The Company also leases office space in 14 other locations, of which 9 locations are in California primarily for claims-related employees. The Company anticipates no difficulty in extending these leases or obtaining comparable office facilities in suitable locations.
On December 31, 2002, the Company entered into a sale-leaseback transaction for $15.8 million of equipment and leasehold improvements and $44.2 million of software. The leaseback transaction has been accounted for as a capital lease. For a summary of the Company's lease obligations, see discussion under Item 7 of this report and Notes 7 and 11 of the Notes to Consolidated Financial Statements.
The selected financial data presented below as of the end of and for each of the years in the five-year period ended December 31, 2002, are derived from, or supplemental to, the Company's consolidated financial statements. The consolidated financial statements as of December 31, 2002 and 2001, and for each of the years in the three-year period ended December 31, 2002, are included in Item 8 of this report.
Increased advertising and other costs through December 31, 2002, associated with increased customer volume, contributed to an increase in deferred policy acquisitions costs (DPAC) of
$15.6 million compared to the balance at December 31, 2001. The Company's DPAC is estimated to be fully recoverable (see Critical Accounting Policies - Deferred Policy Acquisition Costs).
Unpaid losses and loss adjustment expenses ("LAE") increased $34.7 million for the year ended December 31, 2002 primarily due to the increase in reserves for SB 1899 Northridge Earthquake legal defense costs (see further discussion below under Underwriting Results - Homeowner and Earthquake Lines in Runoff and Note 16 to the Notes to Consolidated Financial Statements) and increases in auto reserves. As indicated in the following table, the Company's auto reserves, gross of reinsurance, have increased $31.1 million in the year ended December 31, 2002:
The $ 31.1 million increase in the gross auto reserves for the year ended December 31, 2002, comprises $4.9 million due to the consolidation of 21st of Arizona, growth in reserves attributable to the higher number of insured automobiles of approximately $9.0 million, approximately $7.3 million relating to the effects of higher average loss costs and approximately $9.9 million for strengthening of prior accident year reserves (see further discussion under Critical Accounting Policies - Losses and Loss Adjustment Expenses).
The Company's reported earnings could be significantly different if ending reserves were based on assumptions and estimates different from those used by management (see further discussion in Part 1 of this report under the heading Loss and Loss Adjustment Expense Reserves). During 2002 and 2001, the Company improved the quality and timeliness of the data available to make initial estimates and periodic changes in estimates and has dedicated more resources to understand better the underlying drivers of the changes in frequency and severity trends as they begin emerging. Management believes the decline in the need for recognition of adverse development in 2002 due to prior accident years for the personal auto lines evidences substantial improvement in the accuracy of its estimation processes. Historically, 21st Century actuaries have not projected a range around the carried loss reserves. Rather, they have used several methods and different underlying assumptions to produce a number of point estimates for the required reserves. Management selects the carried reserve after carefully reviewing the appropriateness of the underlying assumptions.
LIQUIDITY AND CAPITAL RESOURCES Holding Company. The parent company's main sources of liquidity historically have been dividends received from its insurance subsidiaries and proceeds from issuance of debt or equity securities. The parent company currently has no indebtedness for borrowed money outstanding, although it has guaranteed a subsidiary's capital lease obligation. The parent's only equity security currently outstanding is its common stock, which has no mandatory dividend obligations.
As of December 31, 2002, the Company's insurance subsidiaries had a combined statutory surplus of $397.4 million compared to $393.1 million at December 31, 2001. Significant changes in surplus were a decrease in nonadmitted assets of $48.8 million, primarily due to the sale-
The Company has not identified any other trends, demands, commitments, events or uncertainties that have or are considered to have a reasonable possibility of having a material impact on the Company's liquidity.
Obligations, Letters of Credit, Guarantees and Transactions with Related Parties. The Company currently has a capital lease obligation resulting from the sale-leaseback transaction discussed earlier. The lease includes a covenant that if AIG ceases to have a majority interest in the Company, or if statutory surplus falls below $300.0 million, or if the net premiums written to surplus ratio is greater than 3.8:1, the Company will either deliver a letter of credit to the lessor or pay the lessor the then outstanding balance, including a prepayment penalty of up to 3%. The Company also has operating leases for its office facilities.
