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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission file number
December 31, 1999 1-12338
VESTA INSURANCE GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 63-1097283
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3760 River Run Drive, 35243
Birmingham, AL
(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
Registrant's telephone number, including area code:
(205) 970-7000
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS CUSIP NUMBER: ON WHICH REGISTERED:
Common Stock, $.01 Par 925391104 Common Stock, $.01 Par
Value Value
Securities registered pursuant to Section 12(g) of the Act:
None
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) AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES [_] NO [X]
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K ((S)229.405 OF THIS CHAPTER) 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 OF THIS
FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [X]
THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE
REGISTRANT AS OF MARCH 20, 2000:
$89,022,908
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK, AS OF
MARCH 20, 2000 is 18,825,832
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE VESTA INSURANCE GROUP, INC. PROXY STATEMENT FOR ITS 2000
ANNUAL MEETING OF STOCKHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III
HEREOF.
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Table of Contents
<TABLE>
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Part I Page
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<C> <S> <C>
Item 1 Business Overview............................................ 1
Recent Developments.......................................... 1
Business Strategy............................................ 2
Personal Lines............................................... 3
Reinsurance Assumed.......................................... 6
Commercial Lines............................................. 7
Reinsurance Ceded............................................ 7
Claims....................................................... 8
Reserves..................................................... 8
Investments.................................................. 11
Regulation................................................... 12
A.M. Best.................................................... 16
Competition.................................................. 16
Relationship with Torchmark.................................. 17
Employees.................................................... 17
Item 2 Properties................................................... 17
Item 3 Legal Proceedings............................................ 17
Item 4 Submission of Matters to a Vote of Security Holders.......... 19
Part II
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Market for Registrants' Common Equity and Related Stockholder
Item 5 Matters...................................................... 20
Item 6 Selected Financial Data...................................... 21
Item 7 Management's Discussion and Analysis of Results of Operations
and Financial Condition..................................... 22
Item 8 Financial Statements and Supplementary Data.................. 32
Part III
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Item 10 Directors and Executive Officers of the Registrants.......... 63
Item 11 Executive Compensation....................................... 63
Security Ownership of Certain Beneficial Owners and
Item 12 Management................................................... 63
Item 13 Certain Relationships and Related Transactions............... 63
Part IV
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Exhibits, Financial Statement Schedules, and Reports on Form
Item 14 8-K.......................................................... 64
</TABLE>
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Special Note Regarding Forward-Looking Statements
Any statement contained in this report which is not a historical fact, or
which might otherwise be considered an opinion or projection concerning the
Company or its business, whether express or implied, is meant as and should be
considered a forward-looking statement as that term is defined in the Private
Securities Litigation Reform Act of 1996. Forward-looking statements are based
on assumptions and opinions concerning a variety of known and unknown risks,
including but not necessarily limited to changes in market conditions, natural
disasters and other catastrophic events, increased competition, changes in
availability and cost of reinsurance, changes in governmental regulations, and
general economic conditions, as well as other risks more completely described
in the Company's filings with the Securities and Exchange Commission,
including exhibit 99.1 to this Report on Form 10-K. If any of these
assumptions or opinions prove incorrect, any forward-looking statements made
on the basis of such assumptions or opinions may also prove materially
incorrect in one or more respects.
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PART I
Item 1. Business
Business Overview
The Company made a strategic decision in 1999 to concentrate its efforts on
a traditionally profitable segment of our company. Our focus is now on
Personal lines which includes Homeowners, Personal Auto, Financial Service and
Other insurance products. In conjunction with our new focus on Personal lines,
we renewed our commitment to the independent agent distribution system which
we believe provides a vehicle of proven profitability and growth. This
strategic decision resulted in a significant curtailment of our traditional
reinsurance and the discontinuance of our commercial operations.
Historically, we maintained a Commercial Lines segment and an Assumed
Reinsurance segment which are mentioned elsewhere in this report. The
Commercial Lines segment offered a variety of commercial property coverages to
principally small businesses. The Assumed Reinsurance segment offered treaty
Reinsurance to small and medium-sized insurance companies and regional
specific Reinsurance for larger insurance companies located throughout the
United States. Consistent with our prior strategy to focus on property and
personal auto coverages, the principal lines of business reinsured by the
Assumed Reinsurance segment were homeowner and commercial property coverages,
non-standard automobile insurance and collateral protection insurance.
Commercial Lines insurance products were distributed through independent
agents, brokers and managing general agents. Reinsurance products have been
offered primarily through Reinsurance intermediaries and brokers.
Recent Developments
The following events have occurred since January 1, 1999 and have had a
significant positive impact on the Company's financial condition:
. Sale of Assumed Reinsurance. On March 24, 1999 the Company sold its
reinsurance assumed business with the exception of a book of homeowner's
business written by CIGNA which we initially assumed through a 100%
reinsurance arrangement, but which is currently being converted to our
Personal Lines operations. The Company received $15 million in exchange
for its commitment to (a) enter into a 100% quota share treaty,
effective January 1, 1999 for all business written on or after that
date; b) use its best efforts to novate to the purchaser or renew on the
purchaser's paper, all assumed treaties except those currently being
converted to primary business and; (c) facilitate the hiring by the
purchaser of several of the Company's reinsurance employees. The Company
is exiting the reinsurance assumed business with this transaction and
continued conversion or commutation and termination of the other assumed
reinsurance business.
. Sale of Vesta County Mutual. On September 10, 1999, the Company entered
into an agreement with Employers Reinsurance Corporation to sell the
authority and the right to control Vesta County Mutual Insurance Company
in Texas. The sale of this non-core asset provided the Company with
$11.2 million to use in reducing its outstanding bank debt.
. Birmingham Investment Group, LLC. On September 30, 1999, the Birmingham
Investment Group, LLC agreed to purchase from the Company in a private
placement transaction 2,950,000 shares of preferred stock at a price of
$8.50 per share or a total of $25,075,000. Each share of preferred stock
carries a dividend of 9% and can be converted into two shares of common
stock. Two members of the Birmingham Investment Group, James A. Taylor
and Larry D. Striplin, Jr., became members of the Board of Directors of
Vesta as part of the transaction. The preferred stock automatically
converts into common stock when the closing price of the Company's
common stock is $8.00 or higher for twenty consecutive trading days.
1
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. New Credit Facility. On September 30, 1999, the Company retired its
existing credit facility under which there had been a technical default
during 1998. The new credit facility included more favorable terms and
provided the Company with greater financial flexibility. That credit
facility was repaid in its entirety subsequent to year end and as of
March 31, 2000, the Company had no outstanding bank debt and a new
credit line of $15 million available for general corporate purposes. See
the Liquidity and Capital Resources section for further information.
. Debt Exchanges and Repurchases. On December 30, 1999, the Company
exchanged $58.8 million of its outstanding 8.525% Capital (Trust
Preferred) Securities due 2022 for approximately $44.1 million of its
newly issued 12.5% Senior Notes due 2005. The exchange resulted in a
reduction of the Company's debt to total capital ratio from 53.5% to
50%. The transaction also increased equity by approximately $9.5
million. On March 17, 2000, the Company repurchased $21.5 million of
these 12.5% Senior Notes and an additional $4.5 million of its 8.75%
Senior Debentures due 2025 for approximately $21 million in cash. As a
result of these repurchases, the Company reduced its total outstanding
indebtedness by $26 million, further reduced its debt to total capital
ratio to 43.5% (including the payoff of the Company's revolving credit
facility) and increased equity by approximately $3.5 million.
. Redomestication. In December 1999, the Company formally redomesticated
Vesta Fire Insurance Corporation, Vesta Insurance Corporation and
Sheffield Insurance Corporation from Alabama to Illinois and Shelby
Casualty Insurance Company from Indiana to Illinois. While the
redomestications will have no material effect on the companies
operations, each company will now be regulated by the Illinois
Department of Insurance.
. Improved rating by A.M. Best Company. On February 25, 2000, A.M. Best
Company upgraded the Company's insurance subsidiaries to "B+" (Very
Good) from "B" (Fair). The "B+" rating places Vesta in the secure
category of A.M. Best's classifications. A.M. Best's upgrade reflects
the agency's assessment of the Company's improved financial condition,
including the Company's reduced debt and improved financial flexibility.
Similarly, when the Company reinstated the payment of dividends on its
Trust Preferred Securities, Duff & Phelps Credit Rating Co. upgraded its
rating on those securities to "B" (financial protection factors will
fluctuate widely according to economic cycles) from "DP" (dividend
arrearages). Duff & Phelps also removed all the Company's rated
operating subsidiaries from "Rating Watch--Down." Moody's Investor
Service also revised its outlook for the ratings of the Company to
"positive" from "negative."
Business Strategy
The Company made a strategic decision in 1999 to concentrate its efforts on
a traditionally profitable segment of our company. Our focus is now on
Personal Lines, which includes Homeowners, Personal Auto, Financial Service
and Other insurance products.
The Company made a significant move in 1999 to consolidate processing for
all Personal Lines business into the Birmingham office. This action had an
immediate and significant impact on the Company's expense ratio, reducing it
to a level of less than 15% for 1999.
The Company is committed to managing expenses in line with the level of
service expected by its customers. The Company views its primary customer as
the Independent Agent who produces the business. In the fall of 1999, the
Company assembled its National Agency Council to identify their expectations
regarding all facets of Company operations. Of primary importance was
reestablishing service standards relating to underwriting processing and
claims adjudication that eroded during the consolidation of processing to
Birmingham. The Company promptly responded to its agent's concerns in this
regard and took the necessary actions to increase the speed and accuracy of
the underwriting processing and claims adjudication.
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Business Written By Segment
The following table provides selected historical information on a Generally
Accepted Accounting Principles (GAAP) basis concerning the business written by
us and the associated underwriting results. This data should be read in
conjunction with our Consolidated Financial Statements and related notes
thereto. For additional information on our business segments, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note N to the Consolidated Financial Statements.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(In thousands, except ratio data)
<S> <C> <C> <C> <C> <C>
Personal
Gross Premiums Written....... $254,991 $346,992 $244,719 $109,661 $105,643
Net Premiums Written......... 227,807 264,840 141,167 69,769 52,157
Net Premiums Earned.......... 248,077 247,064 139,425 63,206 44,796
Loss Ratio................... 66.5% 66.7% 68.3% 40.5% 43.6%
Reinsurance(1)
Gross Premiums Written....... $ 7,215 $287,617 $535,427 $497,537 $353,988
Net Premiums Written......... 15,055 157,729 351,811 373,486 289,565
Net Premiums Earned.......... 96,029 194,261 335,360 342,452 221,933
Loss Ratio................... 49.3% 90.5% 53.5% 59.9% 68.1%
Commercial(1)
Gross Premiums Written....... $ 45,554 $124,412 $ 85,905 $ 44,573 $ 58,428
Net Premiums Written......... 23,392 69,022 33,499 24,801 48,782
Net Premiums Earned.......... 52,230 68,368 42,873 33,678 46,349
Loss Ratio................... 65.9% 80.0% 55.9% 62.8% 61.3%
Combined
Gross Premiums Written....... $307,760 $759,021 $866,051 $651,771 $518,059
Net Premiums Written......... 266,254 491,590 526,475 468,056 390,504
Net Premiums Earned.......... 396,335 509,693 517,658 439,336 313,078
Loss Ratio(2)................ 61.6% 76.4% 57.9% 56.9% 64.0%
Expense Ratio(2)............. 38.2% 51.1% 34.5% 33.4% 31.4%
Combined Ratio(2)............ 99.8% 127.5% 92.4% 90.3% 95.4%
</TABLE>
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(1) As we did not implement our strategy to concentrate exclusively on
Personal lines until 1999, our historical results of operations continue
to reflect significant premium volume in our Reinsurance and Commercial
Lines segments. We expect there will be significantly less of this premium
volume during 2000.
(2) Ratios are for continuing operations (personal and reinsurance lines).
Personal lines Business Segment
General.
The Company has dedicated its resources totally to the Personal Lines
market. These lines have established a strong foundation for profitable growth
in the future. The Company offers a full range of Personal Lines products that
are very competitive across the Personal Lines marketplace. These products
include personal automobile, homeowners, residential fire, and umbrella
coverages.
In 1998, we acquired a large book of homeowners (personal lines) business
from CIGNA. We initially captured the premiums associated with this business
through a reinsurance arrangement. As the policies come up for renewal, we
expect the individual insureds or their agents to renew their coverage with
Vesta.
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During 1999, the Company began the process of converting the CIGNA book to
its own processing system. Total conversion of the CIGNA book will be
completed early in 2001. This conversion offers a much more flexible, user
friendly, cost effective system that can be delivered to the agent at the
point of sale.
Business Mix
The following table sets forth our gross premiums written in its Personal
lines segment by type of insurance offered for the three years indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1999 1998 1997
------------- -------------- --------------
<CAPTION>
(in thousands, except percentage)
<S> <C> <C> <C> <C> <C> <C>
Personal Auto.................... $141,868 55.7% $223,425 64.4% $112,394 45.9%
Homeowners....................... 107,025 42.0% 93,762 27.0% 88,599 36.2
Financial Services............... 4,592 1.8% 20,682 6.0% 37,344 15.3
Other............................ 1,506 .5% 9,123 2.6% 6,382 2.6
-------- ---- -------- ----- -------- -----
$254,991 100% $346,992 100.0% $244,719 100.0%
======== ==== ======== ===== ======== =====
</TABLE>
Personal Auto. We offer standard and non-standard policies in our Personal
Auto insurance line. The standard auto line targets drivers over age 45 with
above average driving records. The non-standard auto line covers the full
spectrum of non-standard drivers. Liability limits up to $500,000 are written
on standard auto policies, with an additional $5 million personal umbrella
limit also available. However, the vast majority of the personal umbrella are
written at limits of $1 million or $2 million. For non-standard auto, we
typically write minimum basic limits that vary by state.
Homeowners. Our Homeowners insurance products cover the full range of homes
starting with lower-valued dwellings in the $10,000 to $50,000 range, through
the middle-valued homes from $50,000 to $150,000, as well as higher valued
homes up to $10,000,000. The majority of homes insured are valued between
$40,000 and $250,000.
As with automobile, the Company is able to provide a broad range of
competitive property products that are available in numerous policy forms. The
Company has products and pricing to fill market needs for low and high value
property. Attractive pricing of each product is supported with additional
features such as replacement cost coverage and numerous discounts.
Financial Services. We provide specialty products protecting collateral and
repossessed property of financial institutions. Certain of these products are
designed to protect the interests of financial institutions against physical
damage to private passenger automobiles and other personal property in those
cases where the borrower fails to insure the collateral in accordance with a
loan agreement. We also have mortgage security products that are designed to
protect the interest of the mortgagee and the mortgagor (borrower) caused by
the mortgagor's failure to obtain property insurance on the mortgaged
property. Coverage is also provided for the properties that are in the process
of foreclosure.
Other. Our Industrial Fire program makes up the majority of this category.
This program is designed to offer fire and allied lines coverage on low-value
dwelling, mobile home, and household contents. All policies are available on
monthly, quarterly, semi-annual, or annual payment modes with premium
discounts given for quarterly, semi-annual, and annual payment modes. All
policies are written on a non-participating basis. This business was developed
through the agency force of Liberty National Life. On May 1, 1995, Liberty
National Life discontinued the marketing and new sales of fire and allied
lines of business. However, this product is available for use by our
independent agencies in selected Southeastern states.
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Marketing.
The Company has selected the Independent Insurance Agent as its primary
method of distribution. The Company feels the Professional Independent Agent
is best able to sell and service the needs of its target market. The Company
views its long term goal of profitable growth being closely tied to the
ability to renew high percentages of the book of business on an annual basis.
Because of the Independent Agent's close relationship with their customer the
Company expects, and has seen in past performance, very favorable renewal
ratios. The partnership with the Independent Agent is viewed as the key to the
Company's long-term success in the Personal Lines marketplace. We currently
have a marketing force of approximately 3,800 agencies in 42 states.
The following table sets forth the principal geographic distribution of our
gross premiums written in our Personal Lines business for the three years
indicated. The states listed below comprise the ten states with the largest
gross premiums written for 1999.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1999 1998 1997
------------- -------------- --------------
(in thousands, except percentages)
<S> <C> <C> <C> <C> <C> <C>
Pennsylvania..................... $ 48,822 19.2% $ 50,185 14.4% $ 24,455 10.0%
West Virginia.................... 26,677 10.5 27,593 8.0 12,823 5.3
Tennessee........................ 20,065 7.9 24,924 7.2 15,890 6.5
Ohio............................. 19,307 7.6 17,942 5.2 10,865 4.5
Texas............................ 18,992 7.5 77,567 22.3 50,660 20.7
Hawaii........................... 18,425 7.3 25,175 7.3 35,686 14.6
Illinois......................... 15,936 6.3 20,029 5.8 12,118 4.6
Alabama.......................... 11,375 4.5 14,641 4.2 18,032 7.4
North Carolina................... 10,426 4.1 11,966 3.4 5,186 2.2
Mississippi...................... 9,883 3.9 11,398 3.3 7,773 3.2
All Other........................ 55,083 21.1 65,572 18.9 51,231 21.0
-------- ---- -------- ----- -------- -----
Total............................ $254,991 100% $346,992 100.0% $244,719 100.0%
======== ==== ======== ===== ======== =====
</TABLE>
The geographic balance reflected above allows for greater profit protection
and more cost effective management of the property catastrophe exposures. We
employ marketing representatives to maintain and expand our agency
relationships in our Personal lines business. In addition, we pay competitive
commission rates to our agents and utilize a profit sharing plan for agencies
which is based on volume of premiums and loss ratios for business written.
Our independent agents have limited authority to bind insurance coverages
without prior approval from us, so long as such coverages fit within our
established guidelines. However, our underwriting staff reviews all coverages
bound by these agents and ultimately decides whether to continue such
coverages. Because of the broad base of our independent agency force, the
contractual limitation on their authority to bind coverage and our
underwriting review procedures, we do not believe that the authority of our
agents to bind us presents any material risk to our operations.
Underwriting.
The underwriting of the Company's products is conducted by a trained staff
of professional underwriters and managers. The Company places a high level of
responsibility at the underwriter level to effectively manage their assigned
markets. The underwriting team is supported by a full range of management
reports available on a scheduled or ad hoc basis used in the analysis of their
territories. Underwriters are expected to make adjustments they view as
necessary due to loss experience or a change in market conditions.
The Company is committed to a consistent underwriting philosophy that is
easily understood by its agents. The Company strongly believes that the
ability to write high volumes of profitable business is directly related to a
close partnership with the Independent Agent. The Company expects the agent to
assume a key role in the underwriting process working closely with the Company
underwriter.
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Making the underwriter easily accessible to the agent supports this
relationship. Underwriters are also expected to make regular field trips to
build agent relationships and understand local markets.
The Company maintains a very conservative philosophy relative to catastrophe
prone markets. The Company typically does not write within 100 miles of the
coastline in the Southeast. In the Northeast and West the Company utilizes high
wind deductibles in order to limit its catastrophe exposure. The Company
continually monitors and controls its production in order to manage its risk in
areas with significant exposure to natural disasters.
