(1) Includes Mountain Valley's balance sheet as of December 31, 2000 and results of operations for the ten months ended December 31, 2000.
(2) Includes North East's balance sheet as of December 31, 1999 and results of operations for the three months ended December 31, 1999.
We own and operate five regionally focused property and casualty insurance companies, including companies that
Mountain Valley was acquired on March 1, 2000; North East was acquired on September 24, 1999. We believe that these acquisitions fully establish us as a regional commercial lines
company in the New England and Mid-Atlantic regions. As evidence of this, only 44% of our consolidated revenues emanated from NJ PPA in 2000, the lowest in our history. This percentage is expected to continue to decline in the future.
Historically, the Insurance Companies' results of operations have been influenced by factors affecting the property and casualty insurance industry in general and the NJ PPA market in particular. The operating results of the U.S. property and casualty insurance industry have generally been subject to significant variations due to competition, weather, catastrophic events, regulation, general economic conditions, judicial trends, fluctuations in interest rates and other changes in the investment environment.
In March 2001, the Company's management determined that certain tax benefits should not have been recognized and that certain deferred tax liabilities had not been recorded. These tax matters, relate to the tax effects of temporary differences arising from MCAIC, which was de-consolidated for financial reporting purposes due to its insolvency in 1992(see Note J in the Notes to the Consolidated Financial Statements). These tax matters have no impact on the operations, cash flow or capital and surplus of the Company's active insurance subsidiaries or on consolidated income before Federal income taxes for the periods presented, nor is the Company subject to penalties and interest on the recording of the deferred tax liabilities.
In addition, retained earnings and thus shareholders' equity at December 31, 1997 was reduced by $126,303, representing the cumulative effect from revising the tax accrual on prior periods' results of operations after Federal income taxes. Finally, deferred tax assets were not recorded for the tax effects of the minimum pension liability that is presented as a component of other comprehensive income. Shareholders' equity at December 31, 1997 increased by $1,539,894, representing the cumulative effect on prior periods' results of revising the tax accrual. The net effect of these prior period adjustments increased shareholders' equity by $1,413,591 at December 31, 1997.
Net income in 2000 improved as a result of improved income before Federal income taxes from the Insurance Companies. The Insurance Companies improvement of $3,748,000 in 2000 was the result of improved loss ratios at our Preserver segment, economies of scale gained from our acquisitions that enabled Motor Club to improve its expense ratio and sharply lower expenses at North East. Mountain Valley's results were largely as anticipated. In 1999, Motor Club and Preserver had incurred $638,000 in losses and expenses related to Hurricane Floyd, which struck New Jersey in September 1999.
These improved underwriting results also offset a $1,419,000 increase in interest expense related to the Convertible Subordinated Debentures and Promissory Notes issued in 1999 and 2000, respectively, related to our acquisitions. Non-recurring expenses related to our acquisitions declined, from $800,000 in 1999 to $354,000 in 2000.
Significantly higher NJ PPA losses occurring in 1999, specifically PIP first party medical claims, had caused 1999 net income to decline. Income before federal income taxes declined $3,813,000 as compared to 1998. This was due to the impact of AICRA on Motor Club. AICRA had been designed to reduce both premiums and losses in NJ PPA.
$1,993,000 or $.94 per share (net of applicable deferred taxes) due to an increase in the fair value of fixed maturity investments accounted for as available-for-sale securities under SFAS No. 115 ("Accounting for Certain Investments in Debt and Equity Securities"); offset by (3) $870,000 or $.41 per share (net of applicable deferred taxes) due to an increase in the minimum required pension liability for the Company sponsored defined benefit pension plan ("Pension Plan") as a result of asset losses and lower interest rates.
Our book value decreased to $12.67 per share at December 31, 1999 from $13.56 per share at December 31, 1998.
