Physicians leases approximately 1,892 square feet of office space in Columbus, Ohio for its headquarters. Sequoia leases office space for its and Citation's headquarters in Monterey, California and for regional claims and underwriting offices in Modesto, Monterey, Ventura, Visalia, Orange, Pleasanton, San Jose, Bakersfield, Clovis and Sacramento, California as well as Midvale, Utah. Nevada Land leases office space in Carson City, Nevada. Vidler and Nevada Land hold significant investments in land, water rights and mineral rights in the southwestern United States. See "Item 1 - Business-Introduction."
Note: Prior year share values have been adjusted to reflect the 1-for-5 Reverse Stock Split effective December 16, 1998, and the treatment of American Physicians Life Insurance Company and Sequoia Insurance Company as discontinued operations. Book value per share is computed by dividing shareholders' equity by the net of total shares issued less shares held as treasury shares.
The consolidated financial statements and other portions of this Annual Report on Form 10-K for the fiscal year ended December 31, 2002 including Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," reflect the effects of (1) the restatements of our consolidated financial statements for all years from 1996 to 2001 inclusive as filed on March 31, 2003 on Form 10-K/A for the fiscal year ended December 31, 2001, and (2) presenting Sequoia Insurance Company as discontinued operations.
The Arizona State Legislature has passed several pieces of legislation which recognize the Harquahala Valley ground water as a future municipal supply for the Phoenix metropolitan area. In 1991, the expansion of irrigated farming in the Valley was prohibited, and the transfer of the ground water to municipalities was authorized. In order to protect the Harquahala Valley ground water from large commercial and industrial users which were moving into the Basin, legislation was enacted in 2000 placing restrictions on commercial and industrial users utilizing more than 100 acre-feet of water annually. These users are required to purchase irrigable land and to withdraw the water that they need from the land at no more than 3 acre-feet per annum per acre of land.
Vidler has closed two sales of Harquahala Valley ground water to an industrial user within the Harquahala Basin:
- - in March 2001, Vidler sold 6,496.5 acre-feet of water rights and 2,589 acres of land. This transaction added $9.4 million to revenues and $2.3 million to gross margin in 2001; and
Vidler anticipates that up to 40,000 acre-feet of water rights will ultimately be permitted from these applications, and put to use in Lincoln County. We anticipate demand from industrial users locating new facilities in Lincoln County, and from municipalities. Under the Lincoln County Land Act, more than 13,000 acres of publicly owned land in southern Lincoln County will be offered for sale near the fast growing City of Mesquite. Additional water will be required if this land is to be developed.
In 1998, Lincoln/Vidler filed for 14,000 acre-feet of water rights for industrial use from the Tule Desert Groundwater Basin. In November 2002, the Nevada State Engineer granted an application for 2,100 acre-feet of water rights, and ruled that another 7,244 acre-feet could be granted, but would be held in abeyance while Lincoln/Nevada pursues additional studies.
As previously disclosed, Lincoln/Vidler had reached conditional agreement to sell an electricity-generating company between 6,700 and 9,000 acre-feet of water, at $3,300 per acre-foot, for a new power plant to be located in southern Lincoln County on a site which was to be acquired from Nevada Land. Due to the unprecedented instability in the energy market and capital market conditions affecting the electricity sector, the electricity-generating company decided not to move forward with the project. Recognizing that a permitted site with permitted water rights will have value once the energy market stabilizes, Vidler purchased the project for $50,000 in February 2003. Vidler is currently reviewing the project with energy companies and utilities. If a financial closing with a third party occurs within two years of the purchase, Vidler is required to make an additional payment to the seller of the project.
The Lincoln County undertaking is an example of a transaction where Vidler can partner with an entity, in this case a governmental entity, to provide the necessary capital and skills to commercially develop water assets.
The Muddy River is a perennial river fed by the Muddy Springs in Southern Nevada, originating in Nevada and flowing into Lake Mead. Currently, Muddy River water rights are utilized for agriculture and electricity generation.
During 2000, Vidler purchased a 51% interest in Fish Springs Ranch, LLC ("Fish Springs") and a 50% interest in V&B, LLC. These companies own the Fish Springs Ranch and other properties totaling approximately 8,600 acres in Honey Lake Valley in Washoe County, 45 miles north of Reno, Nevada. Approximately 8,000 acre-feet of permitted water rights associated with Fish Springs Ranch are transferable to the Reno/Sparks area. The water rights at Fish Springs have been identified as the most economical and proven new source of supply to support new growth in the North Valley communities of Washoe County. This county was in the top 2% of all counties in the U.S. for new home construction between April 1, 2000 and July 1, 2001. According to census data, almost 5,500 new homes were constructed over that 15 month period, a 3.8% increase.
There are 6,000 acre-feet of certificated water rights at Big Springs Ranch, which are the only known practical source of water to support new growth for West Wendover, Nevada and Wendover, Utah.
In 1999, a land exchange was completed in which approximately 70,500 acres of ranchland at Big Springs Ranch was exchanged with the Bureau of Land Management for several parcels of developable land near West Wendover, Nevada, totaling approximately 6,300 acres. West Wendover is adjacent to the Nevada/Utah border in the Interstate 80 corridor. Governmental officials are considering a proposal to adjust the state line and then merge the cities of West Wendover, Nevada and Wendover, Utah. West Wendover is approximately 120 miles from Salt Lake City, Utah, and attracts a significant number of drive-in visitors from Utah, a state where gaming is prohibited. The land owned by Vidler will stay in Nevada.
The first parcel to be developed is approximately 82 acres of industrial land. In September 2002, Vidler sold 7 acres of unimproved land for $500,000, or approximately $71,429 per acre, to a developer who is responsible for installing offsite utilities and access road improvements for an industrial park. We anticipate that these improvements will allow Vidler to sell the remaining 75 acres as higher-value industrial land.
Vidler has almost completed the process of monetizing its water rights in Colorado, through sale or lease.
In 2000, Vidler closed the sale of various water rights and related assets to the City of Golden, Colorado for $1 million, and granted the City options to acquire other water rights over the next 15 years. The City exercised options to acquire water assets for $390,000 in 2001 and $145,000 in 2002. If the remaining options are exercised, the present value of the aggregate purchase price is approximately $1.4 million.
Vidler has not yet stored water for customers at the facility, but the company has been recharging water for its own account since 1998, when the pilot plant was constructed. Vidler purchased the water from the CAP, and intends to resell this water at an appropriate time. At December 31, 2002, Vidler has net recharge credits of approximately 14,000 acre-feet of water at the facility.
Vidler routinely evaluates the purchase of further water-righted properties in Arizona and Nevada. Vidler also continues to be approached by parties who are interested in obtaining a water supply, or discussing joint ventures to commercially develop water assets and/or develop water storage facilities in Arizona, Nevada, and other states.
The majority of Nevada Land's revenues come from the sale of land and water rights. In addition, various types of recurring revenue are generated from use of the company's lands, including leasing, easements, and mineral royalties. Nevada Land also generates interest revenue from land sales contracts where the company has provided partial financing, and from temporary investment of the proceeds of land and water rights sales.
In 2002, Nevada Land generated $2.8 million in revenues from the sale of 28,423 acres of former railroad land. The average sales price of $99 per acre compares to our average basis of $40 per acre in the parcels which were sold, and our average cost of $35 per acre for all of Nevada Land's land, water, and mineral assets. In addition, Nevada Land sold 2,860 acre-feet of permitted water rights for $270,000, as well as 28 acres of surplus land at Spring Valley Ranches for $28,000.
In 2002, 32.8% of land sales were settled for cash, and Nevada Land provided partial financing for the balance. Vendor financing has been collateralized by the land conveyed, typically carries a 10% interest rate, and is subject to a minimum 20% down payment.
This section describes the most significant interests in public companies included in this segment during 2002.
During 1998, 1999, 2000, and 2001, we accumulated a 20.7% shareholding in AOG, a public company which provides on-shore oil rig services in Australia and internationally.
In January 2002, AOG announced that it was raising additional capital to purchase a new deep capacity drilling rig and to refit two existing rigs to perform new long term drilling contracts with ExxonMobil Indonesia and Petroleum Development-Oman. We assisted AOG with the capital raising, providing the company with a short term $US4 million bridging facility, which was repaid with the proceeds of a rights offering which we partly underwrote. As compensation we received 666,666 common shares of AOG valued at $589,000, which were issued as fees for establishing the loan facility and underwriting the rights offering
In July 2002, PICO accepted Ensign (Australia) Holdings Pty. Ltd's cash offer of $A2.70 ($US1.47) for the AOG common shares and $A1.50 ($US0.82) for the AOG options owned by PICO. The sale proceeds were $21.1 million. Over the life of the investment, PICO recorded a total of $10.1 million in pre-tax income and realized gains from AOG, including realized gains of $8.7 million in 2002.
In 2002, HyperFeed generated revenues of $19.8 million, gross margin of $7.1 million, and a net loss from operations of $4.6 million. Net cash flow from operating activities was $2.2 million. At December 31, 2002, HyperFeed had $1.1 million in cash and cash equivalents.
In the fourth quarter of 2002, HyperFeed generated revenues of $4.5 million, gross margin of $1.6 million, and a net loss of $2.8 million. Net cash flow from operating activities was $182,000.
PICO still holds warrants to buy 3,106,163 shares of HyperFeed common stock at an average price of $1.575 per share. At December 31, 2002, the warrants were carried at estimated fair value of $65,000.
PICO owns 130,177 shares of Jungfraubahn, which represents approximately 22.3% of the Company. At December 31, 2002, the market (carrying) value of our holding was $24 million.
In February 2003, Jungfraubahn issued a press release containing an initial review of 2002 operations, using Swiss accounting principles. The full text is available on Jungfraubahn's web-site www.jungfraubahn.com (in the "Shareholders" tab of the "Inside" section).
In September 2002, Jungfraubahn announced its results for the six months to June 30, 2002. In the accompanying Letter to Shareholders, Jungfraubahn explained that the results could not be directly compared to the previous year due to the consolidation of BGF for the first time. Reported revenues were CHF (Swiss Francs) 53.8 million ($US35 million). EBITDA (i.e., earnings before depreciation, interest, and taxes, a non-GAAP measure which investors frequently use as a proxy for gross cash flow, as calculated by Jungfraubahn) was CHF 14.2 million ($US9.2 million), and net income was CHF 3.1 million ($US2 million), or approximately CHF 5.4 per share ($US3.52). Jungfraubahn disclosed that without BGF, passenger revenues would have declined by approximately CHF 600,000 ($US391,000).
Jungfraubahn announced its results for the 2001 financial year on May 23, 2002, so the 2002 results will not be released until after this 10-K has been filed. Jungfraubahn's 2001 results were the second best in Jungfraubahn's history. Revenues were CHF 98.7 million ($US58.6 million), EBITDA as calculated by Jungfraubahn was CHF 30.4 million ($US18.1 million), and net income was CHF 14.2 million ($US8.4 million), or CHF 24.4 per share ($US14.49). Jungfraubahn's operating activities generated net cash flow of CHF 26.7 million ($US15.9 million).
As part of our regular review of securities in an unrealized loss position for the year ended December 31, 2002, we have determined that the decline in market value of three unrelated investments in the Business Acquisitions & Financing segment is other-than-temporary. The total charge recorded is $4.1 million (see "Business Acquisitions and Financing" segment in "Results of Operations - Years Ended December 31, 2002, 2001, and 2000".) By definition, the recording of a charge for other-than-temporary decline in accordance with GAAP does not necessarily mean that we believe that the current decline in value is permanent in economic terms.
A charge for other-than-temporary impairment is a non-cash charge recorded as a realized loss. The basis of the investment is written down from its original cost to current carrying value, which typically is the market price at the balance sheet date when the provision is recorded.
Given the recent deterioration in Accu Holdings core business, and our assessment that there would continue to be downward pressure on Accu's stock price in the short to medium term, during 2002 we concluded that the decline in Accu's market value is
other-than-temporary, primarily due to the extent and duration of the decline in the market value of the security. We recorded a $2.2 million pre-tax impairment of our investment. This impairment was recorded as a realized loss and has reduced the basis of the investment to its market (carrying) value of $3.1 million at December 31, 2002. This other than temporary impairment did not affect PICO's shareholders' equity or book value per share.
RAETIE ENERGIE AG PICO owns 14,755 shares in Raetie Energie, which is a producer of hydro electricity. At December 31, 2002, our investment in Raetia Energie had a basis of $2.7 million and a market value of $5 million.
SIHL In 2000 and 2001, we acquired approximately 10.6% of SIHL for $4 million, through participation in a restructuring/capital raising and open market purchases. SIHL's core business is digital imaging, but the company has surplus property assets in and around Zurich, including a major development project known as Sihlcity. Our investment in SIHL is accounted for under SFAS No. 115.
Although "run off" insurance companies no longer write policies, earned premiums can still arise, for example from policies which were still in force when the company went into "run off", or related to reinsurance. Our insurance companies have purchased reinsurance from specialized insurance companies to limit our potential losses on the insurance coverage we have provided to our policyholders. There are various types of reinsurance contracts, including "swing rated" contracts, where the premium we pay is adjusted retroactively based on the actual loss experience on the block of business which was reinsured. Under U.S. GAAP, if we need to pay for additional reinsurance this is recorded as a reduction in earned premiums, and if reinsurance premiums are returned to us, this is recorded as an increase in earned premiums.
Typically most of the revenues of an insurance company in "run off" come from investment income (i.e., interest from fixed-income securities and dividends from stocks) earned on funds held as part of their insurance business. In addition, from time to time, gains or losses are realized from the sale of investments.
Apart from bonds issued by the U.S. Treasury and government-sponsored enterprises (e.g., Freddie Mac and FNMA) which are held as capital and as deposits or collateral with state regulators, the fixed-income component of our insurance company portfolios consists of high grade corporate issues with 10 or less years to maturity. Every bond we own is rated "1" or "2" by the National Association of Insurance Commissioners, which is the equivalent of investment-grade from the ratings agencies. As of December 31, 2002, none of our bond holdings had declined significantly from cost. We do not own any municipal bonds, or any corporate bonds in the telecommunications, technology, utilities, energy trading, automotive, and consumer finance sectors, and conglomerates which experienced difficulties in 2001 and 2002.
The duration of a bond portfolio measures the amount of time it would take for the cash flows from scheduled interest payments and bond maturities to equal the current value of the portfolio. Duration is an important measure because it indicates the sensitivity of the market value of a bond portfolio to changes in interest rates. If interest rates increase, the market value of existing bonds will decline. During periods when market interest rates decline, such as 2001 and 2002, the market value of existing bonds increases. Typically, the longer the duration, the greater the sensitivity of the value of the bond portfolio to changes in interest rates.
The investment income, and therefore revenue, of a "run off" insurance company is expected to decline over time as fixed-income investments mature or are sold to provide the funds to pay down the company's claims reserves. Unless there is adverse development in prior year loss reserves, typically the expenses of an insurance company in "run off" will be lower than the expenses of an insurance company which is actively writing business.
Due to the long "tail" (i.e., period of time between the occurrence of the alleged event giving rise to the claim, and the claim being reported to us) in the medical professional liability insurance business, it is difficult to accurately quantify future claims liabilities and establish appropriate loss reserves. Our loss reserves are adjusted in the fourth quarter of each year, based on independent actuarial analysis of past, current, and projected claims trends in the 12 months ended September 30 of each year. The actuarial study is carried out annually, as data for a shorter period would be insufficient to form valid estimates.
At December 31, 2002, medical professional liability reserves totaled $30.3 million, net of reinsurance, compared to $34.9 million net of reinsurance at December 31, 2001, and $51.6 million net of reinsurance at December 31, 2000.
At December 31, 2002, our direct reserves, or reserves before reinsurance, essentially equaled the independent actuary's best estimate. The independent actuary is continually reviewing our claims experience and projected claims trends in order to arrive at the most accurate estimate possible. The independent actuary did not explicitly forecast a range of reserves, but arrived at a best estimate through weighting the results of five different projection methods for each accident year, and in total. Under the different projection methods, the lowest direct reserve calculation was approximately $25.3 million, and the highest direct reserve calculation was $38.9 million. Consequently, our loss reserves could be materially different depending on the particular method of calculation chosen.
At December 31, 2002, approximately $10.5 million, or 28.9% of our direct reserves were case reserves, which are the loss reserves established when a claim is reported to us. Our provision for IBNR claims (i.e., the event giving rise to the claim has allegedly occurred, but the claim has not been reported to us) were $17.4 million, or 47.7% of our direct reserves. The loss adjustment expense reserves, totaling $8.5 million, or 23.4% of direct reserves, recognize the cost of handling claims over the next 14 years while the Physicians loss reserves run off.
- - this was partially offset by a $2.2 million increase in the provision for unallocated loss adjustment expense, which effectively recognized the cost of handling Physicians' claims over the remaining run off; and
There were no changes in key actuarial assumption in 2002. It should be noted that such actuarial analyses involves estimation of future trends in many factors which may vary significantly from expectation, which could lead to further reserve adjustments -- either increases or decreases -- in future years. See "Critical Accounting Policies" and "Risk Factors."
