SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998 Commission File Number 0-6964
20TH CENTURY INDUSTRIES
-----------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-1935264
---------- ----------
(State or other jurisdiction of (I.R.S. Employer dentification
incorporation or organization) number)
Suite 700, 6301 Owensmouth Avenue, Woodland Hills, California 91367
- - ------------------------------------------------------------- -----
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (818) 704-3700
Securities registered pursuant to Section 12 (b) of the Act:
------------------------------------------------------------
Common Stock, Without Par Value New York Stock Exchange
- - ------------------------------- -----------------------
(Title of Class) (Name of each exchange on which registered)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements,
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based on the average high and low prices for shares of the Company's
Common Stock on March 15, 1999 as reported by the New York Stock Exchange, was
approximately $519,000,000.
On March 15, 1999, the registrant had outstanding 87,635,364 shares of common
stock, without par value, which is the Company's only class of common stock.
DOCUMENT INCORPORATED BY REFERENCE:
Portions of the definitive proxy statement used in connection with the annual
meeting of shareholders of the registrant, to be held on May 25, 1999, are
incorporated herein by reference into Part III hereof.
1
20TH CENTURY INDUSTRIES
1998 FORM 10-K ANNUAL REPORT
Table of Contents
Page
PART I
------
Item 1. Business 3
Item 2. Properties 22
Item 3. Legal Proceedings 22
Item 4. Submission of Matters to a Vote of Security Holders . 22
PART II
-------
Item 5. Market for Registrant's Common Stock and Related
Stockholder Matters 23
Item 6. Selected Financial Data 24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 27
Item 7a. Quantitative and Qualitative Disclosures about Market Risk 39
Item 8. Financial Statements and Supplementary Data 41
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 72
PART III
--------
Item 10. Directors and Officers of the Registrant 72
Item 11. Executive Compensation 72
Item 12. Security Ownership of Certain Beneficial Owners and
Management 72
Item 13. Certain Relationships and Related Transactions 73
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 74
Signatures 81
2
PART I
------
ITEM 1. BUSINESS
GENERAL
20th Century Industries is an insurance holding company founded in 1958 and
incorporated in California. The term "Company," unless the context requires
otherwise, refers to 20th Century Industries and its wholly owned subsidiaries,
20th Century Insurance Company and 21st Century Casualty Company, both of which
are incorporated in California as property and casualty insurance companies and
licensed in California, Nevada, Oregon and Washington. The Common Stock of the
Company is traded on the New York Stock Exchange under the trading symbol "TW."
The Company, through its subsidiaries, directly markets and underwrites
private passenger automobile, homeowners and personal umbrella
insurance. As a direct response writer, the Company has gained a reputation for
excellent customer service and being among the most efficient and low cost
providers of personal insurance in the markets it serves.
Historically, the Company's business has been concentrated in Southern
California, principally the greater Los Angeles and Orange County areas. In the
mid-1980's, however, the Company began expanding into the San Diego area, and in
the early 1990's, the Northern California area. In August 1996, 20th Century
Insurance Company of Arizona ("20th of Arizona") began writing private passenger
automobile insurance in that state. 20th of Arizona is a joint venture between
the Company, which owns a 49% interest, and American International Group, Inc.
("AIG"), which owns a 51% interest. AIG currently owns a majority interest in
the Company. In December 1998, the Company further expanded its operations and
began writing private passenger automobile policies independently in Nevada,
Oregon and Washington.
The Company began providing homeowners insurance in 1982 and condominium
insurance in 1989. A portion of policies issued or renewed prior to July 23,
1994 included optional earthquake coverage endorsements. In the wake of the
Northridge Earthquake which occurred in the San Fernando Valley area of Southern
California on January 17, 1994 , the Company's writings in these lines were
reduced in the period 1994 to 1998. In compliance with an order by the
California Department of Insurance in June 1994, the Company immediately began
to non-renew
3
earthquake coverage endorsements and to cease writing new
homeowners and condominium policies. The order also required the Company to
begin non-renewing all homeowners and condominium policies effective July 23,
1996.
In late 1996, the Company obtained permission to renew its remaining
homeowners policies effective February 15, 1997. As of that date, approximately
68,000 homeowners insurance policies remained in force. The condominium program
was fully discontinued as of July 23, 1997. The Company is complying with
California's requirement to offer earthquake coverage to its remaining
homeowners customers through a separate residential earthquake insurance policy
underwritten and issued by American Home Assurance Company, a subsidiary of AIG.
The Company is not currently authorized by the California Insurance Commissioner
to offer homeowners insurance to new or former customers. Although the Company
has initiated discussions to obtain that authorization, it is unable to predict
if or when the California Insurance Commissioner will grant the Company's
request. The Company's reentry into the homeowners market is a strategy
intended to complement its auto business and facilitate growth in that line.
LIMITS OF INSURANCE COVERAGE
The Company offers the following insurance coverages for private passenger
automobiles: bodily injury liability; property damage; medical payments;
uninsured and underinsured motorist; rental reimbursement; uninsured motorist
property damage and collision deductible; towing; comprehensive and collision.
Policies are written for a six-month term. Various limits of liability are
underwritten with maximum limits of $500,000 per person and $500,000 per
accident. The most frequent bodily injury liability limits purchased are
$100,000 per person and $300,000 per accident.
The homeowners program utilizes an extended replacement cost policy, thereby
limiting loss to 150% of the amount specified in the contract for Coverage A -
Dwelling and Other Building Structures. Underwriting guidelines provide for a
minimum dwelling amount of $65,000 and a maximum dwelling amount of $500,000.
Personal liability coverage limits of $100,000, $200,000 and $300,000 are
available.
4
The personal umbrella policy ("PUP") is written by 20th Century Insurance
Company and provides liability coverage with a limit of $1,000,000 in excess of
the underlying automobile and homeowners liability coverage. Minimum underlying
automobile limits of $100,000 per person and $300,000 per accident are required
while homeowners must have a minimum of $100,000 personal liability coverage.
The underlying automobile coverage must be written by the Company.
MARKETING
The Company markets its policies directly to customers, without utilizing
or engaging outside agents or brokers, using direct mail, print, radio,
television and internet advertising. Quotes may be requested 24 hours a day, 7
days a week through a convenient toll-free 800 number. Prospective California
policyholders may also obtain an instant rate quotation on the Company's
internet site (http://www.20thCenturyInsurance.com). Traffic to the Company's
internet site continues to increase, offering visitors an additional way to
request a rate quotation, amend their policy, or obtain information about the
Company.
Throughout 1998, the Company actively advertised in California's major
metropolitan markets (Los Angeles and Orange Counties, the Inland Empire, the
Bay Area, San Diego, Sacramento, Fresno and Bakersfield). Automobile quotations
increased 22% over the prior year while the number of vehicles insured on new
policies increased 24 % over the prior year.
The Company continues to increase penetration in the Sacramento and Bay Area
markets, generating approximately 57% more new business from these two markets
in 1998 than in 1997. Approximately 52% of all new business written in 1998 came
from outside the Los Angeles/Orange County areas.
5
UNDERWRITING AND PRICING
The regulatory system in California requires the prior approval of
insurance rates and forms. Within this regulatory framework, the Company
establishes its automobile and homeowners premium rates based primarily on
actuarial analyses of its own historical premium, loss and expense data. These
data are compiled and analyzed to establish overall rate levels as well as
classification differentials. The Company's rates are established at levels
intended to generate underwriting profits and vary for individual policies based
on a number of rating characteristics. The primary characteristics include, by
statute in California, driving record, annual mileage and number of years the
driver has been licensed. A number of other "optional" rating factors are also
permitted in California.
The Company is required to offer insurance to any California prospect who
meets the statutory definition of a "Good Driver." This definition includes all
drivers who have been licensed more than three years and have had no more than
one violation point count under criteria contained in the California Vehicle
Code. These criteria include a variety of moving violations and certain at-
fault accidents.
Effective January 1, 1999, the Company instituted a five-year guaranteed
renewal feature for new and renewed business meeting certain conditions. This
new feature is not a price guarantee.
The Company reviews many of its automobile policies prior to the time of
renewal and as changes occur during the policy period. The customer may contact
the Company to make changes, such as the addition or deletion of drivers or
vehicles, changes in the classification of drivers or usage of vehicles, changes
in garaging location and changes in coverages or limits. Some mid-term changes
may result in premium adjustments and some may result in the policy being
re-underwritten and eventually not renewed because of a substantial increase in
risk.
With respect to the homeowners renewal program which started on February 15,
1997, underwriting procedures include a review of claims and identification of
changes in circumstances that may warrant premium adjustments or cancellation of
coverage in the case of a substantial increase in risk.
6
SERVICING OF BUSINESS
The Company continues to adapt its technological capabilities in keeping
with its business strategies. Computerized systems provide the information
resources, telecommunications and data processing capabilities which support the
technical needs of the Company. In addition to providing ongoing support, the
systems provide the strategic capabilities necessary to manage the Company's
business. During 1997, the Company began the process of significantly upgrading
its technology infrastructure and replacing aging information systems with
newer, more flexible systems. This transition will take several more years to
complete. In 1998, business operations supporting the states of Washington,
Oregon and Nevada commenced using this new infrastructure. As of January 1,
1999, the Company's internal administrative processes, such as payroll and
accounting, have been successfully converted to the new systems.
In November 1998, the Company completed the testing of its internal systems to
ensure they are Year 2000 ("Y2K") compliant. During 1999, the Company expects
to complete the Y2K compliance certification of its significant external
suppliers and internal facilities and equipment that may contain imbedded
technology with Y2K compliance issues. A contingency plan will be in place to
ensure continued service to policyholders in the event of an unforeseen or
uncontrollable failure (discussed in more detail in Management's Discussion and
Analysis, Impact of Year 2000).
CLAIMS
Claims operations include the receipt and analysis of initial loss reports,
assignment of legal counsel, when necessary, and management of the settlement
process. Whenever possible, physical damage claims are handled through the use
of Company drive-in claims facilities, vehicle inspection centers and Direct
Repair Program ("DRP") providers. The claims management staff administers the
claims settlement process and oversees the work of the legal and adjuster
personnel involved in that process. Each claim is carefully analyzed to provide
for fair loss payments, compliance with the Company's contractual obligations
and management of loss adjustment expenses. Liability and property damage
claims are handled by specialists in each area.
7
The Company utilizes its legal staff to handle most aspects of claims
litigation, including trial, from offices in Brea, Ontario, Long Beach, San
Diego and Woodland Hills. In-house attorneys handle approximately 70% of all
lawsuits. Suits which may involve a conflict of interest are assigned to
outside counsel.
Recognizing the need to provide its customers with convenient, local service,
the Company has established eleven Division Service Offices in Los Angeles,
Orange, San Diego and Ventura Counties and the San Francisco Bay Area. Each
Division Service Office is a full service center, normally staffed with between
seventy-five and one hundred employees who provide complete claims services from
initial investigation to final settlement.
The Company makes extensive use of its DRP to expedite the repair process.
The program involves agreements between the Company and over 130 independent
repair facilities. The Company agrees to accept the estimate for damages
prepared by the repair facility without requiring each vehicle to be inspected
by staff adjusters. The facilities selected undergo a screening process before
being accepted, and the Company maintains an aggressive reinspection program to
assure quality results; the Company's reinspection team visits all repair
facilities each month and reinspects approximately 40% of all repairable
vehicles in this program. The customer benefits by getting the repair process
started faster, and the repairs are guaranteed for as long as the customer owns
the vehicle. The Company benefits by not incurring the overhead expense of a
larger staff of appraisers and by negotiating repair rates it believes are
beneficial. Currently, over 30% of all damage repairs are handled using the DRP
method.
The Company has three vehicle inspection centers located in Los Angeles and
Orange Counties. Each vehicle inspection center is staffed with between fifteen
and twenty employees who handle total losses, total thefts and vehicles which
are not driveable.
The Claims Services Division employs approximately 100 people who are
responsible for subrogation, medical payment claims and workers' compensation
claims arising under the homeowners policies.
8
The Company also maintains a Special Investigations Unit with approximately 40
personnel who investigate suspected fraudulent claims. The Company believes its
efforts in this area have been responsible for saving several million dollars
annually.
The Homeowners Division processes all homeowners property claims on a
regional basis and is made up of two units of approximately twelve employees
each. The units are located in Brea and Woodland Hills.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The Company establishes reserves, or liabilities, at each accounting date for
losses and loss adjustment expenses arising from claims, both reported and
unreported, which have been incurred but which remain to be paid. Such reserves
are estimates, as of a particular date, of the amount the Company will
ultimately pay, net of any recoverable salvage and subrogation, for claims
incurred as of the accounting date.
"Case basis" reserves are established for bodily injury liability and uninsured
motorist claims which are either expected to exceed $15,000 or are older than
two years. Such case reserves are based on the specific circumstances of the
claim.
Case reserves for other bodily injury and uninsured motorists claims and for all
other coverages are established at an average case reserve value. These average
values are based on a review of prior claims payments for each coverage.
The Company supplements the case basis reserve estimates with bulk loss reserves
estimated using actuarial methodologies. These reserves are designed to provide
for claims incurred but not reported ("IBNR") to or recorded by the Company as
of the accounting date, changes over time in case reserve estimates, and loss
adjustment expenses which include estimates of the legal and other costs of
settling claims. The actuarial estimates utilize the Company's own historical
loss experience and are reviewed each quarter. The effects of inflation are
implicitly considered in the
9
actuarial estimates, and the Company does not discount its reserves to present
value for financial reporting purposes.
Reserve estimates are necessarily subject to the impact of future changes in
economic and social conditions. Management believes that, given the inherent
variability in any such estimates, the aggregate reserves are within a
reasonable and acceptable range of adequacy. The methods of making such
estimates and for establishing the resulting reserves are reviewed and updated
quarterly and any adjustments resulting therefrom are reflected in earnings
currently.
A rollforward of loss and loss adjustment expense reserves, including the
effects of reserve changes, loss payments, and reinsurance for each of the three
years in the period ended December 31, 1998, is presented in Note 8 of the
Notes to Consolidated Financial Statements.
The following table presents the development of loss and loss adjustment
expense reserves, net of reinsurance, for the years 1988 through 1998. The top
line of the table shows the reserves at the balance sheet date, net of
reinsurance recoverables, for each of the years indicated. The upper portion of
the table indicates the cumulative amounts paid as of subsequent year-ends with
respect to that reserve liability. The lower portion of the table indicates the
re-estimated amount of the previously recorded reserves based on experience as
of the end of each succeeding year, including cumulative payments made since the
end of the respective year. The estimates change as more information becomes
known about the frequency and severity of claims for individual years. A
redundancy (deficiency) exists when the original reserve estimate is greater
(less) than the re-estimated reserves. The deficiencies shown in the 1994, 1995
and 1997 columns, and the smaller redundancy shown in the 1996 column, result
from the additional earthquake losses and loss adjustment expenses recorded
subsequent to 1994. The impact on the redundancy or deficiency shown is $164.75
million for 1994, $104.75 million for 1995, $64.75 million for 1996 and $40
million for 1997.
10
(AMOUNTS IN THOUSANDS)
AS OF DECEMBER 31,
------------------------
1988 1989 1990 1991 1992 1993 1994 1995 1996
-------- -------- -------- -------- -------- -------- --------- --------- --------
Reserves for
losses and loss
adjustment expenses,
net of reinsurance $ 391,748 $472,010 $525,220 $547,098 $554,034 $574,619 $755,101 $552,320 $489,033
Paid (cumulative)
as of:
One year later 197,555 242,757 300,707 320,264 327,634 344,876 519,969 351,985 304,714
Two years later 271,163 328,606 391,970 401,019 403,434 423,713 635,861 485,462 395,922
Three years later 310,757 366,369 420,853 426,412 425,671 443,055 721,445 527,908
Four years later 326,495 377,980 429,791 433,642 432,086 457,430 745,912
Five years later 330,014 381,507 431,791 436,522 434,949 460,857
Six years later 330,879 382,230 432,975 437,365 436,876
Seven years later 331,433 382,108 433,096 437,758
Eight years later 331,344 382,129 433,095
Nine years later 331,421 382,086
Ten years later 331,474
Reserves re-
estimated as of:
One year later 357,220 402,706 473,974 473,209 491,048 490,166 715,637 526,730 424,406
Two years later 342,365 397,847 449,348 461,343 447,880 465,036 725,098 537,635 467,958
Three years later 340,760 389,559 442,508 440,198 438,726 453,431 751,302 579,093
Four years later 333,432 384,948 433,408 437,350 435,128 460,947 790,479
Five years later 332,100 382,331 432,370 436,929 435,942 462,372
Six years later 331,191 381,996 432,661 437,600 437,034
Seven years later 331,274 381,914 433,050 437,706
Eight years later 331,184 382,126 432,949
Nine years later 331,473 381,955
Ten years later 331,361
Redundancy
(Deficiency) $ 60,387 $ 90,055 $ 92,271 $109,392 $117,000 $112,247 $(35,378) $(26,773) $ 21,075
(AMOUNTS IN THOUSANDS)
- - ----------------------
1997 1998
--------- --------
Reserves for
losses and loss
adjustment expenses,
net of reinsurance $388,418 $339,815
Paid (cumulative)
as of:
One year later 251,951
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Reserves re-
estimated as of:
One year later 392,039
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Redundancy
(Deficiency) $ (3,621)
11
Each amount in the preceding table includes the effects of all changes in
amounts for prior periods. The table does not present accident year or policy
year development data. Conditions and trends that have affected the development
of liabilities in the past may not necessarily occur in the future. Therefore,
it would not be appropriate to extrapolate future deficiencies or redundancies
based on the table.
In the consolidated balance sheet, the reserves for losses and loss
adjustment expenses are shown "gross," that is, before reduction for
reinsurance. The table which follows presents the development of gross losses
and loss adjustment expense reserves for calendar years 1996 through 1998. As
in the ten-year table presented net of reinsurance, each amount in the following
table includes the effects of all changes in amounts for prior periods. The
table does not present accident year or policy year development data and it
would not be appropriate to extrapolate future development based on this table.
(Amounts in thousands) 1996 1997 1998
-------- -------- --------
Gross loss and loss adjustment
expense reserves, December 31, $543,529 $437,887 $382,003
Paid (cumulative) as of:
One year later 335,895 283,753
Two years later 437,340
Gross liability re-estimated as of:
End of year 543,529 437,887 382,003
One year later 467,473 436,699
Two years later 513,000
Gross cumulative redundancy 30,529 1,188
The redundancies indicated above result from the additional earthquake
losses and loss adjustment expenses recorded subsequent to 1994.
OPERATING RATIOS
Combined Ratios
Underwriting profit margins are measured by the extent to which the
combined ratios (loss and loss adjustment expense ("LAE") ratio and underwriting
expense ratio) are less than 100% of premium
12
revenues. Combined ratios are used to measure the underwriting success of
property and casualty insurance companies. Losses and loss adjustment expenses
are stated as a percentage of premiums earned because losses may occur over the
life of a particular insurance policy. An important indicator of operating
efficiency, the underwriting expense ratio is based on premiums written for
statutory accounting practices ("SAP") and earned premiums for reporting under
generally accepted accounting principles ("GAAP"). The loss and LAE ratios,
underwriting expense ratios (excluding interest and fees), and combined ratios
for the Company's subsidiaries, on a SAP and GAAP basis, are shown in the
following tables.
YEARS ENDED DECEMBER 31,
------------------------
SAP 1998 1997 1996 1995 1994
- - -------------------------- ----- ----- ----- ----- ------
Loss and LAE ratio 81.0% 77.3% 85.8% 88.7% 173.0%
Underwriting expense ratio 10.7 9.5 9.4 8.7 9.9
----- ----- ----- ----- ------
Combined ratio 91.7% 86.8% 95.2% 97.4% 182.9%
===== ===== ===== ===== ======
YEARS ENDED DECEMBER 31,
------------------------
GAAP 1998 1997 1996 1995 1994
- - -------------------------- ----- ----- ----- ----- ------
Loss and LAE ratio 81.0% 77.3% 85.8% 88.4% 176.8%
Underwriting expense ratio 10.2 9.4 9.3 9.0 9.7
----- ----- ----- ----- ------
Combined ratio 91.2% 86.7% 95.1% 97.4% 186.5%
===== ===== ===== ===== ======
The effects of the Northridge Earthquake and other non-recurring charges
(accelerated amortization of restricted stock grants in 1998 and Y2K costs in
both 1998 and 1997) contributed 6.1 and 3.3 percentage points on both a GAAP and
SAP basis to the 1998 and 1997 combined ratios, respectively. In 1996, 1995 and
1994, the Northridge Earthquake contributed 4.7, 2.9 and 85.1 percentage points,
respectively, on both a GAAP and SAP basis to the combined ratios. In 1997,
most of the improvement in the combined ratio is due to favorable loss trends in
the automobile line. In 1998, the loss and LAE ratio for the automobile line
increased 0.9% and the underwriting expense ratio increased 1.2%. The Company's
underwriting results
13
and loss ratios by line of business are discussed in more
detail in Management's Discussion and Analysis, Underwriting Results, and in
Note 17 of the Notes to Consolidated Financial Statements.
Premiums to Surplus Ratio
The following table shows, for the periods indicated, the Company's statutory
ratios of net premiums written to policyholders' surplus. Because each property
and casualty insurance company has different capital needs, an "appropriate"
ratio of net premiums written to policyholders' surplus for one company may not
be the same as for another company. While there is no statutory requirement
applicable to the Company, guidelines established by the National Association of
Insurance Commissioners provide that such ratio generally should be no greater
than 3 to 1 on a statutory basis.
YEARS ENDED DECEMBER 31,
-------------------------
SAP 1998 1997 1996 1995 1994
- - ----------------------------------- -------- -------- -------- -------- --------
(Amounts in thousands, except ratio)
Net premium written $773,714 $788,600 $827,993 $958,614 $1,032,737
Policyholders' surplus $600,654 $548,043 $436,367 $358,474 $ 207,018
Ratio 1.3:1 1.4:1 1.9:1 2.7:1 4.9:1
The 1994 and 1995 ratios were high because of surplus strain caused by the
Northridge Earthquake. Capital infusions in 1994 and a return to profitable
operations in 1995 resulted in improved surplus levels that reduced the ratio
below 3 to 1 in 1995 and below 2 to 1 in 1996, 1997 and 1998.
INVESTMENTS AND INVESTMENT RESULTS
The Company's investment guidelines emphasize buying high-quality, fixed
income investments. The Investment Committee of the Company's Board of
Directors regularly reviews these guidelines and the performance of the
portfolio. Because of the net operating loss ("NOL") carryforwards available
for tax purposes, the Company's investment strategy emphasized taxable
securities to maximize overall cash flow following the Northridge Earthquake in
1994 until the fourth quarter of 1998, by which time the NOL had
14
been
substantially reduced. While the Company does not invest with a view to
achieving realized gains, securities are bought and sold in order to meet the
main objectives of the investment portfolio. These objectives are to maximize
after-tax investment income and total investment returns while minimizing credit
and liquidity risk. The Company currently has designated all of its portfolio
as "available-for-sale."
The following table summarizes investment results for the five most recent
years:
YEARS ENDED DECEMBER 31,
--------------------------
(Amounts in thousands) 1998 1997 1996 1995 1994
--------- ----------- ----------- ----------- -----------
Average invested assets, at
cost or amortized cost;
includes cash and cash
equivalents $1,147,852 $1,088,864 $1,111,396 $1,193,202 $1,259,871
Net investment income:
Before income taxes $ 75,146 $ 73,463 $ 73,178 $ 81,658 $ 84,761
After income taxes $ 49,248 $ 49,105 $ 52,038 $ 56,597 $ 68,629
Average annual return on
investments:
Before income taxes 6.6% 6.7% 6.6% 6.8% 6.7%
After income taxes 4.3% 4.5% 4.7% 4.7% 5.4%
Net realized investment
gains after income taxes $ 14,716 $ 2,646 $ 4,736 $ 6,634 $ 40,010
Net increase (decrease) in
unrealized gains on
investments after
income taxes $ 3,089 $ 17,478 $ (30,688) $ 73,285 $ (134,660)
Investment income and average invested assets increased in 1998 compared to
1997 due to cash flow from operations and $145.6 million received from AIG in
the third quarter of 1998 for the exercise of warrants to purchase common stock
of the Company (see Note 12 of the Notes to Consolidated Financial
Statements). The decline in the investment portfolio from 1994 through 1997
resulted largely from the sale
15
of investments to generate cash to cover the severe losses and other
ongoing expenses resulting from the Northridge Earthquake. The declining
after-tax return on investments in the previous table is a result of the shift
to taxable securities since 1994; the sale, maturity or early redemption of
older securities with high yields; and re-investment in securities with
significantly lower yields due to general market conditions. In addition, in
1998, a greater portion of the portfolio was invested in commercial paper for
liquidity purposes which yielded a lower return than the portion invested in
bonds.
The following table sets forth the composition of the Company's investments and
cash and cash equivalents at the dates indicated.
DECEMBER 31,
-------------
1998 1997 1996
------------------------- ---------------------- ----------------------
(Amounts in thousands) Amortized Fair Amortized Fair Amortized Fair
Type of Security Cost Value Cost Value Cost Value
- - ------------------------ ------------- ---------- ---------- ---------- ---------- ----------
Fixed maturities:
U.S. Treasury secur-
itites and obliga-
tions of U.S. govern-
ment corporations
and agencies $ 5,971 $ 6,129 $ 6,735 $ 6,758 $ 11,906 $ 11,885
Obligations of
states and politi-
cal subdivisions 159,010 161,739 36,680 39,523 287,277 292,127
Public utilities 162,119 171,545 171,060 175,174 164,509 163,674
Corporate securities 705,291 727,835 838,500 861,253 596,346 596,017
------------- ---------- ---------- ---------- ---------- ----------
Total fixed maturities 1,032,391 1,067,248 1,052,975 1,082,708 1,060,038 1,063,703
Equity securities 250 1,373 250 1,745 250 925
------------- ---------- ---------- ---------- ---------- ----------
Total investments 1,032,641 1,068,621 1,053,225 1,084,453 1,060,288 1,064,628
Cash and cash
equivalents 167,856 167,856 31,268 31,268 18,078 18,078
------------- ---------- ---------- ---------- ---------- ----------
Total investments
and cash and cash
equivalents $ 1,200,497 $1,236,477 $1,084,493 $1,115,721 $1,078,366 $1,082,706
============= ========== ========== ========== ========== ==========
16
COMPETITION
The property and casualty insurance market is highly competitive and is
comprised of a large number of well-capitalized companies, many of which operate
in a number of states and offer a wide variety of products. Several of these
competitors are larger and have greater financial resources than the Company.
Based on earned premium, the Company is the seventh largest writer of private
passenger automobile insurance in California.
The Company's main competition comes from other major writers which concentrate
on the good driver market. The Company generally has sought to avoid, to the
extent regulations permit, the "non-standard," "high-risk" and similar niche
market segments.
The Company's marketing and underwriting strategy is to appeal to careful and
responsible drivers who deal directly with the Company in order to save
significant amounts of money on their insurance premiums. By selling its
products directly to the insured, the Company has eliminated agent and broker
commissions. The Company relies heavily on its centralized operations and its
efficient computerized systems to service its policyholders and claimants.
Consequently, the Company consistently operates with one of the lowest
underwriting expense ratios in the industry and is able to maintain its rates
among the lowest in the markets it serves while still providing quality service
to its customers. As a result, the Company has been able to achieve profitable
growth and to maintain policy renewal rates which it believes are significantly
above industry averages.
REINSURANCE
A reinsurance transaction occurs when an insurer transfers or cedes a portion of
its exposure from direct business written to a reinsurer which assumes that
exposure for a premium. The reinsurance cession does not legally discharge the
insurer from its liability for a covered loss, but provides for reimbursement
from the reinsurer to the insurer for the ceded portion. The Company
periodically monitors the continuing appropriateness of all its reinsurance
arrangements to determine that its reinsurers maintain high A. M. Best ratings
and other indicators of ability to meet their obligations as well as competitive
pricing for the risk involved.
17
The Company's insurance subsidiaries have entered into a five-year quota
share reinsurance agreement with an AIG affiliate covering all ongoing lines of
business. Under this contract, which attaches to the Company's retained risks
net of all other reinsurance, 10% of each subsidiary's premiums earned and
losses and loss adjustment expenses incurred in connection with policies
incepted during the period January 1, 1995 through December 31, 1999 is ceded.
At the end of the five-year period, the AIG affiliate has the option of renewing
the agreement annually for four years at declining coverage percentages. A
ceding commission of 10.8% was earned by the insurance subsidiaries for 1995
and, thereafter, a commission is paid at a rate equal to the prior year's gross
SAP underwriting expense ratio. The ceding commission rate was 9.13%, 9.36% and
9.40% for 1996, 1997 and 1998, respectively.
Since mid-1996, when the homeowners line began to shrink considerably for
reasons discussed earlier, the Company has found it more economical to maintain
100% quota share reinsurance arrangements for its homeowners line rather than
purchasing alternative reinsurance coverage for its remaining exposure to
catastrophes such as fire following earthquake. These reinsurance arrangements
are discussed in more detail in Note 10 of the Notes to Consolidated Financial
Statements.
The Company has a quota share reinsurance treaty for the PUP whereby 60% of
premiums and losses are ceded to the reinsurer. After the effect of the 10%
quota share treaty with AIG, the Company effectively retains 36% of the risk for
this line.
REGULATION
An insurance company is subject to regulation and supervision by the insurance
departments of the states in which it does business. These insurance
departments have broad regulatory, supervisory and administrative powers, such
as:
- - - Licensing of insurance companies and agents
- - - Prior approval of rates, rules and forms
- - - Standards of solvency
- - - Nature of, and limitations on, insurance company investments
- - - Periodic examinations of the affairs of insurers
18
- - - Annual and other periodic reports of the financial condition and results of
operations of insurers
- - - Establishment of accounting rules
- - - Issuance of securities by insurers
- - - Payment of dividends
State regulations are designed principally for the benefit of
policyholders. Currently, the California Department of Insurance ("CDOI") has
primary regulatory jurisdiction over the Company. In general, the current
regulatory requirements in the other states in which the Company is a licensed
insurer are no more stringent than in California.
In June 1994, the CDOI ordered the Company to immediately begin
non-renewing earthquake coverage endorsements and to cease writing new
homeowners and condominium policies and, effective July 23, 1996, to begin
non-renewing all its remaining homeowners and condominium policies. On December
23, 1996, the order was amended, permitting the Company to resume renewing its
remaining homeowners policies effective February 15, 1997, with the statutorily
required offer of earthquake coverage to be made by an affiliate of AIG. The
Company continues to seek approval to resume writing new homeowners policies,
but there is no assurance the CDOI will grant the Company's request. Inability
to write new homeowners policies hinders the Company's efforts to sell
automobile insurance to certain consumers who prefer the convenience of having
both coverages provided by the same insurer.
The operations of the Company are governed by the laws of the State of
California and by the laws of the other states in which it is a licensed
insurer. Changes in those laws can affect the revenues and expenses of the
Company. In 1998, no new laws were enacted by any such state that are expected
to have a material impact on the auto insurance industry.
Ballot Proposition 213 was approved by an overwhelming majority of California
voters on November 5, 1996. This proposition bars certain drivers and most
uninsured drivers from recovering non-economic damages for injuries they suffer
in vehicle accidents. Two lawsuits challenged the constitutionality of the
proposition, but the appellate courts in 1997 upheld the proposition's
constitutionality. The California Supreme Court in March 1998 denied the
petition for review with the plaintiffs thereafter petitioning the
19
U.S. Supreme Court for writ of certiorari. The petition is still pending as
of late March 1999. This proposition has had a beneficial effect on
underwriting profit in 1997 and 1998.
The Company anticipates that legislation allowing third parties to bring an
independent cause of action for a breach of Unfair Claims Practices regulations
and statutes may be introduced in the current legislative session in California.
If such legislation were to be enacted, claims costs would increase, which may
or may not adversely affect the Company's operating results depending on the
Company's ability to pass the increased costs on to its customers through higher
rates.
Additionally, the Company anticipates that the California Insurance
Commissioner will propose changes to the rating regulations during 1999. There
can be no assurance that adoption of such changes would not be detrimental to
the Company's future operating results.
The Company is a member of industry organizations which may advocate
legislative and initiative proposals and which provide financial support to
officeholders and candidates for California statewide public offices. The
Company also makes financial contributions to those officeholders and candidates
who, in the opinion of management, have a favorable understanding of the needs
of the property and casualty insurance industry. In 1998, these contributions
were nominal. The Company believes that such contributions are important to the
future of the property and casualty insurance industry in California and intends
to continue to make such contributions as it determines to be appropriate and in
compliance with applicable law.
HOLDING COMPANY ACT
The Company's subsidiaries are also subject to regulation by the CDOI
pursuant to the provisions of the California Insurance Holding Company System
Regulatory Act (the "Holding Company Act"). Certain transactions defined to be
of an "extraordinary" nature may not be effected without the prior approval of
the CDOI. Such transactions include, but are not limited to, sales, purchases,
exchanges, loans and extensions of credit, and investments made within the
immediately preceding 12 months involving in the net aggregate, more than the
lesser of (i) 3% of the Company's admitted assets or (ii) 25% of the
policyholder's surplus as of the preceding December 31. An extraordinary
transaction also includes a dividend which, together with other dividends or
distributions made within the preceding twelve months, exceeds the greater of
(i) 10% of the insurance company's policyholders' surplus as of the preceding
December 31 or (ii) the insurance
20
company's net income for the preceding calendar year. The California code
further provides that property and casualty insurers may pay dividends only from
earned surplus. The Holding Company Act generally restricts the ability of any
one person to acquire more than 10% of the Company's voting securities without
prior regulatory approval.
NON-VOLUNTARY BUSINESS
Automobile liability insurers in California are required to participate in
the California Automobile Assigned Risk Plan ("CAARP"). Drivers whose driving
records or other relevant characteristics make them difficult to insure in the
voluntary market may be eligible to apply to CAARP for placement as "assigned
risks." The number of assignments for each insurer is based on the total
applications received by the plan and the insurer's market share. With the
passage of AB 650 on January 1, 1997, which requires proof of financial
responsibility for vehicle registration renewals, the number of drivers applying
to CAARP increased, and the Company's share of CAARP assignments grew
commensurately from 6,847 vehicles insured at the end of 1996 to 12,133 vehicles
at the end of 1997. As of December 31, 1998, assigned risk vehicles insured
decreased to 4,485. This is a result of assigned risk participants finding
affordable coverage in the voluntary market as well as drivers who dropped out
of the program after initially responding to the new legislation. The CAARP
assignments have historically produced underwriting losses. As of December 31,
1998, this business represented less than 0.6% of the Company's total gross
premiums written.
Insurers offering homeowners insurance in California are required to
participate in the California Fair Plan ("Fair Plan"). Fair Plan is a state
administered pool of difficult to insure homeowners. Each participating insurer
is allocated a percentage of the total premiums written and losses incurred by
the pool according to its share of total homeowners direct premiums written in
the state. The Company's Fair Plan underwriting results for 1998 were
immaterial.
EMPLOYEES
The Company had 2,284 full and part-time employees at December 31, 1998. The
Company provides medical, pension and 401(k) savings plan benefits to eligible
employees according to the provisions of each plan. The Company believes that
its relationship with its employees is excellent, and employee turnover is
generally very low.
21
ITEM 2. PROPERTIES
The Company leases its Home Office building in Woodland Hills, California,
which contains approximately 230,000 square feet of leasable office space. The
lease was amended in April 1998 to extend its term until November 2014. The
lease may be renewed for two consecutive five-year periods.
In April 1998, the Company signed an agreement to become the primary tenant
of the new 20th Century Plaza project to be completed in late 1999. As part
of its goal to maintain centralized operations, five of the Company's outlying
offices will be incorporated into the 20th Century Plaza. The project includes
the construction of a second office building and a parking structure.
The Company also leases office space in 23 other locations throughout
California. The Company anticipates no difficulty in extending these leases or
obtaining comparable office facilities in suitable locations.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is named as a defendant in
lawsuits related to claim issues. Some of the actions request exemplary or
punitive damages. These actions are vigorously defended unless a reasonable
settlement appears appropriate.
Currently included in this class of litigation are certain actions that
arose out of the Northridge Earthquake. It is believed that a majority of these
actions were filed to resolve claims involving disputed damages or to contest
the applicability of the statute of limitations. While any litigation has an
element of uncertainty, the Company does not believe that the ultimate outcome
of any pending action will have a material effect on its consolidated financial
condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
22
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
(A) PRICE RANGE OF COMMON STOCK
The stock is currently traded on the New York Stock Exchange under the
trading symbol "TW." The following table sets forth the high and low bid prices
for the common stock for the indicated periods.
High Low
-------- --------
1998
- - --------
Fourth Quarter 25-7/8 20-15/16
Third Quarter 29-3/16 22-15/16
Second Quarter 29-1/2 26-3/4
First Quarter 30-3/8 24-3/8
1997
- - --------
Fourth Quarter 27-3/4 23
Third Quarter 25-15/16 21-1/4
Second Quarter 24 16-1/2
First Quarter 18-1/8 16-3/8
(B) HOLDERS OF COMMON STOCK
The approximate number of record holders of common stock on December 31,
1998, was 925.
(C) DIVIDENDS
The Company paid cash dividends on its common stock each year since 1973
through the second quarter of 1994. Dividends were resumed in the fourth
quarter of 1996. Dividends of $0.05 per share were paid in the first three
quarters of 1997 and then doubled to $0.10 per share for the fourth quarter of
1997 and the first quarter of 1998. Dividends increased to $0.16 per share for
each of the last three quarters of 1998.
The parent company is dependent upon dividends from its subsidiaries to
service debt and pay dividends to its stockholders. Based on 1998 operating
results and earned surplus as of December 31, 1998, the Company believes it will
not require regulatory approval in 1999 for any extraordinary dividends.
23
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented below as of the end of
and for each of the years in the five-year period ended December 31, 1998, are
derived from the consolidated financial statements of 20th Century Industries
and its subsidiaries. The consolidated financial statements as of December 31,
1998 and 1997 and for each of the years in the three-year period ended December
31, 1998, are included elsewhere in this Form 10-K. The earnings per share
amounts prior to 1997 have been restated as required to comply with Statement of
Financial Accounting Standards No. 128, Earnings Per Share. For further
discussion of earnings per share, see Note 3 of the Notes to Consolidated
Financial Statements.
24
All dollar amounts set forth in the following tables are in thousands, except
per share data.
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- ---------- -----------
Operations Data:
Net premiums earned $772,864 $785,989 $856,628 $ 963,797 $1,034,003
Net investment income 75,146 73,463 73,178 81,658 84,761
Realized investment gains 22,640 4,071 7,287 10,207 61,554
-------- -------- -------- ---------- -----------
Total Revenues 870,650 863,523 937,093 1,055,662 1,180,318
Net losses and loss adjustment
expenses 626,379 607,775 734,735 851,602 1,828,346
Policy acquisition costs 51,563 44,851 38,175 38,647 43,409
Other operating expenses 27,060 29,047 41,496 48,311 57,198
Proposition 103 expense - - - - 29,124
Interest and fees expense 10,278 13,722 14,260 15,897 8,348
-------- -------- -------- ---------- -----------
Total Expenses 715,280 695,395 828,666 954,457 1,966,425
Income (loss) before federal
income taxes (benefit) 155,370 168,128 108,427 101,205 (786,107)
Federal income taxes (benefit) 54,298 57,199 34,370 31,575 (288,087)
-------- -------- -------- ---------- -----------
Net income (loss) $101,072 $110,929 $ 74,057 $ 69,630 $ (498,020)
======== ======== ======== ========== ===========
Per Share Data:
Basic $ 1.36 $ 1.76 $ 1.05 $ 0.97 $ (9.69)
======== ======== ======== ========== ===========
Diluted $ 1.19 $ 1.37 $ 0.92 $ 0.90 $ (9.69)
======== ======== ======== ========== ===========
Dividends paid per common
share $ 0.58 $ 0.25 $ 0.05 $ - $ 0.32
======== ======== ======== ========== ===========
25
In 1998 and 1997, the Company's financial statements include the effects of
non-recurring charges of $7.7 million and $1.5 million, respectively. Such
charges represent accelerated amortization of restricted stock grants in 1998
and Year 2000 costs in both 1998 and 1997. Additionally, increases in
earthquake reserves in 1998 of $40 million, in 1997 of $24.75 million, in 1996
of $40 million and in 1995 of $60 million offset partially by a $32 million
reduction in the Proposition 103 liability per an order from the CDOI are also
included in the financial statements. In 1994, earthquake-related losses and
expenses were $844.1 million. On an after-tax basis, these additional charges
reduced (increased) basic earnings (loss) per share by $0.46, $0.33, $0.51,
$0.35 and ($10.67) for 1998, 1997, 1996, 1995 and 1994, respectively.
DECEMBER 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
------------- ---------- ---------- ---------- ----------
Balance Sheet Data:
Total investments $ 1,068,621 $1,084,453 $1,064,628 $1,127,112 $ 942,174
Total assets 1,593,156 1,482,454 1,513,755 1,608,886 1,702,810
Unpaid losses and loss
adjustment expenses 382,003 437,887 543,529 584,834 756,243
Unearned premiums 233,689 233,402 231,141 288,927 298,519
Bank loan payable 112,500 157,500 175,000 175,000 160,000
Claims checks payable 34,311 35,569 36,445 49,306 70,725
Stockholders' equity 785,602 582,961 487,707 466,585 317,944
Book value per common share $ 8.97 $ 6.93 $ 5.10 $ 4.69 $ 2.29
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
The Company's financial condition continued to improve in 1998 as shown in
the following table:
(Amounts in thousands, except per share data) 1998 1997 1996
-------- -------- --------
Adjusted operating cash flow (1) $ 87,689 $ 69,673 $ 931
Book value per share $ 8.97 $ 6.93 $ 5.10
Debt to equity ratio (2) 0.15 0.28 0.36
Statutory surplus of insurance
subsidiaries $600,654 $548,043 $436,367
Net written premiums to surplus
ratio 1.3:1 1.4:1 1.9:1
A.M. Best financial rating A- A- B+
S&P financial rating A+ A- BBB+
(1) For 1996, excludes $29.2 million, net of commissions, in homeowners
unearned premiums ceded to reinsurers in July 1996.
(2) Equity adjusted to exclude unrealized investment gains.
With its strong financial position restored, the Company has positioned
itself for renewed and profitable growth. Additionally, the Company's direct
exposure to future earthquake events was substantially eliminated in 1995. The
Company maintains full insurance protection against its only significant
remaining catastrophe exposure in the homeowners line, primarily relating to
potential wild fires and fire following an earthquake event.
27
RESULTS OF OPERATIONS
Units in Force
Units in force for the Company's insurance programs as of December 31 were
as follows (excluding 15,541, 10,853 and 3,006 in 1998, 1997 and 1996,
respectively, of vehicles insured by 20th Century Insurance Company of
Arizona):
1998 1997 1996
--------- --------- ---------
Private Passenger Automobile
(Number of vehicles) 1,130,029 1,076,876 1,011,609
Homeowners
(Number of policies) 55,614 61,024 89,010
Personal Umbrella Policy ("PUP")
(Number of policies) 12,404 11,683 10,223
--------- --------- ---------
Total 1,198,047 1,149,583 1,110,842
========= ========= =========
Information about recent developments relating to units in force within
each major coverage line follows.
PRIVATE PASSENGER AUTOMOBILE. Strong unit growth in the auto business
remains the Company's priority. Vehicles in force grew by 53,153 in 1998,
compared to an increase of 65,267 in 1997. The Company continues to increase
its vehicles in force despite intense competition in the automobile insurance
market. In view of the favorable trends in loss costs and frequency in 1997 and
1998, the Company lowered overall rate levels approximately 3.4% and 3.2% in
1998 and 1997, respectively, and by an additional 6.8% in February 1999.
Through its aggressive marketing efforts and the introduction of rating plans
that offer lower rates to its more profitable, preferred customers and higher
rates for drivers deemed to be greater risks, the Company has been able to
enhance its profitable customer mix. The Company's average customer retention
rate was approximately 96% for both 1998 and 1997.
28
HOMEOWNERS. The Company's position in the homeowners market has always
been intended to complement its auto business and facilitate growth in that
line. Units in force for the Company's homeowners program declined by 9% from
December 31, 1997 to December 31, 1998, mainly due to attrition resulting from
the prohibition by the California Department of Insurance against the Company's
writing any new homeowners policies. Although the Company continues to seek
approval to resume writing new business, it is unable to predict if or when the
California Insurance Commissioner will grant the Company's request which, in
turn, has a negative impact on customer retention.
PUP. The penetration of this coverage has averaged about 1% of the
vehicles in force during each of the three years ended December 31, 1998.
Underwriting Results
Premium revenue and underwriting results for the Company's insurance
programs follow, presented in conformity with generally accepted accounting
principles ("GAAP"). To facilitate comparability, the effects of the
earthquake, non-recurring costs and the Proposition 103 settlement have been
isolated from the core business in the tables below.
29
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
--------- --------- ---------
GROSS PREMIUMS WRITTEN
- - ----------------------
Automobile $858,263 $871,996 $892,287
Homeowners - excluding effects of
Proposition 103 24,806 27,367 34,875
Personal Umbrella 2,548 2,406 2,114
--------- --------- ---------
Subtotal Core Business 885,617 901,769 929,276
Proposition 103 - - 567
--------- --------- ---------
Total $885,617 $901,769 $929,843
========= ========= =========
NET PREMIUMS EARNED
- - -------------------
Automobile $772,267 $781,288 $831,963
Homeowners - excluding effects of
Proposition 103 (294) 3,917 23,872
Personal Umbrella 891 784 772
--------- --------- ---------
Subtotal Core Business 772,864 785,989 856,607
Proposition 103 - - 21
--------- --------- ---------
Total $772,864 $785,989 $856,628
========= ========= =========
UNDERWRITING PROFIT (LOSS)
- - --------------------------
Automobile - excluding effects of
non-recurring costs $120,369 $135,622 $ 81,010
Homeowners - excluding effects of
earthquake and Proposition 103 (5,544) (5,557) (1,394)
Personal Umbrella 703 493 917
--------- --------- ---------
Subtotal Core Business 115,528 130,558 80,533
Earthquake, non-recurring costs and
Proposition 103 (47,666) (26,242) (38,311)
--------- --------- ---------
Total $ 67,862 $104,316 $ 42,222
========= ========= =========
30
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
--------- --------- ---------
COMBINED RATIOS
- - ---------------
Core Business - GAAP
- - --------------------------
Loss and LAE ratio 75.9% 74.2% 81.3%
Underwriting expense ratio 9.2 9.2 9.3
--------- --------- ---------
Combined ratio 85.1% 83.4% 90.6%
========= ========= =========
Company Totals - GAAP
- - --------------------------
Loss and LAE ratio 81.0% 77.3% 85.8%
Underwriting expense ratio 10.2 9.4 9.3
--------- --------- ---------
Combined ratio 91.2% 86.7% 95.1%
========= ========= =========
Automobile - Excluding Non-recurring Costs
Automobile insurance is the primary line of business written by the Company
and has been consistently profitable. The majority of the Company's insured
autos are located in southern California. However, the Company continues to
expand its coverage throughout the state by aggressively marketing its business
in northern California and San Diego County, which accounted for approximately
43% of all new business written in 1998.
The auto line experienced a $120.4 million underwriting profit in 1998
compared to $135.6 million and $81 million in 1997 and 1996, respectively, as
adjusted for the effects of nonrecurring costs. These results were achieved
despite increased competition and the effects of premium rate reductions of 3.2%
and 3.4% effective October 31, 1997, and January 1, 1998, respectively.
Favorable loss trends contributed to the solid underwriting results in all three
years. However, underwriting results for 1998 fell below the 1997 level
primarily due to an increase in claims frequency that emerged principally in the
fourth quarter and the rate decreases mentioned previously.
The 1998 decrease in gross premiums written reflects the 5.0% increase in
insured units coupled with the effect of the premium rate reductions mentioned
above. The 1997 decrease in gross premiums written
31
reflects the 6.5% increase in insured units offset by the effect of the
3.2% premium rate reduction implemented in 1997 and the impact of 1996 rate
reductions which were fully felt in 1997.
Including a first quarter 1999 rate reduction of 6.8%, the Company has
reduced average California auto premiums by more than 25% since 1996. Although
the reduction in premium revenues produced lower top-line and investment income
growth, underwriting margins continue to be favorable.
While a growth in business generally indicates the need for an increase in
incurred but not reported ("IBNR") reserves, favorable development in older case
reserves and the lower frequency and severity of new claims have resulted in the
Company making a smaller provision for IBNR reserves than in the past, favorably
impacting underwriting results.
Homeowners - Excluding Earthquake
Underwriting results for this program are subject to variability caused by
weather-related claims and by infrequent disasters. In 1998, 1997 and 1996, no
significant losses were incurred.
Since July 1, 1996, the Company has maintained reinsurance programs to
provide coverage for its remaining homeowners policies as discussed in Note 10
of the Notes to Consolidated Financial Statements. The Company had previously
maintained separate catastrophe coverage which expired in June 1996. Written
premiums ceded in 1998 totaled $24.5 million compared to $24.4 million in 1997
and $10.7 million in 1996 (excluding the $33.3 million portfolio transfer of
unearned premium liabilities under the 100% quota share reinsurance agreement).
Personal Umbrella Policy
The personal umbrella program has remained stable over the three-year
period ended December 31, 1998, producing approximately $2 million in gross
written premiums each year. Underwriting profits for this business can vary
significantly with the number of claims which occur infrequently.
32
Earthquake
Although the Company did not write new or renewal earthquake premiums in
1995 through 1998, the Company assumes a small amount of earthquake premium from
the California Fair Plan, a state-administered pool of difficult to insure risks
in which insurers are required to participate in proportion to their share of
direct written homeowners coverage in the state. As indicated previously, the
Company recorded additional provisions for the 1994 Northridge Earthquake in
1998, 1997 and 1996 of $40 million, $24.75 million and $40 million,
respectively. The Company remains exposed to possible further upward
development in the estimated cost to resolve certain Northridge Earthquake
claims. Although management believes current reserves are adequate, the outcome
of future events could require changes in previous estimates.
Policy Acquisition and General Operating Expenses
The Company's policy acquisition and general operating expense ratio
continues to be among the most competitive in the industry. As a direct writer,
the Company does not incur agent commissions and, thus, enjoys an expense
advantage over most of its competitors. The ratio of underwriting expenses
(excluding interest and fees) to earned premiums was 10.2% in 1998, 9.4% in 1997
and 9.3% in 1996. Excluding non-recurring charges (accelerated amortization of
restricted stock grants of $2.0 million in 1998 and "Year 2000" ("Y2K") costs of
$5.7 million and $1.5 million in 1998 and 1997, respectively), the expense
ratios remained relatively flat at 9.2% in 1998 and 1997 and 9.3% in 1996
despite a decline in premiums earned and an increase in marketing expenses.
Impact of Year 2000
The Y2K problem arose because some computer programs and hardware utilize
two digits rather than four to define the applicable year. As a result, these
systems, programs and hardware ("Information Technology systems" or "IT
systems") may not calculate dates beyond 1999, which may cause errors or system
failures. In addition, today's business environment contains many non-IT
systems, ranging from elevators to automobiles, which utilize microprocessors,
and these devices are also potentially susceptible to the same or similar types
of date problems.
33
The following discussion summarizes the Company's state of readiness, costs
to address its Y2K issues, the risks inherent in these issues, and the Company's
contingency plans.
State of Readiness
The Company has taken what it believes is a comprehensive approach to
remediating its Y2K issues, as summarized in the following table:
MILESTONE COMPLETION YEAR
- - --------- ---------------
CRITICAL MAINFRAME APPLICATIONS
High level risk assessment 1997
Upgrade of base information systems to be Year 2000 compliant 1998
Complete integration testing of 56 mainframe applications 1998
Replacement of 14 systems with packaged software warranted
to be Y2K compliant 1999
OTHER IT HARDWARE (mainframe, client/server, network,
telecommunications, etc.) Assessment, installation or conversion,
test, and implementation 1999
NON-IT SYSTEMS - including IT systems maintained by third parties
(e.g., banks, vendors, etc.) Inventory and assessment; identify
alternate sources, if required; and implement alternative sources
as needed 1999
The Company plans to complete its compliance testing of all critical components
in the summer of 1999.
Y2K Remediation Costs
The total Year 2000 project cost is estimated to be approximately $8.9
million, which is being expensed as incurred. Approximately one third of that
amount represents the direct cost of personnel in the Company's Information
Services department who have been dedicated to this project, with most of the
remainder representing external consultants. Costs incurred during 1998 were
approximately $5.7 million, compared to $1.5 million for 1997.
Risks
Without regard to the Company's remediation efforts, given the highly
computerized nature of the Company's operations, the Y2K problem would pose a
serious risk to the Company's ability to efficiently and effectively service its
customers, or to conduct its affairs in a profitable manner. Because of the
nature of its operations and the availability of alternate suppliers and service
providers, the potential Y2K issues
34
for the Company in the non-IT area generally are less than for manufacturers or
distributors of non-financial products. Apart from written assurances the
Company has or expects to receive, the Company can offer no assurances that the
impact of the Y2K problem on certain services, such as those provided by
third-party electric utilities, will be insignificant or within the Company's
ability to correct in a fashion timely enough to avoid any potentially
significant adverse impact. Although no remediation plan is capable of
foreseeing every possible contingency that could have a potentially significant
adverse effect, management is confident that the steps taken to address the
Company's Y2K issues will prevent or promptly detect and correct any serious
instances of noncompliance that are reasonably within the Company's ability to
control.
Contingency Plans
For all critical systems within the Company's control, revised contingency
plans that take account of the Y2K issue are scheduled to be tested and in place
by June 1999. These contingency plans generally cover steps the Company would
take, such as use of back-up computer facilities, in the event of a business
interruption from a variety of causes, including the remote possibility of an
interruption caused by one or more Y2K problems. The Company's contingency
planning team is staffed by representatives from all key business departments.
Contingency planning currently under development includes the following
considerations:
- - - Defining a rapid response team including identification of resources and
responsibilities at a departmental level;
- - - Identifying manual procedures to be implemented until the automated
process is recovered, if necessary;
- - - For critical suppliers or service providers not expected to be compliant,
selecting feasible alternate suppliers;
- - - When alternate suppliers are infeasible, addressing any means the Company
can take to assist key suppliers in a timely manner;
- - - Determining key mission critical contingency plans and testing when
feasible before the Year 2000.
35
Investment Income
Net pre-tax investment income was $75.1 million in 1998 compared to $73.5
million in 1997 and $73.2 million in 1996. Average invested assets increased
5.4% in 1998 compared to decreases of 2.0% and 6.9% in 1997 and 1996,
respectively. The increase in 1998 is primarily due to additional cash received
from the exercise of AIG's common stock warrants in the third quarter of 1998 as
discussed in Note 12 of the Notes to Consolidated Financial Statements. The
decline in invested assets for 1997 and 1996 resulted from the decline in net
earned premiums and the sale of investments to meet the payment requirements of
both developing earthquake losses and reinsurance premiums. The average annual
pre-tax yield on invested assets was 6.6% in 1998, 6.7% in 1997 and 6.6% in
1996.
Realized capital gains on the sales of investments increased to $22.6
million for 1998 compared to $4.1 million and $7.3 million for 1997 and 1996,
respectively. The 1998 increase in realized gains is primarily due to the
Company's decision to begin switching its investment portfolio from taxable to
nontaxable securities during 1998 in anticipation of fully utilizing its
remaining net operating loss deduction in 1999. At December 31, 1998, $141.4
million of the Company's total investments at fair value was invested in
tax-exempt bonds with the balance representing 86.8% of the portfolio invested
in taxable securities compared to 97.7% at December 31, 1997.
