, 2002 and have been included in the Notes to the consolidated financial statements included herein. The impact on the Company’s financial statements from the application of the recognition and measurement provisions of FIN No. 45 is dependent on the level of guarantees issued or modified in 2003 and thereafter. No guarantees were issued or modified during the year ended December 31, 2003, which were impacted by the provisions of FIN No. 45.
In January 2003, the FASB issued FIN 46 “Consolidation of Variable Interest Entities”. In December 2003, the FASB issued FIN 46-R, which replaces FIN 46. FIN 46-R clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support form other parties. The effective date of FIN 46-R is March 31, 2004. However, FIN 46-R shall be applied to entities that are considered special-purpose entities no later than as of the end of the first reporting period that ended after December 31, 2003 (as of December 31, 2002 for the Company). The application of FIN 46-R had no effect on our consolidated financial statements as of December 31, 2003. The Company is currently evaluating the impact of FIN 46-R on entities not considered to be special-purpose entities, which would be required to be consolidated as of March 31, 2004. The Company does not anticipate a material impact on its financial position or results of operations from the adoption of FIN 46-R related to these entities.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS No. 150 establishes how an issuer classifies and measures certain free standing financial instruments with characteristics of both liabilities and equity and requires that such instruments be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 for those existing financial instruments subject to the provisions of SFAS No. 150. The Company has not entered into any financial instruments within the scope of SFAS No. 150 since May 31, 2003. The Company’s Deferrable Capital Securities are subject to the provisions of SFAS No. 150. Accordingly, the outstanding balance of the Company’s Deferrable Capital Securities of $20.3 million as of December 31, 2003 has been reclassified to a component of total liabilities from the previous “mezzanine” debt classification. Furthermore, Deferrable Capital Security distributions of $0.9 million, representing the aggregate distributions of our Deferred Capital Securities since the date of adoption, are reflected as a component of income from continuing operations in our consolidated 2003 statement of operations. The classification of Deferrable Capital Securities and Deferrable Capital Security distributions for all prior periods remains unchanged, pursuant to the provisions of SFAS No. 150.
In November 2003, the Emerging Issues Task Force (EITF) of the FASB reached a consensus on quantitative and qualitative disclosures included in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The effective date of the consensus was for fiscal years ending after December 15, 2003. The Company has applied the consensus and the required disclosures are included our discussion of our critical accounting policies and in Note E to the consolidated financial statements.
Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 2003
Principles of Consolidation: The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and include the accounts of Vesta Insurance Group, Inc. and its operating subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Investments: Investment securities are classified as either available for sale or trading. Investment securities classified as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders’ equity. Investment securities classified as trading are also reported at fair value, with unrealized gains and losses reflected in earnings. Mortgage loans, policy loans, and collateral loans are stated at the aggregate unpaid principal balances, net of any unamortized premium or discount and less any allowance for possible losses and other than temporary impairment, if required.
Factors considered by management in determining whether an investment security is other than temporarily impaired includes our intent to hold the security, the credit quality of the security, the severity of the decrease between the security’s cost and market value, the length of time of the security’s impairment and the likelihood that the impairment will reverse in the future. In the event that management determined that a reduction in an investment security’s fair value below its costs basis is other than temporary, the security’s cost basis is reduced to its fair value and a corresponding realized loss is recorded in our consolidated statement of operations as a realized loss. For the year ended December 31, 2003, we recognized other than temporary impairment losses of $3.1 million.
broker, and are accounted for with their related host contracts. Unrealized gains and losses are reflected in income currently. As of December 31, 2003 and 2002, $885 and $(315), respectively, had been recognized in income. Because of the limited liquidity of some of these instruments, the recorded values of these transactions may be different than the values that might be realized if the Company were to sell or close out the transactions prior to maturity. The Company believes that such differences are not significant to the results of operations, financial condition, or liquidity. Such differences would be immediately recognized when the transactions are sold or closed out prior to maturity.
