Net premiums written for 2002, 2001 and 2000 reflect the Company’s recognition of written premiums on the effective date of the policy rather than on the date premiums were billed. This change had no impact on earned premiums.
Basic earnings (loss) per share of common stock at December 31, 2002, 2001, 2000, 1999 and 1998 are computed using the weighted average number of common shares outstanding during the year of 9,322,249, 9,333,425, 9,375,735, 11,383,592 and 12,074,272, respectively. Diluted earnings per share of common stock at December 31, 2002, 2001, 2000, 1999 and 1998 are computed using the weighted average number of common shares outstanding during the year of 9,322,249 9,333,425, 9,382,494, 11,403,081 and 12,089,013, respectively. For further discussion of basic earnings per share and diluted earnings per share, see the “Notes to Consolidated Financial Statements.”
In 2000, 2001 and 2002, the Company derived approximately 23%, 29% and 31% of its healthcare liability earned premium volume, respectively, from policies issued outside the state of California, principally under the Brown & Brown and nonstandard physician programs. In 2001, the Company recognized that these programs were seriously underpriced and implemented significant premium increases, averaging approximately 40% and 30% in 2001 and 2002, respectively, in its principal non-California markets, and immediately instituted more stringent underwriting and pricing guidelines in these states. Despite the significant price increases and more stringent underwriting guidelines, the non-California programs produced significant underwriting losses in 2000, 2001 and 2002.
The Company and Brown & Brown agreed to terminate both the physician and dental programs no later than March 6, 2003. During 2002, the Company continued to issue and renew those policies under the Brown & Brown programs that satisfy the stringent underwriting standards. The Company applied these same standards to the nonstandard physician policies renewed outside California. As of December 31, 2001, 2,997 policies were in force related to the Brown & Brown program. That number was reduced to 813 policies as of December 31, 2002. The Company issued no new nonstandard physician policies outside of California in 2002.
During 2003, the Company will concentrate its efforts on maintaining its core physician and medical group business in California and Delaware. The Company does not expect to initiate any significant new programs outside California during 2003.
The Company rapidly expanded its assumed reinsurance operations since it formed the division in late 1999. Written premiums were $112.8, $112.2 and $30.5 million, respectively for 2002, 2001 and 2000. Earned premiums, which lag behind written premiums, were $122.5, 79.5 and $27.1 million, respectively for 2002, 2001 and 2000.
Loss experience in this segment is based significantly on actuarial estimates, as actual losses are still in their early stages of development. In 2001, the unprecedented September 11, 2001, terrorist attack materially impacted the results in this segment. The Company identified losses of $19.6 million, net of reinsurance benefit as of December 31, 2001, and a further $15.4 million in losses has been recorded in 2002.
The Company underwrites professional and related liability policy coverages for physicians (including oral and maxilofacial surgeons), physician medical groups and clinics, hospitals, dentists, managed care organizations and other providers in the healthcare industry. As a result of the Company’s withdrawal from certain segments of the healthcare industry, the premiums earned are split between core and non-core premium. Core premium represents California and Delaware business excluding the Brown & Brown dental program and hospital business. Non-core business represents other state business related to the Brown & Brown and hospital programs including those in California. The following table summarizes by core and non-core business the underwriting results of the direct healthcare liability insurance segment for the periods indicated.
Premiums written decreased in 2002 to $21.9 million from $56.9 million in 2001 and $80.6 million in 2000. This resulted from significant average rate increases of 40% and 30% in 2001 and 2002, respectively, being offset by even more significant declines in the number of Brown & Brown insureds in 2002 from 2,997 at December 31, 2001, to 813 insureds at December 31, 2002. The increases in rates and the significant decline in insureds resulted from the Company’s remedial actions taken to mitigate the significant losses arising from this business. After March 6, 2003, no new or renewal business will be written in the non-core programs as the Company exists these markets. The decrease in written premium in 2001 was primarily the result of this decline in hospital writings. Premium earned in the non-core direct healthcare liability insurance business decreased as the Company began its withdrawal from states other than California and Delaware and its hospital program wound down in 2002 and 2001 and written premium declined.