As of December 31, 1998, the Company had a pre-tax unrealized gain on fixed
maturity investments of $34.9 million compared to $29.7 million in 1997 and $3.7
million in 1996. Interest rates fell in 1998 and 1997 which increased the fair
value of the bond portfolio for those years.
Liquidity and Capital Resources
Loss and loss adjustment expense payments are the most significant cash
flow requirements of the Company. The Company continually monitors loss
payments to provide projections of future cash requirements. Additional cash
requirements include servicing the bank debt and paying dividends as approved
from time to time by the Company's Board of Directors. With the anticipated
growth of its core auto business and continued settlement of remaining
earthquake losses, the Company expects that future cash flows from operations
will continue to be sufficient to fund future expenditures.
36
The Company has historically written its core business at an underwriting
profit and thus each premium dollar generates a positive cash flow. A
significant part of the decline in 1996 and subsequent increase in cash flow
from operations in 1997 and 1998 is due to the fall and rise, respectively, in
the size of the net book of business during these periods. In 1996,
approximately $29.2 million of the $32.5 million net decrease in cash and cash
equivalents was related to the portfolio transfer of unearned premiums on
homeowners business.
Funds required by 20th Century Industries to pay dividends and meet its
debt obligations are provided by the insurance subsidiaries. Information
regarding the Company's debt service obligation is included in Note 9 of the
Notes to Consolidated Financial Statements. The ability of the insurance
subsidiaries to pay dividends to the parent company is regulated by state law.
Based on the operating results in 1996 and the favorable ratio of premiums to
surplus, the Company was able to resume normal dividends from the insurance
subsidiaries in 1996 to service the parent's debt and dividend requirements.
Based upon 1998 operating results and earned surplus as of December 31, 1998,
the Company believes it will not require regulatory approval in 1999 for any
extraordinary dividends.
The Company's remaining net operating loss carryforward is expected to be
fully utilized during 1999 (see Note 5 of the Notes to Consolidated Financial
Statements). As a result, income tax payments will increase in 1999 and future
years compared to the years 1994 through 1998. To the extent practicable, the
Company's investment portfolio is being switched from taxable to nontaxable
securities in order to minimize future tax payments.
In 1997, the Company embarked on a major project to upgrade its
technological infrastructure and to conform certain of its procedures to
"industry best practices." Although the ultimate cost of this project is not
yet determinable, management believes cash flow from operations as well as
expected improvements in operational efficiencies will be more than adequate to
fund the project's implementation which is expected to be completed over the
next several years.
37
Risk-Based Capital
The National Association of Insurance Commissioners requires property and
casualty insurance companies to calculate and report information under a
Risk-Based Capital ("RBC") formula in their Annual Statements. The RBC
requirements are intended to assist regulators in identifying inadequately
capitalized companies. The RBC calculation is based on the type and mix of
risks inherent in the Company's business and includes components for
underwriting, asset, interest rate and other risks. To the extent that a
subsidiary's surplus fell below prescribed levels, it would be the parent
company's intention to infuse necessary capital to support that entity. The
Company's insurance subsidiaries exceeded their RBC statutory surplus standards
by a considerable margin as of December 31, 1998.
Home Office Lease
The Company leases its Home Office building in Woodland Hills, California,
which contains approximately 230,000 square feet of leasable office space. The
current lease expires in 2014 and may be renewed for two consecutive five-year
periods.
In addition, the Company will expand its headquarters to nearly double the
size of its current facility in late 1999, the anticipated completion date of
construction of the new 20th Century Plaza. The company has signed a 15-year
lease expiring in November 2014, which may be renewed for two consecutive
five-year periods.
Forward-Looking Statements
The Company's management has made in this report, and from time
to time may make in its public filings and press releases as well as in oral
presentations and discussions, forward-looking statements concerning the
Company's operations, economic performance and financial condition.
Forward-looking statements include, among other things, discussions concerning
the Company's potential expectations, beliefs, estimates, forecasts, projections
and assumptions. Forward-looking statements are subject to risks and
uncertainties. Actual results could differ materially from those anticipated by
forward-looking statements due to a number of important factors including, but
not limited to, those discussed elsewhere in this report and in the Company's
other public filings, press releases, oral presentations and discussions and
38
the following: (a) the intensity of competition from other companies in the
insurance industry; (b) the Company's experience with respect to persistency and
claims experience; (c) the Company's ability to distribute and administer
competitive services in a timely, cost-effective manner; (d) the Company's
visibility in the market place and its financial and claims-paying ratings; (e)
the effect of changes in laws and regulations affecting the Company's business,
including changes in tax laws affecting insurance products; (f) market risks
related to interest rates; (g) the Company's ability to develop information
technology and management information systems to support strategic goals while
continuing to control costs and expenses; (h) the costs of defending litigation
and the risk of unanticipated material adverse outcomes in such litigation; (i)
changes in accounting and reporting practices; and (j) the Company's access to
adequate financing to support its future business. The Company does not
undertake any obligation to update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. For
additional information, refer to the Company's filings with the Securities and
Exchange Commission.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
interest rates. In addition to market risk, the Company is exposed to other
risks, including the credit risk related to its financial instruments and the
underlying insurance risk related to its core business. The first column in the
following table shows the financial statement carrying values of the Company's
financial instruments. The Company's investment portfolio is carried at fair
value; the fair value of the Company's variable-rate bank loan payable is
presumed to equal its carrying value. The second column shows the effect on
current carrying values and estimated fair values assuming a 100 basis point
increase in market interest rates and a 10% decline in equity prices. The
following sensitivity analysis summarizes only the exposure to market risk as of
December 31, 1998.
39
(Amounts in thousands)
Estimated Fair
Value at Adjusted
Market Rates/Prices
Carrying Value as Indicated Below
--------------- --------------------
Interest Rate Risk:*
Fixed Maturities Available for Sale $ 1,067,248 $ 998,737
Bank Loan Payable 112,500 112,500
Equity Price Risk:**
Marketable Equity Securities 1,373 1,236
<FN>
* Adjusted interest rates assume a 100 basis point increase in market rates at December 31, 1998.
** Adjusted equity prices assume a 10 percent decline in values at December 31, 1998.
Because the Company historically has generated an underwriting profit, its
cash flow from operations and short term cash position generally is more than
sufficient to meet its obligations for claim payments, which by the nature of
the personal automobile insurance business tend to have an average duration of
less than a year. As a result, the Company generally has the ability to hold
its investments to maturity, and it has been unnecessary for the Company to
employ elaborate market risk management techniques involving complicated asset
and liability duration matching or hedging strategies. For all its financial
assets and liabilities, the Company seeks to maintain reasonable average
durations, consistent with the maximization of income without sacrificing
investment quality and providing for liquidity and diversifications. Financial
instruments are not used for trading purposes.
The sensitivity analysis provides only a limited, point-in-time view of the
market risk sensitivity of the Company's financial instruments. The actual
impact of market interest rate and price changes on the financial instruments
may differ significantly from those shown in the analysis. This analysis is
further limited as it does not consider any actions the Company could take in
response to actual and/or anticipated changes in interest rates and equity
prices.
40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors
20th Century Industries
We have audited the accompanying consolidated balance sheets of 20th
Century Industries and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1998. Our audits
also included the financial statement schedule listed in the Index at Item
14(a). These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
20th Century Industries and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
Los Angeles, California
January 22, 1999
41
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
(Amounts in thousands)
DECEMBER 31,
-------------------------
1998 1997
------------- ----------
Investments, available-for-sale, at fair value:
Fixed maturities $ 1,067,248 $1,082,708
Equity securities 1,373 1,745
------------- ----------
Total investments - Note 4 1,068,621 1,084,453
Cash and cash equivalents 167,856 31,268
Accrued investment income 19,542 20,008
Premiums receivable 70,884 71,494
Reinsurance receivables and recoverables 66,823 70,050
Prepaid reinsurance premiums 31,589 32,154
Deferred income taxes - Note 5 74,330 126,877
Deferred policy acquisition costs - Note 6 16,100 11,510
Other assets 77,411 34,640
------------- ----------
$ 1,593,156 $1,482,454
============= ==========
See accompanying notes to financial statements.
42
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
(Amounts in thousands, except share data)
DECEMBER 31,
-------------------------
1998 1997
------------- ----------
Unpaid losses and loss adjustment expenses - Note 8 $ 382,003 $ 437,887
Unearned premiums 233,689 233,402
Bank loan payable - Note 9 112,500 157,500
Claims checks payable 34,311 35,569
Reinsurance payable 20,628 19,347
Other liabilities 24,423 15,788
------------- ----------
Total liabilities 807,554 899,493
Commitments and contingencies - Notes 11 and 14
Stockholders' equity - Notes 12
Capital Stock
Preferred stock, par value $1.00 per share;
authorized 500,000 shares, none issued - -
Series A convertible preferred stock, par value
$1.00 per share, stated value $1,000 per share;
authorized 376,126 shares, no shares outstanding
in 1998 and 224,950 in 1997 - 224,950
Common stock, without par value; authorized
110,000,000 shares, outstanding 87,624,531
in 1998 and 51,636,361 in 1997 462,268 87,230
Accumulated other comprehensive income - Note 4 23,387 20,298
Retained earnings 299,947 250,483
------------- ----------
Total stockholders' equity 785,602 582,961
------------- ----------
$ 1,593,156 $1,482,454
============= ==========
See accompanying notes to financial statements.
43
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
YEARS ENDED DECEMBER 31,
----------------------------
1998 1997 1996
-------- -------- --------
REVENUES
Net premiums earned - Note 10 $772,864 $785,989 $856,628
Net investment income - Note 4 75,146 73,463 73,178
Realized investment gains - Note 4 22,640 4,071 7,287
-------- -------- --------
870,650 863,523 937,093
LOSSES AND EXPENSES
Net losses and loss adjustment
expenses - Note 8 626,379 607,775 734,735
Policy acquisition costs - Note 6 51,563 44,851 38,175
Other operating expenses 27,060 29,047 41,496
Interest and fees expense - Note 9 10,278 13,722 14,260
-------- -------- --------
715,280 695,395 828,666
-------- -------- --------
Income before federal
income taxes 155,370 168,128 108,427
Federal income taxes - Note 5 54,298 57,199 34,370
-------- -------- --------
NET INCOME $101,072 $110,929 $ 74,057
======== ======== ========
EARNINGS PER COMMON SHARE - Note 3
- - ----------------------------------
BASIC $ 1.36 $ 1.76 $ 1.05
======== ======== ========
DILUTED $ 1.19 $ 1.37 $ 0.92
======== ======== ========
See accompanying notes to financial statements.
44
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Amounts in thousands, except per share data)
Accumulated
Convertible Other
Preferred Common Retained Comprehensive
Stock Stock Earnings Income Total
------------- -------- ---------- ------------- ---------
Balance at January 1, 1996 $ 224,950 $ 85,805 $ 122,322 $ 33,508 $466,585
Comprehensive income:
Net income for the year 74,057 74,057
Change in accumulated other
comprehensive income, net -
Note 4 (30,688) (30,688)
---------
Total comprehensive income 43,369
Cash dividends paid on common
stock ($0.05 per share) (2,576) (2,576)
Cash dividends paid on
preferred stock (20,245) (20,245)
Other 458 116 574
------------ -------- ---------- ------------- ---------
Balance at December 31, 1996 224,950 86,263 173,674 2,820 487,707
---------
Comprehensive income:
Net income for the year 110,929 110,929
Change in accumulated other
comprehensive income, net -
Note 4 17,478 17,478
---------
Total comprehensive income 128,407
Cash dividends paid on common
stock ($0.25 per share) (12,906) (12,906)
Cash dividends paid on
preferred stock (20,245) (20,245)
Other 967 (969) (2)
------------ -------- ---------- ------------- ---------
Balance at December 31, 1997 224,950 87,230 250,483 20,298 582,961
---------
Comprehensive income:
Net income for the year 101,072 101,072
Change in accumulated other
comprehensive income, net -
Note 4 3,089 3,089
---------
Total comprehensive income 104,161
Cash dividends paid on common
stock ($0.58 per share) (41,485) (41,485)
Cash dividends paid on
preferred stock (10,123) (10,123)
Effects of conversion of preferred
stock and exercise of common (224,950) 370,550 145,600
stock warrants
Other 4,488 4,488
------------ -------- ---------- ------------- ---------
Balance at December 31, 1998 $ - $462,268 $ 299,947 $ 23,387 $785,602
============= ======== ========== ============= =========
See accompanying notes to financial statements.
45
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
---------- ---------- ---------
OPERATING ACTIVITIES:
Net income $ 101,072 $ 110,929 $ 74,057
Adjustments to reconcile net income
to net cash provided by (used in) operating
activities:
Provision for depreciation and amortization 10,179 5,598 4,679
Provision for deferred income taxes 50,884 54,569 31,835
Realized gains on sale of investments (22,640) (4,071) (7,287)
Federal income taxes (10,658) 502 (1,430)
Reinsurance balances 5,073 9,616 (38,512)
Unpaid losses and loss adjustment expenses (55,884) (105,642) (41,305)
Unearned premiums 287 2,261 (57,786)
Claims checks payable (1,258) (876) (12,861)
Other 10,634 (3,213) 20,361
---------- ---------- ---------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES 87,689 69,673 (28,249)
46
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
---------- ---------- ---------
INVESTING ACTIVITIES:
Investments available-for-sale:
Purchases $(848,131) $(660,903) $(631,428)
Calls or maturities 23,248 6,981 17,190
Sales 867,441 664,675 636,419
Net purchases of property and
equipment (42,651) (16,585) (3,642)
---------- ---------- ---------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES (93) (5,832) 18,539
FINANCING ACTIVITIES:
Proceeds from exercise of common stock
warrants 145,600 - -
Bank loan principal repayment (45,000) (17,500) -
Dividends paid (51,608) (33,151) (22,821)
---------- ---------- ---------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 48,992 (50,651) (22,821)
---------- ---------- ---------
Net increase (decrease) in cash 136,588 13,190 (32,531)
Cash and cash equivalents, beginning of year 31,268 18,078 50,609
---------- ---------- ---------
Cash and cash equivalents, end of year $ 167,856 $ 31,268 $ 18,078
========== ========== ==========
See accompanying notes to financial statements.
47
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
NOTE 1. DESCRIPTION OF BUSINESS
20th Century Industries, through its wholly owned subsidiaries, 20th
Century Insurance Company and 21st Century Casualty Company (collectively, the
"Company"), is engaged in the sale of private passenger automobile insurance
policies in California, Nevada, Oregon and Washington and homeowners and
personal umbrella insurance policies in California. At this time, almost all of
the Company's business is concentrated in California. The Company also provides
private passenger automobile insurance in Arizona through a joint venture with
American International Group, Inc. ("AIG"), which owned a majority of the
Company's outstanding common stock at December 31, 1998. An order from the
California Department of Insurance ("CDOI") has prohibited the Company from
writing any new homeowners policies since June 1994, and beginning in July 1996,
the Company was required to begin non-renewing these policies. Effective
February 15, 1997, the CDOI allowed the Company to resume renewing its remaining
homeowners policies.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation and Presentation
The accompanying consolidated financial statements include the accounts and
operations of 20th Century Industries and its wholly owned subsidiaries. All
material intercompany accounts and transactions have been eliminated. The
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles ("GAAP") which differ from statutory
accounting practices ("SAP") prescribed or permitted by insurance regulatory
authorities. The preparation of the financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
amounts reported in the financial statements. Actual results could differ from
these estimates.
48
Investments
The Company classifies its investment portfolio as available-for-sale and
carries it at fair value with unrealized gains and losses, net of any tax
effect, reported as accumulated other comprehensive income in a separate
component of stockholders' equity.
Fair values for fixed maturity and equity securities are based on quoted
market prices. The cost of investment securities sold is determined by the
specific identification method.
The Company's 49% interest in 20th Century Insurance Company of Arizona,
which is a joint venture between the Company and AIG and which began operations
in August 1996, has a carrying value of $3,656,000 at December 31, 1998, and is
included in other assets in the consolidated balance sheet. The Company's
equity in the 1998, 1997 and 1996 net loss of this venture amounted to $373,000,
$656,000 and $186,000, respectively, and is included in investment income in the
consolidated statements of income.
Cash and Cash Equivalents
Cash and cash equivalents include cash and short-term investments in demand
deposits having a maturity of three months or less at the date of purchase.
Recognition of Revenues
Insurance premiums are recognized as revenue pro rata over the terms of the
policies. The unearned portion is included in the balance sheet as a liability
for unearned premiums.
Losses and Loss Adjustment Expenses
The estimated liabilities for losses and loss adjustment expenses include
the accumulation of estimates of losses for claims reported prior to the balance
sheet dates, estimates (based upon actuarial analysis of historical data) of
losses for claims incurred but not reported and estimates of expenses for
investigating and adjusting all incurred and unadjusted claims. Amounts
reported are estimates of the ultimate costs of settlement, net of estimated
salvage and subrogation, which are necessarily subject to the impact of future
changes in economic and social conditions. Management believes that, given the
inherent variability in any such estimates, the aggregate reserves are within a
49
reasonable and acceptable range of adequacy. The methods of making such
estimates and for establishing the resulting reserves are reviewed and updated
quarterly and any adjustments resulting therefrom are reflected in current
earnings.
Reinsurance
In the normal course of business, the Company seeks to reduce the loss that
may arise from catastrophes and to reduce its overall risk levels by reinsuring
certain areas of exposure with other insurance enterprises or reinsurers.
Reinsurance premiums and reserves on reinsured business are accounted for on a
basis consistent with those used in accounting for the original policies issued
and the terms of the reinsurance contracts. Amounts applicable to ceded
unearned premiums and ceded claim liabilities are reported as assets in the
accompanying balance sheets. The Company believes that the fair value of its
reinsurance recoverables approximates their carrying amounts.
Policy Acquisition Costs
Policy acquisition costs, principally direct and indirect costs related to
production of business, are deferred and amortized to expense as the related
premiums are earned.
Income Taxes
Deferred income tax assets and liabilities are determined based on the
differences between the financial reporting and the tax bases of assets and
liabilities and are measured using the enacted tax rates and laws.
New Accounting Standards
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income, became effective in the first quarter of 1998. SFAS No.
130 established rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Company's net income or stockholders' equity. Essentially, under SFAS No. 130,
the new label "accumulated other comprehensive income" has replaced that of the
former "unrealized investment gains, net" in the stockholders' equity section of
the consolidated balance sheet. Also, the consolidated statement of
stockholders' equity has been reformatted to conform to the requirements of SFAS
No. 130.
50
In 1997, the Financial Accounting Standards Board also issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information, which
became effective on December 31, 1998. This Statement did not require
disclosure of any significant information beyond that previously provided in
the Company's annual financial statements.
51
NOTE 3. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
(Amounts in thousands, except per share data)
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Numerator:
Net income $101,072 $110,929 $ 74,057
Preferred stock dividends (10,123) (20,245) (20,245)
--------- --------- ---------
Numerator for basic earnings per share:
Income available to common stockholders 90,949 90,684 53,812
Effect of dilutive securities:
Dividends on convertible preferred stock* 10,123 20,245 -
--------- --------- ---------
Numerator for diluted earnings per share:
Income available to common stockholders
after assumed conversions $101,072 $110,929 $ 53,812
========= ========= =========
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding 66,976 51,500 51,465
Effect of dilutive securities:
Restricted stock grants 79 121 49
Employee stock options 315 171 42
Warrants 6,146 9,079 7,092
Convertible preferred stock* 11,368 19,854 -
--------- --------- ---------
17,908 29,225 7,183
Denominator for diluted earnings per share:
Adjusted weighted-average shares outstanding 84,884 80,725 58,648
========= ========= =========
Basic earnings per share $ 1.36 $ 1.76 $ 1.05
========= ========= =========
Diluted earnings per share $ 1.19 $ 1.37 $ 0.92
========= ========= =========
<FN>
* For 1996, the effect of the convertible preferred stock would be
anti-dilutive and, therefore, it is not included in the calculation of diluted
earnings per share for those periods.
52
NOTE 4. INVESTMENTS
A summary of net investment income is as follows:
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
----------------------------
1998 1997 1996
-------- -------- --------
Interest on fixed maturities $70,358 $72,140 $ 71,996
Interest on cash equivalents 5,593 2,333 2,170
Other (371) (654) (183)
-------- -------- --------
Total investment income 75,580 73,819 73,983
Investment expense 434 356 805
-------- -------- --------
Net investment income $75,146 $73,463 $ 73,178
======== ======== ========
A summary of realized investment gains and losses before income taxes is as
follows:
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
----------------------------
1998 1997 1996
-------- -------- --------
Fixed maturities available-for-sale:
Gross realized gains $23,030 $ 6,958 $ 9,608
Gross realized losses (390) (2,887) (2,321)
-------- -------- --------
Net realized investment gains $22,640 $ 4,071 $ 7,287
======== ======== ========
53
The amortized cost, gross unrealized gains and losses, and fair values of
investments as of December 31, 1998 and 1997 are as follows:
(Amounts in thousands)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- - ----------------------------- ---------- ----------- ----------- ----------
1998
- - ----
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 5,971 $ 158 $ - $ 6,129
Obligations of states and
political subdivisions 159,010 3,332 603 161,739
Public utilities 162,119 9,445 19 171,545
Corporate securities 705,291 27,069 4,525 727,835
---------- ----------- ----------- ----------
Total fixed maturities 1,032,391 40,004 5,147 1,067,248
Equity securities 250 1,123 - 1,373
---------- ----------- ----------- ----------
Total investments $1,032,641 $ 41,127 $ 5,147 $1,068,621
========== =========== =========== ==========
1997
- - ----
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 6,735 $ 45 $ 22 $ 6,758
Obligations of states and
political subdivisions 36,680 2,843 - 39,523
Public utilities 171,060 4,347 233 175,174
Corporate securities 838,500 23,688 935 861,253
---------- ----------- ----------- ----------
Total fixed maturities 1,052,975 30,923 1,190 1,082,708
Equity securities 250 1,495 - 1,745
---------- ----------- ----------- ----------
Total investments $1,053,225 $ 32,418 $ 1,190 $1,084,453
========== =========== ========== ==========
54
The amortized cost and fair value of the Company's fixed maturity investments at
December 31, 1998 are summarized, by contractual maturity, as follows:
(Amounts in thousands)
Available-for-sale
-------------------------
Amortized Fair
Fixed maturities due: Cost Value
- - ---------------------- ------------- ----------
1999 $ 2,027 $ 2,065
2000 - 2003 48,446 49,282
2004 - 2008 769,935 795,959
2009 - 2018 211,714 219,663
2019 and after 269 279
-------------- ----------
Total $ 1,032,391 $1,067,248
============= ===========
Expected maturities of the Company's investments may differ from
contractual maturities because certain borrowers have the right to call or
prepay obligations with or without call or prepayment penalties.
Details follow concerning the change in the after-tax net unrealized gain
on investments for 1998, 1997, and 1996, which is included in the accumulated
other comprehensive income in the consolidated balance sheets:
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
-------- -------- ---------
Unrealized gain (loss) on available-for-sale
investments, net of tax expense (benefit)
of $9,587, $10,836 and $(13,974),
respectively $17,805 $20,124 $(25,951)
Less: reclassification adjustment for gains
included in net income, net of tax expense
of $7,924, $1,425 and $2,551, respectively (14,716) (2,646) (4,737)
-------- -------- ---------
Total $ 3,089 $17,478 $(30,688)
======== ======== =========
55
NOTE 5. FEDERAL INCOME TAXES
Federal income tax expense consists of:
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
-------------------------
1998 1997 1996
------- ------- -------
Current tax expense $ 3,414 $ 2,630 $ 2,535
Deferred tax expense 50,884 54,569 31,835
------- ------- -------
$54,298 $57,199 $34,370
======= ======= =======
The Company's net deferred income tax asset is comprised of:
(Amounts in thousands)
DECEMBER 31,
------------------
1998 1997
-------- --------
Deferred tax assets:
Net operating loss carryforward $ 53,587 $ 94,981
Alternative minimum tax credit 16,930 13,927
Unearned premiums 14,147 14,087
Unpaid losses and loss adjustment expenses 6,741 9,811
Non-qualified retirement plans 3,418 3,291
Salvage and subrogation - 3,322
Other - 2,416
-------- --------
94,823 141,835
-------- --------
Deferred tax liabilities:
Unrealized investment gains 12,593 10,930
Deferred policy acquisition costs 5,635 4,028
Salvage and subrogation 745 -
Other 1,520 -
-------- --------
20,493 14,958
-------- --------
Net deferred tax asset $ 74,330 $126,877
======== ========
Ordinarily, the Company's principal deferred tax assets arise from the
discounting of loss reserves for tax purposes, which delays a portion of the
loss deduction, and from the acceleration of 20% of the unearned premium reserve
into taxable income before it is earned. During 1998, the
56
Company utilized net operating loss carryforwards of $115,000,000 to reduce
taxable income. As of December 31, 1998, the Company has a net operating loss
carryforward of approximately $156,000,000 for regular tax purposes expiring in
the year 2009 and an alternative minimum tax credit carryforward of $16,929,000.
Alternative minimum tax credits may be carried forward indefinitely to offset
future regular tax liabilities. The Company expects the net operating loss
carryforward to be fully utilized during 1999.
The Company is required to establish a "valuation allowance" for any
portion of the deferred tax asset that management believes will not be realized.
The Company believes that because of its historically strong earnings
performance, and tax planning strategies available, it is more likely than not
that the Company will realize the benefit of the deferred tax asset, and
therefore, no valuation allowance has been established.
A reconciliation of income tax computed at the federal statutory tax rate,
which was 35% for 1996 through 1998, to total income tax expense follows:
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
----------------------------
1998 1997 1996
-------- -------- --------
Federal income taxes at
statutory rate $54,380 $58,845 $37,949
Decrease due to:
Tax-exempt income, net (403) (1,354) (4,472)
Other 321 (292) 893
-------- -------- --------
Federal taxes on income $54,298 $57,199 $34,370
======== ======== ========
Payments for income taxes were $13,661,000, $3,150,000 and $2,367,500 for
the years ended December 31, 1998, 1997 and 1996, respectively.
57
NOTE 6. POLICY ACQUISITION COSTS
Following is a summary of policy acquisition costs deferred for
amortization against future income and the related amortization charged to
income from operations:
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
-------- ------- -------
Deferred policy acquisition costs
at beginning of year $11,510 $ 9,127 $10,481
Acquisition costs deferred 56,153 47,234 36,821
-------- ------- -------
67,663 56,361 47,302
Acquisition costs amortized and
charged to income during the year 51,563 44,851 38,175
------- ------- -------
Deferred policy acquisition costs
at end of year $16,100 $11,510 $ 9,127
======= ======= =======
NOTE 7. EMPLOYEE BENEFITS
Pension Plan and Supplemental Executive Retirement Plan
The Company sponsors a non-contributory defined benefit pension plan which
covers essentially all employees who have completed at least one year of
service. The benefits are based on employees' compensation during all years of
service. The Company's funding policy is to make annual contributions as
required by applicable regulations. The pension plan's assets consist of
high-grade fixed income securities and cash equivalents.
The Company also sponsors an unfunded supplemental executive retirement
plan which covers certain key employees designated by the Board of Directors.
The supplemental plan benefits are based on years of service and compensation
during the last three years of employment, and are reduced by the benefit
payable from the pension plan.
58
The net periodic pension cost for these plans was $4,117,000, $4,012,000
and $3,925,000 in 1998, 1997 and 1996, respectively. Accrued pension costs
included in the consolidated balance sheets at December 31, 1998 and 1997 are
$3,083,000 and $2,521,000, respectively.
Savings and Security Plan
The Company sponsors a contributory savings and security plan for eligible
employees. The Company provides matching contributions equal to 75% of the
lesser of 6% of an employee's compensation or the amount contributed by the
employee. Contributions charged against operations were $2,728,000, $2,697,000
and $2,556,000 in 1998, 1997 and 1996, respectively.