Future cash payments required under all the Company's lease obligations are summarized below (in millions):
The Company has no long-term debt obligations, purchase obligations or other long-term liabilities on its balance sheet. In addition, the Company has no retained interests in assets transferred to an unconsolidated entity, and no obligations under certain derivative instruments or obligations arising out of variable interests.
RESULTS OF OPERATIONS Overall Results. The Company reported a net loss of $12.3 million, or $0.14 loss per share, on direct premiums written of $998.2 million for the year ended December 31, 2002, compared to a net loss of $27.6 million, or $0.32 loss per share, on direct premiums written of $929.3 million for
Personal Auto Lines Operating Income, as presented in the following tables, is a key measure used by management in monitoring the operating results of the Company's core business. Personal auto lines operating income includes (a) the underwriting revenues and expenses attributable to the (i) personal auto lines, (ii) personal umbrella lines, and (iii) motorcycle lines, plus (b) investment income excluding realized capital gains or losses on the investment portfolio; it also excludes (c) the results of the homeowners and earthquake lines, which are in runoff, and (d) the write-off of software discussed above.
Direct premiums written for the year ended December 31, 2002, increased $96.9 million (10.8%) to $995.8 million in 2002 compared to $898.9 million in 2001 and $881.2 million in 2000. The increase in 2002 included rate increases ($36.7 million) and the effects of the consolidation of 21st of Arizona ($12.9 million). Also, the higher number of insured vehicles in 2002 caused premiums to be $47.3 million higher than in 2001. The increase in 2001 was primarily due to rate increases that more than offset the decline in the number of insured vehicles.
California auto retention was 93% for the year ended December 31, 2002, compared to 92% and 96% for the years ended December 31, 2001 and 2000, respectively. The improvement in 2002 reflects improved service levels and that the Company's major competitors have taken significant rate increases in 2002 and, therefore, its customers are less likely to find more favorable rates elsewhere. In response to rising loss costs beginning in November 2000 and continuing to date, the Company has implemented three base rate increases, made changes in its class plan and adopted stricter underwriting measures. Additionally, as the Company upwardly adjusted its rates, it curtailed advertising for new customers throughout 2000 and most of 2001. During this same period, competitors held rates steady or continued to take decreases. These actions contributed to the declines in retention in 2000 and 2001.
Net premiums earned increased $86.1 million (10.3%) to $924.6 million in 2002, compared to $838.5 million in 2001 and $803.8 million in 2000. The increases in 2002 and 2001 are greater than the proportional increase in the corresponding direct premiums written because of the decrease in the quota share reinsurance arrangement with AIG subsidiaries from 6% in 2001 to
4% in 2002 and from 8% in 2000 to 6% in 2001. In addition, the Company entered into an agreement to cancel future cessions under this treaty as of September 1, 2002. The cancellation resulted in a one-time pre-tax charge of $0.9 million.
Starting in May 2002, the Company began offering motorcycle coverage primarily to its California auto customers. In August 2002, the Company introduced a new private passenger auto policy that does not have certain standard features found in its primary policy. This limited-feature product is similar in most respects to the product offered by many of the Company's competitors and is positioned as a lower-cost alternative for customers who believe they need less coverage than provided by the Company's standard product. In October 2002, the Company enhanced its underwriting guidelines allowing it to provide quotes to certain customers who do not meet California's statutory "good driver" definition but who are considered to be insurable risks within the Company's class plan. Through December 31, 2002, the impact of these new products on the results of operations has been immaterial.
The combined ratio was 98.5% in the year ended December 31, 2002, compared to 103.0% and 105.0% for 2001 and 2000, respectively. Company management remains focused on achieving sustainable 15% growth and a combined ratio of 96%. Since 1980, the Company has simultaneously met those benchmarks only twice (1980 and 1981). The third and fourth quarters of 2002 both marked the first times since 1993 that the Company has achieved both an underwriting profit and growth of 15% in direct premiums written in its auto lines.
In the third quarter of 2002 the Company entered into a catastrophe reinsurance agreement with AIG subsidiaries, Folksamerica Reinsurance Company and Transatlantic Reinsurance Company on its auto lines, which reinsures any covered events up to $30.0 million in excess of $15.0 million. The premium for this reinsurance coverage is approximately $0.1 million per month.
