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, 1998
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 32,591,718 as of March 31, 1998. As of such date, 4,572,015 shares of
common stock were held by subsidiaries of the registrant.
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PICO HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
PAGE NO.
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PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets as of 3
March 31, 1998 and December 31, 1997
Consolidated Statements of Operations 4
for the Three Months Ended March 31, 1998 and 1997
Consolidated Statements of Cash Flows for 5
the Three Months Ended March 31, 1998 and 1997
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 4: Submission of Matters to a Vote of Security Holders 22
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 (UNAUDITED)
(in thousands, except share data)
March 31, December 31,
1998 1997
--------- ------------
ASSETS
Investments $ 149,902 $ 160,297
Cash and cash equivalents 63,669 56,436
Accrued investment income 1,813 1,722
Premiums and other receivables, net 8,673 20,682
Reinsurance receivables 72,828 75,026
Prepaid deposits and reinsurance premiums 1,239 2,235
Deferred policy acquisition costs 5,359 5,321
Surface, water, geothermal and mineral rights 75,305 75,177
Property and equipment, net 8,409 8,551
Deferred income taxes 10,099 2,965
Other assets 5,414 5,931
Net assets of discontinued operations 16,215 15,950
========= =========
Total Assets $ 418,925 $ 430,293
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Loss and loss adjustment expense, net of discount $ 186,245 $ 196,096
Unearned premiums 19,618 21,635
Reinsurance balance payable 8,051 8,076
Deferred gain on retroactive reinsurance 1,876 2,168
Integration liability 451 546
Other liabilities 14,182 15,381
Deferred income taxes 4,995
Taxes payable 1,467 968
Excess of fair value of net assets acquired over purchase price 4,923 5,065
--------- ---------
Total Liabilities 241,808 249,935
--------- ---------
MINORITY INTEREST 66,221 68,207
--------- ---------
COMMITMENTS AND CONTINGENCIES (NOTE 5)
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 32,591,718 in 1998 and 1997 33 33
Additional paid-in capital 43,147 43,147
Retained earnings 82,791 83,718
Accumulated other comprehensive (loss) (5,246) (4,918)
Treasury stock, at cost (common shares 2,492,631) (9,829) (9,829)
--------- ---------
Total Stockholders' Equity 110,896 112,151
--------- ---------
Total Liabilities and Stockholders' Equity $ 418,925 $ 430,293
========= =========
See notes to consolidated financial statements.
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PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except share data)
Three Months Ended March 31,
----------------------------
1998 1997
---- ----
REVENUES:
Premium income $ 9,138 $14,502
Investment income, net 3,376 3,374
Net realized gains on investments 504 2,834
Other income 716 340
-------- -------
Total revenues 13,734 21,050
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EXPENSES:
Loss and loss adjustment expenses 7,995 11,519
Insurance underwriting and other expenses 5,994 6,809
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Total expenses 13,989 18,328
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Equity in earnings (losses) of investee (203) 8
-------- -------
Income (loss) from continuing operations before income taxes and minority interest (458) 2,730
Provision for federal, foreign and state income taxes 1,226 934
-------- -------
Income (loss) from continuing operations before minority interest (1,684) 1,796
Minority interest in loss of subsidiary 705 44
-------- -------
Income (loss) from continuing operations (979) 1,840
Income from discontinued operations, net of federal income tax
provision of $10 and $44 for the three months
of 1998 and 1997, respectively 52 152
-------- -------
Net income (loss) $ (927) $ 1,992
======== =======
Net income (loss) per common share (basic):
Continuing operations $ (0.03) $ 0.06
Discontinued operations 0.00 0.00
-------- -------
Net income (loss) per common share $ (0.03) $ 0.06
======== =======
Weighted average shares outstanding 32,592 32,488
======== =======
Net income (loss) per common share (diluted):
Continuing operations $ (0.03) $ 0.06
Discontinued operations 0.00 0.00
-------- -------
Net income (loss) per common share $ (0.03) $ 0.06
======== =======
Weighted average shares outstanding 32,592 33,363
======== =======
See notes to consolidated financial statements.
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PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)
(in thousands)
Three Months Ended March 31,
----------------------------
1998 1997
---- ----
OPERATING ACTIVITIES
Net cash provided by (used in) operating activities $ 694 $(16,223)
-------- --------
INVESTING ACTIVITIES:
Investments purchased (2,861) (81,941)
Investments sold 10,168 49,199
Investments matured 25 51,349
Net sales of real estate (1)
Proceeds from sale of property and equipment 11
Purchases of property and equipment (114) (315)
Investment in surface, water, geothermal and mineral rights (130)
Investment in affiliate (304)
-------- --------
Net cash provided by investing activities 6,795 18,291
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FINANCING ACTIVITIES:
Proceeds from sale of business (1,882)
Cash transferred to net assets of discontinued operations (9,665)
Purchase of treasury stock (163)
-------- --------
Net cash used by financing activities -- (11,710)
-------- --------
Effect of exchange rate changes on cash (256) 2
-------- --------
NET INCREASE (DECREASE) IN CASH 7,233 (9,640)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 56,436 64,581
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 63,669 $ 54,941
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 440 $ 11,400
======== ========
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. ("PICO") 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 United States
Securities and Exchange Commission (the "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, 1998 and December 31, 1997 and results of
operations and changes in financial position for the three months ended
March 31, 1998 and 1997 have been included and are of a normal recurring
nature. Operating results for the three months ended March 31, 1998 are
not necessarily indicative of the results that may be expected for the
year ending December 31, 1998.
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
Reports on Form 10-K and Form 10-K/A for the year ended December 31, 1997
as filed with the SEC.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses for
each reporting period. The significant estimates made in the preparation
of the Company's consolidated financial statements relate to the
assessment of the carrying value of unpaid losses and loss adjustment
expenses, future policy benefits, deferred policy acquisition costs,
deferred income taxes and contingent liabilities. While management
believes that the carrying value of such assets and liabilities are
appropriate as of March 31, 1998 and December 31, 1997, it is reasonably
possible that actual results could differ from the estimates upon which
the carrying values were based.
