The table below presents our selected consolidated financial information for the years indicated. The table should be read in conjunction with the Consolidated Financial Statements and the related Notes thereto, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information which appears elsewhere in this 2001 Form 10-K. The selected consolidated financial data below, as of December 31, 2001, 2000, 1999 and 1998 and for each of the years in the five-year period ended December 31, 2001, has been derived from our audited Consolidated Financial Statements. The consolidated financial data at December 31, 1997 was derived from our unaudited consolidated financial statements for that year.
Years Ended December 31, 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Combined Ratios: GAAP Combined Ratio: Loss and LAE ratio.................. 81.18% 87.52% 74.08% 70.26% 72.24% Underwriting expense ratio.......... 24.05 26.61 31.32 28.45 29.67 Policyholders dividends............. .85 1.73 .13 ------ ------ ------ ----- ------ Combined ratio...................... 106.08% 115.86% 105.53% 98.71% 101.91% ====== ====== ====== ===== ======
Premiums inforce are an indicator of future written premium trends. Inforce premiums are the total estimated annual premiums of all policies inforce at a point in time. Total inforce premiums decreased by 5.7% to $168.4 million at December 31, 2001 compared to the prior year. This decline supports the slowing trend in premiums written, especially in California, due largely to business lost because of the higher premium rate increases we have been trying to obtain. The number of inforce policies at December 31, 2001 also dropped by 23.6% during the past twelve months.
As shown in the preceding table, our largest premium state, California, had the largest increase in written premiums. We have obtained an average premium rate increase on California renewing policies of approximately 26% for the year ended December 31, 2000 and approximately 36% for policies that renewed in the second half of the year. The market-pricing environment in California has become more favorable to insurers since 1999 in reaction to industry-wide losses in the workers' compensation line, increased reinsurance costs and from competitors exiting from the market and firming their pricing. In Nevada, we began writing premiums on July 1, 1999, which was the first date private carriers were allowed to issue workers' compensation policies in the state.
As a percentage of net earned premiums, the loss and LAE ratio for the year ended December 31, 2000 was 87.5% compared to 74.1% for 1999. The 2000 loss ratio was significantly impacted by the $23.3 million net adverse development, which represents 18.6% of net earned premiums compared to the $9.9 million net adverse development in 1999, which represents 12.0% of net earned premiums. In addition, the expiration of the low level reinsurance agreement is resulting in a higher loss and LAE ratio on policies effective after June 30, 2000 as we are keeping more of the losses.
Under the terms of the indenture relating to the 9 1/2% senior debentures, the debentures may be redeemed by CII Financial at any time at premiums starting at 110% and declining to 100% for redemptions after April 1, 2004. In the event of a change in control of CII Financial, the debenture holders may require that CII Financial repurchase them at the then applicable redemption price, plus accrued and unpaid interest. The indenture also places limitations on incurring certain types of debt, creating liens, disposing of assets, making certain dividend payments or other distributions and entering into transactions with affiliates. In addition, any excess cash flow, as defined in the indenture, is to be offered to debenture holders to redeem the 9 1/2% senior debentures at 100% of the principal amount (without premium) plus accrued and unpaid interest.
Accumulated Retained Common Stock Additional Other Earnings Total Number of Paid-in Comprehensive Comprehensive (Accumulated Stockholder's Shares Amount Capital Income (Loss) Income (Loss) Deficit) Equity ---------------------- ----------- -------------- ------------- ------------ -------------
As used herein, the term "the Company" means CII Financial, Inc. and its subsidiaries, and the term "CII Financial" means CII Financial, Inc., exclusive of such subsidiaries.
Reserve for Loss and Loss Adjustment Expenses. The reserve for workers' compensation loss and loss adjustment expense ("loss and LAE") consists of estimated costs of each unpaid claim reported to the Company prior to the close of the accounting period as well as those incurred but not yet reported. The methods for establishing and reviewing such liabilities are continually reviewed and adjustments are reflected in current operations. The Company does not discount its loss and LAE reserves.
Derivatives. The Company does not currently have any derivative instruments. As of January 1, 2001, the Company implemented Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). The implementation did not result in an adjustment. The Company's policy is to account for derivative instruments on the balance sheet at fair value with changes in fair values reported as part of net income.
Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising the Company's customer base and their dispersion across many different industries. These customers are primarily located in the states in which the Company operates, principally California, Colorado, Nevada and Texas. However, the Company is licensed in and does business in several other states. The Company also has receivables from certain reinsurers. Reinsurance contracts do not relieve the Company from its obligations to injured workers and policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. All reinsurers that the Company has reinsurance recoverables from are rated AA and A+ or better by Fitch Ratings and the A.M. Best Company, respectively.
The low level reinsurance agreement was consummated early in the fourth quarter of 1998 but coverage was made retroactive to July 1, 1998. Therefore, this agreement contained both retroactive (covering claims occurring in the third calendar quarter of 1998) and prospective reinsurance coverage (covering claims occurring after September 30, 1998) and, in accordance with Statement of Financial Accounting Standards No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" ("SFAS No. 113"), the Company bifurcated the low level reinsurance agreement to account for the different accounting treatments. The amount by which the estimated ceded liabilities exceeded the amount paid for the retroactive coverage was reported as a deferred gain and amortized to income as a reduction of incurred losses over the estimated remaining settlement period using the interest method. Any subsequent changes in estimated or actual cash flows related to the retroactive coverage are accounted for by adjusting the previously recorded deferred gain to the balance that would have existed had the revised estimate been available at the inception of the reinsurance transactions, with a corresponding charge or credit to income. The Company recorded an adjustment to increase its deferred gain related to retroactive reinsurance coverage by $2,996,000, $3,662,000 and $4,615,000 in 2001, 2000 and 1999, respectively. For the years ended December 31, 2001, 2000 and 1999, the Company amortized deferred gains of $2,696,000, $5,199,000 and $3,850,000, respectively. Such amortization is included as a reduction in loss and loss adjustment expenses on the accompanying consolidated statements of operations.
In December 2000, CII Financial commenced an offer to exchange the Subordinated Debentures for cash and/or new debentures. To facilitate the exchange, CII Financial borrowed $17.0 million from Sierra and California Indemnity obtained the necessary approval from the California Department of Insurance to pay a dividend of $5.0 million to CII Financial. On May 7, 2001, CII Financial closed its exchange offer on $42.1 million of its outstanding Subordinated Debentures. CII Financial purchased $27.1 million in principal amount of Subordinated Debentures for $20.0 million in cash and issued $15.0 million in 9 1/2% senior debentures, due September 15, 2004, in exchange for $15.0 million in Subordinated Debentures.