SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended June 30, 1999 Commission File Number 0-6964
------
20TH CENTURY INDUSTRIES
- - -----------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-1935264
- - -----------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
Suite 700, 6301 Owensmouth Avenue, Woodland Hills, California 91367
- - -----------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (818) 704-3700
---------------
None
- - -----------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.
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
------------ -----------------
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at July 30, 1999
Common Stock, Without Par Value 87,113,964 shares
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30, December 31,
1999 1998
---------- -------------
(Unaudited)
(Amounts in thousands)
Investments, available-for-sale, at fair value:
Fixed maturities $ 996,246 $ 1,067,248
Equity securities 2,127 1,373
---------- -------------
Total investments - Note 3. . . . . . . . 998,373 1,068,621
Cash and cash equivalents 116,864 167,856
Accrued investment income 15,797 19,542
Premiums receivable 70,073 70,884
Reinsurance receivables and recoverables 65,967 66,823
Prepaid reinsurance premiums 40,416 31,589
Deferred income taxes 85,196 74,330
Deferred policy acquisition costs 20,268 16,100
Other assets 81,167 77,411
---------- -------------
$1,494,121 $ 1,593,156
========== =============
See accompanying notes to financial statements.
2
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
1999 1998
----------- -------------
(Unaudited)
(Amounts in thousands, except share data)
Unpaid losses and loss adjustment expenses . . . . . . $ 305,417 $ 382,003
Unearned premiums. . . . . . . . . . . . . . . . . . . 238,440 233,689
Bank loan payable. . . . . . . . . . . . . . . . . . . 90,000 112,500
Claims checks payable. . . . . . . . . . . . . . . . . 32,518 34,311
Reinsurance payable. . . . . . . . . . . . . . . . . . 31,177 20,628
Other liabilities. . . . . . . . . . . . . . . . . . . 29,694 24,423
----------- -------------
Total liabilities. . . . . . . . . . . . . . . . 727,246 807,554
Stockholders' equity
Capital Stock
Preferred stock, par value $1.00 per share;
authorized 500,000 shares, none issued . . . . . - -
Series A convertible preferred stock, par value
$1.00 per share, stated value $1,000 per share;
authorized 376,126 shares, none outstanding
in 1999 and 1998 . . . . . . . . . . . . . . . . - -
Common stock, without par value; authorized
110,000,000 shares, outstanding 87,364,864
in 1999 and 87,624,531 in 1998 . . . . . . . . . 459,324 462,268
Accumulated other comprehensive income (loss) . . . (26,198) 23,387
Retained earnings . . . . . . . . . . . . . . . . . 333,749 299,947
----------- -------------
Total stockholders' equity . . . . . . . . . . . 766,875 785,602
----------- -------------
$1,494,121 $ 1,593,156
=========== =============
See accompanying notes to financial statements.
3
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------- ------------------
1999 1998 1999 1998
--------- -------- -------- --------
(Amounts in thousands, except per share data)
REVENUES:
Net premiums earned . . . . . . . . . . . . . $192,299 $191,883 $386,644 $385,384
Net investment income . . . . . . . . . . . . 16,201 18,262 34,100 36,594
Realized investment gains . . . . . . . . . . 3,290 7,683 10,538 10,917
--------- -------- -------- --------
211,790 217,828 431,282 432,895
LOSSES AND EXPENSES:
Net losses and loss
adjustment expenses. . . . . . 133,700 133,105 288,379 285,514
Policy acquisition costs. . . . . . . . 21,649 16,931 38,763 31,114
Other operating expenses. . . . . . . 6,842 3,566 9,452 6,435
Interest and fees expense . . . . . . . 1,765 2,677 3,717 5,515
--------- -------- -------- --------
163,956 156,279 340,311 328,578
--------- -------- -------- --------
Income before federal
income taxes . . . . . . . . . 47,834 61,549 90,971 104,317
Federal income taxes - Note 4 . . . 14,911 21,376 29,135 36,276
--------- -------- -------- --------
NET INCOME. . . . . . . . . . . $ 32,923 $ 40,173 $ 61,836 $ 68,041
========= ======== ======== ========
EARNINGS PER COMMON SHARE - Note 2
- - ----------------------------------
BASIC . . . . . . . . . . . . . . . . . . . . $ 0.38 $ 0.68 $ 0.71 $ 1.12
======== ======== ======== ========
DILUTED . . . . . . . . . . . . . . . . . . . $ 0.38 $ 0.49 $ 0.71 $ 0.82
======== ======== ======== ========
See accompanying notes to financial statements.
