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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington DC 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
---------- ----------
Commission File Number: 0-18786
PICO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-2723335
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
875 PROSPECT STREET., SUITE 301
LA JOLLA, CALIFORNIA 92037
(619) 456-6022
(Address and telephone number of principal executive offices)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
The number of shares outstanding of the Registrant's Common Stock, $0.001 par
value, was 32,591,718 as of June 30, 1998. As of such date, 4,572,015 shares of
common stock were held by subsidiaries of the registrant.
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PICO HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
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<S> <C>
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets as of 3
June 30, 1998 and December 31, 1997
Consolidated Statements of Income 4
for the Three and Six Months Ended June 30, 1998 and 1997
Consolidated Statements of Cash Flows for 5
the Six Months Ended June 30, 1998 and 1997
Notes to Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial 10
Condition and Results of Operations
PART II: OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders 27
Item 6: Exhibits and Reports on Form 8-K 27
Signature 28
</TABLE>
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PART I: FINANCIAL INFORMATION
ITEM I: FINANCIAL STATEMENTS
<TABLE>
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share data)
<CAPTION>
June 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
ASSETS
Investments $142,828 $160,297
Cash and cash equivalents 54,433 56,436
Accrued investment income 1,825 1,722
Premiums and other receivables, net 8,897 20,682
Reinsurance receivables 70,960 75,026
Prepaid deposits and reinsurance premiums 11,083 2,235
Deferred policy acquisition costs 5,300 5,321
Surface, water, geothermal and mineral rights 75,573 75,177
Property and equipment, net 8,235 8,551
Deferred income taxes 7,977 2,965
Other assets 4,852 5,931
Net assets of discontinued operations 16,191 15,950
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Total Assets $408,154 $430,293
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Loss and loss adjustment expense, net of discount $175,037 $196,096
Unearned premiums 29,697 21,635
Reinsurance balance payable 9,133 8,076
Deferred gain on retroactive reinsurance 1,876 2,168
Integration liability 355 546
Other liabilities 12,912 15,381
Taxes payable 968
Excess of fair value of net assets aquired over purchase price 4,781 5,065
-------- --------
Total Liabilities 233,791 249,935
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MINORITY INTEREST 62,767 68,207
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COMMITMENTS AND CONTINGENCIES (NOTES 5, 7 AND 9)
SHAREHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized 2,000,000 shares, none issued
Common stock, $.001 par value; authorized 100,000,000 shares,
issued 32,591,718 in 1998 and 1997 33 33
Additional paid-in capital 43,147 43,147
Retained earnings 83,873 83,718
Accumulated other comprehensive loss (5,628) (4,918)
Treasury stock, at cost (common shares 2,492,631) (9,829) (9,829)
-------- --------
Total Stockholders' Equity 111,596 112,151
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Total Liabilities and Stockholders' Equity $408,154 $430,293
======== ========
</TABLE>
See notes to consolidated financial statements.
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<TABLE>
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except per share data)
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
REVENUES:
Premium income $ 8,455 $13,976 $17,593 $28,478
Investment income, net 1,805 2,728 5,181 6,102
Net realized gains on investments 1,970 111 2,474 2,945
Other income 1,424 366 2,140 706
------- ------- ------- -------
Total revenues 13,654 17,181 27,388 38,231
------- ------- ------- -------
EXPENSES:
Loss and loss adjustment expenses 5,666 10,019 13,661 21,538
Insurance underwriting and other expenses 6,522 4,719 12,516 11,484
------- ------- ------- -------
Total expenses 12,188 14,738 26,177 33,022
------- ------- ------- -------
Equity in earnings (losses) of investee (284) 164 (487) 172
------- ------- ------- -------
Income from continuing operations before income taxes
and minority interest 1,182 2,607 724 5,381
Provision (benefit) for federal, foreign and state income taxes (296) 725 930 1,659
------- ------- ------- -------
Income (loss) from continuing operations before
minority interest 1,478 1,882 (206) 3,722
Minority interest in loss (income) of subsidiary (499) 206
------- ------- ------- -------
Income from continuing operations 979 1,882 3,722
Income (loss) from discontinued operations, net of federal
income tax provision (benefit) of $35 and $(24) for the three
months and $44 and $20 for the six months in 1998 and 1997,
respectively 103 (58) 155 94
------- ------- ------- -------
Net income $ 1,082 $ 1,824 $ 155 $ 3,816
======= ======= ======= =======
Net income per common share (basic):
Continuing operations $ 0.03 $ 0.06 $ 0.00 $ 0.12
Discontinued operations 0.00 0.00 0.00 0.00
------- ------- ------- -------
Net income per common share $ 0.03 $ 0.06 $ 0.00 $ 0.12
======= ======= ======= =======
Weighted average shares outstanding 32,592 32,543 32,592 32,515
======= ======= ======= =======
Net income per common share (diluted):
Continuing operations $ 0.03 $ 0.05 $ 0.00 $ 0.11
Discontinued operations 0.00 0.00 0.00 0.00
------- ------- ------- -------
Net income per common share $ 0.03 $ 0.05 $ 0.00 $ 0.11
======= ======= ======= =======
Weighted average shares outstanding 33,765 33,513 33,877 33,430
======= ======= ======= =======
</TABLE>
See notes to consolidated financial statements.
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<TABLE>
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
<CAPTION>
Six Months Ended June 30,
-------------------------
1998 1997
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<S> <C> <C>
OPERATING ACTIVITIES
Net cash used in operating activities $ (2,964) $ (23,757)
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INVESTING ACTIVITIES:
Investments purchased (9,176) (285,395)
Investments sold 14,409 118,373
Investments matured 25 188,506
Net sales of real estate 92 19
Proceeds from sale of property and equipment 11
Purchases of property and equipment (302) (528)
Investment in surface, water, geothermal and mineral rights (934)
Investment in affiliate (477)
Other (2,231)
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Net cash provided by investing activities 1,417 20,975
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FINANCING ACTIVITIES:
Issuance of common stock 274
Proceeds from sale of business (2,964)
Purchase of treasury stock (163)
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Net cash used in financing activities (2,853)
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Effect of exchange rate changes on cash (456) (1)
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NET DECREASE IN CASH (2,003) (5,636)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 56,436 54,916
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 54,433 $ 49,280
======== =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 440 $ 12,650
======== =========
</TABLE>
See notes to consolidated financial statements.
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PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of PICO Holdings, Inc. ("PICO") and Subsidiaries (collectively, the
"Company") have been prepared in accordance with the interim reporting
requirements of Form 10-Q, pursuant to the rules and regulations of the
United States Securities and Exchange Commission (the "SEC"). Accordingly,
they do not include all of the information and notes required by generally
accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments and reclassifications
considered necessary for a fair and comparable presentation of financial
position as of June 30, 1998 and December 31, 1997 and results of
operations for the three and six months ended June 30, 1998 and 1997, and
changes in financial position for the six months ended June 30, 1998 and
1997, have been included and are of a normal recurring nature. Operating
results for the three and six months ended June 30, 1998 are not
necessarily indicative of the results that may be expected for the year
ending December 31, 1998.
These financial statements should be read in conjunction with the
Company's audited financial statements and notes thereto, together with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and Risks and Uncertainties contained in the Company's Annual
Reports on Form 10-K and Form 10-K/A for the year ended December 31, 1997
and Form 10-Q for the quarter ended March 31, 1998 as filed with the SEC.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses for
each reporting period. The significant estimates made in the preparation
of the Company's consolidated financial statements relate to the
assessment of the carrying value of unpaid losses and loss adjustment
expenses, future policy benefits, deferred policy acquisition costs,
deferred income taxes and contingent liabilities. While management
believes that the carrying value of such assets and liabilities are
appropriate as of June 30, 1998 and December 31, 1997, it is reasonably
possible that actual results could differ from the estimates upon which
the carrying values were based.
Global Equity Corporation ("GEC") is included in the consolidated
balances of the Company as of December 31, 1997 and June 30, 1998 and for
the three and six months ended June 30, 1998 based on PICO's increased
ownership in GEC to 51.17% on August 19, 1997. PICO accounted for GEC
under the equity method of accounting for the three and six months ended
June 30, 1997. See also Note 7, "Proposed Business Combination."
2. DISCONTINUED OPERATIONS
On June 16, 1997, PICO announced the signing of a definitive agreement
to sell the Company's life and health insurance subsidiary, American
Physicians Life Insurance Company ("APL") and its wholly-owned subsidiary,
Living Benefit Administrators Agency, Inc. The closing is subject to
certain closing conditions, including regulatory approval which is still
pending. The expected purchase price is approximately $17 million less any
dividend distributed by APL to its sole shareholder, The Physicians
Investment Company ("PIC"), prior to closing. See Note 9, "Subsequent
Events." The purchase price is expected to be paid in cash.
Because APL and its subsidiary represent a major segment of the
Company's business, in accordance with Accounting Principles Board Opinion
No. 30 "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business," APL's operations have been
classified as discontinued operations. The net assets of APL have been
shown as a single line item in the accompanying balance sheets as "Net
assets of discontinued operations." The book value assigned to such net
assets at December 31, 1997 of $15,949,989 and $16,191,263 as of June 30,
1998 was based upon the net book value of APL as of those dates as
determined on the basis of generally accepted accounting principles. The
consolidated statements of income for the three and six months ended June
30, 1998 and 1997 and consolidated statements of cash flow for the six
months ended June 30, 1998 and 1997 reflect the discontinued operations.
The primary remaining assets and liabilities of APL as of those dates were
investments, cash and cash equivalents, and accident and health insurance
reserves. The Company expects to realize a small gain on the sale.
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Following is an unaudited summary of APL's stand alone financial
results for the periods included in the statements of income as
discontinued operations in the accompanying financial statements:
<TABLE>
<CAPTION>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
------------ ------------ ---------- ----------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Total revenues $2,197 $1,204 $4,360 $2,779
Income (loss) before taxes 137 (122) 199 42
Net income (loss) 102 (98) 154 21
Net income per share-Basic and Diluted $ 0.00 $ 0.00 $ 0.00 $ 0.00
</TABLE>
3. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share," effective for financial statements issued after
December 15, 1997. SFAS No. 128 requires dual presentation of "Basic" and
"Diluted" earnings per share ("EPS") by entities with complex capital
structures, replacing "Primary" and "Fully Diluted" EPS under Accounting
Principles Board ("APB") Opinion No. 15. Basic EPS excludes dilution from
common stock equivalents and is computed by dividing income available to
common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
from common stock equivalents, similar to fully diluted EPS, but uses only
the average stock price during the period as part of the computation. The
Company adopted the new method of reporting EPS for the year ended
December 31, 1997, and the June 30, 1997 financial statements have been
restated to reflect the change.
