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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (619) 456-6022
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III or this Form 10-K or any amendment to this
Form 10-K. [ X ]
Approximate aggregate market value of the registrant's common stock held by
nonaffiliates of the registrant (based on the closing sales price of such stock
as reported in the Nasdaq National Market) on March 20, 1998 was $118,539,069.
Excludes shares of common stock held by directors, officers and each person who
holds 5% or more of the registrant's common stock.
Number of shares of common stock, $.001 par value, outstanding as of March 20,
1998 was 32,591,718. As of such date, 4,572,015 shares of common stock were held
by subsidiaries of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the definitive proxy statement for the annual meeting of
stockholders held June 5, 1997 are incorporated by reference in Part
III herein.
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PICO HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
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Page
No.
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PART I.............................................................................................................. 3
Item 1. BUSINESS............................................................................................... 3
Item 2. PROPERTIES............................................................................................. 25
Item 3. LEGAL PROCEEDINGS...................................................................................... 25
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................................... 25
PART II............................................................................................................. 26
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.................................. 26
Item 6. SELECTED FINANCIAL DATA................................................................................ 27
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.......................................................................... 28
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS........................................... 43
Item 8. FINANCIAL STATEMENTS................................................................................... 44
Item 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE........................................................................... 80
PART III............................................................................................................ 80
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................................................... 80
Item 11. EXECUTIVE COMPENSATION................................................................................ 81
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT....................................................................................... 81
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................................ 81
PART IV............................................................................................................. 81
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 10-K...................................... 81
SIGNATURES.......................................................................................................... 84
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PART I
THIS FORM 10-K CONTAINS A NUMBER OF FORWARD-LOOKING STATEMENTS, INCLUDING,
WITHOUT LIMITATION, STATEMENTS ABOUT THE COMPANY'S PLANS FOR EXPANSION,
INVESTING PHILOSOPHY, THE YEAR 2000 COMPUTING SYSTEMS COMPATIBILITY, AND
BUSINESS EXPECTATIONS, WHICH STATEMENTS REFLECT THE COMPANY'S CURRENT VIEWS WITH
RESPECT TO FUTURE EVENTS THAT WILL HAVE AN EFFECT ON THE COMPANY'S FINANCIAL
PERFORMANCE. THE COMPANY CAUTIONS INVESTORS THAT ANY FORWARD-LOOKING STATEMENTS
MADE BY THE COMPANY ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING
THOSE SET FORTH UNDER "BUSINESS RISKS" AND ELSEWHERE HEREIN, THAT COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS OR FROM
HISTORICAL RESULTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS.
ITEM 1. BUSINESS
INTRODUCTION
PICO Holdings, Inc. ("PICO") is a holding company principally engaged in
five industry segments: portfolio investing; property and casualty insurance;
surface, water, geothermal and mineral rights; medical malpractice liability
("MPL") insurance; and other. Management has added the surface, water,
geothermal and mineral rights segment for this annual report based on recent
acquisitions and management's strategic initiatives (see below). PICO has also
been active in life and health insurance operations through 1997, and is under
contract to sell this business. PICO operates through a number of direct and
indirect subsidiaries (with PICO and its subsidiaries, collectively referred to
herein as the "Company"). The Company's objective is to use its resources to
increase shareholder value through investments in businesses which the Company
believes are undervalued or will benefit from additional capital, restructuring
of operations or management, or improved competitiveness through operational
efficiencies with the Company's existing operations. This business strategy was
implemented beginning in 1994 and was not fully in place until 1996. See
"HISTORY OF THE COMPANY." Guinness Peat Group plc ("GPG"), a strategic
investment company domiciled in London, England owns approximately 17.6% of the
Company. GPG is a publicly held company with its shares listed on the London,
Australia and New Zealand stock exchanges.
PICO was incorporated in 1981 and began operations in 1982. Its principal
executive office is located at 875 Prospect Street, Suite 301, La Jolla,
California 92037, and its telephone number is (619) 456-6022.
Subsidiaries
Unless otherwise indicated, each subsidiary is directly or indirectly
wholly-owned by PICO. The Company's operating subsidiaries and their principal
subsidiaries or affiliates are as follows:
Citation Insurance Company ("CIC")
CIC is a California-domiciled insurance company licensed to write commercial
property and casualty insurance in Arizona, California, Colorado, Nevada,
Hawaii, New Mexico and Utah. CIC has also written Workers Compensation
insurance; however, the Company sold that line of business through a transfer to
and sale of its wholly-owned subsidiary, Citation National Insurance Company
("CNIC"), effective June 30, 1997. CNIC wrote no new business in 1997 prior to
its sale. See "History of the Company -- Developments Since the Merger."
Summit Global Management, Inc. ("Summit")
Summit is a Registered Investment Advisor that offers investment management
services to clients throughout the United States.
Nevada Land and Resource Company, LLC ("NLRC")
NLRC is the owner of approximately 1,365,000 acres of deeded land in
northern Nevada. On April 23, 1997, PICO acquired 25.23% of NLRC. Global-Nevada
Land Resource Corporation, a wholly-owned subsidiary of Global Equity
Corporation ("GEC") which is approximately 51.17% owned by the Company, acquired
the remaining 74.77% of NLRC. See "GLOBAL EQUITY CORPORATION" in this section.
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Physicians Insurance Company of Ohio ("Physicians")
Physicians, an Ohio licensed insurance corporation, operates primarily as a
diversified investment and insurance company. Its operations and those of its
direct and indirect subsidiaries include strategic investing, property and
casualty insurance, the runoff of its former MPL insurance claims reserves, and
other. Through 1997, an indirect subsidiary of Physicians engaged in life and
health insurance. That company, American Physicians Life Insurance Company, is
under contract to be sold. Physicians has been licensed as a property and
casualty insurer by the Ohio Department of Insurance ("Ohio Department") since
1976 and is also licensed by the Kentucky Department of Insurance. Disclosure in
this section regarding the business of "Physicians" includes all operations of
its subsidiaries.
Physicians' Subsidiaries and Affiliated Companies
SEQUOIA INSURANCE COMPANY ("SEQUOIA"). Sequoia is a California-domiciled
insurance company licensed to write insurance coverage for property and casualty
risks within the State of California. Sequoia writes business through
independent agents and brokers covering risks located primarily within northern
and central California. Although multiple line underwriting is conducted and at
one time or another all major lines of property and casualty insurance except
workers' compensation and ocean marine have been written, Sequoia has, over the
past few years, transitioned from writing primarily personal lines of business
(automobile, homeowners, etc.) to commercial lines.
AMERICAN PHYSICIANS LIFE INSURANCE COMPANY ("APL"). APL offers critical
illness insurance through "Survivor Key" policies as well as other life and
health insurance products. APL is wholly owned by The Physicians Investment
Company ("PIC"), a subsidiary of Physicians, Sequoia, and CIC. On June 16, 1997,
Physicians entered into an agreement to sell APL and APL's wholly-owned
subsidiary, Living Benefit Administrators Agency, Inc. The closing is subject to
certain closing conditions, which have not yet been met. See "History of the
Company -- Developments Since the Merger".
THE PROFESSIONALS INSURANCE COMPANY ("PRO"). PRO is an Ohio domiciled
insurance company first licensed to write property and casualty insurance in
Ohio in 1979. It is also licensed in Kentucky, West Virginia and Wisconsin.
CLM INSURANCE AGENCY, INC. ("CLM"). CLM, purchased on July 1, 1995, is an
inactive California insurance agency which placed insurance with California
insurers, including Sequoia.
GLOBAL EQUITY CORPORATION. PICO and its subsidiaries own approximately
51.17% of GEC, a Canadian international investment company. PICO increased its
ownership interest in GEC from 38.2% prior to July 30, 1997, to 49.9% on July
30, 1997 and to 51.17% in August 1997 and has consolidated the accounts of GEC
with those of the Company for 1997. Set forth below as of December 31, 1997, are
the names and respective jurisdictions of incorporation of certain direct and
indirect subsidiaries of GEC, all of which are wholly-owned except for NLRC
which is 74.77% owned by Global-Nevada Land Resource Corporation, a wholly-owned
subsidiary of GEC. The following list includes, but is not limited to, all
subsidiaries the total assets of which constituted more than 10% of the
consolidated assets of GEC as of December 31, 1997 or the total revenues of
which constituted more than 10% of the consolidated revenues of GEC during
fiscal 1997. GEC owns approximately 13% of PICO as of December 31, 1997.
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Jurisdiction
of
Subsidiary Incorporation
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Direct:
Forbes & Walker Securities Limited.......................... Canada
Forbes & Walker (USA) Inc................................... Delaware
Indirect:
Forbes & Walker International Limited....................... Barbados
Vidler Water Company, Inc................................... Colorado
Nevada Land and Resource Company, LLC....................... Delaware
Global Equity SA............................................ Switzerland
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Subsidiaries of GEC are either holding companies or inactive, with the
exception of the following: Vidler Water Company, Inc. ("Vidler"), and NLRC. The
other subsidiaries may be utilized in the future in furtherance of the
international investment, asset management or corporate finance activities of
GEC.
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MAJOR BUSINESSES AND PROPERTIES OF GLOBAL EQUITY CORPORATION
Vidler Water Company, Inc.
Effective November 14, 1995, a wholly-owned subsidiary of GEC acquired all
of the outstanding common stock of Vidler. Vidler is a corporation formed under
the laws of the state of Colorado. The purchase price was $5,575,299 in cash.
Vidler is engaged in the water marketing and transfer business. The business
plan calls for Vidler to identify areas where water supplies are needed in the
southwestern United States and then facilitate the transfer from current
ownership to Vidler, and subsequently to municipalities, water districts,
developers and others. This process requires knowledge and skills in the
identification, certification, upgrading, managing, transfer, marketing and
financing of water projects. Vidler has created opportunity through its ability
to aggregate water supplies from disparate owners and locations and redirect the
water to its highest and best use.
As a comprehensive provider of water services, Vidler performs the following
functions:
- Water asset acquisitions, purchasing appropriative water rights,
upgrading the priority and functionality wherever possible, and
marketing the product to the end-user; and
- Development and operation of water recharge (storage) facilities
directed to municipalities and water districts in the southwestern
United States. Storage provides flexibility. Surplus supplies can be
stored inexpensively and can be sold and delivered to meet peak
demands.
Since its acquisition by GEC, Vidler and its immediate parent company have
purchased water rights and related assets in Colorado, Nevada and Arizona.
Nevada Land and Resource Company, LLC
On April 23, 1997, a wholly-owned subsidiary of GEC acquired a 74.77%
interest in NLRC. The remaining 25.23% interest was acquired by PICO. The total
purchase price for NLRC was $48.6 million. NLRC's principal asset consists of
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.
The activities of Vidler and NLRC are considered by PICO to be a reportable
segment of surface, water, geothermal and mineral rights. This determination was
made for this annual report based on the acquisition of the majority ownership
in GEC by PICO and management's strategic initiatives.
Conex Continental Inc.
In August 1996, a wholly-owned subsidiary of GEC made an investment in Conex
Continental Inc. ("Conex"). Conex is a corporation formed under the laws of
Ontario, Canada. At Conex's January 7, 1998 Annual Meeting of Shareholders, the
shareholders approved a plan to change the domicile of Conex to the state of
Delaware and management is working to accomplish this change.
Conex's principal asset is a 60% interest, through a wholly-owned
subsidiary, in a sino-foreign joint venture. This joint venture operates a
manufacturing facility in Guiyang City, Guizhou Province, China and manufactures
wheeled and tracked hydraulic excavators.
A wholly-owned subsidiary of GEC invested approximately $5,000,000 and
received 6,750,000 voting class B preferred shares in August 1996 plus
89,096,888 separate and detachable warrants each exercisable at a price of
approximately $0.0398 into one common share. In 1997, the subsidiary of GEC
exercised warrants and purchased 22,195,043 common shares of Conex at a price of
approximately $0.0398 per common share.
SISCOM, Inc.
In August 1996, GEC purchased 4,000,000 newly-issued voting preferred shares
of SISCOM, Inc. ("SISCOM") for an aggregate purchase price of $1,000,000. The
preferred shares pay quarterly non-cumulative dividends at the rate of 7% per
annum. The preferred shares are convertible on a one-for-one basis into common
shares of SISCOM.
In February 1998, CIC and Sequoia each purchased 625,000 newly-issued
convertible preferred shares of SISCOM for a purchase price of $250,000 each.
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SISCOM is a corporation formed under the laws of the state of Colorado.
SISCOM is a provider of multimedia software solutions to the electronic news
media, Internet providers, and sports industries.
GEC also has a portfolio of investments in other equity securities in the
United States, Europe and Asia. These investments include GEC's investments in
PICO. They also include investments in certain Korean equities which have been
heavily impacted by the recent decline in Korean financial markets. In 1997, GEC
wrote down its investment in these securities to approximately $0.8 million
through an approximate $8.0 million charge to GEC's statement of operations,
including a foreign currency loss of approximately $3.8 million. The preceding
amounts were reduced by minority interests of approximately 48% when
consolidated into the Company's financial statements.
HISTORY OF THE COMPANY
Recent Merger
On November 20, 1996, Citation Holdings, Inc., an Ohio corporation ("Sub"),
merged with and into 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."
Physicians
Physicians was incorporated under the laws of Ohio in September 1976 and was
licensed by the Ohio Department in December 1976. Physicians was formed with the
sponsorship of the Ohio State Medical Association ("OSMA") to provide MPL
insurance coverage to physicians who were members of the OSMA. Physicians was
formed in response to a then-existing crisis in the MPL insurance marketplace in
Ohio. MPL claims had increased substantially in severity and frequency.
Insurance companies providing MPL coverage responded in some cases by increasing
premiums significantly or even by leaving the marketplace. The OSMA sought to
provide a stable insurance provider for its members in the face of this volatile
MPL marketplace by forming Physicians.
Until 1993, OSMA held shares representing a majority of Physicians' voting
power. Physicians' Code of Regulations also contained the requirement that three
OSMA officers sit on Physicians' Board of Directors and that Physicians only
write MPL insurance for the OSMA members. Physicians secured the endorsement of
its insurance products by the OSMA pursuant to an endorsement contract.
The strategic direction of Physicians changed in 1993. First, Physicians
repurchased its shares from the OSMA and amended its Code of Regulations to
delete the requirements that three OSMA officers sit on Physicians' Board. The
MPL product endorsement was terminated and the three Physicians directors who
were affiliated with the OSMA resigned as directors.
Additionally in 1993, Physicians was approached by an investor who could
provide a significant capital infusion. Physicians sold 1,428,571 newly-issued
and authorized shares of Physicians stock, representing, at that time, 32% of
Physicians' voting power, for $5 million to GPG, a London-based strategic
investment company. At that same time, four designees of GPG (Messrs. Broadbent,
whose term expired in 1995, Langley, Hart and Dr. Weiss) were elected to
Physicians' Board. GPG subsequently purchased from Physicians $3.0 million of
additional shares of Physicians stock, thereby increasing GPG's equity position
in Physicians. In May and June 1996, GPG sold a total of 850,000 shares of
Physicians to GEC (which converted into 4,258,415 shares of PICO pursuant to the
Merger).
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During 1995, there was another overall shift in the strategic direction of
Physicians. As discussed further below, Physicians sold its recurring MPL
business, purchased a property and casualty insurance company in California
(Sequoia) which does not write MPL insurance, and made a significant investment
in GEC which operates primarily as an international investment company.
Physicians' objective was and continues to be to use its resources and those of
its subsidiaries and affiliates to increase shareholder value through
investments in businesses which Physicians believes to be undervalued or will
benefit from additional capital, restructuring of operations or management, or
improved competitiveness through operational efficiencies with existing
Physicians operations. This business strategy was implemented beginning in 1994
and was not fully in place until 1996.
On March 7, 1995, Physicians executed the Stock Purchase Agreement with
Sydney Reinsurance Corporation ("SRC") to acquire all of the outstanding stock
of SRC's wholly-owned subsidiary, Sequoia, a property and casualty insurance
company incorporated under the laws of California in 1946 and licensed to write
insurance in California. Sequoia provides light commercial and multiperil
insurance in northern and central California through an independent agency
system. The acquisition price of $1,350,000 was paid in cash on August 1, 1995.
Physicians initially capitalized Sequoia with $2.6 million in paid-in
capital and an additional $5.9 million in paid-in surplus. Subsequently,
Physicians contributed an additional $17.3 million to Sequoia to cover 1995 net
losses, to strengthen Sequoia for purposes of maintaining or improving Sequoia's
"B++" (Very Good) A.M. Best Company rating (See "A.M. BEST COMPANY" under
"Competition")and its NAIC risk-based capital ratio, and to provide capital for
growth.
All policy and claims liabilities of Sequoia prior to closing are the
responsibility of SRC and have been unconditionally and irrevocably guaranteed
by QBE Insurance Group Limited ("QBE"), an Australian corporation of which SRC
indirectly is a wholly-owned subsidiary. Physicians is required to maintain a
minimum surplus in Sequoia of $7.5 million and, through a management agreement,
is supervising the run-off of SRC's liabilities. As part of the management
agreement, Physicians was reimbursed for certain expenses incurred in the
servicing of the business existing prior to closing. Since its acquisition by
Physicians, Sequoia has continued to write light commercial and multiperil
insurance in northern and central California.
On July 14, 1995, Physicians and PRO entered into an Agreement for the
Purchase and Sale of Certain Assets (the "Mutual Agreement") with Mutual
Assurance Inc. ("Mutual"). This transaction was approved by Physicians'
shareholders on August 25, 1995 and closed on August 28, 1995. Pursuant to the
Mutual Agreement, Physicians sold the recurring professional liability insurance
business and related liability insurance business for physicians and other
health care providers (the "Book of Business") of Physicians and PRO. Physicians
and PRO were engaged in, among other things, the business of offering MPL
insurance and related insurance to physicians and other health care providers
principally located in Ohio. Mutual acquired the Book of Business in
consideration of the payment of $6.0 million, plus interest at a rate of 6% per
annum from July 1, 1995 until the date of closing, or an aggregate of $6.1
million.
Simultaneously with execution of the Mutual Agreement, Physicians and Mutual
entered into a Reinsurance Treaty pursuant to which Mutual agreed to assume all
risks attaching after July 15, 1995 under medical professional liability
insurance policies issued or renewed by Physicians on physicians, surgeons,
nurses, and other health care providers, dental practitioner professional
liability insurance policies including corporate and professional premises
liability coverage issued by Physicians, and related commercial general
liability insurance policies issued by Physicians (the "Policies"), net of
inuring reinsurance. The premium payable to Mutual for such reinsurance is an
amount equal to 100% of the premiums paid to Physicians, net of inuring
reinsurance, on the Policies subject to a ceding commission equal to the sum of
(i) the commissions payable by Physicians, to agents procuring the Policies;
(ii) Mutual's allocable share of Physicians' premium taxes or franchise taxes,
whichever is lower; and (iii) Mutual's allocable share of any guaranty fund
assessment against Physicians with respect to premiums paid on the Policies.
Physicians and PRO have reinsured a portion of the insurance written prior
to July 16, 1995 with unaffiliated reinsurers and 100% of the insurance written
between July 16, 1995 and January 1, 1996 with Mutual. Subject to such
reinsurance, Physicians and PRO remain primarily liable to policyholders.
As part of the Mutual Agreement, Physicians and PRO agreed not to sell the
following insurance products for a period of five years ending August 27, 2000,
in any state in which Physicians, PRO or Mutual was licensed to offer MPL
insurance products as of August 28, 1995: professional liability insurance for
physicians, surgeons, dentists, hospitals, ambulatory surgical clinics, and
other health care providers (collectively, "Health Care Providers"); reinsurance
for insurers writing professional liability insurance for such Health Care
Providers; comprehensive general liability insurance for Health Care Providers;
stop loss insurance for Health Care Providers who have contracted to provide
health care services at a fixed rate; and managed care liability insurance
providing coverage for liability arising from errors and omissions of a managed
care organization, for the vicarious liability of a managed care organization
for acts and omissions by contracted and employed providers, and for liability
of directors and officers of a managed care organization.
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Physicians will continue to administer the runoff of claims on policies
written or renewed prior to July 16, 1995. Physicians estimates based upon
actuarial indications that approximately 75% of Physicians' claim liabilities
which existed at the end of 1995 should be paid out by the end of the year 2000.
In 1983, Physicians incorporated Summit and subsequently registered it with
the SEC as an investment adviser. Summit was inactive from 1990 through 1994,
and in January 1995, Summit was reactivated. In addition to its registration
with the SEC, Summit is registered as an investment adviser in California,
Florida, Kansas, Louisiana, Oregon, Virginia and Wisconsin. Summit maintains an
office in California. Funds under management are approximately $700 million,
most of which are funds which Summit is managing on behalf of PICO and its
subsidiaries and affiliates. Summit provides an opportunity for the Company to
be further diversified and will provide fee based revenues. Since February 1995,
Summit has provided investment management services to Physicians and its
insurance affiliates. Summit also offers its services to other individuals and
institutions.
On September 5, 1995, Physicians purchased 21,681,084 common shares of GEC
for $34.4 million in cash. GEC is a Canadian corporation which has its offices
in Toronto, Canada and La Jolla, California. GEC is a publicly-held corporation
and is listed on the Toronto Stock Exchange ("TSE") and The Montreal Exchange
under the symbol "GEQ." Physicians' purchase amounted to 38.2% of GEC's
outstanding common shares. GEC operates primarily as an international investment
company. On July 30, 1997, subsidiaries of PICO purchased 6,616,218 existing
shares of GEC from a non-affiliated shareholder, increasing the Company's
ownership of GEC to approximately 49.9%. On August 19, 1997, PICO and Physicians
purchased 13,586,143 newly issued shares pursuant to a public offering of shares
by GEC. These purchases increased PICO's ownership of GEC to approximately 51.17
%. GEC currently owns 4,258,415 shares, or approximately 13%, of PICO's
outstanding Common Stock.
Immediately prior to the Merger, Physicians operated in five industry
segments: property and casualty insurance, life and health insurance, portfolio
investing, MPL insurance and other. MPL insurance was written by Physicians and
its wholly-owned subsidiary, PRO, an Ohio corporation organized in 1979.
Physicians and PRO sold MPL insurance to physicians, dentists, nurses and other
allied health care professionals. Physicians and PRO discontinued writing MPL
insurance at the end of 1995, but continue to administer the adjustment of
claims and the investment of related assets for policies in force prior to July
16, 1995. Physicians has conducted its life and health insurance business
through APL, an Ohio-domiciled life insurer that was formed in 1978 and is
currently under contract to be sold subject to certain closing conditions,
including regulatory approval, which have yet to be met. In July 1993, APL began
aggressively marketing a critical illness policy which Physicians and APL
believed to be unique to the U.S. market. However, APL's success with this
innovative product has been significantly less than expected. The portfolio
investing segment was engaged in primarily by Physicians. The property and
casualty insurance segment was engaged in by Sequoia, which Physicians acquired
on August 1, 1995. The Company's other operations consisted primarily of
Summit's investment adviser operations.
On December 20, 1996, Physicians transferred its ownership in Summit to
PICO.
In addition to PRO, PIC, APL, and Sequoia, at December 31, 1997, Physicians
had five wholly-owned subsidiaries, none of whose current operations are
material to the financial position of the Company. CLM Insurance Agency, Inc.
("CLM") was purchased by Physicians on July 1, 1995. Prior to 1997, CLM brokered
insurance in California for Sequoia and other unaffiliated companies. CLM is
currently inactive. Raven Development Company was incorporated in Ohio in 1981
as a real estate development corporation. It is currently involved in one
development in central Ohio but is in the process of withdrawing from the real
estate development industry. Medical Premium Finance Company ("MPFC") was
incorporated in Ohio to conduct insurance premium finance business. MPFC ceased
writing new loans effective September 30, 1994, and became totally dormant as of
October 1, 1995. S.M.B. Financial Planning, Inc. ("SMB") is an Ohio corporation
acquired in 1983 to provide financial planning services. SMB has not been
operating for the past five years.
Citation
The following describes the history of PICO, which was previously known as
"Citation Insurance Group", prior to the Merger. All references to "CIG" are
references to PICO as it existed prior to the Merger. CIG was a holding company
principally engaged in writing workers' compensation and commercial property and
casualty insurance through its wholly-owned subsidiaries, CIC and CNIC.
"Citation" refers to CIG and its subsidiaries, excluding Citation General
Insurance Company (CGIC), as they existed before the Merger. CGIC, a
wholly-owned subsidiary of CIG, was placed into conservation in July 1995 by the
State of California. Citation had effectively written off its investment in CGIC
in November 1994.
CIC has historically specialized in providing workers' compensation coverage
for California businesses and, more recently, in Arizona, Colorado and Utah.
8
<PAGE> 9
In October 1989, CIC entered the commercial property and casualty business.
Since that time, CIC has underwritten general liability and property insurance
for small and medium-sized businesses with uniform risk characteristics and
coverage needs. CIC typically provides general liability, theft, inland marine,
property, glass and incidental products liability coverage. Commercial auto and
umbrella liability are written for accounts where CIC writes other lines of
business.
In October 1993, CIG completed the acquisition of Madison Capital, Inc. and
its subsidiaries ("Madison") for which CIG issued 2,158,545 shares of its common
stock and paid $3,650,000 to the former shareholders of Madison in exchange for
all of the issued and outstanding stock of Madison. Madison was merged with and
into CIG and Madison's former wholly-owned subsidiaries, The Canadian Insurance
Company of California, California Consumers Insurance Company and Madison
Acceptance Corporation, became wholly-owned subsidiaries of CIG. In February
1994, the names of The Canadian Insurance Company of California and California
Consumers Insurance Company were changed to Citation General Insurance Company,
(CGIC), and Citation National Insurance Company (CNIC), respectively.
CGIC and CNIC specialized in insuring accounts in commercial
property-oriented business classifications, including investment properties,
retail operations, restaurants, wholesale distribution operations and other
service-related businesses. Until October 1994, they also provided coverage for
artisan contractors.
Madison Acceptance Corporation ("MAC") is licensed by the California
Department of Corporations as an industrial loan company empowered to transact
premium financing in California. MAC does not presently conduct premium
financing operations.
During 1994, Citation increased CGIC's loss reserves and, in the third
quarter of 1994, the increase in CGIC's loss reserves aggregated approximately
$6.2 million. These increases were due primarily to re-evaluation of potential
losses related to construction defect claims emanating from CGIC's artisan
contractor policies written in years prior to the Merger. Subsequent to the
third quarter loss reserve increases, Citation notified the California
Department of Insurance (the "California Department") that the cumulative effect
of these increases brought CGIC below the minimum surplus required by the State.
Citation began working with the California Department to formulate a plan for
resolving the situation. Based upon discussions with the California Department
regarding the possible conservation of CGIC, Citation concluded that its control
over CGIC had become temporary and, as a result, has accounted for the results
of CGIC on the equity method since November 1994, resulting in a write off of
its remaining investment in CGIC of $4.2 million at that date. At that time,
CGIC and CNIC stopped writing any new business.
In February 1995, Citation reached an agreement in principle with the
California Department regarding CGIC. Under the terms of the agreement, an
inter-company pooling reinsurance agreement between CGIC and CNIC was commuted
effective September 30, 1994. In addition, CNIC transferred approximately $1.1
million of securities into a contingency fund for potential further development
of CGIC's loss reserves associated with accident years 1990 to 1994 during which
time the inter-company pooling agreement was in effect. Further, CIG agreed to
pay $600,000 in cash to CGIC and transfer its 25% ownership of CIG's Costa Mesa
property to CGIC. As a result of this agreement, CIG recorded a liability for
the cost of the disposition of CGIC, which includes the above described payments
and transfers which, when combined with its write off of its investment in CGIC,
resulted in a $6.7 million charge to Citation's operating results in 1994.
Further, CIC agreed to acquire the in-force book of business of CGIC for
approximately $1.7 million, which was accrued as a liability of Citation and
recorded as an other asset at December 31, 1994.
During July 1995, CGIC was placed into conservation by the State of
California, effectively transferring control of CGIC's assets to the California
Department. In August 1995, CGIC was placed into liquidation by the State of
California.
On November 30, 1995, CIG contributed all of the capital stock of CNIC to
CIC. This transaction increased the paid-in and contributed surplus of CIC by
$5,303,731. CNIC has been essentially inactive since mid-December 1994.
In February 1994, Citation entered the personal automobile insurance
business in California by offering low limit policies marketed through a
Managing General Agent. Primarily as a result of poor operating results in this
line, Citation decided in early 1995 to withdraw from this business and focus on
its primary business segments, i.e., workers' compensation and commercial
property and casualty.
CIC is currently licensed to write business in Arizona, California,
Colorado, Hawaii, Nevada, New Mexico and Utah and is currently writing business
in Arizona, California, Colorado, Nevada and Utah. CNIC is licensed in
California.
9
<PAGE> 10
Developments Since the Merger
In November 1996, Physicians purchased a $2.5 million convertible debenture
from PC Quote, Inc. ("PC Quote"). Physicians currently owns approximately 16.8%
of PC Quote's outstanding shares. PC Quote is an electronic provider of
real-time securities quotations and news. 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
$2,250,000 with repayment due April 30, 1998. The Company received warrants to
purchase common shares of PC Quote, Inc. in connection with these transactions.
The value of such warrants is not material to the Company's financial position
or results of operations.
On April 14, 1997, GEC and PICO entered into an agreement for the purchase
of NLRC, owner of approximately 1,365,000 acres of deeded land with appurtenant
water, geothermal and mineral rights in Northern Nevada, for a total purchase
price of $48.6 million. The closing date was April 23, 1997.
On June 16, 1997, Physicians announced the signing of a definitive agreement
to sell its wholly-owned life and health insurance subsidiary, APL, and its
wholly-owned subsidiary, Living Benefit Administrators Agency, Inc. to IFS
Insurance Holdings Corporation. Closing is subject to closing conditions,
including regulatory approval which is still pending.
On June 30, 1997, CIC sold its workers' compensation business through a
transfer to and sale of its wholly-owned subsidiary, CNIC, to an unaffiliated
insurance company.
On July 30, 1997, PICO acquired additional common stock of GEC increasing
the Company's ownership to approximately 49.9%.
On August 19, 1997 PICO acquired additional shares of GEC common stock,
increasing the Company's ownership to approximately 51.17%.
On December 17, 1997 Physicians contributed an additional $5.5 million to
Sequoia.
OPERATIONS
The Company operates in five industry segments: portfolio investing;
surface, water, geothermal and mineral rights; property and casualty insurance;
MPL insurance and other. Life and health insurance was written through 1997, but
has been treated as "discontinued operations" due to the pending sale of APL.
Physicians ceased writing MPL insurance at the end of 1995 but continues to
administer the adjustment of claims and the investment of related assets.
Effective June 30, 1997, Citation sold its workers' compensation operations and
its subsidiary, CNIC, principally due to recent changes in California
regulations with regard to rating of policies and to better utilize capital and
concentrate on the synergies of the property and casualty insurance businesses
common to both Sequoia and Citation.
PORTFOLIO INVESTING OPERATIONS
In late 1994, Physicians began the process of changing its strategic
direction from the operation of an MPL insurance business to investing in
businesses which PICO believes are undervalued or will benefit from additional
capital, restructuring of operations or management or improved competitiveness
through operational efficiencies with existing PICO operations. Accordingly, in
January 1995, Physicians reactivated its investment advisory subsidiary, Summit;
in August 1995, Physicians acquired Sequoia and entered new lines of property
and casualty insurance; in September 1995, Physicians purchased 38.2% of GEC, a
Canadian corporation active in international investments, water rights, and
other businesses and in 1996 Physicians acquired control of Citation pursuant to
the Merger.
In July and August 1997, the Company increased its ownership in GEC to
approximately 51.17%. GEC's financial results have been consolidated with those
of the Company, resulting in increased levels of portfolio investing activities.
See Footnote 19 to the Consolidated Financial Statements entitled "Segment
Reporting."
10
<PAGE> 11
GEC is a Canadian corporation engaging in strategic investment; surface,
water, geothermal and mineral rights; and other services. In addition to GEC's
investments in its subsidiaries, GEC also has a portfolio of investments in
other equity securities in the United States, Canada, Europe and Asia. These
investments include GEC's investments in PICO. They also include investments in
certain Korean equities which have been heavily impacted by the recent decline
in Korean financial markets. With the exception of the operations of Vidler and
NLRC, most of GEC's activities fall under the business segment category of
portfolio investing. At times, GEC may come to hold securities of companies for
which no market exists or which may be subject to restrictions on resale. As a
result, a portion of GEC's assets may not be liquid. Furthermore, as a result of
its global diversification with respect to existing investments, GEC'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 or prohibit GEC's ability to withdraw funds, political instability and
fluctuations in currency exchange rates.
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 the recently 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 was
implemented beginning in 1994 and was not fully in place until 1996.
Consequently, the results of this strategy are not fully reflected in prior
years' financial statements, nor are the financial statements indicative of
possible results of this new business strategy in the future. Shareholders will
be 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 Physicians' new strategy since 1995 and the consolidation
with GEC in 1997 have 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 may cause the Company's shareholders' equity to
fluctuate from period to period. At times, the Company may come to 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.
SURFACE, WATER, GEOTHERMAL AND MINERAL RIGHTS
Effective November 14, 1995, a wholly-owned subsidiary of GEC acquired all
the outstanding common stock of 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 needed in the southwestern United
States and then facilitate the transfer from current ownership to Vidler and
subsequently to municipalities, water districts, developers and others. Since
its acquisition, Vidler and its immediate parent company have purchased water
rights and related assets in Colorado, Nevada and Arizona.
NLRC, which is 74.77% owned by GEC and 25.23% by PICO 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.
11
<PAGE> 12
INSURANCE
Premiums
The following table shows the total net premiums written (gross premiums
less premiums ceded pursuant to reinsurance treaties) by line of business by the
Company and its subsidiaries for the periods indicated as reported in financial
statements filed with the Ohio Department and the California Department using
statutory accounting principles:
NET PREMIUMS WRITTEN
BY LINE OF BUSINESS
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
(In Thousands)
<S> <C> <C> <C>
Property and Casualty-Commercial and Other $40,093 $35,201 $10,755
Medical Professional Liability 239 28 11,824
Workers' Compensation (38,730) 1,556 0
------------ ------------ ------------
Total Property and Casualty Premiums $1,602 $36,785 $22,579
------------ ------------ ------------
Life and Health:
Individual:
Life 1,424 1,232 1,122
Health 59 74 86
Annuity 2,121 2,665 1,480
Group:
Life 410 449 475
Health 39 82 274
Annuity 1,087 921 462
------------ ------------ ------------
Total Life and Health Insurance Premiums 5,140 5,423 3,899
------------ ------------ ------------
Total Insurance Premiums $6,742 $42,208 $26,478
============ ============ ============
</TABLE>
Physicians experienced significant declines in MPL net premiums written in
recent years. Net premiums equal direct premiums plus assumed premiums, minus
premiums ceded under reinsurance treaties. The amount of reinsurance assumed by
Physicians over the years has been negligible. However, PRO and Physicians
entered into a 100% quota share reinsurance treaty effective October 1, 1997
whereby PRO ceded and Physicians assumed all of PRO's existing claims
liabilities, net of existing reinsurance. See "REINSURANCE." Direct MPL premiums
written have declined significantly, from near $50 million prior to 1993 to
$22.6 million in 1995, $167,000 in 1996 and to $38,000 in 1997. Additionally,
MPL premiums ceded under reinsurance treaties have varied greatly from year to
year. See "REINSURANCE." APL's premium writings have also declined significantly
since 1994, mostly as a result of exiting the group health insurance business in
mid-1994. Interest in APL's critical illness policy, Survivor Key, has been less
than expected and not enough to offset the decline in health premiums from 1994
levels. Sequoia's property and casualty premium writings are included for the
periods subsequent to August 1, 1995. Citation's premiums are included for
periods after November 20, 1996. The $38.7 million negative workers'
compensation net premiums written in 1997 by CIC reflects the 100% reinsurance
cession of CIC's entire existing book of workers' compensation insurance to CNIC
just prior to the sale of CNIC and the workers' compensation business. See
"INTRODUCTION-Citation Insurance Company."
Property and Casualty Insurance
Sequoia underwrites property and casualty insurance in California only. CIC
underwrites property and casualty insurance in California and, to a lesser
extent in Arizona, Colorado, Nevada and Utah.
Sequoia is licensed to write insurance in California and is represented by
independent insurance agents and has been represented by Physicians'
wholly-owned subsidiary insurance agency, CLM, until 1997. CLM is currently
inactive. Sequoia writes primarily light commercial and multiperil insurance in
northern and central California. Sequoia's principal sources of premium
production represent farm insurance and small to medium-sized commercial
accounts, most of which are located outside of large urban areas. A small amount
of earthquake coverage is provided, either as an endorsement to an existing
insurance policy or as a result of participation in a state-mandated pool. Most
business is written at independently filed rates.
12
<PAGE> 13
CIC underwrites general liability and property insurance for small and
medium-sized businesses, including restaurants, hotels and motels, retail
stores, owners of small commercial centers, and until October 1994, artisan
contractors, with uniform risk characteristics and coverage needs. CIC targets
specific types of accounts within predetermined business classifications
containing certain characteristics including low potential for loss severity, no
long delay between loss occurrence and loss reporting, and a relatively short
and uncomplicated claim settlement process. CIC typically provides general
liability, theft, inland marine, property, glass, commercial automobile,
incidental products liability coverage and umbrella liability. CIC sells
policies through independent producers located in its operating territories.
Net earned premiums, incurred losses and the corresponding loss ratio
(excluding loss adjustment expense ("LAE")) for Sequoia and CIC for 1997 were
(dollars in thousands) $50,232, $23,976 and 47.7%, respectively, excluding
workers' compensation insurance.
This compares to $31,399, $13,908 and 44.3%, respectively, in 1996.
Sequoia and CIC combined results for 1997 by line of business, excluding
workers' compensation insurance, were as
follows:
<TABLE>
<CAPTION>
1997
---------------------------------------------
Net
Premiums Net Losses Net Loss
Earned Incurred* Ratio*
------------ ------------- ------------
(in thousands)
<S> <C> <C> <C>
Fire $824 $73 8.9%
Allied lines 141 96 68.1%
Homeowners multiperil 4 13 325.0%
Commercial multiperil 37,022 14,392 38.9%
Inland marine (39) 0.0%
Earthquake 336 (3) 0.9%
Other liability 814 5,151 632.8%
Auto liability 7,201 3,276 45.5%
Auto physical damage 3,890 1,017 26.1%
------------ -------------
Total $50,232 $23,976 47.7%
============ =============
</TABLE>
- ----------------
* Net losses incurred and net loss ratios shown exclude LAE.
Sequoia's total net loss ratio improved 5.4 percentage points over 1996
principally as a result of improved loss experience in the commercial multiperil
line of business. CIC's results continue to be significantly influenced by
extremely poor claims experience in artisan/contractors (classified above under
"other liability") insurance which is no longer offered by CIC.
The underwriting staffs of Sequoia and CIC (the "P & C Insurance Group") are
solely responsible for the ultimate acceptance, underwriting and pricing of
applications for commercial insurance. Premium pricing levels are based on a
variety of factors, including industry historical loss costs, anticipated loss
costs, acceptable profit margins and anticipated operating expenses.
The objective of pricing structures in all product lines is to provide
sufficient funds to pay all costs of policy issuance and administration, premium
taxes and losses and related claims handling expenses and provide a profit
margin as well. Because pricing structures are based on estimates of future loss
patterns developed from historical information and because losses and expenses
may differ substantially from estimates, product pricing may ultimately prove
inadequate. Factors causing inadequate rates may include catastrophic losses or
a lack of correlation between the loss forecast for the market and that
applicable to the customers which actually purchase the policies. In addition,
if underlying statistical information understates the value of known claims,
forecasts may understate prospective claims patterns.
The P & C Insurance Group's policy is to settle valid claims promptly and
equitably. The P & C Insurance Group employs claim technicians, located in
various locations throughout California, to administer the claim settlement
process. It is the P & C Insurance Group's policy to limit the number of claims
assigned to each technician, based in part on the complexity of the individual
claims. It is also the P & C Insurance Group's policy that the most experienced
technicians handle the most complex claims. In general, claims in litigation are
the most complex and require the most experienced personnel.
13
<PAGE> 14
The Company's claim staff, working closely with claim department
supervisors, may retain independent adjusters, appraisers and defense counsel,
based on the nature of the claim. In addition, the P & C Insurance Group has
implemented procedures and programs to detect and investigate claim fraud and
believes that, to date, these programs have resulted in substantial savings
relative to the claimed amounts involved.
Sequoia has expended considerable effort and expense in streamlining and
reordering its operations in the latter part of 1995 and in 1996 and 1997.
Computer systems have been developed to facilitate decentralization of
underwriting and claims adjusting functions. In evidence of this, in July 1997,
Sequoia and CIC consolidated their home office operations in Monterey,
California. Both companies are in the process of sub-leasing their former office
spaces in Pleasanton and San Jose, California.
The P & C Insurance Group has emphasized the development and maintenance of
information and processing systems for use in all areas of its business.
Management believes that its information and processing systems enable the P & C
Insurance Group to compete effectively through enhanced policyholder services,
efficient underwriting, claim support systems, reduced processing costs and
timely management information. In addition, CIC's systems are not dependent on
specific hardware vendors, thereby providing it with greater control over
hardware costs and flexibility in terms of operating hardware. An internally
integrated software system has been designed for the processing of CIC's
commercial property and casualty business, including automated policy issuance
and claim processing.
CIC's claim function has been supported by its on-line automated claim
system, which has been internally developed and refined over several years.
Utilizing this system, claim technicians have on-line, direct access to all
claim files through their own computer terminal. All P & C computer systems are
expected to be year 2000 compliant by January 1, 1999.
CIC and Sequoia collect premiums either by direct billing or producer
billing. Sequoia has recently developed its own direct billing system and began
utilizing this system for all new and renewal policies, thereby eliminating its
reliance on the outside service vendor.
CIC and Sequoia write property and casualty insurance policies. Most of
CIC's and Sequoia's net premiums are attributable to property and casualty. The
property and casualty insurance industry has been highly cyclical, and the
industry has been in a cyclical downturn over the last several years due
primarily to premium rate competition, which has resulted in lower
profitability. Premium rate levels are related to the availability of insurance
coverage, which varies according to the level of surplus in the industry. 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 property and
casualty 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 (such as hurricanes, windstorms,
earthquakes and fires), 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 that
affect the size of losses and judicial decisions affecting insurers'
liabilities. The demand for property and casualty insurance can also vary
significantly, generally rising as the overall level of economic activity
increases and falling as such activity decreases.
MPL
Prior to the sale of the MPL insurance business in August 1995, Physicians
and PRO sold primarily MPL coverage. Physicians and PRO were represented by
approximately 40 independent insurance agents and by Physicians' wholly-owned
subsidiary insurance agency, PICO Insurance Agency, Inc. While Physicians and
PRO were licensed collectively in the states of Ohio, Kentucky, Michigan, West
Virginia and Wisconsin, MPL coverage was actively sold only in Ohio and
Kentucky. Physicians and PRO continue to administer the adjustment of claims and
the investment of related assets for policies written or renewed prior to July
16, 1995.
Life and Health
APL is represented on a commission basis by approximately 400 independent
agents, some of whom may also be licensed with other unaffiliated companies.
APL, an Ohio-domiciled life insurer, has written life, annuity and group health
insurance since its inception in 1978. In July, 1993, APL began marketing a
critical illness policy which APL believed was unique to the U.S. market. In the
face of heightened competition for group health insurance and to concentrate on
the Survivor Key product, on July 1, 1994, APL ceased writing group, health and
dental coverages with the exception of the Physicians Group Plans, which were
terminated in March 1996. To date, response to APL's critical illness policy,
Survivor Key, has been less than expected. On June 16, 1997, Physicians
announced the signing of a definitive agreement to sell 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. See "HISTORY OF THE COMPANY--Developments Since the Merger".
14
<PAGE> 15
Liabilities for Unpaid Loss and Loss Adjustment Expenses
Liabilities for unpaid loss and LAE are estimated based upon actual and
industry experience, and assumptions and projections as to claims frequency,
severity and inflationary trends and settlement payments. Such estimates may
vary from the eventual outcome. The inherent uncertainty in estimating reserves
is particularly acute for lines of business for which both reported and paid
losses develop over an extended period of time.
Several years or more may elapse between the occurrence of an insured MPL,
or casualty loss, the reporting of the loss and the final payment of the loss.
Loss reserves are estimates of what an insurer expects to pay claimants, legal
and investigative costs and claims administrative costs. The Company's
subsidiaries are required to maintain reserves for payment of estimated losses
and loss adjustment expense for both reported claims and claims which have
occurred but have not yet been reported ("IBNR"). Ultimate actual liabilities
may be materially more or less than current reserve estimates.
Reserves for reported claims are established on a case-by-case basis. Loss
and loss adjustment expense reserves for IBNR are estimated based on many
variables including historical and statistical information, inflation, legal
developments, the regulatory environment, benefit levels, economic conditions,
judicial administration of claims, general trends in claim severity and
frequency, medical costs and other factors which could affect the adequacy of
loss reserves. Management reviews and adjusts IBNR reserves regularly.
The liabilities for unpaid losses and LAE for Physicians, PRO, Sequoia, and CIC
(the "Combined Insurance Group") were $196.1 million in 1997, $252.0 million in
1996, and $229.8 million in 1995, net of discount on MPL reserves. Of those
amounts, the liabilities for unpaid loss and LAE of prior years increased by
$0.9 million in 1997, $2.3 million in 1996 and $3.2 million in 1995. These
changes in reserves for prior years' reserves were due to the following:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------- ------------
(in millions)
<S> <C> <C> <C>
Decrease in provision for prior year claims $ (1.0) $ (2.6) $ (0.3)
Retroactive reinsurance (1.2) - (2.4)
Accretion of reserve discount 3.1 4.9 5.9
------------ ------------- ------------
Net increase decrease in liabilities for unpaid loss
and LAE of prior years $ 0.9 $ 2.3 $ 3.2
============ ============= ============
</TABLE>
See schedule in Note 13 of Notes to the Company's Consolidated Financial
Statements for additional information regarding reserve changes.
Although the Combined Insurance Group's reserves are certified annually by
independent actuaries for each insurance company as required by state law,
significant fluctuations in reserve levels can occur based upon a number of
variables used in actuarial projections of ultimate incurred losses and LAE.
Physicians' liability for unpaid MPL losses and LAE is discounted to reflect
investment income as permitted by the Ohio Department. The method of discounting
is based upon historical payment patterns and assumes an interest rate at or
below Physicians' investment yield, and is the same rate used for statutory
reporting purposes. Physicians uses a 4% discount rate for MPL reserves.
All members of the Combined Insurance Group seek to reduce the loss that may
arise from individually significant claims or other events that cause
unfavorable underwriting results by reinsuring certain levels of risk with other
insurance carriers.
Various reinsurance treaties remain in place to limit the Combined Insurance
Group's exposure levels. See "REINSURANCE" following this section and Note 12 of
Notes to Consolidated Financial Statements - Reinsurance.
Reconciliation of Unpaid Loss and Loss Adjustment Expenses
An analysis of changes in the liability for unpaid losses and LAE for 1997,
1996 and 1995 is set forth in Note 13 of Notes to the Company's Consolidated
Financial Statements.
15
<PAGE> 16
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
The following table presents the development of balance sheet liabilities for
1987 through 1997 for all property and casualty line of business including MPL.
The "Net liability as originally estimated" line shows the estimated liability
for unpaid losses and LAE recorded at the balance sheet date on a discounted
basis for each of the indicated years. Reserves for other lines of business that
Physicians ceased writing in 1989, which are immaterial, are excluded. The
"Gross liability as originally estimated" represents the estimated amounts of
losses and LAE for claims arising in all prior years that are unpaid at the
balance sheet date on an undiscounted basis, including losses that had been
incurred but not reported.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992
------------ ------------ ------------ ------------ ------------ -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Net Liability as originally estimated: $104,495 $109,435 $126,603 $128,104 $129,768 $159,804
Discount 35,146 37,100 36,806 30,230 30,647 31,269
Gross liability as originally estimated: 139,641 146,535 163,409 158,334 160,413 191,073
Cumulative payments as of:
One year later 35,339 27,229 43,725 42,488 42,986 41,550
Two years later 61,228 69,335 84,463 81,536 81,489 73,012
Three years later 96,680 105,274 110,291 108,954 103,505 103,166
Four years later 123,254 122,589 128,737 120,063 120,073 116,278
Five Years later 135,034 136,454 135,170 126,100 127,725 139,028
Six years later 144,405 138,907 138,912 130,146 142,973
Seven years later 145,589 140,451 141,854 142,484
Eight years later 145,733 141,641 152,706
Nine years later 145,431 146,841
Ten years later 147,533
Liability re-estimated as of:
One year later 149,426 148,847 162,653 160,200 188,811 197,275
Two years later 145,432 148,932 162,371 179,915 184,113 179,763
Three years later 149,243 154,177 176,123 172,715 174,790 182,011
Four years later 152,427 165,596 169,488 170,847 177,811 176,304
Five Years later 158,868 163,676 171,532 171,968 172,431 181,721
Six years later 160,414 165,996 170,873 165,255 175,830
Seven years later 164,727 166,144 167,341 168,185
Eight years later 164,893 161,328 170,941
Nine years later 160,683 163,426
Ten years later 161,946
Cumulative Redundancy (Deficiency) ($22,305) ($16,891) ($7,532) ($9,851) ($15,417) $9,352
</TABLE>
RECONCILIATION TO FINANCIAL STATEMENTS
Gross Liability - end of year
Reinsurance recoverable
Net liability - end of year
Net discount
Discounted net liability - end of year
Discounted reinsurance recoverable
Discontinued personal lines insurance
Balance sheet liability (discounted)
Gross re-estimated liability - latest
Re-estimated recoverable - latest
Net re-estimated liability - latest
Net re-estimated discount - latest
Discounted net re-estimated liability - latest
Gross cumulative redundancy (deficiency)
16
<PAGE> 17
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------ ------------ ------------ ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net Liability as originally estimated: $179,390 $153,212 $137,523 $165,629 $128,205
Discount 32,533 20,144 16,568 12,216 9,159
Gross liability as originally estimated: 211,923 173,356 154,091 177,845 137,364
Cumulative payments as of:
One year later 34,207 35,966 27,128 59,918
Two years later 69,037 61,263 65,062
Three years later 90,904 93,908
Four years later 118,331
Five Years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Liability re-estimated as of:
One year later 183,560 170,411 147,324 177,734
Two years later 184,138 163,472 146,653
Three years later 175,308 162,532
Four years later 178,544
Five Years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative Redundancy (Deficiency) $33,379 $10,824 $7,438 $111
RECONCILIATION TO FINANCIAL STATEMENTS
Gross Liability - end of year $248,951 $266,320 $208,351
Reinsurance recoverable (94,860) (88,474) (70,987)
------------ ------------- ------------
Net liability - end of year 154,091 177,846 137,364
Net discount (16,568) (12,217) (9,159)
------------ ------------- ------------
Discounted net liability - end of year 137,523 165,629 128,205
Discounted reinsurance recoverable 91,089 85,217 67,654
------------ ------------- ------------
228,612 250,846 195,859
Discontinued personal lines insurance 1,185 1,178 237
------------ ------------- ------------
Balance sheet liability (discounted) $229,797 $252,024 $196,096
============ ============= ============
Gross re-estimated liability - latest $246,613 $279,119
Re-estimated recoverable - latest (99,960) (101,384)
------------ -------------
Net re-estimated liability - latest 146,653 177,735
Net re-estimated discount - latest (8,589) (9,159)
------------ -------------
Discounted net re-estimated liability - latest $138,064 $168,576
============ =============
Gross cumulative redundancy (deficiency) $7,438 $111
============ =============
</TABLE>
Each decrease or (increase) amount includes the effects of all changes in
amounts during the current year for prior periods. For example, the amount of
the redundancy related to losses settled in 1990, but incurred in 1987 will be
included in the decrease or (increase) amount for 1987, 1988 and 1989.
Conditions and trends that have affected development of the liability in the
past may not necessarily occur in the future. For example, Physicians commuted
reinsurance contracts in several different years that significantly increased
the estimate of net reserves for prior years by reducing the recoverable loss
and LAE reserves for those years. Accordingly, it may not be appropriate to
extrapolate future increases or decreases based on this table.
17
<PAGE> 18
The data in the above table is based on Schedule P from each of the Combined
Insurance Group's 1987 to 1997 Annual Statements, as filed with state insurance
departments; however, the development table above differs from the development
displayed in Schedule P, Part-2, of the insurance Annual Statements as Schedule
P, Part-2, excludes unallocated LAE.
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 lag or "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 Combined
Insurance Group and APL 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 adjustments 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
MPL
Prior to July 16, 1995, Physicians ceded a portion of the insurance it wrote
to unaffiliated reinsurers through reinsurance agreements. Physicians'
reinsurers for insurance policies with effective dates between July 1, 1993 and
July 15, 1995, were TIG Reinsurance Company (rated A (Excellent) by Best),
Transatlantic Reinsurance Company (rated A+ (Superior) by Best) and Cologne
Reinsurance Company of America (rated NR-3 (Rating Procedure Inapplicable) by
Best). Physicians ceded insurance to these carriers on an automatic basis when
retention limits were exceeded. Physicians retained all risks up to $200,000 per
occurrence. All risks above $200,000, up to policy limits of $5 million, were
transferred to reinsurers, subject to the specific terms and conditions of the
various reinsurance treaties. Physicians remains primarily liable to
policyholders for ceded insurance should any reinsurer be unable to meet its
contractual obligations. Physicians has not incurred any material loss resulting
from a reinsurer's breach or failure to comply with the terms of any reinsurance
agreement. MPL insurance written or renewed after July 15, 1995 was fully
reinsured by Mutual.
Property and Casualty
CIC has excess of loss reinsurance treaties for its property and casualty
insurance business with General Reinsurance Corporation ("Gen Re") for policies
written on or after October 1, 1991 through December 31, 1993, and primarily
with North Star Reinsurance Corporation, a subsidiary of Gen Re, and Western
Atlantic Management Corporation, a subsidiary of North American Reinsurance
Corporation, for policies written prior to October 1, 1991. For losses that
occurred from October 1, 1989 to September 30, 1990 on policies written prior to
October 1, 1990, the reinsurers assume liability on that portion of loss which
exceeds $75,000 per occurrence, up to a maximum of $3.0 million per occurrence
for property losses and up to a maximum of $1.0 million per occurrence for
casualty losses. For losses that occur after September 30, 1990, on policies
written prior to October 1, 1991, the maximum coverage for property losses is
$2.0 million. For losses occurring after October 1, 1991 on policies written
between October 1, 1991 and December 31, 1993, the reinsurer assumes liability
on that portion of loss which exceeds $75,000 per occurrence, up to a maximum of
$3.0 million per occurrence for property losses and that portion of loss which
exceeds $125,000 per occurrence, up to a maximum of $3.0 million per occurrence
for casualty losses occurring prior to December 31, 1993. CIC obtains
facultative reinsurance for those policies it issues with policy limits above
its excess of loss reinsurance treaties. Currently, the number of such policies
is insignificant.
CGIC and CNIC's casualty excess of loss reinsurance treaty through December
31, 1993 provided $850,000 of coverage in excess of a retention of $150,000 per
auto liability or general liability loss and was placed with National
Reinsurance Corporation ("National") (75%) and Prudential Reinsurance Company
("Prudential") (25%). Another treaty, placed primarily with Prudential, provided
$3.0 million in additional limits. The $150,000 retention has been in place
since January 1, 1992. Between February 1, 1986, and December 31, 1991, the
retention was $100,000. CIG believes that, before February 1, 1986, the CGIC
reinsurance program had retentions ranging up to $250,000 per occurrence.
18
<PAGE> 19
CGIC and CNIC's property reinsurance program, which covered all policies
incepting before January 1, 1994, is structured as follows:
- A surplus share treaty providing $6.0 million in available limits is
maintained with Prudential (55%) and Munich American Reinsurance Company
("Munich") (45%).
- A property excess of loss treaty provides $450,000 in limits in excess of
a $50,000 per occurrence retention. This treaty is maintained with National
(75%) and Prudential (25%).
- A property catastrophe program, supported by several reinsurers, provided
95% of $8.5 million in excess of a $1.5 million per occurrence retention.
- Several facultative reinsurance agreements provide direct access to as
much as $6.0 million in additional reinsurance coverage as needed.
CGIC's and CNIC's commercial umbrella liability treaty was placed with
Prudential for all policies incepting before January 1, 1994. Prudential
reinsures 95% of the first $1.0 million of umbrella coverage and 100% of any
limits purchased above $1.0 million. The maximum limit reinsured under this
treaty is $5.0 million. For higher umbrella limits, facultative reinsurance is
obtained.
CGIC entered into a Stop Loss reinsurance treaty with Scandinavian
Reinsurance Company, Ltd. ("Scandinavian") in 1991. Since CGIC and CNIC had
entered into an intercompany pooling reinsurance agreement, CNIC shared in the
results of this treaty. This treaty, effective November 1, 1991, involved the
transfer of $8.5 million of portfolio investments to Scandinavian in exchange
for $13,175,000 of coverage, including $6.5 million of existing loss and loss
adjustment expense reserves and $6,675,000 of coverage for potential future
adverse development of loss and loss adjustment expense reserves associated with
accident years 1991 and prior. All $6,675,000 was ceded as of December 31, 1991.
