The Company's revenues have consisted primarily of premiums earned from workers' compensation insurance underwriting, premiums earned from group medical insurance, commission income, net investment income and other income. Premiums earned during a period are the direct premiums earned by the Company on in force policies, net of reinsurance. Commission income is earned from Pan Am's distribution of insurance for insurers other than PICO and PACO. The
commission the Company pays to Pan Am is eliminated when the Company's operations are consolidated. Net investment income represents earnings on the Company's investment portfolio, less investment expenses. Other income consists of TPA fees and other miscellaneous items.
The following combined ratio information is derived from the insurance subsidiaries, PICO and PACO, GAAP operating results:
Net premiums earned. The Company's net premiums earned for 2000 increased 21.3% to $98.2 million from $81.0 million in 1999. The increase in net premiums earned is due to the impact of $32.9 million in premiums ceded during the nine months the Reliance treaties were in effect in 1999. Prior to the impact of quota share agreements, premiums earned for 2000 decreased 17.1% to $93.8 million from $113.0 million in 1999.
Commission income. Commission income increased 32.1% to $6.3 million for 2000 from $4.8 million for 1999. The increase is due to a full year's operating results for the two new California offices which were acquired effective April 30, 1999, rate increases on underlying workers' compensation and accident and health policies, as well as increased premiums placed with insurance carriers other than PICO and PACO. Commission income paid by PICO and PACO to Pan Am is eliminated in consolidation.
Net realized investment gains and losses. The Company had net realized investment losses of $5.6 million for 2000 compared to $1.5 million for 1999. In 2000, the Company recorded an impairment loss of $3.3 million related to its investment in Montlake. In 1999, the Company realized an "other than temporary" decline of $1.6 million on a non-performing investment.
The accident year loss ratio in 2000 was 75.7% compared to a 1999 adjusted accident year loss ratio of 92.0%. The improvement in the accident year loss ratio in 2000 was largely due to increased rates on the California book of business.
Operating expenses. Operating expenses increased 5.1% to $34.5 million for 2000 from $32.8 million for 1999. Operating expenses in 1999 include the benefit of $6.9 million in ceding commissions received in conjunction with the Reliance reinsurance arrangements. The GAAP expense ratio for 2000 was 27.2% compared to an adjusted expense ratio of 29.7% for 1999. The adjusted expense ratio for 1999 eliminates the impact of low layer reinsurance treaties, which were not in effect in 2000. Expense reductions at the insurance companies were largely offset by increased expenses at Pan Am, principally related to the acquisition of two new branch offices effective May 1, 1999.
Net premiums earned. The Company's net premiums earned for 1999 decreased 37.1% to $81.0 million from $128.8 million in 1998. The decline in net premiums earned is due to the factors discussed above related to gross premiums written, as well as the impact of $32.9 million in premiums ceded during the nine months the Reliance treaties were in effect.
Commission income. Commission income increased 47.7% to $4.8 million for 1999 from $3.2 million for 1998. The increase is due to the acquisition by Pan Am of two new California offices which was effective April 30, 1999, as well as increased premiums placed with insurance carriers other than PICO and PACO, which generates non-risk fee income for the Company. Commission income paid by PICO and PACO to Pan Am is eliminated in consolidation.
Net investment income. Net investment income increased 1.6% to $9.7 million for 1999 from $9.5 million for 1998. Average invested assets increased to $160.8 million for 1999 from $156.9 million for 1998. The Company's average yield on its portfolio was 6.0% in 1999 and 6.1% in 1998.
Net income (loss). Net loss for 1999 was $13.7 million compared to $4.9 million in 1998. The 1999 and 1998 net losses are primarily attributable to actions taken by the Company to increase loss reserves on the 1997 and 1998 accident years.
In March 1997, PAULA Financial entered into the Credit Agreement with a commercial bank providing PAULA Financial with a revolving credit facility of $15.0 million until December 31, 1999. On December 31, 1999, PAULA Financial elected to convert all of the borrowings into a term loan maturing on December 31, 2001. At the date of conversion, the line of credit had an outstanding balance of $15.0 million and an interest rate of 8.5%. As of December 31, 2000, the outstanding balance was $11.3 million. The use of the credit facility was for repurchase of the Company's common stock and investments in new ventures.
