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EXHIBIT 13(a)
BANCINSURANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Held to maturity:
Fixed maturities, at amortized cost (fair value $4,691,903 in 2002 and
$4,869,247 in 2001)......................................................... $ 4,487,749 $ 4,746,889
Available for sale:
Fixed maturities, at fair value (amortized cost $15,557,400 in 2002 and
$14,211,422 in 2001)........................................................ 15,912,650 14,273,152
Equity securities, at fair value (cost $6,051,043 in 2002 and $5,981,774 in
2001)....................................................................... 7,203,650 6,715,572
Short-term investments, at cost which approximates fair value................. 25,135,305 5,476,140
---------------- ------------------
TOTAL INVESTMENTS......................................................... 52,739,354 31,211,753
---------------- ------------------
Cash .......................................................................... 4,306,007 19,547,132
Premiums receivable............................................................. 5,910,719 5,189,123
Accounts receivable, net of allowance for doubtful accounts..................... 844,059 590,401
Reinsurance receivable.......................................................... 283,417 90,018
Reinsurance recoverable on paid losses.......................................... - 32,027
Prepaid reinsurance premiums.................................................... 1,228,632 901,482
Deferred policy acquisition costs............................................... 2,653,826 1,522,533
Estimated earnings in excess of billings on uncompleted codification contracts.. 224,837 151,507
Loans to affiliates............................................................. 685,856 699,208
Prepaid federal income taxes.................................................... 295,235 -
Excess of investment over net assets of subsidiaries, net....................... 753,737 2,534,596
Intangible asset, net........................................................... 994,566 864,912
Accrued investment income....................................................... 328,751 338,300
Other assets ................................................................... 1,206,208 997,685
---------------- ------------------
TOTAL ASSETS.............................................................. $ 72,455,204 $ 64,670,677
================ ==================
See accompanying notes to consolidated financial statements.
13(a) - 1
BANCINSURANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Reserve for unpaid losses and loss adjustment expenses.......................... $ 7,559,503 $ 4,872,598
Unearned premiums............................................................... 10,304,769 6,030,273
Experience rating adjustments payable........................................... 4,764,329 6,472,413
Retrospective premium adjustments payable....................................... 3,951,898 3,716,869
Funds held under reinsurance treaties........................................... 1,513,297 1,001,520
Contract funds on deposit....................................................... 1,317,663 1,937,924
Notes payable................................................................... 2,166,355 5,696,839
Taxes, licenses, and fees payable............................................... 297,418 552,873
Federal income taxes payable.................................................... - 374,861
Deferred federal income taxes................................................... 82,027 109,001
Commissions payable............................................................. 1,990,436 1,350,924
Billings in excess of estimated earnings on uncompleted codification contracts.. 93,894 107,452
Other .......................................................................... 1,511,777 1,055,221
---------------- ----------------
TOTAL LIABILITIES......................................................... 35,553,366 33,278,768
---------------- ----------------
Minority interest in consolidated subsidiary:
Redeemable preferred securities of subsidiary trust........................... 8,000,000 -
---------------- ----------------
Shareholders' equity:
Non-voting preferred shares:
Class A Serial Preference shares without par value; authorized 100,000 shares;
no shares issued or outstanding............................................. - -
Class B Serial Preference shares without par value; authorized 98,646 shares;
no shares issued or outstanding ............................................. - -
Common shares without par value; authorized 20,000,000 shares; 6,170,341 shares
issued at December 31, 2002 and 2001, 5,000,291 shares outstanding at December
31, 2002 and 5,770,185 shares outstanding at December 31, 2001............... 1,794,141 1,794,141
Additional paid-in capital...................................................... 1,337,138 1,337,242
Accumulated other comprehensive income.......................................... 995,186 525,048
Retained earnings............................................................... 30,429,515 29,539,902
---------------- ----------------
34,555,980 33,196,333
Less: Treasury shares, at cost (1,170,050 in 2002 and 400,156 in 2001 common
shares)...................................................................... (5,654,142) (1,804,424)
---------------- ----------------
TOTAL SHAREHOLDERS' EQUITY................................................ 28,901,838 31,391,909
---------------- ----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY................................ $ 72,455,204 $ 64,670,677
================ =================
See accompanying notes to consolidated financial statements.
13(a) - 2
BANCINSURANCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME:
Premiums earned .................................................................. $ 41,390,132 $ 38,563,176 $ 25,058,892
Premiums ceded................................................................. (507,895) (254,438) (217,077)
------------- ------------ ------------
Net premiums earned............................................................... 40,882,237 38,308,738 24,841,815
Investment income................................................................. 1,301,511 1,496,621 1,628,306
Net realized gain (loss) on investments........................................... (1,220,477) 22,542 (320,742)
Codification and subscription fees................................................ 3,324,037 2,652,231 1,884,067
Management fees................................................................... 749,442 846,446 659,929
Commission fees................................................................... 8,463 67,065 155,942
Other income...................................................................... 188,815 94,479 1,531,679
------------- ------------ ------------
Total revenue................................................................. 45,234,028 43,488,122 30,380,996
------------- ------------ ------------
LOSSES AND OPERATING EXPENSES:
Losses and loss adjustment expenses............................................... 28,546,254 21,823,538 15,230,041
Reinsurance recoveries............................................................ (231,998) (164,794) (161,411)
Experience rating adjustments..................................................... (1,708,084) 5,155,850 (233,026)
Commission expense................................................................ 7,230,636 5,918,461 3,639,642
Other insurance operating expenses................................................ 3,868,830 3,126,234 2,936,666
Codification and subscription expenses............................................ 2,889,981 2,276,360 1,607,258
General and administrative expenses............................................... 1,195,085 1,057,840 1,482,909
Interest expense ................................................................. 97,575 28,076 257,984
------------- ------------ ------------
Total expenses................................................................ 41,888,279 39,221,565 24,760,063
------------- ------------ ------------
Income before federal income taxes, provision for trust preferred
securities dividends and cumulative effect of change in accounting principle 3,345,749 4,266,557 5,620,933
Federal income tax expense.......................................................... 940,530 1,191,367 1,702,576
------------- ------------ ------------
Income before provision for trust preferred securities dividends and
cumulative effect of change in accounting principle......................... 2,405,219 3,075,190 3,918,357
Preferred dividends on minority interest in consolidated subsidiary - redeemable
preferred securities of subsidiary trust.......................................... (33,748) - -
------------- ------------ ------------
Income before cumulative effect of change in accounting principle............. 2,371,471 3,075,190 3,918,357
Cumulative effect of change in accounting principle................................. (1,481,858) - -
------------- ------------ ------------
Net income.................................................................... $ 889,613 $ 3,075,190 $ 3,918,357
============= ============ ============
Basic net income per share:
Before cumulative effect of change in accounting principle..................... $ .42 $ .53 $ .66
Cumulative effect of change in accounting principle............................ (.26) - -
------------- ------------ ------------
Basic net income per share..................................................... $ .16 $ .53 $ .66
============= ============ ============
Dilutive net income per share:
Before cumulative effect of change in accounting principle..................... $ .41 $ .53 $ .66
Cumulative effect of change in accounting principle............................ (.25) - -
------------- ------------ ------------
Diluted net income per share................................................... $ .16 $ .53 $ .66
============= ============ ============
See accompanying notes to consolidated financial statements.
13(a) - 3
BANCINSURANCE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Net income...................................................................... $ 889,613 $ 3,075,190 $ 3,918,357
Other comprehensive income:
Unrealized holding gains (loss) on securities arising during period,
net of income tax (benefit) expense of $236,478, $(115,164) and $314,841,
respectively.............................................................. 470,138 (223,554) 611,162
------------- ------------ -------------
Comprehensive income............................................................ $ 1,359,751 $ 2,851,636 $ 4,529,519
============= ============ =============
See accompanying notes to consolidated financial statements.
13(a) - 4
BANCINSURANCE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
ACCUMULATED
PREFERRED SHARES ADDITIONAL OTHER
---------------- COMMON PAID-IN COMPREHENSIVE RETAINED
CLASS A CLASS B SHARES CAPITAL INCOME EARNINGS
- ------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 1999............... $ 1,794,141 $ 1,442,773 $ 137,440 $ 22,546,355
Net income........................... 3,918,357
Change in unrealized gain
on investments, net of
income taxes of
$314,841............................ 611,162
Issue of 73,504 treasury
shares in purchase acquisition ..... (37,196) 337,195
Purchase of 349,318 treasury
shares..............................
22,000 shares issued in
connection with the
exercise of stock
options............................. (68,772)
------- -------- ------------ ------------ ------------- -------------
Balance December 31, 2000............... 1,794,141 1,336,805 748,602 26,464,712
Net income........................... 3,075,190
Change in unrealized gain
on investments, net of
income taxes benefit of
$115,164............................ (223,554)
Purchase of 1,050 treasury
shares..............................
Capital contributed in asset
purchase............................ 437
------- -------- ------------ ------------ ------------- -------------
Balance December 31, 2001............... 1,794,141 1,337,242 525,048 29,539,902
NET INCOME........................... 889,613
CHANGE IN UNREALIZED GAIN
ON INVESTMENTS, NET OF
INCOME TAXES EXPENSE OF
$236,478............................ 470,138
PURCHASE OF 770,494 TREASURY
SHARES..............................
600 SHARES ISSUED IN
CONNECTION WITH THE
EXERCISE OF STOCK
OPTIONS............................. (104)
------- -------- ------------ ------------ ------------- -------------
BALANCE DECEMBER 31, 2002............... $ 1,794,141 $ 1,337,138 $ 995,186 $ 30,429,515
======= ======== ============ ============ ============= =============
- -----------------------------------------------------------------------
TOTAL
TREASURY SHAREHOLDERS
SHARES EQUITY
- -----------------------------------------------------------------------
Balance December 31, 1999............... $ (727,420) $ 25,193,289
Net income........................... 3,918,357
Change in unrealized gain
on investments, net of
income taxes of
$314,841............................ 611,162
Issue of 73,504 treasury
shares in purchase acquisition ..... 299,999
Purchase of 349,318 treasury
shares.............................. (1,525,012) (1,525,012)
22,000 shares issued in
connection with the
exercise of stock
options............................. 106,336 37,564
----------- -------------
Balance December 31, 2000............... (1,808,901) 28,535,359
Net income........................... 3,075,190
Change in unrealized gain
on investments, net of
income taxes benefit of
$115,164............................ (223,554)
Purchase of 1,050 treasury
shares.............................. (4,542) (4,542)
Capital contributed in asset
purchase............................ 9,019 9,456
----------- -------------
Balance December 31, 2001............... (1,804,424) 31,391,909
NET INCOME........................... 889,613
CHANGE IN UNREALIZED GAIN
ON INVESTMENTS, NET OF
INCOME TAXES EXPENSE OF
$236,478............................ 470,138
PURCHASE OF 770,494 TREASURY
SHARES.............................. (3,852,611) (3,852,611)
600 SHARES ISSUED IN
CONNECTION WITH THE
EXERCISE OF STOCK
OPTIONS............................. 2,893 2,789
----------- -------------
BALANCE DECEMBER 31, 2002............... $(5,654,142) $ 28,901,838
=========== =============
See accompanying notes to consolidated financial statements.
13(a) - 5
BANCINSURANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income......................................................................... $ 889,613 $ 3,075,190 $ 3,918,357
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized (gain) loss on investments.......................................... 1,220,477 (22,542) 320,742
Net realized loss on goodwill impairment......................................... 1,660,858 - -
Net realized (gain) loss on disposal of property and equipment................... 1,073 (14,800) 1,497
Net realized gain on disposal of subsidiaries.................................... - - (59,936)
Net realized loss on debt forgiveness............................................ - - 30,000
Depreciation and amortization.................................................... 311,459 306,061 327,524
Deferred federal income tax (benefit) expense.................................... (269,166) (86,180) 319,316
Change in operating assets and liabilities:
Premiums receivable........................................................... (721,596) (2,597,506) (378,339)
Accounts and reinsurance receivable, net...................................... (742,180) (1,002,684) 709,732
Deferred policy acquisition costs............................................. (1,131,293) (879,746) (423,594)
Other assets.................................................................. (508,042) (147,402) (121,202)
Reserve for unpaid losses and loss adjustment expenses........................ 2,686,905 1,913,983 (764,397)
Unearned premiums............................................................. 4,274,496 3,289,855 309,642
Experience rating adjustments payable......................................... (1,708,084) 5,155,850 (233,026)
Retrospective premium adjustments payable..................................... 235,029 2,861,302 772,043
Funds held under reinsurance treaties......................................... 511,777 1,001,520 -
Contract funds on deposit..................................................... (620,261) (135,605) (198,648)
Other liabilities............................................................. 356,316 1,525,649 (218,409)
----------- ------------ ------------
Net cash provided by operating activities...................................... 6,447,381 14,242,945 4,311,302
----------- ------------ ------------
Cash flows from investing activities:
Proceeds from held to maturity: fixed maturities due to redemption or maturity.... 1,250,400 1,341,000 1,020,000
Proceeds from available for sale: fixed maturities sold, redeemed and matured..... 5,933,115 7,383,150 6,342,760
Proceeds from available for sale: equity securities sold.......................... 19,056,907 13,175,789 10,288,020
Cost of investments purchased:
Held to maturity: fixed maturities............................................... (1,102,131) (299,955) (884,859)
Available for sale: fixed maturities............................................. (7,530,214) (8,064,552) (5,099,713)
Equity securities................................................................ (20,098,251) (15,288,282) (9,903,848)
Net change in short-term investments and securities purchased under
agreements to resell............................................................. (19,659,165) 543,300 627,764
Purchase of furniture, equipment and leasehold improvements....................... (164,345) (108,822) (86,253)
Cash used in purchase of subsidiary............................................... - - (958,094)
Cash used in acquisition of assets................................................ (25,000) (403,503) -
Other............................................................................. - 11,826 (7,165)
----------- ------------ ------------
Net cash provided by (used in) investing activities........................... (22,338,684) (1,710,049) 1,338,612
----------- ------------ ------------
Cash flows from financing activities:
Proceeds from note payable to bank................................................ 20,040,000 20,350,000 17,157,000
Repayments of note payable to bank................................................ (23,540,000) (19,892,000) (17,160,000)
Proceeds from stock options exercised............................................. 2,789 - 37,564
Acquisition of treasury stock..................................................... (3,852,611) (4,542) (1,525,012)
Issuance of redeemable preferred securities of subsidiary trust................... 8,000,000 - -
----------- ------------ ------------
Net cash provided by (used in) financing activities........................... 650,178 453,458 (1,490,448)
----------- ------------ ------------
Net increase (decrease) in cash.................................................... (15,241,125) 12,986,354 4,159,466
Cash at beginning of year.......................................................... 19,547,132 6,560,778 2,401,312
----------- ------------ ------------
Cash at end of year................................................................ $ 4,306,007 $ 19,547,132 $ 6,560,778
=========== ============ ============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest ......................................................................... $ 100,098 $ 13,398 $ 230,200
=========== ============ ============
Income taxes...................................................................... $ 1,988,102 $ 950,000 $ 1,445,000
=========== ============ ============
Supplemental schedule of noncash investing activities:
Common shares issued in purchase acquisition...................................... $ - $ 9,456 $ 300,000
=========== ============ ============
See accompanying notes to consolidated financial statements.
