The PICO Holdings, Inc. and subsidiaries group of today has very little in common with its predecessor, Citation Insurance Group and subsidiaries. Consequently, these financial statements differ greatly from those presented for periods prior to November 20, 1996, the date of the reverse acquisition between Physicians Insurance Company of Ohio and a subsidiary of Citation Insurance Group in which Physicians Insurance Company of Ohio was the surviving corporation.
Effective December 16, 1998, PICO Holdings, Inc. acquired the remaining outstanding shares of Global Equity Corporation through the PICO/GEC Combination approved by the shareholders of both corporations at shareholders' meetings held on November 20, 1998. Prior to the consummation of the PICO/GEC Combination, PICO and its subsidiaries owned approximately 51.2% of GEC. Under the terms of the PICO/GEC Combination, GEC shareholders received .4628 of a PICO common share for each GEC common share. Immediately thereafter, PICO effected a 1-for-5 Reverse Stock Split. The PICO/GEC Combination and Reverse Stock Split are expected to benefit shareholders from a number of perspectives, including, among other things:
- - resulting in a larger, more liquid publicly traded corporation which is expected to bring about increased analyst coverage; an increased ability to utilize PICO shares as a currency for future transactions and acquisitions; an increased ability for the combined company to access capital markets; and increased liquidity of PICO shares through an increase in the public float; and
In October 1998, Vidler, a 98% owned subsidiary of PICO completed its Arizona groundwater recharge pilot program construction at its MBT Ranch facilities and recharging began on schedule. Vidler has begun implementing the full-scale design and permitting process and will be meeting with potential state and federal recharge customers. Vidler estimates that the total storage capacity of the aquifer underlying this property is in excess of 1,000,000 acre-feet and the "put" and "take" recharge/recovery capacity of the aquifer to be in excess of 100,000 acre-feet per year. This underground water storage facility is located adjacent to the Central Arizona Project in Arizona. In November 1998, Vidler reached an agreement with the Semitropic Water Storage District ("Semitropic"") to acquire 185,000 acre-feet of underground water storage and associated rights to recharge and recover water at Semitropic, located near the California Aqueduct northwest of Bakersfield, California. The strategic location of Semitropic relative to other water delivery systems and storage facilities will enable Vidler to complete exchanges and water transfers in California. The acquisition also complements Vidler's underground water storage facility in Arizona.
Vidler owns and acquires water that has immediate or near term demand and both the institutional and practical means exists to satisfy this demand. Vidler purchases the water acting as an aggregator, wholesaler and developer. In addition, Vidler is developing the underground storage potential of its property at MBT Ranch in Arizona. Storage is critical for the efficient allocation of water in a number of ways:
For the service that a storage facility supplies, fees are charged for recharge (inflow), storage and recovery (outflow).
NLRC is the largest private landowner in the state of Nevada. NLRC's principal asset consists of approximately 1.3 million acres of deeded land located in northern Nevada, together with appurtenant water and mineral rights. NLRC is actively engaged in attempting to maximize the property's value in relation to water rights, mineral rights and land development. PICO acquired NLRC for $39 per acre. Through December 31, 1998, a total of 19,528 acres have been sold, or are in escrow, for an average price per acre of $161. The lowest price per acre received for land where the highest and best use is for grazing was $62. NLRC completed one land exchange of 1,900 acres valued at $224 per acre in which NLRC's wilderness property was exchanged for residential property. In December 1998, NLRC sold 4,777 acres of undeveloped and remote land in Desert Valley, near Winnemucca, Nevada for $1.3 million, or approximately $272 per acre.
During 1997, 1998 and early 1999, the Company acquired an approximate 18% shareholding in Jungfraubahn Holding AG ("Jungfraubahn") based in Interlaken, Switzerland. The average cost of the investment is 216.48 Swiss francs ($153.75) per share. Jungfraubahn shares have a book value in excess of 430 Swiss francs per share and the Company's purchase is at the multiple of 4.5 times 1997's cash flow. Jungfraubahn is in the transportation, tourism and recreational sectors.
AOG is an onshore drilling contractor, drilling for oil, gas, geothermal energy and coal seam methane in Australia and overseas. AOG has a fleet of approximately 29 rigs in 7 countries but has no North American presence. AOG recorded a return on shareholders' equity of 10.7% for the year ended June 30, 1998. AOG's interim results at December 31, 1998 displayed an increase in net income by 72% over the corresponding period.
In addition to the operation of its subsidiaries, the Company's objective is to use its resources and those of its subsidiaries and affiliates to increase shareholder value through investments in businesses that the Company believes are undervalued. The Company's acquisition philosophy is to make selective investments, predominantly in public companies, for the purpose of enhancing and realizing additional value by means of appropriate levels of shareholder influence and control. This could involve the restructuring of the financing or management of the companies in which the Company invests. It may also encompass initiating and facilitating mergers and acquisitions within the relevant industry to achieve constructive rationalization. This business strategy was adopted in late 1994, but was not fully implemented until 1996. Therefore, the results of this business strategy are not fully reflected in the historical financial statements prior to 1996.
See Notes to Consolidated Financial Statements for additional information regarding events affecting PICO subsequent to the date of these financial statements and the Company's website at www.picoholdings.com.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
PICO reported a net loss of $7.2 million, or $1.20 per share, for 1998 compared with net income of $19.5 million, or $3.09 per share, during 1997 and $24.3 million, or $4.39 per share, in 1996. Per share amounts are expressed as basic income or loss per share.
The 1998 net loss included an $11 million loss from continuing operations and $1.8 million in income tax expenses, partially offset by minority interests of $4.5 million and income from discontinued operations of $1.1 million. Compared to 1998's $11 million loss from continuing operations before income taxes and minority interests, 1997 and 1996 produced income of $23.5 million and $34 million, respectively. Of these amounts, net realized gains on investments accounted for $21.4 million and $27.1 million in 1997 and 1996, respectively. This compares to net realized investment losses in 1998 of $4.4 million.
Significant contributors to the Company's $11 million loss from continuing operations before taxes and minority interests included:
This one-time addition to loss and loss adjustment expense reserves was required as a result of individuals being able to claim for occurrences during childbirth or infancy. Prior to attainment of age 18, these individuals were unable to file medical professional liability claims on their own behalf. The statute of limitations limits the time period for making such claims to one to two years from age 18, depending upon the type of claim. Because Physicians did not begin to write significant medical professional liability insurance until the late 1970's, this phenomenon did not materialize in past claims experience. This addition to reserves, based upon actuarial projections by year, strengthens virtually all years that Physicians insured medical professionals.