The Company is committed to providing a level of service consistent with the
expectations of its agents and customers. Programs are in place to manage the
quality of service in several areas. These areas include policy accuracy,
telephone management, and speed of product delivery. The Company has a highly
skilled customer service and processing staff to deliver the level of service
expected. Regular interaction with the Company's agents regarding service
performance is key in monitoring the level of service provided.
Growth Strategy.
A significant potential for internal, organic growth exists in Personal
lines through expansion of our existing products to our existing agency force.
The largest potential exists with both standard and non-standard Personal Auto
lines, which are currently marketed in only 13 and 8 of our active states,
respectively. We plan to market these products to many of our appointed
agencies in additional states in the next several years, thus enabling them to
cross-sell our current Homeowners policyholders. This cross-selling activity
not only will increase premium production but also should improve renewal
retention and, therefore, our loss ratio and underwriting expense ratio.
In addition to the expansion of our Personal Auto insurance products to
other active states, we also plan to expand our low-valued dwelling and high-
valued homeowners products to other active states, as appropriate, based on
state demographics.
Technological Enhancements:
As the Company moves forward, technology will be a key to delivering
superior underwriting and service results. The Company currently utilizes state
of the art imaging technology to manage the processing and underwriting
environment. This allows the Company to manage work in a highly efficient
manner.
The next step in technology advancement centers on the Company's Internet
link with its agents. This vehicle is currently in place for numerous agents
and will be expanded on a countrywide basis during 2000. This will provide the
agent with a direct link to the Company for the submission of new business and
endorsements. This link will also provide the agent direct access to the
Company's processing system, providing the agent with an opportunity to provide
better service to its customer and resulting in operating efficiencies for the
Company.
In conjunction with the Internet link, the Company will provide point of
sale underwriting tools that will allow the agent to qualify an applicant prior
to submitting a bound application. In addition, the Company is piloting the use
of credit scoring in the underwriting process during 2000. Credit scoring will
work in conjunction with the Company's basic underwriting programs to improve
the Company's loss results.
Reinsurance Assumed
General. Reinsurance is a contractual arrangement under which one insurer
(the ceding company) transfers to another insurer (the reinsurer) all or a
portion of a risk or group of risks that the ceding company has undertaken
under the insurance policy or policies it has issued. A ceding company may
purchase Reinsurance for any number of reasons including to obtain, through the
reduction of its liabilities, greater underwriting capacity than its own
capital resources would support, to stabilize its underwriting results, to
protect against catastrophic loss, to withdraw from a line of business and to
manage risk when entering a new line of business.
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We determined that the 1999 A.M. Best ratings downgrade and the increased
competition in the Reinsurance marketplace would cause a significant loss of
Reinsurance premiums in 1999; therefore management decided to exit the
Reinsurance assumed segment. The Company did not write any new Reinsurance
business effective after January 1, 1999. On March 24, 1999, we entered into
an agreement to transfer certain of our reinsurance assumed business to
Hartford Fire Insurance Company (Hart Re). The agreement called for us to
reinsure our North American assumed business underwritten in the Birmingham
office with a January 1, 1999 effective date to Hart Re under a 100% quota
share treaty and for us to use our best efforts to novate the policies to Hart
Re and encourage renewals with Hart Re for policies not novated. We exited the
Reinsurance assumed business with the exception of CIGNA with this
transaction. The continued conversion or commutation and termination of all
other assumed reinsurance business will ultimately result in a complete exit.
We will continue to earn premium and incur losses on certain Reinsurance
assumed contracts until the contracts are terminated through conversion or
commutation. We also have exposure to loss development on business written
before 1999.
Commercial Lines (discontinued)
General. Until 1999, we provided a full spectrum of property, liability and
auto coverage for a broad range of commercial target classes, including
hotels, manufacturers, restaurants, motorcycle dealers, broadcasters and
publishers. We also had designed a complementary group of insurance products
for the trucking industry offered to independent owner-operators of trucks and
small fleets to cover physical damage, non-trucking liability (non-business
use of the vehicle), and cargo risks. In our Commercial Lines business, we had
developed particular expertise with respect to a select group of smaller
account classes, including small office, service and retail business owners;
mini-storage facilities; artisan contractors; and small service garages. We
concluded, however, that in the continuing competitive marketplace, and also
because of the 1999 A.M. Best ratings downgrade, we could not achieve adequate
pricing for these Commercial Lines as required for profitability. We received
final regulatory approval to non renew commercial business in November 1999.
Therefore, all Commercial Lines were discontinued in the fourth quarter of
1999. We will continue to earn premium and incur losses on policies which were
in-force at the date of discontinuance until those policies expire.
Reinsurance Ceded
We seek to manage our risk exposure on personal lines products through the
purchase of Reinsurance, including retrocessional placements for its
Reinsurance business. We obtain Reinsurance principally to reduce our net
liability on individual risks and to provide protection for individual loss
occurrences, including catastrophic losses, in order to stabilize our
underwriting results. In exchange for Reinsurance, we pay to our reinsurers a
portion of the premiums received under the reinsured policies. While the
assuming reinsurer is liable for losses to the extent of the coverage ceded,
Reinsurance does not legally discharge us from primary liability for the full
amount of the policies ceded.
We generally purchase reinsurance separately for our personal, commercial
and reinsurance business. Gross written premiums ceded for 1999 were $41.6
million, which constituted 13.4% of the gross premiums written, and for 1998
were $267.4 million, which constituted 35.1% of the gross premiums written.
The decrease in 1999 was primarily due to the decrease in gross written
premiums in 1999, the cancellation of the 20 percent whole account quota share
treaty and the exit from commercial and reinsurance lines which have required
significantly higher reinsurance costs. See, "Management's Discussion and
Analysis--Overview." While we seek to reinsure a significant portion of our
property catastrophe risks, there can be no assurance that our losses will be
within the coverage limits of the Company's Reinsurance and retrocessional
programs.
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Premiums that the ceding company pays to the reinsurer for excess of loss
coverage are not directly proportional to the premiums that the ceding company
receives because the reinsurer does not assume a proportionate risk. Excess of
loss coverage is priced separately and distinctly from the pricing employed by
the ceding company in connection with its risk since the probability of loss
is different for the reinsurer than the ceding company. In contrast, in pro
rata Reinsurance, premiums that the ceding company pays to the reinsurer are
proportional to the premiums that the ceding company receives, consistent with
the proportional sharing of risk, and the reinsurer generally pays the ceding
company a ceding commission. Generally, the ceding commission is based upon
the ceding company's cost of obtaining the business being reinsured (i.e.,
commissions, premium taxes, assessments and miscellaneous administrative
expenses). The availability and cost of Reinsurance and retrocessional
coverage may vary significantly over time and are subject to prevailing market
conditions.
Should a reinsurer fail to pay claims on Vesta's ceded business, Vesta (or
its insurance subsidiary) is primarily liable for such claims. We seek to
evaluate the credit quality of the reinsurers and retrocessionares to which it
cedes business. No assurance can be given regarding the future ability of any
of our reinsurers to meet their obligations.
Claims
Claims arising under the policies issued by us are managed by our Claims
Department. When we receive notice of a loss, our claims personnel open a
claim file and establish a reserve with respect to the loss. All claims are
reviewed and all payments are made by our employees, with the exception of
claims on certain products, which are adjusted by a managing general agency
and periodically audited by our claims personnel.
Most Personal lines claims are adjusted and paid by staff claims adjusters.
Management believes that utilizing our trained employee adjusters permits
faster, more efficient service at a lower cost.
Claims settlement authority levels are established for each adjuster or
manager based upon each employee's ability and level of experience. Upon loss
notification, each claim is reviewed and assigned to an adjuster or manager
based upon the type of claim. Claims-related litigation is monitored by home
office litigation supervisors. We emphasize prompt, fair and equitable
settlement of meritorious claims, adequate reserving for claims and
controlling of claims adjustment and legal expenses.
Reserves
Our insurance subsidiaries maintain reserves to cover their estimated
ultimate liability for losses and LAE with respect to reported and unreported
claims incurred. To the extent that current reserves prove to be inadequate in
the future, we would have to increase such reserves and incur a charge to
earnings in the period such reserves are increased, which could have a
material adverse effect on our results of operations and financial condition.
The establishment of appropriate reserves is an inherently uncertain process,
and there can be no assurance that ultimate losses will not materially exceed
our estimates. Reserves are estimates involving actuarial and statistical
projections at a given point in time of what we expect to be the cost of the
ultimate settlement and administration of claims based on facts and
circumstances then known, estimates of future trends in claims severity and
other variable factors such as inflation. The inherent uncertainties of
estimating reserves generally are greater with respect to Reinsurance
liabilities due to the diversity of development patterns among different types
of Reinsurance contracts, the necessary reliance on ceding companies for
information regarding reported claims and differing reserving practices among
ceding companies.
With respect to reported claims, reserves are established on a case-by-case
basis. The reserve amounts on each reported claim are determined by taking
into account the circumstances surrounding each claim and policy provision
relating to the type of loss. Loss reserves are reviewed on a regular basis,
and as new data becomes available, appropriate adjustments are made to
reserves.
8
<PAGE>
For incurred but not reported ("IBNR") losses, a variety of methods have
been developed in the insurance industry for determining estimates of loss
reserves. One common method of actuarial evaluation, which we use, is the loss
development method. This method uses the pattern by which losses have been
reported over time and assumes that each accident year's experience will
develop in the same pattern as the historical loss development. We also rely
on industry data to provide the basis for reserve analysis on newer lines of
business (lines written less than three years).
Provisions for inflation are implicitly considered in the reserving
process. Our reserves are carried at the total estimate for ultimate expected
loss without any discount to reflect the time value of money.
Reserves are computed based upon actuarial principles and procedures
applicable to the lines of business written by us. These reserve calculations
are reviewed regularly by management, and, as required by state law, we engage
an independent actuary to render opinions as to the adequacy of statutory
reserves established by management. The actuarial opinions are filed with the
various jurisdictions in which we are licensed. Based on our practices and
procedures, management believes that reserves are adequate as of the valuation
date.
The following table provides a reconciliation of beginning and ending
liability balances on a GAAP basis for the periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1999 1998 1997
--------- --------- ---------
(in thousands)
<S> <C> <C> <C>
Gross Losses and LAE reserves at beginning of
year........................................ $ 504,911 $ 596,797 $ 173,275
Reinsurance Receivable....................... (206,139) (204,336) (60,343)
--------- --------- ---------
Net Losses and LAE reserves at beginning of
year........................................ 298,772 392,461 112,932
Increases (decreases) in provisions for
losses and LAE for
claims incurred:
Current year................................ 268,931 396,091 311,089
Prior year (1).............................. (22,167) (769) (12,451)
Acquisition of Shelby........................ -- -- 300,315
Losses and LAE payments for claims incurred:
Current year................................ (198,503) (269,369) (166,447)
Prior year.................................. (178,883) (219,642) (152,977)
--------- --------- ---------
Net Losses and LAE reserves at end of year... 168,150 298,772 392,461
Reinsurance Receivable....................... 186,559 206,139 204,336
--------- --------- ---------
Gross loss and LAE Reserves.................. $ 354,709 $ 504,911 $ 596,797
========= ========= =========
</TABLE>
(1) The favorable development of $22.2 million is primarily attributable to
positive development on personal lines and on the run out of the assumed
reinsurance lines, commutation gains and additional ceded recoveries.
The reconciliation between statutory basis and GAAP basis reserves for each
of the three years in the period ended December 31, 1999, is shown below:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1999 1998 1997
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Statutory reserves............................... $207,351 $363,139 $391,069
Adjustments for salvage and subrogation (1)...... -- (11,250) (15,553)
Retroactive Reinsurance amounts.................. (39,201) (53,117) 16,945
Gross-up of amounts netted against Reinsurance
recoverable..................................... 186,559 206,139 204,336
-------- -------- --------
Reserves on a GAAP basis......................... $354,709 $504,911 $596,797
======== ======== ========
</TABLE>
9
<PAGE>
- - --------
(1) Salvage and subrogation recoverable amounts were included in the 1999
statutory reserves in accordance with Illinois Department of Insurance
regulations. Prior to 1999, the Company reported its statutory reserves
under Alabama regulations which do not allow such adjustments.
The following table shows the development of the reserves for unpaid losses
and LAE from 1989 through 1999 for our insurance subsidiaries on a GAAP basis
net of Reinsurance recoveries. The top line of the table shows the liabilities
at the balance sheet date for each of the indicated years. This reflects the
estimated amounts of losses and LAE for claims arising in that year and all
prior years that are unpaid at the balance sheet date, including losses
incurred but not yet reported to us. The upper portion of the table shows the
cumulative amounts subsequently paid as of successive years with respect to
the liability. The lower portion of the table shows the reestimated amount of
the previously recorded liability based on experience as of the end of each
succeeding year. The estimates change as more information becomes known about
the frequency and severity of claims for individual years. A redundancy
(deficiency) exists when the reestimated liability at each December 31 is less
(greater) than the prior liability estimate. The "cumulative redundancy
(deficiency)" depicted in the table, for any particular calendar year,
represents the aggregate change in the initial estimates over all subsequent
calendar years.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------------------------
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
------- ------- ------- ------- ------- ------- -------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liability for unpaid
losses and LAE..... $32,861 $27,823 $21,919 $21,976 $29,688 $66,648 $118,733 $112,932 $392,461 $298,772 $168,150
Paid (cumulative)
as of One year
later............. 19,611 11,864 13,166 20,517 20,761 51,527 88,377 86,978 197,477 178,883
Two years later... 24,063 14,949 17,054 20,272 28,766 65,360 116,388 114,704 253,109
Three years later. 27,199 17,096 16,810 20,281 34,776 66,490 125,299 131,342
Four years later.. 29,235 18,093 16,622 23,272 33,139 72,273 137,081
Five years later.. 29,960 19,206 18,140 20,994 38,222 81,156
Six years later... 30,976 20,683 16,218 22,964 46,298
Seven years later. 32,303 20,391 17,922 31,006
Eight years later. 31,856 22,284 25,941
Nine years later.. 33,171 30,299
Ten years later... 41,183
Liability
reestimated as of
End of year....... 32,861 27,823 21,919 21,976 29,688 66,648 118,733 112,932 392,461 298,772 168,150
One year later.... 34,078 28,779 21,853 28,530 28,930 61,033 127,790 99,708 391,692 276,605
Two years later... 33,304 29,431 19,009 27,914 34,219 66,582 110,437 144,986 353,969
Three years later. 33,851 29,130 19,817 26,120 38,940 66,713 118,657 132,761
Four years later.. 32,097 29,578 16,470 30,435 41,517 76,863 146,090
Five years later.. 34,549 26,291 19,862 33,845 50,993 88,770
Six years later... 31,205 29,493 23,760 40,317 53,330
Seven years later. 34,280 36,400 29,574 37,953
Eight years later. 38,955 40,568 33,388
Nine years later.. 44,587 37,804
Ten years later... 48,679
Cumulative
redundancy/
(deficiency)....... (15,818) (9,981) (11,469) (15,977) (23,642) (22,122) (27,357) (19,829) 38,492 22,167
</TABLE>
The table above was significantly affected by the 1998 the revision of
Vesta Fire's statutory loss development (Schedule P) required by the Alabama
Department of Insurance, which corrected the assignment of certain losses to
accident years and is reflected above. In addition, the table reflects certain
GAAP adjustments (see Note C of the Notes to Consolidated Financial
Statements) and for years prior to 1997 excludes the development related to
the 1997 acquisitions of Shelby and Vesta County Mutual.
We reinsured a number of casualty risks in the early 1980's which could
result in claims for coverage of asbestos related and other environmental
impairment liabilities to the extent that such liabilities were not excluded
from the underlying policies. Our exposure to a significant loss from an
asbestos or environmental claim is minimal due to the fact that our
participation in the Reinsurance
10
<PAGE>
treaties relating to these risks is only at the higher levels and our
percentage participation in those layers is relatively low. In addition, we
carry Reinsurance which would mitigate the effect of any losses under these
treaties. While there exists a possibility that we could suffer material loss
in the event of a high number of large losses under these treaties, this is
unlikely in management's judgment.
Investments
Our investment portfolio consists primarily of investment grade fixed
income securities. Asset Allocation Management Company, LLC provides
investment advisory services to us subject to investment policies and
guidelines established by management and the Board of Directors. Our
investments at December 31, 1999, totaled approximately $484 million and were
classified as follows:
<TABLE>
<CAPTION>
Amount at
which Shown
on Balance % of
Type of Investment Sheet Portfolio
------------------ ----------- ---------
(in
thousands)
<S> <C> <C>
Cash and short-term investments........................ $142,703 29.5%
United States Government securities.................... 63,369 13.1%
Asset-backed securities................................ 84,171 17.4%
Corporate bonds........................................ 152,118 31.4%
Foreign government..................................... 3,465 0.7%
Municipal bonds........................................ 36,306 7.5%
Equity securities...................................... 1,865 0.4%
-------- -----
Total................................................. $483,997 100.0%
======== =====
</TABLE>
The value of the fixed maturities portfolio, classified by category, as of
December 31, 1999, was as follows:
<TABLE>
<CAPTION>
Fair
Amortized Cost Value
-------------- --------
(in thousands)
<S> <C> <C>
United States Government............................ $ 64,284 $ 63,369
Asset-backed securities............................. 86,921 84,171
Municipal........................................... 36,651 36,306
Foreign government.................................. 3,594 3,465
Corporate........................................... 157,310 152,118
-------- --------
Total.............................................. $348,760 $339,429
======== ========
</TABLE>
The National Association of Insurance Commissioners ("NAIC") has a bond
rating system that assigns securities to classes called "NAIC designations"
that are used by insurers when preparing their annual statutory financial
statements. The NAIC assigns designations to publicly-traded as well as
privately-placed securities. The designations assigned by the NAIC range from
class 1 to class 6, with a rating in class 1 being of the highest quality. As
of December 31, 1999, 100% of our fixed maturities portfolio, measured on a
statutory carrying value basis, was invested in securities rated in class 1 or
2 by the NAIC, which are considered investment grade. The weighted average
maturity of our fixed income portfolio at December 31, 1999, was 3.87 years.
The weighted average duration of our fixed income portfolio was 3.12 years.
As of December 31, 1999, none of our fixed maturities portfolio was
invested in securities that were rated below investment grade. Less than 1% of
total assets were invested in equity securities, and less than 6% of total
assets were invested in collateralized mortgage obligations secured by
residential mortgages.
11
<PAGE>
Regulation
General.
Our insurance companies are subject to regulation by governmental agencies
in the states in which they do business. The nature and extent of such
regulation varies by jurisdiction, but typically involves prior approval of
the acquisition of control of an insurance company or of any company
controlling an insurance company, regulation of certain transactions entered
into by an insurance company with any of its affiliates, approval of premium
rates for many lines of insurance, standards of solvency and minimum amounts
of capital and surplus which must be maintained, limitations on types and
amounts of investments, restrictions on the size of risks which may be insured
by a single company, licensing of insurers and agents, deposits of securities
for the benefit of policyholders, and reports with respect to financial
condition and other matters. In addition, state regulatory examiners perform
periodic examinations of insurance companies. Such regulation is generally
intended for the protection of policyholders rather than security holders.
