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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
(AMENDMENT NO. 1)
(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, 1998
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
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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 (858) 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
non-affiliates of the registrant (based on the closing sales price of such stock
as reported in the Nasdaq National Market) on March 26, 1999 was $176,722,822.
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 26,
1999 was 13,328,770. As of such date, 4,380,779 shares of common stock were held
by the registrant and subsidiaries of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
(1) None.
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PICO HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
<TABLE>
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Page
No.
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PART I......................................................................................... 3
Item 1. BUSINESS.......................................................................... 3
Item 2. PROPERTIES........................................................................ 20
Item 3. LEGAL PROCEEDINGS................................................................. 20
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................... 21
PART II........................................................................................ 21
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS............. 21
Item 6. SELECTED FINANCIAL DATA........................................................... 22
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS......................................................... 23
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS....................... 47
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................... 48
Item 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.......................................................... 91
PART III....................................................................................... 91
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................... 91
Item 11. EXECUTIVE COMPENSATION........................................................... 92
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................... 99
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................... 99
PART IV........................................................................................ 100
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K.................. 100
SIGNATURES..................................................................................... 112
</TABLE>
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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,
INVESTMENT PHILOSOPHY, THE YEAR 2000 COMPUTING SYSTEMS COMPATIBILITY, BUSINESS
EXPECTATIONS AND REGULATORY UNCERTAINTIES, 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 "RISK FACTORS" 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") and subsidiaries (the "Company") is a
diversified holding company with operations in wholesale water and storage
through its subsidiary Vidler Water Company, Inc.; real estate and minerals
through its subsidiary Nevada Land and Resource Company, LLC; insurance through
its subsidiaries Sequoia Insurance Company and Citation Insurance Company; and
investment management though its subsidiary Summit Global Management, Inc. In
addition, PICO has a number of strategic value investments. 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.
PICO was incorporated in 1981 and began operations in 1982 as an insurance
holding company. PICO was known as Citation Insurance Group prior to the
November 20, 1996 reverse merger between a wholly-owned subsidiary and
Physicians Insurance Company of Ohio ("the Merger"). PICO's 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:
Global Equity Corporation ("GEC")
In September 1995, the Company acquired approximately 38.2% of GEC. In July
1997, the Company purchased an additional 11.7% of GEC from the Mackenzie Fund,
increasing its holdings to approximately 49.9%. On August 18, 1997 GEC issued
shares through a secondary public offering and PICO subscribed additional shares
increasing its ownership of GEC to approximately 51.2%. For a number of reasons,
including the simplification of the structure of the combined companies, on
December 16, 1998, PICO acquired the remaining 48.8% minority interest of GEC
through a combination (the "PICO/GEC Combination") in exchange for PICO common
stock. See the PICO and GEC Joint Management Information Circular and Proxy
Statement dated October 13, 1998 on file with the Securities and Exchange
Commission ("SEC") with Form DEFM14A on October 16, 1998 for additional
information regarding the PICO and GEC Combination approved by shareholders on
November 20, 1998.
Incorporated under the laws of the Province of Ontario, Canada, GEC operates
primarily, both directly and indirectly through its various subsidiaries, as an
international investment and operating company. The emphasis of GEC's investment
strategy is to increase shareholder value through the long-term appreciation of
its assets. GEC's investment portfolio comprises holdings in public equity
securities, strategic investments and convertible instruments in North American,
Asian and European corporations, as well as a diversified portfolio of surface,
water and mineral rights in the western United States, and oil and gas lease
interests in North America.
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Vidler Water Company, Inc. ("Vidler")
Effective November 14, 1995, a wholly-owned subsidiary of GEC acquired all of
the outstanding common stock of Vidler. The purchase price was $5.8 million in
cash. Vidler, a corporation formed under the laws of the state of Colorado,
changed its state of domicile to Delaware in 1998. 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. In 1998, a former employee of Vidler exercised stock options to purchase
approximately 1.9% of Vidler. SEE NOTE 17 OF NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, "OTHER RELATED-PARTY TRANSACTIONS."
As a comprehensive provider of water services, Vidler performs the following
functions:
- Water asset acquisitions, purchasing appropriate 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
made further acquisitions of water rights through the purchase of additional
properties with appurtenant water rights in Arizona, California, Colorado, and
Nevada. In October 1998, Vidler's Arizona groundwater recharge pilot program
construction was completed and recharging began on schedule. Vidler's
underground water storage facility is located adjacent to the Central Arizona
Project in Arizona. Vidler has begun implementing the full-scale design and
permitting process and will be meeting with potential state and federal recharge
customers. Vidler estimates that the total storage capacity of the aquifer
underlying this property is in excess of 1,000,000 acre-feet (one acre of water
one foot deep) and the "put" and "take" recharge/recovery capacity of the
aquifer to be in excess of 100,000 acre-feet per year. Currently, Vidler does
not have a significant amount of water stored in this aquifer. In November 1998
Vidler reached an agreement with the Semitropic Water Storage District
("Semitropic") to acquire 185,000 acre-feet of underground water storage and
associated rights to recharge and recover water at Semitropic located near the
California Aqueduct northwest of Bakersfield, California. The strategic location
of Semitropic relative to other water delivery systems and storage facilities
will enable Vidler to complete exchanges and water transfers in California.
Nevada Land and Resource Company, LLC ("NLRC")
On April 23, 1997, PICO and GEC acquired a 100% membership interest in NLRC.
The total purchase price for NLRC was $48.6 million. NLRC's principal asset
consists of approximately 1.3 million acres of deeded land located in northern
Nevada, together with appurtenant water and mineral rights. NLRC is actively
engaged in activities which it believes will maximize the property's value in
relation to water rights, mineral rights and land sales, exchanges and
development. NLRC is the largest private landowner in the state. NLRC
anticipates that revenues will be generated from the asset by land sales,
exchanges and development and exploration of mineral and water rights. NLRC's
mineral exploration strategy is to identify potential gold discoveries (or other
high unit resources), develop them to the point where a meaningful data set can
be established and then to vend the properties to advanced stage exploration or
production companies.
Citation Insurance Company ("Citation")
Citation is a California-domiciled insurance company licensed to write
property and casualty insurance in Arizona, California, Colorado, Nevada,
Hawaii, New Mexico and Utah. Citation primarily writes commercial property and
casualty insurance. Citation has also written Workers Compensation insurance;
however, Citation 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.
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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 and Nevada. Sequoia writes business through independent agents and
brokers covering risks located primarily within northern and central California
and Nevada. 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 transitioned from
writing primarily personal lines of business (automobile, homeowners, etc.) to
commercial lines.
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 investment operations, property and
casualty insurance, the wind down of the settlement of insurance claims
liabilities arising from Physicians' terminated medical professional liability
("MPL") insurance business (the "runoff"), and other. Through December 4, 1998,
an indirect subsidiary of Physicians, American Physicians Life Insurance Company
("APL"), engaged in life and health insurance. 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. During 1995, there was another overall shift in the strategic
direction of Physicians when it sold its existing MPL insurance business. See
"REGULATORY INSURANCE DISCLOSURES -- REINSURANCE -- MPL." Physicians continues
to administer and adjust its remaining claims and LAE reserves. Based upon
careful analysis of various alternative scenarios for handling the runoff of the
remaining claims reserves, management determined that the best option was to
process the existing claims internally with existing staff, rather than through
a third party administrator or through an outright sale of the claims and LAE
reserves. In addition, although there can be no assurance, 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.
Physicians Investment Company ("PIC")
PIC is a holding company that owned 100% of APL prior to its sale on December
4, 1998. The Company entered into an agreement to sell APL and APL's
wholly-owned subsidiary, Living Benefit Administrators Agency, Inc. On June 16,
1997, APL offered critical illness insurance through "Survivor Key" policies as
well as other life and health insurance products. Physicians owns approximately
65.1% of PIC. Sequoia and Citation own approximately 9.1% and 25.8%,
respectively.
The Professional 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. PRO primarily offered MPL insurance to doctors, dentists
and other medical professionals in Ohio until the sale of its MPL business in
1995. See "REGULATORY INSURANCE DISCLOSURES -- REINSURANCE -- MPL."
Summit Global Management ("Summit")
Summit is a Securities and Exchange Commission ("SEC") registered investment
advisor that offers investment management services in a number of states
including California, Florida, Kansas, Iowa, Louisiana, Oregon, Virginia and
Wisconsin. Summit provides investment management services to PICO and its
subsidiaries. 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. 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.
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SIGNIFICANT MERGERS AND ACQUISITIONS
Merger of Citation and Physicians to form PICO Holdings, Inc.
The following describes the history of PICO, which was previously known as
"Citation Insurance Group", prior to the November 20, 1996 Merger. On November
20, 1996, Citation Holdings, Inc., an Ohio corporation and a wholly-owned
subsidiary of Citation ("Sub"), merged with and into Physicians, 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. 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, Citation and CNIC. "Citation Group" refers to CIG and its
subsidiaries, excluding Citation General Insurance Company ("CGIC"), as they
existed before the Merger. The State of California placed CGIC, a wholly-owned
subsidiary of CIG, into conservation in July 1995. Citation Group had
effectively written off its investment in CGIC in November 1994.
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."
Combination of PICO and GEC
On December 16, 1998, following the requisite regulatory and shareholder
approvals, PICO and GEC announced completion of the combination of the two
corporations through PICO's acquisition of GEC's remaining 48.8% minority
interest. PICO acquired the remaining shares through the issuance to GEC
shareholders of PICO common stock. Immediately following the closing, PICO
effected a 1-for-5 reverse stock split (the "Reverse Stock Split"), reducing the
number of PICO shares issued and outstanding to approximately 9.3 million, net
of approximately 4 million treasury shares.
MAJOR OPERATING SEGMENTS
The Company is a diversified holding company engaged in five major operating
segments: Investment Operations; Surface, Water and Mineral Rights Operations;
Property and Casualty Insurance Operations; Medical Professional Liability
Insurance Operations and Other Operations.
Investment Operations
PICO holds a number of strategic and portfolio investments in both publicly
and privately held corporations. These investments may be passive or they may
represent positions where PICO is able to exert significant influence over the
operating, financing and management strategies and decisions of the corporation.
PICO invests in businesses that it believes to be undervalued or may benefit
from additional capital, restructuring of operations or management or improved
competitiveness through operational efficiencies with existing PICO operations.
The Company makes investments for the purpose of enhancing and realizing
additional value by means of appropriate levels of shareholder influence and
control. This may involve restructuring of the financing or management of the
entities in which the Company invests and initiating or facilitating mergers and
acquisitions. The investments tend to be long term in nature; however, if
returns are not as anticipated, there is an attractive exit, or a more
productive use of capital is identified, the Company divests its position.
Revenues are derived from interest, dividends and realized gains or losses upon
sale of investments. In addition, the change in unrealized gains and losses for
available for sale securities is used as a performance measurement. The Company
invests in a number of industry segments and geographic regions and does not
limit itself in either of these categories but rather uses criteria based on
fundamental value principles in selecting investment targets. Investments
directly related to the insurance operations are included within those segments.
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Surface, Water and Mineral Rights Operations
PICO is engaged in surface, water and mineral rights operations through its
subsidiaries, Vidler and NLRC. Vidler is a comprehensive provider of water
services and, through the acquisition of water assets, water rights and
upgrading priority and functionality of these rights generates revenues by
marketing water to end-users. In addition, Vidler is developing water recharge
(storage) facilities for future operation that will be directed to
municipalities and water districts in the southwestern United States. Surplus
supplies of water will be stored in the facilities and will generate revenues
from storage fees and sales and deliveries to end-users.
NLRC owns approximately 1.3 million acres of deeded land in northern Nevada
together with appurtenant water and mineral rights. NLRC produces revenue by
land sales, land development, land exchanges and leasing for grazing,
agricultural and other uses. As well as the exploration and development of water
rights and mineral rights through outright sales and royalty streams, NLRC is
actively engaged in activities which it believes will maximize the property's
value in relation to water rights, mineral rights, and land development.
Together, GEC and PICO own 100% of the membership interests in NLRC.
Property and Casualty Insurance Operations
PICO owns two property and casualty insurance companies, Citation and
Sequoia. These companies write commercial property and casualty insurance and,
to a lesser extent personal lines of insurance. Workers Compensation insurance
was written until 1997, when the business was sold to a third party. Revenues
are derived from premiums earned on policies written as well as investment
income on assets and investments held by the insurance operations.
MPL Operations
PICO's subsidiaries, Physicians and PRO ceased writing policies in 1995;
however, they continue to administer and adjust remaining claims. Management
continues to handle the runoff of the remaining claims reserves internally. The
operation has retained the investments necessary to fund the payment of claims
and loss adjustment expense ("LAE") reserves as opposed to selling or fully
reinsuring these reserves and giving up the corresponding funds. Revenues are
derived from the investments retained.
Other Operations
PICO provides investment management services through its wholly-owned
subsidiary, Summit. Other operations also are currently, or in prior years were,
conducted by Raven Development Corp., CLM Insurance Agency, and others.
EMPLOYEES
At December 31, 1998, the Company had 155 employees. A total of 7 employees
were engaged in surface, water and mineral rights operations; 114 in property
and casualty insurance operations; 8 in MPL operations; 6 in Summit's investment
management operations and 20 in holding company activities.
EXECUTIVE OFFICERS
The executive officers of PICO are as follows:
<TABLE>
<CAPTION>
Name Age Position
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<S> <C> <C>
Ronald Langley 54 Chairman of the Board, Director
John R. Hart 39 President, Chief Executive Officer and Director
Richard H. Sharpe 43 Chief Operating Officer
Gary W. Burchfield 52 Chief Financial Officer and Treasurer
James F. Mosier 51 General Counsel and Secretary
A. Judson Hill 44 Executive Vice President
Sheila C. Ferguson 37 Financial Controller
Maxim C. W. Webb 37 Vice President, Investments
</TABLE>
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Except for A. Judson Hill, Sheila C. Ferguson and Maxim C. W. Webb, 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.
Sheila C. Ferguson and Maxim C. W. Webb were officers of GEC and became officers
of PICO upon the effective date of the PICO/GEC Combination. A. Judson Hill
joined PICO in 1998 as Executive Vice President.
Mr. Langley has been Chairman of the Board of PICO since November 1996 and 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 PICO since November 1996 and a Director
of Physicians since 1993. Mr. Langley has been a Director of Sequoia since
August 1995 and a Director of Citation since November 1996. Mr. Langley has been
a Director of Hyperfeed Technologies, Inc, (formerly, PC Quote, "Hyperfeed")
since 1995.
Mr. Hart has been President and Chief Executive Officer of PICO since
November 1996 and 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 PICO since November 1996 and 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 Citation since November 1996. Mr. Hart has been a
Director of Hyperfeed since 1997.
Mr. Sharpe has been Chief Operating Officer of PICO since November 1996 and
of Physicians since June 1994, an officer of APL for more than 10 years, and a
Director of APL from June 1993 until December 1998. Mr. Sharpe has been a
Director of Sequoia since August 1995 and a Director of Citation since November
1996.
Mr. Burchfield has been Chief Financial Officer and Treasurer of PICO since
November 1996 and Chief Financial Officer of Physicians since November 1995 and
Treasurer of Physicians 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 PICO since November
1996 and of Physicians since October 1984 and in various other executive
capacities since joining Physicians in 1981.
Mr. Hill joined PICO in November 1998. Prior to joining PICO, he was a
managing director of HSBC Securities, Inc. in 1997 and 1998. For three years
prior to that, he was executive vice president of Thermatrix, Inc., an
industrial controls manufacturing firm.
Ms. Ferguson has served in various capacities with the GEC group of companies
since 1993, including Director, Treasurer and Financial Controller of Forbes
Ceylon Limited from 1993 through 1996. Ms. Ferguson has also served as Financial
Controller for GEC since September 1995 and an officer of GEC since June 1997.
Ms. Ferguson became Financial Controller of PICO November 20, 1998.
Mr. Webb has served in various capacities with the GEC group of companies
since 1993, including Vice President, Investments of Forbes Ceylon Limited from
1994 through 1996. Mr. Webb became an officer of GEC in November 1997 and Vice
President, Investments of PICO on November 20, 1998.
REGULATORY INSURANCE DISCLOSURES
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 for the periods indicated as reported in financial statements filed with
the Ohio Department and the California Department using statutory accounting
practices:
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NET PREMIUMS WRITTEN
BY LINE OF BUSINESS
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
Property and Casualty-Commercial and Other $ 35.5 $ 40.1 $ 35.2
Medical Professional Liability (0.2) 0.2
Workers Compensation and Other (0.6) 2.4
------ ------ ------
Total Property and Casualty Premiums 35.3 39.7 37.6
------ ------ ------
Property & Casualty Excluding
Workers Compensation Insurance and other $ 35.3 $ 40.3 $ 35.2
====== ====== ======
</TABLE>
Commercial property and casualty insurance premiums written by Sequoia and
Citation account for principally all of the Company's property and casualty
premiums in recent years, with the exception of workers' compensation premiums
written prior to July 1997 when that line of business was fully reinsured and
sold along with CNIC. Physicians and PRO ceased writing MPL risks in 1995, but
continue to administer the runoff of the existing claims exposures. 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." Citation's premiums
are included for periods after November 20, 1996, the effective date of the
Merger. SEE "SIGNIFICANT MERGERS AND ACQUISITION."
Property and Casualty Insurance
On March 7, 1995, Physicians executed a stock purchase agreement with Sydney
Reinsurance Corporation ("SRC") to acquire all of the outstanding stock of SRC's
wholly-owned subsidiary, Sequoia. 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.
Sequoia writes primarily light commercial and multiperil insurance in
northern and central California and a small amount in Nevada. 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.
Citation currently underwrites principally the same types of business as
Sequoia, but only in states where Sequoia does not write. Prior to the
centralization of underwriting activities and the implementation of more
stringent underwriting guidelines, Citation wrote 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.
Citation 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. Citation typically
provides general liability, theft, inland marine, property, glass, commercial
automobile, incidental product liability coverage and umbrella liability.
Citation sells policies through independent producers located in its operating
territories.
In an effort to improve the exposure to risks underlying Citation's book of
insurance business and to take advantage of synergies inherent within the two
insurance companies, Sequoia and Citation moved both operations into common
facilities in Monterey, California in 1997. Essentially all new and renewal
insurance business is being underwritten by Sequoia using Sequoia's more
stringent risk selection criteria. However, risks located in states not covered
by Sequoia continue to be written directly by Citation. Effective January 1,
1998, Sequoia and Citation entered into a pooling agreement whereby both
insurance companies pool all their business in force at, or written or renewed
after, the effective date. Both companies share equally in the allocation of
premiums, losses and LAE and insurance expenses.
9
<PAGE> 10
Net earned premiums, incurred losses and the corresponding loss ratio
(excluding loss adjustment expense) for Sequoia and Citation for 1998 were $36
million, $17 million and 45.7%, respectively, excluding workers' compensation
insurance. This compares to $50 million, $24 million and 47.7%, respectively, in
1997. The decline in earned premium from 1997 to 1998 is principally a result of
the more stringent underwriting of Citation's former book of insurance business
following its change in control in November 1996. Increased competition for
commercial property and casualty insurance premiums within northern and central
California has also contributed to the decrease.
Sequoia's and Citation's combined results for 1998 by line of business were
as follows:
PROPERTY AND CASUALTY INSURANCE
NET LOSS RATIO BY LINE OF BUSINESS
<TABLE>
<CAPTION>
1998
-----------------------------------
Net
Premiums Net Losses Net Loss
Earned Incurred* Ratio*
-------- ---------- --------
(in thousands)
<S> <C> <C> <C>
Fire $ 496 $ 212 42.7%
Allied lines 151 76 50.3%
Homeowners multiperil 30 4 13.3%
Commercial multiperil 26,285 10,582 40.3%
Inland marine 3
Earthquake 286 17 5.9%
Other liability 644 2,553 396.4%
Auto liability 5,125 2,058 40.2%
Auto physical damage 3,274 1,071 32.7%
------- -------
Total $36,291 $16,576 45.7%
======= =======
</TABLE>
* Net losses incurred and net loss ratios shown exclude LAE.
The loss ratio for the Sequoia and Citation combined operations improved two
full percentage points from 1997 to 1998. However, Sequoia's total net loss
ratio decreased 5.6 percentage points from 1997 principally as a result of
redundancies in prior year reserves in the commercial multiperil and other
liability lines of business. Citation'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 Citation.
The underwriting staffs of Sequoia and Citation 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 policy at Sequoia and Citation is to settle valid claims promptly and
equitably. Sequoia and Citation employ claim technicians, located in various
locations throughout California, to administer the claim settlement process. It
is Sequoia's and Citation'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 a policy to assign the most experienced technicians to handle the most
complex claims. In general, claims in litigation are the most complex and
require the most experienced personnel.
The Company's claim staff, working closely with claim department supervisors,
may retain independent adjusters, appraisers and
10
<PAGE> 11
defense counsel, based on the nature of the claim. In addition, Sequoia and
Citation have implemented procedures and programs to detect and investigate
claim fraud. To date, it appears these programs resulted in substantial savings
relative to the claimed amounts involved.
Citation and Sequoia write property and casualty insurance policies. Most of
Citation's and Sequoia's net premiums are derived from property and casualty
insurance. 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 capacity 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 to Mutual Assurance Inc.
("Mutual") in August 1995, Physicians and PRO primarily wrote 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 written 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, the effective
date of a 100% quota share reinsurance agreement with Mutual.
As part of the agreement with Mutual, 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.
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.
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.
11
<PAGE> 12
The liabilities for unpaid losses and LAE of Physicians, PRO, Sequoia, and
Citation (the "Insurance Group") were $155 million at December 31, 1998, $196.1
million in 1997, and $252.0 million in 1996, net of discount on MPL reserves and
before reinsurance reserves, which reduce net unpaid losses and LAE. Of those
amounts, the liabilities for unpaid loss and LAE of prior years increased by
$7.3 million in 1998, $3.3 million in 1997, and $2.3 million in 1996. These
reserve changes for prior years' reserves were due to the following:
CHANGE IN UNPAID LOSS AND LAE RESERVES
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Increase (decrease) in provision for prior year claims 7.0 (1.0) (2.6)
Retroactive reinsurance (0.4) 1.2
Accretion of reserve discount 0.7 3.1 4.9
------ ------ ------
Net increase in liabilities for unpaid loss
and LAE of prior years 7.3 3.3 2.3
====== ====== ======
</TABLE>
SEE SCHEDULE IN NOTE 13 OF NOTES TO THE COMPANY'S CONSOLIDATED FINANCIAL
STATEMENTS, "RESERVES FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES" for
additional information regarding reserve changes.
Although the Company's 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. A discount rate of 4% is used for MPL reserves.
All members of the Company's 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 Company's 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 1998,
1997 and 1996 is set forth in NOTE 13 OF NOTES TO THE COMPANY'S CONSOLIDATED
FINANCIAL STATEMENTS, "RESERVE FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES."
12
<PAGE> 13
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
The following table presents the development of balance sheet liabilities for
1988 through 1998 for all property and casualty lines 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,
-----------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Net Liability as originally estimated: $ 109,435 $ 126,603 $ 128,104 $ 129,768 $ 159,804 $ 179,390
Discount 37,100 36,806 30,230 30,647 31,269 32,533
Gross liability as originally estimated: 146,535 163,409 158,334 160,413 191,073 211,923
Cumulative payments as of:
One year later 27,229 43,725 42,488 42,986 41,550 34,207
Two years later 69,335 84,463 81,536 81,489 73,012 69,037
Three years later 105,274 110,291 108,954 103,505 103,166 90,904
Four years later 122,589 128,737 120,063 120,073 116,278 118,331
Five Years later 136,454 135,170 126,100 127,725 139,028 128,773
Six years later 138,907 138,912 130,146 142,973 143,562
Seven years later 140,451 141,854 142,484 147,142
Eight years later 141,641 152,706 146,112
Nine years later 146,841 154,659
Ten years later 149,034
Liability re-estimated as of:
One year later 148,847 162,653 160,200 188,811 197,275 183,560
Two years later 148,932 162,371 179,915 184,113 179,763 184,138
Three years later 154,177 176,123 172,715 174,790 182,011 175,308
Four years later 165,596 169,488 170,847 177,811 176,304 178,544
Five Years later 163,676 171,532 171,968 172,431 181,721 178,584
Six years later 165,996 170,873 165,255 175,830 181,868
Seven years later 166,144 167,341 168,185 177,603
Eight years later 161,328 170,941 170,710
Nine years later 163,426 173,630
Ten years later 166,527
Cumulative Redundancy (Deficiency) $ (19,992) $ (10,221) $ (12,376) $ (17,190) $ 9,205 $ 33,339
RECONCILIATION TO FINANCIAL STATEMENTS
Gross Liability - end of year
Reinsurance recoverable
Net liability before discount - 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 before discount - latest
Net re-estimated discount - latest
Discounted net re-estimated liability - latest
Net cumulative redundancy (deficiency) before discount
</TABLE>
13
<PAGE> 14
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net Liability as originally estimated: $ 153,212 $ 137,523 $ 165,629 $ 128,205 $ 102,877
Discount 20,144 16,568 12,216 9,159 8,515
Gross liability before discount as originally estimated: 173,356 154,091 177,845 137,364 111,392
Cumulative payments as of:
One year later 35,966 27,128 59,918 44,750
Two years later 61,263 65,062 95,574
Three years later 93,908 86,865
Four years later 110,272
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 170,411 147,324 177,734 144,367
Two years later 163,472 146,653 185,366
Three years later 162,532 151,752
Four years later 165,696
Five Years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative Redundancy (Deficiency) $ 7,660 $ 2,339 $ (7,521) $ (7,003)
RECONCILIATION TO FINANCIAL STATEMENTS
Gross Liability - end of year $ 266,320 $ 208,351 $ 166,131
Reinsurance recoverable (88,474) (70,987) (54,740)
--------- --------- ---------
Net liability before discount - end of year 177,846 137,364 111,391
Net discount (12,217) (9,159) (8,515)
--------- --------- ---------
Discounted net liability - end of year 165,629 128,205 102,876
Discounted reinsurance recoverable 85,217 67,654 52,000
--------- --------- ---------
250,846 195,859 154,876
Discontinued personal lines insurance 1,178 237 145
--------- --------- ---------
Balance sheet liability (discounted) $ 252,024 $ 196,096 $ 155,021
========= ========= =========
Gross re-estimated liability - latest $ 284,817 $ 212,564
Re-estimated recoverable - latest (99,450) (68,197)
--------- ---------
Net re-estimated liability before discount - latest 185,367 144,367
Net re-estimated discount - latest (8,515) (8,515)
--------- ---------
Discounted net re-estimated liability - latest $ 176,852 $ 135,852
========= =========
Net cumulative redundancy (deficiency) before discount $ (7,521) $ (7,003)
========= =========
</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 1991, but incurred in 1988 will be
included in the decrease or increase amount for 1988, 1989 and 1990. 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.
14
<PAGE> 15
The data in the above table is based on Schedule P from each of the Company's
Insurance Group's 1988 to 1998 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 (i.e. the lapse of time between the occurrence of a claim and the report
of the claim to the insurer) of 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 Company's
Insurance 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 adjustments to reserves for estimated ultimate losses and LAE. To
the extent reserves prove to be inadequate, the insurance companies would have
to adjust their reserves and incur a charge to income, which could have a
material adverse effect on the financial results of the Company.
REINSURANCE
MPL
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. This transaction was approved by Physicians' shareholders on
August 25, 1995 and closed on August 28, 1995. Pursuant to the Mutual Agreement,
Physicians and PRO sold their professional liability insurance business and
related liability insurance business for physicians and other health care
providers (the "Book of Business"). 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.
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.
Property and Casualty
Effective January 1, 1996, Citation and CNIC have an excess of loss treaty
with National Reinsurance Corporation for property and casualty losses occurring
on or after January 1, 1996. This treaty provides $4.8 million of coverage in
excess of $250,000 per occurrence. An automatic facultative agreement with
Munich American Reinsurance Company 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. Citation has a
commercial umbrella liability agreement with American Reinsurance Company which
reinsures 95% of the first $1 million of umbrella coverage and 100% of any
limits purchased above $1 million, up to $10 million.
15
<PAGE> 16
Effective January 1, 1998, Sequoia and Citation entered into an inter-company
reinsurance pooling agreement for business in force as of January 1, 1998 and
business written thereafter. Per the agreement, Citation cedes 100% of its net
premium and losses to Sequoia and Sequoia then cedes 50% of its net premiums and
losses to Citation. Sequoia and Citation share equally in the underwriting
expenses.
Effective January 1, 1997, Citation 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, Citation has reinsurance providing coverage for both
property and casualty business, excluding umbrella coverage, of $4.8 million
excess of $250,000. For policies written with effective dates March 1, 1997 and
after, Citation has the same reinsurance as Sequoia's 1997 and 1998 reinsurance
program which is outlined as follows. For property business, reinsurance
provides coverage of $10.4 million excess of $150,000. For casualty business,
excluding umbrella coverage, reinsurance provides coverage of $4.9 million
excess of $150,000. Umbrella coverages are reinsured $9.9 million excess of
$100,000. The catastrophe treaties for 1997 provide coverage of 95% of $19
million excess of $1 million per occurrence for the combined losses of Citation
and Sequoia. The catastrophe treaties for 1998 provide coverage of 95% of $14
million excess of $1 million per occurrence. Facultative reinsurance is placed
with various reinsurers.
Effective June 30, 1997, immediately prior to the sale of CNIC, Citation
ceded and CNIC assumed all of Citation's historical workers' compensation net
reserves and inforce workers' compensation policies. CNIC then ceded and
Citation 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, Sequoia and
Citation presently maintain 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 $5.5 million 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 million excess of $150,000 per occurrence. Two excess
catastrophe treaties provide additional property reinsurance up to $10 million
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 million. Facultative reinsurance is placed with
various reinsurers.
Reinsurance recoverable concentration for all property and casualty lines of
business, including MPL, as of December 31, 1998 is summarized in the following
table:
REINSURANCE RECOVERABLE CONCENTRATION
<TABLE>
<CAPTION>
UNEARNED REPORTED UNREPORTED REINSURER
PREMIUMS CLAIMS CLAIMS BALANCES
-------- -------- ---------- ---------
(in millions)
<S> <C> <C> <C> <C>
Sydney Reinsurance Corporation $ 6.5 $ 10.7 $ 17.2
Kemper Reinsurance Company $ 0.6 $ 0.6
Continental Casualty Company $ 0.9 $ 1.0 $ 1.9
Hartford RE Co. $ 0.1 $ 0.1
Hartford Fire Insurance Company $ 0.3 $ 0.7 $ 0.2 $ 1.2
TIG Reinsurance Group $ 1.7 $ 6.1 $ 7.8
Transatlantic Reinsurance Company $ 8.6 $ 8.6
Cologne Reinsurance Company of America $ 0.9 $ 0.9
Mutual Assurance, Inc. $ 5.3 $ 1.6 $ 6.9
General Reinsurance $ 1.8 $ 1.8
National Reinsurance Corporation $ 0.4 $ 1.8 $ 0.6 $ 2.8
</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.
16
<PAGE> 17
Reinsurance Risks
As with other property and casualty insurers, Citation'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. Citation and Sequoia generally
seek to reduce their exposure to such events through individual risk selection
and the purchase of reinsurance. Citation'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 Citation or Sequoia should such
an event occur. While Citation 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. The Company's insurance subsidiaries are
not 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
Citation, Physicians, PRO, 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
Sequoia and Citation and offer more diversified types of insurance coverage,
have greater financial resources and have greater distribution capabilities than
Sequoia and Citation.
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. Citation 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 or Citation will
maintain their ratings. If Sequoia or Citation 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 Citation from B+ to B-. Best recently upgraded Citation'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 Citation's
Best ratings will be maintained or increased.
There is fierce competition in the property and casualty insurance industry
that 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 Citation 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 Citation'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.
17
<PAGE> 18
However, Citation'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. Citation's and
Sequoia's customer bases and prospective revenues are vulnerable to the pricing
actions of larger or more efficient competitors who target Citation's and
Sequoia's desired classifications or individual policyholders and offer
substantially lower rates.
Physicians and its subsidiaries no longer compete in the MPL industry.
Citation sold its workers' compensation businesses in 1997. On December 4, 1998,
the Company sold its life and health insurance subsidiary, APL
Regulation
Physicians, PRO, Sequoia, and Citation are subject to extensive state
regulatory oversight in the jurisdictions in which they are organized and in the
jurisdictions in which they do business.