The following table summarizes the income before Federal income taxes for this segment before the effects of the intercompany pooling agreement with Mountain Valley:
Preserver continues to produce superior results, driven by excellent growth, lower loss ratios and stable underwriting expenses. The following table presents the underwriting ratios for this segment for each of the three years ended December 31:
Commercial Lines business, which grew 20% in 2000, consistent with our overall growth strategy. Commercial lines policy count grew 10%, and the average premium continued to increase as Preserver wrote larger accounts by virtue of its higher Best rating, complete product line offering and competitive pricing. In addition, Preserver was able to increase premiums on certain renewed accounts, as market circumstances were more favorable to do so. We anticipate that such premium increases will continue to be available to Preserver on a selective basis in 2001, without adversely impacting retention.
The 3% growth in Preserver's Personal Property insurance premiums continues to reflect modest amounts of new business written, along with adjustments in the values of properties insured, offset by a continuing slightly higher attrition rate on existing policies in 2000 as compared to 1999. Personal property policy count declined 4% in 2000 as compared 1999.
In 1999, the increase in Commercial Lines insurance premiums of 7% was reflective of the increased number of policies that Preserver wrote during 1999 as compared to 1998. The unchanged amount of Personal Property insurance premiums written by Preserver reflects modest amounts of new business written offset by a slightly higher attrition rate on existing policies in 1999 as compared to 1998; policy count declined by 2%.
Net investment income in 2000 reflects the strong operations and $3 million surplus contributions we made in March 2000. Invested assets continued to grow strongly in all years.
$1,189,000 or 13% in 2000 as compared to 1999. This combined with the 13% increase in insurance premiums reduced the net loss ratio by 23%. Most of the changes in Preserver's net loss ratios in recent years were caused by fluctuations in recoveries from its reinsurance coverage. Preserver's direct loss ratios have steadily improved in recent years as its book matures, retentions improve and pricing in Commercial Lines becomes more favorable, as the following table shows.
Given the relatively small size of the Preserver book of business, a limited number of severe losses can cause relatively wide fluctuations in Preserver's net loss ratio results, depending on whether these losses were severe enough to generate a reinsurance recovery. There have been no trends or indications in
The following table summarizes the income (loss) before Federal income taxes for this segment:
Motor Club results improved in 1999, largely due to economies of scale it gained in expenses as a result of the acquisition of Mountain Valley and North East. Higher loss ratios largely due to the impact of AICRA continued to make profitability in this segment difficult in 2000. The following table presents the underwriting ratios for each of the three years ended December 31:
Despite a small increase in policy count due to increased submissions of PPA business, Motor Club's PPA insurance premiums declined due to the residual effect of the statutorily mandated 1999 rate rollback. No rate increases were received in 2000 and none is presently anticipated in 2001.
The decline in insurance premiums in 1999 as compared to 1998 was also due principally to the rate rollback provisions of AICRA which were implemented commencing in 1999, and not a significant change in the number of policies written during the year.
First party medical or PIP claims continued to produce poorer results in Accident Year 2000, consistent with those experienced in Accident Year 1999 after the AICRA rate rollback and related reforms were implemented. The provision for Accident Year PPA claims was $1,723,000 higher in 1999 as compared to 1998, accounting for 75% of the consolidated increase that year. These losses did not increase until after the rate rollback and
While this acceleration increased the level of reported PIP losses incurred by Motor Club in Accident Years 2000 and 1999, we have reserved for their projected ultimate losses for Accident Years 2000 and 1999, generally using historical loss development patterns which indicate longer development patterns than those that may occur in Accident Years 2000 and 1999.
We will continue to monitor loss development patterns in 2001 and beyond closely, to ensure that the level of reserves carried for PPA is adequate and appropriate as dictated by actual loss development.
legislative provisions of AICRA and other legislative reforms, that this may take longer to occur and that the near-term effects of AICRA may continue to be more negative than originally forecast before improvement begins.
Accordingly, considering these elements, combined with New Jersey's regulatory and legislative history, the enacted legislation, current judicial decisions, current rate freeze and ongoing volatility, we believe there are significant uncertainties with regard to our ongoing NJ PPA operations, which could adversely affect the Company. Consistent with our long-stated goal to increase our identification as a provider of small commercial lines insurance and expand and diversify our operations outside the State of New Jersey, we continue to review strategies to improve the profitability of our NJ PPA business and otherwise to add more value to our shareholders.