During 2001, our medical professional liability insurance claims reserves, net of reinsurance, decreased from $51.6 million to $34.9 million. Claims payments for the year were $6.1 million, accounting for 36% of the net decrease in reserves during 2001. Actuarial analysis of Physicians' loss reserves as of September 30, 2001 concluded that Physicians' reserves against claims were significantly greater than the actuary's projections of future claims payments in 18 of 20 accident years, due to favorable trends in both the "frequency" and "severity" of claims. Consequently, Physicians reduced its reserve for IBNR claims by approximately $10.6 million, which accounted for the remaining 64% of the net decrease in reserves for the year.
Since it is almost seven years since Physicians wrote its last policy, and the direct IBNR claims reserve at December 31, 2002 is $17.4 million, it is conceivable that further favorable development could be recorded in future years if claims trends remain favorable, particularly claims severity. However, we caution (1) that claims can be reported until 2017, and (2) against over-emphasizing claims count statistics - for example, the last claims to be resolved by a "run off" insurance company could be the most complex and the most severe.
Approximately 85% of Citation's reserves are related to one line of business, artisans/contractors liability insurance. The remaining 15% relate to the remaining lines of commercial property and casualty insurance business. The last of Citation's commercial property and casualty insurance policies expired in 2001. As a general rule, based on state statutes of limitations, we believe that:
- - new commercial property and casualty insurance claims can be filed in Arizona until the end of 2003; but
- - no new commercial property and casualty insurance claims can be filed in California. However, in certain limited circumstances, claims filing periods may be extended.
We have purchased excess of loss reinsurance to limit our potential losses. The amount of risk we have retained on each claim varies depending on the accident year, but we can be liable for the first $50,000 to $250,000 per claim.
Citation primarily insured subcontractors, and only rarely insured general contractors. A large percentage of the claims received in 2002 related to Additional Insured Endorsements ("AIE"). In general, these represent claims from general contractors who were not direct policyholders of Citation's, but were named as insureds on policies issued to the company's subcontractor policyholders. Most of Citation's subcontractor insureds are not initially named as defendants in construction defect law suits, but are drawn into litigation against general contractors, typically when the general contractor's legal expenses reach the limit of their own insurance policy. The courts have held that subcontractors who performed only a minor role in the construction can be held in on complicated litigation against general contractors. Accordingly, the cost of legal defenses can be as significant as claims payments. Typically AEI claims are shared among more than one subcontractor and more than one insurance carrier. This reduces the expense to any one carrier, so AEI claims typically involve smaller claims payments than claims from actual policyholders. Since Citation sets an initial case reserve of $20,000 on most claims received, and many AIE claims are closed for a smaller amount, Citation experienced favorable loss development in 2002.
will decline in future years. Although Citation wrote its last artisans/contractors policy in 1995 and the statute of limitations in California is 10 years, this can be extended in some situations.
Over the past 3 years, the trends in open claims and claims paid in the artisans/contractors line of business has been:
At December 31, 2002, Citation's net reserves were carried at $14.6 million, approximately $1 million more than the actuary's best estimate. Given the uncertainties inherent in projecting claims trends in the artisans/contractors line of business, we elected to set higher reserves than the actuary's best estimate, to partially guard against unexpected reserve increases in future years if claims experience deteriorates. Consequently, if current claims trends continue, it is conceivable that favorable development could be recorded in future years.
At December 31, 2002, $4.8 million of Citation's reserves (approximately 33%) were case reserves, $8.1 million of Citation's reserves represented provision for IBNR claims (56%), and the unallocated loss adjustment expense reserve was $1.7 million (11%).
In 2000, Citation's property and casualty insurance claims reserves, net of reinsurance, decreased from $34.6 million to $23.4 million. Claims payments for prior years reduced reserves by $12 million, which led to the net reduction in reserves for the year. This was partially offset by $1.1 million in incurred loss and loss adjustment expenses for the 2000 accident year, consisting of paid losses of $283,000 and additions to reserves of $817,000. Favorable development of $282,000 was recorded in prior year loss reserves.
SEQUOIA INSURANCE COMPANY In 2002, Sequoia generated direct written premiums of $68.3 million, a 26.2% increase from the previous year, primarily due to a 19.7% increase in the average premium per commercial policy. The increase in average premium per commercial policy resulted from various initiatives introduced by Sequoia's management to improve the Company's underwriting results following disappointing loss ratios in 2000 and 2001. These initiatives included a further tightening in underwriting standards, and rate increases in most commercial lines.
Sequoia's loss and loss adjustment expense ratio (i.e., the cost of making provision to pay claims as a percentage of earned premiums) was 66.2% in 2002, 69.1% in 2001, and 67.6% in 2000. The relatively high loss ratios in 2000 and 2001 were caused by claims costs having risen faster than premium rates. The increase in average premium per commercial policy described in preceding paragraphs helped to restore underwriting margins, and contributed to the improved loss ratio in 2002.
Given the short reporting tail with the type of property and casualty insurance business written by Sequoia, changes in prior year loss reserves tend to represent a small percentage of the Company's total reserves.
- - property and casualty insurance operations, and the "run off" of property and casualty insurance and medical professional liability insurance loss reserves; and
- - Physicians Insurance Company of Ohio, $30.3 million. Physicians wrote its last policy in 1995. However, under current law, claims can be made until 2017 for events which allegedly occurred during the periods when we provided insurance coverage to medical professionals; and
Our medical professional liability insurance reserves are certified annually by an independent actuary, as required by Ohio insurance law. Actuarial estimates of our future claims obligations have been volatile. In 2002, there was a $1 million net reduction after independent actuarial studies concluded that Physicians' claims reserves were greater than projected claims payments, and in 2001, we reduced claims reserves by $10.6 million. However, based on independent actuarial analysis, we increased reserves by $1.5 million in 2000. Accordingly, there can be no assurance that our claims reserves are adequate and there will not be reserve increases or decreases in the future.
As required by California insurance law, the loss reserves of Citation Insurance Company and Sequoia Insurance Company are reviewed quarterly, and certified annually, by an independent actuarial firm.
As required by GAAP, our long-lived assets are reviewed regularly to ensure that the estimated future undiscounted cash flows from these assets will at least recover their carrying value. Our management conducts these reviews utilizing the most recent information available; however, the review process inevitably involves the significant use of estimates and assumptions.
In our water rights and water storage business, we develop some projects and assets from scratch. This can require cash outflows (e.g., to drill wells to prove that water is available) in situations where there is no guarantee that the project will ultimately be commercially viable. If we determine that it is probable that the project will be commercially viable, the costs of developing the asset are capitalized (i.e., recorded as an asset in our balance sheet, rather than being charged as an expense). If the project ends up being viable, in the case of a sale, the capitalized costs are included in the cost of land and water rights sold and applied against the purchase price. In the case of a lease transaction or when the asset is fully developed and ready for use, the capitalized costs are amortized (i.e., charged as an expense in our income statement) and match any related revenues.
In the case of most holdings, we apply Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Under this method, the investment is carried at market value in our balance sheet, with unrealized gains or losses being included in shareholders' equity, and the only income recorded is from dividends.
In the case of investments where we have the ability to exercise significant influence over the company we have invested in, we apply the equity method under Accounting Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock".
The application of the equity method (APB No. 18) to an investment may result in a different outcome in our financial statements than market value accounting (SFAS No. 115). The most significant difference between the two policies is that, under the equity method, we include our proportionate share of the investee's earnings or losses in our statement of operations, and dividends received are used to reduce the carrying value of the investment in our balance sheet. Under market value accounting, the only income recorded is dividends.
For equity and debt securities accounted for under SFAS No. 115 which are in an unrealized loss position, we regularly review whether the decline in market value is other-than-temporary. In general, this review requires management to consider several factors, including specific adverse conditions affecting the investee's business and industry, the financial condition of the investee, the long-term prospects of the investee, and the extent and duration of the decline in market value of the investee. Accordingly, management has to make important assumptions regarding our intent and ability to hold the security, and our assessment of the overall worth of the security. Risks and uncertainties in our methodology for reviewing unrealized losses for other-than-temporary declines include our judgments regarding the overall worth of the issuer and its long-term prospects, and our ability to realize on our assessment of the overall worth of the business.
The principal factors leading to the $13.1 million increase in shareholders' equity were the $5.9 million net income and net movements of $4.5 million in unrealized appreciation in investments and $2.6 million in foreign currency translation. In addition, $238,000 of new capital was subscribed to exercise options. These factors were partially offset by a $94,000 increase in treasury stock due to the purchase of PICO shares in deferred compensations plans for directors and employees.