Global Equity Corporation ("GEC") is included in the consolidated
balances of the Company as of December 31, 1997 and March 31, 1998 and for
the three months ended March 31, 1998 based on PICO's increased ownership
in GEC to 51.17% on August 19, 1997. PICO accounted for GEC under the
equity method of accounting for the three months ended March 31, 1997. See
also Note 7, "Subsequent Events."
2. DISCONTINUED OPERATIONS
On June 16, 1997, PICO announced the signing of a definitive agreement
to sell the Company's life and health insurance subsidiary, American
Physicians Life Insurance Company ("APL") and its wholly-owned subsidiary,
Living Benefit Administrators Agency, Inc. The closing is subject to
certain closing conditions, including regulatory approval which is still
pending. The expected purchase price is approximately $17 million and is
expected to be paid in cash.
Because APL and its subsidiary represent a major segment of the
Company's business, in accordance with Accounting Principles Board Opinion
No. 30 "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business," APL's operations have been
classified as discontinued operations. The net assets of APL have been
shown as a single line item in the accompanying balance sheets as "Net
assets of discontinued operations." The book value assigned to such net
assets at December 31, 1997 of $15,949,989 and $16,215,136 as of March 31,
1998 was based upon the net book value of APL as of those dates as
determined on the basis of generally accepted accounting principles. The
consolidated statement of operations and consolidated statement of cash
flow for the three months ended March 31, 1997 have been restated for
comparative purposes to show the discontinued operations. The primary
remaining assets and liabilities of APL as of those dates were
investments, cash and cash equivalents, and accident and health insurance
reserves. The Company expects to realize a small gain on the sale.
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Following is an unaudited summary of APL's stand alone financial
results for the periods included in the statements of operations as
discontinued operations in the accompanying financial statements:
Three Months Three Months
Ended Ended
March 31, March 31,
1998 1997
------------ ------------
(in thousands, except per share amounts)
Total revenues $2,163 $1,575
Income before taxes 62 196
Net income 52 152
Net income per share-Basic and Diluted $ 0.00 $ 0.00
3. EARNINGS (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 128, "Earnings Per Share," effective for financial
statements issued after December 15, 1997. SFAS No. 128 requires dual
presentation of "Basic" and "Diluted" earnings per share ("EPS") by
entities with complex capital structures, replacing "Primary" and "Fully
Diluted" EPS under Accounting Principles Board ("APB") Opinion No. 15.
Basic EPS excludes dilution from common stock equivalents and is computed
by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution from common stock equivalents,
similar to fully diluted EPS, but uses only the average stock price during
the period as part of the computation. The Company adopted the new method
of reporting EPS for the year ended December 31, 1997, and the March 31,
1997 financial statements have been restated to reflect the change.
Reconciliation of the basic and diluted EPS is as follows:
Three Months Ended March 31,
----------------------------------
1998 1997
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(In thousands, except per share amounts)
Net income (loss) $ (927) $ 1,992
======== =======
Basic earnings (loss) per share $ (0.03) $ 0.06
======== =======
Basic weighted average common shares outstanding 32,592 32,488
Options 875
-------- -------
Diluted weighted average common and
common equivalent shares outstanding 32,592 33,363
======== =======
Diluted earnings (loss) per share $ (0.03) $ 0.06
======== =======
4. Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes requirements for
disclosure of comprehensive income and becomes effective for the Company
for the year ending December 31, 1998. Comprehensive income includes such
items as foreign currency translation adjustments, unrealized holding
gains and losses on available for sale securities, and equity changes of
investee company that had only been presented by the Company as a
component of stockholders' equity.
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Reconciliation of net income (loss) as reported in the consolidated
statements of operations to consolidated comprehensive income (loss) is as
follows:
1998 1997
---- ----
(in thousands)
Comprehensive income (loss):
Net income (loss) $ (927) $1,992
Net change in unrealized depreciation on
available for sale investments (130) (338)
Net change in cumulative foreign
currency adjustments (198) 2
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Total comprehensive income (loss) $(1,255) $1,656
======= ======
The income tax effects of items relating to other comprehensive income
(loss) were deferred income tax benefits of $68,000 and $182,000 for the
three months ended March 31, 1998 and 1997, respectively.
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, results of operations, or cash flows.
In connection with the sale of PICO's interests in Nevada Land and
Resource Company, LLC ("NLRC") by the former members, a limited
partnership agreed to act as consultant to NLRC in connection with the
maximization of the development, sales, leasing, royalties or other
disposition of land, water, mineral and oil and gas rights with respect to
the Nevada property. In exchange for these services, the partnership will
receive from NLRC a consulting fee calculated as 50% of any net proceeds
that NLRC actually receives from the sale, leasing or other disposition of
all or any portion of the Nevada property or refinancing of the Nevada
property provided that NLRC has received such net proceeds in a threshold
amount equal to the aggregate of: (i) the capital investment by GEC and
the Company in the Nevada property (ii) a 20% cumulative return on such
capital investment, and (iii) a sum sufficient to pay the United States
federal income tax liability, if any, of NLRC in connection with such
capital investment. Either party may terminate this consulting agreement
in April 2002 if the partnership has not received or become entitled to
receive by that time any amount of the consulting fee. No payments have
been made under this agreement through December 31, 1997. By letter dated
March 13, 1998, NLRC gave notice of termination of the consulting
agreement based on NLRC's determination of a default by the partnership
under the terms of the agreement. By letter dated March 20, 1998, legal
counsel for the partnership wrote to NLRC and stated that the partnership
was not in default under the terms of the consulting agreement.
6. RECENT ACCOUNTING PRONOUNCEMENT
In June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131
establishes standards for disclosure about operating segments in annual
statements and selected information in interim financial reports. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. This statement supersedes SFAS No.
14, "Financial Reporting for Segments of a Business Enterprise." The new
standard becomes effective for the Company for the year ending December
31, 1998, and requires that comparative information from earlier years be
restated to conform to the requirements of this standard. The Company does
not expect this pronouncement to materially change the Company's current
reporting and disclosures.
7. SUBSEQUENT EVENTS
On May 8, 1998, PICO and GEC jointly announced their consideration of
a proposal pursuant to which GEC would become a wholly-owned subsidiary of
PICO. This would be accomplished through a "Plan of Arrangement" whereby
current GEC shareholders would exchange their shares for a direct interest
in the common stock of PICO. The exchange ratio is yet to be determined.
GEC's board of directors established a special committee of directors who
are independent of PICO to consider any proposed transaction from the
perspective of GEC's public minority shareholders. While the companies
stressed that there can be no assurance that any transaction will result
from these discussions, it is anticipated that if a transaction is to
proceed, its terms and conditions will likely be announced within a period
of several weeks from the announcement date.
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On May 11, 1998, PICO filed a Form S-3 with the SEC to register
4,572,015 shares of PICO common stock held by its subsidiaries.
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 "Results of Operations -Three Months Ended March
31, 1998 and 1997," "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
On November 20, 1996, Citation Holdings, Inc., an Ohio corporation ("Sub"),
merged with and into Physicians Insurance Company of Ohio ("Physicians"), (the
"Merger") pursuant to an Agreement and Plan of Reorganization (the "Merger
Agreement") dated as of May 1, 1996, as amended by and among Citation Insurance
Group, Physicians and Sub. Pursuant to the Merger, each outstanding share of
Class A Common Stock of Physicians (the "Physicians Stock") was converted into
the right to receive 5.0099 shares of PICO's common stock. As a result, (i) the
former shareholders of Physicians owned approximately 80% of the outstanding
common stock of PICO immediately after the Merger and controlled the Board of
Directors of PICO and (ii) Physicians became a wholly owned subsidiary of PICO.
Pursuant to the Merger Agreement, PICO also assumed all outstanding options to
acquire Physicians Stock.
As a result of the Merger, the business and operations of Physicians and its
subsidiaries became a substantial majority of the business and operations of the
Company.
Effective upon the Merger, PICO's name, which was previously "Citation
Insurance Group," was changed to "PICO Holdings, Inc." and the Nasdaq symbol for
the Company's stock was changed from "CITN" to "PICO."
The Company's objective is to use its resources and those of its
subsidiaries and affiliates to increase shareholder value through investments in
businesses that the Company believes are undervalued and through the profitable
operation of its operating subsidiaries. The Company'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 the
Company 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. There can be no assurance that sufficient
opportunities will be found or that this business strategy will be successful.
This strategy may negatively impact the business and financial condition and
results of the Company.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 1998 AND 1997
SUMMARY
PICO reported a net loss of $0.9 million, or $0.03 per share for the first
three months of 1998, compared with net income of $2.0 million, or $0.06 per
share during the same 1997 period. Per share amounts are expressed as basic
earnings per share. Net income (loss) for the first quarters of 1998 and 1997
included approximately $52,000 and $152,000 in income from discontinued
operations, net of taxes. First quarter 1997 financial results have been
restated to reflect discontinued operations based upon the June 1997
announcement of the pending sale of the Company's life and health insurance
subsidiary, APL. The completion of this transaction is subject to various
closing conditions which have not yet been met, including obtaining regulatory
approval. See Note 2 of Notes to Consolidated Financial Statements,
"Discontinued Operations," for additional information.
A number of factors contributed to the loss for the first three months of
1998 and to the $2.9 million decline as compared to the same quarter of the
previous year. Accounting for much of the variance between years, first quarter
1997 results included $2.8 million in realized investment gains compared to $0.5
million during the first quarter of 1998.
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Property and casualty insurance operations, consisting of Sequoia Insurance
Company ("Sequoia") and Citation Insurance Company ("CIC"), contributed a net
loss of $0.4 million to the Company's first quarter 1998 consolidated net loss
contrasted to net income of $0.6 million during the 1997 first quarter.
Management estimates that the effects of the "El Nino" phenomenon added
approximately $1.0 million to the costs of the Company's property and casualty
insurance operations during the first quarter of 1998.
In addition, GEC, not included in the first quarter 1997 consolidation,
added a net loss of approximately $0.7 million to the 1998 first quarter
results. Most of the 1998 GEC loss resulted from a $0.4 million non-recurring
adjustment of income tax estimates recorded during 1997.
Shareholders' equity decreased $1.3 million to $110.9 million as of March
31, 1998 from $112.2 million at December 31, 1997. This decline principally
resulted from the $0.9 million net loss for the quarter. Shareholders' equity
per share calculated on an undiluted basis at March 31, 1998 was $3.68, compared
to $3.73 at December 31, 1997.
During the first quarter of 1998, the Company's assets decreased
approximately $11.4 million to $418.9 million. Assets included $16.2 million in
net assets from APL classified as "net assets of discontinued operations."
Revenues of $13.7 million for the first 1998 quarter decreased $7.4 million
from the $21.1 million recorded during the first quarter of 1997. Property and
casualty insurance revenues provided most of this decrease, or $6.0 million, due
to closer scrutiny of risks, tighter underwriting guidelines and continued
aggressive competition within the California commercial property and casualty
insurance marketplace. GEC, first consolidated with the Company in the third
quarter of 1997, added $1.2 million in revenues to the first quarter of 1998.
The decline in realized investment gains previously discussed accounted for
essentially all of the remaining difference.
The Company's ongoing operations are organized into five segments: portfolio
investing; surface, water, geothermal and mineral rights; property and casualty
insurance; medical professional liability insurance, and other operations. GEC's
portfolio investing results are shown separately below for consistency of
presentation and to simplify analysis since GEC's results were not consolidated
with those of PICO during the first quarter of 1997. Life and health insurance
operations are shown as discontinued operations based upon the pending sale of
those operations. See Note 2 of Notes to Consolidated Financial Statements,
"Discontinued Operations," for additional information.
Revenues and income (loss) before taxes and minority interests from
CONTINUING OPERATIONS, by business segment, are shown in the schedules that
follow.
Operating Revenues--Continuing Operations:
Three Months Ended
March 31,
------------------
1998 1997
---- ----
(in millions)
Portfolio Investing $ 0.9 $ 3.3
Portfolio Investing--Global Equity Corporation 1.0
Surface, Water, Geothermal and Mineral Rights 0.2
Property and Casualty Insurance 10.7 16.7
Medical Professional Liability Insurance 0.7 1.0
Other 0.2 0.1
----- -----
Total Revenues-Continuing Operations $13.7 $21.1
===== =====
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Income (Loss) Before Taxes and Minority Interest--Continuing Operations:
Three Months Ended
March 31,
------------------
1998 1997
---- ----
(in millions)
Portfolio Investing $ 0.5 $ 2.8
Portfolio Investing--Global Equity Corporation --
Surface, Water, Geothermal and Mineral Rights (0.4)
Property and Casualty Insurance (0.4) 0.9
Medical Professional Liability Insurance (0.1) (0.7)
Other (0.1) (0.3)
------ ------
Income (Loss) Before Tax and Minority Interest $ (0.5) $ 2.7
====== ======
PORTFOLIO INVESTING
Portfolio investing operations are principally conducted by PICO, Physicians
and GEC. GEC's portfolio investing results are shown separately in the following
section. Investment revenues and realized investment gains or losses generated
by Physicians are first allocated to the medical professional liability ("MPL")
insurance segment equal to the amount of loss reserve discount accretion
recorded during the period. The remainder is shown as portfolio investing
revenue.
Physicians and The Professionals Insurance Company ("PRO") ceased writing
MPL business in 1995. For a number of reasons, including the existence of an
experienced claims adjustment staff and Physicians' success in managing invested
assets, it was decided that it would be more advantageous to manage the assets
remaining at the cessation of writing the MPL insurance 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 and income or losses generated by PICO through its own portfolio
are assigned entirely to portfolio investing. GEC's portfolio investing
operations exclude the results attributable to surface, water, geothermal and
mineral rights segment.
Excluding GEC, which is stated separately below, portfolio investing
revenues for the 1998 first quarter amounted to approximately $0.9 million
compared to $3.3 million during the same 1997 quarter. Investment income from
portfolio investing, excluding realized investment gains, increased $0.3 million
over the first quarter of 1997. This increase principally resulted from
declining MPL loss reserve discount accretion and, consequently, less investment
income allocated to MPL operations. Realized investment gains declined $2.7
million from $2.6 million during the 1997 first quarter to a loss of $0.1
million during the first quarter of 1998. First quarter 1997 realized gains
included more than $1.9 million in realized gains from the sale of the Company's
investment in Amvestors Financial Corporation.
Portfolio investing revenues are summarized below:
PORTFOLIO INVESTING
Three Months Ended
March 31,
------------------
1998 1997
---- ----
(in millions)
Portfolio Investing Revenues:
Realized Investment Gains (Losses) $ (0.1) $ 2.6
Investment Income 1.0 0.7
------ -----
Portfolio Investing Revenues $ 0.9 $ 3.3
====== =====
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Net of expenses, but before taxes, portfolio investing operations, excluding
those of GEC, contributed $0.5 million to pre-tax operating income during the
first quarter of 1998 and $2.8 million during the same 1997 quarter. First
quarter 1997 realized investment gains, as discussed above, accounted for
approximately $1.9 million of this $2.3 million decline. Investment income
varies significantly from period to period, influenced greatly by the timing of
the realization of investment gains and losses. Consequently, future results
cannot and should not be predicted based upon past performance alone.
The breakdown of pre-tax operating income from portfolio investing
operations follows:
PORTFOLIO INVESTING
Three Months Ended
March 31,
------------------
1998 1997
---- ----
(in millions)
Portfolio Investing Income Before Tax:
- --------------------------------------
PICO and Physicians $ 0.5 $ 2.8
===== =====
Portfolio Investing--Global Equity Corporation
GEC is an international investment company with offices in Toronto, Ontario,
Canada and in La Jolla, California. GEC holds a portfolio of equity securities
and convertible instruments in North American, Asian and European companies, as
well as a number of interests in surface, water, geothermal and mineral rights
in the western United States. Such operations are reported below in a separate
segment entitled "Surface, Water, Geothermal and Mineral Rights," and are
excluded from this discussion of GEC's portfolio investments.
Following is a breakdown of GEC's portfolio investing revenues and loss for
the period:
PORTFOLIO INVESTING--GLOBAL EQUITY CORPORATION
Three Months Ended
March 31,
------------------
1998
----
(in millions)
Global Equity Corporation-Revenues:
Realized Investment Gains $ 0.5
Investment Income 0.3
Other Income 0.2
-----
Global Equity Corporation Revenues $ 1.0
=====
GEC Loss Before Tax and Minority Interest:
Global Equity Corporation $ 0.2
Equity in Unconsolidated Affiliates (0.2)
-----
Loss Before Tax and Minority Interest $ -
=====
As shown above, GEC added $1.0 million in revenues to the consolidated group
for the first quarter of 1998, including realized investment gains of $0.5
million. As discussed in the following section, GEC's subsidiaries engaged in
surface, water, geothermal and mineral rights activities contributed additional
revenues to the Company and an additional loss before tax and minority interest.
As of March 31, 1998, on a stand-alone basis, approximately 51% of GEC's assets
consisted of investments in equity securities and cash and cash equivalents. An
additional 44% was invested in surface, water, geothermal and mineral rights.
Although GEC contributed a net loss of approximately $0.7 million to
consolidated operations, excluding taxes, minority interest and the surface,
water, geothermal and mineral rights segment, GEC's portfolio investing
activities broke even for the first quarter of 1998.
12
13
SURFACE, WATER, GEOTHERMAL AND MINERAL RIGHTS
Effective November 14, 1995, a wholly-owned subsidiary of GEC acquired all
the outstanding common stock of Vidler Water Company, Inc. ("Vidler"), a
Colorado corporation engaged in the water marketing and transfer business.
Vidler's business plan calls for Vidler to identify areas where water supplies
are in the greatest demand; to facilitate the transfer of water rights from
current ownership to Vidler; to develop water storage facilities; to reallocate
water to areas where needed through various distribution means; and to sell and
lease water supplies to municipalities, developers and others. Since its
acquisition, Vidler and its immediate parent company have purchased water rights
and related assets in Colorado, Nevada and Arizona. On April 23, 1997, GEC
acquired 74.77% of the common stock of NLRC and PICO acquired the remaining
25.23%. NLRC owns approximately 1.365 million acres of deeded land located in
northern Nevada, together with appurtenant water, geothermal and mineral rights.
NLRC is actively engaged in maximizing the property's value in relation to water
rights, mineral rights, geothermal resources, and land development.
As these subsidiaries of the Company were not part of the consolidated group
until GEC joined the consolidation in the third quarter of 1997, prior years'
results are not included with those of the Company. Revenues from continuing
operations included in the consolidated financial statements of the Company from
surface, water, geothermal and mineral rights generated by Vidler and NLRC were
approximately $172,000 during the first quarter of 1998. Revenues include land
sales; lease of land, principally for grazing purposes; water sales and leasing
and other income. The loss from continuing operations before taxes and minority
interests included in the consolidation generated by these operations amounted
to approximately $437,000 for the three months.
PROPERTY AND CASUALTY INSURANCE
Sequoia and CIC account for all of the ongoing property and casualty ("P &
C") insurance revenues. These companies write predominately light commercial and
multiple peril insurance coverage in central and northern California.
Sequoia and CIC are continually seeking ways to realize savings and take
advantage of synergies and to combine operations, wherever possible. To this
end, Sequoia and CIC consolidated their home office operations in Monterey,
California in July 1997. Both companies are in the process of subleasing their
former office spaces in Pleasanton and San Jose, California.
As shown below, earned premiums made up most of the P & C revenues. Premiums
are earned pro-rata throughout the year according to the coverage dates of the
underlying policies.
PROPERTY AND CASUALTY INSURANCE
Three Months Ended
March 31,
-------------------
1998 1997
---- ----
(in millions)
P & C Revenues:
- ---------------
Earned Premiums - Sequoia $4.6 $7.3
Earned Premiums - Citation 4.6 7.2
Investment Income 1.3 1.7
Realized Investment Gains 0.1 0.2
Other 0.1 0.3
------ -----
Total P&C Revenues $10.7 $16.7
====== =====
P & C Income (Loss) Before Taxes:
- ---------------------------------
Sequoia Insurance Company $ (0.3) $ 0.5
Citation Insurance Company (0.1) 0.4
------ -----
$ (0.4) $ 0.9
====== =====
Total P&C revenues for the first three months of 1998 of $10.7 million were
$6.0 million, or 36%, less than the $16.7 million level of the first quarter of
1997. Total revenues by company for the first three months of 1998 included $5.4
million from CIC and $5.3 million from Sequoia. This compares to $8.3 million
from CIC and $8.4 million from Sequoia during the first quarter of 1997.
Included in these amounts, investment income and realized investment gains from
P&C operations declined $0.5 million from $1.9 million during the first quarter
of 1997 to $1.4 million during the same 1998 period.
13
14
The reduction in P&C earned premiums during the first quarter of 1998
compared to the first quarter of 1997 was due principally to increased
underwriting selectivity of Sequoia's and CIC's management team and continued
aggressive competition for commercial multiple peril business in California.
Much of the decline in Sequoia's earned premiums resulted from a reinsurance
pooling agreement effective January 1, 1998 which provides for the pooling of
all insurance premiums, losses, loss adjustment expenses ("LAE") and
administrative and other insurance operating expenses between Sequoia and CIC.
These items are then split equally between the two companies through the
reinsurance pooling agreement. As a result, the companies' loss and LAE ratios,
expense ratios and combined ratios shown below are very similar for the 1998
period.
P&C insurance operations produced a $0.4 million loss before taxes for the
first quarter of 1998 as compared to income of $0.9 million during the first
quarter of 1997. Sequoia's income before taxes declined $0.8 million from $0.5
million during the first three months of 1997 to a loss of $0.3 million during
the same 1998 period. CIC's first quarter 1998 loss of $0.1 million compares to
$0.4 million in income recorded during the first quarter of 1997. The recent "El
Nino" phenomenon had a significant impact on the 1998 first quarter. Sequoia and
CIC management estimate the cost of storm losses incurred by the companies as a
result of El Nino to be approximately $1.0 million for the first quarter 1998.
Industry ratios as determined on the basis of generally accepted accounting
principles ("GAAP") for CIC are shown in the following chart:
CIC'S GAAP INDUSTRY RATIOS
Three Months Ended
March 31,
------------------
1998 1997
---- ----
Loss and LAE Ratio 84.8% 74.6%
Underwriting Expense Ratio 37.7% 35.7%
----- -----
Combined Ratio 122.5% 110.3%
===== =====
Industry ratios as determined on a GAAP basis for Sequoia were:
SEQUOIA'S GAAP INDUSTRY RATIOS
Three Months Ended
March 31,
------------------
1998 1997
---- ----
Loss and LAE Ratio 83.1% 72.1%
Underwriting Expense Ratio 41.2% 35.9%
----- -----
Combined Ratio 124.3% 108.0%
===== =====
Loss and LAE Ratios, Underwriting Expense Ratios and Combined Ratios are
calculated using net earned premiums as a denominator. Theoretically, a combined
ratio of less than 100% indicates that the insurance company is making a profit
on its base insurance business before consideration of investment income,
realized investment gains or losses, extraordinary items, taxes and other
non-insurance items.