* And a $1.8 million loss attributable to Vidler Water Company, Inc. ("Vidler") and Nevada Land and Resources Company LLC ("NLRC");
The costs incurred by Vidler were principally normal operating costs with the exception of $800,000 absorbed from the attempted initial public offering and private placement.
* PICO overhead costs of approximately $2.1 million, net of revenues.
* Approximately $3 million in realized investment gains from the sale of European equity securities;
* An $0.8 million realized gain from the sale of Physicians' home office building.
Income tax provisions decreased 1998 net income by $1.8 million compared to $7.7 million in 1997 and $13 million in 1996. Although the Company recorded a pre-tax loss in 1998, it was unable to utilize the operating losses generated by GEC in 1998 to reduce income taxes. GEC does not have sufficient prior years taxable income to enable GEC to carry back the current year's tax loss to reduce taxes. In addition, it is uncertain that GEC will be able to generate sufficient Canadian taxable income in the future to offset the current year losses. Changes in estimates of prior deferred tax assets previously recorded by GEC primarily resulted in 1998 income tax expense of $1.8 million.
Revenues for 1998 were $48.2 million, compared to $88.2 million in 1997 and $76.7 million in 1996. Excluding realized investment gains, revenues declined $14.2 million from 1997 and increased $3 million over 1996. A $13.7 million, or 27.6%, decline in P&C insurance earned premiums was primarily responsible for the decline from 1997. Premium income for 1998 of $36.1 million was $2.6 million, or 6.8%, less than in 1996, which included less than two months of Citation's premium income. Property and casualty insurance premium writings declined in 1998 primarily due to more stringent underwriting of CIC's P&C insurance business since its change in ownership, as well as continued aggressive competition for commercial multiple peril insurance business within California. SEE NOTE 1 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES."
Total expenses for 1998 were $58.4 million compared to $ 64.7 million in 1997 and $43.8 million in 1996. Included in the 1998 total were loss and loss adjustment expenses of $30.5 million, compared to $34.3 million during the same 1997 period, and $22.9 million during 1996. Insurance underwriting and other expenses were $16 million, $19.7 million and $19 million for 1998, 1997 and 1996, respectively. These 1998 improvements over 1997 principally resulted from reduced P&C premiums and reduced claims exposure brought about by increased selectivity at CIC and increased competition.
Shares outstanding and per share calculations for prior years have been adjusted to reflect the December 16, 1998 1-for-5 Reverse Stock Split following the PICO/GEC Combination. Prior year amounts also reflect the November 20, 1996 Merger between Physicians and the Citation Insurance Group.
The Company's ongoing operations are organized into five segments: INVESTMENT OPERATIONS; SURFACE, WATER, AND MINERAL RIGHTS; PROPERTY AND CASUALTY INSURANCE; MEDICAL PROFESSIONAL LIABILITY INSURANCE AND OTHER OPERATIONS. Revenues and income before taxes and minority interests from CONTINUING OPERATIONS, by business segment, are shown in the following schedules:
INVESTMENT OPERATIONS include strategic and passive investment operations conducted primarily by PICO, Physicians, GEC and Physicians Investment Company. However, not all investment activities are included within the Investment Operations business segment. For example, investment revenues and INVESTMENT income generated by Physicians are first allocated to the MEDICAL PROFESSIONAL LIABILITY Insurance segment based upon the amount of invested assets to support Physicians' outstanding insurance reserves. The remainder is classified as part of the INVESTMENT OPERATIONS business segment. (See the MEDICAL PROFESSIONAL LIABILITY INSURANCE segment below.) In addition, investment revenues and investment income generated by Sequoia and CIC are included in the PROPERTY AND CASUALTY INSURANCE business segment and those from PRO, in the MEDICAL PROFESSIONAL LIABILITY INSURANCE segment, and not in the INVESTMENT OPERATIONS business segment. SEE NOTE 19 OF NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, "SEGMENT REPORTING."
INVESTMENT OPERATIONS revenues for 1998 were negative at $1.0 million representing a decrease of $25.1 million compared to $24.1 million in revenue recorded in 1997 and a decrease of $28 million compared to $27 million in revenues in 1996. Realized investment gains and losses accounted for nearly all of these decreases compared to prior years. Excluding realized investment gains, INVESTMENT OPERATIONS revenues increased approximately $0.6 million over 1997 and $2.8 million as compared to 1996. Revenues from INVESTMENT OPERATIONS are summarized below:
Included in 1998 INVESTMENT OPERATIONS revenues were approximately $8.2 million in write downs of equity investments, partially offset by realized investment gains from the sale of equity securities. Included in the $21.3 million in 1997 realized investment gains was approximately $27 million before taxes, resulting from the exercise of the Company's warrants to buy common stock of Resource America Inc. and the subsequent sale of that stock. Realized investment gains in 1996, principally from the sale of Physicians' holdings in Fairfield Communities common stock amounted to $26.4 million. Resource America Inc. and Fairfield Communities Inc. were two of the Company's original "value investments" acquired in 1994 and 1995.
Although investment income from the INVESTMENT OPERATIONS segment in 1998 exceeded those amounts reported for the comparable prior year periods, the actual level of investment income has declined from that of 1997 and 1996, excluding non-recurring adjustments and the allocation to MPL. This decrease is due to reduced levels of interest- and dividend-paying securities and the reduction in the size of Physicians' portfolio due to the payment of MPL claims. The INVESTMENT OPERATIONS segment included an approximate $0.8 million increase in investment income recorded during the first quarter of 1998 relating to the elimination of a capitalized interest asset.
At December 31, 1998, the consolidated investment portfolio was in a net unrealized loss position of approximately $2.9 million, net of taxes compared to $2.7 million in unrealized losses at December 31, 1997.
