During 2001 the Company continued its growth, with gross written premium increasing 30.9% to $473.6 million. This growth is attributable to a number of varying factors, the most notable of which were:
- - The 20.0% growth in production from the Company's preferred agent force, which is comprised of independent brokers specializing in various of the Company's product niches.
Furthermore, as a result of the terrorist attacks of September 11, 2001, the Company has endorsed its commercial insurance polices issued during 2002 with the Insurance Services Office ("ISO") terrorism exclusion in states where approved by the respective Insurance Departments. Currently, not all states have approved this ISO terrorism exclusion, and the Company cannot determine whether the state insurance departments which have not yet approved this exclusion will ultimately do so. In its capacity as primary insurer the Company may have a potential gap in its reinsurance protection and could be exposed to potential losses as a result of any terrorist acts. To mitigate this potential exposure to losses arising from terrorist acts, the Company has purchased reinsurance coverage for terrorism with a $10.0 million aggregate policy limit for 2002.
In February 2001, A.M. Best Company reaffirmed the "A+" (Superior) rating for Philadelphia Indemnity Insurance Company, Philadelphia Insurance Company, Mobile USA Insurance Company and Liberty American Insurance Company (collectively the "Insurance Subsidiaries").
Collateralized mortgage and asset backed securities, on a cost basis, amounted to $70.4 million and $272.7 million, respectively, as of December 31, 2001 and $65.6 and $106.8, respectively, as of December 31 2000. The increased investment in collateralized mortgage and asset backed securities was due to the relatively higher after tax rates of return compared to other investment options within the Company's investment objective. This objective is to generate competitive after-tax total rates of return within a prudent level of risk and the constraints of maintaining adequate securities in amount and duration to meet cash requirements of current operations and long-term liabilities, as well as maintaining and improving the Company's A.M. Best rating. The collateralized mortgage and asset backed investments are shorter tranche securities possessing favorable prepayment risk profiles. The Company utilizes professional investment managers for its investments.
The Company's financial instruments are subject to the market risk of potential losses from adverse changes in market rates and prices. The primary market risks to the Company are equity price risk associated with investments in equity securities and interest rate risk associated with investments in fixed maturities. The Company has established, among other criteria, duration, asset quality and asset allocation guidelines for managing its investment portfolio market risk exposure. The Company's investments are held for purposes other than trading and consist of diversified issuers and issues.
The carrying amounts for the Company's investments approximates their estimated fair value except for investments in limited partnerships which are valued at cost. The Company measures the fair value of investments based upon quoted market prices or by obtaining quotes from dealers.
The liability for unpaid loss and loss adjustment expenses ($302.7 million and $237.5 million as of December 31, 2001 and 2000, respectively) reflects the Company's best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events. This liability includes an amount determined on the basis of claim adjusters' evaluations with respect to insured events that have occurred and an amount for losses incurred that have not been reported to the Company. In some cases significant periods of time, up to several years or more, may elapse between the occurrence of an insured loss and the reporting of such to the Company. The method for determining the Company's liability for unpaid loss and loss adjustment expenses includes but is not limited to reviewing past loss experience and considering other factors such as legal, social, and economic developments. The methods of making such estimates and establishing the resulting liabilities are continually reviewed and updated and any adjustments resulting therefrom are made in the accounting period in which the adjustment arose.
Policy acquisition costs ($41.5 million and $33.3 million as of December 31, 2001 and 2000, respectively) which include commissions, premium taxes, fees, and certain other costs of underwriting policies, are deferred and amortized over the same period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable after providing for losses and expenses that are expected to be incurred, based upon historical and current experience. Anticipated investment income is considered in determining whether a premium deficiency exists. The methods of making such estimates and establishing the deferred costs are continually reviewed by the Company, and any adjustments therefrom are made in the accounting period in which the adjustment arose.