Motor Club's expense ratio declined in 2000 as compared to 1999 as a result of lower expenses. In large part the decline in expenses is due to the economies of scale gained from the
(1) Pro Forma results for the twelve months ended December 31, 1999 (2) For the three months ended December 31, 1999 NM = Not Meaningful
Because North East was only included from September 24, 1999, its date of acquisition, for purposes of comparability, the following discussion of this segment is compared with North East's full year of operation in 1999.
An additional contributing factor to the improved ratios is insurance premiums growth of $3,931,000 or 27%, which in part is affected by the aforementioned reductions in reinsurance costs, combined with premium growth, primarily in North East's commercial lines
Mountain Valley is included from March 1, 2000, its date of acquisition. Because Mountain Valley had no net operations prior to our acquisition of it, other than net investment income, no comparison is made with prior years.
As described previously, Mountain Valley has terminated the 100% quota share it maintained. As noted: 1) there is no loss development, adverse or favorable, net of third party reinsurance, that we retain on loss occurrences prior to March 1, 2000; and 2) only Mountain Valley loss occurrences on or after March 1, 2000 will be retained, net of reinsurance, by us. Based on the short period of time that we have owned Mountain Valley, no meaningful loss trends on Accident Year 2000 have been discerned.
Because Mountain Valley has a limited amount of loss experience, ultimate losses and reserves are being provided for based upon reviews of Mountain Valley's historical loss development patterns, prior to application of the quota share, combined with reviews of Preserver's and general industry loss development patterns.
As Accident Year 2000 and subsequent years' losses become more prevalent in relation to older accident years, Mountain
The merger expenses are for Mountain Valley in 2000 and North East in 1999. While we do not rule out the possibility of additional acquisitions, another transaction is unlikely in 2001, and thus these expenditures should decline further in 2001.
$11.5 million in Debt in February 2000 and $10 million in Convertible Subordinated Debentures issued in September 1999. Both are related to our acquisitions of Mountain Valley and North East, respectively, and are discussed in further detail in the section entitled "Financing Activities".
The increase in the amortization of goodwill in 2000 compared to 1999 is due to a full year's charge for North East, acquired on September 24, 1999. The increase in 1999 was for a partial charge of the same item.
Under the applicable rules, the Company is entitled to, and has taken current tax benefits for net operating losses that MCAIC and its subsidiaries have generated since 1992. However, to the extent that the Company does not have positive basis (as defined by the Internal Revenue Code), it may also be required to pay future tax liabilities (which may offset the current tax benefit) subject to certain events which may trigger such payments. Accordingly, when such current tax benefits are recognized, a corresponding deferred tax liability is recorded.
At the time of its insolvency, MCAIC realized approximately $150 million in losses, which generated a net operating loss ("NOL") that could not be utilized at that time by either the Company or MCAIC under applicable IRS regulations and which expire in 2006. Additional net operating losses have been experienced by MCAIC since 1992, some of which were utilized by the Company at a time when it had no tax basis in MCAIC, thus creating a deferred tax liability represented by the $1,917,405 "Excess Loss Account" item (for the year ended December 31, 2000) as shown in Note J of the Notes to the Consolidated Financial Statements. The $150 million of NOL's generated in 1992 will likely increase the Company's excess loss account at the time they expire in 2006.
An excess loss account in a subsidiary generally creates taxable income at the time of the sale, liquidation or other disposition of the subsidiary.
Management expects that the liquidation or other disposition of MCAIC will take place prior to the expiration of these NOL's in 2006 and prior to the corresponding increase in the Company's excess loss account. As the control of the liquidation process rests with the Insurance Department of the State of Oklahoma (the "Receiver") and not with management, there is a potential risk that such tax liability could be incurred by the Company after 2006 when the 1992 generated NOLs will have been converted into the Company's excess loss account. Management believes it is unlikely that such risk will occur, as the liquidation of MCAIC is probable before the expiration of the NOL. However, the tax effects of these transactions are subject to the circumstances of the liquidation process itself and tax-planning strategies exist which could mitigate the impact of such a tax exposure.