Total assets at December 31, 2002 were $396.2 million, compared to $374.4 million at December 31, 2001. Most of the $21.8 million increase in total assets is attributable to an increase in Sequoia's investment portfolio related to growth in that company's book of business, and an increase in the value of equity and fixed-income securities. Total liabilities increased by $8.6 million, primarily due to an increase in Sequoia's claims reserves related to growth in that company's book of business, which was partially offset by a reduction in the reserves of our insurance operations in run off, Physicians and Citation.
PICO reported net income of $5.9 million, or $0.48 per diluted share in 2002, compared with net income of $5.1 million, or $0.41 per diluted share in 2001, and a net loss of $11.3 million, or $0.97 per diluted share, in 2000.
The $5.9 million net income reported in 2002 consisted of an $3.9 million net income before a change in accounting principle, or $0.32 per share, and a change in accounting principle which increased income by $2 million after-tax, or $0.16 per share. From January 1, 2002, PICO adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Intangible Assets," which requires that goodwill and intangible assets with indefinite lives be tested for impairment annually rather than amortized over time. The $2 million in net income recognized reflected the surplus of negative goodwill arising from the 1996 reverse merger of Physicians and Citation Insurance Group (now known as PICO Holdings, Inc.) over the write-off of goodwill items which were determined to be impaired. See Note 20 of Notes to Consolidated Financial Statements, "Cumulative Effect of Changes in Accounting Principle," and the Insurance Operations in Run Off segment.
- - the addition of $454,000 in minority interest, which reflects the interest of outside shareholders in the losses of subsidiaries which are less than 100%-owned by PICO; and
- - income from discontinued operations (i.e., Sequoia) of $2.8 million after tax and a change in accounting principle.
The $2 million tax expense for 2002 consists of several items, which are detailed in Note 7 of Notes to the Consolidated Financial Statements, "Federal, Foreign and State Income Tax." We do not need to pay any federal taxes in cash for 2002 because prior year net operating loss carry-forwards offset our tax provision for the year, however we have provided for the payment of approximately $400,000 in state income taxes.
In 2001, PICO generated $5.1 million in net income, consisting of $6.1 million in net income before a change in accounting principle, or $0.49 per share, and a change in accounting principle which reduced income by $981,000 after-tax, or $0.08 per share. The change in accounting principle resulted from the adoption of the Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This non-cash charge recognized the accumulated after-tax decline in the estimated fair value of warrants we own to buy shares in other companies (principally HyperFeed Technologies, Inc.) from the date we acquired the warrants through to January 1, 2001. The decline in the estimated fair value of warrants during 2001 is recorded in the Business Acquisitions and Financing segment.
A gross provision for tax of approximately $3 million was partially offset by $630,000 in tax benefits, primarily represented by a cash refund following a successful appeal of a prior year tax ruling in Canada. We did not pay any taxes in cash for 2001 because prior year net operating loss carry-forwards offset our tax provision for the year.
PICO incurred a net loss of $11.3 million in 2000. The $6.3 million net loss before an accounting change consisted of a $17.4 million pre-tax loss, which was partially offset by $9.4 million in income tax benefits and the addition of $717,000 in minority interest. Income from discontinued operations was $953,000. In addition, the cumulative effect of an accounting change reduced income by $5 million after-tax. Until December 31, 1999, PICO had discounted the carrying value of its medical professional liability claims reserves, to reflect the fact that some claims will not be paid until many years in the future, but funds from the corresponding premiums can be invested in the meantime. After December 31, 1999, PICO's medical professional liability insurance subsidiaries were no longer allowed to discount claims reserves in the statements they file with the Ohio Department of Insurance, which are prepared on the statutory basis of accounting. With this change in accounting principle, we eliminated the discounting in our financial statements which are prepared on a GAAP basis.
- - comprehensive income of $6.1 million in 2001, consisting of net income of $5.1 million and a movement of $1.9 million in net unrealized appreciation in investments, which were partially offset by a $955,000 reduction in foreign currency translation; and
In 2002, total revenues were $29.3 million, compared to $23.6 million in 2001, and $9.7 million in 2000. Revenues in 2002 were $5.7 million higher than in 2001. Revenues were $12.1 million higher in Business Acquisitions and Financing and $1.2 million higher at Nevada Land, but $4.2 million lower at Vidler and $3.4 million lower in the Insurance Operations in Run Off segment. In 2001, revenues were $13.9 million higher than in 2000, principally due to $14.8 million higher revenues from Vidler. The most significant items in the revenue growth at Vidler were revenues of $9.4 million from the sale of water rights and land in the Harquahala Valley, and $5.7 million from pre-tax gains on the sale of interests in Semitropic.
- - Vidler incurred an $897,000 pre-tax loss on $13.8 million in revenues. Vidler closed on two sales of water rights and land in the Harquahala Valley Irrigation District, which added $6.2 million to revenues and $2.5 million to gross margin. In addition, Vidler closed on two previously announced sales of water rights in Colorado which contributed $5.2 million in revenues and approximately $520,000 in gross margin. The gross margin on these water rights sales was more than offset by Vidler's on-going operating expenses and the costs of developing water assets which will not be monetized until future years;
Vidler generated total revenues of $13.8 million in 2002, compared to $18 million in 2001, and $3.1 million in 2000.
- - the sale of 3,645 acre-feet of transferable ground water and 1,215 acres of land in the Harquahala Valley Irrigation District to golf course developers near Scottsdale, Arizona. This transaction added $5.2 million to revenues and $1.9 million to gross margin;
- - another sale of 54.1% of Vidler's original interest in the Semitropic Water Banking and Exchange Program (i.e., approximately 100,000 acre-feet of storage capacity) for $6.9 million. This transaction added $4.1 million to revenues and to segment income.
Vidler generated revenue of $239,000 in 2002, $235,000 in 2001, and $188,000 in 2000 from leasing some of the company's Colorado water rights. These assets are leased in perpetuity. The lease payments are indexed for inflation, with a minimum annual escalation of 3%.
Lease and royalty income amounted to $721,000 in 2002, compared to $707,000 in 2001, and $716,000 in 2000. Most of this revenue comes from land leases, principally for grazing, agricultural, communications, and easements.
Interest and other revenues contributed $580,000 in 2002, compared to $596,000 in 2001, and $321,000 in 2000.
In 2000, Nevada Land generated revenues from the sale of 61 acre-feet of certificated water rights for $244,000, and a $270,000 gain on a land exchange transaction.
After deducting the cost of land sold, the gross margin on land sales was $1.7 million in 2002, $1.1 million in 2001, and $2.2 million in 2000. This represented a gross margin percentage of 59.6% in 2002, 59.8% in 2001, and 59.2% in 2000. The gross margin on water right sales was $143,000 in 2002, and $12,000 in 2000.
Segment operating expenses were $2.7 million in 2002, $2.3 million in 2001, and $1.6 million in 2000.
Nevada Land recorded income of $484,000 in 2002, compared to $131,000 in 2001 and $1.9 million in 2000.
- - a $2.2 million charge for other-than-temporary impairment of our investment in Accu Holding (see the Accu Holding section of the "Company Summary, Recent Developments and Future Outlook" portion of Item 7);
In addition, Statement of Financial Accounting Standards No. 133, "Accounting For Derivative Instruments and Hedging Activities" income was $402,000, primarily consisting of income of $900,000 from AOG options, which was partially offset by a $410,000 reduction in the estimated fair value of HyperFeed warrants.
In 2000, a net realized loss of $7.8 million was incurred. This primarily represented a $4.6 million loss on the sale of Conex, a $2.5 million write-down of the loan to MKG Enterprises, and a $526,000 loss when a former employee exercised an option which required PICO to sell existing shares in Vidler for less than current book value. When PICO acquired Vidler in the merger with Global Equity Corporation, call options had already been granted to certain employees over existing shares in Vidler. All of these call options have now been exercised.
In this segment, investment income includes interest on cash and short-term fixed-income securities, and dividends from partially owned businesses. Investment income totaled $2.5 million in 2002, $1.9 million in 2001, and $1.6 million in 2000. In 2002, investment income increased $656,000 year over year, primarily due to higher interest income. In 2001, investment income was $246,000 higher than in 2000, principally due to the receipt of $391,000 in dividends from AOG in 2001. AOG did not pay a dividend in 2000.
Segment expenses were $7.4 million in 2002, compared to $10.1 million in 2001, and $9.9 million in 2000. The principal expenses recognized in this segment are PICO's corporate overhead and operating expenses from SISCOM and, in 2000, Conex.
The Business Acquisitions And Financing segment produced pre-tax losses of $1.2 million in 2002, $15.3 million in 2001, and $16.4 million in 2000.
The Insurance Operations in Run Off segment produced $4.3 million in pre-tax income in 2002, consisting of pre-tax profits of $2.1 million from Physicians and $2.2 million from Citation. In 2001, segment income was $16 million, consisting of $13.1 million in income before taxes from Physicians, and $2.9 million from Citation. In 2000, segment income was $2 million, comprised of $768,000 in pre-tax income from Physicians, and $1.2 million from Citation.