In December 1999, the Company formally redomesticated Vesta Fire Insurance
Corporation, Vesta Insurance Corporation, and Sheffield Insurance Corporation
from Alabama to Illinois and Shelby Casualty Insurance Company from Indiana to
Illinois. While the redomestication will have no material effect on the
companies operations, each company will now be regulated by the Illinois
Department of Insurance.
In addition to the regulatory supervision of our insurance subsidiaries, we
are also subject to regulation under the Ohio, Illinois, Hawaii and Texas
Insurance Holding Company System Regulatory Acts. These Holding Company Acts
contain certain reporting requirements including those requiring us (or
Vesta), as the ultimate parent company, to file information relating to our
capital structure, ownership, and financial condition and general business
operations of our insurance subsidiaries. These Holding Company Acts contain
special reporting and prior approval requirements with respect to transactions
among affiliates. The Illinois Holding Company Act is generally the most
significant to us since it governs our relationship with Vesta Fire, our
principal insurance subsidiary.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation, do affect the insurance business. Recently, a
number of state legislatures have considered or have enacted legislative
proposals that alter, and in many cases increase, the authority of state
agencies to regulate insurance companies and holding company systems. In
addition, legislation has been introduced from time to time in recent years
which, if enacted, could result in the federal government assuming a more
direct role in the regulation of the insurance industry.
Alabama Examinations.
For our Assumed Reinsurance business, we historically made estimates for
Reinsurance reports received subsequent to a period end on a combined
underwriting and accident year basis for both statutory and GAAP purposes. As
a result of a routine examination by the Alabama Department of Insurance, we
agreed to revise the accounting for Reinsurance business for statutory
purposes. Effective with its year end 1997 statutory filings, Vesta Fire
revised its statutory accounting for its Assumed Reinsurance business to
reflect only accident/calendar year information. The adjustments essentially
reversed, in the form of a one-time charge, the cumulative effect of the
accounting practice consistently applied over prior years. On a GAAP basis,
the correction was accounted for by restating prior financial statements.
In 1997, Vesta Fire reported statutory capital and surplus of approximately
$355 million. During 1998, the Alabama Department of Insurance completed its
examination of this filing and adjusted the reported amount down to $100.8
million. Although we were able to cure many of the technical
12
<PAGE>
deficiencies which led to the adjustments, certain of the adjustments were
based on accounting methods which needed to be corrected and were not
immediately curable. Using the basis of accounting established in the
examination, we reported Vesta Fire's 1998 statutory capital and surplus as
$217.3 million, after giving effect in 1998 to $125.8 million of "uncurable"
adjustments arising from the examination.
On August 23, 1999, the Alabama Department of Insurance completed its
target examination of Vesta Fire's December 31, 1998 Annual Statement. This
target examination, which we requested, resulted in adjustments of
approximately $9 million. Of those adjustments, which were as of December 31,
1998, we subsequently cured $5.2 million with no material impact on surplus.
At December 31, 1999, Vesta Fire reported $272 million of statutory capital
and surplus.
NAIC.
In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles which will replace the current NAIC Annual Statement Instructions
and Accounting Practices and Procedures manual as the NAIC's primary guidance
on statutory accounting. The Codification provides guidance for areas where
statutory accounting has been silent and changes current statutory accounting
in other areas. The implementation date established by the NAIC is January 1,
2001; however, the effective date will be specified by each insurance
company's state of domicile. We are currently evaluating the potential effect
of the Codification guidance but do not expect it to have a material impact on
our statutory surplus.
State insurance regulators and the NAIC periodically re-examine existing
laws and regulations and their application to insurance companies. In recent
years, the NAIC has approved and recommended to the states for adoption and
implementation, several regulatory initiatives designed to decrease the risk
of insolvency of insurance companies. These initiatives include risk-based
capital requirements for determining the levels of capital and surplus an
insurer must maintain in relation to its insurance and investment risks. Other
NAIC regulatory initiatives impose restrictions on an insurance company's
ability to pay dividends to its stockholders. These initiatives may be adopted
by the various states in which our subsidiaries are licensed; the ultimate
content and timing of any statutes and regulations adopted by the states
cannot be determined at this time. It is not possible to predict the future
impact of changing state and federal regulation on our operations, and there
can be no assurance that existing insurance related laws and regulations will
not become more restrictive in the future or that laws and regulations enacted
in the future will not be more restrictive.
The NAIC's risk-based capital requirements are intended to be used as an
early warning tool to help insurance regulators identify deteriorating or
weakly capitalized companies in order to initiate regulatory action. Such
requirements are not intended as a mechanism for ranking adequately
capitalized companies. The formula defines a minimum capital standard which
supplements the low, fixed minimum capital and surplus requirements previously
implemented on a state-by-state basis.
The NAIC risk-based capital requirements require insurance companies to
calculate and report information under a risk-based formula which attempts to
measure statutory capital and surplus needs based on the risks in a company's
mix of products and investment portfolio. The formula is designed to allow
state insurance regulators to identify potential weakly capitalized companies.
Under the formula, a company determines its "risk-based capital" by taking
into account certain risks related to the insurer's assets (including risks
related to its investment portfolio and ceded Reinsurance) and the insurer's
liabilities (including underwriting risks related to the nature and experience
of its insurance business). Risk-based capital rules provide for different
levels of regulatory attention depending on the ratio of a company's total
adjusted capital to its "authorized control level" of risk-based capital.
13
<PAGE>
At December 31, 1999, the total adjusted risk-based capital as a percentage
of authorized control level were as follows for our insurance subsidiaries:
<TABLE>
<S> <C>
Vesta Fire Insurance Corporation..................................... 527%
The Hawaiian Insurance & Guaranty Company, Limited................... 12,882%
Shelby Casualty Insurance Company.................................... 3,754%
The Shelby Insurance Company......................................... 7,998%
Insura Property and Casualty Company................................. 4,661%
Affirmative Insurance Company........................................ 13,935%
Sheffield Insurance Corporation...................................... 38,451%
Vesta Insurance Corporation.......................................... 15,365%
Vesta Capital Insurance Syndicate, Inc............................... 16,756%
Vesta Lloyds Insurance Company....................................... 2,170%
</TABLE>
Restrictions on Dividends to Stockholders.
Our insurance subsidiaries are subject to various state statutory and
regulatory restrictions, generally applicable to each insurance company in its
state of incorporation, which limit the amount of dividends or distributions
by an insurance company to its stockholders. The restrictions are generally
based on certain levels of surplus, and operating income, as determined under
statutory accounting practices. Ohio, Illinois and Texas law permits dividends
in any year which, together with other dividends or distributions made within
the preceding 12 months, do not exceed the greater of (i) 10% of statutory
surplus as of the end of the preceding year or (ii) the net income for the
preceding year, with larger dividends payable only after receipt of prior
regulatory approval. Hawaii law limits dividends to the lesser of (i) and (ii)
without prior approval. Certain other extraordinary transactions between an
insurance company and its affiliates also are subject to prior approval by the
Department of Insurance. Future dividends from our subsidiaries may be limited
by business and regulatory considerations.
Insurance Regulation Concerning Change or Acquisition of Control.
Certain of our subsidiaries are domestic property and casualty insurance
companies organized under the insurance codes of Ohio, Illinois, Hawaii and
Texas. These insurance codes contain a provision to the effect that the
acquisition or change of "control" of a domestic insurer or of any person that
controls a domestic insurer cannot be consummated without the prior approval
of the relevant insurance regulatory authority. A person seeking to acquire
control, directly or indirectly, of a domestic insurance company or of any
person controlling a domestic insurance company must generally file with the
relevant insurance regulatory authority an application for change of control
(commonly known as a "Form A") containing certain information required by
statute and published regulations and provide a copy of such Form A to the
domestic insurer. In Illinois, control is presumed to exist if any person,
directly or indirectly, owns, controls, holds with the power to vote or holds
proxies representing 10% or more of the voting securities of any other person.
In Texas and Hawaii, control is presumed to exist if any person, directly or
indirectly, or with members of the person's immediate family, owns, controls,
or holds with the power to vote, or if any person other than a corporate
officer or director of a person holds proxies representing, 10% or more of the
voting securities of any other person.
In addition, many state insurance regulatory laws contain provisions that
require pre-notification to state agencies of a change in control of a non-
domestic admitted insurance company in that state. While such pre-notification
statutes do not authorize the state agency to disapprove the change of
control, such statutes do authorize issuance of a cease and desist order with
respect to the non-domestic admitted insurer if certain conditions exist, such
as undue market concentration.
Such requirements may deter, delay or prevent certain transactions
affecting the control or ownership of Vesta, including transactions that could
be advantageous to our stockholders.
14
<PAGE>
Membership in Insolvency Funds and Associations; Mandatory Pools.
Most states require property and casualty insurers to become members of
insolvency funds or associations which generally protect policyholders against
the insolvency of an insurer writing insurance in the state. Members of the
fund or association must contribute to the payment of certain claims made
against insolvent insurers. Maximum contributions required by law in any one
year vary between 1% and 2% of annual premiums written by a member in that
state.
We are also required to participate in various mandatory insurance
facilities or in funding mandatory pools, which are generally designed to
provide insurance coverage for consumers who are unable to obtain insurance in
the voluntary insurance market. Among the pools in which we participate are
those established in coastal states to provide windstorm and other similar
types of property coverage. These pools typically require all companies
writing property insurance in the state for which the pool has been
established to fund deficiencies experienced by the pool based upon each
company's relative premium writings in that state, with any excess funding
typically distributed to the participating companies on the same basis. To the
extent that these assessments are not covered by the Company's Reinsurance
treaties, they may have an adverse effect on us.
Total assessments from insolvency funds, associations and mandatory pools
were $2.3 million, $2.9 million and $.3 million for 1999, 1998, and 1997
respectively. Some of these payments are recoverable through future policy
surcharges and premium tax reductions.
Various states in which we are doing business have established certain
shared market facilities with respect to the coverage of windstorm and
hurricane losses in the state. We are subject to assessments under these
facilities up to certain prescribed limits (which are generally based on our
share of the property insurance market in the state) if funds in the state
facility are inadequate to pay such losses on insured risks. We believe that
such assessments generally would be treated as a catastrophic loss under our
catastrophe Reinsurance programs.
During the past several years, various regulatory and legislative bodies
have adopted or proposed new laws or regulations to deal with the cyclical
nature of the insurance industry, catastrophic events and insurance capacity
and pricing. These regulations include (i) the creation of "market assistance
plans" under which insurers are induced to provide certain coverages, (ii)
restrictions on the ability of insurers to cancel certain policies in mid-
term, (iii) advance notice requirements or limitations imposed for certain
policy non-renewals and (iv) limitations upon or decreases in rates permitted
to be charged.
Effect of Federal Legislation. Although the federal government does not
directly regulate the business of insurance, federal initiatives often affect
the insurance business in a variety of ways. Current and proposed federal
measures which may significantly affect the insurance business include federal
government participation in asbestos and other product liability claims,
pension regulation (ERISA), examination of the taxation of insurers and
reinsurers, minimum levels of liability insurance and automobile safety
regulations.
NAIC-IRIS Ratios. The NAIC has developed its Insurance Regulatory
Information System ("IRIS") to assist state insurance departments in
identifying significant changes in the operations of an insurance company,
such as changes in its product mix, large Reinsurance transactions, increases
or decreases in premiums received and certain other changes in operations.
Such changes may not result from any problems with an insurance company but
merely indicate changes in certain ratios outside ranges defined as normal by
the NAIC. When an insurance company has four or more ratios falling outside
"normal ranges," state regulators may investigate to determine the reasons for
the variance and whether corrective action is warranted. In 1999, Vesta Fire
had four ratios which varied unfavorably from the "usual value" range. The
unfavorable ratios were primarily due to the decline in written premiums
resulting from our exiting the Assumed Reinsurance and Commercial Lines
business segments in 1999.
15
<PAGE>
A.M. Best Rating
A.M. Best, which rates insurance companies based upon factors of concern to
policyholders, recently raised its rating on our insurance subsidiaries to
"B+" (Very Good, in the Secure Rating Category) from "B" (Good, in the
Vulnerable Rating Category). Some of the factors noted by A.M. Best as
contributing to the upgrade include our improved financial condition, debt
restructuring, elimination of noncore business units and our focus on our
personal lines business. We believe that the current A.M. Best rating of "B+"
will assist us in increasing the number of new policy applications and
strengthen our retention ratios on our existing policies as they come up for
renewal.
However, to further strengthen our ability to increase new policy
applications and retain our existing policies, and to open up other
opportunities; we believe we must continue to work towards a higher rating
from A.M. Best. To accomplish that, we will focus on:
. Expanding our core book of business
. Continuing to lower our debt-to-capital ratio
. Continuing to demonstrate the ability to operate profitably.
Each of these three goals is related to our future operating performance
which is subject to a host of uncertainties and risk factors more fully
discussed in exhibit 99.1 to this report.
Competition
Direct writers are making a strong push in the Personal Lines arena. These
companies compete almost exclusively through price. While there is a segment
of the population that is driven exclusively by price, it is the Company's
belief that many consumers desire the advice and counsel of a professional
agent. The Company has developed a business strategy which focuses on this
segment of the market. Accordingly, the Company's relationships with its
independent agents is perhaps the most important component of our current
competitive profile. In order to develop and retain the independent agents
loyalty, the Company has reaffirmed its commitment to the independent agency
distribution by striving to provide innovative solutions to their daily
problems, as well as responding to the agency's needs as quickly as possible.
The property and casualty insurance industry is highly competitive on the
basis of both price and service. We compete for direct business with other
stock companies, specialty insurance organizations, mutual insurance companies
and other underwriting organizations, some of which are substantially larger
and have greater financial resources than we have. In recent years, there has
been a trend in the property and casualty industry toward consolidation which
could result in even more competitive pricing. In the future, the industry,
including us, may face increasing insurance underwriting competition from
banks and other financial institutions.
Relationship with Torchmark
Prior to the initial public offering of our common stock in November 1993,
we were a wholly owned subsidiary of Torchmark Corporation. As of December 31,
1999, Torchmark owned approximately 27% of our issued and outstanding common
stock. Prior to our initial public offering, we entered into several
agreements with Torchmark and certain of its subsidiaries regarding our future
relationship with Torchmark. Among these were a lease agreement, pursuant to
which we leased our headquarters building, and an investment services
agreement, pursuant to which we received investment advice and services in
connection with the management of our investment portfolio. On September 25,
1999, Torchmark and its subsidiaries transferred the ownership of our
headquarters building to an unaffiliated third party. Prior to May of 1995, we
marketed lower value personal dwelling insurance in six states through agents
of Liberty National Life Insurance Company (LNL), pursuant to a written
marketing
16
<PAGE>
agreement between us and LNL. However, LNL terminated this agreement in 1995
and no longer markets these products through its agents. The Company
terminated its investment services agreement with the Torchmark affiliate in
October 1999.
Employees
As of December 31, 1999, we employed 452 persons. Our employees are neither
represented by labor unions nor are they subject to any collective bargaining
agreements. Management knows of no current efforts to establish labor unions
or collective bargaining agreements.
Item 2. Properties
Properties
We lease approximately 111,099 square feet for our home office at 3760
River Run Drive, Birmingham, Alabama under a long-term operating lease from
SG/SPV Property I, LLC, formerly Torchmark Development Corporation, which,
until September 25, 1999 was a wholly owned subsidiary of Torchmark
Corporation. We consider the office facilities to be suitable and adequate for
our current level of operations.
We lease approximately 8,140 square feet for our Hawaiian operations at
1001 Bishop Street Pacific Tower, Honolulu, Hawaii under a long-term operating
lease. We consider the office facilities to be suitable and adequate for our
current and anticipated level of operations in Hawaii.
We own an office building with approximately 175,000 square feet located at
175 Mansfield Avenue, Shelby, Ohio for our Shelby operations. This property is
currently listed and is being marketed for sale.
Item 3. Legal Proceedings
Securities Litigation
Subsequent to the filing of its quarterly report on Form 10-Q for the
period ended March 31, 1998 with the Securities and Exchange Commission, the
Company became aware of certain accounting irregularities consisting of
inappropriate reductions of reserves and overstatements of premium income in
the Company's reinsurance business that had been recorded in the fourth
quarter of 1997 and the first quarter of 1998. The Company promptly commenced
an internal investigation to determine the exact scope and amount of such
reductions and overstatements. This investigation concluded that inappropriate
amounts had, in fact, been recorded and the Company determined it should
restate its previously issued 1997 financial statements and first quarter 1998
Form 10-Q. Additionally, during its internal investigation the Company re-
evaluated the accounting methodology being utilized to recognize earned
premium income in its reinsurance business. The Company had historically
reported certain assumed reinsurance premiums as earned in the year in which
the related reinsurance contracts were entered even though the terms of those
contracts frequently bridged two calendar years. The Company determined that
reinsurance premiums should be recognized as earned over the contract period
and corrected the error in its accounting methodology by restating previously
issued financial statements. The Company issued press releases, which were
filed with the Securities and Exchange Commission, on June 1, 1998 and June
29, 1998 announcing its intention to restate its historical financial
statements.
The Company restated its previously issued financial statements for 1995,
1996 and 1997 and its first quarter 1998 Form 10-Q for the above items by
issuance of a current report on Form 8-K dated August 19, 1998. These
restatements resulted in a cumulative decrease to stockholder's equity of
$75.2 million through March 31, 1998.
17
<PAGE>
Commencing in June 1998, Vesta and several of its current and former
officers and directors were named in several purported class action lawsuits
in the United States District Court for the Northern District of Alabama and
in one purported class action lawsuit in the Circuit Court of Jefferson
County, Alabama. Several of Vesta's officers and directors also have been
named in a derivative action lawsuit in the Circuit Court of Jefferson County,
Alabama, in which Vesta is a nominal defendant.
The class action lawsuit filed in the Circuit Court of Jefferson County,
Alabama has been dismissed and the derivative case has been placed on the
administrative docket. The class actions filed in the United States District
Court for the Northern District of Alabama have been consolidated into a
single action in that district. The class representatives in that action have
filed (a) a consolidated amended complaint alleging that the defendants
violated the federal securities laws and (b) a motion for class certification,
which was granted in 1999. The consolidated amended complaint also added as
defendants Torchmark Corporation and the Company's predecessor auditors, KPMG
LLP. The consolidated amended complaint alleges various violations of the
federal securities law and seeks unspecified but potentially significant
damages.
The Company has notified its directors and officers liability insurance
companies of these lawsuits and the consolidated amended complaint. The
litigation is still in the preliminary stages and there has been no discovery
conducted in the securities case. The Company intends to vigorously defend
this litigation and intends to explore all available rights and remedies it
may have under the circumstances. In related litigation, in September, 1998,
Cincinnati Insurance Company ("Cincinnati"), one of the Company's directors
and officers liability insurance carriers, filed a lawsuit in the United
States District Court for the Northern District of Alabama seeking to avoid
coverage under its directors and officers liability and other policies. The
Company filed a motion to dismiss Cincinnati's complaint on jurisdictional
grounds in federal court (which was granted), and filed a lawsuit against
Cincinnati in the Circuit Court of Jefferson County, Alabama seeking damages
arising out of Cincinnati's actions. Cincinnati has filed an answer and
counterclaim in that case again seeking to avoid coverage.
