The Company's financial statements include increases in earthquake reserves in 1997 of $24.75 million, in 1996 of $40 million and in 1995 of $60 million offset partially by a $32 million reduction in the Proposition 103 liability per an order from the CDOI. In 1994, earthquake-related losses and expenses were $844.1 million. On an after-tax basis, these additional charges reduced (increased) basic earnings (loss) per share by $0.31, $0.51, $0.35 and ($10.67) for 1997, 1996, 1995 and 1994, respectively.
The Company's financial condition continued to improve in 1997 as shown in the following table:
Vehicles in force relating to previously uninsured drivers stood at 68,112, 59,013 and 68,256 at December 31, 1997, 1996 and 1995, respectively. Vehicles in force for the Assigned Risk portion were
While a growth in business generally indicates the need for an increase in incurred but not reported ("IBNR") reserves, favorable development in older case reserves and the lower frequency and severity of new claims have resulted in the Company making a smaller provision for IBNR reserves in 1997 than in 1996 and 1995.
Underwriting results for these programs are subject to variability caused by weather-related claims and by infrequent disasters. In 1997 and 1996, no significant losses were incurred.
The Company has begun a project to modify the applicable portions of its software so that its computer systems will properly calculate dates beyond 1999. The total Year 2000 project cost is estimated to be approximately $6.2 million, which will be expensed as incurred. In 1997, the Company incurred and expensed approximately $1.5 million, and substantially all of the remaining costs are expected to be incurred in 1998. This project is planned for completion in the first quarter of 1999, which provides sufficient time to avoid any adverse impact on the Company's operating systems.
Realized capital gains on the sales of investments have declined over the past three years, as underwriting cashflow has increased and the need to sell investments to cover claim payments and other operating needs has decreased commensurately.
The Company has historically written its core business at an underwriting profit and thus each premium dollar generates a positive cash flow. A significant part of the decline and subsequent increase in cash flow from operations in 1996 and 1997, respectively, is due to the fall and rise, respectively, in the size of the net book of business during these periods.
In 1996 approximately $29.2 million of the $32.5 million net decrease in cash and cash equivalents was related to the portfolio transfer of unearned premiums on homeowners business. Cash flows from operations in 1995 were not sufficient to fund underwriting operations of the Company due to losses from the Northridge Earthquake. For 1995, funds needed to pay these claims, as well as Proposition 103 rebates, came from normal operating cash flows, available cash on deposit, additional loan proceeds of $15 million and preferred stock proceeds of $20 million.
The Company's management has made in this report, and from time to time may make in its public filings and press releases as well as in oral presentations and discussions, forward-looking statements concerning the Company's operations, economic performance and financial condition. Forward-looking statements include, among other things, discussions concerning the Company's potential expectations, beliefs, estimates, forecasts, projections and assumptions. Forward-looking statements are subject to risks and uncertainties. Actual results could differ materially from those anticipated by forward-looking statements due to a number of important factors including those discussed elsewhere in this report and in the Company's other public filings, press releases, oral presentations and discussions and the following: (a) the intensity of competition from other companies in the insurance industry; (b) the Company's experience with respect to persistency and claims experience; (c) the Company's ability to distribute and administer competitive services in a timely, cost-effective manner; (d) the Company's visibility in the market place and its financial and claims paying ratings; (e) the effect of changes in laws and regulations affecting the Company's business, including changes in tax laws affecting insurance products; (f) market risks related to
interest rates; (g) the Company's ability to develop information technology and management information systems to support strategic goals while continuing to control costs and expenses; (h) the costs of defending litigation and the risk of unanticipated material adverse outcomes in such litigation; (i) changes in accounting and reporting practices and (j) the Company's access to adequate financing to support its future business.
We have audited the accompanying consolidated balance sheets of 20th Century Industries and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these 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 20th Century Industries and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, 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.
20TH CENTURY INDUSTRIES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITY AND STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (Amounts in thousands, except per share data)
Fair values for fixed maturity and equity securities are based on quoted market prices. When investment securities are sold, the cost used to determine any realized gain or loss is based on specific identification.
Deferred income tax assets and liabilities are determined based on the differences between the financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws.
* For 1996 and 1995, the effect of the convertible preferred stock would be anti-dilutive and, therefore, it is not included in the calculation of diluted earnings per share for those periods.
A summary of realized investment gains and losses before income taxes is as follows:
The amortized cost, gross unrealized gains and losses, and fair values of investments as of December 31, 1997 and 1996, respectively, are as follows:
Expected maturities of the Company's investments may differ from contractual maturities because certain borrowers have the right to call or prepayment obligations with or without call or prepayment penalties.
The changes in unrealized gains (losses) on investments available-for-sale for 1997, 1996 and 1995 total $17,478,000, $(30,688,000) and $73,285,000, net of deferred income taxes (benefits) of $9,411,000, $(16,524,000) and $39,461,000, respectively.
Ordinarily, the Company's principal deferred tax assets arise from the discounting of loss reserves for tax purposes, which delays a portion of the loss deduction, and from the acceleration of 20% of the unearned premium reserve into taxable income before it is earned. As of December 31, 1997, the Company has a net operating loss carryforward of approximately $271,000,000 for regular tax purposes and $141,000,000 for alternative minimum tax purposes expiring in the year 2009 and an alternative minimum tax credit carryforward of $13,927,000. Alternative minimum tax credits may be carried forward indefinitely to offset future regular tax liabilities.
