SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended September 30, 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 Identification
incorporation or organization) Number)
Suite 700, 6301 Owensmouth Avenue, Woodland Hills, California 91367
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (818) 704-3700
None
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----------------------- ---------------------
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at October 31, 1998
Common Stock, Without Par Value 87,601,698 shares
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, December 31,
1998 1997
-------------- -------------
(Unaudited)
(Amounts in thousands)
Investments, available-for-sale, at fair value:
Fixed maturities $1,097,174 $1,082,708
Equity securities 1,127 1,745
---------- ----------
Total investments - Note 3 1,098,301 1,084,453
Cash and cash equivalents 179,499 31,268
Accrued investment income 20,175 20,008
Premiums receivable 74,999 71,494
Reinsurance receivables and recoverables 64,850 70,050
Prepaid reinsurance premiums 37,898 32,154
Deferred income taxes - Note 4 63,903 126,877
Deferred policy acquisition costs 14,559 11,510
Other assets 50,832 34,639
---------- ----------
$1,605,016 $1,482,453
---------- ----------
---------- ----------
See accompanying notes to financial statements.
2
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
1998 1997
-------------- -------------
(Unaudited)
(Amounts in thousands, except share data)
Unpaid losses and loss adjustment expenses $ 351,590 $ 437,887
Unearned premiums 240,840 233,403
Bank loan payable 123,750 157,500
Claims checks payable 32,588 35,569
Reinsurance payable 21,504 19,347
Other liabilities 16,037 15,787
---------- ----------
Total liabilities 786,309 899,493
---------- ----------
Stockholders' equity
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, none outstanding
in 1998 and 224,950 in 1997 - 224,950
Common stock without par value; authorized
110,000,000 shares, outstanding 87,612,498 in
1998 and 51,636,361 in 1997 461,993 87,230
Retained earnings 319,121 250,482
Accumulated other comprehensive income 37,593 20,298
---------- ----------
Total stockholders' equity 818,707 582,960
---------- ----------
$1,605,016 $1,482,453
---------- ----------
---------- ----------
See accompanying notes to financial statements.
3
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ------------------------
1998 1997 1998 1997
--------- ---------- ----------- ----------
(Amounts in thousands, except per share data)
REVENUES:
Net premiums earned $193,506 $197,676 $578,890 $587,752
Net investment income 19,197 18,612 55,791 54,847
Realized investment gains 6,920 1,452 17,837 2,995
-------- -------- -------- --------
219,623 217,740 652,518 645,594
LOSSES AND EXPENSES:
Net losses and loss
adjustment expenses 139,182 143,238 424,696 439,681
Policy acquisition costs 14,668 10,590 37,181 31,202
Other operating expenses 4,767 9,887 19,802 25,828
Interest and fees expense 2,515 3,256 8,030 9,871
-------- -------- -------- --------
161,132 166,971 489,709 506,582
-------- -------- -------- --------
Income before federal
income taxes 58,491 50,769 162,809 139,012
Federal income taxes - Note 4 20,306 17,551 56,583 47,415
-------- -------- -------- --------
NET INCOME $ 38,185 $ 33,218 $106,226 $ 91,597
-------- -------- -------- --------
-------- -------- -------- --------
EARNINGS PER COMMON SHARE - Note 2
- ----------------------------------
BASIC $ 0.49 $ 0.55 $ 1.60 $ 1.48
-------- -------- -------- --------
-------- -------- -------- --------
DILUTED $ 0.44 $ 0.41 $ 1.27 $ 1.14
-------- -------- -------- --------
-------- -------- -------- --------
See accompanying notes to financial statements.
4
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
Nine Months Ended September 30, 1998
Accumulated
Convertible Other
Preferred Common Retained Comprehensive
Stock Stock Earnings Income Total
------------- ---------- ----------- -------------- ----------
(Amounts in thousands)
Balance at January 1, 1998 $ 224,950 $ 87,230 $ 250,482 $ 20,298 $ 582,960
---------
Comprehensive income:
Net income 106,226 106,226
Change in accumulated other
comprehensive income, net -
Note 3 17,295 17,295
---------
Total comprehensive income 123,521
Cash dividends declared (37,587) (37,587)
Effects of conversion of preferred
stock and exercise of common
stock warrants (224,950) 372,531 147,581
Other 2,232 2,232
--------- ---------- ---------- ---------- ----------
Balance at September 30, 1998 $ - $ 461,993 $ 319,121 $ 37,593 $ 818,707
--------- ---------- ---------- ---------- ----------
--------- ---------- ---------- ---------- ----------
See accompanying notes to financial statements.