Homeowner and Earthquake Lines in Runoff and All Other. Underwriting results of the homeowners and earthquake lines, which are in runoff, were losses of $58.8 million in 2002, $77.6 million in 2001 and $2.7 million in 2000. This line included $37.2 million for the write-off of software development costs in the third quarter of 2002.
The Company has not written any earthquake coverage since 1994 and ceased writing new homeowner policies in September 2001. The Company has executed various transactions to exit from its homeowner line. Under a January 1, 2002 agreement with Balboa Insurance Company ("Balboa"), a subsidiary of Countrywide Financial Corporation ("Countrywide"), 100% of homeowner unearned premium reserves and subsequent related losses were reinsured by Balboa. Obligations relating to the 1994 Northridge Earthquake are not covered by the agreement with Balboa. The Company began non-renewing homeowner policies expiring on February 21, 2002, and thereafter. Substantially all of these customers are being offered homeowner coverage through an affiliate of Countrywide.
On October 10, 2002, a Los Angeles Superior Court granted the Company's motion for summary judgment in the matter of 21st Century Insurance Company vs. People of the State of California ex rel. Bill Lockyer, Attorney General et al. The court determined that the Company's April 21, 1999, settlement with the California Department of Insurance with respect to regulatory actions arising out of the 1994 Northridge Earthquake was fully valid and enforceable. The Court denied the Attorney General's motion seeking to have the settlement declared void and unenforceable, a result that may have allowed the CDI to reinstitute regulatory proceedings with respect to the Company's handling of claims arising out of the 1994 Northridge Earthquake. The CDI has appealed the ruling.
Since 1997, the Company has engaged an external software development company, Computer Sciences Corporation ("CSC"), to develop and install an advanced personal-lines processing system. The system has four main components: Policy, Claims, Billing, and Customer Service. The system is still in development and currently supports less than 2% of the Company's business. To date, the Company has spent nearly $100 million on this project, most of which was paid directly to CSC. In the third quarter of 2002, it became evident through a series of tests and reviews conducted by the Company that material components of this new system do not perform at levels necessary to support the entire operations of the Company, and the Company recorded a one-time pre-tax charge to write-off $37.2 million of previously capitalized software costs.
complete such software, or $104.4 million in total, is recoverable from cost savings from future operations. However, if the remaining software components cannot be successfully implemented, some or all of the remaining $64.4 million carrying value may be written off (see Critical Accounting Policies - Property and Equipment).
Net realized gains on the sale of investments were $10.4 million in 2002 (gross realized gains were $13.1 million, gross realized losses were $2.2 million and investment expenses were $0.4 million) compared to $5.0 million in 2001 and net realized losses of $5.0 million in 2000. At December 31, 2002, $561.4 million (54.5%) of the Company's total investments at fair value were invested in tax-exempt bonds with the remainder, representing 45.5% of the portfolio, invested in taxable securities, compared to 80.2% and 19.8%, respectively, at December 31, 2001.
As of December 31, 2002, the Company had a pre-tax net unrealized gain of $38.5 million compared to a net unrealized loss on fixed maturity investments of $1.5 million in 2001 and a net unrealized gain of $3.7 million in 2000. The Company recognized no other-than-temporary impairments in 2002, 2001 or 2000 (see discussion under Critical Accounting Policies).
CRITICAL ACCOUNTING POLICIES The Company believes its critical accounting policies are those which require management to make significant assumptions or estimates, and to ascertain the appropriateness and timing of any changes in those assumptions or estimates that can have a material effect on the Company's financial condition, results of operations or cash flows. Specifically, the following areas require management to make such assumptions and estimates each time the Company prepares its financial statements: losses and loss adjustment expenses, particularly the liability for unpaid losses and loss adjustment expenses included in the liability section of the Company's balance sheet; the recoverability of certain property and equipment, deferred income taxes, and deferred policy acquisition costs included in the asset section of the Company's balance sheet; and the review of the Company's investments for possible "other-than-temporary" declines in fair value.