The original Credit Agreement contained various financial covenants such as minimum stockholders' equity, minimum statutory surplus, a ratio of debt to stockholders' equity, a ratio of PICO's premiums written to statutory surplus, and a debt service coverage ratio. The Amendment includes waivers for prior violations of certain covenants and modifies or eliminates selected covenants going forward. The Company believes it will be in compliance with the remaining covenants during 2001.
The Credit Agreement also limits the Company's ability to (i) enter new lines of business; (ii) incur or assume debt; (iii) pay dividends and repurchase or retire capital stock; and (iv) make acquisitions, investments and capital expenditures. Under the terms of the Amendment, in the event of default in 2001, the interest rate would increase by 2.0%. Each of PAULA Financial's non-insurance subsidiaries has guaranteed all obligations of PAULA Financial under the Credit Agreement. Additionally, under the terms of the Amendment, the Company has pledged as collateral its stock in PAULA Insurance Company.
Management believes that funds currently available, funds released upon the liquidation of PACO and expense reimbursements and dividends from its non-regulated operating subsidiaries will be sufficient to meet the required principal and interest payments except for a portion of its December 31, 2001 balloon payment. The Company has already begun the process of identifying financing to fully meet its December 31, 2001 payment obligation. Management believes that such financing is available and can be obtained under appropriate and reasonable terms. As alternatives, the Company could sell or securitize non-regulated assets sufficient to meet the remaining obligation. While the Company believes that it is remote that it will not meet its required principal and interest payments when due, in the event of default, the commercial bank may exercise the rights and remedies available to it under law. These remedies could be adverse to the Company's financial condition.
In connection with, and because it desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers to recognize the existence of certain forward-looking statements in this Form 10-K and in any other statement made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Some forward-looking statements may be identified by the use of terms such as "expects," "believes," "anticipates," "intends," or "judgment." Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties, many of which are beyond the Company's control and many of which, with respect to future business decisions, are subject to change. Examples of such uncertainties and contingencies include, among other important factors, those affecting the insurance industry in general, such as the economic and interest rate environment, legislative and regulatory developments and market pricing and competitive trends, and those relating specifically to the Company and its businesses, such as the level of its insurance premiums and fee income, the claims experience of its insurance products, the performance of its investment portfolio, acquisitions of companies or blocks of business, and the ratings by major rating organizations of its insurance subsidiaries. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. The Company disclaims any obligation to update forward-looking information.
PAULA Financial and subsidiaries (collectively referred to as "the Company") is an integrated insurance organization specializing in the production, underwriting and servicing of workers' compensation and accident and health insurance for agribusiness clients in California, Arizona, Oregon, Idaho, Alaska, Texas, Florida, New Mexico and Nevada. For the year ended December 31, 2000, California accounted for 55% of premiums earned. The Company operates from many offices located throughout prime agricultural areas and places coverage with its insurance company subsidiaries and nonaffiliated insurance companies.
Realized gains and losses on sales of investments are computed on the specific-identification basis.
Fixed maturities and invested cash with a book value of $136,311 were on deposit with various regulatory authorities as of December 31, 2000 as required.
In early 1999, the Company made an investment in the recently formed Montlake Insurance Holdings, LLC ("Montlake"), the parent company of Montlake Casualty Company, Ltd., a specialty workers' compensation insurance company. The Company made an initial investment of $5,500 for a 21% equity position and has the option to acquire additional equity. The Company is accounting for its investment in Montlake using the equity method and as such recognizes its share of the net earnings or loss of the unconsolidated affiliate in its consolidated statement of operations.
As of December 31, 2000, Montlake had total assets of $26,268 and net equity of ($3,157). For the year ended December 31, 2000, Montlake had a net loss of $6,493. Based on Montlake's unfavorable 2000 operating results, specifically adverse loss development at its Bermuda captive, which is in run-off, the Company has recorded an impairment loss of $3,273 to reduce the carrying value of its investment in Montlake to $0 as of December 31, 2000.
As of December 31, 1999, Montlake, had total assets of $14,821 and net equity of $3,336. For the year ended December 31, 1999, Montlake had a net loss of $2,385. The Company recognized a loss of
$506 for the year ended December 31, 1999. During 1999, Montlake reimbursed the Company for $325 in expenses incurred by the Company on Montlake's behalf.
