Properties - - ------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin Cheldin, the Company's president, chairman and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties.
Management's Discussion and Analysis of Financial Condition and - - ------------------------------------------------------------------------ Results of Operations - - --------------------- In December 1996, the Company changed its fiscal year end from March 31 to December 31, effective December 31, 1996. As a result of this change, the Company's fiscal year ended December 31, 1996, consisted of nine months. For that reason, management's discussion and analysis includes many comparisons of the Company's fiscal year ended December 31, 1997, which consists of twelve months, to the comparable twelve month period of the prior year. The financial information for the unaudited twelve month period ended December 31, 1996, is included in this discussion for comparisons.
The tax exempt interest income earned (net of bond premium and discount amortization) during the fiscal year ended December 31, 1998, was $1,698,211 compared to $1,809,043 in the fiscal year ended December 31, 1997. In the twelve month period ended December 31, 1996, tax exempt interest income earned totaled $1,770,382.
The Company's investment policy limits investments in any one issuer. This limit was raised from $1,000,000 to $1,500,000 in 1997. This limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues.
All of the Company's fixed maturity investments are high-grade investment quality, all state and municipal tax exempt fixed maturity investments are pre-refunded issues, and all certificates of deposit are FDIC insured.
AAC had a bank line of credit with a variable rate of interest referenced to the bank's LIBOR rate. The bank note payable was paid in full on July 3, 1997, resulting in no amounts being outstanding under the bank credit line. The credit line matured on September 2, 1998, and was not renewed. AAC did not borrow against its line of credit in 1998 or 1997.
Maximum bank note payable - $750,001 Average bank note payable - $296,576 Weighted average interest rate - 7.3%
Dividends paid by Crusader to Unico were $1,500,000 in 1998 and $1,500,000 in 1997. These funds were invested by Unico in U.S. treasury notes and high grade commercial paper.
Crusader's statutory capital and surplus as of December 31, 1998, was $37,611,089, an increase of $6,711,328 (22%) over December 31, 1997. Crusader's statutory capital and surplus as of December 31, 1997, was $30,899,761, an increase of $5,151,004 (20%) over December 31, 1996.
The Company does business with thousands of licensed agents and brokers and does not anticipate it would be materially adversely affected if some of them are temporarily unable to function due to Year 2000 problems. The Company has requested and received information from its bank and reinsurers as to their Year 2000 readiness. Based on the information received to date, the Company believes that it will not be materially adversely affected by its bank or its reinsurers. Due to the nature of the Company's business, it is not dependent on any specific suppliers, and therefore, does not expect to be adversely materially affected by them.
Due to the unusual nature of the problem and lack of historical experience with Year 2000 issues, it is difficult to predict with certainty what will happen after December 31, 1999. As stated above, the Company does not anticipate it will be adversely materially affected by Year 2000 events from its internal operations or from others with whom the Company directly or indirectly does business. However, other events such as general public infrastructure failures, may adversely materially affect the Company's ability to operate during such failures. The Company has no formal contingency plans for Year 2000.
For the fiscal year ended December 31, 1997, income before taxes increased by $1,212,956 (12%) and net income increased by $805,035 (12%) compared to the twelve month period ended December 31, 1996. The increase in pre-tax income was primarily due to an increase of $499,418 (8%) in the underwriting profit from Crusader, an increase in investment income of $762,891 (18%) (excluding realized investment gains).
Crusader's primary line of business is commercial multiple peril "business package" policies. This line of business represented approximately 97% of Crusader's total written premium for both fiscal years ended December 31, 1998 and 1997.