As these subsidiaries of the Company were not part of the consolidated group until 1997, results prior to 1997 are not included with those of the Company. Following is a breakdown of revenues and pre-tax losses before minority interest from SURFACE, WATER, AND MINERAL RIGHTS operations for the periods shown:
As shown above, revenues from SURFACE, WATER, AND MINERAL RIGHTS generated by Vidler and NLRC were approximately $3.4 million and $3.1 million during 1998 and 1997, respectively. Sales of surface, water and mineral rights accounted for $2.2 million in revenue in 1998 and $1.5 million in 1997. Operating revenues made up the remainder of the total. Other revenues include land leases, principally for grazing, agricultural, communications and easement purposes, water sales and leasing and other income. Operating and overhead expenses exceeded revenues for 1998 producing a loss before taxes and minority interests of $1.8 million compared to income of $ 12,000 for 1997.
Vidler's Arizona groundwater recharge pilot program construction has been completed and recharging began on schedule in October 1998. Accordingly, Vidler has begun implementing the full-scale design and permitting process and will be meeting with potential state and federal recharge customers. Vidler estimates that the total storage capacity of the aquifer underlying Vidler's Arizona property, is in excess of 1,000,000 acre-feet and the "put" and "take" recharge/recovery capacity of the aquifer to be in excess of 100,000 acre-feet per year. Vidler expects that it will be able to enter into agreements to lease storage capacity to potential customers within twelve months after the completion of the full-scale design and permitting process. In November 1998, Vidler reached an agreement with the Semitropic
Since Citation became part of the group in November 1996, Citation's activities are not included in the Company's financial results prior to that date. Sequoia has been part of the group since August 1, 1995.
As shown below, earned premiums made up most of the PROPERTY AND CASUALTY INSURANCE segment revenues. Premiums are earned pro-rata throughout the year according to the coverage dates of the underlying policies.
Sequoia's $18.1 million 1998 earned premiums decreased $14.7 million, or 44.8% compared to those of 1997 and $8.2 million, or 31.2% compared to 1996's $26.3 million. Citation earned $18.1 million in premiums in 1998 compared to $17.4 million in 1997 and $5.1 million in 1996 ($50.5 million for the full year 1996, including the period prior to the Merger). Much of the decline in Sequoia's 1998 earned premiums resulted from a reinsurance pooling agreement effective January 1, 1998 which provides for the pooling of all insurance premiums, losses, loss adjustment expenses ("LAE") and administrative and other insurance operating expenses between Sequoia and Citation. The reinsurance pooling agreement calls for these items to be split equally between the two companies. However, the decline in Sequoia's earned premiums due to the reinsurance pooling agreement produced a corresponding increase in Citation's earned premiums. The decline in Citation's earned premiums from 1996 to 1997 resulted from the reinsurance and sale of Citation's workers' compensation business and the renewal of qualified policies of Citation into Sequoia effective March 1, 1997.
Investment income and realized investment gains from PROPERTY AND CASUALTY INSURANCE operations of $5.7 million in 1998 declined slightly from the $5.8 million recorded during 1997 and exceeded those of 1996 by $2.4 million. The increase from 1996 to 1997 principally resulted from an increase in Sequoia's capital.
PROPERTY AND CASUALTY INSURANCE operations produced $2.8 million in income before taxes during 1998, down $2.8 million from the $5.6 million of 1997 and down $0.5 million from the $3.3 million of 1996. As shown above, $0.7 million of the decline from 1997 was attributable to Sequoia, principally due to its higher 1998 expense ratio. Citation produced an $0.8 million loss in 1998 compared to income of $1.3 million, and $1 million in 1997 and 1996, respectively. The primary reason for the Citation 1998 downturn was poor loss experience, principally in the artisan-contractors coverage no longer written by Citation. Consequently, Citation strengthened claims and LAE reserves during 1998 by approximately $3.7 million. The 1997-98 "El Nino" phenomenon had a significant impact on the first and second quarter 1998 results. Although difficult to quantify, Sequoia and Citation management estimate the cost of storm losses incurred by the companies as a result of the 1998 El Nino phenomenon to be approximately $1 million. Loss experience improved significantly
during the second half of 1998, however. Due to favorable claims experience based upon year end actuarial studies, Sequoia reduced loss and LAE reserves by approximately $2.1 million. In addition to being impacted by El Nino, Sequoia's 1998 loss and LAE ratio was also negatively affected by the reinsurance pooling agreement between Sequoia and Citation since Citation's direct business has not been as profitable as that of Sequoia. Conversely, Citation's incurred losses and LAE and its loss and LAE ratio benefited from the reinsurance pooling agreement. Despite the negative pressures of El Nino and the reinsurance pooling agreement Sequoia's loss and LAE ratio improved five full percentage points over 1997 and 10.6 percentage points over 1996, principally due to improved claims experience from prior years. Higher expense ratios for both Sequoia and Citation resulted from the reduced level of premiums, resulting in a higher ratio of overhead expenses to earned premiums. SEE GAAP INDUSTRY RATIOS BELOW.
Loss and LAE Ratios, Underwriting Expense Ratios and Combined Ratios are calculated using net earned premiums as a denominator. Theoretically, a combined ratio of less than 100% indicates that the insurance company is making a profit on its base insurance business before consideration of investment income, realized investment gains or losses, extraordinary items, taxes and other non-insurance items.
Sequoia's loss experience continued to be favorable in 1998 producing a GAAP loss and LAE ratio of 52.3% compared to 57.3% in 1997 and 62.9% in 1996. As previously discussed, Sequoia's loss ratio improved during 1998 even after the negative pressures of the 1997-98 El Nino effect and the reinsurance pooling agreement between Sequoia and Citation. Sequoia's 1997 loss and LAE ratio improved over 1996 principally due to management's efforts to reduce exposure to risk through re-underwriting existing business during 1995 and 1996, tighter underwriting and careful selection of risks. Much of Citation's improved loss and LAE ratio resulted from the reinsurance pooling agreement previously discussed, producing a corresponding decline in Sequoia's individual company results.
Physicians' and PRO's MPL insurance business was sold to Mutual Assurance Inc. ("Mutual") on August 28, 1995. All new and renewal MPL insurance policies written between July 16 and December 31, 1995 were 100% reinsured by Mutual. Physicians and PRO ceased writing new and renewal MPL insurance policies effective January 1, 1996. Physicians continues to administer and adjust the remaining claims and LAE reserves. Based upon careful analysis of various alternative scenarios for handling the runoff of the remaining claims reserves, management decided that the best option was to process the existing claims internally with existing staff, rather than through a third party administrator or through an outright sale of the claims and LAE reserves. In addition, it is expected that shareholders' equity may be better served by retaining the investments necessary to fund the payment of these claims and LAE reserves, managing them along with the rest of the Company's investment holdings, as opposed to selling or fully reinsuring these reserves and giving up the corresponding funds. However, there can be no assurance that funds generated by such retained investments will exceed claims. Accordingly, although the companies effectively ceased writing MPL insurance in 1995, MEDICAL PROFESSIONAL LIABILITY INSURANCE is treated as a separate business segment of continuing operations due to the continued management of claims and associated investments.