4
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
Six Months Ended June 30, 1999
-----------------------------------------------
Accumulated
Other
Common Retained Comprehensive
Stock Earnings Income Total
----------- ---------- --------------- ---------
(Amounts in thousands)
Balance at January 1, 1999. . . . $ 462,268 $299,947 $ 23,387 $785,602
Comprehensive income:
Net income. . . . . . . . . . . . . . . . . . . 61,836 61,836
Change in accumulated other
comprehensive income, net -
Note 3 . . . . . . . . . . . . . . . . . . . (49,585) (49,585)
---------
Total comprehensive income. . . . . . . . . . . 12,251
Cash dividends declared . . . . . . . . . . . . (28,034) (28,034)
Common stock repurchased and retired. (3,138) (3,138)
Other . . . . . . . . . . . . . . . . . . 194 194
----------- ---------- --------------- ---------
Balance at June 30, 1999. . . . . . . $ 459,324 $333,749 $(26,198) $766,875
=========== ========== =============== =========
See accompanying notes to financial statements.
5
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
--------------------
1999 1998
--------- ---------
(Unaudited)
(Amounts in thousands)
OPERATING ACTIVITIES:
Net income. . . . . . . . . . . . . . . . . . . $ 61,836 $ 68,041
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for depreciation and amortization. 6,474 3,685
Provision for deferred income taxes. . . . . 15,834 34,296
Realized gains on sale of investments. . . . (10,640) (10,917)
Federal income taxes . . . . . . . . . . . . 10,932 399
Reinsurance balances . . . . . . . . . . . . 2,578 5,198
Unpaid losses and loss adjustment expenses . (76,586) (54,959)
Unearned premiums. . . . . . . . . . . . . . 4,751 8,345
Claims checks payable. . . . . . . . . . . . (1,793) (5,595)
Other. . . . . . . . . . . . . . . . . . . . 4,468 1,701
--------- ---------
NET CASH PROVIDED BY
OPERATING ACTIVITIES. . . . . . . . . . $ 17,854 $ 50,194
6
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Six Months Ended
June 30,
--------------------
1999 1998
--------- ---------
(Unaudited)
(Amounts in thousands)
INVESTING ACTIVITIES:
Investments available-for-sale:
Purchases. . . . . . . . . . . . . . . . . . $(553,815) $(417,815)
Calls or maturities. . . . . . . . . . . . . 5,040 16,262
Sales. . . . . . . . . . . . . . . . . . . . 552,780 433,301
Net purchases of property and equipment. . . . (19,179) (16,132)
---------- ----------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES. . . . . . . . . . (15,174) 15,616
FINANCING ACTIVITIES:
Bank loan principal repayment. . . . . . . . . (22,500) (22,500)
Common stock repurchased and retired . . . . . (3,138) -
Dividends paid . . . . . . . . . . . . . . . . (28,034) (23,571)
---------- ----------
NET CASH USED IN
FINANCING ACTIVITIES. . . . . . . . . . (53,672) (46,071)
---------- ----------
Net increase (decrease) in cash . . . . . . . . . (50,992) 19,739
Cash and cash equivalents, beginning of year. . . 167,856 31,268
---------- ----------
Cash and cash equivalents, end of quarter . . . . $ 116,864 $ 51,007
========== ==========
See accompanying notes to financial statements.
7
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 1999
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal, recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six-month period ended June 30, 1999,
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. For further information, refer to the consolidated
financial statements and notes thereto included in the 20th Century Industries
Annual Report on Form 10-K for the year ended December 31, 1998.
Certain amounts in the 1998 financial statements have been reclassified to
conform to the 1999 presentation.