For investment contracts without mortality risk (such as deferred annuities and immediate annuities with benefits paid for a certain period), premium deposits and benefit payments are recorded as increases or decreases in a liability account, rather than as revenue and expense. We record as revenue any amounts charged against the liability account for the cost of insurance, policy administration, and surrender penalties. Any interest credited to the liability account and any benefit payments which exceed the contract liability account balance are recorded as expenses. As of December 31, 2003 and 2002, approximately $122.2 million and $112.5 million, respectively, of Vesta’s annuity reserves are subject to discretionary withdrawal without surrender charges or other adjustments.
The costs to acquire blocks of life insurance representing the present value of future profits from such blocks of insurance is also included in deferred policy acquisition costs. We amortize the present value of future profits over the premium payment period. The unamortized present value of future profits was approximately $13.0 million and $13.9 million at December 31, 2003 and 2002, respectively. During 2002, we reduced value of business acquired (“VOBA”) by approximately $6.0 million and recorded deferred revenue of $8.8 million in relation to an increase in our ceded reinsurance with Employers Reinsurance Corporation (“ERC”) from 35% to 62.5%. In 2003, we amortized $.8 million of deferred revenue, and the balance at December 31, 2003 was $7.7 million compared to $8.5 million at December 31, 2002. During the years ending December 31, 2003 and 2002, we recognized amortization expenses associated with future profits of $1.7 million and $1.8 million, respectively. Estimated amortization expense for each of the next five years is as follows (in thousands):
Reinsurance: We report assets and liabilities related to insurance contracts before the effects of reinsurance. Reinsurance receivables and prepaid reinsurance premiums (including amounts related to insurance liabilities) are reported as assets. Estimated reinsurance receivables are recognized in a manner consistent with the liabilities related to the underlying insurance contracts.
Minority Interest: Minority interest in consolidated subsidiaries totaled $1.9 million and $14.8 million and is included in other liabilities at December 31, 2003 and 2002, respectively.
A summary of property and equipment used in the business at December 31, 2003 and 2002 is as follows (in thousands):
Pro forma information regarding net income and earnings per share is required by SFAS No. 123 and has been determined as if Vesta had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2003, 2002, and 2001, respectively: risk-free interest rates of 3.55%, 4.03%, and 5.13%; dividend yields of 4.35%, 2.36%, 1.0%; volatility factor of the expected market price of Vesta’s common stock of 60.67, 79.10, and 88.97, and a weighted-average expected life of the options of ten years.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS No. 150 establishes how an issuer classifies and measures certain free standing financial instruments with characteristics of both liabilities and equity and requires that such instruments be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 for those existing financial instruments subject to the provisions of SFAS No. 150. The Company has not entered into any financial instruments within the scope of SFAS No. 150 since May 31, 2003. The Company’s Deferrable Capital Securities are subject to the provisions of SFAS No. 150. Accordingly, the outstanding balance of the Company’s Deferrable Capital Securities of $20.3 million as of December 31, 2003 has been reclassified to a component of total liabilities from the previous “mezzanine” debt classification. Furthermore, Deferrable Capital Security distributions of $0.9 million, representing the aggregate distributions of our Deferred Capital Securities since the date of adoption, are reflected as a component of income from continuing operations in our consolidated 2003 Statement of Operations. The classification of Deferrable Capital Securities and Deferrable Capital Security distributions for all prior periods remains unchanged, pursuant to the provisions of SFAS No. 150.
In November 2003, the Emerging Issues Task Force (EITF) of the FASB reached a consensus on quantitative and qualitative disclosures included in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The effective date of the consensus was for fiscal years ending after December 15, 2003. The Company has applied the consensus and the required disclosures are included in Note E to the consolidated financial statements.
Effective September 30, 2003, we consummated a stock purchase agreement for the sale of all common stock of Aegis Financial Corporation (Aegis) and its subsidiary States General Life Insurance Company (States General) for $4.6 million. The sales price was financed through a $5.0 million note issued by the buyer payable to Vesta Fire. The note bears interest at a fixed rate of 6%, with interest payments due semi-annually and principal due in September 2006. The note is secured by the common stock of Aegis. The sale of Aegis resulted in the Company recording a loss of $0.9 million, net of tax, which is reflected as a component of discontinued operations.
Effective July 1, 2003, we purchased 25% of the outstanding common stock of Harbor Insurance Group, Inc. in exchange for Instant Insurance Agency (a wholly owned subsidiary), Public Access, LLC (a 70% owned subsidiary) for a total purchase price of $2.1 million. We are accounting for this transaction using equity investment accounting.
