<PAGE> 1
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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 THE QUARTER ENDED SEPTEMBER 30, 1998 COMMISSION FILE NO. 1-12449
SCPIE HOLDINGS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 95-4457980
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
9441 WEST OLYMPIC BOULEVARD 90212
BEVERLY HILLS, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
</TABLE>
(310) 551-5900
(REGISTRANT'S 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
----- -----
At November 6, 1998 the Registrant had issued and outstanding an aggregate
of 12,434,791 shares of its Common Stock.
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<PAGE> 2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- ---------
(UNAUDITED)
<S> <C> <C>
ASSETS
Securities available-for-sale:
Fixed maturity investments, at fair value
(amortized cost 1998 - $701,643;
1997 - $692,811)................................... $734,546 $708,860
Equity investments, at fair value
(cost 1998 - $31,185; 1997 - $17,052)............... 34,952 23,523
-------- --------
Total securities available-for-sale........... 769,498 732,383
Short-term investments.................................. 40,305 53,281
-------- --------
Total investments............................. 809,803 785,664
Cash.................................................... 12,982 13,252
Accrued investment income............................... 10,401 12,202
Reinsurance recoverables................................ 23,309 21,531
Deferred federal income taxes........................... 10,018 16,158
Deferred policy acquisition costs....................... 8,845 520
Property and equipment, net............................. 21,596 19,534
Other assets............................................ 27,001 19,588
-------- --------
Total assets.................................. $923,955 $888,449
======== ========
LIABILITIES
Reserves:
Losses and loss adjustment expenses................... $483,457 $454,971
Unearned premiums..................................... 23,236 22,072
-------- --------
Total reserves................................ 506,693 477,043
Other liabilities....................................... 33,440 50,291
-------- --------
Total liabilities............................. 540,133 527,334
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,
1998 - 11,929,391 shares outstanding
1997 - 12,276,691 shares outstanding................ 1 1
Additional paid-in capital.............................. 36,386 36,386
Retained earnings....................................... 335,213 310,506
Treasury stock, at cost
1998 - 362,700 shares and 1997 -
15,400 shares..................................... (11,614) (416)
Accumulated other comprehensive income..................
23,836 14,638
------- --------
Total stockholders' equity.................... 383,822 361,115
-------- --------
Total liabilities and stockholders' equity.... $923,955 $888,449
======== ========
</TABLE>
See accompanying notes.
2
<PAGE> 3
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Premiums earned $ 38,289 $ 32,972 $117,769 $102,083
Net investment income 9,768 10,798 30,394 32,007
Realized investment gains 3,269 989 7,330 4,176
Other revenue 158 154 428 443
-------- -------- -------- --------
Total revenues 51,484 44,913 155,921 138,709
Expenses:
Losses and loss adjustment expenses 31,931 31,578 99,307 95,322
Other operating expenses 6,767 4,024 20,707 12,607
-------- -------- -------- --------
Total expenses 38,698 35,602 120,014 107,929
-------- -------- -------- --------
Income before federal income taxes 12,786 9,311 35,907 30,780
Federal income taxes 3,374 1,991 9,078 7,335
-------- -------- -------- --------
Net income $ 9,412 $ 7,320 $ 26,829 $ 23,445
======== ======== ======== ========
Basic earnings per share of common stock $ 0.79 $ 0.60 $ 2.21 $ 1.95
Diluted earnings per share of common stock $ 0.78 N/A $ 2.21 N/A
Cash dividend declared per share of common stock $ 0.06 $ 0.05 $ 0.18 $ 0.15
</TABLE>
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER TOTAL
PREFERRED COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE STOCKHOLDERS'
STOCK STOCK CAPITAL EARNINGS STOCK INCOME EQUITY
---------- ------- ---------- -------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1998 $ - $ 1 $ 36,386 $310,506 ($ 416) $14,638 $ 361,115
Comprehensive Income:
Net income - - - 26,829 - - 26,829
Unrealized
comprehensive
income for unrealized
gains on securities
sold, net of
reclassification
adjustments for gains
included in net income 9,198 9,198
---------
Comprehensive income 36,027
---------
Purchase of treasury stock - - - - (11,198) - (11,198)
Cash dividend - - - (2,122) - - (2,122)
--- --- -------- -------- ------ ------- ---------
BALANCE AT SEPTEMBER 30,
1998 $ - $ 1 $ 36,386 $335,213 $(11,614) $23,836 $383,822
=== === ========= ======== ======== ======= ========
</TABLE>
See accompanying notes.