5
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
---------------------------------
1998 1997
------------- ----------------
(Unaudited)
(Amounts in thousands)
OPERATING ACTIVITIES:
Net income $ 106,226 $91,597
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for depreciation and amortization 6,876 4,013
Provision for deferred income taxes 53,662 45,020
Realized gains on sale of investments (17,837) (2,995)
Federal income taxes 329 1,098
Reinsurance balances 1,613 2,175
Unpaid losses and loss adjustment expenses (86,297) (92,748)
Unearned premiums 7,437 17,109
Claims checks payable (2,981) (4,565)
Other (1,861) (7,671)
------- -------
NET CASH PROVIDED BY
OPERATING ACTIVITIES $ 67,167 $53,033
6
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Nine Months Ended September 30,
-------------------------------
1998 1997
--------------- -------------
(Unaudited)
(Amounts in thousands)
INVESTING ACTIVITIES:
Investments available-for-sale:
Purchases $ (674,399) $ (526,819)
Calls or maturities 16,262 4,300
Sales 688,360 536,137
Net purchases of property and equipment (23,422) (10,047)
----------- -----------
NET CASH PROVIDED BY
INVESTING ACTIVITIES 6,801 3,571
FINANCING ACTIVITIES:
Proceeds from exercise of common stock warrants 145,600 -
Bank loan principal repayment (33,750) (6,250)
Dividends paid (37,587) (22,927)
----------- -----------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 74,263 (29,177)
----------- -----------
Net increase in cash and cash equivalents 148,231 27,427
Cash and cash equivalents, beginning of year 31,268 18,078
----------- -----------
Cash and cash equivalents, end of quarter $ 179,499 $ 45,505
----------- -----------
----------- -----------
See accompanying notes to financial statements.
7
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal, recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three and nine month periods ended September 30, 1998, are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998. For further information, refer to the
consolidated financial statements and notes thereto included in the 20th
Century Industries Annual Report on Form 10-K for the year ended December
31, 1997.
8
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. Earnings Per Common Share
The following table sets forth the computation of basic and diluted
earnings per share:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
1998 1997 1998 1997
--------- ----------- ------------ ----------
(Amounts in thousands, except per share data)
Numerator:
Net income $ 38,185 $ 33,218 $ 106,226 $ 91,597
Preferred stock dividends - (5,061) (10,123) (15,184)
-------- -------- --------- ---------
Numerator for basic earnings per share:
Income available to common stockholders 38,185 28,157 96,103 76,413
Effect of dilutive securities:
Dividends on convertible preferred stock - 5,061 10,123 15,184
-------- -------- --------- ---------
Numerator for diluted earnings per share:
Income available to common stockholders
after assumed conversions $ 38,185 $ 33,218 $ 106,226 $ 91,597
-------- -------- --------- ---------
-------- -------- --------- ---------
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding 77,148 51,506 60,098 51,495
Effect of dilutive securities:
Restricted stock grants 45 121 105 121
Employee stock options 289 255 344 121
Warrants 2,995 9,913 8,194 8,686
Convertible preferred stock 5,764 19,854 15,157 19,854
-------- -------- --------- ---------
9,093 30,143 23,800 28,782
Denominator for diluted earnings per share:
Adjusted weighted-average shares outstanding 86,241 81,649 83,898 80,277
-------- -------- --------- ---------
-------- -------- --------- ---------
Basic earnings per share $ 0.49 $ 0.55 $ 1.60 $ 1.48
-------- -------- --------- ---------
-------- -------- --------- ---------
Diluted earnings per share $ 0.44 $ 0.41 $ 1.27 $ 1.14
-------- -------- --------- ---------
-------- -------- --------- ---------
9
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. Earnings per Common Share (Continued)
As a result of AIG's conversion of preferred stock and exercise of common
stock warrants in the third quarter of 1998, the complexity of the
Company's capital structure has been significantly reduced. Accordingly,
the Company's diluted earnings per share calculation will be greatly
simplified starting in the fourth quarter of 1998.
