UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------------------- -----------------------
Commission file number 0-8738
--------------------------------------------------------
BANCINSURANCE CORPORATION
---------------------------
(Exact name of registrant as specified in its charter)
Ohio 31-0790882
- -------------------------------------------------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
250 East Broad Street, Columbus, Ohio 43215
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (614) 228-2800
--------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [ ] NO [X]
The number of outstanding Common Shares of the registrant as of April 30, 2003
was 4,950,291.
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
INDEX
Page No.
PART I - FINANCIAL INFORMATION:
Item 1. Financial Statements
Consolidated Balance Sheets as of
March 31, 2003 (unaudited) and December 31, 2002............................................ 3
Consolidated Statements of Income (Loss) for the
three months ended March 31, 2003 and 2002 (unaudited)...................................... 5
Consolidated Statements of Comprehensive Income (Loss) for the
three months ended March 31, 2003 and 2002 (unaudited)...................................... 6
Consolidated Statements of Cash Flows for the
three months ended March 31, 2003 and 2002 (unaudited)...................................... 7
Notes to Consolidated Financial Statements (unaudited).............................................. 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............................................... 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk................................................................................. 22
Item 4. Controls and Procedures........................................................................... 22
PART II - OTHER INFORMATION AND SIGNATURES
Item 1. Legal Proceedings.................................................................. Not Applicable
Item 2. Changes in Securities and Use of Proceeds.......................................... Not Applicable
Item 3. Defaults Upon Senior Securities.................................................... Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders ............................... Not Applicable
Item 5. Other Information.................................................................. Not Applicable
Item 6. Exhibits and Reports on Form 8-K.................................................................. 22
Signatures................................................................................................ 23
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, December 31,
Assets 2003 2002
----------- -----------
(Unaudited) (Note 2)
Investments:
Held to maturity:
Fixed maturities, at amortized cost (fair value
$4,685,703 in 2003 and $4,691,903 in 2002) ........................... $ 4,483,818 $ 4,487,749
Available for sale:
Fixed maturities, at fair value (amortized cost
$20,277,225 in 2003 and $15,557,400 in 2002) ......................... 20,548,192 15,912,650
Equity securities, at fair value (cost $13,013,747
in 2003 and $6,051,043 in 2002) ...................................... 13,800,993 7,203,650
Short-term investments, at cost which
approximates fair value ................................................ 16,233,509 25,135,305
----------- -----------
Total investments ............................................... 55,066,512 52,739,354
----------- -----------
Cash .......................................................................... 2,169,061 4,306,007
Premiums receivable ........................................................... 7,012,648 5,910,719
Accounts receivable, net of allowance for doubtful accounts ................... 733,281 844,059
Reinsurance receivable ........................................................ 1,300,972 283,417
Prepaid reinsurance premiums .................................................. 5,434,522 1,228,632
Deferred policy acquisition costs ............................................. 4,020,623 2,653,826
Estimated earnings in excess of billings on uncompleted codification contracts. 233,163 224,837
Loans to affiliates ........................................................... 693,674 685,856
Prepaid federal income taxes .................................................. 240,234 295,235
Excess of investment over net assets of subsidiaries, net ..................... 753,737 753,737
Intangible asset, net ......................................................... 975,936 994,566
Accrued investment income ..................................................... 445,961 328,751
Other assets .................................................................. 1,201,777 1,206,208
----------- -----------
Total assets .................................................... $80,282,101 $72,455,204
=========== ===========
(Continued)
3
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets, Continued
March 31, December 31,
Liabilities and Shareholders' Equity 2003 2002
------------ ------------
(Unaudited) (Note 2)
Reserve for unpaid losses and loss adjustment expenses ........................ $ 7,484,979 $ 7,559,503
Unearned premiums ............................................................. 18,163,688 10,304,769
Experience rating adjustments payable ......................................... 6,338,460 4,764,329
Retrospective premium adjustments payable ..................................... 1,085,174 3,951,898
Funds held under reinsurance treaties ......................................... 2,637,450 1,513,297
Contract funds on deposit ..................................................... 793,817 1,317,663
Note payable .................................................................. 3,066,835 2,166,355
Taxes, licenses, and fees payable ............................................. 507,058 297,418
Deferred federal income taxes ................................................. 282,679 82,027
Commissions payable ........................................................... 1,455,536 1,990,436
Billings in excess of estimated earnings on uncompleted codification contracts 90,169 93,894
Other ......................................................................... 967,181 1,511,777
------------ ------------
Total liabilities ............................................... 42,873,026 35,553,366
------------ ------------
Minority interest in consolidated subsidiary:
Redeemable preferred securities of subsidiary trust ...................... 8,000,000 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 March 31, 2003 and December 31, 2002,
4,950,291 shares outstanding at March 31, 2003 and 5,000,291 shares
outstanding at December 31, 2002 ..................................... 1,794,141 1,794,141
Additional paid-in capital ............................................... 1,337,138 1,337,138
Accumulated other comprehensive income ................................... 698,421 995,186
Retained earnings ........................................................ 31,458,517 30,429,515
------------ ------------
35,288,217 34,555,980
Less: Treasury shares, at cost (1,220,050 at March 31, 2003 and 1,170,050
at December 31, 2002 common shares) .................................. (5,879,142) (5,654,142)
------------ ------------
Total shareholders' equity ...................................... 29,409,075 28,901,838
------------ ------------
Total liabilities and shareholders' equity ...................... $ 80,282,101 $ 72,455,204
============ ============
See accompanying notes to consolidated financial statements.
4
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Income (Loss)
(Unaudited)
Three Months Ended
March 31,
2003 2002
------------ ------------
Income:
Premiums earned ................................................................... $ 12,694,234 $ 9,068,619
Premiums ceded ................................................................ (1,533,258) (81,159)
------------ ------------
Net premiums earned ............................................................... 11,160,976 8,987,460
Investment income ................................................................. 372,794 314,898
Net realized gain (loss) on investments ........................................... 234,035 (93,719)
Codification and subscription fees ................................................ 879,716 748,361
Management fees ................................................................... 128,116 321,513
Commission fees ................................................................... 709 1,406
Other income ...................................................................... 14,180 144,389
------------ ------------
Total revenue .............................................................. 12,790,526 10,424,308
------------ ------------
Losses and operating expenses:
Losses and loss adjustment expenses ............................................... 7,334,912 6,420,906
Reinsurance recoveries ............................................................ (1,196,002) (39,966)
Experience rating adjustments ..................................................... 1,574,131 (364,234)
Commission expense ................................................................ 1,391,250 1,458,060
Other insurance operating expenses ................................................ 1,235,188 854,125
Codification and subscription expenses ............................................ 730,224 574,070
General and administrative expenses ............................................... 173,456 77,042
Interest expense .................................................................. 1,878 4,633
------------ ------------
Total expenses ............................................................. 11,245,037 8,984,636
------------ ------------
Income before federal income taxes, provision for trust preferred securities
dividends and cumulative effect of change in accounting principle ........ 1,545,489 1,439,672
Federal income tax expense ............................................................. 408,532 419,188
------------ ------------
Income before provision for trust preferred securities dividends and
cumulative effect of change in accounting principle ...................... 1,136,957 1,020,484
Preferred dividends in minority interest in consolidated subsidiary - redeemable
preferred securities of subsidiary trust .......................................... 107,954 -
------------ ------------
Income before cumulative effect of change in accounting principle .......... 1,029,003 1,020,484
Cumulative effect of change in accounting
principle ......................................................................... - (1,481,858)
------------ ------------
Net income (loss) .......................................................... $ 1,029,003 $ (461,374)
============ ============
Basic net income (loss) per share:
Before cumulative effect of change in accounting principle ........................ $ .20 $ .18
Cumulative effect of change in accounting principle ............................... - (.26)
------------ ------------
Basic net income (loss) per share ................................................. $ .20 $ (.08)
============ ============
Dilutive net income (loss) per share:
Before cumulative effect of change in accounting principle ........................ $ .20 $ .17
Cumulative effect of change in accounting principle ............................... - (.25)
------------ ------------
Diluted net income (loss) per share ............................................... $ .20 $ (.08)
============ ============
See accompanying notes to consolidated financial statements.
5
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)
Three Months Ended
March 31,
2003 2002
----------- ---------
Net income (loss) .................................. $ 1,029,003 $(461,374)
Other comprehensive income:
Unrealized holding gains (losses) on securities
arising during period, net of tax
and reclassification adjustment ............... (296,765) 123,312
----------- ---------
Comprehensive income (loss) ........................ $ 732,238 $(338,062)
=========== =========
See accompanying notes to consolidated financial statements.
6
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
March 31,
2003 2002
------------ -----------
Cash flows from operating activities:
Net income (loss) ............................................................ $ 1,029,003 $ (461,374)
Adjustments to reconcile net income to net cash provided by operating
activities:
Net realized (gain) loss on investments .................................. (234,035) 93,719
Net realized loss on goodwill impairment ................................. - 1,481,858
Depreciation and amortization ............................................ 67,535 92,161
Deferred federal income tax expense ...................................... 353,531 49,755
Change in operating assets and liabilities:
Premiums receivable ................................................... (1,101,929) 21,558
Accounts and reinsurance receivable, net .............................. (5,112,667) (39,563)
Deferred policy acquisition costs ..................................... (1,366,797) (763,508)
Other assets .......................................................... (73,922) (95,574)
Reserve for unpaid losses and loss adjustment expenses ................ (74,524) (1,042,572)
Unearned premiums ..................................................... 7,858,919 2,961,739
Experience rating adjustments payable ................................. 1,574,131 (364,234)
Retrospective premium adjustments payable ............................. (2,866,724) (3,339,890)
Funds held under reinsurance treaties ................................. 1,124,153 95,652
Contract funds on deposit ............................................. (523,846) (393,867)
Other liabilities ..................................................... (873,101) (350,430)
------------ -----------
Net cash used in operating activities ............................... (220,273) (2,054,570)
------------ -----------
Cash flows from investing activities:
Proceeds from held to maturity: fixed maturities due to redemption or maturity - 152,000
Proceeds from available for sale: fixed maturities sold, redeemed and matured 1,585,750 664,250
Proceeds from equity securities sold ......................................... 5,279,079 5,299,277
Cost of investments purchased:
Available for sale fixed maturities ...................................... (6,329,592) (1,366,970)
Equity securities ........................................................ (12,009,356) (5,124,335)
Net change in short-term investments ......................................... 8,901,796 (324,534)
Purchase of furniture, equipment and leasehold improvements .................. (19,350) (19,131)
------------ -----------
Net cash used in investing activities ............................... (2,591,673) (719,443)
------------ -----------
Cash flows from financing activities:
Proceeds from note payable to bank ........................................... 3,000,000 4,990,000
Repayments from note payable to bank ......................................... (2,100,000) (5,600,000)
Acquisition of treasury shares ............................................... (225,000) -
------------ -----------
Net cash provided by (used in) financing activities ................. 675,000 (610,000)
------------ -----------
See accompanying notes to consolidated financial statements.