8
2. Earnings Per Common Share
The following table sets forth the computation of basic and diluted
earnings per share:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- --------------------------
1999 1998 1999 1998
----------- ---------- --------------- ---------
(Amounts in thousands, except per share data)
Numerator:
Net income. . . . . . . . . . . . . . . . . . $ 32,923 $ 40,173 $ 61,836 $ 68,041
Preferred stock dividends - (5,062) - (10,123)
----------- ---------- --------------- ---------
Numerator for basic earnings per share:
Income available to common stockholders . . . 32,923 35,111 61,836 57,918
Effect of dilutive securities:
Dividends on convertible preferred stock. . . - 5,062 - 10,123
----------- ---------- --------------- ---------
Numerator for diluted earnings per share:
Income available to common stockholders
after assumed conversions . . . . . . . . . . $ 32,923 $ 40,173 $ 61,836 $ 68,041
=========== ========== =============== =========
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding . . . . 87,545 51,590 87,589 51,572
Effect of dilutive securities:
Restricted stock grants . . . . . . . . . . . . 49 136 49 136
Employee stock options. . . . . . . . . . . . . 42 332 59 330
Warrants. . . . . . . . . . . . . . . . . . . . - 10,866 - 10,802
Convertible preferred stock . . . . . . . . . - 19,854 - 19,854
----------- ---------- --------------- ---------
Dilutive potential common shares. . . . . . . . 91 31,188 108 31,122
Denominator for diluted earnings per share:
Adjusted weighted-average shares outstanding. 87,636 82,778 87,697 82,694
=========== ========== =============== =========
Basic earnings per share. . . . . . . . . . . . $ 0.38 $ 0.68 $ 0.71 $ 1.12
=========== ========== =============== =========
Diluted earnings per share. . . . . . . . . . . $ 0.38 $ 0.49 $ 0.71 $ 0.82
=========== ========== =============== =========
9
2. Earnings per Common Share (Continued)
As a result of American International Group, Inc.'s ("AIG") conversion of
preferred stock and exercise of common stock warrants in the third quarter of
1998, the complexity of the Company's capital structure has been significantly
reduced. Accordingly, the Company has been able to use a simpler diluted
earnings per share calculation since the fourth quarter of 1998.
3. Investments
The amortized cost, gross unrealized gains and losses, and fair values of
investments as of June 30, 1999, are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ----------- ----------- ----------
(Amounts in thousands)
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies. . . $ 15,748 $ 4 $ 421 $ 15,331
Obligations of states and political
subdivisions . . . . . . . . . . 702,642 1,887 29,722 674,807
Public utilities. . . . . 21,243 - 726 20,517
Corporate securities. . . . . 298,794 1,088 14,291 285,591
---------- ----------- ----------- ----------
Total fixed maturities . . . 1,038,427 2,979 45,160 996,246
Equity securities . . . . . 250 1,877 - 2,127
---------- ----------- ----------- ----------
Total investments. . . . . . . $1,038,677 $ 4,856 $ 45,160 $ 998,373
========== =========== =========== ==========
10
3. Investments (Continued)
Details follow concerning the change during the six months ended June 30, 1999,
in the after-tax net unrealized gain on investments, which is included in
accumulated other comprehensive income in the consolidated balance sheet
(amounts in thousands):
Unrealized loss on available-for-sale investments, net of income
tax benefit of $22,976. . . . . . . . . . . . . . . . . . . . . . $(42,669)
Less: reclassification adjustment for gains included in net income,
net of income tax expense of $3,724 . . . . . . . . . . . . . . . (6,916)
---------
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(49,585)
=========
4. Federal Income Taxes
Income taxes do not bear the expected relationship to pre-tax income
because of tax-exempt investment income and other differences in the recognition
of revenue and expenses for tax and financial statement purposes. At June 30,
1999, the Company had a net operating loss carryforward of approximately $95.7
million for regular tax purposes and an alternative minimum tax credit
carryforward of $30.2 million. The net operating loss carryforwards will expire
in 2009, but is expected to be fully utilized in the year 2000. Alternative
minimum tax credits may be carried forward indefinitely to offset future regular
tax liabilities.