Reconciliation of the basic and diluted EPS is as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1997 1998 1997
------- ------- ------- -------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Net income $ 1,082 $ 1,824 $ 155 $ 3,816
======= ======= ======= =======
Basic earnings per share $ 0.03 $ 0.06 $ 0.00 $ 0.12
======= ======= ======= =======
Basic weighted average common shares outstanding 32,592 32,543 32,592 32,515
Options 1,173 970 1,285 915
------- ------- ------- -------
Diluted weighted average common and
common equivalent shares outstanding 33,765 33,513 33,877 33,430
======= ======= ======= =======
Diluted earnings per share $ 0.03 $ 0.05 $ 0.00 $ 0.11
======= ======= ======= =======
</TABLE>
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4. COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 established requirements for disclosure of
comprehensive income and is effective for the Company for the year ending
December 31, 1998. Comprehensive income includes such items as foreign
currency translation adjustments, unrealized holding gains and losses on
available for sale securities, and equity changes of investee company that
had only been presented by the Company as a component of stockholders'
equity.
Reconciliation of net income as reported in the consolidated statements
of income to consolidated comprehensive income (loss) is as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1997 1998 1997
------ ------ ------- ------
(in thousands) (in thousands)
<S> <C> <C> <C> <C>
Comprehensive income (loss):
Net income $1,082 $1,824 $ 155 $3,816
Net unrealized appreciation (depreciation)
on available for sale investments 454 (608) 324 (946)
Net change in cumulative foreign
currency adjustments (835) (332) (1,033) (330)
------ ------ ------- ------
Total comprehensive income (loss) $ 701 $ 884 $ (554) $2,540
====== ====== ======= ======
</TABLE>
The income tax effects of items relating to other comprehensive income
(loss) were deferred income tax expenses of $244 and $174 for the three
and six months ended June 30, 1998, respectively, and deferred tax
benefits of $327 and $509 for the three and six months ended June 30,
1997, respectively.
5. COMMITMENTS AND CONTINGENCIES
The Company is subject to various litigation which arises in the
ordinary course of its business. Based upon information presently
available, management is of the opinion that such litigation will not have
a material adverse effect on the Company's consolidated financial
position, results of operations, or cash flows.
In connection with the sale of PICO's interests in Nevada Land and
Resource Company, LLC ("NLRC") by the former members, a limited
partnership agreed to act as consultant to NLRC in connection with the
maximization of the development, sales, leasing, royalties or other
disposition of land, water, mineral and oil and gas rights with respect to
the Nevada property. In exchange for these services, the partnership will
receive from NLRC a consulting fee calculated as 50% of any net proceeds
that NLRC actually receives from the sale, leasing or other disposition of
all or any portion of the Nevada property or refinancing of the Nevada
property provided that NLRC has received such net proceeds in a threshold
amount equal to the aggregate of: (i) the capital investment by GEC and
the Company in the Nevada property (ii) a 20% cumulative return on such
capital investment, and (iii) a sum sufficient to pay the United States
federal income tax liability, if any, of NLRC in connection with such
capital investment. Either party may terminate this consulting agreement
in April 2002 if the partnership has not received or become entitled to
receive by that time any amount of the consulting fee. No payments have
been made under this agreement through December 31, 1997. By letter dated
March 13, 1998, NLRC gave notice of termination of the consulting
agreement based on NLRC's determination of a default by the partnership
under the terms of the agreement. By letter dated March 20, 1998, legal
counsel for the partnership wrote to NLRC and stated that the partnership
was not in default under the terms of the consulting agreement. No other
substantive activity has occurred.
6. RECENT ACCOUNTING PRONOUNCEMENT
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 established
standards for disclosure about operating segments in annual statements and
selected information in
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interim financial reports. It also established standards for related
disclosures about products and services, geographic areas and major
customers. This statement supersedes SFAS No. 14, "Financial Reporting for
Segments of a Business Enterprise." The new standard is effective for the
Company for the year ending December 31, 1998, and requires that
comparative information from earlier years be restated to conform to the
requirements of this standard. The Company does not expect this
pronouncement to materially change the Company's current reporting and
disclosures.
7. PROPOSED BUSINESS COMBINATION
On May 8, 1998, PICO and GEC jointly announced their consideration of a
proposal pursuant to which GEC would become a wholly-owned subsidiary of
PICO. This would be accomplished through a "Plan of Arrangement" whereby
current GEC shareholders would exchange their shares for a direct interest
in the common stock of PICO. GEC's board of directors established a
special committee of directors who are independent of PICO to consider any
proposed transaction from the perspective of GEC's public minority
shareholders.
On June 19, 1998, PICO and GEC jointly announced their intentions to
proceed with the Plan of Arrangement, the terms and conditions, and the
exchange ratio of .4628 of a share of PICO for each share of GEC.
Completion of the Plan of Arrangement is subject to regulatory and
shareholder approval.
8. REGISTRATION OF COMMON STOCK HELD BY SUBSIDIARIES
On May 11, 1998, PICO filed a Form S-3 with the SEC to register
4,572,015 shares of PICO common stock held by its subsidiaries. On May 29,
1998, PICO and GEC jointly announced their decision to withdraw those
shares as available for sale.
9. SUBSEQUENT EVENTS
On July 30, 1998, PICO announced the sale by Guinness Peat Group plc
("GPG") of 3,362,585 shares of PICO common stock to several institutional
investors at a price of $4.375 per share. Prior to this sale, GPC owned
approximately 17.6% of the Company. This sale accounts for nearly all of
GPG's holdings in PICO. In addition, PICO acquired 2,064,229 of its own
shares from GPG at a cost of $1.6 million. In return, PICO agreed to assume
GPG's obligations under call option agreements covering 2,064,229 shares of
PICO common stock having an aggregate exercise price of $1.6 million. These
call options expire on November 23, 2003.
These shares are held in treasury by PICO.
On July 31, 1998, APL paid a cash dividend to its sole shareholder,
PIC, in the amount of $8 million. This amount will be subtracted from the
expected purchase price paid for APL. See Note 2, "Discontinued
Operations."
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This section of the Report contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Discussion containing such forward-looking statements may be found in
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the captions "Results of Operations -Three and Six Months Ended
June 30, 1998 and 1997," "Liquidity and Capital Resources," and "Risk Factors
and Uncertainties." Actual results for future periods could differ materially
from those discussed in this section as a result of the various risks and
uncertainties discussed herein. A comprehensive summary of such risks and
uncertainties can be found in the Company's registration statement on Form S-4
(File No. 333-06671), which was declared effective on October 3, 1996.
INTRODUCTION
- ------------
The Company's objective is to use its resources and those of its
subsidiaries and affiliates to increase shareholder value through investments in
businesses that the Company believes are undervalued and through the profitable
operation of its operating subsidiaries. The Company's acquisition philosophy is
to make selective investments, predominantly in public companies, for the
purpose of enhancing and realizing additional value by means of appropriate
levels of shareholder influence and control. This could involve the
restructuring of the financing or management of the companies in which the
Company invests. It may also encompass initiating and facilitating mergers and
acquisitions within the relevant industry to achieve constructive
rationalization. This business strategy was adopted in late 1994, but was not
fully implemented until 1996. There can be no assurance that sufficient
opportunities will be found or that this business strategy will be successful.
This strategy may negatively impact the business and financial condition and
results of the Company.
On November 20, 1996, Citation Holdings, Inc., an Ohio corporation ("Sub"),
merged with and into Physicians Insurance Company of Ohio ("Physicians"), (the
"Merger") pursuant to an Agreement and Plan of Reorganization (the "Merger
Agreement") dated as of May 1, 1996, as amended by and among Citation Insurance
Group, Physicians and Sub. Pursuant to the Merger, each outstanding share of
Class A Common Stock of Physicians (the "Physicians Stock") was converted into
the right to receive 5.0099 shares of PICO's common stock. As a result, (i) the
former shareholders of Physicians owned approximately 80% of the outstanding
common stock of PICO immediately after the Merger and controlled the Board of
Directors of PICO and (ii) Physicians became a wholly owned subsidiary of PICO.
Pursuant to the Merger Agreement, PICO also assumed all outstanding options to
acquire Physicians Stock.
As a result of the Merger, the business and operations of Physicians and its
subsidiaries became a substantial majority of the business and operations of the
Company.
Effective upon the Merger, PICO's name, which was previously "Citation
Insurance Group," was changed to "PICO Holdings, Inc." and the Nasdaq symbol for
the Company's stock was changed from "CITN" to "PICO."
RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED JUNE 30, 1998 AND 1997
SUMMARY
- -------
PICO reported net income of $1.1 million, or $0.03 per share, for the second
quarter of 1998, compared with net income of $1.8 million, or $0.06 per share,
during the same 1997 period. Per share amounts are expressed as basic earnings
per share. Net income for the first six months of 1998 was $0.2 million, or
$0.00 per share, versus $3.8 million, or $0.12 per share, during 1997. Net
income for the second quarters of 1998 and 1997 included income of $0.1 million
and a loss of $0.1 million, respectively, from discontinued operations, net of
taxes. Income from discontinued operations included in net income for the first
six months of 1998 and 1997, net of taxes, was $0.2 million and $0.1 million,
respectively. Discontinued operations include the results of the Company's life
and health insurance subsidiary, APL. See Note 2 of Notes to Consolidated
Financial Statements, "Discontinued Operations," for additional information.
Most of the decline in income for both the second quarter and first half of
1998 as compared to 1997 can be attributed to (1) reduced levels of investment
income as a result of a smaller portfolio of interest- and dividend-paying
securities and (2) reduced income from property and casualty ("P&C") insurance
operations which has seen declining premium levels and increased expense
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ratios resulting from increasing competition and tighter underwriting scrutiny
of Citation Insurance Company's ("CIC") business. Management is continually
looking for ways to realize synergies and to leverage or reduce P&C insurance
loss and loss adjustment expense and underwriting expense ratios, including
expansion into additional states and lines of business. Net income included $0.5
million in income from GEC for the second quarter, and a loss of $0.2 million
for the first six months of 1998. Although not consolidated with PICO until
third quarter 1997, GEC added $0.2 million to PICO's income during both the
second quarter and first half of 1997. Income before taxes and minority interest
are analyzed in the sections that follow.