7
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
(Unaudited)
Three Months Ended
March 31,
--------------------------------
2003 2002
----------- ------------
Net decrease in cash ............................. (2,136,946) (3,384,013)
----------- ------------
Cash at December 31 .............................. 4,306,007 19,547,132
----------- ------------
Cash at March 31 ................................. $ 2,169,061 $ 16,163,119
=========== ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest .................................... $ 856 $ 12,631
=========== ============
Income taxes ................................ $ - $ 110,000
=========== ============
See accompanying notes to consolidated financial statements.
8
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Unaudited)
1. We prepared the Consolidated Balance Sheet as of March 31, 2003, the
Consolidated Statements of Income (Loss) for the three months ended March
31, 2003 and 2002, the Consolidated Statements of Comprehensive Income
(Loss) for the three months ended March 31, 2003 and 2002, and the
Consolidated Statements of Cash Flows for the three months ended March 31,
2003 and 2002 without an audit. In the opinion of management, all
adjustments necessary to present fairly the financial position, results of
operations and cash flows at March 31, 2003 and for all periods presented
have been made.
We prepared the accompanying unaudited consolidated financial statements in
accordance with accounting principles generally accepted in the United
States for interim financial information and with the instructions to the
Quarterly Report on Form 10-Q and Article 10 of Regulation S-X.
2. Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States have been omitted. We recommend that you read
these unaudited Consolidated Financial Statements together with the
financial statements and notes thereto included in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2002. The results of
operations for the period ended March 31, 2003 are not necessarily
indicative of the results of operations for the full year.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities, the disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
3. 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 business 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 2002. As a result, the
remaining goodwill of $179,000 was recorded as a pre-tax impairment charge
to income in 2002.
Intangible assets as of March 31, 2003 and December 31, 2002 were as follows:
As of March 31, 2003 As of December 31, 2002
-------------------------------------------- --------------------------------------------
Accumulated Accumulated
Cost Amortization Net Cost Amortization Net
---------- ------------ -------- ---------- ------------ --------
Amortization Intangibles:
Databases $1,008,773 $(115,172) $893,601 $1,008,773 $(102,562) $906,211
Noncompete agreement 120,394 (38,059) 82,335 120,394 (32,039) 88,355
---------- --------- -------- ---------- --------- --------
Total intangible assets $1,129,167 $(153,231) $975,936 $1,129,167 $(134,601) $994,566
========== ========= ======== ========== ========= ========
9
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Amortization expense related to amortizable intangible assets was $22,379 for
the first quarter of 2003 and $25,491 for the first quarter of 2002. The
estimated amortization expense of intangible assets for the next five years
ending December 31 is as follows:
2003 $ 74,518
2004 74,518
2005 74,518
2006 66,518
2007 50,477
4. Supplemental Disclosure For Earnings (Loss) Per Share:
Three Months Ended
March 31,
2003 2002
---------- -----------
Net income (loss) ............................. $1,029,003 $ (461,374)
---------- -----------
Weighted average common shares outstanding .... 4,996,402 5,770,185
Adjustments for dilutive securities:
Dilutive effect of outstanding options .... 44,731 72,925
---------- -----------
Diluted common shares ......................... 5,041,133 5,843,110
========== ===========
Basic and diluted earnings (loss) per share ... $ .20 $ (.08)
========== ===========
5. 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
March 31, 2003, 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.
6. We have three reportable business segments: property/casualty insurance,
insurance agency and municipal code publishing. The following provides
financial information regarding our reportable segments. 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.
March 31, 2003
----------------------------------------------------------------------------------------------
Municipal
Property/Casualty Insurance Code All Consolidated
Insurance Agency Publishing Other Totals
----------------------------------------------------------------------------------------------
Revenues from external customers ... $11,715,365 $ 709 $ 879,716 $ 5,853 $12,601,643
Intersegment revenues .............. 1,470 137,955 - 140,503 279,928
Interest revenue ................... 353,114 3 - 115,694 468,811
Interest expense ................... 264 - 534 1,080 1,878
Depreciation and amortization ...... 29,557 - 24,749 13,229 67,535
Segment profit ..................... 1,445,494 104,856 148,959 126,108 1,825,417
Income tax expense (benefit) ....... 405,721 35,557 55,705 (88,451) 408,532
Segment assets ..................... 74,764,979 416,403 2,188,798 11,620,208 88,990,888
10
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
March 31, 2002
----------------------------------------------------------------------------------------------
Municipal
Property/Casualty Insurance Code All Consolidated
Insurance Agency Publishing Other Totals
----------------------------------------------------------------------------------------------
Revenues from external customers ... $ 9,340,567 $ 16,708 $ 848,361 $ 2,955 $10,208,591
Intersegment revenues .............. 1,470 84,306 - 27,810 113,586
Interest revenue ................... 321,331 43 - 7,929 329,303
Interest expense ................... 1,870 - 1,581 1,182 4,633
Depreciation and amortization ...... 44,449 14,000 24,193 9,519 92,161
Segment profit ..................... 1,163,435 26,508 272,710 90,605 1,553,258
Income tax expense (benefit) ....... 320,043 9,013 97,024 (6,892) 419,188
Segment assets ..................... 56,249,344 1,137,400 1,962,188 4,139,672 63,488,604
March 31, March 31,
2003 2002
------------ ------------
Revenue
Total revenues for reportable segments $ 12,601,643 $ 10,208,591
Interest revenue 468,811 329,303
Elimination of intersegment revenues (279,928) (113,586)
------------ ------------
Total consolidated revenues $ 12,790,526 $ 10,424,308
============ ============
Profit
Total profit for reportable segments $ 1,699,309 $ 1,462,653
Other profit 126,108 90,605
Elimination of intersegment profits (279,928)
------------
(113,586)
Income before income taxes, provision for preferred dividends
and cumulative effect of change in accounting principle $ 1,545,489 $ 1,439,672
============ ============
Assets
Total assets for reportable segments $ 77,370,680 $ 59,348,932
Other assets 11,620,208 4,139,672
Elimination of intersegment receivables (8,708,787) (2,086,313)
------------ ------------
Consolidated assets $ 80,282,101 $ 61,402,291
============ ============
7. We have three equity plans which provide for granting options to certain
employees and directors of the Company. We account for compensation expense
related to such transactions using the "intrinsic value" based method under
the provisions of the Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," and its related
interpretations.
In December 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FASB Statement No. 123," to provide
alternative methods of transition for a voluntary change to the "fair
value" based method of accounting for stock-based compensation and to
require prominent disclosures about the method of accounting for
stock-based employee compensation and the effect of the method used on
reported results. The fair value of the first quarter 2003 option grants
(no options were granted in the first quarter of 2002) were estimated on
the date of the grant using the Black Scholes option-pricing model with the
following weighted average assumptions:
-------------------------
For the three months
ended March 31,
2003
-------------------------
Fair value of options granted.............................................. $ 4.73
Expected volatility........................................................ 28.20%
Risk free interest rate.................................................... 3.26%
Expected life (in years)................................................... 6
11
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
As we account for stock options using the "intrinsic value" method, no
compensation cost has been recognized in net income for the stock option plans.
Had we accounted for all stock-based employee compensation under the "fair
value" method (SFAS No. 123), our first quarter 2003 net income and earnings per
share would have been reduced as follows:
-------------------
Three months ended
March 31,
2003
-------------------
Net income, as reported......................................................... $ 1,029,003
Deduct: Total stock-based employee
compensation expense determined
under "fair value" based method for
all awards, net of related tax effects..................................... 711
-------------
Pro forma net income............................................................ $ 1,028,292
=============
Compensation expense in the pro forma disclosure is not indicative of future
amounts as options vest over several years and additional grants are generally
made each year.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Bancinsurance is a specialty property insurance holding company. We have three
primary business segments: property/casualty insurance, municipal code
publishing and insurance agency.
Property/Casualty Insurance. Our wholly-owned subsidiary, Ohio Indemnity Company
("Ohio Indemnity"), is a specialty property insurance company. Our principal
sources of revenue are premiums paid by insureds for insurance policies written
by 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 three types of products. First,
ultimate loss insurance, a blanket vendor single interest coverage, is the
primary product we offer to financial institutions nationwide. This 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. Second, creditor
placed insurance, is 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.
Third, 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.
We offer three unemployment insurance protection products. These include bonded
service, excess of loss and mandated bonds. 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 excess of loss coverage to groups of not-for-profit
entities under trust arrangements. We also underwrite state mandated surety
bonds required by certain state departments of labor. This coverage is normally
written as a companion to our other unemployment insurance protection products
and may be necessary for an employer to obtain reimbursing status. In addition,
we entered into an assumed reinsurance agreement for a 15% participation, with
other insurers assuming the remaining exposure. The contract insures a bail bond
company against losses arising from the nonperformance of bail requirements.
Municipal Code Publishing. Our wholly-owned subsidiary, American Legal
Publishing Corporation ("ALPC"), codifies, 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.
12
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Insurance Agency. In July 2002, we formed Ultimate Services Agency, LLC, an Ohio
limited liability company ("USA"). We formed USA to act as an agency for placing
property and casualty insurance policies offered and underwritten by Ohio
Indemnity and by other property and casualty insurance companies. In the fourth
quarter of the 2002 fiscal year, we dissolved our wholly-owned subsidiary, Paul
Boardway and Associates, Inc., which previously acted as a property/casualty
insurance agency.