Given the inherent variability in the estimates, management believes the aggregate reserves are within a reasonable and acceptable range of adequacy(1), although the Company continues to caution that the reserve estimates relating to SB 1899(2) are subject to a greater than normal degree of variability and possible future material adjustment as new facts become known. The methods of making such estimates and establishing the resulting reserves are reviewed and updated quarterly and any resulting adjustments are reflected in current operations(3). Changes in the estimates for these liabilities flow directly to the income statement on a dollar-for-dollar basis. For example, an upward revision of $1 million in the estimated liability for unpaid losses and loss adjustment expenses would decrease underwriting profit, and pre-tax income, by the same $1 million amount. Conversely, a downward revision of $1 million would increase pre-tax income by the same $1 million amount.
- --------------- 1 See further discussion in Part 1, Loss and Loss Adjustment Expenses, and in Part 7 under Financial Condition. 2 See Note 1 above and Note 16 of the Notes to Consolidated Financial Statements. 3 See Note 1 above.
At December 31, 2002, the Company's DTAs total $163.9 million, and its DTLs total $75.0 million. The net of those amounts, $88.9 million, represents the net deferred tax asset reported in the consolidated balance sheet.
Portions of the Company's NOL carryforward are scheduled to expire beginning in 2009, as shown in the table of expirations below (amounts in millions):
With the performance of the Company's core business in the past two quarters running close to management's goals of 15% growth in direct written premiums and a 96% combined ratio, management believes it is reasonable to discount the possibility of future underwriting losses and to conclude it is at least more likely than not that the Company will be able to realize the benefits of its DTAs. If necessary, the Company believes it could implement tax-planning strategies, such as investing a higher proportion of its investment portfolio in taxable securities, in order to generate sufficient future taxable income to utilize the NOL carryforwards prior to their expiration. Accordingly, no valuation allowance has been recognized as of December 31, 2002. However, generating future taxable income is dependent on a number of factors, including regulatory and competitive influences that may be beyond the Company's ability to control. Future underwriting losses could possibly jeopardize the Company's ability to utilize its NOLs. In the event underwriting losses due to either SB 1899 or other causes were to persist, management might be required to reach a different conclusion about the realizability of the DTAs and, if so, to recognize a valuation allowance at that time.
Deferred Policy Acquisition Costs. Deferred policy acquisition costs ("DPAC") include premium taxes and other variable costs incurred in connection with writing business. These costs are deferred and amortized over the period in which the related premiums are earned.
The determination of whether a decline in market value is other than temporary is necessarily a matter of subjective judgment. The timing and amount of realized losses and gains reported in income could vary if conclusions other than those made by management were to determine whether an other-than-temporary impairment exists. However, there would be not impact on equity because any unrealized losses are already included in comprehensive income.
The following table summarizes realized gains and losses for the past three years. Additional information has been provided with respect to how long securities sold at a loss in each year were in an unrealized loss position.
The following table summarizes the fair values of fixed maturity securities sold at a loss or at a gain on the date of sale (amounts in thousands):
- --------------- 1 Impact Funding, LLC, is a limited partnership that was established under California's COIN program (California Organized Investment Network), a voluntary association of California insurers providing funding for low cost housing projects.
the Company's audit committee; he is independent of management. Mr. Renken retired as Senior Partner and Chairman, Executive Committee of Southern California, of accounting firm Deloitte & Touche in 1992 after 33 years with the firm.
- - honest and ethical conduct, including the ethical handing of actual or apparent conflicts of interest between personal and professional relationships;
The Company requires an annual attestation by applicable officers, directors and employees that they are in compliance with these policies. The Company's Board of Directors granted no conflict of interest waivers in 2002.
FORWARD-LOOKING STATEMENTS The Company's management has made in this report, and from time to time may make in its public filings, press releases, and oral presentations and discussions, forward-looking statements concerning the Company's operations, economic performance and financial condition. Forward-looking statements include, among other things, discussions concerning the Company's potential, expectations, beliefs, estimates, forecasts, projections and assumptions. Forward-looking statements may address, among other things, the Company's strategy for growth, underwriting results, product development, computer systems, regulatory approvals, market position, financial results, dividend policy and reserves. It is possible that the Company's actual results, actions and financial condition may differ, possibly materially, from the anticipated results, actions and financial condition indicated in these forward-looking statements. Important factors that could cause the Company's actual results and actions to differ, possibly materially, from those in the specific forward-looking statements include the effects of competition and competitors' pricing actions; adverse underwriting and claims experience, including revived claims under SB 1899; systems and customer service problems; adverse developments in financial markets or interest rates; and results of legislative, regulatory or legal actions, including the inability to obtain approval for rate increases and product changes and adverse actions taken by state regulators in market conduct examinations. The Company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
We have audited the accompanying consolidated statements of operations, stockholders' equity, and cash flows of 21st Century Insurance Group and subsidiaries for the year ended December 31, 2000. Our audit also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations, stockholders' equity and cash flows of 21st Century Insurance Group and subsidiaries for the year ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
21ST CENTURY INSURANCE GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002
21st Century Insurance Group is an insurance holding company founded in 1958 and incorporated in California. The term "Company," unless the context requires otherwise, refers to 21st Century Insurance Group and its consolidated subsidiaries, all of which are wholly owned: 21st Century Insurance Company, 21st Century Casualty Company, 21st Century Insurance Company of Arizona(1) ("21st of Arizona"), 20th Century Insurance Services, inc., and i21 Insurance Services. The latter two companies are not property and casualty insurance subsidiaries, and their results are immaterial.
Unrealized investment gains and losses, net of any tax effect, are included as an element of accumulated other comprehensive income (loss), which is classified as a separate component of stockholders' equity.
Where declines in values of securities below cost or amortized cost are considered to be other than temporary, a charge is reflected in income for the difference between cost or amortized cost and fair value. No such charges were recorded in 2002, 2001 or 2000.
RECOGNITION OF REVENUES Insurance premiums and reinsurance ceding commissions are recognized pro rata over the terms of the policies. The unearned portion of premiums is included in the Consolidated Balance Sheets as a liability for unearned premiums. Installment and other fees for services are recognized in the periods the services are rendered.
DEFERRED POLICY ACQUISITION COSTS Deferred policy acquisition costs ("DPAC") include premium taxes and other variable costs incurred in connection with writing business. These costs are deferred and amortized over the period in which the related premiums are earned. The Company does not consider anticipated investment income in determining the recoverability of these costs. Based on current indications, management believes that these costs will be fully recoverable and, accordingly, no reduction in DPAC has been recognized.
LOSSES AND LOSS ADJUSTMENT EXPENSES The estimated liabilities for losses and loss adjustment expenses ("LAE") include the accumulation of estimates of losses for claims reported prior to the balance sheet dates, estimates (based upon actuarial analysis of historical data) of losses for claims incurred but not reported and for the development of case reserves to ultimate values, and estimates of expenses for investigating, adjusting and settling all incurred claims. Amounts reported are estimates of the ultimate costs of settlement, net of estimated salvage and subrogation. These estimated liabilities are necessarily subject to the outcome of future events, such as changes in medical and repair costs as well as economic and social conditions that impact the settlement of claims. Management believes that, given the inherent variability in any such estimates, the aggregate reserves are
INCOME TAXES Deferred income tax assets and liabilities are determined based on the differences between the financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws.
NEW ACCOUNTING PRONOUNCEMENTS. FAS 148, Accounting for Stock-based Compensation, amends FAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. The effect of this change would be the expensing of the value of the Company's stock-based compensation rather than the current disclosure of the pro forma effect of the stock-based compensation in the footnotes to the financial statements. The amendment is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. The Financial Accounting Standards Board ("FASB") Interpretation No. 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. The Company has no guarantees of this nature.
For each of the three years in the period ended December 31, 2002, the numerator for the calculation of both basic and diluted (loss) earnings per common share is equal to net (loss) income reported for that year. The denominator for the computation of basic (loss) earnings per share was 85,414,076 shares, 85,340,461 shares and 85,186,084 shares for 2002, 2001 and 2000, respectively. The denominator for diluted (loss) earnings per share was 85,414,076 shares, 85,340,461 shares and 85,397,099 shares for 2002, 2001 and 2000, respectively. The difference between basic and diluted (loss) earnings per share denominators is due to employee restricted stock grants and stock options.