Shareholders' equity increased $0.7 million during the second quarter to
$111.6 million at June 30, 1998. This $0.7 million increase over March 31, 1998
resulted from second quarter net income of $1.1 million and unrealized
appreciation of investments held for sale of $0.5 million, partially offset by a
$0.8 million decline in the Company's foreign currency translation adjustment
which goes directly through shareholders' equity rather than going through the
income statement. Shareholders' equity was down $0.6 million for the first six
months of 1998 from $112.2 million at December 31, 1997. This decline
principally resulted from a $1.0 million decline in the foreign currency
translation adjustment, partially offset by $0.3 million of unrealized
appreciation of investments held for sale and net income of $0.2 million for the
first half of 1998. Shareholders' equity per share calculated on an undiluted
basis at June 30, 1998 was $3.71 compared to $3.73 at December 31, 1997.
During the first half of 1998, assets decreased approximately $22.1 million
to $408.2 million. Most of this decline resulted from the payment of claims by
Physicians and was reflected in investments and cash and cash equivalent
balances which were decreased by approximately $19.5 million during the six
months. At the same time, loss and loss adjustment expense reserves dropped by
more than $21.0 million. Assets included $16.2 million in net assets from APL
classified as "net assets of discontinued operations" at June 30, 1998 and $16.0
million at December 31, 1997.
Revenues from continuing operations of $13.7 million for the second quarter
of 1998 equaled those of the prior 1998 quarter but were $3.5 million less than
in the second quarter of 1997. Revenues for the first half of 1998 were $27.4
million, down $10.8 million from the previous year. Premium income was down $5.5
million for the second quarter and $10.9 million for the first half of 1998
compared to the same 1997 periods. As discussed in the property and casualty
section below, several factors have contributed to the reduced property and
casualty insurance revenues, including more selective underwriting of CIC's
risks to reduce exposure to claims and increasing competition for commercial
business in California. Investment income, net of expenses, was down $0.9
million for the quarter and for the six months as a result of the decreasing
level of interest- and dividend-paying investments and a $0.3 million prior
period adjustment to investment income. Realized investment gains, which tend to
fluctuate widely from period to period, were $1.9 million above those of the
second quarter of 1997 and $0.5 million less than those of the first half of
1997. Nearly $2.0 million in investment gains were realized by GEC during the
second quarter of 1998 and $2.5 million during the six months. Revenues by
business segment are shown in the sections that follow.
The Company's ongoing operations are organized into five segments: portfolio
investing; surface, water, geothermal and mineral rights; property and casualty
insurance; medical professional liability insurance, and other operations. GEC's
portfolio investing results are shown separately below for consistency of
presentation and to simplify analysis since GEC's results were not consolidated
with those of PICO during the first half of 1997. Life and health insurance
operations are shown as discontinued operations based upon the pending sale of
those operations. See Note 2 of Notes to Consolidated Financial Statements,
"Discontinued Operations," for additional information.
11
<PAGE> 12
Revenues and income (loss) before taxes and minority interests from
CONTINUING OPERATIONS, by business segment, are shown in the schedules that
follow.
Operating Revenues--Continuing Operations:
- ------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C>
Portfolio Investing $(0.4) $ 0.6 $ 0.5 $ 3.8
Portfolio Investing--Global Equity Corporation 2.3 3.3
Surface, Water, Geothermal and Mineral Rights 0.4 0.6
Property and Casualty Insurance 10.4 15.1 21.1 31.7
Medical Professional Liability Insurance 0.5 1.4 1.2 2.4
Other 0.5 0.1 0.7 0.3
----- ----- ----- -----
Total Revenues-Continuing Operations $13.7 $17.2 $27.4 $38.2
===== ===== ===== =====
</TABLE>
Income (Loss) Before Taxes and Minority Interest--Continuing Operations:
- ------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions)
<S> <C> <C> <C>
Portfolio Investing $(1.1) $(0.6) $ 2.8
Portfolio Investing--Global Equity Corporation 1.5 1.5
Surface, Water, Geothermal and Mineral Rights (0.3) (0.7)
Property and Casualty Insurance 1.4 $2.0 1.0 2.9
Medical Professional Liability Insurance (0.3) 0.9 (0.4) 0.2
Other -- (0.3) (0.1) (0.5)
----- ---- ----- -----
Income Before Tax and Minority Interest $ 1.2 $2.6 $ 0.7 $ 5.4
===== ==== ===== =====
</TABLE>
PORTFOLIO INVESTING
- -------------------
Portfolio investing operations are principally conducted by PICO, Physicians
and GEC. GEC's portfolio investing results are shown separately in the section
following this one. Investment revenues and realized investment gains or losses
generated by Physicians are first allocated to the medical professional
liability ("MPL") insurance segment equal to the amount of loss reserve discount
accretion recorded during the period. The remainder is shown as portfolio
investing revenue.
Physicians and The Professionals Insurance Company ("PRO") ceased writing
MPL business in 1995. For a number of reasons, including the existence of an
experienced claims adjustment staff and Physicians' success in managing invested
assets, it was decided that it would be more advantageous to manage the assets
remaining at the cessation of writing the MPL insurance business than to sell
off or fully reinsure the reserves. As a result, assets are managed for the
maximum overall return, within prudent safety guidelines. Assets are not
designated on an individual security basis as either MPL or portfolio investing.
As a result, Physicians' invested assets
12
<PAGE> 13
produce income in both MPL and portfolio investing segments.
Revenues and income or losses generated by PICO through its own portfolio
are assigned entirely to portfolio investing. GEC's portfolio investing
operations exclude the results attributable to the surface, water, geothermal
and mineral rights segment.
Portfolio investing revenues for the first six months of 1998 excluding GEC,
which is stated separately below, amounted to approximately $0.5 million
compared to $3.8 million during the first six months of 1997. Excluding realized
investment gains, investment income from portfolio investing decreased $0.5
million during the first half of 1998 compared to the same 1997 period. This
decrease was due to reduced portfolio levels of interest- and dividend-paying
securities and a $0.3 million prior period adjustment of investment income
recorded in the second quarter, partially offset by an approximate $0.8 million
increase in investment income during the first quarter of 1998 relating to the
take down of a capitalized interest asset no longer needed. A realized
investment loss of $0.1 million was recorded during the first half of 1998
versus realized investment gains of $2.7 million during 1997, which included
more than $1.9 million in realized gains from the sale of the Company's
investment in Amvestors Financial Corporation. Additional revenues from realized
investment gains of $2.5 million and $2.0 million were recorded during the first
half and the second quarter of 1998, respectively, and are included in the
"Portfolio Investing--Global Equity Corporation" segment following.
During the second quarter of 1998, portfolio investing revenues declined
$1.0 million compared to the 1997 second quarter amount of $0.6 million. As
previously discussed, reduced portfolio levels and a $0.3 million reversal of
previously recorded interest income were primarily responsible for this decline.
Portfolio investing revenues (charges) are summarized below:
<TABLE>
PORTFOLIO INVESTING
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C>
Portfolio Investing Revenues (Charges):
- ---------------------------------------
Realized Investment Gains (Losses) $ -- $0.1 $(0.1) $2.7
Investment Income (Charges) (0.4) 0.5 0.6 1.1
----- ---- ----- ----
Portfolio Investing Revenues (Charges) $(0.4) $0.6 $ 0.5 $3.8
===== ==== ===== ====
</TABLE>
As shown in the following comparison, portfolio investing operations,
excluding those of GEC, contributed a loss of $0.6 million to pre-tax operating
income during the first six months of 1998 compared to income of $2.8 million
during the same 1997 period. As shown above, realized investment gains accounted
for approximately $2.8 million of this $3.4 million swing. Declining levels of
interest- and dividend-paying securities partially offset by the
previously-discussed $0.8 million reversal of a no longer needed capitalized
interest asset account made up the remaining difference.
Portfolio investing produced a pre-tax loss for the second quarter of 1998
of $1.1 million compared to a break even during the second quarter of 1997. Of
this $1.1 million variance between years, $0.3 million resulted from the
previously-discussed reversal of prior period interest income by Physicians. The
remaining $0.8 million decline in portfolio investing pre-tax income resulted
from the reduced portfolio of interest- and dividend-paying securities.
Investment income varies significantly from period to period, influenced
greatly by the timing of the realization of investment gains and losses.
Consequently, future results cannot and should not be predicted based upon past
performance alone.
13
<PAGE> 14
The breakdown of pre-tax operating income or loss from portfolio investing
operations follows:
<TABLE>
PORTFOLIO INVESTING
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C>
Portfolio Investing Income (Loss) Before Tax:
- ---------------------------------------------
PICO and Physicians $(1.1) $(0.2) $(0.6) $2.6
Equity in Unconsolidated Subsidiaries 0.2 0.2
----- ----- ----- ----
Portfolio Investing Pre-Tax Income (Loss) $(1.1) $ -- $(0.6) $2.8
===== ===== ===== ====
</TABLE>
PORTFOLIO INVESTING--GLOBAL EQUITY CORPORATION
- ----------------------------------------------
GEC is an international operating and investment company with offices in
Toronto, Ontario, Canada and in La Jolla, California. GEC holds a portfolio of
equity securities and convertible instruments in North American, Asian and
European companies, as well as operating ownership of a number of interests in
surface, water, geothermal and mineral rights in the western United States. Such
operations are reported below in a separate segment entitled "Surface, Water,
Geothermal and Mineral Rights," and are excluded from this discussion of GEC's
portfolio investments.
Following is a breakdown of GEC's portfolio investing revenues and pre-tax
income for the periods shown:
<TABLE>
PORTFOLIO INVESTING--GLOBAL EQUITY CORPORATION
<CAPTION>
Three Months Six Months
Ended Ended
June 30, June 30,
1998 1998
------------ ----------
(in millions)
<S> <C> <C>
Global Equity Corporation-Revenues:
- -----------------------------------
Realized Investment Gains $ 2.0 $ 2.5
Investment Income 0.3 0.6
Other Income 0.2
----- -----
Global Equity Corporation Revenues $ 2.3 $ 3.3
===== =====
GEC Income (Loss) Before Tax and Minority Interest:
- ---------------------------------------------------
Global Equity Corporation $ 1.8 $ 2.0
Equity in Unconsolidated Affiliates (0.3) (0.5)
----- -----
Income Before Tax and Minority Interest $ 1.5 $ 1.5
===== =====
</TABLE>
As shown above, GEC added $3.3 million and $2.3 million to 1998 first half
and second quarter revenues, respectively, including realized investment gains
of $2.5 million for the six months and $2.0 million for the quarter. As
discussed in the following section, GEC's subsidiaries engaged in surface,
water, geothermal and mineral rights activities contributed additional revenues
to the Company
14
<PAGE> 15
and an additional loss before tax and minority interest. As of June 30, 1998, on
a stand-alone basis, approximately 47% of GEC's assets consisted of investments
in debt and equity instruments and cash and cash equivalents. An additional 37%
represents surface, water, geothermal and mineral rights operations.