Revenues and pre-tax income or loss from MEDICAL PROFESSIONAL LIABILITY INSURANCE operations included the following:
Since the withdrawal of Physicians and PRO from their personal automobile and homeowners lines of business in the late 1980's, MPL has been these two companies' only sources of insurance premiums.
Physicians' claims department staff continues to process the runoff of the remaining MPL loss and loss adjustment expense claims which is progressing routinely. At December 31, 1998, MPL reserves totaled $60.9 million, net of reinsurance and discount. This compares to $77.5 million and $112.9 million at December 31, 1997 and 1996, respectively. MPL loss and LAE reserves continue to decline as a result of the disposition of claims.
Revenues (charges) and pre-tax losses from other operations are summarized below for the past three years:
Pre-tax, OTHER OPERATIONS showed a $0.4 million loss for 1998 compared to a $0.7 million loss in 1997 and a $1.1 million loss during 1996. The improvement in the performance of OTHER OPERATIONS during 1998 compared to 1997 was attributable to approximately $0.1 million in income from CLM compared to a $0.3 million loss during 1997.
GEC elected to treat its Sri Lankan operations as discontinued in recognition of their sale in November and December 1997. These operations produced approximately $3.3 million in pre-tax income during 1997 as recorded in GEC's financial results, prior to the elimination of minority interests when consolidated with PICO. This included approximately $3.5 million of realized pre-tax gain in 1997 on the sale and reversal of a foreign currency translation adjustment relating to those operations of approximately $2.3 million, prior to recognition of minority interest. SEE NOTE 6 OF NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, "DISCONTINUED OPERATIONS."
The Company continually evaluates its existing operations and searches for new opportunities to maximize shareholder value. This strategy causes significant fluctuations in the cash needs of the Company. The Company may need to sell investments, or borrow funds to meet operating cash requirements. In addition, it may become necessary or advantageous for the Company to offer stock or debt through a public or private offering. At times the Company may have excess cash. The Company attempts to invest such cash to provide maximum returns within the constraint of remaining liquid enough to meet expected cash requirements. The Company's primary sources of funds are its available cash, cash from operations, the sale of invested assets, bank borrowings, public and private debt and equity offerings, and management and other fees.
As of December 31, 1995, when Physicians and PRO ceased writing MPL, Physicians and PRO reported unpaid loss and loss adjustment expense reserves of approximately $136.2 million, net of reinsurance. Based upon projections from past actuarial information, more than 75%, or $102 million, of the reserve is expected to be settled by the end of the year 2000. Past experience indicates that funding requirements are typically greatest in years one through three (1996 through 1998), accounting for more than 60% of the total eventual reserve and loss adjustment expense payments. As expected, loss and LAE reserves at December 31, 1996 declined more than 17.1% to $112.9 million after payment of more than $30 million in claims and LAE. During 1997, MPL reserves decreased $35.4 million, or 31.4%, to $77.5 million as of December 31, 1997 after payment of more than $38 million in losses and LAE. MPL reserves declined $16.6 million during 1998 to $60.9 million as of December 31, 1998. This represents a 55.3% decline in net discounted loss and LAE reserves since December 31, 1995.
At December 31, 1998, the investment portfolios of Physicians and PRO contained invested assets of approximately $122.3 million, plus cash and cash equivalents of $9.3 million. These invested assets are in excess of the present value of expected future payouts of losses and loss adjustment expenses of approximately $61 million.
Management attempts to maximize the return on all assets, including those needed to fund the eventual wrap-up of the MPL reserves through, among other things, value investing and managing the invested assets internally rather than liquidating assets to pay a third party to oversee the runoff of the existing claims. Management also elected to handle the runoff of the MPL claims internally to continue to maintain a high standard of claims handling and to maximize shareholder values. While management expects that certain of the Company's current and future investments may increase in value, offsetting some of the decline in assets during the period of runoff, the impact of future market fluctuations on the value of the Company's invested assets cannot be accurately predicted. Although assets will be managed to mature or liquidate according to expected payout projections, at times some invested assets may need to be sold when the stock market is depressed. Such forced sales are expected to occur infrequently and only under extreme circumstances; however, this cannot be guaranteed.
The Company anticipates that Vidler will continue to incur operating losses until they are able to generate significant revenues from development of projects, including water storage and supply programs, leases, royalties, and property sales. Further, Vidler may require funding for acquisitions of surface, water and mineral rights, and other activities. These additional cash needs may require debt or equity funding from sources outside the Company.
As shown in the accompanying consolidated statements of cash flows, operating activities used $21.2 million of cash during 1998 compared to cash used of $62.1 million during 1997 and $10.9 million in 1996. The decline in cash used by operations between 1997 and 1998 of $40.9 million principally consisted of reductions in claims and LAE payments (both property and casualty and MPL) and insurance operating expenses, partially offset by a decreased level of premiums received. Federal income taxes paid in 1998 were $10.5
At December 31, 1998, the Company has no significant commitment for future capital expenditures, other than in the ordinary course of business and as discussed herein. The Company is committed to maintaining Sequoia's capital and statutory policyholder surplus at a minimum of $7.5 million. At December 31, 1998, Sequoia was well above this level. The Company is also committed to maintain Sequoia's Best Rating at or above the "B++" (Very Good) level, which may at some time in the future require additional capital infusions into Sequoia. SEE NOTE 16 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "COMMITMENTS AND CONTINGENCIES."
The Company's principal sources of funds are its available cash resources, operating cash flow, liquidation of non-essential investment holdings, borrowings, public and private debt and equity offerings, funds from consolidated tax savings, and investment management and other fees. At December 31, 1998, the Company had $71.7 million in cash and cash equivalents compared to $56.4 million at December 31, 1997.