13(a) - 6
BANCINSURANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) ORGANIZATION
Bancinsurance Corporation (the "Company" or "Bancinsurance") is a
specialty property insurance holding company incorporated in the State
of Ohio in 1970. Our principal sources of revenue are premiums paid by
insureds for insurance policies issued by our wholly-owned subsidiary,
Ohio Indemnity Company ("Ohio Indemnity"). Ohio Indemnity is licensed
in 47 states and the District of Columbia and for surplus lines in
Texas. As such, Ohio Indemnity is subject to the regulations of the
Department of Insurance of the State of Ohio (the "Department") and the
regulations of each state in which it operates. The majority of Ohio
Indemnity's premiums are derived from two distinct lines of business:
(1) products designed for automobile lenders/dealers and (2)
unemployment insurance protection products. Our automobile
lender/dealer group offers two types of products. First, ultimate loss
insurance, a blanket vendor single interest coverage, is the primary
product we offer to financial institutions nationwide. This lender
product insures banks and financial institutions against damage to
pledged collateral in cases where the collateral is not otherwise
insured. An ultimate loss insurance policy is generally written to
cover a lender's complete portfolio of collateralized personal property
loans, typically automobiles. During 2002, we began issuing creditor
placed insurance policies, which are an alternative to our traditional
blanket vendor single interest product. While both products cover the
risk of damage to uninsured collateral in a lender's automobile loan
portfolio, creditor placed insurance covers a lender's portfolio
through tracking individual borrower insurance. Second, our guaranteed
auto protection insurance ("GAP") pays the difference or gap between
the amount owed by the customer on a lease or loan contract and the
amount of primary insurance company coverage in the event a vehicle is
damaged beyond repair or stolen and never recovered. The GAP product is
sold to automobile dealers, lenders and lessors who then sell coverage
directly to the borrower at the time of purchasing or leasing an
automobile. Our unemployment insurance protection products are utilized
by not-for-profit entities which elect not to pay the unemployment
compensation tax and instead reimburse the state unemployment agencies
for benefits paid by the agency to former employees. Certain national
cost containment firms provide programs to assure that reimbursing
employers discharge their unemployment compensation commitments. Ohio
Indemnity bonds these firms for their program responsibilities. Ohio
Indemnity also provides this coverage to groups of not-for-profits
under trust arrangements. In addition, state mandated surety bonds,
which are required by certain state Departments of Labor are
underwritten. Ohio Indemnity also assumes bail bond coverage. No single
customer of our Company accounts for a predominant share of
consolidated revenue, except for two lender insurance product
customers.
Our wholly-owned subsidiary, American Legal Publishing Corporation
("ALPC"), publishes and distributes ordinances for over 1,500
municipalities and counties nationwide in addition to state
governments. Ordinance codification is the process of collecting,
organizing and publishing legislation for state and local governments.
In July 2002, we formed Ultimate Services Agency, LLC, an Ohio limited
liability company ("USA"). USA will act as an agency for placing
property and casualty insurance policies offered and written by Ohio
Indemnity and by other property and casualty insurance companies. Our
wholly-owned subsidiary, Paul Boardway and Associates, Inc., a
property/casualty insurance agency, was dissolved in the fourth quarter
of 2002.
In December 2002, we organized BIC Statutory Trust I, a Connecticut
special purpose business trust ("BIC Trust"), which issued $8,000,000
of floating rate trust preferred securities in a private placement
offering. BIC Trust was formed for the sole purpose of issuing and
selling the floating rate trust preferred securities and investing the
proceeds from such securities in subordinated notes of the Company,
which notes have the same terms and conditions as the floating rate
trust preferred securities.
(b) BASIS OF FINANCIAL STATEMENT PRESENTATION
Our accompanying consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the
United States ("GAAP") which vary in certain respects from reporting
practices prescribed or permitted by the State of Ohio. Effective
January 1, 2001, the State of Ohio required that insurance companies
domiciled in the State of Ohio prepare their statutory basis financial
statements in accordance with the National Association of Insurance
Commissioners ("NAIC") Accounting Practices and Procedures Manual. The
effects of these differences on shareholders equity and net income are
shown in Note 13.
The preparation of financial statements in conformity with GAAP
requires us to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from these estimates.
(c) CONSOLIDATION POLICY
Our accompanying financial statements include the Company's accounts
and our wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
(d) INVESTMENTS
Investments in held to maturity fixed maturities, which include fixed
maturity securities and preferred stocks with mandatory redemption
features, where we have the ability and intent to hold to maturity or
put date, are carried at amortized cost. Investments in fixed
maturities held as available for sale are carried at fair value. The
unrealized holding gain or loss, net of applicable deferred taxes, is
reflected in other comprehensive income.
13(a) - 7
Available for sale equity securities, which include common stocks and
preferred stocks without mandatory redemption features, are reported at
fair value with unrealized gains or losses, net of applicable deferred
taxes, reflected in other comprehensive income. Short-term investments
are reported at cost which approximates fair value.
Realized gains and losses on disposal of investments are determined by
the specific identification method and are included in net investment
income. The carrying value of investments is revised and the amount of
revision is charged to net realized losses on investments when
management determines that a decline in the value of an investment is
other than temporary.
(e) ACCOUNTS RECEIVABLE
Accounts receivable at December 31, 2002 are comprised of ALPC's
municipal code contract billings. We estimate our allowance for
doubtful accounts and bad debts based upon our assessment of the
collectibility of receivables and prior experience.
(f) EXCESS OF INVESTMENT OVER NET ASSETS OF SUBSIDIARY
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142").
Under SFAS 142, we no longer amortize goodwill and intangibles which
have indefinite lives. SFAS 142 requires that we assess goodwill and
intangibles with indefinite lives for impairment at least annually,
based on the fair value of the related reporting unit. Our annual
impairment assessment will be performed in the fourth quarter on an
on-going basis.
As an initial step in the SFAS 142 implementation process, we assigned
goodwill and intangibles to our property casualty insurance, insurance
agency and municipal code publishing reporting units. Following such
assignment, the fair value of each reporting unit was compared to its
carrying value. Fair values were determined by discounting estimated
future cash flows.
Based on our impairment testing, a net after-tax impairment charge of
$1,481,858 was recognized as a cumulative effect of change in
accounting principle in the first quarter of 2002. The impairment
charge was associated with the August 1999 acquisition of Paul Boardway
and Associates, Inc.
We dissolved Paul Boardway and Associates, Inc. in the fourth quarter
of 2002. As a result, the remaining goodwill of $179,000 was recorded
as a pre-tax impairment charge to income.
(g) INTANGIBLE ASSET
On July 19, 1999, we entered into an Agreement and Plan of Merger with
Westford Group, Inc., an Ohio corporation ("Westford"), whereby
Westford would be merged with and into Bancinsurance. On February 29,
2000, the shareholders of Westford approved the merger. Immediately
following the merger, Westford's wholly-owned subsidiary, ALPC, became
a wholly-owned subsidiary of Bancinsurance. The merger was accounted
for as a purchase. The excess of the fair value of net assets acquired
over the purchase price of approximately $440,782 was allocated to a
database acquired. The database is comprised of municipal code data and
related files. Provision for amortization of the database is based on
an estimated useful life of 20 years reflecting the long-lived nature
of the municipal codes and is computed on the straight-line method.
On June 20, 2001, ALPC, purchased substantially all the net assets of
Justinian Publishing Company, an Ohio Corporation ("Justinian"), for
(1) $403,503 in cash; (2) 2,000 Bancinsurance common shares; and (3) a
$100,000 non-interest bearing promissory note due on the first
anniversary of the closing date. We paid the acquisition consideration
from existing cash reserves. The acquisition was accounted for using
the purchase method. The excess of the fair value of the net assets
acquired over the purchase price of approximately $478,491 was
allocated to a database acquired. The database is comprised of
municipal code data and related files. Provision for amortization of
the database is based on an estimated useful life of 20 years (and is
computed on a straight-line method).
On July 19, 2002, ALPC purchased substantially all the net assets of
Burlington Publishing Systems, a Kentucky corporation, for $100,000
which was made up of $25,000 in cash and a $75,000 non-interest bearing
promissory note payable in five installments of $15,000 on the first,
second, third, fourth and fifth anniversaries of the closing date. The
excess of the fair value of the net assets acquired over the purchase
price of $89,894 was allocated to a database. The database is comprised
of municipal code data and related files. Provision for amortization of
the database is based on an estimated useful life of 20 years and is
computed on the straight-line method.
As a result of assigning goodwill and intangibles to our reporting
units, in connection with our SFAS 142 impairment assessment, we
identified a noncompete agreement in the amount of $120,001 that was
separately classified as an intangible with a definite life of five
years.
(h) RECOGNITION OF REVENUE AND RELATED EXPENSES
Ohio Indemnity's insurance premiums are earned over the terms of the
related insurance policies and reinsurance contracts. For our
lender/dealer insurance products, premiums are earned in proportion to
the risk assumed. For our unemployment insurance protection products,
premiums are earned pro rata over the policy term. The portion of
premiums written applicable to the unexpired portion of insurance
contracts is recorded in the balance sheet as unearned premiums.
Revenue from ALPC municipal code contracts is recognized on the
percentage-of-completion method. Completion is measured based on the
percentage of direct labor costs incurred to date to estimated direct
labor costs for each contract. While we use available information to
estimate total direct labor costs on each contract, actual experience
may vary from estimated amounts. Revenue from code supplements is
recognized on the completed-contract method because the typical
supplement is completed in a few months.
13(a) - 8
Commission fee revenues for USA (and Paul Boardway and Associates prior
to its dissolution) are recognized when earned based on contractual
rates and services provided.
(i) POLICY ACQUISITION COSTS
Acquisition expenses, mainly commissions and premium taxes, related to
unearned premiums are deferred and amortized over the period the
coverage is provided. Anticipated losses and other expenses related to
those premiums are considered in determining the recoverability of
deferred acquisition costs.
(j) RESERVE FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Loss and loss adjustment expense reserves represent our best estimate
of the estimated ultimate net cost of all reported and unreported
losses incurred through December 31. We do not discount loss and loss
adjustment expense reserves. The reserves for unpaid losses and loss
adjustment expenses are estimated using individual case-basis
valuations and statistical analyses. Those estimates are subject to the
effects of trends in loss severity and frequency. Although considerable
variability is inherent in such estimates, we believe the reserves for
losses and loss adjustment expenses are adequate. The estimates are
regularly reviewed and adjusted as necessary as experience develops or
new information becomes known; such adjustments are included in current
operations.
(k) REINSURANCE
In the ordinary course of business, we cede and assume reinsurance with
other insurers and reinsurers. Ceded reinsurance transactions are
attributable to a lender insurance policy. The assumed business
represents a quota share participation in the gross liability of an
insurer covering bail bond business.
(l) EXPERIENCE RATING AND RETROSPECTIVE PREMIUM ADJUSTMENTS
Certain policies are eligible for premium adjustments based upon a
comparison of actual losses to expected losses. For certain policies,
return premiums are calculated and settled on an annual basis. These
balances are presented in the accompanying balance sheets as
retrospective premium adjustments payable. Certain other policies are
eligible for an experience rating adjustment that is calculated and
adjusted from period to period and settled upon cancellation of the
policy. These balances are presented in the accompanying balance sheets
as experience rating adjustments payable.
(m) CONTRACT FUNDS ON DEPOSIT
We have an agreement with a cost containment service firm involving a
program designed to control the unemployment compensation costs of
certain non-profit employers. Pursuant to this agreement, a surety bond
has been issued insuring the payment of certain reimbursable
unemployment compensation benefits on behalf of the employers enrolled
in this program. Certain monies allocated toward the payment of these
benefits are held by us. Together with the cost containment service
firm, we share any residual resulting from the development of benefits
to be paid from the contract funds held on deposit. We record
management fees in the period the residual is shared with the cost
containment service firm. Fees of $749,442, $846,446 and $659,929 were
recognized in 2002, 2001 and 2000, respectively, as a result of this
arrangement.
(n) DEPRECIATION AND AMORTIZATION
Furniture and fixtures are stated at cost and depreciated using the
straight-line method over a three year useful life. Leasehold
improvements are capitalized and amortized over the remaining office
lease term. Maintenance, repairs and minor renewals are charged
directly to expense as incurred.
(o) FEDERAL INCOME TAXES
We file a consolidated federal income tax return with our subsidiaries.
Accordingly, deferred tax liabilities and assets have been recognized
for the expected future tax consequences of events that have been
included in the financial statements or tax returns.
Deferred income taxes are recognized at prevailing income tax rates for
temporary differences between financial statement and income tax bases
of assets and liabilities for which income tax benefits will be
realized in future years.
(p) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is
practicable to estimate that fair value:
Short-term investments and securities purchased under agreements to
resell:
For these short-term investments, the carrying amounts are reasonable
estimates of fair value.
Fixed maturities and equity securities:
Fair values are based upon quoted market prices or dealer quotes for
comparable securities.
Accounts and notes receivable:
The carrying amounts are reasonable estimates of fair value.
Note payable to bank:
Rates currently available to us for debt with similar terms and
remaining maturities are used to estimate fair value of existing debt.
Based on this analysis, the carrying amount is a reasonable estimate of
fair value.
Redeemable preferred securities:
Fair value is estimated using discounted cash flow calculations based
on interest rates currently being offered for similar obligations with
maturities consistent for the obligation being valued.
13(a) - 9
(q) CASH AND CASH EQUIVALENTS
We classify investments as cash equivalents if their original maturity
is three months or less. Cash equivalents are stated at cost, which
approximates fair value.
(m) RECLASSIFICATIONS
Certain prior year amounts have been reclassified in order to conform
to the 2002 presentation.
(2) INVESTMENTS
The amortized cost and estimated fair values of investments in held to
maturity and available for sale securities were as follows:
DECEMBER 31, 2002
-------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------------------------------------------------------------------
HELD TO MATURITY:
FIXED MATURITIES:
US TREASURY SECURITIES AND
OBLIGATIONS OF US GOVERNMENT
CORPORATIONS AND AGENCIES............. $ 1,535,197 $ 32,428 $ - $ 1,567,625
OBLIGATIONS OF STATES AND
POLITICAL SUBDIVISIONS................ 2,952,552 171,726 - 3,124,278
------------- ------------- ------------ -------------
4,487,749 204,154 - 4,691,903
------------- ------------- ------------ -------------
AVAILABLE FOR SALE:
FIXED MATURITIES:
OBLIGATIONS OF STATES AND
POLITICAL SUBDIVISIONS................ 15,529,900 385,668 37,918 15,877,650
CORPORATE SECURITIES................... 27,500 7,500 - 35,000
EQUITY SECURITIES........................ 6,051,043 1,367,886 215,279 7,203,650
------------- ------------- ------------ -------------
21,608,443 1,761,054 253,197 23,116,300
------------- ------------- ------------ -------------
TOTALS............................ $ 26,096,192 $ 1,965,208 $ 253,197 $ 27,808,203
============= ============= ============ =============
December 31, 2001
-------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------------------------
Held to maturity:
Fixed maturities:
US Treasury securities and
obligations of US government
corporations and agencies............. $ 2,235,092 $ 80,093 $ - $ 2,315,185
Obligations of states and
political subdivisions................ 2,415,797 44,541 2,276 2,458,062
Redeemable preferred stock............. 96,000 - - 96,000
------------- ------------- ------------ -------------
4,746,889 124,634 2,276 4,869,247
------------- ------------- ------------ -------------
Available for sale:
Fixed maturities:
Obligations of states and
political subdivisions................ 13,951,094 179,793 108,860 14,022,027
Corporate securities................... 260,328 43,125 52,328 251,125
Equity securities........................ 5,981,774 1,364,753 630,955 6,715,572
------------- ------------- ------------ -------------
20,193,196 1,587,671 792,143 20,988,724
------------- ------------- ------------ -------------
Totals............................ $ 24,940,085 $ 1,712,305 $ 794,419 $ 25,857,971
============= ============= ============ =============
The amortized cost and estimated fair value of investments in held to maturity
and available for sale securities at December 31, 2002, by contractual maturity,
are shown below. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
-------------------------------------------------------------------
HELD TO MATURITY AVAILABLE FOR SALE
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
-------------------------------------------------------------------
Due in one year or less....................... $ 1,399,283 $ 1,419,969 $ 320,420 $ 321,317
Due after one year but less than five years... 794,880 824,155 3,793,480 3,988,548
Due after five years but less than ten years.. 1,809,357 1,938,223 3,852,892 3,935,336
Due after ten years........................... 484,229 509,556 7,590,609 7,667,449
------------- ------------- ------------ -------------
$ 4,487,749 $ 4,691,903 $ 15,557,401 $ 15,912,650
============= ============= ============ =============
13(a) - 10
Investment income, net of expenses, is summarized below:
------------------------------------------------
2002 2001 2000
------------------------------------------------
Held to maturity:
Fixed maturities...................................... $ 119,609 $ 295,469 $ 357,902
Available for sale:
Fixed maturities...................................... 884,811 835,867 733,583
Equity securities..................................... 230,101 196,707 184,805
Short-term investments..................................... 118,141 173,834 315,755
Other...................................................... 9,221 44,176 63,006
Expenses................................................... (60,372) (49,432) (26,745)
------------- ------------ -------------
Investment income..................................... $ 1,301,511 $ 1,496,621 $ 1,628,306
============= ============ =============
Fixed maturity investments were predominately income producing for the
years ended December 31, 2002, 2001 and 2000.
See Note 1(p) for a description of the methods and significant assumptions
used to estimate the fair value of financial instruments.
The proceeds from sales of available-for-sale securities were $24,990,022,
$20,558,939 and $16,630,780 for the years ended December 31, 2002, 2001 and
2000, respectively.
Pre-tax net realized gains (losses) on investments were as follows for each
of the years ended December 31:
------------------------------------------------
2002 2001 2000
------------------------------------------------
Gross realized gains:
Available for sale: fixed maturities....................... $ 35,508 $ 53,314 $ 34,111
equity securities...................... 320,661 665,761 339,940
------------- ------------ -------------
Total gains.............................................. 356,169 719,075 374,051
============= ============ =============
Gross realized losses:
Held to maturity: fixed maturities....................... - 400 -
Available for sale: fixed maturities....................... 187,908 46,992 56,833
equity securities...................... 1,388,738 649,141 637,960
------------- ------------ -------------
Total losses............................................. 1,576,646 696,533 694,793
============= ============ =============
Net realized gains (losses).............................. $ (1,220,477) $ 22,542 $ (320,742)
============= ============ =============
At December 31, 2002, investments having a par value of $4,157,000 were on
deposit with various state insurance departments to meet their respective
regulatory requirements.
(3) DEFERRED POLICY ACQUISITION COSTS
Changes in deferred policy acquisition costs at December 31 are summarized
as follows:
------------------------------
2002 2001
------------------------------
Deferred, January 1.............................. $ 1,522,533 $ 642,787
Additions:
Commissions................................... 1,904,229 1,682,847
Premium tax................................... 135,711 122,837
------------- -------------
2,039,940 1,805,684
Amortization to expense ......................... 908,647 925,938
------------- -------------
Deferred, December 31............................ $ 2,653,826 $ 1,522,533
============= =============
(4) UNCOMPLETED CONTRACTS
Revenues earned on uncompleted codification contracts by ALPC were
$1,492,583 and $1,035,321 and billings to date on those contracts were
$1,361,640 and $991,266, at December 31, 2002 and 2001, respectively. The
excess of costs and estimated earnings over billings to date are presented
in the accompanying balance sheets.
(5) GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying amount of goodwill by reporting unit for the
year ended December 31, 2002 are as follows:
13(a) - 11
Property/Casualty Insurance Municipal
Insurance Agency Code Publishing Total
----------------- ------------- ---------------- ------------
Balance,
Dec. 31, 2001 $ 753,737 $ 1,780,859 $ - $ 2,534,596
Impairment
write-offs - (1,660,858) - (1,660,858)
Noncompete
agreement recognition - (120,001) - (120,001)
------------ ------------- ---------------- ------------
Balance,
December 31, 2002 $ 753,737 $ - $ - $ 753,737
============ ============= ================ ============
Intangible assets as of December 31 were as follows:
AS OF DECEMBER 31, 2002 As of December 31, 2001
---------------------------------------- --------------------------------------
ACCUMULATED Accumulated
COST AMORTIZATION NET Cost Amortization Net
----------- ------------- ----------- ----------- ------------- ----------
Amortization Intangibles:
Databases $ 1,008,773 $ (102,562) $ 906,211 $ 919,273 $ (54,36 $ 864,912
Noncompete agreement 120,394 (32,039) 88,355 - - -
----------- ----------- ----------- ----------- ----------- ----------
Total intangible assets $ 1,129,167 $ (134,601) $ 994,566 $ 919,273 $ (54,361) $ 864,912
=========== =========== =========== =========== ========== ==========
Amortization expense related to amortizable intangible assets was $80,240,
$35,995 and $18,366 during 2002, 2001 and 2000, respectively. The estimated
amortization expense of intangible assets for the next five fiscal years
ending December 31 is as follows:
2003 $ 74,518
2004 74,518
2005 74,518
2006 66,518
2007 50,477
A reconciliation of the previously reported 2001 and 2000 statements of
income information to pro forma amounts that reflect the elimination of
amortization of goodwill is presented below:
2001 2000
--------------------------------- -------------------------------
Per Share Per Share
----------------- ---------------
Amount Basic Diluted Amount Basic Diluted
------ ----- -------- ------ ----- -------
Net income, as reported $ 3,075,190 $ .53 $ .53 $ 3,918,357 $ .66 $ .66
Amortization of goodwill 101,316 .02 .02 102,556 .02 .02
------------ ------ -------- ------------ ----- -------
Pro forma net income $ 3,176,506 $ .55 $ .55 $ 4,020,913 $ .68 $ .68
============ ====== ======== ============ ===== =======
(6) NOTE PAYABLE TO BANK
As of December 31, 2002, we had an unsecured $13,000,000 revolving line of
credit with a maturity date of June 30, 2006 with an outstanding balance
of $2,100,000. The revolving credit agreement provides for interest
payable quarterly, at an annual rate equal to 0.75% less than the prime
rate (3.5% per annum at December 31, 2002). The bank that provides the
credit line is also a policyholder of the Company. Premium from this
policyholder represented 10.2% of revenue for the year ended December 31,
2002.
(7) LEASES AND SHARED EXPENSES
We routinely lease premises for use as administrative offices, vehicles and
office equipment under operating leases for varying periods. Management
expects that in the normal course of business, leases will be renewed or
replaced by other leases.
Consolidated rental expenses under operating leases were $303,781, $267,000
and $198,353 during 2002, 2001 and 2000, respectively.
13(a) - 12
The future minimum lease payments required under these operating leases for
the next five fiscal years ending December 31 are as follows:
YEAR OPERATING
ENDING LEASES
- ----------------------------------
2003 $ 243,679
2004 223,317
2005 175,850
2006 208,769
2007 224,009
----------
$1,075,624
==========
In January 2001, we entered into a new lease for our Columbus office space,
replacing the then existing commitment. Under its provisions, no cash
payments were due until April 1, 2002. Rent expense will be recognized
evenly over the lease term ending December 31, 2008.
(8) REDEEMABLE PREFERRED SECURITIES
On December 4, 2002, our Connecticut special purpose business trust
subsidiary, BIC Statutory Trust I ("BIC Trust"), sold $8 million of
floating rate trust preferred capital securities in an exempt private
placement transaction. BIC Trust was formed for the sole purpose of issuing
these securities. BIC Trust contributed the proceeds from the issuance of
the floating rate trust preferred securities to Bancinsurance who then
issued to BIC Trust junior subordinated debentures with the same terms and
conditions. We have fully and unconditionally guaranteed all of BIC Trust's
obligations with respect to the floating rate trust preferred capital
securities. The floating rate trust preferred capital securities are
presented in the Consolidated Balance Sheets as "Minority interest in
consolidated subsidiary: redeemable preferred securities of subsidiary
trust." The floating rate trust preferred capital securities pay interest
quarterly at a rate equal to three month LIBOR plus four hundred basis
points (5.4% per annum at December 31, 2002), are redeemable at par on or
after December 4, 2007 and mature on December 4, 2032. The impact of the
junior subordinated debentures has been eliminated in our accompanying
financial statements.
(9) FEDERAL INCOME TAXES
Deferred income taxes for 2002 and 2001 reflect the impact of "temporary
differences" between amounts of assets and liabilities for financial
reporting purposes and such amounts as measured on an income tax basis.
Temporary differences which give rise to the net deferred tax liability at
December 31 are as follows:
2002 2001
-------------------------
Deferred tax assets:
Unpaid loss and loss adjustment expense reserves ........ $ 121,063 $ 79,395
Unearned premium reserves ............................... 622,859 354,439
Accrued bonus ........................................... 99,079 99,079
Capital loss carryforward ............................... 442,998 108,988
Other reserves .......................................... 66,908 34,000
Book/tax depreciation differences ....................... 28,109 35,061
Other ................................................... - 28,066
----------- -----------
Subtotal ............................................. 1,381,016 739,028
Deferred tax liabilities:
Unrealized gains on available for sale securities ....... (512,671) (270,479)
Discounting of anticipated salvage and subrogation ...... (2,752) (2,752)
Deferred policy acquisition costs ....................... (902,303) (517,662)
Accrued dividends receivable ............................ (4,182) (3,627)
Other goodwill .......................................... - (42,320)
Book/tax depreciation differences ....................... - (5,574)
Other ................................................... (41,135) (5,615)
----------- -----------
Subtotal ............................................. (1,463,043) (848,029)
----------- -----------
Net deferred tax liability ........................... $ (82,027) $ (109,001)
=========== ===========
Net deferred tax assets and liabilities and federal income tax expense in
future years can be materially affected by changes in enacted tax rates or
by unexpected adverse events.
13(a) - 13
The provision for federal income taxes at December 31 consists of the
following:
2002 2001 2000
---------------------------------------
Current .................................................... $ 1,175,825 $ 1,056,810 $ 1,662,025
Current recoverable ........................................ - - (109,052)
Deferred expense (benefit) ................................. (235,295) 134,557 149,603
----------- ----------- -----------
Federal income taxes .................................... $ 940,530 $ 1,191,367 $ 1,702,576
=========== =========== ===========
The difference between income taxes provided at our effective tax rate and
the 34% federal statutory rate at December 31 is as follows:
2002 2001 2000
----------------------------------------
Federal income tax at statutory rate ....................... $ 1,137,555 $ 1,450,629 $ 1,911,117
Dividends received deduction and tax exempt interest ....... (326,397) (327,644) (282,613)
Business meals and entertainment ........................... 20,238 46,686 41,114
Non-deductible interest expense ............................ - 1,225 12,904
Other ...................................................... 109,134 20,471 20,054
----------- ----------- -----------
Federal income taxes .................................. $ 940,530 $ 1,191,367 $ 1,702,576
=========== =========== ===========
For tax return purposes, as of December 31, 2002, we have capital loss
carryforwards of $1,111,727 that expire, if unused, in 2007.
(10) BENEFIT PLANS
The Ohio Indemnity Company Employee 401(k) and Profit Sharing Plan (the
"401(k) Plan") is available to full-time employees who meet the 401(k)
Plan's eligibility requirements. Under the 401(k) Plan, we match 50% of the
qualified employee's contribution up to 6% of salary. The total cost of the
matching contribution was $133,353, $92,340 and $109,395 for the years
2002, 2001 and 2000, respectively.
(11) STOCK OPTION PLANS
We apply APB Opinion No. 25 and related interpretations in accounting for
stock options issued to employees, officers and directors under our equity
compensation plans. FASB Statement No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), was issued by the FASB in 1995 and changes the
methods for recognition of cost on equity compensation plans similar to
those used by the Company. Adoption of SFAS 123 is optional; however, pro
forma disclosures as if we had adopted the cost recognition requirements
under SFAS 123 in 2002, 2001 and 2000 are presented below.
We have stock options outstanding and exercisable at December 31, 2002
under three equity compensation plans, each of which has been approved by
our security holders. First, our 1984 Stock Option Plan (the "1984 Stock
Option Plan") was open to all employees of the Company and its
subsidiaries. All options were granted to employees of our Company before
May 17, 1994 and had a term of not more than ten years. Under the 1984
Stock Option Plan, options for 40,000 common shares were outstanding at
December 31, 2002 and expire at various dates in 2003 and 2004 and range in
option price per share from $5.25 to $6.00.
Second, our 1994 Stock Option Plan (the "1994 Stock Option Plan") provides
for the grant of options to purchase up to an aggregate of 500,000 common
shares, with a 100,000 common share maximum for any one participant. Key
employees, officers, and directors of, and consultants and advisors to,
Bancinsurance and its subsidiaries are eligible to participate in the 1994
Stock Option Plan. The 1994 Stock Option Plan is administered by the
Compensation Committee which determines to whom and when options will be
granted along with the terms and conditions of the options. Under the 1994
Stock Option Plan, options for 347,900 common shares were outstanding at
December 31, 2002 and expire at various dates from 2004 to 2012 and range
in option price per share from $2.50 to $6.75. Of the options for 347,900
common shares outstanding, 44,000 have been granted to our non-employee
directors and 303,900 have been granted to employees for compensatory
purposes.
Finally, our 2002 Stock Incentive Plan (the "2002 Plan") provides for
awards, including grant of options, to purchase up to an aggregate of
600,000 common shares. Key employees, officers and directors of, and
consultants and advisors to, Bancinsurance and its subsidiaries are
eligible to participate in the 2002 Plan. The 2002 Plan is administered by
the Compensation Committee which determines to whom and when options,
restricted stock or stock appreciation rights will be granted as well as
with the terms and conditions of the award. Under the 2002 Plan, options
for 100,000 common shares were outstanding at December 31, 2002 and expire
in 2012 and have an option price per share of $4.50.
A summary of the status of our stock options as of December 31, 2002, 2001
and 2000 and changes during the year ended on those dates is presented
below:
13(a) - 14
2002 2001 2000
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------------------------------------------------------------------------------------------
Outstanding at beginning of year ..... 355,500 $ 4.81 323,000 $ 4.76 363,500 $ 4.42
Granted .............................. 164,000 4.66 49,000 4.62 16,000 4.04
Exercised ............................ (600) 4.65 (14,000) 2.89 (39,500) 1.55
Expired .............................. - - - - - -
Canceled ............................. (31,000) 5.33 (2,500) 4.75 (17,000) 4.43
---------- ------- ---------- ------ ---------- ------
Outstanding at end of year ........... 487,900 $ 4.73 355,500 $ 4.81 323,000 $ 4.76
---------- ------- ========== ====== ========== ======
Options exercisable at year-end ...... 242,580 209,300 180,500
========== ========== ==========
Shares reserved for issuance ......... 1,042,900 434,500 501,000
========== ========== ==========
Options available for future grant ... 555,000 129,000 178,000
========== ========== ==========
Weighted average fair value of options
granted during the year ............ $ 1.7135 $ 2.0434 $ 2.1071
========== ========== ==========
The fair value of each option granted during 2002, 2001 and 2000 is
estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions: (1) expected volatility of 28.97% for
2002, 35.15% for 2001 and 43.06% for 2000, (2) risk-free interest rate of
5.00% for options granted May 17, 2002, 4.71% for options granted June 4,
2002, 3.86% for options granted July 26, 2002, 3.48% for options granted
October 28, 2002, 3.41% for options granted November 4, 2002, 5.24% for
options granted May 17, 2001, 5.31% for options granted May 30, 2001, 5.20%
for options granted May 31, 2001, 6.72% for options granted May 17, 2000
and 6.52% for options granted May 31, 2000 and (3) expected life of 6 years
for all years.
The following table summarizes weighted-average information by range of
exercise prices for stock options outstanding and exercisable at December
31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------------------------------
NUMBER WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
OUTSTANDING REMAINING EXERCISE EXERCISABLE EXERCISE
RANGE OF EXERCISE PRICES AT 12/31/02 CONTRACTUAL LIFE PRICE AT 12/31/02 PRICE
------------------------------------------------------------------------------------
$ 2.50 - 2.875........................ 21,500 2.88 $ 2.57 21,500 $ 2.57
3.375 - 3.875....................... 34,000 3.93 3.82 34,000 3.82
4.00 - 4.85......................... 282,400 7.83 4.58 96,080 4.65
5.25 - 5.625........................ 112,000 6.60 5.32 53,000 5.37
6.00 - 6.75......................... 38,000 1.48 6.11 38,000 6.11
-------- --------
2.50 - 6.75......................... 487,900 6.56 4.73 242,580 4.73
======== ========
If compensation cost for our 2002, 2001 and 2000 grants for stock-based
compensation plans had been determined consistent with SFAS 123, our net
income and net income per common share would approximate the pro forma
amounts below:
AS REPORTED PRO FORMA
2002 2001 2000 2002 2001 2000
-------------------------------------------------------------------------------
Net income............................ $ 889,613 $ 3,075,190 $ 3,918,357 $ 875,944 $ 3,068,601 $ 3,916,083
---------- ----------- ----------- --------- ----------- -----------
Net income per common share,
diluted............................ $ .16 $ .53 $ .66 $ .16 $ .53 $ .66
---------- ----------- ----------- --------- ----------- -----------
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. Additional awards in future years are
anticipated.
(12) STATUTORY RESTRICTIONS
Generally, Ohio Indemnity is restricted by the insurance laws of the State
of Ohio as to amounts that can be transferred to Bancinsurance in the form
of dividends, loans, or advances without the approval of the Department.
Under these restrictions, during 2003, dividends, loans or advances in
excess of $3,235,322 will require the approval of the Department.
(13) STATUTORY SURPLUS AND NET INCOME
Ohio Indemnity is statutorily required to file financial statements with
state regulatory authorities. The accounting principles used to prepare
these statutory financial statements follow prescribed or permitted
accounting principles, each of which may differ from GAAP. Prescribed
statutory accounting practices include state laws, regulations and general
administrative rules issued by the state of domicile as well as a variety
of publications and manuals of the NAIC. Permitted statutory accounting
practices encompass all accounting practices not so prescribed, but allowed
by the state of domicile. Ohio Indemnity has no permitted statutory
accounting practices.
13(a) - 15
As of December 31, Ohio Indemnity's statutory surplus and net income
determined in accordance with accounting practices prescribed by the
Department differed from shareholders' equity and net income determined in
accordance with GAAP by the following:
SHAREHOLDERS' EQUITY/SURPLUS NET INCOME
---------------------------- --------------------------
2002 2001 2002 2001
------------ ------------- ----------- ------------
Statutory.................................................... $ 32,353,218 $ 29,632,880 $ 1,751,827 $ 2,567,615
Reconciling items:
Non-admitted assets......................................... 91,723 2,818 - -
Deferred policy acquisition costs........................... 2,653,826 1,522,533 1,131,292 879,746
Deferred taxes.............................................. (1,023,087) (538,651) 166,270 (134,557)
Unrealized gain on available for sale fixed maturities...... 355,249 61,730 - -
Provision for reinsurance................................... - 32,027 - -
------------ ------------ ----------- -----------
GAAP......................................................... $ 34,430,929 $ 30,713,337 $ 3,049,389 $ 3,312,804
============ ============ =========== ===========
(14) RESERVE FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the reserve for unpaid losses and loss adjustment expenses is
summarized as follows:
[Dollars in thousands]
2002 2001 2000
-------------------------------------
Balance at January 1............................................ $ 4,873 $ 2,959 $ 3,723
Less reinsurance recoverables.................................. 90 20 2
--------- ---------- ---------
Net Balance at January 1........................................ 4,783 2,939 3,721
--------- ---------- ---------
Incurred related to:
Current year................................................... 29,121 21,759 17,169
Prior years.................................................... (858) (100) (2,100)
--------- ---------- ---------
Total incurred.................................................. 28,263 21,659 15,069
--------- ---------- ---------
Paid related to:
Current year................................................... 21,103 17,074 14,210
Prior years.................................................... 4,667 2,741 1,641
--------- ---------- ---------
Total paid...................................................... 25,770 19,815 15,851
--------- ---------- ---------
Net Balance at December 31...................................... 7,276 4,783 2,939
Plus reinsurance recoverables.................................. 283 90 20
--------- ---------- ---------
Balance at December 31.......................................... $ 7,559 $ 4,873 $ 2,959
========= ========== =========
As a result of changes in estimates of insured events in prior years, the
provision for unpaid losses and loss adjustment expenses decreased by
$858,000, $100,000 and $2,100,000 in 2002, 2001 and 2000, respectively, due
to redundancy in ultimate loss coverage reserves for prior accident years.
(15) REINSURANCE
In the ordinary course of business, we assume and cede reinsurance with
other insurers and reinsurers. Such arrangements serve to enhance our
capacity to write business, provide greater diversification and limit our
maximum loss arising from large risks. Ceded reinsurance is effected by
negotiation on individual risks. Although reinsurance does not discharge
the original insurer from its primary liability to its policyholders, it is
the practice of insurers for accounting purposes to treat reinsured risks
as risks of the reinsurer. The primary insurer would only reassume
liability in those situations where the reinsurer is unable to meet the
obligations it assumed under the reinsurance agreements. The ability to
collect reinsurance is subject to the solvency of the reinsurers.
Our ceded reinsurance transactions are attributable to a lender insurance
policy. The assumed business represents a quota share participation in the
gross liability of an insurer covering bail bond business.
A reconciliation of direct to net premiums, on both a written and earned
basis, for the years ended December 31, 2002, 2001 and 2000 is as follows:
2002 2001 2000
----------------------------- ------------------------------- -----------------------------
PREMIUMS PREMIUMS Premiums Premiums Premiums Premiums
WRITTEN EARNED Written Earned Written Earned
------------- ------------- --------------- -------------- -------------- -------------
Direct $ 45,403,898 $ 40,978,953 $ 44,384,593 $ 38,390,171 $ 26,007,426 $ 25,058,892
Assumed 495,762 411,179 329,739 173,005 - -
Ceded (835,045) (507,895) (1,105,872) (254,438) (186,706) (217,077)
------------ ------------ -------------- ------------- ------------- ------------
$ 45,064,615 $ 40,882,237 $ 43,608,460 $ 38,308,738 $ 25,820,720 $ 2,841,815
============ ============ ============== ============= ============= ============
13(a) - 16
The amounts of recoveries pertaining to reinsurance contracts that were
deducted from losses incurred during 2002, 2001 and 2000 were: $231,998,
$164,794 and $161,411, respectively. Ceded reinsurance decreased commission
expense incurred by $132,344 $160,839 and $49,988, respectively.
(16) RELATED PARTIES
Loans to affiliates at December 31, 2001 included a $96,000 loan to an
officer of the Company. Such indebtedness was due and payable on February
1, 2002. Pursuant to the terms of a Resignation Agreement and Release
between the Company and such officer, we offset the loan payable against
$96,000 that was due and payable by the Company under such Resignation
Agreement and Release at the officers termination on March 31, 2002.
In 1994, we entered into a Split-Dollar Insurance Agreement with a bank, as
trustee, for the benefit of an officer and his spouse. The bank has
acquired a second-to-die policy on the lives of the insureds, in the
aggregate face amount of $2,700,000. At December 31, 2002, we had loaned
the trustee $645,777 under this agreement for payment of insurance
premiums. Amounts loaned by the Company to the trustee are to be repaid, in
full, without interest from any of the following sources: (1) cash
surrender value of the underlying insurance contracts; (2) death benefits;
and/or (3) the sale of 15,750 common shares of the Company contributed by
the officer to the trust. In February 2000, we entered into a Split-Dollar
Insurance Agreement for the benefit of another officer in the face amount
of $1,000,000. At December 31, 2002, $30,000 was included in loans to
affiliates for payment of insurance premiums in accordance with this
agreement. All premiums paid by the Company in accordance with this
agreement are to be repaid, in full, without interest, upon the death,
retirement or termination of the officer.
During 2001 and 2000, we agreed to repurchase common shares of the Company
from two officers of Ohio Indemnity concurrent with the issuance of such
common shares through exercise of stock options. The $22,640 payment in
2001 and the $58,750 payment in 2000 to settle the option grants were
recorded as compensation expense.
We share the Company's executive offices with certain of our consolidated
subsidiaries. Rental, equipment and bookkeeping expenses are allocated
among them pursuant to management fee agreements.
(17) CONCENTRATIONS
Two lender insurance product customers represented $5,804,975 and
$4,612,120 of our net premiums earned in 2002, $4,238,080 and $3,677,520 of
our net premiums earned in 2001 and $0 and $2,683,880 of our net premiums
earned in 2000, respectively.
(18) COMMON SHARE REPURCHASE PROGRAM
On April 25, 2002, the Board of Directors adopted a common share repurchase
program. On May 23, 2002, the Board of Directors increased the aggregate
number of common shares available for repurchase under the repurchase
program to 700,000 common shares from 600,000 common shares originally
approved. The repurchase program expires on December 31, 2003. Through
December 31, 2002, we repurchased 699,224 common shares at an average price
per share of $5.00 under this program. Repurchases were funded by cash
flows from operations.
(19) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Our results of operations have varied, and in the future may vary, from
quarter to quarter principally because of fluctuations in underwriting
results. Consequently, quarterly results are not necessarily indicative of
full year results, nor are they comparable to the results of other
quarters. The following table sets forth certain unaudited quarterly
consolidated financial and operating data:
2002
---------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------------------------------------------------------------
NET PREMIUMS EARNED........................ $ 8,987,460 $ 10,097,226 $ 11,598,795 $ 10,198,756
NET INVESTMENT AND OTHER INCOME............ 1,436,848 1,296,028 977,632 641,283
TOTAL REVENUE.............................. 10,424,308 11,393,254 12,576,427 10,840,039
LOSSES AND OPERATING EXPENSES.............. 8,984,636 10,061,233 12,461,804 10,380,606
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE................................. (1,481,858) - - -
NET INCOME (LOSS).......................... (461,374) 950,951 92,670 307,366
NET INCOME PER COMMON SHARE................ (.08) .17 .02 .05
NET INCOME PER COMMON SHARE,...............