GEC's portfolio investing operations contributed $1.5 million in income to
both the first six months and the second quarter of 1998. As previously
discussed, these amounts included realized investment gains of $2.5 million and
$2.0 million for the first six months and second quarter, respectively.
SURFACE, WATER, GEOTHERMAL AND MINERAL RIGHTS
- ---------------------------------------------
Effective November 14, 1995, a wholly-owned subsidiary of GEC acquired all
the outstanding common stock of Vidler Water Company, Inc. ("Vidler"), a
Colorado corporation engaged in the water marketing and transfer business.
Vidler's business plan calls for Vidler to identify areas where water supplies
are in the greatest demand; to facilitate the transfer of water rights from
current ownership to Vidler; to develop water storage facilities; to reallocate
water to areas where needed through various distribution means; and to sell and
lease water supplies to municipalities, developers and others. Since its
acquisition, Vidler and its immediate parent company have purchased water rights
and related assets in Colorado, Nevada and Arizona. On April 23, 1997, GEC
acquired 74.77% of the common stock of NLRC and PICO acquired the remaining
25.23%. NLRC owns approximately 1.365 million acres of deeded land located in
northern Nevada, together with appurtenant water, geothermal and mineral rights.
NLRC is actively engaged in maximizing the property's value in relation to water
rights, mineral rights, geothermal resources, and land development.
As these subsidiaries of the Company were not part of the consolidated group
until GEC joined the consolidation in the third quarter of 1997, prior years'
results are not included with those of the Company. Revenues from continuing
operations included in the consolidated financial statements of the Company from
surface, water, geothermal and mineral rights generated by Vidler and NLRC were
approximately $0.6 million and $0.4 million during the first half and second
quarter of 1998, respectively. Revenues include land sales; lease of land,
principally for grazing purposes; water sales and leasing and other income.
Operating expenses exceeded revenues for both periods producing losses from
continuing operations before taxes and minority interests of $0.7 million and
$0.3 million for the six months and second quarter, respectively.
PROPERTY AND CASUALTY INSURANCE
- -------------------------------
Sequoia Insurance Company ("Sequoia") and CIC account for all of the ongoing
P&C insurance revenues. These companies write predominately light commercial and
multiple peril insurance coverage in central and northern California.
Sequoia and CIC are continually seeking ways to realize savings and take
advantage of synergies and to combine operations, wherever possible. To this
end, Sequoia and CIC consolidated their home office operations in Monterey,
California in July 1997.
As shown below, earned premiums made up most of the P&C revenues. Premiums
are earned pro-rata throughout the year according to the coverage dates of the
underlying policies.
15
<PAGE> 16
Revenues and pre-tax income from property and casualty operations for the
periods shown were as follows:
<TABLE>
PROPERTY AND CASUALTY INSURANCE
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
P & C Revenues: (in millions)
- ---------------
Earned Premiums - Sequoia $ 4.4 $ 8.0 $ 9.0 $15.3
Earned Premiums - Citation 4.3 5.7 8.8 12.9
Investment Income 1.4 1.2 2.8 2.9
Realized Investment Gains 0.1 0.1 0.2
Other 0.2 0.2 0.4 0.4
----- ----- ----- -----
Total P&C Revenues $10.4 $15.1 $21.1 $31.7
===== ===== ===== =====
P & C Income Before Taxes:
- --------------------------
Sequoia Insurance Company $ 0.7 $ 1.5 $ 0.4 $ 2.0
Citation Insurance Company 0.7 0.5 0.6 0.9
----- ----- ----- -----
Total P&C Income Before Tax $ 1.4 $ 2.0 $ 1.0 $ 2.9
===== ===== ===== =====
</TABLE>
Total P&C insurance revenues for the first six months of 1998 were $21.1
million, down $10.6 million from the first half of 1997. As shown above,
declining earned premiums accounted for $10.4 million of this decrease.
Principally as a result of continuing increased underwriting selectivity of
CIC's business and aggressive competition for commercial multiple peril business
in California, Sequoia's and CIC's earned premiums for the first six months of
1998 were down $6.3 and $4.1 million, respectively, from those of the same 1997
period. Much of the decline in Sequoia's earned premiums resulted from a
reinsurance pooling agreement effective January 1, 1998 which provides for the
pooling of all insurance premiums, losses, loss adjustment expenses ("LAE") and
administrative and other insurance operating expenses between Sequoia and CIC.
The reinsurance pooling agreement calls for these items to be split equally
between the two companies. All new P&C insurance applications and policies
coming up for renewal are now being processed through Sequoia and subjected to
Sequoia's underwriting standards which are much tighter than those previously
employed by CIC. As a result, a significant portion of CIC's prior book of
business has not been renewed.
As compared to the second quarter of 1997, second quarter 1998 P&C revenues
of $10.4 million declined $4.7 million. This $4.7 million decline included a
$5.0 million reduction in earned premiums and a partially offsetting $0.3
million increase in investment income and realized investment gains. As
discussed above, all of CIC's business is now being processed through Sequoia
and is subjected to much tighter underwriting standards resulting in fewer new
policies and fewer renewals than written in the past by CIC. In addition,
competition within California for commercial P&C insurance business continues at
a heightened level.
P&C insurance operations provided $1.0 million in income before taxes for
the first six months of 1998 compared to $2.9 million during the first half of
1997. As shown above, $1.6 million of this $1.9 million decline was attributable
to Sequoia and $0.3 million arose from CIC. Income before taxes for the first
six months of 1997 was greater than during the first half of 1998 due to the
higher level of 1997 earned premiums, lower loss and LAE and expense ratios (see
industry ratios below), and approximately $0.5 million more in realized
investment gains. The recent "El Nino" phenomenon also had a significant impact
on the first six months of 1998. Sequoia and CIC management estimates the cost
of storm losses incurred by the companies as a result of the 1998 El Nino
phenomenon to be approximately $1.0 million.
P&C insurance pre-tax income for the second quarter of 1998 of $1.4 million
was approximately $0.6 million less than the $2.0 million recorded during the
second quarter of 1997. As previously discussed, P&C insurance premiums earned
during the second quarter of 1998 were down $5.0 million from those of the same
1997quarter, while corresponding losses and LAE declined by $4.1 million,
accounting for $0.9 million of the $0.6 million change in pre-tax income between
the two quarters. Partially offsetting this net $0.9 million decline, investment
income and realized investment gains increased approximately $0.3 million. As
shown above, Sequoia's pre-tax income decreased approximately $0.8 million
during the 1998 second quarter as compared to the 1997 second quarter, while
CIC's increased $0.2 million. Much of CIC's improvement resulted from the
reinsurance pooling agreement previously discussed, producing a corresponding
decline in Sequoia's individual company results.
16
<PAGE> 17
Industry ratios as determined on the basis of generally accepted accounting
principles ("GAAP") for CIC for the periods shown were as follows:
CIC'S GAAP INDUSTRY RATIOS
--------------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
Loss and LAE Ratio 64.4% 95.4% 75.0% 83.8%
Underwriting Expense Ratio 43.6% 13.9% 40.5% 26.0%
----- ----- ----- -----
Combined Ratio 108.0% 109.3% 115.5% 109.8%
===== ===== ===== =====
Industry ratios as determined on a GAAP basis for Sequoia for the periods
shown were as follows:
SEQUOIA'S GAAP INDUSTRY RATIOS
------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
Loss and LAE Ratio 51.9% 46.7% 67.8% 58.9%
Underwriting Expense Ratio 47.1% 39.7% 44.1% 37.9%
---- ---- ----- ----
Combined Ratio 99.0% 86.4% 111.9% 96.8%
==== ==== ===== ====
Loss and LAE Ratios, Underwriting Expense Ratios and Combined Ratios are
calculated using net earned premiums as a denominator. Theoretically, a combined
ratio of less than 100% indicates that the insurance company is making a profit
on its base insurance business before consideration of investment income,
realized investment gains or losses, extraordinary items, taxes and other
non-insurance items.
The resulting increase in storm losses from the recent "El Nino" phenomenon
was the principal cause of the increase in the loss and LAE ratios for Sequoia
during the first six months of 1998 as compared to 1997. The improvement in
CIC's loss and LAE ratios during the second quarter and first six months of 1998
was due to the reinsurance pooling agreement with Sequoia effective January 1,
1998 (Sequoia's loss and LAE ratios were much better than those of CIC prior to
the reinsurance pooling agreement) and an improvement in CIC's own book of
business resulting from subjecting CIC's business to the more stringent risk
selection standards of Sequoia beginning in 1997. The increase in the
underwriting expense ratios of both Sequoia and CIC during the second quarter
and first six months of 1998 as compared to those of the same 1997 periods
principally resulted from fixed overhead expenses being spread over a smaller
1998 premium base. The increase in Sequoia's loss and LAE ratio for the three
months ended June 30, 1998, as compared to 1997 was principally a result of
fixed claims overhead expenses being divided by a smaller premium base.
Sequoia and CIC continue to identify and take advantage of synergies and
other cost savings and to lessen the companies' exposure to undue risk. However,
there can be no assurance that Sequoia and CIC will be successful in reducing
their policies with higher loss ratios or that their loss ratios and/or expense
ratios will improve in the future.
MEDICAL PROFESSIONAL LIABILITY OPERATIONS
- -----------------------------------------
Physicians' and PRO's MPL insurance business was sold to Mutual Assurance
Inc. ("Mutual") on August 28, 1995. All new and renewal MPL insurance business
written between July 16 and December 31, 1995 was 100% reinsured by Mutual.
Physicians and PRO ceased writing new and renewal MPL insurance policies
effective January 1, 1996. Physicians continues to administer and adjust the
remaining claims and LAE reserves. Based upon careful analysis of various
alternative scenarios for handling the runoff of the remaining claims reserves,
management determined that the best option was to process the existing claims
internally with existing staff, rather than through a third party administrator
or through an outright sale of the claims and LAE reserves. In addition, it is
17
<PAGE> 18
expected that shareholders' equity may be better served by retaining the
investments necessary to fund the payment of these claims and LAE reserves,
managing them along with the rest of the Company's investment holdings, as
opposed to selling or fully reinsuring these reserves and giving up the
corresponding funds. However, there can be no assurance that funds generated by
such retained investments will exceed claims. Accordingly, although the
companies effectively ceased writing MPL insurance in 1995, MPL is treated as a
separate business segment of continuing operations due to the continued
management of claims and associated investments.
Revenues and pre-tax income or loss from MPL operations included the
following:
MEDICAL PROFESSIONAL LIABILITY INSURANCE
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions)
MPL Revenues:
- -------------
Earned Premiums $(0.2) $0.3 $(0.2) $0.3
Investment Income, Net of Expenses 0.7 1.1 1.4 2.1
----- ---- ----- ----
MPL Revenues $ 0.5 $1.4 $ 1.2 $2.4
===== ==== ===== ====
MPL Income (Loss) Before Tax: $(0.3) $0.9 $(0.4) $0.2
- ----------------------------- ===== ==== ===== ====
Since the withdrawal of Physicians and PRO from their personal automobile
and homeowners lines of business in the late 1980's, MPL has, for all intents
and purposes, been these two companies' only sources of insurance premiums.
MPL insurance revenues amounted to $1.2 million for the first six months of
1998, just half of the $2.4 million recorded during the first six months of
1997. As shown above, approximately $0.5 million of this $1.2 million swing
resulted from adjustments to premiums earned on policies written in prior years.
The remaining $0.7 million decline was attributable to investment income.
Investment income decreased compared to 1997 principally as a result of the
reduced level of MPL claims and the associated reduced level of invested assets
allocated to the MPL insurance business segment. MPL revenues for the second
quarter of 1998 were $0.5 million compared to $1.4 million during the same 1997
quarter.
MPL operations produced a pre-tax loss of approximately $0.4 million during
the first six months of 1998 compared to $0.2 million in income during the same
1997 period. Premium adjustments as shown above accounted for $0.5 million of
this $0.6 million swing between years. The second quarter of 1998 resulted in a
pre-tax loss of $0.3 million compared to $0.9 million in income from the same
1997 quarter. Premium adjustments and reduced investment income as shown above
accounted for $0.9 million of this difference. Increased expenses provided the
remainder of this $1.2 million swing. Although second quarter MPL expenses were
in line with expenses from previous quarters, second quarter 1997 expenses were
abnormally low due to a prior period expense reversal recorded during that
period.
Physicians' claims department staff continues to process the runoff of the
remaining MPL loss and loss adjustment expense claims which is progressing
routinely. At June 30, 1998, MPL reserves totaled approximately $ 64.3 million,
net of reinsurance and discount. This compares to $77.5 million at December 31,
1997. MPL loss and LAE reserves continue to decline as a result the disposition
of claims.
MPL INSURANCE -- LOSS AND LAE RESERVES
June 30, December 31,
1998 1997
-------- ------------
(in millions)
Direct Reserves $106.1 $121.4
Ceded Reserves (33.9) (34.8)
Discount of Net Reserves (7.9) (9.1)
------ ------
Net MPL Reserves $ 64.3 $ 77.5
====== ======
18
<PAGE> 19
Although MPL reserves are certified annually by two independent actuaries,
as required by Ohio insurance regulations, significant fluctuations in reserve
levels can occur based upon a number of variables used in actuarial projections
of ultimate incurred losses and LAE.
OTHER OPERATIONS
- ----------------
Other operations consist principally of the operations of PICO's subsidiary,
Summit Global Management, Inc. ("Summit"). Also included are the activities of
Raven Development Company ("Raven"), a real estate development subsidiary which
is winding down its operations, and CLM Agency, Inc ("CLM"), an independent
California insurance agency with minimal activity.
Revenues and pre-tax income (loss) from other operations are summarized
below for the periods shown:
<TABLE>
OTHER OPERATIONS
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C>
Revenues from Other Operations:
- -------------------------------
Investment Management Services $ 0.3 $ 0.3 $ 0.6 $ 0.6
Less: Intercompany Portfolio Mgmt. Charges (0.1) (0.3) (0.2) (0.4)
Other 0.3 0.1 0.3 0.1
----- ----- ----- -----
Revenue from Other Operations $ 0.5 $ 0.1 $ 0.7 $ 0.3
===== ===== ===== =====
Other Operations-Income (Loss) Before Tax:
- ------------------------------------------
Investment Management Services $ 0.1 $ 0.2
Less: Intercompany Portfolio Mgmt. Charges $(0.1) (0.3) $(0.2) (0.3)
Other 0.1 (0.1) 0.1 (0.4)
----- ----- ----- -----
Other Operations-Income (Loss) Before Tax $ -- $(0.3) $(0.1) $(0.5)
===== ===== ===== =====
</TABLE>
Revenues from other operations increased $0.4 million for the first six
months of 1998 to $0.7 million compared to $0.3 million during the same 1997
period. These revenues for 1998 included approximately $0.4 million in Summit's
investment management fees, excluding those billed to related parties, compared
to $0.2 million during the first half of 1997. In addition, revenues included
$0.1 million in real estate sales generated by Raven during the first six months
of both 1998 and 1997. The first six months of 1998 also included $0.2 million
in commission income from prior periods recorded by CLM in the second quarter.
Revenues from other operations for the second quarter of 1998 of $0.5 million
increased $0.4 million over the second quarter of 1997 due to increased
investment management fees and the CLM commission income. No commission income
was recorded by CLM during the comparable 1997 periods.
Pre-tax, other operations showed a $0.1 million loss for the first six
months and broke even for the second quarter of 1998 compared to a $0.5 million
loss during the first half of 1997 and a $0.3 million loss during the second
quarter of 1997. The improvement in the performance of other operations during
the first six months of 1998 compared to 1997 was attributable to approximately
$0.1 million in income from CLM in 1998 versus none in 1997 and a small amount
of income from Stonebridge Partners AG (a Swiss affiliate which was deactivated
in 1997) compared to a $0.3 million loss during the first six months of 1997.
Income from Summit declined slightly during the first six months of 1998 due to
increased operating expenses. The improvement in second quarter 1998 operations
as compared to 1997 of $0.4 million was due to approximately $0.1 million in
income from CLM in 1998 compared to none in 1997, an approximate $0.1 million
decrease in Summit's income due to increased expenses in 1998, and a $0.4
million improvement in income from other activities, including Raven and
Stonebridge Partners AG.
DISCONTINUED OPERATIONS
- -----------------------
Discontinued operations consist of the operations of APL. APL, Physicians'
wholly-owned life insurance subsidiary, produced
19
<PAGE> 20
revenues of $4.4 million and pre-tax income of approximately $0.2 million during
the first half of 1998. This compares to $2.8 million in revenues and pre-tax
income of $0.1 million in 1997. Second quarter 1998 revenues were $2.2 million
versus $1.2 million in 1997. Pre-tax income for the second quarter of 1998 was
$0.1 million compared to a $0.1 million loss in 1997.
APL has been concentrating its efforts on its unique critical illness
product "Survivor Key" during the past several years. This life insurance
product combines the benefits of a lump sum cash payout upon the diagnosis of
certain critical illnesses with a death benefit. Gross written premiums for
Survivor Key continually increased from 1994 through 1997.
On June 16, 1997, Physicians announced the signing of a binding agreement to
sell APL subject to certain closing conditions including regulatory approval,
which is still pending. See Note 2 to Consolidated Financial Statements,
"Discontinued Operations," regarding the pending sale of APL and its wholly
owned subsidiary.
The net assets of discontinued operations are shown as one line on the
balance sheets as net assets of discontinued operations.
LIQUIDITY AND CAPITAL RESOURCES --JUNE 30, 1998 AND 1997
PICO is a holding company whose assets principally consist of the stock of
its subsidiaries. The Company continually evaluates its existing operations and
searches for new opportunities in order to maximize shareholder value. Because
of this business strategy, the Company's cash needs and those of its
subsidiaries vary considerably from period to period. At times cash may not be
readily available when an opportunity arises requiring the liquidation of
securities, advances from subsidiaries, direct purchases of investments by
subsidiaries, or the borrowing of funds. It may also become necessary and/or
advantageous for the Company to offer stock or debt through public offerings
from time to time. At times the Company may come to possess cash balances in
excess of cash needs. Such cash is invested to provide maximum returns within
the constraint of remaining liquid enough to meet expected future cash
requirements. The Company's principal sources of funds are its available cash
resources, liquidation of assets, bank borrowings, public financings, management
and other fees, and borrowings.
Each company within the group is expected to be able to stand on its own
and cover its own cash flow needs without the need for long-term borrowing or
additional capital infusions from within the Company, with the possible
exceptions of additional capital requirements of Sequoia and CIC to maintain or
improve their Best ratings or to meet minimum capital requirements. Physicians
contributed an additional $5.5 million to Sequoia in 1997 for this purpose.
Nevertheless, from time to time funds may be needed to cover short-term
operating shortfalls (i.e. timing differences) or to expand the Company's
operations (principally through investments and/or acquisitions) both at the
subsidiary level and at the parent company level. Additional funding may be
generated through, among other things, disposition or transfer of existing
assets, issuance of additional capital stock through stock offerings, or through
a public debt offering or other borrowing.
Insurance has always been and continues to be a major source of funds for
the Company. Physicians initially provided virtually all the funding necessary
for the Company to execute its revised business strategy. Since the acquisition
of Sequoia in 1995, management has made significant strides in improving
Sequoia's operating performance. Management has taken a number of steps to
improve CIC's profitability and cash flow since its acquisition in November
1996, including the sale of its workers' compensation business and its
subsidiary, Citation National Insurance Company, in June 1997. Physicians' cash
flows have had the greatest impact on the consolidated group during the past
several years and should continue to do so for the foreseeable future, due to
the wind down of the MPL business. Physicians, Sequoia and Citation had cash and
cash equivalent balances at June 30, 1998 of $ 40.5 million. This compares to
$46.5 million at December 31, 1997. A large portion of Sequoia's and Citation's
investments is kept in the form of cash and cash equivalents to pay claims and
expenses, due to the relatively short lag period between the receipt of premiums
and payment of claims in the commercial property and casualty insurance business
lines written by those companies.
As a result of ceasing to write MPL insurance, Physicians' operating cash
flows have become negative and should continue to be negative for the
foreseeable future. Positive cash flows from other sources within Physicians,
primarily reinsurance recoveries, and the sale of invested assets may partially
or fully offset such uses of cash. Major cash outflows most likely will include
the funding of claims and loss adjustment expenses, investment purchases, and
operating costs.
As of December 31, 1995, when Physicians and PRO ceased writing MPL,
Physicians and PRO reported discounted unpaid loss and loss adjustment expense
reserves of approximately $136.2 million, net of reinsurance. Based upon
projections from past actuarial information, more than 75%, or $102 million, of
these reserves is expected to be settled by the end of the year 2000. Past
experience
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indicates that funding requirements should be greatest in the first through
third years (1996 through 1998), accounting for more than 60% of the total
eventual reserve and loss adjustment expense payments. As expected, loss and LAE
reserves at December 31, 1996 declined more than 17.1% to $112.9 million after
payment of more than $30 million in claims and LAE. During 1997, MPL reserves
decreased $35.4 million, or 31.4%, to $77.5 million as of December 31, 1997
after payment of more than $38 million in losses and LAE. MPL reserves declined
$13.2 million during the first six months of 1998 to $64.3 million. This
represents more than a 50% decline in net discounted loss and LAE reserves since
December 31, 1995.
The Company's insurance subsidiaries attempt to structure the duration of
invested assets to match the cash flows required to settle the related unpaid
claims liabilities. Invested assets provide adequate liquidity to fund projected
claims and LAE payments for the coming years. The Ohio and California Insurance
Departments monitor and set guidelines for the insurance companies' investments.
The Ohio and California Insurance Departments also set minimum levels of
policyholder capital and surplus and monitor these levels through various means.
To the extent that funds necessary for settling claims and paying operating
expenses are not provided by existing cash and cash equivalents, investment
income, reinsurance recoveries, and rental and other income, then invested
assets will be liquidated. Short term and fixed maturity investments are managed
to mature according to projected cash flow needs. Equity securities will be
converted to cash as additional funds are required, with an anticipated maximum
liquidation lead-time of approximately six months.
At June 30, 1998, Physicians' and PRO's investment portfolios on a
stand-alone basis contained invested assets of approximately $122.7 million,
plus cash and cash equivalents of $4.3 million. These invested assets are in
excess of the present value of expected future payouts of losses and loss
adjustment expenses (discounted at 4%) of approximately $64.3 million.
Physicians is in the process of selling APL, its life and health insurance
subsidiary. When sold, the proceeds from this sale will provide additional
available cash.
Management hopes to maximize the return on all assets, including those
needed to fund the eventual wrap-up of the MPL reserves through, among other
things, value investing and managing the invested assets internally rather than
liquidating assets to pay a third party to oversee the runoff of the existing
claims. Management also elected to handle the runoff of the MPL claims
internally to continue to maintain a high standard of claims handling and to
maximize shareholder values. While management expects that certain of the
Company's current and future investments may increase in value, offsetting some
of the decline in assets during the period of runoff, the impact of future
market fluctuations on the value of the Company's invested assets cannot be
accurately predicted. Although assets will be managed to mature or liquidate
according to expected payout projections, at times, in response to abnormal
funding demands, some invested assets may need to be sold at inopportune times
during periods of decline in the stock market or declines in the market values
of the individual securities. Such forced sales are expected to occur
infrequently and only under extreme circumstances; however, this cannot be
guaranteed.
The Company's active P&C insurance subsidiaries, Sequoia and CIC, should
provide positive cash flows from operations once industry combined ratios (See
the discussion of industry ratios under "Property and Casualty Insurance.")
stabilize below 100% and premium writings remain at a constant or increasing
level. At times it may be necessary to liquidate invested assets to provide the
additional funds necessary to cover operating cash needs. Summit has been
producing positive cash flows from operations and is expected to continue to do
so in the future by producing investment management fees in excess of operating
costs.
A significant portion of the Company's assets (approximately 18.5% as of
June 30, 1998) consist of surface, water, geothermal and mineral rights. Since
the acquisitions of Vidler and NLRC by GEC and PICO, administrative and
operating expenses have exceeded their on-going revenues. The Company
anticipates that Vidler and NLRC will continue to incur operating losses from
their operations until such time as they are able to receive significant
revenues from development of projects, including water storage and supply
programs, leases, royalties, and property sales. In addition to cash necessary
to fund operating activities, Vidler and NLRC are expected to require additional
funding for growth through acquisitions of additional surface, water, geothermal
and mineral rights and other activities. These additional cash needs may require
funding from sources outside the Company in the form of debt or equity.
As shown in the accompanying Consolidated Statements of Cash Flows,
operating activities used cash flows of $3.0 million during the first half of
1998 compared to $23.8 million used during the same 1997 period. The main
sources of negative cash flow from operating activities for the first six months
of 1998 were MPL operations and P&C operations. Physicians and PRO produced
negative cash flow from operations of approximately $6.4 million due to the
payment of claims and operating expenses in excess of investment and other
income. Sequoia and CIC, principally as a result of reduced premium levels,
experienced approximately $2.4 million in operating cash outflows during the
same period. These amounts compare to net cash outflows from operations during
the first half of 1997 of $22.9 million from Physicians and PRO and $2.6 million
from Citation and Sequoia. GEC provided positive cash
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flows from operating activities for the first half of 1998 of approximately $8
million, but was not included in the 1997 consolidated financial statements. The
principal sources of the favorable $20.8 million improvement in cash flow from
operations between the first half of 1998 and 1997 were the $8 million added by
GEC and a $12.2 million reduction in the amount of federal income taxes paid in
1998 as compared to 1997. Federal income taxes paid in the first half of 1997
principally arose from realized investment gains recorded in the fourth quarter
of 1996. Federal income tax deposits on 1997 taxable income were for the most
part paid in 1997 since the large realized investment gain from the sale of the
Company's Resource America Inc. common stock occurred in the third quarter of
1997.
Cash provided by investing activities during the first half of 1998 was $1.4
million compared to $21.0 million during the comparable 1997 period. The higher
level of cash provided by investing activities in 1997 resulted from the sales
of mature investments. Since that time, the Company has made significant
investments in surface, water, geothermal and mineral rights. These assets are
still in the process of development and, therefore, did not provide realized
investment gains or losses during the first half of 1998.
No cash was provided or used by financing activities during the first half
of 1998, compared to cash used during the first half of 1997 of $2.9 million.
On May 5, 1997, PICO agreed to provide a line of credit to PC Quote. The
initial credit was for $1 million with repayment due September 30, 1997. The
credit has since been increased to $3,250,000 with repayment due December 31,
1998.
At June 30, 1998, the Company had no significant commitment for future
capital expenditures, other than in the ordinary course of business and as
discussed herein. Vidler has committed approximately $6.3 million in deposits
and options to acquire additional surface, water, geothermal and mineral rights.
The Company has also committed to maintain Sequoia's capital and statutory
policyholder surplus level at a minimum of $7.5 million. Sequoia was well above
this level as of December 31, 1997. The Company has also committed to make every
attempt to maintain Sequoia's Best rating at or above the "B++" (Very Good)
level, which may at some time in the future require additional capital infusions
into Sequoia by the Company.
As discussed in Note 7 to Notes to Consolidated Financial Statements,
"Proposed Business Combination," PICO and GEC have announced their intent to
proceed with a "Plan of Arrangement" whereby GEC shareholders would receive
.4628 of a share of PICO for each share of GEC ("the Business Combination"). GEC
would then become a wholly-owned subsidiary of PICO. While the Plan of
Arrangement, if approved by shareholders and regulatory bodies, will
significantly increase the number of PICO shares outstanding and the number of
shares treated as treasury shares, cash resources should only be affected by the
expenses to implement the Business Combination and any cash needed by GEC to pay
dissenting shareholders for their shares.
The Company continues to address the issue of the compatibility of systems
software with the year 2000. Insurance premium, loss and statistical systems are
particularly critical to the successful operation of the insurance companies. It
is believed that the majority of these systems, which are different among the
various insurance companies, currently correctly interpret the year 2000. The
MPL insurance systems are known, however, to be incompatible. Projects are under
way to test all insurance systems and correct the logic of these systems to make
them compatible with the year 2000. Other operating systems consist of various
accounting, billing, disbursement, and tracking systems which may or may not be
compatible with the year 2000. For the most part, these systems are in the
process of being updated by their vendors. Tests will be run to ensure the
compatibility of these systems, also. Management expects these projects to be
completed by the end of 1998. In addition to resources expended in researching
and correcting systems, additional outlays may be necessary to purchase and
install new software compatible with the year 2000. The estimated costs of this
project are undetermined at this time.
CAPITAL RESOURCES
- -----------------
The Company's principal sources of funds are its available cash resources,
operating cash flow, liquidation of non-essential investment holdings,
borrowings, public and private debt and equity offerings, funds from
consolidated tax savings, and investment management and other fees. At June 30,
1998, the Company had $54.4 million in cash and cash equivalents compared to
$56.4 million at December 31, 1997.
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ADDITIONAL RISK FACTORS AND UNCERTAINTIES
- -----------------------------------------
The statements contained in this report that are not purely historical,
including statements regarding the Company's expectations, beliefs, intentions,
plans or strategies, are forward-looking statements. These forward -looking
statements are subject to risks and uncertainties, including the risks and
uncertainties discussed below. All forward-looking statements included in this
document are based upon information available to the Company on the date hereof,
and the Company assumes no obligation to update any such forward-looking
statements. Readers are cautioned not to place undue reliance upon any such
forward-looking statements. In addition to the risks and uncertainties discussed
in the preceding sections of "Management's Discussion and Analysis of Financial
Condition and Results of Operations," the following risk factors are also
inherent in the Company's business operations:
CHANGE IN STRATEGIC DIRECTION. In late 1994, the Company began the process
of changing its strategic direction from the operation of an MPL insurance
business to investing in businesses which management believes are undervalued or
will benefit from additional capital, restructuring of operations or management
or improved competitiveness through operational efficiencies with existing
operations. Accordingly, in January 1995, the Company reactivated its investment
advisory subsidiary, Summit; in August 1995 acquired Sequoia and entered new
lines of property and casualty insurance; in August 1995 sold its MPL insurance
business; in September 1995 purchased 38.2% of GEC, a Canadian corporation
active in international investments, agricultural services, water rights, and
other businesses; in November 1996 acquired control of Citation Insurance Group
("CIG") pursuant to the Merger; in April 1997 acquired 25.23% ownership of
Nevada Land and Resource Company which owns approximately 1,365,000 acres of
deeded land in northern Nevada; in June 1997 sold its workers' compensation
business; and in July and August 1997, increased its ownership in GEC to 51.17%.
On May 8 and June 19, 1998, the PICO and GEC jointly announced their intentions
to combine through a "Plan of Arrangement". Due to the Company's limited
experience in the operation of the businesses of each of these subsidiaries,
which currently constitute a substantial portion of the Company's operations,
there can be no assurance as to the future operating results of the Company or
acquired businesses of the Company.
The Company will continue to make selective investments for the purpose of
enhancing and realizing additional value by means of appropriate levels of
shareholder influence and control. This could involve the restructuring of the
financing or management of the entities in which the Company invests and
initiating and facilitating mergers and acquisitions. This business strategy has
been implemented gradually during the past three to four years. For this reason
and others, including but not limited to the variability of the securities
markets and the uncertainties associated with trying to predict future results
based upon past performance, PICO's historical financial statements are not
indicative of the possible future results of this new business strategy.
Shareholders are relying on the experience and judgment of the Company's
management to locate, select and develop new acquisition and investment
opportunities. There can be no assurance that sufficient opportunities will be
found or that this business strategy will be successful. Failure to successfully
implement this strategy may negatively impact the business and financial
condition and results of operations of the Company.
