The Company also leases office space for claims offices in San Diego, California; Fresno, California and Tampa, Florida, a sales office in Sacramento, California and Phoenix, Arizona and marketing offices in Addison, Texas and Boca Raton, Florida.
The Company is the owner of two office buildings that were previously occupied by the Company's headquarters, both located in Beverly Hills, California. One building contains approximately 25,000 square feet of office space and the other office building contains approximately 24,000 square feet. Both office buildings are currently unencumbered and are fully leased to unaffiliated parties.
SELECTED CONSOLIDATED FINANCIAL DATA (In thousands, except per share - -------------------------------------------- data)
(1) Financial data as of and for the year ended December 31, 1996 are derived from the consolidated financial statements of Southern California Physicians Insurance Exchange (the Exchange) and its subsidiaries. Financial data as of and for the years ended December 31, 1997 through and 2000 are derived from the financial statements of SCPIE Holdings Inc. (SCPIE Holdings) and its subsidiaries.
(3) Basic earnings per share of common stock at December 31, 2000, 1999 and 1998 are computed using the weighted average number of common shares outstanding during the year of 9,375,735, 11,383,592 and 12,074,272, respectively. All other periods give effect to the merger of the Exchange into a subsidiary of SCPIE Holdings completed on January 29, 1997, including the allocation of approximately 10,000,000 shares of common stock to members of the Exchange in connection therewith. Diluted earnings per share of common stock at December 31, 2000, 1999 and 1998 are computed using the weighted average number of common shares outstanding during the year of 9,382,494, 11,403,081 and 12,089,013, respectively. For further discussion of basic earnings per share and diluted earnings per share, see the notes to consolidated financial statements beginning on page 49.
(4) Net premiums written for 2000 reflects the Company's change in accounting method to recognize written premiums on the effective date of the policy rather than on the date premiums were billed. This change had no impact on the income statement. If 1999 premiums had been recognized under this method, net premiums written would have approximated $174.5 million.
The strategic objective of the reinsurance division is to create a well- balanced portfolio of carefully underwritten assumed reinsurance lines of insurance to add diversity to the direct business of the company. The Company has relied heavily on prior relationships with lead reinsurers and reinsurance intermediaries to gain access to attractive opportunities. In most instances, the Company is a treaty participant at a level in which the reinsured also has a significant share of the losses. In other instances, the Company has also invested in the company managing the reinsurance arrangement. Two officers experienced in this area, who joined the Company in 1999 to start the division, have developed these relationships. If these officers left the employ of the Company for any reason, the Company would have difficulty maintaining the relationships or the business of the division. There is no assurance that the Company will be successful in attracting appropriate reinsurance opportunities or that this business will be profitable.
The Company's historical business is underwriting professional liability insurance for physicians and medical groups in California. In recent years, the Company has followed a strategy for growth, which includes diversifying geographically into states other than California and expanding the insurance products offered by the Company.
Brown & Brown Relationship. The Company has accomplished geographic -------------------------- expansion principally through an arrangement with Brown & Brown, Inc. (Brown & Brown), one of the nation's top independent insurance agency organizations. American Healthcare Indemnity Company (AHI), a subsidiary of SCPIE Holdings, entered into an agreement with Brown & Brown to market professional liability insurance to physicians and small medical groups in selected states commencing January 1, 1998. The program now has been expanded to encompass eight states, the largest in terms of premium volume being Florida, Georgia and Connecticut. Continued expansion of this relationship with Brown & Brown is an important element of the Company's strategy for diversification into states outside California.
Hospital Policies. The Company initially expanded its insurance products ----------------- in 1994 by offering professional liability insurance to hospitals in California. The Company greatly extended its presence in the hospital market in late 1996 through a marketing agreement with a leading healthcare insurance broker. Under this arrangement, the broker placed a coverage with the Company for approximately 75 hospitals, healthcare providers and other organizations in seven states. The Company subsequently attempted to expand its hospital writings through other brokers. The Company encountered severe competitive conditions in all parts of the hospital market. During 2000, the Company incurred unacceptable losses under its hospital policies generally. The Company has adopted stringent underwriting procedures and guidelines for continuing its hospital policies, and at present insures only 15 hospitals. The Company expects little or no improvement in the market, as long as the current conditions exist.
Dentists and Oral Surgeons. The Company has written professional liability -------------------------- insurance for oral surgeons in California for a number of years. Beginning in 2000, the Company expanded its relationship with Brown & Brown to include professional liability coverage for dentists in California and Texas and for oral surgeons nationally. These programs had been underwritten by another insurance company and marketed by Brown & Brown previously. The Company issues its own dentist policies and reinsures the oral surgeon policies issued and renewed by the other insurance company.
reserve estimates. During 2000, the Company continued to establish reserve estimates for the current year at estimates it considered conservative, but at lower levels than in prior years principally due to the change in the mix of business.
The Company has consistently experienced favorable development (i.e., redundancies) in reserves established for prior years. Redundant reserves, which have been recognized or released in every year since 1985, have contributed significantly to reported earnings in recent years. The Company reduced reserves for prior years by $61.2 million, $93.8 million and $53.2 million in the years ended December 31, 1999, 1998 and 1997, respectively. (The 1998 redundancies were offset, in part, by a $28.1 million increase in the loss and LAE reserves for the medical malpractice insurance business assumed from an unaffiliated company in January 1998.) During 2000, the Company experienced adverse loss development in its prior years' reserves for hospitals and significant ongoing losses in this program. The Company also experienced less favorable loss development in its other insurance lines than in prior years. The Company recognized favorable development in prior years' reserves of $42.1 million in 2000, of which only $8.1 million was recognized in the fourth quarter ended December 31, 2000.
The Company has continued to experience-less favorable loss development attributable to prior years' loss and LAE reserves. The Company has established these reserves at levels it considers adequate, but it does not expect any material redundancies to develop during 2001. The Company will continue to establish its loss and LAE reserves at what it believes are conservative levels for the 2001 accident year, but at expected lower levels than during 2000 due to rate actions, stricter underwriting and the change in the mix of business. If the Company does not experience any material favorable reduction during 2001 in prior years' loss reserves, the Company's net income will be adversely affected.
The value of the fixed-maturity portfolio is subject to interest rate risk. Interest rates have risen substantially since December 31, 1998, resulting in a decline in the value of five-year treasury bonds and adversely affecting the carrying value of the Company's fixed-maturity portfolio. At December 31, 2000, the Company's fixed maturities were valued at $0.9 million below amortized cost. If these securities were sold at their current carrying values, the Company would record a realized loss on the sale.
Year Ended December 31, 2000, Compared to Year Ended December 31, 1999 ----------------------------------------------------------------------
As of December 31, 2000 the Company adopted FASB No. 131, Disclosures About Segments of an Enterprise and Related Information, and classified its operations into the direct healthcare liability insurance segment and the assumed reinsurance segment. See Note 13 of Notes to Consolidated Financial Statements.
Net investment income decreased approximately $3.5 million, or 9.4%, to $34.1 million in 2000 from $37.7 million in 1999. This change reflects a decrease in average invested assets from $724.5 million in 1999 to $665.3 million in 2000, due principally to the sale of securities to fund the Company's repurchase of approximately 2.0 million shares of its Common Stock from its public stockholders in November 1999. The average annual return before taxes on the Company's portfolio of fixed-maturity securities was 5.4% in both 1999 and 2000.
Premiums Earned. Premiums earned in the direct healthcare liability --------------- insurance segment increased approximately $3.0 million, or 2.0%, to $149.4 million in 2000 from $146.4 million in 1999. Medical malpractice premiums from physicians and medical groups decreased to approximately $131.2 million in 2000 from $132.8 million in 1999. This decrease in premiums was principally due to the loss of physician and medical group insureds in the highly-price competitive California market. Physicians and small medical groups written through Brown & Brown outside California increased approximately $3.7 million to $22.1 million from $18.4 million in 1999, and the Company earned an additional $5.1 million in dentist and oral surgeon premiums in 2000 written through Brown & Brown. The Company has instituted an average 2001 premium rate increases for physicians in California of approximately 10.6% and is instituting similar increases in a number of other states. The effect of these rate increases is uncertain.
Hospital medical malpractice premiums remained largely unchanged with approximately $10.0 million in 2000 compared to $9.2 million in 1999. The Company has selectively underwritten its hospital business for 2001 and substantially reduced the number of hospitals insured, but at significantly increased premium rates. The Company expects a significant decline in earned premiums from hospitals in 2001 and continued erosion in the number of hospitals insured.
Premiums Earned. Premiums earned in the assumed reinsurance segment ---------------- increased to $27.1 million in 2000, the segment's first full year of operation, from $6.8 million in 1999. The Assumed Reinsurance Division was formed in August of 1999, although the Company had written small amounts of assumed reinsurance for a number of years. Premiums earned during 2000 included approximately $8.8 million under casualty programs, $6.3 million under property programs, $9.4 million under accident and health programs and $2.6 million under its marine program. The Company also earned $6.2 million in other assumed premiums in 2000 under fronting arrangements related to its dentist and oral surgeon programs marketed by Brown & Brown. In 1999, Company had assumed premiums earned of $11.1 million relating to fronting insurance arrangements that are no longer in effect.
Losses and LAE. Assumed reinsurance losses and LAE (other than under -------------- fronting arrangements) were $23.3 million in 2000, or 86.0% of assumed premiums earned, compared to $6.2 million, or 91.2% of premiums earned, in 1999.
The Company did not classify its operations in separate segments in 1999 and prior years.
Losses and LAE. Losses and LAE decreased to $122.8 million in 1999 from --------------- $132.2 million in 1998. As a percentage of premiums earned, losses and LAE decreased to 80.2% in 1999 from 83.7% for the same period in 1998. For 1999, the Company reduced loss and LAE reserves incurred in prior policy years approximately $61.2 million as compared to a reserve reduction of $93.8 million in 1998 for claims incurred in prior policy years.
Federal Income Taxes. Federal income taxes decreased $3.3 million, or --------------------- 26.2%, to $9.3 million in 1999 from $12.6 million in 1998 due primarily to lower realized gains in 1999. The effective tax rate decreased to 23.7% in 1999 from 25.4% in 1998.
Because of uncertainty related to the timing of the payment of claims, cash from operations for a property and casualty insurance company can vary substantially from period to period. During 2000, the Company had positive cash flow from operations of $4.8 million compared to a negative cash flow of $8.8 million in 1999. The positive cash flow in 2000 was principally attributable to increased assumed reinsurance premiums received by the Company and a decrease in loss and LAE payments. The negative cash flow during 1999 was due to unusually high payments of losses.
The Company invests its cash flow from operations in both fixed-maturity securities and equity securities. The Company's current policy is to limit its investment in equity securities and real estate to no more than 8.0% of the total market value of its investments. Accordingly, the Company's portfolio of unaffiliated equity securities had a fair value of $24.4 million at December 31, 2000. The Company plans to continue this focus on fixed-maturity securities for the indefinite future.
The Company has made limited investments in real estate, which have been used almost entirely in the Company's operating activities, with the remainder leased to third parties. The Company leases approximately 95,000 square feet of office space for its headquarters. The lease is for a term of 10 years ending in 2009, and the Company has options to renew the lease for an additional 10 years. The Company has leased to unaffiliated third parties its two former headquarters buildings.
SCPIE Holdings is an insurance holding company whose assets primarily consist of all of the capital stock of its insurance company subsidiaries. Its principal sources of funds are dividends from its subsidiaries and proceeds from the issuance of debt and equity securities. The insurance company subsidiaries are restricted by state regulation in the amount of dividends they can pay in relation to earnings or surplus, without the consent of the applicable state regulatory authority, principally the California Department of Insurance. SCPIE Holdings' principal insurance company subsidiary may pay dividends to SCPIE Holdings in any 12-month period, without regulatory approval, to the extent such dividends do not exceed the greater of (i) 10% of its statutory surplus at the end of the preceding year or (ii) its statutory net income for the preceding year. Applicable regulations further require that an insurer's statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs, and permit the payment of dividends only out of statutory earned (unassigned) surplus unless the payment out of other funds receives regulatory approval. The amount of dividends that the insurance company subsidiaries are able to pay to SCPIE Holdings during 2001 without prior regulatory approval is approximately $24.1 million. Of this amount, approximately $2.9 million may be paid after November 26, 2001, and the remainder on or after December 29, 2001. The Company believes that SCPIE Holdings has sufficient liquid assets and other resources of cash that no dividends will be required until after November 26, 2001.
Common stock dividends paid to stockholders were $0.40 per share in 2000. These dividends were funded through dividends from the Company's insurance subsidiaries. The Company expects to pay dividends in the future. However, payment of dividends is subject to Board approval, earnings and the financial condition of the Company.
During May 2000, the Board of Directors authorized the repurchase of up to 1,000,000 shares of its common stock on the open market. This authorization extended the company's 1999 program that expired in May 2000. Under this extended 1999 program, 360,820 shares have been repurchased.
The investment portfolio of the Company is subject to various market risk exposures, including interest rate risk and equity price risk.
The first two columns of the following table show the financial statement carrying values and related estimated fair values of the fixed-maturity securities and equity investments held by the Company at December 31, 2000 and 1999, respectively. The third column shows the effect on current estimated fair values assuming a 100-basis-point increase in market interest rates and a 10% decline in equity prices (sensitivity analysis). This sensitivity analysis is required by the Securities and Exchange Commission rules issued in 1997.
* Adjusted interest rates assume a 100-basis-point increase in market rates **Adjusted equity prices assume a 10% decline in market values