The investments held by Physicians, PRO, Sequoia, and Citation are strictly
regulated by investment statutes in their states of domicile. In general, these
investment laws place limits on the diversification, the total percentage owned
of any one company and quality of the investment and seek to ensure the
claims-paying ability of the insurer.
Ohio has enacted legislation that regulates insurance holding company
systems, including Physicians and PRO. Physicians and PRO are 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 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 Citation are subject to similar legislation in
California.
Ohio insurance law provides that no person may acquire direct or indirect
control of Physicians or PRO 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 Citation unless it
has obtained the prior written approval of the California Insurance Commissioner
of such acquisition.
Since Physicians and PRO are domiciled in Ohio, the Ohio Department is the
principal supervisor and regulator of each of these companies. Since Sequoia and
Citation 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 and PRO 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.
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<PAGE> 19
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 practices 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.
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 non-statutory
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, Madison Acceptance Corporation ("MAC"), a
wholly-owned subsidiary of Citation 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 of Insurance completed its latest market conduct
examination of Sequoia and CNIC in 1992 and of Citation in 1993. The California
Department also completed a financial examination of Citation in 1997 covering
the three years ended December 31, 1995. The California Department's final
examination report did not require Citation 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 and PRO for the three-year period
1993-1995. Nothing of significance was reported for any of the companies
examined. The Ohio Department began its regular triennial examination of
Physicians and PRO for the years 1996, 1997 and 1998 in March 1999.
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.
Proposition 103, a ballot initiative passed by California voters on November
8, 1988, 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, Citation, 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
19
<PAGE> 20
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 of corrective
action, the regulator is required to perform such examination or analysis the
Superintendent of Insurance considers necessary and the regulator must 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, 1998 exceed the requirements of the Company Action
Level except for Physicians which was at the Regulatory Action Level. Physicians
has been in communication with the Ohio Department of Insurance and will submit
a plan of corrective action within the prescribed period. The Ohio Department
may require additional action to be taken based upon its ongoing regular
triennial examination of Physicians that began March 15, 1999. The decline in
Physicians' Risk-Based Capital level in 1998 was primarily due to the decline in
the year-end market value of PICO common stock.
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 40,708 square feet in
Pickerington, Ohio. Sequoia leases office space for its and Citation's
headquarters in Monterey, California and for 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 and
Summit share office space with PICO in La Jolla, California. NLRC leases office
space in Carson City, Nevada. Vidler and NLRC hold significant investments in
land, water and mineral rights in the western United States. F&WUSA leases
office space in New York City, New York. See "ITEM 1-BUSINESS-INTRODUCTION."
ITEM 3. LEGAL PROCEEDINGS
Members of the Company's Insurance Group 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 potential material pending legal proceedings
other than the following:
On January 10, 1997, GEC commenced an action in British Columbia against MKG
Enterprises Corp. ("MKG"), Vignoble Wines Agency Inc. ("Vignoble") to enforce
repayment of a loan made by GEC to MKG. On the same day, the Supreme Court of
British Columbia granted an order preventing MKG from disposing of certain
assets pending resolution of the action. GEC subsequently brought a motion to
have a receiver-manager appointed for MKG and Vignoble, which motion has been
adjourned. In addition, in March 1999 GEC filed an action in the Supreme Court
of British Columbia against a third party. This action states the third party
had fraudulently entered into loan agreements with MKG. Accordingly, under this
action GEC is claiming damages from the third party and restraining the third
party from further action.
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 was to receive from
NLRC a consulting fee. Either party could terminate this consulting agreement in
April 2002 if by that time, the partnership had not received or become entitled
to receive any amount of the consulting fee. 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.
In November 1998, the partnership sued NLRC for wrongful termination of the
consulting contract. On March 12, 1999, NLRC filed a cross-complaint against the
partnership for breach of written contract, breach of fiduciary duty and seeking
declaratory relief. Management does not believe this litigation will have a
material impact on the Company's financial condition, results of operations or
cash flows.
SEE NOTE 16 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "COMMITMENTS AND
CONTINGENCIES."
20
<PAGE> 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 20, 1998, the Company's shareholders voted to approve the
PICO/GEC combination at the Company's annual meeting of shareholders. The vote
on this matter was 20,021,931 shares in favor and 69,811 shares opposed.
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. The following table sets forth the high and low sale prices as
reported on the Nasdaq National Market. These reported prices reflect
inter-dealer prices without adjustments for retail markups, markdowns or
commissions.
<TABLE>
<CAPTION>
1997 1998
--------------------- ---------------------
High Low High Low
-------- -------- -------- --------
<S> <C> <C> <C> <C>
1st Quarter $23.75 $18.125 $ 35.31 $ 28.44
2nd Quarter $23.125 $18.4375 $ 30.00 $ 20.00
3rd Quarter $31.875 $21.875 $ 21.88 $ 11.56
4th Quarter $32.1875 $29.375 $ 18.75 $ 12.75
</TABLE>
NOTE: AMOUNTS HAVE BEEN ADJUSTED TO REFLECT THE 1-FOR-5 REVERSE STOCK SPLIT
EFFECTIVE DECEMBER 16, 1998.
As of December 31, 1998, the closing sale price of PICO's common stock was
$13.25 and there were 1,492 holders of record.
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.
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<PAGE> 22
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/A and the consolidated financial
statements and the related notes thereto included elsewhere in this document.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------
1998(1) 1997(1) 1996(1) 1995(1) 1994(1)
----------- ----------- ----------- ----------- -----------
(In thousands, except share data)
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS
Revenues
Premium income earned $ 36,131 $ 49,876 $ 38,761 $ 19,542 $ 20,026
Net investment income 9,432 13,520 8,086 9,165 12,452
Other income 1,845 26,623 29,889 12,482 1,596
----------- ----------- ----------- ----------- -----------
Total revenues $ 47,408 $ 90,019 $ 76,736 $ 41,189 $ 34,074
=========== =========== =========== =========== ===========
Income (loss) from continuing operations before
cumulative effect of changes in accounting
principle $ (9,319) $ 19,156 $ 20,404 $ 15,063 $ 16,412
Income from discontinued operations, net 1,075 456 3,301 778 2,483
Cumulative effect of change in accounting principle (4,110)
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (8,244) $ 19,612 $ 23,705 $ 15,841 $ 14,785
=========== =========== =========== =========== ===========
PER COMMON SHARE RESULTS--BASIC:
Income (loss) from continuing operations $ (1.56) $ 3.04 $ 3.69 $ 2.75 $ 2.99
Income from discontinued operations 0.18 0.07 0.59 0.14 0.45
Loss from cumulative effect of change in
accounting principle (0.75)
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (1.38) $ 3.11 $ 4.28 $ 2.89 $ 2.69
=========== =========== =========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 5,981,814 6,302,401 5,538,199 5,487,238 5,487,238
=========== =========== =========== =========== ===========
PER COMMON SHARE RESULTS--DILUTED:
Income (loss) from continuing operations $ (1.56) $ 2.93 $ 3.55 $ 2.75 $ 2.98
Income from discontinued operations 0.18 0.07 0.57 0.14 0.45
Loss from cumulative effect of change in
accounting principle (0.75)
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (1.38) $ 3.00 $ 4.12 $ 2.89 $ 2.68
=========== =========== =========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 5,981,814 6,540,264 5,748,414 5,487,238 5,517,733
=========== =========== =========== =========== ===========
</TABLE>
(1) As restated; see Note 22 of Notes to Consolidated Financial Statements.
Note: Prior year share values have been adjusted to reflect the 1-for-5
Reverse Stock Split effective December 16, 1998 and the November 20,
1996 reverse acquisition between Physicians Insurance Company of Ohio
and Citation Insurance Group. Additionally, prior year operating results
have also been adjusted to reflect the treatment of APL as a
discontinued operation.
For the year ended December 31, 1994, Physicians recorded the cumulative
effect of a change in accounting principle related to the discount rate
associated with loss and loss adjustment expense. The change was applied
retroactively to 1993.
As of August 19, 1997 the Company consolidated GEC. Prior to this
treatment, GEC was accounted for using the equity method. SEE NOTE 2 OF
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "SIGNIFICANT ACQUISITIONS"
FOR ADDITIONAL DISCUSSION.
<TABLE>
<CAPTION>
Years Ended December 31
--------------------------------------------------------
1998(1) 1997(1) 1996(1) 1995(1) 1994(1)
-------- -------- -------- -------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
FINANCIAL CONDITION
Assets $395,176 $430,491 $489,392 $399,292 $297,704
Unpaid losses and loss adjustment expenses,
net of discount $155,021 $196,096 $252,024 $229,797 $180,691
Total liabilities and minority interest $221,746 $318,142 $380,496 $338,517 $261,603
Shareholders' equity $173,430 $112,348 $108,896 $ 60,775 $ 36,101
Book value per share $ 19.38 $ 18.66 $ 17.83 $ 11.65 $ 6.79
</TABLE>
(1) As restated; see Note 22 of Notes to Consolidated Financial Statements.
Note: Prior year book value per share values have been adjusted to reflect the
1-for-5 Reverse Stock Split effective December 16, 1998 and the November 20,
1996 reverse acquisition between Physicians Insurance Company of Ohio and
Citation Insurance Group. Book
22
<PAGE> 23
value per share is computed by dividing shareholders' equity by the net of total
shares issued less shares held as treasury shares.
SEE NOTE 2 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "SIGNIFICANT
ACQUISITIONS" FOR ADDITIONAL DISCUSSION.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
COMPANY SUMMARY AND RECENT DEVELOPMENTS
INTRODUCTION
The PICO Holdings, Inc. and subsidiaries group of today has very little in
common with its predecessor, Citation Insurance Group and subsidiaries.
Consequently, these financial statements differ greatly from those presented for
periods prior to November 20, 1996, the date of the reverse acquisition between
Physicians Insurance Company of Ohio and a subsidiary of Citation Insurance
Group in which Physicians Insurance Company of Ohio was the surviving
corporation.
In response to a review by the staff of the Securities and Exchange
Commission in connection with the Company's Form S-3 registration statement, the
Company has restated previously issued financial statements to (1) reflect the
adoption of equity accounting for PICO's investment in Hyperfeed Technologies,
Inc. ("Hyperfeed"), (2) value Hyperfeed common stock warrants at estimated fair
value and (3) record the carrying value of Hyperfeed common stock warrants
received as consideration of extending the due date on outstanding loans as
interest income during 1997. The previous financial statements presented the
investment in Hyperfeed common stock at market value and the preferred stock and
warrants at cost. The financial statements have also been restated to reverse
previously recorded investment revenue, related to real estate development
projects to the appropriate prior periods. Consequently, the Company's 1998,
1997 and 1996 consolidated financial statements have been restated from amounts
previously reported. The effects of the restatement have been presented in Note
22 of Notes to the Consolidated Financial Statements and have been reflected
herein.
RECENT DEVELOPMENTS AND FUTURE OUTLOOK
ACQUISITION OF REMAINING GEC SHARES
Effective December 16, 1998, PICO Holdings, Inc. acquired the remaining
outstanding shares of Global Equity Corporation through the PICO/GEC Combination
approved by the shareholders of both corporations at shareholders' meetings held
on November 20, 1998. Prior to the consummation of the PICO/GEC Combination,
PICO and its subsidiaries owned approximately 51.2% of GEC. Under the terms of
the PICO/GEC Combination, GEC shareholders received .4628 of a PICO common share
for each GEC common share. Immediately thereafter, PICO effected a 1-for-5
Reverse Stock Split. The PICO/GEC Combination and Reverse Stock Split are
expected to benefit shareholders from a number of perspectives, including, among
other things:
- simplification of PICO's corporate structure and elimination of
cross-ownership of investments between companies;
- elimination of public confusion, costs and duplication of efforts
inherent in maintaining two public entities with similar business
strategies, management and investment philosophies;
- providing a single publicly traded corporation with a distinct value
investment philosophy;
- resulting in a larger, more liquid publicly traded corporation which is
expected to bring about increased analyst coverage; an increased ability
to utilize PICO shares as a currency for future transactions and
acquisitions; an increased ability for the combined company to access
capital markets; and increased liquidity of PICO shares through an
increase in the public float; and
- increased book value per share.
INVESTMENT IN HYPERFEED
During 1998, PICO converted its Hyperfeed debt and accrued interest
outstanding into convertible voting preferred stock and common stock warrants.
The average cost of our investment, including the cost to exercise our warrants,
is approximately $1.52 per share and at December 31, 1998, the carrying value of
our common and preferred stock investment in Hyperfeed is approximately $4.9
million. The fair value of our Hyperfeed warrants at December 31, 1998 is $6.1
million.
23
<PAGE> 24
DEVELOPMENT OF SURFACE WATER AND MINERAL RIGHTS
Vidler Water Company provides long-term reliable water supplies in the
western United States. The company acquires, manages, develops and reallocates
water rights and related storage and distribution assets for municipal
authorities and private industry. Vidler intends to establish a long-term income
stream through the sale or lease of water rights and underground storage
facilities to public and private end users.
The most significant of Vidler's assets is its Arizona underground water
storage facility located in the Harquahala Valley. The business plan is to build
facilities capable of recharging and storing surplus water in a large aquifer
underlying much of the valley. Harquahala Valley is located approximately 75
miles west of the Phoenix metropolitan area and is approximately 300 square
miles in size. When water is stored in the aquifer, it remains in place until
needed, and can be recovered by groundwater wells.
Vidler began aggregating parcels of land necessary for the underground water
storage operation in late 1996. The aggregated lands are located around the
Central Arizona Project, the aqueduct that delivers 1,500,000 acre-feet of water
per year from the Colorado River to Phoenix and Tucson. This proximity to the
Central Arizona Project is a competitive advantage, as it minimizes the costs of
water conveyance facilities. Vidler estimates its recharge and storage facility
will cost approximately $10 million to build.
Vidler intends to charge fees at the time the water is recharged and also
when it is recovered. Additionally, Vidler intends to charge an annual fee on
the cumulative amount of water stored, but not yet recovered. Potential users of
the facility would include: local governments within Arizona, the Las Vegas
Metropolitan area and California, as well as the Bureau of Reclamation.
The facility itself is being constructed in two phases: a pilot facility and
a large-scale facility. The pilot facility is complete and was constructed to
obtain cost/benefit information regarding three recharge methods and to obtain
general hydrogeologic data necessary to submit a permit for the full-scale
facility. The full-scale facility will be for commercial use. In 1997, Vidler
and its consultants began the process of assembling data for submittal to the
Arizona Department of Water Resources to obtain a pilot permit. The pilot permit
was obtained in July 1998. Construction of the pilot facility was completed in
October 1998 and the recharge of water was begun at that time. One test was
conducted at the pilot facility during the late fall of 1998 to determine the
most cost efficient method to recharge water and to collect general data
regarding the hydrogeology of the site. Information from this test was compiled
and submitted in November 1999 to the Arizona Department of Water Resources as
part of Vidler Water Company's full-scale permit process. A second test was
conducted during the fall of 1999 to obtain additional information regarding the
subsurface movement of recharged water.
The permit for the full-scale facility was submitted in November 1999 and
when approved would give Vidler the right to recharge and store 100,000
acre-feet of water per year. Vidler anticipates receiving approval on its
full-scale permit from the Arizona Department of Water Resources during the
second quarter of 2000. Following receipt of the permit, construction of the
full-scale facility will begin. Construction is expected to take approximately 6
months.
To this point, only the pilot facility has been permitted and constructed,
and therefore Vidler has not attempted to store water at commercial levels.
Once permitted and constructed, Vidler's full-scale recharge facility is
anticipated to have the capacity to recharge 100,000 acre-feet per year and
store in excess of 1 million acre-feet of water in the aquifer underlying
Harquahala Valley
Vidler estimated the aquifer's storage volume primarily from a
hydrogeological report prepared in 1990 for the Central Arizona Water
Conservation District by an independant engineering firm . The report concludes
that there is storage capacity of 3.7 million acre-feet which is in excess of
the 1 million acre-feet indicated by Vidler.
Vidler will have the right to recover the quantity of water it recharged to
the subsurface under both the pilot permit and the submitted full-scale permit.
Having water already stored in the aquifer makes recovery of water easier.
Vidler is not required to recover the same molecules of water that it stored,
only the same quantity of water molecules whether or not they were stored in the
aquifer by Vidler.
Recharge/recovery capacity is significant because it indicates how fast
water can be stored underground or pumped from the underground. In wet years, it
is important to have a high recharge capacity so that as much available water as
possible may be stored. In dry years, the critical factor is the ability to
recover water as quickly as possible.
24
<PAGE> 25
NLRC is the largest private landowner in the state of Nevada. NLRC's
principal asset consists of approximately 1.3 million acres of deeded land
located in northern Nevada, together with appurtenant water and mineral rights.
NLRC is actively engaged in attempting to maximize the property's value in
relation to water rights, mineral rights and land development. PICO acquired
NLRC for $39 per acre. Through December 31, 1998, a total of 19,528 acres have
been sold, or are in escrow, for an average price per acre of $161. The lowest
price per acre received for land where the highest and best use is for grazing
was $62. NLRC completed one land exchange of 1,900 acres valued at $224 per acre
in which NLRC's wilderness property was exchanged for residential property. In
December 1998, NLRC sold 4,777 acres of undeveloped and remote land in Desert
Valley, near Winnemucca, Nevada for $1.3 million, or approximately $272 per
acre.
INVESTMENT IN JUNGFRAUBAHN HOLDING A.G.
During 1997, 1998 and early 1999, the Company acquired an approximate 18%
shareholding in Jungfraubahn Holding AG ("Jungfraubahn") based in Interlaken,
Switzerland. The average cost of the investment is 216.48 Swiss francs ($153.75)
per share. Jungfraubahn shares have a book value in excess of 430 Swiss francs
per share and the Company's purchase is at the multiple of 4.5 times 1997's cash
flow. Jungfraubahn is in the transportation, tourism and recreational sectors.
INVESTMENT IN AUSTRALIAN OIL AND GAS CORPORATION LTD.
During 1998 and the first quarter of 1999, the Company acquired stock in
Australian Oil and Gas Corporation Ltd. ("AOG"), whose shares are traded on the
Australian Stock Exchange. As of March 1999, the Company has acquired
approximately 14.9% of the outstanding shares of AOG for approximately $7.1
million. Our average purchase price per share is at a multiple of 3.8 times
AOG's fiscal 1998 operating cash flow per share.
AOG is an onshore drilling contractor, drilling for oil, gas, geothermal
energy and coal seam methane in Australia and overseas. AOG has a fleet of
approximately 29 rigs in 7 countries but has no North American presence. AOG
recorded a return on shareholders' equity of 10.7% for the year ended June 30,
1998. AOG's interim results at December 31, 1998 displayed an increase in net
income by 72% over the corresponding period.
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 prior to 1996. There can be no assurance that sufficient
opportunities will be found or that this business strategy will be successful.
This strategy may negatively impact the business and financial condition and
results of the Company.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
SUMMARY
PICO reported a net loss of $8.2 million, or $1.38 per share, for 1998
compared with net income of $19.6 million, or $3.11 per share, during 1997 and
$23.7 million, or $4.28 per share, in 1996. Per share amounts are expressed as
basic income or loss per share.
Shareholders' equity at December 31, 1998 was $173.4 million, representing an
increase of $61.1 million over December 31, 1997. Book value per share
calculated on an undiluted basis, net of treasury shares, increased to $19.38 at
year end 1998, compared to $18.66 at December 31, 1997. The increase in book
value per share during 1998 resulted primarily from the PICO/GEC Combination and
the purchase of 412,846 PICO treasury shares during the 1998 third quarter at an
average cost of $0.78 per share. On December 31, 1998 options representing
57,307 of the shares were exercised. The remaining shares are held in treasury
subject to option agreements. SEE NOTE 17 OF NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, "OTHER RELATED PARTY TRANSACTIONS."
25
<PAGE> 26
Income from discontinued operations included in net income for 1998, 1997 and
1996, was $1.1 million, $0.5 million and $3.3 million, respectively. Income from
discontinued operations in 1998 includes a $1.1 million gain from the sale of
APL, the Company's former life and health insurance subsidiary, on December 4,
1998. Discontinued operations include the results of APL as well as Global
Equity Corporation's ("GEC") discontinued Sri Lankan operations. SEE NOTE 6 OF
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "DISCONTINUED OPERATIONS," for
additional information.
The 1998 net loss included a $12.6 million loss from continuing operations
and $1.3 million in income tax expense, partially offset by minority interest of
$4.5 million and income from discontinued operations of $1.1 million. Compared
to 1998's $12.6 million loss from continuing operations before income taxes and
minority interest, 1997 and 1996 produced income of $23.8 million and $33.1
million, respectively. Of these amounts, net realized gains on investments
accounted for $21.4 million and $27.1 million in 1997 and 1996, respectively.
This compares to net realized investment losses in 1998 of $4.4 million.
Significant contributors to the Company's $12.6 million loss from continuing
operations before taxes and minority interest included:
- - A $5 million strengthening of Physicians' insurance reserves based upon
year-end actuarial studies;
This one-time addition to loss and loss adjustment expense reserves was
required as a result of individuals being able to file claims for
alleged injury occurring during childbirth or infancy. Prior to
attainment of age 18, these individuals were unable to file medical
professional liability claims on their own behalf. The statute of
limitations limits the time period for making such claims to one to two
years from age 18, depending upon the type of claim. Because Physicians
did not begin to write significant medical professional liability
insurance until the late 1970's, this phenomenon did not materialize in
past claims experience. This addition to reserves, based upon actuarial
projections by year, strengthens virtually all years that Physicians
insured medical professionals.
- - Permanent write-downs of two of GEC's investments by $5.9 million:
1) A write-off of $3 million from a convertible note that has fallen
into default. Management became aware in the fourth quarter of
1998 of substantial additional debt incurred and assets pledged
by the borrower in violation of the loan agreement which has
resulted in a dispute over collateral.
2) In exiting the assets in Sri Lanka, GEC received bonds and shares
as partial consideration. Liquidation of these assets resulted in
a loss. Including realized gains in 1997, the sale of Sri Lankan
assets was approximately at cost.
- - Permanent write-down of Physicians' investments by $2.2 million;
A non-strategic equity investment was written down.
- - And a $1.8 million loss attributable to Vidler and NLRC;
Land sales were limited until an overall assessment was completed.
Realized gains on land sales totaled $1.2 million during this period.
The costs incurred by Vidler were principally normal operating costs
with the exception of $800,000 resulting from the attempted initial
public offering and private placement.
- - PICO overhead costs of approximately $2.1 million, net of revenues.
Taken into account in the operating loss were the following positive factors:
- - Approximately $3 million in realized investment gains from the sale of
European equity securities;
- - Property and casualty insurance income of $2.8 million after an estimated $1
million in increased costs due to the effects of the 1997-98 El Nino
phenomenon;
- - An $800,000 realized gain from the sale of Physicians' home office building.
26
<PAGE> 27
Income or loss before taxes for the three years ended December 31, 1998
included results from PICO's equity ownership of its unconsolidated
subsidiaries. PICO's share of the results of the combined investments were
losses of $1.5 million and $1.6 million in 1998 and 1997, respectively, and
$11,000 of income during 1996. Approximately, $751,000, $1.6 million and $1
million in 1998, 1997 and 1996, respectively relate to PICO's share of the
losses of Hyperfeed. Included in the total is the before tax effect of PICO's
share of Hyperfeed losses, the amortization of goodwill and dilution gains.
Dilution gains were $404,000, $997,000 and $50,000 for 1998, 1997 and 1996,
respectively (See Note 22, of Notes to the Consolidated Financial Statements,
"Restatement of Previously Reported Financial Information"). These dilution
gains principally resulted from Hyperfeed selling its common stock to third
parties. Specifically, the $997,000 dilution gain in 1997 resulted from
Hyperfeed issuing five million shares of Hyperfeed common stock to a third party
at $1 per share plus 500,000 common stock warrants. At that time, PICO's equity
in Hyperfeed common stock was approximately $0.25 per share. PICO owned
approximately 27.8% of Hyperfeed voting stock before the transaction and 16.6%
following. In the event that Hyperfeed records any capital transactions in the
future, PICO could realize additional dilution gains or losses.
Income tax provisions decreased 1998 net income by $1.3 million compared to
$7.8 million in 1997 and $12.7 million in 1996. Although the Company recorded a
pre-tax loss in 1998, it was unable to utilize the operating losses generated by
GEC in 1998 to reduce income taxes. GEC does not have sufficient prior years
taxable income to enable GEC to carry back the current year's tax loss to reduce
taxes. In addition, it is uncertain that GEC will be able to generate sufficient
Canadian taxable income in the future to offset the current year losses. Changes
in estimates of prior deferred tax assets previously recorded by GEC primarily
resulted in 1998 income tax expense of $1.6 million.
Revenues for 1998 were $47.4 million, compared to $90.0 million in 1997 and
$76.7 million in 1996. Excluding realized investment gains and losses, revenues
declined $16.8 million from 1997 and increased $2.2 million over 1996. A $13.7
million, or 27.6%, decline in P&C insurance earned premiums was primarily
responsible for the decline from 1997. Premium income for 1998 of $36.1 million
was $2.6 million, or 6.8%, less than in 1996, which included less than two
months of Citation's premium income. Property and casualty insurance premium
writings declined in 1998 primarily due to more stringent underwriting of CIC's
P&C insurance business since its change in ownership, as well as continued
aggressive competition for commercial multiple peril insurance business within
California. SEE NOTE 1 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "NATURE OF
OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES."
Total expenses for 1998 were $58.4 million compared to $64.7 million in 1997
and $43.6 million in 1996. Included in the 1998 total were loss and loss
adjustment expenses of $30.5 million, compared to $34.3 million during the same
1997 period, and $22.9 million during 1996. Insurance underwriting and other
expenses were $16 million, $18.2 million and $18.8 million for 1998, 1997 and
1996, respectively. These 1998 improvements over 1997 principally resulted from
reduced P&C premiums and reduced claims exposure brought about by increased
selectivity at CIC and increased competition.
Total assets at December 31, 1998 were $395.2 million. This compares to
$430.5 million at the end of 1997. Most of the 1998 decline resulted from the
payment of insurance claims by Physicians and was reflected in investments and
cash and cash equivalent balances which decreased by approximately $29.1 million
from 1997. Surface, water and mineral rights increased $41.5 million as a result
of the Combination with GEC and further acquisitions. Net assets of discontinued
operations declined from $15.9 million at December 31, 1997 to zero as a result
of the sale of APL. Total liabilities declined $28.2 million between years with
year end 1998 loss and loss adjustment expense reserves dropping by more than
$41.1 million, principally as a result of payment of insurance claims.
Shares outstanding and per share calculations for prior years have been
adjusted to reflect the December 16, 1998 1-for-5 Reverse Stock Split following
the PICO/GEC Combination. Prior year amounts also reflect the November 20, 1996
Merger between Physicians and the Citation Insurance Group.
In 1998, PICO recorded a comprehensive loss of $11.2 million. The 1998
comprehensive loss included the $8.2 million net loss, as discussed above, and a
$3 million decrease due to foreign currency translation. Included in 1998
comprehensive loss was an offsetting unrealized gain of $2 million from the
increase in value of Hyperfeed warrants over their 1997 year end value. Overall,
however, unrealized appreciation of investments was offset by unrealized
depreciation of other securities. The 1998 comprehensive loss of $11.2 million
compares to $4.3 million of income in 1997, which included $19.6 million in net
income (including $21.4 million in realized investment gains, before tax), a
$13.1 million loss from net unrealized depreciation of investments and a loss in
accumulated foreign currency reserve of $2.2 million. The primary reason for the
$13.1 million overall depreciation of investments was the sale of PICO's
investment in Resource America, Inc. in 1997 at a gain of approximately $18
million, after tax. Hyperfeed warrants declined in value from
27
<PAGE> 28
year end 1996 to year end 1997, contributing $625,000 in depreciation to 1997.
Comprehensive income for 1996 was $29.6 million, which included $23.7 million in
net income (principally due to realized gains from the sale of PICO's investment
in Fairfield Communities, Inc.) and $5.9 million of unrealized appreciation of
investments (principally Resource America, Inc.).
The Company's ongoing operations are organized into five segments: INVESTMENT
OPERATIONS; SURFACE, WATER, AND MINERAL RIGHTS; PROPERTY AND CASUALTY INSURANCE;
MEDICAL PROFESSIONAL LIABILITY INSURANCE and OTHER OPERATIONS. 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,
-------------------------------
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
Investment Operations $ (1.8) $ 25.9 $ 27.0
Surface, Water and Mineral Rights 3.4 3.1
Property and Casualty Insurance 42.9 57.0 35.3
Medical Professional Liability Insurance 2.4 3.9 12.2
Other Operations 0.5 0.1 2.2
------ ------ ------
Total Revenues-Continuing Operations $ 47.4 $ 90.0 $ 76.7
====== ====== ======
</TABLE>
Income (Loss) Before Taxes and Minority Interest--Continuing Operations:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
Investment Operations $ (8.8) $ 18.1 $ 22.3
Surface, Water and Mineral Rights (1.8)
Property and Casualty Insurance 2.8 5.6 3.3
Medical Professional Liability Insurance (4.4) 0.8 8.5
Other Operations (0.4) (0.7) (1.0)
------ ------ ------
Income (Loss) Before Tax and Minority Interest $(12.6) $ 23.8 $ 33.1
====== ====== ======
</TABLE>
INVESTMENT OPERATIONS
INVESTMENT OPERATIONS include strategic and passive investment operations
conducted primarily by PICO, Physicians, GEC and Physicians Investment Company.
However, not all investment activities are included within the INVESTMENT
OPERATIONS business segment. For example, investment revenues and investment
income generated by Physicians are first allocated to the MEDICAL PROFESSIONAL
LIABILITY INSURANCE segment based upon the amount of invested assets to support
Physicians' outstanding insurance reserves. The remainder is classified as part
of the INVESTMENT OPERATIONS business segment. (See the MEDICAL PROFESSIONAL
LIABILITY INSURANCE segment below.) In addition, investment revenues and
investment income generated by Sequoia and CIC are included in the PROPERTY AND
CASUALTY INSURANCE business segment and those from PRO, in the MEDICAL
PROFESSIONAL LIABILITY INSURANCE segment, and not in the INVESTMENT OPERATIONS
business segment. SEE NOTE 19 OF NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS,
"SEGMENT REPORTING."
INVESTMENT OPERATIONS revenues for 1998 were negative at $1.8 million
representing a decrease of $27.7 million compared to $25.9 million in revenue
recorded in 1997 and a decrease of $28.8 million compared to $27 million in
revenues in 1996. Realized investment gains and losses accounted for nearly all
of these decreases compared to prior years. Excluding realized investment gains,
INVESTMENT OPERATIONS revenues decreased approximately $2 million from 1997 and
increased $2 million as compared to 1996. Revenues from INVESTMENT OPERATIONS
are summarized below:
28
<PAGE> 29
INVESTMENT OPERATIONS REVENUES
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
Investment Operations Revenues (Charges):
Realized Investment Gain (Loss) $ (4.4) $ 21.3 $ 26.4
Investment Income 2.1 2.3 0.6
Other Income 0.5 2.3
------ ------ ------
Investment Operations Revenues (Charges) $ (1.8) $ 25.9 $ 27.0
====== ====== ======
</TABLE>
Included in 1998 INVESTMENT OPERATIONS revenues were approximately $8.2
million in write downs of equity investments, partially offset by realized
investment gains from the sale of equity securities. Included in the $21.3
million in 1997 realized investment gains was approximately $27 million before
taxes, resulting from the exercise of the Company's warrants to buy common stock
of Resource America Inc. and the subsequent sale of that stock. Realized
investment gains in 1996, principally from the sale of Physicians' holdings in
Fairfield Communities common stock amounted to $26.4 million. Resource America
Inc. and Fairfield Communities Inc. were two of the Company's original "value
investments" acquired in 1994 and 1995.
Investment income from the INVESTMENT OPERATIONS segment in 1998 was
approximately $200,000 less than 1997 and $1.5 million greater than 1996. The
decrease from 1997 is due to reduced levels of interest and dividend paying
securities and the reduction in the size of Physicians' portfolio due to the
payment of MPL claims.
Other income in 1997 included $1.8 million in interest income based upon the
value of common stock warrants granted to PICO in 1997 by Hyperfeed as
consideration for extension of loan due dates.