Fiscal Year Ended Fiscal Year Ended 12 Months Ended December 31 December 31 December 31 1998 1997 1996 ---- ---- ---- (Unaudited)
California $31,323,804 $33,048,085 $32,396,631 Washington 1,958,179 4,704,286 5,024,276 Oregon 1,289,054 2,779,691 3,052,379 Arizona 1,095,922 1,346,589 862,352 Ohio 526,004 242,751 - Pennsylvania 416,485 41,511 - Texas 239,563 - - Montana 98,612 - - Kentucky 82,584 - - Nevada 49,096 111,077 90,077 ---------- ---------- ---------- Total $37,079,303 $42,273,990 $41,425,715 ========== ========== ==========
In the fiscal year ended December 31, 1998, gross written premium decreased by $5,194,687 (12%) compared to the fiscal year ended December 31, 1997. In 1998, the Company changed its marketing strategy in the states of Washington and Oregon by discontinuing marketing through an exclusive agent in those states and commencing marketing directly to all retail agents and brokers. This change resulted in a decrease of $4,236,744 or 82% of the total decrease. The Company anticipates that the long-term results of this change will be increased revenues with reduced acquisition expense and less dependence on any one large producer. The foregoing statement is a forward looking statement and actual results may differ materially. Factors which would cause the results to differ include economic conditions in the states of Washington and Oregon, willingness of retail agents and brokers to deal directly with the Company, and competitive conditions.
In 1998, the Company began writing business in the states of Texas, Montana, and Kentucky and increased its writings in the states of Ohio and Pennsylvania; however, it was not enough to offset the decreases in the states of California, Arizona, and Nevada. The decrease in gross written premium in these states was primarily due to intense price competition in the marketplace.
Although the Company attempts to be competitive on price, it believes that maintaining adequate rates and a favorable loss ratio is a better business strategy than increasing premiums at inadequate rates. The validity of this strategy is reflected by the continued profitable loss ratio discussed below.
The Company cannot determine how long this "soft market" condition will continue. In order to grow its premium in this "soft market," the Company is attempting to increase its activities in its existing states by new marketing and incentive programs and by offering new and improved products to its agents and brokers. The Company's geographical expansion plan is based on cloning its California business in other states with similar demographics and legal/regulatory environments. The Company's business package program has been written in California since it began writing business in 1985, and it has proved to be successful. When the Company enters a new state, it initially does so on a limited basis in terms of agent contracts, products, and premium. As the Company develops experience in those states, it then places an emphasis on growth by expanding products and distribution activity. The Company plans to begin writing business in Colorado in 1999 and Illinois in 2000.
Currently, agents and brokers who call for quotes on policies sold by the Company may also have to call competitors for quotes on products which the Company does not offer. Thus, Crusader competes with not only other insurance companies, but with general agents who produce business for other insurance companies. Many of these general agents offer more products than the Company and thus make it easier for the agents and brokers because they can do more business with fewer telephone calls. To provide better service to the Company's agents and brokers, the Company is currently working on additional non-affiliated insurance company products to be offered by its General Agency Operations. In addition to generating additional commission and fee income, the expansion of the General Agency Operation should benefit Crusader because more agents and brokers may do business with the Company.
In the fiscal year ended December 31, 1997, gross written premium increased $848,275 (2%) compared to the twelve month period ended December 31, 1996. This slight increase in written premium was primarily due to increased price competition in the marketplace.
In the fiscal year ended December 31, 1998, Crusader's direct earned premium decreased $2,105,805 (5%) and net premium earned decreased $1,411,699 (4%) from the fiscal year ended December 31, 1997. The decrease in earned premium is directly related to the decrease in written premium in the current fiscal year. In the fiscal year ended December 31, 1997, Crusader's direct earned premium increased $4,053,656 (10%) and net premium earned increased $2,046,778 (6%) over the twelve month period ended December 31, 1996. The percentage of earned ceded premium to gross premium earned was 14% for the fiscal year ended December 31, 1998, 15% for the fiscal year ended December 31, 1997, and 11% for the twelve month period ended December 31, 1996.