Additional limits were purchased during 1992, providing $5.1 million of coverage
for the accident years 1991 and prior. This involved the payment of $3.5 million
in April 1992 representing $3.5 million in existing loss and loss adjustment
expense reserves. All $5.1 million was ceded as of year end 1992. Other
provisions of the treaty permit CGIC and CNIC to purchase additional limits to
protect accident years 1992 through 1995. As of December 31, 1994, CGIC and CNIC
had purchased approximately $2,126,000 of limits for the 1992 accident year, all
of which has been ceded, had purchased approximately $2,182,000 of limits for
the 1993 accident year, all of which has been ceded, and had purchased
approximately $1,950,000 of limits for the 1994 accident year, $1,844,000 of
which has been ceded. The coverage provided by the Stop Loss treaty cannot be
canceled or commuted by the reinsurer. As of December 31, 1996, CNIC has
received payment for all losses ceded to this treaty for accident year 1992.
CNIC has a letter of credit from the reinsurer for unpaid losses ceded to this
treaty for accident years 1993 and 1994.
Effective January 1, 1994, CIC and CNIC have in place reinsurance agreements
for their property and casualty business. CIC and CNIC have an excess of loss
reinsurance treaties with Gen Re for casualty losses occurring from January 1,
1995 through December 31, 1995. This treaty provides $5,850,000 of coverage in
excess of $150,000 per occurrence. CIC and CNIC also have an excess and
commercial umbrella liability treaty with American Reinsurance Company which
reinsures 95% of the first $1.0 million of umbrella coverage and 100% of any
limits purchased above $1.0 million, up to $10.0 million. For property losses, a
surplus share treaty providing up to $4.5 million of proportional coverage is
placed with Munich. A property excess of loss treaty with National Re provides
up to $1,350,000 of coverage in excess of $150,000. Facultative reinsurance
agreements with American Re and Munich Re provide coverage of up to an
additional $6.0 million. Property catastrophe reinsurance is provided by several
reinsurers and provides 95% of $8.5 million of coverage in excess of a $1.5
million per occurrence retention.
Effective March 31, 1995, CIC entered into a reinsurance agreement with
National Re to provide coverage for property and casualty losses incurred in
excess of $50,000 per occurrence up to $150,000, at which level CIC's other
reinsurance agreements provide coverage. This reinsurance agreement provides
reinsurance commission income to CIC on the premiums ceded pursuant to the
agreement.
Effective January 1, 1996, CIC cancelled the property and casualty excess of
loss agreement described above with National Re. In addition, CIC and CNIC
cancelled on a run off basis the surplus share treaty with Munich Re and the pro
rata automatic facultative agreements with American Re and Munich Re. There were
no cancellation penalties associated with the cancellation of these reinsurance
contracts. CIC and CNIC have an excess of loss treaty with National Re for
property and casualty loss occurring on or after January 1, 1996. This treaty
provides $4,750,000 of coverage in excess of $250,000 per occurrence. An
automatic facultative agreement with Munich Re provides coverage up to $6.0
million in excess of $5.0 million per occurrence. Property catastrophe
reinsurance, which is provided by several reinsurers, was increased to provide
95% of $18.5 million of coverage in excess of a $1.5 million per occurrence
retention. The commercial umbrella agreement with American Re continues to
provide coverage as described above.
19
<PAGE> 20
Effective January 1, 1997, CIC cancelled its reinsurance contracts and
replaced them with the following coverages. For policies in force at December
31, 1996 and for policies written with effective dates from January 1, 1997
through February 28, 1997, CIC has reinsurance providing coverage for both
property and casualty business, excluding umbrella coverage, of $4,750,000
excess of $250,000. For policies written with effective dates March 1, 1997 and
after, CIC has the same reinsurance as Sequoia's 1997 reinsurance program which
is outlined as follows. For property business, reinsurance provides coverage of
$10,350,000 excess of $150,000. For casualty business, excluding umbrella
coverage, reinsurance provides coverage of $4,850,000 excess of $150,000.
Umbrella coverages are reinsured $9,900,000 excess of $100,000. The catastrophe
treaties provide coverage of 95% of $19,000,000 excess of $1,000,000 per
occurrence for the combined losses of CIC and Sequoia. Facultative reinsurance
is placed with various reinsurers.
Effective June 30, 1997, immediately prior to the sale of CNIC, CIC ceded
and CNIC assumed all of CIC's historical workers' compensation net reserves and
inforce workers' compensation policies. CNIC then ceded and CIC assumed all of
CNIC's net commercial property and casualty reserves and inforce commercial
property and casualty insurance policies (other than workers' compensation).
Where the reinsurers are "not admitted" for regulatory purposes, the P & C
Insurance Group presently maintains sufficient collateral with approved
financial institutions to secure cessions of paid losses and outstanding
reserves.
With regard to Sequoia, all policy and claims liabilities prior to August 1,
1995 have been 100% reinsured with SRC and unconditionally guaranteed by QBE.
Sequoia, however, retains primary responsibility to its policyholders and
claimants should SRC and QBE fail. Sequoia's net retention for both property and
casualty business, excluding umbrella coverage, is $150,000 per risk or
occurrence. The working layers provide coverage up to $5,500,000 excess of
$150,000 per risk on property losses subject to occurrence limits and unlimited
reinstatements. General liability coverage, excluding umbrella coverage, is
provided up to $3,000,000 excess of $150,000 per occurrence. Two excess
catastrophe treaties provide additional property reinsurance up to $10,000,000
each occurrence, excess of $500,000 each occurrence, with allowances for one
full reinstatement each at pro rata pricing. Sequoia retains the first $100,000
of each umbrella loss up to $5,000,000. Facultative reinsurance is placed with
various reinsurers.
Reinsurance recoverable concentration for all property and casualty lines of
business, including MPL, as of December 31, 1997 is summarized in the following
table:
<TABLE>
<CAPTION>
REINSURANCE RECOVERABLE CONCENTRATION
UNEARNED REPORTED UNREPORTED REINSURER
PREMIUMS CLAIMS CLAIMS BALANCES
-------- ------ ------ --------
(in millions)
<S> <C> <C> <C> <C>
Sydney Reinsurance Corporation $ 0.1 $ 10.0 $14.1 $24.2
Kemper Reinsurance Corporation $ 1.5 $ 1.5
Continental Casualty Company $ 1.1 $ 0.6 $ 1.0 $ 2.7
San Francisco Reinsurance Company $ 0.1 $ 0.2 $ 0.3
TIG Reinsurance Group $ 1.2 $11.1 $12.3
Transatlantice Reinsurance Company $ 9.1 $ 9.1
Cologne Reinsurance Company of America $ 0.9 $ 0.9
Mutual Assurance, Inc. $ 4.1 $ 3.9 $ 8.0
General Reinsurance $ 2.9 $ 2.9
National Reinsurance Corporation $ 3.8 $ 0.5 $ 4.3
</TABLE>
The Company remains contingently liable with respect to reinsurance
contracts in the event that reinsurers are unable to meet their obligations
under the reinsurance agreements in force.
Life and Health
APL's net retention for life insurance products is a maximum of $50,000 per
risk, except for their combined critical illness and life insurance product
which has a maximum of $25,000.
20
<PAGE> 21
Reinsurance Risks
As with other property and casualty insurers, CIC's and Sequoia's operating
results and financial condition can be adversely affected by volatile and
unpredictable natural and man-made 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 CIC or Sequoia 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. None of the Company's insurance
subsidiaries is aware of actual or potential disputes with any of their
respective reinsurers that could materially and adversely impact the financial
results of the Company or is aware of any insolvent reinsurer whose current
obligations to CIC, Physicians, PRO, APL or Sequoia are material to such
companies.
Competition
There are several hundred property and casualty insurers licensed in
California, many of which are larger and have greater financial resources than
the P & C Insurance Group and offer more diversified types of insurance
coverage, have greater financial resources and have greater distribution
capabilities than the P & C Insurance Group.
A.M. BEST COMPANY ("Best") has assigned Sequoia a rating of B++ (Very Good)
and APL has had a Best rating of B+ (Very Good) since 1983. CIC is currently
rated 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 Best of the insurer's financial condition as well as
the expertise and experience of its management. Therefore, Best ratings are
important to policyholders. Best ratings are subject to review and change over
time. There can be no assurance that Sequoia, CIC, or APL will maintain their
ratings. If Sequoia, CIC, or APL fail to maintain their current ratings, it
would possibly have a material adverse effect on their ability to write new
insurance policies as well as potentially reduce their ability to maintain or
increase market share.
As a result of the reported losses and the increase in reserves, primarily
from construction defect claims, in 1995, Best at that time reduced its rating
of CIC from B+ to B-. Best recently upgraded CIC's rating to B+ (Very Good).
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 assurances that CIC's Best
ratings will be maintained or increased.
There is fierce competition in the property and casualty insurance industry
which is populated by large insurers doing business on a countrywide basis, as
well as regional and local insurers. Insurers compete on the basis of price,
product, and service. Many of the competitors in the market have higher ratings
from Best as well as other financial rating services and offer a broader array
of coverages than do CIC and Sequoia.
Commercial insurance markets are commodity-oriented, highly fragmented and
reflective of intense price competition. Nevertheless, because each commercial
risk is somewhat unique in terms of insurance exposure, different insurers can
develop widely divergent estimates of prospective losses. Most insurers attempt
to segment classes within commercial markets so that they target the more
profitable sub-classes with lower, although adequate rates, given the estimated
profitability of the segment. In some cases, no statistics are available for the
sub-classes involved, and the insurer implements discounted rate structures
based solely on theoretical judgment. Finally, different insurers have widely
divergent internal expense positions, due to method of distribution, scale
economies and efficiency of operations. Therefore, although insurance is a
commodity, the price of insurance does not necessarily reflect commodity
pricing.
Sequoia's and CIC's ability to attract and retain customers results from
price structures which have been tailored to attract certain sub-segments of the
commercial insurance market. In addition, several of their competitors have
either restricted writings in California or have withdrawn from the state due to
a variety of competitive pressures and adverse litigation and regulatory
climates.
However, CIC's and Sequoia's marketing is focused in a limited number of
commercial business classifications. In general, these classifications are
considered preferred by most competitors because of historically profitable
results realized from underwriting such classifications. CIC's and Sequoia's
customer bases and prospective revenues are vulnerable to the pricing actions of
larger or more efficient competitors who target CIC's and Sequoia's desired
classifications or individual policyholders and offer substantially lower rates.
21
<PAGE> 22
The life and health insurance industry is highly competitive. There are
approximately 700 life and health insurers licensed in Ohio, many of which are
larger and have greater financial resources than APL. APL currently is rated B+
(Very Good) by Best. APL is, to the Company's knowledge, one of the few life
insurance companies in the U.S. offering a critical illness policy which pays a
lump sum benefit equal to the face amount even if the insured is not terminally
ill (in contemplation of death within twelve months). This critical illness
policy, which is called "Survivor Key," has been the main focus of APL's
marketing efforts in recent years.
Physicians and its subsidiaries no longer compete in the MPL industry. CIC
sold its workers' compensation businesses in 1997. On June 16, 1997, Physicians
announced the signing of a definitive agreement to sell APL. See "HISTORY OF THE
Company--Developments Since the Merger."
Regulation
Physicians, CIC and their respective insurance subsidiaries are subject to
extensive state regulatory oversight in the jurisdictions in which they are
organized and in the jurisdictions in which they do business.
Physicians, PRO, APL, Sequoia, and CIC investments are strictly regulated by
investment statutes in their states of domicile. In general, these investment
laws place limits on the amounts of investment in any one company, the owned
percentage of any one company and the quality of investments and seek to ensure
the claims-paying ability of the insurer.
Ohio has enacted legislation that regulates insurance holding company
systems, including Physicians and its insurance subsidiaries. Each insurance
company in the holding company system is required to register with the Ohio
Department and furnish information concerning the operations of companies within
the holding company system that may materially affect the operations, management
or financial condition of the insurers within the system. Pursuant to these
laws, the Ohio Department may examine Physicians and/or its insurance
subsidiaries at any time and require disclosure of and/or approval of material
transactions involving the insurers within the system, such as extraordinary
dividends from any one of Physicians or any of its insurance subsidiaries. All
material transactions within the holding company system affecting Physicians or
its Ohio-domiciled insurance subsidiaries must be fair and reasonable. Sequoia
and CIC are subject to similar legislation in California.
Ohio insurance law provides that no person may acquire direct or indirect
control of Physicians, PRO or APL unless it has obtained the prior written
approval of the Ohio Superintendent of Insurance for such acquisition unless
such transaction is exempt. Similarly, California insurance law provides that no
person may acquire direct or indirect control of Sequoia or CIC unless it has
obtained the prior written approval of the California Insurance Commissioner of
such acquisition.
Since Physicians, PRO and APL are domiciled in Ohio, the Ohio Department is
the principal supervisor and regulator of each of these companies. Since Sequoia
and CIC are domiciled in California, the California Insurance Commissioner is
its principal supervisor and regulator. However, each of the companies are also
subject to supervision and regulation in the states in which they transact
business, and such supervision and regulation relate to numerous aspects of an
insurance company's business and financial condition. The primary purpose of
such supervision and regulation is to ensure financial stability of insurance
companies for the protection of policyholders. The laws of the various states
establish insurance departments with broad regulatory powers relative to
granting and revoking licenses to transact business, regulating trade practices,
required statutory financial statements, and prescribing the types and amount of
investments permitted. Although premium rate regulations vary among states and
lines of insurance, such regulations generally require approval of the
regulatory authority prior to any changes in rates.
Insurance companies are required to file detailed annual reports (statutory
Annual Statements) with the insurance departments in each of the states in which
they do business, and their financial condition and market conduct are subject
to examination by such agencies at any time.
Physicians, PRO and APL are restricted by the insurance laws of Ohio as to
the amount of dividends they may pay without prior approval. The maximum
dividend that may be paid during any 12-month period without the prior approval
of the Ohio Department is limited to the greater of 10% of the insurer's surplus
as regards policyholders as of the preceding December 31 or the net income of
the insurer for the year ended the previous December 31. Any dividend paid from
other than earned surplus is considered to be an extraordinary dividend and must
be approved.
22
<PAGE> 23
On December 30, 1996, Physicians paid a dividend of approximately $13.2
million to its sole shareholder, PICO. On April 14, 1997, Physicians paid a
dividend of approximately $8.6 million to PICO. With the approval of the Ohio
Department, on November 19, 1997, PRO amended its license to delete the
authority to write MPL insurance and paid a dividend of approximately $5.5
million to its sole shareholder, Physicians. On December 17, 1997, Physicians
contributed an additional $5.5 million to Sequoia. On December 30, 1997,
Physicians paid a dividend of approximately $13.2 million to PICO in the form of
5,557,347 shares of GEC common stock. In January 1998, approximately $15.8
million and $220,000 will be available for payment by Physicians and APL,
respectively, without the prior approval of the Ohio Department. No amounts were
available for payment by PRO based upon December 31, 1997 financial statements.
The California Insurance Code limits the amount of dividends or
distributions an insurance subsidiary may pay in any 12-month period without 30
days prior written notice to the Commissioner to the greater of (a) net income
for the preceding year as determined under statutory accounting principles or
(b) 10% of statutory policyholders' surplus as of the preceding December 31.
Insurers may pay dividends only from earned surplus. Payments of dividends in
excess of these amounts may only be made if the Commissioner has not disapproved
such payment, or specifically approves such payment, within the 30 day-period.
No ordinary dividends were available for payment by Sequoia or CIC based upon
December 31, 1997 financial statements.
The insurance industry is also affected by court decisions. Premium rates
are actuarially determined to enable an insurance company to generate an
underwriting profit. These rates contemplate a certain level of risk. The courts
may undercut insurers' expectations with respect to the level of risk being
assumed in a number of ways, including eliminating exclusions, multiplying
limits of coverage and creating rights for policyholders not set forth in the
contract. These decisions can adversely affect an insurer's profitability.
In recent years, the NAIC and state insurance regulators have been examining
existing laws and regulations, with an emphasis on insurance company investment
and solvency issues, risk-based capital guidelines, interpretations of existing
laws, the development of new laws and the implementation of nonstatutory
guidelines. From time to time, legislation has also been introduced in Congress
that would result in the federal government assuming some role in the regulation
of the insurance industry. Each of the Company's insurance subsidiaries are also
subject to assessment by state guaranty associations to fund the insurance
obligations of insolvent insurers. There can be no assurance that such
assessments will not have an adverse effect on the financial condition of the
Company and its insurance subsidiaries. However, assessments are calculated
based upon market share and none of the Company's insurance subsidiaries has a
significant market share in any line of business in any jurisdiction.
The regulation and supervision of insurance companies by state agencies is
designed principally for the benefit of their policyholders, not their
stockholders. In addition, MAC is subject to regulation by the California
Department of Corporations, which includes various requirements relating to the
financial condition of MAC as well as all aspects of the marketing of premium
financing. MAC is currently totally dormant.
The California Department completed its latest market conduct examination of
Sequoia and CNIC in 1992 and of CIC in 1993. The California Department also
completed a financial examination of CIC in 1997 covering the three years ended
December 31, 1995. The California Department's final examination report did not
require CIC to take any significant action.
The California Department also completed in 1997 a financial examination of
Sequoia covering 1993 through 1996. The Ohio Department completed its regular
triennial examinations of Physicians, PRO and APL for the three year period
1993-1995. Nothing of significance was reported for any of the companies
examined.
In July 1993, the California legislature enacted a series of seven bills to
significantly change the California workers' compensation system (the "1993
Reforms"). The 1993 Reforms increased costs as a result of benefit increases
commencing July 1, 1994 and continuing through July 1, 1996. In addition, the
1993 Reforms reduced revenues through an immediate reduction in minimum rates of
7%. The legislation permitted the Insurance Commissioner to approve rates even
lower. Effective January 1, 1994, the Insurance Commissioner ordered a further
12.7% reduction in minimum rates and a 16% reduction in minimum rates effective
October 1, 1994. Effective January 1995, California's minimum rate law was
replaced by a competitive rating system. The 1993 Reforms contain numerous other
provisions, including limitations on grounds for cancellation of policies. The
Company sold its workers' compensation business in 1997. See
"BUSINESS-Developments Since the Merger."
Proposed federal legislation has been introduced from time to time in recent
years that would provide the federal government with substantial power to
regulate property and casualty insurers, primarily through the establishment of
uniform solvency standards. Proposals also have been discussed to modify or
repeal the antitrust exemption for insurance companies provided by the
McCarran-Ferguson Act. The adoption of such proposals could have a material
adverse impact upon the operations of the Company.
23
<PAGE> 24
Proposition 103, a ballot initiative passed by California voters on November
8, 1988, requires rate rollbacks and prior approval of rates and imposes other
requirements on property and casualty insurers. Proposition 103, by its terms,
does not apply to workers' compensation insurance, but does apply to the types
of property and casualty insurance that Sequoia and CIC write. The rate rollback
provisions of Proposition 103 do not apply to CIC since CIC did not commence
writing property and casualty insurance prior to the effective date of
Proposition 103. Beginning on November 8, 1989, insurance rates may be increased
only after application to and approval by the Insurance Commissioner and, under
certain circumstances, after a public hearing. In June 1993, CIC received final
approval from the California Department for its inland marine and other
liability rate filings. Sequoia has fulfilled its Proposition 103 rate rollback
obligation and received approval from California for its rate filings.
Since 1990, numerous rates and underwriting rules have been filed by CIC and
approved by the California Department including certain rate increases. No
assurance can be given as to what actions, if any, the California Department
will take with respect to the approval of CIC's or Sequoia's future rate
filings.
Substantially all liabilities resulting from the roll back of insurance
rates under Proposition 103 had been settled or reserved for prior to
Physicians' purchase of Sequoia.
Proposition 103 also subjects the insurance industry to California antitrust
and unfair business practices laws (although the relevant provision of
Proposition 103 may only apply to automobile and certain other insurers),
prohibits cancellation or nonrenewal of insurance policies except for specified
reasons and provides that the Insurance Commissioner shall be an elected
official.
Beginning in 1994, Physicians, PRO, APL, CIC, and Sequoia became subject to
the provisions of the Risk-Based Capital for Insurers Model Act (the "Model
Act") which has been adopted by the NAIC for the purpose of helping regulators
identify insurers that may be in financial difficulty. The Model Act contains a
formula which takes into account asset risk, credit risk, underwriting risk and
all other relevant risks. Under this formula, each insurer is required to report
to regulators using formulas which measure the quality of its capital and the
relationship of its modified capital base to the level of risk assumed in
specific aspects of its operations. The formula does not address all of the
risks associated with the operations of an insurer. The formula is intended to
provide a minimum threshold measure of capital adequacy by individual insurance
company and does not purport to compute a target level of capital. Companies
which fall below the threshold will be placed into one of four categories:
Company Action Level, where the insurer must submit a plan of corrective action;
Regulatory Action Level, where the insurer must submit such a plan and the
regulator will issue a corrective order; Authorized Control Level, which
includes the above actions and may include rehabilitation or liquidation; and
Mandatory Control Level, where the regulator must rehabilitate or liquidate the
insurer.
The Model Act is not expected to cause any material change in any of the
insurance companies' future operations. All companies' risk-based capital
results as of December 31, 1997 exceed their minimum thresholds.
OTHER OPERATIONS
The Company conducts its other operations principally through Summit. See
"INTRODUCTION -- Subsidiaries." Other operations are currently or have been in
prior years conducted by Raven Development Corp., CLM Insurance Agency,
Stonebridge Partners AG and others. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" -"OTHER OPERATIONS."
Summit is registered as an investment adviser in California, Florida,
Kansas, Louisiana, Oregon, Virginia and Wisconsin as well as with the SEC. Since
February 1995, Summit has provided investment management services to Physicians
and its insurance affiliates. Summit also offers its services to other
individuals and institutions in the jurisdictions in which it is registered as
an investment adviser and in other states where registration is not required.
The investment advisory business is highly competitive. Many of Summit's
competitors 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.
As a registered investment adviser, Summit is subject to regulation by, and
files annual reports with, the SEC and the securities administrators in some of
the jurisdictions in which it is registered to do business.
EMPLOYEES
At December 31, 1997, the Company, excluding GEC and NLRC, had 172
employees. 158 employees worked in the Company's insurance operations including
121 in property and casualty, 20 in MPL, and 17 in life and health. A total of
eight employees worked in portfolio investing and six were engaged in holding
company activities.
24
<PAGE> 25
EXECUTIVE OFFICERS
The executive officers of PICO are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Ronald Langley 53 Chairman of the Board, Director
John R. Hart 38 President, Chief Executive Officer and
Director
Richard H. Sharpe 42 Chief Operating Officer
Gary W. Burchfield 51 Chief Financial Officer and Treasurer
James F. Mosier 50 General Counsel and Secretary
</TABLE>
Each executive officer of PICO was an executive officer of Physicians prior
to the Merger and became an officer of PICO in November 1996 as a result of the
Merger.
Mr. Langley has been Chairman of the Board of Physicians and PRO since July
1995, Chairman of the Board of Summit since November 1994, and a Director and
Chairman of the Board of GEC since September 1995. Mr. Langley has been a
Director of Physicians since 1993. Mr. Langley has been a Director of Sequoia
since August 1995 and a Director of CIC since November 1996. Mr. Langley has
been a Director of PC Quote, Inc. since 1995.
Mr. Hart has been President and Chief Executive Officer of Physicians and
PRO since July 1995 and President and Chief Executive Officer and a Director of
GEC since September 1995. Mr. Hart has been a Director of Physicians since 1993.
Mr. Hart has been a director of Summit since 1994. Mr. Hart has been a Director
and Chairman of the Board of Sequoia since August 1995 and a Director and
Chairman of the Board of CIC since November 1996. Mr. Hart has been a Director
of PC Quote, Inc. since 1997.
Mr. Sharpe has been Chief Operating Officer of Physicians since June 1994,
an officer of APL for more than 10 years, and a Director of APL since June 1993.
Mr. Sharpe has been a Director of Sequoia since August 1995 and a Director of
CIC since November 1996.
Mr. Burchfield has been Chief Financial Officer of Physicians since November
1995 and Treasurer since November 1994. Mr. Burchfield was Controller of
Physicians from March 1990 to November 1995 and Chief Accounting Officer of
Physicians from December 1993 to November 1995.
Mr. Mosier has served as General Counsel and Secretary of Physicians since
October 1984 and in various other executive capacities since joining Physicians
in 1981.
ITEM 2. PROPERTIES
The Company leases approximately 5,354 square feet in La Jolla, California
for its Principal Executive Offices.
Physicians owns a facility with approximately 56,000 square feet in
Pickerington, Ohio. APL leases office space in Indianapolis, Indiana for its
sales office located there. APL's Cleveland Regional Sales Director leases
office space in Cleveland; APL is a party to the lease and reimburses the
Regional Sales Director for all of the lease costs. Sequoia leases office space
for its headquarters in Monterey, California and for its regional claims and
underwriting offices in Modesto, Monterey, Rancho Cordova, Ventura, Visalia,
Oceanside, Orange, Pleasanton, and San Jose, California, as well as Reno,
Nevada. CLM's only office space consists of a leased facility in Monterey,
California. GEC owns a commercial office building in Toronto, Ontario, Canada
and also shares office space with PICO in La Jolla, California. Vidler and NLRC
lease office space in Ft. Collins, Colorado, and Reno, Nevada, respectively.
Vidler and NLRC hold significant investments in land, water and mineral rights
in the western United States. See "ITEM 1-BUSINESS-INTRODUCTION."
ITEM 3. LEGAL PROCEEDINGS
Members of the Combined Insurance Group and APL are frequently a party in
claims proceedings and actions regarding insurance coverage, all of which the
Company considers routine and incidental to its business. Neither PICO nor its
subsidiaries are parties to any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
25
<PAGE> 26
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of PICO is traded on the Nasdaq National Market under the
symbol PICO. Prior to November 1996, the symbol was CITN. The following table
sets forth for each period indicated, the high and low sale prices as reported
on the Nasdaq National Market. These reported prices reflect interdealer prices
without adjustments for retail markups, markdowns or commissions.
<TABLE>
<CAPTION>
1996 1997
------------------------- -------------------------
High Low High Low
---------- -------- ---------- ---------
<S> <C> <C> <C> <C>
1st Quarter $4.75 $3.50 $4.75 $3.625
2nd Quarter 4.625 3.875 4.625 3.6875
3rd Quarter 4.4375 3.375 6.375 4.375
4th Quarter 4.375 3.375 6.4375 5.875
</TABLE>
As of December 31, 1997, the closing sale price of PICO's common stock was
$6.4375 and there were 1,596 holders of record of PICO's Common Stock.
PICO has not declared or paid any dividends in the last two years and does
not expect to pay any dividends in the foreseeable future.
26
<PAGE> 27
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data of the
Company. The information set forth below is not necessarily indicative of the
results of future operations and should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 of this Form 10-K and the consolidated financial
statements and the related notes thereto included elsewhere herein.
<TABLE>
<CAPTION>
Years Ended December 31
--------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------- -------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS (In thousands, except ratios and per share data)
Revenues
Premiums income earned $ 49,876 $ 38,761 $ 19,542 $ 20,026 $ 50,384
Net investment income 11,686 8,086 9,165 12,452 17,802
Other income 26,017 29,889 12,482 1,596 2,307
------------ ------------ ------------ ------------ ------------
Total revenues $ 87,579 $ 76,736 $ 41,189 $ 34,074 $ 70,493
============ ============ ============ ============ ============
Income (loss) before discontinued operations and
cumulative effect of changes in accounting
principal $ 19,035 $ 21,019 $ 14,895 $ 16,348 $ (2,522)
Income from discontinued operations 456 3,301 778 2,483 3,177
Cumulative effect of change in accounting principal (4,110) (547)
------------ ------------ ------------ ------------ ------------
$ 19,491 $ 24,320 $ 15,673 $ 14,721 $ 108
============ ============ ============ ============ ============
PER COMMON SHARE RESULTS--BASIC:
Income (loss) from continuing operations $ 0.59 $ 0.75 $ 0.54 $ 0.60 $ (0.09)
Income from discontinued operations 0.01 0.12 0.03 0.09 0.12
Loss from cumulative effect of change in
accounting principal (0.15) (0.02)
------------ ------------ ------------ ------------ ------------
Net income $ 0.60 $ 0.87 $ 0.57 $ 0.54 $ 0.01
============ ============ ============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING 32,551,951 28,004,595 27,436,191 27,436,191 27,436,191
============ ============ ============ ============ ============
PER COMMON SHARE RESULTS--DILUTED:
Income (loss) from continuing operations $ 0.57 $ 0.72 $ 0.54 $ 0.59 $ (0.09)
Income from discontinued operations 0.01 0.12 0.03 0.09 0.12
Loss from cumulative effect of change in
accounting principal (0.15) (0.02)
------------ ------------ ------------ ------------ ------------
Net income $ 0.58 $ 0.84 $ 0.57 $ 0.53 $ 0.01
============ ============ ============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING 33,741,265 29,055,669 27,436,191 27,588,667 27,436,191
============ ============ ============ ============ ============
</TABLE>
Note: Prior year share values have been adjusted to reflect the November 20,
1996 reverse acquisition between Physicians Insurance Company of Ohio
and Citation Insurance Group and prior year operating results have been
adjusted to reflect the treatment of APL as a discontinued operation.
