The tax exempt interest income earned (net of bond premium and discount amortization) during the fiscal year ended December 31, 1997, was $1,809,043 compared to $1,770,382 in the twelve month period ended December 31, 1996. In the fiscal year ended March 31, 1996, tax exempt interest income earned totaled $1,738,799.
AAC has a bank line of credit with a variable rate of interest based on fluctuations in the London Interbank Offered Rate ("LIBOR"). This credit line is only used to provide AAC with the additional funds it requires to finance insurance premiums. AAC has been paying this bank note payable from its internal cash flow as well as from intercompany loans from its parent, Unico. The bank note payable was paid in full on July 3, 1997, resulting in no amounts being outstanding under the bank credit line. Due to decreased utilization, AAC decreased this bank credit line from $4,000,000 to $2,000,000 in September 1997.
Fiscal Year Ended --------------------------------- December 31 December 31 1997 1996 ---- ---- (Nine Months)
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, 1998, at which time it is expected to be renewed. As of December 31, 1997, no amounts have been borrowed.
The Company has initiated a review of all computer programs in order that all computer systems will function properly with respect to dates in the year 2000 and thereafter. Some of the older programs were written using two digits rather than four digits to define a year. As a result, these programs have time-sensitive software which would recognize a date of "00" as 1900 rather than 2000. Failure to correct these programs could cause a system failure or miscalculation and disrupt operations or inhibit the Company's ability to conduct normal business activities. The project to review and correct all programs is in progress and is estimated to be completed by the middle of 1999, prior to any anticipated impact on its operating systems. Portions of this project have been completed and tested as of December 31, 1997.
The Company believes that with modification to existing software, the year 2000 issue will not pose significant operational problems for its computer systems. The costs of the project are not expected to have a material adverse effect on the Company's financial position.
Results of Operation: --------------------- General - ------- The Company had net income after taxes of $7,654,362 for the fiscal year ended December 31, 1997, compared to $6,849,327 for the twelve month period ended December 31, 1996, and $5,947,481 for the fiscal year ended March 31, 1996. Total revenue for the fiscal year ended December 31, 1997, was $48,290,721 compared to $45,880,272 for the twelve month period ended December 31, 1996, and $42,468,474 for the fiscal year ended March 31, 1996.
For the twelve month period ended December 31, 1996, income before taxes increased by $1,367,786 (16%) and net income increased by $901,846 (15%) compared to the fiscal year ended March 31, 1996. The increase in pre-tax income was primarily due to an increase of $378,236 (7%) in the underwriting profit from Crusader, an increase in investment income of $369,637 (10%) (excluding realized investment gains), a decrease in other operating expenses of $383,821 (12%), and an increase in net commission and fee income of $252,469 (gross commission and fees less commissions to agents/brokers).
The effect of inflation on the net income of the Company during the fiscal year ended December 31, 1997, was not significant.
Property and Other Liability line of business of $571,589 (29%). For the fiscal year ended December 31, 1997, the Commercial Package premium accounted for 97% of the Crusader's total written premium. Premium written in California increased $651,454 (2%) to $33,048,085 while premiums written outside of California increased $196,821 (2%) to $9,225,905 compared to the twelve month period ended December 31, 1996. The slight increase in written premiums was primarily due to increased competition in the California and Pacific Northwest markets.
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. 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.
Fiscal Year Ended 12 Months Ended Fiscal Year Ended December 31 December 31 March 31 1997 1996 1996 ---- ---- ---- (Unaudited)
Loss ratio 53.1% 56.0% 55.0% Expense ratio 29.1% 26.5% 27.2% ---- ---- ---- Combined ratio 82.2% 82.5% 82.2% ==== ==== ====
Daily Automobile Rental Insurance Program - ----------------------------------------- The daily automobile rental insurance program is produced by Bedford. Bedford receives a commission and a claim administration fee from a non-affiliated insurance company based on premium written. Commission and fee income from the daily automobile rental insurance program are as follows:
Revenues during the fiscal year ended December 31, 1997, were $757,098 a decrease of $40,383 (5%) compared to the same period of the prior year. Revenue for the twelve month period ended December 31, 1996, decreased 9% compared to the prior fiscal year.
Commercial and Personal Automobile Insurance Program - ---------------------------------------------------- Unifax produced commercial auto policies in California for a non-affiliated insurer and received a commission from them based on premium written. Unifax also received a policy service fee from the insured. In February 1997, management decided to discontinue writing new policies in the Unifax commercial automobile program and only serviced and renewed existing policies until the book of business was sold to an non-affiliated third party in June 1997. As consideration for the sale of this book of business, Unifax will receive a percentage of the commission earned for a two year period on policies which were in force at the time of sale.