Cash and securities with carrying values of $6.8 million and $12.4 million were deposited by the Company's subsidiaries under requirements of regulatory authorities as of December 31, 2002 and 2001.
Years Ended December 31, 2002 2001 2000 - ---------------------------------------------------------- Interest on fixed maturities $45,777 $44,722 $48,411 Interest on cash equivalents 922 1,602 2,265 Investment expense (354) (394) (330) - ---------------------------------------------------------- Net investment income $46,345 $45,930 $50,346 - ----------------------------------------------------------
Amortized Fair Cost Value - -------------------------------------------- Fixed maturities due: 2003 $ 4,022 $ 4,098 2004-2007 33,213 35,516 2008-2012 311,671 326,543 2013 and thereafter 537,141 558,424 - ------------------------------------------- Total $ 886,047 $924,581 - -------------------------------------------
A reconciliation of income tax computed at the federal statutory tax rate of 35% to total income tax expense follows:
Depreciation expense on software currently in service was $9.6 million, $10.4 million and $4.1 million in 2002, 2001 and 2000, respectively. Substantially all software development projects in progress are expected to be completed by 2004.
A summary of future minimum lease payments under the capital lease follows:
2003 $12,799 2004 13,962 2005 13,962 2006 13,962 2007 13,962 ------------------------------------------------ Net minimum lease payments 68,647 Less: amount representing interest 8,647 ------------------------------------------------ Present value of minimum lease payments $60,000 ------------------------------------------------
Accounting principles require insurers to record estimates for loss and LAE in the periods in which the insured events, such as automobile accidents, occur. This estimation process requires the Company to estimate both the number of accidents that may have occurred (called "frequency") and the ultimate amount of loss and LAE (called "severity") related to each accident. The Company employs experts called "actuaries" who are professionally trained and certified in the process of establishing estimates for frequency and severity. From time to time, external actuarial experts are engaged from consulting firms to review the work of the Company's actuaries.
Quarterly, the Company's actuaries prepare a new evaluation of loss and LAE indications by accident year, and the Company assesses whether there is a need to adjust reserve estimates pertaining to previous accounting periods. As claims are reported and settled and as other new information becomes available, changes in estimates are made and are included in earnings of the period of the change.
The increases in prior accident year estimates recorded in each of the past three years, net of applicable reinsurance, are summarized below:
For the years ended December 31, 2002 2001 2000 - ------------------------------------------------------------ Personal auto $16,200 $ 45,742 $42,178 Homeowner and Earthquake 56,158 72,265 2,845 - ------------------------------------------------------------ $72,358 $118,007 $45,023 - ------------------------------------------------------------
The following table shows unpaid losses and LAE on a gross and net basis:
At December 31, 2002 and 2001, the Company's reinsurance recoverables, net of payables, from AIG subsidiaries were $18.4 million and $38.8 million, respectively.
- --------------- 1 The Company's homeowner policies do not include any earthquake coverage. 2 This catastrophe coverage does provide protection from the potential for fire following an earthquake and other catastrophes.
discretion as to choice and investment duration, including any amounts the employee elects to invest in Company common stock.
The Company sponsors non-contributory defined benefit pension plans, which cover essentially all employees who have completed at least one year of service. For certain key employees designated by the Board of Directors, the Company sponsors an unfunded supplemental executive retirement plan. The supplemental plan benefits are based on years of service and compensation during the three highest of the last ten years of employment prior to retirement and are reduced by the benefit payable from the pension plan. For other eligible employees, the pension benefits are based on employees' compensation during all years of service. The Company's funding policy is to make annual contributions as required by applicable regulations. At December 31, 2002, the pension plans' assets were comprised of 21% fixed income securities, 58.9% stock index mutual funds and 20.1% cash. Other information regarding the Company's defined benefit pension plans follows:
The Company leases office space in Woodland Hills, California. The lease expires in February 2015 and may be renewed for two consecutive five-year periods. The Company also leases automobiles and office equipment as well as office space in several other locations throughout California, primarily for claims services. Minimum rental commitments under the Company's lease obligations are as follows:
Rental expense charged to operations for the years ended December 31, 2002, 2001 and 2000 was $16.4 million, $15.6 million and $15.5 million, respectively.