Once an insurance company has gone into run off and the last of its policies has expired, typically most revenues will come from investment income. However, even when an insurance company is in "run off", earned premium can arise. For example, with "swing rated" reinsurance, the reinsurance premiums we pay are recalculated based on actual loss experience (i.e., the number and size of claims). Under GAAP, if we required to pay for additional reinsurance this is recorded as a reduction in the earned premium line, while a reduction in the amount of reinsurance we need to pay is recorded as an increase in earned premiums.
Revenues were $2.6 million in 2001, including a $750,000 net realized investment gain. The net realized investment gain consisted of a $731,000 gain on the redemption of all units held in the Rydex URSA mutual fund, and $19,000 in realized gains from the sale of bonds.
Investment income was $679,000 in 2002, $1.1 million in 2001, and $1.5 million in 2000. Investment income varies from year to year, depending on the amount of fixed-income securities held in the portfolio and the prevailing level of interest rates.
Physicians recorded earned premiums of $382,000 in 2002, compared to $755,000 in 2001, and $1.9 million in 2000, representing a reduction in the amount of reinsurance that we need to pay on "swing rated" contracts. The reduced reinsurance requirement resulted from the reduction in IBNR reserves.
In 2002, Physicians recorded a $1.1 million underwriting recovery. The $1 million net reduction in reserves and a $439,000 benefit related to reinsurance more than offset regular loss and loss adjustment expense and operating expenses of $395,000 for the year. The $439,000 benefit represented the final amortization of a deferred gain resulting from a reinsurance contract entered into in 1994, where the gain was deferred and recognized as the related reinsurance recoveries occurred. The changes in reserves are more fully explained in the Physicians section of the "Company Summary, Recent Developments, and Future Outlook" portion of Item 7.
In 2001, the segment reported a $10.5 million underwriting recovery, which resulted in segment income of $13.1 million.
In 2000, after underwriting expenses of $2.6 million, which included a $1.5 million net increase in reserves, segment income of $768,000 was recorded. In addition, reserves increased by $7.3 million due to the elimination of reserve discount included in the cumulative effect of change in accounting principle. The elimination of discounting did not affect the segment in 2000, but resulted in a $5 million after-tax charge to income, which is shown in the "Cumulative Effect of Change in Accounting Principle" line in our Consolidated Statement of Operations. See Note 20 of Notes to Consolidated Financial Statements, "Cumulative Effect of Change in Accounting Principle." Until the end of 1999, we discounted our medical professional liability claims reserves to reflect the fact that some claims will not be paid until future years, but funds from the corresponding premiums can be invested in the meantime. From January 1, 2000, we ceased discounting our reserves to be consistent with the accounting treatment in our statutory financial statements.
From 2001 to 2002, Citation's pre-tax profit declined by $683,000. In 2002, a $612,000 underwriting recovery was recorded, as opposed to a $570,000 expense the year before. However, this $1.2 million improvement was more than offset by a $676,000 decrease in investment income, a $649,000 decrease in earned premium, and the absence in 2002 of negative goodwill which added $568,000 to income in 2001. The reduction in investment income was primarily due to lower interest income and, to a lesser extent, a reduction in invested assets as the "run off" continued. In 2002, Citation recorded earned premiums of negative $424,000 due to reinsurance as discussed in preceding paragraphs, as opposed to premiums of $225,000 earned from the company's last property and casualty policies in 2001.
Sequoia Insurance Company generated total revenues of $52.4 million in 2002, compared to $47.9 million in 2001, and $36.1 million in 2000.
- - During the company's investment and development phase, Vidler Water Company, Inc. utilized cash to purchase properties with significant water rights, to construct improvements at the Vidler Arizona Recharge Facility, to maintain and develop existing assets, to pursue applications for water rights, and to meet financing and operating expenses. During this period, we provided financing to meet Vidler's on-going expenses and to fund capital expenditure and the purchase of additional water-righted properties.
Vidler's water-related assets began to generate significant cash flow in 2001. As commercial use of these assets increases, we expect that Vidler will start to generate free cash flow as receipts from leasing water or storage, and the proceeds from selling land and water rights, begin to overtake maintenance capital expenditure, financing costs, and operating expenses. As water lease and storage contracts are signed, we anticipate that Vidler may be able to monetize some of the contractual revenue streams, which could potentially provide another source of funds;
- - Nevada Land & Resource Company, LLC is actively selling land which has reached its highest and best use, and is not part of PICO's long-term utilization plan for the property. Nevada Land's principal sources of cash flow are the proceeds of cash sales, and collections of principal and interest on sales contracts where Nevada Land has provided vendor financing. Since these receipts and other revenues exceed Nevada Land's operating costs, Nevada Land is generating strong positive cash flow;
- - It is anticipated that the sale of Sequoia Insurance Company will close on or around March 31, 2003. Until then, we expect that Sequoia will generate positive cash flow from increased written premium volume. Shortly after a policy is written, the premium is collected and the funds can be invested for a period of time before they are required to pay claims. Until the sale closes, free cash flow generated by Sequoia is being retained in the company's investment portfolio.
As shown in the Consolidated Statements of Cash Flow, there was a $5.7 million net increase in cash and cash equivalents in 2002, compared to a $1.8 million net increase in 2001.
During 2002, Operating Activities generated cash of $10.8 million, compared to $5.9 million used in 2001, and $20.3 million used in 2000.
In 2002, Investing Activities used cash of $1.1 million. This primarily represented the sale of our holding in AOG for $21.1 million and the subsequent reinvestment of the proceeds in fixed-income securities and a marketable equity security, and regular activity in the investment portfolios of our insurance companies.
In 2001, Investing Activities generated cash of $9 million. The most significant cash inflow was $10.2 million from the sale of part of our interest in Semitropic. Significant cash outflows included the investment of approximately $4 million in SIHL and AOG common stock. Most of the remaining Investing Activities cash flow represents activity in the investment portfolios of our insurance companies, and the temporary investment of surplus funds in fixed-income securities.
In 2002, Financing Activities used $1.4 million of cash, primarily due to the repayment of $1.1 million in non-recourse borrowings collateralized by the farm properties in the Harquahala Valley Irrigation District by Vidler, and a net reduction of $586,000 in Swiss Franc borrowings. Despite these cash payments, the level of borrowings shown on the balance sheet was unchanged year over year, due to the effect of exchange rate movements on Swiss Franc borrowings. The Swiss Franc borrowings form a partial currency hedge against our Swiss assets.
In 2000, there was a $49.5 million cash inflow from Financing Activities, principally due to the rights offering which raised $49.8 million in new equity capital.
- - Vidler, a PICO subsidiary, is party to a lease to acquire 30,000 acre-feet of underground water storage privileges and associated rights to recharge and recover water located near the California Aqueduct, northwest of Bakersfield. The agreement requires a minimum payment of $378,000 per year adjusted annually by the engineering price index until 2007. PICO signed a Limited
The following table provides a summary of our contractual cash obligations and other commitments and contingencies.
In 1993, Guinness Peat Group PLC -- which was the largest shareholder in Physicians at the time -- granted Ronald Langley and John R. Hart (now the Company's Chairman and CEO) call options to buy part of GPG's investment in Physicians at a price equal to GPG's cost ("GPG call options"). Since these call options were granted by GPG over shares it owned in Physicians, the economic cost of the options was borne by GPG. In 1998, when GPG subsequently sold its investment in Physicians, the Company purchased the shares subject to the options from GPG at the exercise price and assumed the call option obligations. This now equates to call options to acquire 355,539 shares of PICO stock at an average exercise price of $3.94 per share. The shares purchased from GPG have been accounted for as treasury stock. As illustrated in the following table, if these options had been exercised at December 31, 2002, there would have been a reduction in book value per share of approximately 2.2%.
At December 31, 2002, the Company's directors and management hold options to acquire 1,687,242, new shares of PICO stock. The options are exercisable at prices ranging from $13.25 to $15.00 per share, with an average exercise price of approximately $14.57 per share. At December 31, 2002, all of these options were "out of the money" (i.e., exercisable at a price higher than the last sale price for PICO stock, which was $13.24). Typically an option-holder will only exercise an option if the stock price is greater than the exercise price. However to illustrate the potential effect, if the GPG call options and all director and management options had been exercised at December 31, 2002, there would have been a reduction in book value per share of approximately 4.1%.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure. SFAS No. 148 provides alternative methods of transaction for those entities that elect to voluntarily adopt the fair value accounting provisions of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 also requires more prominent disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation as well as pro forma disclosure of the effect in interim financial statements. The transition and annual disclosure provisions of SFAS No. 148 included herein. The interim disclosure requirements are effective for the first interim period ending December 15, 2002. The Company has not elected to adopt the fair value accounting provisions of SFAS No. 123.