In February 2003, we completed the acquisition of the approximate 27% remaining ownership from the minority owners of American Founders Financial Corporation. The purchase price for this acquisition was $12.9 million, which approximated the recorded minority interest balance.
Other intangible assets at December 31, 2003 and 2002 are as follows (in thousands):
Subsequent to the filing of the Vesta Fire Insurance Corporation statutory financial statements, Vesta received an unfavorable ruling from an arbitration panel related to its 1997 whole account quota share (see Note G). The Company will incur an estimated reduction to statutory capital and surplus in the amount of $55.8 million related to this ruling. The resulting impact to statutory capital and surplus could place Vesta Fire in “Company Action Level” with respect to its regulatory state of Illinois. Additionally, Vesta Fire has several negative variances from the normal range with respect to measures state insurance regulators often use to identify companies potentially warranting additional attention. The Company has notified the State of Illinois Department of Insurance regarding these matters and, as of March 12, 2004, has not received any notification whether corrective action will be required.
Risk-Based Capital Requirements: The NAIC adopted risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula which attempts to measure statutory capital and surplus needs based on the risks in a company’s mix of products and investment portfolio. The formula is designed to allow state insurance regulators to identify potential weakly capitalized companies. Under the formula, a company determines its “risk-based capital” (“RBC”) by taking into account certain risks related to the insurer’s assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer’s liabilities (including underwriting risks related to the nature and experience of its insurance business). Risk-based capital rules provide for different levels of regulatory attention depending on the ratio of a company’s total adjusted capital to its “authorized control level” of RBC. As noted above, the RBC levels of our primary insurance subsidiary, Vesta Fire, could trigger regulatory attention.
A summary of fixed maturities - trading at December 31, 2003 is as follows (in thousands):
Bonds with a fair value of $66.2 million and $71.2 million were on deposit with certain states in accordance with their insurance regulations at December 31, 2003 and 2002, respectively.
The unrealized loss approximates 1.6% of the fair value of the temporarily impaired securities at December 31, 2003. For those securities identified as having temporary impairments for less than twelve months, management noted that the temporary losses are due to recent increases in U.S. Treasury yields and are not due to deterioration in credit quality or impairment issues. During the second half of 2003, 5-10 year U.S. Treasury yields increased .73% to .83% resulting in a lowering of the market values of these securities. Bonds purchased in the lower interest rate environment of early 2003 showed year-end unrealized losses that are attributable to changes in overall yields and, in management’s opinion, do not represent other than temporary impairment issues.
Two significant factors occurred in 2003 that impacted the cumulative deficiency related to 2002. The first such factor relates to an increase of paid losses and the liability for unpaid losses and loss adjustment expenses of $60.2 million related to reinsurance arbitrations with NRMA, Dorinco and Alfa (see Note G). The $60.2 million noted previously represents the $65.9 million aggregate charge for the 1997 20 percent whole account quote share. Secondly, in 2003, Vesta commuted various reinsurance assumed treaties, at an amount in excess of the booked reserves. The commutations along with additional adverse development on the discontinued lines was approximately $5 million dollars in 2003, all related to prior accident years. In addition, in 2003 Vesta had slight adverse development on the homeowners line of business for accident year 2002. As disclosed last year, in 2002, Vesta received arbitration rulings related to litigation with USF&G and NRMA. Both companies reinsured Vesta companies, and Vesta fully expected to recover all unpaid liabilities. However, as disclosed last year, the impact of these cases resulted in adverse development to Vesta of $37.2 million. The adjustments affect all prior accident years to some extent. In 2001, Vesta had a $30 million charge taken in the discontinued lines of business. The main contribution to the adverse development was liability exposures written in the 1980’s.