The combined ratio is the sum of (1) the net ratio of losses and loss adjustment expenses incurred (including a provision for incurred but not reported losses) to net premiums earned (the "loss ratio") and (2) the ratio of policy acquisition and general operating costs to net premiums earned (the "expense ratio"). The following table shows the loss ratios, expense ratios, and combined ratios of Crusader as derived from data prepared in accordance with generally accepted accounting principles. As shown on the table, the loss ratio continued to improve primarily due to favorable development of prior year losses. Generally, if the combined ratio is below 100%, an insurance company has an underwriting profit; if it is above 100%, a company has an underwriting loss.
The Company's future writings and growth are dependent on market conditions, competition, the Company's ability to introduce new profitable products, and its ability to expand geographically. As of December 31, 1998, Crusader was licensed as an admitted insurance company in the states of California, Arizona, Montana, Nevada, Oregon, and Washington and is approved as a non-admitted surplus lines writer in several other states.
Revenues during the fiscal year ended December 31, 1998, were $807,503 an increase of $50,405 (7%) compared to the same period of the prior year. Revenue for the fiscal year ended December 31, 1997, decreased by $40,383 (5%) compared to the twelve month period ended December 31, 1996.
NCC renewed and serviced existing commercial and personal automobile policies in California for a non-affiliated insurer until August 31, 1996, when the NCC program was discontinued. NCC received a commission and claim administration fee from the non-affiliated insurance company based on premium written and a policy service fee from the insured.
Commercial and personal auto program commission, service fee, and claim administration income are as follows:
Health and Life Insurance Program - - --------------------------------- Commission income from the health and life insurance sales of NIB and AIB is as follows:
Commission income for the fiscal year ended December 31, 1998, increased $31,459 (11%) compared to the fiscal year ended December 31, 1997. For the fiscal year ended December 31, 1997 commission income increased $216,231 (264%) compared to the twelve month period ended December 31, 1996. Commission income in this program has continued to increase primarily as the result of increased sales of workers' compensation insurance and incentive bonus commissions earned as a result of the increased sales.
Membership and fee income in the fiscal year ended December 31, 1998, increased $18,813 (6%) compared to the fiscal year ended December 31, 1997. Membership income increased $10,477 (3%) in the fiscal year ended December 31, 1997, compared to the twelve month period ended December 31, 1996. AAQHC recognized an increase in group memberships in 1998 compared to a decrease in group memberships in 1997 and has continued to increase individual and family memberships.
Premium finance charges and late fees earned on loans decreased $158,024 (13%) in the fiscal year ended December 31, 1998, compared to the fiscal year ended December 31, 1997. The decrease was primarily a result of fewer policies being financed due to a decrease in policies being written by Crusader and an overall decrease in the number of policyholders financing policies. For the fiscal year ended December 31, 1997, premium finance charges and late fees earned on loans decreased $293 compared to the twelve month period ended December 31, 1996.
Additional information regarding investments and investment income is described in the "Management Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
Salaries and Employee Benefits increased $457,794 (12%) for the fiscal year ended December 31, 1998, compared to the fiscal year ended December 31, 1997. Salaries and employee benefits decreased $5,707 in the fiscal year ended December 31, 1997, compared to the twelve month period ended December 31, 1996.
Forward Looking Statements - - -------------------------- Certain statements contained herein that are not historical facts are forward looking. These statements involve risks and uncertainties, many of which are beyond the control of the Company. Such risks and uncertainties could cause actual results to differ materially from these forward looking statements. Factors which could cause actual results to differ materially include those described under Item 1 - Business - "Competition," premium rate adequacy relating to competition or regulation, actual versus estimated claim experience, regulatory changes or developments, unforeseen calamities, general market conditions, the Company's ability to introduce new profitable products, and the Company's ability to expand geographically.
Change of Fiscal Year - - --------------------- On December 16, 1996, the Board of Directors approved a change in the Company's fiscal year end from March 31 to December 31 effective December 31, 1996. As a result of the change, the Company's Consolidated Statements of Operations and Consolidated Statements of Cash Flows for the fiscal year ended December 31, 1996, covers nine months.