SUMMARY RESULTS
The following table sets forth period to period changes in selected financial
data:
----------------------------------------
PERIOD TO PERIOD INCREASE (DECREASE)
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2002-2003
----------------------------------------
AMOUNT %CHANGE
------------------- ---------------
Premiums written .................................. $ 3,408,741 39.9%
Net premiums earned ............................... 2,173,516 24.2%
Investment income ................................. 57,896 18.4%
Net realized gain (loss) on investments ........... 327,754 349.7%
Total revenue ..................................... 2,366,218 22.7%
Loss and loss adjustment expenses,
net of reinsurance recoveries .................... (242,030) (3.8)%
Operating expenses ................................ 2,505,186 96.4%
Interest expense .................................. (2,755) (59.5)%
Operating income .................................. 105,817 7.4%
Cumulative effect of change in accounting principle (1,481,858) 100.0%
Net income ........................................ 1,490,377 323.0%
The combined ratio, which is the sum of the loss ratio and 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 the three months ended March 31:
2003 2002
----------------------
Statutory:
Loss ratio.................................................................. 64.0% 68.2%
Expense ratio............................................................... 34.5% 36.7%
------ ------
Combined ratio.............................................................. 98.5% 104.9%
====== ======
GAAP:
Loss ratio.................................................................. 55.0% 71.0%
Expense ratio............................................................... 36.2% 23.5%
------ ------
Combined ratio.............................................................. 91.2% 94.5%
====== ======
RESULTS OF OPERATIONS
MARCH 31, 2003 AS COMPARED TO MARCH 31, 2002
Premiums. Premiums written increased 39.9% to $11,947,280 in the first quarter
of 2003 from $8,538,539 in the first quarter of 2002. Net premiums earned
increased 24.2% to $11,160,976 in the first quarter of 2003 from $8,987,460 in
2002. We attribute these increases in premiums written and net premiums earned
primarily to growth in our lender/dealer business.
Premiums written related to our ultimate loss and creditor placed insurance
products increased 35.3% to $6,896,464 in the first quarter of 2003 from
$5,098,225 in the first quarter of 2002, including $1,082,802 for creditor
placed insurance which was introduced in the fourth quarter of 2002. Net
premiums earned for these products increased 18.4% to $9,362,969 in the first
quarter of 2003 from $7,905,473 in the first quarter of 2002. We attribute these
increases primarily to growth in creditor placed insurance premiums.
13
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Premiums written related to GAP insurance products increased 209.8% to
$1,312,494 in the first quarter of 2003 from $423,623 in the first quarter of
2002. We attribute this growth in premiums written primarily to an existing
financial institution customer purchasing $783,323 of GAP coverage in the first
quarter of 2003. Net premiums earned increased 198.9% to $443,125 in the first
quarter of 2003 from $148,235 in the first quarter of 2002. This increase has
been largely driven by growth in GAP business over the last eighteen months.
Management believes these increases are due to its establishing a competitive
position in the GAP market.
Premiums written related to our unemployment insurance protection and bail bond
products increased 23.9% to $3,738,322 in the first quarter of 2003 from
$3,016,691 in the first quarter of 2002. Net premiums earned increased 45.1% to
$1,354,882 in the first quarter of 2003 from $933,752 in the first quarter of
2002. We attribute this increase in premiums written and net premiums earned
primarily to increases in premiums on existing policies.
Investment Income. Our $55,066,512 investment portfolio is allocated among fixed
income securities, equity securities and short-term investments. Investment
income increased 18.4% to $372,794 in the first quarter of 2003 from $314,898 in
the first quarter of 2002. An increase in invested assets contributed to this
increase. Our investment income for the first quarter of 2003 was impacted by
lower interest rates and investment yields. The effective duration of our
portfolio at March 31, 2003 was 5.4 years. During the first quarter of 2003, we
recorded realized gains on investment sales of $234,035 compared with realized
losses on investment sales of $93,719 during the first quarter of 2002. The
securities sold during the first quarter of 2003 were sold to either recognize
the gain available, to dispose of the security because of our opportunity to
invest in securities with greater potential return considering capital
preservation or to reposition the tax-exempt fixed maturity position of our
Company. 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
our 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. There were no impairment charges included in net realized
gains for the three months ended March 31, 2003 or included in net realized
losses for the three months ended March 31, 2002.
Codification and subscription fees. Codification and subscription fees generated
by ALPC accounted for $879,716 of our revenues in the first quarter of 2003 and
$748,361 of our revenues in the first quarter of 2002. New state, city and
municipal customers were added since the first quarter of 2002 which benefited
codification contract and subscription revenues.
Management Fees. We have an agreement with a cost containment service firm to
control the unemployment compensation costs of certain non-profit employers.
Pursuant to this agreement, we have issued a surety bond 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 60.2% to $128,116 in the first quarter of 2003 from $321,513 in the
first quarter of 2002. We attribute this decrease primarily to less favorable
unemployment claims experience. We expect management fees to vary from period to
period depending on unemployment levels and claims experience.