The Company continues to progress in its efforts to define the scope and magnitude of the Year 2000 ("Y2K") problem and to execute its plans to ensure information technology and non-information technology systems are Y2K ready. There is an evolving plan to achieve compliance that is currently divided into four phases. As the project has proceeded, overlap of the different phases has occurred.
The Company has relationships with several banks and other financial institutions and service providers that provide business information on a regular basis. In addition, the Company reports financial results on a regular basis to state and federal agencies. While these relationships are important to the Company's business, should any third parties be adversely affected by the Y2K problem, the resulting risk of business interruption should not be significant to the Company. The Company however, has no means of ensuring that these parties will be Year 2000 ready. The inability of those parties to complete their Y2K readiness process could materially impact the Company.
In addition to the risks and uncertainties discussed in the preceding sections of "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this document, the following risk factors should be considered carefully in evaluating PICO and its business. The statements contained in this prospectus that are not purely historical are forward-looking statements within the meaning of Section 27A of the Exchange Act, including statements regarding our expectations, beliefs, intentions, plans or strategies regarding the future. All forward looking statements included in this document are based on information available to us on the date thereof, and we assume no obligation to update any such forward-looking statements.
We will continue to make selective investments, enhance and realize additional value to these acquired companies through our influence and control. This could involve the restructuring of the financing or management of the entities in which we invest and initiating and facilitating mergers and acquisitions. Any acquisition could result in the use of a significant portion of our available cash, significant dilution to you, and significant acquisition related charges. Acquisitions may also result in the assumption of liabilities, including liabilities that are unknown or not fully known at the time of the acquisition, which could have a material adverse effect on us. Furthermore, we may not obtain the anticipated or desired benefits of such transactions. You will be relying on the experience and judgment of management to locate, select and develop new acquisition and investment opportunities. Sufficient opportunities may not be found and this business strategy may not be successful. Failure to successfully implement this strategy could have a material adverse effect on our business, financial condition, results of operations and cash flows.
To successfully manage newly acquired companies, we must, among other things, continue to attract and retain key management and other personnel. The diversion of the attention of management from the day-to-day operations, or difficulties encountered in the integration process, could have a material adverse effect on our business, financial condition, results of operations and cash flows.
* the amount of historical information available during the estimation process;
THERE HAS BEEN A DOWNTURN IN THE PROPERTY & CASUALTY INSURANCE BUSINESS WHICH NEGATIVELY AFFECTS OUR BUSINESS
The cyclical trends in the industry and the industry's profitability can also be affected by volatile and unpredictable developments, including natural disasters, fluctuations in interest rates, and other changes in the investment environment which affect market prices of investments and the income generated from those investments. Inflationary pressures affect the size of losses and court decisions affect insurers' liabilities. These trends may adversely affect our business, financial condition, results of operations and cash flows.
WE MAY BE INADEQUATELY PROTECTED AGAINST MAN MADE AND NATURAL CATASTROPHES
We insure ourselves against catastrophic losses by obtaining insurance through other insurance companies known as reinsurers. The future financial results of our insurance subsidiaries could be adversely affected by disputes with their reinsurers with respect to coverage and by the solvency of the reinsurers.
OUR INSURANCE SUBSIDIARIES COULD BE DOWNGRADED WHICH WOULD NEGATIVELY IMPACT OUR BUSINESS
SUBSTANTIAL REGULATION MAY PREVENT US FROM REALIZING A PROFIT FROM OUR WATER RIGHTS
The water rights held by us and the transferability of these rights to other uses and places of use are governed by the laws concerning water rights in the states of Arizona, California, Colorado and Nevada. The volumes of water actually derived from these rights may vary considerably based upon physical availability and may be further limited by applicable legal restrictions. As a result, the amounts of acre
feet anticipated do not in every case represent a reliable, firm annual yield of water, but in some cases describe the face amount of the water right claims or management's best estimate of such entitlement. Legal impediments exist to the sale or transfer of some of these water rights which in turn may affect their commercial value. If we were unable to transfer or sell our water rights, it could adversely affect our business, financial condition, results of operations and cash flows.
As a result of global investment diversification, our business, financial condition, results of operations and cash flows may be adversely affected by:
* exposure to fluctuations in exchange rates; * the imposition of governmental controls; * the need to comply with a wide variety of foreign and U.S. export laws; * political and economic instability; * trade restrictions; * changes in tariffs and taxes; * volatile interest rates; * changes in certain commodity prices; * exchange controls which may limit our ability to withdraw money; * the greater difficulty of administering business overseas; and * general economic conditions outside the United States.
Our results of operations have been subject to significant fluctuations, particularly on a quarterly basis, and our future results of operations could fluctuate significantly from quarter to quarter and from year to year. Causes of such fluctuations may include the inclusion or exclusion of operating earnings from newly acquired or sold operations.
WE MAY NOT BE ABLE TO RETAIN KEY MANAGEMENT PERSONNEL WE NEED TO SUCCEED
OUR CHARTER DOCUMENTS MAY INHIBIT A TAKEOVER, PREVENTING YOU FROM RECEIVING A PREMIUM ON YOUR STOCK
The Board of Directors has authority to issue up to 2 million shares of preferred stock and to fix the rights, preference, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. Your rights as common stock holders will be subject to, and may be adversely affected by, the rights of the holders of the preferred stock. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock, thereby delaying, deferring or preventing a change in control of PICO. Furthermore, such preferred stock may have other rights, including economic rights senior to the common stock, and, as a result, the issuance thereof could have a material adverse effect on the market value of the common stock.
The initial phase of planning, inventorying and evaluating all information technology systems, and non-information technology systems and their components, for Y2K compliance is approximately 90% complete. The evaluation has not disclosed any significant Y2K processing difficulties or concerns. The focus is primarily on the insurance operations because of the custom applications software used to process insurance policies, policy claims, and insurance underwriting. After internal review and communication with system vendors, the majority of the non-insurance information and non-information technology systems are Y2K compliant and do not require any significant alterations. The focus of remediation is on the insurance specific applications.
The secondary phase of the project, which primarily includes implementing corrections to remedy Y2K deficiencies, is approximately 85% complete. As noted above, the insurance system software has been the primary focus of such efforts. To renovate the insurance systems to a Y2K ready state, our internal information systems staff is in the process of re-writing lines of existing code to function with a four-digit date field. We also replaced existing DOS software with a current Y2K version. Completion of this phase is estimated to be June 30, 1999.