ASSUMING DILUTION........................ (.08) .17 .02 .05
13(a) - 17
2001
---------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------------------------------------------------------------
Net premiums earned........................ $ 7,014,694 $ 10,618,263 $ 10,098,238 $ 10,577,543
Net investment and other income............ 1,669,420 1,291,969 1,320,293 897,702
Total revenue.............................. 8,684,114 11,910,232 11,418,531 11,475,245
Losses and operating expenses.............. 7,790,510 10,728,289 10,410,251 10,292,515
Net income ................................ 654,063 846,258 729,396 845,473
Net income per common share................ .11 .15 .13 .14
Net income per common share, ..............
assuming dilution........................ .11 .15 .13 .14
(20) REGULATORY STANDARD
Ohio Indemnity is subject to a Risk Based Capital test applicable to
property and casualty insurers. The Risk Based Capital test serves as a
benchmark of an insurance enterprise's solvency by state insurance
regulators by establishing statutory surplus targets which will require
certain company level or regulatory level actions. Ohio Indemnity's total
adjusted capital is in excess of all required action levels.
(21) LITIGATION
There are no actions, suits, claims, governmental investigations or
proceedings instituted, pending or, to our knowledge, threatened against
the Company, its subsidiaries or against any of their assets, interests or
rights or against any officer, director or employee of any of them that in
any such case, if decided adversely, could reasonably be expected to have,
individually or in the aggregate, a material adverse effect. Neither the
Company nor any of its subsidiaries is a party to any order, judgment or
decree which has had or could reasonably be expected to have a material
adverse effect on the Company or such subsidiary.
(22) DISPUTE SETTLEMENT
Included in other income for the year ended December 31, 2000, is a
$900,000 payment received in May 2000, in connection with the settlement of
a dispute with an unaffiliated party.
(23) SUPPLEMENTAL DISCLOSURE FOR EARNINGS PER SHARE
2002 2001 2000
---------------------------------------------
Net income......................................................... $ 889,613 $ 3,075,190 $ 3,918,357
------------ ------------ -----------
Income available to common shareholders,
assuming dilution............................................... $ 889,613 $ 3,075,190 $ 3,918,357
------------ ------------ -----------
Weighted average common shares outstanding......................... 5,376,465 5,769,340 5,891,752
Adjustments for dilutive securities:
Dilutive effect of outstanding options.......................... 34,649 20,000 18,831
------------ ------------ -----------
Diluted common shares.............................................. 5,411,114 5,789,340 5,910,583
============ ============ ===========
Net income per common share........................................ $ .16 $ .53 $ .66
Net income per common share, assuming dilution..................... $ .16 $ .53 $ .66
(24) SEGMENT INFORMATION
The Company operates primarily in the property/casualty insurance industry.
There are intersegment management and commission fees. The allocations of
certain general expenses within segments are based on a number of
assumptions, and the reported operating results would change if different
methods were applied. Depreciation and capital expenditures are not
considered material.
DECEMBER 31, 2002
-------------------------------------------------------------------------------------
MUNICIPAL
PROPERTY/CASUALTY CODE INSURANCE ALL CONSOLIDATED
INSURANCE PUBLISHING AGENCY OTHER TOTALS
-------------------------------------------------------------------------------------
Revenues from external customers.... $ 40,953,543 $ 3,324,037 $ 8,463 $ 2,702 $ 44,288,745
Intersegment revenues............... 5,880 - 155,181 146,034 307,095
Interest revenue.................... 1,227,659 - 116 24,603 1,252,378
Interest expense.................... 15,477 11,420 1,327 69,351 97,575
Depreciation and amortization....... 113,591 100,455 28,000 69,413 311,459
Segment profit (loss)............... 4,141,969 522,636 (1,623,255) 611,494 3,652,844
Income tax expense (benefit)........ 1,094,558 196,155 18,549 (368,232) 940,530
Segment assets...................... 66,692,915 2,153,838 299,257 11,702,233 80,848,243
13(a) - 18
DECEMBER 31, 2001
-------------------------------------------------------------------------------------
MUNICIPAL
PROPERTY/CASUALTY CODE INSURANCE ALL CONSOLIDATED
INSURANCE PUBLISHING AGENCY OTHER TOTALS
-------------------------------------------------------------------------------------
Revenues from external customers.... $ 39,793,214 $ 2,652,231 $ 67,065 $ 23,147 $ 42,535,657
Intersegment revenues............... 5,880 - 340,494 81,240 427,614
Interest revenue.................... 1,335,796 - 107 44,176 1,380,079
Interest expense.................... 9,266 3,162 - 15,648 28,076
Depreciation and amortization....... 59,829 78,140 102,122 65,970 306,061
Segment profit (loss)............... 4,545,478 380,425 141,402 (373,134) 4,694,171
Income tax expense (benefit)........ 1,229,850 143,617 87,923 (270,023) 1,191,367
Segment assets...................... 58,283,510 1,878,414 2,610,501 3,967,509 66,739,934
DECEMBER 31, 2000
-------------------------------------------------------------------
MUNICIPAL WORKERS
PROPERTY/CASUALTY CODE INSURANCE COMPENSATION
INSURANCE PUBLISHING AGENCY ADMINISTRATION
-----------------------------------------------------------------
Revenues from external customers.... $ 26,954,064 $1,884,067 $ 155,942 $ 427,036
Intersegment revenues............... 5,880 - 642,113 -
Interest revenue.................... 1,489,992 - 98 -
Interest expense.................... 7,526 - 40 -
Depreciation and amortization....... 118,651 39,823 107,189 2,746
Segment profit (loss)............... 5,751,667 266,025 373,978 (37,177)
Income tax expense (benefit)........ 1,677,890 102,077 161,852 -
Segment assets...................... 40,285,510 1,464,405 2,492,767 -
DECEMBER 31, 2000
-----------------------------------------
TITLE ALL CONSOLIDATED
AGENCY OTHER TOTALS
-----------------------------------------
Revenues from external customers.... $ 115,724 $ 10,280 $ 29,547,113
Intersegment revenues............... - 71,240 719,233
Interest revenue.................... - 63,026 1,553,116
Interest expense.................... 90 250,328 257,984
Depreciation and amortization....... 419 58,696 327,524
Segment profit (loss)............... (37,138) 22,811 6,340,166
Income tax expense (benefit)........ - (239,243) 1,702,576
Segment assets...................... - 2,888,620 47,131,302
2002 2001 2000
----------------------------------------------
Revenue
Total revenues for reportable segments..................................... $ 44,288,745 $ 42,535,657 $ 29,547,113
Interest revenue........................................................... 1,252,378 1,380,079 1,553,116
Elimination of intersegment revenues....................................... (307,095) (427,614) (719,233)
------------- ------------- -------------
Total consolidated revenue................................................. $ 45,234,028 $ 43,488,122 $ 30,380,996
============= ============= =============
Profit
Total profit for reportable segments....................................... $ 3,041,350 $ 5,067,305 $ 6,317,355
Other gain (loss).......................................................... 611,494 (373,134) 22,811
Elimination of intersegment profits........................................ (307,095) (427,614) (719,233)
------------- ------------- --------------
Income before income taxes, provision for preferred dividends
and cumulative effect of change in accounting principle.................. $ 3,345,749 $ 4,266,557 $ 5,620,933
============= ============= ==============
Assets
Total assets for reportable segments....................................... $ 69,146,010 $ 62,772,425 $ 44,242,682
Other assets............................................................... 11,702,233 3,967,509 2,888,620
Elimination of intersegment receivables.................................... (8,393,039) (2,069,257) (1,230,318)
------------- ------------- -------------
Consolidated assets........................................................ $ 72,455,204 $ 64,670,677 $ 45,900,984
============= ============= =============
13(a) - 19
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Bancinsurance Corporation
We have audited the accompanying consolidated balance sheets of Bancinsurance
Corporation as of December 31, 2002 and 2001, and the related consolidated
statements of income, comprehensive income, shareholders' equity, and cash flows
for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Bancinsurance Corporation at December 31, 2002 and 2001, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States.
As discussed in Note 1 to the financial statements, in 2002 the Company changed
its method of accounting for goodwill.
/s/Ernst & Young LLP
Columbus, Ohio
January 24, 2003
13(a) - 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion should be read in conjunction with our consolidated
financial statements and the related footnotes. This discussion contains
forward-looking statements. Forward-looking statements reflect our current views
about future events, are based on assumptions and are subject to known and
unknown risks and uncertainties. Many important factors could cause actual
results or achievements to differ materially from any future results or
achievements expressed or implied by forward-looking statements.
OVERVIEW
The discussions of "Results of Operations" and "Liquidity," address our three
business segments, which are property/casualty insurance, municipal code
publishing and insurance agency. A summary description of the operations of each
of these segments is included below.
Ohio Indemnity Company ("Ohio Indemnity") is a specialty property insurance
company. Our principal sources of revenue are premiums paid by insureds for
insurance policies. Ohio Indemnity is licensed in 47 states and the District of
Columbia and for surplus lines in Texas. As such, Ohio Indemnity is subject to
the regulations of the Department of Insurance of the State of Ohio (the
"Department") and the regulations of each state in which it operates. The
majority of Ohio Indemnity's premiums are derived from two distinct lines of
business: (1) products designed for automobile lenders/dealers and (2)
unemployment insurance protection products. Our automobile lender/dealer group
offers two types of products. First, ultimate loss insurance, a blanket vendor
single interest coverage, is the primary product we offer to financial
institutions nationwide. This lender product insures banks and financial
institutions against damage to pledged collateral in cases where the collateral
is not otherwise insured. An ultimate loss insurance policy is generally written
to cover a lender's complete portfolio of collateralized personal property
loans, typically automobiles. During 2002, we began issuing creditor placed
insurance policies, which are an alternative to our traditional blanket vendor
single interest product. While both products cover the risk of damage to
uninsured collateral in a lender's automobile loan portfolio, creditor placed
insurance covers a lender's portfolio through tracking individual borrower
insurance. Second, our guaranteed auto protection insurance ("GAP") pays the
difference or gap between the amount owed by the customer on a lease or loan
contract and the amount of primary insurance company coverage in the event a
vehicle is damaged beyond repair or stolen and never recovered. The GAP product
is sold to automobile dealers, lenders and lessors who then sell coverage
directly to the borrower at the time of purchasing or leasing an automobile. Our
unemployment insurance protection products are utilized by not-for-profit
entities which elect not to pay the unemployment compensation tax and instead
reimburse the state unemployment agencies for benefits paid by the agency to
former employees. Certain national cost containment firms provide programs to
assure that reimbursing employers discharge their unemployment compensation
commitments. Ohio Indemnity bonds these firms for their program
responsibilities. Ohio Indemnity also provides this coverage to groups of
not-for-profits under trust arrangements. In addition, state mandated surety
bonds, which are required by certain state Departments of Labor are
underwritten. Ohio Indemnity also assumes bail bond coverage. No single customer
of our Company accounts for a predominant share of consolidated revenue, except
for two lender insurance product customers.
Our wholly-owned subsidiary, American Legal Publishing Corporation ("ALPC"),
publishes and distributes ordinances for over 1,500 municipalities and counties
nationwide in addition to state governments. Ordinance codification is the
process of collecting, organizing and publishing legislation for state and local
governments.
In July 2002, we formed Ultimate Services Agency, LLC, an Ohio limited liability
company ("USA"). USA will act as an agency for placing property and casualty
insurance policies offered and written by Ohio Indemnity and by other property
and casualty insurance companies. Our wholly-owned subsidiary, Paul Boardway and
Associates, Inc., a property/casualty insurance agency, was dissolved in the
fourth quarter of 2002.
SUMMARY RESULTS
The following table sets forth period to period changes in selected financial
data:
PERIOD TO PERIOD INCREASE (DECREASE)
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
2001-2002 2000-2001
--------------------------- -------------------------
AMOUNT %CHANGE AMOUNT %CHANGE
-------------- ---------- ------------- ---------
Premiums written...................................... $ 1,456,155 3.3 % $ 17,787,740 68.9 %
Net premiums earned................................... 2,573,499 6.7 % 13,466,923 54.2 %
Investment income..................................... (195,110) (13.0)% (131,685) (8.1)%
Net realized gain (loss) on investments............... (1,243,019) (5,514.2)% 343,284 107.0 %
Total revenue......................................... 1,745,906 4.0 % 13,107,126 43.1 %
Loss and loss adjustment expenses,
net of reinsurance recoveries....................... 6,655,512 30.7 % 6,590,114 3.3 %
Operating expenses.................................... (4,058,297) (23.1)% 8,101,296 85.9 %
Interest expense...................................... 69,499 247.5 % (229,908) (89.1)%
Operating income...................................... (920,808) (21.6)% (1,354,376) (24.1)%
Cumulative effect of change in accounting principle... 1,481,585 100.0 % - -
Net income............................................ (2,185,577) (71.1)% (843,167) (21.5)%
13(a) - 21
The combined ratio, which is the sum of the loss ratio and the expense ratio, is
the traditional measure of underwriting experience for insurance companies. The
following table reflects the loss, expense and combined ratios of Ohio Indemnity
on both a statutory and GAAP basis for each of the years ended December 31:
2002 2001 2000
---------------------------
Statutory:
Loss ratio...................................................... 67.9% 63.9% 59.7%
Expense ratio................................................... 26.0% 23.4% 29.1%
------ ------ -----
Combined ratio.................................................. 93.9% 87.3% 88.8%
====== ====== =====
GAAP:
Loss ratio...................................................... 69.3% 56.5% 60.7%
Expense ratio................................................... 21.0% 35.5% 27.4%
------ ------ -----
Combined ratio.................................................. 90.3% 92.0% 88.1%
====== ====== =====
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 AS COMPARED TO YEAR ENDED DECEMBER 31, 2001
Premiums. Premiums written increased 3.3% to $45,064,615 in 2002 from
$43,608,460 in 2001. Net premiums earned increased 6.7% to $40,882,237 in 2002
from $38,308,738 in 2001. We attribute these increases in premiums written
primarily to GAP policies added and unemployment insurance protection and bail
bond volume increases with existing customers. The growth in net premiums earned
was primarily attributable to a decrease in retrospective premium adjustments
due policyholders in 2002 compared to 2001. We estimate retrospective premium
adjustments through the review of each individual retrospectively rated risk,
comparing case basis loss development with that anticipated in the policy
contract to arrive at the best estimate of return or additional retrospective
premium. We record accrued retrospective premium as an adjustment to earned
premium. In general, retrospective adjustments decrease as losses and loss
adjustment expenses increase. For more information concerning losses and loss
adjustment expenses, see "Losses and Loss Adjustment Expenses" below.