59
NOTE 8. LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
liability for unpaid losses and loss adjustment expenses ("LAE"):
(Amounts in thousands)
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Reserves for losses and LAE, net of reinsurance
recoverables, at beginning of year $388,418 $489,033 $552,320
Add:
Provision for losses and LAE for claims
occurring in the current year, net of
reinsurance 622,758 672,402 760,325
Increase (decrease) in provision for insured
events of prior years, net of reinsurance 3,621 (64,627) (25,590)
--------- --------- ---------
Total incurred losses and loss adjustment
expenses, net of reinsurance 626,379 607,775 734,735
--------- --------- ---------
Deduct losses and LAE payments for claims,
net of reinsurance, occurring during:
The current year 423,031 403,676 446,037
Prior years 251,951 304,714 351,985
--------- --------- ---------
Total payments, net of reinsurance 674,982 708,390 798,022
--------- --------- ---------
Reserve for unpaid losses and LAE, net of
reinsurance recoverables, at year end 339,815 388,418 489,033
Reinsurance recoverables on unpaid
losses, at year end 42,188 49,469 54,496
--------- --------- ---------
Reserves for losses and LAE, gross of
reinsurance recoverables on unpaid losses,
at year end $382,003 $437,887 $543,529
========= ========= =========
60
The 1998 increase in provision for insured events of prior years includes
$40 million related to the Northridge Earthquake. The 1997 and 1996 decreases
in provisions for insured events of prior years is offset by increases in
earthquake losses of $24.75 million and $40 million, respectively.
NOTE 9. BANK LOAN PAYABLE
The Company has entered into a revolving credit facility ("the Facility")
that provides an aggregate commitment of $112.5 million at December 31, 1998.
The commitment decreases by $11.25 million on the first day of each quarter
until April 1, 2001. Principal repayments are required when total outstanding
advances exceed the aggregate commitment. The Company may prepay principal
amounts of the advances, as well as voluntarily cause the aggregate commitment
to be reduced at any time during the term of the Facility.
As of December 31, 1998, the Company's outstanding advances against the
Facility totaled $112.5 million, which approximates its fair value. Interest is
charged at a variable rate based, at the option of the Company, on either (1)
the contractually defined Alternate Base Rate ("ABR") plus a margin of 0.25% or
(2) the Eurodollar Rate plus a margin of .75%. Margins are adjusted in relation
to certain financial and operational levels of the Company. The ABR is defined
as a daily rate which is the higher of (a) the prime rate for such day or (b)
the Federal Funds Effective Rate for such day plus .5% per annum. Interest is
payable at the end of each interest period. The stock of the Company's
insurance subsidiaries is pledged as collateral under the Facility. At December
31, 1998, the annual interest rate for the specified interest period was
approximately 6.3%. Interest paid was $8,660,000 in 1998, $12,758,000 in 1997
and $9,813,000 in 1996.
61
NOTE 10. REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. The Company periodically reviews the financial condition of its
reinsurers to minimize its exposure to losses from reinsurer insolvencies. It
is the Company's policy to hold collateral under related reinsurance agreements
in the form of letters of credit for unpaid losses for all reinsurers not
licensed to do business in the Company's state of domicile.
The effect of reinsurance on premiums written and earned is as follows
(amounts in thousands):
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
Written Earned Written Earned Written Earned
---------- ---------- ---------- ---------- ---------- ----------
Gross $ 885,617 $ 885,332 $ 901,769 $ 899,506 $ 929,843 $ 987,628
Ceded (111,903) (112,468) (113,169) (113,517) (101,850) (131,000)
---------- ---------- ---------- ---------- ---------- ----------
Net $ 773,714 $ 772,864 $ 788,600 $ 785,989 $ 827,993 $ 856,628
========== ========== ========== ========== ========== ==========
Losses and loss adjustment expenses have been reduced by reinsurance ceded
as follows (amounts in thousands):
YEARS ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
--------- --------- ----------
Gross losses and loss
adjustment expenses incurred $706,316 $688,436 $ 839,146
Ceded losses and loss
adjustment expenses incurred (79,937) (80,661) (104,411)
--------- --------- ----------
Net losses and loss
adjustment expenses incurred $626,379 $607,775 $ 734,735
========= ========= ==========
In connection with an investment agreement executed in 1994 with AIG, each
of the Company's insurance subsidiaries entered into a five-year quota share
reinsurance agreement with an AIG affiliate to provide coverage for all ongoing
lines of business. Under this contract, which attaches to the Company's
retained risks net of all other reinsurance, the subsidiaries cede 10% of their
premiums earned and losses incurred in connection with policies incepted during
the period
62
January 1, 1995 through December 31, 1999. The majority of the Company's
reinsurance receivables are due from the AIG affiliate. At the end of the
five-year period, the AIG affiliate may elect to renew the agreement annually at
declining coverage percentages. Ceding commissions of 9.40%, 9.36% and 9.13%
were earned by the insurance subsidiaries for 1998, 1997 and 1996, respectively.
The ceding commission is adjusted annually to equal the prior year's gross SAP
underwriting expense ratio.
In 1996, the Company's insurance subsidiaries entered into a 100% quota
share reinsurance agreement with F&G Re and Risk Capital Re covering the
homeowners line of business. This agreement covers, for a one-year policy term,
all business in force as of July 1, 1996 plus renewal business attaching between
July 1, 1996 and July 23, 1996, effectively terminating with the expiration of
the underlying, one-year policies. Under this contract, 100% of each
subsidiary's homeowners unearned premium reserves as of June 30, 1996 were ceded
50/50 to F&G Re and Risk Capital Re, a total of $33.3 million. Additionally,
100% of written premiums and incurred losses and allocated loss adjustment
expenses subsequent to June 30, 1996, on covered policies, are ceded under this
contract. The Company's insurance subsidiaries earn a commission on ceded
premiums based on a sliding scale dependent on the incurred loss ratio. In
1998, 1997 and 1996, the Company earned commissions at a rate of 12.5% on this
treaty. Homeowners policies renewed February 15, 1997 and subsequent are
covered in full by quota share reinsurance agreements with three reinsurers, as
follows: National Union Fire Insurance Co. of Pittsburgh, PA (50%), a subsidiary
of AIG, F&G Re (25%) and Risk Capital Re (25%). The Company's insurance
subsidiaries earn a commission on ceded premiums based on a sliding scale
dependent on the incurred loss ratio. The Company earned commissions at a rate
of 14% on this treaty for 1998 and 1997.
The Company has a quota share treaty for its Personal Umbrella Policy line
of business whereby it cedes 60% of premiums and losses. After the effect of
the 10% quota share treaty with AIG discussed earlier, the Company effectively
retains 36% of the risk for this line of business.
63
NOTE 11. LEASE COMMITMENTS
The Company leases office space in a building in Woodland Hills,
California. The lease was amended in April 1998 to extend its term until
November 2014. The lease may be renewed for two consecutive five-year periods.
The Company also leases office space in several other locations throughout
California, primarily for claims servicing.
In April 1998, the Company signed an agreement to become the primary tenant
of a new office tower adjacent to its headquarters to be completed in late 1999.
The new building will nearly double the size of its current facility to total
almost 500,000 square feet. This lease expires in November 2014 and may be
renewed for two consecutive five-year periods.
Minimum rental commitments under the Company's lease obligations are as
follows:
1999 $ 11,635,693
2000 15,577,753
2001 14,044,089
2002 13,026,515
2003 11,559,636
Thereafter 117,219,069
Rental expense charged to operations for the years ended December 31, 1998,
1997 and 1996 was $12,879,000, $11,969,000 and $11,243,000, respectively.
NOTE 12. STOCKHOLDERS' EQUITY
During the third quarter of 1998, AIG exercised 16 million warrants to
purchase shares of common stock at a price of $9.10 per share, which increased
the Company's stockholders' equity by $145.6 million. AIG also tendered 224,950
shares of Series A preferred stock for conversion to 19,854,368 shares of common
stock. As a result of these transactions, as well as additional common stock
purchases, AIG now owns a majority interest in the Company.
64
The Company's insurance subsidiaries are subject to restriction as to the
amount of dividends which may be paid to the parent company within any one year
without the approval of the California Department of Insurance ("CDOI"). The
California Insurance Code provides that amounts may be paid as dividends from
earned surplus on an annual, noncumulative basis, without prior approval by the
CDOI, up to the greater of (1) net income for the preceding year, or (2) 10% of
statutory surplus as regards policyholders as of the preceding December 31.
Earned surplus available for dividends as of December 31, 1998 was approximately
$228.7 million.
Surplus of the insurance subsidiaries on a statutory basis at December 31,
1998 and 1997 was $600,654,000 and $548,043,000, respectively. Statutory net
income for the insurance subsidiaries was $154,916,000, $178,727,000 and
$121,780,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
NOTE 13. STOCK-BASED COMPENSATION
The Company has two separate stock compensation plans: the 1995 Stock
Option Plan, which provides for grants of stock options to key employees and
non-employee directors of the Company, and the Restricted Shares Plan, which
provides for stock grants to key employees.
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees ("APB 25") and related
Interpretations in accounting for its stock-based compensation. Under APB 25,
because the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized. Also, under APB 25, the fair value of stock grants made
under the Restricted Shares Plan is amortized to expense over the vesting period
of the grants. This accounting treatment results in compensation expense being
recorded in a manner consistent with that required under SFAS No. 123,
Accounting for Stock-Based Compensation, and, therefore, pro forma net income
and earnings per share amounts would be unchanged from those reported in the
financial statements. SFAS No. 123 requires disclosure of the pro forma net
income and earnings per share as if the Company had accounted for its employee
stock compensation under the fair value method of that Statement.
65
1995 Stock Option Plan
The aggregate number of common shares issued and issuable under the Plan
currently is limited to 4,000,000. At December 31, 1998, 2,219,250 common
shares remain available for future grants. All options granted have ten year
terms. As a consequence of AIG's acquiring a controlling interest in the
Company, vesting was accelerated for all options granted as of July 27, 1998.
Options granted after July 27, 1998, vest over various future periods.
Exercise prices for options outstanding at December 31, 1998 ranged from
$12.50 to $29.25. The weighted-average remaining contractual life of those
options is 8.3 years.
A summary of the Company's stock option activity and related information
follows:
Weighted-Average
Number of Exercise
Options Price
---------- -----------------
Options outstanding January 1, 1996 180,000 $ 12.56
Granted in 1996 396,500 $ 19.64
Exercised in 1996 (8,000) $ 12.50
Forfeited in 1996 (27,000) $ 19.33
----------
Options outstanding December 31, 1996 541,500 $ 17.41
Granted in 1997 649,750 $ 19.81
Exercised in 1997 (27,000) $ 17.14
Forfeited in 1997 (12,500) $ 17.68
----------
Options outstanding December 31, 1997 1,151,750 $ 18.76
Granted in 1998 606,250 $ 29.09
Exercised in 1998 (122,320) $ 18.80
Forfeited in 1998 (16,000) $ 28.36
----------
Options outstanding December 31, 1998 1,619,680 $ 22.53
==========
66
The Company's pro forma information using the Black-Scholes valuation model
follows:
YEARS ENDED DECEMBER 31,
----------------------------
1998 1997 1996
-------- -------- --------
Estimated weighted-average of the fair
value of options granted $ 8.88 $ 7.90 $ 10.70
Pro forma net income (in thousands) $ 94,659 $108,541 $70,522
Pro forma earnings per share - Basic $ 1.26 $ 1.71 $ 0.98
Pro forma earnings per share - Diluted $ 1.12 $ 1.34 $ 0.86
For pro forma disclosure purposes, the fair value of stock options was
estimated at each date of grant using a Black-Scholes option pricing model using
the following assumptions: Risk-free interest rates of 5.02% to 5.65% for 1998,
6.23% to 6.67% for 1997 and 6.51% to 6.54% for 1996; dividend yields ranging
from 1.98% to 2.33% in 1998, 1.14% to 1.44% in 1997 and 1.0% to 1.3% in 1996;
volatility factors of the expected market price of the Company's common stock of
.23, .27 and .39 for 1998, 1997 and 1996, respectively; and a weighted-average
expected life of the options of 8 years in 1998, 8 years in 1997 and 10 years in
1996.
In management's opinion, existing stock option valuation models do not
provide an entirely reliable measure of the fair value of non-transferable
employee stock options with vesting restrictions.
Restricted Shares Plan
The Restricted Shares Plan currently provides for grants of up to 921,920
shares of common stock to be made available to key employees as determined by
the Key Employee Incentive Committee of the Board of Directors. The common
shares granted are restricted. Restrictions are removed on 20% of the shares of
each employee on January 1 of each of the five years following the year of
grant. Upon issuance of grants of common shares under the plan, unearned
compensation equivalent to the market value on the date of grant is charged to
common stock and subsequently amortized in equal monthly installments over the
five-year vesting period of the grant. As a consequence of AIG's acquiring a
controlling interest in the Company, the previously unamortized balance of
$2,280,000 was recognized as a charge to income as of July 27, 1998. Total
amortization
67
expense relating to the Restricted Shares Plan was $2,698,000, $534,900 and
$365,500 in 1998, 1997 and 1996, respectively.
A summary of grants under the plan from 1996 through 1998 follows:
Common Market Price Per
Shares Share on Date of Grant
--------- -----------------------
Outstanding, January 1, 1996 43,883
Granted in 1996 18,600 $ 19.63
Vested in 1996 (13,800)
Canceled or forfeited -
---------
Outstanding, December 31, 1996 48,683
Granted in 1997 89,355 $ 16.50-$17.50
Vested in 1997 (18,444)
Canceled or forfeited -
---------
Outstanding, December 31, 1997 119,594
Granted in 1998 44,100 $ 26.00
Vested in 1998 (163,694)
Canceled or forfeited -
---------
Outstanding, December 31, 1998 -
=========
NOTE 14. LITIGATION
In the normal course of business, the Company is named as a defendant in
lawsuits related to claim issues. Some of the actions request exemplary or
punitive damages. These actions are vigorously defended unless a reasonable
settlement appears appropriate.
Currently included in this class of litigation are certain actions that
arose out of the Northridge Earthquake. It is believed that a majority of these
actions were filed to resolve claims involving disputed damages or to contest
the applicability of the statute of limitations. While any litigation has an
element of uncertainty, the Company does not believe that the ultimate outcome
of any pending action will have a material effect on its consolidated financial
condition or results of operations.
68
NOTE 15. NORTHRIDGE EARTHQUAKE
The Northridge Earthquake, which occurred on January 17, 1994,
significantly affected the operating results and the financial position of the
Company. Provisions charged to income for this event amounted to $40 million,
$24.75 million and $40 million in 1998, 1997 and 1996, respectively.
NOTE 16. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The summarized unaudited quarterly results of operations were as follows:
(Amounts in thousands, except per share data)
QUARTER ENDED
---------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- --------- -------------- -------------
1998
- - ----
Net premiums earned $ 193,501 $ 191,883 $ 193,506 $ 193,974
Investment income $ 18,332 $ 18,262 $ 19,197 $ 19,355
Realized gains $ 3,234 $ 7,683 $ 6,920 $ 4,803
Net income (loss) $ 27,868 $ 40,173 $ 38,184 $ (5,153)
Basic earnings (loss)
per common share $ 0.44 $ 0.68 $ 0.49 $ (0.06)
Diluted earnings (loss)
per common share $ 0.34 $ 0.49 $ 0.44 $ (0.06)
1997
- - ----
Net premiums earned $ 194,969 $ 195,107 $ 197,676 $ 198,237
Investment income $ 17,835 $ 18,400 $ 18,612 $ 18,616
Realized gains $ 1,072 $ 471 $ 1,452 $ 1,076
Net income $ 26,872 $ 31,507 $ 33,218 $ 19,332
Basic earnings per
common share $ 0.42 $ 0.51 $ 0.55 $ 0.28
Diluted earnings per
common share $ 0.34 $ 0.39 $ 0.41 $ 0.23
69
The quarterly earnings per share amounts do not necessarily add to annual
amounts due to the changing dilutive effect of common stock equivalents as the
price of the common stock fluctuates.
Additional Northridge Earthquake reserves of $40 million were recorded in
the fourth quarter of 1998. The second and fourth quarters of 1997 were also
impacted by additional reserves of $6.75 million and $18 million, respectively,
related to the 1994 Northridge Earthquake.
NOTE 17. RESULTS OF OPERATIONS BY LINE OF BUSINESS
The following table presents premium revenue and underwriting profit (loss)
for the Company's insurance lines on a GAAP basis for the years ended December
31.
(Amounts in thousands)
1998
----------------------------------
Personal
Umbrella
Auto Homeowners Policy
-------- ------------ ----------
Gross premiums written $858,263 $ 24,806 $ 2,548
Premiums earned $772,267 $ (294) $ 891
Underwriting profit (loss) $112,703 $ (45,544) $ 703
1997
----------------------------------
Personal
Umbrella
Auto Homeowners Policy
-------- ------------ ----------
Gross premiums written $871,996 $ 27,367 $ 2,406
Premiums earned $781,288 $ 3,917 $ 784
Underwriting profit (loss) $134,130 $ (30,307) $ 493
1996
----------------------------------
Personal
Umbrella
Auto Homeowners Policy
-------- ------------ ----------
Gross premiums written $892,287 $ 35,442 $ 2,114
Premiums earned $831,963 $ 23,893 $ 772
Underwriting profit (loss) $ 81,010 $ (39,705) $ 917
70
AUTO. The $21.4 million decrease in underwriting profit in 1998 compared to
1997 resulted from increased competition, an increase in claims frequency that
emerged principally in the 1998 fourth quarter, and premium rate reductions of
3.2% and 3.4% effective October 31, 1997, and January 1, 1998, respectively. In
addition, non-recurring costs for accelerated amortization of restricted stock
grants of $2.0 million were recorded in 1998 as well as Year 2000 costs of $5.7
million and $1.5 million in 1998 and 1997, respectively. The $53.1 million
increase in underwriting profit in 1997 compared to 1996 was largely the result
of growth in the number of vehicles in force, relatively dry weather, and a
continued strong decline in claim frequencies and severities.
HOMEOWNERS. The 1998, 1997 and 1996 underwriting losses in these lines included
respective provisions for additional earthquake reserves of $40 million, $24.75
million and $40 million, respectively. Also affecting the three years was an
overall decline in premium volume resulting from the CDOI's prohibition against
the Company's writing of any new business in this line since June 1994.
71
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no disagreements with the Company's independent auditors on any
matters of accounting principles or practices, financial statement disclosure or
auditing scope or procedure, or any reportable events.
PART III
--------
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
Information in response to Item 10 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's 1999
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to Item 11 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's 1999
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to Item 12 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's 1999
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
72
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to Item 13 is incorporated by reference from the
Company's definitive proxy statement used in connection with the Company's 1999
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K. All
related party transactions which require disclosure are included in the
Management's Discussion and Analysis or the Notes to Consolidated Financial
Statements.
73
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K
(a) DOCUMENTS FILED WITH THIS REPORT PAGE
(1) FINANCIAL STATEMENTS
The following consolidated financial statements of the Company are
filed as a part of this report:
(i) Report of independent auditors; 41
(ii) Consolidated balance sheets - December 31, 1998 and 1997; 42
(iii) Consolidated statements of income - Years ended December 31, 1998,
1997 and 1996; 44
(iv) Consolidated statements of stockholders' equity - Years ended December
31, 1998, 1997 and 1996; 45
(v) Consolidated statements of cash flows - Years ended December 31, 1998
1997 and 1996; 46
(vi) Notes to consolidated financial statements 48
(2) SCHEDULES
The following financial statement schedule required to be filed by Item 8 and
by paragraph (d) of Item 14 of form 10-K is submitted as a separate section
of this report.
Schedule II - Condensed Financial Information of Registrant 78
Schedules I, III, IV and VI have been omitted as all required data is
included in the Notes to Consolidated Financial Statements.
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commisssion are not required
under the related instructions or are inapplicable and, therefore, have
been omitted.
74
(3) EXHIBITS REQUIRED
The following exhibits required by Item 601 of Regulation S-K and by paragraph
(c) of Item 14 of Form 10-K are listed by number corresponding to the Exhibit
Table of Item 601 of Regulation S-K and are incorporated by reference as
indicated below.
3(a) Articles of Incorporation, as amended, incorporated herein by
reference from the Registrant's Form 10-K for the year ended
December 31, 1994
3(b) By Laws, as amended, filed herewith
The following contract is incorporated herein by reference from the Registrant's
Form 10-K for the year ended December 31, 1985:
10(a) Life Insurance Agreement for key officers
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1987:
10(b) Amendment to 20th Century Industries Restricted Shares Plan
10(c) Split Dollar Insurance Agreement between the Company and
Stanley M. Burke, as trustee of the 1983 Foster Insurance Trust
The following contract is incorporated herein by reference from the Registrant's
Form 10-K for the year ended December 31, 1988:
10(d) Amendment to 20th Century Industries Supplemental Executive
Retirement Plan
75
The following contracts are incorporated herein by reference from the
Registrant's Form 8-K dated October 5, 1994:
10(e) Letter of intent between the Company and American International
Group, Inc.
10(f) Stock Option Agreement between the Company and American
International Group, Inc.
The following contract is incorporated herein by reference from the Registrant's
Form 10-Q dated November 13, 1994:
10(g) Investment and Strategic Alliance Agreement between the Company
and American International Group, Inc.
The following contract is incorporated herein by reference from the Registrant's
Form 10-K for the year ended December 31, 1994:
10(h) Amendment No. 1 to Investment and Strategic Alliance Agreement
between the Company and American International Group, Inc.
The following contract is incorporated herein by reference from the Registrant's
Form S-8 dated July 26, 1995:
10(i) 20th Century Industries Stock Option Plan for eligible employees
and non-employee directors
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1995:
10(j) Amended and Restated Credit Agreement among the Company,
Union Bank, The First National Bank of Chicago, et. al.
10(k) Quota Share Reinsurance Agreement between the Company and
American International Group, Inc., as amended
76
The following contracts are incorporated herein by reference from the
Registrant's Form 10-K for the year ended December 31, 1996:
10(l) Forms of Stock Option Agreements
10(m) Form of Restricted Shares Agreement
10(n) 20th Century Industries Supplemental Executive Retirement Plan, as
amended
10(o) 20th Century Industries Pension Plan, 1994 Amendment and Restatement
10(p) Amendment No. 1 to 20th Century Industries Pension Plan
The following exhibits are incorporated by reference or filed herewith as
indicated:
21 Subsidiaries of the Registrant, incorporated herein by
reference from "Item 1. Business" in the Registrant's Form 10-K
for the year ended December 31, 1998
23 Consent of Independent Auditors, filed herewith
(b) REPORTS ON FORM 8-K.
There were no reports on Form 8-K filed for the three months ended
December 31, 1998.
77
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
(Amounts in thousands, except share data)
DECEMBER 31,
------------------
1998 1997
-------- --------
ASSETS
Cash $154,768 $ 15,264
Prepaid loan fees 2,409 4,204
Other current assets 2,343 2,251
Investment in non-consolidated insurance
subsidiaries and affiliates at equity 733,140 717,439
Other assets 38,114 16,247
-------- --------
$930,774 $755,405
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 20,288 $ 12,550
Accounts payable to subsidiaries and affiliates,
net of receivables 12,384 2,394
Bank loan payable 112,500 157,500
-------- --------
Total liabilities 145,172 172,444
-------- --------
Stockholders' equity:
Capital Stock
Preferred stock, par value $1.00 per share;
authorized 500,000 shares, no shares issued - -
Series A convertible preferred stock, par value
1.00 per share, stated value $1,000 per share;
authorized 376,126 shares, no shares outstanding
in 1998 and 224,950 in 1997 - 224,950
Common stock, without par value; authorized
110,000,000 shares, outstanding 87,624,531
in 1998 and 51,636,361 in 1997 462,268 87,230
Accumulated other comprehensive income of
insurance subsidiaries - net 23,387 20,298
Retained earnings 299,947 250,483
Total stockholders' equity 785,602 582,961
-------- --------
$930,774 $755,405
======== ========
78
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
REVENUES
Dividends received from subsidiaries $ 97,256 $ 69,000 $ 43,000
Interest 3,810 (94) 339
--------- --------- ---------
Total 101,066 68,906 43,339
EXPENSES
Loan interest and fees 10,278 12,942 14,260
General and administrative 820 991 621
--------- --------- ---------
Total 11,098 13,933 14,881
Income before income taxes 89,968 54,973 28,458
Income taxes (refund) 412 (31) (7)
--------- --------- ---------
Net income before equity in
undistributed income of subsidiaries
89,556 55,004 28,465
Equity in undistributed income of
subsidiaries 11,516 55,925 45,592
--------- --------- ---------
NET INCOME $101,072 $110,929 $ 74,057
========= ========= =========
EARNINGS PER COMMON SHARE
Basic $ 1.36 $ 1.76 $ 1.05
========= ========= =========
Diluted $ 1.19 $ 1.37 $ 0.92
========= ========= =========
79
SCHEDULE II
20TH CENTURY INDUSTRIES (PARENT COMPANY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
(Amounts in thousands, except per share data)
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
NET CASH PROVIDED BY
OPERATING ACTIVITIES $117,045 $ 62,844 $ 31,749
INVESTING ACTIVITIES:
Capital contributed to 21st Century
Casualty Company - (2,000) -
Capital contributed to 20th Century Insurance
Company of Arizona (1,470) (1,430) (1,970)
Net purchases of equipment (25,063) (8,301) (855)
--------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES (26,533) (11,731) (2,825)
FINANCING ACTIVITIES:
Proceeds from exercise of warrants 145,600 - -
Bank loan principal repayment (45,000) (17,500) -
Dividends paid (51,608) (33,151) (22,821)
--------- --------- ---------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 48,992 (50,651) (22,821)
--------- --------- ---------
Net increase in cash 139,504 462 6,103
Cash, beginning of year 15,264 14,802 8,699
--------- --------- ---------
Cash, end of year $154,768 $ 15,264 $ 14,802
========= ========= =========
80
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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.
20TH CENTURY INDUSTRIES
(Registrant)
Date: March 22, 1999 By: /s/ William L. Mellick
-------------- -------------------------------------
William L. Mellick
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated on the 22nd of
March, 1999.
SIGNATURE TITLE
- - --------- -----
/s/ William L. Mellick President and Chief Executive Officer
- - --------------------------------- (Principal Executive Officer)
William L. Mellick
/s/ Robert B. Tschudy Senior Vice President
and Chief Financial Officer
- - --------------------------------- (Principal Financial Officer)
Robert B. Tschudy
/s/ John M. Lorentz Controller
- - --------------------------------- (Principal Accounting Officer)
John M. Lorentz
81
SIGNATURE TITLE
- - --------- -----
/s/ M. R. Greenberg
- - ------------------------------ Chairman of the Board
M. R. Greenberg
/s/ William H. Braddock
- - ------------------------------ Director
William H. Braddock
/s/ Florence A. Davis
- - ------------------------------ Director
Florence A. Davis
/s/ John B. De Nault, III
- - ------------------------------ Director
John B. De Nault, III
/s/ William N. Dooley
- - ------------------------------ Director
William N. Dooley
/s/ R. Scott Foster, M.D.
- - ------------------------------ Director
R. Scott Foster, M.D.
/s/ Roxani M. Gillespie
- - ------------------------------ Director
Roxani M. Gillespie
/s/ William L. Mellick
- - ------------------------------ Chief Executive Officer and Director
William L. Mellick
/s/ James P. Miscoll
- - ------------------------------ Director
James P. Miscoll
/s/ Robert M. Sandler
- - ------------------------------ Vice Chairman of the Board
Robert M. Sandler
82
SIGNATURE TITLE
- - --------- -----
/s/ Gregory M. Shepard
- - ------------------------------ Director
Gregory M. Shepard
/s/ Howard I. Smith
- - ------------------------------ Director
Howard I. Smith
/s/ Arthur H. Voss
- - ------------------------------ Director
Arthur H. Voss
83