Other Income. Other income decreased 90.2% to $14,180 in the first quarter of
2003 from $144,389 in the first quarter of 2002. The decrease was primarily the
result of releasing a $100,000 reserve during the first quarter of 2002, related
to the dismissal of a dispute with an unaffiliated party.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses
represent claims associated with insured loss events and expenses associated
with adjusting and recording policy claims, respectively. Losses and loss
adjustment expenses, net of reinsurance recoveries, remained relatively constant
at $6,138,910 in the first quarter of 2003 and $6,380,940 in the first quarter
of 2002. Losses and loss adjustment expenses incurred with respect to our
ultimate loss and creditor placed insurance products decreased 15.3% to
$5,252,278 in the first quarter of 2003 from $6,202,317 in the first quarter of
2002. We attribute this decrease primarily to a 14.2% decrease in paid losses
and loss adjustment expenses to $6,057,946 in the first quarter of 2003 from
$7,057,492 in the first quarter of 2002. Losses and loss adjustment expenses
incurred with respect to our GAP products increased 145.1% to $430,553 in the
first quarter of 2003 from $175,653. This increase was primarily associated with
higher claims severity experience. Losses and loss adjustment expense incurred
with respect to our unemployment insurance protection products increased
15,260.2% to $456,079 in the first quarter of 2003 from $2,970 in the first
quarter of 2002. We attribute these increases to increased benefit payments
associated with rising unemployment insurance obligations in addition to reserve
strengthening. Loss and loss adjustment reserves for future claims were
increased due to persistent weakness in the national economy. For more
information concerning losses and loss adjustment expenses, see "Losses and Loss
Adjustment Expense Reserves" below.
14
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
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 increased 532.2% to $1,574,731 in the first
quarter of 2003 from $(364,234) in the first quarter of 2002. We attribute these
increases primarily to more favorable loss development in our ultimate loss
insurance product line. Experience rating adjustments are calculated and
adjusted from period to period based on policy experience to date and premium
growth. In general, experience rating adjustments increase as loss and loss
adjustment expenses decrease. We anticipate that experience rating adjustments
may fluctuate in future years based upon this calculation. Commission expense
decreased 4.6% to $1,391,250 in the first quarter of 2003 from $1,458,060 in the
first quarter of 2002 due to ceding commissions associated with our creditor
placed insurance product. Other insurance operating expenses increased 44.6% to
$1,235,188 in the first quarter of 2003. We attribute these increases to higher
salaries and related benefits and premium taxes. Codification and subscription
expenses incurred by ALPC increased 27.2% to $730,224 in the first quarter of
2003 from $474,670 in the first quarter of 2002, 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 in 2002.
Amortization expense related to definite-lived intangible assets was $22,379 and
$25,491 during the first quarter of 2003 and 2002, respectively.
Interest expense. Interest expense decreased 59.5% to $1,878 for the first
quarter of 2003 from $4,633 in the first quarter of 2002 due to lower borrowing
levels on the Company's revolving credit line.
Federal Income Taxes. In the first quarter of 2003, we had income (before taxes
and cumulative effect of change in accounting principle) of $1,437,535 and
recorded a provision of $408,532 for income taxes, as compared to income (before
taxes) of $1,439,672 and a provision for income taxes of $419,188 in the first
quarter of 2002. The effective consolidated income tax rate was 28.4% and 29.1%
in the first quarter of 2003 and 2002, respectively.
Preferred Dividends. In December 2002, we organized BIC Statutory Trust I ("BIC
Trust"), a special purpose business trust, which issued $8,000,000 of floating
rate trust preferred capital securities in a private placement offering. BIC
Trust was formed for the sole purpose of issuing and selling the floating rate
trust preferred capital securities and investing the proceeds from such
securities in subordinated notes of the Company. BIC Trust distributes the
interest it receives on the subordinated debt securities to the holder of the
trust preferred to fulfill its dividend obligations. The floating rate trust
preferred capital securities pay interest quarterly at a rate equal to three
month LIBOR plus four hundred basis points (5.34% at March 31, 2003). Dividends
on redeemable trust preferred capital securities are charged to income as they
accrue.
GAAP Combined Ratio. Ohio Indemnity underwrites the Company's specialty
insurance products. Our combined ratio improved to 91.2% for the first quarter
of 2003 from 94.5% for the same period last year. The loss ratio declined to
55.0% for the first quarter of 2003 versus 71.0% for the first quarter of 2002
primarily due to lower paid losses and loss adjustment expenses. This decrease
was partially offset by reserve strengthening in anticipation of higher losses
in future quarters as a result of prolonged weakness in the national economy and
recent automobile credit experience of Ohio Indemnity's customers. The expense
ratio rose to 36.2% for the first quarter of 2003 from 23.5% a year ago,
primarily due to the $1,938,365 increase in experience rating adjustments
expense, which fluctuates based on policy experience to date and premium growth.
15
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
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. The
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 used in operating activities totaled $220,273 in the first quarter of
2003 compared to $2,054,570 in the first quarter of 2002. The increase in 2003
(as compared with 2002) was primarily the result of two factors. First, written
premiums of $11,947,280 were 39.9% higher than in the first quarter of 2002.