<TABLE>
<CAPTION>
Years Ended December 31
-----------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ----------- ------------- ------------ ------------
(In thousands, except ratios and per share data)
FINANCIAL CONDITION
<S> <C> <C> <C> <C> <C>
Assets $ 430,293 $ 490,425 $ 421,816 $ 297,163 $ 297,887
Unpaid losses and loss adjustment expenses,
net of discount $ 196,096 $ 252,024 $ 229,797 $ 180,691 $ 191,735
Total liabilities $ 318,142 $ 380,222 $ 342,466 $ 261,419 $ 271,780
Shareholders' equity $ 112,151 $ 110,203 $ 79,350 $ 35,744 $ 26,107
Book value per share $ 3.73 $ 3.61 $ 3.04 $ 1.40 $ 1.17
</TABLE>
27
<PAGE> 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
COMPANY SUMMARY AND RECENT DEVELOPMENTS
Introduction
Readers of Citation Insurance Group's prior financial statements will find
that these financial statements differ greatly from those presented for periods
prior to December 31, 1996. Whereas Citation Insurance Group was previously
engaged predominantly in property and casualty operations, PICO Holdings, Inc.
specializes in portfolio investing, property and casualty insurance, investment
management, surface, water, geothermal and mineral rights and other services.
These changes are a result of the November 20, 1996 merger of Physicians
Insurance Company of Ohio and a subsidiary of Citation Insurance Group, in which
Physicians Insurance Company of Ohio was the surviving corporation. Upon
consummation of the Merger, Citation Insurance Group changed its name to PICO
Holdings, Inc. For accounting purposes the transaction has been treated as a
reverse acquisition with Physicians Insurance Company of Ohio being the
acquiror. As a result, these financial statements reflect prior years data of
Physicians Insurance Company of Ohio and its subsidiaries and affiliates only.
Citation Insurance Group's information for 1995 and operating results and
account balances prior to the Merger have not been included in these financial
statements. See Note 3 to the Consolidated Financial Statements entitled
"Acquisitions" for further information on the accounting treatment of the
reverse acquisition.
Background
Prior to July 16, 1995, the effective date of Physicians and PRO's 100%
quota share reinsurance of their MPL businesses with Mutual and the subsequent
sale of the rights to these MPL books of business, effective January 1, 1996,
the Physicians group of affiliated companies consisted primarily of two property
and casualty insurance companies writing MPL insurance (Physicians and PRO) and
one life and health insurance company, APL. For various reasons, in November
1994, the respective boards of directors of Physicians and PRO determined that
it was in the best interests of Physicians and PRO and their respective
shareholders to sell their MPL insurance businesses. This sale was part of an
overall shift in the strategic direction of Physicians and PRO.
On August 1, 1995, Physicians purchased Sequoia, a California property and
casualty insurance company writing light commercial and multiple peril insurance
in northern and central California. Sequoia does not write MPL insurance.
On September 5, 1995, Physicians purchased 38.2% of the common stock of GEC,
a Canadian company operating in portfolio investments, agricultural services,
and other business segments. Through acquisitions on July 30 and August 19,
1997, the Company increased its ownership in GEC to an aggregate of
approximately 51.17%. As a result of such acquisition, GEC's financial
statements have been consolidated with those of the Company for 1997.
On November 20, 1996, Physicians and its subsidiaries merged with a
subsidiary of CIG and CIG then changed its name to PICO Holdings, Inc. This
reverse acquisition brought another California property and casualty insurance
company, CIC, into the affiliated group and provided a non-insurance holding
company structure.
In addition to the operation of its subsidiaries, 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. 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. Therefore, the
results of this business strategy are not fully reflected in the historical
financial statements. 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.
See the Notes to Consolidated Financial Statements for additional
information regarding events affecting PICO subsequent to the date of these
financial statements.
28
<PAGE> 29
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
SUMMARY
PICO reported net income of $19.5 million, or $0.60 per share for 1997,
compared with net income of $24.3 million, or $0.87 per share during 1996, and
$15.7 million, or $0.57 per share in 1995. Per share amounts are expressed as
basic earnings per share. Net income for 1997 included income from discontinued
operations of approximately $456,000, net of federal income taxes and minority
interests. Shares outstanding and per share calculations for 1995 have been
adjusted for comparison purposes to reflect the November 20, 1996 merger between
Physicians and the Citation Insurance Group. Year-to-year comparisons are
somewhat distorted as a result of the inclusion of Sequoia beginning August 1,
1995 and the addition of the Citation group effective November 20, 1996. Sequoia
contributed net income of $2.8 million to PICO's 1997 consolidated income, $1.5
million to 1996 and a post-acquisition net loss of $2.5 million to 1995.
Citation's added $1.1 million to 1997 consolidated net income and $675,000 to
1996, following the Merger. GEC's operations added a net loss of $6.1 million to
consolidated income for 1997.
Shareholders' equity per share increased $0.12 during 1997, principally as a
result of the $19.5 million net income, partially offset by a $14.6 million
reduction in unrealized appreciation of investments, net of taxes from January
1, 1997 through December 31, 1997. Shareholders' equity per share calculated on
an undiluted basis at December 31, 1997 was $3.73, compared to $3.61 and $3.04
at December 31, 1996 and 1995, respectively. Prior years per share amounts have
been adjusted to reflect the November 1996 merger. Shareholders' equity of
$112.2 million increased $1.9 million, or 1.8% compared to $110.2 million at
December 31, 1996.
Much of the 1997 decline in unrealized appreciation of investments resulted
from the sale of appreciated securities during the year. Realized investment
gains provided $21.4 million in revenues and income before taxes and minority
interests in 1997, compared to $27.1 million and $5.0 million in 1996 and 1995,
respectively. Realized investment gains during 1997 included a gain of
approximately $2 million from the sale of the Company's holdings in AmVestors
Financial Corporation common stock during the first quarter; approximately $27
million from the sale of the Resource America common stock during the third
quarter; and a realized investment loss of approximately $8 million, before
minority interests, resulting from the write down of GEC's investments in Korean
securities, including a foreign currency loss of approximately $3.8 million (See
"PORTFOLIO INVESTING--GLOBAL EQUITY CORPORATION" following).
During 1997, the Company's assets decreased approximately $60.1 million to
$430.3 million. Reclassification of APL as discontinued operations reduced
assets by $53.4 million.
Revenues of $87.6 million increased $10.9 million over 1996 and $46.5
million over 1995. Property and casualty insurance revenues increased $21.7
million over 1996 and nearly $55 million over 1995. CIC added $21.0 million and
$6.5 million to revenues in 1997 and 1996, respectively, following the Merger.
Sequoia's 1997 revenues were $35.4 million, up $6.7 million from 1996 and up $33
million from the five-month period of inclusion in 1995. GEC provided $1.5
million in revenues during 1997 which was more than offset by approximately $8.0
million in realized investment losses. GEC was not consolidated with the Company
in 1996 and 1995. MPL revenues decreased $8.3 million during 1997 as compared to
1996 and more than $25 million compared to 1995 due to the reduction in earned
premiums associated with the wind down of the business.
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 until the effective date of the Company's majority ownership
of GEC. In addition, as a result of the acquisition of the majority ownership of
GEC and management's strategic initiatives, the surface, water, geothermal and
mineral rights activities of PICO and GEC have been disclosed as a segment in
this annual report. Life and health insurance operations and certain of GEC's
operations are shown as discontinued operations based upon the sale or pending
sale of those operations. See Note 6 of Notes to Consolidated Financial
Statements, "Discontinued Operations" for additional information.
29
<PAGE> 30
Revenues and income before taxes and minority interests from CONTINUING
OPERATIONS, by business segment, are shown in the following schedules:
Operating Revenues--Continuing Operations:
------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1997 1996 1995
------- ------- -------
(in millions)
<S> <C> <C> <C>
Portfolio Investing $30.6 $27.0 $ 8.0
Global Equity Corporation (6.5)
Surface, Water, Geothermal and Mineral Rights 2.5
Property and Casualty Insurance 57.0 35.3 2.5
Medical Professional Liability Insurance 3.9 12.2 29.0
Other 0.1 2.2 1.6
----- ----- -----
Total Revenues-Continuing Operations $87.6 $76.7 $41.1
===== ===== =====
</TABLE>
Income Before Taxes and Minority Interest--Continuing Operations:
-----------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
1997 1996 1995
------- ------- -------
(in millions)
<S> <C> <C> <C>
Portfolio Investing $27.9 $23.3 $ 5.3
Global Equity Corporation (10.1)
Surface, Water, Geothermal and Mineral Rights -
Property and Casualty Insurance 5.6 3.3 (3.7)
Medical Professional Liability Insurance 0.8 8.5 6.0
Other (0.7) (1.1) (0.5)
----- ----- -----
Income Before Tax and Minority Interest $23.5 $34.0 $ 7.1
===== ===== =====
</TABLE>
PORTFOLIO INVESTING
- -------------------
Portfolio investing operations are principally conducted by PICO, Physicians
and GEC. GEC's portfolio investing results are shown separately in the following
section. Investment revenues and realized investment gains or losses generated
by Physicians are first allocated to MPL equal to the amount of loss reserve
discount accretion recorded during the period. The remainder is shown as
portfolio investing revenue.
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 MPL 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 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 of Vidler and NLRC which are assigned to surface,
water, geothermal and mineral rights segment.
Excluding GEC, which is stated separately below, portfolio investing
revenues for 1997 of $30.6 million increased $3.6 million over the $27 million
recorded in 1996 and $22.6 over the $8 million of 1995. Excluding realized
investment gains, portfolio investing increased approximately $700,000 over 1996
and decreased $1.7 million as compared to 1995. The increase in 1997 investment
income over 1997 principally reflects investment income earned by PICO on
dividends from Physicians. The decline in 1996 investment income compared to
1995 was principally due to a significant shift in the mix of the Company's
investment portfolio from interest bearing fixed maturity and cash equivalent
securities toward equity securities. See "PART 1-BUSINESS-HISTORY OF THE
COMPANY-Physicians."
30
<PAGE> 31
Portfolio investing revenues are summarized below:
PORTFOLIO INVESTING
-------------------
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
1997 1996 1995
------- ------- ------
(in millions)
<S> <C> <C> <C>
Portfolio Investing Revenues:
- -----------------------------
Realized Investment Gains $ 29.3 $ 26.4 $ 5.0
Investment Income 1.3 0.6 3.0
------- ------- ------
Portfolio Investing Revenues $ 30.6 $ 27.0 $ 8.0
======= ======= ======
</TABLE>
Most of the $29.3 million in 1997 realized investment gains, or
approximately $27 million before taxes, resulted from the exercise of the
Company's warrants to buy common stock of Resource America and the subsequent
sale of that stock. Resource America was a 1994 investment made by Physicians
after its change in strategic direction. See "ITEM 1-BUSINESS-HISTORY OF THE
COMPANY." Realized investment gains in 1996, principally from the sale of
Physicians' holdings in Fairfield Communities common stock amounted to $26.4
million. This compares to $5.0 million in realized investment gains in 1995.
At December 31, 1997, the consolidated investment portfolio was in a net
unrealized loss position of approximately $2.7 million, net of taxes. This
compares to net unrealized investment gains at December 31, 1996 of
approximately $11.8 million. Much of this decline resulted from the conversion
of unrealized investment gains to realized investment gains resulting from the
sale of the Company's holdings in Resource America common stock during the third
quarter of 1997 and AmVestors Financial Corporation ("AmVestors") common stock
at a gain of $1.3 million, net of tax, during the first quarter of 1997.
Unrealized investment gains, net of taxes, at December 31, 1996 attributable to
Resource America and AmVestors were approximately $9.4 million and $1.2 million,
respectively. PC Quote, one of the Company's technology stocks and a provider of
real time and delayed stock market quotes continued to decline in value during
1997. The Company has provided a loan of $2.5 million and a line of credit of
approximately $2 million, and received certain warrants for the purchase of PC
Quote common stock as an inducement, to provide working capital and other funds
necessary for PC Quote to continue to develop and market its products.
Net of expenses, but before taxes, portfolio investing operations, excluding
those of GEC, contributed $27.9 million to pre-tax operating income in 1997
compared to $23.3 million during 1996 and $5.3 million in 1995. Realized
investment gains, as discussed above, accounted for nearly $29.3 million, $26.4
million and $5.0 million of this pre-tax income in 1997, 1996 and 1995,
respectively. While past results are very encouraging, future results cannot and
should not be predicted based upon past performance alone.
The breakdown of pre-tax operating income from portfolio investing
operations follows:
PORTFOLIO INVESTING
-------------------
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1997 1996 1995
-------- --------- -------
(in millions)
<S> <C> <C> <C>
Portfolio Investing Income Before Tax:
- --------------------------------------
PICO and Physicians $ 27.9 $ 22.3 $ 5.8
Equity in Unconsolidated Subsidiaries 1.0 (0.5)
-------- --------- -------
Portfolio Investing Pre-Tax Income $ 27.9 $ 23.3 $ 5.3
======== ========= =======
</TABLE>
Equity in unconsolidated subsidiaries represents the Company's share of
GEC's net income prior to its consolidation with PICO. GEC's financial results
are consolidated with those of the Company for 1997.
PORTFOLIO INVESTING--GLOBAL EQUITY CORPORATION
- ----------------------------------------------
GEC is an international 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 a number of interests in land, water and mineral rights in the western
United States through Vidler and NLRC. The operations of Vidler and NLRC 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.
31
<PAGE> 32
Following is a breakdown of GEC's portfolio investing revenues and loss:
PORTFOLIO INVESTING--GLOBAL EQUITY CORPORATION
<TABLE>
<CAPTION>
Year Ended
December 31,
------------
1997
----
(in millions)
Global Equity Corporation-Revenues:
- -----------------------------------
<S> <C>
Realized Investment Losses $ (8.0)
Investment Income 1.0
Other Income 0.5
-------
Global Equity Corporation Revenues $ (6.5)
=======
GEC Loss Before Tax and Minority Interest:
- ------------------------------------------
Global Equity Corporation $ (10.1)
-------
Loss Before Tax and Minority Interest $ (10.1)
=======
</TABLE>
Physicians initially acquired approximately 38.2% of GEC on September 5,
1995. PICO and its wholly-owned subsidiaries acquired additional shares of GEC
in July and August 1997, bringing the Company's holdings up to approximately
51.17% as of August 19, 1997. As a result of the increased ownership of GEC,
GEC's results have been consolidated with those of the Company beginning August
19, 1997. Appropriate provisions have been made in these financial statements to
reflect the interests of other GEC shareholders, where applicable.
Most of GEC's $6.5 million in combined revenues and realized investment
losses and $10.1 million loss before taxes and minority interest resulted from
an approximate $8 million write down of GEC's investments in Korean securities.
This permanent write down reflects management's opinion that the decline in the
market value of these securities is "other than temporary" and includes a loss
on foreign currency exchange of approximately $3.8 million. These Korean
investments were heavily impacted by the recent downturn in the Korean and Asian
financial markets. GEC's investment in these Korean securities as of December
31, 1997, subsequent to the write down, is less than $1.0 million.
See "DISCONTINUED OPERATIONS" below regarding GEC's contribution to income
from discontinued operations.
SURFACE, WATER, GEOTHERMAL AND MINERAL RIGHTS
- ---------------------------------------------
Effective November 14, 1995, a wholly-owned subsidiary of GEC acquired all
the outstanding common stock of 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 needed in the southwestern United
States and then facilitate the transfer from current ownership to Vidler, and
subsequently to municipalities, water districts, 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 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 land, water and mineral rights generated by
Vidler and NLRC were $2.5 million. Revenues include land sales; lease of land,
principally for grazing purposes; water sales and leasing and other income.
Income from continuing operations before taxes and minority interests included
in the consolidation amounted to approximately $12,000.
32
<PAGE> 33
PROPERTY AND CASUALTY INSURANCE
- -------------------------------
Sequoia and CIC account for all of the ongoing property and casualty ("P &
C") insurance revenues. These companies write predominately light commercial and
multiple peril insurance coverage in central and northern California. CNIC is no
longer a part of the group following the sale of CNIC on June 30, 1997 along
with CIC's workers compensation business.
Since CIC and CNIC became part of the group in November 1996, their
activities are not included in the Company's financial results prior to that
date. Sequoia has been part of the group since August 1, 1995. Therefore,
Sequoia's financial results are not included with those of the Company prior to
August 1, 1995. Sequoia and CIC are continually seeking ways to realize savings
and synergies and to combine operations, wherever possible. In evidence of this,
Sequoia and CIC consolidated their home office operations in Monterey,
California in July 1997. Both companies are in the process of subleasing their
former office spaces in Pleasanton and San Jose, California.
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.
PROPERTY AND CASUALTY INSURANCE
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1997 1996 1995
----- ----- ------
P & C Revenues: (in millions)
- ---------------
<S> <C> <C> <C>
Earned Premiums - Sequoia $32.8 $26.3 $ 2.4
Earned Premiums - Citation 17.4 5.1
Investment Income 5.6 2.6 0.2
Realized Investment Gains 0.2 0.7
Other 1.0 0.6 (0.1)
----- ----- ------
Total P&C Revenues $57.0 $35.3 $ 2.5
===== ===== ======
P & C Income (Loss) Before Taxes:
- ---------------------------------
Sequoia Insurance Company $ 4.3 $ 2.3 $ (3.7)
Citation Insurance Company 1.3 1.0 -
----- ----- ------
$ 5.6 $ 3.3 $ (3.7)
===== ===== ======
</TABLE>
Total P&C revenues for 1997 of $57.0 million surpassed those of 1996 by
$21.7 million and 1995 by $54.5 million. Of these amounts, CIC added $21.0
million to the 1997 revenues and $6.5 million to 1996 following the merger.
Sequoia's 1997 revenues were $35.4 million, up $6.7 million from 1996 and $33.0
million from the five-month period of the Company's ownership in 1995. Included
in these amounts, investment income and realized investment gains from P&C
operations rose to $5.8 million in 1997, up $2.5 million from 1996 and $5.6
million over 1995. Sequoia's earned premiums increased $6.5 million, or 24.7%,
as compared to 1996 and $30.4 million compared to the partial year of inclusion
in 1995.
P&C income before taxes for 1997 amounted to $5.6 million, an increase of
$2.3 million or 67% over the 1996 level of $3.3 million. CIC added approximately
$300,000 to the 1997 increase due to its inclusion for a full year. Sequoia's
income before taxes increased $2.0 million from 1996 to 1997. Most of Sequoia's
improvement was attributable to greatly improved claims experience. As shown
below, Sequoia's GAAP industry combined ratio declined 5.5 percentage points
during 1997. The P&C loss before taxes for 1995 of $3.7 million included only
five months of Sequoia's income and none of CIC's. Much of Sequoia's five-month
1995 loss was attributable to expenditures that may provide benefits in future
years through improved operating efficiencies. These expenses included, among
others, those associated with development of a new policy quoting and processing
system and integrated claims processing and accounting systems. Software was
developed and is now in use which allows underwriters and agents to
decentralize, rate policies in the field, and download the information via modem
to the home office, allowing them to spend much more time in the field
inspecting risks and servicing policies.
33
<PAGE> 34
Sequoia's direct premium writings for 1997 were $41.0 million, up $3.3
million from the $37.7 million reported for 1996 and down slightly from the
$42.0 million reported by Sequoia for the full year 1995. The $42.0 million of
1995 direct written premium included seven months of activity prior to
Physicians' purchase of Sequoia on August 1, 1995. This reduction in premium
writings in 1997 and 1996 reflects, in part, the increased underwriting
selectivity of Sequoia's management team. Sequoia and CIC stress quality of
business over quantity. As policies came up for renewal in 1995 and through much
of 1996, they were reviewed carefully by underwriting management for excessive
loss experience and unwanted risks. New policy writings have been less than
expected, largely due to increased competition, and have not offset renewal
policies cancelled or non-renewed. The loss of renewal policies with higher loss
ratios and greater exposures to risk may improve Sequoia's loss ratios in the
future. Nevertheless, there can be no assurance that Sequoia and Citation will
be successful in reducing their policies with higher loss ratios or that their
loss ratios will improve in the future.
Industry ratios as determined on the basis of generally accepted accounting
principles ("GAAP") for Citation are shown in the following chart:
CIC'S GAAP INDUSTRY RATIOS
--------------------------
<TABLE>
<CAPTION>
1997
-----
<S> <C>
Loss and LAE Ratio 84.8%
Underwriting Expense Ratio 32.9%
-----
Combined Ratio 117.7%
=====
</TABLE>
Industry ratios as determined on a GAAP basis for Sequoia were:
SEQUOIA'S GAAP INDUSTRY RATIOS
------------------------------
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Loss and LAE Ratio 57.3% 62.9%
Underwriting Expense Ratio 38.1% 38.0%
--------- ---------
Combined Ratio 95.4% 100.9%
========= =========
</TABLE>
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. Sequoia's loss experience improved considerably in 1997
from a GAAP loss ratio of 62.9% in 1996 to 57.3% in 1997. Sequoia's reduced loss
ratios reflect Sequoia's improved loss experience principally resulting from
management's efforts to reduce exposure to risk through re-underwriting existing
business during 1995 and 1996, tighter underwriting and careful selection of
risks.
The management of Sequoia and CIC estimate that storm losses incurred by the
companies as a result of the recent El Nino phenomenon is less than $1.0 million
for the first quarter of 1998.
MEDICAL PROFESSIONAL LIABILITY OPERATIONS
- -----------------------------------------
Physicians' and PRO's MPL insurance business was sold to Mutual on August
28, 1995. Except for a few minor policy coverage extensions and adjustments
which are 100% reinsured by Mutual, for all intents and purposes, the Company
ceased writing MPL policies effective January 1, 1996. The Company 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, the Company 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 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 Company ceased writing MPL insurance, MPL is treated as a separate
business segment of continuing operations due to the continued management of
claims and associated investments.
34
<PAGE> 35
Revenues and pre-tax income or loss from MPL operations included the
following:
MEDICAL PROFESSIONAL LIABILITY INSURANCE
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1997 1996 1995
------- ------- --------
(in millions)
<S> <C> <C> <C>
MPL Revenues:
Earned Premiums $0.2 $7.4 $17.1
Investment Income, Net of Expenses 3.7 4.8 5.9
Income from Sale of MPL Business 6.0
------- ------- --------
MPL Revenues $3.9 $12.2 $29.0
======= ======= ========
MPL Income Before Tax: $0.8 $8.5 $6.0
- ---------------------- ======= ======= ========
</TABLE>
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.
Earned premium steadily declined from $17.1 million in 1995 to $7.4 million in
1996 and slightly less than $240,000 in 1997.
The following table shows the decline in Physicians' and PRO's direct
written premiums over the past five years:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
-------- ------- ------- ------- -------
(in millions)
<S> <C> <C> <C> <C> <C>
Direct Written Premiums $0.0 $0.2 $22.6 $28.0 $37.6
</TABLE>
The marked decline in direct written premiums prior to 1996 is indicative of
the increasing competitive pressures within Ohio which, among other factors, led
Physicians and PRO to increase premium rates, to be more selective in
underwriting and, ultimately, to withdraw from the MPL line of business.
MPL premiums continued to be earned during 1996 based upon premiums written
prior to July 16, 1995, the effective date of the 100 percent quota share treaty
with Mutual. Investment income revenues will continue to accrue to the MPL
runoff.
MPL insurance revenues amounted to $3.9 million during 1997 compared to
$12.2 million and $29.0 million during 1996 and 1995, respectively. The decline
in MPL earned premiums accounted for most of this variance between years, other
than the $6 million in revenues in 1995 from the sale of the Company's MPL
business. Investment income also declined during 1997 as compared to 1996 and
1995, 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 operations produced pre-tax operating income of approximately $765,000
in 1997 compared to income of $8.5 million and $6.0 million during 1996 and
1995, respectively. Results for 1997 were negatively impacted by a $2 million
addition to loss and LAE reserves. This addition to reserves during the third
quarter of 1997 was based upon an actuarial analysis as of June 30, 1997 which
indicated some unfavorable loss experience had occurred during the first six
months of 1997. Pre-tax operating results for 1996 were aided by a $1.4 million
reduction in MPL death, disability and retirement unearned premium reserves
related to the Mutual transaction, and loss and LAE reserve reductions of
approximately $6.0 million due to continued favorable development of MPL
reserves. The $6.0 million pre-tax operating income recorded during 1995 was
equal to the $6.0 million realized on the sale of Physicians' and PRO's MPL
businesses. Investment income was also higher in 1996 and 1995 due to greater
reserve levels and higher loss reserve discount accretion.
Greatly reduced earned premiums, somewhat lower investment income, and
certain non-recurring expense accruals associated with the MPL claims runoff
were responsible for the remainder of the decline in pre-tax MPL income from
1996 to 1997.
Physicians' claims department staff continues to process the runoff of the
remaining MPL loss and loss adjustment expense claims which is progressing
routinely. At December 31, 1997, MPL reserves totaled $ 77.5 million, net of
reinsurance and discount. This compares to $112.9 million and $136.2 million at
December 31, 1996 and 1995, respectively. MPL loss and LAE reserves continue to
decline as a result the disposition of claims.
35
<PAGE> 36
MPL INSURANCE -- LOSS AND LAE RESERVES
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------
1997 1996 1995
--------- --------- ---------
(in millions)
<S> <C> <C> <C>
Direct Reserves $ 121.4 $ 158.4 $ 192.5
Ceded Reserves (34.8) (33.3) (38.5)
Discount of Net Reserves (9.1) (12.2) (17.8)
-------- -------- --------
Net MPL Revenues $ 77.5 $ 112.9 $ 136.2
======== ======== ========
</TABLE>
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 consists principally of Summit's investment management
operations, the wind down of Raven Development Company's ("Raven") real estate
development projects, and various other activities as summarized below:
OTHER OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1997 1996 1995
-------- ------- -------
(in millions)
<S> <C> <C> <C>
Revenues from Other Operations:
- -------------------------------
Investment Management Services $ 1.1 $ 0.8 $ 0.2
Less: Intercompany Portfolio Mgmt. Charges (0.5) (0.5) -
Other (0.5) 1.9 1.4
----- ----- -----
Revenue from Other Operations $ 0.1 $ 2.2 $ 1.6
===== ===== =====
Other Operations-Loss Before Tax:
- ---------------------------------
Investment Management Services $ 0.2 $ 0.1 $(0.1)
Less: Intercompany Portfolio Mgmt. Charges (0.5) (0.5) -
Other (0.4) (0.7) (0.4)
----- ----- -----
Other Operations-Loss Before Tax $(0.7) $(1.1) $(0.5)
===== ===== =====
</TABLE>
Revenues from other operations decreased from $2.2 million in 1996 and $1.6
million in 1995 to approximately $100,000 in 1997. Nearly all this decline
resulted from the wind down of real estate operations of Physician's subsidiary,
Raven, which saw virtually no activity in 1997. The remainder of Raven's real
estate holdings was sold in early 1998. Raven's real estate activity is minimal,
generally consisting of wind down costs.
Investment management revenues and operating income from Summit, before
elimination of intercompany transactions, increased over 1996 and 1995. In 1997
Summit's revenues before intercompany eliminations were $1.1 million compared to
approximately $762,000 in 1996 and $209,000 in 1995. Summit now has more than
$700 million in assets under management, up approximately 75% over a year ago.
Summit's revenues have increased due to the addition of additional clients and
increased intercompany portfolio management fees.
Other operations produced an approximate $700,000 pre-tax loss for 1997
compared to pre-tax losses of $1.1 million and $0.5 million in 1996 and 1995,
respectively.
Under the category of "Other," Stonebridge Partners AG ("Stonebridge"), a
Swiss corporation wholly-owned by Physicians which brokered annuities and other
insurance products within Europe, produced a pre-tax operating loss of
approximately $386,000 in 1997 and a $1 million loss for 1996. The pre-tax loss
for 1995 was $234,000. Stonebridge began operations in late 1995, resulting in
significant start-up costs in 1995 which continued into 1996. For various
reasons, Stonebridge has been unsuccessful in marketing their brokerage
business, as well as in collecting accounts which they believe are due them from
clients. Stonebridge was deactivated in 1997.