Pursuant to Delaware law and by-laws, the Company is obligated to indemnify
its current and former officers and directors for certain liabilities arising
from their employment with or service to the Company. The Company believes
that these indemnification obligations extend to its current and former
officers' and directors' costs of defense and other liabilities which may
arise out of the securities litigation described above.
The Company has purchased directors' and officers' liability insurance
("D&O insurance") for the purposes of covering among other things the costs
incurred in connection with these indemnification obligations. For the period
in which most of the claims against the Company and certain of its directors
and officers were asserted, the Company had in place a primary D&O insurance
policy providing $25 million in coverage and an excess D&O insurance policy
covering for an additional $25 million in coverage. The issuer of the primary
D&O insurance policy, Cincinnati, has attempted to avoid coverage, and the
Company is vigorously resisting its efforts to do so.
Subsequent to the initiation of the class actions described above, the
Company secured additional excess D&O insurance providing coverage for losses
in excess of $50 million up to $110 million, or additional excess coverage of
$60 million for the class actions. The Company has paid for this additional
excess policy in full.
The Company has not currently set aside any financial reserves relating to
any of the above-referenced actions.
Other Litigation
The Company, through its subsidiaries, is routinely a party to pending or
threatened legal proceedings and arbitration relating to the regular conduct
of its insurance business. These proceedings involve alleged breaches of
contract, torts, including bad faith and fraud claims and
18
<PAGE>
miscellaneous other specified relief. Based upon information presently
available, and in light of legal and other defenses available to the Company
and its subsidiaries, management does not consider liability from any
threatened or pending litigation regarding routine matters to be material.
As discussed above, the Company corrected its accounting for assumed
reinsurance business through restatement of its previously issued financial
statements. Similar corrections were made on a statutory accounting basis
through recording cumulative adjustments in Vesta Fire's 1997 statutory
financial statements. The impact of this correction has been reflected in
amounts ceded under the Company's 20 percent whole account quota share treaty
which was terminated on June 30, 1998 on a run-off basis. The Company believes
such treatment is appropriate under the terms of this treaty and has
calculated the quarterly reinsurance billings presented to the treaty
participants accordingly. The aggregate amount included herein as reinsurance
receivable from such reinsurers totaled $54.4 million at December 31, 1999. In
addition the Company collected approximately $48.5 million from significant
reinsurers via the conversion of collateral on hand.
NRMA, one of the participants in the 20 percent whole account quota share
treaty, has filed a lawsuit in the United States District Court for the
Northern District of Alabama contesting the Company's claim and the validity
of the treaty, and is seeking return of $34.5 million in collateral which is
included in the amount above . The Company has filed a demand for arbitration
as provided for by the treaty and has filed a motion to compel arbitration
which was recently granted in the United States District Court action. The
Company has filed for arbitration against the other two participants on the
treaty and those arbitrations are in their early stages. While management
believes its interpretation of the treaty's terms and computations based
thereon are correct, these matters are in their early stages and their
ultimate outcome cannot be determined at this time.
On September 23, 1999, Torchmark Corporation, the Company's largest common
stockholder, filed a lawsuit in the Circuit Court of Jefferson County, Alabama
against the Company asserting breach of contract, conversion and breach of
duty in connection with the Company's preparation and filing of a registration
statement covering its shares in accordance with certain registration rights
claimed by Torchmark. This claim seeks an injunction requiring a registration
statement to be filed, as well as compensatory and punitive damages. This
litigation is in its early stages, and management is unable to assess the
damages that may be awarded, if any. However, management does not believe that
such damages, if any, would materially and adversely affect the Company's
financial position or results of operation.
On June 23, 1999, a subsidiary of Torchmark filed suit in the Circuit Court
of Jefferson County, Alabama against two subsidiaries of the Company. The
lawsuit claims that the Company's subsidiaries have failed to pay certain sums
due under a marketing and administrative services agreement between the
parties. The suit also seeks payment of certain commissions and administrative
expenses. This litigation is in its early stages, and management is unable to
assess the damages that may be awarded, if any. However, management does not
believe that such damages, if any, would materially and adversely affect the
Company's financial position or results of operation.
A dispute has arisen with F&G Re (on behalf of USF&G) under two aggregate
stop loss reinsurance treaties whereby F&G Re assumed certain risk from the
Company. During 1999 F&G Re filed for arbitration under those two treaties.
While management believes its interpretation of the treaties' terms and
computations based thereon are correct, this arbitration is in its early
stages and its ultimate outcome cannot be determined at this time.
Item 4. Submission of Matters to a Vote of Security Holders
None.
19
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matter
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
Market Prices. Our common stock trades on the New York Stock Exchange under
the symbol "VTA." Prior to November 11, 1993, there was no established public
trading market for our common stock.
Quarterly high and low market prices of our common stock in 1999, 1998 and
1997 were as follows:
<TABLE>
<CAPTION>
Quarter Ended High Low
------------- ------ ------
1999
<S> <C> <C>
March 31...................................................... $ 7.94 $ 4.00
June 30....................................................... 6.00 4.00
September 30.................................................. 5.38 4.19
December 31................................................... 4.75 3.75
1998
March 31...................................................... $64.75 $52.13
June 30....................................................... 59.00 20.00
September 30.................................................. 22.13 6.75
December 31................................................... 9.88 5.00
1997
March 31...................................................... $41.50 $30.88
June 30....................................................... 49.00 32.75
September 30.................................................. 59.00 43.63
December 31................................................... 64.50 54.88
</TABLE>
Dividend Policy and History. The declaration and payment of dividends will
be at the discretion of our Board of Directors and will depend upon many
factors, including our financial condition and earnings, the capital
requirements of our operating subsidiaries, legal requirements and regulatory
constraints.
The dividends we paid on our common stock for the past three years were as
follows (in thousands):
<TABLE>
<CAPTION>
Quarter Ended 1999 1998 1997
------------- ---- ---- ----
<S> <C> <C> <C>
March 31...................................................... $698 $691 $697
June 30....................................................... -0- 687 697
September 30.................................................. -0- 695 701
December 31................................................... -0- 697 702
</TABLE>
Illinois, Ohio, Hawaii and Texas impose restrictions on the payment of
dividends to us by our insurance subsidiaries under their regulatory authority
in excess of certain amounts without prior regulatory approval. See,
"Business--Regulation--Restrictions on Dividends to Stockholders."
20
<PAGE>
Item 6. Selected Financial Data
The following information should be read in conjunction with the Company's
Consolidated Financial Statements and related notes reported elsewhere in this
Form 10-K.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data
Gross Premiums Written.. $262,206 $ 634,609 $ 780,146 $607,198 $459,631
Net Premiums Written.... 242,862 422,569 492,978 443,255 341,722
Net Premiums Earned..... 344,106 441,325 474,785 405,658 266,729
Net Investment Income... 26,907 28,862 31,960 21,374 15,311
Gain on sale of Assumed
reinsurance............ 15,000 -- -- -- --
Investment Gains
(Losses)............... 7,956 3,272 3,283 32 276
Other................... 9,327 5,473 2,094 188 216
-------- ---------- ---------- -------- --------
Total Revenues.......... 403,296 478,932 512,122 427,252 282,532
-------- ---------- ---------- -------- --------
Losses and LAE Incurred. 211,701 337,131 274,650 230,636 170,530
Policy Acquisition and
Other Underwriting
Expenses............... 131,300 225,227 163,831 135,495 83,754
Loss on Asset
Impairment............. -- 65,496 -- -- --
Amortization of
Goodwill............... 2,118 5,177 3,065 484 264
Interest Expense........ 13,215 14,054 10,859 10,059 5,273
-------- ---------- ---------- -------- --------
Total Losses and
Expenses............... 358,334 647,085 452,405 376,674 259,821
-------- ---------- ---------- -------- --------
Income (Loss) From
Operations Before
Income Tax............. 44,962 (168,153) 59,717 50,578 22,711
Income Taxes (benefit).. 13,633 (48,555) 21,257 16,428 6,846
Deferrable capital
securities interest,
net of income tax...... 5,632 5,449 5,051 -- --
-------- ---------- ---------- -------- --------
Income (loss) from
continuing operations.. $ 25,697 $ (125,047) $ 33,409 $ 34,150 $ 15,865
Income (loss)from
discontinued
operations............. (2,242) (16,137) 3,451 2,663 6,727
Preferred stock
dividend............... (563) -- -- -- --
Income (loss) available
to stockholders........ $ 22,892 $ (141,184) $ 36,860 $ 36,813 $ 22,592
Basic Earnings per share
from continuing
operations............. $ 1.37 $ (6.74) $ 1.79 $ 1.81 $ .84
Basic Earnings Per Share
available to common
stockholders (2)....... $ 1.22 $ (7.61) $ 1.98 $ 1.95 $ 1.20
Shares used in per share
calculation (2)........ 18,699 18,548 18,600 18,860 18,842
Diluted Earnings Per
Share from continuing
operations (2)......... $ 1.27 $ (6.74) $ 1.75 $ 1.92 $ 1.19
Diluted Earnings Per
Share available to
common stockholders.... 1.16 $ (7.61) $ 1.93 $ 1.92 $ 1.19
Shares used in per share
calculation (2)........ 20,202 18,548 19,053 19,157 18,970
Cash dividends per
share.................. .04 .15 .15 .20 .13
Certain Financial Ratios
and Other Data
GAAP (3)
<CAPTION>
Loss and LAE Ratio...... 61.6% 76.4% 57.9% 56.9% 64.0%
<S> <C> <C> <C> <C> <C>
Underwriting Expense
Ratio.................. 38.2 51.1 34.5 33.4 31.4
-------- ---------- ---------- -------- --------
Combined Ratio.......... 99.8% 127.5% 92.4% 90.3% 95.4%
SAP (1)
<CAPTION>
Loss and LAE Ratio...... 66.5% 90.4% 65.6% 57.9% 57.2%
<S> <C> <C> <C> <C> <C>
Underwriting Expense
Ratio.................. 31.1 42.1 51.7 31.8 33.4
-------- ---------- ---------- -------- --------
Combined Ratio.......... 97.6% 132.5% 117.3% 89.7% 90.6%
-------- ---------- ---------- -------- --------
Net Premiums Written to
Surplus Ratio.......... .89x 2.81x 1.49x 1.53x 1.44x
Surplus................. $271,986 $ 220,210 $ 317,875 $352,695 $318,997
</TABLE>
Balance Sheet Data (at
end of period)
Total Investments and
Cash................... $483,997 $ 634,668 $ 656,816 $427,276 $422,516
Total Assets............ 915,809 1,347,702 1,636,859 871,385 735,758
Reserves For Losses and
LAE.................... 354,709 504,911 596,797 173,275 168,502
Long Term Debt.......... 141,876 98,302 98,602 98,279 98,163
Total Liabilities....... 674,519 1,089,675 1,239,523 599,466 488,499
Deferrable Capital
Securities............. 41,225 100,000 100,000 -- --
Stockholders' Equity.... 200,065 158,027 297,336 271,919 247,259
- - --------
* As a result of the Company's decision in 1999 to discontinue its
commercial lines segment, all periods presented have been reclassified to
present operations on a continuing and discontinued basis.
(1) Statutory data have been derived from the financial statements of the
Company prepared in accordance with SAP and filed with insurance
regulatory authorities.
(2) Restated for 3-for-2 stock split paid on January 22, 1996.
(3) Ratios calculated for continuing operations.
21
<PAGE>
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Overview
The Company writes primary insurance on selected Personal lines risks only,
balanced between risks of property damage (which is susceptible to faster
determination of ultimate loss but is highly unpredictable) and casualty
exposure (which is more predictable but takes longer to determine the ultimate
loss).
In the past, we also wrote primary insurance on a variety of Commercial
Lines risks, as well as treaty Reinsurance for small and mid-size insurance
companies and regional specific Reinsurance for large insurance companies. In
each of these segments, we focused principally on property coverages, for
which ultimate losses generally can be more promptly determined than on
casualty risks. In 1999, we sold the rights to a substantial portion of our
reinsurance assumed business for a pretax gain of $15 million(a large block of
policies 100% reinsured from CIGNA was retained and is being converted from
assumed to direct), and decided to discontinue our commercial lines segment.
The commercial lines segment is discussed herein as a discontinued operation.
Additionally, we sold Vesta County Mutual, a predominately personal auto
carrier, for a pretax gain of $4.8 million. Direct written premiums assumed by
the Company from Vesta County Mutual were $15.5 million, $72.6 million and
$41.8 million in 1999, 1998 and 1997 respectively.
Our revenues from operations are derived primarily from net premiums earned
on risks written or reinsured by our insurance subsidiaries, investment income
and investment gains or losses. Our expenses consist primarily of payments for
claims and underwriting expenses, including agents' commissions and operating
expenses.
This report includes "forward looking statements" which express
expectations of future events and/or results. All statements based on future
expectations rather than on historical facts are forward-looking statements
that involve a number of risks and uncertainties, and the Company cannot give
assurance that such statements will prove to be correct. Please refer to
"Known Trends and Uncertainties" herein and exhibit 99.1 attached hereto for
more information about factors which could affect future results.
Comparison of Fiscal Year 1999 to Fiscal Year 1998
Premiums, Loss and LAE--Personal lines
Gross premiums written for Personal lines decreased by $92.0 million, or
26.5%, to $255.0 million for the year ended December 31, 1999, from $347.0
million for the year ended December 31, 1998. The decrease of was primarily
due to the declines in the Financial Services, and Personal Auto lines (which
includes the sale of Vesta County Mutual), partially offset by the continued
rollover of the CIGNA homeowners business from the assumed reinsurance lines.
Net premiums written for Personal lines decreased by $37.0 million, or
14.0%, to $227.8 million for the year ended December 31, 1999, from $264.8
million for the year ended December 31, 1998. The decrease in net premiums
written was largely attributable to the declines in the Financial Services and
Personal Auto lines (which includes the sale of Vesta County Mutual),
partially offset by the continued rollover of the CIGNA homeowners business
from the assumed reinsurance lines. Net premiums earned for Personal lines
increased $1 million, or .4%, to $248.1 million for the year ended December
31, 1999, from $247.1 million for the year ended December 31, 1998.
Loss and LAE for Personal lines remained flat from 1999 to 1998 at $165.0
million. The loss and LAE ratio for Personal lines for the year ended December
31, 1999 was 66.5% as compared to 66.7% at December 31, 1998.
22
<PAGE>
Premiums, Loss and LAE--Reinsurance
Gross premiums written for Reinsurance decreased by $280.4 million, or
97.5%, to $7.2 million for the year ended December 31, 1999, from $287.6
million for the year ended December 31, 1998. The main contributors to the
reduction of Reinsurance gross premiums written were the novation of certain
treaties to Hart Re, an unearned premium portfolio transfer of a large
reinsurance treaty and the continued roll over of CIGNA homeowners business to
personal lines. Net premiums written for Reinsurance decreased $142.6 million,
or 90.4%, to $15.1 million for the year ended December 31, 1999, from $157.7
million for the year ended December 31, 1998. Net premiums earned for
Reinsurance decreased $98.3 million, or 50.6% to $96.0 million for the year
ended December 31, 1999, from $194.3 million for the year ended December 31,
1998.
Loss and LAE for Reinsurance decreased by $128.4 million, or 73.1% to $47.3
million for the year ended December 31, 1999, from $175.7 for the year ended
December 31, 1998. The dollar amount of loss and loss adjustment expenses
incurred decreased during 1999 due to the decline in net premiums earned, and
improvement in the loss and LAE ratio. The loss and LAE ratio for Reinsurance
for the year ended December 31, 1999 was 49.3% as compared to 90.5% for the
year ended December 31, 1998. The decrease in the loss ratio was primarily
attributable to the decrease in ceded reinsurance costs in 1999 versus 1998, a
decrease in catastrophe losses, positive development from the run out of the
assumed reinsurance line and commutation gains. In addition, the 1999 results
consisted primarily of the 100% quota share reinsurance treaty with CIGNA. The
treaty reinsures primarily a homeowners line for CIGNA which has historically
experienced a loss ratio in the fifties. As the covered business is renewed it
will be transferred to Vesta Fire as the issuing carrier. This treaty was not
included in the sale of the Reinsurance book of business. In 1999, this treaty
accounted for $77.8 million in earned premiums.
Policy Acquisition Expenses and Other Operating Expenses from Continuing
Operations
Policy acquisition expenses from continuing operations decreased by $61.3
million, or 40.9%, to $88.6 million for the year ended December 31, 1999, from
$149.9 million for the year ended December 31, 1998. The decrease in policy
acquisition expenses from continuing operations is primarily attributable to
reductions in earned premiums. Other operating expenses include administrative
costs not directly related to the generation of premium revenue, interest on
debt and goodwill and other intangibles amortization. Administrative costs
from continuing operations (designated as operating expenses on the statement
of operations) decreased $32.7 million. The decrease in administration costs
is primarily attributable to the consolidation of the Shelby operations into
the Birmingham office and other cost reductions enacted by the Company in
response to reduction in premium volume from assumed reinsurance. Premium
taxes and fees also decreased as a result of decreased earned premium. The
decrease in goodwill and other intangibles amortization is attributable to the
write off of $74.5 million ($65.5 million of which related to continuing
operations) of goodwill related to the Shelby acquisition in the fourth
quarter of 1998.
Net Investment Income from Continuing Operations
Net investment income from continuing operations decreased by $2.0 million,
or 6.9%, to $26.9 million for the year ended December 31, 1999, from $28.9
million for the year ended December 31, 1998 due to lower average invested
assets. The weighted average yield on invested assets (excluding realized and
unrealized gains) was 6.5% for the year ended December 31, 1999, compared with
5.8% for the year ended December 31, 1998.
Federal Income Taxes from Continuing Operations
Federal income taxes from continuing operations increased by $62.2 million
to an expense of $13.6 million for the year ended December 31, 1999, from a
$48.6 million benefit for the year ended December 31, 1998. The Company's
effective tax rate for 1999 was 30.7% versus 28.9% in 1998. The
23
<PAGE>
Company's effective tax rate is lower than the federal statutory tax rate
primarily due to investment income from tax exempt securities. The increase in
the effective tax rate for 1999 is due to the Company's decision to replace
the tax exempt securities in its portfolio with higher yielding taxable
securities.
Income /(loss) from discontinued operations, net of tax
Net premiums earned from the discontinued Commercial Lines decreased $16.2
million, or 23.7%, to $52.2 million for the year ended December 31, 1999, from
$68.4 million for the year ended December 31, 1998 as the Company exited this
business in 1999.
Loss and LAE for Commercial Lines decreased $20.3 million, or 37.1%, from
$54.7 million for the year ended December 31, 1998 to $34.4 million for the
year ended December 31, 1999. The loss and LAE ratio for Commercial Lines for
the year ended December 31, 1999, was 65.9% as compared to 80.0% for the year
ended December 31, 1998. The decrease in loss ratio was primarily attributable
to decreased catastrophe losses for the year ended December 31, 1999. Policy
acquisition expenses decreased $4.2 million as a result of the decreased
earned premium. Operating expenses decreased $.8 million from $16.1 million
for the year ended December 31, 1998 to $15.3 million for the year ended
December 31, 1999. The decrease was largely attributable to reduced expenses
from workforce reductions and other reductions consistent with discontinuing
the business, partially offset by severances and other costs. In 1998, $9
million of the loss on asset impairment was attributed to the commercial lines
segment.