3
<PAGE> 4
SCPIE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1998 1997 1998 1997
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income......................................................... $ 9,412 $ 7,320 $ 26,829 $ 23,445
Adjustments to reconcile net income to net cash
provided by operating activities:
Unpaid losses and loss adjustment expenses, and
reinsurance recoverables....................................... (1,691) (474) 26,708 3,794
Accrued investment income........................................ 1,579 1,709 1,801 (258)
Provision for deferred federal income taxes...................... (26) 297 1,187 163
Policy acquisition costs......................................... 499 (210) (8,325) (63)
Unearned premiums................................................ (1,982) (2,249) 1,164 (2,795)
Policyholders' dividends payable................................. - (2,143) - (6,922)
Realized investments gains....................................... (3,269) (989) (7,330) (4,176)
Provisions for amortization and depreciation..................... (422) 1,668 2,014 3,120
Accrued expenses and other liabilities........................... 4,500 (64) (23,711) (3,615)
Changes in other assets.......................................... (636) 1,382 (7,413) (3,352)
-------- --------- -------- ---------
Net cash provided by operating activities................ 7,964 6,247 12,924 9,341
INVESTING ACTIVITIES
Purchases-- fixed maturities.................................... (84,030) (42,194) (232,576) (240,677)
Sales-- fixed maturities........................................ 90,723 38,616 202,848 199,901
Maturities-- fixed maturities................................... 1,565 19,800 29,058 24,024
Purchases--equities............................................. (13,539) (1,118) (17,551) (5,458)
Sales--equities................................................. 3,002 916 5,371 7,874
Change in short-term investments, net........................... 3,407 (25,781) 12,976 (28,354)
-------- ---------- -------- ---------
Net cash provided by (used in) investing activities...... 1,128 (9,761) 126 (42,690)
-------- --------- -------- ---------
FINANCING ACTIVITIES
Issuance of common stock, net of expenses....................... - - - 36,387
Purchase of treasury stock...................................... (6,801) (54) (11,198) (54)
Cash dividends.................................................. (661) (614) (2,122) (1,844)
-------- --------- -------- ---------
Net cash provided by (used in) financing activities...... (7,462) (668) (13,320) 34,489
-------- --------- -------- ---------
Increase (decrease) in cash........................................ (1,630) (4,182) (270) 1,140
Cash at beginning of period........................................ 11,352 9,534 13,252 4,212
-------- --------- -------- ---------
Cash at end of period.............................................. $ 12,982 $ 5,352 $ 12,982 $ 5,352
======== ========= ======== =========
</TABLE>
See accompanying notes.
4
<PAGE> 5
SCPIE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1998
1. BASIS OF PRESENTATION AND REORGANIZATION
Basis of Presentation
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. 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-month and nine-month period 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 SCPIE
Holdings Inc.'s annual report on Form 10-K for the year ended December 31, 1997.
The accompanying September 30, 1998 and 1997 consolidated financial
statements include the accounts and operations, after intercompany eliminations,
of SCPIE Holdings Inc. (SCPIE Holdings) and its wholly-owned subsidiaries,
principally SCPIE Indemnity Company (SCPIE Indemnity), American Healthcare
Indemnity Company (AHI), American Healthcare Specialty Insurance Company (AHSIC)
and SCPIE Management Company (SMC), collectively, the Company.
On January 29, 1997, the Southern California Physicians Insurance Exchange
(the Exchange) consummated its plan and agreement of merger whereby the Exchange
reorganized from a reciprocal insurer to a stock insurance company and became a
wholly owned subsidiary of SCPIE Holdings (the Reorganization). Pursuant to the
Reorganization, the Exchange merged with and into SCPIE Indemnity, a California
stock company and a wholly-owned subsidiary of SCPIE Holdings, the surviving
corporation of the Reorganization. The assets and liabilities of the Exchange
that were merged into SCPIE Indemnity were accounted for at historical cost in a
manner similar to that in a pooling of interests.
The principal purpose of the Reorganization was to improve the Company's
access to the capital markets and to raise capital to permit the growth of
existing business and develop new business opportunities in the professional
liability insurance industry. The Reorganization also provided members of the
Exchange with shares of common stock in exchange for their membership interests
in the Exchange.
Concurrent with the Reorganization, SCPIE Holdings completed an initial
public offering, which generated net proceeds to SCPIE Holdings of approximately
$36.4 million.
Certain 1997 amounts have been reclassified to conform to the 1998
presentation.
2. EARNINGS PER SHARE OF COMMON STOCK
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1998 1997
-------------- -------------
<S> <C> <C>
Numerator:
Net income $26,829 $23,445
Numerator for:
Basic earnings per share of common stock $26,829 $23,445
Diluted earnings per share of common stock $26,829 $23,445
Denominator:
Denominator for basic earnings per share
of common stock - weighted-average
shares outstanding 12,132 12,048
Effect of dilutive securities:
Stock options 16 N/A
-------
Denominator for diluted earnings per
share of common stock adjusted -
weighted-average shares outstanding 12,148 N/A
Basic earnings per share of common stock $ 2.21 $ 1.95
======= =======
Diluted earnings per share of common stock $ 2.21 N/A
=======
</TABLE>
5
<PAGE> 6
3. NEW ACCOUNTING STANDARD
As of January 1, 1998, the Company adopted Financial Accounting Standards
Board Statement No. 130 (FASB 130) "Reporting Comprehensive Income." FASB 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption had no impact on the Company's net income
or stockholders' equity. FASB 130 requires unrealized gains or losses on the
Company's available-for-sale securities, which prior to adoption were reported
separately in stockholders' equity, to be included in other comprehensive
income.
The components of comprehensive income net of related tax, for the
nine-month periods ended September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Net income $26,829 $23,445
Other comprehensive income:
Change in unrealized gains on securities 9,198 3,138
------- -------
Total $36,027 $26,583
======= =======
</TABLE>
4. INVESTMENTS
The Company's investments in available-for-sale securities at September 30,
1998 are summarized as follows:
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
-------- ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Fixed-maturity securities:
Bonds:
U.S. Government and Agencies $307,517 $23,747 $ 16 $331,248
State, Municipalities and
Political Subdivisions 345,399 9,290 402 354,287
Mortgage-backed securities,
U.S. Government 43,634 388 104 43,918
Corporate 5,093 - - 5,093
-------- ------- ------- --------
Total fixed-maturity securities 701,643 33,425 522 734,546
Equity securities 31,185 5,468 1,701 34,952
-------- ------- ------- --------
Total $732,828 $38,893 $ 2,223 $769,498
======== ======= ======= ========
</TABLE>
5. FEDERAL INCOME TAXES
The components of the federal income tax provision in the accompanying
consolidated statements of income are summarized as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Current $ 7,891 $ 7,172
Deferred 1,187 163
------- -------
Total $ 9,078 $ 7,335
======= =======
</TABLE>
A reconciliation of income tax computed at the federal statutory tax rate to
total income tax expense is as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1998 1997
-------- -------
(IN THOUSANDS)
<S> <C> <C>
Federal income tax at 35% $ 12,567 $10,773
Increase (decrease) in taxes resulting from:
Tax-exempt interest (3,641) (3,551)
Dividends received deduction (121) (99)
Goodwill 158 168
Other 115 44
-------- -------
Total $ 9,078 $ 7,335
======== =======
</TABLE>
6
<PAGE> 7
The Internal Revenue Service (IRS) has proposed adjustments to increase the
Company's tax liability for 1993 through 1995 as a result of its examinations.
The Company's management disagrees with the adjustments proposed by the IRS and
has decided to contest the deficiencies proposed by the IRS for these years. The
1993 taxable year has been assigned to the IRS Appeals Office (Appeals Office)
and it is expected that the 1994 and 1995 taxable years will also be assigned to
the Appeals Office shortly.
The Company's management will take all necessary steps to contest the IRS'
position. The Company's management believes that resolution of this matter will
not have a material adverse effect on the Company's financial position or
results of operation.
However, the ultimate outcome cannot be predicted at this time.
6. COMMITMENTS AND CONTINGENCIES
The Company is a defendant in a California action brought by the bankruptcy
estate of an uninsured physician. The bankruptcy estate alleged that the Company
had an undisclosed conflict of interest when it provided the physician with a
free courtesy defense by an attorney who had represented the interests of the
Company's insureds in other cases. In 1995, a jury made a damage award against
the Company of $4.2 million in compensatory damages, and punitive damages which
were reduced to $14.0 million by the trial judge. The Company appealed these
awards to the California district court of appeal. On May 8, 1998, the appellate
court reversed the judgment against the Company in its entirety. The bankruptcy
estate may attempt to obtain a new trial in the California Superior Court in
which the judgment was originally entered. The Company believes that the
bankruptcy estate is not entitled to any additional trial under applicable
California appellate court decisions and will aggressively oppose any such
attempt. The Company believes that the action is entirely without merit and will
continue to aggressively pursue its rights.
Since 1981, the Company has purchased annuities from life insurance
companies to fund obligations under structured settlement agreements with
certain medical malpractice claimants. Annuities having an aggregate purchase
price of approximately $12.3 million were purchased from Executive Life
Insurance Company (ELIC) which was placed in conservatorship during 1991 by the
California Insurance Commissioner. Substantially all of the assets of ELIC have
been transferred to another insurer, which has assumed the restructured
annuities and is obligated to pay varying percentages of the original annuity
benefits as they become due. The Company has determined that it is contractually
obligated for the shortfall amounts under certain of these annuities. At
December 31, 1997, a reserve of $4.0 million (net of expected reinsurance
recoveries of $3.0 million) has been recorded to cover these expected shortfall
payments. The Company believes that the amount of its obligations in excess of
the existing reserves, if any, is not material to its financial position or
results of operations.
The Company is named as 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 Company's management believes that the resolution of these actions
will not have a material adverse effect on the Company's financial position or
results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
For purposes of this Quarterly Report on Form 10-Q, the terms "SCPIE" and
the "Company" refer, at all times prior to January 29, 1997, to Southern
California Physicians Insurance Exchange (the "Exchange") and its subsidiaries,
collectively, and at all times on or after such date, to SCPIE Holdings Inc. and
its subsidiaries, collectively; and the term "SCPIE Holdings" refers at all
times to SCPIE Holdings Inc., excluding its subsidiaries.
GENERAL
Certain statements in this report on Form 10-Q that are not historical 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 which 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. Such risks, uncertainties and other factors include, but are not
limited to, the Company's concentration of business in a single line in a single
state; the Company's entry into new markets; competition and other industry
factors, including uncertainties inherent in the estimate of loss and loss
adjustment expense (LAE) reserves, reinsurance, importance of ratings,
regulatory matters, and changes in healthcare; the availability of bank
financing; and certain structural matters, including the Company's holding
company structure and anti-takeover measures. These risks and uncertainties are
discussed in more detail under "Business--Risk Factors," and "Management's
Discussion and Analysis --General" in the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
Premiums Earned. Premiums earned increased approximately $5.3 million, or
16.1%, to $38.3 million for the three months ended September 30, 1998 from $33.0
million for the same period in 1997. The increase was principally due to a $6.8
million increase in medical malpractice premiums from physicians and medical
groups to approximately $34.2 million for the three months ended September 30,
1998 compared to $27.4 million for the same period in 1997. This increase was a
result of the Company's acquisition of the medical malpractice book of business
of Fremont Indemnity Company (Fremont Indemnity) on January 1, 1998 and initial
premiums attributable to an agency relationship with Poe & Brown, Inc. which
commenced on January 1, 1998. Hospital medical malpractice premiums were
approximately $2.5 million for the three months ended September 30, 1998
compared to $4.0 million for the same period in 1997. This decrease in 1998
hospital medical malpractice premiums was due principally to the loss of one
large integrated hospital account in Florida in late 1997. Assumed reinsurance
premiums were approximately $1.3 million for both the three months ended
September 30, 1998 and 1997.
Net Investment Income. Net investment income decreased approximately $1.0
million, or 9.5%, to $9.8 million for the three months ended September 30, 1998
from $10.8 million for the same period in 1997. Average invested assets
increased to $778.9 million during the three months ended September 30, 1998
7
<PAGE> 8
compared to $751.1 million for the same period in 1997. The average pre-tax
yield on the investment portfolio declined to 5.0% from 5.8% for the same period
in 1997 due to a greater percentage of the portfolio held in 1998 in lower
yielding tax-exempt securities.
