The Company leases approximately 400,000 square feet of office space for its headquarters facilities, which are located in Woodland Hills, California. The lease term expires in February 2015, and the lease may be renewed for two consecutive five-year periods.
The selected financial data presented below as of the end of and for each of the years in the five-year period ended December 31, 2001, are derived from, or supplemental to, the Company's consolidated financial statements. The consolidated financial statements as of December 31, 2001 and 2000, and for each of the years in the three-year period ended December 31, 2001, are included elsewhere in this Form 10-K.
The decrease in statutory surplus from 2000 to 2001 is due primarily to a net statutory loss of $53 million and a $64 million increase in nonadmitted assets, which includes developed software. This was partially offset by a one-time increase of approximately $35 million resulting from the adoption of new codified statutory accounting rules relating mainly to the admissibility of net deferred tax assets. The decrease from 1999 to 2000 was primarily due to $95 million in dividends upstreamed to the holding company, an increase in non-admitted assets of $26 million, which consisted primarily of developed software, partially offset by $11 million in statutory net income.
Personal Auto. Automobile insurance is the primary line of business written by the Company. The Company was licensed to write automobile insurance in 21 states at the end of 2001, compared to 7 states at the end of 2000. Vehicles insured outside of California have accounted for less than 3% of the total in each of the three years ended December 31, 2001. The Company will explore expansion to new states in 2002.
Direct premiums written were $898.9 million in 2001, $881.2 million in 2000 and $855.8 million in 1999. The increases in 2001 and 2000 were due to rate increases that more than offset the decline in the number of insured vehicles. The ability of the Company to implement rate changes in California is subject to regulation by the CDOI, which could materially affect the Company's future operating results.
Net premiums earned were $838.5 million in 2001, $803.8 million in 2000 and $770.2 million in 1999. The increases in 2001 and 2000 are greater than the proportional increase in the corresponding direct premiums written because of the decrease in the quota share reinsurance arrangement with AIG from 8% in 2000 to 6% in 2001 and from 10% in 1999 to 8% in 2000.
Homeowner and Earthquake Lines in Runoff and All Other. The Company has not written any earthquake coverage since 1994 and ceased writing new homeowner policies in September 2001 but, as discussed below, remains exposed to possible upward development in certain loss estimates relating to the 1994 Northridge Earthquake. Under a January 1, 2002 agreement, the Company ceded 100% of its in-force homeowner coverages to an unrelated company and will begin non-renewing homeowner policies expiring on February 21, 2002, and thereafter.
Underwriting results of the homeowners and earthquake lines, which are in runoff, were losses of $77.6 million in 2001, $2.7 million in 2000 and $13.1 million in 1999.
The Company cautions that the recorded estimate for this event is subject to a greater than normal degree of uncertainty for a variety of reasons. For example, some of the claimants allege facts about earthquake damages that ostensibly occurred on January 17, 1994, but many of the claimants are represented by public adjusters or legal counsel who are acting to prevent or delay access of Company personnel to inspect the allegedly damaged property. Thus, in many cases, the best information currently available to the Company is several years old. As new information becomes available in the near term, the Company's estimate of its ultimate exposure may change by an amount that could be material.
Net realized gains on the sale of investments were $5.0 million in 2001 compared to net realized losses of $5.0 million in 2000 and $0.4 million in 1999. At December 31, 2001, $709.3 million (80.2%) of the Company's total investments at fair value were invested in tax-exempt bonds with the remainder, representing 19.8% of the portfolio, invested in taxable securities compared to 90.3% and 9.7%, respectively, at December 31, 2000.
As of December 31, 2001, the Company had a pre-tax net unrealized loss on fixed maturity investments of $1.5 million compared to a net unrealized gain of $3.7 million in 2000 and a net unrealized loss of $62.8 million in 1999.
In 1997, the Company embarked on a major project to upgrade its technological infrastructure and to conform certain of its operational procedures to "best practices." Capital expenditures relating to this project totaled $45.3 million, $20.7 million and $26.3 million in 2001, 2000 and 1999, respectively. The estimated cost to complete this project over the next three years is approximately $40 million. Management believes cash flow from operations as well as expected improvements in operational efficiencies will be more than adequate to fund the project's remaining implementation.
Property & Equipment. The Company's assets at December 31, 2001, include approximately $91.5 million of software development projects in progress (see Note 7 of Notes to Consolidated Financial Statements), which comprise the capitalized costs relating to software systems that are not yet ready for their intended use. Upon completion, which is expected to be in 2004, the software will be depreciated by the straight-line method over its estimated useful life, which is currently estimated at no less than ten years. However, the remaining useful life of the software will necessarily depend on facts and circumstances in the future, such as possible future technological innovations or changes in operation strategies. If at any time the software is determined to have a lesser value than its carrying value, the Company would be required to record a write-down as a charge to operations.