Federal income tax expense consists of:
Six Months Ended June 30,
------------------
1999 1998
-------- --------
(Amounts in thousands)
Current tax expense . . . . . . . . . . . $ 13,301 $ 1,980
Deferred tax expense. . . . . . . . . . . 15,834 34,296
-------- --------
$ 29,135 $ 36,276
======== ========
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
- - ----------------------------------
The Company is principally dependent on premiums and its portfolio of marketable
securities and the investment income thereon to pay claims and operating
expenses and to service outstanding debt. Loss and loss expense payments are
the most significant cash flow requirement of the Company. The Company
continually monitors loss payments to provide projections of future cash
requirements. Cash flow from operations has continued to be sufficient to fund
the Company's needs and planned future expenditures.
Funds required by 20th Century Industries to pay dividends, debt obligations and
holding company expenses are provided by the insurance subsidiaries. The ability
of the insurance subsidiaries to pay dividends to the holding company is
regulated by state law, which allows the payment of up to the lesser of prior
year statutory net income or 10% of surplus without prior approval from the
state. As of June 30, 1999, the Company's insurance subsidiaries had a combined
statutory surplus of $670.1 million and a net written premium to surplus ratio
of 1.2:1 compared to a combined statutory surplus of $586.5 million and a net
written premium to surplus ration of 1.3:1 at June 30, 1998.
Invested assets as of June 30, 1999, had a fair value of $1.1 billion compared
to $1.2 billion at December 31, 1998. The decrease includes a change in
unrealized losses of $76.3 million. All investments in fixed maturities are
investment grade. Of the Company's total investments at June 30, 1999, 30.7%
were invested in taxable fixed-income securities compared to 94.0% at June 30,
1998, and 74.9% at December 31, 1998. To the extent practicable, the Company's
investment portfolio is being transitioned from taxable to nontaxable securities
to enable the Company to minimize future tax payments in anticipation of fully
utilizing its remaining net operating loss carryforward.
12
The fixed maturity available-for-sale portfolio is subject to decline in fair
value as interest rates rise. As of June 30, 1999, the after-tax unrealized
loss on investments was $26.2 million, compared with an unrealized gain of $23.4
million as of December 31, 1998. The Company's strategy has been to minimize the
realization of these losses by holding the underlying investments, to the extent
practicable, until they regain their value. However, as previously mentioned,
the Company is currently transitioning its investment portfolio to a primarily
nontaxable basis and expects that some unrealized losses may be realized in the
future.
At July 1, 1999, the Company has a variable rate credit line available of $78.75
million, all of which is outstanding. Presently, interest is paid monthly;
interest payments for the first six months of 1999 totaled $2.8 million.
Principal repayments of $11.25 million are due on the first day of each calendar
quarter.
During the second quarter of 1999, 20th Century's Board of Directors authorized
the expenditure of $50 million to purchase shares of the Company's common stock.
Implementation of the stock repurchase program began in June and will continue
through the third quarter. As of June 30, 1999, 272,500 shares had been
repurchased at a cost of approximately $3.1 million.
In August 1996, 20th Century Insurance Company of Arizona, a joint venture owned
51% by AIG and 49% by 20th Century Industries, began writing private passenger
automobile policies in that state. As of June 30, 1999, insured vehicles
totaled 18,785, an increase of 34.4% over the total at June 30, 1998. The
Company's investment in and advances to this venture totaled $3.7 million at
June 30, 1999, and is included in other assets in the consolidated balance
sheet. The Company's equity in the net loss of this venture was $(147,000) and
$(272,000) for the three and six months ended June 30, 1999, respectively, and
$(63,000) and $(228,000) for the same 1998 periods, and is included in
investment income in the consolidated statements of income. The statistical and
other
13
information presented hereinafter do not include the activities of 20th
Century Insurance Company of Arizona.
Results of Operations
- - -----------------------
UNITS IN FORCE
Units in force for the Company's insurance programs as of June 30 were as
follows:
1999 1998
---------- ---------
Private Passenger Automobiles
(number of vehicles)
1,154,262 1,116,410
Homeowners
(number of policies)
52,492 57,561
Personal Umbrella
(number of policies). . . . 12,797 12,114
---------- ---------
Total. . . . . . . . . . . . . 1,219,551 1,186,085
========= =========
The core automobile business experienced continued growth in the first six
months of 1999 despite increased competition in the industry. During the 4th
quarter of 1998, the Company began writing private passenger automobile policies
in Nevada, Oregon and Washington, insuring more than 5,500 vehicles in these
states at June 30, 1999. These new markets collectively represent approximately
six million vehicles.