- - The consolidation of certain competitor property and casualty insurance companies has led to the displacement of certain of their independent agency relationships. This consolidation continues to result in new agency
Net Realized Investment Gain: Net realized investment gains were $3.4 million for the year ended December 31, 2001 and $11.7 million for the same period in 2000. The Company realized net investment gains of $8.3 million from the sales of common stock securities and $0.9 million from the sales of fixed maturity securities during the year ended December 31, 2001. These realized net investment gains were offset by $5.8 million in non-cash realized investment losses experienced on certain structured securities as a result of an impairment evaluation in accordance with the recent EITF 99-20 guidance. The proceeds from the sales are being reinvested in fixed maturity securities to increase current investment income and decrease the overall percentage of investments in common stock securities. The net realized investment gains of $11.7 million for the year ended December 31, 2000 were due to sales of certain equity investments which resulted in realized net investment gains amounting to $15.1 million, and were offset by $3.4 million of realized net investment losses from sales of certain fixed income securities. The proceeds from these sales were reinvested principally in fixed maturity securities.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased $48.4 million (36.9%) to $179.7 million for the year ended December 31, 2001 from $131.3 million for the same period of 2000 and the loss ratio increased to 60.7% in 2001 from 57.8% in 2000. The year ended December 31, 2001 included a $4.0 million increase to net loss and loss adjustment expenses arising from business interruption, business personal property, business property and workers' compensation exposures relating to the September 11, 2001 terrorist attacks. Excluding this item, net loss and loss adjustment expenses increased by $44.4 million (33.8%). The increase in net loss and loss adjustment expenses was due principally to:
Other Operating Expenses: Other operating expenses decreased $7.9 million to $6.8 million for the year ended December 31, 2001 from $14.7 million for the same period of 2000. The decrease in other operating expenses was primarily due to the decrease in brokering activities resulting in a decrease in the amount of broker commissions (see "Other Income" above). Goodwill amortization of $1.5 million per year, both for 2001 and 2000 will cease on January 1, 2002 due to the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
- - The growth of Liberty, resulting in an increase of $28.8 million in gross manufactured housing, preferred homeowners and National Flood Insurance Program written premiums.
Other Income: Other income approximated $9.0 million for the year ended December 31, 2000 and $4.7 for the same period of 1999. Other income primarily consists of commissions earned by Liberty on brokered personal lines business, and for the year ended December 31, 1999 only included such income from the July 1999 acquisition date to December 31, 1999. Prospectively the Company anticipates commissions earned on brokered personal lines business to significantly decrease as the Company discontinues brokering activities in favor of writing the business directly.
Income Tax Expense: The Company's effective tax rates for 2000 and 1999 were 32.4% and 29.3%, respectively. The effective rates differed from the 35% statutory rate principally due to investments in tax-exempt securities offset in part by non-deductible goodwill amortization. The increase in the effective tax rate is principally due to a greater investment of cash flows in taxable securities relative to tax-exempt securities.
Philadelphia Consolidated Holding Corp. (PCHC) is a holding company whose principal assets currently consist of 100% of the capital stock of its subsidiaries. The Company's primary sources of funds are dividends from its subsidiaries and payments received pursuant to tax allocation agreements with the insurance subsidiaries. For the year ended December 31, 2001, payments to PCHC pursuant to such tax allocation agreements totaled $18.6 million. The payment of dividends to PCHC from the insurance subsidiaries is subject to certain limitations imposed by the insurance laws of the Commonwealth of Pennsylvania and State of Florida. Accumulated statutory profits or policyholders' surplus of the insurance subsidiaries from which dividends may be paid totaled $111.3 million at December 31, 2001. Of this amount, the insurance subsidiaries are entitled to pay a total of approximately $27.4 million of dividends in 2002 without obtaining prior approval from the Insurance Commissioner of the Commonwealth of Pennsylvania or State of Florida. During 2001 the insurance subsidiaries paid dividends of $13.0 million to PCHC and $3.8 million to Liberty American Insurance Group, Inc., a subsidiary of PCHC.
Two of the Company's Insurance Subsidiaries are members of the Federal Home Loan Bank of Pittsburgh ("FHLB"). A primary advantage of FHLB membership is the ability of members to access credit products from a reliable capital markets provider. The availability of any one member's access to credit is based upon its FHLB eligible collateral. At December 31, 2001 the Insurance Subsidiaries borrowing capacity was $80.8 million. The Insurance Subsidiaries have utilized a portion of its borrowing capacity to purchase a diversified portfolio in investment grade floating rate securities. These purchases were funded by floating rate FHLB borrowings to achieve a positive spread between the rate of interest on these securities and borrowing rates. The remaining borrowing capacity will provide an immediately available line of credit. Borrowings aggregated $31.3 million at December 31, 2001 and bear interest at adjusted LIBOR and mature twelve months from inception. The weighted-average interest rate on borrowings outstanding as of December 31, 2001 was 2.07%.
Under certain reinsurance agreements, the Company is required to maintain investments in trust accounts to secure its reinsurance obligations (primarily the payment of losses and loss adjustment expenses on business it does not write directly). At December 31, 2001, the investment and cash balances in such trust accounts totaled approximately $11.9 million. In addition, various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 2001, the balance on deposit for the benefit of such policyholders totaled approximately $13.5 million.
