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, 2004
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 of (I.R.S. Employer
incorporation or organization) Identification No.)
250 East Broad Street, Columbus, Ohio 43215
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(614) 220-5200
- --------------------------------------------------------------------------------
(Registrant's telephone number,including area code)
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, without par value, of the registrant
as of April 30, 2004 was 4,920,050.
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
INDEX
Page No.
--------------
PART I - FINANCIAL INFORMATION:
Item 1. Financial Statements
Consolidated Statements of Income for the
three months ended March 31, 2004 and 2003 (unaudited)............ 3
Consolidated Balance Sheets as of
March 31, 2004 (unaudited) and December 31, 2003.................. 4
Consolidated Statements of Cash Flows for the
three months ended March 31, 2004 and 2003 (unaudited)............ 6
Notes to Consolidated Financial Statements (unaudited)................. 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................... 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk....................................................... 20
Item 4. Controls and Procedures.............................................. 20
PART II - OTHER INFORMATION AND SIGNATURES
Item 1. Legal Proceedings.................................................... Not Applicable
Item 2. Changes in Securities and Use of Proceeds............................ 20
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..................................... 20
Signatures................................................................... 21
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Income
(Unaudited)
Three Months Ended
March 31,
2004 2003
------------ -------------
Revenues:
Net premiums earned $ 11,507,567 $ 11,160,976
Net investment income 410,835 353,769
Net realized gains on investments 343,872 234,035
Codification and subscription fees 993,461 879,716
Management fees 32,997 128,116
Other income 53,876 14,889
------------ -------------
Total revenues 13,342,608 12,771,501
------------ -------------
Expenses:
Losses and loss adjustment expenses 6,315,626 6,138,910
Experience rating adjustments 535,920 1,574,131
Commission expense 2,112,529 1,391,250
Other insurance operating expenses 1,335,783 1,216,163
Codification and subscription expenses 990,837 730,224
General and administrative expenses 221,872 173,456
Interest expense 226,603 109,832
------------ -------------
Total expenses 11,739,170 11,333,966
------------ -------------
Income before federal income taxes 1,603,438 1,437,535
Federal income tax expense 444,845 408,532
------------ -------------
Net income $ 1,158,593 $ 1,029,003
============ =============
Net income per common share:
Basic $ .24 $ .21
Diluted $ .22 $ .20
See accompanying notes to consolidated financial statements.
3
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, December 31,
2004 2003
-------------- --------------
(Unaudited) (Note 1)
Assets
Investments:
Held to maturity:
Fixed maturities, at amortized cost (fair value
$5,075,045 in 2004 and $5,066,125 in 2003) $ 4,855,659 $ 4,872,012
Available for sale:
Fixed maturities, at fair value (amortized cost
$25,098,217 in 2004 and $28,622,634 in 2003) 25,470,759 28,918,149
Equity securities, at fair value (cost $7,517,850
in 2004 and $7,621,880 in 2003) 9,801,720 10,235,858
Short-term investments, at cost which approximates fair value 31,452,385 28,904,680
Other invested assets 1,049,136 1,049,136
-------------- ---------------
Total investments 72,629,659 73,979,835
-------------- ---------------
Cash 2,998,891 2,949,627
Premiums receivable 8,470,460 10,661,766
Accounts receivable, net 827,611 993,093
Reinsurance recoverables 3,689,455 4,926,446
Prepaid reinsurance premiums 10,164,557 12,244,588
Deferred policy acquisition costs 5,278,384 4,962,150
Estimated earnings in excess of billings on uncompleted codification contracts 220,311 283,336
Loans to affiliates 768,995 770,466
Goodwill 753,737 753,737
Intangible assets, net 901,419 920,048
Accrued investment income 475,760 541,519
Other assets 1,860,679 1,883,125
-------------- ---------------
Total assets $ 109,039,918 $ 115,869,736
============== ===============
4
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets, Continued
March 31, December 31,
2004 2003
------------- -------------
(Unaudited) (Note 1)
Liabilities and Shareholders' Equity
Reserve for unpaid losses and loss adjustment expenses $ 11,816,922 $ 14,385,919
Unearned premiums 24,445,864 25,124,137
Ceded reinsurance premiums payable - 1,721,963
Experience rating adjustments payable 8,698,114 6,997,784
Retrospective premium adjustments payable 1,777,482 5,370,273
Funds held under reinsurance treaties 1,703,770 2,646,693
Contract funds on deposit 2,962,088 1,908,184
Taxes, licenses and fees payable 358,444 1,315,443
Current federal income taxes 490,990 511,091
Deferred federal income taxes 776,523 852,625
Deferred ceded commissions 976,907 1,224,938
Commissions payable 2,574,102 2,660,979
Billings in excess of estimated earnings on uncompleted codification contracts 201,424 143,888
Notes payable 653,757 53,276
Other liabilities 1,781,943 2,122,515
Trust preferred debt issued to affiliates 15,465,000 15,465,000
------------- -------------
Total liabilities 74,683,330 82,504,708
------------- -------------
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, 2004 and December 31, 2003,
4,920,050 shares outstanding at March 31, 2004 and December 31, 2003 1,794,141 1,794,141
Additional paid-in capital 1,337,138 1,337,138
Accumulated other comprehensive income 1,753,232 1,920,265
Retained earnings 35,497,925 34,339,332
------------- -------------
40,382,436 39,390,876
Less: Treasury shares, at cost (1,250,291 common shares at March 31, 2004
and December 31, 2003) (6,025,848) (6,025,848)
------------- -------------
Total shareholders' equity 34,356,588 33,365,028
------------- -------------
Total liabilities and shareholders' equity $ 109,039,918 $ 115,869,736
============= =============
See accompanying notes to consolidated financial statements.
5
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
March 31,
2004 2003
------------ -------------
Cash flows from operating activities:
Net income $ 1,158,593 $ 1,029,003
Adjustments to reconcile net income to net cash used in operating activities:
Net realized gains on investments (343,872) (234,035)
Amortization 76,867 67,535
Deferred federal income tax expense 9,945 353,531
Change in assets and liabilities:
Premiums receivable 2,191,306 (1,101,929)
Accounts receivable, net 165,482 110,778
Reinsurance recoverables 1,236,991 (1,017,555)
Prepaid reinsurance premiums 2,080,031 (4,205,890)
Deferred policy acquisition costs (316,234) (1,366,797)
Other assets, net 152,701 (73,922)
Reserve for unpaid losses and loss adjustment expenses (2,568,997) (74,524)
Unearned premiums (678,273) 7,858,919
Ceded reinsurance premiums payable (1,721,963) -
Experience rating adjustments payable 1,700,330 1,574,131
Retrospective premium adjustments payable (3,592,791) (2,866,724)
Funds held under reinsurance treaties (942,923) 1,124,153
Contract funds on deposit 1,053,904 (523,846)
Deferred ceded commissions (248,031) -
Other liabilities, net (1,346,532) (873,101)
------------ -------------
Net cash used in operating activities (1,933,466) (220,273)
------------ -------------
Cash flows from investing activities:
Proceeds from held to maturity fixed maturities due to redemption or maturity 10,000 -
Proceeds from available for sale fixed maturities sold, redeemed or matured 7,464,762 1,585,750
Proceeds from available for sale equity securities sold 2,917,269 5,279,079
Cost of investments purchased:
Available for sale fixed maturities (4,454,875) (6,329,592)
Available for sale equity securities (2,006,721) (12,009,356)
Net change in short-term investments and other invested assets (2,547,705) 8,901,796
Other - (19,350)
------------ ---------------
Net cash provided by (used in) investing activities 1,382,730 (2,591,673)
------------ -------------
Cash flows from financing activities:
Proceeds from note payable to bank 3,000,000 3,000,000
Repayments of note payable to bank (2,400,000) (2,100,000)
Acquisition of treasury stock - (225,000)
------------ --------------
Net cash provided by financing activities 600,000 675,000
------------ -------------
Net increase (decrease) in cash 49,264 (2,136,946)
Cash at December 31 2,949,627 4,306,007
------------ -------------
Cash at March 31 $ 2,998,891 $ 2,169,061
============ =============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 222,590 $ 112,156
Income taxes $ 455,000 $ -
See accompanying notes to consolidated financial statements.
6
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
1. BASIS OF PRESENTATION
We prepared the consolidated balance sheet as of March 31, 2004, the
consolidated statements of income for the three months ended March 31,
2004 and 2003 and the consolidated statements of cash flows for the three
months ended March 31, 2004 and 2003 without an audit. In the opinion of
management, all adjustments necessary to present fairly the financial
position, results of operations and cash flows of Bancinsurance
Corporation ("Bancinsurance") and subsidiaries (collectively, the
"Company") as of March 31, 2004 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.
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, 2003. The
results of operations for the period ended March 31, 2004 are not
necessarily indicative of the results of operations for the full 2004
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.
Certain prior year amounts have been reclassified to conform to the 2004
presentation.
2. TRUST PREFERRED DEBT ISSUED TO AFFILIATES
In December 2002, we organized BIC Statutory Trust I ("BIC Trust I"), a
Connecticut special purpose business trust, which issued $8,000,000 of
floating rate trust preferred capital securities in an exempt private
placement transaction. In September 2003, we organized BIC Statutory Trust
II ("BIC Trust II"), a Delaware special purpose business trust, which
issued $7,000,000 of floating rate trust preferred capital securities in
an exempt private placement transaction. BIC Trust I and BIC Trust II
(collectively, the "Trusts") were formed for the sole purpose of issuing
and selling the floating rate trust preferred capital securities and
investing the proceeds from such securities in junior subordinated
debentures of the Company. In connection with the issuance of the trust
preferred capital securities, the Company issued junior subordinated
debentures of $8,248,000 and $7,217,000 to BIC Trust I and BIC Trust II,
respectively. The floating rate trust preferred capital securities and the
junior subordinated debentures have substantially the same terms and
conditions. The Company has fully and unconditionally guaranteed the
obligations of the Trusts with respect to the floating rate trust
preferred capital securities. The Trusts distribute the interest received
from the Company on the junior subordinated debentures to the holders of
their floating rate trust preferred capital securities to fulfill their
dividend obligations with respect to such trust preferred securities. BIC
Trust I's floating rate trust preferred capital securities, and the junior
subordinated debentures issued in connection therewith, pay dividends and
interest, as applicable, on a quarterly basis at a rate equal to three
month LIBOR plus four hundred basis points (5.12% and 5.34% at March 31,
2004 and 2003, respectively), are redeemable at par on or after December
4, 2007 and mature on December 4, 2032. BIC Trust II's floating rate trust
preferred capital securities, and the junior subordinated debentures
issued in connection therewith, pay dividends and interest, as applicable,
on a quarterly basis at a rate equal to three month LIBOR plus four
hundred and five basis points (5.16% at March 31, 2004), are redeemable at
par on or after September 30, 2008 and mature on September 30, 2033.
Interest on the junior subordinated debentures is charged to income as it
accrues. Interest expense related to the junior subordinated debentures
for the three months ended March 31, 2004 and 2003 was $202,694 and
$107,954, respectively. The Company was in compliance with all provisions
of our debt covenants at March 31, 2004.
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities," which requires the consolidation of certain entities considered
to be variable interest entities ("VIEs"). An entity is considered to be a
VIE when it has equity investors who lack the characteristics of having a
controlling financial interest, or its capital is insufficient to permit
it to finance its activities without additional subordinated financial
support. Consolidation of a VIE by an investor is required when it is
determined that the investor will absorb a majority of the VIE's
7
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
expected residual returns if they occur, or both. The Company adopted FIN
46 on July 1, 2003. Upon adoption, BIC Trust I was deconsolidated
effective July 1, 2003 with prior periods reclassified in the consolidated
financial statements. The deconsolidation did not have any impact on net
income. In accordance with FIN 46, BIC Trust II was not consolidated upon
formation in September 2003.
3. STOCK OPTION PLANS
We have three equity incentive plans which allow 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.
As we account for stock options using the "intrinsic value" method, no
compensation cost has been recognized in net income for the equity
incentive 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 (no options were granted in the first quarter of 2004):
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
==================
Basic and diluted earnings per share would not be impacted if the "fair
value" based method had been applied to all awards. 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.