The underwriting expense ratio increased in 2001 versus 2000 as the Company expensed previously deferred acquisition costs in 2001 in light of the unprofitability of the non-core business. The underwriting expense ratio changed from 48.2% in 2001 to 20.3% in 2002. The primary reason for the change was the expense charge in 2001 of acquisition costs previously deferred and the impact of closing out of state offices.
The loss ratio declined in 2002 to 100.4% from 105.9% in 2001. The year 2002 and 2001 loss ratios were impacted by 12.6 and 24.7 percentage points, respectively, because of the World Trade Center terrorist attack. The loss ratios without the effect of the World Trade Center terrorist attack were 87.8% and 81.2% for 2002 and 2001 respectively. This increase represents changes in 2002 to the initial estimates of loss ratios for prior years as more information became available and was reported to the Company.
As a result of the Insurance Subsidiaries’ decline in statutory surplus in 2001 and the resulting impact on the capital adequacy ratios under the A.M. Best and NAIC capital adequacy models, the Company attempted to raise additional capital in the first half of 2002. Due to market conditions at that time, its capital raising efforts were unsuccessful. In the latter half of 2002, the Company focused on attaining a reinsurance agreement to retrocede the future written and earned premium after June 30, 2002, related to its assumed reinsurance business. This course of action culminated in the signing of a reinsurance agreement with a subsidiary of GoshawK in December 2002. This treaty cedes effectively all of the unearned premium and future reported premium after June 30, 2002, for the assumed business written for underwriting years 2001 and 2002 by the Company ($129.3 million in 2002 and approximately $63 million to be written in future periods.) This treaty relieves the Company of significant underwriting leverage in 2002 and 2003 and significantly improves the Company’s risk-based capital adequacy ratios under both the A.M. Best and NAIC models.
The treaty has no limitations on loss recoveries and includes a profit-sharing provision should the combined ratios calculated on the base premium ceded be below 100%. The treaty requires GoshawK to reimburse the Company for its acquisition and administrative expenses. In addition, the Company is required to pay GoshawK additional premium in
excess of the base premium ceded of 14.3% or an estimated $27.5 million. The additional premium reduced 2002 earned premium by $18.5 million and will reduce 2003 earned premium by an estimated $9 million.
The GoshawK reinsurance treaty has both prospective and retroactive elements as defined in Financial Accounting Standards Board Statement (FASB) No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. As such, any gains under the contract will be deferred and amortized to income based upon the expected recovery. No gains are anticipated currently. Losses related to future earned premium ceded, as well as, as development on losses related to existing earned premium ceded after June 30, 2002, will ultimately determine whether a gain will be recorded under the contract.
Net investment income decreased $3.7 million or 10.2% to $32.2 million in 2002 from $35.9 million in 2001. This decrease is primarily a result in the decline in average rate of return from 5.2% in 2001 to 4.7% in 2002. 2001 net investment income increased approximately $1.7 million to $35.9 million from $34.2 million in 2000. This increase was a result of a 1.1% increase in average invested assets and a shift in investment mix from tax-exempt securities to higher-yielding taxable bonds in 2001. The average rate of return on invested assets was 5.1% and 5.2% in 2001 and 2000, respectively. The Company realized $18.9 million in capital gains in 2002 versus $5.7 million in 2001. This increased statutory capital for insurance regulatory purposes and improved the Insurance Subsidiaries’ risk-based capital ratios. During 2001, the Company realized $5.7 million of investment gains as compared to $0.4 million in realized investment losses in 2000.
In November 2001, the Company arranged a letter of credit facility in the amount of $50 million with Barclays Bank PLC. Letters of credit issued under the facility fulfill the requirements of Lloyd’s and guarantee loss reserves under reinsurance contracts. As of December 31, 2002, letter of credit issuance under the facility was approximately $46.3 million. Securities of $50.1 million are pledged as collateral under the facility.
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). Preparation of financial statements in accordance with GAAP requires
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 date, the Company believes that loss and LAE reserve levels and the Company’s rate making process adequately incorporate the effects of inflation.