Deferred Policy Acquisition Costs. Deferred policy acquisition costs ("DPAC") include premium taxes and other variable costs incurred in connection with writing business. These costs are deferred and amortized over the period in which the related premiums are earned. The Company does not consider anticipated investment income in determining the recoverability of these costs. Based on current indications and an assumed loss and loss adjustment expense ratio of 85.2%, management believes that these costs will be fully recoverable and, accordingly, no reduction in DPAC or premium deficiency has been recognized.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of 21st Century Insurance Group and subsidiaries at December 31, 2000 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
BASIS OF CONSOLIDATION AND PRESENTATION The accompanying consolidated financial statements include the accounts and operations of the Company. All material intercompany accounts and transactions have been eliminated. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP") which differ from statutory accounting practices ("SAP") prescribed or permitted by insurance regulatory authorities. The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from these estimates.
Fair values for fixed maturity and equity securities are based on quoted market prices. The cost of investment securities sold is determined by the specific identification method. Where declines in values of securities below cost or amortized cost are considered to be other than temporary, a charge is reflected in income for the difference between cost or amortized cost and estimated net realizable value.
CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash, demand deposits and short-term investments in money market mutual funds having a maturity of three months or less at the date of purchase.
RECOGNITION OF REVENUES Insurance premiums and reinsurance ceding commissions are recognized pro rata over the terms of the policies. Installment and other fees for services are recognized in the periods the services are rendered. The unearned portion of premiums is included in the Consolidated Balance Sheets as a liability for unearned premiums. Unearned ceding commissions are reported as a reduction of deferred policy acquisition costs in the balance sheet.
REINSURANCE In the normal course of business, the Company seeks to reduce its exposure to losses that may arise from catastrophes and to reduce its overall risk levels by obtaining reinsurance from other insurance enterprises or reinsurers. Reinsurance premiums and reserves on reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts.
Cash and securities with carrying values of $12.4 million and $0.5 million were deposited by the Company's subsidiaries under requirements of regulatory authorities as of December 31, 2001 and 2000.
Details follow concerning the changes in the after-tax items included in "Accumulated other comprehensive income (loss)" in the Consolidated Statement of Stockholders' Equity for 2001, 2000 and 1999.
There were no income tax payments required for the years ended December 31, 2001 and 2000. Payments for income taxes were $19.5 million for the year ended December 31, 1999. As of December 31, 2001, the Company has a federal income tax refund receivable of $4.5 million.
Total advertising costs included in deferred acquisition costs in 2001, 2000 and 1999 were $18.7 million, $9.7 million, and $21.3 million, respectively.
Depreciation expense on software currently in service was $10.4 million, $4.1 million and $2.6 million in 2001, 2000 and 1999, respectively. Substantially all software development projects in progress are expected to be completed by 2004.
The provision for losses and LAE recorded in 2001 for insured events of prior years primarily resulted from the Company's recognition of earthquake losses under SB 1899, as discussed in Note 16, and from the Company's under-estimate of changes in personal auto loss severity trends that became apparent in 2001. The loss and LAE provision recorded in 2000 for insured events of prior years primarily resulted from the Company's over-estimate in 1999 of the beneficial effect on loss costs of laws passed in prior years that limited the ability of uninsured motorists and drunk drivers to collect non-economic damages.
NOTE 9. REINSURANCE - -------------------- The Company's insurance subsidiaries cede business to AIG subsidiaries under a quota share reinsurance agreement. Under this contract, which attaches to the Company's retained risks net of all other reinsurance, the subsidiaries ceded 10% of their premiums earned and losses and loss adjustment expenses incurred in connection with policies incepted during the period January 1, 1995, through December 31, 1999, 8% in 2000, 6% in 2001 and 4% in 2002. The majority of the Company's reinsurance receivables are due from the AIG subsidiaries.
Losses and loss adjustment expenses have been reduced by reinsurance ceded as follows:
At December 31, 2001 and 2000, the Company's reinsurance recoverables, net of payables, from AIG subsidiaries were $38.8 million and $48.7 million, respectively.