Application of the Company's new strategy since 1995 has resulted in a
greater concentration of equity investments held by the Company. Market values
of equity securities are subject to changes in the stock market, which will
cause the Company's shareholders' equity to fluctuate from period to period. At
times the Company may hold securities of companies for which no market exists or
which may be subject to restrictions on resale. As a result, periodically, a
portion of the Company's assets may not be readily marketable, which would
restrict the Company's ability to liquidate its interests in these entities.
PICO and GEC through NLRC and Vidler have committed a significant portion
of their assets to surface, water, geothermal and mineral rights. There can be
no assurance that the market value of these assets will increase over time. In
addition, there are a number of risks associated with the successful development
of the Company's and GEC's water rights business including, but not limited to,
water price volatility; environmental concerns; political opposition;
uncertainty of future demand / revenues; concentration of revenue sources in a
limited number of assets; and dependence on key personnel. There can be no
assurance that Vilder and NLRC will be successful in developing their surface,
water, geothermal and mineral rights assets.
DEPENDENCE ON KEY PERSONNEL. The Company has several key executive officers,
the loss of whom could have a significant adverse effect on the Company. In
particular, Ronald Langley, PICO's Chairman, and John R. Hart, PICO's President
and Chief Executive Officer, play key roles in the Company's and GEC's
investment decisions. Messrs. Langley and Hart have entered into employment
agreements with PICO and a wholly-owned subsidiary of GEC as of December 31,
1997, all for a period of four years. Messrs. Langley and Hart are key to the
implementation of the Company's new strategic focus, and the ability of the
Company
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to implement its current strategy is dependent on its ability to retain the
services of Messrs. Langley and Hart.
RISKS REGARDING PHYSICIANS; CONTINUING MPL LIABILITY. In August 1995, the
MPL insurance business and related liability insurance business of Physicians
and PRO were sold. Physicians and PRO retained all assets and liabilities
related to insurance policies written prior to the sale of the recurring book of
business. Physicians and PRO will continue to administer claims and loss
adjustment expenses under MPL insurance policies issued or renewed prior to July
16, 1995. Cash flow needed to fund the day-to-day operations and the payment of
claims and claims expenses will be provided by investment income, lease income,
and proceeds from the sale or maturity of securities.
Under the terms of the Company's MPL policies, these policies have an
extended reporting period for claims. Under Ohio law the statute of limitations
is one year after the cause of action accrues. Also, under Ohio law there is a
four-year statutory time bar; however, this has been construed judicially to be
unconstitutional in situations where the plaintiff could not have reasonably
discovered the injury in that four-year period. Claims of minors must be brought
within one year of the date of majority. As a result, some claims may be
reported a number of years following the expiration of the MPL policy period.
Physicians and PRO have established reserves to cover losses and loss adjustment
expense on claims incurred under the MPL policies issued or renewed to date
including not only those claims reported to date, but also those incurred but
not yet reported. The amounts established and to be established by Physicians
and PRO for loss and LAE reserves are estimates of future costs based on various
assumptions and, in accordance with Ohio law, have been discounted (adjusted to
reflect the time value of money). These estimates are based on actual and
industry experience and assumptions and projections as to claims frequency,
severity and inflationary trends and settlement payments. In accordance with
Ohio law, Physicians and PRO annually obtain a certification from an independent
actuary that respective reserves for losses and LAE are adequate. Physicians and
PRO also obtain a concurring actuarial opinion.
Physicians' and PRO's reserves for losses and LAE for prior years developed
favorably in 1994, and these reserves were decreased by $12.7 million in 1994.
Reserves also developed favorably in 1995; however, accretion of reserve
discount exceeded the amount of favorable development and retroactive
reinsurance, resulting in a $3.2 million increase in liabilities for prior
years' claims. As a result of continued favorable claims experience, reserves
for prior years' claims were further reduced in the first and fourth quarters of
1996. However, based upon actuarial indications from data through June 30, 1997,
Physicians' MPL claims reserves were increased by $2 million during the third
quarter of 1997 due to somewhat deteriorated claims experience during the first
six months of 1997. At the same time, favorable development of Physicians' and
PRO's discontinued personal lines reserves (automobile, homeowner, etc.) allowed
reserve reductions of $750,000 during the third quarter of 1997. Due to the
inherent uncertainties in the reserving process there is a risk that Physicians'
and PRO's reserves for losses and LAE could prove to be inadequate which could
result in a decrease in earnings and shareholders' equity. Adverse reserve
development can reduce statutory policyholders' surplus or otherwise limit the
growth of such policyholders' surplus and, correspondingly, shareholders'
equity.
LOSS RESERVE EXPERIENCE. The inherent uncertainties in estimating loss
reserves are greater for some insurance products than for others, and are
dependent on the length of the reporting tail associated with a given product,
the diversity of historical development patterns among various aggregations of
claims, the amount of historical information available during the estimation
process, the degree of impact that changing regulations and legal precedents may
have on open claims, and the consistency of reinsurance programs over time,
among other things. Because MPL and commercial casualty claims may not be fully
paid for several years or more, estimating reserves for such claims can be more
uncertain than estimating reserves in other lines of insurance. As a result,
precise reserve estimates cannot be made for several years following a current
accident year for which reserves are initially established.
There can be no assurance that the insurance subsidiaries in the group have
established reserves adequate to meet the ultimate cost of losses arising from
such claims. It has been necessary, and will over time continue to be necessary,
for the insurance companies to review and make appropriate adjustment to
reserves for estimated ultimate losses, LAE, future policy benefits, claims
payables, and annuity and other policyholder funds. To the extent reserves prove
to be inadequate, the insurance companies would have to adjust their reserves
and incur a charge to earnings, which could have a material adverse effect on
the financial results of the Company.
REINSURANCE RISKS. Prior to the June 30, 1997 sale of Citation National
Insurance Company ("CNIC"), all of CNIC's existing insurance risks and claims
liabilities, except for those insuring workers' compensation, were transferred
to CIC through reinsurance treaties in order to effect the sale of CNIC and the
Company's workers' compensation business. As with other P & C insurers, CIC's
and Sequoia's operating results and financial condition can be adversely
affected by volatile and unpredictable natural and man-made
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disasters, such as hurricanes, windstorms, earthquakes, fires, and explosions.
CIC and Sequoia generally seek to reduce their exposure to such events through
individual risk selection and the purchase of reinsurance. CIC's and Sequoia's
estimates of their exposures depend on their views of the possibility of a
catastrophic event in a given area and on the probable maximum loss to the
insurance companies should such an event occur. While CIC and Sequoia attempt to
limit their exposure to acceptable levels, it is possible that an actual
catastrophic event or multiple catastrophic events could significantly exceed
the probable maximum loss previously assumed, resulting in a material adverse
effect on the financial condition and results of operations of the Company.
The future financial results of the insurance subsidiaries could be
adversely affected by disputes with their respective reinsurers with respect to
coverage and by the solvency of such reinsurers.
RISKS REGARDING SUMMIT GLOBAL MANAGEMENT. Summit is registered as an
investment adviser in California, Florida, Kansas, Louisiana, Oregon, Virginia
and Wisconsin, as well as with the SEC. Summit must file periodic reports with
the SEC and must be available for periodic examination by the SEC. Summit is
subject to Section 206 of the Investment Advisers Act of 1940, which prohibits
material misrepresentations and fraudulent practices in connection with the
rendering of investment advice, and to the general prohibitions of Section 208
of such Act. If Summit were to violate the Investment Advisers Act prohibitions,
it would risk criminal prosecution, SEC injunctive actions and the imposition of
sanctions ranging from censure to revocation of registration in an
administrative hearing.
The investment adviser business is highly competitive. There are several
thousand investment advisers registered in the states in which Summit does
business, many of which are larger and have greater financial resources than
Summit. There can be no assurance that Summit will be able to compete
effectively in the markets that it serves.
GLOBAL INVESTMENT VOLATILITY. As a result of global diversification,
investment decisions already made and which may be made in the future,
particularly with regard to GEC, the Company's revenues may be adversely
affected by economic, political and governmental conditions in countries where
it maintains investments or operations, such as volatile interest rates or
inflation, the imposition of exchange controls which could restrict the
Company's ability to withdraw funds, political instability and fluctuations in
currency exchange rates.
FLUCTUATIONS IN HISTORICAL OPERATING RESULTS, P & C RESERVES. PICO's
operating results over the past five years have been volatile. During the past
several years, the levels of the reserves for PICO's insurance subsidiaries have
been very volatile. As a result of its claims experience and the level of
existing reserves with respect to its P & C insurance business, CIC has had to
significantly increase these reserves in a number of the past several years.
There can be no assurance that significant increases with respect to the
reserves for the P & C business will not be necessary in the future, that the
level of reserves for PICO's insurance subsidiaries will not be volatile in the
future, or that any such increases or volatility will not have an adverse effect
on PICO's operating results and financial condition.
COMPETITION. There are several hundred P & C insurers licensed in
California, many of which are larger and have greater financial resources than
CIC, and Sequoia; offer more diversified types of insurance coverage; have
greater financial resources and have greater distribution capabilities than the
insurance companies of the group. The presence of these competitors or
competitive developments in the future could adversely affect the Company's
business and results of operations.
A.M. BEST RATINGS. A.M. Best ("Best") has assigned Sequoia a rating of B++
(Very Good) and APL has had a Best rating of B+ (Very Good) since 1983. CIC was
recently upgraded from a B- (Adequate) to a B+ (Very Good) by Best. Physicians
and PRO are currently rated, and have been for a number of years, NR-3 (rating
procedure inapplicable). Best's ratings reflect the assessment of A.M. Best and
Company of the insurer's financial condition, as well as the expertise and
experience of management. Therefore, Best ratings are important to
policyholders. Best ratings are subject to review and change over time. Failure
to maintain or improve their Best ratings could have a material adverse effect
on the ability of the insurance companies to write new insurance policies, as
well as potentially reduce their ability to maintain or increase market share.
Management believes that many potential customers will not insure with an
insurer that carries a Best rating of less than B+, and that customers who do so
will demand lower rate structures. There can be no assurance that any of the
insurance companies' ratings will be maintained or increased, and a downgrade
would likely adversely affect the Company's business and results of operations.
CYCLICAL NATURE OF THE P&C INDUSTRY. The P & C insurance industry has been
highly cyclical, and the industry has
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been in a cyclical downturn over the last several years due primarily to
competitive pressures on pricing, which has resulted in lower profitability.
