Basic earnings (loss) per share of common stock at December 31, 2006, 2005, 2004, 2003, and 2002 are computed using the weighted average number of common shares outstanding during the year of 9,524,570, 9,455,391, 9,387,556, 9,352,070 and 9,322,249, respectively. Diluted earnings per share of common stock at December 31, 2006, 2005, 2004, 2003 and 2002 are computed using the weighted average number of common shares outstanding during the year of 9,657,059, 9,549,353, 9,387,556, 9,352,070 and 9,322,249 respectively. For further discussion of basic earnings per share and diluted earnings per share, see “Note 10 to Consolidated Financial Statements.”
During 2002 and 2003, the Company largely completed its withdrawal from the assumed reinsurance market and medical malpractice insurance outside of California and Delaware. The actions taken by the Company to exit the liability business other than California and Delaware and the quota share reinsurance agreement with Rosemont Re, have significantly reduced capital requirements related to the net premium written to surplus ratio in both the A.M. Best and NAIC capital adequacy models. The capital requirements associated with the reserve to surplus ratio continue to decline as the Company settles the claims in its non-core businesses.
Direct healthcare liability insurance premiums written are earned on a daily pro rata basis over the terms of the policies. Accordingly, unearned premiums represent the portion of premiums written which is applicable to the unexpired portion of the policies in force. Reinsurance premiums assumed are estimated based on information provided by ceding companies. The information used in establishing these estimates is reviewed and subsequent adjustments are recorded in the period in which they are determined. These premiums are earned over the terms of the related reinsurance contracts.
administration and settlement of both known and unknown claims. Such liabilities are established based on known facts and interpretation of circumstances, including the Company’s experience with similar cases and historical trends involving claim payment patterns, loss payments and pending levels of unpaid claims, as well as court decisions and economic conditions. The effects of inflation are implicitly considered in the reserving process. Establishing appropriate reserves is an inherently uncertain process; the ultimate liability may be in excess of or less than the amount provided. Any increase in the amount of reserves, including reserves for insured events of prior years, could have an adverse effect on the Company’s results for the period in which the adjustments are made. The Company utilizes its internal actuarial staff in establishing its reserves. The Company does not discount its loss and loss adjustment expense reserves.
Because the reserve establishment process is by definition an estimate, actual results will vary from amounts established in earlier periods. The Company recognizes such differences in the periods they are determined. Since reserves accumulate on the balance sheet over several years until all claims are settled, a determination of inadequacy or redundancy could easily have a significant impact on earnings and therefore stockholders’ equity. The Company has established net reserves of $367.2 million and gross reserves of $405.4 million as of December 31, 2006 respectively, not including the retrospective reserves ceded under the Rosemont Re treaty. Reserves attributable to the operating segments of the Company are as follows:
The Company’s best estimate of reserves may change as credible data emerges. When the determination is made, resulting reserve changes are reflected in then-current operations. Due to the size of an insurance company’s reserves for losses, even a small change in estimates could have a material effect on results of operations for the period in which the change is made.
for the Assumed Reinsurance Reserves, the future reports from ceding companies could indicate the need for more reserves or less reserves depending on the circumstances of the individual contracts. The Company receives notice of increase and decreases in reserves every reporting period. The Company considers it reasonably possible that an increase or decrease of 10% could occur over time.
The primary factor affecting the adequacy of reserve estimates in the core area is the trend in pure loss costs (the combination of frequency and average severity changes) related to malpractice coverage. The inherent pure loss cost trend included in the setting of the 2004, 2005 and 2006 reserves has been 3.3%, 2.2% and 1.2% respectively. The primary factor which has decreased the pure loss cost trend during this timeframe has been a significant decline in the frequency of claims. The frequency of claims declined 13.1% in 2004, 21.1% in 2005 and 4.6% in 2006. The Company does not know of any empiric reason for the decline in claim frequency but believes it may represent a general decline in the propensity of claimants to sue or file claims against doctors after the great deal of publicity that surrounded the effect that medical malpractice insurance rates had on the practice of medicine in various parts of the country. The Company believes other companies have reported in the media that this decline in frequency has occurred across the country as well as in California where the Company primarily operates. At 2006 reserve levels, a 1% change in pure loss costs trend produces a change in reserves of approximately $7.6 million. Such changes are reflected in the period of change. Reserves related to medical malpractice coverage account for over 90% of core reserves.
The net reserves for non-core healthcare operations as of December 31, 2006 consist of the following:
Company issued policies allow extended periods of time to elapse before the judicial or settlement process is completed. Individual settlements or judgments will determine the final incurred losses and thus the adequacy of these reserves. The recent experience has been generally consistent with Company expectations, but no assurance can be given that the Company’s current experience will continue. If the average settlement ultimately achieved is different by $12,000 for the current average reserve, the ultimate reserves will be affected by approximately $1.6 million.