With respect to the Company's excess loss account created by the Company's utilization of MCAIC's post 1992 NOL's, these excess losses will likely result in the Company recognizing taxable income in the year MCAIC is liquidated or otherwise disposed of. The effect of the deferred taxes attributable to such income has been reflected on Consolidated Financial Statements accompanying this Report.
Liquidity is a measure of the ability to generate sufficient cash to meet cash obligations as they come due. Cash outflows can be variable because of uncertainties regarding settlement dates for liabilities for unpaid losses and because of the potential for large losses either individually or in the aggregate.
As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. The Company uses cash to pay debt service, Federal income taxes and operating expenses. We also may provide capital to our subsidiaries. Maximum amounts of dividends that can be taken without regulatory approval are prescribed by statute (See Note K of Notes to Consolidated Financial Statements).
The Insurance Companies are highly liquid, receiving substantial cash from premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal outflows of cash are payments of claims, taxes, interest, operating expenses and dividends. Accordingly, the Insurance Companies maintain investment and reinsurance programs generally intended to provide adequate funds to pay claims without forced sales of investments. The Insurance Companies model their exposure to catastrophes and generally have the ability to pay claims without selling securities. Even in years of greater catastrophe frequency, the Insurance Companies have been able to pay claims without liquidating any investments. The Insurance Companies' policy with respect to fixed maturity investments is to purchase only those that are of investment grade quality.
As a company with insurance subsidiaries that invests substantial sums in fixed income securities, we are accustomed to fluctuations in the value of our fixed income investments. We have identified one hundred percent of those investments as available for sale pursuant to SFAS 115. Accordingly, changes in the value of those investments are recorded as other comprehensive income. Because our investment portfolios are composed completely of securities which are generally highly liquid (i.e., U.S. government securities and investment grade corporate bonds), and that our credit reviews have not indicated any downgrades, there are no grounds to believe that the unrealized gains (in 2000) or losses incurred (in 1999) are other than temporary. In addition, the combination of the duration of the portfolio being sufficiently short (approximately 3.46 and 3.60 years at December 31, 2000 and 1999, respectively), combined with the highly liquid nature of those securities and our proclivity to hold those bonds to maturity (although they are classified as available-for-sale), the par value of those bonds should be fully realized at maturity, resulting in those unrealized gains and losses being temporary.
In addition, we generally believe that the longer-term trend for future movements in interest rates is toward lower interest rates, which has occurred and has positively affected the value of fixed income investments and has converted those unrealized losses to unrealized gains. We believe the combination of
economic circumstances, which is resulting in slower overall economic growth, modest inflation and real long-term interest rates that remain historically high, all combines to result in lower longer-term interest rate trends.
To date, we have only increased staffing nominally to provide home office support to our acquisitions. In 2001, we expect to increase staffing further to support our expanded enterprise and this may increase the expense ratio. We are also making certain capital improvements, particularly with regard to technology platforms at Mountain Valley and Preserver. These capital outlays are anticipated to total at least $1 million in 2001, with additional similar investments also anticipated in 2002 and beyond.
Aside from the changes in operating expenditures noted previously, particularly the investments in technology and expenditures associated with the acquisition of Mountain Valley and North East, no unusual or nonrecurring operating expenditures have been incurred over this period.
The payout ratio of losses, other than PIP in NJ PPA, has not fluctuated substantially over this period. Our cash flow from operations is expected to increase as we increase our revenue through additional premium writings, specifically commercial lines and continue to reduce our expenses and expense ratio. This will be offset somewhat by the development and payment of losses on the new PPA which Motor Club is writing.
We did not pay dividends on our common stock in 2000, 1999 and 1998.
In connection with our acquisition of Mountain Valley, on February 29, 2000 we borrowed $11.5 million ("Debt") from our three Executive Committee members. For more information on the Debt, please refer to Note H in the Notes to Consolidated
In connection with our acquisition of North East, we issued $10 million of Convertible Subordinated Debentures ("Debentures"), on September 23, 1999, in one series, under a plan previously approved by our shareholders. For more information on the Debentures, please refer to Note I in the Notes to Consolidated Financial Statements.