The Company produced net cash from operations of $115.1 million in 2001, $47.0 million in 2000 and $47.4 million in 1999. Operating cash included cash provided from tax benefits as a result of the exercise of employee stock options amounting to $25.8 million, $0.1 million and $0.3 million for 2001, 2000 and 1999, respectively. Management believes that the Company has adequate liquidity to pay all claims and meet all other cash needs.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income, changes in shareholders' equity and cash flows present fairly, in all material respects, the financial position of Philadelphia Consolidated Holding Corp. and Subsidiaries (the "Company") at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The consolidated financial statements include the accounts of the Company prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). All significant intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements requires making estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Fixed maturity investments, classified as Available for Sale, are carried at market value with the change in unrealized appreciation (depreciation) credited or charged directly to shareholders' equity, net of applicable deferred income taxes. Income on fixed maturities is recognized on the accrual basis.
The Company adopted the provisions of Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities" on January 1, 2001. The provisions of SFAS 133 require, among other things, that all derivatives be recognized in the consolidated balance sheets as either assets or liabilities and measured at fair value. The corresponding derivative gains and losses should be reported based upon the hedge relationship, if such a
In November 2000, the Emerging Issues Task Force of the Financial Accounting Standards Board ("FASB") reached a consensus on impairment accounting for retained beneficial interests ("EITF 99-20"). Under this consensus, impairment on certain beneficial interests in securitized assets must be recognized when (1) the asset's fair value is below its carrying value, and (2) there has been an adverse change in estimated cash flows. Previously, impairment on such assets was recognized when the asset's carrying value exceeded estimated cash flows discounted at a risk free rate of return. The adoption of EITF 99-20 on April 1, 2001 by the Company had an immaterial effect on earnings and financial position. During 2001 certain structured securities were subject to re-evaluation under EITF 99-20 as a result of an adverse change in estimated cash flows due to credit rating downgrades. This re-evaluation resulted in non-cash realized investment losses of $5.8 million for the year ended December 31, 2001.
Cash equivalents, consisting of fixed maturity investments with maturities of three months or less when purchased and money market funds, are stated at cost which approximates market value.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 eliminates the practice of amortizing goodwill through periodic charges to earnings and establishes a new methodology for recognizing and measuring goodwill and other intangible assets. Under this new accounting standard, the Company will cease goodwill amortization on January 1, 2002 and will also review goodwill and other intangible assets for any impairment or other effects of the new standard. The Company will adopt the provisions of SFAS No. 142 as of January 1, 2002, and does not anticipate a material impact on financial position or results of operations. Goodwill amortization was $1.5 million in 2001, $1.5 million in 2000 and $0.8 million in 1999.
Premiums are generally earned on a pro rata basis over the terms of the policies. Premiums applicable to the unexpired terms of the policies in-force are reported as unearned premiums. The Company records an allowance for doubtful accounts for premiums receivable balances estimated to be uncollectible. At December 31, 2001 and 2000 the allowance for doubtful accounts amounted to $1.0 million and $1.4 million, respectively.
- - Under SAP, certain assets, designated as "Non-admitted Assets" (such as prepaid expenses) are charged against surplus.
Dividend Restrictions: The Insurance Subsidiaries are subject to various regulatory restrictions which limit the maximum amount of annual shareholder dividends allowed to be paid. The maximum dividend which the Insurance Subsidiaries may pay to Philadelphia Insurance during 2002 without prior approval is $27.4 million. Dividends paid for the years ended December 31, 2001 and 2000 were $16.8 and $0 million, respectively.
(1) Original cost adjusted for amortization of premiums and accretion of discounts. (2) Estimated market values have been based on quoted market prices.
There are no material investments in fixed maturity securities that were non-income producing during the years ended December 31, 2001, 2000, and 1999. Investment expense includes $107,000, $182,000, and $212,000, in investment management fees paid to a director of the Company in 2001, 2000, and 1999, respectively. These transactions are in the ordinary course of business at negotiated prices comparable to those of transactions with other investment advisors.
The Company's share of the investments in the trust accounts is included in investments and cash equivalents, as applicable, in the accompanying consolidated balance sheets.
Included in property and equipment are costs incurred in developing or purchasing information systems technology of $6.3 million and $5.4 million in 2001 and 2000, respectively. Amortization of these costs was $0.8 million, $0.6 million and $0.3 million for the years ended December 31, 2001, 2000 and 1999, respectively. Depreciation expense, excluding amortization of capitalized information systems technology costs, was $1.4 million, $1.4 million and $1.5 million, for the years ended December 31, 2001, 2000, and 1999, respectively.
(1) 1999 Adjusted to include $3,323 gross unpaid loss and loss adjustment expenses for Mobile USA Insurance Company as of acquisition date.
(3) 1999 Adjusted to include $2,175 net unpaid loss and loss adjustment expenses for Mobile USA Insurance Company as of acquisition date.
As a result of changes in estimates of insured events in prior years, the Company increased losses and loss adjustment expenses incurred by $13.4 million in 2001. Such development was primarily due to losses emerging at a higher rate on automobile leases expiring in 2001 on residual value policies underwritten in prior years than had been originally anticipated when the initial reserves were estimated.