Second, paid losses and loss adjustment expenses of $7,230,989 were 2.8% lower
than the first quarter of 2002.
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 fixed income
securities constituting the largest allocation. Cash and short-term investments
at March 31, 2003 amounted to $18,402,570 or 32.2% 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 $606,829 and $221,179 during the first
quarter of 2003 and 2002, respectively. The 174.4% increase was primarily due to
realized gains on investments sold.
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.
As of March 31, 2003, we have a $13,000,000 unsecured revolving line of credit
with a maturity date of June 30, 2006 with an outstanding balance of $3,000,000.
The revolving line of credit provides for interest payable quarterly at an
annual rate equal to 0.75% less than the prime rate. Under the terms of the
revolving credit agreement, we will not permit our consolidated shareholders
equity to be less than $20,000,000 and Ohio Indemnity's ratio of net premiums
written to policyholders surplus to exceed 3.0:1.
We do not anticipate receiving any cash dividends from Ohio Indemnity in 2003.
As of March 31, 2003, we have sufficient capital resources available at the
parent company to fund interest payments, distributions on trust preferred
securities and other administrative expenses. Dividends from Ohio Indemnity and
our line of credit provide us with additional liquidity that could be used for
short-term cash if cash from operations and investments is not sufficient.
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 $459,000 and $888,000 at March 31, 2003 and
December 31, 2002, respectively.
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.
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 expenses.
16
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
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 have used 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.
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 March 31, 2003.
Our market risk sensitive instruments are entered into for purposes other than
trading.
The carrying value of our investment portfolio as of March 31, 2003 was
$55,066,512, 45.5% of which is invested in fixed income securities, 25.1% in
equity securities and 29.5% 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.
With respect to our investment portfolio, during the quarter ended March 31,
2003, 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, 2002.
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.
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 continued aggressive financing offers
by some of our customers, helped lender/dealer premium growth during the first
quarter of 2003. Automobile loan volume in the second quarter of 2003 may be
impacted by tighter credit as financial institutions seek to limit higher losses
due to an increased number of defaults and repossessions. 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 during the second quarter of 2003. In addition, ALPC's
municipal code publishing fees may decline due to state and local government
budget reductions associated with current economic conditions. 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 and benefit charges
associated with rising unemployment insurance protection obligations increase,
we anticipate an increase in losses and loss adjustment experience in the second
quarter of 2003. Our outlook for the remainder of 2003 remains cautious.
FORWARD-LOOKING INFORMATION
Statements in this "Management's Discussion and Analysis of Financial Condition
and Results of Operations" that indicate our intentions, hopes, beliefs,
expectations or predictions of the future are forward-looking statements. It is
important to note that our actual results could differ materially from those
projected in such forward-looking statements. Forward-looking statements are not
guarantees of performance. They involve risks, uncertainties and assumptions.
Many of the factors that will determine our actual results are beyond our
ability to control or predict. We caution you not to put undue reliance on
forward-looking statements. In addition, we have no obligation, and we do not
intend, to update forward-looking statements after the date hereof, even if new
information, future events, or other circumstances have made them incorrect or
misleading. For those statements, we claim the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995.
17
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
The risks and uncertainties that may affect the operations, performance,
development and results of our business, include the following: changes in
property and casualty reserves; premium and investment growth; product pricing
environment; availability of credit; performance of financial markets;
fluctuations in interest rates; availability and pricing of reinsurance; acts of
war and terrorist activities; rating agency actions; competition; adverse state
and federal legislation and regulation, including limitations on premium levels,
and increases in prescribed amounts of capital and surplus; price inflation for
items such as replacement parts and repair labor; litigation and administrative
proceedings; ability to achieve targeted expense savings; ability to achieve
premium targets and profitability goals; and general economic conditions.
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. 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 temporarily impaired," 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.
The following table summarizes the total pretax gross unrealized loss recorded
in our shareholder's equity at March 31, 2003 and 2002, respectively, by
invested asset class.
-----------------------------
2003 2002
-----------------------------
Fixed maturities:
Obligations of states and political subdivisions......................... $ 132,394 $ 264,555
Corporate securities..................................................... - 38,395
Equity securities:
Public utilities......................................................... - 43,499
Banks, trusts and insurance companies.................................... - 43,607
Industrial and miscellaneous............................................. 426,944 482,616
------------- -------------
$ 559,338 $ 872,672
============= =============
18
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
At March 31, 2003, 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 March 31, 2003, 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.................................................................. $ 4,894,702 $ 93,500
7-12 months................................................................. 487,643 15,390
Greater than 12 months...................................................... 1,929,385 23,504
------------ -------------
Total................................................................. 7,311,730 132,394
------------ -------------
Equities:
0-6 months.................................................................. 966,784 225,508
7-12 months................................................................. 410,643 116,376
Greater than 12 months...................................................... 303,678 85,060
------------ -------------
Total................................................................. 1,681,105 426,944
------------ -------------
Total................................................................. $ 8,992,835 $ 559,338
============ =============
We believe we have the ability to hold debt securities with unrealized losses at
March 31, 2003 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 March 31, 2003.