The resulting increase in storm losses from the recent "El Nino" phenomenon
was the principal cause of the increase in the loss and LAE ratio for both
Sequoia and CIC during the first quarter of 1998 as compared to the first
quarter of 1997. The increase in the underwriting expense ratios of both Sequoia
and CIC during the first quarter of 1998 as compared to the first quarter of
1997 is principally the result of fixed overhead expenses being spread over a
smaller premium base in 1998.
Although Sequoia and CIC continue to identify and take advantage of
synergies and other cost savings and to lessen the companies' exposure to undue
risk, there can be no assurance that Sequoia and CIC will be successful in
reducing their policies with higher loss ratios or that their loss ratios and/or
expense ratios will improve in the future.
14
15
MEDICAL PROFESSIONAL LIABILITY OPERATIONS
Physicians' and PRO's MPL insurance business was sold to Mutual Assurance
Inc. ("Mutual") on August 28, 1995. Except for a few minor policy coverage
extensions and adjustments which are 100% reinsured by Mutual, for all intents
and purposes, the Company ceased writing MPL policies effective January 1, 1996.
The Company 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, the Company 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 Company's 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 the Company 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 and pre-tax income or loss from MPL operations included the
following:
MEDICAL PROFESSIONAL LIABILITY INSURANCE
Three Months Ended
March 31,
------------------
1998 1997
---- ----
(in millions)
MPL Revenues:
- -------------
Investment Income, Net of Expenses $ 0.7 $ 1.0
----- -----
MPL Revenues $ 0.7 $ 1.0
===== =====
MPL Loss Before Tax: $(0.1) $(0.7)
- -------------------- ===== =====
Since the withdrawal of Physicians and PRO from their personal automobile
and homeowners lines of business in the late 1980's, MPL has, for all intents
and purposes, been these two companies' only sources of insurance premiums.
MPL insurance revenues amounted to $0.7 million and $1.0 million during the
first quarters of 1998 and 1997, respectively. As shown above, these revenues
were attributable solely to investment income. The decline in investment income
as compared to 1997 principally resulted from the reduced level of MPL claims
and the associated reduced level of invested assets allocated to the MPL
insurance business segment.
MPL operations produced a pre-tax loss of approximately $0.1 million in the
first quarter of 1998 compared to a $0.7 million loss during the same 1997
period. This improvement over 1997 resulted from a 52% reduction in MPL
insurance operating expenses and a 60% reduction in loss and LAE costs.
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, 1998, MPL reserves totaled approximately $ 69.6 million,
net of reinsurance and discount. This compares to $77.5 million at December 31,
1997. MPL loss and LAE reserves continue to decline as a result the disposition
of claims.
MPL INSURANCE--LOSS AND LAE RESERVES
March 31, December 31,
1998 1997
---- ----
(in millions)
Direct Reserves $112.4 $121.4
Ceded Reserves (34.3) (34.8)
Discount of Net Reserves (8.5) (9.1)
------ ------
Net MPL Reserves $ 69.6 $ 77.5
====== ======
15
16
Although MPL reserves are certified annually by two independent actuaries,
as required by Ohio insurance regulations, significant fluctuations in reserve
levels can occur based upon a number of variables used in actuarial projections
of ultimate incurred losses and LAE.
OTHER OPERATIONS
Other operations consists principally of the operations of PICO's
subsidiary, Summit Global Management, Inc. ("Summit"). Summit's investment
management operations and various other minor activities are summarized below:
OTHER OPERATIONS
Three Months Ended
March 31,
------------------
1998 1997
---- ----
(in millions)
Revenues from Other Operations:
- -------------------------------
Investment Management Services $ 0.3 $ 0.3
Less: Intercompany Portfolio Mgmt. Charges (0.1) (0.2)
----- -----
Revenue from Other Operations $ 0.2 $ 0.1
===== =====
Other Operations-Loss Before Tax:
- ---------------------------------
Investment Management Services $ 0.1
Less: Intercompany Portfolio Mgmt. Charges (0.1) (0.2)
Other (0.2)
----- -----
Other Operations-Loss Before Tax $(0.1) $(0.3)
===== =====
Revenues from other operations increased from $0.1 million to $0.2 million
comparing the first quarter of 1998 to the same 1997 quarter. Although Summit's
revenues remained virtually the same during both periods, consolidated revenues
from Summit's operations actually increased by approximately $1.0 million as a
result of less of its revenues arising from related parties in the first quarter
of 1998 compared to the same 1997 period.
First quarter 1998 losses from other operations of $0.1 million before taxes
improved approximately $0.2 million compared to the first quarter of 1997 loss
of $0.3 million. On a stand-alone basis, Summit made a small profit before and
after taxes. As shown above, the 1997 first quarter included an approximate $0.2
million loss from "other" sources, principally the Company's investment in a now
dormant Swiss corporation which brokered annuities and other insurance products
within Europe. This company was deactivated in 1997.
DISCONTINUED OPERATIONS
Discontinued operations consist of the operations of APL. APL, Physicians'
wholly-owned life insurance subsidiary, produced revenues of $1.4 million and
pre-tax income of approximately $62,000 during the first quarter of 1998. This
compares to $586,000 million in revenues and $196,000 in pre-tax income during
the same 1997 period.
APL has been concentrating its efforts on its unique critical illness
product "Survivor Key" during the past several 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 continually increased from 1994 through 1997.
On June 16, 1997, Physicians announced the signing of a binding agreement to
sell APL subject to certain closing conditions including regulatory approval,
which is still pending. See Note 2 to Consolidated Financial Statements,
"Discontinued Operations," regarding the pending sale of APL and its wholly
owned subsidiary.
The net assets of discontinued operations are shown as one line on the
balance sheets as net assets of discontinued operations.
16
17
LIQUIDITY AND CAPITAL RESOURCES --MARCH 31, 1998 AND 1997
PICO Holdings, Inc. is a holding company whose assets principally consist of
the stock of its subsidiaries. PICO continually evaluates its existing
operations and searches for new opportunities in order to maximize shareholder
value. Because of this business strategy, PICO's cash needs and those of its
subsidiaries vary considerably from period to period. At times cash may not be
readily available when an opportunity arises requiring the liquidation of
securities, advances from subsidiaries, direct purchases of investments by
subsidiaries, or the borrowing of funds. It may also become necessary and/or
advantageous for PICO to offer stock or debt through public offerings from time
to time. At times PICO may come to possess cash balances in excess of cash
needs. Such cash is invested to provide maximum returns within the constraint of
remaining liquid enough to meet expected future cash requirements. PICO's
principal sources of funds are its available cash resources, liquidation of
assets, bank borrowings, public financings, management and other fees, and
borrowings.
It is expected that each of PICO's major subsidiaries currently within the
group will be able to stand on its own and cover its own cash flow needs without
the need for long-term borrowing or additional capital infusions, with the
possible exceptions of additional capital requirements of Sequoia and CIC to
maintain or improve their Best ratings or to meet minimum capital requirements.
Physicians contributed an additional $5.5 million to Sequoia in 1997 for this
purpose. However, from time to time funds may be needed to cover short-term
operating shortfalls (i.e. timing differences) or to expand the Company's
operations (principally through investments and/or acquisitions) both at the
subsidiary level and at the parent company level. Additional funding may be
generated through, among other avenues, disposition or transfer of existing
assets, issuance of additional capital stock through a public offering, or
through a public debt offering or other borrowing.
Insurance has always been and continues to be a major source of funds for
the Company. Physicians initially provided virtually all the funding necessary
for the Company to execute its revised business strategy. Since the acquisition
of Sequoia in 1995, management has made significant strides in improving
Sequoia's operating performance. Management has taken a number of steps to
improve CIC's profitability and cash flow since its acquisition in November
1996, including the sale of its workers' compensation business and its
subsidiary, Citation National Insurance Company, in June 1997. Physicians' cash
flows have had the greatest impact on the consolidated group during the past
several years and should continue to do so for the foreseeable future, due to
the wind down of the MPL business. Physicians, Sequoia and Citation had cash and
cash equivalent balances at March 31, 1998 of $38.8 million, This compares to
$46.5 million at December 31, 1997. A large portion of Sequoia's and Citation's
investments is kept in the form of cash and cash equivalents to pay claims and
expenses due to the relatively short lag period between the receipt of premiums
and payment of claims in the commercial property and casualty insurance business
lines written by those companies.
As a result of ceasing to write MPL insurance, Physicians' operating cash
flows have become, and should continue for the foreseeable future, to be
negative. Positive cash flows from other sources within Physicians, primarily
reinsurance recoveries, investment income and the sale of invested assets may
partially offset such uses of cash. Major cash outflows most likely will include
the funding of claims and loss adjustment expenses, investment purchases,
dividend distributions, and operating costs.
As of December 31, 1995, when Physicians and PRO ceased writing MPL,
Physicians and PRO reported discounted unpaid loss and loss adjustment expense
reserves of approximately $136.2 million, net of reinsurance. Based upon
projections from past actuarial information, more than 75%, or $102 million, of
these 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 (1996 through 1998), accounting for more than 60% of the
total eventual reserve and loss adjustment expense payments. As expected, loss
and LAE reserves at December 31, 1996 declined more than 17.1% to $112.9 million
after payment of more than $30 million in claims and LAE. During 1997, MPL
reserves decreased $35.4 million, or 31.4%, to $77.5 million as of December 31,
1997 after payment of more than $38 million in losses and LAE. MPL reserves
declined $7.9 million during the first quarter of 1998 to $69.6 million.
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 provide adequate liquidity to
fund projected claims and LAE payments for the coming years. The Ohio and
California Insurance Departments monitor and set guidelines for the insurance
companies' investments. The Ohio and California Insurance Departments also set
minimum levels of policyholder capital and surplus and monitor these levels
through various means.
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 other 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.
17
18
At March 31, 1998, Physicians' and PRO's investment portfolios on a
stand-alone basis contained invested assets of approximately $122.8 million,
plus cash and cash equivalents of $7.3 million. These invested assets are in
excess of the present value of expected future payouts of losses and loss
adjustment expenses (discounted at 4%) of approximately $77.5 million.
Physicians is in the process of selling APL, its life and health insurance
subsidiary. When sold, the proceeds from this sale may provide additional
available cash.
Disregarding any appreciation or depreciation of Physicians' investment
portfolio and the results of the operations of its subsidiaries and affiliates,
on a stand alone basis Physicians should experience a decline in total assets
and total liabilities as a result of the payment of claims, loss adjustment
expenses and operating expenses. Absent unfavorable loss experience and
operating and other expenses in excess of investment income, shareholders'
equity should remain relatively unaffected. Income in excess of expenses,
favorable claims experience, appreciation of investments and increases in the
equities of subsidiaries and affiliates all would increase shareholders' equity
and, ultimately, total assets.
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. Management 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 certain of the
Company's current and future investments may increase in value, offsetting some
of the decline in assets during the period of runoff and increasing shareholder
value, the impact of future market fluctuations on the value of the Company's
invested assets cannot be accurately predicted. Although assets 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 are
expected to occur infrequently and only under extreme circumstances; however,
this cannot be guaranteed.
The Company's active insurance P & C subsidiaries, Sequoia and CIC, should
provide positive cash flows from premium writings, investment income, and the
sale of invested assets. Cash will be used to fund the payment of their own
claims and operating expenses, as well as in purchasing investments. Summit
should produce positive cash flow in the form of investment management fees in
excess of operating costs.
As shown in the accompanying Consolidated Statements of Cash Flows, the
Company provided cash flows of $0.7 million through operating activities in the
first quarter of 1998 and used $16.2 million during the same 1997 period. The
increase in cash provided by operating activities as compared to 1997 primarily
resulted reduced operational cash outlays by Physicians and the inclusion of GEC
in the consolidated financial results during the first quarter of 1998. Net cash
provided by operating activities consisted of $7.7 million from GEC, $0.1
million from Sequoia, $0.3 million from Summit, and $0.3 from Physicians
Investment Company. Net cash used in operating activities included $5.0 million
from Physicians, $0.3 million from PRO, $0.1 million from PICO, and $2.3 million
from CIC.
Cash provided by investing activities during the first quarter of 1998 of
$6.8 million principally reflects fixed income securities maturities and sales
and investment gains realized. Cash provided from investing activities was $18.3
million during the first quarter of 1997.
No cash used in or provided by financing activities during the first quarter
of 1998, compared to cash provided by financing activities of $11.7 million
during the first quarter of the previous year.
In November 1996, Physicians purchased a $2.5 million convertible debenture
from PC Quote. On May 5, 1997, PICO agreed to provide a line of credit to PC
Quote. The initial credit was for $1 million with repayment due September 30,
1997. The credit has since been increased to $2,250,000 with repayment due May
31, 1998.
At March 31, 1998, the Company had no significant commitment for future
capital expenditures, other than in the ordinary course of business and as
discussed herein. The Company has also committed to maintain Sequoia's capital
and statutory policyholder surplus level at a minimum of $7.5 million. Sequoia
was well above this level as of December 31, 1997. The Company has also
committed to make every attempt to maintain Sequoia's Best rating at or above
the "B++" (Very Good) level, which may at some time in the future require
additional capital infusions into Sequoia by the Company.
18
19
The Company continues to address the issue of the compatibility of systems
software with the year 2000. Insurance premium, loss and statistical systems are
particularly critical to the successful operation of the insurance companies. It
is believed that the majority of these systems, which are different among the
various insurance companies, currently accept the year 2000 logic. The MPL
insurance systems are known, however, to be incompatible. Projects are under way
to test all insurance systems and correct the logic of these systems to make
them compatible with the year 2000. Other operating systems consist of various
accounting, billing, disbursement, and tracking systems which may or may not be
compatible with the year 2000. For the most part, these systems are in the
process of being updated by their vendors. Tests will be run to ensure the
compatibility of these systems, also. Management expects these projects to be
completed by the end of 1998. In addition to resources expended in researching
and correcting systems, additional outlays may be necessary to purchase and
install new software compatible with the year 2000. The estimated costs of this
project are undetermined at this time.
CAPITAL RESOURCES
The Company's principal sources of funds are its available cash resources,
operating cash flow, liquidation of non-essential investment holdings,
borrowings, public debt and equity offerings, funds from consolidated tax
savings, and investment management and other fees. At March 31, 1998, the
Company had $63.7 million in cash and cash equivalents compared to $56.4 million
at December 31, 1997.
ADDITIONAL 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 August 1995 Physicians sold its MPL
insurance business; in September 1995 Physicians purchased 38.2% of GEC, a
Canadian corporation active in international investments, agricultural services,
water rights, and other businesses; in November 1996 Physicians acquired control
of Citation Insurance Group ("CIG") pursuant to the Merger; in April 1997 PICO
acquired 25.23% ownership of Nevada Land and Resource Company which owns
approximately 1,365,000 acres of deeded land in northern Nevada; in June 1997
PICO sold its workers' compensation business; and in July and August 1997, PICO
increased its ownership in GEC to 51.17%. 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 fully 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.
19
20
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 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. Messrs. Langley and Hart have entered into employment
agreements with PICO and a wholly-owned subsidiary of GEC as of December 31,
1997. 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. However, based upon actuarial indications from data through
June 30, 1997, Physicians' MPL claims reserves were increased by $2 million
during the third quarter of 1997 due to somewhat deteriorated claims experience
during the first six months of 1997. At the same time, favorable development of
Physicians' and PRO's discontinued personal lines reserves (automobile,
homeowner, etc.) allowed reserve reductions of $750,000 during the third quarter
of 1997. 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 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.
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There can be no assurance that the insurance subsidiaries in the group 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. Prior to the June 30, 1997 sale of Citation National
Insurance Company ("CNIC"), all of CNIC's existing insurance risks and claims
liabilities, except for those insuring workers' compensation, were transferred
to CIC through reinsurance treaties in order to effect the sale of CNIC and the
Company's workers' compensation business. As with other P & C insurers, CIC'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 and Sequoia
generally seek to reduce their exposure to such events through individual risk
selection and the purchase of reinsurance. CIC'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 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, 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 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. PICO's
operating results over the past five years have been volatile. During the past
several years, the levels of the reserves for PICO'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, CIC has had to
significantly increase these reserves in a number of the past several years.
There can be no assurance that significant increases with respect to the
reserves for the P & C business will not be necessary in the future, that the
level of reserves for PICO's insurance subsidiaries will not be volatile in the
future, or that any such increases or volatility will not have an adverse effect
on PICO's operating results and financial condition.
COMPETITION. There are several hundred P & C insurers licensed in
California, many of which are larger and have greater financial resources than
CIC, 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.
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A.M. BEST RATINGS. A.M. Best ("Best") has assigned Sequoia a rating of B++
(Very Good) and APL has had a Best rating of B+ (Very Good) since 1983. CIC was
recently upgraded from a B- (Adequate) to a B+ (Very Good) 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.
INSURANCE COMPANY CAPITAL AND SURPLUS TESTING. In the past few years, the
NAIC has developed risk-based capital ("RBC") measurements for both property and
casualty and life and health insurers. The measures provide the various state
regulators with varying levels of authority based on the adequacy of an
insurer's RBC. The insurance companies' RBC results are reported annually in
their statutory Annual Statements to the insurance departments.
PART II: OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders:
None.
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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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, 1998 By: /s/ GARY W. BURCHFIELD
-----------------------
Gary W. Burchfield
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
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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
+++ 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.
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