Realized Investment Gains and Other Revenue. Realized investment gains were
approximately $3.3 million for the three months ended September 30, 1998
compared to realized gains of $1.0 million for the same period in 1997.
Losses and LAE. Losses and LAE increased $0.3 million, or 1.1%, to $31.9
million for the three months ended September 30, 1998 from $31.6 million for the
same period in 1997. As a percentage of premiums earned, losses and LAE
decreased to 83.4% for the three months ended September 30, 1998 from 95.8% for
the same period in 1997. For the three months ended September 30, 1998, the
Company reduced loss and LAE reserves incurred in prior policy years
approximately $15.6 million as compared to a reserve reduction of $9.0 million
for the same period in 1997 for claims incurred in prior policy years.
Other Operating Expenses. Other operating expenses increased $2.8 million,
or 68.2%, to $6.8 million for the three months ended September 30, 1998 from
$4.0 million for the same period in 1997. The ratio of other operating expenses
to premiums earned is referred to as the expense ratio, which was 17.7% for the
three months ended September 30, 1998 and 12.2% for the same period in 1997.
This increase in the expense ratio is due primarily to the amortization of
non-recurring costs related to the Fremont Indemnity acquisition, along with
higher expenses associated with the higher premium volume and general personnel
increases.
Federal Income Taxes. Federal income tax expense increased $1.4 million, to
$3.4 million for the three months ended September 30, 1998 from $2.0 million for
the same period in 1997. The effective tax rate increased to 26.4% for the three
months ended September 30, 1998 compared to 21.4% for the three months ended
September 30, 1997 due to higher realized gains during the 1998 quarter.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
Premiums Earned. Premiums earned increased approximately $15.7 million, or
15.4%, to $117.8 million for the nine months ended September 30, 1998 from
$102.1 million for the same period in 1997. The increase was principally due to
a $21.4 million increase in medical malpractice insurance premiums from
physicians and medical groups that were approximately $106.4 million for the
nine months ended September 30, 1998 compared to $85.0 million for the same
period in 1997. Hospital medical malpractice premiums were approximately $7.7
million for the nine months ended September 30, 1998 compared to $12.1 million
for the same period in 1997. This decrease was due to the loss of one large
Florida integrated hospital account in late 1997. Assumed reinsurance premiums
were approximately $3.3 million for the nine months ended September 30, 1998
compared to $4.3 million for the same period in 1997.
Net Investment Income. Net investment income decreased approximately $1.6
million, or 5.0%, to $30.4 million for the nine months ended September 30, 1998
from $32.0 million and for the same period in 1997. Average invested assets
increased to $773.3 million during the nine months ended September 30, 1998
compared to $736.7 million for the same period in 1997. The average pre-tax
yield on the investment portfolio declined to 5.2% for the nine months ended
September 30, 1998 compared to 5.8% for the same period in 1997 due to a greater
percentage of the portfolio held in 1998 in lower yielding tax-exempt
securities.
Realized Investment Gains and Other Revenue. Realized investment gains were
approximately $7.3 million for the nine months ended September 30, 1998 compared
to $4.2 million for the same period in 1997.
Losses and LAE. Losses and LAE increased $4.0 million, or 4.2%, to $99.3
million for the nine months ended September 30, 1998 from $95.3 million for the
same period in 1997. As a percentage of premiums earned, losses and LAE
decreased to 84.3% for the nine months ended September 30, 1998 from 93.4% for
the same period in 1997. For the nine months ended September 30, 1998, the
Company reduced loss and LAE reserves incurred in prior policy years
approximately $48.9 million as compared to a reserve reduction of approximately
$36.0 million in loss and LAE reserves for the nine months ended September 30,
1997 for claims incurred in prior policy years.
Other Operating Expenses. Other operating expenses increased $8.1 million,
or 64.3%, to $20.7 million for the nine months ended September 30, 1998 from
$12.6 million for the same period in 1997. The expense ratio was 17.6% for the
nine months ended September 30, 1998 and 12.4% for the same period in 1997. This
increase in the expense ratio is due primarily to the amortization of
non-recurring costs related to the Fremont Indemnity acquisition. Additionally,
other operating expenses include certain one-time charges related to the Fremont
Indemnity acquisition and higher expenses associated with the higher premium
volume and general personnel increases.
Federal Income Taxes. Federal income taxes increased $1.8 million, or 23.8%,
to $9.1 million for the nine months ended September 30, 1998 from $7.3 million
for the same period in 1997. The effective tax rate increased to 25.3% for the
nine months ended September 30, 1998 from 23.8% for the same period in 1997.
8
<PAGE> 9
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of the Company's 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 claims, LAE, operating expenses,
reinsurance premiums and taxes. SCPIE has also paid significant dividends, in
the form of premium credits, to its policyholders in each year since 1980. In
1996, SCPIE declared a final dividend to policyholders of the Exchange of $9.0
million, which was paid principally in the form of premium credits during 1997.
Except for this final dividend, after the Reorganization, the Company has ceased
paying such premium credit dividends to its policyholders.
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 nine months of 1998, the
cash provided by operating activities for the Company was $12.9 million compared
to $16.3 million during the corresponding 1997 period prior to the payment of
policyholders' dividends.
The Company invests its positive cash flow from operations in both fixed
maturity securities and equity securities. A change in SCPIE's investment
philosophy in 1993 resulted in an increase in the purchase of equity securities
and a reduction in the purchase of fixed maturity securities. The Company's
current policy is to limit its investment in equity securities and real estate
to no more than 8.0% of the total market value of its investments. Accordingly,
SCPIE's portfolio of unaffiliated equity securities was $35.0 million, or 4.3%
of invested assets, at September 30, 1998. The Company plans to continue this
focus on fixed maturity securities investments for the indefinite future. The
Company has made limited investments in real estate, which is used entirely in
the Company's operating activities.
The Company maintains a portion of its investment portfolio in high quality,
short-term securities to meet short-term operating liquidity requirements,
including the payment of losses and LAE. Short-term investments totaled $40.3
million, or 5.0% of invested assets, at September 30, 1998. The Company believes
that all of its short-term and fixed maturity securities are readily marketable.
SCPIE Holdings is an insurance holding company whose assets principally
consist of all of the capital stock of its insurance subsidiaries. SCPIE
Holdings' principal sources of funds will be 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 subsidiary may pay dividends to
SCPIE Holdings in any year, 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 net income for the preceding year.
Applicable regulations further require that an insurer's 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 is approved by the Insurance Commissioner. The
amount of dividends the insurance subsidiaries are able to pay to SCPIE Holdings
during 1998 without prior regulatory approval is approximately $27.5 million.
Dividends of $25.0 million were paid during the first nine months of 1998.
Based on historical trends, market conditions and its business plans, the
Company believes that its sources of funds will be sufficient to meet its
liquidity needs over the next 18 months and beyond. However, because economic,
market and regulatory conditions may change, there can be no assurance that the
Company's sources of funds will be sufficient to meet these liquidity needs. The
short- and long-term liquidity requirements of the Company may vary because of
the uncertainties regarding the settlement dates for unpaid claims.
On July 24, 1998, the Company entered a lease covering approximately 95,000
square feet of office space for new Company headquarters. The lease is for a
term of 10 years and the Company expects to occupy this space in early March
1999. The Company estimates that expenditures of approximately $6.0 million in
capital improvements, equipment and relocation costs will be incurred in
connection with this relocation. The Company does not expect any other material
capital expenditures during the next three months.
During May 1998, the Board of Directors extended the term of the stock
repurchase program in the open market until the 1999 Annual Meeting of
Stockholders. The Company has repurchased 384,400 shares through October 31,
1998 at a total cost of $12.3 million.
IMPACT OF YEAR 2000
The Company has determined that significant portions of its software require
modifications so that its computer systems will function properly with respect
to dates in the Year 2000 and thereafter. The following discussion summarizes
the Company's state of readiness, costs to address the Year 2000 issues, the
risks of the Company's Year 2000 issues and the Company's contingency plans.
The Company is 98% complete in implementing its Year 2000 remediation plan
for information technology (IT) systems and anticipates the entire project to be
complete by December 31, 1998. For non-IT systems (i.e., telecommunications
systems, elevators, and other devices which utilize microprocessors and
third-party providers of information), the Company has contacted all of its
major vendors and suppliers to determine level of compliance.