The Company's financial statements as of December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998 and the independent auditors' reports are included in this report as listed in the index of this report.
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
We have audited the accompanying consolidated balance sheets of PICO Holdings, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1997 consolidated financial statements of Global Equity Corporation (all expressed in Canadian dollars), a 51.2% owned consolidated subsidiary as of December 31, 1997, which constituted 42% of consolidated total assets as of December 31, 1997. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Global Equity Corporation (all expressed in Canadian dollars), is based solely on the report of such other auditors. The consolidated financial statements of the Company for the year ended December 31, 1996 were audited by other auditors whose report, dated April 7, 1997, expressed an unqualified opinion on those statements.
In our opinion, based on our audits and the report of the other auditors, the 1998 and 1997 consolidated financial statements present fairly, in all material respects, the consolidated financial position of PICO Holdings, Inc. and subsidiaries as of December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles.
We have audited the consolidated statements of operations, shareholders' equity and cash flows of PICO Holdings, Inc. and subsidiaries for the year ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and the cash flows of PICO Holdings, Inc. and subsidiaries for the year ended December 31, 1996, in conformity with generally accepted accounting principles.
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS'EQUITY, CONTINUED FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
PICO Holdings, Inc. and subsidiaries (collectively, the "Company") is a diversified holding company with operations in wholesale water and storage through its subsidiary Vidler Water Company, Inc., real estate and minerals through its subsidiary Nevada Land and Resource Company, LLC, insurance through its subsidiaries Sequoia Insurance Company and Citation Insurance Company, and investment management though its subsidiary Summit Global Management, Inc. In addition, the Company has a number of strategic value investments. Also two subsidiaries, Physicians Insurance Company of Ohio and The Professionals Insurance Company, are in the process of winding down their medical professional liability insurance operations.
Effective December 16, 1998, PICO Holdings Inc. ("PICO") acquired the remaining 48.8% of the outstanding stock of Global Equity Corporation ("GEC") through a Plan of Arrangement (the "PICO/GEC Combination") whereby GEC shareholders received .4628 of a newly issued PICO common share for each GEC share surrendered. Immediately following the close of the transaction, PICO consummated a 1-for-5 reverse stock split (the "Reverse Stock Split"). Accordingly, all share amounts included herein are restated to reflect the Reverse Stock Split.
Nevada Land and Resource Company, LLC ("NLRC"). NLRC's primary asset is approximately 1.3 million acres of deeded land with appurtenant water, and mineral rights in northern Nevada. NLRC is actively engaged in maximizing the property's value in relation to water rights, mineral rights, and land development. GEC owns a 74.77% membership interest, and PICO owns the remaining 25.23%.
Sequoia Insurance Company ("Sequoia"). Sequoia is a California insurance company licensed to write insurance coverage for property and casualty risks ("P&C") within the states of California and Nevada. Sequoia writes business through independent agents and brokers covering risks located primarily within northern and central California and Nevada. Although multiple line underwriting is conducted, and at one time or another all major lines of property and casualty insurance except workers' compensation and ocean marine have been written, over the past few years Sequoia transitioned from writing primarily personal lines of business (automobile, homeowners, etc.) to commercial lines.
Investments in which the Company owns between 20% to 50% of the voting interest, has the ability to exercise significant influence and which are made for long term operating purposes, are accounted for under the equity method of accounting. Accordingly, the Company's share of income or losses are included in consolidated results. Currently, the Company classifies its 32% common stock ownership in Conex as an equity investment.
The Company applies the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This statement, among other things, requires investment securities to be divided into three categories: held to maturity, available for sale, and trading. The Company classifies all investments that are not made for long term operating purposes as available for sale. Investments with a readily determinable fair value are carried at fair value, while other investments are carried at cost. Unrealized gains or losses on investments recorded at fair value are recorded net of tax and included in accumulated other comprehensive income or loss.
The Company regularly reviews the carrying value of its investments for impairment. A decline in the market value of any investment below cost that is deemed other than temporary is written down to net realizable value. Adjustments for write-downs are reflected in realized gains or losses on investments in the consolidated statements of operations.
The Company invests domestically and abroad. Approximately $32.7 million and $46.2 million of the Company's investments at December 31, 1998 and 1997, respectively, were invested internationally. The Company's most significant foreign currency exposure is in Europe, Asia and Australia.
Property and equipment are carried at cost, net of accumulated depreciation. Depreciation is computed on the straight-line method over the estimated lives of the assets ranging from 5 to 45 years. Maintenance and repairs are charged to expense as incurred, while significant improvements are capitalized. Gains or losses on the sale of property and equipment are included in other income.
Goodwill represents the difference between the purchase price and the fair value of the net assets (including tax attributes) of companies acquired in purchase transactions. The Company recorded negative goodwill (i.e., excess of fair value of assets acquired over purchase price) as a result of the acquisition of Citation Insurance Group in November 1996. Negative goodwill is included in "Other Liabilities" in the accompanying consolidated balance sheets, and is being amortized on the straight line method over 10 years. For the years ended December 31, 1998, 1997 and 1996 amortization of negative goodwill was approximately $568,000.
The Company applies the provisions of SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and periodically evaluates whether events or circumstances have occurred that may affect the estimated useful life or the recoverability of long-lived assets. Impairment of long-lived assets is triggered when the estimated future undiscounted cash flows (excluding interest charges) do not exceed the carrying amount. If the events or circumstances indicate that the remaining balance may be permanently impaired, such potential impairment will be measured based upon the difference between the carrying amount and the fair value of such assets determined using the estimated future discounted cash flows (excluding interest charges) generated from the use and ultimate disposition of the respective long-lived asset.
Stock options of 1,096,972, 276,543 and 339,218 for 1998, 1997 and 1996, respectively and 223,187 warrants in 1998, were not included in the calculation of weighted average shares because the impacts of such instruments were anti-dilutive.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 established requirements for disclosure of comprehensive income and is effective for the Company for the year ended December 31, 1998. The Company adopted the new standard for the year ended 1998, and has reclassified previous financial statements to conform to the new presentation. Comprehensive income or loss includes foreign currency translation, and unrealized holding gains and losses on available for sale securities, which prior to adoption were reported separately in stockholders' equity.