Premiums written related to our lender insurance products increased 0.2% to
$37,486,639 in 2002 from $37,412,473 in 2001. We attribute this increase to an
increase in automobile lending, driven by aggressive financing offers by some of
our customers, which helped lender premiums remain relatively constant. We
believe the continuing economic downturn has slowed consumer spending on
automobiles and therefore, automobile lending has declined for our other
customers. Net premiums earned related to our lender insurance products
increased 5.0% to $35,060,911 in 2002 from $33,400,437 in 2001. We primarily
attribute this increase to the decrease in retrospective premium adjustments.
Premiums written related to our GAP insurance products increased 59.8% to
$2,631,083 in 2002 from $1,646,279 in 2001. Net premiums earned related to our
GAP insurance products increased 90.6% to $939,014 in 2002 from $492,754 in
2001. We attribute this growth in GAP premiums written and earned to an agent
transferring a book of business to us during the third quarter of 2001. As a
result, we recorded a full year of activity with respect to such book of
business in 2002 compared to a partial year in 2001.
Premiums written related to our unemployment insurance protection and bail bond
products increased 8.7% to $4,946,893 in 2002 from $4,549,708 in 2001. Net
premiums earned increased 10.6% to $4,882,312 in 2002 from $4,415,547 in 2001.
We attribute this increase in premiums written and earned primarily to the
assumption of bail bond coverage.
Investment Income. Our $52,739,354 investment portfolio is allocated among fixed
income securities, equity securities and short-term investments. Investment
income decreased 13.0% to $1,301,511 in 2002 from $1,496,621 in 2001. Our
investment income in recent years has been negatively impacted by declining
yields on new investments. As of December 31, 2002 and 2001, the average yield
on our portfolio was 2.5% and 3.5%, respectively. The effective duration of our
portfolio at December 31, 2002 and 2001 was 6.1 years. We seek to invest in
investment grade obligations of states, municipalities and political
subdivisions because the majority of the interest income from such investments
is tax-exempt and such investments have generally resulted in more favorable net
yields. We have the ability and intent to hold held to maturity fixed income
securities to maturity or the put date. As a result, we carry held to maturity
fixed income securities at amortized costs. With respect to the equity portion
of our portfolio, we regularly evaluate factors that may impact the national
economy as well as the outlook for corporate profits.
During 2002, we determined that an other than temporary decline in the value of
certain investments had occurred and recorded an impairment on investments held
of $931,531, which is included in realized loss on investments in our
Consolidated Statements of Income. Net realized investment losses were
$1,220,477 in 2002 compared with net realized investment gains of $22,542 in
2001. For more information concerning impairment of investments, see "Other Than
Temporary Impairment of Debt and Equity Securities" below.
Codification and Subscription Fees. Codification and subscription fees generated
by ALPC accounted for $3,324,037 of our revenues in 2002 and $2,652,231 of our
revenues in 2001. We attribute the increase in fees primarily to new
codification contracts and to a lesser extent, our acquisition in June 2001 of
the net assets of Justinian Publishing Company, which contributed $490,833 and
$301,631 in revenue in 2002 and 2001, respectively. In addition, growth in
subscriptions and state league programs contributed to the increase.
13(a) - 22
Management Fees. We have an agreement with a cost containment service firm
involving a program designed to control the unemployment compensation costs of
certain non-profit employers. Pursuant to this agreement, a surety bond has been
issued insuring the payment of certain reimbursable unemployment compensation
benefits on behalf of the employers enrolled in this program. We hold certain
monies allocated toward the payment of these benefits. Together with the cost
containment service firm, we share any residual resulting from the development
of benefits to be paid from the contract funds held on deposit. We record
management fees in the period the residual is shared with the cost containment
service firm. Our management fees decreased 11.5% to $749,442 in 2002 from
$846,446 in 2001. We primarily attribute this decrease to less favorable
unemployment claims experience. We expect management fees to vary from period to
period depending on unemployment levels and claims experience.
Commission Fees. Net commission fees generated by Paul Boardway and Associates
declined to $8,463 in 2002 from $67,065 in 2001. As a result of strategies
initiated in 2000 to preserve business acquired from Paul Boardway and
Associates in 1999, we transferred business to another agency representing Ohio
Indemnity. We dissolved Paul Boardway and Associates in the fourth quarter of
2002.
Other Income. Other income increased 140.1% to $188,815 in 2002 from $78,631 in
2001. The increase was primarily the result of releasing a $100,000 reserve
related to the dismissal of a dispute with an unaffiliated party.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses, net of
reinsurance recoveries, increased 30.7% to $28,314,256 in 2002 from $21,658,744
in 2001. Losses and loss adjustment expenses incurred with respect to our lender
insurance products increased 22.6% to $25,561,076 in 2002 from $20,842,930 in
2001. With the continued slowdown in the U.S. economy and high consumer debt,
financial institutions are experiencing a rise in delinquency dollars. As loan
defaults, bankruptcies and automobile repossessions increased in frequency, we
experienced higher losses and loss adjustment expenses. Losses and loss
adjustment expenses incurred with respect to our GAP products increased 420.7%
to $1,531,311 in 2002 from $294,076 in 2001. We attribute these increases to
increases in earned premiums and deterioration in underwriting quality of the
book of business over time. Losses and loss adjustment expenses incurred with
respect to our unemployment insurance protection products increased 134.2% to
$1,221,869 in 2002 from $521,738 in 2001. We attribute these increases primarily
to increased benefit charges associated with rising unemployment insurance
obligations in addition to reserve strengthening. For more information
concerning losses and loss adjustment expenses, see "Losses and Loss Adjustment
Expense Reserves" below.
Operating Expenses. Our operating expenses consist of experience rating
adjustments, commission expense, other insurance operating expenses,
codification and subscription expenses and general and administrative expenses.
Experience rating adjustments decreased 133.1% to $(1,708,084) in 2002 from
$5,155,850 in 2001. We attribute these decreases primarily to less favorable
loss development in our lender products line. Experience rating adjustments are
calculated and adjusted from period to period based on policy experience to date
and premium growth. We anticipate that experience rating adjustments may
fluctuate in future years based upon this calculation. Commissions, other
insurance operating and general and administrative expenses increased 21.2% to
$15,005,532 in 2002 from $12,378,895 in 2001. Commissions and other insurance
operating expense increases were consistent with overall premium activity in
2002. Codification and subscription expenses incurred by ALPC increased 27.0% to
$2,889,981 in 2002 from $2,276,360 in 2001, which increase was consistent with
growth in codification and subscription revenues. Increases in general and
administrative expenses were primarily the result of increases in salaries and
related benefits and consulting.
Cumulative Effect of Change in Accounting Principle. Effective January 1, 2002,
we adopted Statement of Financial Accounting Standards No. 142, Goodwill and
Other Intangible Assets ("SFAS 142"). Under SFAS 142, we no longer amortize
goodwill and intangibles which have indefinite lives. SFAS 142 requires that we
assess goodwill and intangibles with indefinite lives for impairment at least
annually based on the fair value of the related reporting unit. We will perform
our annual impairment assessment in the fourth quarter on an on-going basis.
As an initial step in the SFAS 142 implementation process, we assigned goodwill
and intangibles to our property/casualty insurance, insurance agency and
municipal code publishing business segments. Following such assignment, the fair
value of each business segment was compared to its carrying value. Fair values
were determined by discounting estimated future cash flows.
Based on our impairment testing, a net after-tax impairment charge of $1,481,858
was recognized as a cumulative effect of the change in accounting principle in
the first quarter of 2002. The impairment charge was associated with the August
1999 acquisition of Paul Boardway and Associates, Inc.
We dissolved Paul Boardway and Associates, Inc. in the fourth quarter of 2002.
As a result, the remaining goodwill of $179,000 was recorded as a pre-tax
impairment charge to income.
Amortization expense related to definite-lived intangible assets was $80,240,
$35,995 and $18,366 during 2002, 2001 and 2000, respectively. The increase in
amortization expense in 2002 compared with 2001 is primarily associated with a
database acquired by ALPC in June 2001.
Interest expense. Interest expense increased 247.5% to $97,575 for 2002 from
$28,076 in 2001 due to higher borrowing levels on the Company's revolving credit
line.
Federal Income Taxes. In 2002, we had income (before taxes, provision for trust
preferred securities dividends and cumulative effect of change in accounting
principle) of $3,345,749 and recorded a provision of $940,530 for income taxes,
as compared to income before taxes of $4,266,557 and a provision for income
taxes of $1,191,367 in 2001. The effective consolidated income tax rate was
28.1% and 27.9% in 2002 and 2001, respectively.
13(a) - 23
GAAP Combined Ratio. Our combined ratio was 90.3% of net premiums earned for
2002 compared to 92.0% in the prior year. We attribute the 1.7% decrease to the
lower expense ratio. The loss ratio increased to 69.3% for 2002 from 56.5% a
year ago principally because of the impact of continued weakness in the U.S.
economy. The expense ratio declined to 21.0% for 2002 from 35.5% in the prior
year principally because of higher expense ratios in 2001 which resulted from
increases in experience rating adjustments related to the addition of a
significant policy in the second quarter of 2001.
YEAR ENDED DECEMBER 31, 2001 AS COMPARED TO YEAR ENDED DECEMBER 31, 2000
Premiums. Premiums written in 2001 increased 68.9% to $43,608,460 from
$25,820,720 in 2000. Net premiums earned in 2001 increased 54.2% to $38,308,738
from $24,841,815 in 2000. We attribute these increases in premiums written and
net premiums earned primarily to growth in the number of new policies that we
issued in 2001 as a result of the addition of four significant financial
institutions (and numerous smaller financial institutions) as lender insurance
customers. Increased automobile lending, which resulted in higher premium volume
on existing policies, also contributed to overall premium growth in fiscal year
2001. Lender insurance premiums written increased by $15,536,257 during 2001
over 2000. New policy sales benefited from our expanded marketing department and
expanded sales through agency relationships to regional and community financial
institutions. The GAP premiums written increased from $293,800 in 2000 to
$1,646,279 in 2001 primarily as a result of an agent transferring a book of
business to the Company. Premiums written for our unemployment insurance
protection products increased by $899,004 during 2001 over 2000 primarily as a
result of growth in mandated surety bonds and increases in premiums on our
existing excess of loss business. During the third quarter of 2001, we assumed
Bail Bond coverage in New Jersey. Premiums written for this business were
$329,739 in 2001.
Investment Income. Investment income (before taxes and excluding net realized
capital gains/losses) decreased 8.1% to $1,496,621 in 2001 from $1,628,306 in
2000. The decrease in investment income was primarily the result of a decrease
in average portfolio yield. As of December 31, 2001 and 2000, the average yield
on our portfolio was 3.5% and 4.6%, respectively. The effective duration of our
portfolio at December 31, 2001 was 6.1 years compared with 5.9 years at December
31, 2000. During 2001, we realized gains on investments of $22,542 compared with
realized losses of $320,742 in 2000. During the fourth quarter of 2001, we
recorded a realized loss on equity investments of $388,333. The Company's
investment strategy is based on current market conditions and tax considerations
which we regularly monitor.
Codification and Subscription Fees. Codification and subscription fees generated
by ALPC accounted for $1,884,067 of our revenues in 2000 and $2,652,231 of our
revenues in 2001. The increase in codification and subscription fees in 2001 was
primarily attributable to our acquisition of Justinian Publishing Company which
contributed $301,631 in additional fees. In addition, growth in subscriptions
and state league programs contributed to the increase.
Management Fees. Management fees increased 28.3% in 2001 from $659,929 in 2000
to $846,446 in 2001. The increase was the result of a 19.2% decline in calendar
year benefits charges which were partially offset by a 4.4% reduction in bonded
service fees, thus increasing the residual reserve distribution. We expect fees
to vary from year to year depending on unemployment levels and claims experience
in the bonded service program.
Commission Fees. Net commission fees generated by our Paul Boardway and
Associates subsidiary accounted for $67,065 of our revenues in 2001 and $155,942
of our revenues in 2000. The decline in commission fees was primarily the result
of our action taken during 2000 to preserve the business acquired from Paul
Boardway and Associates in 1999 and to provide a claim servicing location closer
to our customers. During the first half of 2000, we transferred several policies
to another general agency who represents Ohio Indemnity.
Other Income. Other income decreased from $988,919 in 2000 to $78,631 in 2001.
The decrease was primarily the result of recognition of a one-time payment of
$900,000 received by the Company in the second quarter of 2000 in settlement of
a dispute with an unaffiliated party.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses
increased 43.7% in 2001 to $21,658,744 from $15,068,630 in 2000. The resulting
net loss and loss adjustment expense GAAP ratios were 56.5% and 60.7% in 2000
and 2001, respectively. The increase in the loss and loss adjustment expense
ratio during 2001 was primarily the result of higher dollar losses than expected
due to growth in our lender insurance products. Our GAP business incurred loss
and loss adjustment expenses of $294,076 in 2001 and $25,362 in 2000. Losses and
loss adjustment expenses for our unemployment insurance protection products
increased $211,429 from 2000 to 2001, which was primarily caused by less
favorable claims experience and higher claims incurred. Our bail bond insurance
business incurred loss and loss adjustment expenses of $103,803 in 2001.
Partially offsetting these increases, during 2000, we released $304,604 of loss
reserves due to the rescission of the auto warranty contract program.