At December 31, 1998, the consolidated investment portfolio was in a net
unrealized loss position of approximately $2.5 million, net of taxes compared to
$2.6 million in unrealized losses at December 31, 1997.
Net of expenses, but before taxes, INVESTMENT OPERATIONS increased 1998
pre-tax operating loss by $8.8 million as compared to income of $18.1 million in
1997 and $22.3 million in 1996. Realized investment losses, as discussed
previously and shown in the previous table, accounted for nearly $4.4 million of
the 1998 amount and realized investment gains of $21.3 million and $26.4 million
were included in 1997 and 1996, respectively. As shown in the table below, the
Company's INVESTMENT OPERATIONS income can fluctuate greatly from year to year.
A number of factors contribute to these fluctuations, including, among other
things, the mix of the Company's portfolio, timing of the Company's realization
of capital gains, the volume of trading and demand for individual securities the
Company owns and fluctuations in the U.S. and world stock and bond markets in
general. Therefore, future results cannot and should not be predicted based upon
past performance alone. See "RISK FACTORS."
The breakdown of operating income before tax from INVESTMENT OPERATIONS is as
follows:
INVESTMENT OPERATIONS INCOME BEFORE TAX
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
Investing Income (Loss) Before Tax:
PICO, GEC and Physicians $ (7.3) $ 19.7 $ 22.3
Income (loss) in Investee (1.5) (1.6)
------ ------ ------
Investing Income (Loss) Before Tax $ (8.8) $ 18.1 $ 22.3
====== ====== ======
</TABLE>
Equity in unconsolidated investee includes the Company's share of its
investment in GEC's net income in 1996 prior to its consolidation with PICO in
addition to the results from its investment in Hyperfeed for all years
presented. GEC's financial results were first consolidated with those of the
Company in 1997. In 1998 the loss is comprised of the results from Hyperfeed and
Conex.
29
<PAGE> 30
SURFACE, WATER, 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 has purchased or leased water rights and related
assets in Colorado, Nevada, Arizona and California. Vidler controls water rights
in Nevada, Arizona and Colorado. In Nevada and Arizona, Vidler controls 12,000
acre feet and approximately 41,000 acre feet, respectively. There are no known
legal impediments for the sale of these water rights. In addition, there are no
known legal impediments pertaining to the conveyance of the Nevada water.
Conveyance of the Arizona water underlying Vidler's Arizona water rights is
subject to additional regulatory approval. Vidlers' Colorado water rights amount
to approximately 3,000 acre feet and certain of these may be subject to
regulatory approval in the State Water Courts for the sale and transfer of these
rights.
On April 23, 1997, GEC acquired a 74.77% membership interest in NLRC and
PICO acquired the remaining 25.23% interest. NLRC owns approximately 1.3 million
acres of deeded land located in northern Nevada, together with appurtenant
surface, water and mineral rights. NLRC is actively engaged in activities it
believes will maximize the property's value in relation to water rights, mineral
rights and land development.
As these subsidiaries of the Company were not part of the consolidated group
until 1997, results prior to 1997 are not included with those of the Company.
Following is a breakdown of revenues and pre-tax losses before minority interest
from SURFACE, WATER, AND MINERAL RIGHTS operations for the periods shown:
SURFACE, WATER, AND MINERAL RIGHTS
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997
-------- --------
(in millions)
<S> <C> <C>
Revenues - Surface, Water and Mineral Rights:
Sale of Surface, Water, Mineral Rights - Vidler $ 0.2
Operating Revenues - Vidler 0.4 $ 0.3
Sale of Surface, Water, Mineral Rights - NLRC 2.0 1.5
Operating Revenues - NLRC 0.8 1.3
------ ------
Segment Total Revenues $ 3.4 $ 3.1
====== ======
Income (Loss) Before Tax and Minority Interest:
Vidler Water Company, Inc. $ (2.0) $ (0.6)
Nevada Land and Resources Company LLC 0.2 0.6
------ ------
Loss Before Tax and Minority Interest $ (1.8) $ --
====== ======
</TABLE>
A portion of the lease revenue Vidler receives is from leases under a
perpetual agreement. Payments for these leases are indexed to the consumer price
index ("CPI"), with a 3% minimum increase per year. Currently, approximately 35%
of Vidler's total revenue is subject to this type of lease. Once water rights or
assets are leased in perpetuity, they cannot be leased again unless the lease is
cancelled, if cancelable. Consequently, future revenue growth beyond the limits
of these CPI escalators is dependent upon growth in leases not subject to
perpetual agreements, development of existing assets, and acquisition of
additional water rights and water related assets for subsequent lease or sale.
The sale of water rights or assets reduces future revenue streams from water
rights and assets until those assets can be replaced.
As shown above, revenues from SURFACE, WATER, AND MINERAL RIGHTS generated by
Vidler and NLRC were approximately $3.4 million and $3.1 million during 1998 and
1997, respectively. Sales of surface, water and mineral rights accounted for
$2.2 million in revenue in 1998 and $1.5 million in 1997. Operating revenues
made up the remainder of the total. Other revenues include land leases,
principally for grazing, agricultural, communications and easement purposes,
water sales and leasing and other income. Operating and
30
<PAGE> 31
overhead expenses exceeded revenues for 1998 producing a loss before taxes and
minority interests of $1.8 million compared to income of $12,000 for 1997.
In November 1998, Vidler reached an agreement with the Semitropic Water
Storage District to acquire 185,000 acre-feet of underground water storage and
associated rights to recharge and recover water at the District, located near
the California Aqueduct northwest of Bakersfield, California. The strategic
location of the District relative to other water delivery systems and storage
facilities will enable Vidler to complete exchanges and water transfers in
California. The acquisition also complements Vidler's underground water storage
facility located adjacent to the Central Arizona Project in Arizona. The
agreement with Semitropic is an operating lease for $2.3 million per year over
ten years and allows Vidler to use the asset for thirty five years. Revenue will
be generated from the asset through the recharge, storage, and recovery of
water.
NLRC holds title to 1.3 million acres located in northern Nevada, at an
average cost of $39 per acre, and is the largest private landowner in the state.
NLRC anticipates that revenues will be generated from the asset by land sales,
exchanges and development and exploitation of mineral and water rights. During
1997 and 1998, NLRC completed, or has in escrow, sales of 19,528 acres of land
with an average price of $161 per acre. As NLRC progresses with its land
assessment and is able to further prioritize properties, NLRC anticipates
increasing its land available for sale, exchange, or development.
NLRC's mineral exploitation strategy is to identify potential gold
discoveries (or other high unit resources), develop them to the point where a
meaningful data set can be established and then vend the properties to advanced
stage exploration or production companies. To date, exploration work continues
to advance over a dozen areas that have been identified as containing anomalous
gold values. Several companies have expressed an interest in receiving data
packages from NLRC for the purpose of analyzing potential mineral exploration
opportunities. In addition, Santa Fe Pacific Gold Corporation has leased 4,320
acres from NLRC, which includes a 3.5% net smelter royalty on production.
PROPERTY AND CASUALTY INSURANCE
Sequoia and Citation account for all of the ongoing revenues of the PROPERTY
AND CASUALTY ("P&C") INSURANCE business segment. These companies write
predominately light commercial and multiple peril insurance coverage in central
and northern California and Nevada. Sequoia and Citation are continually seeking
ways to realize savings and take advantage of synergies and to combine
operations, wherever possible. To this end, Sequoia and Citation consolidated
their home office operations in Monterey, California in July 1997. Prior to June
30, 1997, Citation and CNIC wrote workers' compensation insurance policies. CNIC
is no longer a part of the group following its sale on June 30, 1997 along with
Citation's workers compensation business.
Since Citation became part of the group in November 1996, Citation's
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.
As shown below, earned premiums made up most of the PROPERTY AND CASUALTY
INSURANCE segment revenues. Premiums are earned pro-rata throughout the year
according to the coverage dates of the underlying policies.
31
<PAGE> 32
PROPERTY AND CASUALTY INSURANCE
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
P&C Insurance Revenues:
Earned Premiums - Sequoia $ 18.1 $ 32.8 $ 26.3
Earned Premiums - Citation 18.1 17.4 5.1
Investment Income 5.5 5.6 2.6
Realized Investment Gains 0.2 0.2 0.7
Other 1.0 1.0 0.6
------ ------ ------
Total P&C Revenues $ 42.9 $ 57.0 $ 35.3
====== ====== ======
P&C Insurance Income (Loss) Before Taxes:
Sequoia Insurance Company $ 3.6 $ 4.3 $ 2.3
Citation Insurance Company (0.8) 1.3 1.0
------ ------ ------
Total P&C Income Before Taxes $ 2.8 $ 5.6 $ 3.3
====== ====== ======
</TABLE>
Total PROPERTY AND CASUALTY INSURANCE revenues for 1998 of $42.9 million
were $14.1 million less than the $57 million recorded in 1997 and $7.6 million
greater than the $35.3 million of 1996, which included less than two months of
Citation's revenues. Declining earned premiums accounted for most of this
decrease between years, principally as a result of continuing increased
underwriting selectivity applied to Citation's business and aggressive
competition for commercial multiple peril business within the state of
California. Total PROPERTY AND CASUALTY INSURANCE earned premiums for 1998 were
$36.2 million compared to $50.2 million in 1997 and $31.4 million in 1996. All
new P&C insurance applications and policies scheduled to renew are now being
processed through Sequoia and subjected to Sequoia's underwriting standards
which are much tighter than those previously employed by Citation. As a result,
a significant portion of Citation's prior book of business has not been renewed.
As previously mentioned, increased competition within the state of California
for commercial insurance has also decreased 1998 earned premiums. Direct premium
writings in 1998 for Sequoia were $40.7 million, down $0.3 million from the
$41.0 million of 1997 and up $3 million from the $37.7 million reported for
1996. Citation wrote $1.9 million in direct premiums in 1998, compared to $14.9
million in 1997 and $57.4 million for the full year of 1996, including the
period prior to the Merger. Citation's 1997 direct written premiums declined
from those of 1996 due to the renewal of qualified policies of Citation into
Sequoia effective March 1, 1997 and the subsequent sale of CNIC and the workers
compensation business on June 30, 1997.
Sequoia's $18.1 million 1998 earned premiums decreased $14.7 million, or
44.8% compared to those of 1997 and $8.2 million, or 31.2% compared to 1996's
$26.3 million. Citation earned $18.1 million in premiums in 1998 compared to
$17.4 million in 1997 and $5.1 million in 1996 ($50.5 million for the full year
1996, including the period prior to the Merger). Much of the decline in
Sequoia's 1998 earned premiums resulted from a reinsurance pooling agreement
effective January 1, 1998 which provides for the pooling of all insurance
premiums, losses, loss adjustment expenses ("LAE") and administrative and other
insurance operating expenses between Sequoia and Citation. The reinsurance
pooling agreement calls for these items to be split equally between the two
companies. However, the decline in Sequoia's earned premiums due to the
reinsurance pooling agreement produced a corresponding increase in Citation's
earned premiums. The decline in Citation's earned premiums from 1996 to 1997
resulted from the reinsurance and sale of Citation's workers' compensation
business and the renewal of qualified policies of Citation into Sequoia
effective March 1, 1997.
Investment income and realized investment gains from PROPERTY AND CASUALTY
INSURANCE operations of $5.7 million in 1998 declined slightly from the $5.8
million recorded during 1997 and exceeded those of 1996 by $2.4 million. The
increase from 1996 to 1997 principally resulted from an increase in Sequoia's
capital.
32
<PAGE> 33
PROPERTY AND CASUALTY INSURANCE operations produced $2.8 million in income
before taxes during 1998, down $2.8 million from the $5.6 million of 1997 and
down $0.5 million from the $3.3 million of 1996. As shown above, $0.7 million of
the decline from 1997 was attributable to Sequoia, principally due to its higher
1998 expense ratio. Citation produced an $0.8 million loss in 1998 compared to
income of $1.3 million, and $1 million in 1997 and 1996, respectively. The
primary reason for the Citation 1998 downturn was poor loss experience,
principally in the artisan-contractors coverage no longer written by Citation.
Consequently, Citation strengthened claims and LAE reserves during 1998 by
approximately $3.7 million. The 1997-98 "El Nino" phenomenon had a significant
impact on the first and second quarter 1998 results. Although difficult to
quantify, Sequoia and Citation management estimate the cost of storm losses
incurred by the companies as a result of the 1998 El Nino phenomenon to be
approximately $1 million. Loss experience improved significantly during the
second half of 1998, however. Due to favorable claims experience based upon year
end actuarial studies, Sequoia reduced loss and LAE reserves by approximately
$2.1 million. In addition to being impacted by El Nino, Sequoia's 1998 loss and
LAE ratio was also negatively affected by the reinsurance pooling agreement
between Sequoia and Citation since Citation's direct business has not been as
profitable as that of Sequoia. Conversely, Citation's incurred losses and LAE
and its loss and LAE ratio benefited from the reinsurance pooling agreement.
Despite the negative pressures of El Nino and the reinsurance pooling agreement
Sequoia's loss and LAE ratio improved five full percentage points over 1997 and
10.6 percentage points over 1996, principally due to improved claims experience
from prior years. Higher expense ratios for both Sequoia and Citation resulted
from the reduced level of premiums, resulting in a higher ratio of overhead
expenses to earned premiums. SEE GAAP INDUSTRY RATIOS BELOW.
Industry ratios as determined on the basis of generally accepted accounting
principles ("GAAP") for Citation are shown in the following chart:
CITATION'S GAAP INDUSTRY RATIOS
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Loss and LAE Ratio 84.9% 84.8%
Underwriting Expense Ratio 41.5% 32.9%
------ ------
Combined Ratio 126.4% 117.7%
====== ======
</TABLE>
Industry ratios as determined on a GAAP basis for Sequoia were:
SEQUOIA'S GAAP INDUSTRY RATIOS
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Loss and LAE Ratio 52.3% 57.3% 62.9%
Underwriting Expense Ratio 43.4% 38.1% 38.0%
------ ------ ------
Combined Ratio 95.7% 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 continued to be favorable in 1998 producing a GAAP
loss and LAE ratio of 52.3% compared to 57.3% in 1997 and 62.9% in 1996. As
previously discussed, Sequoia's loss ratio improved during 1998 even after the
negative pressures of the 1997-98 El Nino effect and the reinsurance pooling
agreement between Sequoia and Citation. Sequoia's 1997 loss and LAE ratio
improved over 1996 principally due to management's efforts to reduce exposure to
risk through re-underwriting existing business during 1995 and 1996, tighter
underwriting and careful selection of risks. Much of Citation's improved loss
and LAE ratio resulted from the reinsurance pooling agreement previously
discussed, producing a corresponding decline in Sequoia's individual company
results.
Although direct written premiums written decreased by 8.7% from 1997 to 1998,
other acquisition expenses increased by 2.4%, or $109,000. This increase in
other acquisition expenses resulted from a 1.5% increase in other expenses of
PICO's commercial property and casualty insurance companies, Sequoia and
Citation. Other expenses are those expenses of the insurance companies other
than premium taxes, commissions, loss adjustment expenses and non-insurance
expenses. These expenses include salaries, benefits and other expenses of sales
and marketing staff. Although the levels of direct written premiums and
insurance underwriting expenses has decreased (principally due to realizations
of synergies and reductions of overhead expenses), the level of sales and
marketing expenses has not decreased correspondingly. As a result, the
percentage of other expenses (principally sales and marketing) has actually
increased,
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<PAGE> 34
resulting in a greater deferral of acquisition expenses as a percentage of
unearned premiums. The impact of this 1.5% increase in the other expense
acquisition percentage was to increase deferred acquisition costs at December
31, 1998 by approximately $279,000. As premiums increase or sales, marketing and
other acquisition expenses decrease, this percentage should decrease to or below
the 1997 level.
MEDICAL PROFESSIONAL LIABILITY INSURANCE
Physicians' and PRO's MPL insurance business was sold to Mutual Assurance
Inc. ("Mutual") on August 28, 1995. All new and renewal MPL insurance policies
written between July 16 and December 31, 1995 were 100% reinsured by Mutual.
Physicians and PRO ceased writing new and renewal MPL insurance policies
effective January 1, 1996. Physicians continues to administer and adjust the
remaining claims and LAE reserves. Based upon careful analysis of various
alternative scenarios for handling the runoff of the remaining claims reserves,
management decided 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
companies effectively ceased writing MPL insurance in 1995, MEDICAL PROFESSIONAL
LIABILITY INSURANCE is treated as a separate business segment of continuing
operations due to the continued management of claims and associated investments.
Physicians' and PRO's assets are not designated on an individual security
basis as belonging either to the MEDICAL PROFESSIONAL LIABILITY INSURANCE or the
INVESTMENT Operations business segment. Consequently, Physicians' invested
assets produce income in both the MEDICAL PROFESSIONAL LIABILITY INSURANCE and
INVESTMENT OPERATIONS segments. All of PRO's revenues and pre-tax income are
assigned to the MEDICAL PROFESSIONAL LIABILITY INSURANCE segment. However, all
investment income and realized investment gains generated by Physicians from
assets in excess of those needed to support the MPL claims are allocated to the
Investment Operations segment. SEE NOTE 19 OF NOTES TO THE CONSOLIDATED
FINANCIAL STATEMENTS, "SEGMENT REPORTING."
Revenues and pre-tax income or loss from MEDICAL PROFESSIONAL LIABILITY
INSURANCE operations included the following:
MEDICAL PROFESSIONAL LIABILITY INSURANCE
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
MPL Revenues:
Earned Premiums $ (0.2) $ 0.2 $ 7.4
Investment Income, Net of Expenses 2.6 3.7 4.8
------ ------ ------
MPL Revenues $ 2.4 $ 3.9 $ 12.2
====== ====== ======
MPL Income (Loss) Before Tax $ (4.4) $ 0.8 $ 8.5
====== ====== ======
</TABLE>
Since the withdrawal of Physicians and PRO from their personal automobile and
homeowners lines of business in the late 1980's, MPL has been these two
companies' only sources of insurance premiums.
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
reinsurance treaty with Mutual. Investment income revenues will continue to
accrue to the MPL runoff.
MPL insurance revenues were $2.4 million in 1998 compared to $3.9 million
during 1997 and $12.2 million during 1996. The decline in MPL earned premiums
accounted for most of the variance as compared to 1996. Declining investment
income was the principal contributor to the difference between 1998 and 1997 MPL
revenues. Investment income continued to decline in 1998 as it had in 1997 and
1996, principally as a result of the reduced level of MPL claims and,
correspondingly, the resultant reduced level of invested assets allocated to the
MEDICAL PROFESSIONAL LIABILITY INSURANCE business segment.
34
<PAGE> 35
MPL operations produced a 1998 pre-tax loss of approximately $4.4 million
compared to income of $0.8 million in 1997 and $8.5 million in income in 1996.
Results for 1998 and 1997 were negatively impacted by additions to loss and LAE
reserves, approximately $5 million in 1998 and $2.2 million in 1997. These
additions to reserves during the third quarter of 1997 and the fourth quarter of
1998 were based upon actuarial analyses indicating some deterioration of
Physicians' loss experience. The addition to 1998 reserves included additions to
loss and LAE reserves for virtually all loss years (years in which losses were
incurred). These additions primarily were necessitated by an increased incidence
of claims reported on behalf of claimants that allegedly were injured as minors
and had now attained the age of majority. 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 favorable development of
MPL reserves. As discussed above, MPL investment income and earned premiums
continually declined from 1996 through 1998 due to the runoff of the MPL
business and the decreasing level of loss and LAE reserves.
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, 1998, MPL reserves totaled $60.9 million, net of
reinsurance and discount. This compares to $77.5 million and $112.9 million at
December 31, 1997 and 1996, respectively. MPL loss and LAE reserves continue to
decline as a result of the disposition of claims.
MPL INSURANCE -- LOSS AND LAE RESERVES
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
Direct Reserves $ 97.1 $121.4 $158.4
Ceded Reserves (27.7) (34.8) (33.3)
Discount of Net Reserves (8.5) (9.1) (12.2)
------ ------ ------
Net MPL Reserves $ 60.9 $ 77.5 $112.9
====== ====== ======
</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 activities of Raven Development Company ("Raven"), a now
inactive real estate development subsidiary.
35
<PAGE> 36
Revenues (charges) and pre-tax losses from other operations are summarized
below for the past three years:
OTHER OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
1998 1997 1996
------ ------ ------
(in millions)
<S> <C> <C> <C>
Revenues from Other Operations:
Investment Management Services $ 1.1 $ 1.1 $ 0.8
Less: Intercompany Portfolio Mgmt. Charges (0.4) (0.5) (0.5)
Other (0.2) (0.5) 1.9
------ ------ ------
Revenue from Other Operations $ 0.5 $ 0.1 $ 2.2
====== ====== ======
Other Operations-Loss Before Tax:
Investment Management Services $ 0.1 $ 0.2 $ 0.1
Less: Intercompany Portfolio Mgmt. Charges (0.4) (0.5) (0.5)
Other (0.1) (0.4) (0.6)
------ ------ ------
Other Operations-Loss Before Tax $ (0.4) $ (0.7) $ (1.0)
====== ====== ======
</TABLE>
Revenues from OTHER OPERATIONS were $500,000 in 1998 compared to $100,000 in
1997 and $2.2 million in 1996. Nearly all the decline from 1996 was due to the
wind down of real estate development operations of Physicians' subsidiary,
Raven, which had virtually no activity in 1997 and little activity in 1998.
Raven sold its final real estate holdings in early 1998.
Revenues for 1998 included approximately $700,000 in Summit's investment
management fees, excluding those billed to related parties, compared to $600,000
during 1997 and $300,000 in 1996. In addition, although offset by miscellaneous
charges in other areas, 1998 revenues included $0.1 million in real estate sales
generated by Raven and $200,000 in insurance commissions recorded by CLM. There
were no real estate sales or commission income recorded by Raven and CLM during
1997. Raven and CLM recorded $1.6 million and $200,000, respectively, in
revenues during 1996.
Pre-tax, OTHER OPERATIONS showed a $400,000 loss for 1998 compared to a
$700,000 loss in 1997 and a $1 million loss during 1996. The improvement in the
performance of OTHER OPERATIONS during 1998 compared to 1997 was attributable to
approximately $100,000 in income from CLM compared to a $300,000 loss during
1997.
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
$9.2 million and pre-tax income of $300,000 in 1998 prior to its sale. This
compares to $5.3 million and $9 million in revenues in 1997 and 1996,
respectively, and a pre-tax loss of $112,000 in 1997 and $4 million of pre-tax
income in 1996. 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.
On June 16, 1997, Physicians announced the signing of a binding agreement to
sell APL subject to certain closing conditions. The closing took place on
December 4, 1998. The Company received $9 million in cash from the sale in
addition to an $8 million dividend prior to the sale, and recorded a gain of
$1.1 million, included in discontinued operations on the consolidated statements
of operations.
GEC 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
36
<PAGE> 37
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."
LIQUIDITY AND CAPITAL RESOURCES -- YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
In the past, the assets of the insurance subsidiaries had been a major source
of funds for the Company. However, due to the use of those assets to satisfy
claims, and to adhere to the stringent guidelines of the state insurance
departments, these funds are no longer as readily available. Since the
acquisition of GEC, the Company has used the cash acquired to carry out the
investment acquisitions, and other operations of PICO. In addition, the $45
million public offering of GEC provided the funds necessary to acquire GEC's
interest in NLRC, as well as the initial European investments.
The Company continually evaluates its existing operations and searches for
new opportunities to maximize shareholder value. This strategy causes
significant fluctuations in the cash needs of the Company. The Company may need
to sell investments, or borrow funds to meet operating cash requirements. In
addition, it may become necessary or advantageous for the Company to offer stock
or debt through a public or private offering. At times the Company may have
excess cash. The Company attempts to invest such cash to provide maximum returns
within the constraint of remaining liquid enough to meet expected cash
requirements. The Company's primary sources of funds are its available cash,
cash from operations, the sale of invested assets, bank borrowings, public and
private debt and equity offerings, and management and other fees.
Each company within the group is operated to sustain its own operations
without the need for long-term borrowings or additional capital infusions from
within the Company, with the possible exceptions of additional capital
requirements of Sequoia and CIC to maintain or improve their Best ratings or to
meet minimum capital requirements. Physicians contributed an additional $5.5
million to Sequoia in 1997 for this purpose. Nevertheless, funds may be needed
to cover short-term operating shortfalls, to purchase investments or proceed
with an acquisition.
Physicians initially provided virtually all the funding necessary for the
Company. Since the acquisition of Sequoia in 1995, management made significant
strides in improving Sequoia's operating performance. Management has taken a
number of steps to improve Citation's profitability and cash flow since its
acquisition in November 1996, including the June 1997 sale of its workers'
compensation business and its subsidiary, Citation National Insurance Company.
During the past several years, Physicians' cash flow had the greatest impact on
the consolidated group and should continue to do so for the foreseeable future
due to the wind down of the MPL business. At December 31, 1998, Physicians,
Sequoia and Citation had a combined cash and cash equivalent balance of $60.6
million compared to $46.5 million at December 31, 1997. 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 Sequoia and
Citation, a significant amount of their investment balances is in cash and cash
equivalents.
Physicians' operating cash flows, as a result of ceasing to write MPL
insurance, are negative and should continue to be negative for the foreseeable
future. Positive cash flows from other sources within Physicians, primarily
reinsurance recoveries, and the sale of invested assets may partially or fully
offset uses of cash. Major cash outflows will likely include the funding of
claims and loss adjustment expenses, investment purchases, and operating costs.
As of December 31, 1995, when Physicians and PRO ceased writing MPL,
Physicians and PRO reported 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 the reserve is
expected to be settled by the end of the year 2000. Past experience indicates
that funding requirements are typically greatest in years one through three
(1996 through 1998), accounting for more than 60% of the total eventual reserve
and loss adjustment expense payments. As expected, loss and LAE reserves at
December 31, 1996 declined more than 17.1% to $112.9 million after payment of
more than $30 million in claims and LAE. During 1997, MPL reserves decreased
$35.4 million, or 31.4%, to $77.5 million as of December 31, 1997 after payment
of more than $38 million in losses and LAE. MPL reserves declined $16.6 million
during 1998 to $60.9 million as of December 31, 1998. This represents a 55.3%
decline in net discounted loss and LAE reserves since December 31, 1995.
The Company's insurance subsidiaries attempt to structure the duration of
invested assets to match the cash flows required to settle the related unpaid
claims liabilities. Invested assets provide adequate liquidity to fund projected
claims and LAE payments for the coming years. The Ohio and California Insurance
Departments monitor and set guidelines for the insurance companies' investments.
The Ohio and California Insurance Departments also set minimum levels of
policyholder capital and surplus and monitor these levels through various means.
37
<PAGE> 38
To the extent that funds necessary for settling claims and paying operating
expenses are not provided by existing cash and cash equivalents, investment
income, reinsurance recoveries, and rental and other income, then invested
assets will be liquidated. Short term and fixed maturity investments are managed
to mature according to projected cash flow needs. Equity securities will be
converted to cash, as additional funds are required, with an anticipated maximum
liquidation lead-time of approximately six months.
At December 31, 1998, the investment portfolios of Physicians and PRO
contained invested assets of approximately $122.3 million, plus cash and cash
equivalents of $9.3 million. These invested assets are in excess of the present
value of expected future payouts of losses and loss adjustment expenses of
approximately $61 million.
Management attempts to maximize the return on all assets, including those
needed to fund the eventual wrap-up of the MPL reserves through, among other
things, value investing and managing the invested assets internally rather than
liquidating assets to pay a third party to oversee the runoff of the existing
claims. Management also elected to handle the runoff of the MPL claims
internally to continue to maintain a high standard of claims handling and to
maximize shareholder values. While management expects that certain of the
Company's current and future investments may increase in value, offsetting some
of the decline in assets during the period of runoff, the impact of future
market fluctuations on the value of the Company's invested assets cannot be
accurately predicted. Although assets will be managed to mature or liquidate
according to expected payout projections, at times some invested assets may need
to be sold when the stock market is depressed. Such forced sales are expected to
occur infrequently and only under extreme circumstances; however, this cannot be
guaranteed.
The Company's active P&C insurance subsidiaries, Sequoia and Citation, should
provide cash flows from operations once industry combined ratios (SEE "PROPERTY
AND CASUALTY INSURANCE.") stabilize below 100% and premiums remain at a constant
or increasing levels. At times, it may be necessary to liquidate invested assets
to provide the additional funds necessary to cover operating expenses. Summit
produces positive cash flow from operations, which is expected to continue.
The Company anticipates that Vidler will continue to incur operating losses
until they are able to generate significant revenues from development of
projects, including water storage and supply programs, leases, royalties, and
property sales. Further, Vidler may require funding for acquisitions of surface,
water and mineral rights, and other activities. These additional cash needs may
require debt or equity funding from sources outside the Company.
As shown in the accompanying consolidated statements of cash flows, operating
activities used $21.2 million of cash during 1998 compared to cash used of $62.1
million during 1997 and $10.9 million in 1996. The decline in cash used by
operations between 1997 and 1998 of $40.9 million principally consisted of
reductions in claims and LAE payments (both property and casualty and MPL) and
insurance operating expenses, partially offset by a decreased level of premiums
received. Federal income taxes paid in 1998 were $10.5 million less than in
1997, primarily due to the differences in pre-tax income between years. The
$62.1 million in cash used by operations in 1997 also included a $9.7 million
use of funds from reclassification of APL's year-end 1996 cash balances to
discontinued operations in 1997. The $10.4 million decrease in cash from
operations comparing 1998 to 1996 was a direct result of increased cash outflow
from insurance operations and increased operating expenses in other areas,
including the start-up and operation of NLRC in 1997 and 1998 and increased
activities within Vidler in 1997 and 1998.
The primary use of operating cash flow during 1998 was $56.3 million in
insurance claims and LAE, net of reinsurance recoveries. This compares to $69.6
million in 1997 and $39.2 million in 1996. Other expenses for 1998, including
insurance and other operating costs, accounted for $26.9 million in additional
cash outflows compared to $29.1 million and $19 million in 1997 and 1997,
respectively. Premiums received amounted to $35.5 million in 1998, $41.6 million
in 1997 and $29.2 million in 1996, net of ceded reinsurance payments. The
increase in premiums from 1996 to 1997 was due to the November 20, 1996 Merger
resulting in the inclusion of Citation for a full year beginning in 1997. The
decrease in premiums from 1997 to 1998 was due to increased selectivity of
Citation's insurance risks following its change in control and increased
competition for commercial property and casualty insurance in California.
Investment income, other than realized investment gains and losses, amounted to
$10.7 million in 1998, compared to $13.1 million and $7.8 million in 1997 and
1996, respectively.
Cash flow from investing activities for 1998 was $40.8 million compared to $68.1
million provided in 1997 and $31.4 million in 1996. For 1998, cash investing
activities included $17 million of cash received from the sale of APL, and $10.1
million receipt from the disposition of the Sri Lankan investments. In addition,
the Company sold property, generating approximately $6.5 million. The Company
used cash to pay $1.7 million in direct costs associated with the acquisition of
the remaining shares of GEC. Purchases of $4.1 million were made for additional
surface, water and mineral rights, offset by sales of $518,000. The cash
provided by investing activities in 1997
38
<PAGE> 39
resulted primarily from $52 million of cash provided by net investment
transactions, and $18.1 million of cash provided by consolidation of GEC.
Specifically, significant uses of investment cash in 1997 include the purchase
of NLRC for $48.6 million, and $36.7 million used to acquire shares of GEC
common stock. Cash provided by investing activities in 1996 principally
reflected the maturity of fixed income securities and investment proceeds from
the sale of Fairfield Communities, Inc.
Financing activities during 1998 used cash of $3.8 million, primarily due the
purchase of the Company's own stock for $1.6 million, offset by $200,000 in
proceeds received from the exercise of options on treasury shares, as discussed
in NOTE 17 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "OTHER RELATED PARTY
TRANSACTIONS." In addition, $2.3 million was paid to Semitropic for water
storage. These payments are required annually through the year 2008. During
1997, financing activities used $14.3 million primarily to repay borrowings,
offset by proceeds of $2 million from the sale of GEC warrants. In 1996,
financing activities provided cash of $69,000.
At December 31, 1998, the Company has no significant commitment for future
capital expenditures, other than in the ordinary course of business and as
discussed herein. The Company is committed to maintaining Sequoia's capital and
statutory policyholder surplus at a minimum of $7.5 million. At December 31,
1998, Sequoia was well above this level. The Company is also committed 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. SEE NOTE 16 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, "COMMITMENTS
AND CONTINGENCIES."
During 1998, the Company purchased 857,000 shares of common stock of
Australian Oil and Gas Corporation Ltd. ("AOG"), whose shares are traded on the
Australian Stock Exchange, for $803,000. During 1999, an additional 5.9 million
shares were acquired for $6.3 million. As of March 1999, the Company owns a
14.9% interest in AOG. Also during 1997 and 1998, the Company purchased 16,350
shares of Jungfraubahn Holding AG ("Jungfraubahn") based in Interlaken,
Switzerland. In February 1999, an additional 70,000 shares were acquired. In
total the Company holds a 17.6% shareholding for $15.9 million. The acquisition
was financed with $7 million in cash and the remaining balance in debt.
CAPITAL RESOURCES
The Company's principal sources of funds are its available cash resources,
operating cash flow, liquidation of non-essential investment holdings,
borrowings, public and private debt and equity offerings, funds from
consolidated tax savings, and investment management and other fees. At December
31, 1998, the Company had $71.7 million in cash and cash equivalents compared to
$56.4 million at December 31, 1997.
THE COMPANY'S STATE OF READINESS FOR THE YEAR 2000
The Company continues to progress in its efforts to define the scope and
magnitude of the Year 2000 ("Y2K") problem and to execute its plans to ensure
information technology and non-information technology systems are Y2K ready.
There is an evolving plan to achieve compliance that is currently divided into
four phases. As the project has proceeded, overlap of the different phases has
occurred.
The initial phase of planning, inventorying and evaluating all information
technology systems, and non-information technology systems and their components,
for Y2K compliance is approximately 90% complete. The evaluation has not
disclosed any significant Y2K processing difficulties or concerns. The focus is
primarily on the insurance operations of the Company because of the custom
applications software used to process insurance policies, policy claims, and
insurance underwriting. After internal review and communication with system
vendors, the majority of the non-insurance information and non-information
technology systems are deemed Y2K compliant and do not require any significant
alterations. The focus of remediation is on the insurance specific applications.
The secondary phase of the project, which primarily includes implementing
corrections to remedy Y2K deficiencies, is approximately 90% complete. As noted
above, the insurance systems software has been the primary focus of such
efforts. To renovate the insurance systems to a Y2K ready state, the Company's
internal information systems staff is re-writing lines of existing code to
function with a four-digit date field. The Company also replaced existing DOS
software with a current Y2K compliant version.
Testing and validation of each system comprises phase three. As hardware
and software changes are made to the systems, they are tested for compliance.
This phase continues as insurance specific applications are reprogrammed and
tested. Final completion of this phase
39
<PAGE> 40
should be by the end of the second quarter of 1999. Despite the best efforts by
management, problems will arise requiring the Company to quickly respond while
there is still time. Phase four, when completed, will set forth contingency
plans addressing potential business interruption and failure, is expected to be
finalized during the last half of 1999.
THIRD PARTY RELATIONSHIPS
The Company has relationships with several banks and other financial
institutions and service providers that provide business information on a
regular basis. In addition, the Company reports financial results on a regular
basis to state and federal agencies. While these relationships are important to
the Company's business, should any third parties be adversely affected by the
Y2K problem, the resulting risk of business interruption should not be
significant to the Company. The Company however, has no means of ensuring that
these parties will be Year 2000 ready. The inability of those parties to
complete their Y2K readiness process could materially impact the Company.
THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
The financial impact of making the required systems changes has not been
material, nor is it expected to be material, to the Company's consolidated
financial position, results of operations or cash flows. For the year ending
December 31, 1998 the Company incurred approximately $85,000 for hardware and
computer programming. The Company expects to incur another $40,000 to $60,000 to
complete the project.
THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES AND CONTINGENCY PLANS
A reasonable, most likely worst case scenario of the Y2K impact would be a
slow down in internal and external reporting, and insurance related processing
of policies, claims and underwriting functions. It is unlikely the Company would
experience any material business cessation or significant business disruption.
The Company is completing its specific plans to continue operations in case
of unexpected delays in completing remediation or if Y2K problems impact the
Company in unforeseen ways. It appears many business systems could function
manually for a limited amount of time. The Company anticipates completing its
contingency plan during the last half of 1999. Overall, the Company is
approximately 85% complete in its Y2K project.
RISK FACTORS
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," and elsewhere in this document, the following risk
factors should be considered carefully in evaluating PICO and its business. The
statements contained in this prospectus that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Exchange
Act, including statements regarding our expectations, beliefs, intentions, plans
or strategies regarding the future. All forward looking statements included in
this document are based on information available to us on the date thereof, and
we assume no obligation to update any such forward-looking statements.
IF WE DO NOT SUCCESSFULLY LOCATE, SELECT AND MANAGE INVESTMENTS AND ACQUISITIONS
OR IF OUR INVESTMENTS OR ACQUISITIONS OTHERWISE FAIL OR DECLINE IN VALUE, OUR
FINANCIAL CONDITION COULD SUFFER
We invest in businesses that we believe are undervalued or that will benefit
from additional capital, restructuring of operations or improved competitiveness
through operational efficiencies.
Failures and/or declines in the market values of businesses we invest in or
acquire, as well as our failure to successfully locate, select and manage
investment and acquisition opportunities, could have a material adverse effect
on our business, financial condition, results of operations and cash flows. Such
business failures, declines in market values, and/or failure to successfully
locate, select and manage investments and acquisitions could result in inferior
investment returns compared to those which may have been attained had we
successfully located, selected and managed new investments and acquisition
opportunities, or had our investments or acquisitions not failed
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or declined in value. We could also lose part or all of our investments in these
businesses and experience reductions in our net income, cash flows, assets and
shareholders' equity.
We will continue to make selective investments, and endeavor to enhance and
realize additional value to these acquired companies through our influence and
control. This could involve the restructuring of the financing or management of
the entities in which we invest and initiating and facilitating mergers and
acquisitions. Any acquisition could result in the use of a significant portion
of our available cash, significant dilution to you, and significant acquisition
related charges. Acquisitions may also result in the assumption of liabilities,
including liabilities that are unknown or not fully known at the time of the
acquisition, which could have a material adverse effect on us.
We do not know of any reliable statistical data that would enable us to
predict the probability of success or failure of our investments or to predict
the availability of suitable investments at the time we have available cash. You
will be relying on the experience and judgment of management to locate, select
and develop new acquisition and investment opportunities. Sufficient
opportunities may not be found and this business strategy may not be successful.
We have made a number of investments in the past that have been highly
successful, such as Fairfield Communities, Inc., which we sold in 1996 and
Resource America, Inc., which we sold in 1997. We have also made investments
that have lost money, such as our approximate $4 million loss from Korean
investments in 1997 and approximately $5 million in investments written down in
1998. We reported net realized investment gains in 1997 of $27.1 million and in
1996 of $21.4 million; however, we reported a net realized investment loss of
$4.4 million for 1998. Our financial statements indicate net unrealized
investment gains, before taxes, of $16.8 million at December 31, 1996, as
adjusted, $6.6 million at December 31, 1997,as adjusted, and net unrealized
investment losses of $4.9 million at December 31, 1998, as adjusted.
Our ability to achieve an acceptable rate of return on any particular
investment is subject to a number of factors which are beyond our control,
including increased competition and loss of market share, quality of management,
cyclical or uneven financial results, technological obsolescence, foreign
currency risks and regulatory delays.
Our investments may not achieve acceptable rates of return and we may not
realize the value of the funds invested; accordingly, these investments may have
to be written down or sold at their then-prevailing market values.
We may not be able to sell our investments in both private and public
companies when it appears to be advantageous to do so and we may have to sell
these investments at a discount. Investments in private companies are not as
marketable as investments in public companies. Investments in public companies
are subject to prices determined in the public markets and, therefore, values
can vary dramatically. In particular, the ability of the public markets to
absorb a large block of shares offered for sale can affect our ability to
dispose of an investment in a public company.
To successfully manage newly acquired companies, we must, among other things,
continue to attract and retain key management and other personnel. The diversion
of the attention of management from the day-to-day operations, or difficulties
encountered in the integration process, could have a material adverse effect on
our business, financial condition, results of operations and cash flows.
WE MAY MAKE INVESTMENTS AND ACQUISITIONS THAT MAY YIELD LOW OR NEGATIVE RETURNS
FOR AN EXTENDED PERIOD OF TIME, WHICH COULD TEMPORARILY OR PERMANENTLY DEPRESS
OUR RETURN ON INVESTMENTS
We generally make strategic investments and acquisitions that tend to be long
term in nature. We invest in businesses that we believe to be undervalued or may
benefit from additional capital, restructuring of operations or management or
improved competitiveness through operational efficiencies with our existing
operations. We may not be able to develop acceptable revenue streams and
investment returns. We may lose part or all of our investment in these assets.
The negative impacts on cash flows, income, assets and shareholders' equity may
be temporary or permanent. We make investments for the purpose of enhancing and
realizing additional value by means of appropriate levels of shareholder
influence and control. This may involve restructuring of the financing or
management of the entities in which we invest and initiating or facilitating
mergers and acquisitions. These processes can consume considerable amounts of
time and resources. Consequently, costs incurred as a result of these
investments and acquisitions may exceed their revenues and/or increases in their
values for an extended period of time until we are able to develop the potential
of these investments and acquisitions and increase the revenues, profits and/or
values of these investments. Ultimately, however, we may not be able to develop
the potential of these assets that we anticipated.
IF MEDICAL MALPRACTICE INSURANCE CLAIMS TURN OUT TO BE GREATER THAN THE RESERVES
WE ESTABLISH TO PAY THEM, WE MAY NEED TO LIQUIDATE CERTAIN INVESTMENTS IN ORDER
TO SATISFY OUR RESERVE REQUIREMENTS
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Under the terms of our medical malpractice liability policies, there is an
extended reporting period for claims. Under Ohio law the statute of limitations
is one year after the cause of action accrues. Also, under Ohio law a person
must make a claim within four years; however, the courts have determined that
the period may be longer in situations where the insured could not have
reasonably discovered the injury in that four-year period. Claims of minors must
be brought within one year of the date of majority. As a result, some claims may
be reported a number of years following the expiration of the medical
malpractice liability policy period.
Physicians Insurance Company of Ohio and The Professionals Insurance Company
have established reserves to cover losses on claims incurred under the medical
malpractice liability policies including not only those claims reported to date,
but also those that may have been incurred but not yet reported. The reserves
for losses are estimates based on various assumptions and, in accordance with
Ohio law, have been discounted 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 Insurance Company
of Ohio and The Professionals Insurance Company annually obtain a certification
from an independent actuary that their respective reserves for losses are
adequate. They also obtain a concurring actuarial opinion. Due to the inherent
uncertainties in the reserving process, there is a risk that Physicians
Insurance Company of Ohio's and The Professionals Insurance Company's reserves
for losses could prove to be inadequate. This could result in a decrease in
income and shareholders' equity. If we underestimate our reserves, they could
reach levels which are lower than required by law.
Reserves are money that we set aside to pay insurance claims. We strive to
establish a balance between maintaining adequate reserves to pay claims while at
the same time using our cash resources to invest in new companies.
IF WE UNDERESTIMATE THE AMOUNT OF INSURANCE CLAIMS, OUR FINANCIAL CONDITION
COULD BE MATERIALLY MISSTATED AND OUR FINANCIAL CONDITION COULD SUFFER
Our insurance subsidiaries may not have established reserves adequate to meet
the ultimate cost of losses arising from claims. It has been, and will continue
to be, necessary for our insurance subsidiaries to review and make appropriate
adjustments to reserves for claims and expenses for settling claims. Inadequate
reserves could have a material adverse effect on our business, financial
condition, results of operations and cash flows. Inadequate reserves could cause
our financial condition to fluctuate from period to period and cause our
financial condition to appear to be better than it actually is for periods in
which insurance claims reserves are understated. In subsequent periods when we
discover the underestimation and pay the additional claims, our cash needs will
be greater than expected and our financial results of operations for that period
will be worse than they would have been had our reserves been accurately
estimated originally.
The inherent uncertainties in estimating loss reserves are greater for some
insurance products than for others, and are dependent on:
- the length of time in reporting claims;
- the diversity of historical losses among 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.
Because medical malpractice liability and commercial casualty claims may not
be completely paid off for several years, estimating reserves for these types of
claims can be more uncertain than estimating reserves for other types of
insurance. As a result, precise reserve estimates cannot be made for several
years following the year for which reserves were initially established.
During the past several years, the levels of the reserves for our insurance
subsidiaries have been very volatile. As a result of our claims experience, we
have had to significantly increase these reserves in the past several years.
Significant increases in the reserves may be necessary in the future, and the
level of reserves for our insurance subsidiaries may be volatile in the future.
These increases or volatility may have an adverse effect on our business,
financial condition, results of operations and cash flows.
THERE HAS BEEN A DOWNTURN IN THE PROPERTY & CASUALTY INSURANCE BUSINESS WHICH,
IN THE SHORT TERM, HINDERS OUR ABILITY TO PROFIT FROM THIS INDUSTRY
The property and casualty insurance industry has been highly cyclical, and
the industry has been in a cyclical downturn over the last several years. This
is due primarily to competitive pressures on pricing, which has resulted in
lower profitability for us. Pricing is a function of many factors, including the
capacity of the property and casualty industry as a whole to underwrite
business, create
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policyholders' surplus and generate positive returns on their investment
portfolios. 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 by volatile and unpredictable developments, including natural
disasters, fluctuations in interest rates, and other changes in the investment
environment which affect market prices of investments and the income generated
from those investments. Inflationary pressures affect the size of losses and
court decisions affect insurers' liabilities. These trends may adversely affect
our business, financial condition, results of operations and cash flows by
reducing revenues and profit margins, by increasing ratios of claims and
expenses to premiums, and by decreasing cash receipts. Capital invested in our
insurance companies may produce inferior investment returns during periods of
downturns in the insurance cycle due to reduced profitability.
STATE REGULATORS COULD REQUIRE CHANGES TO THE OPERATIONS OF OUR INSURANCE
SUBSIDIARIES AND/OR TAKE THEM OVER IF WE FAIL TO MAINTAIN ADEQUATE RESERVE
LEVELS
In the past few years, the National Association of Insurance Commissioners
has developed risk-based capital measurements for both property and casualty and
life and health insurers. These measurements prescribe the reserve levels that
insurance companies must maintain. The Commissioners have delegated to the state
regulators varying levels of authority based on the adequacy of an insurer's
reserves. The insurance companies' reserve levels are reported annually in their
statutory annual statements to the insurance departments.
Failure to meet one or more reserve levels may result in state regulators
requiring the insurance company to submit a business plan demonstrating
achievement of the required reserve levels. This may include the addition of
capital, a restructuring of assets and liabilities, or changes in operations. At
or below certain lower reserve levels, state regulators may supervise the
operation of the insurance company and/or require the liquidation of the
insurance company. Such insurance department actions could adversely affect our
business, financial condition, results of operations and cash flows and decrease
the value of our investments in our insurance subsidiaries. If the insurance
departments were to require changes in the operations of our insurance
subsidiaries, we may incur additional expenses and we may lose customers. If the
insurance departments were to require additional capital in our insurance
subsidiaries or a restructuring of our assets and liabilities, our investment
returns could suffer. If the insurance departments were to place our insurance
companies under their supervision, we would lose customers, our revenues may
decrease more rapidly than our expenses, and our investment returns would
suffer. We may even lose part or all of our investments in our insurance
subsidiaries if our insurance subsidiaries are liquidated by the insurance
departments.
WE MAY BE INADEQUATELY PROTECTED AGAINST MAN MADE AND NATURAL CATASTROPHES,
WHICH COULD REDUCE THE AMOUNT OF CAPITAL SURPLUS AVAILABLE FOR INVESTMENT
OPPORTUNITIES
As with other property and casualty insurers, 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. Our insurance subsidiaries generally seek to reduce their exposure
to catastrophic events through individual risk selection and the purchase of
reinsurance. Our insurance subsidiaries' 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 created by that event. While our insurance
subsidiaries attempt to limit their exposure to acceptable levels, it is
possible that an actual catastrophic event or multiple catastrophic events could
significantly exceed the maximum loss anticipated, resulting in a material
adverse effect on our business, financial condition, results of operations and
cash flows. Such events could cause unexpected insurance claims and expenses for
settling claims well in excess of premiums, increasing cash needs, reducing
surplus and reducing assets available for investments. Capital invested in our
insurance companies may produce inferior investment returns as a result of these
additional funding requirements.
We insure ourselves against catastrophic losses by obtaining insurance
through other insurance companies known as reinsurers. The future financial
results of our insurance subsidiaries could be adversely affected by disputes
with their reinsurers with respect to coverage and by the solvency of the
reinsurers.
OUR INSURANCE SUBSIDIARIES COULD BE DOWNGRADED WHICH WOULD NEGATIVELY IMPACT OUR
BUSINESS
Our insurance subsidiaries' ratings may not be maintained or increased, and a
downgrade would likely adversely affect our business, financial condition,
results of operations and cash flows. A.M. Best and Company's ("A.M. Best")
ratings reflect the assessment of A.M. Best of an insurer's financial condition,
as well as the expertise and experience of its management. Therefore, A.M. Best
ratings are
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important to policyholders. A.M. Best ratings are subject to review and change
overtime. Failure to maintain or improve our A.M. Best ratings could have a
material adverse effect on the ability of our insurance subsidiaries to
underwrite 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 an A.M. Best rating of
less than B+, and that customers who do so will demand lower rates.
Our insurance subsidiaries are currently rated as follows:
- Sequoia Insurance Company B++ (Very Good)
- Citation Insurance Company B+ (Very Good)
- Physicians Insurance Company of Ohio NR-3 (rating procedure
inapplicable)
- The Professionals Insurance Company NR-3 (rating procedure
inapplicable)
POLICY HOLDERS MAY NOT RENEW THEIR POLICIES, WHICH WOULD UNEXPECTEDLY REDUCE OUR
REVENUE STREAM
Insurance policy renewals have historically accounted for a significant
portion of our net revenue. We may not be able to sustain historic renewal rates
for our products in the future. A decrease in renewal rates would reduce our
revenues. It would also decrease our cash receipts and the amount of funds
available for investments and acquisitions. If we were not able to reduce
overhead expenses correspondingly, this would adversely affect our business,
financial condition, results of operations and cash flows.
IF WE ARE REQUIRED TO REGISTER AS AN INVESTMENT COMPANY, THEN WE WILL BE SUBJECT
TO A SIGNIFICANT REGULATORY BURDEN
We at all times intend to conduct our business so as to avoid being regulated
as an investment company under the Investment Company Act of 1940. However, if
we were required to register as an investment company, our ability to use debt
would be substantially reduced, and we would be subject to significant
additional disclosure obligations and restrictions on our operational
activities. Because of the additional requirements imposed on an investment
company with regard to the distribution of earnings, operational activities and
the use of debt, in addition to increased expenditures due to additional
reporting responsibilities, our cash available for investments would be reduced.
The additional expenses would reduce income. These factors would adversely
affect our business, financial condition, results of operations and cash flows.
SUBSTANTIAL REGULATION MAY PREVENT US FROM REALIZING A PROFIT FROM OUR WATER
RIGHTS
The water rights held by us and the transferability of these rights to other
uses and places of use are governed by the laws concerning water rights in the
states of Arizona, California, Colorado and Nevada. The volumes of water
actually derived from these rights may vary considerably based upon physical
availability and may be further limited by applicable legal restrictions. As a
result, the amounts of acre feet anticipated do not in every case represent a
reliable, firm annual yield of water, but in some cases describe the face amount
of the water right claims or management's best estimate of such entitlement.
Legal impediments exist to the sale or transfer of some of these water rights,
which in turn may affect their commercial value. If we were unable to transfer
or sell our water rights, we will not be able to make a profit, we will not have
enough cash receipts to cover cash needs, and we may lose some or all of our
value in our water rights investments.
OUR FUTURE WATER REVENUES ARE UNCERTAIN AND DEPEND ON A NUMBER OF FACTORS, WHICH
MAY MAKE OUR REVENUE STREAMS AND PROFITABILITY VOLATILE
We engage in various water rights acquisition, management, development, sale
and lease activities. Accordingly, our long-term future profitability will be
primarily dependent on our ability to develop and sell or lease water and water
rights, and will be affected by various factors, including timing of
acquisitions, transportation arrangements, and changing technology. To the
extent we possess junior or conditional water rights, such rights may be
subordinated to superior water right holders in periods of low flow or drought.
Our current water rights and the transferability of these rights to other
uses and places of use are governed by the laws concerning water rights in the
states of Arizona, California, Colorado and Nevada. The volumes of water
actually derived from these rights may vary considerably based upon physical
availability and may be further limited by applicable legal restrictions. Legal
impediments exist to sale or transfer of some of these water rights which may
affect their commercial value.
In addition to the risk of delays associated with receiving all necessary
regulatory approvals and permits, we may also encounter unforeseen technical
difficulties which could result in construction delays and cost increases with
respect to our water development
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projects.
OUR WATER ASSETS MAY BECOME CONCENTRATED IN A LIMITED NUMBER OF FACILITIES,
MAKING OUR GROWTH AND PROFITABILITY VULNERABLE TO FLUCTUATIONS IN LOCAL
ECONOMIES AND GOVERNMENTAL REGULATIONS.
We anticipate that in the future, a substantial majority of Vidler's revenues
and asset value may be derived from a single asset, the MBT Ranch water storage
facility. Currently, we have obtained only a pilot permit for the recharge and
storage of a limited amount of water at that facility. We have not yet applied
for a recovery permit and have applied for, but not yet received, a full-scale
permit for that facility. There can be no assurance (i) that we will be able to
obtain permits for the facility at the recharge, storage or recovery levels
anticipated, or at all, (ii) that the full-scale storage facility will have the
capacity currently anticipated, or (iii) that we will be able to contract with
third parties for storage of water on commercially reasonable terms, or at all.
A majority of our water revenue historically has been derived from the Vidler
Tunnel. Although we have recently begun to acquire additional water assets, we
anticipate that our revenues will be derived from a limited number of water
assets for the foreseeable future.
THE PRICE OF WATER IS VOLATILE, WHICH CAN HAVE A SIGNIFICANT EFFECT ON OUR COSTS
OF ACQUIRING WATER AND THE PRICES AT WHICH WE ARE ABLE TO SELL WATER.
Our profitability is significantly affected by changes in the market price of
water. Water prices may in the future fluctuate widely and are affected by
climatic, demographic and technologic factors affecting demand.
ENVIRONMENTAL REGULATIONS MAY DETRACT FROM OUR FUTURE REVENUE STREAMS AND
PROFITABILITY BY LIMITING OUR CUSTOMER BASE.
Water we lease or sell may be subject to regulation as to quality by the
United States Environmental Protection Agency (the "EPA") acting pursuant to the
federal Safe Drinking Water Act ("SDWA"). While environmental regulations do not
directly affect us, the regulations regarding the quality of water distributed
affects our intended customers and may, therefore, depending on the quality of
our water, impact the price and terms upon which we may in the future sell our
water or water rights.
OUR WATER SALES MAY MEET WITH POLITICAL OPPOSITION IN CERTAIN LOCATIONS, THEREBY
LIMITING OUR GROWTH IN THESE AREAS
The transfer of water rights from one use to another may affect the economic
base of a community and will, in some instances, be met with local opposition.
Moreover, certain of the end users of our water rights (i.e., municipalities)
regulate the use of water in order to control or deter growth.
WE ARE DIRECTLY IMPACTED BY INTERNATIONAL AFFAIRS, WHICH DIRECTLY EXPOSES US TO
THE ADVERSE EFFECTS OF ANY FOREIGN ECONOMIC OR GOVERNMENTAL INSTABILITY
As a result of global investment diversification, our business, financial
condition, results of operations and cash flows may be adversely affected by:
- exposure to fluctuations in exchange rates;
- the imposition of governmental controls;
- the need to comply with a wide variety of foreign and U.S. export
laws;
- political and economic instability;
- trade restrictions;
- changes in tariffs and taxes;
- volatile interest rates;
- changes in certain commodity prices;
- exchange controls which may limit our ability to withdraw money;
- the greater difficulty of administering business overseas; and
- general economic conditions outside the United States.
Changes in any or all of these factors could result in reduced market values
of investments, loss of assets, additional expenses, reduced
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investment income, reductions in shareholders' equity due to foreign currency
fluctuations and a reduction in our global diversification.
OUR COMMON STOCK PRICE MAY BE LOW WHEN YOU WANT TO SELL YOUR SHARES
The trading price of our common stock has historically been, and is expected
to be, subject to fluctuations. The market price of the common stock may be
significantly impacted by:
- quarterly variations in financial performance;
- shortfalls in revenue or earnings from levels forecast by securities
analysts;
- changes in estimates by such analysts;
- product introductions;
- our competitors' announcements of extraordinary events; such as
- acquisitions;
- litigation; and
- general economic conditions.
Our results of operations have been subject to significant fluctuations,
particularly on a quarterly basis, and our future results of operations could
fluctuate significantly from quarter to quarter and from year to year. Causes of
such fluctuations may include the inclusion or exclusion of operating earnings
from newly acquired or sold operations. At December 31, 1996, the closing price
of our common stock on the Nasdaq National Market was $20.63 per share, compared
to $13.25 at December 31, 1998. On a quarterly basis between these two dates,
closing prices have ranged from a high of $32.19 at December 31, 1997 to a low
of $13.25 at December 31, 1998. From January 1 through November 12, 1999,
closing prices have ranged from a low of $13.00 per share on January 4 to a high
of $25.31 on June 30.
Statements or changes in opinions, ratings, or earnings estimates made by
brokerage firms or industry analysts relating to the markets in which we do
business or relating to us specifically could result in an immediate and adverse
effect on the market price of our common stock.
WE MAY NOT BE ABLE TO RETAIN KEY MANAGEMENT PERSONNEL WE NEED TO SUCCEED, WHICH
COULD ADVERSELY AFFECT OUR ABILITY TO MAKE SOUND INVESTMENT DECISIONS
We have several key executive officers. If they depart, it could have a
significant adverse effect. In particular, Ronald Langley, our Chairman, and
John R. Hart, our President and Chief Executive Officer, play key roles in
investment decisions. Messrs. Langley and Hart have entered into employment
agreements with us dated as of December 31, 1997, for a period of four years.
Messrs. Langley and Hart are key to the implementation of our strategic focus,
and our ability to successfully develop our current strategy is dependent upon
our ability to retain the services of Messrs. Langley and Hart.
OUR CHARTER DOCUMENTS MAY INHIBIT A TAKEOVER, PREVENTING YOU FROM RECEIVING A
PREMIUM ON YOUR SHARES
The Board of Directors has authority to issue up to 2 million shares of
preferred stock and to fix the rights, preference, privileges and restrictions,
including voting rights, of those shares without any further vote or action by
the shareholders. Your rights as common stock holders will be subject to, and
may be adversely affected by, the rights of the holders of the preferred stock.
The issuance of preferred stock, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a majority
of our outstanding voting stock, thereby delaying, deferring or preventing a
change in control of PICO. Furthermore, such preferred stock may have other
rights, including economic rights senior to the common stock, and, as a result,
the issuance thereof could have a material adverse effect on the market value of
the common stock.
WE ARE SUBJECT TO YEAR 2000 RISKS FOR WHICH WE MAY NOT BE PREPARED, WHICH COULD
CREATE INTERNAL ADMINISTRATIVE PROBLEMS REQUIRING COSTLY, INEFFICIENT REMEDIAL
MEASURES
Many currently installed computer systems and software products are not
capable of distinguishing 20th century dates from 21st century dates. As a
result, in less than one year, computer systems and/or software used by many
companies in a very wide variety of applications may experience operating
difficulties unless they are modified or upgraded to adequately process
information involving, related to or dependent upon the century change.
Significant uncertainty exists in the software and information services
industries concerning the scope and magnitude of problems associated with the
century change. In light of the potentially broad effects of the year 2000 on a
wide range of business systems, we may be affected.
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We continue to progress in our efforts to define the scope and magnitude of
the Year 2000 ("Y2K") problem and to execute our plans to ensure information
technology and non-information technology systems are Y2K compliant.
The initial phase of planning, inventorying and evaluating all information
technology systems, and non-information technology systems and their components,
for Y2K compliance is complete. The evaluation has not disclosed any significant
Y2K processing difficulties or concerns. The focus has primarily been on the
insurance operations of Vista because of the custom applications software used
to process insurance policies, policy claims, and insurance underwriting.
Fortunately, the majority of the non-insurance information and non-information
technology systems are deemed Y2K compliant and do not require any significant
alterations. The focus of remediation is on the insurance specific applications.
The second phase of the project, which primarily includes implementing
corrections to remedy Y2K deficiencies, is approximately complete. As noted
above, the insurance systems software has been the primary focus of the efforts.
To renovate the insurance systems to a Y2K ready state, our internal information
systems staff is re-writing lines of existing code to function with a four-digit
date field. We have also replaced existing DOS software with a current Y2K
compliant version.
Phase three pertains to testing and validation of each system. As hardware
and software changes are made to the systems, they are tested for compliance.
This phase will continue as each insurance application is reprogrammed. Despite
the best efforts by management, problems will arise requiring us to quickly
respond while there is still time. Phase four, when completed, will set forth
contingency plans addressing potential business interruption and failure, is
expected to be finalized during the last quarter of 1999.
We have relationships with several banks and other financial institutions and
service providers that provide business information to us on a regular basis. In
addition, we report financial results on a regular basis to state and federal
agencies. While these relationships are important to our business, should any
third party be adversely affected by the Y2K problem, the resulting risk of
business interruption should not be significant to us. However, the inability of
those parties to complete their Y2K readiness process could materially impact us
in a manner that we have not foreseen.
The likely worst case scenario is a partial failure of some accounting and
reporting functions that could be corrected by manually recording and delivering
the required information.
THE FOREGOING FACTORS, INDIVIDUALLY OR IN THE AGGREGATE, COULD MATERIALLY
ADVERSELY AFFECT OUR OPERATING RESULTS AND COULD MAKE COMPARISON OF
HISTORIC OPERATING RESULTS AND BALANCES DIFFICULT OR NOT
MEANINGFUL RISK FACTORS
ITEM 7.A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company's balance sheets include a significant amount of assets and
liabilities whose fair value are subject to market risk. Market risk is the risk
of loss arising from adverse changes in market interest rates or prices. The
Company currently has interest rate risk as it relates to its fixed maturity
securities and mortgage loans, equity price risk as it relates to its marketable
equity securities, and foreign currency risk as it relates to investments
denominated in foreign currencies. The Company's bank debt is short-term in
nature as the Company generally secures rates for periods of approximately one
to three years and therefore approximates fair value. At December 31, 1998, the
Company had $32.6 million of fixed maturity securities and mortgage loans, $46.2
million of marketable equity securities that were subject to market risk, and
$32.7 million of investments denominated in foreign currencies, primarily Swiss
francs. The Company's investment strategy is to manage the duration of the
portfolio relative to the duration of the liabilities while managing interest
rate risk.
The Company uses two models to analyze the sensitivity of its assets and
liabilities subject to the above risks. For its fixed maturity securities, and
mortgage loans, the Company uses duration modeling to calculate changes in fair
value. For its marketable securities the Company uses a hypothetical 20%
decrease in the fair value to analyze the sensitivity of its market risk assets
and liabilities. For investments denominated in foreign currencies the Company
uses a hypothetical 20% decrease in the local currency of that investment.
Actual results may differ from the hypothetical results assumed in this
disclosure due to possible actions taken by management to mitigate adverse
changes in fair value and because the fair value of a securities may be affected
by credit concerns of the issuer, prepayment rates, liquidity, and other general
market conditions. The sensitivity analysis duration model produced a loss in
fair value of $419,000 for a 100 basis point decline in interest rates on its
fixed securities and mortgage loans. The hypothetical 20% decrease in fair value
of the Company's marketable equity securities produced a loss in fair value of
$9.2 million that would impact the unrealized appreciation in
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shareholders' equity. The hypothetical 20% decrease in the local currency of the
Company's foreign denominated investments produced a loss of $6.5 million that
would impact the unrealized appreciation and foreign currency translation in
shareholders' equity.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements as of December 31, 1998 and 1997 and for
each of the three years in the period ended December 31, 1998 and the
independent auditors' reports are included in this report as listed in the index
of this report.
SELECTED QUARTERLY FINANCIAL DATA
Summarized unaudited quarterly financial data (in thousands, except share and
per share amounts) for 1998 and 1997 are shown below. In management's opinion,
the interim financial data contains all adjustments necessary for a fair
presentation of results for such interim periods. Prior period share and per
share amounts have been adjusted to conform to the current period presentation
reflecting the December 16, 1998 1-for-5 Reverse Stock Split.
AS PREVIOUSLY REPORTED
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1997 1997 1997 1997 1998 1998 1998 1998
---------- ---------- ------------- ------------ ---------- ---------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Premium income $ 14,503 $ 13,976 $ 11,622 $ 9,775 $ 9,138 $ 8,455 $ 8,805 $ 9,733
Net investment income and
net realized gains (losses) 6,208 2,839 29,461 (5,429) 3,880 3,775 2,236 2,862
Total revenues 21,050 17,181 43,808 6,146 13,734 13,654 12,180 8,652
Net income (loss) 1,992 1,824 17,860 (2,184) (927) 1,082 729 (8,039)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Basic:
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss) per share $ 0.31 $ 0.28 $ 2.97 $ (0.36) $ (0.15) $ 0.18 $ 0.13 $ (1.30)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Weighted average common
and equivalent shares
outstanding 6,434,860 6,445,790 6,018,466 6,019,817 6,019,817 6,019,817 5,711,304 6,178,675
Diluted:
Net income (loss) per share $ 0.30 $ 0.27 $ 2.84 $ (0.36) $ (0.15) $ 0.17 $ 0.12 $ (1.30)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Weighted average common
and equivalent shares
outstanding 6,609,817 6,639,827 6,278,038 6,019,817 6,019,817 6,254,573 6,158,606 6,178,675
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
</TABLE>
48
<PAGE> 49
AS RESTATED
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1997 1997 1997 1997 1998 1998 1998 1998
---------- ---------- ------------- ------------ ---------- ---------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Premium income $ 14,503 $ 13,976 $ 11,622 $ 9,775 $ 9,138 $ 8,455 $ 8,805 $ 9,733
Net investment income and
net realized gains (losses) 6,208 3,428 30,588 (5,311) 3,068 3,775 2,236 (4,059)
Total revenues 21,050 17,769 44,935 6,265 12,922 13,654 12,180 8,653
Net income (loss) 1,621 1,453 18,241 (1,703) (1,678) 934 600 (8,100)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Basic:
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss) per share $ 0.25 $ 0.23 $ 3.03 ($ 0.28) ($ 0.28) $ 0.16 $ 0.11 ($ 1.31)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Weighted average common
and equivalent shares
outstanding 6,434,860 6,445,790 6,018,466 6,019,817 6,019,817 6,019,817 5,711,304 6,178,675
Diluted:
Net income (loss) per share $ 0.25 $ 0.22 $ 2.91 ($ 0.28) ($ 0.28) $ 0.15 $ 0.10 ($ 1.31)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Weighted average common
and equivalent shares
outstanding 6,609,817 6,639,827 6,278,038 6,019,817 6,019,817 6,254,573 6,158,606 6,178,675
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
</TABLE>
SEE NOTE 22 TO NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
49
<PAGE> 50
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1998 AND 1997
AND FOR EACH OF THE
THREE YEARS IN THE PERIOD
ENDED DECEMBER 31, 1998 AS RESTATED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED
<TABLE>
<S> <C>
Independent Auditors' Reports .............................................. 51-53
Consolidated Balance Sheets as of December 31, 1998 and 1997 (As Restated) 54
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 (As Restated) ....................... 56
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1998, 1997, and 1996 (As Restated) ........... 57
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 (As Restated) ........................ 60
Notes to Consolidated Financial Statements (As Restated) ................... 61
</TABLE>
50
<PAGE> 51
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
PICO Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of PICO
Holdings, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the years then ended. 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 did not audit the
1997 consolidated financial statements of Global Equity Corporation (all
expressed in Canadian dollars), a 51.2% owned consolidated subsidiary as of
December 31, 1997, which constituted 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.
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 and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
1998 and 1997 consolidated financial statements present fairly, in all material
respects, the consolidated financial position of PICO Holdings, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the consolidated results of
their operations and their cash flows for the years then ended, in conformity
with generally accepted accounting principles.
As discussed in Note 22, the accompanying 1998 and 1997 consolidated
financial statements have been restated.
DELOITTE & TOUCHE LLP
San Diego, California
March 26, 1999 (January 26, 2000 as to Note 22)
51
<PAGE> 52
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 LLP
Chartered Accountants
Toronto, Canada
March 17, 1998
52
<PAGE> 53
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of
PICO Holdings, Inc.
We have audited the consolidated statements of operations, shareholders' equity
and cash flows of PICO Holdings, Inc. and subsidiaries for the year 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 audit.
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, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and the
cash flows of PICO Holdings, Inc. and subsidiaries for the year ended December
31, 1996, in conformity with generally accepted accounting principles.
As discussed in Note 22, the accompanying 1996 consolidated financial statements
have been restated.
PricewaterhouseCoopers LLP
San Diego, California
April 7, 1997, except as to the information presented in Note 22, for which the
date is January 26, 2000
53
<PAGE> 54
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
ASSETS
<TABLE>
<CAPTION>
1998 1997
------------- -------------
(AS RESTATED, See Note 22)
<S> <C> <C>
Investments:
Available for sale:
Fixed maturities $ 32,642,140 $ 43,266,291
Equity securities and other investments 60,624,253 84,738,322
Short-term investments 21,098,702 28,757,220
Real estate 2,046,685 4,013,270
------------- -------------
Total investments 116,411,780 160,775,103
Cash and cash equivalents 71,654,196 56,435,789
Premiums and other receivables, net 10,414,017 20,681,568
Reinsurance receivables 55,624,830 75,025,576
Prepaid deposits and reinsurance premiums 2,187,387 2,234,688
Accrued investment income 1,295,550 1,722,282
Surface, water and mineral rights 116,653,211 75,177,015
Property and equipment, net 1,851,502 8,550,807
Deferred policy acquisition costs 5,548,634 5,320,716
Income taxes receivable 6,522,454
Other assets 7,011,957 5,932,248
Net deferred income taxes 2,684,729
Net assets of discontinued operations 15,949,989
------------- -------------
Total assets $ 395,175,518 $ 430,490,510
============= =============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
54
<PAGE> 55
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
December 31, 1998 and 1997
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
1998 1997
------------- -------------
(AS RESTATED, See Note 22)
<S> <C> <C>
Policy liabilities and accruals:
Unpaid losses and loss adjustment expenses, net of discount $ 155,020,696 $ 196,095,518
Unearned premiums 20,804,432 21,634,897
Reinsurance balance payable 12,068,890 8,076,659
Deferred gain on retroactive reinsurance 1,800,994 2,168,393
Other liabilities 20,216,707 15,380,716
Taxes payable 968,059
Integration liability 152,000 546,147
Net deferred income taxes 7,185,656
Excess of fair value of net assets acquired over purchase price 4,496,551 5,064,536
------------- -------------
Total liabilities 221,745,926 249,934,925
------------- -------------
Minority Interest 68,207,311
-------------
Commitments and Contingencies (Notes 11, 12, 13, 14, 15, 16, 17 and 20)
Preferred stock, $.01 par value, authorized 2,000,000; none issued
Common stock, $.001 par value; authorized 100,000,000; issued 13,328,778 and
6,518,344 shares in 1998 and 1997, respectively 13,329 6,518
Additional paid-in capital 183,154,588 43,173,179
Accumulated other comprehensive loss (7,705,165) (4,751,531)
Retained earnings 75,504,882 83,749,061
------------- -------------
250,967,634 122,177,227
Less treasury stock, at cost (4,380,779 common shares in 1998 and 498,526 in 1997) (77,538,042) (9,828,953)
------------- -------------
Total shareholders' equity 173,429,592 112,348,274
------------- -------------
Total liabilities and shareholders' equity $ 395,175,518 $ 430,490,510
============= =============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
55
<PAGE> 56
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -----------
(AS RESTATED, See Note 22)
<S> <C> <C> <C>
Revenues:
Premium income $ 36,131,415 $ 49,876,404 $38,760,705
Net investment income 9,432,012 13,520,107 8,086,156
Net realized gain (loss) on investments (4,411,805) 21,393,331 27,080,236
Sale of surface, water, and mineral rights 2,242,200 1,494,088
Other income 4,014,692 3,735,447 2,809,183
------------ ------------ -----------
Total revenues 47,408,514 90,019,377 76,736,280
------------ ------------ -----------
Expenses:
Loss and loss adjustment expenses 30,528,007 34,330,327 22,932,490
Amortization of policy acquisition costs 10,877,142 11,567,460 1,875,324
Cost of surface, water, and mineral rights sold 1,067,503 605,578
Insurance underwriting and other expenses 15,972,883 18,176,891 18,821,296
------------ ------------ -----------
Total expenses 58,445,535 64,680,256 43,629,110
------------ ------------ -----------
Equity in income (loss) of unconsolidated affiliates (1,522,480) (1,577,876) 10,539
------------ ------------ -----------
Income (loss) from continuing operations before income taxes
and minority interest (12,559,501) 23,761,245 33,117,709
Provision for federal, foreign and state income taxes 1,292,334 7,807,971 12,714,336
------------ ------------ -----------
Income (loss) from continuing operations
before minority interest (13,851,835) 15,953,274 20,403,373
Minority interest in loss of subsidiary 4,532,632 3,202,461
------------ ------------ -----------
Income (loss) from continuing operations (9,319,203) 19,155,735 20,403,373
Income from discontinued operations, net (Note 6) 1,075,024 456,283 3,301,229
------------ ------------ -----------
Net income (loss) $ (8,244,179) $ 19,612,018 $23,704,602
============ ============ ===========
Net income (loss) per common share - basic:
Continuing operations $ (1.56) $ 3.04 $ 3.69
Discontinued operations 0.18 0.07 0.59
------------ ------------ -----------
Net income (loss) per common share $ (1.38) $ 3.11 $ 4.28
============ ============ ===========
Weighted average shares outstanding 5,981,814 6,302,401 5,538,199
============ ============ ===========
Net income (loss) per common share - diluted:
Continuing operations $ (1.56) $ 2.93 $ 3.55
Discontinued operations 0.18 0.07 0.57
------------ ------------ -----------
Net income (loss) per common share $ (1.38) $ 3.00 $ 4.12
============ ============ ===========
Weighted average shares outstanding 5,981,814 6,540,264 5,748,414
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
56
<PAGE> 57
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AS RESTATED, SEE NOTE 22
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Additional
Common Paid-In Retained
Stock Capital Earnings
-------- ------------- -------------
<S> <C> <C> <C>
Balance, January 1, 1996 $ 5,487 $ 17,404,228 $ 40,432,441
Comprehensive Income for 1996
Net income 23,704,602
Retirement of treasury stock in
connection with CIG merger (266) (780,186)
Issuance of common stock in
connection with CIG merger 1,276 26,293,091
Issuance of common stock upon exercise
of options 73,920
-------- ------------- -------------
Balance, December 31, 1996 $ 6,497 $ 42,991,053 $ 64,137,043
======== ============= =============
</TABLE>
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive Loss
----------------------------
Net Unrealized Equity
Appreciation Foreign Changes
(Depreciation) Currency of Investee Treasury
on Investments Translation Company Stock Total
------------- ----------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1996 $ 4,727,123 $ (14,792) $ (979,066) $ (801,032) $ 60,774,389
Comprehensive Income for 1996
Net unrealized depreciation on investments
net of deferred taxes of $3.2 million 5,891,940
Foreign currency translation (12,367)
Total Comprehensive Income 29,584,175
Equity changes of investee
company (7,295) (7,295)
Purchase of common stock
by affiliate (5,844,600) (5,844,600)
Retirement of treasury stock in
connection with CIG merger 780,452
Issuance of common stock in
connection with CIG merger (2,000,075) 24,294,292
Issuance of common stock upon exercise
of options 20,580 94,500
------------- ---------- ----------- ------------ -------------
Balance, December 31, 1996 $ 10,619,063 $ (27,159) $ (986,361) $ (7,844,675) $ 108,895,461
============= ========== =========== ============ =============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
57
<PAGE> 58
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AS RESTATED, SEE NOTE 22
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Additional
Common Paid-In Retained
Stock Capital Earnings
------- ------------ ------------
<S> <C> <C> <C>
Balance, December 31, 1996 $ 6,497 $ 42,991,053 $ 64,137,043
Comprehensive Income for 1997
Net income 19,612,018
Issuance of common stock
upon exercise of options 21 344,979
Purchase of common stock
in connection with CIG merger (162,853)
------- ------------ ------------
Balance, December 31, 1997 $ 6,518 $ 43,173,179 $ 83,749,061
======= ============ ============
</TABLE>
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive Loss
----------------------------
Net Unrealized Equity
Appreciation Foreign Changes
(Depreciation) Currency of Investee Treasury
on Investments Translation Company Stock Total
------------ ------------ ----------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 10,619,063 $ (27,159) $ (986,361) $ (7,844,675) $ 108,895,461
Comprehensive Income for 1997
Net unrealized depreciation on investments
net of deferred taxes of $7.1 million
and reclassification adjustment of
$9.3 million (13,169,501)
Foreign currency translation (2,173,934)
Total Comprehensive Income 4,268,583
Equity changes of investee
company 986,361 986,361
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 CIG merger (162,853)
------------ ------------ ---------- ------------ -------------
Balance, December 31, 1997 $ (2,550,438) $ (2,201,093) $ -- $ (9,828,953) $ 112,348,274
============ ============ ========== ============ =============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
58
<PAGE> 59
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AS RESTATED, SEE NOTE 22
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Additional
Common Paid-In Retained
Stock Capital Earnings
----------- ------------ ------------
<S> <C> <C> <C>
Balance, December 31, 1997 $ 6,518 $ 43,173,179 $ 83,749,061
Comprehensive Loss for 1998
Net loss (8,244,179)
Issuance of common stock
upon acquisition of minority
interest of GEC, net of costs
of $1.7 million 6,811 131,381,409
Acquisition of 412,846 shares of
treasury stock 8,400,000
Exercise of 57,307 options on
treasury stock 200,000
----------- ------------ ------------
Balance, December 31, 1998 $ 13,329 $183,154,588 $ 75,504,882
=========== ============ ============
</TABLE>
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive Loss
-----------------------------
Net Unrealized
Appreciation Foreign
(Depreciation) Currency Treasury
on Investments Translation Stock Total
-------------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Balance, December 31, 1997 $ (2,550,438) $ (2,201,093) $ (9,828,953) $ 112,348,274
Comprehensive Loss for 1998
Net unrealized depreciation on investments
net of deferred tax of $21,000 and
reclassification adjustment of $2.4 million $ 38,651
Foreign currency translation (2,992,285)
Total Comprehensive Loss (11,197,813)
Issuance of common stock
upon acquisition of minority
interest of GEC, net of costs
of $1.7 million (57,709,089) 73,679,131
Acquisition of 412,846 shares of
treasury stock (10,000,000) (1,600,000)
Exercise of 57,307 options on
treasury stock 200,000
------------ ------------ ------------ -------------
Balance, December 31, 1998 $ (2,511,787) $ (5,193,378) $(77,538,042) $ 173,429,592
============ ============ ============ =============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
59
<PAGE> 60
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
(AS RESTATED, See Note 22)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (8,244,179) $ 19,612,018 $ 23,704,602
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Deferred taxes 7,156,521 576,418 1,602,897
Depreciation and amortization 1,492,097 1,181,495 2,131,742
(Gain) loss on sale of investments 4,411,805 (21,393,331) (27,080,236)
Gain on disposal of discontinued operations (1,105,012) (1,413,012)
Gain on sale of real estate (1,174,697)
Equity in (earnings) losses of investee 1,522,480 1,577,876 (10,539)
Interest income recorded for value of Hyperfeed warrants (1,834,035)
Minority interest (4,532,632) (3,202,461)
Changes in assets and liabilities, net of effects of acquisitions:
Premiums and other receivables (6,276,903) 4,878,240 4,803,716
Reinsurance receivables and payables 23,392,977 20,528,708 23,417,931
Accrued investment income 426,732 1,370,499 (302,998)
Deferred policy acquisition costs (227,918) 56,623 4,034,743
Unpaid losses and loss adjustment expenses (41,074,822) (57,033,716) (31,097,669)
Future policy benefits (2,011,233)
Discontinued operations (2,186,355)
Unearned premiums (830,465) (13,173,128) (14,378,764)
Other adjustments, net 3,851,032 (11,602,112) 4,327,851
------------ ------------ ------------
Net cash used in operating activities (21,212,984) (62,056,273) (10,857,957)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of available for sale investments:
Fixed maturities 15,215,844 53,988,484 23,236,398
Equity securities 9,602,798 94,473,149 88,415,361
Proceeds from maturity of available for sale investments 2,925,000 9,250,000 10,731,369
Purchases of available for sale investments:
Fixed maturities (5,935,894) (23,082,301) (40,871,986)
Equity securities (9,685,616) (95,175,078) (59,995,893)
Net sales of short-term investments 4,627,225 13,388,506 8,314,267
Proceeds from the sales of real estate 74,761 270,978 1,564,389
Purchases of surface, water and mineral rights (4,143,988) (2,336,851)
Proceeds from the sale of surface, water and mineral rights 518,943
Proceeds from sale of property and equipment 6,510,166 215,882 106,996
Purchases of property and equipment (859,267) (984,623) (106,110)
Purchased cash from consolidated subsidiary 18,108,171
Proceeds from sale of business 27,130,343
Acquisition costs for purchase of minority interest in GEC (1,665,613)
Investments in and advances to affiliates (1,886,714)
Other investing activities, net (1,635,197)
------------ ------------ ------------
Net cash provided by investing activities 40,792,791 68,116,317 31,394,791
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of bank and other borrowings (16,489,329) (331,895)
Payment of lease obligations (2,400,150)
Net increase in annuity and other policyholders' funds 306,179
Proceeds from the sale of warrants issued by GEC 2,006,567
Proceeds from the sale of treasury stock 200,000
Repurchase of treasury stock (1,600,000)
Proceed from exercise of stock options 182,147 94,500
------------ ------------ ------------
Net cash provided by (used in) financing activities (3,800,150) (14,300,615) 68,784
------------ ------------ ------------
Effect of exchange rate changes on cash (561,250) 95,304 (12,367)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 15,218,407 (8,145,267) 20,593,251
Cash and cash equivalents, beginning of year 56,435,789 64,581,056 43,987,805
------------ ------------ ------------
Cash and cash equivalents, end of year $ 71,654,196 $ 56,435,789 $ 64,581,056
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest, net of amounts capitalized $ 380,000 $ 200,959
============ ============ ============
Income taxes (recovered) paid $ 440,000 $ 10,895,019 $ (1,546,045)
============ ============ ============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
60
<PAGE> 61
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED
---------------
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES:
Organization and Operations:
PICO Holdings, Inc. and subsidiaries (collectively, the "Company") is a
diversified holding company with operations in wholesale water and storage
through its subsidiary Vidler Water Company, Inc., real estate and minerals
through its subsidiary Nevada Land and Resource Company, LLC, insurance through
its subsidiaries Sequoia Insurance Company and Citation Insurance Company, and
investment management though its subsidiary Summit Global Management, Inc. In
addition, the Company has a number of strategic value investments. Also two
subsidiaries, Physicians Insurance Company of Ohio and The Professionals
Insurance Company, are in the process of winding down their medical professional
liability insurance operations.
Effective December 16, 1998, PICO Holdings Inc. ("PICO") acquired the
remaining 48.8% of the outstanding stock of Global Equity Corporation ("GEC")
through a Plan of Arrangement (the "PICO/GEC Combination") whereby GEC
shareholders received .4628 of a newly issued PICO common share for each GEC
share surrendered. Immediately following the close of the transaction, PICO
consummated a 1-for-5 reverse stock split (the "Reverse Stock Split").
Accordingly, all share amounts included herein are restated to reflect the
Reverse Stock Split.
The Company's primary subsidiaries as of December 31, 1998 are as
follows:
Global Equity Corporation ("GEC"). Prior to the PICO/GEC Combination,
GEC was a publicly held corporation listed on the Toronto Stock Exchange and The
Montreal Exchange under the symbol "GEQ". Following the PICO/GEC Combination,
PICO owns 100% of GEC. The Chairman of the Board of Directors ("Chairman") and
the President and Chief Executive Officer ("CEO") of the Company are the
Chairman and CEO of GEC, respectively. GEC is a Canadian corporation engaging in
strategic investments; surface, water, and mineral rights; and other activities,
operating primarily in the United States, but also with investments in Canada,
Asia, Europe, and the Caribbean. GEC holds a portfolio of equity and debt
securities, and interests in surface, water and mineral rights through Vidler
Water Company, Inc. and Nevada Land and Resource Company, LLC.
Vidler Water Company, Inc. ("Vidler"). Vidler is a majority-owned
Delaware corporation that was originally formed under the laws of the state of
Colorado. Vidler is engaged in the acquisition, aggregation, marketing, storage
and transfer of water and water rights for municipal and private industry use in
the southwestern United States. Vidler attempts to identify areas where water
supplies are needed in the southwestern United States and then to facilitate the
transfer from current ownership to Vidler, and subsequently to municipalities,
water districts, developers and others. Since its acquisition, Vidler has
purchased water rights and related assets in California, Colorado, Nevada and
Arizona.
Nevada Land and Resource Company, LLC ("NLRC"). NLRC's primary asset is
approximately 1.3 million acres of deeded land with appurtenant water, and
mineral rights in northern Nevada. NLRC is actively engaged in maximizing the
property's value in relation to water rights, mineral rights, and land
development. GEC owns a 74.77% membership interest, and PICO owns the remaining
25.23%.
Sequoia Insurance Company ("Sequoia"). Sequoia is a California
insurance company licensed to write insurance coverage for property and casualty
risks ("P&C") within the states of California and Nevada. Sequoia writes
business through independent agents and brokers covering risks located primarily
within northern and central California and Nevada. 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, over the past few years Sequoia transitioned from writing
primarily personal lines of business (automobile, homeowners, etc.) to
commercial lines.
Citation Insurance Company ("Citation"). Citation is a
California-domiciled insurance company licensed to write commercial property and
casualty insurance in Arizona, California, Colorado, Nevada, Hawaii, New Mexico
and Utah.
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<PAGE> 62
Physicians Insurance Company of Ohio ("Physicians"). Prior to selling
its book of medical professional liability ("MPL") insurance business in 1995,
Physicians engaged in providing MPL insurance coverage to physicians and
surgeons, primarily in Ohio. On August 28, 1995, Physicians entered into an
agreement with Mutual Assurance, Inc. ("Mutual") pursuant to which Physicians
sold its recurring MPL insurance business to Mutual. Physicians still holds MPL
unpaid losses and loss adjustment expense liabilities that are being settled.
Summit Global Management, Inc. ("Summit"). Summit is an investment
advisory company, which provides investment management services in a number of
states throughout the United States. The majority of Summit's assets under
management are those of affiliates.
Unconsolidated Affiliates:
Conex Continental Inc. ("Conex"). Formed under the laws of the Province
of Ontario, Canada and re-domiciled in Delaware on April 6, 1998, shares of
Conex trade on the Canadian Dealer Network. The principal asset of Conex is a
60% interest in a foreign joint venture, Guizhou Jonyang Machinery Industry Co.,
Ltd. The joint venture operates a manufacturing plant in Guiyang City, Guizhou
Province, China, producing wheeled and tracked hydraulic excavators.
Hyperfeed Technologies, Inc., (formerly, PC Quote) ("Hyperfeed").
Hyperfeed is a NASDAQ listed Company that provides real-time financial market
data to professionals and consumer markets worldwide through its proprietary
datafeed, Hyperfeed 2000. In addition, Hyperfeed offers software authoring and
development tools for integration of data into financial applications.
Principles of Consolidation:
The accompanying consolidated financial statements include the accounts
of the Company and its majority owned subsidiaries, and have been prepared in
conformity with generally accepted accounting principles. All significant
intercompany balances and transactions have been eliminated. Investments in
entities in which the Company does not have control, but has the ability to
exercise significant influence over operating and financial policies (generally
20% - 50% ownership), are accounted for by the equity method.
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, 1998 and 1997, it is reasonably possible that
actual results could differ from the estimates upon which the carrying values
were based.
Investments:
The Company's investment portfolio at December 31, 1998 and 1997 is
comprised of investments with fixed maturities, including U.S. government
instruments, certificates of deposit, and corporate bonds; equity securities,
including investments in common and preferred stocks, and warrants; other
investments, including debentures of public and private companies and oil and
gas leases; short term investments, including, certificates of deposit, U.S.
Treasuries and mortgage securities; and real estate.
Investments in which the Company owns between 20% to 50% of the voting
interest, has the ability to exercise significant influence are accounted for
under the equity method of accounting. Accordingly, the Company's share of
income or losses are included in consolidated results. Currently, the Company
classifies its 32% common stock ownership in Conex and its investment in
Hyperfeed as equity investments.
The Company applies the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." This statement, among other things, requires investment
securities to be divided into three categories: held to maturity, available for
sale, and trading. The Company classifies all investments that are not made
62
<PAGE> 63
for long term operating purposes as available for sale. Investments with a
readily determinable fair value are carried at fair value, while other
investments are carried at cost. Unrealized gains or losses on investments
recorded at fair value are recorded net of tax and included in accumulated other
comprehensive income or loss.
The Company regularly reviews the carrying value of its investments for
impairment. A decline in the market value of any investment below cost that is
deemed other than temporary is written down to net realizable value. Adjustments
for write-downs are reflected in realized gains or losses on investments in the
consolidated statements of operations.
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.
The Company invests domestically and abroad. Approximately $32.7
million and $46.2 million of the Company's investments at December 31, 1998 and
1997, respectively, were invested internationally. The Company's most
significant foreign currency exposure is in Europe, Asia and Australia.
Real estate represents the carrying value of real property held for
investment.
Cash and Cash Equivalents:
Cash and cash equivalents include highly liquid debt instruments
purchased with original maturities of three months or less.
Surface, Water and Mineral Rights:
Water rights consist of various water interests acquired independently
or in conjunction with the acquisition of real properties. Water rights are
stated at cost and, when applicable, consist of an allocation of the original
purchase price between water rights and other assets acquired based on their
relative fair values. In addition, costs directly related to the acquisition and
development of water rights are capitalized. Surface and mineral rights and land
improvements are carried at cost. This cost includes, when applicable, the
allocation of the original purchase price, costs directly related to
acquisition, and interest and other costs directly related to developing land
for its intended use. Amortization of land improvements is computed on the
straight-line method over the estimated useful lives of the improvements ranging
from 5 to 15 years. Provision is made for any diminution in value that is
considered to be other than temporary.
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 and
repairs are charged to expense as incurred, while significant improvements are
capitalized. Gains or losses on the sale of property and equipment are included
in other income.
Deferred Acquisition Costs:
Costs of the insurance companies that vary with and are primarily
related to the acquisition of new and renewal insurance contracts, net of
reinsurance ceding commissions, are deferred and amortized over the terms of the
policies for property and liability insurance. 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. The Company recorded negative goodwill (i.e., excess of
fair value of assets acquired over purchase price) as a result of the
acquisition of Citation Insurance Group in November 1996. Negative goodwill is
included in "Other Liabilities" in the accompanying consolidated balance sheets,
and is being amortized on the straight line method over 10 years. For the years
ended December 31, 1998, 1997 and 1996 amortization of negative goodwill was
approximately $568,000.
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<PAGE> 64
Impairment of Long-Lived Assets:
The Company applies the provisions of SFAS No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and
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) for the lowest level for
which there are identifiable cash flows that are independent of the cash flows
of other groups of assets do not exceed the carrying amount. The Company
prepares and analyzes cash flows at various levels of grouped assets. The
Company reviews cash flows for significant individual assets held within a
subsidiary, and for a subsidiary taken as a whole. 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:
Reserves for MPL and property and casualty insurance 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 MPL insurance claims have
been adjusted to reflect the time value of money (discounting).
Recognition of Premium Revenue:
MPL and other property and casualty insurance premiums written are
earned principally on a monthly pro rata basis over the lives of the policies.
The premiums applicable to the unexpired terms of the policies are included in
unearned premiums.
Income Taxes:
The Company's provision for income tax expense includes federal, state,
local and foreign income taxes currently payable and those deferred because of
temporary differences between the income tax and financial reporting bases of
the 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, management
considers whether it is more likely than not that any 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 be established or
modified.
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 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 that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in earnings. The
Company adopted the new method of reporting EPS for the year ended December 31,
1997, and the 1996 financial statements were restated in 1997 to reflect the
change.
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<PAGE> 65
Reconciliation of the Basic and Diluted EPS is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
Net income (loss) $ (8,244,179) $19,612,018 $23,704,602
============ =========== ===========
Basic income (loss) per share $ (1.38) $ 3.11 $ 4.28
============ =========== ===========
Basic weighted average common shares outstanding 5,981,814 6,302,401 5,538,199
Options 237,863 210,215
------------ ----------- -----------
Diluted weighted average common and
common equivalent shares outstanding 5,981,814 6,540,264 5,748,414
============ =========== ===========
Diluted income (loss) per share $ (1.38) $ 3.00 $ 4.12
============ =========== ===========
</TABLE>
Stock options of 1,096,972, 276,543 and 339,218 for 1998, 1997 and
1996, respectively and 223,187 warrants in 1998, were not included in the
calculation of weighted average shares because the impacts of such instruments
were anti-dilutive.
Comprehensive Loss
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 established requirements for disclosure of comprehensive
income and is effective for the Company for the year ended December 31, 1998.
The Company adopted the new standard for the year ended 1998, and has
reclassified previous financial statements to conform to the new presentation.
Comprehensive income or loss includes foreign currency translation, and
unrealized holding gains and losses on available for sale securities, which
prior to adoption were reported separately in stockholders' equity. The
components of accumulated other comprehensive loss are as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net unrealized loss on securities $(2,511,787) $(2,550,438)
Foreign currency translation (5,193,378) (2,201,093)
=========== ===========
Accumulated other comprehensive loss $(7,705,165) $(4,751,531)
=========== ===========
</TABLE>
Accumulated other comprehensive loss is net of deferred income tax
benefit of $1.3 million for the years ended December 31, 1998 and 1997.
Translation of Foreign Currency:
Financial statements of foreign operations are translated into U.S.
dollars using average rates of exchange in effect during the year for revenues,
expenses, gains and losses, and the exchange rate in effect at the balance sheet
date for assets and liabilities. Unrealized exchange gains and losses arising on
translation are reflected within accumulated other comprehensive loss.
Reclassifications:
Certain amounts in the financial statements for prior periods have been
reclassified to conform to the current year presentation.
Recent Accounting Pronouncements:
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No.
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<PAGE> 66
133 establishes accounting and reporting standards for derivative instruments,
including instruments embedded in other contracts and for hedging activities. It
requires recognition of all derivatives as either assets or liabilities in the
consolidated balance sheet, and measure those instruments at fair value. The new
standard, as amended, becomes effective for fiscal years beginning after June
15, 2000. Management has not assessed the impacts this statement may have on the
Company's consolidated financial statements.
2. SIGNIFICANT ACQUISITIONS:
On December 16, 1998, PICO acquired the remaining 48.8% of GEC, making
it a wholly-owned subsidiary. This was accomplished through an exchange of PICO
shares for GEC shares at the exchange ratio of .4628 of a PICO share for each
share of GEC. PICO issued a total of 6,810,426 shares of PICO common stock to
former GEC shareholders. PICO subsidiaries hold 3,110,837 of these newly issued
shares which are recorded at cost, as treasury stock in the consolidated balance
sheets of the Company. Net of the shares issued to affiliates, PICO issued
3,699,589 common shares valued at the average market price per share 5 days
before, and after the announcement of the transaction. This average was
approximately $22.10 per share (post reverse split). In addition, PICO exchanged
223,187 PICO warrants with an exercise price of $23.80 per share for all the
outstanding GEC warrants using the same exchange ratio. PICO also exchanged
484,967 stock options to GEC officers, two current GEC directors and a former
GEC director in exchange for surrendering their GEC stock options. These grants
placed the participants in a substantially similar position regarding shares and
exercise price and vesting.