The insurance subsidiaries underwrite workers' compensation, accident and health and life insurance policies. Participating workers' compensation policies represented approximately 25%, 18%, and 28% of net written premium for the years ended December 31, 2000, 1999 and 1998, respectively. Dividends are recorded as a liability based on estimates of ultimate amounts expected to be declared by the insurance subsidiaries' Boards of Directors, at their discretion.
The EPS calculations for the years ended December 31, 2000, 1999 and 1998 were based upon the weighted average number of shares of common stock outstanding. The EPS-assuming dilution calculations were based upon the weighted average number of shares of common stock outstanding adjusted for the effect of convertible securities, and options and warrants considered common stock equivalents. Stock options and warrants are considered to be common stock equivalents, except when their effect is antidilutive.
Unrealized investment gains (losses) on common stock at December 31, 2000 and 1999 are as follows:
Until August 2000, an affiliate of a significant holder of the Company's stock also acted as one of the Company's investment advisors. Fees paid for such investment services totaled $212, $264, and $244 in 2000, 1999 and 1998, respectively.
The unfavorable incurred development for prior periods in 2000 in the liability for unpaid losses and loss adjustment expenses is principally due to reserve development on the 1998 accident year. The continued development on the 1998 accident year was largely attributable to extended claim durations for the California book of business. To a lesser extent, the 1999 accident year also had adverse reserve development, principally related to experience in Texas.
The unfavorable incurred development for prior periods in 1998 in the liability for unpaid losses and loss adjustment expenses is due to reserve development on the 1997 accident year for the California book of business in excess of what was anticipated given past reserving trends.
Each of the Company's non-insurance subsidiaries has guaranteed all obligations of PAULA Financial under the Credit Agreement. Additionally, under the terms of the Amendment, the Company has pledged as collateral its stock in PAULA Insurance Company.
The Company and its subsidiaries file a consolidated Federal income tax return. Income tax benefit for the years ended December 31, 2000, 1999 and 1998 is shown as follows:
The recoverability of the net deferred tax asset is demonstrated by anticipated future operating results, available tax planning strategies and taxes paid in prior years. Management believes that it is more likely than not that the results of future operations and various tax planning strategies will generate sufficient taxable income in the periods necessary to realize the net deferred tax asset.
The Company received Federal income tax refunds of $326 during the year ended December 31, 2000. The Company received Federal income tax refunds of $955 and made Federal income tax payments of $326 during the year ended December 31, 1999. The Company received Federal income tax refunds of $1,552 and made Federal income tax payments of $65 during the year ended December 31, 1998.
At December 31, 2000, the Company had a tax net operating loss carryforward of $19,301 that begins to expire in 2018.
A large portion of the reinsurance is effected under reinsurance contracts known as treaties. PAULA Insurance Company ("PICO") maintains excess of loss and catastrophic reinsurance arrangements to protect it against losses above its retention on workers' compensation policies. Additionally, PICO has also chosen from time to time to quota-share a portion of its retained claims exposure. In a quota share reinsurance contract, the Company and the reinsurer share premiums, losses and loss adjustment expenses on a proportional basis based on each party's interest in the quota-shared risk.
In the fourth quarter of 1998, PICO entered into a two-year excess of loss reinsurance arrangement with a retention of $50. Concurrent with this agreement, PICO entered into an excess of loss agreement which covers a portion of the losses in the $40 excess of $10 layer and a quota-share agreement which covers a portion of losses below $10. These treaties were settled and commuted effective September 30, 1999. On January 27, 2000, the Company received a $41,989 cash settlement. The settlement amount included the return of net premiums ceded during the twelve months the treaty was in effect plus a substantial break-up fee. The Company recorded a $773 loss as a result of this transaction. The settlement was accounted for as a commutation.
become exercisable to purchase PAULA common stock with a value equal to two times the Right's exercise price. In addition, if on or after such event the Company is merged out of existence or 50% or more of its assets or earning power are sold, each Right (other than Rights held by the 10% stockholder) will become exercisable to purchase common shares of the acquiring corporation with a value equal to two times the Right's exercise price. The Rights expire in ten years unless previously triggered and are subject to redemption by the Board of Directors prior to being triggered.