Failures and/or declines in the market values of businesses we invest in or acquire, as well as our failure to successfully locate, select and manage investment and acquisition opportunities, could have a material adverse effect on our business, financial condition, the results of operations and cash flows. Such business failures, declines in market values, and/or failure to successfully locate, select and manage investments and acquisitions could result in inferior investment returns compared to those which may have been attained had we successfully located, selected and managed new investments and acquisition opportunities, or had our investments or acquisitions not failed or declined in value. We could also lose part or all of our capital these businesses and experience reductions in our net income, cash flows, assets and shareholders' equity.
We will continue to make selective acquisitions, and endeavor to 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.
Summarized unaudited quarterly financial data (in thousands, except share and per share amounts) for 2002 and 2001 are shown below. In management's opinion, the interim financial data contains all adjustments necessary for a fair presentation of results for such interim periods and are of a normal recurring nature. The following as reported figures differ from previously reported quarterly results due to reporting Sequoia Insurance Company as a discontinued operation (Recasted). During 2002, the Company determined that it needed to record other-than-temporary impairments on marketable securities and reverse the equity method accounting for the investment in Jungfraubahn (Restated). As a result the first three quarters for the year ended December 31, 2002 have been restated from the amounts previously reported. The quarterly periods for the year ended December 31, 2001 have been previously restated in the Company's 2001 Form 10-K/A filed with the Securities and Exchange Commission.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PICO Holdings, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 20 to the financial statements, in 2002 the Company changed its accounting for goodwill as a result of the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," and in 2000 the Company changed its method of accounting for medical professional liability claims reserves.
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
- owning and developing land and the related mineral rights and water rights through Nevada Land & Resource Company, LLC;
Nevada Land & Resource Company, LLC ("Nevada Land"). Nevada Land is a Delaware Limited Liability Company, which owns approximately 1.2 million acres of land in northern Nevada. Nevada Land's business includes selling land and water rights, and leasing property.
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. During 2002, PICO agreed to sell Sequoia, and consequently has reported its results as discontinued operations in the accompanying consolidated financial statements. Unless indicated otherwise, information in these Notes to Consolidated Financial Statements exclude Sequoia.
Physicians Insurance Company of Ohio ("Physicians"). Prior to selling its book of medical professional liability ("MPL") insurance business in 1995, Physicians engaged in providing MPL insurance coverage to physicians and surgeons, primarily in Ohio. On August 28, 1995, Physicians entered into an agreement with Mutual Assurance, Inc. ("Mutual") pursuant to which Physicians sold its recurring MPL insurance business to Mutual. Physicians is in "run off." This means that it is handling claims arising from historical business, and selling investments when funds are needed to pay claims.
The preparation of financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses for each reporting period. The significant estimates made in the preparation of the Company's consolidated financial statements relate to the assessment of the carrying value of investments, unpaid losses and loss adjustment expenses, deferred policy acquisition costs, land and water rights, deferred income taxes and contingent liabilities. While management believes that the carrying value of such assets and liabilities are appropriate as of December 31, 2002 and 2001, it is reasonably possible that actual results could differ from the estimates upon which the carrying values were based.
Revenue on the sale of land, water, and water rights is recognized in full when (a) there is a legally binding sale contract; (b) the profit is determinable (i.e., the collectibility of the sales price is reasonably assured, or any amount that will not be collectible can be estimated); (c) the earnings process is virtually complete (i.e., the Company is not obliged to perform significant activities after the sale to earn the profit, meaning the Company has transferred all risks and rewards to the buyer); and (d) the buyer's initial and continuing investment are adequate to demonstrate a commitment to pay for the property. If these conditions are not met, the Company records the cash received as a deposit until the conditions to recognize full profit are met.
The Company regularly and methodically reviews the carrying value of its investments for impairment. When there is a decline in value of an investment to below cost, that is deemed other-than-temporary, a loss is recorded within net realized losses in the consolidated statement of operations and the security is written down to its fair value. Impairment charges of $4.1 million, $3 million and $161,000 are included in realized losses for the years ended December 31, 2002, 2001 and 2000, respectively related to various securities where the unrealized losses had been deemed other-than-temporary. If a security is impaired and continues to decline in value, additional impairment charges are recorded in the period of the decline if deemed other-than-temporary. Subsequent recoveries of such securities are reported as an unrealized gain and part of other comprehensive results in future periods. Realized gains on impaired securities are recorded only when sold. Included in 2001 and 2000 are impairment charges of $500,000 and $2.5 million, respectively, related to loans where recovery of the outstanding amounts due was deemed unlikely. (See Note 15)
Net investment income includes amortization of premium and accretion of discount on the level yield method relating to bonds acquired at other than par value. Realized investment gains and losses are included in income and are determined on the specific identity basis and are recorded on a trade date basis.
Cash and cash equivalents include highly liquid instruments purchased with original maturities of three months or less.
Land, water rights, water storage, and land improvements are carried at cost. Water rights consist of various water interests acquired independently or in conjunction with the acquisition of real properties. Water rights are stated at cost and, when applicable, consist of an allocation of the original purchase price between water rights and other assets acquired based on their relative fair values. In addition, costs directly related to the acquisition and development of water rights are capitalized. This cost includes, when applicable, the allocation of the original purchase price, costs directly related to acquisition, and interest and other costs directly related to developing land and water rights for its intended use. Amortization of land improvements is computed on the straight-line method over the estimated useful lives of the improvements ranging from 5 to 15 years. Provision is made for any diminution in value that is considered to be other-than-temporary.
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. Buildings and leasehold improvements are depreciated over 15-20 years, office furniture and fixtures are generally depreciated over seven years, and computer equipment is depreciated over 3 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.
The Company applies the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." As such, the Company records an impairment charge when the condition exists where the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair value. Impairment of long-lived assets is triggered when the estimated future undiscounted cash flows, excluding interest charges, for the lowest level for which there are identifiable cash flows that are independent of the cash flows of other groups of assets do not exceed the carrying amount. The Company prepares and analyzes cash flows at appropriate levels of grouped assets under SFAS No. 144. 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.
Reserves for MPL and property and casualty insurance unpaid losses and loss adjustment expenses include amounts determined on the basis of actuarial estimates of ultimate claim settlements, which include estimates of individual reported claims and estimates of incurred but not reported claims. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and updated based on current circumstances, and any adjustments are reflected in current operations.
The Company's provision for income tax expense includes federal, state, local and foreign income taxes currently payable and those deferred because of temporary differences between the income tax and financial reporting bases of the assets and liabilities. The liability method of accounting for income taxes also requires the Company to reflect the effect of a tax rate change on accumulated deferred income taxes in income in the period in which the change is enacted.
Basic earnings per share are computed by dividing net earnings by the weighted average shares outstanding during the period. Diluted earnings per share are computed similar to basic earnings per share except the weighted average shares outstanding are increased to include additional shares from the assumed exercise of stock options and warrants using the treasury method, if dilutive. The number of additional shares is calculated by assuming that the outstanding options and warrants were exercised, and that the proceeds were used to acquire shares of common stock at the average market price during the period.
For the year ended December 31, 2000, earnings per share for basic and diluted is the same as the calculation of diluted earnings per share excludes the options and warrants outstanding during the year because the Company reported a loss from continuing operations and consequently the impact of those options and warrants would be anti-dilutive. For the years ended December 31, 2002 and 2001, there was no difference between basic and diluted earnings per share because the average stock price of PICO stock during the year was less than the strike prices of the options outstanding and to include those options would be anti-dilutive to the calculation. Stock options of 1.7 million in 2002, 1.8 million in 2001, 1.1 million in 2000 were excluded from the calculation of the diluted weighted average shares outstanding.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51". FIN 46 requires the consolidation of certain variable interest entities by the primary beneficiary of the entity if the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or if the equity investors lack the characteristics of a controlling financial interest. FIN 46 is effective for variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied in the first interim or annual period beginning after June 15, 2003. The Company has no significant interest in variable interest entities and believes the effect of the adoption of FIN 46 will not be material to its results of operations and financial position.
Conex accounted for its 60% interest in the sino-foreign joint venture using the equity method of accounting due the fact that it did not have majority financial control over the policies and procedures of the joint venture. The functional currency for
At December 31, the cost and carrying value of investments held by continuing operations were as follows:
The amortized cost and carrying value of investments in fixed maturities at December 31, 2002, by contractual maturity, are shown below. Expected maturity dates may differ from contractual maturity dates because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
During 2002, 2001 and 2000, the Company recorded other-than-temporary impairments of $4.1 million, $3 million, and $161,000, respectively, on equity securities to recognize what is expected to be other-than-temporary declines in value primarily due to the extent and duration of the decline in market values of the equity securities. In addition, in 2001 and 2000, the Company recorded losses on loans of $500,000 and $2.5 million, respectively, to recognize other-than-temporary declines in the value of loans.