Principles of Consolidation - - --------------------------- The consolidated financial statements include the accounts of Unico American Corporation and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.
Basis of Presentation - - --------------------- The consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP). As described in Note 14, the Company's insurance subsidiary also files financial statements with regulatory agencies prepared on a statutory basis of accounting which differs from generally accepted accounting principles.
The Company had net unrealized investment gains of $1,998,536 as of December 31, 1998, and net unrealized investment gains of $1,222,095 as of December 31, 1997.
Income Taxes - - ------------ The provision for federal income taxes is computed on the basis of income as reported for financial reporting purposes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and are measured using the enacted tax rates and laws expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted.
Premiums and Notes Receivable - The carrying amounts reported in the balance sheet for these instruments approximate the fair values.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) - - --------------------------------------------------------------- Restricted Funds - - ---------------- Restricted funds are as follows: Fiscal Year Ended December 31 ----------------------------- 1998 1997 ---- ---- Restricted Funds: Premium trust funds (1) $2,867,099 $2,668,472 Assigned to state agencies (2) 2,725,000 2,725,000 --------- --------- Total restricted funds $5,592,099 $5,393,472 ========= =========
Reinsurance - - ----------- The Company cedes reinsurance to provide for greater diversification of business, to allow management to control exposure to potential losses arising from large risks by reinsuring certain levels of risk in various areas of exposure, to reduce the loss that may arise from catastrophes, and to provide additional capacity for growth. Prepaid reinsurance premiums and reinsurance receivables are reported as assets and represent ceded unearned premiums and reinsurance recoverable on both paid and unpaid losses, respectively. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies.
Revenues, income before income taxes and assets by segment were as follows:
NOTE 2 - ADVANCE PREMIUM AND PREMIUM DEPOSITS - - --------------------------------------------- Some of the Company's health and life programs require payments of premium prior to the effective date of coverage, and accordingly, invoices are sent out as early as two months prior to the coverage effective date. Insurance premiums received for coverage months effective after the balance sheet date are recorded as advance premiums.
NOTE 3 - INVESTMENTS (continued) - - -------------------------------- A summary of the unrealized appreciation (depreciation) on investments carried at market and the applicable deferred federal income taxes is shown below:
Due in one year or less $ 8,887,129 $ 8,934,493 Due after one year through five years 60,551,170 62,555,458 Due after five years through ten years 26,920,513 27,982,769 ---------- ---------- Total fixed maturities $96,358,812 $99,472,720 ========== ==========
NOTE 3 - INVESTMENTS (continued) - - -------------------------------- Short-term investments have an initial maturity of one year or less and consist of the following:
NOTE 5 - PREMIUMS AND NOTES RECEIVABLE, NET - - ------------------------------------------- Premiums and notes receivable are substantially secured by unearned premiums and funds held as security for performance.
NOTE 6 - DEFERRED POLICY ACQUISITION COSTS - - ------------------------------------------ Deferred policy acquisition costs, net of ceding commission, consist of commissions, premium taxes, inspection fees, and certain other underwriting costs which are related to and vary with the production of Crusader Insurance Company policies. These costs are incurred by Crusader and include allocated expenses of other Unico subsidiaries. Policy acquisition costs are deferred and amortized as the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income, including investment income.
(*) Decreases in incurred losses and loss adjustment expenses related to the indicated prior years reflect favorable loss experience during these years attributable to a number of combined factors which have produced favorable frequency and severity trends in recent years. In addition, actuarial assumptions based on historical trends have proven to be conservative.