Employees of the Company receive an annual year-end bonus based upon the results of the Company. Amounts expensed under bonus programs were $280, $432 and $641 for the years ended December 31, 2000, 1999 and 1998, respectively.
In 1998, the Company implemented a key employee/consultant loan program which provides funds exclusively for the borrowers' purchase of Company stock. The Company has authorized loans of up to $1,000. The loans are full recourse, bear interest at the rate of 8.5% per annum, payable quarterly, have a three-year maturity and are secured by the stock purchased. The loan program was reviewed and approved by the Compensation Committee of the Board of Directors. As of December 31, 2000 and 1999, the Company had extended loans in the amount of $570. Such amounts are included in other receivables in the accompanying consolidated financial statements.
The fair value for options granted in 2000, 1999 and 1998 was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions: risk-free interest rate of 6.0% in 2000 and 1999 and 5.3% in 1998, average option exercise period of seven years, and a volatility factor of 50%. The fair value for options granted prior to 1998 was estimated at the date of grant using the minimum value method. The risk-free interest rate used for options granted during 1995 and 1996 was 6.4%. An average option exercise period of seven years was used. Pro forma net loss does not reflect options granted prior to 1995. During the initial phase-in period of SFAS 123, the full impact of calculating compensation cost for stock options is not reflected in the pro forma net loss amounts presented above because compensation cost is reflected over the options' vesting periods and compensation cost for options granted prior to January 1, 1995 is not considered.
The insurance subsidiaries are required to file statutory financial statements with state insurance regulatory authorities. Accounting practices used to prepare these statutory financial statements differ from generally accepted accounting principles ("GAAP"). Such differences include the following: (1) reserves for losses and loss adjustment expenses must meet certain minimum requirements, (2) reserves for policyholder dividends are recorded as a restriction on surplus until declared, (3) Federal income taxes are recorded when payable, (4) fixed maturities are carried at admitted values, (5) certain assets are non-admitted and (6) acquisition expenses are expensed when incurred. Amounts reported to regulatory authorities as compared to amounts included in the accompanying
consolidated financial statements on a GAAP basis for the years ended December 31, 2000, 1999 and 1998 follow:
Statutory accounting practices for the insurance subsidiaries are prescribed or permitted by the Department of Insurance of the State of California ("California DOI"). Prescribed accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC") as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state and may change in the future. Furthermore, the NAIC's project to codify statutory accounting practices was approved by the NAIC in March 1998. The approval included a provision for commissioner discretion in determining appropriate statutory accounting for insurers in their state. Consequently, prescribed and permitted accounting practices may continue to differ from state to state. Codification became effective on January 1, 2001. The implementation of codification resulted in an increase in PICO's statutory surplus of $1.2 million. There was no material impact in PACO's statutory surplus.
Insurance regulatory authorities impose various restrictions on the payment of dividends and advances by insurance companies. As of December 31, 2000, the maximum dividend and advance payments that may be made during 2001 by PACO to PAULA Financial without prior approval of the regulatory authorities are limited to the greater of net income for the preceding year or 10% of policyholder surplus as of the preceding December 31 and approximate $288.
Effective January 2001, the Company entered into a one-year service agreement with InsureTrade.com. Future obligations under the service agreement are not material. InsureTrade.com is a subscription-based, internet-enabled, supply chain management solution that facilitates property and casualty insurance transactions. The Chairman and Chief Executive Officer of the Company is also the founder and Chairman of InsureTrade.com.
The following table sets forth the different levels of RBC that may trigger regulator involvement and the actions that may be triggered:
The comprehensive plan required at the Company Action Level and certain other levels must: (i) identify the conditions in the insurer that contribute to the failure to meet the capital requirements; (ii) contain proposed corrective actions that the insurer intends to make and that would be expected to result in compliance with capital requirements; (iii) provide certain projections of the insurer's financial results for the current year and at least the four succeeding years; (iv) identify key assumptions impacting the insurer's projections and the sensitivity of the projections to the assumptions; and (v) identify the quality of, and problems associated with, the insurer's business, including, but not