Regulations on California health care medical providers to small businesses became effective on July 1, 1993 (AB 1672). These regulations now cover small businesses with 2 to 50 employees. These regulations, among other things, created an alliance of health insurance companies called the Health Insurance Plan of California ("HIPC"). There are currently 20 insurance companies in the alliance. The premiums charged by the insurance companies in the alliance were approved by the State of California and are very competitive. To meet this competition, insurance companies marketing programs outside of HIPC were forced to lower their rates to small groups. The impact of these regulations on the Company was and will continue to be lower revenues from reduced sales on its small business group programs. CIGNA revised its rates in July 1996 and July 1997. In July 1996, some rates were increased which resulted in loss of business and others were decreased to retain existing business. In July 1997 all rates were increased which contributed to a further loss of business.
Individual medical and dental programs - -------------------------------------- Individual medical programs are not affected by AB 1672, and all of the Company's major insurance carriers provide the Company with individual medical insurance programs. Commission income from the individual medical and dental programs continues to increase due to aggressive marketing and the quality of the Company's customer service. However, the increases in commission income on the individual programs, which generally have lower premiums than group programs, were not enough to offset the loss of commission income from the group programs.
Commission income for the fiscal year ended December 31, 1997, increased $216,231 (264%) compared to the twelve month period ended December 31, 1996. The increase was primarily 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, 1997, increased $10,477 (3%) compared to the twelve month period ended December 31, 1996. Membership income increased $48,737 (18%) in the twelve months ended December 31, 1996, compared to the fiscal year ended March 31, 1996. These increases are attributable to an increase in individual and family members in the Association which offset the decrease in group memberships.
Premium Finance Program - ----------------------- Premium finance charges and late fees earned from financing policies are as follows:
Premium finance charges and late fees earned on loans decreased $293 in the fiscal year ended December 31, 1997, compared to the twelve month period ended December 31, 1996. For the twelve months ended December 31, 1996, premium finance charges and late fees earned on loans decreased $88,054 (7%) compared to the fiscal year ended March 31, 1996. The number of AAC loans decreased primarily as a result of fewer Crusader policies being financed in California.
Commissions to Agents/Brokers (not including commissions on Crusader policies which are reflected in policy acquisition costs) are generally related to gross commission income. Commissions to agents and brokers decreased $217,776 (17%) for the fiscal year ended December 31, 1997, compared to the twelve month period ended December 31, 1996. This decrease was primarily related to the 14% decrease in health and life insurance commission income. During the twelve month period ended December 31, 1996, commission expense decreased $75,297 (6%) compared to fiscal year ended March 31, 1996. This decrease was also primarily due to a 4% decrease in health and life insurance commissions.
Other Operating Expenses generally do not change significantly with changes in production. This is true for both increases and decreases in production. Other operating expenses decreased $126,384 (5%) during the fiscal year ended December 31, 1997, compared to the twelve month period ended December 31, 1996. The decrease was primarily due to a decrease in interest expense of $101,425 as a result of the reduction in the Company's bank note payable.
Other operating expenses decreased $383,821 (12%) during the twelve month period ended December 31, 1996, compared to the fiscal year ended March 31, 1996. This decrease was primarily due to a decrease in interest expense of $166,893 as a result of the reduction in the Company's bank note payable.
We have audited the accompanying consolidated balance sheet of Unico American Corporation and subsidiaries as of December 31, 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unico American Corporation and subsidiaries as of December 31, 1997, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.
We have audited the accompanying consolidated balance sheets of Unico American Corporation and its subsidiaries as of December 31, 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for the nine months ended December 31, 1996 and the year ended March 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Unico American Corporation and its subsidiaries as of December 31, 1996, and the consolidated results of operations and cash flows for the nine months ended December 31, 1996 and the year ended March 31, 1996 in conformity with generally accepted accounting principles.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997, THE NINE MONTHS ENDED DECEMBER 31, 1996 AND THE FISCAL YEAR ENDED MARCH 31, 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------- Nature of Business - ------------------ Unico American Corporation is an insurance holding company. Unico American Corporation and its subsidiaries, all of which are wholly owned (the "Company"), provides primarily in California, property, casualty, health and life insurance, and related premium financing.
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 16, 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.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) - --------------------------------------------------------------- Fair Value of Financial Instruments - ----------------------------------- The Company has used the following methods and assumptions in estimating its fair value disclosures:
Revenue Recognition - ------------------- a. General Agency Operations ----------------------------- Commissions and service fees due the Company are recognized as income on the effective date of the insurance policies.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) - --------------------------------------------------------------- Losses and Loss Adjustment Expenses - ----------------------------------- The process of establishing loss reserves involves significant judgmental factors. The reserves for unpaid losses and loss adjustment expenses are based on estimates of ultimate claim cost, including claims incurred but not reported. These estimates are reviewed regularly; and as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments are reflected in results of operations in the period in which they become known. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.
Restricted Funds - ---------------- Restricted funds are as follows: Fiscal Year Ended December 31 ------------------------------ 1997 1996 ---- ---- Restricted Funds: Premium trust funds (1) $2,668,472 $2,642,932 Assigned to state agencies (2) 2,725,000 725,000 --------- ---------- Total restricted funds $5,393,472 $3,367,932 ========= =========
Statement of Financial Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive Income," and Statement of Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures about Segments of an Enterprise and Related Information," were issued in June 1997 and are effective for fiscal years beginning after December 15, 1997. SFAS No. 130 establishes standards for the reporting and display of comprehensive income, which includes net income and changes in equity except those resulting from investments by, or distributions to stockholders. SFAS No. 131 establishes standards for disclosures related to business operating segments. The Company is currently evaluating the impact that these statements will have on the consolidated financial statements.
NOTE 2 - ADVANCE PREMIUMS - ------------------------- Unico subsidiaries selling auto, health, life, and dental insurance policies require payments of premium prior to the effective date of coverage. To conform with the above requirement, invoices are sent out as early as two months prior to the effective date of the policy and payments are received prior to the policy effective date. Insurance premiums received by these subsidiaries for coverage effective after the balance sheet date are recorded as advance premiums.
NOTE 3 - INVESTMENTS (continued) - -------------------------------- Net realized investment gains and (losses) are summarized as follows:
NOTE 3 - INVESTMENTS (continued) - ------------------------------- The amortized cost and estimated market values of investments in fixed maturities by categories are as follows:
NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION) - ----------------------------------------------------------------- Property and equipment consist of the following:
NOTE 9 - FUNDS HELD AS SECURITY FOR PERFORMANCE - ----------------------------------------------- Funds held as security for performance represent funds received from the Company's daily automobile rental program which guarantee the contractual obligations of its customers.
Fiscal Year Ended December 31 ----------------------------- 1997 1996 ---- ---- Note payable - bank $ - $750,001 ======= =======
NOTE 12 - LEASE COMMITMENT - -------------------------- 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 total rent expense under this lease agreement was $1,025,952 for the fiscal year ended December 31, 1997, $769,464 for the nine month period ended December 31, 1996, and $1,025,952 for the fiscal year ended March 31, 1996.
Crusader has reinsurance agreements with National Reinsurance Corporation and NAC Reinsurance Corporation, both California admitted reinsurers. National Reinsurance Corporation was acquired by General Reinsurance Corporation in 1996. Crusader also has additional catastrophe reinsurance from various other reinsurance companies of which 77% of the participating reinsurers are admitted in California. These reinsurance agreements help protect Crusader against liabilities in excess of certain retentions, including major or catastrophic losses which may occur from any one or more of the property and/or casualty risks which Crusader insures. Crusader's retention increased from $150,000 to $250,000 per risk on July 1, 1997. This retention is subject to a maximum dollar amount and to catastrophe and clash covers. The catastrophe and clash covers (subject to a maximum occurrence and annual aggregate amount) help protect the Company from one loss occurrence affecting multiple policies. The premium ceded to the reinsurers for the catastrophe and clash covers and for all exposures over $500,000 is a fixed percentage of the premium charged by Crusader. On exposures up to $500,000, the reinsurer charges a provisional rate which is subject to adjustment and is based on the amount of losses ceded, limited by a maximum percentage that can be charged by the reinsurer. On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays a commission to Crusader, which includes a reimbursement of the cost of acquiring the portion of the premium that is ceded. Crusader does not currently assume any reinsurance from other insurance companies. The Company intends to continue obtaining reinsurance although the availability and cost may vary from time to time.
NOTE 13 - REINSURANCE (continued) - -------------------------------- The effect of reinsurance on premiums written, premiums earned, and incurred losses is as follows:
NOTE 14 - CONTINGENCIES - ----------------------- The Company's federal income tax returns for the fiscal years ended March 31, 1990, through March 31, 1994, were examined by the Internal Revenue Service. The primary issue of the examination was the loss reserve deductions for the fiscal years under audit. Any changes in the these deductions resulting from the examination would be a temporary difference. Since any tax increase from this temporary difference should be offset by a tax decrease in subsequent years, no tax liability has been accrued. The issue is currently under appeal. Management estimated and accrued $300,000 of interest expense in the fiscal year ended March 31, 1995, related to this temporary difference. No change was made to this accrual as of December 31, 1997.
Crusader Insurance Company statutory capital and surplus is as follows: As of December 31, 1997 $30,899,761 As of December 31, 1996 $25,748,757
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 which may be made without prior approval as of December 31, 1997, is $6,658,352. After taking into account the dividends paid by Crusader to its parent in 1997 of $1,500,000, the remaining dividend which may be made without prior approval as of December 31, 1997, is $5,158,352.
NOTE 17 - 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, 1997, of the 373,948 options outstanding, 275,046 options were currently 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 Exercise Price ------- -------------- Outstanding at March 31, 1995 680,000 $3.4375 to $4.375 Options granted - Options exercised - Options terminated - -------- Outstanding at March 31, 1996 680,000 $3.4375 to $4.375 Options granted - Options exercised (114,651) $3.4375 to $3.85 Options terminated (4,650) $3.50 ------- Outstanding at December 31, 1996 560,699 $3.4375 to $4.375 Options granted - Options exercised (186,751) $3.4375 to $3.50 Options terminated - ------- Outstanding at December 31, 1997 373,948 $3.4375 to $4.375 =======
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 20 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - ------------------------------------------------------ Summarized unaudited quarterly financial data for each of the calendar years 1997 and 1996 is set forth below: