Subsequent to the acquisition discussed above, A.M. Best Company reaffirmed the "A+" (superior) rating for Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company and assigned an "A+" (superior) rating to Mobile USA Insurance Company and Liberty American Insurance Company. Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company have been assigned an "A" claims paying ability rating by Standard and Poor's.
As noted previously in the "Operations" section, the Company closed on its acquisition of Liberty on July 16, 1999. The purchase price paid at closing consisted of $25.0 million in the Company's common stock (1,037,772 shares) plus $20.0 million in cash. The purchase also includes a contingent cash payment of up to $5.0 million based upon the combined earnings of 1999 and 2000 of the acquired business.
Liberty is a producer and underwriter of highly specialized mobile homeowners and homeowners property and casualty business primarily in Florida, and also in Arizona and Nevada. For the year ended December 31, 1999, Liberty produced $81.0 million of mobile homeowners, homeowners and NFIP annual gross written premiums of which $32.0 million was written by either Mobile USA Insurance Company or Philadelphia Indemnity Insurance Company and $49.0 million was brokered to insurance companies outside the consolidated group.
Collateralized mortgage and asset backed securities, on a cost basis, amounted to $48.5 million and $39.4 million, respectively, as of December 31, 1999 and $42.8 and $46.4, respectively, as of December 31 1998. These securities are short tranche securities possessing favorable prepayment risk profiles.
- - Expansion of marketing efforts relating to commercial lines, specialty lines and specialty property and inland marine products through the increase in the Company's field organization of approximately 20% to a total of 185 professionals as well as the increase in the Company's preferred agents (16 new relationships in 1999) wherein business relationships are formed with brokers specializing in certain of the Company's business niches. The respective gross written and net written premium increases for commercial lines, specialty lines and specialty property and inland marine products for the year ended December 31, 1999 vs. 1998 amount to $17.3 million and $5.1 million for commercial lines, $18.1 million and $14.8 million for specialty lines, and $20.5 million and $10.5 million for specialty property and inland marine.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased $33.0 million (49.7%) to $99.4 million in 1999 from $66.4 million in 1998 and the loss ratio increased to 60.3% in 1999 from 54.1% in 1998. The increase in net loss and loss adjustment expenses was due to the following: a $5.0 million increase to unpaid loss and loss adjustment expenses for Nursing Home and Assisted Living commercial multi peril package policies which had been written in prior periods due to an increase in the incidence and amount of claims under the general liability coverage of these policies; $6.1 million in loss and loss adjustment expenses for property catastrophe losses resulting from Hurricane Floyd, Hurricane Irene and Arizona storms occurring during the third and fourth quarters; and a 34.4% growth in net earned premiums.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $15.4 million (40.1%), to $53.8 million in 1999 from $38.4 million in 1998. This increase was due primarily to the 34.4% growth in net earned premiums and to relative changes in the Company's product and distribution mix.
Overall premium growth has been offset in part by the loss of accounts in certain market niches due to inadequate pricing levels being experienced as a result of market competition. Consistent with its underwriting focus, the Company has maintained pricing levels for its insurance products reflective of its underwriting assessment. As a result, loss in premium writings will occur due to inadequate pricing levels.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased $11.4 million (20.7%) to $66.4 million in 1998 from $55.0 million in 1997 and the loss ratio decreased to 54.1% in 1998 from 54.7% in 1997. The increase in net loss and loss adjustment expenses was due primarily to the 22.0% growth in net earned premiums.
The acquisition of Liberty provides the platform for the Company to enter the personal lines property and casualty insurance business. During 1999, Liberty produced $81.0 million of mobile homeowners, homeowners, NFIP annual gross written premiums of which $32.0 million was written by either Mobile USA Insurance Company or Philadelphia Indemnity Insurance Company and $49.0 million was brokered to insurance companies outside of the consolidated group. During the year 2000 the Company anticipates rolling over previously brokered mobile homeowners business along with growing the brokered homeowners business and NFIP on which it receives commission income.
The Company also anticipates some cross selling opportunities to arise between its personal and commercial lines business niches, wherein certain of the Company's commercial lines agents also possess personal lines mobile homeowners and homeowners books of business which may now be solicited by the Company. The Company also is pursuing cross selling opportunities within its preferred agency base for its portfolio of commercial niche insurance products.
Management believes that its mixed marketing strategy and specialization is a strength, in that it provides the market intelligence and flexibility to quickly deploy the marketing efforts of the Company's direct production underwriters from market segments where pricing is soft to market segments with emerging opportunities. Additionally, through the mixed marketing strategy, the Company's production underwriters have established relationships with approximately 4,000 brokers, thus facilitating a regular flow of submissions.
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, 1999, payments to PCHC pursuant to such tax allocation agreements totaled $7.4 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 of the insurance subsidiaries from which dividends may be paid totaled $82.7 million at December 31, 1999. Of this amount, the insurance subsidiaries are entitled to pay a total of approximately $22.2 million of dividends in 2000 without obtaining prior approval from the Insurance Commissioner of the Commonwealth of Pennsylvania or State of Florida. After the acquisition of Liberty, the insurance subsidiaries entered into an intercompany reinsurance pooling agreement. During the fourth quarter of 1999, in order to allocate policyholder surplus amongst the insurance subsidiaries to support their respective participation percentages in this intercompany reinsurance
pooling agreement, Philadelphia Insurance Company paid a $17.5 million dividend to PCHC which PCHC subsequently contributed to Liberty American Insurance Company and Mobile USA Insurance Company in the amounts of $11.3 million and $6.2 million, respectively.
On May 4, 1998, the consolidated capitalization of the Company increased by approximately $99.0 million from the sale of FELINE PRIDESSM and Trust Preferred securities. The sales of FELINE PRIDESSM consisted of 9,350,000 units of Income Prides with a stated amount of $10.00, 1,000,000 units of Growth Prides with a face amount equal to the stated amount, and 1,000,000 units of separate Trust Preferred securities with a stated amount of $10.00. The Company utilized $25.7 million of the net proceeds during 1999 for its acquisition of Liberty, contributed $33.1 million of the net proceeds to its subsidiaries in 1998, of which, $20.0 million was contributed to the insurance subsidiaries. Additionally, during 1998 and 1999 $15.2 million was utilized by the Company to buy back its common stock under its stock buy-back authorization. The Company anticipates using the remaining proceeds for general corporate purposes, which may include acquisitions (including, without limitation, acquisitions of programs or books of business), capital expenditures, additional capital contributions to its subsidiaries and the repurchase by the Company of its common stock. The Company is obligated to make cash distributions through May 15, 2001, at a rate of 7.0% of the stated amount per annum for the Income Prides and the separate Trust Preferred securities and contract adjustment payments at the rate of .50% per annum of the $10.00 stated amount to the holders of the Growth Prides.
The insurance subsidiaries, which operate under an intercompany reinsurance pooling agreement, must have certain levels of policyholders' surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners (the "NAIC") suggest that a property and casualty insurer's ratio of annual statutory net premium written to policyholders' surplus should not exceed 3-to-1. The ratio of combined annual statutory net premium written by the insurance subsidiaries to their combined policyholders' surplus was 1.1-to-1.0 and 1.0-to-1.0 for 1999 and 1998, respectively. Management believes that the policyholders' surplus, which was $179.3 million at December 31, 1999, will be sufficient to support current and anticipated premium writings.
In December 1998, the NAIC adopted the "NAIC Accounting Practices and Procedures Manual for Property and Casualty Insurance Companies, for Life, Accident and Health Insurance Companies, and for Health Maintenance Organizations" ("Accounting Practices and Procedures Manual") as submitted by the NAIC Accounting Practices and Procedures Task Force. This comprehensive guide to Statutory Accounting Principles is effective January 1, 2001. While this manual is intended to establish a comprehensive basis of accounting recognized and adhered to, it is not intended to pre-empt state legislative and regulatory authority. The Company will adopt the standards of the Accounting Practices and Procedures Manual as of January 1, 2001 as applied to statutory reporting, and is presently assessing its impact on financial position and results of operations of the insurance subsidiaries.
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, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. 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 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 the opinion expressed above.
Goodwill amounted to $28.8 million and $0.4 million at December 31, 1999 and 1998, respectively. Goodwill is being amortized on a straight line basis over 20 years. The carrying value of goodwill is reviewed for recoverability based on the undiscounted cash flows of the businesses acquired over the remaining amortization period. Should the review indicate that goodwill is not recoverable, the Company would recognize an impairment loss.
Goodwill amortization was $0.8 million in 1999, $0.1 million in 1998 and $0.1 million in 1997. Goodwill and related amortization has increased due to the acquisition of Liberty American Insurance Group, Inc. ("Liberty"), (formerly the Jerger Company, Inc.)
On July 16, 1999, Philadelphia Insurance closed on its acquisition of Liberty (Mobile USA Insurance Company, Liberty American Insurance Company, Mobile Homeowners Insurance Agencies, Inc., and MHIA Premium Finance Company) for a purchase price of $45.0 million, and a contingent additional amount of up to $5.0 million based upon the future earnings for the acquired business. Of the purchase price, $20.0 million was paid in cash and the balance in 1,037,772 shares of common stock of the Company. Any contingent additional amount will be paid in cash. The acquisition is being accounted for using the purchase method of accounting. Goodwill resulting from the acquisition amounted to $29.2 million. This amount represents the excess of acquisition costs over the fair value of net assets acquired.
Accounting Principles: The Insurance Subsidiaries are required to report to certain regulatory agencies on the basis of Statutory Accounting Practices ("SAP"). The statutory financial statements are prepared in accordance with accounting practices prescribed or permitted by the Insurance Departments of the Commonwealth of Pennsylvania and the State of Florida. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as Commonwealth and State laws, regulations, and general administrative rules. Permitted Statutory Accounting Practices encompass all accounting practices not so prescribed.
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 2000 without prior approval is $22.2 million. Dividends paid for the years ended December 31, 1999 and 1998 were $17.5 million and $0, respectively.
Risk-Based Capital: Risk-based capital is designed to measure the acceptable amount of capital an insurer should have based on the inherent specific risks of each insurer. Insurers failing to meet this benchmark capital level may be subject to scrutiny by the insurer's domiciliary insurance department, and ultimately, rehabilitation or liquidation. Based on the standards, the Insurance Subsidiaries capital and surplus at December 31, 1999 is in excess of the prescribed risk-based capital requirements.
The sources of net investment income for the years ended December 31, 1999, 1998, and 1997 are as follows (in thousands):
There are no investments in fixed maturity securities that were non-income producing during the years ended December 31, 1999, 1998, and 1997. Investment expense includes $212,000, $189,000, and $164,000, in investment management fees paid to a director of the Company in 1999, 1998, and 1997, respectively. These transactions are in the ordinary course of business at negotiated prices comparable to those of transactions with other investment advisors.
Realized pre-tax gains (losses) on the sale of investments for the years ended December 31, 1999, 1998, and 1997 are as follows (in thousands):
Included in property and equipment are costs incurred in developing or purchasing information systems technology of $3.5 million and $2.7 million in 1999 and 1998, respectively. Amortization of these costs was $0.3 million, $0.2 million and $0.2 million for the years ended December 31, 1999, 1998 and 1997, respectively. Depreciation expense, excluding amortization of capitalized information systems technology costs, was $1.5 million, $1.2 million and $0.9 million, for the years ended December 31, 1999, 1998, and 1997, respectively.
(1) Adjusted to include $3,323 gross unpaid loss and loss adjustment expenses for Mobile USA Insurance Company as of acquisition date. (2) Adjusted to include $1,148 reinsurance recoverables for Mobile USA Insurance Company as of acquisition date. (3) Adjusted to include $2,175 net unpaid loss and loss adjustment expenses for Mobile USA Insurance Company as of acquisition date.