The acquisition was accounted for using the purchase method of
accounting. Accordingly, a portion of the purchase price was allocated to the
net assets acquired based on their estimated fair values as noted in the
following table:
<TABLE>
<S> <C>
Purchase Price:
Value of approximately 3.7 million PICO shares exchanged $ 81,760,917
Direct costs of acquisition 1,665,613
Value of GEC options assumed 2,731,975
------------
$ 86,158,505
============
Allocation of Purchase Price:
Historic GEC shareholders' equity acquired $ 58,801,561
Adjustments to assets and liabilities acquired:
Increase in book value of surface, water and mineral rights 36,945,129
Increase in book value of PICO common stock owned by GEC 3,342,610
Deferred income tax liability (12,930,795)
------------
$ 86,158,505
============
</TABLE>
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<PAGE> 67
The following table reflects unaudited pro forma combined results of
operations of the Company and GEC on the basis that the acquisition had taken
place at the beginning of the fiscal year for each of the periods presented:
<TABLE>
<CAPTION>
(Unaudited)
1998 1997
------------ -----------
<S> <C> <C>
Total revenues $ 47,408,514 $90,019,377
Income (loss) before income taxes (17,100,625) 20,558,784
Net income (loss) (17,300,443) 13,207,096
Net income (loss) per share - basic $(1.93) $1.38
Net income (loss) per share - diluted $(1.93) $1.34
</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 at the
beginning of the period or of future results of operations of the consolidated
entities.
On April 23, 1997, GEC and PICO acquired 100% of the membership
interest of NLRC, a Delaware limited liability company. The total purchase price
was approximately $48.6 million. A wholly-owned subsidiary of GEC, Global Nevada
Land Resource Corporation, owns 74.77% of the membership interests of NLRC. PICO
paid approximately $12 million for the remaining 25.23% membership 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.
3. INVESTMENTS:
At December 31, the cost and carrying value of available for sale
investments are as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Carrying
Cost Gains Losses Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
1998:
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 6,991,162 $ 63,105 $ (43,919) $ 7,010,348
Corporate securities 12,943,949 184,032 13,127,981
Mortgage-backed
securities 12,503,811 12,503,811
------------ ------------ ------------ ------------
32,438,922 247,137 (43,919) 32,642,140
Equity securities 65,521,756 5,017,651 (9,915,154) 60,624,253
------------ ------------ ------------ ------------
Total $ 97,960,678 $ 5,264,788 $ (9,959,073) $ 93,266,393
============ ============ ============ ============
</TABLE>
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<PAGE> 68
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Carrying
Cost Gains Losses Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
1997:
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
securities 12,000,000 12,000,000
------------ ------------ ------------ ------------
43,417,705 327,706 (479,120) 43,266,291
Equity securities 78,066,344 12,921,372 (6,249,394) 84,738,322
------------ ------------ ------------ ------------
Total $121,484,049 $ 13,249,078 $ (6,728,514) $128,004,613
============ ============ ============ ============
</TABLE>
The amortized cost and carrying value of investments in fixed
maturities at December 31, 1998, by contractual maturity, are shown below.
Expected maturity dates may differ from contractual maturity dates because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Carrying
Cost Value
----------- -----------
<S> <C> <C>
Due in one year or less $ 3,778,239 $ 3,787,630
Due after one year through five years 13,959,770 14,156,407
Due after five years through ten years 2,197,102 2,194,292
Mortgage-backed securities 12,503,811 12,503,811
----------- -----------
$32,438,922 $32,642,140
=========== ===========
</TABLE>
Investment income is summarized as follows for each of the years ended
December 31:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ ------------
<S> <C> <C> <C>
Investment income from:
Available for sale:
Fixed maturities $ 1,694,345 $ 3,665,643 $ 4,883,162
Equity securities 585,330 2,956,309 1,546,020
Short-term investments
and other 7,540,967 7,412,342 2,332,626
----------- ------------ ------------
Total investment income 9,820,642 14,034,294 8,761,808
Investment expenses (388,630) (514,187) (675,652)
----------- ------------ ------------
Net investment income $ 9,432,012 $ 13,520,107 $ 8,086,156
=========== ============ ============
</TABLE>
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<PAGE> 69
Pre-tax net realized gains (losses) on investments were as follows for
each of the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ ------------
<S> <C> <C> <C>
Gross realized gains:
Available for sale:
Fixed maturities $ 201,665 $ 300,167 $ 36,123
Equity securities 3,825,708 31,083,312 27,469,731
----------- ------------ ------------
Total gain 4,027,373 31,383,479 27,505,854
----------- ------------ ------------
Gross realized losses:
Available for sale:
Fixed maturities (178,770) (1,253,139) (292,612)
Equity securities (8,260,408) (8,737,009) (133,006)
----------- ------------ ------------
Total losses (8,439,178) (9,990,148) (425,618)
----------- ------------ ------------
Net realized gain (loss) $(4,411,805) $ 21,393,331 $ 27,080,236
=========== ============ ============
</TABLE>
During 1998, the Company recorded $8.2 million in permanent write downs
of investments to recognize what is expected to be other than temporary declines
in the market values of those securities.
Approximately $26.8 million of the total gross realized gains for the
year ended December 31, 1997 were generated from the conversion of Resource
America, Inc. warrants and the immediate sale of the converted common stock. For
the year ended 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.
These write-downs have been recorded as a realized loss.
During 1998, the Company purchased 857,000 shares of Australian Oil and
Gas ("AOG") for $803,000. During 1999, an additional 5.9 million shares were
acquired for $6.3 million. As of March 1999, the Company owns a 14.9% interest
in AOG. Also during 1998, the Company purchased 5,000 shares of Jungfraubahn
Holding AG ("Jungfraubahn") based in Interlaken, Switzerland. In February 1999,
70,000 additional shares were acquired. In total the Company purchased a 17.6%
shareholding for $15.9 million. The acquisition was financed with $7 million in
cash and the remaining balance in debt.
4. INVESTMENT IN UNCONSOLIDATED AFFILIATES:
At December 31, 1998, the Company's investment in Conex consisted of
ownership of 32% of Conex's outstanding common stock, $5 million in preferred
stock and $2.1 million in advances. In addition, the Company owns warrants to
purchase additional Conex common stock. The common stock investment at December
31, 1998 is accounted for using the equity method of accounting, while the
remaining investment balances are carried at cost. At December 31, 1998, the
Company's equity method investment had been reduced to zero due to recurring
Conex losses. For the year ended December 31, 1998 the Company's equity in
losses of this investee totaled $771,000. The Company's interest in Conex is not
currently material to the Company's financial position or results of operations.
At December 31, 1998, the Company's investment in Hyperfeed consisted
of 2,370,000 shares of common stock (representing 16.7% of the common shares
outstanding) and 4,786,547 shares of preferred stock, representing a 24% diluted
voting interest and an additional 4,055,195 common stock warrants, which, on a
diluted basis, would represent an additional 17% voting interest. The common and
preferred stock are presented using the equity method of accounting for
investments in common stock as prescribed by APB No. 18, and have a combined
carrying value of $4.9 million at December 31, 1998. The difference between the
carrying value of the investment and the underlying equity in the net assets or
liabilities of Hyperfeed is considered goodwill and is being amortized over 10
years on a straight line basis. At December 31, 1998, the common stock warrants
are carried in accordance with SFAS No. 115 at an estimated fair value of $6.1
million using the Black Scholes option pricing model, with an unrealized gain of
$1.3 million net of deferred income tax liability. The Black Scholes pricing
model incorporates assumptions in calculating an estimated fair value.
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<PAGE> 70
The following assumptions were used in the computations: no dividend
yield for all years; a risk-free interest rates ranging from 5% to 6%; a three
year expected life for the 1997 calculation and a two year expected life for the
1998 calculation; and a historical 4 year cumulative volatility of 133%. The
market value of the common shares and preferred shares based on the December 31,
1998 closing price of Hyperfeed common stock is approximately $5 million and
$10.2 million, respectively.
At December 31, 1997, the investment in Hyperfeed consisted of
2,050,000 shares of common stock (representing 16.5% of the common shares
outstanding) and 1,269,032 common stock warrants, which on a diluted basis would
represent an additional 9% voting interest. The investment in common stock had
an equity carrying value of $706,000 at December 31, 1997. At December 31, 1997,
the common stock warrants are carried in accordance with SFAS No. 115 at an
estimated fair value of $887,000 using the Balck Scholes option pricing model,
with an unrealized loss of $625,000 net of a deferred income tax asset. The
market value of the common shares based on the December 31, 1997 closing price
of Hyperfeed common stock was approximately $1.9 million.
During the three years ended December 31, 1998, Hyperfeed recorded
various capital transactions that affected PICO's voting ownership percentage.
In 1997, Hyperfeed sold 5 million shares common stock and warrants to purchase
500,000 shares of common stock at $1 per share, for net proceeds of $4.7
million. As a result, PICO's voting ownership declined from 27.8% prior to the
transaction to 16.6%. This gave rise to a dilution gain of $997,000. Deferred
taxes are provided on each dilution transaction. During 1998, there were various
capital transactions, other than the debt conversion, that affected PICO's
voting ownership percentage. In summary, PICO's ownership percentage increased
from 16.4% at the beginning of 1998 to 18% at June 30, 1998 then declined to
17.7% at September 30, 1998. After giving effect to the debt conversion in
December, PICO's voting ownership at December 31, 1998 was 37.7%. PICO's voting
ownership percentage in Hyperfeed at the beginning of 1996 was 28.5% and 27.9%
at the end of 1996.
In December 1998, the Company converted its $2.5 million Hyperfeed
debenture, $3.3 million line of credit and $969,000 in accrued interest into
1,907,463 shares of Hyperfeed Series A voting convertible preferred shares,
2,879,077 series B voting convertible preferred shares, and 3,106,163 million
warrants to purchase Hyperfeed common shares, expiring in 2006. See Note 22 for
additional information.
5. SURFACE, WATER AND MINERAL RIGHTS:
Through its subsidiaries Vidler and NLRC, PICO owns surface, water and
mineral rights consisting of various real properties, surface rights, water
rights and mineral rights in California, Arizona, Colorado and Nevada. The costs
assigned to the various components of surface and mineral rights, water rights,
and land improvements at December 31, were as follows:
<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
NLRC:
Surface and mineral rights $ 53,905,167 $55,713,051
Vidler:
Water rights 20,012,797 9,745,657
Land improvements, net 2,499,189 1,619,259
Surface rights 40,236,058 8,099,048
------------ -----------
Surface, water and mineral rights $116,653,211 $75,177,015
============ ===========
</TABLE>
6. DISCONTINUED OPERATIONS:
On June 16, 1997, the Company announced a definitive agreement to sell
its life and health insurance subsidiary, American Physicians Life ("APL"). The
closing was completed on December 4, 1998. Proceeds from the sale were $17
million in cash. On August 21, 1997, GEC announced an agreement to sell its Sri
Lankan subsidiaries. The closings occurred during 1997 for consideration of
$17.3 million in cash and $7.7 million in marketable securities. Approximately
$15 million of the $25 million purchase price was received in 1997, and the
remaining balance was received in 1998.
Because these subsidiaries represented major segments of the Company's
business, in accordance with APB No. 30 "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business,"
operations for all of 1998, 1997 and 1996
70
<PAGE> 71
have been classified as discontinued operations. The net assets are shown as a
single line item in the accompanying balance sheet as "Net assets of
discontinued operations."
The following reconciles income (loss) from continuing operations to
net income (loss) :
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Income (loss) from continuing operations
before income taxes and minority interest $(12,559,501) $ 23,761,245 $33,117,709
Provision for income taxes 1,292,334 7,807,971 12,714,336
Minority interest 4,532,632 3,202,461
------------ ------------ -----------
Income (loss) from continuing operations (9,319,203) 19,155,735 20,403,373
------------ ------------ -----------
Income from discontinued operations, net of
income taxes of $86,000 in 1998, $965,000 in 1997
and $701,000 in 1996 and minority interest of $489,000 in 1997 345,716 892,275 3,301,229
Gain (loss) on disposal of discontinued operations, net of
income tax of $375,000 in 1998 and $1.3 million in 1997
and foreign currency of $1.2 million in 1997 729,308 (160,250)
Minority interest (275,742)
------------ ------------ -----------
Income from discontinued operations 1,075,024 456,283 3,301,229
------------ ------------ -----------
Net income (loss) $ (8,244,179) $ 19,612,018 $23,704,602
============ ============ ===========
</TABLE>
Following is an unaudited summary of APL's stand alone financial
results for the periods included in the statements of operations as discontinued
operations:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ----------- ----------
<S> <C> <C> <C>
Total revenues $9,172,435 $ 5,310,330 $9,031,846
Income (loss) before taxes 431,650 (112,012) 4,002,406
Net income (loss) 345,716 (167,327) 3,301,229
Net income (loss) per share - basic $0.07 ($0.03) $0.60
Net income (loss) per share - diluted $0.07 ($0.03) $0.57
</TABLE>
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. Operating results for 1996 are
not shown since this period was prior to the effective date of
consolidation of GEC with PICO.
<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 $0.05
Net income per share - diluted $0.04
</TABLE>
71
<PAGE> 72
7. PREMIUMS AND OTHER RECEIVABLES:
Premiums and other receivables consisted of the following at December
31:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Agents' balances and unbilled premiums $ 7,513,754 $ 20,723,259
Other accounts receivable 2,994,788 77,333
------------ ------------
10,508,542 20,800,592
Allowance for doubtful accounts (94,525) (119,024)
------------ ------------
$ 10,414,017 $ 20,681,568
============ ============
</TABLE>
8. FEDERAL INCOME TAX:
The Company and its U.S. subsidiaries, excluding U.S. subsidiaries of
GEC, 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>
1998 1997
------------ ------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 10,358,223 $ 6,800,000
Loss reserves 11,142,641 17,312,601
Unearned premium reserves 1,265,960 1,319,214
Unrealized depreciation on securities 2,683,119
Deferred gain on retroactive reinsurance 612,338 758,938
Integration liability 51,680 185,690
Other, net 1,557,275 1,438,862
------------ ------------
Total deferred tax assets 27,671,236 27,815,305
------------ ------------
Deferred tax liabilities:
Reinsurance receivables 8,484,586 10,868,442
Deferred policy acquisition costs 1,886,536 1,809,043
Unrealized appreciation on securities 243,775 131,597
Revaluation of surface, water and mineral rights 14,880,795 4,986,358
NLRC land sales 455,000
Accretion of bond discount 62,888 72,076
Depreciation 153,339 463,060
------------ ------------
Total deferred tax liabilities 26,166,919 18,330,576
------------ ------------
Net deferred tax assets before
valuation allowance 1,504,317 9,484,729
Less valuation allowance (8,689,973) (6,800,000)
------------ ------------
Net deferred tax asset (liability) $ (7,185,656) $ 2,684,729
============ ============
</TABLE>
72
<PAGE> 73
The deferred tax asset valuation allowance as of December 31, 1998 and
1997 relates to the net operating loss carryforwards (NOL's) of Citation, PICO,
GEC and its subsidiaries. NOL's for U.S. corporations, and to a similar extent
Canadian tax NOL's, are subject to the separate return limitation rules.
Therefore, certain of these NOL's can only be used to offset the respective
future taxable income generated by Citation, PICO, GEC and its subsidiaries,
individually. Due to the uncertainty related to future income of these
subsidiaries, the Company recorded a valuation allowance to reflect the
estimated amount of deferred tax assets that may not be realized. Deferred tax
assets and liabilities, 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 realization of deferred tax assets.
Pre-tax income (loss) from continuing operations for the years ended
December 31 was under the following jurisdictions:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Domestic $ (8,478,440) $ 36,248,709 $ 33,147,935
Foreign (4,081,061) (12,487,464) (30,226)
------------ ------------ ------------
Total $(12,559,501) $ 23,761,245 $ 33,117,709
============ ============ ============
</TABLE>
Income tax expense (benefit) from continuing operations for each of the
years ended December 31 consists of the following:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Current tax expense (benefit):
U.S. federal $ (5,415,430) $ 9,292,120 $ 11,042,744
Foreign 358,759
------------ ------------ ------------
Total tax expense (benefit) (5,056,671) 9,292,120 11,042,744
------------ ------------ ------------
Deferred tax expense (benefit):
U.S. federal $ 3,205,910 $ 2,068,300 $ 1,671,592
Foreign 3,143,095 (3,552,449)
------------ ------------ ------------
Total tax expense (benefit) 6,349,005 (1,484,149) 1,671,592
------------ ------------ ------------
Total income tax expense $ 1,292,334 $ 7,807,971 $ 12,714,336
============ ============ ============
</TABLE>
The difference between income taxes provided at the Company's
effective tax rate and federal statutory rate is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Federal income tax expense (benefit) at statutory rate $ (4,081,166) $ 8,363,895 $ 11,648,332
Change in valuation allowance 1,889,973 (136,000) (53,323)
Investment valuation 3,434,307
Other 49,220 (419,924) 1,119,327
------------ ------------ ------------
Federal income tax expense $ 1,292,334 $ 7,807,971 $ 12,714,336
============ ============ ============
</TABLE>
Provision has not been made for U.S. or additional foreign tax on the
undistributed earnings of foreign subsidiaries. It is not practical to estimate
the amount of additional tax that might be payable. At December 31, 1998 and
1997, the Company had a $6.5 million income tax receivable and a $1 million
income tax payable, respectively. The aggregate NOL's of approximately $24.2
expire between 1999 and 2013. There is an annual limitation on the utilization
of PICO's, Citation's and Sequoia's NOL's of approximately $1.4 million.
73
<PAGE> 74
9. PROPERTY AND EQUIPMENT:
The major classifications of property and equipment are as follows at
December 31:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Land $ 1,923,015
Buildings 7,012,657
Office furniture, fixtures and equipment $ 5,796,110 6,265,524
Building and leasehold improvements 22,988 12,499
------------ ------------
5,819,098 15,213,695
Accumulated depreciation (3,967,596) (6,662,888)
------------ ------------
Net book value $ 1,851,502 $ 8,550,807
============ ============
</TABLE>
Depreciation expense was $1.3 million, $873,000, and $751,000 in 1998,
1997, and 1996, respectively.
10. DEFERRED POLICY ACQUISITION COSTS:
Changes in deferred policy acquisition costs were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Balance, January 1 $ 5,320,716 $ 5,377,339 $ 2,894,644
Additions:
Commissions 6,711,752 7,677,146 4,158,421
Other 4,540,307 4,431,623 1,860,247
Acquired in merger 1,593,930
Ceding commissions (43,819) (13,596) (397,698)
------------ ------------ -----------
Deferral of expense 11,208,240 12,095,173 7,214,900
------------ ------------ -----------
Adjustment for expected gross
profits on investment and
life-type contracts resulting
from SFAS 115 mark-to-market 17,556
Adjustment for premium
deficiency (103,180) (584,366)
Amortization to expense (10,877,142) (11,567,430) (2,205,530)
------------ ------------ -----------
Balance, December 31 $ 5,548,634 $ 5,320,716 $ 7,921,570
============ ============ ===========
</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 DECEMBER 16, 1998 1-FOR-5 REVERSE STOCK SPLIT):
On December 16, 1998, PICO acquired the remaining shares of GEC. This
was accomplished through an exchange of PICO shares for GEC shares at the
exchange ratio of .4628 of a PICO share for each share of GEC. PICO issued a
total of 6,810,426 shares of PICO common stock to former GEC shareholders. PICO
subsidiaries hold 3,110,837 of these newly issued shares which are recorded as
treasury stock in the consolidated balance sheets of the Company. Following the
transaction, PICO has 13,328,778 shares of common stock issued and outstanding
of which 4,380,779 million are accounted for as treasury stock, at cost in the
consolidated balances sheets. In addition, PICO exchanged 223,187 PICO warrants
with an exercise price of $23.80 per share for
74
<PAGE> 75
all the outstanding GEC warrants using the same exchange ratio. The original
October 23, 1998 expiration date of the warrants was extended to June 30, 1999.
No other warrants exist. PICO also exchanged 484,967 stock options to GEC
officers, two current GEC directors and a former GEC director in exchange for
surrendering their GEC stock options. These grants placed the participants in a
substantially similar position regarding shares and exercise price, vested
according to their original terms.
On May 9, 1996, the Company, Guinness Peat Group plc ("GPG") and GEC
entered into an agreement whereby GPG agreed to sell 851,683 common shares of
the Company's common stock to GEC at an average price of approximately $18.00
per share. Prior to the sale, GPG owned approximately 40% of the Company's
common stock. Following the sale, GPG and GEC owned approximately 23% and 16% of
the Company's common stock, respectively. Subsequent to the Merger with CIG in
November 1996, GPG and GEC owned approximately 19% and 13.1%, respectively. The
shares of the Company owned by GEC are recorded as treasury stock in the
Company's consolidated balance sheet. GPG sold 64,800 PICO shares in May 1997
pursuant to Securities Exchange Commission Rule 144 on the open market,
decreasing its ownership of the Company to approximately 17.6%. On July 23,
1998, GPG sold 672,517 unregistered shares of PICO common stock to several
institutional investors, representing substantially all of GPG's holdings in
PICO. PICO acquired 412,846 shares from GPG at a cost of $1.6 million, and
assumed call option obligations for the delivery of these shares when the
options are exercised. These call options expire on December 30, 2003 and are
held by PICO's chairman of the board and president and chief executive officer.
On December 31, 1998, 57,307 of these options were exercised for a total of
$200,000.
On November 30, 1998, the Company eliminated the 1991 Shareholder
Rights Plan, which had been adopted by Citation Insurance Group prior to its
acquisition by PICO. The action was taken by unanimous vote of PICO's
independent directors, as required by the terms of the Plan, and on the
recommendation of management.
Pursuant to direction by the Board of Directors in the last quarter of
1997, management is in the process of terminating the CIG ESOP. No contributions
were made to the plan in 1998, 1997 or 1996.
Stock Option Plans
PICO Holdings' 1995 Non-Qualified Stock Option Plan. PICO was
authorized to issue 521,030 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 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. A total of 512,005 options have been issued from this plan. No
options were granted from the plan in 1998. The Company granted stock options in
1996 and 1995 under this plan in the form of incentive stock options and
non-qualified stock options. All issued options from this plan are fully vested.
PICO Holdings' 1998 Option Plan. PICO is authorized to issue 100,000
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. On October 22, 1998, PICO granted 100,000
non-qualified common stock options to an officer of the Company at an exercise
price of $15.625 per share. The options granted vest monthly over three years,
expiring October 22, 2008.
PICO Holdings' 1998 GEC/PICO Option Plan. As discussed above, PICO
assumed 484,967 options to existing GEC option holders pursuant to the
acquisition of the remaining shares of GEC by exchanging PICO options for GEC
options. The options granted from this plan placed the participants in an
economically equivalent position regarding the number of shares, exercise price,
and with vesting according to their original terms.
75
<PAGE> 76
A summary of the status of the Company's stock options is presented
below for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------ ---------------------- ----------------------
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 514,405 $ 13.55 551,901 $ 14.15 516,019 $ 13.45
Granted 100,000 15.63 14,028 13.45
Exercised (21,000) 16.45 (7,014) 13.45
Canceled (2,400) 30.00 (16,496) 33.20 (14,028) 13.45
Options assumed in merger 484,967 18.41 42,896 22.45
Outstanding at end of year 1,096,972 15.89 514,405 13.55 551,901 14.15
Exercisable at end of year 1,002,528 15.91 514,405 13.55 499,130 13.45
Weighted-average fair value
of options granted during
the year $ 10.23 $ 18.10
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------- ---------------------------------
Weighted
Average Weighted
Number Remaining Average Number Weighted
Range of Outstanding Contractual Exercise Exercisable Average
Exercise Prices at 12/31/98 Life Price at 12/31/98 Exercise Price
- --------------------- ----------- ----------- -------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$13.45 to $14.40 512,005 6.64 $13.55 512,005 $13.55
$15.63 to $18.40 584,967 3.37 $17.93 490,523 $18.38
--------- ---------
$13.45 to $18.40 1,096,972 4.89 $15.89 1,002,528 $15.91
========= =========
</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 1998, 1997 and 1996, 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 62% for 1998 grants, and 50% for 1997 and 1996
grants.
Had compensation cost for the Company's stock-based compensation plans
been determined consistent with SFAS No. 123, the Company's net income (loss)
and net income (loss) per share would approximate the following pro forma
amounts for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Reported net income (loss) $ (8,244,179) $ 19,612,018 $ 23,704,602
SFAS No. 123 charge (56,836) (1,462,477) (1,954,185)
------------ ------------ ------------
Pro forma net income (loss) $ (8,301,015) $ 18,149,541 $ 21,750,417
============ ============ ============
Pro forma net income (loss) per share - basic $ (1.39) $ 2.88 $ 3.93
============ ============ ============
Pro forma net income (loss) per share - diluted $ (1.39) $ 2.78 $ 3.78
============ ============ ============
</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
76
<PAGE> 77
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>
1998 1997
----------- -----------
<S> <C> <C>
Estimated reinsurance recoverable on:
Unpaid losses and loss adjustment expense (net of
discount of $2,739,332 and $3,332,309, respectively) $52,000,444 $67,654,430
Reinsurance recoverable on paid losses and loss expenses 1,126,785 4,671,146
----------- -----------
53,127,229 72,325,576
Other balances receivable from reinsurers 2,497,601 2,700,000
----------- -----------
Reinsurance receivables $55,624,830 $75,025,576
=========== ===========
</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.
CONCENTRATION OF REINSURANCE (in millions)
<TABLE>
<CAPTION>
Unearned Reported Unreported Reinsurer
Premiums Claims Claims Balances
-------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Sydney Reinsurance Corporation $ 6.5 $ 10.7 $ 17.2
Kemper Reinsurance Company $ 0.6 $ 0.6
Continental Casualty Company $ 0.9 $ 1.0 $ 1.9
Hartford RE Co. $ 0.1 $ 0.1
Hartford Fire Insurance Company $ 0.3 $ 0.7 $ 0.2 $ 1.2
TIG Reinsurance Group $ 1.7 $ 6.1 $ 7.8
Transatlantic Reinsurance Company $ 8.6 $ 8.6
Cologne Reinsurance Company of America $ 0.9 $ 0.9
Mutual Assurance, Inc. $ 5.3 $ 1.6 $ 6.9
General Reinsurance $ 1.8 $ 1.8
National Reinsurance Corporation $ 0.4 $ 1.8 $ 0.6 $ 2.8
</TABLE>
Immediately prior to the sale of Sequoia to Physicians by Sydney
Reinsurance Corporation ("SRC") in 1995, Sequoia and SRC entered into a
reinsurance treaty whereby all policy and claims liabilities of Sequoia prior to
the date of purchase by Physicians are the responsibility of SRC. Payment of
SRC's reinsurance obligations under this treaty has been unconditionally and
irrevocably guaranteed by QBE Insurance Group Limited should SRC be unable to
meet its obligations under the reinsurance agreement.
The Company entered into a reinsurance treaty in 1995 with Mutual
Assurance Inc. ("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 retroactive reinsurance arrangement
with respect to its MPL business. As a result, Physicians initially recorded a
deferred gain on retroactive reinsurance of $3.4 million in 1994. Deferred gains
are being amortized
77
<PAGE> 78
into income over the expected payout of the underlying claims using the interest
method. The unamortized gain as of December 31, 1998 and 1997 was $1.8 million
and $2.2 million, 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.
The following is a summary of the net effect of reinsurance activity on
the consolidated financial statements for 1998, 1997, and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Direct premiums written $ 41,792,175 $ 46,634,157 $ 44,423,399
Reinsurance premiums assumed 93,277 183,945 274,296
Reinsurance premiums ceded (6,598,800) (7,125,152) (7,140,634)
------------ ------------ ------------
Net premiums written $ 35,286,652 $ 39,692,950 $ 37,557,061
============ ============ ============
Direct premiums earned 42,760,312 60,474,680 58,059,587
Reinsurance premiums assumed 141,734 220,564 281,019
Reinsurance premiums ceded (6,770,631) (10,818,840) (19,579,901)
------------ ------------ ------------
Net premiums earned $ 36,131,415 $ 49,876,404 $ 38,760,705
============ ============ ============
Losses and loss adjustment expenses incurred:
Direct 32,124,801 47,890,333 35,969,535
Assumed 261,504 427,371 69,541
Ceded (2,501,772) (17,045,189) (17,458,446)
------------ ------------ ------------
29,884,533 31,272,515 18,580,630
Effect of discounting on losses and
loss adjustment expenses (Note 13) 643,474 3,057,812 4,351,860
------------ ------------ ------------
Net losses and loss adjustment expenses $ 30,528,007 $ 34,330,327 $ 22,932,490
============ ============ ============
</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"). Citation 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 ("NAIC"), 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,
1998, 1997, and 1996, the Ohio Department permitted Physicians to discount its
losses and loss adjustment expenses related to its MPL claims to reflect
anticipated investment income. Such permission was granted due primarily to the
longer claims settlement period related to MPL business as compared to most
other
78
<PAGE> 79
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 $85.8 million, net of discounting of $11.3 million
at December 31, 1998 and $108.7 million, net of discounting of $12.5 million at
December 31, 1997.
Activity in the reserve for unpaid claims and claim adjustment expenses
was as follows for each of the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Balance at January 1 $ 196,095,518 $ 252,023,546 $ 229,796,606
Less reinsurance recoverables (67,654,430) (89,493,139) (92,474,112)
------------- ------------- -------------
Net balance at January 1 128,441,088 162,530,407 137,322,494
------------- ------------- -------------
Incurred loss and loss adjustment expenses
for current accident year claims 23,242,512 33,440,000 20,806,194
Incurred loss and loss adjustment expenses
for prior accident year claims 7,009,420 (980,469) (2,609,907)
Retroactive reinsurance (367,399) (1,187,016)
Provision for deferral of gain on retroactive
reinsurance (145,135)
Accretion of discount 643,474 3,057,812 4,881,338
------------- ------------- -------------
Total incurred 30,528,007 34,330,327 22,932,490
------------- ------------- -------------
Net balances acquired in merger 41,293,239
------------- ------------- -------------
Effect of retroactive reinsurance 367,399 1,187,018 145,135
------------- ------------- -------------
Payments for claims occurring during:
Current accident year (11,468,646) (13,886,002) (6,964,436)
Prior accident years (44,847,596) (55,720,662) (32,198,515)
------------- ------------- -------------
Total paid (56,316,242) (69,606,664) (39,162,951)
------------- ------------- -------------
Net balance at December 31 103,020,252 128,441,088 162,530,407
Plus reinsurance recoverables 52,000,444 67,654,430 89,493,139
------------- ------------- -------------
Balance at December 31 $ 155,020,696 $ 196,095,518 $ 252,023,546
============= ============= =============
</TABLE>
14. EMPLOYEE BENEFIT PLAN:
PICO maintains a 401(k) Defined Contribution Plan covering
substantially all employees of the Company. Matching contributions are based on
a percentage of employee compensation. In addition, the Company may make a
discretionary contribution at the end of the Plan's fiscal year within limits
established by the Employee Retirement Income Securities Act. During 1998, 1997,
and 1996, expenses for contributions by the Company were $618,000, $365,000, and
$334,000, respectively. APL, a former subsidiary of the Company, holds the Plan
assets. Another subsidiary is responsible for the management of the 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, 1998, $3.2 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 31, 1999. On July 31,
1998, APL
79
<PAGE> 80
paid an $8 million dividend to Physicians Investment Company. On December 17,
1997, a subsidiary of Physicians, The Professional Insurance Company ("PRO"),
paid Physicians a cash dividend of approximately $5.5 million. A dividend
payment of $13.2 million was made on December 30, 1997 from Physicians to PICO
Holdings, Inc. in the form of GEC common stock.
16. COMMITMENTS AND CONTINGENCIES:
The Company leases some of its offices under non-cancelable operating
leases that expire at various dates through October 2008. Total rent expense was
$1.5 million, $1.5 million and $1.7 million for the years ended December 31,
1998, 1997 and 1996, respectively. Future minimum rental payments required under
the leases for the years ending December 31, are as follows:
<TABLE>
<S> <C>
1999 $ 3,421,897
2000 3,079,735
2001 2,921,695
2002 2,781,787
2003 2,413,243
Thereafter 11,084,790
-----------
Total $25,703,147
===========
</TABLE>
In November 1998, Vidler entered into an operating lease to acquire
185,000 acre-feet of underground water storage privileges and associated rights
to recharge and recover water located near the California Aqueduct northwest of
Bakersfield. The agreement requires Vidler to pay for these privileges and
rights a minimum of $2.3 million per year for 10 years beginning October 1998.
The agreement calls for the lease payments to be adjusted annually by the
engineering price index. The $2.3 million minimum annual lease payment is
included in the above summary of future minimum rental payments. On October 7,
1998, PICO signed an agreement guaranteeing payment of Vidler's obligations
under the agreement. The maximum obligation under this guarantee is $3.2
million, adjusted annually by the engineering price index. The guarantee expires
October 7, 2008.
On January 10, 1997, GEC commenced an action in British Columbia
against MKG Enterprises Corp. ("MKG"), Vignoble Wines Agency Inc. ("Vignoble")
to enforce repayment of a $5 million loan made by GEC to MKG. On the same day,
the Supreme Court of British Columbia granted an order preventing MKG from
disposing of certain assets pending resolution of the action. GEC subsequently
brought a motion to have a receiver-manager appointed for MKG and Vignoble,
which motion has been adjourned. In addition, in March 1999 GEC filed an action
in the Supreme Court of British Columbia against a third party. This action
states the third party had fraudulently entered into loan agreements with MKG.
Accordingly, under this action GEC is claiming damages from the third party and
restraining the third party from further action.
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 was to 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 could terminate
this consulting agreement in April 2002 if the partnership had 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, 1998. By
letter dated March 13, 1998, NLRC gave notice of termination of the consulting
agreement based on NLRC's determination of default by the partnership under the
terms of the agreement. In November 1998, the partnership sued NLRC for wrongful
termination of the consulting contract. On March 12, 1999, NLRC filed a
cross-complaint against the partnership for breach of written contract, breach
of fiduciary duty and seeking declaratory relief.
The Company is subject to various other litigation that 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.
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<PAGE> 81
17. OTHER RELATED-PARTY TRANSACTIONS:
Effective September, 1995, the Company entered into consulting
contracts with 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. During 1996,
each of the Directors received $300,000 in fees and $450,000 in bonuses. The
same two directors also entered into consulting contracts with a subsidiary of
GEC for similar services. The compensation paid to each of those Directors under
that arrangement was $300,000 in 1996. These contracts were superseded by the
January 1997 contracts described below.
In January 1997, the consulting arrangements described above were
terminated and replaced with a revised consulting contract that increased the
annual base consulting fees for the two directors to $800,000 each beginning
January 1, 1997. On December 31, 1997, these two directors became employees of
the Company; the terms of employment were similar to the consultant arrangements
described above. The employment agreements entered into by the two directors
superceded the prior consulting agreements. Each is entitled to an incentive
award based on the growth of the Company's book value per share in excess of a
threshold that is calculated as 80% of the previous five year average return for
the S&P 500. No award was paid during 1998, 1997 or 1996 under this program.
Summit is a Registered Investment Advisor providing investment advisory
services to managed accounts including the Company's subsidiaries. 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 on the grant date. No options have been exercised
under this agreement. Two of the Company's directors, now officers of the
Company, were instrumental in establishing the operations of Summit and are
entitled to receive 50% of the first $1 million of profits attributed to PICO's
ownership of Summit's common stock. No compensation was paid under this
arrangement during 1998, 1997, or 1996.
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 was not
eligible to receive any incentive payment, until he was continuously employed by
Sequoia 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 Citation. The increase in value of Citation will be measured from
January 1, 1998. The Company recorded compensation expense of $110,000 and
$250,000 during the years ended December 31, 1998 and 1997, respectively,
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 estimated fair value of the
subsidiary's stock at the time of grant. Therefore, no compensation has been
recorded by the Company related to these arrangements. During 1998, 18,950
options to acquire approximately 1.9% of Vidler were exercised for $108,000.
In 1998, the Company entered into an agreement with its president and
chief executive officer to defer a portion of his regular compensation in a
Rabbi Trust account held in the name of the Company. The deferrals are included
within the Company's consolidated balance sheet. Salary deferrals to the trust
amounted to $316,000 for 1998.
The Company acquired 412,846 shares of its common stock at a cost of
$1.6 million, and assumed call option obligations for the delivery of these
shares when the options are exercised. These call options expire on December 30,
2003 and are held by PICO's chairman of the board and president and chief
executive officer. On December 31, 1998, 57,307 of these options were exercised
for a total of $200,000.
18. STATUTORY INFORMATION:
The Company and its insurance subsidiaries are subject to regulation by
the insurance departments of the states of domicile
81
<PAGE> 82
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 to discount
its MPL unpaid loss and loss adjustment expense reserves, including related
reinsurance recoverable 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, 1998, 1997 and 1996 and policyholders'
surplus as of December 31, 1998, 1997, and 1996 on the statutory accounting
basis are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C>
Physicians Insurance Company of Ohio:
Statutory net income $ 2,556,946 $ 28,967,115 $ 21,807,610
Policyholders' surplus 31,515,421 54,790,265 69,464,034
The Professionals Insurance Company:
Statutory net income $ 105,286 $ 1,167,208 $ 1,330,733
Policyholders' surplus 3,516,143 3,922,382 7,684,701
American Physicians Life Insurance:***
Statutory net income $ 220,968 $ 2,709,570
Policyholders' surplus 12,776,934 11,809,784
Sequoia Insurance Company:*
Statutory net income (loss) $ 4,284,251 $ 1,161,670 $ (982,953)
Policyholders' surplus 23,568,505 21,069,190 14,445,550
Citation Insurance Company:**
Statutory net loss $ (4,395,534) $ (1,380,920) $ (3,069,661)
Policyholders' surplus 21,811,840 29,112,651 25,596,903
</TABLE>
* Purchased August 1, 1995
** Purchased November 20, 1996
*** Sold December 4, 1998
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, 1998, 1997, and
1996, statutory surplus of approximately $27.1 million, $37.8 million and $38.4
million, respectively, is reflected in both the parent and subsidiary-owned
insurance companies.
82
<PAGE> 83
19. SEGMENT REPORTING:
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 is effective for the year
ended December 31, 1998, and comparative information from earlier years has been
restated to conform to the requirements of this standard.
The Company is a diversified holding company engaged in five major
operating segments: Investment Operations; Surface, Water and Mineral Rights
Operations; Property and Casualty Insurance Operations; Medical Professional
Liability ("MPL") Insurance Operations and Other Operations.
Segment performance is measured by revenues and segment profit before
tax in addition to changes in shareholders' equity. This information provides
the basis for calculation of return on shareholders' equity, which is the main
performance measurement used in analyzing segment performance. In addition,
assets identifiable with segments are disclosed as well as capital expenditures,
and depreciation and amortization. The Company has operations and investments
both in the U.S. and abroad. Information by geographic region is also similarly
disclosed.
Investment Operations
PICO holds a number of strategic and portfolio investments in both
publicly and privately held corporations. These investments may be passive or
they may represent positions where PICO is able to exert significant influence
over the operating, financing and management strategies and decisions of the
corporation. PICO invests in businesses that it believes to be undervalued or
may benefit from additional capital, restructuring of operations or management
or improved competitiveness through operational efficiencies with existing PICO
operations. The Company makes investments for the purpose of enhancing and
realizing additional value by means of appropriate levels of shareholder
influence and control. This may involve restructuring of the financing or
management of the entities in which the Company invests and initiating or
facilitating mergers and acquisitions. The investments tend to be long term in
nature however if returns are not as anticipated, there is an attractive exit,
or a more productive use of capital is identified, the Company divest its
position. Revenues are derived from interest, dividends and realized gains or
losses upon sale of investments. In addition, the change in unrealized gains and
losses for available for sale securities is used as a performance measurement.
The Company invests in a number of industry segments and geographic regions and
does not limit itself in either of these categories but rather uses criteria
based on fundamental value principles in selecting investment targets.
Investments directly related to the insurance operations are included within
those segments.
Surface, Water and Mineral Rights Operations
PICO is engaged in surface, water and mineral rights operations through
its subsidiaries, Vidler and NLRC. Vidler is a comprehensive provider of water
services and, through the acquisition of water assets, water rights and
upgrading priority and functionality of these rights generates revenues by
marketing water to end-users. In addition, Vidler is developing water recharge
(storage) facilities for future operation that will be directed to
municipalities and water districts in the southwestern United States. Surplus
supplies of water will be stored in the facility and storage fees will generate
revenues, and when water is sold and delivered to the end-user.
NLRC owns a large inventory of surface, water and mineral rights.
Revenue is generated from surface rights by land sales, land development, land
exchanges and leasing for grazing, agricultural and other uses. Revenue is
generated from the exploration and development of water rights and mineral
rights in the form of outright sales and royalty streams.
Property and Casualty Insurance
PICO owns two property and casualty insurance companies, Citation and
Sequoia. These companies are licensed to write commercial property and casualty
insurance and, to a lesser extent personal lines of insurance. Workers
Compensation insurance was written until 1997, when the business was sold to a
third party. Revenues are derived from premiums earned on policies written as
well as investment income on assets and investments held by the insurance
operations.
83
<PAGE> 84
MPL Operations
PICO's subsidiaries, Physicians and PRO ceased writing policies in
1995; however continue to administer and adjust remaining claims. Management
continues to handle the runoff of the remaining claims reserves internally. The
operation has retained the investments necessary to fund the payment of claims
and LAE reserves as opposed to selling or fully reinsuring these reserves and
giving up the corresponding funds. Revenues are derived from the investments
retained.
The following is the segment results for December 31, 1998, 1997 and
1996 (in thousands):
<TABLE>
<CAPTION>
Surface, Water Property
Investment and Mineral and
Operations(A) Rights Casualty MPL Other(B) Consolidated
------------- -------------- -------- -------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
1998:
Revenues (charges) $ (1,859) $ 3,412 $ 42,927 $ 2,420 $ 509 $ 47,409
Income (loss) before income taxes (8,731) (1,818) 2,825 (4,442) (394) (12,560)
Identifiable assets 75,285 118,288 138,408 62,774 421 395,176
Depreciation and amortization 693 185 496 81 37 1,492
Capital expenditures 117 4,783 648 86 7 5,641
1997:
Revenues $ 25,903 $ 3,105 $ 56,433 $ 3,896 $ 682 $ 90,019
Income (loss) before income taxes 18,004 12 5,556 765 (576) 23,761
Identifiable assets 116,142 74,737 158,760 78,756 2,096 430,491
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 (loss) before income taxes 22,307 3,307 8,469 (965) 33,118
Identifiable assets 54,423 204,124 151,341 79,228 489,116
Depreciation and amortization 746 959 427 2,132
Capital expenditures 55 51 106
</TABLE>
84
<PAGE> 85
Segment information by geographic region follows (in thousands):
<TABLE>
<CAPTION>
United
States Canada Europe Asia Consolidated
--------- -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C>
1998:
Revenues (charges) $ 48,308 $ (2,233) $ 3,364 $ (2,030) $ 47,409
Income (loss) before income taxes (13,666) 560 2,588 (2,042) (12,560)
Identifiable assets 361,458 7,811 21,653 4,254 395,176
Depreciation and amortization 1,233 259 1,492
Capital expenditures 5,641 5,641
1997:
Revenues $ 94,002 $ 3,861 $ 175 $ (8,019) $ 90,019
Income (loss) before income taxes 34,393 (2,700) 87 (8,019) 23,761
Identifiable assets 364,907 37,411 21,080 7,093 430,491
Depreciation and amortization 852 329 1,181
Capital expenditures 985 985
1996:
Revenues $ 76,578 $ 158 $ 76,736
Income (loss) before income taxes 33,149 $ 1,013 (1,044) 33,118
Identifiable assets 461,068 28,048 489,116
Depreciation and amortization 2,132 2,132
Capital expenditures 106 106
</TABLE>
(A) Investment Operations 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 Investment Operations segment at December 31, 1998 was insignificant
compared to $6 million and $56 million as of December 31, 1997, and 1996,
respectively. Investment revenues (charges) thereon was approximately
$(1.6) million, $2 million and $27 million, for the years ended December
31, 1998, 1997, and 1996, 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
1996 relating to the discontinued life and health insurance segment.
Income statement amounts for 1998, 1997 and 1996 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
for cash, cash equivalents, short-term investments, receivables, accounts
payable and accrued liabilities approximate fair value because of the short
maturity of these instruments.
85
<PAGE> 86
- - INVESTMENTS: Fair values are estimated based on quoted market prices, or
dealer quotes for comparable securities. Fair value of warrants to purchase
common stock of publicly traded companies is estimated based on values
determined by the use of accepted valuation models at the time of
acquisition. Fair value for equity securities that do not have a readily
determinable fair value is estimated based on the value of the underlying
common stock. The Company regularly evaluates the carrying value of
securities to determine whether there has been any diminution in value that
is other than temporary and adjusts the value accordingly.
- - DEPOSITS WITH REINSURERS AND REINSURANCE RECOVERABLES: The carrying amounts
of deposits with reinsurers and reinsurance recoverable with fixed amounts
due are reasonable estimates of fair value.
- - INVESTMENT IN AFFILIATE: Investments in affiliated companies which the
Company owns between 20% and 50%, are carried at equity value. The balance
of the investment is regularly evaluated to determine whether there has been
any impairment.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
--------------------------- ----------------------------
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 $92,752,898 $ 92,752,898 $ 85,193,009 $ 85,193,009
Investment securities 93,266,393 113,525,765 128,004,613 128,004,613
Deposits with reinsurers and
reinsurance recoverables 3,624,285 3,624,285 7,371,146 7,371,146
</TABLE>
21. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
Summarized unaudited financial data for 1998 and 1997 are shown below.
In management's opinion, the interim financial data contains all adjustments,
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 acquisition of the minority
interest of GEC, and the 1-for-5 reverse stock split.
The Company computes income (loss) per common share for each quarter
independently of income (loss) per share for the year. The sum of the quarterly
income (loss) per share may not equal the income (loss) 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 income during
the year. Fluctuations by quarter in revenues and net income (loss) are
primarily due to realized gains or losses on investments.
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<PAGE> 87
AS RESTATED, See Note 22
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
1998:
Revenues $ 12,922,305 $13,654,231 $12,179,799 $ 8,652,179
Net Income (loss) $ (1,677,617) $ 933,751 $ 600,343 $(8,100,656)
Basic:
Income (loss) per common share $ (0.28) $ 0.16 $ 0.11 $ (1.31)
Number of shares used in calculation 6,019,817 6,019,817 5,711,304 6,178,675
Diluted:
Income (loss) per common share $ (0.28) $ 0.15 $ 0.10 $ (1.31)
Number of shares used in calculation 6,019,817 6,254,573 6,158,606 6,178,675
1997:
Revenues $ 21,050,205 $17,769,204 $44,935,784 $ 6,264,184
Net Income (loss) $ 1,620,658 $ 1,452,545 $18,240,748 $(1,701,931)
Basic:
Income (loss) per common share $ 0.25 $ 0.23 $ 3.03 $ (0.28)
Number of shares used in calculation 6,434,860 6,445,790 6,018,466 6,019,817
Diluted:
Income (loss) per common share $ 0.25 $ 0.22 $ 2.91 $ (0.28)
Number of shares used in calculation 6,609,817 6,639,827 6,278,038 6,019,817
</TABLE>
87
<PAGE> 88
AS PREVIOUSLY REPORTED
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
1998:
Revenues $13,734,067 $13,654,231 $12,179,799 $ 8,652,179
Net Income (loss) $ (927,480) $ 1,082,355 $ 729,261 $(8,039,497)
Basic:
Income (loss) per common share $ (0.15) $ 0.18 $ 0.13 $ (1.30)
Number of shares used in calculation 6,019,817 6,019,817 5,711,304 6,178,675
Diluted:
Income (loss) per common share $ (0.15) $ 0.17 $ 0.12 $ (1.30)
Number of shares used in calculation 6,019,817 6,254,573 6,158,606 6,178,675
1997:
Revenues $21,050,205 $17,180,640 $43,808,203 $ 6,146,294
Net Income (loss) $ 1,991,660 $ 1,823,916 $17,860,455 $(2,184,410)
Basic:
Income (loss) per common share $ 0.31 $ 0.28 $ 2.97 $ (0.36)
Number of shares used in calculation 6,434,860 6,445,790 6,018,466 6,019,817
Diluted:
Income (loss) per common share $ 0.30 $ 0.27 $ 2.84 $ (0.36)
Number of shares used in calculation 6,609,817 6,639,827 6,278,038 6,019,817
</TABLE>
22. RESTATEMENT OF PREVIOUSLY REPORTED FINANCIAL INFORMATION
In response to a review by the staff of the United States Securities
and Exchange Commission in connection with the Company's Form S-3 registration
statement, the Company has restated previously issued financial statements to
(1) reflect the adoption of equity accounting for PICO's investment in HyperFeed
Technologies, Inc. ("Hyperfeed"), (2) value Hyperfeed common stock warrants at
estimated fair value and (3) record the carrying value of Hyperfeed common stock
warrants received as consideration for extending the due date on outstanding
loans, as interest income during 1997. The financial statements have also been
restated to reverse previously recorded investment revenue, related to real
estate development projects to the appropriate prior periods. The previous
financial statements presented the investment in Hyperfeed common stock at
market
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<PAGE> 89
value, and the preferred stock and warrants received in 1998 as a result of the
debt conversion at cost. Consequently, the Company's 1998, 1997 and 1996
consolidated financial statements have been restated from amounts previously
reported. Presented in the table below are the effects of the adjustments on
previously reported information as of and for the three years ended December 31,
1998.
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1998 December 31, 1997 December 31, 1996
---------------------------- ---------------------------- --------------------------
As Previously As Previously As Previously
Reported As Restated Reported As Restated Reported As Restated
------------ ------------ ------------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Total revenues $ 48,220,276 $ 47,408,514 $ 88,185,342 $90,019,377 $76,736,280 $76,736,280
Total expenses 58,449,781 58,445,535 64,682,337 64,680,256 43,773,072 43,629,110
Equity in income (loss) of
unconsolidated affiliates (771,117) (1,522,480) (1,577,876) 1,013,385 10,539
------------ ------------ ------------ ----------- ----------- -----------
Income (loss) from continuing
operations before income taxes
and minority interest (11,000,622) (12,559,501) 23,503,005 23,761,245 33,976,593 33,117,709
Provision for taxes 1,762,395 1,292,334 7,670,128 7,807,971 12,957,811 12,714,336
------------ ------------ ------------ ----------- ----------- -----------
Income (loss) from continuing
operations before minority interest (12,763,017) (13,851,835) 15,832,877 15,953,274 21,018,782 20,403,373
Minority interest 4,532,632 4,532,632 3,202,461 3,202,461
------------ ------------ ------------ ----------- ----------- -----------
Income (loss) from continuing
operations (8,230,385) (9,319,203) 19,035,338 19,155,735 21,018,782 20,403,373
Discontinued operations 1,075,024 1,075,024 456,283 456,283 3,301,229 3,301,229
------------ ------------ ------------ ----------- ----------- -----------
Net income (loss) $ (7,155,361) $ (8,244,179) $ 19,491,621 $19,612,018 $24,320,011 $23,704,602
============ ============ ============ =========== =========== ===========
Net income (loss) per share - basic $ (1.20) $ (1.38) $ 3.09 $ 3.11 $ 4.39 $ 4.28
============ ============ ============ =========== =========== ===========
Net income (loss) per share - diluted $ (1.20) $ (1.38) $ 2.98 $ 3.00 $ 4.23 $ 4.12
============ ============ ============ =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
--------------------------------- ---------------------------------
As Previously As Previously
Reported As Restated Reported As Restated
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Investments $ 117,150,365 $ 116,411,780 $ 160,297,216 $ 160,775,103
Deferred tax asset $ 2,965,080 $ 2,684,729
Total assets $ 395,914,103 $ 395,175,518 $ 430,292,974 $ 430,490,510
Deferred tax liabilities $ 7,258,949 $ 7,185,656
Total liabilities $ 221,819,219 $ 221,745,926 $ 249,934,925 $ 249,934,925
Unrealized loss, net of tax $ (2,904,587) $ (2,511,787) $ (2,717,248) $ (2,550,438)
Retained earnings $ 76,562,974 $ 75,504,882 $ 83,718,335 $ 83,749,061
Total shareholders' equity $ 174,094,884 $ 173,429,592 $ 112,150,738 $ 112,348,274
</TABLE>
As a result of applying equity accounting for the investment in
Hyperfeed, the Company recorded for the years ended December 31, 1998, 1997 and
1996, equity in losses of $751,000, $1.6 million and $1 million, respectively.
For the year ended December 31, 1998, the individual components of the above are
PICO's share of the losses of Hyperfeed of $979,000, amortization of goodwill of
$176,000 and dilution gains of $404,000. For the year ended December 31, 1997,
PICO's share of the loss of Hyperfeed was $2.4 million, amortization of goodwill
was $147,000 and dilution gains were $1 million. For the year ended December 31,
1996, PICO's share of the loss of Hyperfeed was $910,000, amortization of
goodwill was $143,000 and dilution gains were $50,000. Equity in losses reflect
the pre-tax effect of PICO's share of the losses of Hyperfeed based on common
stock ownership percentage in 1996 and 1997 and the combination of the common
stock and preferred stock ownership percentage in 1998 (the preferred stock was
acquired on December 18, 1998 and PICO's losses from that date forward were
based on the combined percentage), amortization of goodwill
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<PAGE> 90
based on a straight line, 10 year amortization period, and any dilution gains or
losses that arise from third party capital infusions into Hyperfeed.
During 1997, PICO received Hyperfeed common stock warrants as
consideration for extending the due date of the loans to Hyperfeed. As part of
the restatement, in accordance with SFAS 91, PICO estimated the value of these
warrants using the Black Scholes option pricing model. The effects of recording
the warrants increased interest income by $1.8 million and income tax expense by
$624,000 for the year ended December 31, 1997.
As a result of applying equity accounting to the investment in
Hyperfeed, the recorded value of the common stock and voting convertible
preferred stock decreased $4.6 million to $4.9 million at December 31, 1998. At
December 31, 1997 and 1996 the recorded investment value decreased $1.2 million
and $2.7 million, respectively. In addition, the effect of recording the common
stock warrants at fair value increased the carrying value of the warrants by
$3.8 million at December 31, 1998. The restatement effects at December 31, 1997
of the initial recording of the warrants at $1.8 million and subsequent decline
in fair value resulted in an overall increase of $887,000.
See footnote 4 for additional information.
In 1995, Raven Development Company ("Raven"), a wholly-owned
subsidiary, began the orderly withdrawal from the real estate development
business through the sale of its remaining land and improved residential lots in
Ohio. Over the course of a number of years, affiliated companies made loans to
Raven for the purchase of land and the development of infrastructure. Raven
capitalized the interest cost on a stand-alone basis and the affiliated
companies recorded interest income. In consolidation the affiliated companies
annually recorded an entry to reverse the effects of the interest income and the
capitalized interest. However, the capitalized interest cost was allocated to
each lot sold by Raven and became part of the cost of sales. the elimination of
the interest component of cost of sales was not made in consolidation and, as a
result, a credit remained in the capitalized interest account. In the first
quarter of 1998, as the last of Raven's lots were sold, the cost of lots sold
was adjusted to reverse the cumulative credit in the capitalized interest
account, resulting in an adjustment to investment income of approximately
$800,000. The impact of this restatement was a reduction of revenues of
$812,000 and an increase in the net loss by $533,000 for 1998, and an increase
in net income of $1,000 and $95,000 in 1997 and 1996, respectively. In addition,
shareholders' equity was unchanged at December 31, 1998 and the 1997
shareholders' equity increased by $533,000.
23. SUBSEQUENT EVENTS (UNAUDITED)
In connection with the matter described in paragraph 4 of Note 16,
effective September 1, 1999, the parties entered into a settlement agreement
wherein they agreed that the lawsuit would be dismissed without prejudice, and
that NLRC would deliver a report on or before June 30, 2002 to the limited
partnership of the amount of the consulting fee which would be owed by NLRC to
the limited partnership if the consulting agreement were in effect.
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<PAGE> 91
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
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The Board of Directors is divided into three classes, with the terms of office
of each class ending in successive years.
The following table sets forth information regarding the Company's directors,
including their ages, a brief description of their business experience, certain
directorships held by each of them and the year in which each became a director
of the Company.
<TABLE>
<CAPTION>
Director Name Business Experience Age Since
------------- ------------------- --- -----
<S> <C> <C> <C>
Directors with terms ending in
1999:
John R. Hart President of Quaker Holdings Limited, an 39 1996
investment company, since 1991; Principal with
Detwiler, Ryan & Company, Inc., an investment
bank, from 1982 to 1991; Director of Physicians
since 1993; President and CEO of Physicians
since 1995; President and CEO and Director of
Global Equity Corporation since 1995; Director
of Hyperfeed; President and CEO and Director of
the Company since 1996.
Ronald Langley Director and officer of Pacific Southwest 54 1996
Corporation, a strategic investment company,
from 1989 to 1992; Director of Physicians since
1993; Chairman of Physicians since 1995:
Chairman and Director of Global Equity
Corporation since 1995; Chairman of Summit
Global Management, Inc. since 1994; Director of
Hyperfeed; Chairman and Director of the Company
since 1996.
John D. Weil President, Clayton Management Company, a 58 1996
strategic investment company; Director of Todd
Shipyards Corporation, Oglebay Norton Company,
Southern Investors Service Company, Inc.,
Allied Health Products, Inc., and Baldwin &
Lyons, Inc.
Directors with terms ending in
2000:
S. Walter Foulkrod, III, Esq. Attorney; owner of S. Walter Foulkrod, III & 57 1996
Associates, Attorneys at Law, Harrisburg, PA,
since 1994; President and Chairman of Foulkrod,
Reynolds & Havas, PC, from 1984 to 1994;
Director of Physicians since 1988.
Richard D. Ruppert, MD Physician; President of Medical College of Ohio 68 1996
from 1978 to 1993; President of American
Society of Internal Medicine from 1992 to 1993;
Director of Physicians since 1988.
Directors with terms ending in
2001:
Robert R. Broadbent Retail consultant since 1989; Chairman of 77 1996
Higbee Company from 1984 to 1989; President,
CEO, Director and Vice Chairman of the Higbee
Company from 1979 to 1984; President and Chief
Executive Officer of Liberty House - Mainland
from 1976 to 1978; Chairman and CEO of Gimbel's
from 1973 to 1976; Director of Physicians from
1993 to 1995.
</TABLE>
91
<PAGE> 92
<TABLE>
<S> <C> <C> <C>
Carlos C. Campbell President of C.C. Campbell & Company, Reston, 61 1998
Virginia, since 1985; Director of Resource
America, Inc., Fidelity Mortgage Funding, Inc.,
and Passport Health.
David A. Williams CEO of Beutel Goodman & Co. Ltd. From 1991 to 56 1998
1995; President, Roxborough Holdings Limited,
Toronto, Ontario since 1995; Director of Global
Equity Corporations, Enhanced Marketing
Services, Equisure Financial Network, FRI
Corporation, Krystal Bond Corporation, Octagon
Industries Ltd., Phoenix Duff and Phelps Corp.,
Pinetree Capital Corporation, Micropulse Inc.,
Radiant Energy Corporation, and Signature
Brands Ltd.
</TABLE>
For information on the executive officers of Registrant, see Part I, Item 1.,
"Executive Officers."
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
executive officers, directors and persons who beneficially own more than 10% of
the Company's Common Stock to file initial reports of ownership and reports of
changes in ownership with the Securities and Exchange Commission ("SEC"). Such
persons are required by SEC regulations to furnish the Company with copies of
all Section 16(a) forms filed by such persons.
Based on a review of the copies of these reports received by the Company and
written representations from certain reporting persons that they have complied
with the relevant filing requirements, the Company believes that all filing
requirements have been complied with on a timely basis for the fiscal year ended
December 31, 1998.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information concerning the compensation for
fiscal year 1998 of the (i) Chief Executive Officer of the Company (ii) the
executive officers of the Company as of December 31, 1998 (Messrs. Langley,
Hart, Sharpe, Burchfield, and Mosier are sometimes hereinafter referred to as
"Named Officers"). Amounts under the caption "Bonus" are amounts earned for
performance during the year including amounts paid after the end of the year.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long-Term
Compensation
Annual Compensation Awards
------------------------- Securities
Underlying
Options All Other
NAME AND PRINCIPAL POSITION Year Salary Bonus (Shares) Compensation
---- -------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Chief Executive Officer:
- ------------------------
John R. Hart(1)(2) 1998 $800,000 -0- -0- $22,000(7)
President and Chief 1997 $800,000(3) -0- -0- -0-
Executive Officer 1996 $300,000 $450,000 175,347(4) -0-
Executive Officers(2):
- ----------------------
Ronald Langley(5) 1998 $800,000 -0- -0- $22,000(7)
Chairman of the 1997 $800,000(3) -0- -0- -0-
Board of Directors 1996 $300,000 $450,000 175,347(4) -0-
</TABLE>
92
<PAGE> 93
<TABLE>
<S> <C> <C> <C> <C> <C>
Richard H. Sharpe(6) 1998 $199,029 -0- -0- $22,000(7)
Chief Operating Officer 1997 $165,317 $ 18,340 -0- $18,734(7)
1996 $139,376 $ 28,000 60,119(4) $14,362(7)
Gary W. Burchfield(8) 1998 $164,640 -0- -0- $20,930(7)
Chief Financial Officer 1997 $135,000 $ 13,500 -0- $15,618(7)
And Treasurer 1996 $102,170 $ 35,000 42,083(4) $10,506(7)
James F. Mosier(9) 1998 $126,910 -0- -0- $18,512(7)
General Counsel 1997 $113,017 $ 12,570 -0- $12,796(7)
and Secretary 1996 $ 82,835 $ 27,000 42,083(4) $ 8,497(7)
</TABLE>
- ----------------------
(1) Mr. Hart became President and CEO of the Company on November 20, 1996.
Prior to that time he was President and CEO of Physicians since July 15,
1995.
(2) Includes compensation received from Physicians prior to the Merger, as well
as compensation received from the Company.
(3) Mr. Langley and Mr. Hart were each compensated $533,328 by the Company for
consulting services in 1997 in the areas of investment banking, investment
portfolio analysis, and analysis of operations. In addition, Mr. Langley
and Mr. Hart entered into consulting agreements with a subsidiary of Global
Equity Corporation for annual compensation of $266,672 each for consulting
services in the areas of investment banking, investment portfolio analysis,
and analysis of operations. On December 31, 1997, Mr. Langley and Mr. Hart
each signed employment agreements with the Company on terms substantially
similar to the consulting agreements.
(4) Options issued by Physicians prior to the November 1996 Merger under the
Physicians Insurance Company of Ohio 1995 Non-Qualified Stock Option Plan
and assumed by the Company upon the Merger. All options are fully vested.
(5) Mr. Langley became Chairman of the Board of Directors of Physicians on July
15, 1995. He became Chairman of the Board of Directors of the Company on
November 20, 1996.
(6) Mr. Sharpe became Chief Operating Officer of Physicians on June 3, 1994. He
became Chief Operating Officer of the Company on November 20, 1996.
(7) Represents amounts contributed by the Company to the PICO Holdings, Inc.
Employees 401(k) Retirement Plan and Trust. This retirement plan conforms
to the requirements of the Employee Retirement Income Security Act.
(8) Mr. Burchfield became Chief Financial Officer and Treasurer of Physicians
on November 3, 1995. He became Chief Financial Officer and Treasurer of the
Company on November 20, 1996.
(9) Mr. Mosier became General Counsel and Secretary of Physicians in 1984. He
became General Counsel and Secretary of the Company on November 20, 1996.
OPTION GRANTS IN LAST FISCAL YEAR
Options to purchase 100,000 shares of the Company's Common Stock were granted
during the year ended December 31, 1998 to A. Judson Hill, Executive Vice
President, as shown in Item 11, Summary Compensation Table.
OPTION EXERCISES AND FISCAL 1998 YEAR-END VALUE
The following table provides information concerning options held as of December
31, 1998 by the persons named in the Summary Compensation Table. No options were
exercised in 1998 by such individuals.
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<PAGE> 94
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Number of Securities Underlying Value of Unexercised
Unexercised In-the-Money-Options
Options at 12/31/98 At 12/31/98(1)
-------------------------------- -------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Ronald Langley(2) 406,747 -0- -0- -0-
John R. Hart(2) 406,747 -0- -0- -0-
Richard H. Sharpe 60,119 -0- -0- -0-
Gary W. Burchfield 42,083 -0- -0- -0-
James F. Mosier 42,083 -0- -0- -0-
</TABLE>
- ---------------
(1) Based on the closing price of the Company's Common Stock on December 31,
1998 on the Nasdaq National Market of $13.25 per share.