The total Year 2000 project cost is estimated to be approximately $1.8
million which is being expensed as incurred. All costs incurred to date
represent the direct cost of the Company's information systems department
personnel. Costs incurred through September 30, 1998 approximated $1.6 million,
of which $0.7 million were incurred in 1998.
Given the highly computerized nature of the Company's operations, the Year
2000 problem, if unresolved, would pose a serious risk to the Company's ability
to efficiently and effectively service its policyholders. Although no
remediation plan can identify all potential exposures, management believes that
the
9
<PAGE> 10
steps taken to address the Year 2000 issue will prevent or promptly detect and
allow for correction any significant instances of noncompliance that are
reasonably within the Company's control.
If unforeseen events result in the Company's critical systems
malfunctioning, contingency plans similar to that employed in the event of
business interruption would be enacted. These plans have been developed and will
be tested no later than March 31, 1999.
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 Company's 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 Company's
ratemaking process adequately incorporate the effects of inflation.
PART II -- OTHER INFORMATION
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in a California action brought by the bankruptcy
estate of an uninsured physician. The bankruptcy estate alleged that the Company
had an undisclosed conflict of interest when it provided the physician with a
free courtesy defense by an attorney who had represented the interests of the
Company's insureds in other cases. In 1995, a jury made a damage award against
the Company of $4.2 million in compensatory damages, and punitive damages which
were reduced to $14.0 million by the trial judge. The Company appealed these
awards to the California district court of appeal. On May 8, 1998, the appellate
court reversed the judgment against the Company in its entirety. The bankruptcy
estate may attempt to obtain a new trial in the California Superior Court in
which the judgment was originally entered. The Company believes that the
bankruptcy estate is not entitled to any additional trial under applicable
California appellate court decisions and will aggressively oppose any such
attempt. The Company believes that the action is entirely without merit and will
continue to aggressively pursue its rights.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herewith.
10 The 1997 Equity Participation Plan of SCPIE Holdings Inc. (incorporated by
reference from Exhibit A to the Company's Proxy Statement filed with the
Commission on March 30, 1998.)
27 Financial Data Schedule
(b) Not applicable.
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: November 13, 1998 By: /s/ PATRICK T. LO
------------------------------------------
Patrick T. Lo
Vice President and Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10Q FOR
THE QUARTER ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 734,546
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 34,952
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 809,803
<CASH> 12,982
<RECOVER-REINSURE> 23,309
<DEFERRED-ACQUISITION> 8,845
<TOTAL-ASSETS> 923,955
<POLICY-LOSSES> 483,457
<UNEARNED-PREMIUMS> 23,236
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 1
<OTHER-SE> 383,821<F1>
<TOTAL-LIABILITY-AND-EQUITY> 923,955
117,769
<INVESTMENT-INCOME> 30,394
<INVESTMENT-GAINS> 7,330
<OTHER-INCOME> 428
<BENEFITS> 99,307
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 20,707
<INCOME-PRETAX> 35,907
<INCOME-TAX> 9,078
<INCOME-CONTINUING> 26,829
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 26,829
<EPS-PRIMARY> 2.21
<EPS-DILUTED> 2.21<F2>
<RESERVE-OPEN> 464,652<F3>
<PROVISION-CURRENT> 148,238
<PROVISION-PRIOR> (48,931)
<PAYMENTS-CURRENT> 5,615
<PAYMENTS-PRIOR> 98,196
<RESERVE-CLOSE> 460,148
<CUMULATIVE-DEFICIENCY> (48,931)
<FN>
<F1>TREASURY STOCK OF $11,614 IS INCLUDED AS A REDUCTION OF OTHER STOCKHOLDERS'
EQUITY. ACCUMULATED OTHER COMPREHENSIVE INCOME OF $23,836 IS INCLUDED AS A
COMPONENT OF STOCKHOLDERS' EQUITY.
<F2>THE ADOPTION OF FASB 128 DID NOT HAVE AN IMPACT ON THE PRIOR PERIOD PER SHARE
CALCULATIONS AS THE COMPANY HAD ONLY COMMON STOCK OUTSTANDING.
<F3>INCLUDES LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES THE COMPANY ASSUMED UNDER A
REINSURANCE AGREEMENT FROM FREMONT INDEMNITY COMPANY AS OF JANUARY 1, 1998.
</FN>
</TABLE>