Our subsidiary, American Founders, is a defendant in a lawsuit brought by a judgment creditor of IFS Holdings, Inc. - the former holder of American Founders’ series A and C preferred stock - alleging that American Founders redeemed its Series A and Series C preferred stock from IFS Holdings, Inc. for less than “reasonably equivalent value,” and, therefore, engaged in a voidable fraudulent transfer. American Founders believes (i) that the redemption transaction was for reasonably equivalent value; and (ii) that the allegations brought against it in this lawsuit are without merit. Due to IFS’s bankruptcy in 2001, the real party in interest to pursue this claim is the bankruptcy trustee administering IFS’ estate in bankruptcy. Since assuming this position, the trustee has not pursued any discovery or otherwise attempted to resolve this case. In the opinion of management, resolution of the lawsuit is not expected to have a material adverse effect on our financial position. However, depending upon the amount and timing, an unfavorable resolution of this matter could materially affect American Founders’ future operations or cash flows in a particular period.
On June 19, 2002, the panel in the NRMA arbitration issued an order to bifurcate the arbitration and scheduled a hearing for the week of October 28, 2002 to decide the issue of coverage for developmental losses under the treaty. On September 6, 2002, the panel notified the parties that it would make such determination on this specific issue on the papers and filings submitted by the parties without the necessity of a live hearing. On November 6, 2002 the panel notified the Company that it ruled that the treaty does not apply to loss occurrences prior to July 1, 1997. Primarily, as a result, Vesta recorded a $23.6 million pre-tax charge as a revision of our estimated reinsurance recoverable in the third quarter of 2002. Since this ruling did not set a binding precedent regarding Vesta’s other arbitrations, we did not record any change in our estimate of our recoverable from the other treaty participants as a result from this ruling. In February, 2003, Vesta filed a petition to vacate the NRMA panel ruling in the U.S. District court for the Northern District of Alabama. On April 8, 2003 the court ruled that since the arbitration proceedings have not been fully exhausted, it was dismissing Vesta’s petition without prejudice of the parties to seek the court’s review of any final arbitration award.
On December 16, 2002, Dorinco filed a motion seeking an order that the treaty does not cover developmental losses related to loss occurrences prior to July 1, 1997. On May 1, 2003, the panel in the arbitration ruled that Dorinco was not responsible for losses on any policy or other insurance or reinsurance contract terminated prior to July 1, 1997 and that the arbitration will continue with respect to losses whenever occurring, on policies or other insurance or reinsurance contract in force at July 1, 1997. On January 27, 2004, the panel ruled that its May 1, 2003 ruling also extended to premium transactions under policies that had expired as of July 1, 1997. The hearing in the Dorinco arbitration was previously scheduled for the two weeks of March 8 through March 12, and April 26 thru April 30, 2004. Recently, those hearing dates were adjourned and the new hearing dates are presently being rescheduled, most likely for 2005.
We are in arbitration with CIGNA Property and Casualty Insurance Company (now ACE USA) under a personal lines insurance quota share reinsurance agreement, whereby we assumed certain risks from CIGNA. During September 2000, CIGNA filed for arbitration under the reinsurance agreement, seeking payment of the balances that CIGNA claimed were due under the terms of the treaty. At that time, the treaty was terminated on a cut-off basis. In the pending arbitration Vesta is seeking, among other things, recoupment of all believed improper excessive
expense allocations and charges from CIGNA. The arbitration was bifurcated into two phases with Phase I concentrating on the interpretation of the intent of the parties related to the expense reimbursement provisions of the treaty at the time it was entered. Phase II, which has now been completed, related to any remaining issues between the parties, including those that exist with regard to an audit of expenses ceded to the treaty. The Phase I hearing was held in February 2002 and the panel ruled that (i) the Company is responsible for the payment of ceding commissions provided for in the treaty and should pay any outstanding billings for commissions and paid claims, plus interest; (ii) the Company may proceed with an audit of expenses ceded to the treaty; and (iii) the parties should identify any further issues to be brought before the arbitration panel for phase two of the hearing. During the course of preparing for and conducting the expense audit, the Company determined that it should revise its estimated reinsurance receivable and recorded during the second quarter of 2003 a pre-tax valuation allowance of $9.4 million as a component of discontinued operations. As a result of the expense audit conducted during Phase II, the Company has now recovered from ACE $462,000 in overcharged expense items. The only remaining issue in the arbitration is ACE’s motion for attorney fees incurred in Phase I of the arbitration and Vesta’s request for interest on the overcharged expense items recovered in Phase II.
