UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 30, 2005
Commission File No. 1-12449
SCPIE HOLDINGS INC.
(Exact name of registrant as specified in its charter)
DELAWARE | 95-4557980 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
1888 Century Park East, Los Angeles, California 90067
www.scpie.com
(Address of principal executive offices and internet site)
(310) 551-5900
(Registrants telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes x No ¨
Indicate the number of shares outstanding of each of the issuers classes of stock, as of the latest practicable date.
Class |
Outstanding at August 4, 2005 | |
Preferred stock, par value $1.00 per share Common stock, par value $0.0001 per share |
No shares outstanding 9,969,392 shares |
PART I FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, 2005 |
DECEMBER 31, 2004 |
|||||||
(unaudited) | ||||||||
ASSETS |
||||||||
Securities available-for-sale: |
||||||||
Fixed maturity investments, at fair value (amortized cost 2005 - $428,145; 2004 - $454,278) |
$ | 427,262 | $ | 454,817 | ||||
Equity investments, at fair value (cost 2005 - $12,028; 2004 - $12,100) |
16,340 | 16,173 | ||||||
Total securities available-for-sale |
443,602 | 470,990 | ||||||
Mortgages |
10,400 | 10,400 | ||||||
Cash and cash equivalents |
83,195 | 94,390 | ||||||
Total investments and cash and cash equivalents |
537,197 | 575,780 | ||||||
Accrued investment income |
5,688 | 5,849 | ||||||
Premiums receivable |
44,503 | 12,603 | ||||||
Assumed reinsurance receivable |
75,857 | 119,937 | ||||||
Reinsurance recoverable |
138,162 | 197,520 | ||||||
Deferred policy acquisition costs |
9,400 | 9,063 | ||||||
Deferred federal income taxes |
47,102 | 48,454 | ||||||
Property and equipment, net |
2,641 | 2,954 | ||||||
Other assets |
7,179 | 7,475 | ||||||
Total assets |
$ | 867,729 | $ | 979,635 | ||||
LIABILITIES |
||||||||
Reserves: |
||||||||
Losses and loss adjustment expenses |
$ | 552,014 | $ | 638,747 | ||||
Unearned premiums |
73,459 | 43,811 | ||||||
Total reserves |
625,473 | 682,558 | ||||||
Amounts held for reinsurance |
27,331 | 77,519 | ||||||
Other liabilities |
17,739 | 25,036 | ||||||
Total liabilities |
670,543 | 785,113 | ||||||
Commitments and contingencies |
||||||||
STOCKHOLDERS EQUITY |
||||||||
Preferred stock par value $1.00, 5,000,000 shares authorized, no shares issued or outstanding |
||||||||
Common stock, par value $.0001, 30,000,000 shares authorized, 12,792,091 shares issued, 2005 9,469,392 shares outstanding 2004 9,404,604 shares outstanding |
1 | 1 | ||||||
Additional paid-in capital |
37,127 | 37,127 | ||||||
Retained earnings |
259,553 | 256,177 | ||||||
Treasury stock, at cost 2005 2,822,699 shares and 2004 2,887,487 shares |
(97,517 | ) | (97,654 | ) | ||||
Subscription notes receivable |
(2,928 | ) | (3,018 | ) | ||||
Accumulated other comprehensive income |
950 | 1,889 | ||||||
Total stockholders equity |
197,186 | 194,522 | ||||||
Total liabilities and stockholders equity |
$ | 867,729 | $ | 979,635 | ||||
See accompanying notes to Consolidated Financial Statements.
2
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SIX MONTHS ENDED | THREE MONTHS ENDED | ||||||||||||||
JUNE 30, |
JUNE 30, |
||||||||||||||
2005 |
2004 |
2005 |
2004 |
||||||||||||
Revenues: |
|||||||||||||||
Net premiums earned |
$ | 65,037 | $ | 67,641 | $ | 32,451 | $ | 31,228 | |||||||
Net investment income |
8,799 | 10,550 | 4,132 | 5,118 | |||||||||||
Realized investment gains (loss) |
6 | 1,715 | (10 | ) | (631 | ) | |||||||||
Other revenue |
174 | 365 | 60 | 85 | |||||||||||
Total revenues |
74,016 | 80,271 | 36,633 | 35,800 | |||||||||||
Expenses: |
|||||||||||||||
Losses and loss adjustment expenses |
53,058 | 65,769 | 27,147 | 32,828 | |||||||||||
Underwriting and other operating expenses |
15,719 | 16,806 | 6,854 | 6,576 | |||||||||||
Total expenses |
68,777 | 82,575 | 34,001 | 39,404 | |||||||||||
Income (loss) before income taxes |
5,239 | (2,304 | ) | 2,632 | (3,604 | ) | |||||||||
Income tax expense (benefit) |
1,863 | (815 | ) | 927 | (1,288 | ) | |||||||||
Net income (loss) |
$ | 3,376 | $ | (1,489 | ) | $ | 1,705 | $ | (2,316 | ) | |||||
Basic earnings (loss) per share |
$ | 0.36 | $ | (0.16 | ) | $ | 0.18 | $ | (0.25 | ) | |||||
Diluted earnings (loss) per share |
$ | 0.35 | $ | (0.16 | ) | $ | 0.18 | $ | (0.25 | ) | |||||
Cash dividend declared and paid per share of common stock |
$ | | $ | | $ | | $ | |
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY
(DOLLARS IN THOUSANDS)
(UNAUDITED)
COMMON STOCK |
ADDITIONAL PAID-IN CAPITAL |
RETAINED EARNINGS |
TREASURY STOCK |
STOCK SUBSCRIPTION NOTES |
ACCUMULATED COMPREHENSIVE INCOME (LOSS) |
TOTAL STOCKHOLDERS EQUITY |
|||||||||||||||||||
BALANCE AT JANUARY 1, 2005 |
$ | 1 | $ | 37,127 | $ | 256,177 | $ | (97,654 | ) | $ | (3,018 | ) | $ | 1,889 | $ | 194,522 | |||||||||
Net income |
| | 3,376 | | | | 3,376 | ||||||||||||||||||
Unrealized losses on securities, net of applicable income tax benefit of $417 |
| | | | | (774 | ) | (774 | ) | ||||||||||||||||
Change in minimum pension liability, net of applicable income tax benefit of $73 |
| | | | | (137 | ) | (137 | ) | ||||||||||||||||
Unrealized foreign currency gain |
| | | | | (28 | ) | (28 | ) | ||||||||||||||||
Comprehensive income |
2,437 | ||||||||||||||||||||||||
Stock subscription notes repaid |
90 | 90 | |||||||||||||||||||||||
Treasury stock reissued |
| | | 137 | | | 137 | ||||||||||||||||||
COMMON STOCK |
ADDITIONAL PAID-IN CAPITAL |
RETAINED EARNINGS |
TREASURY STOCK |
STOCK SUBSCRIPTION NOTES |
ACCUMULATED COMPREHENSIVE INCOME (LOSS) |
TOTAL STOCKHOLDERS EQUITY |
|||||||||||||||||||||
BALANCE AT JUNE 30, 2005 |
$ | 1 | $ | 37,127 | $ | 259,553 | $ | (97,517 | ) | $ | (2,928 | ) | $ | 950 | $ | 197,186 | |||||||||||
BALANCE AT JANUARY 1, 2004 |
$ | 1 | $ | 37,281 | $ | 264,063 | $ | (98,006 | ) | $ | (3,312 | ) | $ | 4,161 | $ | 204,188 | |||||||||||
Net loss |
| | (1,489 | ) | | | | (1,489 | ) | ||||||||||||||||||
Unrealized losses on securities, net of applicable income taxes of $4,647 |
| | | | | (8,625 | ) | (8,625 | ) | ||||||||||||||||||
Change in minimum pension liability, net of applicable income taxes of ($105) |
| | | | | (195 | ) | (195 | ) | ||||||||||||||||||
Unrealized foreign currency gain |
| | | | | 120 | 120 | ||||||||||||||||||||
Comprehensive income |
| (10,189 | ) | ||||||||||||||||||||||||
Treasury stock reissued |
| (531 | ) | | 772 | (192 | ) | | 49 | ||||||||||||||||||
Stock subscription notes repaid |
| | | | 10 | | 10 | ||||||||||||||||||||
BALANCE AT JUNE 30, 2004 |
$ | 1 | $ | 36,750 | $ | 262,574 | $ | (97,234 | ) | $ | (3,494 | ) | $ | (4,539 | ) | $ | 194,058 | ||||||||||
See accompanying notes to Consolidated Financial Statements.