4. OTHER COMPREHENSIVE INCOME
The related federal income tax effects of each component of other
comprehensive income (loss) are as follows:
Three Months Ended March 31, 2004
------------------------------------
Before-tax Income Net-of-tax
amount tax effect amount
---------- ---------- -----------
Net unrealized holding gains (losses) on securities:
Unrealized holding gains arising during 2004 $ 90,791 $ 30,869 $ 59,922
Less: reclassification adjustments for gains realized in net income 343,872 116,916 226,956
---------- ---------- -----------
Net unrealized holding losses (253,081) (86,048) 167,033)
---------- ---------- -----------
Other comprehensive loss $ (253,081) $ (86,048) $ (167,033)
========== ========== ===========
Three Months Ended March 31, 2003
------------------------------------
Before-tax Income Net-of-tax
amount tax effect amount
---------- ---------- -----------
Net unrealized holding gains (losses) on securities:
Unrealized holding losses arising during 2003 $ (215,609) $ (73,307) $ (142,302)
Less: reclassification adjustments for gains realized in net income 234,035 79,572 154,463
---------- ---------- -----------
Net unrealized holding losses (449,644) (152,879) (296,765)
---------- ---------- -----------
Other comprehensive loss $ (449,644) $ (152,879) $ (296,765)
========== ========== ===========
8
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
5. REINSURANCE
Several of our insurance producers have formed sister reinsurance
companies, commonly referred to as a producer-owned reinsurance company
("PORC"). The primary reason for an insurance producer to form a
reinsurance company is to realize the underwriting profits and investment
income from the insurance premiums generated by that producer. In return,
the Company receives a ceding commission, which is based on a percentage
of the premiums ceded. Such arrangements align business partners with the
Company's interests while preserving valued customer relationships. The
majority of the Company's reinsurance consists of producer-owned
reinsurance arrangements.
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. We report balances pertaining to
reinsurance transactions "gross" on the balance sheet, meaning that
reinsurance recoverables on unpaid losses, ceded experience rating
adjustments payable and ceded unearned premiums are not deducted from
insurance reserves but are recorded as assets.
The Company's ceded reinsurance transactions are attributable to our
lender/dealer business. Effective January 1, 2003, the Company entered
into a producer-owned reinsurance arrangement with a new lender/dealer
producer whereby 100% of that producer's premiums (along with the
associated risk) was ceded to its PORC. This reinsurance arrangement was
cancelled effective December 31, 2003. Effective October 1, 2003, the
Company entered into a producer-owned reinsurance arrangement with an
existing lender/dealer customer whereby 100% of that customer's premiums
(along with the associated risk) was ceded to its PORC. For both
reinsurance arrangements, the Company has obtained collateral in the form
of a letter of credit and a trust from the reinsurers to secure their
obligations. Under the provisions of the reinsurance agreements, the
collateral must be equal to or greater than 100% to 102% of the reinsured
reserves and the Company has immediate access to such collateral if
necessary.
The Company also assumes bail bond business at a 5% quota share
participation. This participation was changed from 15% in 2003 to 5% in
2004.
A reconciliation of direct to net premiums, on both a written and earned
basis, for the three months ended March 31, 2004 and 2003 is as follows:
March 31, March 31,
2004 2003
----------------------------- ------------------------------
Premiums Premiums Premiums Premiums
written earned written earned
------------- ------------ ------------- -------------
Direct $ 10,721,323 $ 14,946,221 $ 17,660,195 $ 12,595,210
Assumed 40,686 86,850 26,233 99,024
Ceded (281,063) (3,525,504) (5,739,148) (1,533,258)
------------- ------------ ------------- -------------
Total $ 10,480,946 $ 11,507,567 $ 11,947,280 $ 11,160,976
============= ============ ============= =============
The amounts of recoveries pertaining to reinsurance that were deducted
from losses and loss adjustment expenses incurred during first quarter
2004 and 2003 were $930,998 and $1,196,002, respectively. The amount of
recoveries pertaining to reinsurance that was deducted from experience
rating adjustments during first quarter of 2004 was $1,164,377 (none in
2003). During first quarter 2004 and 2003, ceded reinsurance (increased)
decreased commission expense incurred by $(6,157) and $2,016,312,
respectively.
6. 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
previously approved. The repurchase program expired 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. There were no repurchases for the three months
ended March 31, 2004.
9
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
7. SUPPLEMENTAL DISCLOSURE FOR EARNINGS PER SHARE
Three Months Ended
March 31,
2004 2003
----------- ------------
Net income $ 1,158,593 $ 1,029,003
----------- ------------
Income available to common shareholders,
assuming dilution 1,158,593 1,029,003
----------- -----------
Weighted average common shares outstanding 4,920,050 4,996,402
Adjustments for dilutive securities:
Dilutive effect of outstanding options 233,467 44,731
----------- ------------
Diluted common shares 5,153,517 5,041,133
=========== ============
Earnings per common share:
Basic $ .24 $ .21
Diluted $ .22 $ .20
8. SEGMENT INFORMATION
We have three reportable business segments: (1) Property/Casualty
Insurance; (2) Municipal Code Publishing; and (3) Insurance Agency. The
following provides financial information regarding our reportable business
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 assumptions were applied. Depreciation and capital expenditures
are not considered material.
March 31, 2004
-------------------------------------------------------------
Municipal Reportable
Property/Casualty Code Insurance Segment
Insurance Publishing Agency Total
----------------- ----------- --------- -------------
Revenues from external customers $ 11,940,213 $ 993,461 $ 480 $ 12,934,154
Intersegment revenues 1,470 - 70,545 72,015
Interest revenue 424,523 - 33 424,556
Interest expense 82 480 - 562
Depreciation and amortization 55,418 34,109 - 89,527
Segment profit 1,873,762 2,143 93,553 1,969,458
Income tax expense 534,322 2,832 31,472 568,626
Segment assets 98,089,378 2,611,379 555,886 101,256,643
March 31, 2003
-------------------------------------------------------------
Municipal Reportable
Property/Casualty Code Insurance Segment
Insurance Publishing Agency Total
----------------- ----------- --------- -------------
Revenues from external customers $ 11,715,365 $ 879,716 $ 709 $ 12,595,790
Intersegment revenues 1,470 - 137,955 139,425
Interest revenue 353,114 - 3 353,117
Interest expense 264 534 - 798
Depreciation and amortization 29,557 24,746 - 54,303
Segment profit 1,445,494 148,959 104,856 1,699,309
Income tax expense 405,721 55,705 35,557 496,983
Segment assets 74,764,979 2,188,798 416,903 77,370,680
10
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
The following is a reconciliation of the segment results to the consolidated
amounts reported in the consolidated financial statements.
March 31, March 31,
2004 2003
-------------- -------------
Revenues
Total revenues for reportable segments $ 12,934,154 $ 12,595,790
Other revenues 57,585 5,853
Interest revenue 447,694 449,786
Elimination of intersegment revenues (96,825) (279,928)
-------------- -------------
Total consolidated revenues $ 13,342,608 $ 12,771,501
============== =============
Profit
Total profit for reportable segments $ 1,969,458 $ 1,699,309
Other gain (loss) (269,195) 18,154
Elimination of intersegment profits (96,825) (279,928)
-------------- -------------
Income before federal income taxes $ 1,603,438 $ 1,437,535
============== =============
Assets
Total assets for reportable segments $ 101,256,643 $ 77,370,680
Parent company assets 8,180,733 11,620,208
Elimination of intersegment receivables (397,458) (8,708,787)
-------------- -------------
Total consolidated assets $ 109,039,918 $ 80,282,101
============== =============
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Bancinsurance Corporation ("Bancinsurance") is a specialty property insurance
holding company incorporated in the State of Ohio in 1970. Bancinsurance
Corporation and its subsidiaries (collectively, the "Company") have three
reportable business segments: (1) property/casualty insurance; (2) municipal
code publishing; and (3) insurance agency, each of which are described in more
detail below.
PRODUCTS AND SERVICES
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 for insurance policies written by Ohio
Indemnity. Ohio Indemnity, an Ohio corporation, is licensed in 47 states, the
District of Columbia and for surplus lines in Texas. As such, Ohio Indemnity is
subject to the regulations of the Ohio Department of Insurance (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 compensation and bail bond products.
Our automobile lender/dealer line offers three types of products. First,
ULTIMATE LOSS INSURANCE(R) ("ULI"), 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. A ULI policy
is generally written to cover a lender's complete portfolio of collateralized
personal property loans, typically automobiles. Second, creditor placed
insurance ("CPI") 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, CPI covers the portfolio
through tracking individual borrowers' insurance coverage. The lender purchases
physical damage coverage for loan collateral after a borrower's insurance has
lapsed. Third, our guaranteed auto protection insurance ("GAP") pays the
difference or "gap" between the amount owed by the customer on a loan or lease
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 and provides coverage on either an
individual or portfolio basis.
We offer three types of unemployment compensation products: (1) UCassure; (2)
excess of loss; and (3) mandated bonds. Our unemployment compensation products
are utilized by not-for-profit entities that elect not to pay the unemployment
compensation tax and instead reimburse the state unemployment agencies for
benefits paid by the agencies to the entities' former employees. Certain
national cost containment firms provide programs to ensure that reimbursing
employers discharge their unemployment compensation commitments. Through its
UCassure and bonded service products, Ohio Indemnity insures these national cost
containment firms for their program service responsibilities. Ohio Indemnity's
bonded service program was discontinued at the end of 2003 and replaced by the
UCassure product which provides Ohio Indemnity greater control in the
distribution and expense management of the product. Ohio Indemnity also provides
excess of loss coverage, under trust arrangements, to groups of not-for-profit
entities that want to declare reimbursing status for their
11
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
unemployment compensation obligations. We also underwrite state mandated surety
bonds. Certain states require that reimbursing employers post a bond as a
security for the performance of their reimbursing obligations. In addition to
the unemployment compensation products, we provide bail bond coverage through an
assumed reinsurance agreement for 5% participation, with other insurers assuming
the remaining exposure. This agreement insures a bail bond company against
losses arising from the nonperformance of bail requirements. Our participation
in this bail bond program changed from 15% in 2003 to 5% in 2004.
The Company sells its insurance products through a network of distribution
channels, including three managing general agents, approximately thirty
independent agents and direct sales.
Municipal Code Publishing. Our wholly-owned subsidiary, American Legal
Publishing Corporation ("ALPC"), codifies, publishes, supplements and
distributes ordinances for over 1,800 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.
Insurance Agency. Ultimate Services Agency, LLC ("USA"), a wholly-owned
subsidiary, acts as an agency for placing property/casualty insurance policies
offered and underwritten by Ohio Indemnity and by other property/casualty
insurance companies.
ECONOMIC FACTORS, OPPORTUNITIES, CHALLENGES AND RISKS
The Company's results of operations have historically varied from quarter to
quarter principally due to fluctuations in underwriting results and timing of
investment sales. The Company's primary source of revenue and cash is derived
from premiums collected and investment activity. The majority of our premium
revenues are dependent on the demand for our customers' automobile financing
programs. Increased automobile sales generally cause increased demand for
automobile financing and, in turn, our lender/dealer products. Our ULI and CPI
claims experience is impacted by the rate of loan defaults, bankruptcies and
automobile repossessions among our customers. As delinquency dollars rise, our
claims experience is expected to increase. In addition, the state of the used
car market has a direct impact on our GAP claims. As used car prices decline,
there is a larger gap between the balance of the loan or lease and the actual
cash value of the automobile, which results in higher severity of GAP claims.
Our unemployment compensation products are directly impacted by the nation's
unemployment levels. As unemployment levels rise, we would anticipate an
increase in the frequency of claims. In addition, the interest rate and market
rate environment can have an impact on the yields and valuation of our
investment portfolio.
The Company is focused on opportunities in specialty insurance to extend our
product offerings with appropriate levels of risk that will enhance the
Company's operating performance. Our strategy emphasizes long-term growth
through increased market penetration, product line extensions, and providing our
customers and agents with superior service and innovative technology.
REINSURANCE TRANSACTIONS
During 2003 Ohio Indemnity selectively began to respond to growth opportunities
through producer-owned reinsurance. This involves an insurance producer forming
a sister reinsurance company, commonly referred to as a producer-owned
reinsurance company ("PORC"). The primary reason for an insurance producer to
form a reinsurance company is to realize the underwriting profits and investment
income from the insurance premiums generated by that producer. In return, the
Company receives a ceding commission, which is based on a percentage of the
premiums ceded.
In consultation with one of our larger lender/dealer customers during 2003, we
provided them a variety of risk management solutions. This resulted in our
customer making an informed business decision to move their coverage to another
one of our lender/dealer products that better fit their changing needs. In
conjunction with this change in products, Ohio Indemnity reinsured 100% of this
customer's premiums (along with the associated risk) to its PORC beginning in
fourth quarter 2003 (the "Reinsurance Transaction").
Effective January 1, 2003, we entered into a 100% producer-owned reinsurance
arrangement for a new lender/dealer producer. This arrangement was cancelled at
the end of 2003.
See note 5 to the consolidated financial statements for additional information
regarding the Company's reinsurance.
12
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
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,
------------------------------------
2003-2004
------------------------------------
Amount % Change
------------ --------
Net premiums earned $ 346,591 3.1%
Net realized gains on investments 109,837 46.9%
Total revenues 571,107 4.5%
Losses and loss adjustment expenses 176,716 2.9%
Experience rating adjustments (1,038,211) (66.0)%
Commissions and other insurance expenses 840,899 32.3%
Income before federal income taxes 165,903 11.5%
Net income 129,590 12.6%
Net income increased 12.6% to $1,158,593, or $0.22 per diluted share, for the
first quarter 2004 from $1,029,003, or $0.20 per diluted share, for the same
period last year. The first quarter 2004 results were particularly influenced by
improved margins in the Company's property/casualty insurance segment and an
increase in net realized gains on investments.
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
statutory combined ratio is the sum of the ratio of losses to premiums earned
plus the ratio of statutory underwriting expenses to premiums written after
reducing both premium amounts by dividends to policyholders. Statutory
accounting principles differ in certain respects from accounting principles
generally accepted in the United States ("GAAP"). Under statutory accounting
principles, policy acquisition costs and other underwriting expenses are
recognized immediately, not at the same time premiums are earned. To convert
underwriting expenses to a GAAP basis, policy acquisition expenses are deferred
and recognized over the period in which the related premiums are earned.
Therefore, the GAAP combined ratio is the sum of the ratio of losses to premiums
earned plus the ratio of underwriting expenses to premiums earned. The following
table reflects Ohio Indemnity's loss, expense and combined ratios on both a
statutory and a GAAP basis for the three months ended March 31:
2004 2003
---- ----
GAAP:
Loss ratio 60.1% 69.1%
Expense ratio 29.9% 24.7%
---- ----
Combined ratio 90.0% 93.8%
==== ====
Statutory:
Loss ratio 58.2% 64.0%
Expense ratio 35.9% 34.5%
---- ----
Combined ratio 94.1% 98.5%
==== ====
RESULTS OF OPERATIONS
MARCH 31, 2004 COMPARED TO MARCH 31, 2003
Net Premiums Earned. Net premiums earned increased 3.1% to $11,507,567 in the
first quarter 2004 from $11,160,976 in the first quarter 2003. Net premiums
earned for the first quarter 2004 benefited from strong growth in CPI and GAP.
These increases were partially offset by a decline in ULI compared to the prior
year.
CPI net premiums earned grew 128.0% to $1,579,663 for the first quarter 2004
from $692,792 for the same period last year as the product was introduced in the
fourth quarter 2002. Net premiums earned for GAP were $1,065,360 for the first
quarter 2004 versus $443,124 a year ago, an increase of 140.4%. This growth was
due to the purchase of GAP coverage by two large financial institution customers
in the first half of 2003 and increased volume with existing customers. ULI net
premiums earned declined 12.4% to $7,592,278 for the first quarter 2004 from
$8,670,179 a year ago as a result of the Reinsurance Transaction. Excluding the
impact of the Reinsurance Transaction, ULI net premiums earned for the first
quarter 2004 were comparable to the same period last year.
13
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
First quarter 2004 net premiums earned for unemployment compensation and bail
bond products (collectively, "UC") declined 6.2% to $1,270,266 from $1,354,881
in the first quarter 2003. This was primarily due to discontinuation of the
bonded service program at the end of 2003, which was replaced by the Company's
UCassure product at the beginning of 2004. UCassure provides the Company with
more control in the distribution and expense management of this product.
Investment Income. At March 31, 2004, our $72,629,659 investment portfolio was
allocated as follows: fixed maturity securities (41.8%); equity securities
(13.5%); short-term investments (43.3%); and other invested assets (1.4%). We
seek to invest in investment-grade obligations of states 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. Net investment income increased 16.1% to $410,835 in the first quarter
2004 from $353,769 in the first quarter 2003 due to an increase in invested
assets, which was partially offset by lower interest rates and yields on the
investment portfolio.
We recorded net realized gains on investments of $343,872 in the first quarter
2004 compared with $234,035 in the first quarter 2003. This increase was a
combination of the timing of sales of individual securities and
other-than-temporary impairments on investments. We generally decide whether to
sell securities based upon investment opportunities and tax consequences. We
regularly evaluate the quality of our investment portfolio. When we believe that
a specific security has suffered an other-than-temporary decline in value, the
difference between the cost and estimated fair value is charged to income as a
realized loss on investments. There were $86,696 in impairment charges included
in net realized gains on investments in the first quarter 2004 (none in the
first quarter 2003). This impairment charge in the first quarter 2004 related to
one fixed income security. For more information concerning impairment charges,
see "Other-Than-Temporary Impairment of Investments" below.
Codification and Subscription Fees. ALPC's codification and subscription fees
increased 12.9% to $993,461 in the first quarter 2004 compared to $879,716 in
the first quarter 2003 principally due to printing services provided to an
existing customer.
Management Fees. Through our UCassure and bonded service products, we insure the
payment of certain reimbursable unemployment compensation benefits to be paid
from monies allocated toward the payment of these benefits. We have an agreement
with a cost containment service firm to control the unemployment compensation
costs of certain non-profit employers. 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 that the residual is shared with the cost containment service firm.
Our management fees in the first quarter 2004 decreased 74.2% to $32,997 from
$128,116 in the first quarter 2003 as a result of rising unemployment
compensation obligations related to the increased level of unemployment. We
expect management fees to vary from period to period depending on unemployment
levels and claims experience.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses ("LAE")
represent claims associated with insured loss events and expenses associated
with adjusting and recording policy claims, respectively. Losses and LAE
increased 2.9% to $6,315,626 in the first quarter 2004 from $6,138,910 in the
first quarter 2003. CPI and GAP losses and LAE increased $924,098 and $407,487,
respectively, which is consistent with the growth in business. ULI losses and
LAE declined 14.4% to $4,318,082 for the first quarter 2004 from $5,045,502 a
year ago primarily due to favorable loss development within this product line.
UC losses and LAE declined $427,449 to $120,052 for the first quarter 2004
principally due to a book of business cancelled at the end of 2003. For more
information concerning losses and LAE, see "Losses and Loss Adjustment Expense
Reserves" below.
Experience Rating Adjustments. The experience rating adjustment is primarily
influenced by ULI policy experience-to-date and premium growth. Experience
rating adjustments decreased $1,038,211 in the first quarter 2004 compared to a
year ago as a result of ceded experience rating adjustments associated with the
Reinsurance Transaction. Management anticipates that experience rating
adjustments may fluctuate in future periods based upon loss experience and
premium growth.
Commissions and Other Insurance Operating Expenses. Commission expense rose
51.8% to $2,112,529 in the first quarter 2004 from $1,391,250 in the first
quarter 2003 principally due to higher commission rates in our CPI product line
combined with a decrease in ceding commissions. CPI commission rates tend to be
higher compared to the Company's other lender/dealer products due to additional
costs incurred by producers providing tracking services for customers. Ceding
commissions declined in the first quarter 2004 versus a year ago due to the
cancellation of a 100% producer-owned reinsurance arrangement at the end of
2003. Other insurance operating expenses increased 9.8% to $1,335,783 in the
first quarter 2004 from $1,216,163 a year ago primarily due to an increase in
salaries and consulting expenses.
Codification and Subscription Expenses. Codification and subscription expenses
incurred by ALPC increased 35.7% to $990,837 in the first quarter 2004 from
$730,224 in the first quarter 2003 principally due to increases in salaries,
outside printing and consulting expenses.
Interest Expense. Interest expense increased $116,771 to $226,603 for the first
quarter 2004 compared to a year ago as a result of the Company's $7.2 million
trust preferred debt offering in September 2003. The proceeds from this
financing provided additional financial flexibility for the Company. See
"Liquidity and Capital Resources" for a more detailed description of the trust
preferred debt.
14
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Federal Income Taxes. The Company's effective income tax rate was 27.7% and
28.4% for the three months ended March 31, 2004 and 2003, respectively. The
decrease in the effective tax rate was primarily due to an increase in tax
exempt interest income.
GAAP Combined Ratio. The Company's specialty insurance products are underwritten
by Ohio Indemnity, whose results represent the Company's combined ratio. For the
first quarter 2004, the combined ratio improved 3.8% (380 basis points) to 90.0%
from 93.8% the prior year. The loss ratio declined to 60.1% for the first
quarter 2004 from 69.1% a year ago principally due to the decrease in experience
rating adjustments associated with the Reinsurance Transaction. The expense
ratio increased to 29.9% for the first quarter 2004 from 24.7% a year ago,
primarily due to a higher amount of CPI commissions and lower ceding
commissions.
BUSINESS OUTLOOK
During 2004, we will continue to focus on opportunities emerging in specialized
insurance markets. We believe our specialized underwriting expertise, strong
financial ratings and solid customer relationships will enable us to benefit in
the marketplace. Further, an increase in customer appreciation for risk
management products and services should provide for additional opportunities in
the marketplace.
Initial signs of improvement in the national economy have not yet been
experienced by many of our customers, which contributes to continuation of
sluggish market conditions and margin pressures. If loan defaults, bankruptcies
and automobile repossessions continue to increase, we would anticipate an
increase in the frequency of losses and LAE for our ULI and CPI products.
Increased incentives being offered on new cars by dealers and manufacturers have
depressed the value of the used car market, although there are signs that used
car prices are stabilizing. If used car prices continue to decline, we would
anticipate an increase in the severity of losses and LAE for our GAP products.
In addition, if unemployment levels remain high, we would expect higher claims
experience and lower management fees from our UC products. Our outlook for the
remainder of 2004 remains cautious.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and capital resources demonstrate the overall financial strength of
the Company and its ability to generate sufficient cash flows from its
operations and borrow funds at competitive rates to meet operating and growth
needs. As of March 31 2004 and December 31, 2003, the Company's capital
structure consists of trust preferred debt issued to affiliates, borrowings from
our revolving line of credit and shareholders' equity and is summarized in the
following table:
March 31, December 31,
2004 2003
------------ ------------
Trust preferred debt issued to BIC Statutory Trust I $ 8,248,000 $ 8,248,000
Trust preferred debt issued to BIC Statutory Trust II 7,217,000 7,217,000
Bank note payable 600,000 -
------------ ------------
Total debt obligations 16,065,000 15,465,000
------------ ------------
Total shareholders' equity 34,356,588 33,365,028
------------ ------------
Total capitalization $ 50,421,588 $ 48.830.028
============ ============
Ratio of total debt obligations to total capitalization 31.9% 31.7%
In December 2002, we organized BIC Statutory Trust I ("BIC Trust I"), a
Connecticut special purpose business trust, which issued $8,000,000 of floating
rate trust preferred capital securities in an exempt private placement
transaction. In September 2003, we organized BIC Statutory Trust II ("BIC Trust
II"), a Delaware special purpose business trust, which issued $7,000,000 of
floating rate trust preferred capital securities in an exempt private placement
transaction. BIC Trust I and BIC Trust II (collectively, the "Trusts") were
formed for the sole purpose of issuing and selling the floating rate trust
preferred capital securities and investing the proceeds from such securities in
junior subordinated debentures of the Company. In connection with the issuance
of the trust preferred capital securities, the Company issued junior
subordinated debentures of $8,248,000 and $7,217,000 to BIC Trust I and BIC
Trust II, respectively. The floating rate trust preferred capital securities and
the junior subordinated debentures have substantially the same terms and
conditions. The Company has fully and unconditionally guaranteed the obligations
of the Trusts with respect to the floating rate trust preferred capital
securities. The Trusts distribute the interest received from the Company on the
junior subordinated debentures to the holders of their floating rate trust
preferred capital securities to fulfill their dividend obligations with respect
to such trust preferred securities. BIC Trust I's floating rate trust preferred
capital securities, and the junior subordinated debentures issued in connection
therewith, pay dividends and interest, as applicable, on a quarterly basis at a
rate equal to three month LIBOR plus four hundred basis points (5.12% and 5.34%
at March 31, 2004 and 2003, respectively), are redeemable at par on or after
December 4, 2007 and mature on December 4, 2032. BIC Trust II's floating rate
trust preferred capital securities, and the junior subordinated debentures
issued in connection therewith, pay dividends and interest, as applicable, on a
quarterly basis at a rate equal to three month LIBOR plus four hundred and five
basis points (5.16% at March 31, 2004), are redeemable at par on or after
September 30, 2008 and mature on September 30, 2033. The proceeds from the
junior subordinated debentures were used for general corporate purposes and
provided additional financial flexibility for the Company. The terms of the
junior subordinated debentures contain various restrictive covenants. As of
March 31, 2004, the Company was in compliance with all such covenants.
15
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
We also have a $10,000,000 unsecured revolving line of credit with a maturity
date of June 30, 2007 with a $600,000 outstanding balance at March 31, 2004
(none at December 31, 2003). The revolving line of credit provides for interest
payable quarterly at an annual rate equal to the prime rate less 75 basis
points. Under the terms of the revolving credit agreement, our consolidated
shareholders' equity must not fall below $20,000,000 and Ohio Indemnity's ratio
of net premiums written to policyholders surplus cannot exceed three to one.
The short-term cash requirements of our property/casualty business primarily
consists of paying losses and LAE, reinsurance premiums and day-to-day operating
expenses. Historically, the Company has met those requirements through cash
receipts from operations, which consist primarily of insurance premiums
collected, reinsurance recoveries and investment income. Our investment
portfolio is 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.
Because of the nature of the risks we insure, losses and LAE 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 property/casualty insurance products. Therefore,
we believe that we can estimate our cash needs to meet our loss and expense
obligations through the end of 2004. 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 2004. At March 31, 2004, cash and short-term
investments amounted to $34,451,276 or 45.6% of our total cash and invested
assets.
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.
Cash flows used in operating activities totaled $1,933,466 and $220,273 for the
three months ended March 31, 2004 and 2003, respectively. The increase in the
first quarter 2004 (as compared to the first quarter 2003) was primarily the
result of an increase in retrospective premium adjustments paid in the first
quarter 2004 compared to a year ago. These retrospective premiums adjustments
are typically paid annually each first fiscal quarter.
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
without the approval of the Ohio Department of Insurance (the "Department").
During 2004, the maximum amount of dividends that may be paid to Bancinsurance
by Ohio Indemnity without prior approval is limited to $3,629,310. We do not
anticipate receiving any cash dividends from Ohio Indemnity in 2004.
Ohio Indemnity is subject to a Risk Based Capital test applicable to
property/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 as of March 31, 2004.
Given the Company's historic cash flow and current financial results, management
believes that the cash flows from operating activities will provide sufficient
liquidity for the operations of the Company. Our line of credit provides us with
additional liquidity that could be used for short-term cash requirements if cash
from operations and investments is not sufficient. If necessary, we believe our
financial strength continues to provide us with the flexibility and capacity to
obtain funds externally through debt or equity financings on both a short-term
and long-term basis.
DISCLOSURES ABOUT MARKET RISK
During the quarter ended March 31, 2004, 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, 2003. We do not anticipate material changes in our
primary market risk exposures or in how these exposures are managed in future
reporting periods based upon what is known or expected to be in effect during
future reporting periods. For a description of our primary market risk
exposures, see our Annual Report on Form 10-K for the fiscal year ended December
31, 2003.
CRITICAL ACCOUNTING POLICIES
The preparation of the consolidated financial statements requires us to make
estimates, assumptions and judgments that affect the reported amounts of assets,
revenues, liabilities and expenses and related disclosures of contingent assets
and liabilities. We regularly evaluate these estimates, assumptions and
judgments. 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, assumptions and judgments under
different assumptions or conditions. Set forth below are the critical accounting
policies that we believe require significant estimates, assumptions and
judgments and are critical to an understanding of our consolidated financial
statements.
16
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
OTHER-THAN-TEMPORARY IMPAIRMENT OF INVESTMENTS
We continually monitor the difference between the 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. 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 discussion summarizes our process of reviewing our investments for
possible impairment.
Fixed Maturities. On a monthly basis, we review our fixed maturity securities
for impairment. We consider the following factors when evaluating potential
impairment:
- the length of time and extent to which the estimated fair value has
been less than book value;
- 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
principal and interest/dividend payments on the securities in
question;
- the financial condition and future prospects of the issuer,
including any specific events that may influence the issuer's
operations and its ability to make future scheduled principal and
interest payments on a timely basis;
- the independent auditor's report on the issuer's most recent
financial statements;
- buy/hold/sell recommendations of 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 estimated fair value.
Equity Securities. On a monthly basis, we review our equity securities for
impairment. We consider the following factors when evaluating potential
impairment:
- the length of time and extent to which the estimated fair value has
been less than book value;
- whether the decline appears to be related to general market or
industry conditions or is issuer-specific;
- the financial condition and future 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 most recent
financial statements;
- buy/hold/sell recommendations of 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 estimated fair value.
In addition to the monthly valuation procedures described above, we continually
monitor developments affecting our invested assets, paying particular attention
to events that might give rise to impairment write-downs. There were $86,696 in
impairment charges included in net realized gains on investments in the first
quarter 2004 (none in the first quarter 2003). This impairment charge in the
first quarter 2004 related to one fixed income security. Additional impairments
within the portfolio during 2004 are possible if current economic and financial
conditions worsen.
The following table summarizes, for all securities in an unrealized loss
position at March 31, 2004, the estimated fair value and pre-tax gross
unrealized losses by length of time those securities have been continuously in
an unrealized loss position.
Gross
Estimated unrealized
fair value losses
------------ -------------
Fixed maturities:
6 months or less $ 3,626,309 $ 22,330
7-12 months 1,477,594 12,405
Greater than 12 months 1,187,301 27,393
------------ -------------
Total fixed maturities 6,291,204 62,128
------------ -------------
Equities:
6 months or less 1,551,473 88,264
7-12 months - -
Greater than 12 months - -
------------ -------------
Total equities 1,551,473 88,264
------------ -------------
Total $ 7,842,677 $ 150,392
============ =============
17
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
As of March 31, 2004, the Company had unrealized losses on 25 fixed maturity
securities totaling $62,128, including 15, 5, and 5 securities that maintained
an unrealized loss position for 6 months or less, 7-12 months, and greater than
12 months, respectively. All 25 fixed maturity securities each had a fair value
to cost ratio equal to or greater than 97% as of March 31, 2004.
As of March 31, 2004, the Company had unrealized losses on 14 equity securities
totaling $88,264, which all maintained an unrealized loss position for 6 months
or less. Out of the 14 equity securities, 10 securities had a fair value to cost
ratio equal to or greater than 95%, 3 securities had a fair value to cost ratio
between 81% and 89%, and one security had a fair value to cost ratio equal to
73% as of March 31, 2004.
LOSSES AND LOSS ADJUSTMENT EXPENSE RESERVES
Our projection of ultimate loss and 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
and LAE 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 our historical loss development
experience. In using this historical information, we assume that past loss
development is predictive of future development. Our assumptions allow for
changes in claims and underwriting operations, 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 materially from our estimates and from
amounts recorded by us.
We conduct a reserve study using historical losses and LAE by product line or
coverage within product line. We compute a range of reasonable estimates as well
as select an estimate of indicated reserves. The indicated range includes
estimates of expected losses and LAE given the information currently available
to us.
As of March 31, 2004, our indicated reserve range for losses and LAE was $9.4
million to $14.3 million. As our gross reserve of $11.8 million as of March 31,
2004 falls within this range, we believe it is a reasonable provision in the
aggregate for our unpaid losses and LAE obligations as of March 31, 2004.
As of March 31, 2004, losses and LAE reserves, net of reinsurance recoverables,
totaled $8.1 million. Management's recorded best estimate, on a net basis, is
based on various assumptions, including but not limited to, historical
experience and historical loss patterns.
We did not experience any significant change in the number of claims paid (other
than for growth in our business), average claim paid or average claim reserve
that would be inconsistent with the types of risks we insured in prior years.
The increase in claims opened correlates to the increase in policies in force.
Our reserves reflect anticipated salvage and subrogation included as a reduction
to loss and LAE reserves in the amount of $302,762. 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 or material
levels of exposure to claims-made extended reporting options.
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 as follows:
- ULI - non-aggregate limit
- ULI - aggregate limit (in which the policy runs at a target loss
ratio)
- CPI
- GAP
- UC
Our reserves for these independently estimated principal insurance products
comprise the majority of our total recorded loss and allocated LAE reserves as
of March 31, 2004 on both 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).
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BANCINSURANCE CORPORATION
AND SUBSIDIARIES
Annual accident year loss development triangles were used to estimate ultimate
loss and allocated LAE for the ULI non-aggregate limit, CPI, GAP and UC
policies. Our data for the ULI aggregate limit policies consisted of premium and
loss data and target loss ratio by insured bank. This data was used to determine
the required reserve under the target 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.
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 ultimate
losses. Therefore, ultimate values for immature accident years are often based
on alternative estimation techniques.
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 2000 through 2003.
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 UC reserve is pure IBNR and the ULI, CPI 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% to 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.
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 income statement as work progresses. Adjustments to contract cost estimates
are made in the periods in which the facts that 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 deferred revenue which is carried as a
liability.
OFF-BALANCE SHEET TRANSACTIONS
We do not have any off-balance sheet arrangements that either have, or are
reasonably likely to have, a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources that is
considered material.
FORWARD-LOOKING INFORMATION
Certain statements made in this report are forward-looking and are made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. These statements include, without limitation, 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 fiscal year 2004 and beyond. The
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties that may cause actual results to differ materially from
those statements. Factors that might cause actual results to differ from those
statements 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 or 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 filings with the Securities and Exchange Commision, including
the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2003, any one of which factors 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.
19
BANCINSURANCE CORPORATION
AND SUBSIDIARIES
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 - Disclosures About Market Risk."
ITEM 4. CONTROLS AND PROCEDURES
With the participation of our management, including our principal executive
officer and principal financial officer, we have evaluated the effectiveness of
our disclosure controls and procedures (as defined in Rules 13a-15 and 15d-15 of
the Securities Exchange Act of 1934 (the "Exchange Act")) as of the end of the
period covered by this report. Based upon that evaluation, our principal
executive officer and principal financial officer have concluded that such
disclosure controls and procedures are effective as of the end of the period
covered by this report to ensure that material information relating to the
Company and its consolidated subsidiaries is made known to them, particularly
during the period for which our periodic reports, including this report, are
being prepared.
In addition, there were no changes during the period covered by this report in
our internal control over financial reporting (as defined in Rules 13a-15 and
15d-15 of the Exchange Act) that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company did not repurchase any common shares during the first quarter 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1* Certification of Principal Executive Officer Pursuant to Rule 13a-14
under the Securities Exchange Act of 1934, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2* Certification of Principal Financial Officer Pursuant to Rule 13a-14
under the Securities Exchange Act of 1934, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1* Certification of Principal Executive Officer and Principal Financial
Officer 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
The Company furnished a Form 8-K, dated February 25, 2004, on
February 25, 2004 to report the issuance of a press release by the
Company announcing results of operations for the fourth quarter
ended December 31, 2003.
- ---------------------
* Filed with this Quarterly Report on Form 10-Q.
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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 7, 2004 By: /s/Si Sokol
----------------------------------------
Si Sokol
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: May 7, 2004 By: /s/Sally Cress
----------------------------------------
Sally Cress
Treasurer and Secretary
(Principal Financial Officer)
21