NOTE 10 - NOTE PAYABLE - BANK - - ----------------------------- American Acceptance Corporation ("AAC"), the Company's premium finance subsidiary, had a line of credit with Union Bank which was used only to fund its premium finance operation. Interest on the note is referenced to the London Interbank Offered Rate ("LIBOR"). The note amount was collateralized by the assets of AAC and is guaranteed by the Company. The credit line matured September 2, 1998, and was not renewed. AAC did not borrow against this line of credit in 1998 or 1997. The loan agreement contained certain covenants including restrictions on certain transactions between AAC and the Company and the maintenance of certain financial ratios. AAC was in compliance with all terms of its loan agreement.
NOTE 10 - NOTE PAYABLE - BANK (continued) - - ---------------------------------------- In addition to the AAC line of credit, Unico has a $2,000,000 line of credit with Union Bank. Interest on this line is referenced to LIBOR and is payable monthly. The agreement contains certain covenants including maintenance of certain financial ratios. This credit line expires September 2, 1999, at which time it is expected to be renewed. As of December 31, 1998 and 1997, no amounts were borrowed.
December 31, 1999 $1,025,952 December 31, 2000 $1,025,952 December 31, 2001 $1,025,952 December 31, 2002 $1,025,952 December 31, 2003 (through March 31, 2007) $4,360,296 --------- Total minimum payments $8,464,104 ========= Erwin Cheldin, the Company's president, chairman, and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations 100% of the space it leases.
Fiscal year ended December 31, 1998 $563,160 Fiscal year ended December 31, 1997 $545,906 Fiscal year ended December 31, 1996 (nine months) $364,226
NOTE 14 - STATUTORY CAPITAL AND SURPLUS - - --------------------------------------- Crusader is required to file an annual statement with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities ("statutory"). Statutory accounting practices differ in certain respects from generally accepted accounting principles. The more significant of these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) all bonds are recorded at amortized cost, regardless of trading activity; (c) non-admitted assets are charged directly against surplus; (d) loss reserves and unearned premium reserves are stated net of reinsurance; and (e) federal income taxes are recorded when payable. Additionally, the cash flow presentation is not consistent with generally accepted accounting principles and a reconciliation from net income to cash provided by operations is not presented.
Fiscal year ended December 31, 1998 $8,243,434 Fiscal year ended December 31, 1997 $6,658,352 Fiscal year ended December 31, 1996 (nine months) $3,526,515
The Company believes that Crusader's statutory capital and surplus was sufficient to support the insurance premiums written based on guidelines established by the NAIC.
Crusader is restricted in the amount of dividends it may pay to its parent in any twelve (12) month period without prior approval of the California Department of Insurance. Presently, without prior approval, Crusader may pay a dividend in any twelve (12) month period to its parent equal to the greater of (a) 10% of Crusader's statutory policyholders' surplus or (b) Crusader's statutory net income for the preceding calendar year. The maximum dividend that may be made without prior approval as of December 31, 1998, is $8,243,434. After taking into account the dividends paid by Crusader to its parent in 1998 of $1,500,000, the remaining dividend which may be made without prior approval as of December 31, 1998, is $6,743,434.
NOTE 15 - INCENTIVE STOCK OPTION PLAN - - ------------------------------------- The Company under its 1985 stock option plan provides for the grant of "incentive stock options" to officers and key employees. The options and prices set forth below have been adjusted, where applicable, for all subsequent stock splits, reverse stock splits, and stock dividends. All options were granted at fair market value. As of December 31, 1998, all options outstanding were exercisable. There are no additional options available for future grant under the 1985 plan. The changes in the number of common shares under option are summarized as follows:
Options granted - Options exercised (90,082) $3.50 to $4.375 Options terminated (89,320) $3.50 ------- Outstanding at December 31, 1998 194,546 $3.4375 to $4.375 =======
NOTE 16 - TAXES ON INCOME The provision for taxes on income consists of the following:
The income tax provision reflected in the consolidated statements of operations is less than the expected federal income tax on income as shown in the table below:
NOTE 18 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - - ------------------------------------------------------ Summarized unaudited quarterly financial data for each of the calendar years 1998 and 1997 is set forth below: