The Company leases its Home Office building in Woodland Hills, California, which contains approximately 234,000 square feet of leasable office space. The lease was amended in October 1994 which extended the lease term until November 1999. The lease may be renewed for two consecutive five-year periods.
The Company also leases office space in 24 other locations throughout California. The Company anticipates no difficulty in extending these leases or obtaining comparable office facilities in suitable locations.
The selected consolidated financial data presented below as of the end of and for each of the years in the five-year period ended December 31, 1996 are derived from the consolidated financial statements of 20th Century Industries and its subsidiaries. The consolidated financial statements as of December 31, 1996 and 1995 and for each of the years in the three-year period ended December 31, 1996 are included elsewhere in this Form 10-K.
(1) For 1996, excludes $29.2 million, net of commissions, in homeowner and condominium unearned premiums ceded to reinsurers in July 1996.
The number of vehicles in force began growing again in the fourth quarter of 1996 for the first time in nine quarters. Meanwhile, the Company did not need to resort to workforce cutbacks or layoffs during this particularly challenging time to maintain its low expense ratio. As a result, the Company's most important resources, its dedicated and experienced employees, are in a unique position to capitalize on the opportunities for growth and improved customer service that lie ahead.
Recent legislative changes could cause increases in the number of policies issued to previously uninsured motorists or drivers eligible to participate in the California Assigned Risk Plan ("CAARP"). Because both categories historically have been characterized by underwriting losses, growth in those areas would dampen future underwriting results; in view of the current political and regulatory climate, it is difficult to envision that premium rates for such risk categories could be adjusted to adequate levels in the near future. Vehicles in force relating to previously uninsured drivers stood at 59,013, 68,256 and 73,518 at December 31, 1996, 1995 and 1994, respectively. Vehicles in force for this segment of the auto line rose 1,619 (2.7%) in the first two months of 1997. Vehicles in force for the Assigned Risk segment were 6,847, 8,204 and 7,285 as of December 31, 1996, 1995 and 1994, respectively. In the first two months of 1997, Assigned Risk vehicles increased by 1,501 units (21.9%), bringing them generally back to the 1995 level. It is too early to tell whether these rates of growth will continue.
HOMEOWNER AND CONDOMINIUM. On December 23, 1996, the DOI amended its previous order to permit the Company to begin renewing homeowner policies effective February 15, 1997. At that time approximately 68,000 homeowner policies remained in force. Those renewals will be subject to an overall 6% rate increase effective April 1, 1997. Unless the Company is granted permission to resume writing new homeowner policies, the impact of this line on future underwriting results is likely to remain insignificant.
YEARS ENDED DECEMBER 31, -------------------------------- 1996 1995 1994 ---- ---- ---- (Amounts in thousands) Underwriting profit (loss) Automobile-excluding the effects of Earthquake and Prop. 103 $ 81,010 $ 73,755 $ 11,261 Homeowner and Condominium - excluding effects of Earthquake and Prop. 103 (1,394) (438) 337 Personal Excess Liability - excluding the effects of Earthquake and Prop. 103 917 418 1,120 -------- -------- --------- Subtotal Core Business 80,533 73,735 12,718 Earthquake and Prop 103 (38,311) (48,498) (936,792) -------- -------- --------- Total $ 42,222 $ 25,237 $(924,074) -------- -------- --------- -------- -------- ---------
YEARS ENDED DECEMBER 31, -------------------------------- 1996 1995 1994 ---- ---- ---- CORE BUSINESS - - ------------- Loss and Loss Adjustment Expense Ratio 81.3% 83.7% 89.0% Underwriting Expense Ratio 9.3 8.8 9.8 -------- -------- -------- Combined Ratio 90.6% 92.5% 98.8% -------- -------- -------- -------- -------- --------
COMPANY TOTALS - - -------------- Loss and Loss Adjustment Expense Ratio 85.8% 88.4% 176.8% Underwriting Expense Ratio 9.3 9.0 9.7 -------- -------- -------- Combined Ratio 95.1% 97.4% 186.5% -------- -------- -------- -------- -------- -------- Automobile
Gross written premiums in 1996 decreased 10% from 1995 reflective of the 4.6% reduction in insured units and, to a lesser extent, the effect of the three premium rate reductions implemented in 1996 (a total reduction of 11.5%). The impact on gross written premiums of the 1996 rate reductions will not be fully felt until the end of the first quarter 1997, six months after the latest reduction was implemented. Net earned premiums also declined in 1995 reflecting both a reduction in insured vehicles and the impact of the quota share treaty with the AIG affiliate.
Underwriting results for these programs are subject to variability caused by weather-related claims and by infrequent disasters. In 1996, no significant losses were incurred. In 1995, the
The Company has maintained reinsurance programs to provide coverage through the planned run-off period of its remaining homeowner policies. Effective July 1996, the Company entered into a 100% quota share reinsurance agreement with F&G Re and Risk Capital Re on its remaining homeowners book. These companies assumed the total liability for related unearned premium reserves at June 30, 1996 of $33.3 million in exchange for cash payment by the Company. The Company received commission on the transfer of approximately $4.2 million, or 12.5%. The total commission rate per the agreement is subject to ultimate loss and expense ratios experienced, and is not to exceed 22.5% or to be less than 5.0%.
decline would decrease cash flow, even without consideration of Earthquake losses, until the patterns of cash inflows (premiums) and outflows (claims) reach equilibrium.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of 20th Century Industries and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. 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.
As discussed in Note 2 to the financial statements, in 1994 the Company changed its method of accounting for investments.
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 (Amounts in thousands, except per share data)
The Company's 49% interest in 20th Century Insurance Company of Arizona, which is a joint venture between the Company and American International Group, Inc. ("AIG") and which began operations in August 1996, has a carrying value of $1,784,000 at December 31, 1996, and is included in other assets in the consolidated balance sheet. The Company's equity in the 1996 net loss of this venture amounted to $186,000 and is included in investment income in the consolidated statement of operations.
The estimated liabilities for losses and loss adjustment expenses 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 estimates of expenses for investigating and adjusting all incurred and unadjusted claims. Amounts reported are estimates of the ultimate costs of settlement, net of estimated salvage and subrogation, which are necessarily subject to the impact of future changes in economic and social conditions. Management believes that, given the inherent variability in any such estimates, the aggregate reserves are within a reasonable and acceptable range of adequacy. The methods of making such estimates and for establishing the resulting reserves are continually reviewed and updated and any adjustments resulting therefrom are reflected in current earnings.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting and Disclosure of Stock-Based Compensation," became effective with fiscal years beginning after December 15, 1995. Stock-based compensation is accounted for in accordance with the requirements set forth in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Additional financial statement disclosures required by SFAS No. 123 are included in Note 12.
YEARS ENDED DECEMBER 31, ------------------------------------ 1996 1995 1994 ---- ---- ---- (Amounts in thousands)
Interest and dividends on fixed maturities $ 71,996 $ 74,286 $ 82,125 Interest on short-term cash investments (demand deposits) 2,170 8,049 3,210 Other (183) 109 128 ---------- ---------- ---------- Total investment income 73,983 82,444 85,463 Investment expense 805 786 702 ---------- ---------- ---------- Net investment income $ 73,178 $ 81,658 $ 84,761 ---------- ---------- ---------- ---------- ---------- ----------
The amortized cost, gross unrealized gains and losses, and fair values of fixed maturities as of December 31, 1996 and 1995, respectively, are as follows:
YEARS ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 ---- ---- ---- (Amounts in thousands)
YEARS ENDED DECEMBER 31, ------------------------------ 1996 1995 ---- ---- (Amounts in thousands)
Deferred tax assets: Net operating loss carryforward $ 142,422 $ 181,393 Unearned premiums 16,180 18,207 Unpaid losses and loss adjustment expenses 13,170 14,728 Alternative minimum tax credit 11,200 8,778 Salvage and subrogation 7,506 - Non-qualified retirement plans 3,063 2,903 Other 2,058 2,868 ---------- ---------- 195,599 228,877 ---------- ---------- ---------- ---------- Deferred tax liabilities: Deferred policy acquisition costs 3,223 3,668 Salvage and subrogation - 936 Unrealized investment gains 1,519 18,043 ---------- ---------- 4,742 22,647 ---------- ---------- Net deferred tax asset $ 190,857 $ 206,230 ---------- ---------- ---------- ----------
The Company is required to establish a "valuation allowance" for any portion of the deferred tax asset that management believes will not be realized. In order to realize the net deferred tax asset, the Company must have the ability to generate sufficient future taxable income to realize the tax benefits. Taxable income for 1996 and 1995 totaled $137.9 million, and except for the losses arising from the Northridge Earthquake, the Company has been profitable for each of the past 10 years. Over the last five years, the Company's combined ratio has been approximately 98% excluding the Northridge Earthquake, and investment earnings have averaged approximately $98 million a year over the same five year period. Historically, the Company has generated almost all of its profits from its automobile line of business. As of July 23, 1995, the Company was out of the earthquake line of business. This withdrawal will substantially reduce the Company's exposure to future earthquake catastrophes. The Company could also increase its future taxable income by converting the remainder of its investments in tax-exempt securities, which represented approximately 25% of the portfolio at December 31, 1996, and investing new cash flow into taxable securities.
A reconciliation of income tax computed at the federal statutory tax rate, which was 35% for 1994 through 1996, to total income tax expense follows:
YEAR ENDED DECEMBER 31, ----------------------------- 1996 1995 1994 ---- ---- ---- (Amounts in thousands) Federal income taxes (benefits) at statutory rate $ 37,949 $ 35,422 $(275,138)
Decrease due to: Tax-exempt income, net (4,472) (3,520) (13,535) Adjustment of deferred tax for 1% increase in tax rate - - 1,696 Other 893 (327) (1,110) --------- --------- --------- Federal taxes (benefits) on income $ 34,370 $ 31,575 $(288,087) --------- --------- --------- --------- --------- ---------
Payments for income taxes were $2,367,500, $65,000 and $-0- for the years ended December 31, 1996, 1995 and 1994, respectively.
costs reflected in the consolidated balance sheets at December 31, 1996 and 1995 are $4,073,000 and $5,637,000, respectively.
The Company has entered into a revolving credit facility ("the Facility") that provides an aggregate commitment of $202.5 million at December 31, 1996. The commitment decreases by $11.25 million on the first day of each quarter until April 1, 2001. Principal repayments are required when total outstanding advances exceed the aggregate commitment. The Company may prepay principal amounts of the advances, as well as voluntarily cause the aggregate commitment to be reduced at any time during the term of the Facility.
As of December 31, 1996, the Company's outstanding advances against the Facility totaled $175 million, which approximates its fair value. Interest is charged at a variable rate based, at the option of the Company, on either (1) the contractually defined Alternate Base Rate ("ABR") plus a margin of 0.25% or (2) the Eurodollar Rate plus a margin of 1.00%. Margins are adjusted in relation to certain financial and operational levels of the Company. The ABR is defined as a daily rate which is the higher of (a) the prime rate for such day or (b) the Federal Funds Effective Rate for such day plus .5% per annum. Interest is payable at the end of each interest period. The stock of the Company's insurance subsidiaries is pledged as collateral under the Facility. At December 31, 1996, the annual interest rate for the specified interest period was approximately 6.7%. Interest paid was $9,813,000 in 1996, $12,636,000 in 1995 and $7,277,000 in 1994.
In connection with an investment agreement executed in 1994 with AIG (see Note 16), each of the Company's insurance subsidiaries entered into a five-year quota share reinsurance agreement with an AIG affiliate to provide coverage for all ongoing lines of business. Under this contract, which attaches to the Company's retained risks net of all other reinsurance, 10% of each subsidiary's premiums earned and losses incurred in connection with policies incepted during the period January 1, 1995 through December 31, 1999 are ceded. The majority of the Company's reinsurance receivables are due from the AIG affiliate. At the end of the five-year period, the AIG affiliate may elect to renew the agreement annually at declining coverage percentages. Ceding commissions of 9.13% and 10.8% were earned by the insurance subsidiaries for 1996 and 1995, respectively. The ceding commission is adjusted annually to equal the actual underwriting expense ratio.
The Company had a homeowners excess-of-loss reinsurance treaty with General Reinsurance Corporation which was canceled May 1, 1996. In this excess treaty, the reinsurer's limit was $650,000 in excess of the Company's retention of $300,000 per risk, subject to a maximum reinsurer's limit of $1,300,000 per occurrence. The Company has a quota share treaty for its Personal Excess Liability Policy line whereby it cedes 60% of its business.
Rental expense charges to operations for the years ended December 31, 1996, 1995 and 1994 were $11,243,000, $12,062,000 and $11,694,000, respectively.