Operating Expenses. Our operating expenses consist of experience rating
adjustments, commission expense, other insurance operating expenses,
codification and subscription expenses, amortization of deferred policy
acquisition costs and general and administrative expenses. Experience rating
adjustments increased from $(233,026) in 2000 to $5,155,850 in 2001. Experience
rating adjustments are calculated and adjusted from period to period based on
policy experience to date and premium growth. Management anticipates that the
experience rating adjustment may fluctuate in future years based on this
calculation. Commission expense increased 62.6% during 2001 from $3,639,642 in
2000 to $5,918,461 in 2001. The increase in 2001 was consistent with the overall
premium activity for 2001. Other insurance operating expenses increased 6.5% as
a result of increases in state and local insurance taxes, rent and office
supplies. Codification and subscription expenses incurred by ALPC increased
41.6% to $2,276,360 in 2001 from $1,607,258 for the period February 29, 2000,
the date ALPC was acquired, through December 31, 2000. General and
administrative expenses decreased 28.7% from $1,482,909 in 2000 to $1,057,840 in
2001, primarily as a result of decreases in claims administration and title and
appraisal related expenses. During 2000, we ceased providing claims
administration and title and appraisal services.
13(a) - 24
Federal Income Taxes. In 2001, we had income before taxes of $4,266,557 and
recorded a provision of $1,191,367 for income taxes, as compared to income
before taxes of $5,620,933 and a provision for income taxes of $1,702,576 in
2000. The effective consolidated income tax rate was 27.9% and 30.3% in 2001 and
2000, respectively. In 2001, the deductible for dividends received and tax
exempt interest was 15.9% higher compared with the prior year.
GAAP Combined Ratio. Our combined ratio was 92.0% of net premiums earned for
2001 compared to 88.1% the prior year. The 3.9% increase is attributable to the
higher expense ratio. Expressed as a percentage of premiums earned, the loss
ratio declined to 56.5% for 2001 from 60.7% a year ago. The expense ratio rose
to 35.5% for 2001 from 27.4% the prior year, principally due to a
reclassification of experience rating adjustment expenses during the fourth
quarter of 2000.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of our ability to generate sufficient cash flows to meet
the short and long-term cash requirements of our business operations. Our
short-term cash needs of our property/casualty business primarily consist of
paying losses and loss adjustment expenses and day-to-day operating expenses.
Those needs are met through cash receipts from operations, which consist
primarily of insurance premiums collected and investment income. Our investment
portfolio is also a source of additional liquidity through the sale of readily
marketable fixed maturities, equity securities and short-term investments. After
satisfying our cash requirements, excess cash flows from these underwriting and
investment activities are used to build the investment portfolio and thereby
increase future investment income.
Cash flows from operations totaled $6,447,381 in 2002 compared to $14,242,945
and $4,311,302 in 2001 and 2000, respectively. The decline in 2002 (as compared
with 2001) was the result of several factors. First, paid losses and loss
adjustment expenses of $28,314,256 were 30.7% higher than in 2001, significantly
outpacing the 3.3% increase in written premiums. Our premiums written totaled
$45,064,615 in 2002. We attribute the improvement in 2001 operational cash flows
compared with 2000 to a 68.9% increase in written premiums as compared with
2000.
We do not anticipate receiving any cash dividends from Ohio Indemnity in 2003.
We have sufficient resources available at the parent company to fund interest
payments, distributions on trust preferred securities and other administrative
expenses.
We have a $13,000,000 unsecured revolving line of credit with a maturity date of
June 30, 2006. The revolving line of credit provides for interest payable
quarterly at an annual rate equal to 0.75% less than the prime rate. The bank
that provides the line of credit is also a policyholder of Ohio Indemnity.
ALPC derives its funds principally from codification and subscription fees which
are currently sufficient to meet its operating expenses. USA derives its funds
principally from commission fees which are currently sufficient to meet its
operating obligations. When expanding our business through acquisitions, we have
selected growth opportunities to build upon existing strengths and industry
experience. As each business segment is continually evaluated with goals of
increased revenue and profitability, management will reposition assets to those
areas which contribute to our overall financial objectives.
On December 4, 2002, our Connecticut special purpose business trust subsidiary,
BIC Statutory Trust I ("BIC Trust") sold $8 million of floating rate trust
preferred capital securities in an exempt private placement transaction. BIC
Trust was formed for the sole purpose of issuing these securities. BIC Trust
contributed the proceeds from the issuance of the floating rate trust preferred
securities to Bancinsurance who in turn issued junior subordinated debentures
with the same terms and conditions. We plan to use the proceeds for general
corporate purposes. We have fully and unconditionally guaranteed BIC Trust's
obligations with respect to the floating rate trust preferred capital
securities.
We maintain a level of cash and liquid short-term investments which we believe
will be adequate to meet our anticipated cash needs without being required to
liquidate intermediate-term and long-term investments through the end of 2003.
Because of the nature of the risks we insure, losses and loss adjustment
expenses emanating from the insurance policies that we issue are characterized
by relatively short settlement periods and quick development of ultimate losses
compared to claims emanating from other types of insurance products. Therefore,
we believe that we can estimate our cash needs to meet our losses and expenses
through the end of 2003.
Our investment portfolio is allocated among investment-grade fixed income
securities, equity securities and short-term investments, with short-term
investments and securities purchased under agreements to resell constituting the
largest allocation. Cash and short-term investments at December 31, 2002
amounted to $29,441,312 or 51.6% of our total cash and invested assets. The fair
values of our held to maturity fixed income securities are subject to market
fluctuations but are carried on our balance sheet at amortized cost because we
have the ability and intent to hold held to maturity fixed income securities to
maturity or put date. Available for sale fixed income securities are reported at
fair value with unrealized gains or losses, net of applicable deferred taxes,
reflected in accumulated other comprehensive income. We earned net investment
income of $81,034 and $1,519,163 during 2002 and 2001, respectively. The 94.7%
decrease was primarily due to realized losses on investments sold, and, to a
lesser extent, declining yields on new investments.
Interest rate risk is the risk that interest rates will change and cause a
decrease in the value of an insurer's investments. We mitigate this risk by
attempting to ladder the maturity schedule of our investments with the expected
payouts of our liabilities. To the extent that liabilities come due more quickly
than assets mature, we would have to sell assets prior to maturity and recognize
a gain or loss.
All our material capital commitments and financial obligations are reflected in
our financial statements, except our risk on surety bonds and state mandated
performance bonds, written in connection with our unemployment insurance
protection products. Our financial statements include reserves for losses on
these products for any claims filed and for an estimate of incurred but not
reported losses. Such reserves were $888,000 and $425,500 at December 31, 2002
and 2001, respectively.
13(a) - 25
Under applicable insurance statutes and regulations, Ohio Indemnity is required
to maintain prescribed amounts of capital and surplus as well as statutory
deposits with the appropriate insurance authorities. Ohio Indemnity is in
compliance with all applicable statutory capital and surplus requirements. Ohio
Indemnity's investments consist only of permitted investments under Ohio
insurance laws.
DISCLOSURE ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in market rates and
prices, such as interest rates, foreign currency exchange rates, commodity
prices and other relevant market rate or price changes. Market risk is
influenced by the volatility and liquidity in the markets in which the related
underlying assets are traded. The following is a discussion of our primary
market risk exposures and how we manage those exposures as of December 31, 2002.
Our market risk sensitive instruments are entered into for purposes other than
trading.
The carrying value of our investment portfolio as of December 31, 2002 was
$52,739,354, 38.7% of which is invested in fixed income securities, 13.6% in
equity securities and 47.7% in short-term investments. The primary market risk
to our investment portfolio is interest rate risk associated with investments in
fixed income securities as well as fixed-rate short-term investments. We have no
foreign currency exchange risk or direct commodity risk.
For fixed income securities, our short-term liquidity needs and the potential
liquidity needs of our business are key factors in managing our portfolio. The
portfolio duration relative to the liabilities' duration is primarily managed
through cash market transactions. For additional information regarding our
objectives and strategies pertaining to our investment portfolio, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
With respect to our investment portfolio, for the year ended December 31, 2002,
there were no material changes in our primary market risk exposures or in how
these exposures were managed compared to the year ended December 31, 2001. We do
not anticipate material changes in our primary market risk exposures or in how
those exposures are managed in future reporting periods based upon what is known
or expected to be in effect during future reporting periods.
The following table summarizes those financial instruments held by us at
December 31, 2002, which are sensitive to changes in interest rates. Such
instruments are held for purposes other than trading. We have excluded from the
financial instruments shown below those fixed-rate instruments with a maturity
of less than 12 months at December 31, 2002 because we have determined the
interest rate risk related to those instruments is relatively immaterial. Also,
we have excluded from the cash flow information disclosed below cash receipts
and payments related to interest. In the normal course of business, we also face
risks that are either nonfinancial or non-quantifiable. Such risks principally
include credit risk and legal risk and are not represented in the following
table:
PROJECTED CASH FLOWS
-----------------------------------------------------------------------------------------------
DECEMBER 31,
2002
2003 2004 2005 2006 2007 THEREAFTER TOTAL FAIR VALUE
-----------------------------------------------------------------------------------------------
Assets
Fixed income securities:
Held to maturity............... $ 1,400,000 $ 135,000 $ 145,000 $ - $ 500,000 $ 2,245,000 $ 4,425,000 $ 4,691,903
Available for sale............. $ 15,912,650
Loans to affiliates.............. $ 675,777 $ 675,777 $ 651,050
Weighted Average Interest Rate:
Fixed income securities........ 5.74% 6.80% 4.75% - 4.37% 4.74%
Loans to affiliates............ 0.00%
The amounts reported as cash flows in the table above for held-to-maturity fixed
income securities represent par values at maturity date or call date, if
applicable. The fair values of fixed income securities as disclosed in the table
above are based upon quoted market prices or dealer quotes for comparable
securities. The fair values of the loans to affiliates are based upon the amount
of total cash flows discounted over the applicable term at interest rates that
approximate market yields on similar investments at December 31, 2002. The cash
flows for the loans to affiliates represent the principal amounts outstanding at
December 31, 2002.
FACTORS TO CONSIDER FORWARD-LOOKING
We expect improvement in our underwriting results in 2003 as a result of our
renewed focus on opportunities emerging in specialized insurance markets within
the financial services industry. We are making progress on profit improvement
strategies by reviewing each policy loss ratio and managing the loss ratio by
increasing premiums and/or amending or canceling coverages. We are increasing
our independent agents and will continue to penetrate larger financial
institutions. We believe our specialized underwriting expertise, strong
financial ratings and solid agency relationships will enable us to benefit in a
soft insurance market. Further, an increase in customer appreciation for risk
management products and services is expanding opportunities for us to capitalize
on our strategies in the marketplace.
13(a) - 26
TRENDS
The Company's results of operations have historically varied from quarter to
quarter principally because of fluctuations in underwriting results, and we
expect this trend to continue. The majority of our revenues are dependent on the
demand for our customers' automobile financing programs. (Increased automobile
sales cause increased demand for automobile financing and our products.) An
increase in automobile lending, driven by aggressive financing offers by some of
our customers in 2002, helped lender premiums remain relatively constant during
2002. We anticipate that as financing incentives are phased-out and the economic
downturn continues, consumer spending on automobiles may decline and, therefore,
automobile lending may also decrease in the first half of 2003. We are uncertain
how long the current economic downturn will continue and when a sustained
recovery may occur. Any further decline in general economic conditions would
likely result in reduced revenues. With the continued downturn in the economy,
continued corporate downsizing and high consumer debt, financial institutions
are seeing a rise in delinquency dollars. As loan defaults, bankruptcies and
automobile repossessions continue to increase in frequency, we anticipate an
increase in losses and loss adjustment experience in the first half of 2003.
FORWARD-LOOKING INFORMATION
Certain statements made in this report are forward-looking and are made pursuant
to the safe harbor provisions of the Securities Litigation Reform Act of 1995.
These statements include certain discussions relating to future revenue,
underwriting income, premium volume, investment income and other investment
results, business strategies, profitability, liquidity, capital adequacy,
anticipated capital expenditures and business relationships, as well as any
other statements concerning the year 2003 and beyond. The forward-looking
statements involve risks and uncertainties that may cause results to differ
materially from those anticipated in those statements. Factors that might cause
results to differ from those anticipated include, without limitation, changes in
underwriting results affected by adverse economic conditions, fluctuations in
the investment markets, changes in the retail marketplace, changes in the laws
of regulations affecting the operations of the company, changes in the business
tactics or strategies of the company, the financial condition of the company's
business partners, changes in market forces, litigation and the other risk
factors that have been identified in the company's filing with the SEC, any one
of which might materially affect the operations of the company. Any
forward-looking statements speak only as of the date made. We undertake no
obligation to update any forward-looking statements to reflect events or
circumstances arising after the date on which they are made.
INFLATION
We do not consider the impact of inflation to be material in the analysis of our
overall operations.
INSURANCE REGULATORY MATTERS
The NAIC has developed a risk-based capital measurement formula to be applied to
all property/casualty insurance companies. The risk based capital measurement
formula has been enacted into the Ohio Revised Code. This formula calculates a
minimum required statutory net worth based on the underwriting, investment,
credit, loss reserve and other business risks inherent in an individual
company's operations. Under the current formula, any insurance company which
does not meet the applicable risk-based capital measurement threshold could be
forced to reduce the scope of its operations and ultimately could become subject
to statutory receivership proceedings. Based on our analysis, our statutory net
worth is in excess of the applicable thresholds and no corrective action is
necessary.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires us to make
estimates, assumptions and judgments that affect the reported amounts of assets,
revenues and expenses and related disclosures of contingent assets and
liabilities. We regularly evaluate our critical accounting policies, assumptions
and estimates, including those related to insurance revenue and expense
recognition, asset impairment, loss reserves and valuation and impairment of
intangible assets such as goodwill. We base our estimates on historical
experience and on various assumptions that we believe to be reasonable under the
circumstances. This process forms the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following critical accounting policies require significant
judgments and estimates in the preparation of our consolidated financial
statements.
Other Than Temporary Impairment of Debt and Equity Securities
We continually monitor the difference between our cost and the estimated fair
value of our investments, which involves uncertainty as to whether declines in
value are temporary in nature. If we believe a decline in the value of a
particular available for sale investment is temporary, we record the decline as
an unrealized loss in our shareholders' equity. If we believe the decline in
any investment is "other than temporary," we write down the carrying value of
the investment and record a realized loss on our consolidated statement of
income. Our assessment of a decline in value includes our current judgment as
to the financial position and future prospects of the entity that issued the
investment security. If that judgment changes in the future, we may ultimately
record a realized loss after having originally concluded that the decline in
value was temporary.
13(a) - 27
The following table summarizes the total pretax gross unrealized loss recorded
in our shareholder's equity at December 31, 2002 and 2001, by invested asset
class.