36
<PAGE> 37
DISCONTINUED OPERATIONS
- -----------------------
Discontinued operations consists of the operations of APL, the Company's
life and health insurance subsidiary and GEC's former Sri Lankan subsidiaries
which engaged in various activities including stock and commodity brokerage and
agricultural services.
APL, Physicians' wholly-owned life insurance subsidiary, produced revenues
of $5.3 million and a pre-tax loss of $112,000 during 1997. This compares to
$9.0 million and $6.8 million in revenues and $4.0 million and approximately
$859,000 million in pre-tax income in 1996 and 1995, respectively. Revenues and
income before tax for 1996 included realized investment gains of approximately
$3.9 million from the sale of APL's investment in Fairfield Communities common
stock.
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 are still pending. See "HISTORY OF THE COMPANY--Developments Since the
Merger" regarding the pending sale of APL and its wholly owned subsidiary.
GEC has elected to treat its Sri Lankan operations as discontinued in
recognition of their sale in November and December 1997. These operations
produced approximately $3.3 million in pre-tax income during 1997 as recorded in
GEC's financial results, prior to the elimination of minority interests when
consolidated with PICO. This included approximately $3.5 million of realized
pre-tax gain in 1997 on the sale and reversal of a foreign currency translation
adjustment relating to those operations of approximately $2.3 million, prior to
recognition of minority interest. See Note 6 of Notes to the Consolidated
Financial Statements, "Discontinued Operations."
The net assets of the discontinued operations of APL have been shown as one
line on the 1997 balance sheet as net assets of discontinued operations totaling
$15.9 million.
LIQUIDITY AND CAPITAL RESOURCES -- YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
PICO Holdings, Inc. is a holding company whose assets principally consist of
the stock of its subsidiaries. PICO continually evaluates the operations of its
existing operations and searches for new opportunities in order to maximize
shareholder value. Because of this business strategy, PICO'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 PICO to offer stock or debt through public
offerings from time to time. At times PICO 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. PICO, the parent company, had a minimal cash and cash equivalent
balance at year-end 1997 compared to a $13.1 million balance at the end of 1996.
The year-end 1996 balance reflected the receipt of a $13.2 million cash dividend
from Physicians.
The history of the Company is one of change and changing cash requirements.
In 1995, Physicians took a significant step in changing its strategic direction
by selling its ongoing MPL insurance business and related liability insurance
business. During 1995, Physicians reactivated its investment advisory
subsidiary, Summit; acquired a California property and casualty insurance
company, Sequoia; and purchased 38.2% of GEC, a Canadian corporation active in
international investments, surface, water, geothermal and mineral rights, and
other businesses. See "ITEM 1--BUSINESS--HISTORY OF THE COMPANY." In 1996,
Physicians took another large step in the continuing process of changing its
strategic direction to maximize shareholder value with the reverse acquisition
of Citation. On April 23, 1997, GEC and PICO purchased NLRC, owner of
approximately 1,365,000 acres of deeded land in Northern Nevada, for a total
purchase price of $48.6 million. During 1997, PICO increased its ownership in
GEC to approximately 51.17 %. On June 16, 1997, Physicians announced the signing
of a definitive agreement to sell its wholly-owned life and health insurance
subsidiary, APL, and its wholly-owned subsidiary. In November and December 1997,
GEC sold its investment in its Sri Lankan subsidiaries, providing funds for
repayment of debt and additional investments.
PICO's principal sources of funds are its available cash resources, bank
borrowings, public financings, repayment of subsidiary advances, funds
distributed from its subsidiaries as tax sharing payments, management and other
fees, and borrowings and dividends from its subsidiaries.
37
<PAGE> 38
It is expected that each of PICO's major subsidiaries currently within the
group will 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, 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. However, 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 avenues, disposition or transfer of existing
assets, issuance of additional capital stock through a public offering, 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. Sequoia made a profit of approximately $2.8
million in 1997 and produced positive cash flows of $9.3 million from
operations. 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, CNIC, in June
1997. CIC used nearly $13.7 million in cash in operating activities during 1997.
Much of CIC's negative operating cash flow relates to its unusually high GAAP
combined industry ratio of 117.7% for 1997. SEE MANAGEMENT'S DISCUSSION AND
ANALYSIS-PROPERTY AND CASUALTY INSURANCE. Physicians' cash flows have had the
greatest impact on the consolidated group during the past three 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 December 31, 1997 of $9.3 million, $38.3 million, and a deficit of $1.1
million, respectively. This compares to $12.5 million, $19.1 million, and
$843,000, respectively, at the end of 1996. 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, and should continue for the foreseeable future, to be
negative. Positive cash flows from other sources within Physicians, primarily
reinsurance recoveries, investment income and the sale of invested assets may
partially offset such uses of cash. Major cash outflows most likely will include
the funding of claims and loss adjustment expenses, investment purchases,
dividend distributions, and operating costs. The Company's active insurance P &
C subsidiaries, Sequoia and CIC, should provide positive cash flows from premium
writings, investment income, and the sale of invested assets. Cash will be used
to fund the payment of their own claims and operating expenses, as well as in
purchasing investments. Summit should produce positive cash flow in the form of
investment management fees in excess of 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 are expected to be settled by the end of the year 2000. Past
experience 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 of approximately $77.5 million at December 31, 1997, decreased an
additional $35.4 million, or 31.4%, after payment of more than $38 million in
losses and LAE.
The Company's insurance subsidiaries attempt to structure the duration of
their invested assets to match the cash flows required to settle the related
unpaid claims liabilities. Their 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 vehicles such as RBC. All the Company's insurance subsidiaries
have more than adequate, if not strong, RBC levels as of December 31, 1997.
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 other income, 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 December 31, 1997, Physicians' and PRO's investment portfolios on a
stand-alone basis contained invested assets of approximately $120.6 million,
plus cash and cash equivalents of $10.8 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 $77.5 million.
Physicians is in the process of selling APL, its life and health insurance
subsidiary. When sold, the proceeds from this sale may provide additional
available cash.
38
<PAGE> 39
Disregarding any appreciation or depreciation of Physicians' investment
portfolio and the results of the operations of its subsidiaries and affiliates,
on a stand alone basis Physicians should experience a decline in total assets
and total liabilities as a result of the payment of claims, loss adjustment
expenses and operating expenses. Absent unfavorable loss experience and
operating and other expenses in excess of investment income, shareholders'
equity should remain relatively unaffected. Income in excess of expenses,
favorable claims experience, appreciation of investments and increases in the
equities of subsidiaries and affiliates all would increase shareholders' equity
and, ultimately, total assets.
PICO management hopes to maximize the return of 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 and increasing shareholder
value, 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.
As previously mentioned, reinsurance recoveries (reimbursement of covered
losses from reinsurers) will be a significant source of incoming funds in
upcoming years as claims are settled. As shown in the accompanying financial
statements, consolidated reinsurance receivables amounted to $75.0 million at
December 31, 1997 compared to $97.0 million at December 31, 1996. Physicians'
and PRO's reinsurance receivables were $38.0 million at December 31, 1997 and at
December 31, 1996. Of the $37 million difference between the $75.0 million
consolidated total at December 31, 1997 and the $38.0 million of Physicians and
PRO, $30.3 million was recorded on Sequoia's financial statements, most of which
is due from SRC and guaranteed by QBE. See "ITEM 1--BUSINESS--HISTORY OF THE
COMPANY." Of the remainder, $6.7 million resulted from the inclusion of CIC.
Unsecured reinsurance risk is concentrated in the companies and amounts
shown in the table under Note 12 ("Reinsurance") to the Consolidated Financial
Statements as of December 31, 1997. Most companies listed are highly rated
companies with significant sources of capital.
As an additional source of funding, PICO's subsidiaries as they grow and
accumulate increasing amounts of retained earnings may be able to return some of
PICO's investment in the form of dividend distributions; however, this cannot be
assured. On December 30, 1997, Physicians paid a dividend of $13.2 million to
PICO in the form of GEC stock. This dividend was the maximum dividend that could
be paid under Ohio insurance regulations without specific approval by the Ohio
department.
As shown in the accompanying Consolidated Statements of Cash Flows, the
Company used cash flows of $62.1 million for operations in 1997 and $10.8
million in 1996, compared to $15.1 million in 1995. Cash consumed by operations
in 1997 increased $51.2 million over 1996 and $46.9 million over 1995. The
increase in cash used for operations as compared to 1996 and 1995 included
increased MPL claims and expense payments, federal, foreign and state income tax
payments, and the inclusion of CIC in the consolidated group. Net cash used for
operating activities consisted of $49.3 million from Physicians, $2.2 million
from PRO, $13.7 from CIC, $1.6 million from PICO, and $11.8 million from others,
including a $9.7 million reclassification of APL's cash and cash equivalents to
discontinued operations on the balance sheet at December 31, 1997. Net cash
provided by operating activities included $9.2 million from Sequoia and $7.3
million from GEC.
Cash provided by investing activities in 1997 of $68.1 million principally
reflects fixed income securities maturities and sales and investment gains
realized from the sale of Resource America, Inc. and AmVestors. Cash provided
from investing activities was $31.4 million and $37.6 million in 1996 and 1995,
respectively
Cash used for financing activities increased to $14.3 million, compared to
cash provided of $69,000 and $439,000 in 1996 and 1995, respectively. The
approximate $14 million decrease in funds provided by financing activities
reflects repayments of debt incurred by GEC.
GEC financed acquisitions in its investment portfolio of more than $75
million during 1997. This was accomplished through a mixture of equity,
borrowings, minority interests, operating cash flow and disposition of non-core
assets. GEC held approximately $11.1 in cash and cash equivalents at December
31, 1997.
In November 1996, Physicians purchased a $2.5 million convertible debenture
from PC Quote. 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 $2,250,000 with repayment due April
30, 1998.
39
<PAGE> 40
At December 31, 1997, the Company had no significant commitment for future
capital expenditures, other than in the ordinary course of business and as
discussed herein. 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. During 1997 Physicians
contributed an additional $5.5 million in paid-in capital to Sequoia.
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 accept the year 2000 logic. 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 that is 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, bank
borrowings, public debt and equity offerings, advances and repayment of balances
between subsidiaries and PICO, funds from consolidated tax savings, investment
management and other fees, and borrowings. During August 1997, GEC issued new
common stock of 25 million shares, raising more than $44.0 million in funds, net
of costs. At December 31, 1997, the Company had $56.4 million in cash and cash
equivalents compared to $64.6 million and $44.0 million at December 31, 1996 and
1995, respectively.
ADDITIONAL RISK FACTORS AND UNCERTAINTIES
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, Physicians began the process of
changing its strategic direction from the operation of an MPL insurance business
to investing in businesses which PICO believes are undervalued or will benefit
from additional capital, restructuring of operations or management or improved
competitiveness through operational efficiencies with existing PICO operations.
Accordingly, in January 1995, Physicians reactivated its investment advisory
subsidiary, Summit; in August 1995 Physicians acquired Sequoia and entered new
lines of property and casualty insurance; in August 1995 Physicians sold its MPL
insurance business; in September 1995 Physicians purchased 38.2% of GEC, a
Canadian corporation active in international investments, agricultural services,
water rights, and other businesses; in November 1996 Physicians acquired control
of Citation Insurance Group ("CIG") pursuant to the Merger; in April 1997 PICO
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
PICO sold its workers' compensation business; and in July and August 1997, PICO
increased its ownership in GEC to 51.17%. 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
the recently 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
only recently been implemented, however, and it is not fully reflected in prior
years' financial statements, nor are the financial statements indicative of
possible results of this new business strategy in the future. 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 Physicians' new strategy since 1995 has resulted in a greater
concentration of equity investments held by Physicians, and, consequently, the
Company. Market values of equity securities are subject to changes in the stock
market, which may cause the Company's shareholders' equity to fluctuate from
period to period. At times, the Company may come to 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.
40
<PAGE> 41
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.
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. Messrs. Langley and Hart are key to the implementation of the Company's
new strategic focus, and the ability of the Company 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,
Physicians sold its and PRO's MPL insurance business and related liability
insurance business. 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. Physicians and PRO have
established reserves to cover losses and loss adjustment expense ("LAE") on
claims incurred under the MPL policies issued or renewed to date. 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 that their respective reserves for losses and
LAE are adequate from an independent actuary. 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. Management believes that the reserving methods and assumptions are
reasonable and prudent and that Physicians' and PRO's reserves for losses and
LAE are adequate. Due to the inherent uncertainties in the reserving process
there is a risk, however, 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 surplus
or otherwise limit the growth of such surplus
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.
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.
41
<PAGE> 42
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 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 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. None of the Company's insurance
subsidiaries is aware of actual or potential disputes with any of their
respective reinsurers that could materially and adversely impact the financial
results of the Company, or is aware of any insolvent reinsurer whose current
obligations to CIC, Physicians, PRO, APL, or Sequoia are material to such
companies.
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 Securities and Exchange Commission (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 DIVERSIFICATION OF INVESTMENTS. 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 four of the past six 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.
42
<PAGE> 43
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.
CYCLICAL NATURE OF THE P&C INDUSTRY. The P & C insurance industry has been
highly cyclical, and the industry has been in a cyclical downturn over the last
several years due primarily to premium rate competition, which has resulted in
lower profitability. Premium rate levels are related to the availability of
insurance coverage, which varies according to the level of surplus in the
industry. 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. The
demand for P & C insurance can also vary significantly, generally rising as the
overall level of economic activity increases and falling as such activity
decreases.
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. At December 31, 1997, the PICO, PRO, APL, CIC and Sequoia annual
statements reported more than adequate RBC levels.
ITEM 7.A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Not applicable.
43
<PAGE> 44
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements as of December 31, 1997 and 1996 and for
each of the three years in the period ended December 31, 1997 and the
independent auditors' reports are included in this report as listed in the index
on page 45 of this report.
SELECTED QUARTERLY FINANCIAL DATA
Summarized unaudited quarterly financial data (in thousands, except share and
per share amounts) for 1997 and 1996 are shown below. In management's opinion,
the interim financial data contains all adjustments, consisting of only normal
recurring accruals, necessary for a fair presentation of results for such
interim periods. Prior period amounts have been adjusted to conform with the
current period presentation, including reclassification for discontinued
operations and adjustment to shares and net income (loss) per share values due
to the Merger.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30,
1996 1996 1996 1996 1997 1997
----------- ------------ ----------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Net premium income $ 6,629 $ 7,112 $ 7,710 $ 17,310 $ 14,503 $ 13,976
Investment income, net 2,211 1,756 4,150 27,049 6,208 2,839
Total revenues 10,563 9,426 12,183 44,563 21,050 17,181
Net income (loss) 1,972 (772) 1,355 21,765 1,992 1,824
----------- ------------ ----------- ----------- ----------- -----------
Basic:
----------- ------------ ----------- ----------- ----------- -----------
Net income (loss) per share $ 0.07 ($ 0.03) $ 0.05 $ 0.73 $ 0.06 $ 0.06
----------- ------------ ----------- ----------- ----------- -----------
Weighted average common
and equivalent shares
outstanding 27,436,191 27,436,191 27,436,191 29,716,050 32,487,898 32,542,551
Diluted:
Net income (loss) per share $ 0.07 (0.03) $ 0.05 $ 0.71 $ 0.06 $ 0.05
----------- ------------ ----------- ----------- ----------- -----------
Weighted average common
and equivalent shares
outstanding 28,606,993 28,536,676 28,366,972 30,583,339 33,362,680 33,512,735
<CAPTION>
-------------------------------
September 30, December 31,
1997 1997
------------ -------------
<S> <C> <C>
Net premium income $ 11,622 $ 9,775
Investment income, net 29,461 (5,429)
Total revenues 43,808 5,541
Net income (loss) 17,860 (2,184)
----------- ------------
Basic:
----------- ------------
Net income (loss) per share $ 0.55 $ ($0.07)
----------- ------------
Weighted average common
and equivalent shares
outstanding 32,584,960 32,591,650
Diluted:
Net income (loss) per share $ 0.53 $ 0.06
----------- ------------
Weighted average common
and equivalent shares
outstanding 33,882,821 34,053,596
</TABLE>
44
<PAGE> 45
PICO HOLDINGS, INC. AND SUBSIDIARIES
AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1997 AND 1996
AND FOR EACH OF THE
THREE YEARS IN THE PERIOD
ENDED DECEMBER 31, 1997
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Reports.................................. 46-46.2
Consolidated Balance Sheets as of December 31, 1997 and 1996... 47-48
Consolidated Statements of Income for the Years
Ended December 31, 1997, 1996 and 1995................... 49
Consolidated Statement of Changes in Shareholders' Equity
for the Years Ended December 31, 1997, 1996, and 1995.... 50-51
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1997, 1996 and 1995................... 52
Notes to Consolidated Financial Statements..................... 53-80
45
<PAGE> 46
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
PICO Holdings, Inc.:
We have audited the accompanying consolidated balance sheet of PICO
Holdings, Inc. and subsidiaries as of December 31, 1997, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for the year ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit. We did not audit the
1997 consolidated financial statements of Global Equity Corporation (all
expressed in Canadian dollars), a 51.17% owned consolidated subsidiary, which
constitutes 42% of consolidated total assets as of December 31, 1997. Those
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts included for Global Equity
Corporation (all expressed in Canadian dollars), is based solely on the report
of such other auditors. The consolidated balance sheet of the Company as of
December 31, 1996, and the related consolidated statements of income,
shareholders' equity, and cash flows for the years ended December 31, 1996 and
1995 were audited by other auditors whose report, dated April 7, 1997, expressed
an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, based on our audit and the report of the other auditors, the
1997 consolidated financial statements present fairly, in all material respects,
the consolidated financial position of PICO Holdings, Inc. and subsidiaries as
of December 31, 1997, and the consolidated results of their operations and their
cash flows for the year ended December 31, 1997, in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
San Diego, California
March 27, 1998
46
<PAGE> 47
AUDITORS' REPORT TO THE SHAREHOLDERS
We have audited the consolidated statement of financial position of Global
Equity Corporation ("GEC") as at December 31, 1997 and the consolidated
statements of operations, deficit and changes in financial position for the year
then ended. These financial statements are the responsibility of GEC's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards
in Canada. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of GEC as at December 31, 1997 and the
results of its operations and the changes in its financial position for the year
then ended in accordance with generally accepted accounting principles in
Canada.
Accounting principles generally accepted in Canada vary in certain significant
respects from accounting principles generally accepted in the United States in
GEC's circumstances, as described in note 14 to GEC's consolidated financial
statements.
KPMG
Chartered Accountants
Toronto, Canada
March 17, 1998
46.1
<PAGE> 48
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of
PICO Holdings, Inc.
We have audited the consolidated balance sheet of PICO Holdings, Inc. and
subsidiaries as of December 31, 1996 and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the two years in the
period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
PICO Holdings, Inc. and subsidiaries as of December 31, 1996 and the
consolidated results of their operations and their cash flows for each of the
two years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND, L.L.P.
San Diego, California
April 7, 1997
46.2
<PAGE> 49
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
ASSETS
<TABLE>
<CAPTION>
1997 1996
--------------- ----------------
<S> <C> <C>
Investments:
Available for sale:
Fixed maturities, at fair value $ 43,266,291 $ 156,864,826
Equity securities, at fair value 85,067,951 79,534,612
Investment in affiliate, at equity 28,047,764
Short-term investments, at cost 28,757,220 848,658
Real estate 3,205,754 1,546,445
--------------- ----------------
Total investments 160,297,216 266,842,305
Cash and cash equivalents 56,435,789 64,581,056
Premiums and other receivables, net 20,681,568 14,876,282
Reinsurance receivables 75,025,576 96,984,261
Prepaid deposits and reinsurance premiums 2,234,688 5,225,054
Accrued investment income 1,722,282 3,372,715
Surface, water, geothermal and mineral rights 75,177,015
Property and equipment, net 8,550,807 4,717,366
Deferred policy acquisition costs 5,320,716 7,921,570
Deferred income taxes 2,965,080 5,625,922
Other assets 5,932,248 7,588,351
Net assets of discontinued operations 15,949,989
Assets held in separate accounts 5,601,828
Net assets of acquired business held for sale 7,088,508
=============== ================
Total assets $ 430,292,974 $ 490,425,218
=============== ================
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
47
<PAGE> 50
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, CONTINUED
DECEMBER 31, 1997 AND 1996
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
1997 1996
---------------- ----------------
<S> <C> <C>
Policy liabilities and accruals:
Unpaid losses and loss adjustment expenses, net of discount $ 196,095,518 $ 252,023,546
Future policy benefits 13,776,207
Annuity and other policyholders' funds 31,739,736
Unearned premiums 21,634,897 35,296,803
Reinsurance balance payable 8,076,659 7,315,939
Deferred gain on retroactive reinsurance 2,168,393 3,355,409
Other liabilities 15,380,716 22,394,118
Taxes payable 968,059 776,784
Integration liability 546,147 1,368,000
Liabilities related to separate accounts 5,601,828
Excess of fair value of net assets acquired over purchase price 5,064,536 6,293,084
---------------- ----------------
Total liabilities 249,934,925 379,941,454
---------------- ----------------
Minority Interest 68,207,311 280,184
---------------- ----------------
Commitments (Notes 3, 6, 11, 12,13, 14, 15, 16, and 17)
Preferred stock, $.01 par value, authorized 2,000,000; none issued
Common stock, $.001 par value; authorized 100,000,000; issued 32,591,718
and 32,486,718 shares in 1997 and 1996, respectively 32,592 32,487
Additional paid-in capital 43,147,105 42,965,063
Net unrealized appreciation (depreciation) on investments (2,717,248) 11,837,511
Cumulative foreign currency translation adjustment (2,201,093) (27,159)
Equity changes of investee company (986,361)
Retained earnings 83,718,335 64,226,714
----------------
----------------
121,979,691 118,048,255
Less treasury stock, at cost (common shares 2,492,631 in 1997 and 1,940,315 in 1996) (9,828,953) (7,844,675)
---------------- ----------------
Total shareholders' equity 112,150,738 110,203,580
---------------- ----------------
Total liabilities and shareholders' equity $ 430,292,974 $ 490,425,218
================ ================
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
48
<PAGE> 51
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Revenues:
Premium income $49,876,404 $ 38,760,705 $ 19,541,731
Investment income, net 11,686,072 8,086,156 9,164,616
Net realized gains on investments 21,393,331 27,080,236 5,018,853
Real estate sales 1,546,588 1,547,423 1,336,501
Gain on sale of MPL business 6,000,000
Other income 3,077,369 1,261,760 126,815
----------- ------------ ------------
Total revenues 87,579,764 76,736,280 41,188,516
----------- ------------ ------------
Expenses:
Loss and loss adjustment expenses 34,330,327 22,932,490 23,171,588
Amortization of policy acquisition costs 10,069,308 1,875,324 722,719
Cost of land sales 646,543 1,458,781 1,501,421
Insurance underwriting and other expenses 19,030,581 17,506,477 8,225,875
----------- ------------ ------------
Total expenses 64,076,759 43,773,072 33,621,603
----------- ------------ ------------
Equity in earnings (losses) of investee 1,013,385 (459,928)
----------- ------------ ------------
Income from continuing operations before income taxes
and minority interest 23,503,005 33,976,593 7,106,985
Provision (benefit) for federal, foreign and state income taxes 7,670,128 12,957,811 (7,752,049)
----------- ------------ ------------
Income from continuing operations
before minority interest 15,832,877 21,018,782 14,859,034
Minority interest in loss of subsidiary 3,202,461 35,867
----------- ------------ ------------
Income from continuing operations 19,035,338 21,018,782 14,894,901
Income from discontinued operations, net of federal income tax
provisions of $2,201,010, $701,177, and $80,895 for 1997, 1996,
and 1995, respectively and 1997 minority interest of $764,418 456,283 3,301,229 778,075
----------- ------------ ------------
Net income $19,491,621 $ 24,320,011 $ 15,672,976
=========== ============ ============
Net income per common share (basic):
Continuing operations $ 0.59 $ 0.75 $ 0.54
Discontinued operations 0.01 0.12 0.03
----------- ------------ ------------
Net income per common share $ 0.60 $ 0.87 $ 0.57
=========== ============ ============
Weighted average shares outstanding 32,551,951 28,004,595 27,436,191
=========== ============ ============
Net income per common share (diluted):
Continuing operations $ 0.57 $ 0.72 $ 0.54
Discontinued operations 0.01 0.12 0.03
----------- ------------ ------------
Net income per common share $ 0.58 $ 0.84 $ 0.57
=========== ============ ============
Weighted average shares outstanding 33,741,265 29,055,669 27,436,191
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
49
<PAGE> 52
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
Net
Unrealized Foreign Equity
Additional Appreciation Currency Changes
Common Paid-In (Depreciation) Retained Translation of Investee
Stock Capital on Investments Earnings Adjustment Company
------------ ---------------- ----------------- --------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 $ 27,436 $ 17,326,279 $ (4,748,349) $ 24,233,727
Net income 15,672,976
Foreign currency translation
adjustment (14,792)
Equity changes of investee
company (979,066)
Net unrealized appreciation
on investments, net of
adjustment to deferred
policy acquisition costs
of $544,162 and
deferred taxes of
$12,246,591 28,576,166
Issuance of common stock
upon exercise of options 56,000
------------ ---------------- ----------------- --------------- ------------- -------------
Balance, December 31, 1995 27,436 17,382,279 23,827,817 39,906,703 (14,792) (979,066)
------------ ---------------- ----------------- --------------- ------------- -------------
Net income 24,320,011
Foreign currency translation
adjustment (12,367)
Equity changes of investee
company (7,295)
Net unrealized depreciation
on investments, net of
adjustment to deferred
policy acquisition costs of
$17,556 and deferred
taxes of $6,590,684 (11,990,306)
Purchase of common stock
by affiliate, held in treasury
Retirement of treasury stock in
connection with the Merger (1,330) (779,122)
Issuance of common stock in
connection with the Merger 6,381 26,287,986
Issuance of common stock
upon exercise of options 73,920
------------ ---------------- ----------------- --------------- ------------- -------------
Balance, December 31, 1996 $ 32,487 $ 42,965,063 $ 11,837,511 $ 64,226,714 $ (27,159) $ (986,361)
------------ ---------------- ----------------- --------------- ------------- -------------
<CAPTION>
Treasury
Stock Total
--------------- -----------------
<S> <C> <C>
Balance, January 1, 1995 $ (1,095,032) $ 35,744,061
Net income 15,672,976
Foreign currency translation
adjustment (14,792)
Equity changes of investee
company (979,066)
Net unrealized appreciation
on investments, net of
adjustment to deferred
policy acquisition costs
of $544,162 and
deferred taxes of
$12,246,591 28,576,166
Issuance of common stock
upon exercise of options 294,000 350,000
--------------- -----------------
Balance, December 31, 1995 (801,032) 79,349,345
--------------- -----------------
Net income 24,320,011
Foreign currency translation
adjustment (12,367)
Equity changes of investee
company (7,295)
Net unrealized depreciation
on investments, net of
adjustment to deferred
policy acquisition costs of
$17,556 and deferred
taxes of $6,590,684 (11,990,306)
Purchase of common stock
by affiliate, held in treasury (5,844,600) (5,844,600)
Retirement of treasury stock in
connection with the Merger 780,452
Issuance of common stock in
connection with the Merger (2,000,075) 24,294,292
Issuance of common stock
upon exercise of options 20,580 94,500
--------------- -----------------
Balance, December 31, 1996 $ (7,844,675) $ 110,203,580
--------------- -----------------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
50
<PAGE> 53
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY, CONTINUED
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
Net
Unrealized Foreign Equity
Additional Appreciation Currency Changes
Common Paid-In (Depreciation) Retained Translation of Investee
Stock Capital on Investments Earnings Adjustment Company
----------- --------------- ---------------- --------------- -------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 32,487 $ 42,965,063 $ 11,837,511 $ 64,226,714 $ (27,159) $ (986,361)
Net income 19,491,621
Foreign currency translation
adjustment (2,173,934)
Equity changes of investee
company 986,361
Net unrealized depreciation
on investments, net of
deferred taxes
of $6,060,413 (14,554,759)
Issuance of common stock
upon exercise of options 105 344,895
Increase in ownership of
subsidiary holding common
stock of the Company
Purchase of common stock
in connection with merger (162,853)
----------- --------------- ---------------- --------------- -------------- ------------
Balance, December 31, 1997 $ 32,592 $ 43,147,105 $ (2,717,248) $ 83,718,335 $ (2,201,093) $ -
=========== =============== ================ =============== ============== ============
<CAPTION>
Treasury
Stock Total
-------------- ----------------
<S> <C> <C>
Balance, December 31, 1996 $ (7,844,675) $ 110,203,580
Net income 19,491,621
Foreign currency translation
adjustment (2,173,934)
Equity changes of investee
company 986,361
Net unrealized depreciation
on investments, net of
deferred taxes
of $6,060,413 (14,554,759)
Issuance of common stock
upon exercise of options 345,000
Increase in ownership of
subsidiary holding common
stock of the Company (1,984,278) (1,984,278)
Purchase of common stock
in connection with merger (162,853)
-------------- ----------------
Balance, December 31, 1997 $ (9,828,953) $ 112,150,738
============== ================
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
51
<PAGE> 54
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
---------------- --------------- ----------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 19,491,621 $ 24,320,011 $ 15,672,976
Adjustments to reconcile net income to net cash used in
operating activities:
Deferred taxes 440,656 1,990,334 (7,891,246)
Depreciation and amortization 1,181,495 2,131,742 2,114,986
Realized gains on investments (29,344,391) (30,949,863) (4,018,672)
Gain from disposition of MPL business (6,000,000)
Equity in (earnings) losses of investee (1,013,385) 459,928
Minority interest in loss of subsidiary (3,202,461)
Write down of investment 8,018,922
Changes in assets and liabilities, net of effects
from acquisition of business:
Premiums and other receivables 4,878,240 4,803,716 (5,241,564)
Reinsurance receivables and payables 20,528,708 23,417,931 (75,607,649)
Accrued investment income 1,370,499 (302,998) 1,800,431
Deferred policy acquisition costs 56,623 4,034,743 (1,716,745)
Unpaid losses and loss adjustment expenses (57,033,716) (31,097,669) 49,105,562
Future policy benefits (2,011,233) 1,512,337
Discontinued operations (2,186,355)
Unearned premiums (13,173,128) (14,378,764) 14,746,411
Other (13,082,986) 8,197,478 (79,730)
---------------- --------------- ----------------
Net cash used in operating activities (62,056,273) (10,857,957) (15,142,975)
---------------- --------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of investments:
Fixed maturities 53,988,484 23,236,398 121,651,938
Equity securities 94,473,149 88,415,361 9,258,500
Proceeds from maturity of fixed maturity investments 9,250,000 10,731,369 19,471,068
Purchases of investments:
Fixed maturities (23,082,301) (40,871,986) (24,776,663)
Equity securities (95,175,078) (59,995,893) (53,145,781)
Net sales (purchases) of short-term investments 13,388,506 8,314,267 (7,364,404)
Net sales of real estate 270,978 1,564,389 1,062,798
Increase in surface, water, geothermal and mineral rights (2,336,851)
Proceeds from sale of property and equipment 215,882 106,996 70,782
Purchases of property and equipment (984,623) (106,110) (1,023,317)
Proceeds from disposition of MPL business 6,000,000
Investment in affiliate (35,986,088)
Purchased cash from acquiring consolidated subsidiary 18,108,171 2,428,623
---------------- --------------- ----------------
Net cash provided by investing activities 68,116,317 31,394,791 37,647,456
---------------- --------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of bank and other borrowings (16,489,329) (331,895) (77,129)
Net increase in annuity and other policyholders' funds 306,179 166,476
Proceeds of warrants issued by GEC 2,006,567
Issuance of common stock 182,147 94,500 350,000
---------------- --------------- ----------------
Net cash provided by (used in) financing activities (14,300,615) 68,784 439,347
---------------- --------------- ----------------
Effect of exchange rate changes on cash 95,304 (12,367) (14,792)
---------------- --------------- ----------------
Net increase (decrease) in cash and cash equivalents (8,145,267) 20,593,251 22,929,036
Cash and cash equivalents, beginning of year 64,581,056 43,987,805 21,058,769
---------------- --------------- ----------------
Cash and cash equivalents, end of year $ 56,435,789 $ 64,581,056 $ 43,987,805
================ =============== ================
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest, net of amounts capitalized $ 200,959 $ 2,427
================ =============== ================
Federal income taxes (recovered) paid $ 10,895,019 $ (1,546,045) $ 2,347,000
================ =============== ================
</TABLE>
The accompanying notes are an integral part of the financial statements.