Stockholder's equity of the insurance subsidiaries on a statutory basis at December 31, 1996 and 1995 was $436,367,000 and $358,474,000, respectively. Statutory net income (loss) for the insurance subsidiaries was $ 121,780,000, $118,562,000, and $(657,331,000) for the years ended December 31, 1996, 1995 and 1994, respectively.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for its stock-based compensation. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized; however, SFAS No. 123 requires disclosure of the pro forma net income and earnings per share as if the Company had accounted for its employee stock compensation under the fair value method of that Statement. Under APB 25, the fair value of stock grants made under the Restricted Shares Plan is amortized to expense over the vesting periods of the grants. This accounting treatment results in compensation expense being recorded in a manner consistent with that required under Statement 123 and, therefore, pro forma net income and earnings per share amounts would be unchanged from those reported in the financial statements.
The aggregate number of common shares issued and issuable under the Plan currently is limited to 1,000,000. All options granted have ten year terms and vest over various future periods.
Forfeited in 1996 (27,000) $19.33 ----------- Options outstanding December 31, 1996 541,500 $17.41 ----------- -----------
A summary of grants under the plan from 1994 through 1996 follows:
Common Market Price Per Shares Share on Date of Grant -------- ----------------------
Outstanding, January 1, 1994 56,715 Granted in 1994 25,000 $27.38 Vested in 1994 (18,543) Canceled or forfeited - -------- Outstanding, December 31, 1994 63,172 Granted in 1995 35,813 $11.17 Vested in 1995 (40,224) Canceled or forfeited (14,878) -------- Outstanding, December 31, 1995 43,883 Granted in 1996 18,600 $19.63 Vested in 1996 (13,800) Canceled or forfeited - -------- Outstanding, December 31, 1996 48,683 -------- --------
The Northridge, California earthquake, which occurred on January 17, 1994, significantly affected the operating results and the financial position of the Company. Subsequently, the Company and other members of the property and casualty insurance industry have revised their estimates of claim costs and related expenses several times.
share, at a price and liquidation value of $1,000 per share and convertible into common shares at a conversion price of $11.33 per share, and (ii) 16,000,000 Series A Warrants to purchase an aggregate 16,000,000 shares of the Company's Common Stock at $13.50 per share (collectively, the "Investment Agreement"). In 1995, an additional 20,000 shares of preferred stock were issued to AIG in exchange for $20,000,000 of equity capital. The Series A Preferred Stock ranks senior to the Common Stock with respect to dividend and liquidation rights. Cash dividends of $20,245,500 and $14,622,750 were paid on the preferred stock in 1996 and 1995, respectively. Preferred stock dividends in kind of $4,950,000, representing 4,950 additional shares, were issued on June 26, 1995. The Investment Agreement required the exercise price of the Series A Warrants to be reduced $.08 per share for each million dollars of gross losses and allocated loss adjustment expenses in excess of $945 million with respect to the Northridge Earthquake through December 31, 1995. As the Company's estimate of the gross losses and loss adjustment expenses for the Northridge Earthquake rose to $1 billion at December 31, 1995, the exercise price of the Series A Warrants declined to $9.10 per share where it remains. The Common Stock Warrants are generally exercisable from February 1998 to February 2007.
Primary earnings (loss) per common share $ .35 $ .46 $ .33 $ (.22)
Primary earnings (loss) per common share $ (.12) $ .18 $ .44 $ .36
Fully diluted earnings per common share * * $ .39 $ .33
The fourth quarter of 1996 was impacted by pre-tax charges of $40 million in additional reserves related to the 1994 Northridge Earthquake. It was also adversely affected by weather-related claims amounting to approximately $8.0 million.
The first quarter 1995 net loss was impacted by $14.2 million in pre-tax losses resulting from a series of severe storms as well as $6.0 million of catastrophe reinsurance premiums related to the additional reinsurance coverage purchased in order to provide reinsurance coverage for the declining earthquake exposure. The second and fourth quarters of 1995 were adversely affected by increases in the net pre-tax loss for the Northridge Earthquake of $18 million and $10 million, respectively.
---- Homeowner Personal (Amounts in thousands) Auto Lines and Condominium Excess Liability --------------- ----------------- ------------------ Gross premiums written $ 892,287 $ 35,442 $ 2,114 --------------- ----------------- ------------------ --------------- ----------------- ------------------ Premiums earned $ 831,963 $ 23,893 $ 772 --------------- ----------------- ------------------ --------------- ----------------- ------------------ Underwriting profit (loss) $ 81,010 $ (39,705) $ 917 --------------- ----------------- ------------------ --------------- ----------------- ------------------