Muhl vs. Vesta is a case pending in the supreme Court of the State of New York, County of New York, brought by the Liquidator of Midland Insurance Company (“Midland”), claiming recoveries under two alleged retrocession agreements (Pool I and Pool III) between Midland and Interstate Fire Insurance Company, Vesta’s predecessor in interest. The Liquidator’s claims against Vesta under Pool I and Pool III have been severed.
Vesta vs. New Cap Re is an arbitration against an Australian reinsurer, to collect reinsurance recoverables pursuant to two accident year excess of loss ratio reinsurance agreements. In the arbitration, New Cap Re challenged Vesta’s earlier draw on a Letter of Credit for $7.5 million which was held in connection with one of the two contracts. Shortly after the arbitration commenced, New Cap Re became the subject of insolvency proceedings in Australia and an ancillary proceeding in the U.S. Bankruptcy Court in New York. The Bankruptcy Court stayed all pending litigation and arbitration against New Cap Re, and we appealed that ruling to the Southern District of New York, and ultimately to the U.S. Court of Appeals for the Second Circuit, which recently affirmed the Bankruptcy Court’s stay of the arbitration against New Cap Re. Hence, our efforts to recover losses as well as New Cap Re’s efforts to challenge the earlier draw on the $7.5 million Letter of Credit by us are stayed and the company’s options may be limited to seeking adjudication of the dispute in Australia.
We lease office space for our home office and subsidiary offices and other equipment under operating lease arrangements. Rental expense for operating leases was $11.1 million, $13.9 million, and $6.2 million for the years ending December 31, 2003, 2002 and 2001 respectively.
Vesta’s effective income tax rate differed from the statutory income tax rate as follows:
Net operating loss carryforwards expire in periods through 2023 with approximately $68.2 million of the total expiring after 2018.
As part of the purchase accounting for our December 2000 acquisition of Instant Auto, we recorded valuation allowance of $7.3 million for net operating losses that were generated prior to the acquisition. The utilization of these net operating losses is subject to a number of acquisition-related limitations and, accordingly, we recorded a valuation allowance as part of purchase accounting.
While we anticipate being profitable in future periods, the combination of significant cumulative losses in recent years and uncertainty with respect to our year-end deferred tax asset balances within a reasonable time frame, warrants the recording of a valuation allowance under SFAS No. 109. Accordingly, we recorded a valuation allowance of $75.4 million for the year ended December 31, 2003, which represents our net deferred tax asset balance for which corresponding deferred tax liabilities did not offset. This increase in our valuation allowance, coupled with the $7.3 million valuation allowance that existed at December 31, 2002, resulted in an aggregate deferred tax asset valuation allowance of $82.7 million as of December 31, 2003.
Vesta has a Shareholders’ Rights Plan that provides for the payment of a dividend of one preferred stock purchase right to be attached for each outstanding share of common stock. Each Right, if and when it becomes exercisable, will entitle the registered holder to purchase from Vesta one one-hundreth (1/100) of a share of Vesta’s Series B Junior participating Preferred Stock at a price of $30.00 per one one-hundreth of a share. The Rights will be
In 2002, we purchased 218 thousand shares of treasury stock on the open market for approximately $1.4 million. In the first quarter, we issued 57 thousand shares of treasury stock in exchange for 328 thousand shares of Instant Insurance Holdings, Inc. held by four minority shareholders. As of December 31, 2003, the Board of Directors has authorized the Company to acquire up to 5.0 million shares of treasury stock.
As of December 31, 2002, the Agent Stock Incentive Plan terminated and the shares held in the Agent Stock Incentive Plan Trust were returned to the Company and held in Treasury.
The standard property-casualty segment consists of two principal lines of business: (1) underwriting only residential property insurance in capacity constrained states; and (2) underwriting residential property and automobile insurance in states where we can profitably offer both products through independent agents. Vesta’s insurance products are distributed primarily through approximately 2,525 independent agencies in 16 states. Our residential property lines target families (1) with multiple insurance policies; (2) who own more than one automobile; and (3) who live in a home valued between $100,000 and $350,000. Our standard personal auto line targets drivers over age thirty-five with above average driving records.