3
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, |
||||||||
2005 |
2004 |
|||||||
OPERATING ACTIVITIES |
||||||||
Net income (loss) |
$ | 3,376 | $ | (1,489 | ) | |||
Adjustments to reconcile net income to net cash used in operating activities: |
||||||||
Provisions for amortization and depreciation |
2,543 | 3,788 | ||||||
Provision for deferred federal income taxes |
1,863 | (815 | ) | |||||
Realized investment gains |
(6 | ) | (1,715 | ) | ||||
Changes in operating assets and liabilities: |
||||||||
Deferred acquisition costs |
(337 | ) | (1,533 | ) | ||||
Accrued investment income |
161 | 992 | ||||||
Unearned premiums |
29,648 | 24,575 | ||||||
Loss and loss adjustment expense reserves |
(86,733 | ) | (17,860 | ) | ||||
Reinsurance recoverable |
59,358 | (29,348 | ) | |||||
Amounts held for reinsurance |
(50,188 | ) | 12,599 | |||||
Other liabilities |
(7,297 | ) | (8,763 | ) | ||||
Premium receivable |
12,180 | (25,445 | ) | |||||
Other assets |
555 | 1,275 | ||||||
Net cash used in operating activities |
(34,877 | ) | (43,739 | ) | ||||
INVESTING ACTIVITIES |
||||||||
Purchasesfixed maturities |
(45,295 | ) | (171,844 | ) | ||||
Salesfixed maturities |
59,851 | 217,225 | ||||||
Maturitiesfixed maturities |
8,899 | 7,391 | ||||||
Short-term purchases and sales net |
| (195 | ) | |||||
Salesequities |
| 3,764 | ||||||
Net cash provided by investing activities |
23,455 | 56,341 | ||||||
FINANCING ACTIVITIES |
||||||||
Reissuance of treasury shares |
137 | 241 | ||||||
Repayment of stock subscriptions |
90 | (182 | ) | |||||
Net cash provided by financing activities |
227 | 59 | ||||||
Increase (decrease) in cash and cash equivalents |
(11,195 | ) | 12,661 | |||||
Cash and cash equivalents at beginning of period |
94,390 | 62,095 | ||||||
Cash and cash equivalents at end of period |
$ | 83,195 | $ | 74,756 | ||||
See accompanying notes to Consolidated Financial Statements.
4
SCPIE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 2005
1. | BASIS OF PRESENTATION |
The accompanying unaudited consolidated financial statements include the accounts and operations, after intercompany eliminations, of SCPIE Holdings Inc. (SCPIE Holdings) and its direct and indirect wholly-owned subsidiaries, principally SCPIE Indemnity Company (SCPIE Indemnity), American Healthcare Indemnity Company (AHI), American Healthcare Specialty Insurance Company (AHSIC), SCPIE Underwriting Limited (SUL) and SCPIE Management Company (SMC), collectively, the Company.
These financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with instructions to Form 10-Q and Article 7 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP 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 six-month period ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the consolidated financial statements and notes thereto included in the SCPIE Holdings Annual Report on Form 10-K for the year ended December 31, 2004.
Certain 2004 amounts have been reclassified to conform to the 2005 presentation.
2. | NEW ACCOUNTING STANDARD |
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123R, Share-Based Payment (SFAS No. 123R) that will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity instrument issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, the principles that the Company currently employs to account and report its employee stock option awards. SFAS No. 123R is effective for the first interim reporting period that begins after June 15, 2005. The Company will implement this standard in the third quarter of 2005. The Company cannot estimate the impact of implementing this standard on future net income, but the standard would have decreased recent net income by approximately $0.03 - $0.09 per diluted share.
3. | EARNINGS PER SHARE |
The following table sets forth the computation of basic and diluted earnings per share:
SIX MONTHS ENDED JUNE 30, |
THREE MONTHS ENDED JUNE 30, |
|||||||||||||
2005 |
2004 |
2005 |
2004 |
|||||||||||
(IN THOUSANDS, EXCEPT PER SHARE DATA) |
||||||||||||||
Net income (loss) |
$ | 3,376 | $ | (1,489 | ) | $ | 1,705 | $ | (2,316 | ) | ||||
Numerator for: |
||||||||||||||
Basic earnings (loss) per share of common stock |
3,376 | (1,489 | ) | 1,705 | (2,316 | ) | ||||||||
Diluted earnings (loss) per share of common stock |
3,376 | (1,489 | ) | 1,705 | (2,316 | ) | ||||||||
Denominator |
||||||||||||||
Denominator for basic earnings per share of common stock weighted-average shares outstanding |
9,417 | 9,395 | 9,429 | 9,411 | ||||||||||
Effect of dilutive securities: |
||||||||||||||
Stock options |
163 | | 163 | | ||||||||||
Denominator for diluted earnings per share of common stock adjusted weighted-average shares outstanding |
9,580 | 9,395 | 9,592 | 9,411 | ||||||||||
Basic earnings (loss) per share of common stock |
$ | 0.36 | $ | (0.16 | ) | $ | 0.18 | $ | (0.25 | ) | ||||
Diluted earnings (loss) per share of common stock |
$ | 0.35 | $ | (0.16 | ) | $ | 0.18 | $ | (0.25 | ) |
5
4. | INVESTMENTS |
The Companys investments in available-for-sale securities at June 30, 2005 are summarized as follows:
COST OR AMORTIZED COST |
GROSS UNREALIZED GAINS |
GROSS UNREALIZED LOSSES |
FAIR VALUE | |||||||||
(IN THOUSANDS) | ||||||||||||
Fixed-maturity securities: |
||||||||||||
Bonds: |
||||||||||||
U.S. government and agencies |
$ | 131,530 | $ | 1,786 | $ | 878 | $ | 132,438 | ||||
Mortgage-backed and asset-backed |
83,810 | 245 | 1,678 | 82,377 | ||||||||
Corporate |
212,805 | 1,474 | 1,832 | 212,447 | ||||||||
Total fixed-maturity securities |
428,145 | 3,505 | 4,388 | 427,262 | ||||||||
Common stocks |
12,028 | 4,312 | | 16,340 | ||||||||
Total |
$ | 440,173 | $ | 7,817 | $ | 4,388 | $ | 443,602 | ||||
The following table illustrates the gross unrealized losses included in the Companys investment portfolio and the fair value of those securities, aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position as of June 30, 2005.
LESS THAN 12 MONTHS |
12 MONTHS OR MORE |
TOTAL | ||||||||||||||||
GROSS UNREALIZED LOSSES |
FAIR VALUE |
GROSS UNREALIZED LOSSES |
FAIR VALUE |
GROSS UNREALIZED LOSSES |
FAIR VALUE | |||||||||||||
(IN THOUSANDS) | ||||||||||||||||||
Fixed-maturity securities: |
||||||||||||||||||
Bonds: |
||||||||||||||||||
U.S. government and agencies |
$ | 533 | $ | 56,267 | $ | 346 | $ | 14,035 | $ | 878 | $ | 70,302 | ||||||
Mortgage-backed and asset-backed |
152 | 9,151 | 1,526 | 64,086 | 1,678 | 73,237 | ||||||||||||
Corporate |
329 | 63,677 | 1,504 | 63,322 | 1,832 | 126,999 | ||||||||||||
Total fixed-maturity securities |
1,014 | 129,095 | 3,376 | 141,443 | 4,388 | 270,538 | ||||||||||||
Total common stock |
| | | | | | ||||||||||||
Total |
$ | 1,014 | $ | 129,095 | $ | 3,376 | $ | 141,443 | $ | 4,388 | $ | 270,538 | ||||||
The Company held 174 investment positions with unrealized losses as of June 30, 2005. All of the investments are investment grade and the unrealized losses are primarily due to interest rate fluctuations. The Company held 64 securities that were in an unrealized loss position for 12 months or more.