2002 2001
-----------------------
Fixed maturities:
Obligations of states and political subdivisions............ $ 37,918 $ 111,136
Corporate securities........................................ - 52,328
Equity securities:
Public utilities............................................ 12,333 1,968
Banks, trusts and insurance companies....................... - 117,175
Industrial and miscellaneous................................ 202,946 511,812
---------- ----------
$ 253,197 $ 794,419
========== ==========
At December 31, 2002, we did not own any material non-investment grade
securities. We believe that a high quality investment portfolio is more likely
to generate a stable and predictable investment return. Aside from interest rate
risk, we do not believe a material risk, relative to earnings or liquidity, is
inherent in holding investment grade securities.
Our equity portfolio does not include any material, non-publicly traded
securities.
The following table summarizes, for all securities in an unrealized loss
position at December 31, 2002, the aggregate fair value and gross unrealized
loss by length of time those securities have been continuously in an unrealized
loss position.
GROSS
FAIR UNREALIZED
VALUE LOSS
-----------------------------
Fixed maturities:
0-6 months................................................ $ 2,200,627 $ 13,677
7-12 months............................................... 136,304 1,168
Greater than 12 months.................................... 1,292,755 23,073
------------ ----------
Total............................................... 3,629,686 37,918
------------ ----------
Equities:
0-6 months................................................ 1,105,406 144,825
7-12 months............................................... 84,810 12,178
Greater than 12 months.................................... 341,098 58,276
------------ ----------
Total............................................... 1,531,314 215,279
------------ ----------
Total............................................... $ 5,161,000 $ 253,197
============ ==========
We have the ability to hold debt securities with unrealized losses at December
31, 2002 for a period of time sufficient to allow for a recovery in market
value.
The following table presents information regarding our fixed maturity
investments, by remaining period to maturity date, that were in an unrealized
loss position at December 31, 2002.
AMORTIZED ESTIMATED
COST FAIR VALUE
-------------------------
Remaining period to maturity date:
One year or less...................................................... $ - $ -
Over one year but less than five years................................ 5,000 4,992
Over five years but less than ten years............................... 775,992 767,710
Over ten years........................................................ 2,886,613 2,856,984
----------- -----------
Total............................................................... $ 3,667,605 $ 3,629,686
=========== ===========
The following discussion summarizes our process of reviewing our investments for
possible impairment.
13(a) - 28
Fixed Maturities. On a monthly basis, we review our fixed maturities for
impairment. We consider the following factors when evaluating potential
impairment:
- The degree to which any appearance of impairment is attributable to an
overall change in market conditions (e.g., interest rates);
- The degree to which an issuer is current or in arrears in making
principle and interest payments on the debt securities in question;
- The issuer's current financial condition and its ability to make
future scheduled principal and interest payments on a timely basis;
- The independent auditors' report on the issuer's recent financial
statements;
- Buy/hold/sell recommendations of outside investment advisors and
analysts;
- Relevant rating history, analysis and guidance provided by rating
agencies and analysts; and
- Our ability and intent to hold the security for a period of time
sufficient to allow for recovery in the market value.
Equities. On a monthly basis we review our equity investments for impairment. We
consider the following factors when evaluating potential impairment:
- Whether the decline appears to be related to general market or
industry conditions or is issuer-specific;
- The relationship of market prices per share to book value per share at
date of acquisition and date of evaluation;
- Our ability and intent to hold the security for a period of time
sufficient to allow for recovery in the market value;
- The financial condition and near-term prospects of the issuer,
including any specific events that may influence the issuer's
operations;
- The recent income or loss of the issuer;
- The independent auditor's report on the issuer's recent financial
statements;
- Any buy/hold/sell recommendations of investment advisors; and
- Rating agency announcements.
The monthly valuation procedures described above are in addition to our ongoing
responsibility to continually monitor developments affecting those invested
assets, paying particular attention to events that might give rise to impairment
write-downs. Included in 2002 net realized losses were other than temporary
impairment charges of $931,531. Impairment charges included $108,750 in fixed
maturities and $822,781 in equity securities. No impairment charges were
recorded during 2001 and 2000.
We recorded aggregate losses of $79,158 in 2002 on $2,953,741 in sales of fixed
maturity securities. We realized losses of $565,957 in 2002 on $17,892,836 in
sales of equity securities. The majority of our securities sold were above
market value in the six months preceding sale. Although we had the ability to
continue holding these investments, our intent to hold them changed in 2002 due
primarily to decisions to modify our asset allocation and duration within the
portfolio to lessen exposure to a particular credit or industry or tax
considerations. None of these securities were sold out of necessity to raise
cash.
The size of our investment portfolio provides us with flexibility in determining
which individual investments should be sold to achieve our primary investment
goals of assuring our ability to meet our commitments to policyholders and other
creditors and maximizing our investment returns. In order to meet the objective
of maintaining a flexible portfolio that can achieve these goals, our equity and
a majority of our fixed maturity investments are classified as
available-for-sale. We continually evaluate these instruments, and our purchases
and sales of investments are based on our cash requirements, the characteristics
of our insurance liabilities and current market conditions. At the time we
determine an other than temporary impairment in the value of a particular
investment has occurred, we consider the current facts and circumstances and
make a decision to either record a writedown in the carrying value of the
security or sell the security; in either case, recognizing a realized loss.
Losses and Loss Adjustment Expense Reserves
Our projection of ultimate loss and loss adjustment expense ("LAE") reserves are
estimates of future events, the outcomes of which are unknown to us at the time
the projection is made. Considerable uncertainty and variability are inherent in
the estimation of loss reserves. As a result, it is possible that actual
experience may be materially different than the estimates reported. As such, we
cannot guarantee that future experience will be as expected or recorded by us.
In establishing our reserves, we tested our data for reasonableness, such as
ensuring there are no case outstanding reserves on closed claims, and
consistency with data used in our previous estimates. We found no material
discrepancies or inconsistencies in our data.
Our estimates of ultimate loss are based on historical loss development
experience. In using this historical information, we assume that past loss
development is predictive of future development. The majority of our losses are
short-tail in nature and adjustments to reserve amounts occur rather quickly.
Our assumptions allow for changes in claims and underwriting expectations, as
now known or anticipated, which may impact the level of required reserves or the
emergence of losses. However, we do not anticipate any extraordinary changes in
the legal, social or economic environments that could affect the ultimate
outcome of claims or the emergence of claims from causes not currently
recognized in our historical data. Such extraordinary changes or claims
emergence may impact the level of required reserves in ways that are not
presently quantifiable. Thus, while we believe our reserve estimates are
reasonable given the information currently available, actual emergence of losses
could deviate from amounts recorded by us.
13(a) - 29
We conduct a reserve study using generally accepted actuarial methods each
quarter from which point estimates of ultimate losses and loss adjustment
expenses by product line or coverage within product line are selected. In
selecting the point estimates, data points are reviewed and judgment is applied
broadly. Each quarter we record our best estimate of the liability for loss and
LAE reserve by considering these point estimates. Our best estimate recognizes
that there is uncertainty underlying the actuarial point estimates. Reasonable
range estimates around the point estimates are used by us to validate our best
estimate of the liability.
Our indicated reserve range for loss and LAE is $5.7 million to $8.7 million. As
our recorded gross reserve of $7.6 million falls within this range we believe it
is a reasonable provision for our unpaid loss and LAE obligations as of December
31, 2002.
Our reserves reflect anticipated salvage and subrogation, included as a
reduction to loss reserves in the amount of $45,000. We record reserves on an
undiscounted basis. We do not provide coverage that could reasonably be expected
to produce asbestos and/or environmental liability claims activity. We do not
provide coverage that could reasonably be expected to produce material levels of
exposure to claims-made extended reporting options.
We prepared our analysis based on each category of our business. The first is
ultimate loss collateral protection provided to banks on automobile loans.
Ultimate loss insurance coverage is provided in two forms. One is standard
coverage and the other is aggregate limit coverage in which the policy runs at a
maximum loss ratio. The second is GAP coverage. Third is unemployment insurance
protection coverage to cover the unemployment exposure on non-profit
organizations.
Our 2002 written premium is summarized in the following table:
Category 2002 Written Premium
- -------- --------------------
Direct $ 45,403,898
Assumed 495,762
Ceded (835,045)
------------
$ 45,064,615
We prepared our estimates of the gross and net loss and allocated LAE
liabilities using loss development triangles for each category of our business:
- Ultimate Loss Insurance - non-aggregate limit
- Ultimate Loss Insurance - aggregate limit
- GAP
- Unemployment Insurance Protection
Our reserve for these independently estimated categories comprise the majority
of our total recorded loss and allocated LAE reserves as of December 31, 2002 on
a gross and net of reinsurance basis. We prepared independent estimates for
unallocated LAE reserves.
Annual accident year loss development triangles were used to estimate ultimate
loss and allocated LAE for the ultimate loss non-aggregate limit policies, GAP
and unemployment insurance protection policies. Our data for the ultimate loss
aggregate limit policies consisted of premium and loss data and maximum loss
ratio by insured bank. This data was used to determine the required reserve
under the maximum loss ratio.
We computed loss reserve estimates by applying the following generally accepted
actuarial techniques to paid and case incurred loss and allocated LAE data:
- Paid Loss Development Method
- Incurred Loss Development Method
The reported (case incurred) loss development method relies on the assumption
that, at any given state of maturity, ultimate losses can be predicted by
multiplying cumulative reported losses (paid losses plus case reserves) by a
cumulative development factor. The validity of the results of this method
depends on the stability of our claim reporting and settlement rates, as well as
the consistency of our case reserve levels. Case reserves do not have to be
adequately stated for this method to be effective; they only need to have a
fairly consistent level of adequacy at all stages of maturity.
Historical "age-to-age" loss development factors ("LDF") were calculated to
measure the relative development of an accident year from one maturity point to
the next. We then selected appropriate age-to-age LDFs based on these historical
factors. We used the selected factors to project the ultimate losses.
The paid loss development method is mechanically identical to the incurred loss
development method described above, except the paid method does not rely on case
reserves or claim reporting patterns in making projections.
The validity of the results from using a loss development approach can be
affected by many conditions, such as our claim department processing changes, a
shift between single and multiple payments per claim, legal changes or
variations in our mix of business from year to year. Also, because the
percentage of losses paid for immature years is often low, development factors
are volatile. A small variation on the number of claims paid can have a
leveraging effect that can lead to significant changes in estimated ultimates.
Therefore, ultimate values for immature accident years are often based on
alternative estimation techniques.
13(a) - 30
Activity in the reserve for unpaid losses and LAE is summarized as follows:
[Dollars in thousands]
2002 2001 2000
---------------------------------------
Balance at January 1............................................ $ 4,873 $ 2,959 $ 3,723
Less reinsurance recoverables.................................. 90 20 2
--------- ---------- ----------
Net Balance at January 1........................................ 4,783 2,939 3,721
--------- ---------- ----------
Incurred related to:
Current year................................................... 29,121 21,759 17,169
Prior years.................................................... (858) (100) (2,100)
Total incurred.................................................. 28,263 21,659 15,069
--------- ---------- ----------
Paid related to:
Current year................................................... 21,103 17,074 14,210
Prior years.................................................... 4,667 2,741 1,641
--------- ---------- ----------
Total paid...................................................... 25,770 19,815 15,851
--------- ---------- ----------
Net Balance at December 31...................................... 7,276 4,783 2,939
Plus reinsurance recoverables.................................. 283 90 20
--------- ---------- ----------
Balance at December 31.......................................... $ 7,559 $ 4,873 $ 2,959
========= ========== ==========
As a result of changes in estimates of insured events in prior years, the
provision for unpaid losses and LAE decreased by $858,000, $100,000 and
$2,100,000 in 2002, 2001 and 2000, respectively, due to redundancy in vendor
single interest-aggregate limit coverage reserves for prior accident years.
We prepared our estimate of unallocated LAE reserves using the relationship of
calendar year unallocated LAE payments to calendar year loss payments. Our
selected unallocated LAE factor of 3% was selected judgmentally based on a
review of historical unallocated LAE-to-loss payments from 1998 to 2002. The
incurred but not reported ("IBNR") reserve is then split into IBNR on known
claims and IBNR on claims yet to be reported (pure IBNR). This is based on our
assumption that all of the unemployment insurance protection reserve is pure
IBNR and the vendors single interest and GAP policies will have a one week lag
in claim reporting. The unallocated LAE factor is applied to 50% of pure IBNR
reserves and 50% of the remaining reserves on the premise that half of our
unallocated LAE costs are incurred when the claim is reported and the other half
when the claim is closed.
Insurance Revenue and Expense Recognition
Premium for property and casualty related coverages, net of premium ceded to
reinsurers, are recognized as income over the policy period in proportion to the
risk assumed. Policy acquisition costs, primarily commission expenses and
premium taxes, are capitalized and expensed over the terms of the related
policies on the same basis as the related premiums are earned. Selling and
administrative expenses that are not primarily related to premium written are
expensed as incurred.
Codification and Subscription Revenue and Expense Recognition
Revenue from ALPC's municipal code contract is principally recognized on the
percentage-of-completion method; completion is measured based on the percentage
of direct labor costs incurred to date compared to estimated direct labor costs
for each contract. While we use available information to estimate total direct
labor costs on each contract, actual experience may vary from estimated amounts.
Stock Options
We account for compensation expense under the "intrinsic value" based method
under the provisions of Accounting Principles Board Opinion 25. As such, no
compensation cost has been recognized for the stock option plans. We are
currently assessing the voluntary change to the fair value based approach of
accounting for stock based employee compensation for 2003, but have yet to make
a final determination.
Intangible Assets (Goodwill)
As required by Statement of Financial Accounting Standards (SFAS) No. 142, we
ceased amortizing goodwill effective January 1, 2002. Based on the impairment
test required by SFAS No. 142 in the quarter ended March 31, 2002, a
non-recurring charge of $1,481,858 after-tax was taken against income and is
reported as cumulative effect of change in accounting principle in the income
statement. As of December 31, 2002, our remaining goodwill balance was $753,737.
Special Purpose Vehicles or Off Balance Sheet Business Arrangements
We do not utilize any special purpose financing vehicles or have any undisclosed
off-balance sheet arrangements. Similarly, we hold no fair value contracts for
which a lack of marketplace quotations would necessitate the use of fair value
techniques.
13(a) - 31