The Company is authorized to issue up to 500,000 shares of preferred stock, $1 par value, and 376,126 shares of Series A convertible preferred stock, $1 par value, none of which were outstanding at December 31, 2002 or 2001.
Shares of common stock issued pursuant to the exercise of employee stock options and restricted stock grants were 69,657 in 2002, 39,893 in 2001 and 234,300 in 2000. Shares of common stock repurchased by the Company in 2000 numbered 883,400. No shares were repurchased in 2002 or 2001.
1995 STOCK OPTION PLAN The aggregate number of common shares authorized under the plan currently is limited to 10,000,000. At December 31, 2002, 4,382,232 common shares remain available for future grants. The plan has been approved by the Company's stockholders, and all options granted have ten-year terms. As a consequence of AIG's acquiring a controlling interest in the Company, vesting was accelerated for all options previously granted through July 27, 1998. Options granted after July 27, 1998, vest over various future periods.
For pro forma disclosure purposes, the fair value of stock options was estimated at each date of grant using the following assumptions:
RESTRICTED SHARES PLAN The Restricted Shares Plan, which was approved by the Company's stockholders, currently provides for grants of up to 1,421,920 shares of common stock to be made available to key employees. Twenty percent of the number of shares granted vest on the anniversary date of each of the five years following the year of grant. Upon issuance of grants under the plan, unearned compensation equivalent to the market value on the date of grant is charged to common stock and subsequently amortized in equal monthly installments over the five-year vesting period of the grant. Total amortization expense relating to the Restricted Shares Plan was $0.5 million, $0.7 million and $0.2 million in 2002, 2001 and 2000, respectively. Unamortized restricted stock grants totaled $1.0 million, $1.8 million and $3.3 million at the end of 2002, 2001 and 2000, respectively.
Statutory surplus and statutory net (loss) income for the Company's insurance subsidiaries were as follows:
The Company is also regulated by the provisions of the California Insurance Holding Company System Regulatory Act (the "Holding Company Act"). Many transactions that are defined to be of an "extraordinary" nature may not be effected without the prior approval of the CDI. In addition, there are limits on the insurance subsidiaries' dividend paying capacity. In 2003, the Company estimates that its insurance subsidiaries have capacity to pay approximately $21.6 million in dividends to their parent without prior approval of the CDI.
Effective January 1, 2001, the State of California required that domiciliary insurance companies prepare their statutory-basis financial statements in accordance with the NAIC Accounting Practices and Procedures Manual (Codification). As a result of adopting the Codification, the Company's statutory capital and surplus increased by approximately $35 million in 2001, mainly due to the treatment accorded previously nonadmitted deferred tax assets.
In the normal course of business, the Company is named as a defendant in lawsuits related to claim and insurance policy issues, both on individual policy files and by class actions seeking to attack the use of various databases, vendors and claims practices generally. Many suits seek generally unspecified extracontractual and punitive damages as well as contractual damages far in excess of the Company's estimates. The Company cannot estimate the amount or range of loss that could result from an unfavorable outcome on these suits. It denies liability for any such alleged damages and believes that it has a number of valid defenses to the litigation. The Company has not established reserves for potential extracontractual or punitive damages, or for damages in excess of estimates the Company believes are correct and reasonable. Nevertheless, extracontractual and punitive damages, if assessed against the Company, could be material in an individual case or in the aggregate. The Company may choose to settle litigated cases for amounts in excess of its own estimate of contractual damages to avoid the expense and/or risk of litigation.
On October 10, 2002, a Los Angeles Superior Court granted the Company's motion for summary judgment in the matter of 21st Century Insurance Company vs. People of the State of California ex rel. Bill Lockyer, Attorney General et al. The court determined that the Company's April 21, 1999, settlement with the California Department of Insurance ("CDI") with respect to regulatory actions arising out of the 1994 Northridge Earthquake was fully valid and enforceable. The Court denied the Attorney General's motion seeking to have the settlement declared void and unenforceable, a result that may have allowed the CDI to reinstitute regulatory proceedings with respect to the Company's handling of claims arising out of the 1994 Northridge Earthquake. The CDI has appealed the ruling.