3. Investments
The amortized cost, gross unrealized gains and losses, and fair values of
investments as of September 30, 1998, are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------- ------------- -----------
(Amounts in thousands)
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 6,990 $ 263 - $ 7,253
Obligations of states and political
subdivisions 32,725 3,310 - 36,035
Public utilities 172,137 12,572 - 184,709
Corporate securities 828,363 42,446 1,632 869,177
---------- -------- -------- ----------
Total fixed maturities 1,040,215 58,591 1,632 1,097,174
Equity securities 250 877 - 1,127
---------- -------- -------- ----------
Total investments $1,040,465 $59,468 $1,632 $1,098,301
---------- -------- -------- ----------
---------- -------- -------- ----------
10
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. Investments (Continued)
Details follow concerning the change during the nine months ended September
30, 1998, in the after-tax net unrealized gain on investments, which is
included in accumulated other comprehensive income in the consolidated
balance sheet (amounts in thousands):
Unrealized gain on available-for-sale investments, net of
income taxes of $12,744 $23,724
Less: reclassification adjustment for gains included in net
income, net of income taxes of $3,462 (6,429)
-------
Total $17,295
-------
-------
4. Federal Income Taxes
Income taxes do not bear the expected relationship to pre-tax income
because of tax-exempt investment income and other differences in the
recognition of revenue and expenses for tax and financial statement
purposes. At September 30, 1998, the Company had a net operating loss
carryforward of approximately $133.8 million and $2.2 million for regular
and alternative minimum tax purposes, respectively, and an alternative
minimum tax credit carryforward of $16.7 million. The net operating loss
carryforwards will expire in 2009. Alternative minimum tax credits may be
carried forward indefinitely to offset future regular tax liabilities.
Federal income tax expense consists of:
Nine Months Ended Sept. 30,
---------------------------
1998 1997
------------ ------------
(Amounts in thousands)
Current tax expense $ 2,921 $ 2,395
Deferred tax expense 53,662 45,020
------- -------
$56,583 $47,415
------- -------
------- -------
11
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. 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 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of this
Statement has 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. Total comprehensive income amounted to $58.1 million and
$123.5 million for the three and nine months ended September 30, 1998,
respectively, and $47.3 million and $100.6 million for the same 1997
periods.
In 1997, the Financial Accounting Standards Board also issued SFAS No. 131,
DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. The
Company plans to adopt this Statement effective December 31, 1998, and
believes that this Statement will not require disclosure of any significant
information beyond that already provided in the Company's annual financial
statements.
12
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
The core automobile business experienced continued profitable growth in the
first nine months of 1998 despite increased competition in the industry. The
number of voluntary insured autos during the first nine months of 1998 increased
by 56,872 compared to an increase of 49,017 for the same period of 1997. As of
September 30, 1998, the Company's insurance subsidiaries had a combined
statutory surplus of $621.7 million and a net written premium to surplus ratio
of 1.2:1. Having been recently granted licenses in the states of Nevada, Oregon
and Washington, the Company expects to begin writing policies by the end of the
year in these new markets, which collectively represent approximately six
million vehicles.
During the third quarter of 1998, American International Group Inc. ("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. The proceeds from this transaction have been invested in short-term
cash equivalents pending management's evaluation of the best available means to
deploy the Company's excess capital. 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, AIG now owns a majority interest in the Company.
Following this change in control, 20th Century's board of directors was
reconstituted, and AIG Chairman and Chief Executive Officer M.R. Greenberg was
elected as chairman of 20th Century Industries.
Invested assets as of September 30, 1998 were approximately $1.2 billion. All
investments in fixed maturities are investment grade. Of the Company's total
investments at September 30, 1998, 96.2% were invested in taxable fixed-income
securities, in keeping with the Company's strategy of maximizing the realization
of its remaining net operating loss carryover.
13
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
Loss and loss expense payments are the most significant cash flow requirement of
the Company. The Company continually monitors loss payments to provide
projections of future cash requirements. Cash flow from operations, which rose
26.7% for the first nine months of 1998 compared to the same 1997 period, has
continued to be more than sufficient to fund loss payments.
At October 1, 1998, the Company has a variable rate credit line available of
$112.5 million, all of which is outstanding. Presently, interest is paid
monthly; interest payments for the first nine months of 1998 totaled $6.8
million.