For the reasons discussed above, as well as the $15 million gain from the
sale of reinsurance renewal rights to Hart Re, net loss from discontinued
operations improved by $13.9 million, to a loss of $2.2 million for the year
ended December 31, 1999 from a loss of $16.1 million for the year ended
December 31, 1998.
Net Income (loss)
For the reasons discussed above, net income increased by $164.7 million, to
income of $23.5 million for the year ended December 31, 1999, from a $141.2
million loss for the year ended December 31, 1998.
Comparison of Fiscal Year 1998 to Fiscal Year 1997
Premiums, Loss and LAE--Personal lines
Gross premiums written for Personal lines increased by $102.3 million, or
41.8%, to $347.0 million for the year ended December 31, 1998, from $244.7
million for the year ended December 31, 1997. Included in the $102.3 increase
in gross premiums written for Personal lines was a $101.0 million increase in
gross premiums written due to a full year of Shelby premiums in 1998 versus
six months of Shelby premiums in 1997. The remaining increase of $1.3 million
was primarily due to the transfer of business from assumed Reinsurance to
Personal lines following the acquisition of Vesta County Mutual partially
offset by premium reductions in the Financial Services lines and Hawaiian
Insurance & Guaranty("HIG").
Net premiums written for Personal lines increased by $123.6 million, or
87.5%, to $264.8 million for the year ended December 31, 1998, from $141.2
million for the year ended December 31, 1997. The increase in net premiums
written was largely attributable to the writings from Shelby and the transfer
of business from assumed Reinsurance to Personal lines following the
acquisition of Vesta County Mutual. Net premiums earned for Personal lines
increased $107.7 million, or 77.3%, to $247.1 million for the year ended
December 31, 1998, from $139.4 million for the year ended December 31, 1997.
24
<PAGE>
Loss and LAE for Personal lines increased by $69.7 million, or 73.2%, to
$164.9 million for the year ended December 31, 1998, from $95.2 million for
the year ended December 31, 1997. The increase in loss and loss adjustment
expenses was primarily attributable to a full year of losses for Shelby
included in 1998 versus only six months of losses for Shelby in 1997. The loss
and LAE ratio for Personal lines for the year ended December 31, 1998 was
66.7% as compared to 68.3% at December 31, 1997.
Premiums, Loss and LAE--Reinsurance
Gross premiums written for Reinsurance decreased by $247.8 million, or
46.3%, to $287.6 million for the year ended December 31, 1998, from $535.4
million for the year ended December 31, 1997. The main contributors to the
reduction of Reinsurance gross premiums written were the continuation of
increased competition in the market place coupled with the Company's
unwillingness to follow the market price, the modification of one large treaty
and the cancellation of another large treaty. The acquisition of Vesta County
Mutual resulted in the further shift of $27 million of private passenger
automobile writings which had been recorded on the Reinsurance line in 1997 to
Personal lines in 1998. Net premiums written for Reinsurance decreased $194.1
million, or 55.2%, to $157.7 million for the year ended December 31, 1998,
from $351.8 million for the year ended December 31, 1997. Net premiums earned
for Reinsurance decreased $141.1 million, or 42.1% to $194.3 million for the
year ended December 31, 1998, from $335.4 million for the year ended December
31, 1997.
Loss and LAE for Reinsurance decreased by $3.8 million, or 2.1% to $175.7
million for the year ended December 31, 1998, from $179.5 for the year ended
December 31, 1997. The dollar amount of loss and loss adjustment expenses
incurred decreased during 1998 due to the decline in net premiums earned. The
loss and LAE ratio for Reinsurance for the year ended December 31, 1998 was
90.5% as compared to 53.5% for the year ended December 31, 1997. The increase
in the loss ratio was primarily attributable to the decreases in earned
premiums due to pricing pressures and market competition, higher ceded
Reinsurance costs in 1998 versus 1997 and an increase of $18.7 million in
catastrophe losses.
Included in the Reinsurance results for 1998, were two large 100% Quota
share Reinsurance treaties for CIGNA and HomePlus which cover selected
homeowners lines. As the covered business is renewed it will be transferred to
Vesta Fire as the issuing carrier. In 1998, these treaties accounted for
$107.4 million in gross written premiums.
Policy Acquisition Expenses and Other Operating Expenses from Continuing
Operations
Policy acquisition expenses increased by $16.7 million, or 13.1%, to $149.9
million for the year ended December 31, 1998, from $133.2 million for the year
ended December 31, 1997. The increase in policy acquisition costs is primarily
attributable to additional marketing staff salaries and additional agents
incentives. Other operating expenses from continuing operations include
administrative costs not directly related to the generation of premium
revenue, premium taxes and fees, interest on debt and goodwill amortization.
Administrative costs from continuing operations (designated as operating
expenses on the statement of operations) increased $44.7 million. The increase
in administration costs is primarily attributable to increased costs related
to the Shelby operations and increased information system costs. The increase
in premium taxes and fees is directly related to the increase in direct
premiums written. The increase in goodwill amortization is attributable to a
full year of amortization of the goodwill related to the Shelby acquisition
versus six months of amortization in 1997.
Net Investment Income from Continuing Operations
Net investment income decreased by $3.1 million, or 9.7%, to $28.9 million
for the year ended December 31, 1998, from $32.0 million for the year ended
December 31, 1997. The weighted average yield on invested assets (excluding
realized and unrealized gains) was 5.8% for the year ended December 31, 1998,
compared with 5.8% for the year ended December 31, 1997.
25
<PAGE>
Loss on Asset Impairment
During the fourth quarter of 1998, management evaluated goodwill pursuant
to our existing policies. The evaluation indicated an impairment of goodwill
acquired as part of the Shelby acquisition. The events that led to this
conclusion include our inability to integrate the Shelby acquisition as
planned and the resulting high level of expenses and the recording of
significant operating losses in 1998. As a result of these evaluations, the
unamortized goodwill attributable to the Shelby acquisition was reduced by
$74.5 million, of which $9.0 million is attributable to the discontinued
Commercial Lines. See Note C of the Notes of the Consolidated Financial
Statements.
Federal Income Taxes from Continuing Operations
Federal income taxes decreased by $69.8 million to a benefit of $48.5
million for the year ended December 31, 1998, from an expense of $21.3 million
for the year ended December 31, 1997. The Company's effective tax rate for
1998 was 28.9% versus 35.7% in 1997. The Company's effective tax rate is lower
than the federal statutory tax rate primarily due to investment income from
tax exempt securities. The decrease in the effective tax rate for 1998 is
primarily due to the Company's purchase of tax exempt securities.
Income /(loss) from discontinued operations, net of tax
Net premiums earned from the discontinued Commercial Lines increased $25.5
million, or 59.4%, to $68.4 million for the year ended December 31, 1998, from
$42.9 million for the year ended December 31, 1997 due to the inclusion of a
full year of Shelby premiums in 1998 versus six months of Shelby premiums in
1997.
Loss and LAE for Commercial Lines increased $30.7 million, or 127.9%, from
$24.0 million for the year ended December 31, 1997 to $54.7 million for the
year ended December 31, 1998. The loss and LAE ratio for Commercial Lines for
the year ended December 31, 1998, was 80.0% as compared to 55.9% for the year
ended December 31, 1997. The increase in loss ratio was primarily attributable
to increased market competition and catastrophe losses for the year ended
December 31, 1998. Policy acquisition expenses increased $6.4 million as a
result of the increased earned premium. Operating expenses increased $7.8
million from $8.3 million for the year ended December 31, 1997 to $16.1
million for the year ended December 31, 1998. The increase was largely
attributable a full year of Shelby operations in 1998 versus six months in
1997. In 1998, $9 million of the loss on asset impairment was attributed to
the commercial lines segment.
For the reasons discussed above, income/ (loss) from discontinued
operations decreased by $19.6 million, to a loss of $16.1 million for the year
ended December 31, 1998 from income of $3.5 million for the year ended
December 31, 1997.
Net Income (loss)
For the reasons discussed above, net income decreased by $178.1 million, to
a loss of $141.2 million for the year ended December 31, 1998, from $36.9
million for the year ended December 31, 1997.
Liquidity and Capital Resources
Vesta is a holding company whose principal asset is its investment in the
capital stock of the companies constituting the Vesta Group, a group of wholly
owned property and casualty insurance companies including Vesta Fire. The
insurance subsidiaries comprising the Vesta Group are individually supervised
by various state insurance regulators. Vesta Fire is our principal operating
subsidiary and reinsures substantially all business from our other operating
subsidiaries.
26
<PAGE>
The principal uses of funds at the holding company level are to pay
operating expenses, principal and interest on outstanding indebtedness and
deferrable capital securities and dividends to stockholders if declared by the
Board of Directors. During the last three years, our insurance subsidiaries
have produced operating results and paid dividends sufficient to fund our
needs. Except for the regulatory restrictions described above, we are not
aware of any demands or commitments of the insurance subsidiaries that would
prevent them from paying dividends sufficient to meet our anticipated needs
(including debt service) for at least the next twelve months. See, "Business--
Regulation."
Dividends
As a holding company with no other business operations, we rely primarily
upon dividend payments from Vesta Fire to meet our cash requirements
(including its debt service) and to pay dividends to our stockholders.
Transactions between Vesta and its insurance subsidiaries, including the
payment of dividends to Vesta by such subsidiaries, are subject to certain
limitations under the insurance laws of those subsidiaries' domiciliary
states. The insurance laws of the state of Illinois, where Vesta Fire is
domiciled, permit the payment of dividends in any year which, together with
other dividends or distributions made within the preceding 12 months, do not
exceed the greater of 10% of statutory surplus as of the end of the preceding
year or the net income for the preceding year, with larger dividends payable
only after receipt of prior regulatory approval.
Non-recurring sources
In addition to dividends from its subsidiaries we determined to seek
additional equity capital and other alternative sources of funds during 1999.
On March 24, 1999 the Company sold its reinsurance assumed business (with
the exception of the CIGNA homeowner's reinsurance business that is currently
being converted to primary operations) to The Hartford Fire Insurance Company
("Hart Re"). The Company received $15 million in exchange for its commitment
to (a) enter into a 100% quota share treaty, effective January 1, 1999 for all
business written on or after that date; (b) use its best efforts to novate to
the purchaser or renew on the purchaser's paper, all assumed treaties except
those currently being converted to primary business and; (c) facilitate the
hiring by Hart Re of several of the Company's reinsurance employees.
On September 10, 1999, we sold our authority and right to control and
manage the affairs of Vesta County Mutual Insurance Company for $11.2 million.
We recognized a gain of $4.8 million, which is included in other income,
during the third quarter of 1999. In 1999, Vesta County Mutual had $44.5
million of direct written premium, of which we assumed $29.6 million. Also in
1999, we received $173,000 in interest income from a $2.5 million surplus
debenture issued by Vesta County Mutual in exchange for our contribution of
capital in a like amount. This debenture was repaid by Vesta County Mutual in
connection with the sale.
On September 30, 1999, the Company issued 2,950,000 shares of its Series A
Convertible Preferred Stock to a single investor in exchange for cash proceeds
of approximately $25 million. The terms of this Preferred Stock are discussed
below under "--Long Term Debt and Preferred Stock."
Commercial Credit Facilities
During 1998, we failed to maintain certain financial covenants contained in
our former revolving credit agreement with a group of commercial lenders led
by First Union National Bank. In exchange for a waiver of remedies by these
banks, we agreed on April 13, 1999 to amend our credit agreement with them in
several respects, including shortening the maturity of approximately $70
million in loans thereunder. In connection with this amendment, we also issued
warrants to them, which would have
27
<PAGE>
become accessible for up to 6.6% of our common stock if we had been unable to
prepay minimum levels of principal and interest on an accelerated schedule. On
September 30, 1999, we repaid all amounts owing under this former credit
facility (approximately $56 million), cancelled the credit agreement related
thereto and cancelled all of the warrants which had been issued to those
banks. This $56 million payment was funded primarily from three sources: (i)
the $11.2 million in proceeds received from the transaction involving Vesta
County Mutual, (ii) the $25 million in proceeds received from the sale of the
Preferred Stock and (iii) the $20 million borrowed under the credit facilities
established with The Banc on September 30, 1999.
On September 30, 1999, we established collateralized revolving credit
facilities in the aggregate amount of $20 million with The Banc Corporation
and its banking subsidiary The Bank, consisting of a $15 million loan from The
Bank and a $5 million loan from The Banc Corporation.
On December 30, 1999, we repaid $15 million of the principal amount
outstanding under The Banc credit facilities and cancelled the related credit
agreements. In connection with the repayment of this debt, we restructured our
commercial credit facility to consist of the following lines of credit, each
of which was provided by The Bank:
. a $5 million unsecured line;
. an additional $10 million line, secured by a pledge of the management
contract between our wholly owned management company, J. Gordon Gaines,
Inc., and our operating insurance subsidiaries.
Each of these credit facilities bore interest at The Bank's prime rate and
were to mature on December 29, 2001. As of December 31, 1999, we had borrowed
all $5 million available under the unsecured line, and we had not borrowed any
amounts under the $10 million secured line. Subsequent to December 31, 1999,
we repaid the $5 million outstanding on the unsecured line of credit, and we
cancelled the credit agreements related to both lines of credit effective
February 29, 2000.
On March 3, 2000 we established a revolving credit facility with First
Commercial Bank, Birmingham, Alabama ("First Commercial") which consists of
the following lines of credit:
. a $7.5 million unsecured line which bears interest at First Commercial's
prime rate + 1/4%;
. an additional $7.5 million line, secured by a pledge of the management
contract between our wholly owned management company, J. Gordon Gaines,
Inc., and our operating insurance subsidiaries.
Each of these newly established credit facilities mature on December 31, 2002.
In addition, the credit agreements related to these facilities contain typical
financial covenants which require us to maintain certain financial standards.
As of March 30, 2000, all $15 million under these lines of credit was
available for general corporate purposes.
Long Term Debt and Preferred Stock
In 1995, we issued $100 million principal amount of our 8.75% Senior
Debentures due 2025. As of December 31, 1999, all $100 million of these senior
debentures remained outstanding.
In 1997, our single purpose finance subsidiary, Vesta Capital Trust I,
issued $100 million principal amount of its 8.525% Deferrable Interest Capital
Securities. We have unconditionally guaranteed Vesta Capital Trust's
obligation to make semi-annual distributions on these capital securities, and
we have issued a debenture in a like amount to Vesta Capital Trust which
requires us to make interest payments in the same amounts and at the same time
as the distributions which are payable on these capital securities. The terms
of the capital securities and the underlying debenture permit us to defer
interest payments on the debentures, and, therefore, distributions on the
capital securities, for up to
28
<PAGE>
ten years. We exercised this right of deferral with respect to the semi-annual
payment originally due July 15, 1999. While we have elected to resume payment
on these capital securities effective January 15, 2000, including all accrued
amounts due since July 15, 1999, we may elect to defer payments again in the
future. In the event we elect to defer such payments again in the future, we
will not be permitted to pay any dividends on our common stock or other equity
securities, including the preferred stock held by the Birmingham Investment
Group, LLC. As of December 31, 1999, approximately $41 million of these 8.525%
Deferrable Capital Securities remained outstanding, after giving effect to the
exchange involving the Company's 12.5% Senior Notes at December 30, 1999
(discussed below).
On December 30, 1999, the Company issued approximately $44 million of its
12.50% Senior Notes due 2005, in exchange for approximately $59 million of its
then outstanding 8.525% Deferrable Capital Securities. The resulting after-tax
gain of $9.5 million was recorded directly to retained earnings. As of
December 31, 1999, approximately $44.1 million of the 12.50% Senior Notes
remained outstanding. The 12.5% Senior Notes have one million warrants
attached that become exercisable in the event that the notes are still
outstanding on December 31, 2004. Based on the probability of exercise,
Vesta's stock price at the date of issuance and other factors, the value of
the warrants is immaterial to the financial statements.
On September 30, 1999, we issued approximately $25 million of our Series A
Convertible Preferred Stock to the Birmingham Investment Group, LLC in which
we sold 2,950,000 shares of our preferred stock at $8.50 per share. Each share
of the preferred stock is convertible into two shares of our common stock and
carries a cumulative dividend rate of 9%, compounded semi-annually. The
preferred stock will automatically be converted into shares of common stock at
the date at which our common stock achieves an average closing price of $8.00
per share for twenty consecutive trading days. As of December 31, 1999, all
$25 million of this preferred stock remained outstanding. Upon resumption of
the distributions payable on the capital securities described above, we expect
to declare dividends on this preferred stock of approximately $1.1 million
semi-annually.
Annual distribution obligations for the Company's long term debt and
preferred stock outstanding at December 31, 1999 are as follows:
<TABLE>
<CAPTION>
Annual Interest
Security Principal Obligation
-------- ------------- ---------------
<S> <C> <C>
8.75%Senior Debentures due 2025................... $ 100 million $ 8.8 million
8.525% Deferrable Capital Securities due 2027..... $41.2 million $ 3.6 million
12.5% Senior Notes due 2005....................... $44.1 million $ 5.5 million
Series A Convertible Preferred Stock.............. $25.1 million $2.25 million
</TABLE>
Subsequent to December 31, 1999, the Company re-purchased $4.5 million of
the 8.75% Senior Debentures due 2025 for approximately $3.3 million plus
accrued interest through March 14, 2000. Also subsequent to December 31, 1999,
the Company re-purchased approximately $21.5 million of its 12.5% Senior Notes
due 2005 for approximately $17.7 million plus accrued interest through March
14, 2000.
Covenants
The Credit Agreements and Indentures related to the Company's commercial
credit facilities and long term debt described above contain various covenants
which restrict the Company's ability to incur additional indebtedness, issue
additional preferred stock, dispose of certain assets and pay dividends on its
common stock in excess of $.15 per share on an annual basis. In addition,
these agreements require Vesta to maintain certain minimum levels of
consolidated net income, statutory consoldiated net income and statutory
surplus, which levels vary from quarter to quarter over the term of the credit
agreement, and also require Vesta Fire's "total adjusted capital" to be at
least 150% of the applicable
29
<PAGE>
"company action level" for Vesta Fire's risk based capital at any time. The
Company's ability to comply with these covenants and financial tests may be
affected by events beyond the Company's control, including economic, financial
and industry conditions. Failure to comply with covenants may result in a
default under the Company's credit agreements and/or indentures, and if any
such default were not remedied within the applicable grace period, if any, the
lenders under such agreements would be entitled to declare the amounts
outstanding thereunder due and payable.
Subsidiaries
The principal sources of funds for our insurance subsidiaries are premiums,
investment income and proceeds from the sale or maturity of invested assets.
Such funds are used principally for the payment of claims, operating expenses,
commissions and the purchase of investments. On a consolidated basis, net cash
(used in) operations for the year ended December 31, 1999 and 1998, was
$(103.3) million and $(47.1) million, respectively. The $103.3 net cash used
in operations is primarily attributable to the declines in loss reserves and
unearned premium reserves as a result of the Company's exit from the
reinsurance assumed and commercial lines business.
Known Trends and Uncertainties
Significant factors influencing results of operations include the supply
and demand for property and casualty insurance and reinsurance, as well as the
number and magnitude of catastrophic losses such as hurricanes, windstorms,
fires and severely cold weather.
The Company seeks to manage its risk exposure by adjusting the mix and
volume of business written in response to changes in price, maintaining
extensive reinsurance and retrocessional programs and applying the Company's
knowledge of primary insurance markets to its reinsurance business.
The Company has historically followed a practice of reinsuring a portion of
in its primary business to reduce the variability of its earnings. The
Company's loss reserve levels historically have remained relatively stable
from year to year despite changes in premium volume. The Company is continuing
to cede portions of insurance risks while using its capital base to gradually
increase, on a selective basis, its retention of certain property risks.
Because catastrophe loss events are by their nature unpredictable,
historical results of operations may not be indicative of expected results of
future operations. The Company markets its primary personal insurance products
throughout the United States. While the Company seeks to reduce its exposure
to catastrophic events through the purchase of reinsurance, the occurrence of
one or more major catastrophes in any given period could have a material
adverse impact on the Company's results of operations and financial condition
and could result in substantial outflows of cash as losses are paid.
Other certain known trends and uncertainties which may affect our future
results are discussed more fully below.
Competition: The property and casualty insurance industry is highly
competitive on the basis of both price and service. In recent years there has
been a trend in the property and casualty industry toward consolidation which
could result in even more competitive pricing. We also face competition from
foreign insurance companies, captive insurance companies and risk retention
groups. In the future, the industry, including us, may face increasing
insurance underwriting competition from banks and other financial
institutions. See, "Business--Competition".
Insurance Ratings: See "Summary," "Risk Factors" and "Business--A.M. Best
Rating" for further discussion.
30
<PAGE>
Litigation: See "Business--Legal Proceedings" and Note J to the
Consolidated Financial Statements for discussion of the current status of
litigation.
Reliance on Performance of Reinsurers: We evaluate the credit quality of
the reinsurers and retrocessionares to which it cedes business. No assurance
can be given regarding the future ability of any of our reinsurers to meet
their obligations. See, "Risk Factors" on page 10.
Inflation: We do not believe our results over the last three fiscal years
have been materially affected by inflation due in part to the predominantly
short-tail nature of our business. The potential adverse impacts of inflation
include: (i) a decline in the market value of our fixed maturity investment
portfolio, (ii) an increase in the ultimate cost of settling claims which
remain unresolved for a significant period of time, and (iii) an increase in
our operating expenses. Historically, the effect of inflation on our reserves
has not been material.
Year 2000
We do not believe we experienced any material operational problems as a
result of the date change to the Year 2000. However, the Y2K issue is also a
concern from an underwriting standpoint regarding the extent of liability for
coverage under various general liability, property and directors and officers
liability and product policies. We believe that minimal coverage could exist
under some current liability and product policies. This exposure should be
minimal as Commercial Lines business has historically excluded any
manufacturing risks which produce computer and computer dependent products.
The Insurance Services Office ("ISO") recently developed policy language
providing that there is no coverage for certain Y2K occurrences. The liability
exclusion has been accepted in over forty states and a companion filing for
property has been accepted in at least twenty states at this time. Several
states have not adopted or approved the property exclusion form citing
specifically that, because there is no coverage under the current property
contracts, there is no reason to accept a clarifying endorsement. We addressed
the Y2K issue by attaching the ISO exclusionary language to all general
liability policies with a rating classification which we believed could
potentially have Y2K losses. The Insurance Services Office exclusionary
language endorsement is included on all property policies. We believe these
actions should minimize our exposure to Y2K losses.
The foregoing information constitutes a Year 2000 Readiness Disclosure
pursuant to the Year 2000 Information and Readiness Disclosure Act.
Market Risk of Financial Instruments
Vesta's principal assets are financial instruments, which are subject to
the market risk of potential losses from adverse changes in market rates and
prices. Our primary risk exposures are interest rate risk on fixed maturity
investments and equity price risk for domestic stocks.
Vesta manages its exposure to market risk by selecting investment assets
with characteristics such as duration, yield and liquidity to reflect the
underlying characteristics of the related insurances.
The following table sets forth the estimated market values of our fixed
maturity investments and equity investments resulting from a hypothetical
immediate 100 basis point increase in interest rates and a 10% decline in
market prices for equity exposures, respectively from levels prevailing at
December 31, 1999.
<TABLE>
<CAPTION>
Amount
--------------
(in thousands)
<S> <C>
Fixed Maturity Investments.................................... $330,943
Equity Investments............................................ $ 1,679
</TABLE>
31
<PAGE>
The decrease in fair values based on an increase in interest rates was
determined by estimating the present value of future cash flows using various
models, primarily duration modeling.
The decrease in fair value of equity securities based on a decrease in the
market prices of all equity securities was estimated as 10% of the fair value.
Item 8. Financial Statements and Supplementary Data
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants......................................... 33
Independent Auditors' Report.............................................. 34
Consolidated Balance Sheets at December 31, 1999 and 1998................. 35
Consolidated Statements of Operations and Comprehensive Income (loss) for
each of the years in the three-year period ended December 31, 1999....... 36
Consolidated Statements of Stockholders' Equity for each of the years in
the three-year period ended December 31, 1999............................ 37
Consolidated Statements of Cash Flows for each of the years in the three-
year period ended December 31, 1999...................................... 38
Notes to Consolidated Financial Statements................................ 39
</TABLE>
32
<PAGE>
Report of Independent Accountants
To the Stockholders of
Vesta Insurance Group, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) present fairly, in all material respects, the
financial position of Vesta Insurance Group., Inc. and its subsidiaries at
December 31, 1999 and 1998, and the results of their operations and their cash
flows for the years then ended in conformity with accounting principles
generally accepted in the United States. In addition, in our opinion, the
financial statement schedules listed in the index appearing under Item
14(a)(2) present fairly, in all material aspects, the information set forth
therein at December 31, 1999 and 1998 and the years then ended when read in
conjunction with the related consolidated financial statements. These
financial statements and financial statement schedules are the responsibility
of the Company's management; our responsibility is to express an opinion on
these financial statements and financial statement schedules. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States which 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,
assessing the accounting principles and estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers, LLP
Birmingham, Alabama
March 12 , 2000
33
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Vesta Insurance Group, Inc.
Birmingham, Alabama:
We have audited the consolidated balance sheet (not presented herein) of
Vesta Insurance Group, Inc. and subsidiaries as of December 31, 1997 and the
related consolidated statements of operations, comprehensive income,
stockholders' equity and cash flow for the year then ended. In connection with
our audit of the consolidated financial statements, we also have audited the
1997 financial statement schedules as listed in the index appearing at Item
14(a)(2). These financial statements and financial statement schedules are the
responsibility of Vesta's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedules based
on our audits.
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 financial position of Vesta
Insurance Group, Inc. and subsidiaries at December 31, 1997, and the results
of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles. Also in our opinion,
the related financial statement schedules, when considered in relation to the
basic consolidated financial statements taken as a whole, present fairly, in
all material respects, the information set forth therein.
KPMG LLP
Birmingham, Alabama
March 27, 1998, except
as to the statements of
comprehensive income
which is as of April 19, 1999
and Note N and Note S
which are as of
March 30, 2000
34
<PAGE>
VESTA INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
--------------------
1999 1998
-------- ----------
<S> <C> <C>
Assets:
Investments:
Fixed maturities available for sale--at fair value
(cost: 1999--$348,760;
1998--$446,516)........................................ $339,429 $457,219
Equity securities--at fair value: (cost: 1999--$2,092;
1998--$18,127)......................................... 1,865 21,099
Short-term investments.................................. 125,026 131,029
-------- ----------
Total investments...................................... 466,320 609,347
Cash.................................................... 17,677 25,321
Accrued investment income............................... 5,460 7,194
Premiums in course of collection (net of allowances for
losses of $2,412 in
1999 and $1,712 in 1998)............................... 41,206 121,948
Reinsurance balances receivable......................... 193,345 265,903
Reinsurance recoverable on paid losses.................. 77,925 111,577
Deferred policy acquisition costs....................... 40,357 90,855
Property and equipment.................................. 15,602 18,442
Income tax receivable................................... -- 17,950
Deferred income taxes................................... 13,489 19,090
Other assets............................................ 19,514 35,681
Goodwill and other intangibles.......................... 24,914 24,394
-------- ----------
Total assets........................................... $915,809 $1,347,702
======== ==========
Liabilities:
Reserves for:
Losses and loss adjustment expenses..................... 354,709 504,911
Unearned premiums....................................... 133,029 309,515
-------- ----------
487,738 814,426
Deferred gain on retroactive reinsurance................ 3,275 9,848
Reinsurance balances payable............................ 3,439 49,028
Other liabilities....................................... 33,191 48,071
Short term debt......................................... 5,000 70,000
Long term debt.......................................... 141,876 98,302
-------- ----------
Total liabilities...................................... 674,519 1,089,675
Commitments and contingencies: See Note I
Deferrable Capital Securities............................ 41,225 100,000
Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares
authorized, issued: 1999-- 2,950,000 shares, 1998--0... 30 --
Common stock, $.01 par value, 32,000,000 shares
authorized, issued: 1999--18,964,322 and 1998--
18,964,322............................................. 190 190
Additional paid-in capital.............................. 179,046 156,465
Accumulated other comprehensive income, net of tax
(benefit) expense of $(3,346) and $4,786 in 1999 and
1998, respectively..................................... (6,213) 8,889
Retained earnings....................................... 41,862 10,120
Treasury stock (283,086 and 310,918 shares at cost at
December 31, 1999 and 1998, respectively).............. (13,048) (15,592)
Receivable from issuance of restricted stock............ (1,802) (2,045)
-------- ----------
Total stockholders' equity............................. 200,065 158,027
-------- ----------
Total liabilities, Deferrable Capital Securities and
stockholders' equity.................................. $915,809 $1,347,702
======== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
35
<PAGE>
VESTA INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Year Ended December
31,
-----------------------------
1999 1998 1997
-------- --------- --------
<S> <C> <C> <C>
Revenues:
Net premiums written........................... $242,862 $ 422,569 $492,978
Decrease (increase) in unearned premium........ 101,244 18,756 (18,193)
-------- --------- --------
Net premiums earned............................ 344,106 441,325 474,785
Net investment income.......................... 26,907 28,862 31,960
Gain on sale of assumed reinsurance renewal
rights........................................ 15,000 -- --
Realized investment gains...................... 7,956 3,272 3,283
Other.......................................... 9,327 5,473 2,094
-------- --------- --------
Total revenue................................. 403,296 478,932 512,122
Expenses:
Losses and loss adjustment expenses incurred... 211,701 337,131 274,650
Policy acquisition expenses.................... 88,638 149,905 133,220
Operating expenses............................. 42,662 75,322 30,611
Interest on debt............................... 13,215 14,054 10,859
Loss on asset impairment....................... -- 65,496 --
Goodwill and other intangible amortization..... 2,118 5,177 3,065
-------- --------- --------
Total expenses................................ 358,334 647,085 452,405
Income (loss)from continuing operations before
taxes and deferred
capital securities............................ 44,962 (168,153) 59,717
Income taxes (benefit)......................... 13,633 (48,555) 21,257
Deferred capital security interest, net of tax. 5,632 5,449 5,051
-------- --------- --------
Income (loss) from continuing operations....... 25,697 (125,047) $ 33,409
Income (loss) from discontinued operations, net
of tax........................................ (2,242) (16,137) 3,451
Net income (loss)............................. 23,455 (141,184) 36,860
Preferred stock dividend....................... (563) -- --
-------- --------- --------
Income (loss) available to common stockholders. $ 22,892 $(141,184) $ 36,860
======== ========= ========
Basic net income (loss) from continuing
operations per common share................... $1.37 $(6.74) $1.79
======== ========= ========
Basic net income (loss) available to common
stockholders per common share................. $1.22 $ (7.61) $1.98
======== ========= ========
Diluted net income (loss) from continuing
operations per common share................... $1.27 $ (6.74) $1.75
======== ========= ========
Diluted net income (loss) available to common
stockholders per common share................. $1.16 $ (7.61) $1.93
======== ========= ========
STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Net income (loss)............................... $ 23,455 $(141,184) $ 36,860
Other comprehensive income, net of tax:
Unrealized holding gains (losses) on available-
for-sale securities net of tax (benefit)
expense of $(5,347), $2,676 and $2,778 in
1999, 1998 and 1997, respectively............. (9,930) 1,187 7,521
Less realized gains on available-for-sale
securities net of tax expense of $2,784,
$1,145 and $1,149 in 1999, 1998 and 1997,
respectively.................................. 5,172 2,127 2,134
-------- --------- --------
(15,102) (940) 5,387
Gain on extinguishments of Deferrable Capital
Securities net of tax expense of $5,141....... 9,548 -- --
-------- --------- --------
Comprehensive income (loss)..................... $ 17,901 $(142,124) $ 42,247
======== ========= ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
36
<PAGE>
VESTA INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated Receivable
Additional Other From
Preferred Common Paid-in Comprehensive Retained Treasury Restricted
Stock Stock Capital Income (Loss) Earnings Stock Stock Total
--------- ------ ---------- ------------- -------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1996................... -- $190 $161,037 $ 4,442 $120,011 $(10,554) $(3,207) $271,919
Net income.............. -- -- -- -- 36,860 -- 36,860
Change in restricted
stock receivable....... -- -- -- -- -- -- (684) (684)
Treasury stock
acquisitions........... -- -- -- -- -- (21,164) -- (21,164)
Treasury stock issued
for options exercised.. -- -- (1,061) -- -- 6,302 -- 5,241
Common dividends
declared (0.15 per
share)................. -- -- -- -- (2,797) -- -- (2,797)
Net change in unrealized
gains net of tax of
$3,927................. -- -- -- 5,387 -- -- -- 5,387
Tax benefit from
exercise of stock
options................ -- -- 2,574 -- -- -- -- 2,574
--- ---- -------- ------- -------- -------- ------- --------
Balance, December 31,
1997................... -- 190 162,550 9,829 154,074 (25,416) (3,891) 297,336
Net income.............. -- -- -- -- (141,184) -- -- (141,184)
Change in restricted
stock receivable....... -- -- -- -- -- -- 1,846 1,846
Treasury stock issued
for options exercised.. -- -- (6,833) -- -- 9,824 -- 2,991
Common dividends
declared (.15 per
share)................. -- -- -- -- (2,770) -- -- (2,770)
Net change in unrealized
gains net of tax of
$(1,531)............... -- -- -- (940) -- -- -- (940)
Tax benefit from
exercise of stock
options................ -- -- 748 -- -- -- -- 748
--- ---- -------- ------- -------- -------- ------- --------
Balance, December 31,
1998................... -- 190 156,465 8,889 10,120 (15,592) (2,045) 158,027
Net income.............. -- -- -- -- 23,455 -- -- 23,455
Preferred Stock
dividend............... -- -- -- -- (563) -- -- (563)
Change in restricted
stock receivable....... -- -- -- -- -- -- 243 243
Treasury stock issued
for restricted stock... -- -- (2,464) -- -- 2,544 -- 80
Common dividends
declared (0.04 per
share)................. -- -- -- -- (698) -- -- (698)
Net change in unrealized
gains net of tax of
$(8,133)............... -- -- -- (15,102) -- -- -- (15,102)
Issuance of preferred
stock.................. 30 -- 25,045 -- -- -- -- 25,075
Extinguishment of
Deferrable Capital
Securities, net of tax
of $5,141.............. -- -- -- -- 9,548 -- -- 9,548
--- ---- -------- ------- -------- -------- ------- --------
Balance, December 31,
1999................... 30 $190 $179,046 $(6,213) $ 41,862 $(13,048) $(1,802) $200,065
=== ==== ======== ======= ======== ======== ======= ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
37
<PAGE>
VESTA INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
For the Year Ended December
31,
-------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Operating Activities:
Net income (loss)............................. $ 23,455 $(141,184) $ 36,860
Adjustments to reconcile net income (loss) to
cash provided from operations................
Changes in:
Loss and LAE reserves........................ (150,202) (91,886) 140,152
Unearned premium reserves.................... (176,485) (55,537) 38,350
Deferred income taxes........................ 7,911 9,434 3,959
Accrued income taxes......................... 18,401 (34,933) (18,354)
Reinsurance balances payable................. (45,589) (7,869) 5,735
Other liabilities............................ (21,875) (26,633) 18,617
Premiums in course of collection............. 153,299 179,874 (285,188)
Reinsurance recoverable on paid losses....... 33,651 25,063 (8,515)
Other assets................................. 4,965 2,403 15,519
Policy acquisition costs deferred............. (48,739) (153,331) (112,981)
Policy acquisition costs amortized............ 99,237 164,600 105,209
Investment gains.............................. (7,956) (3,272) (3,283)
Amortization and depreciation................. 6,237 11,647 4,803
Goodwill impairment........................... -- 74,496 --
(Gain) Loss on disposition of property, plant,
equipment.................................... 410 -- (38)
--------- --------- ---------
Net cash used in operations.................. (103,280) (47,128) (59,155)
Investing Activities:
Investments sold, matured, and called:
Fixed maturities available for sale--matured,
called and sold............................. 293,966 156,377 283,723
Equity securities............................ 21,588 3,822 2,291
Investments acquired:
Fixed maturities available for sale.......... (193,621) (116,007) (52,871)
Equity securities............................ (1,071) (4,323) --
Net cash paid for acquisition................ -- -- (245,811)
Net (increase) decrease in short-term
investments.................................. 6,003 (12,005) (13,610)
Disposition of Vesta County Mutual............ 11,200 -- --
Additions to property and equipment........... (2,294) (5,659) (4,182)
Dispositions of property and equipment........ 671 1,677 289
--------- --------- ---------
Net cash provided from (used in) investing
activities.................................. 136,442 23,882 (30,171)
Financing Activities:
Net change in short term debt................. (65,000) 25,000 23,000
Issuance of long term debt and deferrable
capital securities........................... 44,082 -- 100,321
Retirement of long term debt and deferrable
capital securities........................... (44,589) (300) --
<CAPTION>
Issuance of treasury stock.................... -- -- 6,302
<S> <C> <C> <C>
Acquisition of treasury stock................. -- -- (21,164)
Dividends paid................................ (698) (2,770) (2,797)
Preferred stock issuance...................... 25,075 -- --
Capital contributions from exercising stock
options...................................... 324 4,836 828
--------- --------- ---------
Net cash provided from (used in) financing
activities................................... (40,806) 26,766 106,490
--------- --------- ---------
Increase (decrease) in cash.................... (7,644) 3,520 17,164
Cash at beginning year......................... 25,321 21,801 4,637
--------- --------- ---------
Cash at end of year............................ $ 17,677 $ 25,321 $ 21,801
========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
38
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A--Significant Accounting Policies
Financial Statement Presentation: Vesta Insurance Group, Inc. (Vesta), and
subsidiaries (the Company), was incorporated by Torchmark Corporation
("Torchmark") on July 9, 1993 and capitalized on July 16, 1993 with a $50
million contribution from Torchmark and the contribution from Torchmark of all
of the outstanding common stock of J. Gordon Gaines, Inc., Liberty National
Reinsurance Company, Ltd, and Vesta Fire Insurance Corporation (Vesta Fire)
and its wholly-owned subsidiaries. On November 18, 1993, the Company completed
an initial public offering of common stock which resulted in proceeds to the
Company of approximately $51 million. At year-end 1999, Torchmark held
approximately 5.1 million of the outstanding common stock of the Company with
the balance publicly traded.
Nature of Operations: The Company is a holding company for a group of
property and casualty insurance companies (the "Vesta Group") that offer
primary insurance on personal risks. The lead insurer in the Vesta Group is
Vesta Fire. The Company focuses primarily on private passenger auto and
property coverages. In 1999, the Company discontinued its commercial line of
business. See note R and S. The Company also exited its reinsurance assumed
line of business with the exception of a large block of business being
converted from assumed to direct. (see Note R)
The availability and cost of reinsurance and retrocessional coverage may
vary significantly over time and are subject to prevailing market conditions.
Pricing on both assumed and ceded reinsurance weakened slightly in 1998 and
1999 due to increased availability of reinsurance market capacity.
Use of Estimates in the Preparation of the 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 during the reporting period.
Actual results could differ materially from those estimates. These estimates
and assumptions are particularly important in determining the premiums in
course of collection, reserves for losses and loss adjustment expenses,
deferred policy acquisition costs and reinsurance recoverables.
Investments: Investment securities are classified as available for sale and
reported at fair value, with unrealized gains and losses excluded from
earnings and reported in a separate component of stockholders' equity.
Short-term investments are carried at cost and include investments in
certificates of deposit and other interest-bearing time deposits with original
maturities of one year or less.
Gains and losses realized on the disposition of investments are recognized
as revenues and are determined on a specific identification basis. Unrealized
gains and losses on equity securities and fixed maturities available for sale,
net of deferred income taxes, are reflected directly in stockholders' equity.
If an investment becomes permanently impaired, such impairment is treated as a
realized loss and the investment is adjusted to net realizable value.
Determination of Fair Values of Financial Instruments: Fair values for
cash, short-term investments, short-term debt, receivables and payables
approximate their carrying value. Fair values for investment securities and
long-term debt are based on quoted market prices where available. Otherwise,
fair values are based on quoted market prices of comparable instruments.
39
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A--Significant Accounting Policies (continued)
Cash: Cash consists of balances on hand and on deposit in banks and
financial institutions.
Recognition of Premium Revenue: Earned premiums on primary business are
generally recognized as revenue on a pro rata basis over the policy term.
Earned premiums on assumed reinsurance is recognized as revenue over the
contract period as reported by the cedant.
Losses and Loss Adjustment Expenses: The liability for losses and loss
adjustment expenses ("LAE") includes an amount determined from loss reports
and individual cases. It also includes an amount for losses incurred but not
reported ("IBNR") which is based on past experience. Such liabilities are
necessarily based on estimates and, while management believes that the amount
is adequate, the ultimate liability may be in excess of or less than the
amounts provided. The methods for making such estimates and for establishing
the resulting liabilities are continually reviewed, and any adjustments are
reflected in earnings currently. These reserves are established on an
undiscounted basis and are reduced for estimates of salvage and subrogation.
Deferred Acquisition Costs: Commissions and other costs that vary with and
are primarily related to the production of new and renewal business are
deferred and amortized over the terms of the policies or reinsurance treaties
to which they relate. Anticipated investment income is considered in
determining recoverability of deferred acquisition costs.
Reinsurance: Reinsurance enables an insurance company, by assuming or
ceding reinsurance, to diversify its risk and limit its financial exposure to
risk and catastrophic events. However, reinsurance does not ordinarily relieve
the primary insurer from its obligations to the insured. In the ordinary
course of business, Vesta assumes business from other insurance organizations
and also reinsures certain risks with other insurance organizations.
Income Taxes: Vesta accounts for income taxes using the asset and liability
method under which deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases.
Property and Equipment: Property and equipment is reported at cost less
allowances for depreciation. Depreciation is recorded primarily on the
straight line method over the estimated useful lives of these assets which
range from 1 to 9 years. Ordinary maintenance and repairs are charged to
income as incurred.
Goodwill: The company amortizes goodwill on a straight-line basis over a
period of 15 years.
Reclassification: Certain amounts in the financial statements presented
have been reclassified from amounts previously reported in order to be
comparable between years. These reclassifications have no effect on previously
reported stockholders' equity or net income during the period involved.
Income Per Share: Basic EPS is computed by dividing income available to
common stockholders by the weighted average common shares outstanding for the
period. Weighted average common shares outstanding for each period are as
follows: 1999-18,698,773, 1998-18,548,612, 1997-18,600,000. Diluted EPS is
calculated by adding to shares outstanding the additional net effect of
potentially dilutive securities or contracts which could be exercised or
converted into common shares. Weighted average diluted shares outstanding for
each period are as follows: 1999-20,202,061, 1998-18,548,612, 1997-19,053,000.
40
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A--Significant Accounting Policies (continued)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1999 1998 1997
------- --------- -------
(in thousands except per
share data)
<S> <C> <C> <C>
BASIC NET INCOME PER SHARE:
Weighted average common shares outstanding......... 18,699 18,549 18,600
Net income (loss) available to common shareholders. $22,892 $(141,184) $36,860
Basic net income (loss) per share available to
common shareholders............................... $ 1.22 $ (7.61) $ 1.98
DILUTED NET INCOME PER SHARE:
Weighted average common shares outstanding......... 18,699 18,549 18,600
Net effect of assumed conversion of Preferred stock. 1,503 -- --
Net effect of the assumed exercise of stock options
based on the treasury stock method using average
market price for the year.......................... -- -- 453
------- --------- -------
Total weighted average common shares and common
stock equivalents outstanding...................... 20,202 18,549 19,053
Net income......................................... $23,455 $(141,184) $36,860
Diluted net income per share....................... $ 1.16 $ (7.61) $ 1.93
</TABLE>
Long lived assets: The Company evaluates long-lived assets and certain
identifiable intangibles held and used by an entity for impairment whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. This evaluation is based on undiscounted future
projected cash flows of the asset or asset group. If an impairment exists, the
amount of such impairment is calculated based on the estimated fair value of
the assets. Fair value is generally determined by discounting future projected
cash flows of the asset or asset group under review.
In accordance with Accounting Principles Board Opinion (APB) No. 17,
"Intangible Assets," the recoverability of goodwill not identified with assets
subject to an impairment loss is reviewed for impairment, on an acquisition by
acquisition basis, whenever events or changes in circumstances indicate that
it may not be recoverable. If such an event occurred, the Company would
prepare projections of future discounted cash flows for the applicable
acquisition. The projections are for the remaining term of the goodwill using
a discount rate and terminal value that would be customary for evaluating
insurance company transactions. The Company believes this discounted cash flow
approach approximates fair market value.
New Accounting Standard. In June 1998, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 requires all derivatives to be recorded on the balance sheet at fair
value, In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133. This statement defers the effective date of SFAS No. 133.
As a result, SFAS No. 133 will not be effective for the Company, until the
year 2001. The impact of the reporting requirements of SFAS No. 133 on the
Company will depend on the nature and amount of derivative instruments the
Company might have at date of implementation. The Company does not currently
believe the impact will be material.
In December 1999, the staff of the Securities and Exchange Commission
("SEC") issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition
in Financial Statements." SAB No. 101 summarizes the SEC staff's views in
applying generally accepted accounting principles to the recognition of
revenues. The Company has evaluated the impact of the reporting requirements
of SAB No. 101 and has determined that there will be no material impact on its
consolidated results of operations, financial position or cash flows.
41
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note B--Asset Impairment
During the fourth quarter of 1998, management evaluated goodwill
recoverability pursuant to the Company's existing policies. The evaluation
indicated an impairment of goodwill acquired as part of the Shelby
Acquisition. The events that led to this conclusion include the Company's
inability to integrate the Shelby acquisition as planned and the resulting
high level of expenses, and the recording of significant operating losses in
1998.
The Company's measurement of this impairment was based on cash flow
analysis using projections for the remaining term of the goodwill and a
weighted average cost of capital and terminal value deemed appropriate for
evaluating companies similar to Vesta. The weighted average cost of capital
and future premium growth rates used were 12% and 5% respectively. The
assumptions used in this analysis represent management's best estimate of
future results. However, actual results could differ from these estimates.
As a result of this measurement, the unamortized goodwill attributable to
the Shelby Acquisition was reduced by $74.5 million, of which $65.5 million
was attributable to continuing operations and $9 million to discontinued
operations.
Note C--Statutory Accounting and Regulation
Insurance subsidiaries of Vesta are required to file statutory financial
statements with state insurance regulatory authorities. Accounting principles
used to prepare these statutory financial statements differ from generally
accepted accounting principles (GAAP). The most significant differences
between GAAP and statutory accounting principles are as follows: (a)
acquisition costs of obtaining new business are deferred and amortized over
the policy period rather than charged to operations as incurred; (b) deferred
income taxes are provided for temporary differences between financial and
taxable earnings; (c) certain items are reported as assets (property and
equipment, agents' balances, prepaid expenses) rather than being charged
directly to surplus as nonadmitted items; (d) statutory accounting disallows
reserve credits for reinsurance in certain circumstances; (e) bonds are
recorded at their market values instead of amortized costs.
A reconciliation of Vesta's insurance subsidiaries' reported statutory net
income (loss) to Vesta's consolidated GAAP net income (loss) is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1999 1998 1997
-------- --------- ---------
<S> <C> <C> <C>
Statutory net income (loss).............. $ 67,234 $(107,074) $ (44,941)
Accounting Irregularities(1)............. -- 7,715 --
Deferral of acquisition costs............ 48,739 153,331 112,981
Amortization of acquisition costs........ (99,237) (164,600) (105,209)
Effects of retroactive reinsurance....... 6,573 7,097 (16,945)
Differences in insurance policy
liabilities............................. 9,429 14,910 13,177
Reinsurance premium and loss accrual..... -- -- 46,785
Deferred income taxes.................... (11,365) 39,293 2,732
Income (loss) of non-insurance entities
and other............................... 3,705 (10,751) 32,011
Investment gains......................... 495 -- 276
Goodwill and other intangible
amortization............................ (2,118) (6,609) (4,007)
Loss on asset impairment................. -- (74,496) --
-------- --------- ---------
GAAP net income (loss)................... $ 23,455 $(141,184) $ 36,860
======== ========= =========
</TABLE>
42
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note C--Statutory Accounting and Regulation (continued)
A reconciliation of Vesta's insurance subsidiaries' reported statutory
stockholders' equity to Vesta's consolidated GAAP stockholders' equity is as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Statutory stockholder's equity........... $ 271,986 $ 220,210 $ 317,875
Deferred gain on retroactive reinsurance. (3,275) (9,848) (16,945)
Differences in insurance policy
liabilities............................. 7,044 55,343 15,554
Deferred policy acquisition costs........ 40,357 90,855 102,124
Deferred income taxes.................... 13,489 19,090 7,310
Nonadmitted assets....................... 13,689 22,131 297
Goodwill and other intangible assets..... 24,914 24,394 96,141
Net liabilities of non-insurance
entities................................ (163,208) (274,850) (231,204)
Unrealized gain (loss) on investments (4,931) 10,702 6,184
--------- --------- ---------
GAAP stockholders' equity................ $ 200,065 $ 158,027 $ 297,336
========= ========= =========
</TABLE>
- - --------
(1) In June 1998, the Company completed an internal investigation which
resulted in a reduction of net income of approximately $13.6 million
relating to the fourth quarter of 1997 and the first quarter of 1998. For
GAAP purposes, the amounts relating to 1997 were corrected in 1997, while
for statutory purposes, the amounts related to the fourth quarter of 1997
were recorded in the 1998 statutory reports as the 1997 statutory reports
had been filed prior to such discovery.
The excess, if any, of stockholders' equity of the insurance subsidiaries
on a GAAP basis over that as reported on a statutory basis is not available
for distribution to its stockholders without regulatory approval.
The Company's insurance subsidiaries are subject to regulation by the
insurance departments of states in which they are licensed and undergo
examinations by those departments. The Alabama Department of Insurance
("ADOI") completed its examination of Vesta Fire's 1997 statutory report and
issued its report on December 18, 1998. The ADOI completed a target
examination on Vesta Fire's 1998 filing and issued its report on July 9, 1999.
On November 30, 1999, Vesta Fire, Vesta Insurance Corporation and Sheffield
Insurance Corporation and redomesticated from Alabama to Illinois and Shelby
Casualty Insurance Company redomesticated from Indiana to Illinois for
regulatory purposes.
Restrictions on Dividends to Stockholders. The Company's insurance
subsidiaries are subject to various state statutory and regulatory
restrictions, generally applicable to each insurance company in its state of
incorporation, which limit the amount of dividends or distributions by an
insurance company to its stockholders. The payment of dividends by Vesta Fire
is subject to certain limitations imposed by the insurance laws of the State
of Illinois. The restrictions are generally based on certain levels of
surplus, investment income and operating income, as determined under statutory
accounting practices. Illinois and most other states that regulate Vesta
Fire's operations permit dividends in any year which together with other
dividends or distributions made within the preceding 12 months, do not exceed
the greater of (i) 10% of statutory surplus as of the end of the preceding
year or (ii) the statutory net income for the preceding year, with larger
dividends payable only upon prior regulatory approval. Certain other
extraordinary transactions between an insurance company and its affiliates,
including sales, loans or investments which in any twelve-month period
aggregate at least 3% of its admitted assets or 25% of its statutory capital
and surplus, also are subject to prior approval by the Department of
Insurance.
43
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note C--Statutory Accounting and Regulation (continued)
Risk-Based Capital Requirements. The NAIC adopted risk-based capital
requirements that require insurance companies to calculate and report
information under a risk-based formula which attempts to measure statutory
capital and surplus needs based on the risks in a company's mix of products
and investment portfolio. The formula is designed to allow state insurance
regulators to identify potential weakly capitalized companies. Under the
formula, a company determines its "risk-based capital" ("RBC") by taking into
account certain risks related to the insurer's assets (including risks related
to its investment portfolio and ceded reinsurance) and the insurer's
liabilities (including underwriting risks related to the nature and experience
of its insurance business). Risk-based capital rules provide for different
levels of regulatory attention depending on the ratio of a company's total
adjusted capital to its "authorized control level" ("ACL") of RBC. Based on
calculations made by the Company, the Company exceeds RBC requirements.
Note D--Investment Operations
Investment income is summarized as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Fixed maturities.............................. $24,215 $27,930 $23,876
Equity securities............................. 135 422 248
Short-term investments........................ 9,885 9,323 12,763
------- ------- -------
34,235 37,675 36,887
Less investment expense....................... (2,130) (2,617) (927)
------- ------- -------
Investment income............................. $32,105 $35,058 $35,960
Investment income allocated to discontinued
operations................................... (5,198) (6,196) (4,000)
Net investment income from
continuing operations........................ $26,907 $28,862 $31,960
======= ======= =======
</TABLE>
An analysis of gains (losses) from investments is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1999 1998 1997
-------- ------- ------
<S> <C> <C> <C>
Realized investment gains (losses) from:
Fixed maturities................................ $ (250) $ 159 $3,000
Equity securities............................... 8,206 3,113 283
-------- ------- ------
$ 7,956 $ 3,272 $3,283
-------- ------- ------
Net change in unrealized investment gains
(losses) on:
Fixed maturities available for sale............. $(15,634) $ 4,060 $3,772
Equity securities available for sale............ (3,199) (6,531) 5,542
Less: Applicable tax (benefit) expense .......... (3,731) (1,531) 3,927
-------- ------- ------
Net change in unrealized gains (losses).......... $(15,102) $ (940) $5,387
======== ======= ======
</TABLE>
44
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note D--Investment Operations (continued)
A summary of fixed maturities and equity securities by amortized cost and
estimated fair value at December 31, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
1999: Cost Gains Losses Value
- - ----- --------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
United States Government............. $ 64,284 $ 158 $ 1,073 $ 63,369
States, municipalities and political
subdivisions........................ 36,651 241 586 36,306
Foreign governments.................. 3,594 -- 129 3,465
Corporate............................ 157,310 34 5,226 152,118
Mortgage-backed securities, GNMA
collateral.......................... 86,921 29 2,779 84,171
-------- ------- ------- --------
Total Fixed Maturities.............. 348,760 462 9,793 339,429
Equity securities..................... 2,092 82 309 1,865
-------- ------- ------- --------
Total portfolio..................... $350,852 $ 544 $10,102 $341,294
======== ======= ======= ========
<CAPTION>
1998:
- - -----
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
United States Government............. $72,935 $ 2,509 $ 28 $ 75,416
States, municipalities and political
subdivisions........................ 124,358 3,386 -- 127,744
Foreign governments.................. 3,619 128 30 3,717
Corporate............................ 157,831 3,931 180 161,582
Mortgage-backed securities, GNMA
collateral.......................... 87,773 1,058 71 88,760
-------- ------- ------- --------
Total Fixed Maturities.............. 446,516 11,012 309 457,219
Equity securities..................... 18,127 4,079 1,107 21,099
-------- ------- ------- --------
Total portfolio..................... $464,643 $15,091 $ 1,416 $478,318
======== ======= ======= ========
</TABLE>
A schedule of fixed maturities held for investment by contractual maturity
at December 31, 1999 is shown below on an amortized cost basis and on a fair
value basis. Actual maturities could differ from contractual maturities due to
call or prepayment provisions.
<TABLE>
<CAPTION>
Cost or
Amortized Fair
Cost Value
--------- --------
<S> <C> <C>
Due in one year or less................................ $ 36,276 $ 35,853
Due from one to five years............................. 127,765 124,093
Due from five to ten years............................. 79,372 77,078
Due in ten years or more............................... 18,426 18,234
-------- --------
$261,839 $255,258
Mortgage backed securities, including
GNMA's and GNMA collateral............................ 86,921 84,171
-------- --------
Total.................................................. $348,760 $339,429
======== ========
</TABLE>
Proceeds from the sale of equity securities were $22 million, $4 million
and $2 million in 1999, 1998 and 1997, respectively. Gross gains realized on
those sales were $8.2 million, $3.1 million and $.3 million in 1999, 1998 and
1997, respectively. Proceeds from sales, maturities and calls of fixed
maturities were $294 million in 1999, $156 million in 1998 and $284 million in
1997. Gross gains realized on those sales were $1.7 million in 1999, $.2
million in 1998 and $3.4 million in 1997. Gross losses on those sales were $2
million in 1999, $.02 million in 1998 and $.3 million in 1997.
45
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note E--Property and Equipment
A summary of property and equipment used in the business is as follows:
<TABLE>
<CAPTION>
December 31, Estimated
--------------- Useful
1999 1998 Lives
------- ------- ---------
<S> <C> <C> <C>
Building and real estate......................... $15,664 $15,664 3-9 yrs
Data processing equipment........................ 11,818 20,874 3-5 yrs
Furniture and office equipment................... 6,218 6,066 1-5 yrs
Other............................................ 6,780 6,408 1-5 yrs
------- -------
40,480 49,012
Accumulated Depreciation......................... 24,878 30,570
------- -------
Net Property and Equipment....................... $15,602 $18,442
======= =======
</TABLE>
Depreciation expense on property and equipment used in the business was
$4.3 million, $4.2 million, and $2.9 million each of the years 1999, 1998,
1997
Note F--Deferred Policy Acquisition Costs
Deferred policy acquisition costs for the years ended December 31, 1999,
1998 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1999 1998 1997
-------- --------- ---------
<S> <C> <C> <C>
Balance at beginning of year.............. $ 90,855 $ 102,124 $ 75,532
Deferred policy acquisition costs acquired
in acquisition of Shelby................. -- -- 18,820
Deferred during period.................... 48,739 153,331 112,981
Amortized during period................... (99,237) (164,600) (105,209)
-------- --------- ---------
Balance at end of year.................... $ 40,357 $ 90,855 $ 102,124
======== ========= =========
</TABLE>
Commissions comprise the majority of the additions to deferred policy
acquisition costs in each year.