The Company’s internal actuaries review the experience of individual contracts as well as review actuarial information received from the ceding companies. Since the last premiums were written on this business several years ago, the reporting of new losses should be relatively infrequent. The late reporting experienced by the Company does not appear to be related to any one type of contract or any specific contract and seems random in nature. These “surprises” would not normally be expected when looking at general reinsurance statistics relating to loss development.
In addition, because the Company is no longer in the reinsurance business, it is actively trying to commute certain contracts which may have a transaction cost to the Company but will improve its capital ratios under the A.M. Best capital adequacy model.
The Company believes that Occupational Accident reserves should be relatively stable at this point and the remaining reserves are based primarily on amounts currently reported to the Company by the ceding companies. As time passes, the ability of the underlying insureds to accurately reserve the large excess of loss type cases should improve. However, since the reporting of losses through the worldwide reinsurance market is often slow and is dependent upon the reporting by the ceding companies, the adequacy of these reserves has a potential for volatility and no assurances can be given that further adverse development will not occur. A 10% change in the reported losses would have resulted in a $4.9 million change in these reserves as of December 31, 2006.
Deferred policy acquisition costs include commissions, premium taxes and other variable costs incurred in connection with writing business. Deferred policy acquisition costs are reviewed to determine if they are recoverable from future income, including investment income. If such costs are estimated to be unrecoverable, they are expensed. Recoverability is analyzed
The Company evaluates the securities in its available-for-sale investment portfolio on at least a quarterly basis for declines in market value below cost for the purpose of determining whether these declines represent other than temporary declines. A decline in the fair value of an available-for-sale security below cost that is judged to be other than temporary is realized as a loss in the current period and reduces the cost basis of the security.
At December 31, 2006, the Company had $44.7 million of net deferred income tax assets. Net deferred income tax assets consist of the net temporary differences created as a result of amounts deductible or revenue recognized in periods different for tax return purposes than for accounting purposes. These deferred income tax assets include an asset of $20.4 million for a net operating loss carryforward that will begin to expire in 2021. A net operating loss carryforward is a tax loss that may be carried forward into future years. It reduces taxable income in future years and the tax liability that would otherwise be incurred.
The Company’s estimate of future taxable income uses the same assumptions and projections as in its internal financial projections. These projections are subject to uncertainties primarily related to future underwriting results. If the Company’s results are not as profitable as expected, the Company may be required in future periods to record a valuation allowance for all or a portion of the deferred income tax assets. Any valuation allowance would reduce the Company’s earnings.
The Company has been a leading writer of medical malpractice insurance for physicians and healthcare providers in California for many years. In 1996, the Company began expansion into other professional liability products and into other geographical markets. The principal product expansion was into professional liability insurance for hospitals. From 1997 through 1999, the
During 2007, the Company will continue to concentrate its efforts on its core physician and medical group business in California and Delaware and settling outstanding claims in the non-core business.
Premiums written for the core direct healthcare liability insurance business decreased 2.8% and 1.4% in 2006 and 2005 primarily due to a decrease in premiums related to loss rated policies for which experience has been improving. Premiums earned decreased 3.4% in 2006 and increased 3.5% in 2005 respectively. The decrease in earned premium for 2006 was primarily the result of decreases in premium written related to loss rated policies as loss experience improved. The increase in earned premium in 2005 relates primarily to a 6.5% rate increase effective January 1, 2005 for most California policies.
The Company has historically had a high renewal rate in its core business. The renewal rates of insureds who were offered renewal was 96% for 2006, 95% for 2005 and 92% for 2004. The Company primarily loses insureds due to underwriting actions taken by the Company, or by insureds moving to competitors, leaving their practice, retiring or joining a health facility that provides for their insurance. These losses are offset by new sales activities. New policies written in 2006, 2005, and 2004, were 868, 1,077, and 1,045, respectively. The core business policies inforce at year end 2006, 2005, and 2004 were 10,289, 10,397, and 10,684 policies, respectively.
The loss ratio (loss and LAE related to premium earned) for 2006 was 70.6% compared to loss ratios of 70.9% and 80.6% for 2005 and 2004 respectively. The 0.3% decrease in the ratio between 2006 and 2005, and the 9.7% decrease in the ratio between 2005 and 2004, primarily reflect the fact that the frequency of claims declined 4.6% and 21.1% during these respective periods. These declines were partially offset by increases in the estimate of the average cost of claims.