Funds required by 20th Century Industries to pay dividends, debt obligations and
holding company expenses are provided by the insurance subsidiaries. The ability
of the insurance subsidiaries to pay dividends to the holding company is
regulated by state law.
In August 1996, 20th Century Insurance Company of Arizona, a joint venture owned
51% by AIG and 49% by 20th Century Industries, began writing private passenger
automobile policies in that state. As of September 30, 1998, insured vehicles
totaled 14,795, an increase of 60.1% over the total at September 30, 1997. The
Company's investment in and advances to this venture totaled $3,712,000 at
September 30, 1998, and is included in other assets in the consolidated balance
sheet. The Company's equity in the net loss of this venture was $(84,000) and
$(312,000) for the three and nine months ended September 30, 1998, respectively,
and $(201,000) and $(533,000) for the same 1997 periods, and is included in
investment income in the consolidated statement of income. The statistical and
other information presented hereinafter do not include the activities of 20th
Century Insurance Company of Arizona.
14
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
RESULTS OF OPERATIONS
UNITS IN FORCE
Units in force for the Company's insurance programs as of September 30 were as
follows:
1998 1997
--------- -----------
Private Passenger Automobiles
(number of vehicles) 1,127,006 1,066,842
Homeowner and Condominium
(number of policies) 56,305 61,850
Personal Excess Liability
(number of policies) 12,161 10,914
--------- ---------
Total 1,195,472 1,139,606
--------- ---------
--------- ---------
Strong unit growth in the auto business remains the Company's priority. The
Company's voluntary auto units in force increased by 6.4% compared to a year ago
to 1,121,615 units in force at September 30, 1998 from 1,053,779 units in force
at September 30, 1997. Voluntary auto units grew 56,872 (5.3%) in the first
nine months of 1998, 12,079 (1.1%) of which occurred in the third quarter. This
compared to an increase in units of 49,017 (4.9%) for the first nine months of
1997, 12,880 (1.2%) of which occurred in the third quarter. 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 represent greater risks, the Company has been able to enhance
its profitable customer mix. The Company's average customer retention rate for
third quarter 1998 was an excellent 96.9% despite a very competitive business
climate.
15
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
Assigned Risk units decreased by 6,742 (55.6%) to 5,391 units during the first
nine months of 1998 compared to an increase of 6,216 units (90.8%) for the same
period in 1997. This is a result of former Assigned Risk participants finding
affordable coverage in the voluntary market as well as drivers who dropped out
of the program after initially responding to new legislation, effective January
1, 1997, aimed at decreasing the number of uninsured motorists in California.
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 homeowners program declined by 9.0% between September 30, 1997, and
September 30, 1998, mainly due to attrition resulting from the Company's
inability to write new homeowners policies in accordance with an order by the
California Department of Insurance. 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.
16
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
UNDERWRITING RESULTS
Premium revenue, underwriting results and combined ratios for the Company's
insurance programs were as follows:
Three Months Ended Sept, 30, Nine Months Ended Sept. 30,
---------------------------- ---------------------------
1998 1997 1998 1997
----------- -------------- ----------- -------------
(Amounts in thousands)
Gross Premiums Written
Automobile $218,299 $220,429 $644,309 $661,213
Homeowners and Condo 1,596 1,852 24,565 26,455
PELP 727 702 1,925 1,812
-------- -------- -------- --------
Total $220,622 $222,983 $670,799 $689,480
-------- -------- -------- --------
-------- -------- -------- --------
Net Premiums Earned
Automobile $193,283 $197,481 $578,226 $584,787
Homeowners and Condo - - (1) 2,392
PELP 223 195 665 573
-------- -------- -------- --------
Total $193,506 $197,676 $578,890 $587,752
-------- -------- -------- --------
-------- -------- -------- --------
Underwriting Profit (Loss)
Automobile $ 36,523 $ 36,050 $100,362 $101,858
Homeowners and Condo (1,698) (2,108) (3,591) (11,200)
PELP 65 20 440 383
-------- -------- -------- --------
Total $ 34,890 $ 33,962 $ 97,211 $ 91,041
-------- -------- -------- --------
-------- -------- -------- --------
Combined Ratios
Automobile 81.11% 81.75% 82.64% 82.58%
Homeowners and Condo - - - -
PELP 71.01% 89.66% 33.90% 33.13%
Total 81.96% 82.82% 83.21% 84.51%
17
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
AUTOMOBILE
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. Approximately 42% of all new business
written in the first nine months of 1998 came from these regions.
