1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington DC 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
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: 0-18786
PICO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-2723335
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
875 PROSPECT STREET., SUITE 301
LA JOLLA, CALIFORNIA 92037
(619) 456-6022
(Address and telephone number of principal executive offices)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---- ----
The number of shares outstanding of the Registrant's Common Stock, $0.001 par
value, was 32,486,718 as of May 9, 1997. As of such date, 4,572,015 shares of
common stock were held by a subsidiary and an affiliate of the registrant.
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PICO HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
PAGE NO.
--------
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets as of 3
March 31, 1997 and December 31, 1996
Consolidated Statements of Operations 4
for the Three Months Ended March 31, 1997 and 1996
Consolidated Statements of Cash Flows for 5
the Three Months Ended March 31, 1997 and 1996
Notes to Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial 9
Condition and Results of Operations
PART II: OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K 22
Signature 23
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PART I: FINANCIAL INFORMATION
ITEM I: FINANCIAL STATEMENTS
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31, December 31,
1997 1996
--------- -----------
(unaudited)
ASSETS
Investments $ 255,233 $ 266,842
Cash and cash equivalents 62,380 64,581
Investment income receivable 3,284 3,373
Premiums receivable 10,626 14,876
Reinsurance receivables 86,448 96,984
Prepaid deposits and reinsurance premiums 3,240 5,225
Deferred policy acquisition costs 7,310 7,922
Property and equipment, net 5,518 4,717
Deferred income taxes 5,651 5,626
Other assets 5,476 7,588
Net assets of acquired business held for sale 7,281 7,089
Assets held in separate accounts 5,795 5,602
--------- ---------
Total Assets $ 458,243 $ 490,425
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Loss and loss adjustment expense, net of discount $ 239,446 $ 252,024
Future policy benefits 13,774 13,776
Annuity and other policyholders' funds 32,128 31,740
Unearned premiums 30,576 35,297
Reinsurance balances 5,650 7,316
Deferred gain on retroactive reinsurance 3,319 3,355
Integration liability 1,173 1,368
Other liabilities 8,783 23,731
Excess of fair value of net assets acquired over purchase price 6,123 6,293
Liabilities related to separate accounts 5,795 5,601
--------- ---------
Total Liabilities 346,767 380,501
--------- ---------
MINORITY INTEREST (324) (280)
--------- ---------
SHAREHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized 2,000,000 shares,
none issued
Common stock, $.001 par value; authorized 100,000,000 shares,
issued 32,486,718 32 32
Additional paid-in capital 42,802 42,965
Treasury stock, at cost (common shares 1,940,315) (7,845) (7,845)
Retained earnings 66,218 64,227
Cumulative foreign currency adjustments (25) (27)
Unrealized appreciation on investments 11,500 11,838
Equity changes of investee company (882) (986)
--------- ---------
Total Stockholders' Equity 111,800 110,204
--------- ---------
Total Liabilities and Stockholders' Equity $ 458,243 $ 490,425
========= =========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(in thousands, except share data)
Three Months Ended March 31,
---------------------------
1997 1996
---- ----
REVENUES: (unaudited)
Premium income $ 15,088 $ 7,175
Investment income 4,194 2,594
Realized gains on investments 2,940 704
Real Estate sales 1,496
Commission and other income 403 247
----------- -----------
Total revenues 22,625 12,216
----------- -----------
EXPENSES:
Loss and loss adjustment expenses 11,519 2,772
Future policy benefits 276 99
Interest credited to policyholders 580 585
Policy acquisition costs 51
Cost of real estate sales 1,404
Insurance underwriting and other expenses 7,288 4,600
----------- -----------
Total expenses 19,663 9,511
----------- -----------
Equity in earnings of investee 8 206
----------- -----------
Income before income taxes 2,970 2,911
Provision for federal and state income taxes 978 939
----------- -----------
Net income $ 1,992 $ 1,972
=========== ===========
Net income per common share (primary and fully diluted) $ 0.06 $ 0.07
=========== ===========
Weighted average number of shares outstanding 33,423,501 27,281,355
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
Three Months Ended
------------------
March 31, March 31,
1997 1996
------ ------
OPERATING ACTIVITIES:
Net cash (used in) provided by operating activities $ (16,363) $ (5,733)
------------ ------------
INVESTING ACTIVITIES:
Investments purchased (87,044) (16,002)
Investments sold 51,617 27,178
Investments matured 51,349 3,128
Net sales of real estate (1) 1,483
Proceeds from sale of property and equipment 10
Purchases of property and equipment (315) (27)
------------ ------------
Net cash (used in) provided by investing activities 15,606 15,770
------------ ------------
FINANCING ACTIVITIES:
Net increase in annuity and other policyholders' funds 599
Proceeds from sale of business (1,882)
(Purchase) issuance of treasury stock (163)
------------ ------------
Net cash (used in) providing financing activities (1,446) 0
------------ ------------
Effect of exchange rate changes on cash 2 (2)
------------ ------------
NET (DECREASE) INCREASE IN CASH (2,201) 10,035
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 64,581 43,988
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 62,380 $ 54,023
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for:
Interest $ 0 $ 0
============ ============
Income taxes $ 11,400,000 $ 0
============ ============
Conversion of Series A preferred stock
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
PICO Holdings, Inc. and Subsidiaries (the "Company") have been prepared in
accordance with the interim reporting requirements of Form 10-Q, pursuant
to the rules and regulations of the Securities and Exchange Commission
("SEC"). Accordingly, they do not include all of the information and notes
required by generally accepted accounting principles for complete
financial statements.
In the opinion of management, all adjustments and reclassifications
considered necessary for a fair and comparable presentation of financial
position as of March 31, 1997 and December 31, 1996 and results of
operations and cash flows for the three months ended March 31, 1997 and
March 31, 1996 have been included and are of a normal recurring nature.
Operating results for the three months ended March 31, 1997, are not
necessarily indicative of the results that may be expected for the year
ending December 31, 1997.
These financial statements should be read in conjunction with the
Company's audited financial statements and notes thereto, together with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and Risks and Uncertainties contained in the Company's Annual
Report on Form 10-K for the year ended December 31, 1996 as filed with the
SEC.
2. ACQUISITION
On November 20, 1996, Physicians Insurance Company of Ohio ("Physicians")
consummated a transaction (the "Merger") pursuant to which Citation
Holdings, Inc. ("Holdings"), a wholly owned subsidiary of Citation
Insurance Group ("CIG"), merged with and into Physicians pursuant to an
Agreement and Plan of Reorganization dated as of May 1, 1996 with
Physicians being the accounting acquiror. Pursuant to the Merger, each
outstanding share of the common stock of Physicians was converted into the
right to receive 5.0099 shares of CIG's common stock. CIG's other
significant direct and indirect subsidiaries just prior to the merger were
CIC and CNIC. Upon the consummation of the merger, CIG changed its name to
PICO Holdings, Inc., which is the continuing registrant.
As a result of the Merger, the former shareholders of Physicians own
approximately 80% of the outstanding common stock of the Company and
control the Board of Directors of the Company. Accordingly, for accounting
purposes, the merger has been treated as a recapitalization of Physicians
with Physicians as the acquirer (i.e., a reverse acquisition). Therefore,
the statements of operations and cash flows for the three month period
ended March 31, 1996 represent the historical results of Physicians and
its subsidiaries, which is the predecessor entity.
The Merger was accounted for under the purchase method of accounting.
Financial results for the year ended December 31, 1996 include the
operations of CIG as if the Merger had occurred on November 1, 1996.
Financial activity for the period November 1, 1996 through November 20,
1996 was not significant.
The excess of the fair value of the net assets acquired over the purchase
price of such net assets (negative goodwill) is being amortized over a 10
year period using the straight-line method. As discussed in Note 7, the
Company entered into a Letter of Intent in January 1997 to sell the net
assets related to CIC's workers' compensation operations. The sale of the
net assets related to CIC's workers' compensation operations is expected
to be completed in the second quarter of 1997.
The Company has accounted for the allocation of the purchase price and the
net assets of CIC's workers' compensation line of business in accordance
with the FASB's Emerging Issues Task Force Abstract 87-11 "Allocation of
Purchase Price to Assets to be Sold" ("EITF 87-11"). Accordingly, the net
assets related to CIC's workers' compensation line of business as of March
31, 1997 and December 31, 1996 have been reflected on a single line item
in the accompanying balance sheet as Net Assets of Acquired Business Held
for Sale. The fair value assigned to such net assets was based upon
management's estimate of the proceeds from the sale of CIC's workers'
compensation line of business of approximately $7.7 million less the
estimated loss from operations for such line of business during the
expected holding period of November 1996 through April 1997 of
approximately $0.5 million.
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PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED
The pre-tax loss from operations related to CIC's workers' compensation
line of business excluded from the Company's statement of operations for
the three months ended March 31, 1997 was approximately $192,318.
The difference between the carrying amount of the net assets of CIC's
workers compensation line of business at the date of sale and the actual
proceeds from such sale will result in a reallocation of the purchase
price of CIG. Such reallocation is expected to be inmaterial.
The following unaudited pro forma information presents a summary of
consolidated results of operations of the Company and CIG and its
subsidiaries for the three months ended March 31, 1996 as if the
acquisition of CIG and its subsidiaries occurred at the beginning of 1996,
with proforma adjustments to give effect to the amortization of goodwill
and the accounting for CIC's workers' compensation line of business held
for sale in accordance with EITF 87-11, as discussed above (in thousands,
except per share data):
1996
---------
Total revenues $ 22,322
Income before income taxes 3,567
Net income (2,628)
Net income per share $ 0.08
These unaudited pro forma results have been prepared for comparative
purposes and do not purport to be indicative of the results of operations
which actually would have resulted had the combinations been in effect on
January 1, 1996 or of future results of operations of the consolidated
entity.
3. INVESTMENTS
Equity securities include certain warrants to purchase the common stock of
a publicly traded company. The estimated fair value of such warrants is
their intrinsic value based on the quoted market price of the underlying
common stock of the investee company. The estimated fair value and cost of
such warrants were $17,480,407 and $240,000, respectively, as of March 31,
1997, and $14,530,957 and $240,000, respectively, as of December 31, 1996.
4. EARNINGS
Primary net income per share is computed by dividing net income by the
weighted average number of common stock and common stock equivalents
outstanding for the period with the average number of common stock
equivalents outstanding calculated using the treasury stock method
based on the average market price of the shares during the period.
Fully diluted net income per share is computed on the same basis,
except that, if it results in a more dilutive impact, the number of
common stock equivalents related to stock options is based on the
period-end market value of the shares instead of the average market
value during the period. The weighted average number of shares
outstanding for the three months ended March 31, 1996 used in the
calculation of earnings per share have been recomputed to give effect
to the stock exchange ratio utilized in connection with the reverse
acquisition of Citation Insurance Group consummated on November 20,
1996 (Note 2).
5. COMMITMENTS AND CONTINGENCIES
The Company is subject to various litigation which arises in the
ordinary course of its business. Based upon information presently
available, management is of the opinion that such litigation will not
have a material adverse effect on the Company's consolidated financial
position or results of operations.
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PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED
6. RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128 Earnings per
Share ("SFAS No. 128"). SFAS No. 128 requires dual presentation of
newly defined basic and diluted earnings per share on the face of the
income statement for all entities with complex capital structures. The
accounting standard is effective for fiscal years ending December 15,
1997, including interim periods. The Company does not believe that the
adoption of SFAS No. 128 will have a material impact on the computation
of its earnings per share in future periods.
7. SUBSEQUENT EVENTS
In January 1997, the Company signed a Letter of Intent to sell the net
assets related to CIC's workers' compensation business. Under the
terms of the Letter of Intent, the transaction will be structured as a
purchase of all the issued and outstanding shares of stock of CNIC.
CIC will reinsure all of its workers' compensation business into CNIC
and transfer all employees working on the workers' compensation
business to CNIC prior to the closing. The purchase price was estimated
to be approximately $7.7 million and would be paid in cash.
On May 7, 1997 PICO Holdings, Inc. ("PICO") announced the signing of
the definitive agreement for the sale of CIC's and CNIC's workers'
compensation business to Fremont Compensation Insurance Group. The sale
price was approximately $7.5 million. The transaction will take the
form of a sale of the outstanding shares of CNIC. The transaction is
subject to regulatory approval and satisfaction of closing conditions.
Closing is expected to occur mid-year.
On April 14, 1997, GEC and PICO announced an agreement for the purchase
of Nevada Land and Resource Company, LLC, owner of approximately
1,365,000 acres of deeded land in northern Nevada. The total purchase
price is approximately $53.7 million. GEC will own approximately 75
percent of Nevada Land and Resource. PICO Holdings, Inc. Will pay
approximately $12 million for the remaining interest. PICO Holdings,
Inc. and Physicians have committed to purchase a debenture from GEC for
approximately $25 million to help finance GEC's portion.
GEC will finance its portion of the acquisition in part by issuing to
Phyisicians a 7% debenture in the principal amount of approximately $25
million (U.S.). The debenture will mature on the earlier of 180 days
after the closing of the land acquisition or the closing of any public
offering of common shares of GEC within 180 days. If a public offering
of shares is not completed, the debenture will be convertible upon
maturity into nearly 9.4 million common shares of GEC. If a public
offering of shares is completed, the debenture will be convertible
into the number of shares that will enable PICO to maintain its
approximate 38.2% ownership interest in GEC. This offering would carry
an exercise price of C$2.59 per share.
On April 24, 1997, PICO and GEC announced the completion of the
purchase of Nevada Land and Resource Company, LLC. and the financing
as defined above was consummated.
Also on April 14, 1997, Physicians paid a dividend of approximately
$8.6 million to PICO Holdings, Inc. This dividend was not considered
an "extraordinary" dividend requiring specific regulatory approval,
since (1) it was paid out of statutory surplus, and (2) it, plus all
other dividends paid by Physicians within the previous twelve months,
did not exceed Physicians' net income as filed with the Ohio Insurance
Department for the previous calendar year ended December 31, 1996 of
approximately $21.8 million.
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This section of the Report contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Discussion containing such forward-looking statements may be found in
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the captions "Background," "Results of Operations--Three Months
Ended March 31, 1997 and 1996," "Liquidity and Capital Resources," and "Risk
Factors and Uncertainties." Actual results for future periods could differ
materially from those discussed in this section as a result of the various risks
and uncertainties discussed herein. A comprehensive summary of such risks and
uncertainties can be found in the Company's registration statement on Form S-4
(File No. 333-06671), which was declared effective on October 3, 1996.
INTRODUCTION
- ------------
Readers of the Company's prior financial statements will find that these
financial statements differ greatly from those presented for periods prior to
December 31, 1996. Whereas the Company was previously engaged predominantly in
property and casualty operations, PICO Holdings, Inc. and subsidiaries ("PICO"
or "the Company") currently operates primarily as an insurance and investment
company, specializing in portfolio investing, property and casualty insurance,
life and health insurance, and investment management and other services.
These changes are a result of the November 20, 1996 merger of Physicians
Insurance Company of Ohio and a subsidiary of the Company, in which Physicians
Insurance Company of Ohio was the surviving corporation ("the Merger"). Upon
consummation of the Merger, the Company which was previously known as Citation
Insurance Group changed its name to PICO Holdings, Inc. For accounting purposes
the Merger was treated as a reverse acquisition with Physicians Insurance
Company of Ohio ("Physicians") being the acquiror. As a result, these financial
statements reflect prior years data of Physicians and its subsidiaries and
affiliates only. Citation Insurance Group's prior years' operating results and
account balances prior to the Merger have not been included in these financial
statements. See PICO's Form 10-K as filed with the United States Securities and
Exchange Commission for the fiscal year ended December 31, 1996, Note 3 to the
Consolidated Financial Statements entitled "Acquisitions" for further
information on the accounting treatment of the reverse acquisition.
BACKGROUND
- ----------
Prior to July 16, 1995, the effective date of Physicians' and The Professionals
Insurance Company's ("PRO")'s 100% quota share reinsurance of their medical
professional liability ("MPL") businesses with Mutual Assurance, Inc. ("Mutual")
and the subsequent sale of the rights to these MPL books of business, effective
January 1, 1996, the Physicians Insurance Company of Ohio group of affiliated
companies consisted primarily of two property and casualty insurance companies
writing MPL insurance (Physicians and PRO) and one life and health insurance
company-American Physicians Life Insurance Company ("APL"). For various
reasons, in November 1994, the respective boards of directors of Physicians and
PRO determined that it was in the best interests of Physicians and PRO and their
respective shareholders to sell their MPL insurance businesses. This sale was
part of an overall shift in the strategic direction of Physicians and PRO.
On August 1, 1995, Physicians purchased Sequoia Insurance Company ("Sequoia"), a
California property and casualty insurance company writing light commercial and
multiple peril insurance in northern and central California. Sequoia does not
write MPL insurance.
On September 5, 1995, Physicians purchased 38.2% of the common stock of Global
Equity Corporation ("GEC"), a Canadian company operating in portfolio
investments, agricultural services, and other business segments.
On November 20, 1996, Physicians and its subsidiaries merged with a subsidiary
of Citation Insurance Group ("CIG") and CIG changed its name to PICO Holdings,
Inc. This reverse merger brought two more California property and casualty
insurance companies into the affiliated group: Citation Insurance Company
("CIC") and Citation National Insurance Company ("CNIC"), collectively referred
to as "Citation". This merger also provided a noninsurance holding company able
to engage in portfolio investing and other activities with fewer restrictions
than those imposed upon insurance companies.
See Note 7 of these Consolidated Financial Statements for additional information
regarding events affecting PICO subsequent to March 31, 1997.
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
In addition to the operation of PICO's subsidiaries, PICO's objective is to use
its resources and those of its subsidiaries and affiliates to increase
shareholder value through investments in businesses which PICO believes are
undervalued. PICO's acquisition philosophy is to make selective investments,
predominantly in public companies, for the purpose of enhancing and realizing
additional value by means of appropriate levels of shareholder influence and
control. This could involve the restructuring of the financing or management of
the companies in which PICO invests. It may also encompass initiating and
facilitating mergers and acquisitions within the relevant industry to achieve
constructive rationalization. This business strategy was adopted in late 1994,
but was not fully implemented until 1996. Therefore, the results of this
business strategy are not fully reflected in the historical financial statements
prior to 1996.
RESULTS OF OPERATIONS -- THREE MONTHS ENDED MARCH 31, 1997 AND 1996
SUMMARY
- -------
PICO reported net income of approximately $2.0 million or $.06 per share for the
first three months of 1997, compared with net income of approximately $2.0
million, or $.07 per share during the same 1996 period. Period-to-period
comparisons are somewhat distorted due to the addition of the Citation group
effective November 20, 1996. Citation added approximately $0.3 million to
consolidated net income during the first quarter of 1997.
Adjusted book value per share increased to $3.66 during the first quarter of
1997 from $3.61 at December 31, 1996. Shareholders' equity increased $1.6
million over the December 31, 1996 level to $111.8 million, principally as a
result of the $2.0 million net income, partially offset by a $338,000 decline in
unrealized appreciation of securities, net of tax.
Net realized investment gains accounted for more than $2.9 million of pre-tax
income during the first quarter of 1997, compared to $0.7 million during the
same 1996 period. First quarter 1996 results included $3.5 million in medical
professional liability reserve reductions due to favorable claims experience,
pre-tax.
First quarter 1997 results include $155,000 from the amortization of negative
goodwill related to the November 20, 1996 merger between Physicians and the
former Citation Insurance Group. Anticipation of amortization $6.1 million of
negative goodwill will increase pre-tax revenues by approximately $620,000
each year through the year 2006.
PICO's operations are organized into five segments: portfolio investing, life
and health insurance, property and casualty insurance, medical professional
liability insurance, and other operations.
Revenues and pre-tax income by segment are shown in the following schedules:
PICO HOLDINGS, INC.
THREE MONTHS ENDED
MARCH 31,
------------------
1997 1996
---- ----
(in millions)
REVENUES BY BUSINESS SEGMENT:
- ----------------------------
Portfolio Investing $ 3.2 $ 0.5
Life and Health Insurance 1.6 1.7
Property and Casualty Insurance 16.6 4.6
Medical Professional Liability Insurance 1.1 3.8
Other 0.1 1.6
----- -----
Total Revenues $22.6 $12.2
===== =====
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
THREE MONTHS ENDED
MARCH 31,
------------------
1997 1996
---- ----
(in millions)
PRE-TAX INCOME (LOSS) BY BUSINESS SEGMENT:
- ------------------------------------------
Portfolio Investing $2.9 $0.0
Life and Health Insurance 0.2 0.3
Property and Casualty Insurance 0.9 (0.3)
Medical Professional Liability Insurance (0.7) 3.1
Other (0.3) (0.2)
---- ----
Total Pre-tax Operating Income $3.0 $2.9
==== ====
PORTFOLIO INVESTING
- -------------------
Portfolio investing operations are principally conducted by Physicians within
certain regulatory guidelines established by the Ohio Department of Insurance.
Investment revenues and realized investment gains or losses generated by
Physicians and PRO are first allocated to MPL equal to the amount of loss
reserve discount accretion recorded during the period. The remainder is shown as
portfolio investing revenue.
For a number of reasons including the existence of an experienced claims
department and Physicians' success in managing invested assets, it was decided
that it would be more advantageous for Physicians to manage the assets remaining
at the cessation of writing MPL business than to sell off or fully reinsure the
reserves. As a result, assets are managed for the maximum overall return, within
prudent safety guidelines. Assets are not designated on an individual security
basis as either MPL or portfolio investing. As a result, Physicians' invested
assets produce income in both MPL and portfolio investing segments.
Revenues from portfolio investing operations increased to $3.2 million during
the first quarter of 1997, representing a $2.7 million improvement over the
first quarter of 1996. Net realized investment gains from portfolio investing of
$2.6 million accounted for $2.4 million of this increase. Investment income
attributable to portfolio investing in the first quarter of 1997 increased
nearly $300,000 over the 1996 first quarter, principally as a result of an
approximate $400,000 decrease in discount accretion related to the declining
level of MPL claims.
Portfolio investing revenues are summarized below:
PORTFOLIO INVESTING
THREE MONTHS ENDED
MARCH 31,
-------------------
1997 1996
---- ----
(in millions)
REVENUES:
- --------
Realized Investment Gains $2.6 $0.2
Investment Income 0.6 0.3
---- ----
Portfolio Investing Revenues $3.2 $0.5
==== ====
Net unrealized investment gains at March 31, 1997 amounted to $11.5 million, net
of taxes, down $338,000 from the December 31, 1996 level. Part of this decline
resulted from the conversion of unrealized investment gains to realized
investment gains during the first quarter as a result of sale of Physicians'
holdings in its Amvestors common stock at a gain of $1.3 million, net of tax.
Unrealized gains, net of taxes, attributable to Amvestors at December 31, 1996
were $1.2 million.
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
This does not include all of the appreciation of Physicians' investment in GEC
common stock, since GEC is recorded on Physicians' books at GEC's equity value
which, per share, is less than the fair market value of the GEC stock.
Management believes its new strategic focus is succeeding as well as or better
than expected, as evidenced by growth during the past two to three years. PICO
intends to continue to make selective investments for the purpose of enhancing
and realizing additional value by means of appropriate levels of shareholder
influence and control, as well as to operate its subsidiaries to obtain maximum
shareholder value. Nevertheless, while past results are very encouraging, future
results cannot and should not be predicted based upon past performance alone.
Portfolio investing operations contributed $2.9 million to pre-tax income during
the first quarter of 1997, compared to a break-even during the first quarter of
1996. Increased realized investment gains in the first quarter of 1997 accounted
for nearly all the fluctuation between years.
The breakdown of pre-tax income from portfolio investing operations follows:
PORTFOLIO INVESTING
THREE MONTHS ENDED
MARCH 31,
-----------------------
1997 1996
---- ----
(in millions)
PRE-TAX INCOME:
- --------------
Physicians and PRO $ 3.2 $ (0.3)
Equity in Unconsolidated Subsidiaries 0.0 0.2
Other (0.3) 0.1
-------- --------
Investment Banking Operating Income $ 2.9 $ 0.0
======== ========
Equity in unconsolidated subsidiaries represents Physicians' share of GEC's
operating income.
LIFE AND HEALTH INSURANCE
- -------------------------
APL, Physicians' wholly-owned life insurance subsidiary, produced the following
revenues and pre-tax income:
LIFE AND HEALTH INSURANCE
THREE MONTHS ENDED
MARCH 31,
-------------------
1997 1996
---- ----
(in millions)
REVENUES:
- --------
Net Earned Premiums $0.6 $0.5
Investment Income 0.8 0.8
Realized Investment Gains 0.1 0.3
Other Income 0.1 0.1
---- ----
Revenues from Life and Health Insurance $1.6 $1.7
==== ====
PRE-TAX INCOME:
- ---------------
PIC/APL $0.2 $0.3
==== ====
First quarter 1997 and 1996 revenues were nearly identical at $1.6 million and
$1.7 million, respectively. The principal difference in revenues between the two
quarters was a $0.1 million increase in earned premiums and a $0.2
12
13
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
million decrease in realized capital gains. The increase in earned premiums
reflects growth in APL's critical illness product, "Survivor Key," which APL has
been concentrating its efforts on during the past few years. This life insurance
product combines the benefits of a lump sum cash payout upon the diagnosis of
certain critical illnesses with a death benefit. Gross written premiums for
Survivor Key have increased from $96,000 in 1994 to $257,000 in 1995 and
$547,000 in 1996. Gross written Survivor Key premiums for the first quarter of
1997 were $150,000 compared to $112,000 during the first quarter of 1996.
The following exhibit shows the breakdown of life and health net earned
premiums:
LIFE AND HEALTH INSURANCE NET EARNED PREMIUMS
THREE MONTHS ENDED
MARCH 31,
--------------------
1997 1996
---- ----
(in millions)
Life Insurance $ 0.6 $ 0.4
Health Insurance 0.0 0.1
---- ----
Net Earned Premiums $0.6 $0.5
==== ====
Life and health operations resulted in first quarter 1997 pre-tax income of
$164,000. This compares to $260,000 in 1996 first quarter. Realized investment
gains decreased approximately $200,000 as compared to the first quarter of 1996,
accounting for most of this difference. Going the opposite direction, earned
premiums increased approximately $100,000 over the 1996 first quarter.
PROPERTY AND CASUALTY INSURANCE
- -------------------------------
Sequoia, CIC and CNIC currently account for all of the ongoing property and
casualty ("P & C") insurance revenues. These companies predominately write light
commercial and multi peril insurance coverage in central and northern
California.
Since CIC and CNIC became part of the group in November 1996, their activities
are not included in PICO's first quarter 1996 results. Sequoia, however, has
been part of the group since August 1995.
Total P & C revenues for the first quarter of 1997 of $16.6 million exceeded
those of the 1996 first quarter by $12.0 million. Of this $12.0 million
increase, $7.2 million was added by CIC and CNIC, accompanied by a $3.2 million
increase in Sequoia's earned premiums. Investment income rose $1.5 million
during the same period. Citation added $1.1 million in investment income and a
realized investment loss of $236,000 during the 1997 first quarter.
PROPERTY AND CASUALTY INSURANCE
THREE MONTHS ENDED
MARCH 31,
--------------------
1997 1996
---- ----
(in millions)
REVENUES:
- --------
Earned Premiums- Sequoia $7.3 $4.1
Earned Premiums- Citation 7.2
Investment Income 1.7 0.2
Realized Investment Gains 0.2 0.2
Other 0.2 0.1
---- ----
P & C Revenues $16.6 $ 4.6
===== =====
13
14
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
PRE-TAX INCOME (LOSS):
---------------------
Sequoia and Citation $ 0.9 $ (0.3)
===== =======
Sequoia added nearly $500,000 to the first quarter pre-tax income of $900,000,
compared to $300,000 loss during the comparable 1996 period. Citation, not
included in the first quarter 1996 results, contributed $400,000 in pre-tax
income to the first three months of 1997.
Although Sequoia's earned premiums increased $3.2 million during the first
quarter of 1997, direct written premiums actually declined. Sequoia's first
quarter 1997 direct premium writings were $7.9 million compared to $10.7 million
during the first quarter of 1996. Sequoia's first quarter 1996 ratio of earned
premiums to written premiums was much lower than during the comparable 1997
period due to the fact that Sequoia was purchased on August 1, 1995, resulting
in only eight months worth of inforce premiums in Sequoia's book of business
available to be earned as of March 31, 1996, compared to a full twelve months
available at the end of the first quarter of 1997.
The reduction in direct premium writings reflects the increased underwriting
selectivity of Sequoia's new management team. Sequoia stresses quality of
business over quantity. As policies come up for renewal, they are reviewed
carefully by underwriting management for excessive loss experience and unwanted
risks. While new business writings have not offset renewal policies canceled or
non-renewed, new policy writings have been better than expected. The loss of
renewal policies with higher loss ratios and greater exposures to risk may
improve Sequoia's loss ratios in the future. However, there can be no assurance
that Sequoia will be successful in reducing its policies with higher loss ratios
or that its loss ratios will improve in the future.
Property and casualty insurance operations produced pre-tax income of $857,000.
Citation contributed $412,000 of this amount.
Sequoia's ratios as determined on the basis of generally accepted accounting
principles ("GAAP") were as follows:
FIRST
QUARTER FISCAL
1997 1996
---- ----
Loss and LAE Ratio 72.1% 62.9%
Underwriting Expense Ratio 35.9% 38.0%
----- -----
GAAP Combined Ratio 108.0% 100.9%
===== =====
Sequoia's increased first quarter 1997 loss and LAE ratio as compared to the
12-month 1996 ratio reflects the impact of heavy California GAAPia flooding
during the first three months of the year.
A combined ratio of 100% indicates that insurance operations are breaking even
without the aid of investment income. On a GAAP basis, after considering the
effects of deferred acquisition costs, Sequoia's first quarter 1997 combined
ratio was 108.0% Although Sequoia's GAAP combined ratio was eight percentage
points higher than break-even for the first quarter of 1997, Sequoia realized
investment gains of $462,000, producing a pre-tax profit of $422,000.
Citation's ratios excluding the workers' compensation line of business were:
FIRST
QUARTER
1997
--------
Loss and LAE Ratio 74.6%
Underwriting Expense Ratio 35.7%
-----
GAAP Combined Ratio 110.3%
=====
14
15
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
MPL OPERATIONS
- --------------
Physicians' and PRO's MPL insurance businesses were sold to Mutual on August 28,
1995. Except for a few minor policy coverage extensions and adjustments, for all
intents and purposes, Physicians ceased writing MPL policies effective January
1, 1996. Physicians continues to administer and adjust the remaining claims and
LAE reserves. Based upon careful analysis of various alternative scenarios for
handling the runoff of the remaining claims reserves, Physicians determined that
the best option was to process the existing claims internally with existing
staff, rather than through a third party administrator or through an outright
sale of the claims and LAE reserves. In addition, it is expected that
shareholders' equity may be better served by retaining the investments necessary
to fund the payment of these claims and LAE reserves, managing them along with
the rest of the Physicians' investment holdings, as opposed to selling or fully
reinsuring these reserves and giving up the corresponding funds. However, there
can be no assurance that funds generated by such retained investments will
exceed claims. Accordingly, although Physicians ceased writing MPL insurance,
MPL is treated as a separate business segment of continuing operations due to
the continued management of claims and associated investments. Revenues from MPL
operations included the following:
MEDICAL PROFESSIONAL LIABILITY INSURANCE
THREE MONTHS ENDED
MARCH 31,
---------------------
1997 1996
------- ------
(in millions)
REVENUES:
- ---------
Earned Premiums $ 0.0 $2.5
Investment income, Net of Expenses 1.1 1.3
----- ----
MPL Revenues $ 1.1 $3.8
===== ====
PRE-TAX INCOME (LOSS): $(0.7) $3.1
- ---------------------- ===== ====
Since the withdrawal of Physicians and PRO from personal automobile and
homeowners lines of business in the late 1980's, MPL has been these two
companies' only sources of significant insurance premiums. The decline in earned
premium from $2.5 million during the first quarter of 1996 to zero in the first
quarter of 1997 is a result of the withdrawal from the MPL line of business
beginning with the 100 percent quota share treaty with Mutual effective July 16,
1995.
The following table shows the decline in Physicians' and PRO's direct written
premiums over the past five years:
1996 1995 1994 1993 1992
-------- ------- ------- ------- -----
(in millions)
$0.2 $22.6 $28.0 $37.6 $52.6
The decline in direct written premiums shown above is reflective of the
increasing competitive pressures within Ohio which, among other factors, led
Physicians and PRO to increase premium rates, to be more selective in
underwriting and, ultimately, to withdraw from the MPL line of business.
MPL premiums continued to be earned during 1996 based upon premiums written
prior to July 16, 1995, the effective date of the 100 percent quota share treaty
with Mutual. Very few, if any, MPL premiums will be earned in 1997. Investment
income revenues will continue to accrue to the MPL runoff.
15
16
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
MPL operations produced a pre-tax loss of $0.7 million during the first quarter
of 1997 compared to $3.1 million in income during the first quarter of 1996.
Operating costs accompanied by certain non-recurring expense accruals associated
with the runoff of the MPL business were responsible for this first quarter 1997
loss. First quarter 1996 results were improved by a $3.5 million reduction in
reserve estimates due to continued favorable claims experience. Reserves
continued to develop favorably during the remainder of 1996, resulting in
further reserve reductions in the fourth quarter of 1996.
Physicians' claims department staff continues to process the runoff of the
remaining MPL loss and loss adjustment expense claims which is progressing
routinely. At March 31, 1997, MPL reserves totaled $106.3 million, net of
reinsurance and discount. This compares to $112.9 million at December 31, 1996.
MPL loss and LAE reserves continue to decline as a result the disposition of
claims.
MPL INSURANCE - LOSS AND LAE RESERVES
AS OF AS OF
MARCH 31, YEAR END,
1997 1996
-------- --------
(in millions)
Direct Reserves $151.2 $158.4
Ceded Reserves (33.6) (33.3)
Discount of Net Reserves (11.3) (12.2)
------ ------
Net MPL Reserves $106.3 $112.9
====== ======
OTHER OPERATIONS
- ----------------
Other operations consist principally of Summit Global Management's ("Summit")
investment management operations, the wind down of Raven Development Company's
("Raven") real estate development projects, and various other activities as
summarized below:
OTHER OPERATIONS
THREE MONTHS ENDED
MARCH 31,
------------------
1997 1996
------- ------
(in millions)
REVENUES:
- --------
Real Estate Development $0.0 $1.5
Investment Management 0.3 0.2
Other 0.0 (0.1)
Less: Intercompany Elimination (Summit) (0.2) 0.0
---- ----
Revenue from Other Operations $0.1 $1.6
==== ====
PRE-TAX INCOME (LOSS):
- ---------------------
Investment Management $0.1 $0.0
Other (0.2) (0.2)
Less: Intercompany Elimination (Summit) (0.2) 0.0
---- ----
Pre-Tax Income-Other Operations $ (0.3) $ (0.2)
==== ====
Due to very few lots remaining in Raven's real estate inventory as a result of
its withdrawal from the real estate development business, the Company's real
estate activity is minimal. There were no real estate sales during the first
quarter of 1997, compared to $1.5 million during the comparable 1996 quarter
when a large tract of land was sold.
16
17
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Investment management revenues and operating income from Summit, before
elimination of intercompany transactions, increased over the 1996 first quarter
by approximately $100,000. Summit has more than $400 million in assets under
management. Summit's revenues have increased due to additional clients and
increased, but competitive portfolio management fees charged to the insurance
companies.
Under the category of "Other," Stonebridge Partners AG ("Stonebridge"), a Swiss
corporation 80 percent owned by Physicians which brokers annuities and other
insurance products within Europe, produced a pre-tax loss of approximately
$220,000 during the first quarters of both 1996 and 1997. Stonebridge began
operations in late 1995, resulting in significant start-up costs in 1995, which
continued into 1996. Management believes that the Stonebridge concept is a good
one which fits well with PICO's other businesses; however, for various reasons,
Stonebridge has been unsuccessful in marketing their brokerage business, as well
as in collecting accounts which they believe are due them from clients.
Management has taken steps to limit additional downside exposure, although there
can be no assurance that such steps will be successful. Additional operating
losses will most likely be incurred in 1997 as a result of Stonebridge.
RISK FACTORS AND UNCERTAINTIES
In addition to the risks and uncertainties discussed in the preceding sections
of "Management's Discussion and Analysis of Financial Condition and Results of
Operations," the following risk factors are also inherent in the Company's
business operations:
CHANGE IN STRATEGIC DIRECTION. In late 1994, Physicians began the process of
changing its strategic direction from the operation of an MPL insurance business
to investing in businesses which PICO believes are undervalued or will benefit
from additional capital, restructuring of operations or management or improved
competitiveness through operational efficiencies with existing PICO operations.
Accordingly, in January 1995, Physicians reactivated its investment advisory
subsidiary, Summit; in August 1995 Physicians acquired Sequoia and entered new
lines of property and casualty insurance; in September 1995 Physicians purchased
38.2% of GEC, a Canadian corporation active in international investment banking,
agricultural services, water rights, and other businesses; and in 1996
Physicians acquired control of Citation Insurance Group pursuant to the Merger.
Due to the Company's limited experience in the operation of the businesses of
each of these subsidiaries, which currently constitute a substantial portion of
the Company's operations, there can be no assurance as to the future operating
results of the Company or the recently acquired businesses of the Company.
The Company will continue to make selective investments for the purpose of
enhancing and realizing additional value by means of appropriate levels of
shareholder influence and control. This could involve the restructuring of the
financing or management of the entities in which the Company invests and
initiating and facilitating mergers and acquisitions. This business strategy has
only recently been implemented, however, and it is not reflected in prior years'
financial statements, nor are the financial statements indicative of possible
results of this new business strategy in the future. Shareholders are relying on
the experience and judgment of the Company's management to locate, select and
develop new acquisition and investment opportunities. There can be no assurance
that sufficient opportunities will be found or that this business strategy will
be successful. Failure to successfully implement this strategy may negatively
impact the business and financial condition and results of operations of the
Company.
Application of Physicians' new strategy since 1995 has resulted in a greater
concentration of equity investments held by Physicians, and consequently, the
Company. Market values of equity securities are subject to changes in the stock
market, which may cause the Company's shareholders' equity to fluctuate from
period to period. At times, the Company may come to hold securities of companies
for which no market exists or which may be subject to restrictions on resale. As
a result, periodically, a portion of the Company's assets may not be readily
marketable.
INTEGRATION OF CERTAIN OPERATIONS. CIG and Physicians completed the Merger with
the expectation that the Merger would result in certain benefits for the
combined company. Achieving the anticipated benefits of the Merger will depend
in part upon whether certain of the two companies' business operations can be
integrated in an efficient and effective manner. There can be no assurance that
this will occur or that cost savings in operations will be achieved. The
successful combination of the two companies will require, among other things,
integration of the companies' respective product offerings, medical management
of health care claims and management information systems enhancements. The
difficulties
17
18
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
of such integration may be increased by the necessity of coordinating
geographically separated organizations. The integration of certain operations
following the Merger will require the dedication of management resources which
may temporarily distract attention from the day-to-day business of the combined
companies. There can be no assurance that integration will be accomplished
smoothly or successfully. Failure to effectively accomplish the integration of
the two companies' operations could have an adverse effect on the Company's
results of operations and financial condition following the Merger.
DEPENDENCE ON KEY PERSONNEL. The Company has several key executive officers, the
loss of whom could have a significant adverse effect on the Company. In
particular, Ronald Langley, PICO's Chairman, and John R. Hart, PICO's President
and Chief Executive Officer, play key roles in the Company's and GEC's
investment decisions. Although neither officer is party to an employment
agreement, they have entered into consulting agreements with PICO and various of
its subsidiaries. Messrs. Langley and Hart are key to the implementation of the
Company's new strategic focus, and the ability of the Company to implement its
current strategy is dependent on its ability to retain the services of Messrs.
Langley and Hart.
RISKS REGARDING PHYSICIANS; CONTINUING MPL LIABILITY. In August 1995,
Physicians sold its and PRO's MPL insurance business and related liability
insurance business. Physicians and PRO retained all assets and liabilities
related to insurance policies written prior to the sale of the recurring book of
business. Physicians and PRO will continue to administer claims and loss
adjustment expenses under MPL insurance policies issued or renewed prior to
July 16, 1995.
Cash flow needed to fund the day-to-day operations and the payment of claims and
claims expenses will be provided by investment income, lease income, and
proceeds from the sale or maturity of securities. Physicians and PRO have
established reserves to cover losses and loss adjustment expense ("LAE") on
claims incurred under the MPL policies issued or renewed to date. The amounts
established and to be established by Physicians and PRO for loss and LAE
reserves are estimates of future costs based on various assumptions and, in
accordance with Ohio law, have been discounted (adjusted to reflect the time
value of money). These estimates are based on actual and industry experience and
assumptions and projections as to claims frequency, severity and inflationary
trends and settlement payments. In accordance with Ohio law, Physicians and PRO
annually obtain a certification that their respective reserves for losses and
LAE are adequate from an independent actuary. Physicians and PRO also obtain a
concurring actuarial opinion. Physicians' and PRO's reserves for losses and LAE
for prior years developed favorably in 1994, and these reserves were decreased
by $12.7 million in 1994. Reserves also developed favorably in 1995; however,
accretion of reserve discount exceeded the amount of favorable development and
retroactive reinsurance, resulting in a $3.2 million increase in liabilities for
prior years' claims. As a result of continued favorable claims experience,
reserves for prior years' claims were further reduced in the first and fourth
quarters of 1996. Management believes that the reserving methods and assumptions
are reasonable and prudent and that Physicians' and PRO's reserves for losses
and LAE are adequate. Due to the inherent uncertainties in the reserving process
there is a risk, however, that Physicians' and PRO's reserves for losses and LAE
could prove to be inadequate which could result in a decrease in earnings and
shareholders' equity. Adverse reserve development can reduce statutory surplus
or otherwise limit the growth of such surplus.
Under Ohio law the statute of limitations is one year after the cause of action
accrues. Also under Ohio law there is a four-year statutory time bar; however
this has been construed judicially to be unconstitutional in situations where
the plaintiff could not have reasonably discovered the injury in that four-year
period. Claims of minors must be brought within one year of the date of
majority.
LOSS RESERVE EXPERIENCE. The inherent uncertainties in estimating loss reserves
are greater for some insurance products than for others, and are dependent on
the length of the reporting tail associated with a given product, the diversity
of historical development patterns among various aggregations of claims, the
amount of historical information available during the estimation process, the
degree of impact that changing regulations and legal precedents may have on open
claims, and the consistency of reinsurance programs over time, among other
things. Because MPL, workers' compensation and commercial casualty claims may
not be fully paid for several years or more, estimating reserves for such claims
can be more uncertain than estimating reserves in other lines of insurance. As a
result, precise reserve estimates cannot be made for several years following a
current accident year for which reserves are initially established.
18
19
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
There can be no assurance that the insurance subsidiaries in the group,
including APL, have established reserves adequate to meet the ultimate cost of
losses arising from such claims. It has been necessary, and will over time
continue to be necessary, for the insurance companies to review and make
appropriate adjustment to reserves for estimated ultimate losses, LAE, future
policy benefits, claims payables, and annuity and other policyholder funds. To
the extent reserves prove to be inadequate, the insurance companies would have
to adjust their reserves and incur a charge to earnings, which could have a
material adverse effect on the financial results of the Company.
REINSURANCE RISKS. As with other P & C insurers, CIC's, CNIC's, and Sequoia's
operating results and financial condition can be adversely affected by volatile
and unpredictable natural and man-made disasters, such as hurricanes,
windstorms, earthquakes, fires, and explosions. CIC, CNIC, and Sequoia generally
seek to reduce their exposure to such events through individual risk selection
and the purchase of reinsurance. CIC's, CNIC's, and Sequoia's estimates of their
exposures depend on their views of the possibility of a catastrophic event in a
given area and on the probable maximum loss to the insurance companies should
such an event occur. While CIC, CNIC, and Sequoia attempt to limit their
exposure to acceptable levels, it is possible that an actual catastrophic event
or multiple catastrophic events could significantly exceed the probable maximum
loss previously assumed, resulting in a material adverse effect on the financial
condition and results of operations of the Company.
The future financial results of the insurance subsidiaries could be adversely
affected by disputes with their respective reinsurers with respect to coverage
and by the solvency of such reinsurers. None of the Company's insurance
subsidiaries is aware of actual or potential disputes with any of their
respective reinsurers that could materially and adversely impact the financial
results of the Company, or is aware of any insolvent reinsurer whose current
obligations to CIC, CNIC, Physicians, PRO, APL, or Sequoia are material to such
companies.
RISKS REGARDING SUMMIT GLOBAL MANAGEMENT. Summit is registered as an investment
adviser in California, Florida, Kansas, Louisiana, Oregon, Virginia and
Wisconsin, as well as with the Securities and Exchange Commission (the "SEC").
Summit must file periodic reports with the SEC and must be available for
periodic examination by the SEC. Summit is subject to Section 206 of the
Investment Advisers Act of 1940, which prohibits material misrepresentations and
fraudulent practices in connection with the rendering of investment advice, and
to the general prohibitions of Section 208 of such Act. If Summit were to
violate the Investment Advisers Act prohibitions, it would risk criminal
prosecution, SEC injunctive actions and the imposition of sanctions ranging from
censure to revocation of registration in an administrative hearing.
The investment adviser business is highly competitive. There are several
thousand investment advisers registered in the states in which Summit does
business, many of which are larger and have greater financial resources than
Summit. There can be no assurance that Summit will be able to compete
effectively in the markets that it serves.
GLOBAL DIVERSIFICATION OF INVESTMENTS. As a result of global diversification,
investment decisions already made and which may be made in the future,
particularly with regard to GEC, the Company's revenues may be adversely
affected by economic, political and governmental conditions in countries where
it maintains investments or operations, such as volatile interest rates or
inflation, the imposition of exchange controls which could restrict the
Company's ability to withdraw funds, political instability and fluctuations in
currency exchange rates.
FLUCTUATIONS IN HISTORICAL OPERATING RESULTS, P & C RESERVES. Citation's
operating results over the past five years have been volatile. During the past
several years, the levels of the reserves for CIG'S insurance subsidiaries have
been very volatile. As a result of its claims experience and the level of
existing reserves with respect to its P & C insurance business, Citation has had
to significantly increase these reserves in three of the past five years.
There can be no assurance that significant increases with respect to the
reserves for the P & C or workers' compensation business will not be necessary
in the future, that the level of reserves for CIG'S insurance subsidiaries will
not be volatile in the future, or that any such increases or volatility will not
have an adverse effect on Citation's operating results and financial condition.
SALE OF WORKERS COMPENSATION BUSINESS. Subject to the satisfaction of certain
closing conditions, the workers' compensation business of Citation is expected
to be sold pursuant to a definitive agreement signed by the respective parties
on May 7, 1997. Closing is expected to occur mid-year. However, there can be no
assurance at this point in time that
19
20
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
the closing will occur, or that Citation will otherwise be successful in selling
its workers compensation operations on favorable terms, if at all.
COMPETITION. There are several hundred P & C insurers licensed in California,
many of which are larger and have greater financial resources than CIC,
CNIC, and Sequoia; offer more diversified types of insurance coverage; have
greater financial resources and have greater distribution capabilities than the
insurance companies of the group.
A.M. BEST RATINGS. A.M. Best ("Best") has recently assigned Sequoia a rating of
B++ (Very Good) and APL has had a Best rating of B+ (Very Good) since 1983. CIC
is currently rated B- (Adequate) and CNIC is currently rated C (Marginal) by
Best. Physicians and PRO are currently rated, and have been for a number of
years, NR-3 (rating procedure inapplicable). Best's ratings reflect the
assessment of A.M. Best and Company of the insurer's financial condition, as
well as the expertise and experience of management. Therefore, Best ratings are
important to policyholders. Best ratings are subject to review and change over
time. Failure to maintain or improve their Best ratings could have a material
adverse effect on the ability of the insurance companies to write new insurance
policies, as well as potentially reduce their ability to maintain or increase
market share. Management believes that many potential customers will not insure
with an insurer that carries a Best rating of less than B+, and that customers
who do so will demand lower rate structures. There can be no assurance that any
of the insurance companies' ratings will be maintained or increased.
CYCLICAL NATURE OF THE P & C INDUSTRY. The P & C insurance industry has been
highly cyclical, and the industry has been in a cyclical downturn over
the last several years due primarily to premium rate competition, which has
resulted in lower profitability. Premium rate levels are related to the
availability of insurance coverage, which varies according to the level of
surplus in the industry. The level of surplus in the industry varies with
returns on invested capital and regulatory barriers to withdrawal of surplus.
Increases in surplus have generally been accompanied by increased price
competition among P & C insurers. The cyclical trends in the industry and the
industry's profitability can also be affected significantly by volatile and
unpredictable developments, including natural disasters, fluctuations in
interest rates, and other changes in the investment environment which affect
market prices of insurance companies' investments and the income from those
investments. Inflationary pressures affect the size of losses and judicial
decisions affect insurers' liabilities. The demand for P & C insurance can also
vary significantly, generally rising as the overall level of economic activity
increases and falling as such activity decreases.
LIQUIDITY AND CAPITAL RESOURCES -- THREE MONTHS ENDED MARCH 31. 1997 AND 1996
Physicians' primary sources of cash inflows include investment income,
reinsurance recoveries, the sale of invested assets and rental and fee income.
Premium income has been and will continue to be negligible, if any. Major cash
outflows include the funding of claims and loss adjustment expenses, investment
funding, dividend distributions, and the payment of operating costs.
Physicians alone as of March 31, 1997 reported discounted unpaid loss and loss
adjustment expense reserves of approximately $106.3 million, net of reinsurance.
Based upon projections from past actuarial information, more than 75% of the
original reserves are expected to be settled by the end of the year 2000. Past
experience indicates that funding requirements should be greatest in the first
through third years, accounting for more than 60% of the total eventual reserve
and loss adjustment expense payments. Operating expenses associated with the
discontinued MPL line of business have been significantly reduced in 1996 and
are expected to continue to decline. As evidence of Physicians' cutbacks,
employee counts have been reduced by nearly two-thirds during the past year.
The Company's insurance subsidiaries attempt to structure the duration of their
invested assets to match the cash flows required to settle the related unpaid
claims liabilities. Their invested assets should provide adequate liquidity to
fund projected claims and LAE payments for the foreseeable future, based upon
current projections.
To the extent that funds necessary for settling claims and paying operating
expenses are not provided by existing cash and cash equivalents, investment
income, reinsurance recoveries, and rental and fee income, invested assets will
be liquidated. Short term and fixed maturity investments are managed to mature
according to projected cash flow needs. Equity securities will be converted to
cash as additional funds are required, with an anticipated maximum liquidation
lead time of approximately six months.
20
21
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Nevertheless, timing and amounts of claims payments can only be estimated until
they actually occur. Actual payouts may differ substantially from estimates.
Although abets will be managed to mature or liquidate according to expected
payout projections, at times, in response to abnormal funding demands, some
invested assets may need to be sold at inopportune times during periods of
decline in the stock market or declines in the market values of the individual
securities. Such forced sales should occur infrequently and only under extreme
circumstances; however this cannot be guaranteed.
At March 31, 1997, Physicians' investment portfolio on a stand alone basis
contained invested assets of approximately $172.8 million, plus cash and cash
equivalents of $4.6 million. These invested assets are well in excess of the
present value of expected future payouts of losses and loss adjustment expenses
of $106.3 million.
Management hopes to maximize the return of all assets, including those needed
to fund the eventual wrap-up of the MPL reserves through, among other things,
value investing and managing the invested assets internally rather than
liquidating assets to pay a third party to oversee the runoff of the existing
claims. Physicians also elected to handle the runoff of the MPL claims
internally to continue to maintain a high standard of claims handling and to
maximize shareholder values. While management expects that Physicians' current
and future investments will increase in value, offsetting some of the decline in
assets during the period of runoff and increasing shareholder value, no
guarantees can be given.
As previously mentioned, reinsurance recoveries (reimbursement of covered losses
from reinsurers) will be a significant source of incoming funds in upcoming
years as claims are settled.
Most of the Sequoia reinsurance receivable represents claims reserves and loss
adjustment expense reserves ceded 100% to SRC immediately prior to PICO's
purchase of Sequoia. These reserves ceded to SRC have been unconditionally and
irrevocable guaranteed by QBE, the indirect parent of SRC.
As an additional source of funding, PICO's subsidiaries as they grow and
accumulate increasing amounts of retained earnings may be able to return some of
PICO's investment in the form of dividend distributions; however, this cannot be
assured. In December 1996, Physicians paid a dividend of $13.2 million to PICO.
In April 1997, Physicians paid PICO an additional dividend of $8.6 million.
Cash and cash equivalents decreased from $64.6 million at December 31, 1996 to
$62.4 million as of March 31, 1997. This compares to $54.0 million as of March
31, 1996. The $2.2 million decrease from the year end 1996 level consisted of
$16.4 million used by operating activities and $1.4 million used by financing
activities, partially offset by $15.6 million provided by investing activities.
Cash used by operating activities increased $10.6 million over that used during
the first three months of 1996, principally as a result of the payment of
federal income taxes in the first quarter of 1997 based upon 1996 estimated
taxable income.
At March 31, 1997, the Company had no significant commitments for future capital
expenditures, other than in the ordinary course of business and to provide
certain funding for Stonebridge, which has subsequently been limited. The
Company has also committed to maintain Sequoia's capital and statutory
policyholder surplus level at a minimum of $7.5 million. The Company has also
committed to make every attempt to maintain Sequoia's Best rating at or above
B++ (Very Good), which may at some time in the future require additional
infusions into Sequoia by the Company. The Company also committed to purchase
for approximately $25 million a debenture from GEC. The Company committed to
invest approximately $16 million in a limited liability corporation which owns
land in Nevada. GEC has committed to purchase the remaining interest of this
limited liability corporation. This deal was closed on April 24, 1997. See Notes
to Consolidated Financial Statements, Note 7, "Subsequent Events".
CAPITAL RESOURCES
In the past three years, PICO has completed significant transactions impacting
shareholders' equity of PICO and the ownership of PICO. In 1993, PICO purchased
PICO shares from the OSMA for $1.0 million. In December 1993, GPG purchased
1,428,571 newly-issued shares of PICO Stock for $5.0 million. In accordance with
the original stock purchase
21
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
agreement, GPG was entitled to purchase up to $5.0 million of additional shares
of PICO Stock at any time at a per share price equal to the average of the bid
prices for the shares of PICO Stock as reported by Nasdaq for the 20 trading
days immediately preceding the date GPG notifies PICO of the intent to purchase.
In 1994, GPG exercised $3.0 million of its option and purchased 631,579
additional shares of PICO Stock.
Shareholder dividends payable by PICO or its insurance subsidiaries are subject
to certain limitations imposed by Ohio or California law, according to the state
of domicile. Generally, the limitations are determined using the greater of the
prior year's statutory net income or 10% of statutory policyholder surplus.
Physicians paid a dividend to PICO in April 1997 of approximately $8.6 million,
which did not require regulatory approval.
In the past few years, the NAIC has developed risk-based capital ("RBC")
measurements for both property and casualty and life insurers. The measures
provide the various state regulators with varying levels of authority based on
the adequacy of an insurer's RBC. The State of Ohio enacted the NAIC's RBC rules
effective March 3, 1996. However, disclosure of each company's RBC adequacy was
required to be reported in their statutory annual statements filed with the
various departments of insurance for 1994 and 1995. At December 31, 1996, the
PICO, PRO, APL, CIC, CNIC, and Sequoia annual statements reported more than
adequate RBC levels.
PART II: OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K:
(a) Exhibits:
See Exhibit Index.
(b) Reports on Form 8-K:
None.
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23
PICO HOLDINGS, INC. AND SUBSIDIARIES
SIGNATURE
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.
PICO HOLDINGS, INC.
Dated: May 15, 1997 By: /s/ Gary W. Burchfield
----------------------------------------
Gary W. Burchfield
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)
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24
EXHIBITS INDEX
--------------
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
+ 2.2 Agreement and Plan of Reorganization, dated as of May 1, 1996 among PICO,
Citation Holdings, Inc., and Physicians and amendment thereto dated August 14,
1996 and related Merger Agreement.
+++++ 2.3 Second Amendment to Agreement and Plan of Reorganization dated November 12, 1996.
# 2.4 Agreement and Debenture, dated November 14, 1996 and November 27, 1996,
respectively, by and between Physicians and PC Quote, Inc.
## 2.5 Purchase and Sale Agreement by, between and among Nevada Land and Resource
Company, LLC, GEC, Western Water Company and Western Land
Joint Venture dated April 9, 1997.
+++++ 3.1 Amended and Restated Articles of Incorporation of PICO.
+ 3.2.2 Amended and Restated Bylaws of PICO.
++++ 4.2 First Amendment to Rights Agreement dated April 30, 1996.
+++++ 4.3 Second Amendment to Rights Agreement dated November 20, 1996.
-* 10.7 Key Officer Performance Recognition Plan.
* 10.8 Flexible Benefit Plan.
-* 10.9 Amended and Restated 1983 Employee Stock Option Plan.
-**** 10.10 Salary Reduction Profit Sharing Plan as amended and restated effective January 1,
1994 and Amendments Nos. 1 and 2 thereto dated March 13, 1995 and March 15, 1995,
respectively.
-* 10.11 Employee Stock Ownership Plan and Trust Agreement.
-*** 10.11.1 Amended Employee Stock Ownership Plan and Trust Agreement.
- -***** 10.11.2 Amendment to Employee Stock Ownership Plan dated October 1, 1992.
-**** 10.11.3 Amendment to Employee Stock Ownership Plan dated March 15, 1995.
* 10.16 Office Lease between CIC and North Block Partnership dated July, 1990.
*** 10.16.1 Amendments Nos. 1 and 2 to Office Lease between CIC and North Block Partnership
dated January 6, 1992 and February 5, 1992, respectively.
**** 10.16.2 Amendments Nos. 3 and 4 to Office Lease between CIC and North Block Partnership
dated December 6, 1993 and October 4, 1994, respectively.
-* 10.22 1991 Employee Stock Option Plan.
-***** 10.23 PICO Severance Plan for Certain Executive Officers,
Senior Management and Key Employees of the Company and its
Subsidiaries, including form of agreement.
-# 10.55 Consulting Agreements, effective January 1, 1997,
regarding retention of Ronald Langley and John R. Hart as
consultants by Physicians and GEC.
++ 10.57 PICO 1995 Stock Option Plan.
-+++ 10.58 Key Employee Severance Agreement and Amendment No. 1 thereto, each made as of
November 1, 1992, between PICO and Richard H. Sharpe and Schedule A identifying
other substantially identical Key Employee Severance Agreements between PICO and
certain of the executive officers of PICO.
+++ 10.59 Agreement for Purchase and Sale of Shares, dated May 9, 1996, among Physicians,
GPG and GEC.
++ 10.60 Agreement for Purchase and Sale of Certain Assets, dated July 14, 1995 between
Physicians, PRO and Mutual Assurance, Inc.
++ 10.61 Stock Purchase Agreement dated March 7, 1995 between Sydney Reinsurance
Corporation and Physicians.
++ 10.62 Letter Agreement, dated September 5, 1995 between Physicians, Christopher
Ondaatje and the South East Asia Plantation Corporation Limited.
++++ 10.63 Amendment No. 1 to Agreement for Purchase and Sale of Certain Assets, dated
July 30, 1996 between Physicians, PRO and Mutual Assurance, Inc.
+++++ 16.1 Letter regarding change in Certifying Accountant from Deloitte & Touche, LLP,
independent auditors.
# 21 Subsidiaries of PICO.
27 Financial Data Schedule.
-------------
* Incorporated by reference to exhibit of same number filed with Registration Statement
on Form S-1 (File No. 33-36383).
*** Incorporated by reference to exhibit of same number filed with 1992 Form 10-K.
**** Incorporated by reference to exhibit of same number filed with 1994 Form 10-K.
***** Incorporated by reference to exhibit bearing the same number filed with
Registration Statement on Form S-4 (File No. 33-64328).
+ Filed as Appendix to the prospectus in Part I of Registration Statement on
Form S-4 (File No. 333-06671).
++ Incorporated by reference to exhibit filed with Physicians' Registration
Statement No. 33-99352 on Form S-1 filed with the SEC on November 4, 1995.
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EXHIBITS INDEX (CONTINUED)
--------------------------
+++ Incorporated by reference to exhibit filed with Registration
Statement on Form S-4 (File No. 333-06671).
++++ Incorporated by reference to exhibit filed with Amendment No. 1
to Registration Statement No. 333-06671 on Form S-4.
+++++ Incorporated by reference to exhibit of same number filed
with Form 8-K dated December 4, 1996.
# Incorporated by reference to exhibit of same number filed
with Form 10-K dated April 15, 1997.
## Incorporated by reference to exhibit of same number filed
with Form 10-K/A dated April 30, 1997.
- Executive Compensation Plans and Agreements.
25