During 2002, the Company sold its interest in Australian Oil and Gas ("AOG") for a realized gain of $8.8 million in response to a take over bid. The sale proceeds of $21.1 million were received in cash. At December 31, 2001, the Company owned 9,867,391 shares valued at a total market price of $7.5 million. During 2001, the Company purchased 1,026,732 shares of AOG for $941,000 and received 414,615 shares as a dividend valued at $333,000.
During the fourth quarter of 2000, the Company increased its voting ownership in Accu Holding AG, a Swiss corporation, to 28.3%. PICO lacks the ability to exercise significant influence based on consideration of a number of factors and therefore accounts for the holding using SFAS No. 115. Our original investment in Accu Holding had a cost basis of $5.5 million and a market value of $3.1 million. Given the recent deterioration in Accu's core business, and the Company's assessment that there would continue to be downward pressure on Accu's stock price in the short to medium term, during 2002 the Company concluded that the decline in Accu's market value was other-than-temporary, and recorded a $2.2 million pre-tax impairment loss. This was recorded as a realized loss and has reduced the cost basis of the investment to its market value of $3.1 million at December 31, 2002.
In 2001, the Company recorded a pre-tax provision of $2.1 million for an other-than-temporary decline in the market value of this security. During 2002, the stock continued to decline which, combined with an announcement from SIHL that a total sale of the company for more than the current market value of the stock was unlikely, caused the Company to record an additional $1.6 million pre-tax impairment for an other-than-temporary decline. The charge reduced our basis in SIHL to $768,000, which is equivalent to market value at December 31, 2002.
The Company owns 130,177 shares of Jungfraubahn, which represents approximately 22.3% of the outstanding shares of Jungfraubahn. At December 31, 2002, the market value of the investment was $24 million and had an unrealized gain of $2.4 million, net of tax. During 2002, the Company acquired 17,505 shares for approximately $2.8 million, and became the largest shareholder in Jungfraubahn. Despite the increase in our shareholding to more than 20%, the Company continues to account for this investment under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." At this time, the Company does not believe that it has the requisite ability to exercise "significant influence" over the financial and operating policies of Jungfraubahn, and therefore do not apply the equity method of accounting.
At December 31, 2002, the Company's investment in HyperFeed consisted of 11,026,888 shares of common stock, representing 44% of the common shares outstanding; and 3,106,163 common stock warrants which on a diluted basis would represent an additional 6% voting interest if exercised. During 2002, PICO exercised 949,032 common stock warrants in HyperFeed for $305,000. The common stock is recorded using the equity method of accounting. At December 31, 2002, the carrying value of the investment in common stock was $498,000 after recording losses of $2 million before tax and the common stock warrants are valued at an estimated fair value of $65,000, using the Black-Scholes option-pricing model. The warrants are reported as a derivative instrument under the provisions of SFAS No. 133 and consequently gains and losses for each period are reflected in the caption "Net Realized Loss on Investments" in the Statement of Operations. The difference between the carrying value of the investment and the underlying equity in the net assets or liabilities of HyperFeed is
The Black-Scholes pricing model incorporates assumptions in calculating an estimated fair value. The following assumptions were used in the computations: no dividend yield for all years; a risk-free interest rate of 1% - 2.5%; a one year expected life; and a historical 5 year cumulative volatility of 109% to 126%.
During the three years ended December 31, 2002, HyperFeed recorded various capital transactions that affected PICO's voting ownership percentage. During 2002, our voting percentage declined slightly due to the issue of new shares for option exercises, and increased by approximately 2% upon PICO's exercise of 949,032 common stock purchase warrants. In 2001, HyperFeed issued 491,000 shares of common stock related to an acquisition which resulted in a dilution gain of $352,000 to PICO. In 2000, HyperFeed issued 164,000 shares of common stock related to conversion of stock options, which resulted in a dilution gain to PICO of approximately $208,000. Deferred taxes are provided on each dilution transaction. These transactions diluted PICO's ownership percentage approximately 1% to 35% at June of 2001 and through the conversion of preferred shares and exercise of warrants, PICO increased its voting ownership to 42.4% by the end of December 31, 2001, and to 44% at December 31, 2002.
The market value of the common shares at December 31, 2002 and 2001 based on the closing price of HyperFeed common stock is $3.3 million, and $6.1 million, respectively.
The Company and its U.S. subsidiaries file a consolidated federal income tax return. Non-U.S. subsidiaries file tax returns in various foreign countries. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
The State of California has completed income tax audits on the Company's consolidated tax returns for tax years ended December 31, 1997 and 1998. As part of these audits the California Franchise Tax Board ("FTB") is challenging, among other things, the Company's ability to deduct dividends received from PICO's non-California insurance company. Based partly on the recent California Court of Appeal decision in Ceridian vs. Franchise Tax Board, the FTB is challenging the Company's ability to exclude intercompany dividends from income tax. The Company has formally appealed the proposed assessments and is currently awaiting a hearing before the California State Board of Equalization ("SBE").
Provision has not been made for U.S. or additional foreign tax on the $2.5 million of undistributed earnings of foreign subsidiaries. It is not practical to estimate the amount of additional tax that might be payable. Rate differences of $854,000 at December 31, 2002 reflect foreign losses tax effected at the local statutory rate, which is typically as much as 20% lower than the US statutory rate of 34%. At December 31, 2002 and 2001, the Company had no federal income tax payable or receivable; however, at December 31, 2002, the Company had a state tax payable of $400,000. As of December 31, 2002, the Company has net operating loss carryforwards of $29 million. The Company has consolidated NOL's that expire as follows:
At the Annual Meeting of Shareholders on October 19, 2000, shareholders voted to amend the Articles of Incorporation to eliminate the Company's preferred shares. This amendment became effective January 16, 2001.
In March 2000, an investment partnership registered as PICO Equity Investors, L.P. acquired 3,333,333 shares of PICO stock for approximately $50 million. PICO Equity Investors, an entity managed by PICO Equity Investors Management, LLC, which is owned by three of PICO's current directors (including PICO's chairman of the board and PICO's president and chief executive officer), will exercise all voting and investment decisions with respect to these shares for up to 10 years. There is no monetary compensation for the management of either partnership. PICO used the $49.8 million net proceeds to develop existing water and water storage assets, acquire additional water assets, acquire investments, and for general working capital needs.
PICO Holdings 1999 Stock Option Agreement. PICO is authorized to issue 10,665 shares of common stock pursuant to awards granted as non-qualified stock options and other similar stock-based awards. In January 1999, PICO granted 10,665 non-qualified common stock options to an officer of the Company at an exercise price of $13.25 per share. The options were immediately vested and expire in 10 years.
PICO Holdings 2000 Non-Statutory Stock Option Plan. PICO is authorized to issue 1,200,000 shares of common stock to employees and non-employee directors of and consultants to the Company, pursuant to awards granted as non-qualified stock options. In April 2000, PICO granted, subject to approval by the Company's shareholders obtained in October 2000, 1,091,223 non-qualified common stock options to employees and non-employee directors of the Company (1,082,223 to employees and 9,000 to directors) at an exercise price of $15 per share. All options in this plan are fully vested at December 31, 2002.
In July 2001, PICO granted 100,000 non-statutory stock options to an employee at an exercise price of $15 per share. All options in this plan are fully vested at December 31, 2002. They expire in July 2021.
In August 2001, PICO granted 8,777 non-statutory stock options to an employee at an exercise price of $15 per share. A total of 2,925 of these stock options vested in August 2001, 2,926 stock options vested in August 2002, and 2,926 stock options will vest on August 2, 2003. All options in this plan will expire in August 2021.
PICO Holdings 2001 Stock Option Agreements. PICO is authorized to issue 46,223 shares of common stock pursuant to awards granted in individual non-qualified stock option agreements. In August 2001, PICO granted the total to three employees of the Company. The exercise price for these non-statutory stock options is $15 per share. One-third of these stock options vested in August 2001, one-third vested in August 2002, and the remaining will vest in August 2003. All of these non-statutory stock options expire in August 2021.
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 each year: no dividend yield; risk-free interest rates are different for each grant, and range from 4.9% to 6.97%; expected lives of options are estimated at 10 years for 2001 and 2000; and volatility of 42% for the 2001 grants and 51% for the 2000 grants. No options were granted in 2002.