The Company's voluntary automobile program realized an underwriting profit of
$36.1 million for the three months ended September 30, 1998, compared to $36.0
million for the comparable 1997 period. The underwriting profit for the first
nine months of 1998 was $99.3 million compared to $102.7 million for the same
period last year. These results were achieved despite increased competition and
the effects of premium rate reductions of 3.2% and 3.5% effective October 31,
1997, and January 1, 1998, respectively. The combined ratio for the first nine
months of 1998 was 82.6 versus 82.1 for the same period last year. Unallocated
loss adjustment expenses and underwriting expenses for the first nine months of
1998 include approximately $5.4 million incurred to modify computer systems to
make them "Year 2000 compliant," and underwriting expenses also include an
increase in advertising expense of $1.7 million compared to the same prior year
period and approximately $2.0 million related to the accelerated amortization of
restricted stock due to the change in control resulting from AIG's conversion of
preferred stock and exercise of common stock warrants.
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 severity of new claims have resulted in the
Company making a smaller provision for IBNR reserves than in the past,
favorably impacting underwriting results.
18
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
Assigned Risk units produced underwriting gains of $377,000 and $1,076,000 for
the three and nine months ending September 30, 1998, respectively, compared to
an underwriting gain of $84,000 and an underwriting loss of $868,000 for the
comparable periods in 1997. The underwriting profit for the nine months in 1998
reflected a 55.6% decline in the number of Assigned Risk vehicles coupled with
an improved loss ratio over the same period last year.
HOMEOWNERS AND CONDOMINIUM
In December 1996, the Company was granted authority to offer renewals of
policies for approximately 68,000 homeowner insurance customers beginning
February 15, 1997. This renewal business is covered by a quota share
reinsurance agreement, which cedes 100% of all risk to three reinsurers, as
follows:
Reinsurer Participation
- ---------- ----------------
National Union Fire Insurance Co. of Pittsburgh, PA
(A subsidiary of AIG) 50%
United States Fidelity & Guaranty Company 25%
Risk Capital Reinsurance Company 25%
Earthquake coverage, which the Company is obliged to offer in conjunction with
its homeowner policies, is provided through American Home Assurance Company, a
subsidiary of AIG; no earthquake exposures are assumed by the Company. As of
September 30, 1998, more than 56,000 policies had been renewed, which are
approximately 82.8% of those eligible. Homeowners policies in force on June 30,
1996 or renewed before July 23, 1996 (which do not include earthquake
19
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
coverage) were ceded 100% in equal participations to United States Fidelity &
Guaranty Company and Risk Capital Reinsurance Company. This coverage was
effective until the underlying policies expired or were renewed.
Because of the reinsurance agreements in place, the Company's exposure to
weather-related and disaster claims has been significantly reduced, and its
remaining exposure under these programs primarily relates to development on
policies incepted prior to July 1, 1996. The underwriting losses for this line
were $1.7 million and $3.6 million for the three and nine months ending
September 30, 1998, respectively, compared to underwriting losses of $2.1
million and $11.2 million for the same periods in 1997. The 1997 results
included a $6.75 million pre-tax provision recorded in the second quarter in
connection with an earthquake-related lawsuit.
The Company remains exposed to possible further upward development in the
estimated cost to resolve certain claims stemming from the 1994 Northridge
Earthquake. Although management believes current reserves are adequate, the
outcome of future events could require changes in previous estimates.
PERSONAL EXCESS LIABILITY PROGRAM (PELP)
Units in force increased by 11.4% compared to a year ago to 12,161 units in
force at September 30, 1998 from 10,914 units in force at September 30, 1997.
Gross premiums written in the third quarter and first nine months of 1998
increased by 3.5% and 6.3%, respectively, compared to the same periods in 1997.
The growth in this business is primarily attributable to a cross-selling
campaign, which began late in 1997.
20
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
Underwriting profits for this line can vary significantly with the number of
claims, which occur infrequently. The PELP line is subject to two quota share
reinsurance agreements resulting in a net retention by the Company of
approximately 36%.