(2) In addition to these options shown above, Mr.Langley and Mr. Hart have a
right to purchase shares of the Company under Call Option Agreements
assumed by the Company in August 1998; see Item 12, footnote 4.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Messrs. Weil and Foulkrod, and Dr. Ruppert, serve as members of the Compensation
Committee. Mr. Langley and Mr. Hart have been directors and executive officers
of GEC since September 5, 1995.
REPORT OF THE COMPENSATION COMMITTEE
This report of the Compensation Committee (the "Compensation Committee"), and
the Stock Price Performance Graph set forth below, shall not be deemed
incorporated by reference by any general statement incorporating by reference
this Form 10-K into any filing under the Securities Act of 1933, as amended (the
"Securities Act") or under the Securities Exchange Act of 1934, as amended (the
"Exchange Act") except to the extent that the Company specifically incorporates
this information by reference, and shall not otherwise be deemed filed under the
Securities Act or the Exchange Act.
COMMITTEE MEMBERS
The three-member Compensation Committee of the Board of Directors is a standing
committee composed entirely of outside Directors. Mr. Weil is the chairman and
Mr. Foulkrod and Dr. Ruppert are the other members.
COMMITTEE FUNCTIONS
The Compensation Committee is responsible for assuring that all of the executive
compensation programs of the Company are developed, implemented, and
administered in a way that supports the Company's fundamental philosophy that a
significant proportion of executive compensation should be effectively linked to
company performance.
The Compensation Committee meets on a regularly scheduled basis. It reviews and
approves the overall executive compensation program which includes both base pay
and incentive compensation. It considers and approves individual executive
officer compensation packages based on recommendations of the Company's Chief
Executive Officer. It recommends, for the approval of the full Board, any
modification to the compensation package of the Company's Chief Executive
Officer.
EXECUTIVE COMPENSATION PHILOSOPHY
94
<PAGE> 95
The Board of Directors of Physicians retained an independent compensation
expert, William M. Mercer, Incorporated ("Mercer"). In 1996, Mercer conducted an
analysis of marketplace executive compensation levels. The scope of Mercer's
study covered the Company's Chairman and President and Chief Executive Officer.
The objectives of Mercer's study were as follows:
- - Analyze the scope, responsibilities and skill requirements of the jobs
performed by Messrs. Langley and Hart and compare and contrast to
comparable benchmark executive positions found in the marketplace.
- - Develop an appropriate methodology for selecting comparable benchmark jobs,
industry categories and a peer group of companies comparable to the Company
in terms of business focus, industry classification and size; and competing
for senior executives with the skills, expertise and talent demonstrated by
the Company's top two executives.
- - For the appropriate benchmark jobs, industry category and peer company
group, collect information on marketplace compensation levels and practices
from compensation surveys and peer company proxy statements. The companies
included in the peer company group are not necessarily those included in
the Nasdaq Insurance Stock Index. Determine the most relevant marketplace
compensation levels and to compare actual Company compensation levels.
- - Develop alternate approaches for structuring the total compensation package
for the Company's top two executives, in terms of compensation elements to
be used, the mix of total pay and how short and long term incentive
compensation might be structured to accurately reflect performance.
Mercer's study recommended to the Compensation Committee a compensation strategy
with the following objectives:
- - To provide a total compensation package that:
- is competitive with market rates for executives with similar skill,
talent and job requirements.
- is closely linked to the Company's strategy and the role of covered
executives in building shareholder value through growing the book value
and, ultimately, the market value of the Company.
- - To retain critical executive talent by:
- providing a reasonable and competitive level of current income (cash
flow).
- providing for loss of future incentive opportunity if an executive
terminates employment before unrealized investment gains are realized.
- - To link executive rewards to shareholder interests by:
- tying incentive awards to growth in book value which ultimately
translates into increased market price per share (as investments are
liquidated for gains, and the Company grows earnings).
- granting additional stock options in the future once current options
are exercised or expire.
The Compensation Committee believes that to accomplish these goals, the
executive compensation program should be based on three distinct components:
base pay, annual incentives, and long-term incentives. The Company obtains
industry and peer group surveys, and consults with independent experts, to
evaluate the Company's executive compensation programs in comparison with those
offered by its comparable competitors.
The Compensation Committee has considered amendments to the Internal Revenue
Code denying deductions for annual compensation to certain executives in excess
of $1 million, subject to certain exceptions. The Company's compensation
structure has been such that it does not believe that it is likely that the $1
million cap will affect the Company in the near future. The Internal Revenue
Service has issued proposed regulations which, among other things, provide for a
transition period of three years for plans previously approved by shareholders.
The Company is studying the proposed regulations, but has not yet determined
what steps may be required or desirable with respect to its existing plans.
95
<PAGE> 96
EXECUTIVE COMPENSATION PROGRAM
The features of the executive compensation program as recommended by Mercer and
approved by the Compensation Committee are:
BASE COMPENSATION. A fixed rate, to be reviewed annually. Future adjustments
will take into account movement in executive compensation levels, changes in job
responsibilities, and the size of the Company.
INCENTIVE AWARDS. Based on growth of book value per share in a fiscal year.
Awards are earned when a pre-determined threshold is surpassed. If book value
per share of the Company exceeds this threshold, the incentive award is equal to
5% of the increase in book value per share multiplied by the number of shares
outstanding at the beginning of the fiscal year. The threshold for 1998 is 19%.
In addition, the Board of Directors of Physicians granted options under the
Physicians Insurance Company of Ohio 1995 Non-Qualified Stock Option Plan. The
options granted under said option plan were designed to reinforce the
relationship between the Company's future performance and the executive's
potential future financial rewards. These options were assumed by PICO Holdings,
Inc. on November 20, 1996. In line with this philosophy of providing incentives
to Executive Officers, the Company agreed to convert the GEC options of said
officers on an economically equivalent basis, to options to purchase shares of
the Company effective with the close of the PICO/GEC Combination.
GOALS OF COMPENSATION COMMITTEE
The Compensation Committee attempts to align executive compensation with the
value achieved by the executives for the Company's shareholders. The Company's
compensation program for executives emphasizes a combination of base salary,
discretionary bonuses, and stock options designed to attract, retain, and
motivate executives who will maximize shareholder value. The Compensation
Committee considers individual and Company performance, as well as compensation
paid by comparable companies.
Executives also participate in other employee benefit programs, including health
insurance, group life insurance, and the Company's 401(k) Plan.
DISCUSSION OF 1998 COMPENSATION FOR THE CHIEF EXECUTIVE OFFICER
No bonus was paid with respect to the Company's performance in 1998. In 1997,
the Compensation Committee recommended to the Board of Directors, and the Board
of Directors accepted the recommendation, that it was appropriate for the CEO
and the Chairman to be compensated as employees, rather than as consultants.
Accordingly, effective December 31, 1997, the CEO and Chairman entered into
employment agreements with the Company. The terms of these employment agreements
are substantially similar to the terms of the consulting agreements.
August 3, 1998 Compensation Committee
John D. Weil, Chairman
S. Walter Foulkrod, III, Esq.
Richard D. Ruppert, MD
As stated above, the Compensation Committee believes the interest of
Company shareholders is best served by aligning the CEO's short-term
compensation, over and above competitive fixed annual rate of pay, with an
increase in the Company's book value per share which will ultimately be
reflected in higher market values per share. Specifically, a threshold was set
at 80% of the S&P 500's annualized total return for the five previous calendar
years. For 1998, this threshold was approximately 19%. Since the increase in the
Company's book values per share in 1998 was approximately 4.5%, and did not
exceed the threshold, no bonus, i.e. short-term incentive, was payable for 1998.
The Compensation Committee awarded long term incentives in 1995 in the
form of 175,247 non-qualified stock options at the then current market value. In
addition, the Committee recommended that the CEO's options with GEC, initially
granted in 1995, be converted on an economically equivalent basis to purchase
shares of the Company upon consummation of the GEC/PICO transaction, December
16, 1998. Finally the Committee recommended and the Board agreed that the
Company assume in August 1998 GPG's obligations to the CEO and Chairman under
November 1993 Call Option Agreements.
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<PAGE> 97
The Committee believes that the compensation provided by this
combination of fixed annual compensation, and short-term and long term
incentives provides a mechanism to fairly compensate the CEO while providing the
CEO with a strong incentive to maximize shareholder value.
STOCK PRICE PERFORMANCE GRAPH
The graph below compares cumulative total return of the Company, the Nasdaq
Insurance Stocks Index, and the Nasdaq Stock Market (U.S. Companies) for the
period January 1, 1994 through December 31, 1998.
[PERFORMANCE GRAPH]
The graph assumes $100 was invested on January 1, 1994 in the Company's Common
Stock, the Nasdaq Stock Market (U.S. Companies) Index, and the Nasdaq Insurance
Stocks Index, and that all dividends were reinvested. The performance of PICO
Holdings, Inc. stock on this graph represents the historical performance of
shares of Citation Insurance Group, which was renamed PICO Holdings, Inc. on
November 20, 1996. It does not represent the historical stock performance of
Physicians Insurance Company of Ohio.
EMPLOYMENT AND CHANGE IN CONTROL ARRANGEMENTS
Mr. Langley and Mr. Hart each entered into employment agreements effective
December 31, 1997 with the Company. Total compensation to Mr. Langley and Mr.
Hart under these employment agreements is $800,000 each on an annual basis.
These employment agreements include a change in control clause providing that if
there is a change of control before December 31, 1999, the Company shall
immediately pay each employee a total lump sum of $2.4 million and an amount
equal to three times the highest annual bonus paid to the employee in the last
three years.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information, as of March 26, 1999, with respect
to the beneficial ownership of the Company's Common Stock entitled to vote by
each person known by the Company to be the beneficial owner of more that 5% of
Common Stock, and by each director, each Named Officer (as defined below) and
all executive officers, former chief executive officers, and directors as a
group.
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<PAGE> 98
Except as otherwise indicated, each person has sole investment and voting power,
subject to community property laws. As of March 26, 1999, there were 13,328,778
shares of the Company issued and outstanding. Of these shares, 4,380,780 are
held by the Company and its subsidiaries, and may therefore not be voted under
California law. The following table excludes shares of the Company held by the
Company and its subsidiaries since those shares are not entitled to vote.
<TABLE>
<CAPTION>
Number of Shares and Nature Percentage Ownership of
Name and Address of Beneficial Owner of Beneficial Ownership(1) Voting Shares
------------------------------------ --------------------------- -----------------------
<S> <C> <C>
Ronald Langley(2)(4) 621,725 6.0%
John R. Hart(3)(4) 616,170 5.9%
Robert R. Broadbent 11,949 *
Carlos C. Campbell -0- *
S. Walter Foulkrod, III, Esq. 2,904 *
Richard D. Ruppert, MD(5) 6,974 *
John D. Weil(6) 529,518 5.1%
David A. Williams 78,693 *
Richard H. Sharpe(7) 67,527 *
Gary W. Burchfield(8) 47,043 *
James F. Mosier(9) 47,303 *
A. Judson Hill(10) 100,000 *
Sheila C. Ferguson(11) 3,986 *
Maxim C. W. Webb(12) 29,409 *
Executive Officers and Directors as a Group (14 persons) 2,163,201 20.8%
</TABLE>
- ----------------
* Less than one percent (1%)
(1) Sole voting and investment power unless otherwise indicated.
(2) Of these shares, 555,863 represent beneficial ownership of currently
exercisable options. 551 shares are held in the Company's 401(k) Plan. Mr.
Langley has been Chairman and a Director of GEC since September 5, 1995. He
has been Chairman, and a Director of the Company since November 20, 1996.
(3) Of these shares, 613,170 represent beneficial ownership of currently
exercisable options. Mr. Hart has been President and CEO and a Director of
GEC since September 5, 1995. He has been President and CEO of the Company
since November 20, 1996.
(4) Mr. Langley and Mr. Hart formerly had stock options, granted in 1995, to
purchase shares of GEC; these shares were converted on December 17, 1998
into economically equivalent stock options to purchase shares of the
Company. Mr. Langley and Mr. Hart each had 1993 call option agreements with
GPG; in August 1998, the Company assumed GPG's obligations with respect to
these 412,846 options. Mr. Langley exercised 57,307 of his call options in
December 1998 and has 149,116 call option remaining. Mr. Hart has not
exercised any call options and has 206,423 call options remaining.
(5) Dr. Ruppert shares voting and investment power with his wife.
98
<PAGE> 99
(6) Of these shares, 495,558 are owned by a partnership which Mr. Weil
controls.
(7) Of these shares, 60,119 represent beneficial ownership of currently
exercisable options. In addition, 2,897 shares are held in the Company's
401(k) Plan.
(8) Of these shares, 42,083 represent beneficial ownership of currently
exercisable options. In addition, 805 shares are held in the Company's
401(k) Plan.
(9) Of these shares, 42,083 represent beneficial ownership of currently
exercisable options. In addition, 2,371 shares are held in the Company's
401(k) Plan.
(10) Mr. Hill has beneficial ownership of 100,000 options to buy shares of the
Company. Mr. Hill's options vest monthly over three years in equal
increments beginning November 3, 1998.
(11) Of these shares, 3,702 represent beneficial ownership of currently
exercisable options. In addition, 284 shares are held in the Company's
401(k) Plan.
(12) Of these shares, 29,177 represent beneficial ownership of currently
exercisable options. In addition, 232 shares are held in the Company's
401(k) Plan.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Langley and Mr. Hart entered into employment agreements with the Company,
effective December 31, 1997. See Part II, Item 8., Note 17. Mr. Langley and Mr.
Hart are entitled to receive 50% of the first $1 million of the profits of
Summit Global Management, Inc. See Part II, Item 8., Note 17.
99
<PAGE> 100
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS.
<TABLE>
<S> <C>
1. FINANCIAL STATEMENTS.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Reports.......................................... 51-53
Consolidated Balance Sheets as of December 31, 1998 and 1997
(As Restated).................................................... 54
Consolidated Statements of Operations for the Years
Ended December 31, 1998, 1997 and 1996 (As Restated)............. 56
Consolidated Statements of Shareholders' Equity
for the Years Ended December 31, 1998, 1997, and 1996
(As Restated).................................................... 57
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1998, 1997 and 1996 (As Restated)............. 60
Notes to Consolidated Financial Statements (As Restated)............... 61
2. FINANCIAL STATEMENT SCHEDULES.
Independent Auditors' Reports.......................................... 101-102
Schedule I - Condensed Financial Information of Registrant
(As Restated).................................................... 103
Schedule II - Valuation and Qualifying Accounts........................ 105
Schedule V - Supplementary Insurance Information (As Restated)......... 106
</TABLE>
100
<PAGE> 101
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES
To the Shareholders and Board of Directors of
PICO Holdings, Inc.:
We have audited the consolidated financial statements of PICO Holdings, Inc. and
subsidiaries (the "Company") for the years ended December 31, 1998 and 1997, and
our report thereon (which expresses an unqualified opinion and includes an
explanatory paragraph relating to the restatement disclosed in Note 22) appears
on page 51. Our audits of the consolidated financial statements also included
the 1998 and 1997 financial statement schedules of the Company, listed in Item
14. These 1998 and 1997 financial statement schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion based on
our audits. We did not audit the 1997 consolidated financial statements of
Global Equity Corporation (all expressed in Canadian dollars), a 51.2% owned
consolidated subsidiary as of December 31, 1997, which constituted 42% of the
Company's 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 in the Company's 1997
financial statement schedules for Global Equity Corporation (as expressed in
Canadian dollars), is based solely on the report of such other auditors. In our
opinion, based on our audits and the report of the other auditors, such 1998 and
1997 financial statement schedules, when considered in relation to the basic
1998 and 1997 consolidated financial statements taken as a whole, present fairly
in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
San Diego, California
March 26, 1999 (January 26, 2000 as to Note 22)
101
<PAGE> 102
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of
PICO Holdings, Inc.
Our report on the consolidated statements of operations, shareholders' equity
and cash flows of PICO Holdings, Inc. and subsidiaries (the "Company") for the
year ended December 31, 1996, (which expresses an unqualified opinion and
includes an explanatory paragraph relating to the restatement disclosed in Note
22 to the consolidated financial statements) is included on page 53 of this Form
10-K/A. In connection with our audit of such financial statements, we have also
audited the financial statement schedules listed in the index on page 101 of
this Form 10-K/A.
In our opinion, these financial statement schedules referred to above, when
considered in relation to the basic consolidated statements of operations,
shareholders' equity and cash flows taken as a whole, present fairly, in all
material respects, the information required to be included therein.
PricewaterhouseCoopers LLP
San Diego, California
April 7, 1997, except as to the information presented in Note 22 to the
consolidated financial statements, for which the date is January 26, 2000
102
<PAGE> 103
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)
On December 16, 1998, following the requisite regulatory and shareholder
approvals, PICO Holdings, Inc. ("PICO") and Global Equity Corporation ("GEC")
announced completion of the combination of the two corporations through PICO's
acquisition of GEC's remaining 48.8% minority interest. PICO acquired the
remaining shares through the issuance to GEC shareholders of PICO common stock.
Immediately following the closing, PICO effected a 1-for-5 reverse stock split,
reducing the number of PICO shares issued and outstanding. Accordingly, issued
and treasury share counts have been restated in the December 31, 1997 Condensed
Balance Sheet which follows.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
------------- -------------
(AS RESTATED, See Note 22)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 437,303 $ 81,820
Investments in subsidiaries 167,796,130 109,186,357
Equity securities and other investments 3,528,522 2,699,577
Deferred income taxes 3,077,667 1,649,898
Other assets 11,358,091 1,226,566
------------- -------------
Total assets $ 186,197,713 $ 114,844,218
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued expense and other liabilities $ 12,768,121 $ 2,495,944
------------- -------------
Preferred stock, $.01 par value, authorized 2,000,000 shares; none issued
Common stock, $.001 par value, authorized 100,000,000 shares: issued
13,328,778 and 6,518,344 in 1998 and 1997, respectively 13,329 6,518
Additional paid-in capital 183,154,588 43,173,179
Accumulated other comprehensive loss (7,705,165) (4,751,531)
Retained earnings 75,504,882 83,749,061
------------- -------------
250,967,634 122,177,227
Less treasury stock (4,380,780 shares in 1998 and 498,526 in 1997) (77,538,042) (9,828,953)
------------- -------------
Total shareholders' equity 173,429,592 112,348,274
------------- -------------
Total liabilities and shareholders' equity $ 186,197,713 $ 114,844,218
============= =============
</TABLE>
This statement should be read in conjunction with the notes to the consolidated
financial statements included in the Company's 1998 Form 10-K/A
103
<PAGE> 104
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Two-
For the Year For the Year Month Period
Ended Ended Ended
December 31, December 31, December 31,
1998 1997 1996
------------ ------------ ------------
(AS RESTATED, See Note 22)
<S> <C> <C> <C>
Investment income, net $ 544,424 $ 648,229
Equity in income (loss) of subsidiaries (5,910,480) 20,578,825 $ 19,332,493
------------ ------------ ------------
Total revenues (5,366,056) 21,227,054 19,332,493
Expenses 2,660,813 2,874,895 928,288
------------ ------------ ------------
Income (loss) from continuing operations before income taxes (8,026,869) 18,352,159 18,404,205
Expense (benefit) for income taxes 1,292,334 (803,576)
------------ ------------ ------------
Income (loss) from continuing operations (9,319,203) 19,155,735 18,404,205
Income from discontinued operations of subsidiaries, net 1,075,024 456,283 3,097,307
------------ ------------ ------------
Net income (loss) $ (8,244,179) $ 19,612,018 $ 21,501,512
============ ============ ============
CONDENSED STATEMENTS OF CASH FLOWS
(AS RESTATED, See Note 22)
Cash flow from operating activities:
Net income (loss) $ (8,244,179) $ 19,612,018 $ 21,501,512
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Equity in income (loss) of subsidiaries 5,910,480 (20,578,825) (19,332,493)
Income from discontinued operations of subsidiaries, net (1,075,024) (456,283) (3,097,307)
Changes in assets and liabilities:
Accrued expenses and other liabilities 10,074,675 (1,040,789) 811,638
Other assets (11,559,294) 1,296,193 (437,405)
------------ ------------ ------------
Net cash used in operating activities (4,893,342) (1,167,686) (554,055)
------------ ------------ ------------
Cash flow from investing activities:
Dividends from subsidiary 22,152,608 13,212,592
Sale of investments 14,527,455
Purchase of investments (9,278,630) (33,561,639)
------------ ------------ ------------
Net cash provided by (used in) investing activities 5,248,825 (11,409,031) 13,212,592
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents 355,483 (12,576,717) 12,658,537
Cash and cash equivalents, beginning of period 81,820 12,658,537
------------ ------------ ------------
Cash and cash equivalents, end of year $ 437,303 $ 81,820 $ 12,658,537
============ ============ ============
</TABLE>
This statement should be read in conjunction with the notes to the consolidated
financial statements included in the Company's 1998 Form 10-K/A
104
<PAGE> 105
SCHEDULE II
PICO HOLDINGS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions
---------------------------
(1) (2)
Balance at Charged to Charged to Balance
Beginning Costs and Other at End
Description of Period Expenses Accounts Deduction of Period
----------- ---------- ----------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C>
Year-end December 31, 1998
Allowance for Doubtful Accounts, net $ 119,024 $ 61,204 $ (85,703) $ 94,525
Valuation Allowance for
Deferred Federal Income Taxes $6,800,000 $ 1,889,973 $8,689,973
Year-end December 31, 1997
Allowance for Doubtful Accounts, net $ 116,917 $ 142,789 $(140,682) $ 119,024
Valuation Allowance for
Deferred Federal Income Taxes $6,664,000 $ 136,000 $6,800,000
Year-end December 31, 1996
Allowance for Doubtful Accounts, net $ 78,000 $ (117,470) $ 156,387 $ 116,917
Valuation Allowance for
Deferred Federal Income Taxes $ 6,664,000 $6,664,000
</TABLE>
(1) Increases and decreases in provisions for the allowance for doubtful
accounts are charged to expense accounts. Changes in the allowance for
deferred federal income taxes are charged to provision (benefit) for
federal, foreign and state income taxes except for amounts relating to
unrealized investment gains and losses.
(2) Changes in the valuation allowance relating to unrealized investment gains
and losses are netted against the net unrealized appreciation
(depreciation) on investments account. The change in the valuation
allowance recorded in 1996 occurred prior to the Merger and was acquired in
the Merger.
105
<PAGE> 106
SCHEDULE V
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
December 31, 1996
<TABLE>
<CAPTION>
Future
Policy
Benefits, Amortization
Deferred Losses, Losses of Deferred
Policy Claims Net and Policy Other Net
Acquisition and Loss Unearned Premium Investment Loss Acquisition Operating Premiums
Costs Expenses Premiums Revenue Income Expenses Costs Expenses Written
----------- -------- ------- ------- --------- -------- ----------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Medical
professional
liability $142,965 $ 7,362 $4,881 $ 2,605 $ 272 $ 1,010 $ 28
Other property
and casualty $ 5,421 109,058 $34,808 31,399 2,540 20,328 1,603 10,100 37,529
-------- -------- ------- ------- ------ ------- ------ -------- -------
Total medical
professional
liability and property
and casualty 5,421 252,023 34,808 38,761 7,421 22,933 1,875 11,110 37,557
Other operations 665 7,711
-------- -------- ------- ------- ------ ------- ------ -------- -------
Total continuing 5,421 252,023 34,808 $38,761 $8,086 $22,933 $1,875 $ 18,821 $37,557
======= ====== ======= ====== ======== =======
Discontinued life
and health* 2,501 45,516 489
-------- -------- -------
$7,922 $297,539 $35,297
====== ======== =======
</TABLE>
* Amounts needed to reconcile to balance sheet accounts from discontinued life
and health insurance segment not reclassified for 1996. In 1997, the Company
entered into a definitive agreement to sell its indirectly wholly-owned life
and health insurance subsidiary, American Physicians Life Insurance Company
and its wholly-owned subsidiary. The closing occurred on December 4, 1998.
The Company's 1997 life and health insurance operations have been classified
as discontinued operations 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." Net income for 1996 has also been
reclassified for comparative purposes to reflect the discontinued operations.
See Note 6 to the Consolidated Financial Statements, "Discontinued
Operations."
106
<PAGE> 107
SCHEDULE V
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION AS RESTATED, See Note 22
(In thousands)
December 31, 1997
<TABLE>
<CAPTION>
Losses, Amortization
Deferred Claims Losses of Deferred
Policy and Loss Net and Policy Other Net
Acquisition Expense Unearned Premium Investment Loss Acquisition Operating Premiums
Costs Reserves Premiums Revenue Income Expenses Costs Expenses Written
----------- -------- ------- ------- ---------- -------- ----------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Medical
professional
liability $108,926 $ 239 $ 3,656 $ 1,244 $ 1,887 $ 240
Other property
and casualty $5,321 87,170 $21,635 49,637 5,614 33,086 $11,567 6,461 39,453
------ -------- ------- ------- ------- ------- ------- ------- -------
Total medical
professional
liability and property
and casualty 5,321 196,096 21,635 49,876 9,270 34,330 11,567 8,348 39,693
Other operations 4,250 10,435
------ -------- ------- ------- ------- ------- ------- ------- -------
Total continuing $5,321 $196,096 $21,635 $49,876 $13,520 $34,330 $11,567 $18,783 $39,693
====== ======== ======= ======= ======= ======= ======= ======= =======
</TABLE>
In 1997, the Company entered into a definitive agreement to sell its indirectly
wholly-owned life and health insurance subsidiary, American Physicians Life
Insurance Company and its wholly-owned subsidiary. The closing occurred on
December 4, 1998. The Company's 1997 life and health insurance operations have
been classified as discontinued operations 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." Net income for 1996 has
also been reclassified for comparative purposes to reflect the discontinued
operations. See Note 6 to the Consolidated Financial Statements, "Discontinued
Operations."
107
<PAGE> 108
SCHEDULE V
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
December 31, 1998
<TABLE>
<CAPTION>
Losses, Amortization
Deferred Claims Losses of Deferred
Policy and Loss Net and Policy Other Net
Acquisition Expense Unearned Premium Investment Loss Acquisition Operating Premiums
Costs Reserves Premiums Revenue Income Expenses Costs Expenses Written
----------- -------- ------- ------- ---------- -------- ----------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Medical
professional
liability $ 85,877 $ (159) $2,580 $ 5,628 $ 1,156 $ (220)
Other property
and casualty $5,549 69,144 $20,804 36,290 5,500 24,900 $10,877 4,325 35,507
------ -------- ------- -------- ------ ------- ------- ------- --------
Total medical
professional
liability and property
and casualty 5,549 155,021 20,804 36,131 8,080 30,528 10,877 5,481 35,287
Other operations 1,352 11,560
------ -------- ------- -------- ------ ------- ------- ------- --------
Total continuing $5,549 $155,021 $20,804 $ 36,131 $9,432 $30,528 $10,877 $17,041 $ 35,287
====== ======== ======= ======== ====== ======= ======= ======= ========
</TABLE>
108
<PAGE> 109
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 Hyperfeed.
# 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.
*10.8 Flexible Benefit Plan
*10.16 Office Lease between Citation and North Block Partnership dated
July, 1990.
***10.16.1 Amendments Nos. 1 and 2 to Office Lease between Citation 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 Citation and
North Block Partnership dated December 6, 1993 and October 4,
1994, respectively.
- -*****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. Letter regarding change in Certifying Accountant
from Deloitte & Touche LLP,
+++++16.1. Independent auditors.
#21. Subsidiaries of PICO.
23.1. Independent Auditors' Consent - Deloitte & Touche LLP.
23.2. Consent of Independent Accountants - PricewaterhouseCoopers LLP.
23.3. Accountants' Consent - KPMG LLP.
27. Financial Data Schedule.
###28. Form S-8, Registration Statement under the Securities Act of
1933, for the PICO Holdings, Inc. Employees 401(k) Retirement
Plan and Trust, Registration No. 333-36881.
####29. Form S-8, Registration Statement under the Securities Act of
1933, for the Physicians Insurance Company of Ohio 1995
Non-Qualified Stock Option Plan and assumed by PICO Holdings,
Inc., Registration No. 333-32045.
</TABLE>
109
<PAGE> 110
- ------------------------
* 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 22, 1998 and January 8, 1999, PICO filed Form 8-K and Form
8-K/A, respectively, announcing jointly with GEC the December 16, 1998 closing
of the PICO/GEC Combination and the 1-for-5 Reverse Stock Split.
On October 9, 1998, PICO filed a Form 8-K announcing the conversion of
the Company's Hyperfeed subordinated convertible debenture, working capital
loans and accrued interest into Hyperfeed 5% Convertible Preferred Stock and
common stock warrants.
On October 9, 1998, PICO filed a Form 8-K announcing jointly with GEC
the September 18, 1998 filing with the SEC of their Joint Proxy Statement in
connection with the PICO/GEC Combination.
On July 21, 1998, PICO filed a Form 8-K announcing the favorable
response by GEC's independent committee of directors regarding the PICO/GEC
Combination including disclosure of the share exchange ratio.
On May 20, 1998, PICO file a From 8-K announcing PICO's consideration
of the proposed PICO/GEC Combination through a Plan of Arrangement.
110
<PAGE> 111
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.
111
<PAGE> 112
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: January 27, 2000
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 January 19, 2000 by the following persons
in the capacities indicated.
<TABLE>
<S> <C>
/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
/s/ David A. Williams Director
- ------------------------------------
David A. Williams
/s/ Carlos C. Campbell Director
- ------------------------------------
Carlos C. Campbell
/s/ Robert R. Broadbent Director
- ------------------------------------
Robert R. Broadbent
/s/ John D. Weil Director
- ------------------------------------
John D. Weil
</TABLE>
112
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
333-136881 and 333-32045 of PICO Holdings, Inc. (the "Company") on Form S-8 of
our reports dated March 26, 1999, January 26, 2000 as to Note 22 (which
expresses an unqualified opinion and includes an explanatory paragraph relating
to the restatement disclosed in Note 22) appearing in this Annual Report on Form
10-K/A of the Company for the year ended December 31, 1998.
DELOITTE & TOUCHE LLP
San Diego, California
January 26, 2000
113
<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,
except as to the information presented in Note 22 to the consolidated financial
statements, for which the date is January 26, 2000 (which expresses an
unqualified opinion and includes an explanatory paragraph relating to the
restatement disclosed in Note 22), on our audit of the consolidated statements
of operations, shareholders' equity and cash flows and consolidated financial
statement schedules of PICO Holdings, Inc. for the year ended December 31, 1996
which report is included in this annual report on Form 10-K/A.
PricewaterhouseCoopers LLP
San Diego, California
January 26, 2000
114
<PAGE> 1
EXHIBIT 23.3
ACCOUNTANTS' CONSENT
The Board of Directors
PICO Holdings, Inc.
We consent to the incorporation by reference in the Amendment No. 4 to
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/A of PICO Holdings, Inc. for the year ended December
31, 1998.
KPMG LLP
Chartered Accountants
Toronto, Canada
January 26, 2000
115
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF INCOME OF PICO
HOLDINGS, INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 32,642
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 60,624
<MORTGAGE> 0
<REAL-ESTATE> 2,047
<TOTAL-INVEST> 116,412
<CASH> 71,654
<RECOVER-REINSURE> 1,127
<DEFERRED-ACQUISITION> 5,549
<TOTAL-ASSETS> 395,176
<POLICY-LOSSES> 155,021
<UNEARNED-PREMIUMS> 20,804
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
13
0
<COMMON> 0
<OTHER-SE> 173,416
<TOTAL-LIABILITY-AND-EQUITY> 395,176
36,131
<INVESTMENT-INCOME> 9,432
<INVESTMENT-GAINS> (4,412)
<OTHER-INCOME> 6,257
<BENEFITS> 30,528
<UNDERWRITING-AMORTIZATION> 10,877
<UNDERWRITING-OTHER> 17,040
<INCOME-PRETAX> (6,952)
<INCOME-TAX> 1,292
<INCOME-CONTINUING> (9,319)
<DISCONTINUED> 1,075
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,244)
<EPS-BASIC> (1.38)
<EPS-DILUTED> (1.38)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