The Company has the ability and intent to hold securities with unrealized losses until they recover their value. In the future, information may come to light or circumstances may change that would cause the Company to write-down or sell these securities and incur a realized loss. As of June 30, 2005, the Company held $83,195 in cash and cash equivalents.
6
5. | FEDERAL INCOME TAXES |
A reconciliation of income tax expense (benefit) computed at the federal statutory tax rate to total income tax expense is summarized as follows:
SIX MONTHS ENDED JUNE 30, |
THREE MONTHS ENDED JUNE 30, |
|||||||||||||
2005 |
2004 |
2005 |
2004 |
|||||||||||
(IN THOUSANDS) | (IN THOUSANDS) | |||||||||||||
Federal income tax expense (benefit) at 35% |
$ | 1,834 | $ | (806 | ) | $ | 922 | $ | (1,261 | ) | ||||
Increase in taxes resulting from: |
||||||||||||||
Foreign and miscellaneous |
29 | (9 | ) | 5 | (27 | ) | ||||||||
Total income tax expense (benefit) |
$ | 1,863 | $ | (815 | ) | $ | 927 | $ | (1,288 | ) | ||||
6. | COMPREHENSIVE INCOME (LOSS) |
The following table reconciles net loss and comprehensive income (loss) for the periods presented:
SIX MONTHS ENDED JUNE 30, |
THREE MONTHS ENDED JUNE 30, |
|||||||||||||||
2005 |
2004 |
2005 |
2004 |
|||||||||||||
(IN THOUSANDS) | ||||||||||||||||
Net income (loss) |
$ | 3,376 | $ | (1,489 | ) | $ | 1,705 | $ | (2,316 | ) | ||||||
Other comprehensive income (loss) before tax: |
||||||||||||||||
Unrealized gains (losses) on securities |
(1,191 | ) | (13,272 | ) | 6,446 | (20,090 | ) | |||||||||
Unrealized foreign currency gains (losses) |
(28 | ) | 120 | 17 | 47 | |||||||||||
Change in minimum pension liability |
(210 | ) | (300 | ) | (105 | ) | (150 | ) | ||||||||
Other comprehensive income (loss) before tax |
1,947 | (14,941 | ) | 8,063 | (22,509 | ) | ||||||||||
Income tax expense (benefit) related to securities |
(417 | ) | (4,647 | ) | 2,255 | (7,032 | ) | |||||||||
Income tax benefit related to pension liability |
(73 | ) | (105 | ) | (36 | ) | (53 | ) | ||||||||
Comprehensive income (loss) |
$ | 2,437 | $ | (10,189 | ) | $ | 5,844 | $ | (15,424 | ) | ||||||
7. | BUSINESS SEGMENTS |
The Company classifies its business into two segments: Direct Healthcare Liability Insurance and Assumed Reinsurance. Segments are designated based on the types of products provided and based on the risks associated with the products. Direct healthcare liability insurance represents professional liability insurance for physicians, oral and maxillofacial surgeons and dentists, healthcare facilities and other healthcare providers. Assumed reinsurance represents the book of assumed worldwide reinsurance of professional, commercial and personal liability coverages, commercial and residential property risks and accident and health, workers compensation and marine coverages. Other includes items not directly related to the operating segments such as net investment income, realized investment gains and losses, and other revenue. In December 2002, the Company entered into a 100% quota share reinsurance agreement with Rosemont Reinsurance Ltd. (Rosemont Re) (formerly known as GoshawK Re), a subsidiary of GoshawK Insurance Holdings plc, a publicly held London-based insurer and reinsurer, that divested substantially all of the Companys ongoing assumed reinsurance operations. The Company has one ongoing assumed reinsurance treaty for the 2003 underwriting year.
7
The following tables present information about reportable segment income (loss) and segment assets as of and for the periods indicated (dollars in thousands):
SIX MONTHS ENDED JUNE 30, 2005 |
DIRECT HEALTHCARE LIABILITY |
ASSUMED REINSURANCE |
OTHER |
TOTAL |
|||||||||||
Premiums written |
$ | 95,534 | $ | (849 | ) | $ | 94,685 | ||||||||
Premiums earned |
$ | 64,627 | $ | 410 | $ | 65,037 | |||||||||
Net investment income |
| | $ | 8,799 | 8,799 | ||||||||||
Realized investment gains |
| | 6 | 6 | |||||||||||
Other revenue |
| | 174 | 174 | |||||||||||
Total revenues |
64,627 | 410 | 8,979 | 74,016 | |||||||||||
Losses and loss adjustment expenses |
48,754 | 4,304 | | 53,058 | |||||||||||
Other operating expenses |
14,107 | 1,612 | | 15,719 | |||||||||||
Total expenses |
62,861 | 5,916 | | 68,777 | |||||||||||
Segment income (loss) before income taxes |
$ | 1,766 | $ | (5,506 | ) | $ | 8,979 | $ | 5,239 | ||||||
Segment assets |
$ | 54,319 | $ | 213,603 | $ | 599,807 | $ | 867,729 | |||||||
SIX MONTHS ENDED JUNE 30, 2004 |
DIRECT HEALTHCARE LIABILITY |
ASSUMED REINSURANCE |
OTHER |
TOTAL |
|||||||||||
Premiums written |
$ | 95,493 | $ | (3,278 | ) | $ | 92,215 | ||||||||
Premiums earned |
$ | 61,934 | $ | 5,707 | $ | 67,641 | |||||||||
Net investment income |
| | $ | 10,550 | 10,550 | ||||||||||
Realized investment gains |
| | 1,715 | 1,715 | |||||||||||
Other revenue |
| | 365 | 365 | |||||||||||
Total revenues |
61,934 | 5,707 | 12,630 | 80,271 | |||||||||||
Losses and loss adjustment expenses |
55,833 | 9,936 | | 65,769 | |||||||||||
Other operating expenses |
12,671 | 4,135 | | 16,806 | |||||||||||
Total expenses |
68,504 | 14,071 | | 82,575 | |||||||||||
Segment income (loss) before income taxes |
$ | (6,570 | ) | $ | (8,364 | ) | $ | 12,630 | $ | (2,304 | ) | ||||
Segment assets |
$ | 62,852 | $ | 274,831 | $ | 653,988 | $ | 991,671 |
8
THREE MONTHS ENDED JUNE 30, 2005 |
DIRECT HEALTHCARE LIABILITY |
ASSUMED REINSURANCE |
OTHER |
TOTAL |
||||||||||||
Premiums written |
$ | 4,040 | $ | (291 | ) | $ | 3,749 | |||||||||
Premiums earned |
$ | 32,431 | $ | 20 | $ | 32,451 | ||||||||||
Net investment income |
| | $ | 4,132 | 4,132 | |||||||||||
Realized investment gains |
| | (10 | ) | (10 | ) | ||||||||||
Other revenue |
| | 60 | 60 | ||||||||||||
Total revenues |
32,431 | 20 | 4,182 | 36,633 | ||||||||||||
Losses and loss adjustment expenses |
24,112 | 3,035 | | 27,147 | ||||||||||||
Other operating expenses |
6,736 | 118 | | 6,854 | ||||||||||||
Total expenses |
30,848 | 3,153 | | 34,001 | ||||||||||||
Segment income (loss) before income taxes |
$ | 1,583 | $ | (3,133 | ) | $ | 4,182 | $ | 2,632 | |||||||
Segment assets |
$ | 54,319 | $ | 213,603 | $ | 599,807 | $ | 867,729 | ||||||||
THREE MONTHS ENDED JUNE 30, 2004 |
DIRECT HEALTHCARE LIABILITY |
ASSUMED REINSURANCE |
OTHER |
TOTAL |
||||||||||||
Premiums written |
$ | 2,753 | $ | 7 | $ | 2,760 | ||||||||||
Premiums earned |
$ | 29,986 | $ | 1,242 | $ | 31,228 | ||||||||||
Net investment income |
| | $ | 5,118 | 5,118 | |||||||||||
Realized investment gains |
| | (631 | ) | (631 | ) | ||||||||||
Other revenue |
| | 85 | 85 | ||||||||||||
Total revenues |
29,986 | 1,242 | 4,572 | 35,800 | ||||||||||||
Losses and loss adjustment expenses |
25,224 | 7,604 | | 32,828 | ||||||||||||
Other operating expenses |
6,272 | 304 | | 6,576 | ||||||||||||
Total expenses |
31,496 | 7,908 | | 39,404 | ||||||||||||
Segment income (loss) before income taxes |
$ | (1,510 | ) | $ | (6,666 | ) | $ | 4,572 | $ | (3,604 | ) | |||||
Segment assets |
$ | 62,852 | $ | 274,831 | $ | 653,988 | $ | 991,671 |
Premiums written represents the premiums charged on policies issued during a fiscal period. Premiums earned represents the portion of premiums written that is recognized as income in the financial statements for the periods presented and earned on a pro-rata basis over the term of the policies.
