SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1994 Commission File Number 0-6964
20TH CENTURY INDUSTRIES
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-1935264
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) number)
Suite 700, 6301 Owensmouth Avenue, Woodland Hills, California 91367
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 704-3700
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Without Par Value
-------------------------------
(Title of Class)
Series A Preferred Stock, $1,000 Stated Value
---------------------------------------------
(Title of Class)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
----- -----
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based on the average bid and asked prices for shares of the
Company's Common Stock on March 9, 1995 as reported by the New York Stock
Exchange, was approximately $454,525,896.
On March 9, 1995, the registrant had outstanding 51,495,636 shares of common
stock, without par value, which is the Company's only class of common stock.
DOCUMENT INCORPORATED BY REFERENCE:
Portions of the definitive proxy statement used in connection with the annual
meeting of shareholders of the registrant, to be held on May 25, 1995, are
incorporated herein by reference into Part III hereof.
2
20TH CENTURY INDUSTRIES
1994 FORM 10-K ANNUAL REPORT
Table of Contents
Page
PART I
------
Item 1. Business.................................... 3
Item 2. Properties.................................. 25
Item 3. Legal Proceedings........................... 25
Item 4. Submission of Matters to a Vote of Security
Holders............................... 26
PART II
-------
Item 5. Market for Registrant's Common Stock and
Related Stockholder Matters........... 28
Item 6. Selected Financial Data..................... 30
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................ 32
Item 8. Financial Statements and Supplementary
Data.................................. 49
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial
Disclosure............................ 80
PART III
--------
Item 10. Directors and Executive Officers of the
Registrant............................ 80
Item 11. Executive Compensation...................... 80
Item 12. Security Ownership of Certain Beneficial
Owners and Management................. 80
Item 13. Certain Relationships and Related
Transactions.......................... 80
PART IV
-------
Item 14. Exhibits, Financial Statement Schedule and
Reports on Form 8-K................... 81
Signatures.................................. 90
3
PART I
------
ITEM 1. BUSINESS
GENERAL
20th Century Industries is an insurance holding company incorporated in
California. Predecessor companies were originally founded in 1956 by Mr.
Louis W. Foster who retired as Chief Executive Officer and Chairman of the
Board in 1994. Executive offices are located at 6301 Owensmouth Avenue,
Woodland Hills, California 91367. The telephone number of the Corporate
Office is (818) 704-3700. The term "Company", unless the context requires
otherwise, refers to 20th Century Industries and its wholly-owned
subsidiaries, 20th Century Insurance Company and 21st Century Casualty
Company, both of which are property and casualty insurance companies licensed
in California.
The Company directly markets and underwrites private passenger
automobile liability and physical damage and personal excess liability
insurance through 20th Century Insurance Company and similarly markets private
passenger automobile liability and physical damage insurance through 21st
Century Casualty Company. Prior to an order by the California Department of
Insurance in June 1994 (see below), the Company marketed and underwrote
homeowners insurance through 20th Century Insurance Company and condominium
insurance through 21st Century Casualty Company.
The Company believes it has been able to grow profitably by (1) adhering
to its strategy of marketing to responsible prospects with relatively
uncomplicated insurance needs, (2) selling directly to the customer, (3)
centralizing and streamlining its marketing, customer service and policy
change processing, and (4) providing a rate structure that the Company
believes is among the lowest in the market it serves.
The Company limits its underwriting of private passenger automobile
insurance to those drivers defined by California statute as "Good Drivers."
The Company's automobile program has consistently and profitably (excluding
the Proposition 103 rollback and the earthquake impact in 1994) grown to
1,132,605 vehicles in force as of December 31, 1994. For a further discussion
regarding the impact of Proposition 103 and the earthquake losses, as well as
subsequent capital financing, refer to Notes 12, 13 and 14, respectively, of
the Notes to Consolidated Financial Statements.
4
The Company had been issuing homeowners policies through 20th Century
Insurance Company since 1982 and condominium policies through 21st Century
Casualty Company since 1989; however, an earthquake occurred in the San
Fernando Valley area of California on January 17, 1994 resulting in
unprecedented losses to the Company. In order to reduce the Company's
earthquake exposure, it ceased writing new homeowners and condominium
insurance and ceased renewing earthquake coverage endorsements in accordance
with an order by the California Department of Insurance in June 1994. The
Company continues to renew existing homeowner and condominium policies for two
more annual renewal periods, excluding earthquake coverage. All earthquake
coverage will be terminated by July 23, 1995 and all homeowners and
condominium coverages will be terminated by July 23, 1997.
In 1988, the Company expanded its product line to include the Personal
Excess Liability Policy (PELP) to complement its existing automobile and
homeowners programs. Policies in force totaled 11,072 at December 31, 1994.
The same direct selling and centralized processing strategies apply to PELP.
LIMITS OF INSURANCE COVERAGE
The Company offers private passenger automobile bodily injury liability,
property damage liability, medical payments, uninsured motorist,
comprehensive, collision and towing coverages. Policies are written for a
six-month term. Various limits of liability are offered with maximum limits
of $500,000 per person and $500,000 per accident. The most frequent bodily
injury liability limits are $100,000 per person and $300,000 per accident.
The 20th Century Insurance Company homeowners program utilized a
replacement cost insurance policy which covered the dwelling and its contents.
Program rules provided for a minimum dwelling amount of $50,000 and a maximum
dwelling amount of $500,000. Personal liability coverage limits of $100,000,
$200,000 and $300,000 were available.
The 21st Century Casualty Company condominium program utilized a
replacement cost policy which covered the condominium unit owner's contents up
to the policy limits. Contents coverage limits were offered between a minimum
5
of $25,000 and a maximum of $250,000. Limits for personal liability coverage
of $100,000, $200,000 and $300,000 were also available.
The Personal Excess Liability Policy (PELP) is written in 20th Century
Insurance Company and provides liability coverage with a limit of $1,000,000
in excess of the underlying automobile and homeowners liability coverage.
Minimum underlying automobile limits of $100,000 per person and $300,000 per
accident are required while homeowners must have $100,000 personal liability
coverage. The underlying automobile coverage must be written by the Company.
MARKETING
The Company markets directly to the customer and writes its policies
without utilizing or engaging outside agents or brokers. The Company uses
direct mail and print and radio advertising to market its policies. The
Company continues to develop a substantial amount of its new business by
referrals from existing policyholders. This was particularly true in 1994 as
all planned newspaper, radio and direct mail advertising was cancelled due to
the January 17th earthquake. During 1994, approximately 86% of new automobile
business and 56% of new homeowners business was obtained from referrals by
current customers. The Company ceased writing new homeowner and condominium
owners policies in June 1994 as a consequence of the serious losses associated
with the Northridge earthquake.
The Company's marketing efforts in recent years have focused on the
Sacramento, San Francisco and San Jose areas in Northern California and the
San Diego area in Southern California. Approximately 25% of new business
production for the Company comes from these areas.
UNDERWRITING
The rate regulatory system in California requires the prior approval of
rates. Within this regulatory framework, the Company establishes its
automobile premium rates based on actuarial analysis of its own historical
premium, loss and expense data. These data are compiled and analyzed to
establish overall rate levels as well as classification differentials. The
Company's rates are established at levels intended to generate underwriting
profits and vary for individual policies based on a number of rating charac-
teristics. These characteristics include driving record, number of years a
driver has been licensed, annual mileage, vehicle usage, value of the
automobile and limits and deductibles selected.
6
20th Century Insurance Company's automobile risk selection guidelines
are designed to insure careful, responsible individuals as indicated by the
prospect's violation and accident history, and 21st Century Casualty Company's
guidelines are designed for the writing of statutorily defined "Good Drivers."
In 1994, approximately 61% of those individuals who inquired about
purchasing automobile insurance were sent applications for 20th Century
Insurance Company following a preliminary screening by the Company's marketing
representatives. Another 28% were determined to be eligible for a 21st
Century Casualty insurance application. These application assignments were
based on prior insurance and driving record. Approximately 84% of the
applications returned to 20th Century Insurance Company and 67% of those
returned to 21st Century Casualty Company were accepted by the Company for
issuance of a policy based on verification of driving record.
The Company reviews many of its automobile policies at the time of
renewal and/or as changes occur during the policy period. The customer may
contact the Company to make changes, such as the addition or deletion of
drivers or vehicles, changes in the classification of drivers or usage of
vehicles, changes in garaging location and changes in coverages or limits.
Some mid-term changes may result in premium adjustments and some may result in
the policy being reunderwritten and eventually not renewed because of a
substantial increase in hazard.
SERVICING OF BUSINESS
The Company has successfully achieved operating savings and maintained
an extremely low expense ratio because of its efficient processing of all
aspects of customer service. The Company will continue to design and
implement effective systems, fully supported by computers, to improve service
and efficiency in the marketing, policy service, underwriting and claims
functions. As in the past, the Company will increase its processing
capabilities to meet growing workload demands. The computer systems provide
the information resources and data processing capabilities which support the
business and technical needs of the Company. In addition to providing ongoing
support, the systems provide the strategic capabilities necessary to manage
the Company's business. The Company's electronic digital voice communications
system facilitated more than 29.9 million originations during 1994. Each
Division Service Office has its own telephone system, which is tied to the
centralized home office system, to service its customers.
7
CLAIMS
Claims operations include the receipt and analysis of initial loss
reports, assignment of legal counsel and settlement approval. Whenever
possible, physical damage claims are handled through the use of Company drive-
in claims and vehicle inspection centers. The claims management staff
administers the claims settlement process and directs the legal and adjuster
components of that process. Each claim is carefully analyzed to provide for
fair loss payments, to comply with the Company's contractual obligations and
to minimize loss adjustment expense. Liability and material damage claims are
handled by specialists in each area. In order to handle the heavy volume of
claims received as a result of the Northridge Earthquake, the Company engaged
outside adjuster firms.
The Company utilizes its staff of 59 full-time attorneys who handle all
aspects of claims litigation, including trial, from offices in Brea, Ontario,
Long Beach and Woodland Hills. Staff attorneys handle more than 75% of the
Company's lawsuits. Suits which may involve a conflict of interest are
assigned to outside counsel.
Recognizing the need to provide its customers with convenient, local
service, the Company has established 10 Division Service Offices in Los
Angeles, Orange, San Diego and Ventura Counties. Each Division Service Office
is a full service center, staffed with between seventy-five and one-hundred
employees who provide complete claims services from initial investigation to
final conclusion. While most policy changes are processed centrally by
telephone through the Woodland Hills Home Office, each Division Service Office
has at least two customer service representatives to assist "walk-ins."
The Company has thirteen drive-in claims facilities in Los Angeles,
Orange, San Diego and Ventura Counties. Each drive-in facility is staffed
with between two and five employees.
The Specialty Division is comprised of three vehicle inspection centers
located in Los Angeles and in Orange Counties. Each vehicle inspection center
is staffed with between fifteen and twenty employees who handle total losses,
total thefts and vehicles which are not driveable.
The Claims Services Division employs over 100 people who are responsible
for subrogation and medical payments claims for all programs and workers'
compensation claims arising under the homeowners policy.
8
The Homeowners Division processes all homeowners property claims on a
regional basis and is made up of three units of approximately twenty employees
each. The units are located in Monrovia, Santa Ana and Woodland Hills.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The Company establishes reserves, or liabilities, for the future payment
of losses and loss adjustment expenses for claims, both reported and
unreported, which were incurred as of an accounting date. Such reserves are
estimates, as of a particular date, of the amount the Company will ultimately
pay for claims incurred as of the accounting date.
"Case basis" reserves are established for bodily injury liability and
uninsured motorist claims which are either expected to exceed $15,000 or older
than two years. Such case reserves are based on the specific circumstances,
merits and relevant contractual policy provisions of the claim. Anticipated
effects of inflation are included in the case reserve.
Case reserves for other bodily injury and uninsured motorists claims and
for all other coverages are established by an average case reserve value.
These average values are based on a monthly review of recent claims payments
for each coverage.
The Company supplements the case loss reserve estimates with loss
reserves estimated using actuarial methodologies. These reserves are designed
to provide for claims incurred by, but not reported to or recorded by, the
Company as of the accounting date (IBNR) and for changes over time in
individual case reserve estimates. The actuarial reserves are estimated using
actuarial techniques and the Company's own historical loss experience and are
reviewed each quarter.
9
The claims and legal costs estimated to settle incurred claims are
included in reserves for loss adjustment expenses. These reserves are
determined using actuarial techniques and the Company's own historical
experience.
Anticipated effects of inflation are implicitly considered in the
actuarial estimates of liabilities for loss and loss adjustment expenses.
Amounts reported are estimates of the ultimate net costs of settlement
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 reasonable and
acceptable range of adequacy. The methods of making such estimates and for
establishing the resulting reserves are continually reviewed and updated and
any adjustments resulting therefrom are reflected in earnings currently.
The Company does not discount to present value loss and loss adjustment
expense reserves expected to be paid in future periods.
10
The following table provides a reconciliation of beginning and ending
reserves for losses and loss adjustment expenses, net of reinsurance
recoverable, for the indicated periods to the gross amounts reported in the
Company's consolidated financial statements.
YEARS ENDED DECEMBER 31,
----------------------------------
1994 1993 1992
---- ---- ----
(AMOUNTS IN THOUSANDS)
Reserves for losses and loss adjustment
expenses, net of reinsurance recover-
ables on unpaid losses, at beginning
of year $ 574,619 $554,034 $547,098
Incurred losses and loss adjustment
expenses, net of reinsurance:
Provision for insured events of
the current year, non-earthquake
related, net of reinsurance 1,028,983 930,437 838,263
Provision for insured events of the
current year, earthquake related,
net of reinsurance 868,407 - -
Decrease in provision for
insured events of prior years,
net of reinsurance (84,453) (62,986) (73,889)
---------- -------- ---------
Total incurred losses and loss
adjustment expenses, net of
reinsurance 1,812,937 867,451 764,374
---------- -------- ---------
Payments, net of reinsurance:
Losses and loss adjustment expenses
attributable to insured events of
the current year, non-earthquake re-
lated, net of reinsurance 578,598 519,232 437,174
Losses and loss adjustment expenses
attributable to insured events of
the current year, earthquake related,
net of reinsurance 708,981 - -
Losses and loss adjustment expenses
attributable to insured events of
prior years, net of reinsurance 344,876 327,634 320,264
---------- -------- --------
Total payments, net of reinsurance 1,632,455 846,866 757,438
---------- -------- --------
Reserves for losses and loss adjustment
expenses, net of reinsurance recover-
ables on unpaid losses, at year end 755,101 574,619 554,034
Reinsurance recoverables on unpaid
losses, at year end 1,142 2,871 507
---------- -------- --------
Reserves for losses and loss adjust-
ment expenses, gross of reinsurance
recoverables on unpaid losses, at
year end $ 756,243 $577,490 $554,541
========== ======== ========
11
The following table reconciles the reserves reported in the Company's
consolidated financial statements prepared in accordance with generally
accepted accounting principles (GAAP) and those reported in the statements
filed with the California Department of Insurance in accordance with statutory
accounting principles (SAP). In 1994, the Company began to record estimated
recoveries for salvage and subrogation on a SAP basis. Prior to 1994, such
anticipated recoveries were recorded only on a GAAP basis.
DECEMBER 31,
-----------------------------------
1994 1993 1992
---- ---- ----
(AMOUNTS IN THOUSANDS)
Reserves reported on a
SAP basis $755,101 $620,939 $596,444
Adjustments:
Reinsurance recoverables on unpaid
losses and LAE 1,142 2,871 507
Estimated recovery for salvage
and subrogation - (46,320) (42,410)
-------- -------- --------
Reserves reported on a GAAP basis $756,243 $577,490 $554,541
======== ======== ========
The following table represents the development of GAAP balance sheet
reserves, net of reinsurance, for the years 1984 through 1994. The top line
of the table shows the reserves at the balance sheet date, net of reinsurance
recoverables on unpaid losses and loss adjustment expenses, for each of the
years indicated. Such net amounts represent estimated losses and loss
adjustment expenses unpaid as of the particular balance sheet date for claims
arising prior to the balance sheet date whether or not reported. The upper
portion of the table indicates the cumulative amounts paid as of successive
years with respect to that reserve liability. The lower portion of the table
indicates the re-estimated amount of the previously recorded reserves based on
experience as of the end of each succeeding year, including cumulative
payments made since the end of the respective year. The estimate changes as
more information becomes known about the frequency and severity of claims for
individual years. A redundancy (deficiency) exists when the original reserve
estimate is greater (less) than the re-estimated reserves at December 31,
1994.
Each amount in the following table includes the effects of all changes
in amounts for prior periods. The table does not present accident year or
policy year development data. Conditions and trends that have affected the
development of liabilities in the past may not necessarily occur in the
future. Therefore, it may not be appropriate to extrapolate future
deficiencies or redundancies based on the table.
12
AS OF DECEMBER 31,
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1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(AMOUNTS IN THOUSANDS)
Reserves for
losses and loss
adjustment exp.$105,178 $144,972 $206,266 $297,853 $391,748 $472,010 $525,220 $547,098 $554,034 $574,619 $755,101
Paid (cumulative)
as of:
One year later 76,665 102,660 138,944 180,516 197,555 242,757 300,707 320,264 327,634 344,876
Two years later 105,218 139,652 187,448 238,947 271,163 328,606 391,970 401,019 403,434
Three years later 118,982 158,555 211,477 272,955 310,757 366,369 420,853 426,412
Four years later 126,037 168,627 226,550 289,901 326,495 377,980 429,791
Five years later 130,206 174,716 233,287 296,310 330,014 381,507
Six years later 132,306 176,744 235,367 297,764 330,879
Seven years later 132,656 176,947 235,510 298,098
Eight years later 132,713 176,968 235,515
Nine years later 132,625 176,995
Ten years later 132,618
Reserves re-
estimated as of:
One year later 112,962 156,341 227,848 294,504 357,220 402,706 473,974 473,209 491,048 490,166
Two years later 124,233 171,218 230,412 302,991 342,365 397,847 449,348 461,343 447,880
Three years later 130,349 173,717 237,587 304,925 340,760 389,559 442,508 440,198
Four years later 131,056 178,400 239,096 302,661 333,432 384,948 433,408
Five years later 133,089 178,651 237,528 298,764 332,100 382,331
Six years later 133,070 177,732 236,026 298,603 331,191
Seven years later 133,069 177,104 235,819 298,319
Eight years later 132,755 177,088 235,698
Nine years later 132,671 177,038
Ten years later 132,644
Redundancy
(Deficiency) $(27,466) $(32,066) $(29,432) $ (466) $ 60,557 $89,679 $91,812 $106,900 $106,154 $84,453
13
Reconciliations for the indicated periods between (1) the net reserves
for losses and loss adjustment expenses at year end (the original reserve
estimate in the ten-year table on the previous page) and the related gross
reserves for losses and loss adjustment expenses on the balance sheet at
year end and (2) the net re-estimated reserves and the related gross re-
estimated reserves as of the end of the latest re-estimation period are as
follows:
1993 1994
---- ----
(AMOUNTS IN THOUSANDS)
Gross Liability - End of Year $577,490 $756,243
Reinsurance Recoverable 2,871 1,142
Net Liability - End of Year 574,619 755,101
Gross Re-Estimated Liability - Latest $492,671
Re-Estimated Recoverable - Latest 2,505
Net Re-Estimated Liability - Latest 490,166
Gross Cumulative Redundancy (Deficiency) $ 84,819
14
OPERATING RATIOS
Loss and Expense Ratios
Loss and expense ratios are traditionally used to interpret the under-
writing experience of property and casualty insurance companies. Losses
and loss adjustment expenses are stated as a percentage of premiums earned
as losses may occur over the life of a particular insurance policy.
Underwriting expenses are stated as a percentage of premiums written for
statutory accounting purposes and as a percentage of earned premiums for
GAAP purposes. Underwriting profit margins are a reflection of the extent
to which the combined loss and expense ratios are less than 100%. The loss
ratios, expense ratios (excluding interest), and combined ratios for the
Company's subsidiaries, each on a SAP and GAAP basis, are shown in the
following tables.
YEARS ENDED DECEMBER 31,
--------------------------------------------
Companywide - SAP 1994 1993 1992 1991 1990
----------------- ---- ---- ---- ---- ----
Loss Ratio 173.0% 88.0% 85.9% 88.2% 86.4%
Expense Ratio 9.9 10.5 10.0 9.7 10.0
----- ---- ---- ---- ----
Combined Ratio 182.9% 98.5% 95.9% 97.9% 96.4%
===== ==== ==== ==== ====
YEARS ENDED DECEMBER 31,
-------------------------------------------
Companywide - GAAP 1994 1993 1992 1991 1990
------------------ ---- ---- ---- ---- ----
Loss Ratio 177.6% 87.7% 85.3% 86.3% 85.8%
Expense Ratio 10.1 10.7 10.0 9.9 10.1
----- ---- ---- ---- ----
Combined Ratio 187.7% 98.4% 95.3% 96.2% 95.9%
===== ==== ==== ==== ====
The Northridge Earthquake contributed 85.1% on both a GAAP and SAP
basis to the 1994 loss ratios.
15
Premiums to Surplus Ratio
The following tables show, for the periods indicated, the Company's
statutory and GAAP ratios of net premiums written to policyholders'
surplus. Since each property and casualty insurance company has different
capital needs, an "appropriate" ratio of net premiums written to
policyholders' surplus for one company may not be the same as for another
company. While there is no statutory requirement applicable to the Company
which establishes a permissible net premium to surplus ratio, guidelines
established by the National Association of Insurance Commissioners provide
that such ratio should generally be no greater than 3 to 1 on a statutory
basis.
The Company's net premiums written to policyholders' surplus ratio was
adversely affected by the Northridge Earthquake. The California Department
of Insurance (DOI) has approved the current ratio and is working with the
Company to improve its surplus levels. The DOI ordered the Company to
cease writing new homeowners and condominium business and cease renewing
earthquake coverage endorsements. For further discussion, see Management's
Discussion and Analysis - Financial Condition.
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
SAP 1994 1993 1992 1991 1990
--- ---- ---- ---- ---- ----
(AMOUNTS IN THOUSANDS, EXCEPT RATIO)
Net premiums written $1,032,737 $1,021,902 $918,443 $833,194 $740,249
Policyholders' surplus $ 207,018 $ 582,176 $500,619 $406,655 $337,367
Ratio 4.9:1 1.8:1 1.8:1 2.0:1 2.2:1
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
GAAP 1994 1993 1992 1991 1990
---- ---- ---- ---- ---- ----
(AMOUNTS IN THOUSANDS, EXCEPT RATIO)
Net premiums written $1,032,737 $1,021,902 $918,443 $833,194 $740,249
Policyholders' surplus $ 442,871 $ 694,555 $597,203 $491,064 $407,921
Ratio 2.3:1 1.5:1 1.5:1 1.7:1 1.8:1
16
INVESTMENTS AND INVESTMENT RESULTS
The Company's investment guidelines are reviewed by the Investment
Committee which is comprised of five directors.
The guidelines emphasize buying high-quality fixed income investments.
Because of the net operating loss (NOL) carryforwards which resulted from
the 1994 Northridge Earthquake, the Company sold all of its appreciated
tax-exempt bonds and used the proceeds to pay losses and re-invested the
remainder in taxable government and corporate bonds and commercial paper.
Until the NOL is substantially utilized, the Company's investable cash will
go into taxable securities. While the Company's policy is generally to
hold these investments until maturity, its ongoing monitoring and
evaluation of investment holdings and market conditions may, from time to
time, result in selected sales of investments prior to maturity. The
Company has designated all of its portfolio as "available-for-sale". See
Note 1 of the Notes to Consolidated Financial Statements, "Investments."
17
The following table summarizes investment results for the periods and as
of the dates shown:
YEARS ENDED DECEMBER 31,
------------------------------------------------------------
1994 1993 1992 1991 1990
---- ---- ---- ---- ----
(AMOUNTS IN THOUSANDS)
Average invested assets
(at amortized cost)
(includes cash and
cash equivalents) $1,190,751 (1) $1,384,926 $1,273,168 $1,161,816 $1,017,004
Net investment income:
Before income taxes 84,761 97,574 94,255 90,043 81,056
After income taxes 68,629 87,915 85,442 79,706 71,386
Average annual return
on investments:
Before income taxes 6.7%(1) 7.1% 7.4% 7.8% 8.0%
After income taxes 5.4%(1) 6.3% 6.7% 6.9% 7.0%
Net realized investment
gains after income taxes 40,010 10,874 7,589 6,030 2,356
Net increase (decrease)
in unrealized gains
on fixed maturity
investments after
income taxes (134,660) 39,863 12,832 24,838 (4,545)
(1) The investment portfolio decreased substantially as a result of the sale
of investments to generate realized capital gains to offset the severe
losses caused by the Northridge Earthquake. The lower return on invest-
ments is a result of selling older securities with higher yields and re-
investing in taxable securities with lower current yields. In addition,
available cash was invested in commercial paper which yielded a lower
interest rate than that earned on the bond portfolio.
18
The following table sets forth the composition of the investments
and cash and cash equivalents of the Company at the dates indicated.
DECEMBER 31,
----------------------------------------------------------------------
1994 1993 1992
----------------------------------------------------------------------
(AMOUNTS IN THOUSANDS)
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
Type of Security COST VALUE COST VALUE COST VALUE
---------------- ---------- --------- ---------- ---------- ---------- ----------
Fixed Maturities:
U.S. Treasury Secur-
ities and obliga-
tions of U.S. Govern-
ment corporations
and agencies $ 240,690 $ 232,678 $ 6,258 $ 6,777 $ 8,350 $ 8,956
Obligations of
states and politi-
cal sub-divisions 292,723 261,614 1,273,231 1,399,173 1,151,668 1,225,333
Public utilities 147,241 139,173 11,060 11,935 20,158 20,620
Corporate secur-
ities 322,177 307,941 131,467 149,876 126,316 136,001
---------- ---------- ---------- ---------- --------- ---------
Total Fixed Maturities 1,002,831 941,406 1,422,016 1,567,761 1,306,492 1,390,910
Common Stock 539 768 - - - -
Nonredeemable
Preferred Stock - - 539 539 539 539
---------- ---------- ---------- ---------- ---------- ---------
Total Investments 1,003,370 942,174 1,422,555 1,568,300 1,307,031 1,391,449
---------- ---------- ---------- ---------- ---------- ----------
Cash and Cash
Equivalents 249,834 249,834 17,894 17,894 14,978 14,978
---------- ---------- ---------- ---------- ---------- ----------
Total Investments
and Cash and Cash
Equivalents $1,253,204 $1,192,008 $1,440,449 $1,586,194 $1,322,009 $1,406,427
========== ========== ========== ========== ========== ==========
In 1994, the Company implemented Statement of Financial Accounting
Standards No.115,"Accounting for Certain Investments in Debt and Equity Secur-
ities". For a further discussion of this new standard, refer to Note 1 of the
Notes to Consolidated Financial Statements, "Investments".
19
COMPETITION
The property and casualty insurance market is highly competitive and is
comprised of a large number of well capitalized companies, many of which
operate in a number of states and offer a wide variety of lines of business.
Several of these competitors are larger and have greater financial resources
than the Company. Based on published statistics, the Company is the fifth
largest writer of private passenger automobile insurance in California.
While the Company competes with all private passenger automobile
insurers in the state, the Company is in more direct competition with other
major writers which concentrate on the larger good driver market than with
those which specialize in "non-standard", "high-risk" or other niche market
segments.
The Company's marketing and underwriting strategy is to appeal to
careful and responsible drivers who are willing to deal direct with the
Company in order to save a significant amount of money on their insurance
premium. As a result, the Company is able to maintain policy renewal rates
well above the industry average.
By selling its products directly to the insured, the Company has
eliminated agents and brokers commissions. The Company provides the same
services as agents, but at a reduced cost. The Company also relies heavily on
its centralization of operations and its computerized information services
system to efficiently service its policyholders and claimants.
Consequently, the Company consistently operates with one of the lowest
underwriting and loss adjustment expense ratios in the industry and is able to
maintain its rates among the lowest in the market it serves.
REINSURANCE
The Company purchases reinsurance to reduce its loss in the event of a
catastrophe or from infrequent, large individual claims. A reinsurance trans-
action occurs when the Company transfers (cedes) a portion of its exposure
from direct business written to a reinsurer which assumes that exposure for a
premium. The reinsurance cession does not legally discharge the Company from
its liability for a covered primary loss, but provides for reimbursement from
the reinsurer to the Company for the ceded portion.
20
The Company reviews the financial condition of its reinsurers with its
reinsurance intermediary at annual treaty renewal. Participants with
financial difficulties, if any, can be removed at that time. The Company is
presently not aware of any of its reinsurers experiencing financial
difficulties.
Following the January 17, 1994 Northridge Earthquake, the Company's
reinsurance coverage of 75% of $100 million in excess of $10 million was
reinstated at a cost of $13 million and additional reinsurance of 75% of the
next $100 million was purchased effective April 1, 1994, for approximately
$3 million. These treaties expired on June 30, 1994.
This reinsurance program was renewed for the period from July 1, 1994
through June 30, 1995, with amended terms, for a total annual premium of
approximately $28 million. Coverage under these treaties is provided by a
number of domestic, foreign and London market companies in layers as follows:
Catastrophe Company Reinsurance
Loss Layer Retention Amount
----------------- ----------- -----------
first $ 10,000,000 $10,000,000 $ 0
next $ 90,000,000 $ 7,200,000 $ 82,800,000
next $100,000,000 $ 5,000,000 $ 95,000,000
In order to provide reinsurance coverage for the declining earthquake
exposure, the Company also purchased from National Indemnity Company
additional reinsurance in excess of the underlying $200 million. An
additional layer beginning at $400 million effective June 16, 1994 and
decreasing by $50 million each month through February 15, 1995 was purchased
for a total premium of approximately $21.8 million.
An extension of the additional coverage from National Indemnity Company
was purchased effective January 23, 1995 for a total premium of approximately
$7.8 million. This coverage begins at a limit of $200 million and decreases
in increments ranging from $25 million to $35 million on the 1st and the 16th
of each month beginning March 1, 1995 through May 1, 1995. The treaty expires
May 15, 1995.
The Company also has an excess of loss reinsurance treaty on its
homeowners line with General Reinsurance Corporation. The reinsurer's limit
21
is $650,000 in excess of the Company's retention of $300,000 per risk, subject
to a maximum reinsurer's limit of $1,300,000 per occurrence.
The Company has a quota share reinsurance treaty for the Personal Excess
Liability Program. Underwriters Reinsurance Company is the lead reinsurer for
this treaty. The Company retains 40% and cedes 60% of each risk under this
treaty.
REGULATION
The Company and its subsidiaries are subject to regulation and
supervision by the California Department of Insurance ("DOI") which has broad
regulatory, supervisory and administrative powers, related primarily to:
1. licensing of insurance companies and agents,
2. prior approval of rates, rules, and forms,
3. standards of solvency,
4. nature of, and limitations on, insurance company investments,
5. periodic examination of the affairs of insurers,
6. annual and other periodic reports of the financial condition and
results of operations of insurers,
7. the establishment of accounting rules regarding loss and loss
adjustment expense and other reserves, and
8. the issuance of securities by insurers.
Regulation by the DOI is designed principally for the benefit of
policyholders. The DOI conducts periodic examinations of the Company's
insurance subsidiaries.
In January 1995, the Company and the DOI reached a settlement concerning
the Company's Proposition 103 rollback liability, wherein $78 million was
allocated for customer refunds consistent with rollback obligations establish-
ed through a DOI administrative hearing during 1992. A more detailed discus-
sion of Proposition 103 can be found in Note 12 of the Notes to Consolidated
Financial Statements.
The operations of the Company are influenced by the laws of the State of
California and changes in those laws can affect the revenues and expenses of
the Company. The Company is a member of industry organizations which may
22
advocate legislative and initiative proposals and which provide financial
support to officeholders and candidates for California statewide public
offices. The Company also makes financial contributions to those
officeholders and candidates who, in the opinion of management, have a
favorable understanding of the needs of the property and casualty insurance
industry. In 1994, these contributions were approximately $81,000. The
Company believes that such contributions are important to the future of the
property and casualty insurance industry in California and intends to continue
to make such contributions as it determines to be appropriate.
PROPOSED LEGISLATION
Property/casualty insurers are continuing to promote federal legislation
which would provide economic protection, and help save lives, in the event of
natural disasters such as earthquakes.
In September 1994, a revised version of H.R. 2873, the Natural Disaster
-------
Protection Act, was reported out of the House Public Works Committee. While
it did not reach the House floor in 1994, this revised version will likely
serve as the basis for discussion when the 104th Congress convenes in 1995.
Rather than the primary insurance fund posed by the original bill, the
new version, called the Natural Disaster Protection Partnership Act,
establishes a private Natural Disaster Protection Corporation funded by
insurers, reinsurers and state insurance pools to provide catastrophic
coverage for residential property losses. Fund shortages could be covered by
federal loans.
In return for protection by this reinsurance, all participating insurers
must provide earthquake and volcanic eruption coverage along with their
standard homeowner policies. The new bill retrains required state disaster
mitigation plans, but would not cover commercial losses, including apartments
and businesses.
Legislation has been introduced (SB 49) within the California state
legislature to make certain changes to the Financial Responsibility law and
impose arbitration requirements for specific third-party bodily injury claims.
A bill has been introduced to reinstate third-party bad faith (AB 1083). Two
bills are pending that contain proposals for a no-fault system for the
compensation of automobile injury claims (AB 607 and SB 1229).
23
At this time, it is uncertain what may be the likelihood of passage of
any of these state legislative proposals or their potential for future
amendments or agreement or veto by the state's governor.
HOLDING COMPANY ACT
The Company's subsidiaries are subject to regulation by the California
Department of Insurance pursuant to the provisions of the California Insurance
Holding Company System Regulatory Act (the "Holding Company Act"). The DOI
may examine the affairs of the subsidiaries at any time. Certain transactions
defined to be of an "extraordinary" type may not be effected without the prior
approval of the California Department of Insurance. Such transactions
include, but are not limited to, sales, purchases, exchanges, loans and
extensions of credit, and investments made within the immediately preceding 12
months involving in the net aggregate, more than the lesser of 5% of the
Company's admitted assets or surplus as to policyholders, as of the preceding
December 31. An extraordinary transaction also includes a dividend which,
together with other dividends or distributions made within the preceding
twelve months, exceeds the greater of 10% of the insurance company's
policyholders' surplus as of the preceding December 31 or the insurance
company's net income for the preceding calendar year. The California code
further provides that property and casualty insurers may pay dividends only
from earned surplus. The Holding Company Act generally restricts the ability
of any one person to acquire more than 10% of the Company's voting securities
without prior regulatory approval.
ASSIGNED RISKS
Automobile liability insurers in California are required to participate
in the California Automobile Assigned Risk Plan (CAARP). Each company is
required to write liability insurance coverages for drivers applying to CAARP
for placement as "assigned risks" because their driving records or other
relevant characteristics make them difficult to insure in the voluntary
market. The number of assignments for each insurer is based on the total
applications received by the plan and the insurer's market share.
The number of applicants to CAARP and number of assigned risk policies
in force for the Company declined between 1992 and 1993 and then climbed again
in 1994 as follows:
24
APPLICATIONS TO CAARP POLICIES IN FORCE
YEAR DURING YEAR AT DECEMBER 31
---- --------------------- -----------------
1992 131,426 6,403
1993 125,670 6,427
1994 136,572 7,285
During 1990, rates for CAARP were extremely competitive with those in
the voluntary market. In February 1989, CAARP filed for an increase of
112.3%. The Insurance Commissioner granted an interim rate increase of 85%
effective October 1, 1990. CAARP appealed the Commissioner's decision to the
Superior Court, which ruled in favor of the full 112.3%. In 1994, the
Commissioner and CAARP reached an agreement which allowed the interim rate
increase of 85% to become permanent while CAARP agreed to withdraw its lawsuit
and submit a revised rate filing. In September 1994, CAARP proposed a rate
increase of 12.8% which the Commissioner cut by more than half to 5.2%.
The 85% rate increase and a requirement implemented by the Superior
Court that an applicant be certified as eligible for assignment contributed to
the decline in the number of applicants to CAARP between 1992 and 1993. The
increased rate level, while not making the remaining assigned risk business
profitable, did at least cause it to be less unprofitable. The future effect
of the assigned risk plan on the Company cannot be predicted because it
depends on the ability of CAARP to achieve and maintain an adequate rate
level.
EMPLOYEES
The Company had approximately 2300 full and part-time employees at
December 31, 1994. The Company provides medical, pension and 401K savings
plan benefits to its employees according to the provisions of each plan. The
Company believes that its relationship with its employees is excellent, and
employee turnover generally is very low.
25
ITEM 2. PROPERTIES
The Company leases its Home Office building in Woodland Hills,
California, which contains approximately 234,000 square feet of leasable
office space. The lease was amended in October 1994 which expanded the lease
term until November 1999. The lease may be renewed for two consecutive five-
year periods.
The Company also leases office space in nineteen other locations
throughout Southern California. The Company anticipates no difficulty in
extending these leases or obtaining comparable office facilities in comparable
locations.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company has been named as a defendant in lawsuits
incident to its business. Currently included in this class of litigation are
almost 50 actions that arise out of Northridge earthquake claims. It is
believed that a majority of these claims were filed to protect statutes of
limitations. Some of the actions request exemplary or punitive damages. These
actions are vigorously defended unless a reasonable settlement appears
appropriate. While any litigation has an element of uncertainty, the Company
does not believe that the ultimate outcome of these pending actions will have
a material adverse effect on its consolidated financial condition or results
of its operations.
On January 27, 1995, the California Department of Insurance issued an
order which among other things, addressed the issue of the Company's rebate
liability associated with Proposition 103. The order, based upon a stipulated
agreement with the Company, required refunds to policyholders, while providing
immediate cpital additions to improve the Company's financial strength, and
financial resources for possible increases in earthquake claims. On March 28,
1995, suit was filed by a consumer group, challenging the settlement and the
resultant order issued by the Insurance Commissioner. The Company is advised
by counsel, and believes that any challenge to the settlement will be unsuc-
cessful. A more detailed discussion of the settlement can be found in Note 12
of the Notes to Consolidated Financial Statements.
26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
As a result of the dramatic decline in financial strength of the Company
due to the gross losses caused by the Northridge Earthquake, a special meeting
of the shareholders was held on December 15, 1994 to vote on the following
matters:
1. INVESTMENT AGREEMENT PROPOSAL - An investment and Strategic Alliance
Agreement dated as of October 17, 1994 between the Company and American
International Group, Inc., a Delaware corporation ("AIG"), including, among
other things, (a) the sale to AIG, or to certain wholly owned subsidiaries
that AIG may designate, for an aggregate purchase price of $216 million, of
(i) 200,000 shares of the Company's Series A Convertible Preferred Stock,
stated value $1,000 per share which are convertible into shares of common
stock without par value, at a conversion price of $11.33 per share (subject to
customary antidilution provisions), and (ii) 16 million Series A Warrants to
purchase an aggregate of 16 million shares of Common Stock at an exercise
price of $13.50 per share; (b) the issuance of shares of Common Stock upon
conversion of shares of Series A Preferred Stock and upon exercise of the
Series A Warrants in accordance with their terms; and (c) the issuance of
additional shares of Series A Preferred Stock at the election of the Company
in the event gross losses and allocated loss adjustment expenses associated
with the January 17, 1994 Northridge, California Earthquake exceed $850
million.
2. INCREASED AUTHORIZED CAPITAL PROPOSAL - An amendment to the Company's
Articles of Incorporation increasing the number of authorized shares of Common
Stock from 80 million shares to 110 million shares.
27
3. TRANSFER RESTRICTIONS PROPOSAL - An amendment to the Company's Articles
of Incorporation to include certain restrictions, effective for up to 38
months following the consummation of the Transaction, on the transferability
and ownership of shares of stock designed to prevent transactions in stock
that, under certain circumstances, could trigger limitations under the
Internal Revenue Code of 1986 on the Company's ability to utilize net
operating losses (including gross losses and allocated loss adjustment
expenses related to the Northridge Earthquake) to offset taxable income in
future years.
4. INDEMNIFICATION AGREEMENTS PROPOSAL - Ratification of certain
Indemnification Agreements that have been entered into between the Company and
its subsidiaries and their directors and executive officers and the approval
of any such Indemnification Agreements that may be entered into in the future
between the Company and its subsidiaries and their directors, officers,
employees or other agents.
The shareholders approved all four of the above matters.
28
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
(a) PRICE RANGE OF COMMON STOCK
The stock is currently traded on the New York Stock Exchange under the
trading symbol "TW". The following table sets forth the high and low bid
prices for the common stock for the indicated periods.
High Low
---- ---
1994
Fourth Quarter 12-7/8 9-5/8
Third Quarter 17-3/8 8-3/4
Second Quarter 19-3/8 14-1/4
First Quarter 28-1/8 18-7/8
1993
Fourth Quarter 30-7/8 25-1/8
Third Quarter 32-3/8 28-1/8
Second Quarter 32 27-3/4
First Quarter 34 25-3/4
29
(b) HOLDERS OF COMMON STOCK
The approximate number of record holders of the Common Stock on December
31, 1994 was 1,328.
(c) DIVIDENDS
The Company paid regular cash dividends on its Common Stock each year
since 1973 through the second quarter of 1994. Dividends were paid at the
rate of $.16 per share for each of the first two quarters of 1994, $.16 per
share per quarter during 1993, and $.13 per share per quarter during 1992.
Due to the adverse impact of the Northridge Earthquake on the financial
strength of the Company, no dividends were paid in the last two quarters of
1994. The Company's ability to pay future dividends will necessarily depend
upon the earnings and financial condition of its Insurance Subsidiaries. 20th
Century Industries paid cash dividends of $16,471,000 in 1994.
As a holding company, the Company is dependent upon dividends from its
subsidiaries to pay dividends to its stockholders. The Company's subsidiaries
are subject to California laws that restrict their ability to distribute
dividends. California law permits a casualty insurance company to pay
dividends, within any 12-month period, without any prior regulatory approval,
in an amount up to the greater of 10% of policyholders' surplus as of the
preceding December 31 or the insurance company's net income for the calendar
year preceding the date the dividend is paid. The California insurance code
further provides that property and casualty insurers may pay dividends only
from earned surplus. Under these rules, 20th Century Insurance Company and
21st Century Casualty Company are unable to pay dividends to the Company
during 1995 without prior approval. See Note 10 of the Notes to Consolidated
Financial Statements.
30
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented below for, and as of
the end of, each of the years in the five-year period ended December 31, 1994
are derived from the consolidated financial statements of 20th Century
Industries and its subsidiaries. The consolidated financial statements as of
December 31, 1994 and 1993 and for each of the years in the three-year period
ended December 31, 1994 are included elsewhere in this Form 10-K. All dollar
amounts set forth in the following tables are in thousands, except per share
data. For a further discussion regarding the impact of Proposition 103 and
the Northridge Earthquake on the results of 1994, refer to Notes 12 and 13,
respectively, of the Notes to Consolidated Financial Statements.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
1994 1993 1992 1991 1990
---- ---- ---- ---- ----
Operations Data:
Net premiums earned $1,034,003 $ 989,712 $ 896,353 $810,636 $732,695
Net investment income 84,761 97,574 94,255 90,043 81,056
Realized investment gains 61,554 16,729 11,498 9,137 3,569
Other income (loss) (46) (180) (116) (274) 146
---------- ---------- ---------- -------- --------
Total Revenues 1,180,272 1,103,835 1,001,990 909,542 817,466
---------- ---------- ---------- -------- --------
Net losses and loss
adjustment expenses 944,530 867,451 764,374 697,521 613,015
Net earthquake losses and
related expenses 883,816 - - - -
Policy acquisition costs 43,409 48,375 41,996 38,372 36,338
Other operating expenses 57,214 57,545 48,337 42,303 36,520
Proposition 103 expense 29,124 3,474 3,474 6,195 21,023
Interest expense 8,286 44 33 361 654
---------- ---------- ---------- -------- --------
Total Expenses 1,966,379 976,889 858,214 784,752 707,550
---------- ---------- ---------- -------- --------
Income (loss)before
federal income taxes
and cumulative effect
of change in accounting
for income taxes (786,107) 126,946 143,776 124,790 109,916
Federal income taxes
(benefit) (288,087) 18,350 26,309 21,253 11,194
---------- --------- --------- -------- --------
Income (loss) before cumu-
lative effect of change in
accounting for income
taxes (498,020) 108,596 117,467 103,537 98,722
Cumulative effect of change
in accounting for income
taxes - 3,959 - - -
---------- --------- --------- -------- --------
Net Income (Loss) $ (498,020) $ 112,555 $ 117,467 $103,537 $ 98,722
========== ========= ========= ======== ========
31
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1994 1993 1992 1991 1990
---- ---- ---- ---- ----
Per Share Data:
PRIMARY -
Before cumulative effect
of change in accounting
for income taxes $ (9.69) $ 2.11 $ 2.29 $ 2.02 $ 1.92
Cumulative effect of
change in accounting
for income taxes - .08 - - -
---------- -------- -------- -------- --------
Net Income (loss) $ (9.69) $ 2.19 $ 2.29 $ 2.02 $ 1.92
========== ========= ========= ======== ========
FULLY DILUTED -
Before cumulative effect
of change in accounting
for income taxes $ (9.69)
Cumulative effect of
change in accounting
for income taxes -
----------
Net Income (loss) $ (9.69)
==========
Dividends paid per share $ .32 $ .64 $ .52 $ .42 $ .32
========== ========= ========= ======== ========
DECEMBER 31,
-----------------------------------------------------------
1994 1993 1992 1991 1990
---- ---- ---- ---- ----
Balance Sheet Data:
Total investments $ 942,174 $1,422,555 $1,307,031 $1,200,067 $1,074,177
Total assets 1,702,810 1,644,670 1,498,330 1,372,628 1,238,060
Unpaid losses and loss
adjustment expenses 756,243 577,490 554,541 548,377 526,258
Unearned premiums 298,519 299,941 267,556 245,290 219,801
Long-term debt 160,000 - - - 3,333
Claims checks payable 70,725 41,535 39,329 36,884 32,192
Stockholders' equity 317,944 655,209 575,674 484,578 402,365
Book value per common share $ 2.29 $ 12.74 $ 11.19 $ 9.43 $ 7.83
32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INDUSTRY OVERVIEW AND COMPANY STRATEGY
The property and casualty insurance business has a history of
fluctuating results, and underwriting profitability has tended to vary in
cycles. Insurer profitability is influenced by many factors, including
price competition, claim frequency and severity, crime rates, natural
disasters, economic conditions, interest rates, state regulations and laws and
changes in the legal system and court decisions. One of the challenging and
unique features of the property and casualty insurance business is that its
products must be priced before costs are fully known because premiums are
charged before claims are incurred.
Insurance industry price levels tend to change with underwriting
results. As companies experience underwriting losses, prices tend to increase
and competition decreases. As underwriting results improve, prices tend to
decrease and competition increases.
The Company engages in private passenger automobile, homeowners,
condominium, earthquake and personal excess liability insurance primarily in
Southern California. The Northridge Earthquake on January 17, 1994 resulted
in unprecedented losses for the Company. In order to reduce future earthquake
exposure, the Company ceased writing new homeowner and condominium insurance
in accordance with an order received from the California Department of
Insurance in June 1994. However, the Company continues to renew existing
homeowner and condominium policies for two more annual renewal periods,
excluding earthquake coverage. All earthquake coverages will be terminated by
July 23, 1995, and all homeowners and condominium coverage will be terminated
by July 23, 1997.
Policies in force for the Company's two major programs were as follows:
DECEMBER 31,
------------------------------------------
1994 1993 1992
---- ---- ----
Policies in Force
Automobile 1,132,605 1,130,446 1,018,656
Homeowners and Other 217,239 244,786 228,709
-------------- ----------- -----------
Total 1,349,844 1,375,232 1,247,365
============== =========== ===========
Underwriting results for the business written by the Company, excluding
earthquake, are sensitive to weather-related claims and may vary substantially
33
from one period to another depending on weather during the periods. Results
for the first and fourth quarters of the year are particularly vulnerable to
weather patterns. Quarterly loss and loss adjustment expense ratios for the
most recent three years are as follows:
YEAR 1Q 2Q 3Q 4Q
---- ----- ----- ----- -----
1992 88.0 81.6 82.9 88.5
1993 90.3 83.9 86.5 89.9
1994 312.1 116.9 143.1 142.4
While the quarterly loss and loss adjustment expense ratios generally
exhibit the pattern expected to be caused by weather influences, they also
show the variability caused by the fortuitous events which are the basic
subject of the insurance process. More specifically, the effect of the
Southern California fires in October 1993 and the Northridge Earthquake in
January 1994 can be seen in the ratios for the fourth quarter of 1993 and all
of 1994, respectively. The Northridge Earthquake contributed 215.0%, 28.7%,
51.3%, and 49.2% to the loss ratios for each of the four quarters in 1994,
respectively. Excluding the Northridge Earthquake, the loss ratios follow the
expected pattern caused by weather influences in the first and fourth
quarters. Refer to Management's Discussion and Analysis - Financial Condition
for a further discussion of the earthquake impact.
Property insurance results are subject to the variability introduced by
the chance occurrences of natural or man-made disasters such as earthquakes,
fires, windstorms, floods and riots. The Company minimizes its exposure to
riot-related damage by not writing commercial risks, and its exposure to
conflagration is reduced because it does not accept business in close
proximity to designated brush hazard areas. The Company reported claims
totaling approximately $4.3 million, after reinsurance, as a result of the
Southern California fires in the fourth quarter of 1993; however, it was
assessed an additional $2.6 million as its share of California Fair Plan
losses. Hurricanes and similar wind-related catastrophes are not generally
considered to be a significant exposure in California. The Company does not
have a significant exposure to floods as flood damage is not covered under the
homeowners policy.
Because the Company does not write property or liability insurance for
commercial risks, its exposure to losses caused by exposure to radon or caused
by environmental pollution is insignificant. The Company has received no such
claims under the homeowners policy and believes the probability of a
success-
34
ful claim of this nature to be remote. Removal of asbestos materials
necessitated by earthquake claims has been included in the estimated loss
values for these claims.
The Company had been writing earthquake insurance since 1982. Since
that time, the Company has always believed that its major catastrophe exposure
was to a loss caused by an earthquake. The Company reduced its net exposure
from such an event with the purchase of reinsurance in amounts based on global
reinsurance market conditions and the Company's estimates of its exposure.
The exposure from such a loss was consistently reviewed each calendar quarter.
Prior to the Northridge Earthquake, the Company had purchased property
catastrophe reinsurance for a catastrophe up to $110 million.
Following the January 17, 1994 Northridge Earthquake, the Company's
reinsurance coverage of 75% of $100 million in excess of $10 million was
reinstated at a cost of $13 million and additional reinsurance of 75% of the
next $100 million was purchased effective April 1, 1994, for approximately
$3 million. These treaties expired on June 30, 1994.
This reinsurance program was renewed for the period from July 1, 1994
through June 30, 1995, with amended terms, for a total annual premium of
approximately $28 million. Coverage under these treaties is provided by a
number of domestic, foreign and London market companies in layers as follows:
Catastrophe Company Reinsurance
Loss Layer Retention Amount
----------------- ----------- -----------
first $ 10,000,000 $10,000,000 $ 0
next $ 90,000,000 $ 7,200,000 $ 82,800,000
next $100,000,000 $ 5,000,000 $ 95,000,000
In order to provide reinsurance coverage for the declining earthquake
exposure, the Company also purchased from National Indemnity Company
additional reinsurance in excess of the underlying $200 million. An
additional layer beginning at $400 million effective June 16, 1994 and
decreasing by $50 million each month through February 15, 1995 was purchased
for a total premium of approximately $21.8 million.
An extension of the additional coverage from National Indemnity Company
was purchased effective January 23, 1995 for a total premium of approximately
$7.8 million. This coverage begins at a limit of $200 million and decreases
in increments ranging from $25 million to $35 million on the 1st and the 16th
35
of each month beginning March 1, 1995 through May 1, 1995. The treaty expires
May 15, 1995.
Financial Condition
Impact of the Northridge Earthquake
-----------------------------------
The Northridge, California Earthquake, which occurred on January 17,
1994 ("Northridge Earthquake"), has significantly affected the financial
condition of the Company and its operating results for the entire year of
1994. The Northridge Earthquake occurred in an area in which the Company's
homeowners and earthquake business was concentrated and the forces of the
earthquake were much greater and caused significantly more damage than usually
associated with an event of this Richter magnitude.
The resulting losses from the earthquake continue to place pressure on
the Company and its financial condition. The Company experienced a reduction
in its historical pattern of growth, ceased all advertising and marketing for
new policies, and suspended its quarterly dividend for the third and fourth
quarters of fiscal 1994. As of December 31, 1994, total estimated gross
losses and allocated loss adjustment expenses from the Northridge Earthquake
reached $940 million.
On June 9, 1994, the Company announced an order by the California
Department of Insurance ("DOI") designed to reduce the Company's earthquake
exposure. The DOI ordered the Company's insurance subsidiaries, 20th Century
Insurance Company and 21st Century Casualty Company (the "Insurance
Subsidiaries") to discontinue writing new homeowners, condominium owners and
earthquake insurance and to discontinue renewal of existing earthquake
insurance. The DOI also approved a 17% rate increase for the homeowners
program. The Insurance Subsidiaries agreed to offer renewal without
earthquake coverage to existing homeowners and condominium owners
policyholders for two more annual renewal periods. The Company also agreed to
increase the combined statutory surplus of the Insurance Subsidiaries to at
least $250 million by June 30, 1994.
On June 30, 1994, the Company obtained a $175 million bank line (the
"Bank Credit Agreement") through The First National Bank of Chicago and Union
Bank (the "Lenders") of which $160 million has been borrowed and is
outstanding at December 31, 1994. Loan proceeds of $120 million were used to
increase
36
the statutory surplus of the Insurance Subsidiaries to minimum levels
mandated by the DOI. The five-and-one-half year reducing-revolver loan
features interest-only payments for the first 18 months. Beginning January 1,
1996, the aggregate commitment will be automatically reduced $35 million and
$8.75 million thereafter on the first day of each quarter through the
facility's maturity date of January 1, 2000. Principal repayments are
required when total outstanding advances exceed the aggregate commitment.
Under the terms of the Bank Credit Agreement, all of the outstanding shares of
capital stock of the Insurance Subsidiaries have been pledged as collateral.
In order to provide reinsurance coverage for the declining earthquake
exposure, the Company also purchased from National Indemnity Company
additional reinsurance in excess of the underlying $200 million. An
additional layer beginning at $400 million effective June 16, 1994 and
decreasing by $50 million each month through February 15, 1995 was purchased
for a total premium of approximately $21.8 million.
On September 8, 1994, the Company revised upward its estimated gross
losses and allocated loss adjustment expenses from the Northridge Earthquake
expected to be sustained by the Insurance Subsidiaries to approximately $815
million. The Company became in violation of the net worth maintenance and
other financial covenants under the Bank Credit Agreement. The statutory
surplus of the Insurance Subsidiaries was reduced from approximately $252
million on June 30, 1994 to approximately $71 million on September 30, 1994,
the ratio of the Insurance Subsidiaries' total net written premiums to
statutory surplus increased to 14:1 and the Company's stockholders' equity
declined to approximately $163 million. These adverse developments put a
severe financial strain on the Company.
On September 8, 1994, the Company notified the Lenders that the Company
was in default under the Bank Credit Agreement and, on September 12, 1994, the
Lenders imposed the default rate of interest on outstanding loans and notified
the Company that no additional loans would be available while any default was
continuing. The Lenders also requested prompt information concerning the
steps the Company was taking to restore the capital of its Insurance
Subsidiaries and to cure the default. On September 20, 1994, the Lenders
requested that the Company deposit $25 million in a cash collateral account
with one of the agent banks to secure its obligations under the Bank Credit
Agreement. The Lenders also presented the Company with a series of capital
investment alternatives and required the Company to select and take action to
raise the required capital.
37
The DOI, after discussions with the Company's management, requested that
the Company expeditiously implement a plan that would provide a more
appropriate level of surplus at the Insurance Subsidiaries. At the same time,
an agreement was reached among the DOI, two consumer intervenors and the
Company regarding the Company's proposed automobile insurance rate increase
that had been filed for approval in December, 1993. On September 14, 1994,
the Commissioner approved a 6% rate increase, which was estimated to generate
an additional $56 million a year in revenues. The agreement provided that the
6% rate increase would decrease to 3% when the Insurance Subsidiaries' total
net written premium to statutory surplus ratio had reached 3:1. See the
discussion regarding the impact of the Proposition 103 rollback below.
On October 17, 1994, the Company entered into an Investment and
Strategic Alliance Agreement (the "Investment Agreement") with American
International Group, Inc. ("AIG"), to provide $216 million of equity capital.
The agreement provided for, among other things (a) the sale to AIG, or to
certain wholly-owned subsidiaries that AIG may designate, for an aggregate
purchase price of $216 million, of (i) 200,000 shares of Series A Convertible
Preferred Stock stated value $1,000 per share (the "Series A Preferred
Stock"), which are convertible into shares of Common Stock at a conversion
price of $11.33 per share (subject to customary antidilution provisions), and
(ii) 16 million Series A Warrants to purchase an aggregate of 16 million
shares of Common Stock at an exercise price of $13.50 per share (subject to
adjustment as described in the Investment Agreement); (b) the issuance of
shares of Common Stock upon conversion of shares of Series A Preferred Stock
and upon exercise of the Series A Warrants in accordance with their terms; and
(c) the issuance of additional shares of Series A Preferred Stock on the terms
described in the Investment Agreement at the election of the Company in the
event gross losses and allocated loss adjustment expenses associated with the
Northridge Earthquake exceed $850 million (the "Transaction").
The Company also negotiated with the Lenders the terms of an amendment
and waiver to the Bank Credit Agreement (the "Amendment and Waiver") in order
to facilitate the proposed transaction with AIG. The Amendment and Waiver,
which was executed and delivered by the Company and the Lenders on October 17,
1994, conditionally waived the Lenders' rights to pursue remedies based on
existing defaults pending consummation of the Transaction, and made certain
amendments to the Bank Credit Agreement, effective upon the closing of the
Transaction.
38
At a special shareholder meeting held on December 15, 1994, (the
"Closing Date"), the Investment Agreement was approved. Subsequently, Holders
of the Series A Preferred Stock, voting separately as a class, elected two of
the Company's eleven directors. Holders of Common Stock were not entitled to
vote in the election of such two directors. Since the Company's gross losses
and allocated loss adjustment expenses related to the Northridge Earthquake
have exceeded $850 million, AIG shall, if requested by the Company, contribute
up to an additional $70 million to the Company in exchange for shares of
Series A Preferred Stock having an aggregate liquidation value equal to the
contributed amount plus an additional liquidation amount based on a formula
designed to compensate AIG for its proportional share of the Company's after-
tax loss resulting from the gross losses and allocated loss adjustment
expenses relating to the Northridge Earthquake in excess of $850 million. The
Company may determine not to obtain some or all of the additional capital from
AIG in light of certain rules under the Internal Revenue Code governing the
Company's ability to utilize its net operating losses to offset taxable income
in future years. The Series A Preferred Stock will be entitled to a per annum
cumulative dividend equal to 9% payable quarterly. At the option of the
Company, during the next three years, dividends may be paid in cash or in kind
(whereby, a holder receives, in lieu of cash, shares of Series A Preferred
Stock having a liquidation value equal to the dividends declared).
The Series A Warrants are, by their terms exercisable at any time fol-
lowing the first anniversary of the consummation of the Transaction. However,
both the exercise and sale of Series A Warrants are subject to transfer re-
strictions in the Company's Articles of Incorporation, which limit exercise or
sale of the warrants until February 1998. The exercise price of $13.50 per
share and the number of shares of Common Stock obtainable per Series A
Warrants are subject to adjustment pursuant to customary antidilution
provisions. The exercise date may be accelerated in the event the Company's
Board of Directors approves such an acceleration, and shall automatically be
accelerated to any earlier date that AIG is entitled to acquire additional
securities of the Company pursuant to the standstill provisions of the Invest-
ment Agreement. These Warrants will expire on the thirteenth anniversary of
the Closing Date.
39
In addition, in the event the Company's total gross
losses and allocated loss adjustment expenses with respect to the Northridge
Earthquake exceed $945 million, the exercise price shall be reduced by $0.08
per share for each million dollars of gross losses and allocated loss
adjustment expenses in excess of $945 million (provided that the exercise
price shall never be reduced to less than $1.00 per share as a result of
Northridge Earthquake losses); provided, however, that no adjustment to the
Exercise Price shall be made with respect to increases in gross losses and
allocated loss adjustment expenses reflected in financial statements following
the 1995 year-end audited financial statements of the Company.
In connection with the Investment Agreement, subsidiaries of AIG and
each of the Insurance Subsidiaries have entered into a five-year quota share
reinsurance agreement for 10% of each of the subsidiaries' policies incepting
on and after January 1, 1995. At AIG's option, the agreements may be renewed
annually for four years following the initial term, with an annual reduction
of 2% in the quota share percentage ceded to AIG's subsidiaries.
The Investment Agreement also provides that the Company and AIG use
their respective best efforts to negotiate and mutually agree upon a joint
venture agreement whereby the Company and AIG will form a new subsidiary or
subsidiaries to engage in the Company's automobile insurance business in
states outside California.
Impact of Proposition 103 Rollback
----------------------------------
On August 18, 1994, the California Supreme Court issued a decision (the
"Proposition 103 Ruling") reversing a lower court ruling that had upheld the
Company's challenge to the constitutionality of certain regulations and an
administrative order issued by the Commissioner pursuant to California
Proposition 103. The effect of the Proposition 103 Ruling was to reinstate
the Commissioner's order directing that the Company issue refunds totaling
approximately $78.3 million, plus interest at 10% per annum from May 8, 1989,
to policyholders who purchased insurance from the Insurance Subsidiaries
between November 8, 1988 and November 8, 1989.
On September 2, 1994, the Company filed a petition for rehearing with
the California Supreme Court which was denied. The Company filed a petition
for a writ of certiorari with the United States Supreme Court.
40
Barring action by the U.S. Supreme Court to reverse the Proposition 103
Ruling, the Commissioner's refund order obligated the Company to pay
approximately $122 million, which included accrued interest through December
31, 1994. Prior to the Supreme Court ruling, the Company had $51 million
accrued, and recorded an additional $71 million in September of 1994.
On January 27, 1995, the Company announced a settlement of rebate
liabilities associated with Proposition 103. As a result, the Company
allocated $78 million for customer refunds, consistent with the Company's
liability established through a DOI administrative hearing during 1992.
Interest on the liability established through the original refund order will
not be assessed.
Initially, the Company will refund $46 million to customers specified in
the agreement as soon as practicable, representing an average payment per
household of $80.00, approximately 7.5 percent of premiums paid between
November 8, 1988 and November 7, 1989. The remaining $32 million will be set
aside for additional customer refunds conditioned on the ultimate level of
claim costs associated with the 1994 Northridge Earthquake.
Prior to this settlement, the Company had accrued approximately $122
million with respect to its possible Proposition 103 liability. Therefore, as
of December, 1994, the Company reduced its accrual $44 million.
As part of the settlement, the Company withdrew its request for a
hearing with the United States Supreme Court to appeal the California Supreme
Court decision in the Proposition 103 test case "20th Century vs. Garamendi"
and agreed to abide by the terms of Commissioner Quackenbush's order. Upon
announcement of the settlement, a consumer group objected to the settlement
terms, and threatened legal action. The Company is advised by counsel, and
believes that any challenge to the settlement will be unsuccessful.
Another condition of this agreement required the Company to obtain new
capital of $50 million and contribute the funds to the surplus of the
Insurance Subsidiaries. Of the $50 million, $30 million must be obtained
by March 31, 1995. Available to the Company were an additional $15 million
under the existing bank credit facility and up to $70 million in "Earthquake
Preferred" stock which could be issued to AIG.
41
In the latter part of March, 1995, the Company issued an additional $20
million in Preferred Stock to AIG and borrowed an additional $10 million
against its existing bank credit facility.
RESULTS OF OPERATIONS
Underwriting Results
Premiums earned and underwriting results for the Company's two major
programs were as follows:
DECEMBER 31,
------------------------------------------
1994 1993 1992
---- ---- ----
Premiums Earned
Automobile $ 981,893,000 $908,522,000 $823,680,000
Homeowners and Other 52,110,000 81,190,000 72,673,000
-------------- ------------ ------------
Total $1,034,003,000 $989,712,000 $896,353,000
============== ============ ============
Underwriting Profit (Loss)
Automobile $ (45,854,000) $ 25,064,000 $ 36,890,000
Homeowners and Other (877,487,000) (11,598,000) 1,714,000
-------------- ------------ ------------
Total $ (923,341,000) $ 13,466,000 $ 38,604,000
============== ============ ============
Impact of the Northridge Earthquake
-----------------------------------
The Northridge Earthquake has resulted in substantial losses. Since the
event occurred, the Company and other members of the property and casualty
insurance industry have revised their estimates of claim costs and related
expenses several times. Because of the unusual nature of the ground motion
during the earthquake, the earthquake produced significant damage to
structures beyond normal expectations. Delayed discovery of the severity of
damages has caused claims to be reevaluated as the additional damage becomes
known and has made the estimation process extremely difficult. The Company
estimates total gross losses and allocated loss adjustment expenses for this
catastrophe to be $940 million at December 31, 1994. Unallocated loss
adjustment, FAIR Plan assessments and other earthquake related expenses are
estimated to be an additional $20 million. By mid-July, the Company had
received all of the $76.3 million in catastrophe and per-risk reinsurance
recoverables due to this event. As of December 31, 1994, the Company has
received 35,327 homeowners and condominium claims and 10,139 automobile
claims. Because of the difficulties of estimation noted above, it is possible
that the Company's Northridge Earthquake loss estimates will increase. Should
42
the earthquake losses exceed current estimates, $32 million in reserves
related to the Proposition 103 settlement will be available to offset the
additional earthquake losses. However, should the earthquake losses exceed
$974 million, future financial periods will be impacted and additional capital
may be required. The capital transaction with AIG includes provision for the
Company to receive up to an additional $70 million of capital from AIG to
cover excess losses. The Company, however, may determine not to obtain some
or all of the additional capital from AIG in light of certain rules under the
Internal Revenue Code governing the Company's ability to utilize its net
operating losses to offset taxable income in future years, or the Company
could elect to obtain some or all of the additional capital from AIG
notwithstanding the fact that the issuance of securities in exchange for such
capital could result in a limitation on the Company's ability to utilize its
net operating losses.
On a pre-tax basis, net incurred claims and expenses, including
reinsurance reinstatement costs, total $883.8 million. The net after-tax
charge against year-to-date earnings for all costs for this event is $574.5
million, or $11.18 per share.
As of December 31, 1994, the Company had paid approximately $785 million
in gross losses and allocated loss adjustment expenses related to the
Northridge Earthquake. Funds to make payments came from normal operating cash
flows of $226 million, reinsurance proceeds of $76.3 million, and the sale or
maturity of approximately $483 million in investments. The funds needed to
pay remaining earthquake related losses and expenses will come from normal
positive operating cash flows, from loan proceeds and from the proceeds of the
capital transaction with AIG.
Operations Excluding the Effects of the Northridge Earthquake and Proposition
------------------------------------------------------------------------------
103 Rollback
------------
Automobile
Automobile insurance continues to be the major line of business written
by the Company and has been consistently profitable. Excluding earthquake
related claims and expenses, the earthquake reinsurance reinstatement premium
and the Proposition 103 rollback, the Company would have realized an
automobile underwriting profit of $10,127,000. Because of the cessation of
advertising, total automobile policies in force for 1994 remained level with
43
1993, compared to an 11.0% increase in 1993 over 1992. Earned premiums grew
8.1% in 1994 compared to 10.4% in 1993. Automobile underwriting profits have
declined over the last three years due to the increase in losses from Assigned
Risk business and no rate increases during this period of time.
The automobile insurance business written by the Company is comprised of
"Good Drivers", as defined by California statute. While this business would
have been acceptable to the Company before Proposition 103, those who had no
prior insurance would have been written at a higher rate level than those who
had been insured prior to being written by the Company. The underwriting
losses produced by this segment of the market suggests that the former
differential was appropriate. These drivers have produced automobile
underwriting losses of $31,134,000 in 1994, compared to $16,877,000 in 1993
and $9,719,000 in 1992.
Overall automobile underwriting results are also affected by assigned
risk policies in force. Such policies remained level between 1992 and 1993
and then increased in 1994. Underwriting losses for assigned risk business
were $3,800,000 in 1994, compared to $3,031,000 in 1993 and $1,862,000 in
1992.
The Company was granted an overall increase in automobile rates of 6%,
which took effect on October 7, 1994. Prior to this increase, the Company had
not revised its automobile rates since 1988.
Homeowners and Other Programs
As mentioned previously, the Company no longer writes new homeowners or
condominium policies or earthquake coverage endorsements as ordered by the
DOI. The Company continues to write new Personal Excess Liability Policies.
Additionally, the Company will continue to renew existing homeowner and
condominium policies without earthquake through July, 1997. Due to the
Company's intent to exit the homeowners' market, policies in force for
homeowners and the other programs combined decreased 11.3% in 1994 compared to
an increase of 7.0% in 1993.
Underwriting results for these programs are subject to variability
caused by weather-related claims and by infrequent disasters. Excluding
earthquake related claims and expenses, the earthquake reinsurance
reinstatement and the Proposition 103 rollback, the underwriting profit (loss)
for
44
these lines was $(21,514,000) in 1994, $(11,598,000) in 1993 and $1,714,000
in 1992. Results in 1994 include approximately $35,000,000 of catastrophe
reinsurance premiums related to the additional reinsurance coverage. Results
in 1993 were influenced by $4.6 million in claims due to rainy weather in the
first quarter of the year; and by claims of approximately $4.3 million, after
reinsurance, plus a $2.6 million assessment for the Company's share of
California Fair Plan losses, due to the Southern California fires in the
fourth quarter of the year. Results in 1992 included rainy weather in the
first and fourth quarters of the year.
The Company also received a homeowner rate increase averaging 17%
effective August 1, 1994. The proposed increase reflects the rising costs of
claim payments in this product line and a modest provision for weather and for
catastrophes.
Policy Acquisition and General Operating Expenses
The Company's policy acquisition and general operating expense ratio
continues to be one of the lowest in the industry. The ratio of underwriting
expenses (excluding interest) to earned premiums was 10.1% in 1994, 10.7% in
1993 and 10.0% in 1992. The Company's efficiency, as reflected in its expense
advantage over its competitors, enables the Company to maintain its price
leadership and provide for future growth and profitability.
Investment Income
Net pre-tax investment income was $84,761,000 in 1994, $97,574,000 in
1993 and $94,255,000 in 1992 which produced an increase (decrease) over the
prior year of (13.1%) and 3.5% for 1994 and 1993, respectively. Average
invested assets decreased 14.0% in 1994 from 1993 and increased 8.8% in 1993
over 1992. Average annual pre-tax yield on invested assets has declined from
7.4% in 1992 to 7.1% in 1993 to 6.7% in 1994 because of lower interest rates
available on bonds purchased in 1992 and 1993 and because bonds that had been
purchased previously with rates that were higher than currently available were
sold in 1994 to generate cash for paying earthquake claims. In addition, in
1994, available cash was invested in commercial paper which yielded a lower
interest rate then that earned on the bond portfolio.
Realized capital gains on the sales of investments has increased from
$11,498,000 in 1992, to $16,729,000 in 1993 and to $61,554,000 in 1994.
45
As of December 31, 1994, the Company had a net unrealized loss on bonds
of $61,425,000 compared to a net unrealized gain in 1993 and 1992 of
$145,746,000 and $84,418,000, respectively. The primary reason for the shift
from an unrealized gain to an unrealized loss is that interest rates rose
sharply since late 1993 causing a reduction in fair value of the bond
portfolio, and the Company had recognized significant gains on the portion of
the bond portfolio sold in 1994.
The Company's investment guidelines currently emphasize buying high-
quality, fixed income, taxable securities because of the Company's substantial
net operating loss carryforward. While the Company's policy is generally to
hold these investments until maturity, its ongoing monitoring and evaluation
of investment holdings and market conditions may, from time to time, result
in selected sales of investments prior to maturity. The Company has designated
its portfolio as "available-for-sale," and it is carried at fair value as of
December 31, 1994 in accordance with the standards set forth in Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The Company implemented this new standard January
1, 1994. For a more complete description of this new standard, see Note 1 of
the Notes to Consolidated Financial Statements, "Investments".
Income Taxes
In 1993, the Company adopted Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes", which requires the recognition of
deferred tax liabilities and tax assets for the expected future tax
consequences of temporary differences between the carrying amount and the tax
bases of assets and liabilities. For further discussion, refer to Note 4 of
the Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has experienced positive cash flow from
operating activities. Due to the severe earthquake losses, the Company did
not generate a positive cash flow from operating activities in 1994. The
Company paid for these losses with cash from operations, investment sales,
loan proceeds and equity financing. Funds needed to pay for remaining
earthquake related losses and expenses will come from normal positive
operating cash flows and from available cash on deposit. As of December 31,
1994, the Com-
46
pany had total cash of $249,834,000 and total investments of $942,174,000. Of
the Company's total investments, $229,216,000 at fair value was invested in
tax-exempt state and municipal bonds and the balance was invested in taxable
government, corporate and municipal securities.
Statutory regulations require the majority of the Company's investments
to be made in high-grade securities to provide ample protection for
policyholders. The Company primarily invests in long-term fixed maturity
investments such as bonds.
Loss and loss expense payments are the most significant cash flow
requirements of the Company. The Company continually monitors the loss
payments to provide projections of future cash requirements. The Company
generally generates enough cash flow to allow for monthly investments in the
Cash Management Fund which is the source for purchasing long-term investments
such as bonds. In order to help pay for the earthquake losses in 1994, the
Company capitalized on the substantial unrealized gain in its bond portfolio
by selling off bonds with higher market values. This resulted in capital
gains of $61,554,000.
In order to realize capital gains to increase statutory surplus, to
provide cash for earthquake claims payments and to maximize investment income,
the Company has restructured its investment portfolio to increase the
proportion of investment-grade taxable instruments. Accordingly, the entire
portfolio is shown as available-for-sale. As of December 31, 1994, the
portfolio contained 76% taxable instruments compared to 13% a year earlier.
All of the Company's investments are of high-quality and very liquid.
In prior years, the Company's most significant capital requirement
resulted from its need to maintain an acceptable ratio of net premiums written
to policyholders' surplus. In 1994, the losses from the Northridge Earthquake
were so severe that the Company obtained a $160 million bank loan for its
subsidiaries and equity financing from American International Group, Inc.
(AIG). See Notes 7 and 14 of the Notes to Consolidated Financial Statements.
At December 31, 1994, the Company has $200 million of preferred stock
outstanding, bearing interest at 9% per year payable quarterly. This results
in a dividend of $18 million a year, or $4,500,000 per quarter. The Company
also has a revolving credit line obligation of $160 million, with interest
obligations varying according to market conditions. First quarter 1995
interest payments are estimated to be $3,900,000.
47
In March 1995, the Company issued an additional $20 million of preferred
stock and borrowed another $10 million against the existing bank credit
facility in order to increase the surplus of its Insurance Subsidiaries
pursuant to an order by the California Department of Insurance. Dividends
required in June 1995 and subsequent quarters will be $4,950,000. Interest
for the credit facility will be approximately $3,700,000 for the second
quarter of 1995.
Funds required by 20th Century Industries to pay dividends are provided
by the Insurance Subsidiaries. The ability of the Insurance Subsidiaries to
pay dividends to the holding company is regulated by state law. Because of
statutory regulations which require dividends to be paid from earned surplus,
no dividends may be paid by the subsidiaries in 1995 without prior approval.
The order from the DOI in January, 1995 specifically provides that the
Insurance Subsidiaries may pay dividends to service existing debt and
preferred stock obligations, and to service the additional contributions. The
DOI and the Company have been in constant communication, and currently the DOI
is permitting the Company to operate at a net premiums written to surplus
ratio in excess of 3:1. The Company has requested approval from the DOI for
an extraordinary dividend to pay the required dividends and interest, and
anticipates a favorable response.
Stockholders' equity decreased $337.3 million between 1993 and 1994 from
$655.2 million to $317.9 million, respectively, while book value per common
share decreased $10.45 from $12.74 to $2.29 for the same time period.
For years prior to 1994, the Company's cash outlays for income taxes
generally exceeded income tax expense recorded in accordance with generally
accepted accounting principles. This resulted primarily because of the
reduction of the unearned premium deduction and the discounting of unpaid loss
reserve mandated by the Tax Reform Act of 1986.
In 1994, the losses caused by the Northridge Earthquake resulted in a
net operating loss of approximately $788.5 million and $759.5 million for
regular tax and alternative minimum tax, respectively. Of these amounts,
$238.0 million and $350.0 million for regular tax and alternative minimum tax,
respectively, were carried back to the previous three years offsetting most of
the taxable income for those years and resulting in a tax refund of $74.1
million. The balance of the 1994 net operating loss ($550.0 million and
$408.0 million for regular tax and alternative minimum tax, respectively) will
offset taxable income for future years. For the next two to three years, the
Company
48
expects to have very small cash outlays for income taxes, specifically
alternative minimum tax. Until the net operating losses are fully utilized,
the Company expects that cash outlays for income taxes will be less than
income tax expense recorded in accordance with generally accepted accounting
principles. The net operating loss carryforwards will expire in the year
2009.
RISK-BASED CAPITAL
The National Association of Insurance Commissioners (NAIC) requires
property and casualty insurance companies to calculate and report information
under a Risk-Based Capital (RBC) formula effective with the filing of their
1994 annual statements due March 1, 1995. The RBC requirements are intended
to assist regulators in identifying inadequately capitalized companies. The
RBC calculation is based on the type and mix of risks inherent in the
Company's business and includes components for underwriting, asset, interest
rate and other risks. The Company implemented the RBC formula for year-end
1994 and has exceeded the minimum RBC requirements. Therefore, no corrective
action is required.
HOME OFFICE LEASE
The Company leases its Home Office building in Woodland Hills,
California, which contains approximately 234,000 square feet of leasable
office space. The lease was amended in October 1994 which extended the lease
term until November 1999. The lease on this building may be renewed for two
consecutive five-year periods.
49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
Board of Directors
20th Century Industries
We have audited the accompanying consolidated balance sheets of 20th
Century Industries and subsidiaries as of December 31, 1994 and 1993, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1994. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These financial statements and schedule 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 in accordance with generally accepted auditing
standards. Those standards 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. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As more fully discussed in Notes 7, 12, 13 and 14, the Company's
financial position has been adversely impacted by an earthquake in the
Southern California area and other events occurring in 1994.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of 20th Century Industries and subsidiaries at December 31, 1994 and 1993, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1994, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
As described in Note 1, 20th Century Industries and subsidiaries adopted
in 1994 the provisions of Statement of Financial Accounting Standard No. 115,
"Accounting for Certain Investments in Debt and Equity Securities". As
described in Note 4, 20th Century Industries and subsidiaries adopted in 1993
the provisions of Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes".
ERNST & YOUNG LLP
Los Angeles, California
February 17, 1995
50
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
------------------------------
1994 1993
---- ----
(Amounts in thousands)
Investments:
Fixed maturities, held-to-maturity
at amortized cost (fair value,
1993 $1,289,895) $ - $1,177,565
Fixed maturities - available-for-
sale, at fair value, 1994 and lower
of aggregate amortized cost or aggregate
fair value, 1993 (amortized cost, 1994
$1,002,831; aggregate fair value, 1993
$277,866) 941,406 244,451
Equity securities, at fair value
(cost, 1994 $539;
1993 $539) 768 539
---------- ----------
Total investments - Note 2 942,174 1,422,555
Cash and cash equivalents 249,834 17,894
Accrued investment income 19,631 28,247
Premiums receivable 90,236 87,241
Income taxes receivable 74,064 1,396
Deferred income taxes - Note 4 276,570 40,905
Deferred policy acquisition
costs - Note 3 14,776 15,712
Furniture, equipment and leasehold
improvements; at cost less accumulated
depreciation, 1994 $42,171; 1993 $35,414 13,307 17,409
Other assets 22,218 13,311
---------- ----------
$1,702,810 $1,644,670
========== ==========
The accompanying notes are an integral part of this statement.
51
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31,
-----------------------------
1994 1993
---- ----
(Amounts in thousands, except share data)
Unpaid losses and loss adjustment
expenses - Note 6 $ 756,243 $ 577,490
Unearned premiums 298,519 299,941
Bank loan payable - Note 7 160,000 -
Claims checks payable 70,725 41,535
Proposition 103 payable - Note 12 78,307 49,185
Other liabilities - Note 5 21,072 21,310
---------- ----------
Total liabilities 1,384,866 989,461
---------- ----------
Commitments - Note 9 and
Contingencies - Note 11
Stockholders' equity - Note 10
Capital Stock
Preferred stock, par value $1.00
per share; authorized 500,000
shares, none issued
Series A convertible preferred stock,
stated value $1,000 per share, authorized
376,126 shares, outstanding 200,000
in 1994 200,000 -
Common stock without par value;
authorized 110,000,000 shares,
outstanding 51,472,471 in 1994
and 51,447,471 in 1993 69,340 68,848
Common stock warrants 16,000 -
Unrealized investment losses, net - Note 2 (39,777) -
Retained earnings 72,381 586,361
---------- ----------
Total stockholders' equity 317,944 655,209
---------- ----------
$1,702,810 $1,644,670
========== ==========
The accompanying notes are an integral part of this statement.
52
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
---------------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands, except per share data)
REVENUES:
Net premiums earned - Note 8 $ 1,034,003 $ 989,712 $ 896,353
Net investment income - Note 2 84,761 97,574 94,255
Realized investment gains 61,554 16,729 11,498
Other (46) (180) (116)
----------- ---------- ----------
1,180,272 1,103,835 1,001,990
----------- ---------- ----------
LOSSES AND EXPENSES:
Net losses and loss adjustment
expenses - Note 6 944,530 867,451 764,374
Net earthquake losses and related
expenses - Note 6 883,816 - -
Policy acquisition costs 43,409 48,375 41,996
Other operating expenses 57,214 57,545 48,337
Proposition 103 expense - Note 12 29,124 3,474 3,474
Interest expense 8,286 44 33
----------- ---------- ----------
1,966,379 976,889 858,214
----------- ---------- ----------
Income (loss) before federal income
taxes and cumulative effect
of change in accounting for
income taxes (786,107) 126,946 143,776
Federal income taxes (benefit) -
Note 4 (288,087) 18,350 26,309
----------- ---------- ----------
Income (loss)before cumulative effect
of change in accounting for income
taxes (498,020) 108,596 117,467
Cumulative effect of change in
accounting for income taxes - 3,959 -
----------- ---------- ----------
NET INCOME (LOSS) $ (498,020) $ 112,555 $ 117,467
=========== ========== ==========
EARNINGS (LOSS) PER COMMON
SHARE - NOTE 1
PRIMARY -
Before cumulative effect of
change in accounting for
income taxes $ (9.69) $ 2.11 $ 2.29
Cumulative effect of change in
accounting for income taxes - .08 -
----------- ---------- ----------
NET INCOME (LOSS) $ (9.69) $ 2.19 $ 2.29
=========== ========== ==========
FULLY DILUTED -
Before cumulative effect of
change in accounting for
income taxes $ (9.69)
Cumulative effect of change
in accounting for income taxes -
-----------
NET INCOME (LOSS) $ (9.69)
===========
The accompanying notes are an integral part of this statement.
53
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1992, 1993 and 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
CONVERTIBLE
PREFERRED STOCK COMMON STOCK UNREALIZED
$1 PAR VALUE WITHOUT COMMON INVESTMENT
PER SHARE PAR VALUE STOCK GAINS RETAINED
AMOUNT AMOUNT WARRANTS (LOSSES) EARNINGS
-------- --------- -------- -------- -----------
Balance at January 1, 1992 $ - $ 68,060 $ - $ - $416,517
Net income for the year 117,467
Effects of common stock issued
under restricted shares plan 371
Cash dividends paid ($.52 per
share) (26,741)
------ -------- ------- ------- ---------
Balance at December 31, 1992 - 68,431 - - 507,243
Net income for the year 112,555
Effects of common stock issued
under restricted shares plan 417
Unrealized pension loss (511)
Cash dividends paid ($.64 per
share) (32,926)
------ -------- ------- -------- ---------
Balance at December 31, 1993 - 68,848 - - 586,361
Net loss for the year (498,020)
Effects of common stock issued
under restricted shares plan 492
Effect of implementing change in
accounting for investments at
January 1, 1994 - Note 2 36,757
Net decrease in unrealized gains
on portfolio classified as avail-
able-for-sale from January 1, 1994
to December 31, 1994 - Note 2 (76,683)
Unrealized gain on marketable
equity securities, net of
deferred taxes of $80 149
Issuance of Series A
Preferred Stock - Note 10 200,000
Issuance of Series A Common
Stock Warrants - Note 10 16,000
Unrealized pension gain 511
Cash dividends paid
($.32 per share) (16,471)
-------- ------- ------- -------- --------
Balance at December 31, 1994 $200,000 $69,340 $16,000 $(39,777) $ 72,381
======== ======= ======= ======== ========
The accompanying notes are an integral part of this statement.
54
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-------------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
OPERATING ACTIVITIES:
Net Income (loss) $(498,020) $ 112,555 $ 117,467
Adjustments to reconcile net income
to net cash provided (used) by operating
activities:
Provision for depreciation
and amortization 7,195 7,203 6,127
Provision for deferred income taxes (214,522) (6,518) (4,682)
Realized gains on sale of invest-
ments, fixed assets, etc. (61,470) (16,515) (11,343)
Effects of common stock issued
under restricted shares plan 492 417 371
Increase in premiums receivable (2,995) (9,614) (7,091)
(Increase) decrease in accrued
investment income 8,616 (147) (1,854)
(Increase) decrease in deferred
policy acquisition costs 936 (2,367) (1,723)
Increase in unpaid losses and loss
adjustment expenses 178,753 22,950 6,164
Increase (decrease) in unearned premiums (1,422) 32,385 22,266
Increase in claims checks payable 29,190 2,206 2,445
Increase in Proposition 103 payable 29,122 3,474 3,474
Change in other assets, other
liabilities and accrued income
taxes (81,026) (6,376) 1,539
--------- --------- ---------
NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES (605,151) 139,653 133,160
55
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
INVESTING ACTIVITIES:
Investments purchased - held-
to-maturity - (308,543) (452,096)
Investments purchased-available-
for-sale (821,822) - -
Investments called or matured - held-
to-maturity - 19,760 47,820
Investments called or matured - avail-
able-for-sale 27,531 14,323 -
Investments sold - held-to-maturity - 58,116 308,703
Investments sold - available-for-sale 1,275,091 117,503 -
Net purchases of furniture, equip-
ment and leasehold improvements (3,238) (4,895) (8,320)
---------- ---------- ----------
NET CASH PROVIDED (USED) BY
INVESTING ACTIVITIES 477,562 (103,736) (103,893)
FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock 200,000 - -
Proceeds from issuance of common stock
warrants 16,000 - -
Payments on installment contract - (75) (414)
Proceeds from bank loan 160,000 - -
Dividends paid (16,471) (32,926) (26,741)
---------- ---------- ----------
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES 359,529 (33,001) (27,155)
---------- ---------- ----------
Net increase in cash 231,940 2,916 2,112
Cash, beginning of year 17,894 14,978 12,866
---------- ---------- ----------
Cash, end of year $ 249,834 $ 17,894 $ 14,978
========== ========== ==========
The accompanying notes are an integral part of this statement.
56
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF ACCOUNTING POLICIES
Basis of Consolidation and Presentation
The accompanying financial statements include the accounts of 20th
Century Industries and its wholly-owned subsidiaries, 20th Century Insurance
Company and 21st Century Casualty Company. All material intercompany accounts
and transactions have been eliminated. The consolidated financial statements
have been prepared in conformity with generally accepted accounting principles
which differ in some respects from those followed in reports to insurance
regulatory authorities.
Investments
Prior to the adoption in 1994 of Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and
Equity Securities", the Company adhered to less stringent requirements and
management believed that it had the ability to hold its investments to
maturity and intended to do so. However, the Company also recognized that it
could be appropriate to sell a security prior to maturity in response to
unforeseen changes in circumstances. Recognizing the need for the ability to
respond to changes in tax position and in market conditions, the Company had
designated a portion of its investment portfolio as "available-for-sale".
These fixed income securities were valued in the aggregate at the lower of
amortized cost or fair value. The remainder of the Company's portfolio was
designated as "held-for-investment" and valued at amortized cost.
The Company adopted SFAS 115 at January 1, 1994. SFAS 115 requires that
fixed maturity securities are to be classified as either held-to-maturity,
available-for-sale, or trading. Held-to-maturity debt securities are to be
reported at amortized cost; trading securities are to be reported at fair
value, with unrealized gains or losses included in earnings; and available-
for-sale securities are to be reported at fair value, with unrealized gains or
losses excluded from earnings and reported in a separate component of
shareholders' equity.
57
Because these rules are more stringent than in prior years, the Company
during 1994 has reclassified its portfolio into the available-for-sale
category. (See Note 2).
Fair values for fixed maturity and equity securities are based on quoted
market prices. Unrealized investment gains and losses on available-for-sale
securities are credited or charged directly to stockholders' equity, net of
any tax effect. When investment securities are sold, the cost used to
determine any realized gain or loss is based on specific identification.
Cash and Cash Equivalents
Cash and cash equivalents include cash and short-term investments in
demand deposits.
Reinsurance
In the normal course of business, the Company seeks to reduce the loss
that may arise from catastrophes or other events that cause unfavorable
underwriting results by reinsuring certain levels of risk in various areas of
exposure with other insurance enterprises or reinsurers. Reinsurance premiums
and reserves on reinsured business are accounted for on a basis consistent
with those used in accounting for the original policies issued and the terms
of the reinsurance contracts. Amounts applicable to ceded unearned premiums
and ceded claim liabilities are reported as assets in the accompanying balance
sheets.
Furniture, Equipment and Leasehold Improvements
Furniture, equipment and leasehold improvements are recorded at cost. The
provision for depreciation is computed on the straight-line method over the
estimated useful lives of the related assets which generally range from 5 to
7 years. Leasehold improvements are capitalized and amortized over the
shorter of the life of the asset or the lease term. Maintenance and repair
costs are charged to operations when incurred. Depreciation and amortization
expense was $7,256,000, $7,158,000 and $6,020,000 for 1994, 1993 and 1992,
respectively.
58
Income Recognition
Premiums written are recorded as earned proportionately over the term of
the policy.
Losses and Loss Adjustment Expenses
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 net costs of settlement 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 reasonable and acceptable
range of adequacy. The methods of making such estimates and for establishing
the resulting reserves are continually reviewed and updated and any
adjustments resulting therefrom are reflected in earnings currently.
Policy Acquisition Costs
Policy acquisition costs, principally direct and indirect costs directly
related to production of business, are deferred and amortized against the
premiums earned.
Income Taxes
Income taxes for 1993 and 1994 have been provided using the liability
method in accordance with SFAS No. 109, "Accounting for Income Taxes". Under
that method, deferred tax assets and liabilities are determined based on the
differences between their financial reporting and their tax bases and are
measured using the enacted tax rates. Income taxes for 1992 have been
provided for using the deferred method.
Earnings (Loss) Per Common Share
Earnings (loss) per common share are computed using the weighted average
number of common shares outstanding during the respective periods. The
weighted average number of shares was 51,387,120 for the year ended
December 31, 1994, 51,411,968 for 1993 and 51,394,806 for 1992. Primary
earnings per share amounts
59
for 1993 and 1992 reflect a simple capital
structure in which there were no securities in existence allowing common stock
to be acquired as a result of exercising the conversion rights of such
securities. The 1994 primary and fully diluted loss per share amounts reflect
a complex capital structure in which securities exist that allow for the
acquisition of additional common stock through the exercise of conversion
rights in these securities. However, as there is a net loss for the year,
primary and fully diluted loss per share amounts for 1994 are the same, as
including the convertible securities in the computation of the loss per share
would be antidilutive.
Fair Values of Financial Instruments
The carrying amounts of financial instruments other than investment
securities, approximate their fair values. For investment securities, fair
values are based on quoted market prices. The carrying amounts and fair
values for all investment securities are disclosed in Note 2.
Reclassifications
The accompanying 1992 and 1993 financial statements have been
reclassified to conform with the 1994 presentation.
NOTE 2. INVESTMENT INCOME
As of January 1, 1994, the Company adopted the provisions of SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities" for
investments held as of or acquired after that date. In accordance with SFAS
No. 115, prior-period financial statements have not been restated to reflect
the change in accounting principle.
In accordance with the criteria contained in SFAS No. 115, certain fixed
maturities previously classified as held-to-maturity (with an amortized cost
of $166,786,000 and fair value of $189,921,000) were transferred to the
available-for-sale category; in addition, the carrying value of the existing
available-for-sale portfolio was adjusted to fair value as of January 1, 1994.
The effect of adopting SFAS 115 on January 1, 1994 increased fixed maturity
investments available-for-sale by $56,549,000, decreased deferred taxes by
$19,792,000, and increased stockholders' equity by $36,757,000. In the three-
month period ended March 31, 1994, those net unrealized holding gains
decreased by $15,551,000 (net of deferred income taxes of $8,374,000).
Effective March 31, 1994, the Company, in response to the unprecedented losses
resulting from the Northridge Earthquake
60
( see Note 13 ), reclassified the
balance of its investment portfolio as available-for-sale, increasing
stockholders' equity by $19,719,000 (net of deferred income taxes of
$10,618,000). In the nine-month period ended December 31, 1994, net
unrealized holding gains on the Company's bond portfolio decreased from
$40,925,000 (net of deferred income taxes of $22,036,000) at March 31, 1994 to
a net unrealized loss of $39,926,000 (net of deferred income taxes of
$21,499,000) at December 31, 1994 or a decrease of $80,851,000 (net of
deferred income taxes of $43,535,000). The aggregate of the changes in
unrealized gains (losses) for 1994 as discussed above totals $76,683,000,
which is reflected in the Consolidated Statement of Stockholders' Equity.
61
A summary of net investment income is as follows:
YEARS ENDED DECEMBER 31,
-----------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
Interest and dividends on fixed
maturities $ 82,125 $ 97,771 $ 93,626
Dividends on equity securities 11 40 40
Interest on short-term cash
investments (demand deposits) 3,210 522 791
Other 117 11 99
-------- -------- --------
Total investment income 85,463 98,344 94,556
Investment expense 702 770 301
-------- -------- --------
Net investment income $ 84,761 $ 97,574 $ 94,255
======== ======== ========
A summary of realized investment gains and losses before income taxes and
proceeds from the sale of bonds is as follows:
YEARS ENDED DECEMBER 31,
-----------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
Fixed maturities available-for-sale:
Gross realized gains $ 65,300 $ 11,528 $ -
Gross realized losses (3,746) (99) -
Fixed maturities held-to-maturity:
Gross realized gains - 5,300 12,554
Gross realized losses - - (1,056)
---------- -------- --------
Net realized investment gains $ 61,554 $ 16,729 $ 11,498
========== ======== ========
Proceeds from sale of bonds
(calls and maturities excluded) $1,275,091 $175,619 $308,703
========== ======== ========
62
The amortized cost, gross unrealized gains and losses, and fair
values of fixed maturities as of December 31, 1994 and 1993, respectively, are as
follows:
Gross Gross
Amortized Unrealized Unrealized Fair
1994 Cost Gains Losses Value
---- --------- ---------- ----------- -----------
Available-for-sale: (Amounts in thousands)
U.S. Treasury securities and obli-
gations of U.S. government cor-
porations and agencies $ 240,690 $ 65 $ 8,077 $ 232,678
Obligations of states and political
subdivisions 292,723 355 31,464 261,614
Public utilities 147,241 11 8,079 139,173
Corporate securities 322,177 1,594 15,830 307,941
----------- -------- ------- -----------
Total available-for-sale $ 1,002,831 $ 2,025 $63,450 $ 941,406
=========== ======== ======= ===========
1993
----
Held-to maturity:
U.S. Treasury securities and obli-
gations of U.S. government corp-
orations and agencies $ 6,258 $ 519 $ - $ 6,777
Obligations of states and political
subdivisions 1,028,780 93,118 590 1,121,307
Public utilities 11,060 875 - 11,935
Corporate securities 131,467 18,408 - 149,876
----------- -------- ------ -----------
Total held-to-maturity $ 1,177,565 $112,920 $ 590 $ 1,289,895
=========== ======== ====== ===========
Available-for-sale:
Obligations of states and political
subdivisions $ 244,451 $ 33,420 $ 5 $ 277,866
----------- -------- ------ -----------
Total available-for-sale $ 244,451 $ 33,420 $ 5 $ 277,866
=========== ======== ====== ===========
63
The maturity distribution of the Company's fixed maturity investments at
December 31, 1994 was as follows: (Amounts in thousands)
Available-for-Sale
---------------------------
Amortized Fair
Fixed maturities due: Cost Value
--------------------- ---------- --------
1995 $ 11,056 $ 10,927
1996 - 1999 223,727 216,932
2000 - 2004 241,483 232,175
2005 - 2014 288,982 268,718
2015 and after 237,583 212,654
---------- --------
Total $1,002,831 $941,406
========== ========
Expected maturities of the Company's investment portfolios differ from
contractual maturities because certain borrowers have the right to call or
prepay obligations with or without call or prepayment penalties.
NOTE 3. POLICY ACQUISITION COSTS
YEARS ENDED DECEMBER 31,
-------------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
Deferred policy acquisition costs
amortized in the year $ 15,712 $ 13,345 $ 11,622
Policy acquisition costs incurred
during the year 42,473 50,742 43,719
--------- -------- --------
Total policy acquisition costs 58,185 64,087 55,341
Deferred policy acquisition costs
at end of the year 14,776 15,712 13,345
-------- -------- --------
Policy acquisition costs for
current year $ 43,409 $ 48,375 $ 41,996
======== ======== ========
64
NOTE 4. FEDERAL INCOME TAXES
In 1993, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 109, "Accounting for Income Taxes". The adoption of SFAS 109
changes the Company's method of accounting for income taxes from the deferred
method to the liability method. The liability method requires the recognition
of deferred tax liabilities and tax assets for the expected future tax
consequences of temporary differences between the carrying amounts and the tax
bases of assets and liabilities. The adjustments to the January 1, 1993
balance sheet to adopt SFAS 109 totaled $3,959,000, which is reflected in the
1993 statement of income as the effect of a change in accounting principle.
Federal income tax expense consists of:
YEARS ENDED DECEMBER 31,
------------------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
Current tax expense (benefit) $ (73,565) $ 24,868 $ 30,991
Deferred tax expense (benefit) (214,522) (6,518) (4,682)
--------- -------- --------
$(288,087) $ 18,350 $ 26,309
========= ======== ========
The Company's net deferred income tax asset is composed of:
YEARS ENDED DECEMBER 31,
-----------------------------
1994 1993
---- ----
(Amounts in thousands)
Deferred Tax Assets:
Net operating loss carryforward $192,334 $ -
Unearned premiums 20,810 20,898
Loss reserves 21,886 19,621
Alternative minimum tax credit 8,084 -
Proposition 103 14,138 3,337
Unrealized investment losses 21,419 -
Non-qualified retirement plans 2,761 2,578
Other 1,373 1,088
-------- --------
282,805 47,522
-------- --------
Deferred Tax Liabilities:
Deferred policy acquisition costs 5,173 5,499
Salvage and subrogation 1,062 1,118
-------- --------
6,235 6,617
-------- --------
Net Deferred Tax Asset $276,570 $ 40,905
======== ========
65
Under normal operations, the Company's principal deferred tax assets
arise due to the discounting of loss reserves for tax purposes which delays a
portion of the loss deduction and the acceleration of 20% of the unearned
premium reserve into taxable income before it is earned. As a result of the
losses arising from the Northridge Earthquake, the Company, as of December 31,
1994, after available carryback, has a net operating loss carryforward of
approximately $550,000,000 for regular tax purposes and $408,000,000 for
alternative minimum tax purposes expiring in the year 2009 and an alternative
minimum tax credit carryforward of $8,084,000.
The Company is required to establish a "valuation allowance" for any
portion of the deferred tax asset that management believes will not be
realized. In order to utilize the deferred tax assets, the Company must have
the ability to generate sufficient future taxable income to realize the tax
benefits. The Company has available the following tax-planning strategies to
generate additional taxable income in the future above historical levels:
1) The Company as of December 31, 1994 has approximately 76% of its
$1 billion investment portfolio invested in taxable securities
compared to 13% at December 31, 1993. By converting its investment
portfolio from tax-exempt securities (and investing new cash flow)
into taxable securities, the Company has significantly increased
its future taxable income.
2) The Company could reinsure outstanding loss reserves and thus
eliminate the temporary difference related to the discounting
of loss reserves for tax purposes.
The Company has a strong record of profitable operations. Except for
the losses arising from the Northridge Earthquake, the Company has been
profitable for each of the past 10 years. Over the last five years, the
Company's combined ratio on a GAAP basis has been approximately 97% and
investment earnings have averaged approximately $95 million a year over the
same five year period. Historically, the Company has generated almost all of
its profits from its automobile line of business. In accordance with the
order by the California Department of Insurance, the Company is withdrawing
from the homeowners and earthquake lines of business. The Company cannot
renew any homeowner policies which include earthquake coverage with effective
dates on or after July 23, 1994 and thus will be completely out of the
earthquake line of business by July 23,
66
1995 and out of the homeowners line of business by July 23, 1997. This will
substantially reduce the Company's exposure to future earthquake catastrophes.