The premiums written and earned in 2005 were generated by policyholders exercising their right to purchase tail coverage. The negative premiums written and earned in 2004 represent reinsurance premiums paid by the Company in connection with the reinstatement of excess of loss layers for older years. After March 6, 2003, no new or renewal business has been written in the non-core programs.
The Company ceased writing assumed reinsurance business at the end of the 2003 underwriting year. The premium written in 2005 and 2004 is almost entirely attributable to the one Lloyd’s syndicate that the Company supported in 2003. The premium earned in 2004 is also primarily from this syndicate. Premiums written and earned in 2006 were primarily additional premium received for earlier periods.
The underwriting loss in 2004 was principally attributable to unexpected adverse loss development during 2004 principally in connection with the Lloyd’s syndicates, additional losses incurred under a single excess of loss directors and officers liability insurance treaty, and losses involving issuers of bail and immigration bonds.
Net loss reserves related to the assumed reinsurance segment declined from $87.8 million at December 31, 2004 to $59.2 million in 2005 and $49.0 million in 2006 as reserves were settled and 2002 and 2003 underwriting years for the London syndicates closed and settlements were made in 2005 and 2006.
In 2005 the Company sold its stock interest in a privately held insurance company for a $4.4 million gain.
The Company currently has a net deferred tax asset of $44.7 million as of December 31, 2006, of which $20.4 million relates to a net operating loss carryforwards which begin to expire in 2021. The Company will be able to utilize this carryforward to reduce taxes in future periods. The losses in recent years which gave rise to the operating loss carryforward were primarily generated by underwriting losses in the non-core direct healthcare liability and assumed reinsurance businesses. Since these operations are now in run-off and the core business has historically been profitable on both a GAAP and tax basis, after consideration of investment income, the Company’s projections indicate that it is more likely than not that the net operating loss carryforward will be fully utilized within the carryforward period.
SCPIE Holdings is an insurance holding company whose assets primarily consist of all of the capital stock of its Insurance Subsidiaries. Its principal sources of funds are dividends from its subsidiaries and proceeds from the issuance of debt and equity securities. The Insurance Subsidiaries are restricted by state regulation in the amount of dividends they can pay in relation to earnings or surplus, without the consent of the applicable state regulatory authority, principally the California Department of Insurance. SCPIE Holdings’ principal insurance company subsidiary, SCPIE Indemnity, may pay dividends to SCPIE Holdings in any 12-month period, without regulatory approval, to the extent such dividends do not exceed the greater of (i) 10% of its statutory surplus at the end of the preceding year or (ii) its statutory net income for the preceding year. Applicable regulations further require that an insurer’s statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs, and permit the payment of dividends only out of statutory earned (unassigned) surplus unless the payment out of other funds receives regulatory approval. The amount of dividends that SCPIE Indemnity is able to pay to SCPIE Holdings during 2007 without prior regulatory approval is approximately $22.4 million.
(including dividends from the Insurance Subsidiaries) will be sufficient to meet the liquidity needs of SCPIE Holdings over the next 18 months.
The Company has certain contractual obligations and commercial commitments principally for providing for the payments of loss and LAE expenses, operating leases for office space for its headquarters and letters of credit to provide security in connection with the assumed reinsurance segment. The table below presents the contractual payments estimated to be due by period or expiration period for each obligation or commitment:
Unlike many other forms of contractual obligations, loss and LAE reserves do not have definitive due dates, and the ultimate payment dates are subject to a number of variables and uncertainties. The liability shown in the table represents the Company’s best estimate of the unpaid cost of settling claims, including claims that have been incurred but not yet reported, and the time period in which such claims will be resolved. The amounts shown are gross of any reinsurance that the Company estimates will be recoverable on resolution of the claims. A portion of the assumed reinsurance business, principally the occupational accident reserves and the cession to Rosemont Re, are on a funds withheld basis and therefore projected reserve payments of $50.7 million included in the preceding table will be funded by a draw down of funds withheld balances rather than cash.
Since November, 2001, the Company has had a letter of credit facility in the amount of $50 million with Barclays Bank PLC. Letters of credit issued under the facility collateralize loss reserves under reinsurance contracts. As of December 31, 2006, letter of credit issuance under the facility was approximately $22.2 million. Securities of $24.4 million are pledged as collateral under the facility.
The primary effect of inflation on the Company is considered in pricing and estimating reserves for unpaid losses and LAE for claims in which there is a long period between reporting and settlement, such as medical malpractice claims. The actual effect of inflation on the Company’s results cannot be accurately known until claims are ultimately settled. Based on actual results to
The Company’s Consolidated Financial Statements and related notes, including supplementary data, are set forth in the “Index” on page 58 hereof.