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 1997, 1996 and 1995 totaled $273.5 million, and except for the losses arising from the Northridge Earthquake in 1994, 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 96% excluding the Northridge Earthquake, and net investment income has averaged approximately $82 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. The Company exited the earthquake line of business in 1995, which substantially eliminated the Company's exposure to future earthquake catastrophes.
The Company believes that because of its historically strong earnings performance, and the tax planning strategies available, it is more likely than not that the Company will realize the benefit of the deferred tax asset, and therefore, no valuation allowance has been established.
Payments for income taxes were $3,150,000, $2,367,500 and $65,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company sponsors a non-contributory defined benefit pension plan which covers essentially all employees who have completed at least one year of service. The benefits are based on employees' compensation during all years of service. The Company's funding policy is to make annual contributions as required by applicable regulations. The pension plan's assets consist of high-grade fixed income securities and cash equivalents.
The net periodic pension cost for these plans was $4,012,000, $3,925,000 and $3,147,000 in 1997, 1996 and 1995, respectively. Accrued pension costs included in the consolidated balance sheets at December 31, 1997 and 1996 are $2,521,000 and $4,073,000, respectively.
The Company sponsors a contributory savings and security plan for eligible employees. The Company provides matching contributions equal to 75% of the lesser of 6% of an employee's compensation or the amount contributed by the employee. Contributions charged against operations were $2,697,000, $2,556,000 and $2,376,000 in 1997, 1996 and 1995, respectively.
The Company has entered into a revolving credit facility ("the Facility") that provides an aggregate commitment of $157.5 million at December 31, 1997. 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, 1997, the Company's outstanding advances against the Facility totaled $157.5 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, 1997, the annual interest rate for the specified interest period was approximately 6.7%. Interest paid was $12,758,000 in 1997, $9,813,000 in 1996 and $12,636,000 in 1995.
respectively. The ceding commission is adjusted annually to equal the prior year's gross SAP underwriting expense ratio.
The Company has two separate stock compensation plans: the 1995 Stock Option Plan, which provides for grants of stock options to key employees and non-employee directors of the Company, and the Restricted Shares Plan, which provides for stock grants to key employees.
The aggregate number of common shares issued and issuable under the Plan currently is limited to 4,000,000. All options granted have ten year terms and vest over various future periods.
The Company's pro forma information using the Black-Scholes valuation model follows:
The Restricted Shares Plan currently provides for grants of up to 921,920 shares of common stock to be made available to key employees as determined by the Key Employee Incentive Committee of the Board of Directors. The common shares are restricted for five years retroactive to the first day of the year of grant. Restrictions are removed on 20% of the shares of each employee on January 1 of each of the five years following the year of grant. At December 31, 1997, 205,519 common shares remain available for future grants. Upon issuance of grants of common shares under the plan, unearned compensation equivalent to the market value on the date of grant is charged to
A summary of grants under the plan from 1995 through 1997 follows:
In accordance with a settlement with the DOI in 1995 regarding rebate liabilities associated with Proposition 103, the Company offset a portion of the 1995 increase in earthquake losses associated with the 1994 Northridge Earthquake (see Note 16) with $32 million in funds previously set aside for potential Proposition 103 rebates. In addition, as part of the settlement, the Company contributed $30 million to the surplus of the insurance subsidiaries with funds obtained from the existing bank credit facility and from the issuance of 20,000 additional shares of preferred stock to AIG (see Notes 9 and 17, respectively).
The Northridge Earthquake, which occurred on January 17, 1994, significantly affected the operating results and the financial position of the Company. The Company has recorded additional losses related to the 1994 event of $24.75 million, $40 million and $60 million in 1997, 1996, and 1995, respectively. In accordance with the terms of a settlement with the California Department of Insurance, the Company offset a portion of the 1995 increase in earthquake losses with $32 million in funds previously set aside for potential Proposition 103 rebates (see Note 15).
On December 16, 1994, the Company received $216 million of equity capital from AIG and, in exchange, issued (i) 200,000 shares of Series A 9% Convertible Preferred Stock, par value $1.00 per 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, initially at $13.50 per share subject to a formula that resulted in a permanent reduction to $9.10 per share. In 1995, an additional 20,000 shares of preferred stock were issued to AIG in exchange for $20,000,000 of equity capital. In addition, preferred stock dividends in kind of $4,950,000, representing 4,950 additional shares, were issued on June 26, 1995. The Common Stock Warrants are generally exercisable from February
1998 to February 2007. There are no restrictions on the redemption of the Convertible Preferred Stock shares.
The 1996 and first three quarters of 1997 earnings per share amounts have been restated to comply with SFAS No. 128 (see Note 3).
The second and fourth quarters of 1997 were impacted by pre-tax charges of $6.75 million and $18 million, respectively, in additional reserves related to the 1994 Northridge Earthquake.
HOMEOWNER AND CONDOMINIUM. The 1997, 1996 and 1995 underwriting losses in these lines included respective provisions for additional earthquake reserves of $24.75 million, $40 million and $60 million, the latter of which was partially offset by a $2 million reduction in Proposition 103 rebates. Also affecting the three years was an overall decline in premium volume resulting from an order from the DOI. In addition, 1995 was impacted by first quarter weather-related losses of $14.2 million and earthquake-related catastrophe reinsurance premiums of $24 million.