The Company's estimates of future taxable income are based on its
historical profitable operations and the equity financing received from
American International Group ("AIG") to replace diminished statutory capital
(See Note 14). The Company believes the AIG transaction will provide
sufficient statutory capital to allow the Company, in combination with its
significantly reduced exposure to catastrophic losses, to return to its
historical levels of profitability. The Company believes that the capital
transaction with AIG does not create any limitations on the ability of the
Company to utilize the net operating loss carryforward. The Company believes
that because of its historically strong earnings performance and the tax
planning strategies available, it is more likely than not that the Company
will realize the benefit of the deferred tax assets, and therefore, no
valuation allowance has been established.
Income taxes do not bear the expected relationship to income because of
differences in the recognition of revenue and expense for tax and financial
reporting purposes. The tax effects of such differences are:
YEARS ENDED DECEMBER 31,
------------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
Federal income tax (benefit)
at statutory rate $(275,138) $ 44,431 $ 48,884
(Decrease) increase due to:
Tax-exempt income, net (13,535) (24,492) (22,960)
Alternative minimum tax - - (454)
Salvage and subrogation - - (88)
Adjustment of deferred tax for
1% increase in tax rate 1,696 (1,074) -
Other (1,110) (515) 927
--------- -------- --------
Federal taxes on income $(288,087) $ 18,350 $ 26,309
========= ======== ========
The statutory tax rate was 35% for 1994 and 1993 and 34% for 1992.
Cash paid for income taxes was $-0-, $26,026,000, and $32,303,000 for
the years ended December 31, 1994, 1993 and 1992, respectively.
67
NOTE 5. EMPLOYEE BENEFITS
Pension Plan and Supplemental Executive Retirement Plan
In 1988, the Company adopted a non-contributory defined benefit pension
plan (Pension Plan) which covers essentially all employees who have completed
at least one year of service. The benefits are based on employees'
compensation during all years of service. The Company's funding policy is to
make annual contributions as required by applicable regulations. The Pension
Plan's assets consist of high-grade fixed income securities and cash
equivalents.
Effective January 1, 1988, the Company adopted an unfunded Supplemental
Executive Retirement Plan (Supplemental Plan) which covers certain key
employees, designated by the Board of Directors. The Supplemental Plan
benefits are based on years of service and compensation during the last three
years of employment, and are reduced by the benefit payable from the Pension
Plan.
The net periodic pension cost for these plans reflected in the 1994,
1993 and 1992 Consolidated Statements of Operations is $3,722,000, $2,998,000
and $2,398,000, respectively. Accrued pension costs reflected in the
Consolidated Balance Sheets at December 31, 1994 and 1993 are $4,713,000 and
$6,811,000, respectively.
Savings and Security Plan
The Company has a qualified contributory savings and security plan for
eligible employees which incorporates Section 401(k) of the Internal Revenue
Code to permit certain pre-tax contributions by participants. Under the plan
(which is voluntary as to an employee's participation), the Company matches
75% of all employee contributions up to a limit of 6% of each participating
employee's compensation. Contributions charged against operations were
$2,210,000, $1,943,000 and $1,516,000 in 1994, 1993 and 1992, respectively.
68
NOTE 6. LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses is
summarized as follows:
1994 1993
---- ----
(AMOUNTS IN THOUSANDS)
Reserves for losses and loss adjustment
expenses, net of reinsurance recover-
ables on unpaid losses, at beginning
of year $ 574,619 $554,034
Incurred losses and loss adjustment
expenses, net of reinsurance:
Provision for insured events of the
current year, non-earthquake related,
net of reinsurance 1,028,983 930,437
Provision for insured events of the
current year, earthquake related,
net of reinsurance 868,407 -
Decrease in provision for
insured events of prior years,
net of reinsurance (84,453) (62,986)
---------- --------
Total incurred losses and loss
adjustment expenses, net of
reinsurance 1,812,937 867,451
---------- --------
Payments, net of reinsurance:
Losses and loss adjustment expenses
attributable to insured events of
the current year, earthquake related,
net of reinsurance 708,981 -
Losses and loss adjustment expenses
attributable to insured events of
the current year, non-earthquake re-
lated, net of reinsurance 578,598 519,232
Losses and loss adjustment expenses
attributable to insured events of
prior years, net of reinsurance 344,876 327,634
---------- --------
Total payments, net of reinsurance 1,632,455 846,866
---------- --------
Reserves for losses and loss adjustment
expenses, net of reinsurance recover-
ables on unpaid losses, at year end 755,101 574,619
Reinsurance recoverables on unpaid
losses, at year end 1,142 2,871
---------- --------
Reserves for losses and loss adjust-
ment expenses, gross of reinsurance
recoverables on unpaid losses, at
year end $ 756,243 $577,490
========== ========
As a result of changes in estimates of insured events in prior years, the
provision of losses and loss adjustment expenses (net of reinsurance
recoveries of $400,000 and $(366,000) in 1993 and 1994, respectively)
decreased by $62,986,000 and $84,453,000 in 1993 and 1994, respectively, due
to a combination of improvements in the claims handling process, unanticipated
decreases in frequency and random fluctuations in severity.
69
NOTE 7. DEBT
Effective June 30, 1994, the Company secured a five and one-half year
reducing-revolver credit facility (the Facility), with an aggregate commitment
of $175 million through The First National Bank of Chicago and Union Bank (the
Agents).
As of December 31, 1994, the Company's outstanding advances against the
Facility totalled $160 million for which loan origination fees to the Agents
of $7.2 million were incurred. Loan fees are being amortized over the five-
and-one-half year life of the Facility. Interest is charged at a variable
rate based, at the option of the Company, on either (1) the higher of (a) the
prime rate or (b) the sum of the Federal Funds Effective Rate plus 0.5%, plus
a margin of 2.0%, or (2) the Eurodollar rate plus a margin of 3.25%. Margins
will be reduced in relation to certain financial and operational levels of the
Company. Interest is payable at the end of each interest period. The stock
of the Company's Insurance Subsidiaries is pledged as collateral under the
loan agreement. At December 31, 1994, the annual interest rate for the
specified interest period was approximately 9.25%. Interest paid as of
December 31, 1994 was $7,277,000.
Beginning January 1, 1996, the aggregate commitment will be
automatically reduced $35 million, and $8.75 million thereafter on the first
day of each quarter through the Facility's maturity date of January 1, 2000.
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.
With the increase in Northridge Earthquake losses and resulting decline
in equity, the Company was in default of certain financial covenants of the
Facility. The Company deposited $25 million in a cash collateral account with
one of the agent banks to secure its obligations under the Bank Credit
Agreement. The Company and the Agents and Lenders agreed to amendments to the
loan agreement to waive the events of default in order to facilitate the
capital transaction with American International Group (AIG). (See Note 14).
Upon the closing of the capital transaction, the default condition was cured.
NOTE 8. REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. The Company periodically reviews the financial condition of its
70
reinsurers to minimize its exposure to significant losses from reinsurer
insolvencies. It is the Company's policy to hold collateral under related
reinsurance agreements in the form of letters of credit for unpaid losses for
all reinsurers not licensed to do business in the Company's state of
domicile. At December 31, 1994, there were no insurance agreements in force
with any such unauthorized reinsurers.
The effect of reinsurance on premiums written and earned is as follows
(amounts in thousands):
1994 1993 1992
----------------------- ---------------------- ------------------
Written Earned Written Earned Written Earned
---------- ---------- ---------- ---------- -------- --------
Direct $1,091,663 $1,093,086 $1,033,895 $1,001,510 $926,708 $904,442
Ceded (58,926) (59,083) (11,993) (11,798) (8,265) (8,089)
--------- ---------- ---------- ---------- -------- --------
Net premiums $1,032,737 $1,034,003 $1,021,902 $ 989,712 $918,443 $896,353
========== ========== ========== ========== ======== ========
Loss and loss adjustment expenses have been reduced by reinsurance ceded
totaling $76,815,000, $3,700,000, and $1,333,000 for 1994, 1993 and 1992,
respectively.
At December 31, 1994 and 1993, reinsurance receivable/recoverable was
$2,737,000 and $3,318,000, respectively, and ceded unearned premium was
$1,237,000 and $1,393,000, respectively.
The Company has a homeowners excess of loss reinsurance treaty with
General Reinsurance Corporation. In this excess treaty, the reinsurer's limit
is $650,000 in excess of the Company's retention of $300,000 per risk, subject
to a maximum reinsurer's limit of $1,300,000 per occurrence.
Following the January 17, 1994 Northridge Earthquake, the Company's
reinsurance coverage of 75% of $100 million in excess of $10 million was
reinstated at a cost of $13 million and additional reinsurance of 75% of the
next $100 million was purchased effective April 1, 1994, for approximately
$3 million. These treaties expired on June 30, 1994.
This reinsurance program was renewed for the period from July 1, 1994
through June 30, 1995, with amended terms, for a total annual premium of
approxi-
71
mately $28 million. Coverage under these treaties is provided by a
number of domestic, foreign and London market companies in layers as follows:
Catastrophe Company Reinsurance
Loss Layer Retention Amount
----------------- ----------- -----------
first $ 10,000,000 $10,000,000 $ 0
next $ 90,000,000 $ 7,200,000 $ 82,800,000
next $100,000,000 $ 5,000,000 $ 95,000,000
In order to provide reinsurance coverage for the declining earthquake
exposure, the Company also purchased from National Indemnity Company
additional reinsurance in excess of the underlying $200 million. An
additional layer beginning at $400 million effective June 16, 1994 and
decreasing by $50 million each month through February 15, 1995 was purchased
for a total premium of approximately $21.8 million.
An extension of the additional coverage from National Indemnity Company
was purchased effective January 23, 1995 for a total premium of approximately
$7.8 million. This coverage begins at a limit of $200 million and decreases
in increments ranging from $25 million to $35 million on the 1st and the 16th
of each month beginning March 1, 1995 through May 1, 1995. The treaty expires
May 15, 1995.
The Company has a quota share treaty for its Personal Excess Liability
Policy business with Underwriters Reinsurance Company and others. Effective
January 1, 1993, the Company cedes 60% of its business; prior to 1993, 90% was
ceded under this treaty.
NOTE 9. LEASE COMMITMENTS
The Company leases office space in a building in Woodland Hills,
California. The lease was amended in October 1994, extending the lease term
until November 1999. The lease may be renewed for two consecutive 5 year
periods.
The Company also leases office space in several other locations
throughout Southern California, primarily for claims servicing.
72
Minimum rental commitments under the above lease obligations are as
follows:
1995 $10,701,000
1996 10,684,000
1997 10,246,000
1998 8,824,000
1999 7,881,000
Thereafter 3,642,000
Rental expense charges to operations for the years ended December 31,
1994, 1993 and 1992 were $11,694,000, $11,259,000, and $10,572,000,
respectively.
NOTE 10. STOCKHOLDERS' EQUITY
Capital Stock:
On December 16, 1994, the Company received $216 million of equity
capital from American International Group, Inc. ("AIG") and in exchange,
issued (i) 200,000 shares of Series A 9% Convertible Preferred Stock, par
value $1.00 per share, at a price and liquidation value of $1,000 per share
and convertible into common shares at a conversion price of $11.33 per share,
and (ii) 16,000,000 Series A Warrants to purchase an aggregate 16,000,000
shares of the Company's Common Stock at $13.50 per share. The Company
received aggregate consideration of $200,000,000 for the shares of the
Preferred Stock and $16,000,000 for the Warrants. The Series A Preferred
Stock ranks senior to the Common Stock in respect to dividend and liquidation
rights. The Common Stock Warrants are generally exercisable from February
1998 to February 2007. See Note 14 of the Notes to Consolidated Financial
Statements for further discussion regarding the agreement between the Company
and AIG.
Retained Earnings:
The insurance subsidiaries have restrictions affecting the amount of
stockholder dividends which may be paid within any one year without the
approval of the California Department of Insurance. The California Insurance
Code provides that amounts may be paid as dividends from earned surplus on an
annual noncumulative basis of the greater of (1) net income for the preceding
year, or (2) 10 percent of statutory surplus as regards policyholders as of
the preceding December 31, without prior approval by the California Department
of Insurance. As both Insurance Subsidiaries had negative earned surplus at
December 31, 1994, no dividends may be paid to the Company during 1995 without
prior approval.
73
Stockholder's equity of the Insurance Subsidiaries on a statutory
accounting basis at December 31, 1994 and 1993 was $207,018,000 and
$582,176,000, respectively. Statutory net income (loss) for the Insurance
Subsidiaries was $(657,331,000), $96,218,000 and $105,959,000 for the years
ended December 31, 1994, 1993, and 1992, respectively.
Restricted Shares Plan:
The plan provides for grants of common shares not to exceed 921,920
shares to be made to key employees as determined by the Key Employee Incentive
Committee of the Board of Directors. At December 31, 1994, 334,409 common
shares remain available for future grants. Upon issuance of grants of common
shares under the plan, unearned compensation equivalent to the market value on
the date of grant is charged to common stock and subsequently amortized in
equal monthly installments over the 5-year period of the grant. Amortization
of unearned compensation was $431,000, $320,000 and $255,000 in 1994, 1993 and
1992, respectively. At December 31, 1994 and 1993, unearned compensation, net
of amortization, was $1,153,000 and $915,000, respectively. The common shares
are restricted for 5 years retroactive to the first day of the year of grant.
Restrictions are removed on 20% of the shares of each employee on January 1 of
each of the 5 years following the year of grant. A summary of grants
outstanding under the plan from 1992 through 1994 is as follows:
COMMON MARKET PRICE PER
SHARES SHARE ON DATE OF GRANT
------ ----------------------
Outstanding, December 31, 1991 46,488
Granted in 1992 33,940 $20.63
Vested in 1992 25,478
Cancelled or forfeited -
-------
Outstanding, December 31, 1992 54,950
Granted in 1993 21,225 $28.13
Vested in 1993 19,460
Cancelled or forfeited -
-------
Outstanding, December 31, 1993 56,715
Granted in 1994 25,000 $27.38
Vested in 1994 18,543
Cancelled or forfeited -
-------
Outstanding, December 31, 1994 63,172
=======
74
NOTE 11. LITIGATION
Lawsuits arising from claims under insurance contracts are provided for
through loss and loss adjustment expense reserves established on an ongoing
basis. From time to time, the Company has been named as a defendant in
lawsuits incident to its business. Some of these actions assert claims for
exemplary or punitive damages which are not insurable under California
judicial decisions. The Company vigorously defends these actions unless a
reasonable settlement appears appropriate. While any litigation has an
element of uncertainty, the Company is confident that the ultimate outcome of
pending actions will not have a material adverse effect on its consolidated
financial condition or results of operations.
NOTE 12. PROPOSITION 103
On January 27, 1995, the Company announced a settlement of rebate
liabilities associated with Proposition 103, which was passed by California
voters on November 8, 1988. The agreement applies to both Insurance
Subsidiaries, 20th Century Insurance Company and 21st Century Casualty
Company, and applies to those customers insured between November 8, 1988 and
November 7, 1989. At December 31, 1994, $78 million is recorded as a
liability.
Initially, the Company will refund $46 million to customers specified in
the agreement as soon as practicable, representing an average payment per
household of $80.00, approximately 7.5 percent of premiums paid between
November 8, 1988 and November 7, 1989. The remaining $32 million will be set
aside for additional customer refunds conditioned on the ultimate level of
claim costs associated with the 1994 Northridge Earthquake.
This settlement required the Company to withdraw its request for a
hearing with the United States Supreme Court to appeal the California Supreme
Court decision in the Proposition 103 test case "20th Century vs. Garamendi"
and abide by the terms of Commissioner Quackenbush's order. Upon announcement
of the settlement, a consumer group objected to the settlement terms, and
threatened legal action. The Company is advised by counsel, and believes that
any challenge to the settlement will be unsuccessful.
Another condition of this agreement required the Company to obtain new
capital of $50 million and contribute the funds to the surplus of the
Insurance Subsidiaries, consisting of $30 million by March 31, 1995 and
$20 million by Decem-
75
ber 31, 1995. Available to the Company were are an additional $15 million un-
der the existing bank credit facility and up to $70 million in preferred stock
which could be issued to AIG. See Note 17 for further discussion.
NOTE 13. NORTHRIDGE EARTHQUAKE
The Northridge, California Earthquake, which occurred on January 17,
1994, significantly affected the operating results and the financial position
of the Company for 1994. The earthquake occurred in an area in which the
Company's homeowners and earthquake coverages were concentrated. Since the
event occurred, the Company and other members of the property and casualty
insurance industry have revised their estimates of claim costs and related
expenses several times. Because of the unusual nature of the ground motion
during the earthquake, the earthquake produced significant damage to
structures beyond normal expectations. Delayed discovery of the severity of
damages has caused claims to be reevaluated as the additional damage becomes
known and has made the estimation process extremely difficult. The Company
currently estimates total gross losses and allocated loss adjustment expenses
for this catastrophe to be $940 million. Unallocated loss adjustment expense,
FAIR plan assessments and other earthquake related expenses are estimated to
be an additional $20 million. The charge for the year against pre-tax
earnings, after reduction for $76.3 million of reinsurance, was $883.8
million.
Should the earthquake losses increase above $974 million, future
financial periods will be impacted and additional capital may be required.
NOTE 14. CAPITAL TRANSACTION
As a result of the earthquake losses discussed in Note 13, the Company
found it necessary to obtain additional capital to increase the combined
statutory surplus of the Insurance Subsidiaries.