9
8. | COMMITMENTS AND CONTINGENCIES |
The Company is named as a defendant in various legal actions primarily arising from claims made under insurance policies and contracts. These actions are considered by the Company in estimating the loss and loss adjustment expense reserves. The Companys management believes that the resolution of these actions will not have a material adverse effect on the Companys financial position or results of operations.
Highlands Insurance Group
Between January 1, 2000, and April 30, 2001, the Company issued endorsements to certain policyholders of the insurance company subsidiaries of Highlands Insurance Group, Inc. (HIG). Under these endorsements, the Company agreed to assume the policy obligations of the HIG insurance company subsidiaries, if the subsidiaries became unable to pay their obligations by reason of having been declared insolvent by a court of competent jurisdiction. The coverages included property, workers compensation, commercial automobile, general liability and umbrella. The gross premiums written by the HIG subsidiaries were approximately $88.0 million for the subject policies. In February 2002, the Texas Department of Insurance placed the principal HIG insurance company subsidiaries under its supervision while HIG voluntarily liquidated their claim liabilities.
During 2002 and 2003, all of the HIG insurance company subsidiaries (with the exception of a California subsidiary) were merged into a single Texas domiciled subsidiary, Highlands Insurance Company (Highlands). Highlands has advised the Company that the HIG insurance company subsidiaries have paid losses and loss adjustment expense (LAE) under the subject policies of more than $67 million and that at June 30, 2005 had established case loss reserves of $10 million, net of reinsurance. Based on a limited review of the exposures remaining, the Company estimates that incurred but not reported losses are $5 million, for a total loss and LAE reserve of $15 million. This estimate is not based on a full reserve analysis of the exposures. To the extent Highlands is declared insolvent at some future date by a court of competent jurisdiction and is unable to pay losses under the subject policies, the Company would be responsible to pay the amount of the losses incurred and unpaid at such date and would be subrogated to the rights of the policyholders as creditors of Highlands. The Company may also be entitled to indemnification of a portion of this loss from certain of Highlands reinsurers.
On November 6, 2003, the State of Texas obtained an order in the Texas District Court appointing the Texas Insurance Commissioner as the permanent Receiver of Highlands and placing the Receiver in possession of all assets of Highlands. The order expressly provided that it did not constitute a finding of Highlands insolvency nor an authorization to liquidate Highlands. The Receiver continues to resolve Highlands claim liabilities and otherwise conduct its business, as part of his efforts to rehabilitate Highlands. If an order of liquidation is ultimately entered and becomes final, the Company would likely be required to assume Highlands then remaining obligations under the subject policies.
Letters of Credit
The Company has a letter of credit facility in the amount of $50 million with Barclays Bank PLC. Letters of credit issued under the facility fulfill the collateral requirements of Lloyds and guarantee loss reserves under certain other reinsurance contracts. As of June 30, 2005, letter of credit issuance under the facility was approximately $44.5 million. Securities of $49 million are pledged as collateral under the facility.
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9. | STOCK-BASED COMPENSATION |
The following table illustrates the effect on net income and earnings per share if the Company applied the fair value recognition provision as defined in Financial Accounting Standards Board Statement (FASB) No. 123, Accounting of Stock-Based Compensation:
SIX MONTHS ENDED JUNE 30, |
THREE MONTHS ENDED JUNE 30, |
|||||||||||||||
2005 |
2004 |
2005 |
2004 |
|||||||||||||
(IN THOUSANDS, EXCEPT PER SHARE DATA) | ||||||||||||||||
Net income (loss) as reported |
$ | 3,376 | $ | (1,489 | ) | $ | 1,705 | $ | (2,316 | ) | ||||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards net of related tax effects |
(228 | ) | (340 | ) | (112 | ) | (198 | ) | ||||||||
Pro forma net income |
$ | 3,148 | $ | (1,829 | ) | $ | 1,593 | $ | (2,514 | ) | ||||||
Earnings per share: |
||||||||||||||||
Basic as reported |
$ | 0.36 | $ | (0.16 | ) | $ | 0.18 | $ | (0.25 | ) | ||||||
Basic pro forma |
$ | 0.33 | $ | (0.20 | ) | $ | 0.17 | $ | (0.27 | ) | ||||||
Diluted as reported |
$ | 0.35 | $ | (0.16 | ) | $ | 0.18 | $ | (0.25 | ) | ||||||
Diluted pro forma |
$ | 0.33 | $ | (0.20 | ) | $ | 0.17 | $ | (0.27 | ) |
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 ranging from 2.79% to 3.46%; dividend yields ranging from 0.66% to 1.14%; volatility factors of the expected market price of the Companys common stock of .2287 and a weighted average expected life of the options ranging from three to ten years.
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
SCPIE Holdings is a holding company owning subsidiaries engaged in providing insurance and reinsurance products. The Company is primarily a provider of medical malpractice insurance and related liability insurance products to physicians, healthcare facilities and others engaged in the healthcare industry in California and Delaware, its core healthcare liability markets. Previously, the Company had also been actively engaged in the medical malpractice insurance business and related products in other states and the assumed reinsurance business. During 2002 and 2003, the Company largely completed its withdrawal from the assumed reinsurance market and medical malpractice insurance outside of California and Delaware.
The Companys insurance business is organized into two reportable business segments: direct healthcare liability insurance and assumed reinsurance operations. Primarily due to significant losses on medical malpractice insurance outside of the state of California and assumed reinsurance business losses arising out of the September 11, 2001, World Trade Center terrorist attack, the Company incurred significant losses. The resulting reductions in surplus and corresponding decrease in capital adequacy ratios under both the A.M. Best Company (A.M. Best) and National Association of Insurance Commissioners (NAIC) capital adequacy models required the Company to take actions to improve its long-term capital adequacy position. The primary actions taken by the Company were to effect an orderly withdrawal from healthcare liability insurance markets outside of California and Delaware and from the assumed reinsurance market in its entirety. All of the healthcare liability insurance policies in these other markets expired during the first quarter of 2004. In December 2002, the Company entered into a 100% quota share reinsurance agreement to retrocede to another insurer the majority of reinsurance business written in 2002 and 2001. During 2003, the Company participated in only one ongoing reinsurance syndicate. The Company continues to settle and pay claims incurred in the non-core healthcare and assumed reinsurance operations.
The actions taken by the Company have reduced significantly capital requirements related to premium writing to surplus ratios in both the A.M. Best and NAIC capital adequacy models. The capital requirements required by the reserve to surplus ratio continue to decline as the Company settles the claims in its non-core businesses.
11
Critical Accounting Policies
The Companys discussion and analysis of its financial condition and results of operations are based upon the Companys consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). Preparation of financial statements in accordance with GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related notes. Management believes that the following critical accounting policies, among others, affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Premium Revenue Recognition
Direct healthcare liability insurance premiums written are earned on a daily pro rata basis over the terms of the policies. Accordingly, unearned premiums represent the portion of premiums written which is applicable to the unexpired portion of the policies in force. Reinsurance premiums assumed are estimated based on information provided by ceding companies. The information used in establishing these estimates is reviewed and subsequent adjustments are recorded in the period in which they are determined. These premiums are earned over the terms of the related reinsurance contracts.
Loss and Loss Adjustment Expense Reserves
Unpaid losses and loss adjustment expenses are comprised of case reserves for known claims, incurred but not reported reserves for unknown claims and any potential development for known claims, and reserves for the cost of administration and settlement of both known and unknown claims. Such liabilities are established based on known facts and interpretation of circumstances, including the Companys experience with similar cases and historical trends involving claim payment patterns, loss payments and pending levels of unpaid claims, as well as court decisions and economic conditions. The effects of inflation are considered in the reserving process. Establishing appropriate reserves is an inherently uncertain process; the ultimate liability may be in excess of or less than the amount provided. Any increase in the amount of reserves, including reserves for insured events of prior years, could have an adverse effect on the Companys results for the period in which the adjustments are made. The Company utilizes both its internal actuarial staff and independent consulting actuaries in establishing its reserves. The Company does not discount its loss and loss adjustment expense reserves.
The Company had a growing volume of assumed reinsurance business between 1999 and 2002. Assumed reinsurance is a line of business with inherent volatility. Ultimate loss experience for the assumed reinsurance operation is based primarily on reports received by the Company from the underlying ceding insurers. Many losses take several years to be reported through the system. The Company relies heavily on the ceding entitys estimates of ultimate incurred losses, especially those of Lloyds syndicates. Ceding entities, representing over 65% of the reinsurance assumed business for the 1999 to 2003 underwriting years (based on gross written premiums), submit reports to the Company containing ultimate incurred loss estimates reviewed by independent or internal actuaries of the ceding entities. These reported ultimate incurred losses are the primary basis for the Companys reserving estimates. In other cases, the Company relies on its own internal estimates determined primarily by experience to date, individual knowledge of the specific reinsurance contract, industry experience and other actuarial techniques to determine reserve requirements.
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Because the reserve establishment process is by definition an estimate, actual results will vary from amounts established in earlier periods. The Company recognizes such differences in the periods they are determined. Since reserves accumulate on the balance sheet over several years until all claims are settled, a determination of inadequacy or redundancy could easily have a significant impact on earnings and therefore stockholders equity. The Company has established net reserves of $447.8 million as of June 30, 2005, after considering both prospective and retrospective reinsurance. The net reserves attributable to the operating segments of the Company are as follows:
Summary of Net Loss and LAE Reserves
By Segment
JUNE 30, 2005 |
DECEMBER 31, 2004 | |||||
(IN MILLIONS) | ||||||
Direct Healthcare Liability Insurance |
||||||
Core |
$ | 257.8 | $ | 257.2 | ||
Non-Core |
75.2 | 97.4 | ||||
Assumed Reinsurance Segment |
114.8 | 87.8 | ||||
Total net loss and LAE reserves |
447.8 | 442.4 | ||||
Ceded loss reserves |
91.8 | 183.6 | ||||
Retrospective reserves |
12.4 | 12.7 | ||||
Loss and LAE reserves |
$ | 552.0 | $ | 638.7 | ||
The increase in the assumed reinsurance segment net reserves at June 30, 2005 was attributable to the closing of the 2002 underwriting year of one Lloyds syndicate into the 2003 underwriting year of that same syndicate. The Company is the principal participant in the 2003 underwriting year for this syndicate. As part of the closing, the Company assumed additional reserve liabilities and received assets in the same amount. This had the effect of increasing loss and LAE reserves, but had no effect on net income, retained earnings or statutory surplus of the Company. This type of transaction, called reinsurance to close, is a normal event in the Lloyds market. The net reserves-to-statutory surplus ratio of the Company improved to 3.09 to 1 at June 30, 2005 from 3.3 to 1 at December 31, 2004. The standard generally followed in the industry is 3.0 to 1. See Risk FactorsNecessary Capital and Surplus in the SCPIE Holdings Annual Report on Form 10-K for the year ended December 31, 2004.
A 1% difference in the ultimate value of reserves, net of reinsurance recoverable, would decrease or increase future pretax earnings by $4.5 million.
Deferred Policy Acquisition Costs
Deferred policy acquisition costs include commissions, premium taxes and other variable costs incurred in connection with writing business. Deferred policy acquisition costs are reviewed to determine if they are recoverable from future income, including investment income. If such costs are estimated to be unrecoverable, they are expensed. Recoverability is analyzed based on the Companys assumptions related to the underlying policies written, including the lives of the underlying policies, future investment income, and level of expenses necessary to maintain the policies over their entire lives. Deferred policy acquisition costs are amortized over the period in which the related premiums are earned.
Investments
The Company considers its fixed maturity and equity securities as available-for-sale securities. Available-for-sale securities are sold in response to a number of issues, including the Companys liquidity needs, the Companys statutory surplus requirements and tax management strategies, among others. Available-for-sale securities are recorded at fair value. The related unrealized gains and losses, net of income tax effects, are excluded from net income and reported as a component of stockholders equity.
The Company evaluates the securities in its available-for-sale investment portfolio on at least a quarterly basis for declines in market value below cost for the purpose of determining whether these declines represent other than temporary declines. Some of the factors the Company considers in the evaluation of its investments are:
| the extent to which the market value of the security is less than its cost basis; |
| the length of time for which the market value of the security has been less than its cost basis; |
13
| the financial condition and near-term prospects of the securitys issuer, taking into consideration the economic prospects of the issuers industry and geographical region, to the extent that information is publicly available; and |
| the Companys ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. |
A decline in the fair value of an available-for-sale security below cost that is judged to be other than temporary is realized as a loss in the current period and reduces the cost basis of the security.
Income taxes
At June 30, 2005, the Company had $47.1 million of net deferred income tax assets. Net deferred income tax assets consist of the net temporary differences created as a result of amounts deductible or revenue recognized in periods different for tax return purposes than for accounting purposes. These deferred income tax assets include an asset of $19.5 million for a net operating loss carryforward that will expire in 2021. A net operating loss carryforward is a tax loss that may be carried forward into future years. It reduces taxable income in future years and the tax liability that would otherwise be incurred.
The Company believes it is more likely than not that the deferred income tax assets will be realized through its future earnings. As a result, the Company has not recorded a valuation allowance. The Companys core operations have historically been profitable on both a GAAP and tax basis. The losses incurred in 2001 to 2004 have been primarily caused by losses in the non-core healthcare and assumed reinsurance businesses. Since the core healthcare liability operation has improved over the past years and the non-core healthcare liability and assumed operations are now in run-off, the Company believes it should return to a position of taxable income, thus enabling it to utilize the net operating loss carryforward.
The Companys estimate of future taxable income uses the same assumptions and projections as in its internal financial projections. These projections are subject to uncertainties primarily related to future underwriting results. If the Companys results are not as profitable as expected, the Company may be required in future periods to record a valuation allowance for all or a portion of the deferred income tax assets. Any valuation allowance would reduce the Companys earnings.
Statutory Accounting Matter
State insurance laws and regulations prescribe accounting practices for determining statutory net income and equity for insurance companies. In addition, state regulators may permit statutory accounting practices that differ from prescribed practices. On June 21, 2005, the California Department of Insurance (CDI) issued a report of examination of SCPIE Indemnity, a wholly-owned insurance company subsidiary of SCPIE Holdings, as of December 31, 2003. In the report, the CDI recommended that certain investments of SCPIE Indemnity be treated as non-admitted assets for purposes of the statutory accounting statements filed with the CDI as of the date of the examination and subsequently. The investments at issue were pledged as security for the letter of credit used to support the Lloyds capital requirement of SCPIE Underwriting Limited (SUL), another wholly-owned subsidiary of SCPIE Holdings. SULs Lloyds business is 100% reinsured by SCPIE Indemnity. At the request of the CDI, the pledged assets have since been transferred to SUL in exchange for SULs issuance of a promissory note to SCPIE Indemnity in the principal amount of the value of the pledged assets, and SCPIE Holdings has contributed 100% of the stock of SUL to SCPIE Indemnity. On May 11, 2005, the CDI issued a permitted practice letter to SCPIE Indemnity, which restored the admitted asset status of the pledged securities. The effect of treating the pledged assets as non-admitted as of December 31, 2003 and 2004 would have been to reduce statutory surplus of SCPIE Indemnity by $30.3 million as of those dates to $110.0 million and $106.2 million, respectively, and the effect of the contribution and permitted practice restored the statutory surplus of SCPIE Indemnity by approximately $32.0 million as of June 30, 2005. Statutory surplus at June 30, 2005 was $144.7 million.
The foregoing treatment of the pledged assets as non-admitted and the restoration of these assets to admitted status have no effect on the consolidated financial statements of the Company under GAAP, except that SCPIE Indemnitys ability to pay dividends to SCPIE Holdings, during 2005, without special approval of the CDI, is reduced by approximately $3 million. No dividends have been paid in 2005, and the maximum amount that could be paid, as revised, is approximately $10.6 million. See Note 5 of Notes to Consolidated Financial Statements in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2004. As of June 30, 2005, SCPIE Holdings held $3.4 million of cash and cash equivalents. SCPIE Indemnity has no present plans of paying dividends to SCPIE Holdings during 2005.
14
Forward Looking Statements
Certain statements in this report on Form 10-Q that are not historical in fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors based on the Companys estimates and expectations concerning future events that may cause the actual results of the Company to be materially different from historical results or from any results expressed or implied by such forward-looking statements. Actuarial estimates of losses and LAE, expectations concerning the Companys ability to retain current insureds at profitable levels, successful withdrawal from the assumed reinsurance business, obtaining necessary rate change regulatory approvals, expansion of liability insurance business in its principal market and improved performance and profitability are dependent upon a variety of factors, including future economic, competitive and market conditions, frequency and severity of catastrophic events, future legislative and regulatory actions, uncertainties and potential delays in obtaining premium rate approvals, the level of ratings from recognized rating services, the inherent uncertainty of loss and LAE estimates in both the core and discontinued non-core businesses (including a contingent liability related to Highlands Insurance Company), and the cyclical nature of the property and casualty insurance industry, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. The Company is also subject to certain structural risks as an insurance holding company, including statutory restrictions on dividends and other intercompany transactions. In light of the significant uncertainties inherent in the forward-looking information herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the Companys objectives or plans will be realized. These risks and uncertainties, as well as the Companys critical accounting policies, are discussed in more detail under Business Risk Factors, Managements Discussion and Analysis Overview, and Managements Discussion and Analysis Critical Accounting Policies in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2004.
Information Regarding Non-GAAP Measures
The Company has presented information in this report with respect to premiums written, an operating measure which in managements opinion provides investors useful industry specific information to evaluate and perform meaningful comparisons of the Companys performance. Premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period less any reinsurance. Premiums written is a statutory measure of production levels. Premiums earned, a comparable GAAP measure, represents the portion of premiums written that is recognized as income in the financial statements for the periods presented and earned on a pro-rata basis over the term of the policies.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
Direct Healthcare Liability Insurance Segment
The Company underwrites professional and related liability policy coverages for physicians (including oral and maxillofacial surgeons), physician medical groups and clinics, hospitals, dentists, managed care organizations and other providers in the healthcare industry. As a result of the Companys withdrawal from certain segments of the healthcare industry, the premiums earned are allocated between core and non-core premium. Core premium represents California and Delaware business excluding dentist and hospital business. Non-core business represents business related to physician and dental programs formerly conducted for the Company primarily in states outside California and Delaware by a national independent insurance agency, other state non-standard physician programs and hospital programs including those in California.
15
The following table summarizes by core and non-core businesses the underwriting results of the direct healthcare liability insurance segment for the periods indicated (dollars in thousands):
Direct Healthcare Liability Insurance Segment
Underwriting Results
CORE |
NON-CORE* |
TOTAL* |
||||||||||
SIX MONTHS ENDED JUNE 30, 2005 |
||||||||||||
Premiums written |
$ | 95,376 | $ | 158 | $ | 95,534 | ||||||
Premiums earned |
$ | 64,457 | $ | 170 | $ | 64,627 | ||||||
Losses and LAE incurred |
48,762 | (8 | ) | 48,754 | ||||||||
Underwriting expenses |
14,030 | 77 | 14,107 | |||||||||
Underwriting gain |
$ | 1,665 | $ | 101 | $ | 1,766 | ||||||
Loss ratio |
75.6 | % | ||||||||||
Expense ratio |
21.8 | % | ||||||||||
Combined ratio |
97.4 | % | ||||||||||
SIX MONTHS ENDED JUNE 30, 2004 |
||||||||||||
Premiums written |
$ | 96,189 | $ | (696 | ) | $ | 95,493 | |||||
Premiums earned |
$ | 62,542 | $ | (608 | ) | $ | 61,934 | |||||
Losses and LAE incurred |
52,063 | 3,770 | 55,833 | |||||||||
Underwriting expenses |
12,571 | 100 | 12,671 | |||||||||
Underwriting loss |
$ | (2,092 | ) | $ | (4,478 | ) | $ | (6,570 | ) | |||
Loss ratio |
83.2 | % | ||||||||||
Expense ratio |
20.1 | % | ||||||||||
Combined ratio |
103.3 | % |
* | The ratios for the segment total and non-core business are not meaningful due to the run-off status of non-core business. |
Core Business
Premiums written were $95.4 million and premiums earned were $64.5 million in the six months ended June 30, 2005; compared to $96.2 million and $62.5 million in the six months ended June 30, 2004. Premiums earned increased primarily due to the effect on most policies of a 6.5% rate increase implemented on January 1, 2005, somewhat offset by a decline in policies in-force of 2.3%.
The loss ratio (losses and LAE related to premiums earned) for the six months ended June 30, 2005 was 75.6% compared to 83.2% in the six months ended June 30, 2004. The decrease in the loss ratio is due primarily to the 6.5% rate increase effective January 1, 2005, as well as lower loss estimates for 2005, principally due to a decline in claim frequency.
The underwriting expense ratio (expenses related to premiums earned) increased to 21.8% in the first six months ended June 30, 2005 from 20.1% in the first six months of 2004. The change is primarily attributable to an increase in nondeferrable general expenses. In addition, an increasing proportion of new business acquired has been through agents and brokers which increases commission expenses.
Non-Core Business
The premiums written and earned for the six months ended June 30, 2005 result primarily from extended reporting endorsements issued under expired policies. After March 6, 2003, no new or renewal business was written in the non-core programs, as the Company exited these markets.
16
The underwriting gain in the first six months ended June 30, 2005 was diminimus and reflects the fact that no significant changes in reserve levels were required during this period.
Assumed Reinsurance Segment
Assumed reinsurance represents the book of assumed worldwide reinsurance of professional, commercial and personal liability coverages, commercial and residential property risks and accident and health, workers compensation and marine coverages.
The following table summarizes the underwriting results of the assumed reinsurance segment for the periods indicated (dollars in thousands):
Assumed Reinsurance Segment Underwriting Results |
||||||||
FOR THE SIX MONTHS ENDED JUNE 30, |
2005 |
2004 |
||||||
Premiums written |
$ | (849 | ) | $ | (3,278 | ) | ||
Premiums earned |
$ | 410 | $ | 5,707 | ||||
Underwriting expenses |
||||||||
Losses |
4,304 | 9,936 | ||||||
Underwriting and other operating expenses |
1,612 | 4,135 | ||||||
Underwriting loss |
$ | (5,506 | ) | $ | (8,364 | ) | ||
The earned premium in 2005 and 2004 is primarily from the one ongoing assumed reinsurance program for the 2003 underwriting year.
The underwriting loss in the six months ended June 30, 2005 is primarily related to increased reserve estimates reported to the Company for a few contracts. Increased reserves related to contracts covering bail and immigration bonds, Lloyds syndicates and World Trade Center losses were reported to the Company during the quarter ended June 30, 2005.
The Rosemont Re reinsurance treaty entered into in December 2002 effectively cedes all of the unearned premium and future reported premium after June 30, 2002, for the assumed reinsurance business written for underwriting years 2001 and 2002 by the Company. This treaty relieves the Company of significant underwriting risk and written premium leverage and significantly improves the Companys risk-based capital adequacy ratios under both the A.M. Best and NAIC models. The treaty has no limitations on loss recoveries and includes a profit-sharing provision should the combined ratios calculated on the base premium ceded be below 100%. The treaty requires Rosemont Re to reimburse the Company for its acquisition and administrative expenses.