POLICY ACQUISITION COSTS AND OTHER OPERATING EXPENSES
The Company's policy acquisition and other operating expense ratio continues to
be one of the lowest 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. Net underwriting expenses, which consist of policy acquisition
costs and other operating expenses, decreased by $1.0 million (5.1%) and $47,000
(0.1%) for the third quarter and nine months ended September 30, 1998,
respectively, compared to the same periods in 1997. The ratio of net
underwriting expenses (excluding loan interest and fees) to net premiums earned
for the third quarter and nine months ended September 30, 1998 was 10.0% and
9.8%, respectively, compared to 10.3% and 9.7% for the same periods in 1997.
IMPACT OF YEAR 2000
The "Year 2000 problem" ("Y2K") 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.
21
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
The following discussion summarizes the Company's state of readiness, costs to
address the Company's Y2K issues, the risks inherent in these issues, and the
Company's contingency plans. This discussion includes "forward-looking"
statements about the outcome of future events, whose outcomes may differ from
those reasonably expected by management.
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 DATE
- ----------------------------------------------------------------------------------------
CRITICAL MAINFRAME APPLICATIONS
- ----------------------------------------------------------------------------------------
High level risk assessment & start of project January 1997
- ----------------------------------------------------------------------------------------
Upgrade of base information systems to be Year 2000 compliant April 1998
- ----------------------------------------------------------------------------------------
Replacement of 14 systems with packaged software warranted to be
Y2K compliant January 1999
- ----------------------------------------------------------------------------------------
Complete integration testing of 56 mainframe applications November 1998
- ----------------------------------------------------------------------------------------
OTHER IT HARDWARE (mainframe, client/server, network,
telecommunications, etc.) Assessment, installation or conversion, November 1998 to
test, and implementation June 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 October 1998 to
as needed June 1999
- ----------------------------------------------------------------------------------------
Where the above table shows a range of completion dates, the earlier dates
relate to the systems and suppliers deemed to be critical, whereas the later
dates pertain to non-critical systems and suppliers.
Y2K Remediation Costs
The total Year 2000 project cost is estimated to be approximately $8.0 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
22
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
project, with most of the remainder representing external consultants. Costs
incurred during 1997 were approximately $1.5 million, compared to $5.4 million
for the first nine months of 1998.
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 Company's exposure to potential Y2K issues in the non-IT area 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, revised contingency plans that take account of the Y2K
issue are scheduled to be in place in November 1998, followed by a test of the
revised contingency plans in December 1998. For non-critical systems, the
completion is scheduled for December 1998 followed by testing during the April
to June 1999 period. These contingency plans generally cover steps the Company
would take in the event of a business interruption from a variety of causes,
including back-up computer facilities.
23
20TH CENTURY INDUSTRIES AND SUBSIDIARIES
ITEM 2. (CONTINUED)
INVESTMENT INCOME
Net pre-tax investment income increased 3.1% and 1.7% during the third quarter
and nine months ended September 30, 1998, respectively, compared to the same
periods in 1997. Average invested assets increased 8.6% and 3.8% for the third
quarter and nine months ended September 30, 1998, respectively, compared to the
same 1997 periods. The increases in both investment income and
invested assets are primarily due to additional cash received from the exercise
of AIG's common stock warrants in the third quarter of 1998.
The average annual pre-tax yield on invested assets for both the three and nine
month periods ended September 30, 1998 was 6.4% and 6.6%, respectively, compared
to 6.8% and 6.7%, respectively, for the same periods in 1997.
Realized gains on sales of investments increased in the first nine months of
1998 to $17.8 million from $3.0 million for the same period in 1997. Realized
gains for the third quarter of 1998 increased to $6.9 million from $1.5 million
for the same 1997 quarter. The increases in realized gains are due to favorable
conditions in the bond market as a result of decreasing interest rates.
24
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Reports on Form 8-K
A report on Form 8-K was filed with the Securities and Exchange Commission
on August 10, 1998, regarding American International Group's exercise of 16
million warrants to purchase common stock and the tender of 224,750 shares
of Series A preferred stock for conversion to common stock.
25
SIGNATURES
Pursuant to the requirements of the Securities and 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 November 9, 1998 /s/ William L. Mellick
--------------------------- -------------------------------------
WILLIAM L. MELLICK
President and Chief Executive Officer
Date November 9, 1998 /s/ Robert B. Tschudy
-------------------------- -------------------------------------
ROBERT B. TSCHUDY
Senior Vice President and
Chief Financial Officer
26