Accumulated other comprehensive loss is net of deferred income tax benefit of $1.5 million for the years ended December 31, 1998 and 1997.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS No. 131 establishes standards for disclosure about operating segments in annual statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise". The new standard is effective for the year ended December 31, 1998, and comparative information from earlier years has been restated to conform to the requirements of this standard.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including instruments embedded in other contracts and for hedging activities. It requires recognition of all derivatives as either assets or liabilities in the consolidated balance sheet, and measure those instruments at fair value. The new standard becomes effective for fiscal years beginning after June 15, 1999. Management does not expect this statement to have a material effect on the Company's consolidated financial statements.
On December 16, 1998, PICO acquired the remaining 48.8% of GEC, making it a wholly-owned subsidiary. This was accomplished through an exchange of PICO shares for GEC shares at the exchange ratio of .4628 of a PICO share for each share of GEC. PICO issued a total of 6,810,426 shares of PICO common stock to former GEC shareholders. PICO subsidiaries hold 3,110,837 of these newly issued shares which are recorded as treasury stock in the consolidated balance sheets of the Company. In addition, PICO exchanged 223,187 PICO warrants with an exercise price of $23.80 per share for all the outstanding GEC warrants using the same exchange ratio. PICO also exchanged 484,967 stock options to GEC officers, two current GEC directors and a former GEC director in exchange for surrendering their GEC stock options. These grants placed the participants in a substantially similar position regarding shares and exercise price and vesting.
The following table reflects unaudited pro forma combined results of operations of the Company and GEC on the basis that the acquisition had taken place at the beginning of the fiscal year for each of the periods presented:
At December 31, the cost and carrying value of available for sale investments are as follows:
During 1998, the Company recorded $8.2 million in permanent write downs of investments to recognize what is expected to be other than temporary declines in the market values of those securities.
Approximately $26.8 million of the total gross realized gains for the year ended December 31, 1997 were generated from the conversion of Resource America, Inc. warrants and the immediate sale of the converted common stock. For the year ended December 31, 1997, GEC recorded a permanent write down of $8.0 million (of which approximately $3.8 million represented the realization of accumulated foreign currency translation adjustments recorded by GEC) in the value of its investment in Korean securities in recognition of what is expected to be an other than temporary decline in the market value of those securities. These write-downs have been recorded as a realized loss.
Through its subsidiaries Vidler and NLRC, PICO owns surface, water and mineral rights consisting of various real properties, surface rights, water rights and mineral rights in California, Arizona, Colorado and Nevada. The costs assigned to the various components of surface and mineral rights, water rights, and land improvements at December 31, were as follows:
The following reconciles income (loss) from continuing operations to net income (loss) :
Following is an unaudited summary of APL's stand alone financial results for the periods included in the statements of operations as discontinued operations:
Following is an unaudited summary of these Sri Lankan companies stand alone financial results for the period included as discontinued operations in the accompanying financial statements. Operating results for 1996 are not shown since this period was prior to the effective date of consolidation of GEC with PICO
Pre-tax income (loss) from continuing operations for the years ended December 31 was under the following jurisdictions:
Income tax expense (benefit) from continuing operations for each of the years ended December 31 consists of the following:
The difference between income taxes provided at the Company's effective tax rate and federal statutory rate is as follows:
Provision has not been made for U.S. or additional foreign tax on the undistributed earnings of foreign subsidiaries. It is not practical to estimate the amount of additional tax that might be payable. At December 31, 1998 and 1997, the Company had a $6.5 million income tax receivable and a $1 million income tax payable, respectively. The aggregate NOL's of approximately $24.2 expire between 1999 and 2013. There is an annual limitation on the utilization of PICO's, Citation's and Sequoia's NOL's of approximately $1.4 million.
Depreciation expense was $1.3 million, $873,000, and $751,000 in 1998, 1997, and 1996, respectively.
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 1998, 1997 and 1996, respectively: no dividend yield for all years; risk-free interest rates are different for each grant and range from 5.94% to 6.97%; the expected lives of options are estimated at 7 years; and a volatility of 62% for 1998 grants, and 50% for 1997 and 1996 grants.
Immediately prior to the sale of Sequoia to Physicians by Sydney Reinsurance Corporation ("SRC") in 1995, Sequoia and SRC entered into a reinsurance treaty whereby all policy and claims liabilities of Sequoia prior to the date of purchase by Physicians are the responsibility of SRC. Payment of SRC's reinsurance obligations under this treaty has been unconditionally and irrevocably guaranteed by QBE Insurance Group Limited should SRC be unable to meet its obligations under the reinsurance agreement.
In 1994, the Company entered into a retroactive reinsurance arrangement with respect to its MPL business. As a result, Physicians initially recorded a deferred gain on retroactive reinsurance of $3.4 million in 1994. Deferred gains are being amortized into income over the expected payout of the underlying claims using the interest method. The unamortized gain as of December 31, 1998 and 1997 was $1.8 million and $2.2 million, respectively.
Physicians and PRO prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the Ohio Department of Insurance ("Ohio Department"). Citation and Sequoia prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the California Department of Insurance. Prescribed statutory accounting practices include guidelines contained in various publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Ohio Department's prescribed accounting practices do not allow for discounting of claim liabilities. However, for the years ended December 31, 1998, 1997, and 1996, the Ohio Department permitted Physicians to discount its losses and loss adjustment expenses related to its MPL claims to reflect anticipated investment income. Such permission was granted due primarily to the longer claims settlement period related to MPL business as compared to most other types of property and casualty insurance lines of business. Property and casualty insurance companies are permitted to discount claims liabilities under generally accepted accounting principles to the extent that the discounting of claims liabilities by such entities is prescribed or permitted by statutory accounting principles.
The method of discounting utilized by Physicians is based on historical payment patterns and assumes an interest rate at or below Physicians' investment yield, and is the same rate used for statutory reporting purposes. Physicians uses a discount rate of 4%. The carrying value of MPL reserves gross as to reinsurance was approximately $85.8 million, net of discounting of $11.3 million at December 31, 1998 and $108.7 million, net of discounting of $12.5 million at December 31, 1997.
PICO maintains a 401(k) Defined Contribution Plan covering substantially all employees of the Company. Matching contributions are based on a percentage of employee compensation. In addition, the Company may make a discretionary contribution at the end of the Plan's fiscal year within limits established by the Employee Retirement Income Securities Act. During 1998, 1997, and 1996, expenses for contributions by the Company were $618,000, $365,000, and $334,000, respectively. APL, a former subsidiary of the Company, holds the Plan assets. Another subsidiary is responsible for the management of the assets.