The Rosemont Re reinsurance treaty has both prospective and retroactive elements as defined in FASB No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. As such, any gains under the contract will be deferred and amortized to income based upon the expected recovery. No gains are anticipated currently. Losses related to future earned premium ceded, as well as development on losses related to existing earned premium ceded after June 30, 2002, will ultimately determine whether a gain will be recorded under the contract. The retroactive accounting treatment required under FASB 113 requires that a charge to income be recorded to the extent premiums ceded under the contract are in excess of the estimated losses and expenses ceded under the contract.
Other Operations
Net investment income decreased 16.6% to $8.8 million for the six months ended June 30, 2005 from $10.6 million in for the six months ended June 30, 2004. Investment income reflects an 8% reduction in average fixed maturity investments and a decrease in the average rate of return on invested assets from 3.4% to 3.2% for the six months ended June 30, 2004 and June 30, 2005, respectively. The decline in invested assets was as a result of the claim payments related to the run-off of the non-core healthcare liability and assumed reinsurance businesses.
17
Net realized investment gains of $6 thousand were recorded for the six months ended June 30, 2005 versus realized invested gains of $1.7 million in the six months ended June 30, 2004.
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004
Direct Healthcare Liability Insurance Segment
The following table summarizes by core and non-core businesses the underwriting results of the direct healthcare liability insurance segment for the periods indicated (dollars in thousands):
Direct Healthcare Liability Insurance Segment
Underwriting Results
CORE |
NON-CORE* |
TOTAL* |
||||||||||
THREE MONTHS ENDED JUNE 30, 2005 |
||||||||||||
Premiums written |
$ | 4,025 | $ | 15 | $ | 4,040 | ||||||
Premiums earned |
$ | 32,413 | $ | 18 | $ | 32,431 | ||||||
Losses and LAE incurred |
24,135 | (23 | ) | 24,112 | ||||||||
Underwriting expenses |
6,734 | 2 | 6,736 | |||||||||
Underwriting gain |
$ | 1,544 | $ | 39 | $ | 1,583 | ||||||
Loss ratio |
74.5 | % | ||||||||||
Expense ratio |
20.8 | % | ||||||||||
Combined ratio |
95.3 | % | ||||||||||
THREE MONTHS ENDED JUNE 30, 2004 |
||||||||||||
Premiums written |
$ | 3,707 | $ | (954 | ) | $ | 2,753 | |||||
Premiums earned |
$ | 30,946 | $ | (960 | ) | $ | 29,986 | |||||
Losses and LAE incurred |
24,685 | 539 | 25,224 | |||||||||
Underwriting expenses |
6,284 | (12 | ) | 6,272 | ||||||||
Underwriting loss |
$ | (23 | ) | $ | (1,487 | ) | $ | (1,510 | ) | |||
Loss ratio |
79.8 | % | ||||||||||
Expense ratio |
20.3 | % | ||||||||||
Combined ratio |
100.1 | % |
* | The ratios for the segment total and non-core business are not meaningful due to the run-off status of non-core business. |
Core Business
Premiums written were $4.0 million and premiums earned were $32.4 million in the three months ended June 30, 2005; compared to $3.7 million and $30.9 million in the three months ended June 30, 2004. Premiums earned increased primarily due to the effect on most policies of a 6.5% rate increase implemented on January 1, 2005, somewhat offset by a decline in policies in-force of 2.3%.
The loss ratio (losses and LAE related to premiums earned) for the second quarter 2005 was 74.5% compared to 79.8% in the second quarter 2004. The decrease in the loss ratio is due primarily to the 6.5% rate increase effective January 1, 2005, as well as lower loss estimates for 2005, principally due to a decline in claim frequency.
The underwriting expense ratio (expenses related to premiums earned) increased to 20.8% in the second quarter 2005 from 20.3% in the second quarter 2004. The change is primarily attributable to an increase in non-deferrable general expenses. In addition, an increasing proportion of new business acquired has been through agents and brokers which increases commission expenses.
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Non-Core Business
The premiums written and earned for the second quarter of 2005 result primarily from extended reporting endorsements issued under expired policies. After March 6, 2003, no new or renewal business was written in the non-core programs, as the Company exited these markets.
The underwriting gain in the second quarter of 2005 was diminimus and reflects the fact that no significant changes in reserve levels were required during the quarter.
Assumed Reinsurance Segment
The following table summarizes the underwriting results of the assumed reinsurance segment for the periods indicated (dollars in thousands):
Assumed Reinsurance Segment Underwriting Results |
||||||||
FOR THE THREE MONTHS ENDED JUNE 30, |
2005 |
2004 |
||||||
Premiums written |
$ | (291 | ) | $ | 7 | |||
Premiums earned |
$ | 20 | $ | 1,242 | ||||
Underwriting expenses |
||||||||
Losses |
3,035 | 7,604 | ||||||
Underwriting and other operating expenses |
118 | 304 | ||||||
Underwriting loss |
$ | (3,133 | ) | $ | (6,666 | ) | ||
The earned premium in 2005 and 2004 is primarily from the one ongoing assumed reinsurance program for the 2003 underwriting year.
The underwriting loss in the second quarter 2005 is primarily related to increased reserve estimates reported to the Company for a few contracts. Increased reserves related to contracts covering bail and immigration bonds, Lloyds syndicates and World Trade Center losses were reported to the Company during the quarter ended June 30, 2005.
The Rosemont Re reinsurance treaty entered into in December 2002 effectively cedes all of the unearned premium and future reported premium after June 30, 2002, for the assumed reinsurance business written for underwriting years 2001 and 2002 by the Company. This treaty relieves the Company of significant underwriting risk and written premium leverage and significantly improves the Companys risk-based capital adequacy ratios under both the A.M. Best and NAIC models. The treaty has no limitations on loss recoveries and includes a profit-sharing provision should the combined ratios calculated on the base premium ceded be below 100%. The treaty requires Rosemont Re to reimburse the Company for its acquisition and administrative expenses.
The Rosemont Re reinsurance treaty has both prospective and retroactive elements as defined in FASB No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. As such, any gains under the contract will be deferred and amortized to income based upon the expected recovery. No gains are anticipated currently. Losses related to future earned premium ceded, as well as development on losses related to existing earned premium ceded after June 30, 2002, will ultimately determine whether a gain will be recorded under the contract. The retroactive accounting treatment required under FASB 113 requires that a charge to income be recorded to the extent premiums ceded under the contract are in excess of the estimated losses and expenses ceded under the contract.
Other Operations
Net investment income decreased 19.3% to $4.1 million for the three months ended June 30, 2005 from $5.1 million for the three months ended June 30, 2004. Investment income reflects a 10% reduction in average fixed maturity investments and a decrease in the average rate of return on invested assets from 3.4% to 3.0% for the three months ended June 30, 2004 and 2005, respectively. The decline in invested assets was as a result of the claim payments related to the run-off of the non-core healthcare liability and assumed reinsurance businesses.
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Net realized investment losses of $10 thousand were recorded for the second quarter 2005 versus net realized invested losses of $0.6 million in the second quarter 2004.
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of the Companys liquidity are insurance premiums, net investment income, recoveries from reinsurers and proceeds from the maturity or sale of invested assets. Funds are used to pay losses, LAE, operating expenses, reinsurance premiums and taxes.
Because of uncertainty related to the timing of the payment of claims, cash from operations for a property and casualty insurance company can vary substantially from period to period. During the first six months of 2005, the Company had negative cash flow from operations of $34.9 million compared to a negative cash flow of $43.7 million in 2004. The negative cash flow in 2005 and 2004 is related to claims payments associated with the non-core physician and assumed reinsurance programs, which are now in run-off. The Company maintains a significant portion of its investment portfolio in high-quality short-term securities and cash to meet short-term operating liquidity requirements, including the payment of losses and LAE. Cash and cash equivalents investments totaled $83.2 million or 15.5% of invested assets, at June 30, 2005. The Company believes that all of its short-term and fixed maturity securities are readily marketable and have scheduled maturities in line with projected cash needs. Premiums generated by the Companys core operations have historically produced positive cash flow after consideration of investment income.
The Company invests its cash flow from operations principally in taxable fixed maturity securities. The Companys current policy is to limit its investment in unaffiliated equity securities and mortgage loans to no more than 8% of the total market value of its investments. The market value of the Companys portfolio of unaffiliated equity securities was $16.3 million at June 30, 2005. The Company plans to continue its emphasis on fixed maturity securities investments for the indefinite future.