The Company's voluntary auto units in force increased by 3.7% compared to a year
ago from 1,109,536 units in force at June 30, 1998 to 1,150,740 units in force
at June 30, 1999. Voluntary auto units grew 25,196 (2.2%) in the first six
months of 1999, 14,918 (1.3%) of which occurred in the second quarter. This
compared to an increase in units of 44,793 (4.2%) for the first six months of
1998, 20,348 (1.9%) of which occurred in the second quarter. In view of
favorable trends in loss
14
costs in 1997 and 1998, the Company lowered overall
rate levels approximately 3.4% and 3.2% in 1998 and 1997, respectively, and by
an additional 6.8% in February 1999. The Company's average customer retention
rate for the second quarter of 1999 was an excellent 96.3% despite a very
competitive business climate.
The Company's position in the homeowners market has always been intended to
complement its auto business and facilitate growth in that line. Prior to its
mid-1994 suspension of homeowner sales, 20th Century insured more than 210,000
residences in California, of which more than 40 percent also had their
automobiles insured by the Company. Although the Company has continued to renew
its existing homeowners policies, units in force for the homeowners program has
been declining since 1994. Homeowner units in force declined by 8.8% from June
30, 1998, to June 30, 1999. In late April 1999, the Company and the California
Department of Insurance ("CDOI") reached a mutual agreement whereby the Company
was permitted to resume sales of new homeowners policies in California.
Resumption of sales is expected to begin in the second half of 1999. As part of
the agreement, the Company committed $6 million to create a non-profit fund to
benefit certain individuals and non-profit entities impacted by the Northridge
earthquake. The Company also committed $750,000 for general use by the
California Research and Assistance Fund and for public education and outreach
activities. The total of $6.75 million was recorded as a pre-tax charge in the
second quarter of 1999.
15
UNDERWRITING RESULTS
Premium revenue, underwriting results and combined ratios for the Company's
insurance programs were as follows:
Three Months Ended June 30, Six Months Ended June 30,
---------------------- ----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(Amounts in thousands)
Gross Premiums Written
Automobile . . . . . . . $ 209,208 $ 213,754 $ 424,541 $ 426,009
Homeowners . . . 13,392 14,383 21,417 22,969
Personal Umbrella. . . . 754 654 1,341 1,199
---------- ---------- ---------- ----------
Total. . . . . . . . . . $ 223,354 $ 228,791 $ 447,299 $ 450,177
========== ========== ========== ==========
Net Premiums Earned
Automobile . . . . . . . $ 192,033 $ 191,660 $ 386,159 $ 384,943
Homeowners . . . . . . . 7 - 7 -
Personal Umbrella. . . . 259 223 478 441
---------- ---------- ---------- ----------
Total. . . . . . . . . . $ 192,299 $ 191,883 $ 386,644 $ 385,384
========== ========== ========== ==========
Underwriting Profit (Loss)
Automobile . . . . . . . $ 38,247 $ 38,509 $ 59,115 $ 63,839
Homeowners . . . . . . . (8,226) (424) (9,281) (1,893)
Personal Umbrella. . . . 88 195 216 374
---------- ---------- ---------- ----------
Total. . . . . . . . . . $ 30,109 $ 38,280 $ 50,050 $ 62,320
========== ========== ========== ==========
Combined Ratios (GAAP)
Automobile . . . . . . 80.08% 79.90% 84.69% 83.42%
Homeowners . . . . . . . - - - -
Personal Umbrella. . . . 66.22% 12.02% 54.95% 15.02%
Total. . . . . . . 84.34% 80.05% 87.06% 83.83%
16
AUTOMOBILE
Automobile insurance is the primary line of business written by the Company and
has been consistently profitable. The majority of the Company's insured autos
are located in southern California. The Company continues to expand its
coverage throughout the state by aggressively marketing its business in northern
California and San Diego County, which accounted for approximately 51.3% of all
new business written in the first six months of 1999. During the 4th quarter of
1998, the Company also began writing automobile policies in Nevada, Oregon and
Washington, though to date the impact of this business on the financial results
of the Company has been immaterial. Approximately $1.7 million of premiums were
written in these states in the first half of 1999.