Our non-standard insurance policies, which generally are issued for the minimum limits of liability coverage mandated by state laws, provide coverage to drivers who find it difficult to obtain insurance from standard insurance companies due to a number of factors, including lack of prior coverage, failure to maintain continuous coverage, age, prior accidents, driving violations, type of vehicle or limited financial resources. Most of the non-standard policies issued by our insurance companies are administered by our affiliated underwriting agencies, which perform or supervise all of the administrative functions associated with the design, sale and subsequent servicing of a non-standard personal automobile insurance policy. Our insurance companies also issue insurance policies that are administered by unaffiliated underwriting agencies with established customer bases in order to capture business in markets other than those targeted by our affiliated underwriting agencies. In these instances, we collect fees to compensate us both for the use of our certificates of authority to transact insurance business in selected markets as well as for assuming the risk that the unaffiliated underwriting agency will continuously and effectively administer these policies. We generally reinsure a higher percentage of this business relative to the business administered by our affiliated underwriting agencies.
We provide a variety of life insurance products through American Founders Financial Corporation, a holding company for two life insurance companies domiciled in Texas. In 2000, we purchased a 72% interest in American
Founders. On February 18, 2003, we purchased the remaining shares held by minority holders and now own 100% of American Founders. At December 31, 2003, American Founders had in force approximately $2.0 billion (face value) of life and annuity products. American Founders markets traditional life products, universal life products, fixed-rate annuities, pension contracts and related products through independent agents located throughout the U.S. In the fourth quarter of 2002, we decided to exit the health insurance business line which was previously included in the life insurance segment. The results for the health insurance line have been reclassified to discontinued operations for all periods presented in this report.
The following tables present selected financial data by segment for the respective years ended December 31 (in thousands):
Vesta’s outstanding balance of the line of credit at December 31, 2003 and 2002 is as follows (in thousands):
Effective February 1, 2003, we entered a $30 million revolving credit arrangement with First Commercial Bank of Birmingham, Alabama (“First Commercial”), secured by a pledge of 358,375 shares of our holding company’s ownership in the common stock of Affirmative Insurance Holdings, Inc. representing approximately 40.6% of Affirmative’s issued and outstanding shares of capital stock as of December 31, 2003. The credit facility bears interest at First Commercial’s prime rate and will mature no earlier than June 30, 2005. As of December 31, 2003, we had drawn the entire $30 million available under this Agreement.
As of December 31, 2003, the Company has recorded, as a component of other liabilities, $14.3 million related to consideration for nonstandard agency acquisitions made by the Company in 2002. These balances bear interest between 8.5% and 9.0% and are payable as follows: $10.4 million in 2004, $3.6 million in 2005, $.2 million in 2006 and $.1 million in 2007.
During 1995, the FASB issued SFAS No. 123. The Statement defines a fair value based method of accounting for an employee stock option. It also allows an entity to continue using the intrinsic value based accounting method prescribed by APB Opinion No. 25. Vesta has continued to use this method to account for its stock options and other forms of stock based compensation. However, SFAS No. 123 requires entities electing to remain with the intrinsic method of accounting to provide pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied as well as other disclosures about Vesta’s stock-based employee compensation plans. Information about Vesta’s stock based compensation plans and the related required disclosures follow.
Of the 759,311 outstanding options at December 31, 2003, 399,311 were exercisable.
The following table shows expiration dates and weighted average exercise price for all outstanding options and options currently exercisable at December 31, 2003:
As discussed in Note R, Vesta discontinued its (1) commercial operations, effective the fourth quarter of 1999; (2) reinsurance assumed operations, effective the fourth quarter of 2000; (3) health insurance business line, effective the fourth quarter of 2002; and (4) consulting business line, effective the fourth quarter of 2002. All quarters prior to such effective dates have been reclassified in accordance with APB Opinion No. 30 and SFAS No. 144 for presentation of discontinued operations.
We consummated the sale of Aegis Financial Corporation and its subsidiary States General Life Insurance Company (States General) effective September 30, 2003 for $4.6 million. For the year ended December 31, 2003, we recorded a loss of $4.4 million, net of tax, for our health operations and our consulting business, including the aforementioned loss on the sale of Aegis.
Assets and liabilities of the commercial and reinsurance assumed businesses are primarily comprised of the following at December 31, 2003 and 2002 (in thousands):