Bryan Speck, individually, and on behalf of others similarly situated v. 21st - ----------------------------------------------------------------------------- Century Insurance Company, 21st Century Casualty Company, and 21st Century - -------------------------------------------------------------------------- Insurance Group, was filed on June 20, 2002 in Los Angeles Superior Court. The - --------------- plaintiff seeks national class action certification, injunctive relief, and unspecified actual and punitive damages. The complaint contends that 21st Century uses "biased" software in determining the value of total-loss automobiles. The plaintiff alleges that database providers use improper methodology to establish comparable auto values and populate their databases with biased figures. 21st Century and other carriers allegedly subscribe to the programs to unfairly reduce claim costs. This case is consolidated with similar actions against other insurers for discovery and pre-trial motions. 21st Century intends to vigorously defend the suit with other defendants in the coordinated proceedings.
SB 1899, effective from January 1, 2001, to December 31, 2001, allowed the re-opening of previously closed earthquake claims arising out of the 1994 Northridge Earthquake. The Company's first constitutional challenge to SB 1899 came to an unsuccessful result on April 29, 2002, when the United States Supreme Court refused to hear the Company's case (see Note 16 of the Notes to Consolidated Financial Statements). A subsidiary of the Company, 21st Century Casualty Company, filed a new challenge to the constitutionality of SB 1899 on February 13, 2003. The viability of this case is being reviewed as a result of a subsequent Ninth Circuit Court
of Appeals decision. The Company currently has lawsuits pending against it in connection with claims under SB 1899; many of these lawsuits have multiple plaintiffs. Damages in excess of the Company's reasonable estimates for these claims could be material individually or in the aggregate.
The Company has filed a civil complaint against California-based Unlimited Adjusting Company ("Unlimited") and its principal Jung Ho Park ("John Park"). The suit alleges Unlimited and John Park illegally induced insureds into filing additional unnecessary and fraudulent claims with the Company stemming from the 1994 Northridge Earthquake. The Company is ultimately seeking up to $10 million in compensatory damages.
The Company cautions that the recorded estimates for this event are subject to a greater than normal degree of uncertainty for a variety of reasons.
First, determining in 2001 and subsequently whether alleged damage was caused or exacerbated by a 1994 earthquake is inherently difficult. Company experts and experts representing claimants could have materially different views of both causation and the necessity and cost of a particular method of repair. The purpose of the one-year time period in the policy is precisely to avoid the problems inherent in attempting to adjust stale claims. In the event of a difference of opinion, an expensive mediation or litigation process is needed to obtain resolution. Results from this process, particularly the jury process, are not predictable with precision.
Fourth, additional Northridge Earthquake claims have been filed in 2002 outside of the reporting window established by SB 1899. The Company currently has approximately 40 such claims that are apparently based on alternative legal theories. Thus, the Company could continue to receive additional Northridge Earthquake claims in the future that may require additional reserves.
Although approximately one-third of the SB 1899 claims are settled, more than two-thirds of the remaining claims are in litigation and thus may prove more difficult to settle.
Third quarter 2002 and fourth quarter 2001 results were impacted by $46.9 and $50.0 million, respectively, related to earthquake claims arising out of California Senate Bill 1899. In addition, the third quarter of 2002 included a charge of $37.2 million for the write-off of software development costs, and the fourth quarter of 2001 included a charge of $9.6 million associated with workforce reductions and the settlement of litigation matters.
- --------------- 1 Basic and diluted amounts are the same for all periods presented.
- --------------- 1 The ratio cannot be calculated, as the denominator is zero.
Effective January 1, 2002, the Company acquired AIG's 51% interest in 21st Insurance Company of Arizona (21st of Arizona). The Company previously held a 49% interest in 21st of Arizona, which writes personal auto exclusively in Arizona. The Company's primary purpose in acquiring 21st of Arizona was to provide an additional entity to facilitate the Company's planned expansion into other states.
The purchase price was $4.4 million, which approximated 51% of 21st of Arizona's GAAP book value. No research and development assets were acquired, and no goodwill was recorded.
The following is a summarized balance sheet of 21st of Arizona as of December 31, 2001.