The Company's voluntary automobile program realized an underwriting profit of
$38.6 million for the three months ended June 30, 1999, compared to $38.1
million for the comparable 1998 period. Underwriting profits for the first six
months of 1999 were $59.5 million compared to $63.1 million for the same prior
year period. These results were achieved despite increased competition and the
effects of premium rate reductions previously mentioned. The 1999 decrease in
gross premiums written reflects the 3.7% increase in insured units offset by the
effect of the 6.8% premium rate reductions effective in the first quarter of the
year. The combined ratios for the second quarter and six months ended June 30,
1999, were 79.8% and 84.5%, respectively, versus 79.9% and 83.4%, respectively,
for the same periods last year. During 1999, overall average loss costs have
flattened whereas since 1997 the Company's underwriting results had benefited
from favorable loss trends. Loss provisions in the first two quarters of 1999
may not be indicative of conditions that will impact losses in the future, which
could exceed recent experience. Certain California legislation in the process
of being finalized is expected to raise average claim settlement costs starting
after the first of the year, although it is impossible at this point to estimate
the likely the impact of this development on future underwriting results.
17
Unallocated loss adjustment expenses and underwriting expenses for the first six
months of 1999 include approximately $1.6 million ($1.1 million in the second
quarter) incurred to modify computer systems to make them "Year 2000 compliant"
compared to $2.3 million for the first six months of 1998 ($1.2 million in the
second quarter). Underwriting expenses also include an increase in depreciation
expense of $2.0 million as a result of the Company's strategy to upgrade its
technology infrastructure and systems as well as an increase in advertising
expense of $5.9 million compared to the same prior year period.
Assigned Risk units produced underwriting losses of $400,000 and $414,000 for
the three and six months ending June 30, 1999, respectively, compared to
underwriting gains of $397,000 and $698,000 for the same periods in 1998. The
decreased underwriting profit reflects a 48.8% decline in the number of Assigned
Risk vehicles coupled with a 28.3% rate reduction effective February 1, 1999.
HOMEOWNERS
In December 1996, the Company was granted authority to offer renewals of
policies for approximately 68,000 homeowner insurance customers beginning
February 15, 1997. This renewal business is covered by a quota share
reinsurance agreement, which cedes 100% of all risk to three reinsurers, as
follows:
Reinsurer. . . . . . . . . . . . . . . . . . . . . . Participation
- - ---------------------------------------------------- --------------
National Union Fire Insurance Co. of Pittsburgh, PA
(A subsidiary of AIG). . . . . . . . . . . . . . . . 50%
United States Fidelity & Guaranty Company. . . . . . 25%
Risk Capital Reinsurance Company . . . . . . . . . . 25%
18
Earthquake coverage, which the Company is obliged to offer in conjunction with
its homeowner policies, is provided through American Home Assurance Company, a
subsidiary of AIG; no earthquake exposures are assumed by the Company.
Homeowners policies in force on June 30, 1996, or renewed before July 23, 1996,
(which do not include earthquake coverage) were ceded 100% in equal
participations to United States Fidelity & Guaranty Company and Risk Capital
Reinsurance Company. This coverage was effective until the underlying policies
expired or were renewed.
Because of the reinsurance agreements in place, the Company's exposure to
weather-related and disaster claims has been significantly reduced, and its
remaining exposure under these programs primarily relates to development on
policies incepted prior to July 1, 1996. The underwriting losses for this line
were $8.2 million and $9.3 million for the three and six months ending June 30,
1999, respectively, compared to underwriting losses of $0.4 million and $1.9
million for the same periods in 1998. Non-recurring charges of $6.75 million
are included in the underwriting results for the three and six months ending
June 30, 1999, as a result of the previously discussed mutual agreement between
the Company and the CDOI whereby the Company will resume sales of new homeowners
policies in California. The Company plans to reevaluate its reinsurance
arrangements prior to resuming homeowners insurance sales later in 1999.
The Company remains exposed to possible further upward development in the
estimated cost to resolve certain claims stemming from the 1994 Northridge
Earthquake. Although management believes current reserves are adequate, the
outcome of future events could require changes in previous estimates.