On December 15, 1994, at a special shareholders meeting, a definitive
agreement entered into between the Company and American International Group,
Inc. ("AIG"), to provide $216 million of equity capital was approved. The
agreement provides for an investment and strategic alliance agreement which
provides for the issuance of, (i) 200,000 shares of the Company's Series A 9%
Convertible Preferred Stock (the "Preferred Stock"), par value $1.00 per
share, at a price and liquidation value of $1,000 per share convertible into
common shares at a conversion price of $11.33 per share, and (ii) 16,000,000
Series A Warrants (the "Warrants") to purchase an aggregate 16,000,000 shares
of the Company's Common Stock at $13.50 per share.
76
The Company received aggregate consideration of $200,000,000 for the shares of
the Preferred Stock and $16,000,000 for the Warrants (collectively, the
"Investment Agreement").
The Investment Agreement also provides for a 10% quota share reinsurance
agreement applicable to the Company's entire book of business, thereby
improving the Company's ability to sustain growth.
In addition to AIG's capital investment and quota share agreement, the
Company and AIG are negotiating a strategic business alliance agreement for
joint ventures for the sale of automobile insurance outside California. This
alliance will enable the Company to expand its business into other geographic
areas.
Upon approval by the shareholders, AIG, as holders of the Preferred
Stock, voting separately as a class, elected two of the Company's eleven
directors. Holders of Common Stock were not entitled to vote in the election
of such two directors.
An amendment to the Company's Articles of Incorporation to increase the
number of authorized shares of Common Stock without par value from 80,000,000
to 110,000,000 shares was also approved by shareholders. This proposed
amendment was necessary in order to permit the full exercise of conversion
privileges under the Investment Agreement.
77
NOTE 15. UNAUDITED QUARTERLY RESULTS
The summarized unaudited quarterly results of operations were as follows:
QUARTER ENDED
-----------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
(Amounts in thousands, except per share data)
1994
----
Revenues $ 290,560 $ 333,481 $ 280,883 $ 275,348
Net income (loss) $(339,993) $ 4,880 $(114,254) $ (48,653)
Earnings (loss) per
common share $ (6.61) $ .09 $ (2.22) $ (.95)
1993
----
Revenues $ 263,101 $ 272,873 $ 281,339 $ 286,522
Net income $ 23,924 $ 34,824 $ 31,018 $ 22,789
Earnings per
common share $ .47 $ .67 $ .61 $ .44
The fourth quarter 1993 net income was impacted by approximately $4.3
million in net losses and $2.6 million in assessments for the Company's share
of California Fair Plan losses as a result of the Southern California fires.
The net income for all four quarters of 1994 reflect the impact of the
January 17 Northridge Earthquake, which were as follows: first quarter,
$551.3 million; second quarter, $76.5 million; third quarter, $129.8 million;
and fourth quarter, $126.2 million. The second quarter 1994 net income
reflects approximately $50 million in realized capital gains from the sale of
investments. The third quarter 1994 net income reflects additional deferred
revenue of $43.6 million and interest expense of $28 million related to the
Proposition 103 order directing the Company to issue refunds totaling
approximately $78.3 million, plus interest at 10% per annum from May 8, 1989
to September 30, 1994. The fourth quarter 1994 net income reflects the
reversal of all Proposition 103 interest accrued of approximately $44 million
in accordance with a settlement with the California Department of Insurance.
78
NOTE 16. RESULTS OF OPERATIONS BY LINE OF BUSINESS
The following table presents premium revenue and underwriting profit
(loss) for the Company's auto lines and homeowner and other lines on a GAAP
basis.
1994
----
Homeowner
(Amounts in thousands) Auto Lines and Other Lines
---------- ---------------
Direct premiums written $ 991,268 $ 87,395
========= ==========
Premiums earned $ 981,893 $ 52,110
========= ==========
Underwriting loss $ (45,854) $ (877,487)
========= ==========
1993
----
Homeowner
Auto Lines and Other Lines
---------- ---------------
Direct premiums written $ 932,497 $ 101,398
========= =========
Premiums earned $ 908,522 $ 81,190
========= =========
Underwriting profit (loss) $ 25,064 $ (11,598)
========= =========
1992
----
Homeowner
Auto Lines and Other Lines
---------- ---------------
Direct premiums written $ 841,610 $ 85,098
========= =========
Premiums earned $ 823,680 $ 72,673
========= =========
Underwriting profit $ 36,890 $ 1,714
========= =========
In 1994, both the Auto and Homeowner lines experienced an underwriting
loss due to the high level of claims incurred as a result of the January
17 Northridge Earthquake and the cost of the Proposition 103 rollback order.
In 1993, the Homeowners line experienced an underwriting loss primarily
as a result of first quarter weather-related losses of approximately $4.6
million, and the third quarter Southern California fires with related net
losses incurred of approximately $4.3 million and $2.6 million in assessments
for the Company's share of California Fair Plan losses. The underwriting
loss also included losses of approximately $1.0 million related to the 1991
Oakland, California fire.
In 1992, the Homeowners line experienced an underwriting profit despite
losses incurred of approximately $2.1 million related to the 1991 Oakland,
California fire.
79
NOTE 17. SUBSEQUENT EVENT (unaudited)
On January 28, 1995, the California Department of Insurance, as part of
the Proposition 103 settlement, ordered the Company to contribute an
additional $50 million to the Insurance Subsidiaries' surplus, including $30
million by March 31, 1995. In March 1995, the Company received $20 million
from the issuance of preferred stock to AIG and $10 million from the existing
bank credit facility and contributed such funds to the Insurance Subsidiaries'
surplus.
80
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no disagreements with the Company's independent auditors on
any matters of accounting principles or practices, financial statement
disclosure or auditing scope or procedure, or any reportable events.
PART III
--------
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
Information in response to Item 10 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's
1995 Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to Item 11 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's
1995 Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to Item 12 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's
1995 Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to Item 13 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's
1995 Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
81
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED WITH THIS REPORT
(1) FINANCIAL STATEMENTS. PAGE
----
The following consolidated financial statements of the Company
are filed as part of this report:
(i) Report of independent accountants;...................... 49
(ii) Consolidated balance sheets-December 31, 1994 and 1993;. 50
(iii) Consolidated statements of operations--Years ended
December 31, 1994, 1993 and 1992;....................... 52
(iv) Consolidated statement of changes in stockholders'equity--
Years ended December 31, 1994, 1993 and 1992;........... 53
(v) Consolidated statements of cash flows--Years ended
December 31, 1994, 1993 and 1992;....................... 54
(vi) Notes to consolidated financial statements.............. 56
(2) SCHEDULES
The following financial statement schedule required to be filed
by Item 8 and by paragraph (d) of Item 14 of Form 10-K is
submitted as a separate section of this report.
Schedule II - Condensed Financial Information of Registrant..... 85
Schedules I, III, IV, and VI have been omitted as all required data
is included in the Notes to Consolidated Financial Statements.
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission
are not required under the related instructions or are
inapplicable, and therefore have been omitted.
82
(3) EXHIBITS REQUIRED.
The following exhibits required by Item 601 of Regulation S-K and
by paragraph (c) of Item 14 of Form 10-K are listed by number
corresponding to the Exhibit Table of Item 601 of Regulation S-K.
3 Articles of Incorporation as amended and By-Laws, amended,
for the fiscal year ended December 31, 1994 of the Company.
4 A Specimen Common Stock Certificate is incorporated herein
by reference from the Registrant's Form 10-K for the fiscal
year ended December 31, 1985, in which it was included as an
exhibit.
10 The contracts listed below as 10(a) and 10(b) are
incorporated herein by reference from the Registrant's Form
10-K for the fiscal year ended December 31, 1985, and 10(c)
through 10(g) are amended or added for the fiscal year ended
December 31, 1987, 10(h) and 10(i) are for the fiscal year
ended December 31, 1988, 10(j) and 10(k) are for the fiscal
year ended December 31, 1989, 10(l) is amended for the
fiscal year ended December 31, 1990, 10(m) is amended for
the fiscal year ended December 31, 1994, 10(n) is amended
for the fiscal year ended December 31, 1995, 10(o) and 10(p)
are incorporated herein by reference from the Registrant's
Form 8-K dated October 5, 1994, 10(q) is for the fiscal year
ended December 31, 1995, 10(r) through 10(t) are
incorporated herein by reference from the Registrant's
Form 10-Q dated November 13, 1994, and 10(u) through 10(w)
are for the fiscal year ended December 31, 1995.
10(a) First Amended Employment Agreement and
Retirement Agreement between the Company and
Louis W. Foster.
10(b) Life Insurance Agreement for key officers.
10(c) 20th Century Industries Restricted Shares Plan,
as amended.
10(d) Restricted Shares Agreement.
10(e) Split Dollar Insurance Agreement between the
Company and Stanley M. Burke, as trustee of the
1983 Foster Insurance Trust.
10(f) Property Reinsurance Agreement No. 7288 between
the Company and General Reinsurance Corporation.
10(g) Note payable with Bank of America.
10(h) 20th Century Industries supplemental executive
retirement plan, as amended.
83
10(i) Amendment and restatement of 20th Century
Industries pension plan.
10(j) Software system agreement between the Company
and Management Science America, Inc.
10(k) Employment contract for a key officer.
10(l) 20th Century Industries Savings and Security
Plan, as amended.
10(m) Property Catastrophe Reinsurance Agreement No.
P3341-1 and 2 between the Company and Guy
Carpenter and Company, Inc., a reinsurance
intermediary, as amended.
10(n) PELP Reinsurance Contract, as amended.
10(o) Letter of intent between the Company and
American International Group, Inc.
10(p) Stock Option Agreement between the Company and
American International Group, Inc.
10(q) Property Catastrophe Excess of Loss Reinsurance
Agreement between 20th Century Insurance Company
and/or 21st Century Casualty Company and
National Indemnity Company.
10(r) Credit Agreement between the Company, Union Bank
and The First National Bank of Chicago.
10(s) Investment and Strategic Alliance Agreement
between the Company and American International
Group, Inc.
10(t) Amendment and Waiver between the Company, Union
Bank and The First National Bank of Chicago.
10(u) Amendment No. 2 and Waiver between the Company,
Union Bank and The First National Bank of
Chicago.
10(v) Amendment No. 1 to Investment and Strategic
Alliance Agreement between the Company and
American Internal Group, Inc.
10(w) Quota Share Reinsurance Agreement between 20th
Century Insurance Company and New Hampshire
Insurance Company and 21st Century Casualty
Company and New Hampshire Insurance Company.
22 Subsidiaries of Registrant.
29 Information from reports furnished to state
insurance regulatory authorities.
29(a) 20th Century Insurance Company
29(b) 21st Century Casualty Company
These documents are incorporated herein by reference to the
paper document filed by March 31, 1995 pursuant to a contin-
uing hardship exemption granted under Rule 202 of Regulation
S-T
84
(b) REPORTS ON FORM 8-K.
The Registrant filed two Form 8-K's during the three months ended
December 31, 1994 as follows:
1. October 5, 1994 The Company filed with the Commission
copies of the executed letter of intent,
with exhibits, and the executed Stock
Option Agreement, dated September 26, 1994
by and between the Company and American
International Group, Inc.
2. December 22, 1994 A. The Company expects earthquake
claims to total $900 million, up $85
million from a previous estimate.
The Company will have access to
additional capital through American
International Group, Inc. under the
terms of an investment plan
currently pending Shareholder
approval.
B. The Company appointed John B.
DeNault, formerly Vice Chairman of
the Board, as Chairman of the
Company's Board of Directors,
succeeding company founder, Louis W.
Foster, who is now Chairman of the
Board, Emeritus. In addition, Rex
J. Bates was named Vice Chairman of
the Board.
C. The Company closed the
capitalization and joint venture
plan with American International
Group, Inc. Under the plan, AIG
invested $216 million of equity
capital in the Company in return for
convertible preferred stock and
warrants.
85
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
ASSETS
DECEMBER 31,
------------------------------
1994 1993
---- ----
(Amounts in thousands, except share data)
Cash $ 31,283 $ 123
Accrued interest income 499 -
Other current assets 1,701 1,022
Accounts receivable from subsidiaries 4,050 -
Investment in non-consolidated insurance
subsidiaries at equity 442,871 694,555
Equipment, at cost, less accumulated
depreciation - 1994 $1,078; 1993 $807 1,568 1,825
Other assets 17,323 4,616
-------- --------
$499,295 $702,141
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable to subsidiaries $ 3,705 $ 33,159
Accounts payable and accrued expenses 17,646 13,773
Bank loan payable 160,000 -
-------- --------
Total liabilities 181,351 46,932
-------- --------
Stockholders' equity:
Capital Stock
Preferred stock, par value $1.00 per share;
authorized 500,000 shares, none issued
Series A convertible preferred stock,
stated value $1,000 per share, authorized
376,126 shares, outstanding 200,000 in
1994 200,000 -
Common stock, without par value; author-
ized 110,000,000 shares, outstanding
51,472,471 in 1994 and 51,447,471 in
1993 69,340 68,848
Common stock warrants 16,000 -
Retained earnings 32,604 586,361
-------- --------
Total stockholders' equity 317,944 655,209
-------- --------
$499,295 $702,141
======== ========
See note to condensed financial statements.
86
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
-----------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands, except per share data)
REVENUES
Interest $ 1,139 $ 2 $ -
Commissions 1 1 2
--------- -------- --------
Total 1,140 3 2
EXPENSES
General and administrative 9,034 645 466
--------- -------- --------
Loss before income tax refund (7,894) (642) (464)
Refund of income taxes (2,763) (225) (51)
--------- -------- --------
Net loss before equity in net
income of insurance subsidiaries (5,131) (417) (413)
Net income (loss) of non-consolidated
insurance subsidiaries (492,889) 112,972 117,880
--------- -------- --------
NET INCOME (LOSS) $(498,020) $112,555 $117,467
========= ======== ========
Earnings (loss) per common share $ (9.69) $ 2.19 $ 2.29
========= ======== ========
See note to condensed financial statements.
87
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
--------------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
OPERATING ACTIVITIES:
Net Income (loss) $(498,020) $112,555 $ 117,467
Adjustments to reconcile net
income to net cash provided
(used) by operating activities:
Net (income) loss of non-consolidated
insurance subsidiaries 492,889 (112,972) (117,880)
Reimbursement of depreciation and
amortization by non-consolidated
subsidiaries 550 586 595
Loss on sale of fixed assets 42 138 186
Effects of common stock issued
under restricted shares plan 492 417 371
Dividends received from non-consolidated
insurance subsidiaries 16,471 33,120 26,741
Increase (decrease) in deferred
compensation benefits (502) 3,114 96
Change in other assets, other
liabilities, and accrued
income taxes (42,504) 14,171 14,941
--------- -------- ---------
NET CASH PROVIDED (USED) BY OPERATING
ACTIVITIES $ (30,582) $ 51,129 $ 42,517
See note to condensed financial statements.
88
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
(Continued)
Years Ended December 31,
--------------------------------------------
1994 1993 1992
---- ---- ----
(Amounts in thousands)
INVESTING ACTIVITIES:
Capital contributed to 21st Century
Casualty Company $ (40,841) $(17,500) $(15,000)
Capital contributed to 20th Century
Insurance Company (256,612) - -
Purchase of equipment (478) (946) (1,006)
Proceeds from sale of equipment 144 291 264
--------- --------- ---------
NET CASH USED BY INVESTING ACTIVITIES (297,787) (18,155) (15,742)
FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock 200,000 - -
Proceeds from issuance of stock warrants 16,000 - -
Proceeds from bank loan 160,000 - -
Dividends paid (16,471) (32,926) (26,741)
--------- -------- --------
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES 359,529 (32,926) (26,741)
--------- -------- --------
Net increase in cash 31,160 48 34
Cash, beginning of year 123 75 41
--------- -------- --------
Cash, end of year $ 31,283 $ 123 $ 75
========= ======== ========
Supplemental disclosures of cash flow information:
Cash paid for interest was $7,277,000, $-0- and $-0- for the years ended December
31, 1994, 1993 and 1992, respectively.
See note to condensed financial statements.
89
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
NOTE TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements should be read in
conjunction with the consolidated financial statements and notes thereto of
20th Century Industries and Subsidiaries.
90
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
(Registrant)
Date: March 28, 1995 By:
-------------- ----------------------------------
William L. Mellick
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated on the 28th of
March, 1995.
SIGNATURE TITLE
--------- -----
Chief Executive Officer
------------------------------ (Principal Executive Officer)
William L. Mellick
Vice President,
Chief Financial Officer and
Chief Actuary (Principal
------------------------------ Financial Officer)
Charles I. Petit
Treasurer and Assistant Secretary
------------------------------ (Principal Accounting Officer)
Margaret Chang
91
SIGNATURE TITLE
--------- -----
----------------------------- Chairman of the Board
John B. DeNault
------------------------------ Vice Chairman of the Board
Rex J. Bates
------------------------------ Director
Neil H. Ashley
----------------------------- Director
Stanley M. Burke
------------------------------ Director
John B. DeNault III
------------------------------ Director
Louis W. Foster
------------------------------ Director
R. Scott Foster, M.D.