52
<PAGE> 55
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------
1. ORGANIZATION AND OPERATIONS:
Organization:
PICO Holdings, Inc. and subsidiaries (the "Company") is predominately
an insurance and investment company specializing in commercial property
and casualty insurance; portfolio investing; surface, water, geothermal
and mineral rights; medical professional liability insurance and other
services (Note 19). Surface, water, geothermal and mineral rights has
been added as a segment for this annual report based on recent
acquisitions and management's strategic initiatives. As discussed in Note
3, Physicians Insurance Company of Ohio consummated a reverse merger
transaction on November 20, 1996 with a wholly owned subsidiary of
Citation Insurance Group, with Physicians Insurance Company of Ohio being
the accounting acquirer. Pursuant to the merger, each outstanding share
of the Common Stock of Physicians Insurance Company of Ohio was converted
into the right to receive 5.0099 shares of Citation Insurance Group
common stock. Upon the consummation of the merger, Citation Insurance
Group changed its name to PICO Holdings, Inc. ("PICO"), which is the
continuing registrant. Any references to "the Company" herein as of dates
or for periods prior to the merger, refer to Physicians Insurance Company
of Ohio and its subsidiaries, which included Summit Global Management,
Inc. prior to the consummation of the merger. The Company's principal
subsidiaries as of December 31, 1997 are as follows:
Wholly Owned Subsidiaries (Direct and Indirect):
- Physicians Insurance Company of Ohio ("Physicians"), which owns the
following subsidiaries:
- The Professionals Insurance Company ("PRO")
- Physicians Investment Company ("PIC"), which owns American
Physicians Life Insurance Company ("APL"), which owns Living
Benefit Administrators Agency, Inc.
- Sequoia Insurance Company ("Sequoia")
- Raven Development Company ("Raven")
- CLM Insurance Agency, Inc.
- Citation Insurance Company ("CIC")
- Summit Global Management, Inc. ("Summit")
Majority-owned Subsidiaries:
- Global Equity Corporation ("GEC"). GEC is a publicly held corporation
and is listed on the Toronto Stock Exchange and The Montreal Exchange
under the symbol "GEQ". The Chairman of the Board of Directors
("Chairman") and the Chief Executive Officer ("CEO") of the Company
are the Chairman and CEO of GEC, respectively. The Company acquired an
approximate 38% ownership in GEC on September 5, 1995. The Company
increased its ownership in GEC to approximately 49.9% on July 30, 1997
and to approximately 51.17% on August 19, 1997 (Note 3). As a result,
GEC has been included in the consolidated accounts of the Company for
1997. The Company previously accounted for GEC utilizing the equity
method of accounting wherein the Company's share of GEC's net income
or loss was included in the equity in earnings (losses) of investee on
the statements of income.
- Nevada Land and Resource Company, LLC ("NLRC"). The Company acquired
NLRC on April 23, 1997. PICO owns 25.23% of NLRC and Global-Nevada
Land Resource Corporation, a wholly-owned subsidiary of GEC owns the
remaining 74.77% (Note 3). NLRC owns approximately 1,365,000 acres of
deeded land with appurtenant water, geothermal and mineral rights in
northern Nevada.
53
<PAGE> 56
Equity Investment:
Investments in entities in which the Company owns between 20% to 50%
of the voting interest and has the ability to exercise significant
influence and which are made for long term operating purposes, are
accounted for on the equity method of accounting. The Company had no
investment of this type at December 31, 1997 (Note 5).
Operations:
Prior to selling its book of medical malpractice business in 1995,
Physicians engaged in providing medical professional liability coverage
to physicians, surgeons, dentists and nurses, primarily in the state of
Ohio. On August 28, 1995, Physicians entered into an agreement with
Mutual Assurance, Inc. ("Mutual") pursuant to which Physicians sold its
recurring medical professional liability insurance ("MPL") business and
that of its wholly owned subsidiary, PRO, to Mutual. Physicians and PRO
still hold MPL unpaid losses and loss adjustment expense liabilities that
are being settled.
APL provides life and health insurance coverage in a number of states
and is shown as discontinued operations due to a definitive agreement
entered into on June 16, 1997 to sell APL and its wholly owned
subsidiary, Living Benefit Administrators Agency, Inc.
Sequoia, acquired August 1, 1995, writes property and casualty
insurance (primarily light commercial and multi-peril) in California
(Note 3).
CIC and its wholly-owned subsidiary, CNIC, were acquired November 20,
1996 through a reverse acquisition (Note 3). CIC writes commercial
property and casualty insurance in Arizona, California, Colorado, and
Utah. Prior to July 1997, CIC wrote workers compensation insurance.
However, as discussed in Note 3, the Company entered into a Letter of
Intent in January 1997 and sold CNIC and all of the net assets related to
CIC's workers' compensation business effective June 30, 1997. Such net
assets are reflected in the accompanying consolidated balance sheet as of
December 31, 1996 as "Net Assets of Acquired Business Held for Sale."
CNIC previously wrote commercial property and casualty insurance
primarily in the state of California, but ceased writing new business
effective December 1994. For the years ended December 31, 1997 and 1996,
approximately 72% and 89%, respectively, of CIC's direct written premiums
were in California. Consequently, CIC's and Sequoia's operating results
are expected to be largely dependent on their ability to write profitable
insurance in California.
Summit offers investment management services, primarily to its
affiliates.
GEC is a Canadian corporation engaging in strategic investment;
surface, water, geothermal and mineral rights; and other services,
operating primarily in the United States, but also with operations in
Canada, Asia, Europe, and the Caribbean. At times, GEC may come to hold
securities of companies for which no market exists or which may be
subject to restrictions on resale. As a result, a portion of GEC's assets
may not be liquid. Furthermore, as a result of its global diversification
with respect to existing investments, GEC'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 or prohibit GEC's ability to withdraw funds, political
instability and fluctuations in currency exchange rates.
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 needed in the southwestern United States
and then facilitate the transfer from current ownership to Vidler, and
subsequently to municipalities, water districts, developers and others.
Since its acquisition, Vidler and its immediate parent company have
purchased water rights and related assets in Colorado, Nevada and
Arizona.
NLRC, which is 74.77% owned by GEC and 25.23% by PICO 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.
CLM is an inactive California insurance agency which placed insurance
with California insurers, including Sequoia.
Raven Development Company is a real estate development company in
Ohio. It is in the process of withdrawing from all real estate
development activities and is currently involved in only one development
in Ohio.
54
<PAGE> 57
As discussed in Note 11, approximately 17.6% of the Company's common
stock was owned by Guinness Peat Group plc as of December 31, 1997 and
19% as of December 31, 1996. In addition, GEC and CIC own approximately
13.1% and 1%, respectively, of the Company's common stock as of December
31, 1996 and 1997. The Company's common stock owned by GEC and CIC has
been accounted for as treasury stock in the Company's consolidated
financial statements.
2. SIGNIFICANT ACCOUNTING PRINCIPLES:
The following is a description of the significant accounting policies
and practices followed in the preparation of the Company's consolidated
financial statements:
Principles of Consolidation:
The accompanying consolidated financial statements include the
accounts of the Company and its subsidiaries (Note 1). All significant
intercompany accounts and transactions have been eliminated in
consolidation.
Basis of Presentation:
The accompanying consolidated financial statements have been prepared
in conformity with generally accepted accounting principles.
Investments:
The Company applies the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". Under SFAS No. 115,
investments in available for sale securities are recorded at estimated
fair value. Unrealized holding gains and losses on investments classified
as available-for-sale, net of the adjustment to deferred policy
acquisition costs and deferred income taxes, are excluded from earnings
and are reported as a separate component of shareholders' equity. The
Company's entire portfolio of debt and equity securities has been
designated as available-for-sale.
The estimated fair value of fixed maturity and equity securities other
than those carried at equity is based upon quoted market prices or dealer
quotes for comparable securities
A decline in the market value of any available for sale security below
cost that is deemed other than temporary is charged to earnings and
results in the establishment of a new cost basis for the security (Note
4).
Investment income includes amortization of premium and accretion of
discount on the level yield method relating to bonds acquired at other
than par value. Realized investment gains and losses are included in
income and are determined on the identified certificate basis and are
recorded on a trade date basis.
Short-term investments, which consist of certificates of deposit with
an original maturity of greater than three months, are stated at cost,
which approximates fair value.
Real estate represents costs incurred in connection with certain land
development projects and commercial real estate held for resale. Indirect
costs associated with the land development projects, including interest,
are capitalized as part of real estate costs. Selling, general and
administrative expenses related to development projects are expensed as
incurred.
Cash Equivalents:
The Company and its subsidiaries consider highly liquid debt
instruments purchased with an original maturity of three months or less
to be cash equivalents.
Surface, Water, Geothermal and Mineral Rights:
Surface, Water, Geothermal and mineral rights are carried at cost.
This cost includes, when applicable, costs directly related to
acquisition, and interest and other costs directly related to developing
the assets for their intended use.
55
<PAGE> 58
Property and Equipment:
Property and equipment are carried at cost, net of accumulated
depreciation. Depreciation is computed on the straight-line method over
the estimated lives of the assets ranging from 5 to 45 years.
Maintenance, repairs and minor renewals are charged to expense as
incurred, while significant renewals and betterments are capitalized.
The cost and related accumulated depreciation of assets sold are
removed from the related accounts, and the resulting gains or losses are
reflected in operations.
Deferred Acquisition Costs:
Certain costs of acquiring new insurance business, net of reinsurance
ceding commissions, are deferred and amortized over the terms of the
policy for property and liability insurance and over the average lives of
investment and universal life-type contracts, based on the present value
of the estimated gross profit amounts expected to be realized over the
lives of the contracts, and over the premium paying periods of ordinary
and group life insurance contracts. Future investment income has been
taken into consideration in determining the recoverability of such costs.
Goodwill:
Goodwill represents the difference between the purchase price and the
fair value of the net assets (including tax attributes) of companies
acquired in purchase transactions. Both positive and negative goodwill
are amortized on a straight-line basis over a period of 10 years. There
was negative goodwill (i.e., excess of fair value of assets acquired over
purchase price) as of December 31, 1996 resulting from the acquisition of
Citation Insurance Group in November 1996 (Note 3). Positive goodwill is
included in "Other Assets" in the accompanying consolidated balance
sheets.
Impairment of Long-Lived Assets:
The Company periodically evaluates whether events or circumstances
have occurred that may affect the estimated useful life or the
recoverability of long-lived assets. Impairment of long-lived assets is
triggered when the estimated future undiscounted cash flows (excluding
interest charges) do not exceed the carrying amount. If the events or
circumstances indicate that the remaining balance may be permanently
impaired, such potential impairment will be measured based upon the
difference between the carrying amount and the fair value of such assets
determined using the estimated future discounted cash flows (excluding
interest charges) generated from the use and ultimate disposition of the
respective long-lived asset.
Reinsurance:
The Company records all reinsurance assets and liabilities on the
gross basis, including amounts due from reinsurers and amounts paid to
reinsurers relating to the unexpired portion of reinsured contracts
(prepaid reinsurance premiums).
Unpaid Losses and Loss Adjustment Expenses:
As more fully described in Note 13, reserves for MPL and property and
casualty unpaid losses and loss adjustment expenses include amounts
determined on the basis of actuarial estimates of ultimate claim
settlements, which include estimates of individual reported claims and
estimates of incurred but not reported claims. The methods of making such
estimates and for establishing the resulting liabilities are continually
reviewed and updated based on current circumstances, and any adjustments
resulting therefrom are reflected in current operations. Reserves for MPL
unpaid losses and loss adjustment expenses for medical professional
liability claims have been adjusted to reflect the time value of money
(discounting).
Future Policy Benefits and Annuity and Other Policyholders' Funds:
Liabilities for future policy benefits have been calculated using the
net level premium method based on actuarial assumptions as to anticipated
mortality, withdrawals and interest rates ranging from 3.5% to 8%.
Annuity and other policyholders' funds have been calculated based on
contract-holders' contributions plus interest credited, less applicable
contract charges.
56
<PAGE> 59
Recognition of Premium Revenue:
MPL and other property and casualty insurance premiums written are
earned principally on a monthly pro rata basis over the life of the
policy. The premiums applicable to the unexpired terms of the policies
are included in unearned premiums.
Amounts charged on universal life-type contracts that represent the
cost of the insurance component of payments received are recognized as
premium income when earned. Amounts assessed against universal life
policyholder funds to compensate the Company for future services are
reported in unearned premiums and are recognized in income using the same
assumptions and factors used to amortize capitalized acquisition costs.
Premiums on ordinary and group life contracts, including critical
illness, are recognized when due, and premiums on accident and health
contracts are recognized over the contract period. Unearned premiums have
been principally calculated using the monthly pro rata method, resulting
in the earning of premiums evenly over the terms of the policies.
Income Taxes:
The Company's income tax expense includes deferred income taxes
arising from temporary differences between the tax and financial
reporting bases of assets and liabilities. The liability method of
accounting for income taxes also requires the Company to reflect the
effect of a tax rate change on accumulated deferred income taxes in
income in the period in which the change is enacted.
In assessing the realization of deferred income taxes, the Company's
management considers whether it is more likely than not that the deferred
income tax assets will be realized. The ultimate realization of deferred
income tax assets is dependent upon the generation of future taxable
income during the period in which temporary differences become
deductible. If future income does not occur as expected, a deferred
income tax valuation allowance may need to be established.
Earnings per Share:
In February 1997, the Financial Accounting Standards Board ("FASB")
issued 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 1996 and 1995 financial statements have been restated to
reflect the change.
57
<PAGE> 60
Reconciliation of the basic and diluted EPS is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------------
1997 1996 1995
------------ ------------- ------------
(in thousands except per share amounts)
<S> <C> <C> <C>
Net income $19,492 $24,320 $15,673
------------ ------------- ------------
Basic earnings per share $0.60 $0.87 $0.57
Basic weighted average common shares outstanding 32,552 28,005 27,436
------------ ------------- ------------
Options 1,189 1,051
------------ ------------- ------------
Diluted weighted average common and
common equivalent shares outstanding 33,741 29,056 27,436
============ ============= ============
Diluted earnings per share $0.58 $0.84 $0.57
============ ============= ============
</TABLE>
The weighted average number of shares outstanding for the year ended
December 31, 1995 used in the calculation of earnings per share have been
recomputed to give effect to the stock exchange ratio utilized in
connection with the reverse acquisition of Citation Insurance Group
consummated on November 20, 1996 (Note 3). Stock options of 1,382,715,
1,696,092 and 2,580,098 for 1997, 1996 and 1995, respectively, were not
included in the calculation of weighted average shares because the
impacts of such options were anti-dilutive.
Separate Accounts:
Separate account assets and liabilities represent contract-holders'
funds that have been segregated into accounts with specific investment
objectives and are recorded at estimated fair market value based upon
quoted market prices. The investment income and gains or losses of these
accounts accrue directly to the contract-holders. The activity of the
separate accounts is not reflected in the consolidated statements of
income and cash flows, except for the fees that the Company receives for
administrative services.
Translation of Foreign Currency:
Revenues and expenses of foreign operations are translated at average
rates of exchange in effect during the year. Assets and liabilities are
translated at the exchange rates in effect at the balance sheet date.
Unrealized exchange gains and losses arising on translation, net of
applicable deferred income taxes, are reflected in shareholders' equity.
Use of Estimates in Preparation of Financial Statements:
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 December 31, 1997 and 1996, it is reasonably possible
that actual results could differ from the estimates upon which the
carrying values were based.
Reclassifications:
Certain amounts in the financial statements for prior periods have
been reclassified to conform with the 1997 presentation.
58
<PAGE> 61
Recent Accounting Pronouncements:
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income", SFAS No. 130 establishes requirements for disclosure of
comprehensive income and becomes 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 are currently being presented by the Company as a component
of stockholders' equity.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information". SFAS No. 131
establishes standards for disclosure about operating segments in annual
statements and selected information in interim financial reports. It also
establishes 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 becomes 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.
3. ACQUISITIONS:
On November 20, 1996, Physicians consummated a transaction (the
"Merger") pursuant to which Citation Holdings, Inc. ("Holdings"), a
wholly owned subsidiary of Citation Insurance Group ("CIG"), merged with
and into Physicians pursuant to an Agreement and Plan of Reorganization
dated as of May 1, 1996 with Physicians being the accounting acquiror.
Pursuant to the Merger, each outstanding share of the common stock of
Physicians was converted into the right to receive 5.0099 shares of CIG's
common stock. CIG's other significant direct and indirect subsidiaries
just prior to the merger were CIC and CNIC. Upon the consummation of the
merger, CIG changed its name to PICO Holdings, Inc., which is the
continuing registrant.
As a result of the Merger, the former shareholders of Physicians own
approximately 80% of the outstanding common stock of the Company and
control the Board of Directors of the Company. Accordingly, for
accounting purposes, the merger has been treated as a recapitalization of
Physicians with Physicians as the acquirer (i.e., a reverse acquisition).
Therefore, the statements of income, changes in shareholders' equity and
cash flows of the year ended December 31, 1995 represent the historical
results of Physicians and its subsidiaries, which is the predecessor
entity. Physicians' equity as of December 31, 1995 and the changes in its
equity for the year ended December 31, 1995 have been retroactively
recapitalized for the equivalent number of shares of PICO Holdings,
Inc.'s common stock received in the merger transaction. The difference
between the par value of Physicians' and PICO Holdings, Inc.'s common
stock has been added to additional paid-in capital.
The Merger was accounted for under the purchase method of accounting.
Financial results for the year ended December 31, 1996 include the
operations of CIG as if the Merger had occurred on November 1, 1996.
Financial activity for the period November 1, 1996 through November 20,
1996 was not significant.
59
<PAGE> 62
The allocation of the purchase price of CIG was as follows:
<TABLE>
<S> <C>
Purchase Price:
Value of CIG approximately 6,381,000 shares exchanged $ 23,231,667
Acquisition costs 979,000
Value of CIG options assumed 83,625
------------
$ 24,294,292
============
Allocation of Purchase Price:
Historic CIG shareholders' equity $ 34,060,405
Adjust assets and liabilities:
Write down of workers' compensation net assets held for sale (3,652,894)
Write down of property and equipment (820,500)
Deferred income taxes 2,962,861
Integration liability (1,716,201)
Other (859,526)
Excess of fair value of net assets acquired over purchase price (5,679,853)
------------
$ 24,294,292
============
</TABLE>
The allocation of the purchase price was adjusted as of December 31,
1997 to reflect changes from the estimates made as of December 31, 1996.
These changes in estimates did not affect the purchase price; however,
the net result was a decrease in negative goodwill from $6,293,084
estimated at December 31, 1996 to $5,679,853 recorded as of December 31,
1997.
The excess of the fair value of the net assets acquired over the
purchase price of such net assets (negative goodwill) is being amortized
over a 10 year period using the straight-line method. As discussed in
Note 1, the Company entered into a Letter of Intent in January 1997 and,
effective June 30, 1997, sold CNIC and the net assets related to CIC's
workers' compensation operations.
The FASB's Emerging Issues Task Force Abstract 87-11 "Allocation of
Purchase Price to Assets to be Sold" ("EITF 87-11") provides guidance on
the accounting for the purchase price allocation to components of
acquired businesses expected to be sold within one year of the
acquisition date. The guidance in EITF 87-11 states the following:
- expected cash flows from the operations of the net assets of acquired
entities that are expected to be sold within one year of the date of
acquisition should be considered in the purchase price allocation, and
- earnings or losses relating to the operation of the net assets to be
sold should not affect earnings or losses of the acquiring company
during the holding period (i.e., the date of acquisition to the date
of sale).
The Company accounted for the allocation of the purchase price and the
net assets of CIC's workers' compensation line of business in accordance
with the EITF 87-11 guidance stated above. Accordingly, the net assets
related to CIC's workers' compensation line of business as of December
31, 1996 are reflected on a single line item in the accompanying balance
sheet as Net Assets of Acquired Business Held for Sale. The fair value
assigned to such net assets was based upon management's estimate of the
proceeds from the sale of CIC's workers' compensation line of business of
approximately $7.7 million less the estimated loss from operations for
such line of business during the expected holding period of November 1996
through April 1997 of approximately $0.5 million.
The difference between the carrying amount of the net assets of CIC's
workers compensation line of business at the date of sale and the actual
proceeds from such sale resulted in a reallocation of the purchase price
of CIG of $3,652,894. This amount differed from the $2,864,092 estimated
as of December 31, 1996 by $788,802.
60
<PAGE> 63
On August 1, 1995, the Company acquired from Sydney Reinsurance
Corporation ("SRC") all the outstanding stock of SRC's wholly owned
subsidiary, Sequoia, a property and casualty insurance company. The
acquisition price of $1,350,000 was paid in cash August 1, 1995.
Approximately $350,000 was paid to acquire Sequoia's fixed assets, while
the remaining $1,000,000 was used in the purchase of intangible assets
and goodwill. These intangible assets are being amortized over a 10-year
period using the straight-line method. The Company used available working
capital to make the purchase. All policy and claims liabilities of
Sequoia prior to closing are the responsibility of SRC and have been
unconditionally and irrevocably guaranteed by QBE Insurance Group Limited
("QBE"), a publicly-held corporation based in Sydney, Australia, of which
SRC indirectly is a wholly-owned subsidiary. Sequoia's operating results
are included in the consolidated statements of income for the years ended
December 31, 1997 and 1996 and for the period August 1, 1995 to December
31, 1995.
The Company is required to maintain a minimum surplus in Sequoia of
$7.5 million and, through a management agreement, will supervise the
run-off of SRC's liabilities. As part of the management agreement,
Sequoia will be reimbursed $4.8 million in management fees by the seller
for processing the run off of claims and policy receivables and servicing
the business existing prior to closing. This management fee is to be
received from SRC over a three-year period and is recognized based on the
percentage of completion method based on total anticipated claims.
Approximately $1.0 million, $1.7 million and $1.6 million have been
recognized as management fee income for the years ended December 31, 1997
and 1996 and for the period August 1, 1995 through December 31, 1995,
respectively.
The following unaudited pro forma information presents (i) a summary
of consolidated results of operations of the Company and CIG and its
subsidiaries for the years ended December 31, 1996 and 1995 as if the
acquisition of CIG and its subsidiaries occurred at the beginning of
1995, with proforma adjustments to give effect to the amortization of
goodwill and the accounting for CIC's workers' compensation line of
business held for sale in accordance with EITF 87-11, as discussed above
(in thousands, except per share data) and (ii) a summary of consolidated
results of operations of the Company and Sequoia for the year ended
December 31, 1995 as if the acquisition of Sequoia had occurred at the
beginning of 1995, with pro forma adjustments to give effect to the
amortization of goodwill and related income tax effects (in thousands,
except per share data):
<TABLE>
<CAPTION>
(Unaudited)
1996 1995
------- --------
<S> <C> <C>
Total revenues $133,539 $118,658
Income before income taxes 35,572 8,588
Net income 16,564 16,076
Net income per share-Basic $0.59 $0.58
Net income per share-Diluted $0.57 $0.58
</TABLE>
These unaudited pro forma results have been prepared for comparative
purposes and do not purport to be indicative of the results of operations
which actually would have resulted had the combinations been in effect on
January 1, 1995 or of future results of operations of the consolidated
entities.
On September 5, 1995, Physicians purchased 38.2% of the outstanding
common shares of GEC for $34.4 million. Approximately $33.5 million was
paid to acquire the net assets, while the remaining $887,000 was
allocated to goodwill. The goodwill is being amortized over a 10-year
period using the straight-line method. Physicians used available working
capital to make the purchase. On July 30, 1997, Physicians, PRO, Sequoia,
and CIC purchased from Mackenzie Financial Corporation 6,616,218
additional shares of GEC at a total cost of $11,406,435 increasing the
Company's ownership of GEC to approximately 49.9%. On August 19, 1997,
PICO and Physicians acquired through a public offering 13,586,143
additional shares of GEC at a cost of $25,270,266, increasing PICO's
ownership in GEC to approximately 51.17%.
61
<PAGE> 64
GEC is included in the consolidated results of the Company for 1997.
The following unaudited information presents a summary of the stand alone
results of operations of GEC for 1997 and the pro forma consolidated
results of operations of the Company and GEC for 1996 as if the
acquisition of a majority interest in GEC occurred at the beginning of
1996:
<TABLE>
<CAPTION>
(unaudited)
1997 1996
---------------- ---------------
<S> <C> <C>
Total revenues (realized losses) ($4,010,902) $98,787,093
Income (loss) from continuing operations
before taxes and minority interest (10,631,709) 37,656,935
Discontinued operations, net of taxes 564,698 3,301,229
Minority interest in loss (income) of subsidiary (110,253) 2,254,570
Net income (loss) (6,630,108) 24,664,085
Net income per share-Basic - $0.88
Net income per share-Diluted - $0.84
</TABLE>
The unaudited pro forma results for 1996 have been prepared for
comparative purposes and do not purport to be indicative of the results of
operations which actually would have resulted had the combinations been in
effect on January 1, 1996 or of future results of operations of the
consolidated entity.
As discussed in Note 1, on April 23, 1997, GEC and the Company
purchased NLRC. The total purchase price was approximately $48.6 million.
A wholly-owned subsidiary of GEC owns 74.77% of NLRC. The Company paid
approximately $12 million for the remaining interest. GEC financed its
portion of the acquisition in part by issuing to the Company a 7%
debenture in the principal amount of approximately $25 million. The
debenture was subsequently repaid along with accrued interest.
In connection with the sale of their interests in 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. The partnership has yet to formally respond to NLRC regarding
the notice of termination.
On August 26, 1997 CIC purchased 113,743 newly issued shares of The
Physicians Investment Company ("PIC") and Sequoia purchased 40,162 newly
issued shares of PIC. The purchase price was $56.26 per share.
On July 1, 1997, Sequoia purchased all of the outstanding shares of
MacCready & Gutmann Insurance Services Nevada, Inc., a licensed Nevada
insurance agency, for $550,000 in cash and other considerations.
62
<PAGE> 65
4. INVESTMENTS:
At December 31, the cost (amortized cost for fixed maturities) and
estimated fair value of available for sale investments are as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Unrealized Unrealized Fair
1997: Cost Gains Losses Value
--------------- -------------- --------------- -----------------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 13,147,587 $ 130,540 $ (190,174) $ 13,087,953
Corporate securities 18,270,118 197,166 (288,946) 18,178,338
Mortgage-backed and
other securities 12,000,000 12,000,000
--------------- -------------- --------------- -----------------
43,417,705 327,706 (479,120) 43,266,291
Equity securities 78,648,715 12,921,373 (6,502,137) 85,067,951
--------------- -------------- --------------- -----------------
Total $ 122,066,420 $ 13,249,079 $ (6,981,257) $ 128,334,242
=============== ============== =============== =================
</TABLE>
Excluded from above are fixed maturity and equity securities
investments with estimated fair values of $18,186,963 and $5,503,877,
respectively, that have been classified as net assets of discontinued
operations on the consolidated balance sheet as of December 31, 1997.
<TABLE>
<CAPTION>
Gross Gross Estimated
Unrealized Unrealized Fair
1996: Cost Gains Losses Value
--------------- -------------- --------------- -----------------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 74,508,884 $ 319,041 $ (439,085) $ 74,388,840
Corporate securities 108,858,788 1,191,257 (369,254) 109,680,791
Mortgage-backed and
other securities 25,212,464 100,847 (50,326) 25,262,985
--------------- -------------- --------------- -----------------
208,580,136 1,611,145 (858,665) 209,332,616
Equity securities 61,688,546 19,907,520 (2,061,454) 79,534,612
--------------- -------------- --------------- -----------------
Total $ 270,268,682 $ 21,518,665 $ (2,920,119) $ 288,867,228
=============== ============== =============== =================
</TABLE>
Included above are fixed maturity investments with an estimated fair
value of $52,467,790 that have been classified as net assets of acquired
business held for sale on the consolidated balance sheet as of December
31, 1996.
63
<PAGE> 66
Equity securities as of December 31, 1996 include certain warrants to
purchase the common stock of a publicly traded company. The estimated
fair value of such warrants is their intrinsic value based on the quoted
market price of the underlying common stock of the investee company. The
estimated fair value and cost of such warrants were $14,530,957 and
$240,000, respectively, as of December 31, 1996. The warrants were
converted in 1997.
The amortized cost and estimated fair value of investments in fixed
maturities at December 31, 1997, by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
--------------- --------------
<S> <C> <C>
Due in one year or less $1,409,756 $1,418,473
Due after one year through five years 16,929,665 16,777,155
Due after five years through ten years 10,335,597 10,330,609
Due after ten years 2,742,687 2,740,054
Mortgage-backed and other securities 12,000,000 12,000,000
--------------- --------------
$43,417,705 $43,266,291
=============== ==============
</TABLE>
Investment income is summarized as follows for each of the years ended
December 31:
<TABLE>
<CAPTION>
1997 1996 1995
-------------- -------------- ---------------
<S> <C> <C> <C>
Investment income from:
Available for sale:
Fixed maturities $ 3,665,643 $ 4,883,162 $ 6,192,869
Equity securities 1,122,274 1,546,020 439,028
Short-term investments
and other 7,412,342 2,332,626 2,896,678
-------------- -------------- ---------------
Total investment income 12,200,259 8,761,808 9,528,575
Investment expenses (514,187) (675,652) (363,959)
-------------- -------------- ---------------
Net investment income $ 11,686,072 $ 8,086,156 $ 9,164,616
============== ============== ===============
</TABLE>
64
<PAGE> 67
Pre tax net realized gains (losses) on investments were as follows for
each of the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Gross realized gains:
Available for sale:
Fixed maturities $ 300,167 $ 36,123 $ 625,189
Equity securities 31,083,312 27,469,731 6,101,557
------------ ------------ ------------
Total gains 31,383,479 27,505,854 6,726,746
------------ ------------ ------------
Gross realized losses:
Available for sale:
Fixed maturities (1,253,139) (292,612) (1,465,357)
Equity securities (8,737,009) (133,006) (242,536)
------------ ------------ ------------
Total losses (9,990,148) (425,618) (1,707,893)
------------ ------------ ------------
Net realized gains $ 21,393,331 $ 27,080,236 $ 5,018,853
============ ============ ============
</TABLE>
Approximately $26.8 million of the total gross realized gains for the
year ended December 31, 1997 were generated from the conversion of the
Company's Resource America, Inc. warrants and the immediate sale of the
converted common stock. As of December 31, 1997, GEC recorded a permanent
write down of $8.0 million (of which approximately $3.8 million
represented the realization of accumulated foreign currency translation
adjustments recorded by GEC) in the value of its investment in Korean
securities in recognition of what is expected to be an other than
temporary decline in the market value of those securities. The value of
these securities was sharply impacted by the recent decline in the Korean
financial market This write down has been recorded as a realized loss. In
1996, approximately $26.0 million of the total gross realized gains for
the year resulted from the sale of the Company's Fairfield Communities,
Inc. common stock in November 1996.
5. INVESTMENTS IN AFFILIATE:
Investments in entities which the Company owns between 20% to 50% of
the voting interest and has the ability to exercise significant influence
and which are made for long term operating purposes, are accounted for on
the equity method of accounting. The financial statements of all
affiliates of the Company have been consolidated with those of the
Company for 1997 as a result of the increase in the Company's ownership
in GEC to approximately 51.17%. However, the following information
presents a summary of the financial position of GEC as of December 31,
1996 along with the results of operations for the year ended December 31,
1996 and the three- month period ended December 31, 1995.
<TABLE>
<CAPTION>
1996 1995
--------------------------------
<S> <C> <C>
Total assets $ 121,897,000
Total liabilities 11,880,000
Minority interest 22,724,000
Shareholders' equity 87,293,000
Total revenue 22,051,000 $ 6,685,000
Income (loss) before income taxes 4,997,000 (340,000)
Net income (loss) 2,653,000 (1,204,000)
</TABLE>
6. DISCONTINUED OPERATIONS
On June 16, 1997, Physicians announced the signing of a definitive
agreement to sell its indirectly wholly-owned life and health insurance
subsidiary, American Physicians Life Insurance Company ("APL") and its
wholly-owned subsidiary, Living Benefit Administrators Agency, Inc. to IFS
Insurance Holdings Corporation. The closing is subject to certain closing
conditions, including regulatory approval which is still pending. The
expected purchase price is approximately $17 million and is expected to be
paid in cash.
65
<PAGE> 68
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 for all of 1997
have been classified as discontinued operations. Net income for 1996 and
1995 have also been reclassified for comparative purposes to reflect the
discontinued operations. In addition, the net assets of APL have been
shown as a single line item in the accompanying 1997 balance sheet as "Net
assets of discontinued operations" at December 31, 1997.
The GAAP book value assigned to such net assets at December 31, 1997
of $15,949,989 was based upon the net book value of APL as of December 31,
1997 as determined on the basis of generally accepted accounting
principles. The primary remaining assets and liabilities of APL as of that
date were investments, cash and cash equivalents, and accident and health
insurance reserves. The Company expects to realize a small gain on the
sale.
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>
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
Total revenues $5,310,330 $9,031,846 $6,756,453
Income (loss) before taxes (112,012) 4,002,406 858,970
Net income (loss) (167,327) 3,301,229 778,075
Net income per share-Basic and Diluted $0.00 $0.11 $0.02
</TABLE>
On August 21, 1997, GEC announced the signing of a definitive
agreement to sell its Sri Lankan subsidiaries. The closings occurred on
November 19 and December 22, 1997. The purchase price was approximately
$25 million paid in cash of $17.3 million and marketable securities of
$7.7 million. A gain of approximately $3.5 million was realized on the
sale before taxes.
Because these subsidiaries represent a major segment of GEC'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," these companies' operations for the year ended
December 31, 1997 have been classified as discontinued operations.
Operating results for 1996 and 1995 are not shown since these periods were
prior to the effective date of consolidation of GEC and PICO.
Following is an unaudited summary of these Sri Lankan companies stand
alone financial results for the period included as discontinued operations
in the accompanying financial statements:
<TABLE>
<CAPTION>
1997
------------
<S> <C>
Total revenues $12,449,347
Income before taxes
and minority interests 3,309,699
Minority interest in income of subsidiary 764,418
Net income 288,956
Net income per share-Basic and Diluted $0.00
</TABLE>
66
<PAGE> 69
7. PREMIUMS AND OTHER RECEIVABLES:
Premiums and other receivables consisted of the following at December
31:
<TABLE>
<CAPTION>
1997 1996
----------------- -----------------
<S> <C> <C>
Agents' balances and unbilled premiums $20,723,259 $14,993,199
Other accounts receivable 77,333
----------------- -----------------
20,800,592 14,993,199
Allowance for doubtful accounts (119,024) (116,917)
----------------- -----------------
$20,681,568 $14,876,282
================= =================
</TABLE>
8. FEDERAL INCOME TAX:
The Company and its U.S. subsidiaries file a consolidated
life/non-life federal income tax return. Non-U.S. subsidiaries file tax
returns in various foreign countries.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes.
Significant components of the Company's deferred tax assets and
liabilities are as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
-------------- --------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 6,800,000 $ 6,719,612
Loss reserves 17,312,601 19,018,582
Future policy benefits 798,894
Unearned premium reserves 1,319,214 2,011,642
Deferred gain on retroactive reinsurance 758,938 1,140,839
Integration liability 185,690 527,341
Other, net 1,713,417 1,154,432
-------------- --------------
Total deferred tax assets 28,089,860 31,371,342
-------------- --------------
Deferred tax liabilities:
Reinsurance receivables 10,868,442 10,325,734
Deferred policy acquisition costs 1,809,043 2,563,812
Unrealized appreciation on securities 125,801 6,060,413
Revaluation of Vidler net assets purchased 1,950,000
Revaluation of NLRC net assets purchased 3,036,358
Accretion of bond discount 72,076 106,529
Depreciation 463,060 24,932
-------------- --------------
Total deferred tax liabilities 18,324,780 19,081,420
-------------- --------------
Net deferred tax assets before
valuation allowance 9,765,080 12,289,922
Less valuation allowance (6,800,000) (6,664,000)
-------------- --------------
Net deferred tax assets $ 2,965,080 $ 5,625,922
============== ==============
</TABLE>
The deferred tax asset valuation allowances as of December 31, 1997
and 1996 relate to the net operating loss carryforwards (NOL's) of CIC,
PICO and Sequoia. Such NOL's are subject to the separate return
limitation year rules and, therefore, can only be used to offset the
respective future taxable income generated by CIC, PICO and Sequoia.
Given management's uncertainty as to the ability of CIC, PICO and Sequoia
to generate sufficient future taxable income to utilize such NOL's, they
do not currently believe that it is more likely than not that the
deferred tax asset related to such NOL's will be realized. Net deferred
tax assets, the recorded valuation allowance and federal income tax
expense in future years can be significantly affected by changes in
enacted tax rates or by changes in circumstances that would influence
management's conclusions as to the ultimate realizability of deferred tax
assets.
67
<PAGE> 70
Income tax expense (benefit) from continuing operations consists of
the following for each of the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
-------------- --------------- --------------
<S> <C> <C> <C>
Current $ 9,292,120 $ 11,042,744 $ 221,997
Deferred (1,621,992) 1,915,067 (7,974,046)
-------------- --------------- --------------
$ 7,670,128 $ 12,957,811 $ (7,752,049)
============== =============== ==============
</TABLE>
The difference between income taxes provided at the Company's
effective tax rate and federal statutory rate is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- --------------
<S> <C> <C> <C>
Federal income tax at statutory rate $ 8,226,052 $ 11,891,807 $ 2,416,375
Change in the valuation allowance (136,000) (53,323) (9,408,371)
Other (419,924) 1,119,327 (760,053)
--------------- --------------- --------------
Federal income tax expense (benefit) $ 7,670,128 $ 12,957,811 $ (7,752,049)
=============== =============== ==============
</TABLE>
The aggregate NOL's of approximately $25,009,452 expire between 1999
and 2012. There is an annual limitation on the NOL's of approximately
$1,400,000.
9. PROPERTY AND EQUIPMENT:
The major classifications of property and equipment are as follows at
December 31:
<TABLE>
<CAPTION>
1997 1996
--------------- ---------------
<S> <C> <C>
Land $ 1,923,015 $ 500,016
Buildings 7,012,657 4,841,059
Office furniture, fixtures and equipment 6,265,524 4,361,510
Building and leasehold improvements 12,499 678,223
--------------- ---------------
15,213,695 10,380,808
Accumulated depreciation (6,662,888) (5,663,442)
--------------- ---------------
Net book value $ 8,550,807 $ 4,717,366
=============== ===============
</TABLE>
Depreciation expense was $872,969, $751,000, and $589,000 in 1997,
1996, and 1995, respectively.
68
<PAGE> 71
10. DEFERRED POLICY ACQUISITION COSTS:
Changes in deferred policy acquisition costs are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- -------------- --------------
<S> <C> <C> <C>
Balance, January 1 $ 5,377,339 $ 2,894,644 $ 2,812,936
Additions
Commissions 7,677,146 4,158,421 3,303,513
Other 2,933,501 1,860,247 582,763
Acquired in merger 1,593,930
Ceding commissions (13,596) (397,698) (864,432)
--------------- -------------- --------------
Deferral of expense 10,597,051 7,214,900 3,021,844
--------------- -------------- --------------
Adjustment for expected gross
profits on investment and
life-type contracts resulting
from SFAS 115 market-to-market 17,556 (544,163)
Adjustment for premium
deficiency (584,366) (1,305,099)
Amortization to expense (10,069,308) (2,205,530) (1,090,874)
--------------- -------------- --------------
Balance, December 31 $ 5,320,716 $ 7,921,570 $ 2,894,644
=============== ============== ==============
</TABLE>
The difference between the December 31, 1996 ending balance of
$7,921,570 and the January 1, 1997 beginning balance of $5,377,339 is
equal to the amount of deferred policy acquisition costs attributable to
1997 discontinued operations of APL.
11. SHAREHOLDERS' EQUITY (ALL SHARE AMOUNTS HAVE BEEN RESTATED TO GIVE EFFECT
TO THE STOCK EXCHANGE RATIO UTILIZED IN CONNECTION WITH THE REVERSE
ACQUISITION OF CIG (NOTE 3):
In December 1993, the Company issued 7,156,997 common shares (adjusted
for the merger exchange rate) to Guinness Peat Group plc for $5,000,000.
In accordance with their original stock purchase agreement, Guinness Peat
Group plc was entitled to purchase additional common shares at a price
based upon the average closing bid price of the stock for a period prior
to the date of notice of intent to buy up to an aggregate purchase price
of $5,000,000. In June 1994, the Company issued 3,164,147 common shares
(adjusted for the merger exchange rate) to Guinness Peat Group plc for
$3,000,000, increasing their ownership to approximately 40%.
On May 9, 1996, the Company, Guinness Peat Group plc ("GPG"), and GEC
entered into an agreement whereby GPG agreed to sell 4,258,415 common
shares (adjusted for the merger exchange rate) of the Company's common
stock to GEC in two blocks, subject to regulatory approval, at an average
price of approximately $3.60 per share. GPG agreed to sell the shares to
GEC at a discount to market due to their status as restricted stock and
in consideration of the quantity of shares to be purchased. On May 13,
and June 4, 1996 GEC purchased the shares. Prior to these transactions,
GPG owned approximately 40% of the Company's common stock. Following
these transactions, GPG and GEC owned approximately 23% and 16% of the
Company's common stock, respectively. GPG and GEC owned approximately 19%
and 13.1%, respectively, of the Company's common stock subsequent to the
merger with CIG in November 1996. The shares of the Company owned by GEC
have been accounted for as treasury shares in the Company's consolidated
financial statements. GPG sold 324,000 shares of PICO in May 1997
pursuant to Securities Exchange Commission Rule 144 on the open market to
an unrelated party or parties, decreasing its ownership of the Company as
of December 31, 1997 to approximately 17.6%.
In connection with the merger, the PICO Board of Directors adopted a
Stockholders' Rights Plan and, pursuant to such Plan, declared a dividend
on its common stock of one right (a "Right") for each share of common
stock outstanding. Upon the occurrence of certain events, each Right
becomes exercisable to purchase 1/100 of a share of Series A Junior
Participating Cumulative Preferred Stock at an initial price of $35.00.
The Rights expire on July 22, 2001 and prior to the occurrence of certain
events, may be redeemed at a price of $.01 per Right. Of the Company's
2,000,000 authorized shares of preferred stock, 1,000,000 shares have
been designated as Series A Junior Participating Cumulative Preferred
Stock. Each share of Series A Junior Participating Cumulative Preferred
Stock shall entitle the holder thereof to 100 votes on all matters
submitted to a vote of the stockholders of the Company.
69
<PAGE> 72
In connection with the merger, CIG's existing Employee Stock Ownership
Plan ("ESOP") continued in effect. Pursuant to direction by the Board of
Directors in the last quarter of 1997, management is in the process of
terminating the CIG ESOP. Such plan covers substantially all of the
employees of the Company and its subsidiaries. Contributions are made to
the plan at the discretion of the Board of Directors. No contributions
were made to the plan in 1996 or 1997.
The Company sponsors various stock-based incentive compensation plans
(the "Plans"). The Company applies APB Opinion No. 25 and related
interpretations in accounting for the Plans and, therefore, does not
recognize any compensation cost related to such plans. In 1995, the FASB
issued SFAS No. 123, "Accounting for Stock-Based Compensation . Adoption
of the cost recognition provisions of SFAS No. 123 is optional and the
Company has decided not to elect these provisions of SFAS No. 123.
However, pro forma disclosures of the impact on the Company's net income
and earnings per share for the years ended December 31, 1997, 1996 and
1995 as if the Company adopted the cost recognition provisions of SFAS
123 are presented below.
Under the Plans, Physicians is authorized to issue 2,572,029 shares of
Common Stock pursuant to awards granted in various forms, including
incentive stock options (intended to qualify under Section 422 of the
Internal Revenue Code of 1986, as amended), non-qualified stock options,
and other similar stock-based awards to full-time employees (including
officers) and directors. The total options available for future grants as
of December 31, 1997 were 25,050. The Company granted stock options in
1996 and 1995 under the Plans in the form of incentive stock options and
non-qualified stock options. In conjunction with the Merger, the Company
assumed all of Physicians' options outstanding. The exercise price of all
options granted was equal to the fair market value of the Company's
common stock at the date of grant.
No options were granted in 1997. The Company granted stock options in
1996 and 1995 to employees and directors. The stock options granted in
1996 and 1995 have terms of 10 years. The options granted to directors
were vested immediately on the grant date. The options granted to
employees vest either (i) at the rate of 25%, 33% or 50% per year on each
of the first four, three or two year anniversaries of the date of grant,
as applicable, or (ii) at a rate of 33% upon grant and 33% per year on
each of the first two anniversaries of the date of grant. All options
granted under the CIG plan became fully vested upon consummation of the
merger.
A summary of the status of the Company's stock options is presented
below for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
--------------------------- ---------------------------- ---------------------------
Weighted Weighted Weighted
# Shares of Average # Shares of Average # Shares of Average
Underlying Exercise Underlying Exercise Underlying Exercise
Options Prices Options Prices Options Prices
------------ ------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 2,759,506 $2.83 2,580,095 $2.69 500,990 $0.70
Granted 70,138 2.69 2,580,095 2.69
Exercised (105,000) 3.29 (35,069) 2.69 (500,990) 0.70
Canceled (82,480) 6.64 (70,138) 2.69
Options assumed in merger 214,480 4.49
Outstanding at end of year 2,572,026 2.71 2,759,506 2.83 2,580,095 2.69
Exercisable at end of year 2,572,026 2.71 2,495,651 2,029,009
Weighted-average fair value
of options granted during
the year $3.62 $1.62
</TABLE>
The fair value of each stock option granted is estimated on the date
of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions for grants in 1996 and 1995, respectively:
no dividend yield for all years; risk-free interest rates are different
for each grant and range from 5.94% to 6.97%; the expected lives of
options are estimated at 7 years; and a volatility of 50% for all grants.
70
<PAGE> 73
The following table summarizes information about stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ---------------------------------------------------------- --------------------------
Weighted
Average Weighted
Number Remaining Average Number Weighted
Range of Outstanding Contractual Exercise Exercisable Average
Exercise Prices at 12/13/97 Life Price at 12/31/97 Exercise Price
- ----------------------------- ----------- ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C>
$2.69 to $2.88 2,560,026 7.64 $2.69 2,560,026 $2.69
$6.00 12,000 5.48 $6.00 12,000 $6.00
----------- ----------
$2.69 to $6.00 2,572,026 7.63 $2.71 2,572,026 $2.71
=========== ==========
</TABLE>
Had compensation cost for the Company's stock-based compensation plans
been determined consistent with SFAS No. 123, the Company's net income
and net income per common share would approximate the pro forma amounts
below for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------- ------------
<S> <C> <C> <C>
Net income, as reported $ 19,491,621 $ 24,320,011 $ 15,672,976
SFAS No. 123 charge (1,462,477) (1,954,185) (1,005,921)
------------ ------------ ------------
Pro forma net income $ 18,029,144 $ 22,365,826 $ 14,667,055
============ ============ ============
Pro forma net income per common share: Basic $ 0.55 $ 0.80 $ 0.53
============ ============ ============
Pro forma net income per common share: Diluted $ 0.53 $ 0.77 $ 0.53
============ ============ ============
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are
not indicative of future amounts.
12. REINSURANCE:
In the normal course of business, the Company's insurance subsidiaries
have entered into various reinsurance contracts with unrelated
reinsurers. The Company's insurance subsidiaries participate in such
agreements for the purpose of limiting their loss exposure and
diversifying their business. Reinsurance contracts do not relieve the
Company's insurance subsidiaries from their obligations to policyholders.
All reinsurance assets and liabilities are shown on a gross basis in
the accompanying consolidated financial statements. Amounts recoverable
from reinsurers are estimated in a manner consistent with the claim
liability associated with the reinsured policy. Such amounts are included
in "reinsurance receivables" in the consolidated balance sheets as
follows:
<TABLE>
<CAPTION>
1997 1996
--------------- -----------------
<S> <C> <C>
Estimated reinsurance recoverable on:
Unpaid losses and loss adjustment expense (net of
discount of $3,332,309 and $3,259,190, respectively) $ 67,654,430 $ 85,213,815
Reinsurance recoverable on paid losses and loss expenses 4,671,146 4,279,324
Future policy benefits 2,537,789
--------------- -----------------
72,325,576 92,030,928
Other balances receivable from reinsurers 2,700,000 4,953,333
--------------- -----------------
Reinsurance receivables $ 75,025,576 $ 96,984,261
=============== =================
</TABLE>
Unsecured reinsurance risk is concentrated in the companies shown in
the table below. The Company remains contingently liable with respect to
reinsurance contracts in the event that reinsurers are unable to meet
their obligations under the reinsurance agreements in force.
71
<PAGE> 74
CONCENTRATION OF REINSURANCE
(in millions)
<TABLE>
<CAPTION>
Unearned Reported Unreported Reinsurer
Premiums Claims Claims Balances
----------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
Sydney Reinsurance Corporation $ 0.1 $ 10.0 $ 14.1 $ 24.2
Kemper Reinsurance Company $ 1.5 $ 1.5
Continental Casualty Company $ 1.1 $ 0.6 $ 1.0 $ 2.7
San Francisco Reinsurance Company $ 0.1 $ 0.2 $ 0.3
TIG Reinsurance Group $ 1.2 $ 11.1 $ 12.3
Transatlantic Reinsurance Company $ 9.1 $ 9.1
Cologne Reinsurance Company of America $ 0.9 $ 0.9
Mutual Assurance, Inc. $ 4.1 $ 3.9 $ 8.0
General Reinsurance $ 2.9 $ 2.9
National Reinsurance Corporation $ 3.8 $ 0.5 $ 4.3
</TABLE>
As more fully described in Note 3, immediately prior to the sale of
Sequoia to Physicians by SRC, Sequoia and SRC entered into a reinsurance
treaty whereby all policy and claims liabilities of Sequoia prior to the
date of purchase by the Company are the responsibility of SRC. Payment of
these reinsurance liabilities has been unconditionally and irrevocably
guaranteed by QBE Insurance Group Limited.
The Company entered into a reinsurance treaty in 1995 with Mutual in
connection with the sale of Physicians' MPL business to Mutual. This
treaty is a 100% quota share treaty covering all claims arising from
policies issued or renewed with an effective date after July 15, 1995. At
the same time, Physicians terminated two treaties entered into in 1994
and renewed in 1995. The first of these was a claims-made agreement under
which Physicians' retention was $200,000, for both occurrence and
claims-made insurance policies. Claims are covered up to $1 million. The
second treaty reinsured claims above $1 million up to policy limits of $5
million on a true occurrence and claims-made basis, depending on the
underlying insurance policy.
In 1994, the Company entered into a retrospective reinsurance
arrangement with respect to its MPL business. As a result, Physicians
initially recorded a deferred gain on retroactive reinsurance of
$3,445,123 in 1994. Deferred gains are being amortized into income over
the expected payout of the underlying claims using the interest method.
The unamortized gain as of December 31, 1997 and 1996 was $2,168,393 and
$2,874,128, respectively.
Effective October 1, 1997, PRO and Physicians entered into a 100%
quota share reinsurance treaty wherein PRO agreed to cede and Physicians
agreed to assume all of PRO's existing claims liabilities including
allocated loss adjustment expenses, but excluding unallocated loss
adjustment expenses. Physicians is to administer the settlement of all
claims under PRO's policies issued prior to the effective date of the
100% quota share treaty for which Physicians will be reimbursed for
direct expenses incurred in adjusting PRO's claims. This 100% quota share
reinsurance treaty is secondary to all of PRO's reinsurance treaties in
effect prior to its effective date.
72
<PAGE> 75
The following is a summary of the net effect of reinsurance activity
on the consolidated financial statements for 1997, 1996, and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
------------------ ---------------- ----------------
<S> <C> <C> <C>
Direct premiums written $ 46,634,157 $ 44,423,399 $ 35,788,854
Reinsurance premiums assumed 183,945 274,296 140,303
Reinsurance premiums ceded (7,125,152) (7,140,634) (12,094,692)
------------------ ---------------- ----------------
Net premiums written $ 39,692,950 $ 37,557,061 $ 23,834,465
================== ================ ================
Direct premiums earned 60,474,680 58,059,587 28,823,985
Reinsurance premiums assumed 220,564 281,019 141,496
Reinsurance premiums ceded (10,818,840) (19,579,901) (9,423,750)
------------------ ---------------- ----------------
Net premiums earned $ 49,876,404 $ 38,760,705 $ 19,541,731
================== ================ ================
Losses and loss adjustment expenses incurred:
Direct 47,890,333 35,969,535 47,057,111
Assumed 427,371 69,541 33,285
Ceded (17,045,189) (17,458,446) (27,305,248)
------------------ ---------------- ----------------
31,272,515 18,580,630 19,785,148
Effect of discounting on losses and
loss adjustment expenses (Note 13) 3,057,812 4,351,860 3,386,440
------------------ ---------------- ----------------
Net losses and loss adjustment expenses $ 34,330,327 $ 22,932,490 $ 23,171,588
================== ================ ================
</TABLE>
13. RESERVES FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES:
Reserves for unpaid losses and loss adjustment expenses on MPL and
property and casualty business represent management's estimate of
ultimate losses and loss adjustment expenses and fall within an
actuarially determined range of reasonably expected ultimate unpaid
losses and loss adjustment expenses.
Reserves for unpaid losses and loss adjustment expenses are estimated
based on both company-specific and industry experience, and assumptions
and projections as to claims frequency, severity, and inflationary trends
and settlement payments. Such estimates may vary significantly from the
eventual outcome. In management's judgment, information currently
available has been appropriately considered in estimating the loss
reserves and reinsurance recoverable of the insurance subsidiaries.