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PERSONAL UMBRELLA POLICY (PUP)
Units in force increased by 5.6% compared to a year ago to 12,797 units in force
at June 30, 1999 from 12,114 units in force at June 30, 1998. Gross premiums
written in the second quarter of 1999 increased by 15.3% compared to the same
quarter in 1998 and by 11.8% in the first six months of 1999 compared to the
same prior year period. The growth in this business is primarily attributable
to a cross-selling campaign, which began late in 1997. Underwriting profits for
this line can vary significantly with the number of claims, which occur
infrequently. The PUP line is subject to two quota share reinsurance agreements
resulting in a net retention by the Company of approximately 36%.
POLICY ACQUISITION COSTS AND OTHER OPERATING EXPENSES
The Company's policy acquisition and other operating expense ratio continues to
be one of the lowest in the industry. As a direct writer, the Company does not
incur agent commissions and thus enjoys an expense advantage over most of its
competitors. Net underwriting expenses, which consist of policy acquisition
costs and other operating expenses, increased by $8.0 million (39.0%) for the
second quarter of 1999 compared to the same quarter in 1998 and by $10.7 million
(28.4%) for the first six months of 1999 compared to the same prior year period.
The increase in net underwriting expenses in the second quarter resulted from
the previously discussed $6.75 million non-recurring homeowner charges as well
as an additional $3.0 million in advertising expenses incurred over the same
quarter of last year. On a year-to-date basis, advertising expenses increased
by $5.9 million over the same period last year. The ratio of net underwriting
expenses (excluding loan interest and fees, but including the non-recurring
charges and additional advertising expenses previously discussed) to net
premiums earned for the second quarter and six months ended June 30, 1999, was
14.8% and 12.5%, respectively, compared to 10.7% and 9.7% for the same periods
in 1998.
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INVESTMENT INCOME
Net pre-tax investment income decreased 11.3% and 6.8% during the quarter and
six months ended June 30, 1999, respectively, compared to the same periods in
1998. The average annual pre-tax yield on invested assets for the three and six
month periods ended June 30, 1999, was 5.5% and 5.7%, respectively, compared to
6.7% for both the same periods in 1998. The decreases in pre-tax investment
results are primarily due to the transition, described in the following
paragraph, of invested assets from taxable to non-taxable securities, which have
a lower yield. Average invested assets increased 9.1% and 9.9% for the quarter
and six months ended June 30, 1999, respectively, compared to the same 1998
periods. The increase in invested assets is primarily due to additional cash
received from the exercise of AIG's common stock warrants in the third quarter
of 1998.
Realized gains on sales of investments decreased in the first six months of 1999
to $10.6 million from $10.9 million for the same period in 1998. Realized gains
for the second quarter of 1999 decreased to $3.3 million from $7.7 million for
the same 1998 quarter. The decrease in realized gains for the second quarter is
primarily due to a decrease in the number of bond sales and a downturn in the
bond market. Year-to-date realized gains have decreased less than 4% from the
prior year. During this period, the Company began transitioning its investment
portfolio from taxable to nontaxable securities in anticipation of fully
utilizing its remaining net operating loss carryforward. At June 30, 1999,
$655.0 million of the Company's total cash and investments at fair value was
invested in tax-exempt bonds with the balance representing 41.1% of the
portfolio invested in taxable securities compared to 98.7% at June 30, 1998.
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IMPACT OF YEAR 2000
The Y2K problem arose because some computer programs and hardware were designed
to use two digits rather than four to define the applicable year. As a result,
these systems, programs and hardware ("Information Technology systems" or "IT
systems") may not properly calculate dates beyond 1999, which may cause errors
or system failures. In addition, today's business environment contains many
non-IT systems, ranging from elevators to automobiles, which utilize
microprocessors, and these devices are also potentially susceptible to the same
or similar types of date problems.
The following discussion summarizes the Company's state of readiness, costs to
address its Y2K issues, the risks inherent in these issues, and the Company's
contingency plans.
