The Company leases its Home Office building in Woodland Hills, California, which contains approximately 230,000 square feet of leasable office space. The lease was amended in April 1998 to extend its term until November 2014. The lease may be renewed for two consecutive five-year periods.
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, 1998, are derived from the consolidated financial statements of 20th Century Industries and its subsidiaries. The consolidated financial statements as of December 31, 1998 and 1997 and for each of the years in the three-year period ended December 31, 1998, are included elsewhere in this Form 10-K. The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, Earnings Per Share. For further discussion of earnings per share, see Note 3 of the Notes to Consolidated Financial Statements.
In 1998 and 1997, the Company's financial statements include the effects of non-recurring charges of $7.7 million and $1.5 million, respectively. Such charges represent accelerated amortization of restricted stock grants in 1998 and Year 2000 costs in both 1998 and 1997. Additionally, increases in earthquake reserves in 1998 of $40 million, 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 are also included in the financial statements. 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 $0.46, $0.33, $0.51, $0.35 and ($10.67) for 1998, 1997, 1996, 1995 and 1994, respectively.
PRIVATE PASSENGER AUTOMOBILE. Strong unit growth in the auto business remains the Company's priority. Vehicles in force grew by 53,153 in 1998, compared to an increase of 65,267 in 1997. The Company continues to increase its vehicles in force despite intense competition in the automobile insurance market. In view of the favorable trends in loss costs and frequency in 1997 and 1998, the Company lowered overall rate levels approximately 3.4% and 3.2% in 1998 and 1997, respectively, and by an additional 6.8% in February 1999. Through its aggressive marketing efforts and the introduction of rating plans that offer lower rates to its more profitable, preferred customers and higher rates for drivers deemed to be greater risks, the Company has been able to enhance its profitable customer mix. The Company's average customer retention rate was approximately 96% for both 1998 and 1997.
HOMEOWNERS. The Company's position in the homeowners market has always been intended to complement its auto business and facilitate growth in that line. Units in force for the Company's homeowners program declined by 9% from December 31, 1997 to December 31, 1998, mainly due to attrition resulting from the prohibition by the California Department of Insurance against the Company's writing any new homeowners policies. Although the Company continues to seek approval to resume writing new business, it is unable to predict if or when the California Insurance Commissioner will grant the Company's request which, in turn, has a negative impact on customer retention.
reflects the 6.5% increase in insured units offset by the effect of the 3.2% premium rate reduction implemented in 1997 and the impact of 1996 rate reductions which were fully felt in 1997.
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 than in the past, favorably impacting underwriting results.
Since July 1, 1996, the Company has maintained reinsurance programs to provide coverage for its remaining homeowners policies as discussed in Note 10 of the Notes to Consolidated Financial Statements. The Company had previously maintained separate catastrophe coverage which expired in June 1996. Written premiums ceded in 1998 totaled $24.5 million compared to $24.4 million in 1997 and $10.7 million in 1996 (excluding the $33.3 million portfolio transfer of unearned premium liabilities under the 100% quota share reinsurance agreement).
Risks Without regard to the Company's remediation efforts, given the highly computerized nature of the Company's operations, the Y2K problem would pose a serious risk to the Company's ability to efficiently and effectively service its customers, or to conduct its affairs in a profitable manner. Because of the nature of its operations and the availability of alternate suppliers and service providers, the potential Y2K issues
for the Company in the non-IT area generally are less than for manufacturers or distributors of non-financial products. Apart from written assurances the Company has or expects to receive, the Company can offer no assurances that the impact of the Y2K problem on certain services, such as those provided by third-party electric utilities, will be insignificant or within the Company's ability to correct in a fashion timely enough to avoid any potentially significant adverse impact. Although no remediation plan is capable of foreseeing every possible contingency that could have a potentially significant adverse effect, management is confident that the steps taken to address the Company's Y2K issues will prevent or promptly detect and correct any serious instances of noncompliance that are reasonably within the Company's ability to control.
Net pre-tax investment income was $75.1 million in 1998 compared to $73.5 million in 1997 and $73.2 million in 1996. Average invested assets increased 5.4% in 1998 compared to decreases of 2.0% and 6.9% in 1997 and 1996, respectively. The increase in 1998 is primarily due to additional cash received from the exercise of AIG's common stock warrants in the third quarter of 1998 as discussed in Note 12 of the Notes to Consolidated Financial Statements. The decline in invested assets for 1997 and 1996 resulted from the decline in net earned premiums and the sale of investments to meet the payment requirements of both developing earthquake losses and reinsurance premiums. The average annual pre-tax yield on invested assets was 6.6% in 1998, 6.7% in 1997 and 6.6% in 1996.
Loss and loss adjustment expense payments are the most significant cash flow requirements of the Company. The Company continually monitors loss payments to provide projections of future cash requirements. Additional cash requirements include servicing the bank debt and paying dividends as approved from time to time by the Company's Board of Directors. With the anticipated growth of its core auto business and continued settlement of remaining earthquake losses, the Company expects that future cash flows from operations will continue to be sufficient to fund future expenditures.
In addition, the Company will expand its headquarters to nearly double the size of its current facility in late 1999, the anticipated completion date of construction of the new 20th Century Plaza. The company has signed a 15-year lease expiring in November 2014, which may be renewed for two consecutive five-year periods.
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, but not limited to, those discussed elsewhere in this report and in the Company's other public filings, press releases, oral presentations and discussions and
The accompanying consolidated financial statements include the accounts and operations of 20th Century Industries and its wholly owned subsidiaries. All material intercompany accounts and transactions have been eliminated. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles ("GAAP") which differ from statutory accounting practices ("SAP") prescribed or permitted by insurance regulatory authorities. The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from these estimates.
The Company's 49% interest in 20th Century Insurance Company of Arizona, which is a joint venture between the Company and AIG and which began operations in August 1996, has a carrying value of $3,656,000 at December 31, 1998, and is included in other assets in the consolidated balance sheet. The Company's equity in the 1998, 1997 and 1996 net loss of this venture amounted to $373,000, $656,000 and $186,000, respectively, and is included in investment income in the consolidated statements of income.
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
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income, became effective in the first quarter of 1998. SFAS No. 130 established rules for the reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or stockholders' equity. Essentially, under SFAS No. 130, the new label "accumulated other comprehensive income" has replaced that of the former "unrealized investment gains, net" in the stockholders' equity section of the consolidated balance sheet. Also, the consolidated statement of stockholders' equity has been reformatted to conform to the requirements of SFAS No. 130.
In 1997, the Financial Accounting Standards Board also issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, which became effective on December 31, 1998. This Statement did not require disclosure of any significant information beyond that previously provided in the Company's annual financial statements.
The amortized cost, gross unrealized gains and losses, and fair values of investments as of December 31, 1998 and 1997 are as follows:
The amortized cost and fair value of the Company's fixed maturity investments at December 31, 1998 are summarized, by contractual maturity, as follows:
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. During 1998, the
Company utilized net operating loss carryforwards of $115,000,000 to reduce taxable income. As of December 31, 1998, the Company has a net operating loss carryforward of approximately $156,000,000 for regular tax purposes expiring in the year 2009 and an alternative minimum tax credit carryforward of $16,929,000. Alternative minimum tax credits may be carried forward indefinitely to offset future regular tax liabilities. The Company expects the net operating loss carryforward to be fully utilized during 1999.
The Company is required to establish a "valuation allowance" for any portion of the deferred tax asset that management believes will not be realized. The Company believes that because of its historically strong earnings performance, and 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.
A reconciliation of income tax computed at the federal statutory tax rate, which was 35% for 1996 through 1998, to total income tax expense follows:
Payments for income taxes were $13,661,000, $3,150,000 and $2,367,500 for the years ended December 31, 1998, 1997 and 1996, respectively.
The net periodic pension cost for these plans was $4,117,000, $4,012,000 and $3,925,000 in 1998, 1997 and 1996, respectively. Accrued pension costs included in the consolidated balance sheets at December 31, 1998 and 1997 are $3,083,000 and $2,521,000, respectively.
The 1998 increase in provision for insured events of prior years includes $40 million related to the Northridge Earthquake. The 1997 and 1996 decreases in provisions for insured events of prior years is offset by increases in earthquake losses of $24.75 million and $40 million, respectively.
The Company has entered into a revolving credit facility ("the Facility") that provides an aggregate commitment of $112.5 million at December 31, 1998. 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, 1998, the Company's outstanding advances against the Facility totaled $112.5 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 .75%. 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, 1998, the annual interest rate for the specified interest period was approximately 6.3%. Interest paid was $8,660,000 in 1998, $12,758,000 in 1997 and $9,813,000 in 1996.
In connection with an investment agreement executed in 1994 with AIG, 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, the subsidiaries cede 10% of their premiums earned and losses incurred in connection with policies incepted during the period
January 1, 1995 through December 31, 1999. 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 9.40%, 9.36% and 9.13% were earned by the insurance subsidiaries for 1998, 1997 and 1996, respectively. The ceding commission is adjusted annually to equal the prior year's gross SAP underwriting expense ratio.
In 1996, the Company's insurance subsidiaries entered into a 100% quota share reinsurance agreement with F&G Re and Risk Capital Re covering the homeowners line of business. This agreement covers, for a one-year policy term, all business in force as of July 1, 1996 plus renewal business attaching between July 1, 1996 and July 23, 1996, effectively terminating with the expiration of the underlying, one-year policies. Under this contract, 100% of each subsidiary's homeowners unearned premium reserves as of June 30, 1996 were ceded 50/50 to F&G Re and Risk Capital Re, a total of $33.3 million. Additionally, 100% of written premiums and incurred losses and allocated loss adjustment expenses subsequent to June 30, 1996, on covered policies, are ceded under this contract. The Company's insurance subsidiaries earn a commission on ceded premiums based on a sliding scale dependent on the incurred loss ratio. In 1998, 1997 and 1996, the Company earned commissions at a rate of 12.5% on this treaty. Homeowners policies renewed February 15, 1997 and subsequent are covered in full by quota share reinsurance agreements with three reinsurers, as follows: National Union Fire Insurance Co. of Pittsburgh, PA (50%), a subsidiary of AIG, F&G Re (25%) and Risk Capital Re (25%). The Company's insurance subsidiaries earn a commission on ceded premiums based on a sliding scale dependent on the incurred loss ratio. The Company earned commissions at a rate of 14% on this treaty for 1998 and 1997.
The Company leases office space in a building in Woodland Hills, California. The lease was amended in April 1998 to extend its term until November 2014. The lease may be renewed for two consecutive five-year periods. The Company also leases office space in several other locations throughout California, primarily for claims servicing.
Rental expense charged to operations for the years ended December 31, 1998, 1997 and 1996 was $12,879,000, $11,969,000 and $11,243,000, respectively.
Surplus of the insurance subsidiaries on a statutory basis at December 31, 1998 and 1997 was $600,654,000 and $548,043,000, respectively. Statutory net income for the insurance subsidiaries was $154,916,000, $178,727,000 and $121,780,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
For pro forma disclosure purposes, the fair value of stock options was estimated at each date of grant using a Black-Scholes option pricing model using the following assumptions: Risk-free interest rates of 5.02% to 5.65% for 1998, 6.23% to 6.67% for 1997 and 6.51% to 6.54% for 1996; dividend yields ranging from 1.98% to 2.33% in 1998, 1.14% to 1.44% in 1997 and 1.0% to 1.3% in 1996; volatility factors of the expected market price of the Company's common stock of .23, .27 and .39 for 1998, 1997 and 1996, respectively; and a weighted-average expected life of the options of 8 years in 1998, 8 years in 1997 and 10 years in 1996.
expense relating to the Restricted Shares Plan was $2,698,000, $534,900 and $365,500 in 1998, 1997 and 1996, respectively.
Currently included in this class of litigation are certain actions that arose out of the Northridge Earthquake. It is believed that a majority of these actions were filed to resolve claims involving disputed damages or to contest the applicability of the statute of limitations. While any litigation has an element of uncertainty, the Company does not believe that the ultimate outcome of any pending action will have a material effect on its consolidated financial condition or results of operations.
HOMEOWNERS. The 1998, 1997 and 1996 underwriting losses in these lines included respective provisions for additional earthquake reserves of $40 million, $24.75 million and $40 million, respectively. Also affecting the three years was an overall decline in premium volume resulting from the CDOI's prohibition against the Company's writing of any new business in this line since June 1994.