The Company leases approximately 95,000 square feet of office space for its headquarters. The lease is for a term of 10 years ending in 2008, and the Company has two options to renew the lease for a period of five years each.
SCPIE Holdings is an insurance holding company whose assets primarily consist of all of the capital stock of its insurance company subsidiaries. Its principal sources of funds are dividends from its subsidiaries and proceeds from the issuance of debt and equity securities. The insurance company subsidiaries are restricted by state regulation in the amount of dividends they can pay in relation to earnings or surplus, without the consent of the applicable state regulatory authority, principally the California Department of Insurance. SCPIE Holdings principal insurance company subsidiary, SCPIE Indemnity, may pay dividends to SCPIE Holdings in any 12-month period, without regulatory approval, to the extent such dividends do not exceed the greater of (i) 10% of its statutory surplus at the end of the preceding year or (ii) its statutory net income for the preceding year. Applicable regulations further require that an insurers statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs, and permit the payment of dividends only out of statutory earned (unassigned) surplus unless the payment out of other funds receives regulatory approval. The amount of dividends that SCPIE Indemnity is able to pay to SCPIE Holdings during 2005 without prior regulatory approval is approximately $10.6 million. As of June 30, 2005, no dividends had been paid to SCPIE Holdings.
In March 2004, the Board of Directors suspended the Companys quarterly dividends. The payment and amount of cash dividends in the future will depend upon, among other factors, the Companys operating results, overall financial condition, capital requirements and general business conditions. As of June 30, 2005, SCPIE Holdings held cash and short-term securities of $3.4 million. Based on historical trends, market conditions and its business plans, the Company believes that its sources of funds (including dividends from the insurance company subsidiaries) will be sufficient to meet the liquidity needs of SCPIE Holdings over the next 18 months.
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The Companys capital adequacy position has been weakened by the losses in the non-core business. On November 14, 2003, A.M. Best (the leading rating organization for the insurance industry), after a review of the third quarter 2003 results, reduced the rating of the Insurance Subsidiaries to B (Fair), with a negative outlook. In July 2005, A.M. Best reaffirmed the Insurance Subsidiaries rating with no changes. A.M. Best assigns this rating to companies that have, in its opinion, a fair ability to meet their current obligations to policyholders, but are financially vulnerable to adverse changes in underwriting and economic conditions. The NAIC has developed a methodology for measuring the adequacy of an insurers surplus which includes a risk-based capital (RBC) formula designed to measure state statutory capital and surplus needs. The RBC rules provide for different levels of regulatory attention based on four thresholds determined under the formula. At December 31, 2004, the RBC level of each insurance company subsidiary exceeded the threshold requiring the least regulatory attention.
The Company believes that it has the ability to fund its continuing operations from its premiums written and investment income. The Company plans to continue its focus on the efficient operation of its core business, while at the same time continuing to adjudicate and settle claims incurred in its discontinued non-core business. As the Company continues to run-off the non-core loss and LAE reserves, its capital adequacy position should improve.
As of June 30, 2005, the Companys statutory surplus was approximately $144.7 million. The principal differences between statutory surplus and stockholders equity are deferred policyholder acquisition costs and the deferred federal income tax asset. The Company believes its statutory surplus will increase over time and provide a basis for improved ratings from A.M. Best. This process could be accelerated if additional capital were obtained by the Company. Although the Company believes an increase in the A.M. Best rating would be beneficial to the Companys ongoing operations, especially in the area of new business opportunities, there is no assurance that such rating would be increased in the event the Company raised additional capital or whether the Company could raise such capital in appropriate amounts and on reasonable terms.
EFFECT OF INFLATION
The primary effect of inflation on the Company is considered in pricing and estimating reserves for unpaid losses and LAE for claims in which there is a long period between reporting and settlement, such as medical malpractice claims. The actual effect of inflation on the Companys results cannot be accurately known until claims are ultimately settled. Based on actual results to date, the Company believes that loss and LAE reserve levels and the Companys rate making process adequately incorporate the effects of inflation.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The Company is subject to various market risk exposures, including interest rate risk and equity price risk.
The Company invests its assets primarily in fixed maturity securities, which at June 30, 2005 comprised 79.5% of total investments at market value. Corporate bonds represent 49.7% and U.S. government bonds represent 31.0% of the fixed-maturity investments, with the remainder consisting of mortgage-backed and asset-backed securities. Equity securities, consisting primarily of common stocks, account for 3.0% of total investments at market value. Mortgage loans represent 1.9% of the investment portfolio. The remainder of the investment portfolio consists of cash and highly liquid short-term investments, which are primarily overnight bank repurchase agreements and short-term money market funds.
The value of the fixed maturity portfolio is subject to interest rate risk. As market interest rates decrease, the value of the portfolio increases with the opposite holding true in rising interest rate environments. A common measure of the interest sensitivity of fixed-maturity assets is modified or effective duration, a calculation that takes maturity, coupon rate, yield and call terms to calculate an average age of the expected cash flows. The longer the duration, the more sensitive the asset is to market interest rate fluctuations. The effective duration of the fixed maturity portfolio at June 30, 2005 was 4.1 years.
The value of the common stock equity investments is dependent upon general conditions in the securities markets and the business and financial performance of the individual companies in the portfolio. Values are typically based on future economic prospects as perceived by investors in the equity markets.
At June 30, 2005, the carrying value of the investment portfolio included $3.4 million in net unrealized gains. At December 31, 2004, the investment portfolio included $4.6 million in net unrealized gains.
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ITEM 4. | DISCLOSURE CONTROLS AND PROCEDURES |
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to the Companys management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures were effective at the reasonable assurance level.
There have been no significant changes in the Companys internal controls over financial reporting during the Companys most recent fiscal quarter that may have materially affected, or are reasonably likely to materially affect the Companys internal controls over financial reporting.
PART II OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
The Company is named as a defendant in various legal actions and arbitration proceedings primarily arising from claims made under insurance policies and contracts. These actions are considered by the Company in estimating the loss and loss adjustment expense reserves. The Companys management believes that the resolution of these actions will not have a material adverse effect on the Companys financial position or results of operations.
ITEM 2. | CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES |
None.
ITEM 3. | DEFAULTS UNDER SENIOR SECURITIES |
None.
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS |
At the Annual Meeting of Stockholders held on May 24, 2005, the following individuals were reelected to the Board of Directors for a term ending in 2008; Charles B. McElwee, MD, 4,705,833 votes for, 1,905,536 withheld authority; William A. Renert, MD, 4,703,282 votes for, 1,908,087 withheld authority; Henry L. Stoutz, MD, 4,702,797 votes for, 1,908,572 withheld authority; Ronald H. Wender, MD, 4,620,084 votes for, 1,991,285 withheld authority; Donald J. Zuk, 4,685,897 votes for, 1,925,472 withheld authority. The other directors, whose terms of office continued after the meeting were Mitchell S. Karlan, MD, Willis T. King, Jr., Louis H. Masotti, PhD, Jack E. McCleary, MD, Wendell L. Moseley, MD, Donald P. Newell, and Reinhold A. Ullrich, MD.
ITEM 5. | OTHER INFORMATION |
On August 2, 2005, the Audit Committee of the Company appointed Ernst & Young LLP as independent auditors for the Company and its subsidiaries for the current fiscal year ending December 31, 2005.
On July 2, 2005, Patrick S. Grant, Senior Vice President, Marketing retired as an officer and employee of the Company. Mr. Grant will remain available to consult with the Company.
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ITEM 6. | EXHIBITS AND REPORTS ON FORM 8-K |
(a) | The following exhibits are included herewith. |
NUMBER |
DOCUMENT | |
31.1 | Certifications of Registrants Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certifications of Registrants Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002. These certifications are being furnished solely to accompany this Quarterly Report on Form 10-Q and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference into any filing of the Company. |
(b) | None. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SCPIE HOLDINGS INC. | ||||||||
Date: August 5, 2005 | By: | /s/ Donald J. Zuk | ||||||
Donald J. Zuk President and Chief Executive Officer | ||||||||
Date: August 5, 2005 | By: | /s/ Robert B. Tschudy | ||||||
Robert B. Tschudy Senior Vice President and Chief Financial Officer |
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