State of Readiness
The Company has taken what it believes is a comprehensive approach to
remediating its Y2K issues as summarized in the following table:
MILESTONE . . . . . . . . . . COMPLETION YEAR
- - --------- ---------------
CRITICAL MAINFRAME APPLICATIONS
High level risk assessment . . . . . . . . . . . . . . 1997
Upgrade of base information systems to be Year 2000 compliant . . . . 1998
Complete integration testing of 56 mainframe applications. . . . . . 1998
Replacement of 14 systems with packaged software warranted to be Y2K compliant 1999
OTHER IT HARDWARE (mainframe, client/server, network, telecommunications,
etc.) Assessment, installation or conversion, test, and implementation. 1999
NON-IT SYSTEMS - including IT systems maintained by third parties (e.g.,
banks, vendors, etc.) Inventory and assessment; identify 1999
22
Testing of critical computer applications was completed in November 1998.
Testing of all hardware and operating system software was successfully completed
by June 30, 1999. As of June 30, 1999, all critical business systems and
processes are either Year 2000 ready or have a contingency plan to insure that,
in the few cases where the Company is waiting for a vendor to be compliant,
there will be no interruption. Contingency planning activities were completed
by June 30, 1999. The Company's testing and progress by our vendors indicate
that it is very unlikely that these plans will need to be executed. Throughout
the remainder of 1999, the Year 2000 project team will emphasize quality control
measures to maintain the compliance of our systems and will closely monitor the
compliance efforts of the critical vendors who provide key services to our
customers.
Y2K Remediation Costs
The total Year 2000 project cost is estimated to be approximately $9.5 million,
which is being expensed as incurred. Approximately one third of that amount
represents the direct cost of personnel in the Company's Information Services
department who have been dedicated to this project, with most of the remainder
representing external consultants. Costs incurred during the first half of 1999
and 1998 were $1.6 million and $2.3 million, respectively. Total costs incurred
through June 30, 1999, were $8.8 million.
Risks
Without regard to the Company's remediation efforts, given the highly
computerized nature of the Company's operations, the Y2K problem would pose a
serious risk to the Company's ability to efficiently and effectively service its
customers, or to conduct its affairs in a profitable manner. Because of the
nature of its operations and the availability of alternate suppliers and service
providers, the potential Y2K issues for the Company in the non-IT area generally
are less than for manufacturers or distributors of non-financial products.
Apart from written assurances the Company has or expects to receive, the Company
can offer no assurances that the impact of the Y2K problem on certain services,
such as those provided by third-party electric utilities, will be insignificant
or within the Company's ability to correct in a fashion timely enough to avoid
any
23
potentially significant adverse impact. Although no remediation plan is
capable of foreseeing every possible contingency that could have a potentially
significant adverse effect, management is confident that the steps taken to
address the Company's Y2K issues will prevent or promptly detect and correct any
serious instances of noncompliance that are reasonably within the Company's
ability to control.
Contingency Plans
For all critical systems within the Company's control, revised contingency plans
that take account of the Y2K issue were in place by the end of the second
quarter of 1999. These contingency plans generally cover steps the Company
would take, such as use of back-up computer facilities, in the event of a
business interruption from a variety of causes, including the remote possibility
of an interruption caused by one or more Y2K problems. The Company's
contingency planning team is staffed by representatives from all key business
departments. Contingency planning includes the following considerations and
precautions:
- - - Defining a transition plan which describes all requirements for
information systems and business systems support as the Company enters the year
2000, including a rapid response team and the identification of resources and
responsibilities at each departmental level;
- Restrictions on vacations at the end of December 1999 and the beginning of
January 2000;
- Identifying manual procedures to be implemented until the automated
process is recovered, if necessary;
- For critical suppliers or service providers not expected to be compliant,
selecting feasible alternate suppliers;
- When alternate suppliers are infeasible, addressing any means the Company
can take to assist key suppliers in a timely manner;
- Determining key mission critical contingency plans and testing when
feasible before the Year 2000.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended June 30, 1999.
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SIGNATURES
Pursuant to the requirements of the Securities and 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
-------------------------
(Registrant)
Date August 13, 1999 /s/ William L. Mellick
------------------------------ ----------------------
WILLIAM L. MELLICK
President and Chief Executive Officer
Date August 13, 1999 /s/ Robert S. Tschudy
------------------------------ ----------------------
ROBERT B. TSCHUDY
Senior Vice President and
Chief Financial Officer
26