The regulations of the Departments of Insurance in the states where the Company's insurance subsidiaries are domiciled generally restrict the ability of insurance companies to pay dividends or make other distributions. Based upon statutory financial statements filed with the insurance departments as of December 31, 1998, $3.2 million was available for distribution by the Company's wholly-owned insurance subsidiaries to the parent company without the prior approval of the Department of Insurance in the states in which the Company's insurance subsidiaries are domiciled, through December 31, 1999. On July 31, 1998, APL paid an $8 million dividend to Physicians Investment Company. On December 17, 1997, a subsidiary of Physicians, The Professional Insurance Company ("PRO"), paid Physicians a cash dividend of approximately $5.5 million. A dividend payment of $13.2 million was made on December 30, 1997 from Physicians to PICO Holdings, Inc. in the form of GEC common stock.
In connection with the sale of their interests in NLRC by the former members, a limited partnership agreed to act as consultant to NLRC in connection with the maximization of the development, sales, leasing, royalties or other disposition of land, water, mineral and oil and gas rights with respect to the Nevada property. In exchange for these services, the partnership was to receive from NLRC a consulting fee calculated as 50% of any net proceeds that NLRC actually receives from the sale, leasing or other disposition of all or any portion of the Nevada property or refinancing of the Nevada property provided that NLRC has received such net proceeds in a threshold amount equal to the aggregate of: (i) the capital investment by GEC and the Company in the Nevada property (ii) a 20% cumulative return on such capital investment, and (iii) a sum sufficient to pay the United States federal income tax liability, if any, of NLRC in connection with such capital investment. Either party could terminate this consulting agreement in April 2002 if the partnership had not received or become entitled to receive by that time any amount of the consulting fee. No payments have been made under this agreement through December 31, 1998. By letter dated March 13, 1998, NLRC gave notice of termination of the consulting agreement based on NLRC's determination of default by the partnership under the terms of the agreement. In November 1998, the partnership sued NLRC for wrongful termination of the consulting contract. On March 12, 1999, NLRC filed a cross-complaint against the partnership for breach of written contract, breach of fiduciary duty and seeking declaratory relief.
Effective September, 1995, the Company entered into consulting contracts with two Directors for a three-year period at a combined fee of $300,000 annually for their services as officers of the Company related to analysis of the Company's operations, investment banking activities, and analysis and recommendation on the Company's investment portfolio. During 1996, each of the Directors received $300,000 in fees and $450,000 in bonuses. The same two directors also entered into consulting contracts with a subsidiary of GEC for similar services. The compensation paid to each of those Directors under that arrangement was $300,000 in 1996. These contracts were superseded by the January 1997 contracts described below.
In January 1997, the consulting arrangements described above were terminated and replaced with a revised consulting contract that increased the annual base consulting fees for the two directors to $800,000 each beginning January 1, 1997. On December 31, 1997, these two directors became employees of the Company; the terms of employment were similar to the consultant arrangements described above. The employment agreements entered into by the two directors superceded the prior consulting agreements. Each is entitled to an incentive award based on the growth of the Company's book value per share in excess of a threshold that is calculated as 80% of the previous five year average return for the S&P 500. No award was paid during 1998, 1997 or 1996 under this program.
The Company and its insurance subsidiaries are subject to regulation by the insurance departments of the states of domicile and other states in which the companies are licensed to operate and file financial statements using statutory accounting practices prescribed or permitted by the respective Departments of Insurance. Prescribed statutory accounting practices include a variety of publications of the NAIC, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. Physicians has received written approval from the Ohio Department to discount its MPL unpaid loss and loss adjustment expense reserves, including related reinsurance recoverable using a 4% discount rate. Statutory practices vary in certain respects from generally accepted accounting principles. The principal variances are as follows:
2) Deferred policy acquisition costs are expensed for statutory accounting purposes.
3) Deferred federal income taxes are not recognized for statutory accounting purposes.
The Company and its wholly-owned insurance subsidiaries' net income (loss) for the years ended December 31, 1998, 1997 and 1996 and policyholders' surplus as of December 31, 1998, 1997, and 1996 on the statutory accounting basis are as follows:
- ----------- * Purchased August 1, 1995 ** Purchased November 20, 1996 *** Sold December 4, 1998
Certain insurance subsidiaries are owned by other insurance subsidiaries. In the table above, investments in such subsidiary- owned insurance companies are reflected in statutory surplus of both the parent and subsidiary-owned insurance company. As a result, at December 31, 1998, 1997, and 1996, statutory surplus of approximately $27,084,648, $37,768,506 and $38,423,146, respectively, is reflected in both the parent and subsidiary-owned insurance companies.
PICO's subsidiaries, Physicians and PRO ceased writing policies in 1995; however continue to administer and adjust remaining claims. Management continues to handle the runoff of the remaining claims reserves internally. The operation has retained the investments necessary to fund the payment of claims and LAE reserves as opposed to selling or fully reinsuring these reserves and giving up the corresponding funds. Revenues are derived from the investments retained.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that fair value:
- INVESTMENTS: Fair values are estimated based on quoted market prices, or dealer quotes for comparable securities. Fair value of warrants to purchase common stock of publicly traded companies is estimated based on values determined by the use of accepted valuation models at the time of acquisition. Equity securities that do not have a readily determinable fair value are accounted for using the cost method and fair values are estimated based on the value of the underlying common stock. The Company regularly evaluates the carrying value of securities to determine whether there has been any diminution in value that is other than temporary and adjusts the value accordingly.
- INVESTMENT IN AFFILIATE: Investments in affiliated companies which the Company owns between 20% and 50%, and are carried as a long term operating investment are carried at equity value. The balance of the investment is regularly evaluated to determine whether there has been any impairment.
Summarized unaudited financial data for 1998 and 1997 are shown below. In management's opinion, the interim financial data contains all adjustments, consisting of only normal recurring accruals, necessary for a fair presentation of results for such interim periods. Prior period amounts have been adjusted to conform to the current period presentation, including reclassification for discontinued operations, and adjustment to shares and net income (loss) per share values due to the acquisition of the minority interest of GEC, and the 1-for-5 reverse stock split.