The Company entered into a reinsurance treaty in 1995 with Mutual Assurance Inc. ("Mutual") in connection with the sale of Physicians' MPL business to Mutual. This treaty is a 100% quota share treaty covering all claims arising from policies issued or renewed with an effective date after July 15, 1995. At the same time, Physicians terminated two treaties entered into in 1994 and renewed in 1995. The first of these was a claims-made agreement under which Physicians' retention was $200,000, for both occurrence and claims-made insurance policies. Claims are covered up to $1 million. The second treaty reinsured claims above $1 million up to policy limits of $5 million on a true occurrence and claims-made basis, depending on the underlying insurance policy.
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 were amortized into income over the expected payout of the underlying claims using the interest method. Deferred gains of $439,000, $530,000 and $268,000 in 2002, 2001 and 2000, respectively were recorded in income. The unamortized gain at December 31, 2002 was zero and $439,000 at December 31, 2001.
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. Total contribution expense incurred by the Company, including payments to employees of Sequoia Insurance Company, was $837,000 in 2002, $855,000 in 2001 and $864,000 in 2000.
The Company leases some of its offices under non-cancelable operating leases that expire at various dates through October 2008. Rent expense was $1 million for each year in the three years ended December 31, 2002.
Future minimum rental payments required under the leases for the years ending December 31, are as follows:
Vidler, a PICO subsidiary, is party to a lease to acquire 30,000 acre-feet of underground water storage privileges and associated rights to recharge and recover water located near the California Aqueduct, northwest of Bakersfield. The agreement requires a minimum payment of $378,000 per year adjusted annually by the engineering price index until 2007. PICO signed a Limited Guarantee agreement with Semitropic Water Storage District ("Semitropic") that requires PICO to guarantee Vidler's annual obligation up to $519,000, adjusted annually by the engineering price index.
In 2000, PICO Holdings loaned a total of $2.2 million to Dominion Capital Pty. Ltd. ("Dominion Capital"), a private Australian company. In 2001, $1.2 million of the loans became overdue. Negotiations between PICO and Dominion Capital to reach a settlement agreement on both the overdue loan of $1.2 million and the other loan of $1 million proved unsuccessful. Accordingly, PICO has commenced a legal action through the Australian courts against Dominion Capital to recover the total amount due to PICO Holdings. Due to the inherent uncertainty involved in pursuing legal action, and our ability to realize the assets collateralizing the loans, PICO has recorded an allowance for the total outstanding balance of $2.3 million for the loans and interest. PICO has been awarded summary judgment in relation to the principle and interest on the $1.2 million loan and, as a result, Dominion Capital has been placed in receivership. The court appointed receiver is in the process of ascertaining Dominion Capital's assets and liabilities. A court trial date has been set for June 30, 2003 in connection with PICO's $1 million loan and interest.
On March 6, 1996, Charles E. Bancroft, the President and Chief Executive Officer of Sequoia entered into an incentive agreement with Sequoia after its acquisition by Physicians. Under the terms of this incentive agreement, Mr. Bancroft is to receive a payment equal to ten percent of the increase in Sequoia's value upon his retirement, removal from office for reasons other than cause, or the sale of Sequoia to a third party. For purposes of the incentive agreement, the increase in Sequoia's value is to be measured from August 1, 1995; the date Physicians acquired Sequoia. Mr. Bancroft was not eligible to receive any incentive payment, until he was continuously employed by Sequoia from August 1, 1995 through August 1, 1998. The Company recorded compensation expense related to this arrangement of $283,000, 250,000 and $160,000 during the years ended December 31, 2002, 2001 and 2000, respectively. The total accrued incentive will be paid upon the successful completion of the pending sale of Sequoia, which is expected to close on or around March 31, 2003.
In 1998, the Company entered into an agreement with its president and chief executive officer to defer a portion of his 1998 regular compensation in a deferred compensation Rabbi Trust account held in the name of the Company. The deferrals are included within the Company's consolidated balance sheet. Salary deferrals to the trust amounted to $316,000 for 1998. There were no deferrals into this trust in 2002, 2000 or 2001. During 2002, four other Directors elected to defer all or part of their fees into a Rabbi Trust account. Combined deferrals to these accounts were $94,000 for the year. The trusts purchase only PICO stock on the open market. The PICO common stock held in the accounts is subject to the claims of outside creditors, and is reported as treasury stock in the consolidated financial statements.
In August 1998, the Company acquired 412,846 shares of its common stock at a cost of $1.6 million, and assumed call option obligations for the delivery of these shares when the options are exercised. These call options expire on December 30, 2003 and are held by the chairman of PICO's board and its chief executive officer. On December 31, 1998, 57,307 of these options were exercised for $200,000.
(1) Certain assets are designated as "non-admitted assets" and charged to shareholders' equity for statutory accounting purposes (principally certain agents' balances and office furniture and equipment).
(1) The Professionals Insurance Company was merged with Physicians Insurance Company of Ohio on December 21, 2001.
PICO Holdings, Inc. is a diversified holding company. The Company acquire businesses which management believes are undervalued at the time, and have the potential to provide a superior rate of return over time, after considering the risk involved. The over-riding objective is to generate superior long-term growth in shareholders' equity, as measured by book value per share. The Company accounts for segments as described in the significant accounting policies in Note 1.
Currently the major businesses are owning and developing water rights and water storage operations through Vidler Water Company, Inc.; owning and developing land and the related mineral rights and water rights through Nevada Land & Resource Company, LLC; "running off" the property and casualty loss reserves of Citation Insurance Company and the medical professional liability loss reserves of Physicians Insurance Company of Ohio; the acquisition and financing of businesses; and property and casualty insurance in California and Nevada through Sequoia Insurance Company. In October 2002, the Company signed a definitive agreement to sell Sequoia, and is therefore accounted for as a discontinued operation.
Vidler is engaged in the following water rights and water storage activities:
o acquiring water rights, redirecting the water to its highest and best use, and then generating cash flow from either leasing the water or selling the right;
o purchase and storage of water for resale in dry years.
This segment is comprised of Physicians Insurance Company of Ohio and Citation Insurance Company.
Until 1995, Physicians and Professionals wrote medical professional liability insurance, mostly in the state of Ohio. Professionals merged with and into Physicians on December 21, 2001. Physicians has stopped writing new business and is being "run off." This means that it is handling claims arising from historical business, and selling investments when funds are needed to pay claims.
In the past, Citation wrote commercial property and casualty insurance in California and Arizona. Sequoia now directly writes all business in California and Nevada. Citation ceased writing business in December 2000, and is now "running-off" the loss reserves from its existing business.
In this segment, revenues come from premiums earned on policies written and investment income on the assets held by the insurance companies. As expected during the run-off process, the bulk of this segment's revenues come from investment income. Investments directly related to the insurance operations are included within those segments. The assets of discontinued operations are included within the Insurance Run Off segment as the equity of the discontinued operations is owned by Physicians.
- INVESTMENTS: Fair values are estimated based on quoted market prices, or dealer quotes for the actual or 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. Fair value for equity securities that do not have a readily determinable fair value is 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.
Effective July 1, 2001 the Company adopted SFAS No. 141, "Business Combinations," and effective January 1, 2002, SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 prospectively prohibits the pooling of interests method of accounting for business combinations initiated after June 30, 2001. SFAS No. 142 establishes a new method of testing goodwill for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The adoption of SFAS No. 142 is reflected in Company's consolidated financial statements as a cumulative effect of change in accounting principle. The cumulative adjustment of $2 million is comprised of a gain from recognizing negative goodwill of $2.8 million offset by write-off's of goodwill of $800,000. Had the Company ceased amortizing goodwill as of the first day of the earliest period presented, net income or loss for each of the years ended December 31, would be as follows:
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 138, "Accounting for Certain Derivative Instruments and Hedging Activities." As amended, SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position measure those instruments at fair value and recognize changes in fair value in earnings for the period of change unless the derivative qualifies as an effective hedge that offsets certain exposure. As a result of this adoption, the Company recorded a transition adjustment in the first quarter of 2001 that decreased net income by approximately $1 million, net of a $500,000 tax benefit and increased other comprehensive income by the same amount (no effect on shareholders' equity). These adjustments are reported as a cumulative effect of change in accounting principle in the accompanying consolidated financial statements.
In the fourth quarter of 2000, the Company received notification from the Ohio Department of Insurance that it would no longer permit the Company to discount its MPL reserves for statutory accounting practices. Accordingly, the Company discontinued discounting its MPL reserves in its statutory filing with the Ohio Department of Insurance and financial statements prepared in accordance with GAAP for the year ended December 31, 2000. The effect of this change was to increase the unpaid losses and loss adjustment expenses reserve by $7.5 million and a cumulative effect of accounting principle of $5 million, or $0.43 per share, net of an income tax benefit of approximately $2.5 million. Had the change been made as of