Physicians and PRO prepare their statutory financial statements in
accordance with accounting practices prescribed or permitted by the Ohio
Department of Insurance ("Ohio Department"). CIC, CNIC and Sequoia
prepare their statutory financial statements in accordance with
accounting practices prescribed or permitted by the California Department
of Insurance. Prescribed statutory accounting practices include
guidelines contained in various publications of the National Association
of Insurance Commissioners, as well as state laws, regulations, and
general administrative rules. Permitted statutory accounting practices
encompass all accounting practices not so prescribed. The Ohio
Department's prescribed accounting practices do not allow for discounting
of claim liabilities. However, for the years ended December 31, 1997,
1996, and 1995, the Ohio Department permitted Physicians to discount its
losses and loss adjustment expenses related to its MPL claims to reflect
investment income. Such permission was granted due primarily to the
longer claims settlement period related to MPL business as compared to
most other types of property and casualty insurance lines of business.
Property and casualty insurance companies are permitted to discount
claims liabilities under generally accepted accounting principles to the
extent that the discounting of claims liabilities by such entities is
prescribed or permitted by statutory accounting principles.
The method of discounting utilized by Physicians is based on
historical payment patterns and assumes an interest rate at or below
Physicians' investment yield, and is the same rate used for statutory
reporting purposes. Physicians uses a discount rate of 4%. The carrying
value of MPL reserves gross as to reinsurance was approximately $108.7
million, net of discounting of $12.5 million at December 31, 1997 and
$141.8 million, net of discounting of $15.5 million at December 31, 1996.
73
<PAGE> 76
Activity in the reserve for unpaid claims and claim adjustment
expenses was as follows for each of the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
----------------- ----------------- -------------------
<S> <C> <C> <C>
Balance at January 1 $ 252,023,546 $ 229,796,606 $ 180,691,044
Less reinsurance recoverables (89,493,139) (92,474,112) (26,335,327)
----------------- ----------------- -------------------
Net balance at January 1 162,530,407 137,322,494 154,355,717
----------------- ----------------- -------------------
Incurred loss and loss adjustment expenses
for current accident year claims 33,440,000 20,806,194 17,886,560
Incurred loss and loss adjustment expenses
for prior accident year claims (980,469) (2,609,907) (335,958)
Retroactive reinsurance (1,187,016) (2,422,308)
Provision for deferral of gain on retroactive
reinsurance (145,135) 2,115,011
Accretion of discount 3,057,812 4,881,338 5,928,283
----------------- ----------------- -------------------
Total incurred 34,330,327 22,932,490 23,171,588
----------------- ----------------- -------------------
Net balances acquired in merger 41,293,239
----------------- ----------------- -------------------
Effect of retroactive reinsurance 1,187,018 145,135 (2,115,011)
----------------- ----------------- -------------------
Payments for claims occurring during:
Current accident year (13,886,002) (6,964,436) (1,357,986)
Prior accident years (55,720,662) (32,198,515) (36,731,814)
----------------- ----------------- -------------------
Total paid (69,606,664) (39,162,951) (38,089,800)
----------------- ----------------- -------------------
Net balance at December 31 128,441,088 162,530,407 137,322,494
Plus reinsurance recoverables 67,654,430 89,493,139 92,474,112
----------------- ----------------- -------------------
Balance at December 31 $ 196,095,518 $ 252,023,546 $ 229,796,606
================= ================= ===================
</TABLE>
14. EMPLOYEE BENEFITS PLANS:
PICO maintains a 401(k) Defined Contribution Plan (the "Plan")
covering substantially all employees of PICO, Physicians, Sequoia, APL,
Summit, Vidler, NLRC, and Forbes & Walker. Matching contributions to the
Plan are based on a percentage of employee compensation, as well as
amounts contributed by employees. In addition, the Company may make a
discretionary contribution at the end of the Plan's fiscal year within
limits established by ERISA. During 1997, 1996, and 1995, expenses for
contributions made to the Plan were $365,000, $334,000, and $133,000,
respectively.
Plan assets for the defined contribution plan are held by one of the
Company's subsidiaries. Another subsidiary is responsible for management
of the Plan's assets.
15. REGULATORY MATTERS:
The regulations of the Departments of Insurance in the states where
the Company's insurance subsidiaries are domiciled generally restrict the
ability of insurance companies to pay dividends or make other
distributions. Based upon statutory financial statements filed with the
insurance departments as of December 31, 1997, $16.0 million was
available for distribution by the Company's wholly-owned insurance
subsidiaries to the parent company without the prior approval of the
Department of Insurance in the states in which the Company's insurance
subsidiaries are domiciled, through December 29, 1998. The total eligible
distributions in 1998 are approximately $29.2 million. On December 17,
1997, PRO paid a dividend of approximately $5.5 million to Physicians in
cash. A dividend payment of $13,212,593 was made on December 30, 1997
from Physicians to PICO Holdings, Inc. in the form of GEC common stock.
74
<PAGE> 77
16. COMMITMENTS AND CONTINGENCIES:
The Company leases some of its offices under noncancellable operating
leases which expire through February 2001. Total rental expense for the
years ended December 31, 1997, 1996 and 1995 was $1,470,301, $1,714,265
and $395,239, respectively. Future minimum rental payments required under
the leases are as follows:
Years Ending December 31, (in thousands)
<TABLE>
<S> <C>
1998 $1,040
1999 934
2000 816
2001 452
2002 439
-----------
$3,681
===========
</TABLE>
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 consolidated financial position,
results of operations or cash flows of the Company.
17. OTHER RELATED-PARTY TRANSACTIONS:
In 1994, the Company entered into a consulting agreement for a
combined annual fee of $200,000 with two of its directors for consulting
services related to the Company's investment activities, investment
banking services and analysis of operations. Effective January 1, 1995,
the Company revised the agreement with these directors to a combined
annual fee of $300,000. Effective September 11, 1995, the previous
agreements were terminated and the Company entered into consulting
arrangements with the same two Directors for a three-year period at a
combined fee of $300,000 annually for their services as officers of the
Company related to analysis of the Company's operations, investment
banking activities, and analysis and recommendation on the Company's
investment portfolio. The Company paid a combined fee of $300,000 and
$305,000 to each of these two Directors for 1996 and 1995, respectively.
In addition, the aforementioned directors were awarded a bonus of
$450,000 each in 1996. These contracts were superceded by the January
1997 contracts described below.
Summit is a Registered Investment Advisor providing investment
advisory services to managed accounts including the Company's
subsidiaries. Although dormant for several years, Summit commenced active
operations on January 1, 1995. On January 1, 1995, Summit's President and
CEO was granted an option expiring December 31, 2004 to purchase 49% of
Summit's common shares for a nominal amount, which represented the fair
value of such options on the grant date. No options have been exercised
under this agreement. Two of the Company's directors were instrumental in
establishing the operations of Summit and are entitled to receive 50% of
the first $1,000,000 of profits attributed to Physicians' ownership of
common stock. No compensation was paid to each of those directors under
this arrangement in 1997, 1996, or 1995. Effective January 1, 1996,
Summit entered into a contract to provide investment management services
to Physicians, PRO, Sequoia, APL, and Separate Accounts A and B of APL.
Summit also entered into a contract to provide investment management
services to CIC on December 1, 1996.
Effective September 11, 1995, the same two directors also entered into
consulting contracts with a subsidiary of GEC. They are to render
services in the areas of investment banking, investment portfolio
analysis, and management and operational analysis. The compensation paid
to each of those Directors under this arrangement was $150,000 and
$45,445 in 1996 and 1995, respectively. Each was to receive $150,000
annually for rendering such services through September 11, 1998. These
contracts were superseded by the January 1997 contracts described below.
On September 26, 1995, the same two directors of the Company, who are
also officers and directors of GEC, were granted options by GEC to
purchase up to 1,549,833 shares of common stock of GEC at an exercise
price of $2.50 (Cdn.) per share, which was the closing market price of
GEC shares on the Toronto Stock Exchange on the date of grant. Such
options are immediately exercisable. In addition, on October 24, 1995,
each was granted options by GEC to purchase 950,167 additional shares of
common stock of GEC at an exercise price of $2.45 (Cdn.) per share. All
of these options are exercisable.
75
<PAGE> 78
In January 1997, the consulting arrangements described above between
two of the Company's directors and the Company, SGM, and GEC were
terminated and were replaced with a single consulting arrangement between
each of the directors, a wholly-owned subsidiary of GEC and PICO. Under
the new consulting arrangement, the Company's Board of Directors
increased the annual base consulting fees for the two directors who
perform consulting services related to investment activities, investment
banking services and analysis of operations to $800,000 each beginning
January 1, 1997. In addition, each is entitled to an incentive award
based on the growth of the Company's book value during 1997, above a
threshold rate of return. PICO will be responsible for two-thirds of the
consulting fee and a wholly-owned subsidiary of GEC will be responsible
for one-third. Effective December 31, 1997, these two directors became
employees of the Company and a subsidiary of GEC; the terms of employment
were similar to the consultant arrangements described above. The
employment agreements entered into by the two directors, effective
December 31, 1997, superceded and replaced the prior consulting
agreements.
On March 6, 1996, Charles E. Bancroft, the President and Chief
Executive Officer of Sequoia, entered into an incentive agreement with
Sequoia after its acquisition by Physicians. Under the terms of this
incentive agreement, Mr. Bancroft is to receive a payment equal to ten
percent of the increase in Sequoia's value upon his retirement, removal
from office for reasons other than cause, or the sale of Sequoia to a
third party. For purposes of the incentive agreement, the increase in
Sequoia's value is to be measured from August 1, 1995, the date
Physicians acquired Sequoia. Mr. Bancroft will not be eligible to receive
any incentive payment, and no such incentive payment will be considered
to be earned, until Mr. Bancroft had been an employee of Sequoia
continuously from August 1, 1995 through August 1, 1998. On March 20,
1998 this incentive agreement was clarified to include the combined
increase in value of Sequoia and CIC. The increase in value of CIC will
be measured from January 1, 1998. The Company recorded compensation
expense of $250,000 during the year ended December 31, 1997 related to
this arrangement.
Certain of the Company's subsidiaries have stock option arrangements
with officers and other employees for stock of the respective subsidiary.
Options are granted under these arrangements at the fair value of the
subsidiary's stock. Therefore, no compensation has been recorded by the
Company related to these arrangements.
On December 30, 1996, Physicians paid a dividend of approximately
$13.2 million to its sole shareholder, PICO. On April 14, 1997,
Physicians paid a dividend of approximately $8.6 million to PICO. With
the approval of the Ohio Department, on November 19, 1997, PRO amended
its license to delete the authority to write MPL insurance and on
December 17, 1997 paid a dividend of approximately $5.5 million to its
sole shareholder, Physicians. On December 17, 1997, Physicians
contributed an additional 5.5 million to Sequoia. On December 30, 1997,
Physicians paid a dividend of approximately $13.2 million to PICO in the
form of 5,557,347 shares of GEC common stock.
In November 1996, Physicians purchased a $2.5 million convertible
debenture from PC Quote, Inc. Physicians currently owns approximately
16.8% of PC Quote, Inc. On May 5, 1997, PICO agreed to provide a line of
credit to PC Quote, Inc. The initial credit was for $1 million with
repayment due September 30, 1997. The credit has since been increased to
$2,250,000 with repayment due April 30, 1998. The Company received
warrants to purchase common shares of PC Quote, Inc. in connection with
these transactions. The value of such warrants is not material to the
Company's financial position or results of operations.
76
<PAGE> 79
18. STATUTORY INFORMATION:
The Company and its insurance subsidiaries are subject to regulation
by the insurance departments of the states of domicile and other states
in which the companies are licensed to operate and file financial
statements using statutory accounting practices prescribed or permitted
by the respective Departments of Insurance. Prescribed statutory
accounting practices include a variety of publications of the NAIC, as
well as state laws, regulations and general administrative rules.
Permitted statutory accounting practices encompass all accounting
practices not so prescribed. Physicians has received written approval
from the Ohio Department of Insurance to discount its MPL unpaid loss and
loss adjustment expense reserves, including related reinsurance
recoverables using a 4% discount rate. Statutory practices vary in
certain respects from generally accepted accounting principles. The
principal variances are as follows:
1) Certain assets are designated as "non-admitted assets" and charged
to shareholders' equity for statutory accounting purposes
(principally certain agents' balances and office furniture and
equipment).
2) Deferred policy acquisition costs are expensed for statutory
accounting purposes.
3) Deferred federal income taxes are not recognized for statutory
accounting purposes.
4) Equity in net income of subsidiaries and affiliates is credited
directly to shareholders' equity for statutory accounting
purposes.
5) Fixed maturity securities classified as available for sale are
carried at amortized cost.
6) Loss and loss adjustment expense reserves and unearned premiums
are reported net of the impact of reinsurance for statutory
accounting purposes.
The Company and its wholly owned insurance subsidiaries' net income
(loss) for the years ended December 31, 1997, 1996 and 1995 and
policyholders' surplus as of December 31, 1997, 1996, and 1995 on the
statutory accounting basis are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------ ------------
<S> <C> <C> <C>
Physicians Insurance Company of Ohio
Statutory net income $ 28,967,115 $ 21,807,610 $ 13,212,594
Policyholders' surplus 54,790,265 69,464,034 83,380,498
The Professionals Insurance Company:
Statutory net income $ 1,167,208 $ 1,330,733 $ 403,378
Policyholders' surplus 3,922,382 7,684,701 6,024,645
American Physicians Life Insurance:
Statutory net income $ 220,968 $ 2,709,570 $ 731,813
Policyholders' surplus 12,776,934 11,809,784 9,658,540
Sequoia Insurance Company*
Statutory net income $ 1,161,670 $ (982,953) $ (3,319,089)
Policyholders' surplus 21,069,190 14,445,550 10,254,113
Citation Insurance Company**
Statutory net income $ (1,380,920) $ (3,069,661) -
Policyholders' surplus 29,112,651 25,596,903 -
</TABLE>
- -------------------
* Purchased August 1, 1995
** Purchased November 20, 1996
Certain insurance subsidiaries are owned by other insurance
subsidiaries. In the table above, investments in such subsidiary-owned
insurance companies are reflected in statutory surplus of both the parent
and subsidiary-owned insurance company. As a result, at December 31,
1997, 1996, and 1995, statutory surplus of approximately $37,768,506,
$38,423,146 and $25,937,298, respectively, is reflected in both the
parent and subsidiary-owned insurance companies.
77
<PAGE> 80
19. SEGMENT REPORTING:
The Company's operations are organized into five principal segments:
portfolio investing; surface, water, geothermal and mineral rights;
property & casualty insurance; MPL (Note 1) and other. As a result of the
acquisition in August 1997 of the majority ownership in GEC and
management's strategic initiatives, the surface, water, geothermal and
mineral rights activities of the Company and GEC have been disclosed as a
reportable segment in this annual report. Other operations include
Summit's investment management services and the Company's real estate
development and other activities. Portfolio investing for 1997 includes
the portfolio investing activities of GEC.
At December 31, the principal industry segments are as follows (in
thousands):
<TABLE>
<CAPTION>
Surface, Water,
Geothermal Property
Portfolio and Mineral and
Investing (A) Rights Casualty MPL Other (B) Consolidated
--------------------------------------------------------------- ------------
1997:
- -----
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 24,069 $ 2,500 $ 56,433 $ 3,896 $ 682 $87,580
Income before income taxes 17,748 12 5,556 765 (578) 23,503
Identifiable assets 116,477 74,737 158,760 78,756 1,563 430,293
Depreciation and amortization 325 34 761 53 8 1,181
Capital expenditures 271 28 634 44 8 985
1996:
- -----
Revenues $ 26,994 $ 35,280 $ 12,244 $ 2,218 $76,736
Income before income taxes 23,310 3,307 8,469 (1,109) 33,977
Identifiable assets 56,264 204,124 151,341 78,696 490,425
Depreciation and amortization 746 959 427 2,132
Capital expenditures 55 51 106
1995:
- -----
Revenues $ 8,021 $ 2,485 $ 29,049 $ 1,634 $41,189
Income before income taxes 5,313 (3,722) 6,026 (510) 7,107
Identifiable assets 57,800 100,978 193,133 69,905 421,816
Depreciation and amortization 1,972 139 4 2,115
Capital expenditures 267 720 36 1,023
</TABLE>
(A) Portfolio investing identifiable assets include certain
investments held by one of the Company's regulated insurance
subsidiaries which is no longer writing new business. Management
believes that this component of the insurance subsidiary's assets
is in excess of the amount of the subsidiary's assets that will
be required to settle its claims liabilities. The amount of the
insurance subsidiary's assets included in the portfolio investing
segment were approximately $6 million, $56 million and $58
million as of December 31, 1997, 1996, and 1995, respectively.
Investment income revenue thereon was approximately $2 million,
$27 million and $8 million, for the years ended December 31,
1997, 1996, and 1995, respectively.
(B) The life and health insurance segment was discontinued in 1997.
Included in "Other" are amounts of identifiable assets of
approximately $68,000 for both 1996 and 1995. Income statement
amounts for 1997, 1996 and 1995 are classified as discontinued
operations.
20. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable
to estimate that fair value:
- CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS: The carrying
amounts of cash and cash equivalents and short-term investments
approximate their estimated fair values.
78
<PAGE> 81
- FIXED MATURITIES AND EQUITY INVESTMENT SECURITIES: Fair values are
based upon quoted market prices, or dealer quotes for comparable
securities. In addition, the Company owns certain warrants to purchase
the common stock of a publicly traded company. The estimated fair
value of such warrants is their intrinsic value based on the quoted
market price of the underlying common stock of the investee company.
- DEPOSITS WITH REINSURERS AND REINSURANCE RECOVERABLES: The carrying
amounts of deposits with reinsurers and reinsurance recoverables with
fixed amounts due are reasonable estimates of fair value.
- INVESTMENT IN AFFILIATE: Estimated fair value of GEC for 1996 is based
upon its quoted market price on the Toronto Stock Exchange translated
at the exchange rates in effect at the balance sheet date.
- SEPARATE ACCOUNTING: Separate account assets and liabilities are
carried at market value, which is based upon quoted market prices.
- POLICYHOLDER LIABILITIES FOR ANNUITY AND OTHER POLICYHOLDER FUNDS:
Policyholder liabilities for annuity and other policyholder funds
include reserves without mortality or morbidity risks. The fair value
is estimated by discounting future payments at rates currently offered
for similar financial instruments.
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
------------------------------------- ----------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------------- ----------------- --------------- ---------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents and
short-term investments $ 85,193,009 $ 85,193,009 $ 65,429,714 $ 65,429,714
Investment securities 213,255,572 213,255,572 290,413,673 290,413,673
Deposits with reinsurers and
reinsurance recoverables 7,371,146 7,371,146 5,878,483 5,878,483
Investment in affiliate 28,047,764 52,143,007
Assets held in separate accounts 5,601,828 5,601,828
Financial liabilities:
Policyholder liabilities for
investment-type insurance
contracts 44,116,065 42,362,323
Liabilities related to separate
accounts 5,601,828 5,601,828
</TABLE>
79
<PAGE> 82
21. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
Summarized unaudited financial data for 1997 and 1996 are shown below.
In management's opinion, the interim financial data contains all
adjustments, consisting of only normal recurring accruals, necessary for
a fair presentation of results for such interim periods. Prior period
amounts have been adjusted to conform to the current period presentation,
including reclassification for discontinued operations, and adjustment to
shares and net income (loss) per share values due to the Merger.
The Company computes earnings per common share for each quarter
independently of earnings per share for the year. The sum of the
quarterly earnings per share may not equal the earnings per share for the
year because of: (i) transactions affecting the weighted average number
of shares outstanding in each quarter; and (ii) the uneven distribution
of earnings during the year.
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
1997:
- -----
<S> <C> <C> <C> <C>
Revenues $ 21,050,205 $ 17,180,640 $ 43,808,203 $ 5,540,716
Net Income (loss) $ 1,991,660 $ 1,823,916 $ 17,860,455 $ (2,184,410)
Basic:
Earnings (loss) per common share $ 0.06 $ 0.06 $ 0.55 $ (0.07)
Number of shares used in calculation 33,423,501 33,508,820 33,869,718 32,591,650
Diluted:
Earnings (loss) per common share $ 0.06 $ 0.05 $ 0.53 $ (0.06)
Number of shares used in calculation 33,362,680 33,512,735 33,882,821 34,053,596
1996:
- -----
Revenues $ 10,563,318 $ 9,426,646 $ 12,183,066 $ 44,563,250
Net Income (loss) $ 1,971,720 $ (771,762) $ 1,354,993 $ 21,765,060
Basic:
Earnings (loss) per common share $ 0.07 $ (0.03) $ 0.05 $ 0.73
Number of shares used in calculation 27,436,191 27,436,191 27,436,191 29,716,050
Diluted:
Earnings (loss) per common share $ 0.07 $ (0.03) $ 0.05 $ 0.71
Number of shares used in calculation 28,606,993 28,536,676 28,366,972 30,583,339
</TABLE>
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
During 1997, PICO changed its accountants as described in the
following documents: 8-K, filed June 12, 1997; 8-K/A, filed June
26, 1997; 8-K, filed July 16, 1997; 8-K/A, filed September 24,
1997; and 8-K/A2, filed September 26, 1997. All these reports were
filed with the SEC concerning the Company's change in accountants.
PART III
Certain information required by Part III is omitted from this
Report, in that PICO will file its Proxy Statement pursuant to
Regulation 14A not later than 120 days after the end of the fiscal
year covered by this Report, and certain information included
therein is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to the directors and executive
officers of PICO will be set forth in PICO's Proxy Statement to be
used in connection with its 1998 annual meeting of shareholders,
and such information is hereby incorporated by reference.
Information with respect to delinquent filings pursuant to
Item 405 of Regulation S-K is incorporated by reference to the
Proxy Statement as set forth under the caption "Executive
Compensation and Other Matters -- Section 16(a) Beneficial
Ownership Reporting Compliance."
80
<PAGE> 83
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive compensation is
incorporated by reference to the Proxy Statement under the caption
"Executive Compensation and Other Matters."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to ownership of equity securities of
PICO by certain beneficial owners and management is incorporated
by reference to the Proxy Statement as set forth under the caption
"General Information --- Stock Ownership of Certain Beneficial
Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related
transactions is incorporated by reference to the Proxy Statement
under the captions "Executive Compensation and Other Matters --
Certain Transactions" and "Executive Compensation and Other
Matters -- Compensation Committee Interlocks and Insider
Participation."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 10-K
(A) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS.
1. FINANCIAL STATEMENTS.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Reports.................................. 46-46.2
Consolidated Balance Sheets as of December 31, 1997 and 1996... 47-48
Consolidated Statements of Income for the Years
Ended December 31, 1997, 1996 and 1995................... 49
Consolidated Statement of Changes in Shareholders' Equity
for the Years Ended December 31, 1997, 1996, and 1995.... 50-51
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1997, 1996 and 1995................... 52
Notes to Consolidated Financial Statements..................... 53-80
2. FINANCIAL STATEMENT SCHEDULES.
To be filed by amendment.
Independent Auditors' Reports..........................................
Schedule II - Condensed Financial Information of Registrant............
Schedule III - Supplementary Insurance Information.....................
Schedule V - Valuation and Qualifying Accounts.........................
</TABLE>
81
<PAGE> 84
3. EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
------ -----------
<S> <C>
+ 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 By-laws 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 the 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.
</TABLE>
82
<PAGE> 85
<TABLE>
<S> <C>
+++++ 16.1. Letter regarding change in Certifying Accountant from Deloitte & Touche, LLP,
Independent auditors.
# 21. Subsidiaries of PICO.
23.1. Independent Auditors' Consent - Deloitte & Touche LLP.
23.2. Consent of Independent Accountants - Coopers & Lybrand L.L.P.
23.3. Accountants' Consent - KPMG
27. Financial Data Schedule.
### 28. Form S-8, Registration Statement under the Securities Act of 1933, for the
PICO Holdings, Inc. Employee's 401(k) Retirements Plan and Trust, Registration
No. 333-36881.
#### 29. Form S-8, Registration Statement under the Securities Act of 1933, for Physicians
Insurance Company of Ohio 1995 Non-Qualified Stock Option Plan and assumed by
PICO Holdings, Inc., Registration No. 333-32045.
</TABLE>
----------
* 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.
***** 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 14, 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.
- Executive Compensation Plans and Agreements.
# 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 10-K/A dated April 30, 1997.
### Incorporated by reference to Form S-8 filed with the
Securities and Exchange Commission (File No.
333-36881).
#### Incorporated by reference to Form S-8 filed with the
Securities and Exchange Commission (File No.
333-32045).
(b) REPORTS ON FORM 8-K.
On December 4, 1996 and December 30, 1996, PICO filed
a Form 8-K and a Form 8-K/A, respectively, with the United
States Securities and Exchange Commission. The Form 8-K
reported the consummation of the Merger, the amendment of
PICO's Articles of Incorporation and By-laws and a change in
the Company's accountants. The Form 8-K/A provided the pro
forma financial information of PICO for the quarter ended
and as of September 30, 1996 with respect to the Merger. See
also Item 9 of Part II of this report for a listing of
additional 8-K documents filed.
83
<PAGE> 86
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 31, 1998
PICO Holdings, Inc.
By: /s/ John R. Hart
-----------------------------
John R. Hart
Chief Executive Officer
President and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below on March 31, 1998 by the following persons in the
capacities indicated.
/s/ Ronald Langley Chairman of the Board
- ----------------------------------
Ronald Langley
/s/ John R. Hart Chief Executive Officer, President and
- ---------------------------------- Director
John R. Hart
/s/ Gary W. Burchfield Chief Financial Officer and Treasurer
- ---------------------------------- (Chief Accounting Officer)
Gary W. Burchfield
/s/ S. Walter Foulkrod, III, Esq. Director
- ----------------------------------
S. Walter Foulkrod, III, Esq.
/s/ Richard D. Ruppert, MD Director
- ----------------------------------
Richard D. Ruppert, MD
Director
- ----------------------------------
Dr. Gary H. Weiss
/s/ Dr. Marshall J. Burak Director
- ----------------------------------
Dr. Marshall J. Burak
/s/ Robert R. Broadbent Director
- ----------------------------------
Robert R. Broadbent
/s/ John D. Weil Director
- ----------------------------------
John D. Weil
84
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
333-36881 and 333-32045 of PICO Holdings, Inc. on Form S-8 of our report dated
March 27, 1998, appearing in this Annual Report on Form 10-K of PICO Holdings,
Inc. for the year ended December 31, 1997.
DELOITTE & TOUCHE LLP
San Diego, California
March 31, 1998
85
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements on
Form S-8 (File Nos. 333-36881 and 333-32045) of our reports dated April 7, 1997,
on our audits of the consolidated financial statements of PICO Holdings, Inc.
COOPERS & LYBRAND, L.L.P.
San Diego, California
March 30, 1998
<PAGE> 1
EXHIBIT 23.3
ACCOUNTANTS' CONSENT
The Board of Directors
PICO Holdings, Inc.
We consent to the incorporation by reference in the Registration Statements
(Nos. 333-36881 and 333-32045) on Forms S-8 of PICO Holdings, Inc. of our
report dated March 17, 1998 relating to the consolidated statement of financial
position of Global Equity Corporation as at December 31, 1997, and the related
consolidated statements of operations, deficit and changes in financial
position for the year then ended, which report appears in the annual report on
Form 10-K of PICO Holdings, Inc. dated March 31, 1998.
KPMG
Chartered Accountants
Toronto, Canada
March 31, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENTS OF OPERATIONS OF PICO
HOLDINGS, INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 43,266
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 85,068
<MORTGAGE> 0
<REAL-ESTATE> 3,206
<TOTAL-INVEST> 160,297
<CASH> 56,436
<RECOVER-REINSURE> 4,671
<DEFERRED-ACQUISITION> 5,321
<TOTAL-ASSETS> 430,293
<POLICY-LOSSES> 196,096
<UNEARNED-PREMIUMS> 21,635
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 6,266
0
0
<COMMON> 33
<OTHER-SE> 112,151
<TOTAL-LIABILITY-AND-EQUITY> 430,293
49,876
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<INVESTMENT-GAINS> 21,393
<OTHER-INCOME> 3,077
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<UNDERWRITING-AMORTIZATION> 10,069
<UNDERWRITING-OTHER> 9,845
<INCOME-PRETAX> 26,705
<INCOME-TAX> 7,670
<INCOME-CONTINUING> 19,035
<DISCONTINUED> 1,869
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,492
<EPS-PRIMARY> 0.60
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<PROVISION-PRIOR> 0
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<PAYMENTS-PRIOR> 0
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</TABLE>