The Company sponsors non-contributory defined benefit pension plans, which cover essentially all employees who have completed at least one year of service. For certain key employees designated by the Board of Directors, the Company sponsors an unfunded supplemental executive retirement plan. The supplemental plan benefits are based on years of service and compensation during the last three years of employment and are reduced by the benefit payable from the pension plan. For other eligible employees, the pension benefits are based on employees' compensation during all years of service. The Company's funding policy is to make annual contributions as required by applicable regulations. At December 31, 2001, the pension plans' assets comprised 30% fixed income securities and 70% stock index mutual funds. Other information regarding the Company's defined benefit pension plans follows:
The Company leases office space in Woodland Hills, California. The lease expires in February 2015 and may be renewed for two consecutive five-year periods. The Company also leases office space in several other locations throughout California, primarily for claims services. Minimum rental commitments under the Company's lease obligations are as follows:
Rental expense charged to operations for the years ended December 31, 2001, 2000 and 1999 was $15.6 million, $15.5 million and $14.4 million, respectively.
The Company is authorized to issue up to 500,000 shares of preferred stock, $1 par value, and 376,126 shares of Series A convertible preferred stock, $1 par value, none of which were outstanding at December 31, 2001 or 2000.
Shares of common stock issued pursuant to the exercise of employee stock options and restricted stock grants were 39,893, 234,300 and 92,108 in 2001, 2000 and 1999, respectively. Shares of common stock repurchased by the company in 2001, 2000, 1999 numbered -0-, 883,400 and 1,748,684, respectively.
The aggregate number of common shares issued and issuable under the plan currently is limited to 10,000,000. At December 31, 2001, 5,391,379 common shares remain available for future grants. The plan has been approved by the Company's shareholders, and all options granted have ten-year terms. As a consequence of AIG's acquiring a controlling interest in the Company, vesting was accelerated for all options previously granted through July 27, 1998. Options granted after July 27, 1998, vest over various future periods.
Exercise prices for options outstanding at December 31, 2001, ranged from $12.50 to $29.25. The weighted-average remaining contractual life of those options is 7.97 years.
SFAS No. 123, Accounting for Stock-Based Compensation, requires disclosure of the pro forma net (loss) income and (loss) earnings per share as if the Company had accounted for its employee stock options under the fair value method. The Company's pro forma information using the Black-Scholes valuation model follows:
The Company is also regulated by the provisions of the California Insurance Holding Company System Regulatory Act (the ''Holding Company Act''). Many transactions that are defined to be of an ''extraordinary'' nature may not be effected without the prior approval of the CDOI. In addition, there are limits on the insurance subsidiaries' dividend paying capacity. In 2002, the Company estimates that its insurance subsidiaries have capacity to pay approximately $20 million in dividends to their parent without prior approval of the CDOI.
Effective January 1, 2001, the State of California required that domiciliary insurance companies prepare their statutory-basis financial statements in accordance with the NAIC Accounting Practices and Procedures Manual (Codification). As a result of adopting the Codification, the Company's statutory capital and surplus increased by approximately $35 million, mainly due to the treatment accorded previously non-admitted deferred tax assets.
In the normal course of business, the Company is named as a defendant in lawsuits related to claim and other insurance policy issues. Some of the actions request extra-contractual and/or punitive damages. These actions are vigorously defended unless a reasonable settlement appears appropriate. In the opinion of management, except for the matters discussed in Note 16 below, the ultimate outcome of such litigation is not expected to be material to the Company's results of operations or cash flows.
In December 2001, the Company settled, subject to court approval, for a maximum of $4.2 million all matters related to various overtime pay lawsuits that were filed in the third quarter of 2001. The $4.2 million settlement was charged to operations in the fourth quarter of 2001.
The Company cautions that the recorded estimate for this event is subject to a greater than normal degree of uncertainty for a variety of reasons. For example, some of the claimants allege facts about earthquake damages that ostensibly occurred on January 17, 1994, but many of the claimants are represented by legal counsel who are acting to prevent access of Company personnel to inspect the allegedly damaged property. Thus, in many cases, the best information currently available to the Company is several years old. As new information becomes available in the near term, the Company's estimate of its ultimate exposure may change by an amount that could be material.
NOTE 18. RESULTS OF OPERATIONS BY LINE OF BUSINESS - ---------------------------------------------------
Personal Auto Lines. The underwriting loss for the personal auto lines decreased by $15.4 million in 2001 compared to 2000. The decrease is primarily due to the effects of rate increases that more than offset the effects of a decline in the number of insured vehicles. Underwriting profit in the personal auto lines decreased by $118.9 million in 2000 compared to 1999. The decrease was caused principally by the over estimate in 1999 of the beneficial effect on loss costs of laws passed in prior years which limited the rights of uninsured motorists and drunk drivers to collect non-economic damages.
Effective January 1, 2002, the Company acquired AIG's 51% interest in 21st of Arizona for $4.4 million, which approximated its GAAP book value. The Company previously held a 49% interest in 21st of Arizona, which writes personal auto exclusively in Arizona.