-------------------------------------
AMORTIZED ESTIMATED
COST FAIR VALUE
-------------------------------------
Remaining period to maturity date:
One year or less...................................................... $ 414,283 $ 414,072
Over one year but less than five years................................ 282,786 281,243
Over five years but less than ten years............................... 1,432,148 1,422,442
Over ten years........................................................ 5,314,907 5,193,972
------------- --------------
Total $ 7,444,124 $ 7,311,729
============= ==============
The following discussion summarizes our process of reviewing our investments for
possible impairment.
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.
19
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
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;
- Buy/hold/sell recommendations of investment advisors and analysts; 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. There were no impairment charges included in net realized gains and
net realized losses for the three months ended March 31, 2003 and 2002,
respectively.
Included in net realized gain on investments of $234,035 during the first
quarter of 2003, were aggregate losses of $10,065 on $495,250 in sales of fixed
maturity securities. We realized losses of $10,694 in the first quarter of 2003
on $173,096 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 2003 due primarily to decisions to modify our asset allocation and duration
within the portfolio to lessen exposure to particular credit 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 securities, 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 March 31, 2003 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 quickly.
Our estimates 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.
20
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
We conduct a reserve study using historical loss and loss adjustment expenses by
product line or coverage within product line. We compute a range of reasonable
estimates as well as a select estimate of indicated reserves. The indicated
range includes estimates of expected losses and loss adjustment expenses given
the information currently available to us.
Our indicated reserve range for loss and LAE is $5.2 million to $6.5 million. As
our March 31, 2003 gross reserve of $6.1 million falls within this range, we
believe it is a reasonable provision for our unpaid loss and LAE obligations as
of March 31, 2003.
Our reserves reflect anticipated salvage and subrogation, included as a
reduction to loss reserves in the amount of $39,000. 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 premiums written in the first quarter of 2003 are summarized in the
following table:
Category Written Premium
-------- ---------------
Direct $ 17,660,195
Assumed 26,233
Ceded (5,739,148)
------------
$ 11,947,280
We prepared our estimates of the gross and net loss and allocated LAE (expenses
that can be specifically assigned to a particular claim) liabilities using loss
development triangles for each of our principal insurance products:
- Ultimate Loss Insurance - non-aggregate limit
- Ultimate Loss Insurance - aggregate limit
- GAP
- Unemployment Insurance Protection
Our reserve for these independently estimated principal insurance products
comprise the majority of our total recorded loss and allocated LAE reserves as
of March 31, 2003 on a gross and net of reinsurance basis. We prepared
independent estimates for unallocated LAE reserves (expenses associated with
adjusting and recording policy claims, other than those included in allocated
LAE).
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.
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.
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
Premiums 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 premiums written are
expensed as incurred.
21
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
CODIFICATION AND SUBSCRIPTION REVENUE AND EXPENSE RECOGNITION
Revenue from 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 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.
Under this method, the costs incurred and the related revenues are included in
the statements of operations as work progresses. Adjustments to contract cost
estimates are made in the periods in which the facts which require such
revisions become known. If a revised estimate indicates a loss, such loss is
provided for in its entirety. The amount by which revenues are earned in advance
of contractual collection dates is an unbilled receivable and the amount by
which contractual billings exceed earned revenues is unrealized revenue which is
carried as a liability.
STOCK OPTIONS
We account for compensation expense for stock options under the "intrinsic
value" based method in accordance with the provisions of Accounting Principles
Board Opinion No. 25. Accordingly, no compensation cost has been recognized for
the stock option plans.
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 that we conducted 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 March 31, 2003, 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.
Item 3. Quantitative and Qualitative Disclosures
About Market Risk
The information required by this item is included under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Disclosure About Market Risk".
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we have
evaluated our disclosure controls and procedures (as defined in Rules 13a-14 and
15d-14 of the Securities Exchange Act of 1934) as of a date within 90 days prior
to the filing of this report. Based upon that evaluation, our principal
executive officer and principal financial officer have concluded that such
disclosure controls and procedures are effective and designed to ensure that
material information relating to the Company and its consolidated subsidiaries
would be made known to them. There have not been any significant changes in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date of our evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
A Form 8-K, dated March 5, 2003 was filed by the Company on
March 6, 2003 to report the issuance of a press release by the
Company announcing results of operations for the fiscal year
ended December 31, 2002.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BANCINSURANCE CORPORATION
-------------------------
(Registrant)
Date: May 13, 2003 By: /s/Si Sokol
------------------- --------------------------------------------
Si Sokol
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: May 13, 2003 By: /s/Sally Cress
------------------- --------------------------------------------
Sally Cress
Treasurer and Secretary
(Principal Financial and Accounting
Officer)
23
CERTIFICATIONS
I, Si Sokol, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Bancinsurance
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules l3a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 13, 2003 /s/ Si Sokol
--------------- ------------------------------------------------
Si Sokol
Chairman and Chief Executive Officer
(Principal Executive Officer)
I, Sally Cress, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Bancinsurance
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules l3a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 13, 2003 /s/ Sally J. Cress
--------------- -----------------------------------------------
Sally J. Cress
Treasurer and Secretary
(Principal Financial and Accounting Officer)