In November 2000 the Company, pursuant to a Board of Directors authorization, entered into an unsecured revolving credit facility for aggregate borrowings of up to $22.0 million at any one time outstanding with a maturity date of 364 days after closing. During 2000, $22.0 million of the facility was utilized by the Company to pay a withholding tax liability as a result of the CEO electing to have shares otherwise issuable withheld in satisfaction of the minimum withholding tax attributable to the exercise of stock options. Borrowings under the facility bore interest at adjusted LIBOR and unused commitments under the facility were subject to a fee of 20 basis points per annum. Interest expense amounted to $0.1 million and $0.2 million for the years ended December 31, 2001 and 2000, respectively. During the first quarter 2001 the Company repaid all aggregate borrowings and cancelled the commitment under this revolving credit facility.
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2001 and 2000 are as follows (in thousands):
Income taxes recoverable amounted to $13.3 million at December 31, 2000. Of such amount, $8.6 million of prior year tax payments were received during January 2001. The remaining recoverable amount was applied to 2001.
On May 16, 2001, the Company issued 4.0 million common shares to satisfy the stock purchase contract obligation from the Company's 1998 FELINE PRIDESSM offering. The issuance of such shares resulted in a $98.9 million increase in Shareholders' Equity and a corresponding decrease in the Minority Interest In Consolidated Subsidiaries balance.
Basic and diluted earnings per share are calculated as follows (dollars and share data in thousands, except per share data):
Under the Company's stock option plan, stock options may be granted for the purchase of common stock at a price not less than the fair market value on the date of grant. Options are primarily exercisable after the expiration of five years following the grant date. Under this plan, the Company has reserved 2,475,000 shares of common stock for issuance pursuant to options granted under the plan.
Employee Stock Purchase Plan (the "Stock Purchase Plan"): The aggregate maximum number of shares that may be issued pursuant to the Stock Purchase Plan as amended is 1,000,000. Shares may be purchased under the Stock Purchase Plan by eligible employees during designated one-month offering periods established by the Compensation Committee of the Board of Directors at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. The purchase price of shares may be paid by the employee over six years pursuant to the execution of a promissory note. The promissory note(s) are collateralized by such shares purchased under the Stock Purchase Plan and are interest free. Under the Stock Purchase Plan, the Company issued 103,855 and 54,463 shares in 2001 and 2000, respectively. The weighted-average fair value of those purchase rights granted in 2001 and 2000 was $3.85 and $3.08, respectively.
Directors Stock Purchase Plan ("Directors Plan"): The Directors Plan has been established for the benefit of non-employee Directors. The aggregate maximum number of shares that may be issued pursuant to the Directors Plan is 50,000. Non-employee Directors, during monthly offerings periods, may designate a portion of his or her fees to be used for the purchase of shares under the terms of the Directors Plan at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. Under the Directors Plan, the Company issued 1,709 and 2,207 shares in 2001 and 2000, respectively. The weighted-average fair value of those purchase rights granted in 2001 and 2000 was $4.56 and $2.64, respectively.
13,528 shares in 2001 and 2000, respectively. The weighted-average fair value of those purchase rights granted in 2000 was $2.48.
The loss and loss adjustment expense reserves ceded under such arrangements were $52.6 million and $42.0 million at December 31, 2001 and 2000, respectively. The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The percentage of ceded reinsurance reserves (excluding reserves ceded to voluntary and mandatory pool mechanisms) that are with companies rated "A" (Excellent) or better by A.M. Best Company is 97.0% and 99.2% as of December 31, 2001 and 2000, respectively. Additionally, approximately 3%, 4% and 4% of the Company's net written premiums for the years ended December 31, 2001, 2000, and 1999, respectively, were assumed from an unrelated reinsurance company.
The Company has a defined contribution Profit Sharing Plan, which includes a 401K feature, covering substantially all employees. Under the plan, employees may contribute up to an annual maximum of the lesser of 15% of eligible compensation or the applicable Internal Revenue Code limit in a calendar year. The Company makes a matching contribution in an amount equal to 75% of the participant's pre-tax contribution, subject to a maximum of 6% of the participant's eligible compensation. The Company may also make annual discretionary profit sharing contributions at each plan year end. Participants are fully vested in the Company's contribution upon completion of four years of service. The Company's total contributions to the plan were $0.6 million, $0.6 million and $0.3 million in 2001, 2000, and 1999, respectively.
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 2001 and 2000 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown (in thousands, except share and per share data):
The segments follow the same accounting policies used for the Company's consolidated financial statements as described in the summary of significant accounting policies. Management evaluates a segment's performance based upon certain underwriting results.