Pricing is a function of many factors, including the capacity of the P&C
industry as a whole to write business, which varies according to the level of an
individual company's policyholders' surplus and policyholders' surplus of the
P&C industry and returns on the investment portfolio. The level of surplus in
the industry varies with returns on invested capital and regulatory barriers to
withdrawal of surplus. Increases in surplus have generally been accompanied by
increased price competition among P & C insurers. The cyclical trends in the
industry and the industry's profitability can also be affected significantly by
volatile and unpredictable developments, including natural disasters,
fluctuations in interest rates, and other changes in the investment environment
which affect market prices of insurance companies' investments and the income
from those investments. Inflationary pressures affect the size of losses and
judicial decisions affect insurers' liabilities. These trends may adversely
affect the Company's business, financial condition and results of operations.
INSURANCE COMPANY CAPITAL AND SURPLUS TESTING. In the past few years, the
NAIC has developed risk-based capital ("RBC") measurements for both property and
casualty and life and health insurers. The measures provide the various state
regulators with varying levels of authority based on the adequacy of an
insurer's RBC. The insurance companies' RBC results are reported annually in
their statutory Annual Statements to the insurance departments. Failure to meet
one or more RBC level may result in state regulators requiring the insurance
company to submit a business plan demonstrating attainment of the required RBC
level. This may entail the addition of capital, a restructuring of assets and
liabilities, or changes in operations. At or below certain lower RBC levels,
state regulators may supervise the operation of the insurance company and/or
require the liquidation of the insurance company. Failing to meet RBC levels
could adversely affect the Company's business, financial condition and results
of operations.
INTEGRATION OF CERTAIN OPERATIONS. CIG and Physicians completed the Merger
with the expectation that the Merger would result in certain benefits for the
combined company. Achieving the anticipated benefits of the Merger will depend
in part upon whether certain of the two companies' business operations can be
integrated in an efficient and effective manner. There can be no assurance that
this will occur or that cost savings in operations will be achieved. The
successful combination of the two companies will require, among other things,
integration of the companies' respective product offerings, medical management
of health care claims and management information systems enhancements. The
difficulties of such integration may be increased by the necessity of
coordinating geographically separated organizations. The integration of certain
operations following the Merger will require the dedication of management
resources which may temporarily distract attention from the day-to-day business
of the combined companies. There can be no assurance that integration will be
accomplished smoothly or successfully. Failure to effectively accomplish the
integration of the two companies' operations could have an adverse effect on the
Company's results of operations and financial condition following the Merger.
RISKS ASSOCIATED WITH FAILURE TO MANAGE GROWTH. The Company's growth
internally and through its numerous acquisitions has placed, and further
expansion would continue to place, significant strain on its limited personnel,
management and other resources. The Company's ability to manage any future
growth may require it to attract, train, motivate and manage new employees
successfully, to integrate new employees effectively into its operations and to
continue to improve its operational, financial, management and information
systems and controls. The failure to manage any further growth effectively could
have a material adverse effect on the Company's business, financial condition
and results of operations.
FAILURE TO QUALIFY FOR EXEMPTION UNDER INVESTMENT COMPANY ACT. The Company
at all times intends to conduct its business so as not to become regulated as an
investment company under the Investment Company Act. However, if the company
fails to qualify for exemption from registration as an investment company, its
ability to use leverage would be substantially reduced, and it would be subject
to significant additional disclosure obligations and restrictions on its
operational activities.
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PART II: OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders:
None.
Item 6: Exhibits and Reports on Form 8-K:
(a) Exhibits:
See Exhibit Index.
(b) Reports on Form 8-K:
Form Date Filed Description
- ------ -------------- ---------------------------------------------------
8-K May 20, 1998 Initial announcement that PICO is considering a
proposal in which PICO would combine with Global
Equity Corporation through a Plan of Arrangement.
8-K July 21, 1998 Announcement of favorable response by Global Equity
Corporation's independent committee of directors
regarding Plan of Arrangement. Disclosure of share
exchange ratio.
27
<PAGE> 28
PICO HOLDINGS, INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PICO HOLDINGS, INC.
Dated: August 12, 1998 By: /s/ Gary W. Burchfield
--------------------------------
Gary W. Burchfield
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
28
<PAGE> 29
EXHIBITS INDEX
--------------
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
+ 2.2 Agreement and Plan of Reorganization, dated as of May 1,
1996 among PICO, Citation Holdings, Inc., and Physicians
and amendment thereto dated August 14, 1996 and related
Merger Agreement.
+++++ 2.3 Second Amendment to Agreement and Plan of Reorganization
dated November 12, 1996.
# 2.4 Agreement and Debenture, dated November 14, 1996 and
November 27, 1996, respectively, by and between Physicians
and PC Quote, Inc.
## 2.5 Purchase and Sale Agreement by, between and among Nevada
Land and Resource Company, LLC, GEC, Western Water Company
and Western Land Joint Venture dated April 9, 1997.
+++++ 3.1 Amended and Restated Articles of Incorporation of PICO.
+ 3.2.2 Amended and Restated Bylaws of PICO.
++++ 4.2 First Amendment to Rights Agreement dated April 30, 1996.
+++++ 4.3 Second Amendment to Rights Agreement dated November 20,
1996.
-* 10.7 Key Officer Performance Recognition Plan.
* 10.8 Flexible Benefit Plan.
-* 10.9 Amended and Restated 1983 Employee Stock Option Plan.
-**** 10.10 Salary Reduction Profit Sharing Plan as amended and
restated effective January 1, 1994 and Amendments Nos. 1
and 2 thereto dated March 13, 1995 and March 15, 1995,
respectively.
-* 10.11 Employee Stock Ownership Plan and Trust Agreement.
-*** 10.11.1 Amended Employee Stock Ownership Plan and Trust Agreement.
- -***** 10.11.2 Amendment to Employee Stock Ownership Plan dated October
1, 1992.
-**** 10.11.3 Amendment to Employee Stock Ownership Plan dated March 15,
1995.
* 10.16 Office Lease between CIC and North Block Partnership dated
July, 1990.
*** 10.16.1 Amendments Nos. 1 and 2 to Office Lease between CIC and
North Block Partnership dated January 6, 1992 and February
5, 1992, respectively.
**** 10.16.2 Amendments Nos. 3 and 4 to Office Lease between CIC and
North Block Partnership dated December 6, 1993 and October
4, 1994, respectively.
-* 10.22 1991 Employee Stock Option Plan.
- -***** 10.23 PICO Severance Plan for Certain Executive Officers, Senior
Management and Key Employees of the Company and its
Subsidiaries, including form of agreement.
-# 10.55 Consulting Agreements, effective January 1, 1997,
regarding retention of Ronald Langley and John R. Hart as
consultants by Physicians and GEC.
++ 10.57 PICO 1995 Stock Option Plan.
-+++ 10.58 Key Employee Severance Agreement and Amendment No. 1
thereto, each made as of November 1, 1992, between PICO
and Richard H. Sharpe and Schedule A identifying other
substantially identical Key Employee Severance Agreements
between PICO and certain of the executive officers of
PICO.
+++ 10.59 Agreement for Purchase and Sale of Shares, dated May 9,
1996, among Physicians, GPG and GEC.
++ 10.60 Agreement for Purchase and Sale of Certain Assets, dated
July 14, 1995 between Physicians, PRO and Mutual
Assurance, Inc.
++ 10.61 Stock Purchase Agreement dated March 7, 1995 between
Sydney Reinsurance Corporation and Physicians.
++ 10.62 Letter Agreement, dated September 5, 1995 between
Physicians, Christopher Ondaatje and the South East Asia
Plantation Corporation Limited.
++++ 10.63 Amendment No. 1 to Agreement for Purchase and Sale of
Certain Assets, dated July 30, 1996 between Physicians,
PRO and Mutual Assurance, Inc.
+++++ 16.1 Letter regarding change in Certifying Accountant from
Deloitte & Touche LLP, independent auditors.
# 21 Subsidiaries of PICO.
27 Financial Data Schedule.
### 99. Announcement of PICO's consideration of proposed
combination with GEC through a Plan of Arrangement.
#### 99. Announcement of GEC's independent committee of directors
favorable response to the proposed Plan of Arrangement.
Disclosure of share exchange ratio.
- -------------------
* Incorporated by reference to exhibit of same number filed
with Registration Statement on Form S-1 (File No.
33-36383).
*** Incorporated by reference to exhibit of same number filed
with 1992 Form 10-K.
**** Incorporated by reference to exhibit of same number filed
with 1994 Form 10-K.
29
<PAGE> 30
***** Incorporated by reference to exhibit bearing the same
number filed with Registration Statement on Form S-4 (File
No. 33-64328).
+ Filed as Appendix to the prospectus in Part I of
Registration Statement on Form S-4 (File No. 333-06671).
++ Incorporated by reference to exhibit filed with
Physicians' Registration Statement No. 33-99352 on Form
S-1 filed with the SEC on November 4, 1995
+++ Incorporated by reference to exhibit filed with
Registration Statement on Form S-4 (File No. 333-06671).
++++ Incorporated by reference to exhibit filed with Amendment
No. 1 to Registration Statement No. 333-06671 on Form S-4.
+++++ Incorporated by reference to exhibit of same number filed
with Form 8-K dated December 4, 1996.
# Incorporated by reference to exhibit of same number filed
with Form 10-K dated April 15, 1997.
## Incorporated by reference to exhibit of same number filed
with Form 10-K/A dated April 30, 1997.
### Incorporated by reference to exhibit of same number filed
with Form 8-K dated May 20, 1998.
#### Incorporated by reference to exhibit of same number filed
with Form 8-K dated July 21, 1998.
- Executive Compensation Plans and Agreements.
30
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF INCOME OF PICO
HOLDINGS, INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 35,838
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 75,860
<MORTGAGE> 0
<REAL-ESTATE> 2,099
<TOTAL-INVEST> 142,828
<CASH> 54,433
<RECOVER-REINSURE> 3,192
<DEFERRED-ACQUISITION> 5,300
<TOTAL-ASSETS> 408,154
<POLICY-LOSSES> 175,037
<UNEARNED-PREMIUMS> 29,697
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 33
<OTHER-SE> 111,563
<TOTAL-LIABILITY-AND-EQUITY> 408,154
17,593
<INVESTMENT-INCOME> 5,181
<INVESTMENT-GAINS> 2,474
<OTHER-INCOME> 2,140
<BENEFITS> 13,661
<UNDERWRITING-AMORTIZATION> 5,559
<UNDERWRITING-OTHER> 6,957
<INCOME-PRETAX> 1,085
<INCOME-TAX> 930
<INCOME-CONTINUING> 0
<DISCONTINUED> 155
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 155
<EPS-PRIMARY> 0.00
<EPS-DILUTED> 0.00
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