During 1998, the Company issued 10.350 million FELINE PRIDESSM at $10.00 per security and PCHC Financing I, the Company's business trust subsidiary, issued 1,000,000 7.0% Trust Originated Preferred Securities with a stated liquidation amount per trust preferred security equal to $10.00. The 10.350 million FELINE PRIDESSM consisted of 9.350 million units referred to as Income Prides and 1.000 million units referred to as Growth Prides. Each Income Prides consists of a unit comprised of (a) a purchase contract under which the holder will purchase a number of shares of Philadelphia Consolidated Holding Corp. common stock no later than May 16, 2001 (ranging from .3858 to .4706 shares per FELINE PRIDESSM) under the terms specified in the stock purchase contract and (b) beneficial ownership of a 7.0% Trust Originated Preferred Security issued by PCHC Financing I and representing an undivided beneficial ownership in the assets of PCHC Financing I. Each holder will receive aggregate cumulative cash distributions at the annual rate of 7.00% of the $10.00 stated amount for the security, payable quarterly in arrears. Each Growth Prides consists of a unit with a face amount of $10.00 comprised of (a) a purchase contract under which (i) the holder will purchase a number of shares of Philadelphia Consolidated Holding Corp. common stock no later than May 16, 2001 (ranging from .3858 to .4706 shares per FELINE PRIDESSM) under the terms specified in the stock purchase contract and (ii) the Company will pay the holder contract adjustment payments at the rate of .50% of the stated amount per annum and (b) a 1/100 undivided beneficial ownership interest in a treasury security having a principal amount at maturity equal to $1,000 and maturing on May 15, 2001. The applicable distribution rate on the trust originated securities that remain outstanding during the period May 16, 2001 through May 16, 2003, will be reset so that the market value of the Trust Originated Preferred Securities will be equal to 100.5 percent of the stated amount. The Company may limit the reset rate to be no higher than the rate on the two-year benchmark treasury plus 255 basis points. The guarantee by the Company is a full and unconditional guarantee on a subordinated unsecured basis with respect to the Trust Originated Preferred Securities, but will not apply to any payment of distributions except to the extent the Trust shall have funds available therefor.
In addition to stock options granted pursuant to the Company's stock option plan, the Company's Board of Directors have granted previous awards of 2,613,492 stock options.
The Company has established a non-qualified Employee Stock Purchase Plan (the "Stock Purchase Plan"). The aggregate maximum number of shares that may be issued pursuant to the Stock Purchase Plan is 500,000. 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 112,228 and 51,794 shares in 1999 and 1998, respectively. The weighted-average fair value of those purchase rights granted in 1999 and 1998 was $2.52 and $2.70, respectively.
In addition, the Company has also established a non-qualified Directors Stock Purchase Plan ("Directors Plan") 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. No shares have been issued pursuant to the Directors Plan as of December 31, 1999.
On September 9, 1999, the Company's Board of Directors increased the authorization for the Company to repurchase up to a total of $30.0 million of its common stock. As of December 31, 1999, the Company had repurchased 1.0 million shares for approximately $15.2 million under this authorization.
In the normal course of business, the Company has entered into various reinsurance contracts with unrelated reinsurers. The Company participates in such agreements for the purpose of limiting loss exposure and diversifying business. Reinsurance contracts do not relieve the Company from its obligation to policyholders.
The Company's operations are classified into four reportable business segments: The Commercial Lines Underwriting Group which has underwriting responsibility for the Commercial Automobile and Commercial multi-peril package insurance products; The Specialty Lines Underwriting Group which has underwriting responsibility for the professional liability insurance products; The Specialty Property Underwriting Group which has underwriting responsibility for the large property and Inland Marine insurance products; and The Personal Lines Group which designs, markets and underwrites personal property and casualty insurance products for the Mobile Homeowners and Homeowners markets. The reportable segments operate solely within the United States.