46
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note G--Reserves for Losses and Loss Adjustment Expenses
The table below presents a reconciliation of beginning and ending loss and
LAE reserves for the last three years:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Gross Losses and LAE reserves at beginning
of year.................................. $ 504,911 $ 596,797 $ 173,275
Reinsurance Recoverable................... (206,139) (204,336) (60,343)
--------- --------- ---------
Net Losses and LAE reserves at beginning
of year.................................. 298,772 392,461 112,932
Increases (decreases) in provisions for
losses and LAE for claims incurred:
Current year............................. 268,931 396,091 311,089
Prior year............................... (22,167) (769) (12,451)
Acquisition of Shelby..................... -- -- 300,315
Losses and LAE payments for claims
incurred:
Current year............................. (198,503) (269,369) (166,447)
Prior year............................... (178,883) (219,642) (152,977)
--------- --------- ---------
Net Losses and LAE reserves at end of
year..................................... 168,150 298,772 392,461
Reinsurance Recoverable................... 186,559 206,139 204,336
--------- --------- ---------
Gross loss and LAE Reserves............... $ 354,709 $ 504,911 $ 596,797
========= ========= =========
</TABLE>
The favorable development of $22.2 million is primarily attributable to
positive development on personal lines and on the run out of the assumed
reinsurance lines, commutation gains and additional ceded recoveries.
Note H--Related Party Transactions
Vesta leases office space from SG/SPU Property I, LLC, formerly Torchmark
Development Corporation, which, until September 25, 1999 was a wholly owned
subsidiary of Torchmark Corporation. Rent expense of $1.7 million,
$1.2 million and $.7 million was charged to operations for the years ended
December 31, 1999, 1998 and 1997, respectively, related to this lease
agreement.
Waddell & Reed Asset Management Company, ("WRAMCO"), provides investment
advice and services to the Company and its subsidiaries in connection with the
management of their respective portfolios pursuant to an Investment Services
Agreement. The Company paid $.6 million, $.6 million and $.4 million in fees
to WRAMCO pursuant to the Investment Services Agreement in 1999, 1998 and
1997, respectively. In 1999, the Company cancelled the Investment Services
Agreement with WRAMCO.
On September 13, 1993, Vesta Fire Insurance Corporation, a wholly owned
subsidiary of the Company ("Vesta Fire"), and Liberty National Life Insurance
Company ("Liberty National"), a wholly owned subsidiary of Torchmark, entered
into a Marketing and Administrative Services Agreement, pursuant to which
Vesta Fire marketed certain of its industrial fire insurance products through
agents of Liberty National. Under this agreement, Liberty National pays to
Vesta Fire an amount equal to all premiums collected by Liberty National after
deducting all expenses incurred by Liberty National which are directly
attributable to the industrial fire insurance products and after deducting a
fee for administrative services. Such fee for 1999, 1998 and 1997 was $1
thousand, $.9 million and $1.4 million, respectively. This agreement was
terminated effective April 30, 1995, and these products are no longer marketed
through Liberty National agents.
47
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note I--Commitments and Contingencies
Securities Litigation
Subsequent to the filing of its quarterly report on Form 10-Q for the
period ended March 31, 1998 with the Securities and Exchange Commission, the
Company became aware of certain accounting irregularities consisting of
inappropriate reductions of reserves and overstatements of premium income in
the Company's reinsurance business that had been recorded in the fourth
quarter of 1997 and the first quarter of 1998. The Company promptly commenced
an internal investigation to determine the exact scope and amount of such
reductions and overstatements. This investigation concluded that inappropriate
amounts had, in fact, been recorded and the Company determined it should
restate its previously issued 1997 financial statements and first quarter 1998
Form 10-Q. Additionally, during its internal investigation the Company re-
evaluated the accounting methodology being utilized to recognize earned
premium income in its reinsurance business. The Company had historically
reported certain assumed reinsurance premiums as earned in the year in which
the related reinsurance contracts were entered even though the terms of those
contracts frequently bridged two years. The Company determined that
reinsurance premiums should be recognized as earned over the contract period
and corrected the error in its accounting methodology by restating previously
issued financial statements. The Company issued press releases, which were
filed with the Securities and Exchange Commission, on June 1, 1998 and
June 29, 1998 announcing its intention to restate its historical financial
statements.
The Company restated its previously issued financial statements for 1995,
1996 and 1997 and its first quarter 1998 Form 10-Q for the above items by
issuance of a current report on Form 8-K dated August 19, 1998. These
restatements resulted in a cumulative decrease to stockholder's equity of
$75.2 million through March 31, 1998.
Commencing in June 1998, Vesta and several of its current and former
officers and directors were named in several purported class action lawsuits
in the United States District Court for the Northern District of Alabama and
in one purported class action lawsuit in the Circuit Court of Jefferson
County, Alabama. Several of Vesta's officers and directors also have been
named in a derivative action lawsuit in the Circuit Court of Jefferson County,
Alabama, in which Vesta is a nominal defendant.
The class action lawsuit filed in the Circuit Court of Jefferson County,
Alabama has been dismissed and the derivative case has been placed on the
administrative docket. The class actions filed in the United States District
Court for the Northern District of Alabama have been consolidated into a
single action in that district. The class representatives in that action have
filed (a) a consolidated amended complaint alleging that the defendants
violated the federal securities laws and (b) a motion for class certification,
which was granted in 1999. The consolidated amended complaint also added as
defendants Torchmark Corporation and the Company's predecessor auditors, KPMG
LLP. The consolidated amended complaint alleges various violations of the
federal securities law and seeks unspecified but potentially significant
damages.
The Company has notified its directors and officers liability insurance
companies of these lawsuits and the consolidated amended complaint. The
litigation is still in the preliminary stages and there has been no discovery
conducted in the securities case. The Company intends to vigorously defend
this litigation and intends to explore all available rights and remedies it
may have under the circumstances. In related litigation, in September, 1998,
Cincinnati Insurance Company ("Cincinnati"), one of the Company's directors
and officers liability insurance carriers, filed a lawsuit in the United
States District Court for the Northern District of Alabama seeking to avoid
coverage under its directors and officers liability and other policies. The
Company filed a motion to dismiss Cincinnati's complaint on
48
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note I--Commitments and Contingencies (continued)
jurisdictional grounds in federal court (which was granted), and filed a
lawsuit against Cincinnati in the Circuit Court of Jefferson County, Alabama
seeking damages arising out of Cincinnati's actions. Cincinnati has filed an
answer and counterclaim in that case again seeking to avoid coverage.
Pursuant to Delaware law and by-laws, the Company is obligated to indemnify
its current and former officers and directors for certain liabilities arising
from their employment with or service to the Company. The Company believes
that these indemnification obligations extend to its current and former
officers' and directors' costs of defense and other liabilities which may
arise out of the securities litigation described above.
The Company has purchased directors' and officers' liability insurance
("D&O insurance") for the purposes of covering among other things the costs
incurred in connection with these indemnification obligations. For the period
in which most of the claims against the Company and certain of its directors
and officers were asserted, the Company had in place a primary D&O insurance
policy providing $25 million in coverage and an excess D&O insurance policy
covering for an additional $25 million in coverage. The issuer of the primary
D&O insurance policy, Cincinnati, has attempted to avoid coverage as discussed
above, and the Company is vigorously resisting its efforts to do so.
Subsequent to the initiation of the class actions described above, the
Company secured additional excess D&O insurance providing coverage for losses
in excess of $50 million up to $110 million, or additional excess coverage of
$60 million for the class actions. The Company paid for this additional excess
policy in full in 1998.
These matters are in their early stages and their ultimate outcome cannot
be determined. Accordingly, the Company has not currently set aside any
financial reserves relating to any of the above-referenced actions.
Other Litigation and Arbitration
The Company, through its subsidiaries, is routinely a party to pending or
threatened legal proceedings and arbitration relating to the regular conduct
of its insurance business. These proceedings involve alleged breaches of
contract, torts, including bad faith and fraud claims and miscellaneous other
specified relief. Based upon information presently available, and in light of
legal and other defenses available to the Company and its subsidiaries,
management does not consider liability from any threatened or pending
litigation regarding routine matters to be material.
As discussed above, the Company corrected its accounting for assumed
reinsurance business through restatement of its previously issued financial
statements. Similar corrections were made on a statutory accounting basis
through recording cumulative adjustments in Vesta Fire's 1997 statutory
financial statements. The impact of this correction has been reflected in
amounts ceded under the Company's 20 percent whole account quota share treaty
which was terminated on June 30, 1998 on a run-off basis. The Company believes
such treatment is appropriate under the terms of this treaty and has
calculated the quarterly reinsurance billings presented to the three treaty
participants accordingly. The aggregate amount included herein as recoverable
from such reinsurers totaled $54.4 million at December 31, 1999. The Company
has collected approximately $48.5 million from significant reinsurers via the
conversion of collateral on hand.
49
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note I--Commitments and Contingencies (continued)
NRMA, one of the participants in the 20 percent whole account quota share
treaty, has filed a lawsuit in the United States District Court for the
Northern District of Alabama contesting the Company's claim and the validity
of the treaty, and is seeking return of the $34.5 million. The Company has
filed a demand for arbitration as provided for the treaty and has filed a
motion to compel arbitration which was recently granted in a United States
District Court action. The Company has filed for arbitration against the other
two participants on the treaty and those arbitrations are in their early
stages. While management believes its interpretation of the treaty's terms and
computations based thereon are correct, these matters are in their early
stages and their ultimate outcome cannot be determined at this time.
A dispute has arisen with F&G Re (on behalf of USF&G) under two aggregate
stop loss reinsurance treaties whereby F&G Re assumed certain risk from the
Company. During 1999 F&G Re filed for arbitration under those two treaties.
While management believes its interpretation of the treaties' terms and
computations based thereon are correct, this arbitration is in its early
stages and its ultimate outcome cannot be determined at this time.
On September 23, 1999, Torchmark Corporation, the Company's largest common
stockholder, filed a lawsuit in the Circuit Court of Jefferson County, Alabama
against the Company asserting breach of contract, conversion and breach of
duty in connection with the Company's preparation and filing of a registration
statement covering its shares in accordance with certain registration rights
claimed by Torchmark. This claim seeks an injunction requiring a registration
statement to be filed, as well as compensatory and punitive damages. This
litigation is in its early stages, and management is unable to assess the
damages that may be awarded, if any. However, management does not believe that
such damages, if any, would materially and adversely affect the Company's
financial position or result of operation.
On June 23, 1999, a subsidiary of Torchmark filed suit in the Circuit Court
of Jefferson County, Alabama against two subsidiaries of the Company. The
lawsuit claims that the Company's subsidiaries have failed to pay certain sums
due under a marketing and administrative services agreement between the
parties. The suit also seeks payment of certain commissions and administrative
expenses. This litigation is in its early stages, and management is unable to
assess the damages that may be awarded, if any. However, management does not
believe that such damages, if any, would materially and adversely affect the
Company's financial position or results of operation.
Under insurance guaranty fund laws, in most states, insurance companies
doing business therein can be assessed up to prescribed limits for
policyholder losses incurred by insolvent companies. The Company does not
believe such assessments will be materially different from amounts already
provided for in the financial statements.
Leases: The Company leases office space for its home office and HIG under
operating lease arrangements. These leases contain various renewal options and
escalation clauses. Rental expense for operating leases was $2.1 million, $1.8
million, and $1.2 million, for the years ending December 31, 1999, 1998, and
1997, respectively. Future minimum rental commitments required under these
leases are approximately $1.5 million per year.
Concentrations of Credit Risk: Vesta maintains a highly-diversified
investment portfolio with limited concentrations in any given region,
industry, or economic characteristic. At December 31, 1999, the
50
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note I--Commitments and Contingencies (continued)
investment portfolio consisted of securities of the U.S. government or U.S.
government backed securities (13.1%); mortgage backed securities GNMA
collateral (17.4%); investment grade corporate bonds (31.4%); cash and short-
term investments (29.5%); securities of state and municipal governments
(7.5%); securities of foreign governments (0.7%); and corporate common stocks
(0.4%). Corporate equity and debt investments are made in a wide range of
industries. All of Vesta's investments at year-end 1999 were rated investment
grade.
Note J--Supplemental Disclosures for Cash Flow Statement
The following table summarizes Vesta's non-cash investing and financing
activities and amounts recorded for interest and income taxes paid.
<TABLE>
<CAPTION>
Year Ended
December 31,
----------------
1999 1998 1997
---- ---- ------
<S> <C> <C> <C>
Paid in capital from tax benefit of stock option
exercises.............................................. -- $748 $2,574
</TABLE>
The following table summarizes certain amounts paid during the period:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Interest paid...................................... $10,174 $11,193 $15,113
Income taxes paid.................................. $ -- $ -- $22,571
</TABLE>
Note K--Reinsurance
Vesta engages in reinsurance ceded transactions as part of its overall
underwriting and risk management strategy. Vesta's reinsurance ceded programs
include coverages which limit the amount of individual claims to a fixed
amount or percentage and which limit the amount of claims related to
catastrophes.
The effect on premiums earned and losses and loss adjustment expenses
incurred of reinsurance ceded transactions are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1999 1998 1997
------- -------- --------
<S> <C> <C> <C>
Reinsurance ceded:
Premiums ceded................................. $91,759 $310,652 $300,799
Losses and LAE recovered
and recoverable............................... $97,758 $199,026 $345,780
</TABLE>
The amounts of reserves for unpaid losses and loss adjustment expenses and
unearned premiums that Vesta would remain liable for should reinsuring
companies be unable to meet their obligations are as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
-----------------
1999 1998
-------- --------
<S> <C> <C>
Losses and loss adjustment expense...................... $186,558 $206,139
Retroactive Reinsurance Receivable...................... 3,275 9,848
Unearned premiums....................................... 3,512 49,916
-------- --------
$193,345 $265,903
======== ========
</TABLE>
51
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Vesta engages in assumed reinsurance transactions as part of its overall
business strategy. The effect on premiums earned and losses and loss
adjustment expenses of all assumed reinsurance transactions, including
involuntary pools, are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Premiums assumed................................ $116,678 $341,956 $495,063
Losses and loss adjustment expenses assumed..... 69,348 230,497 333,488
</TABLE>
The effect of reinsurance on premiums written and earned, including
premiums for discontinued operations is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------------ -------------------- --------------------
Written Earned Written Earned Written Earned
-------- -------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Direct......... $300,545 $371,416 $ 471,404 $ 478,389 $ 330,624 $ 323,394
Assumed........ 7,215 116,678 287,617 341,956 535,427 495,063
Ceded.......... (41,506) (91,759) (267,431) (310,652) (339,576) (300,799)
-------- -------- --------- --------- --------- ---------
Net premiums.. $266,254 $396,335 $ 491,590 $ 509,693 $ 526,475 $ 517,658
======== ======== ========= ========= ========= =========
</TABLE>
Note L--Income Taxes
Income tax expense (benefit) for the years ended December 31, 1999, 1998,
and 1997 was allocated as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------- -------- -------
<S> <C> <C> <C>
Tax expense (benefit) from continuing operations... $13,633 $(48,555) $21,257
Tax expense (benefit) from discontinued operations. (1,208) (8,689) 1,859
Deferrable Capital Securities...................... (3,075) (3,076) (2,719)
------- -------- -------
$ 9,350 $(60,320) $20,397
======= ======== =======
</TABLE>
Income tax expense (benefit) attributable to income from operations
consists of:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1999 1998 1997
------- -------- -------
<S> <C> <C> <C>
Current tax expense (benefit)................... $ 1,060 $(17,951) $25,848
Deferred tax expense (benefit).................. 11,365 (39,293) (2,732)
Discontinued operations income benefit
(expense)...................................... 1,208 8,689 (1,859)
------- -------- -------
Total tax expense from continuing
operations.................................... $13,633 $(48,555) $21,257
======= ======== =======
</TABLE>
52
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note L--Income Taxes (continued)
Vesta's effective income tax rate differed from the statutory income tax
rate as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1999 1998 1997
------------ ------------- ------------
Amount % Amount % Amount %
------- --- -------- --- ------- ---
<S> <C> <C> <C> <C> <C> <C>
Statutory federal income tax
rate.......................... $14,198 35% $(67,543) (35%) $22,759 35%
Increases (reductions) in tax
resulting from:
Tax exempt investment income.. (2,204) (5) (2,246) (2) (2,019) (2)
State income tax.............. -- -- -- -- 337 --
Goodwill...................... 188 .4 13,109 8
Other......................... 243 .6 (564) -- 2,039 2
------- --- -------- --- ------- ---
$12,425 31% $(57,244) (29%) $23,116 35%
======= === ======== === ======= ===
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities included in
other liabilities at December 31, 1999 and 1998 are presented below:
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Deferred tax assets:
Unearned and advance premiums............................ $ 9,122 $20,312
Discounted unpaid losses................................. 8,217 13,615
Net operating loss/AMT credit carryforward............... 20,077 38,049
Goodwill................................................. 7,140 7,983
Retroactive Reinsurance.................................. 1,146 3,447
Deferred Compensation.................................... 695 775
------- -------
Total deferred tax assets................................. $46,397 $84,181
======= =======
</TABLE>
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Deferred tax liabilities:
Deferred acquisition costs.............................. $20,565 $35,335
Contingent commissions.................................. 2,002 4,005
Unrealized gains........................................ (1,779) 6,446
Fixed assets............................................ 2,889 2,606
Contingent receivables.................................. 2,748 4,764
Salvage and subrogation................................. 100 248
Reinsurance Recoverables................................ 5,958 10,982
Other................................................... 425 705
------- -------
Total deferred tax liabilities........................... $32,908 $65,091
------- -------
Net deferred tax asset................................... $13,489 $19,090
======= =======
</TABLE>
Deferred tax assets are to be reduced by a valuation allowance if it is
more likely than not that some portion or all of the deferred tax assets will
not be realized. The Company has determined that the benefits of its deferred
tax assets are realizable and accordingly, no valuation allowance has been
recorded at December 31, 1999 and 1998. Net operating loss carryforwards
expire in 2019.
53
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note M--Retirement Plans
Vesta has a defined contribution retirement and savings plan and a
supplemental executive retirement plan. These plans are fully funded at year-
end 1999. Vesta's total cost for benefits under these plans was $.1 million
for 1999, $.1 million for 1998 and $.7 million for 1997.
Note N--Segment Information
During 1998, the Company adopted SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which requires companies to report
financial and descriptive information about their reportable operating
segments. The Company writes personal and commercial insurance products
throughout the United States and reinsurance for companies located throughout
the United States. All revenues are generated from external customers and the
Company does not have a reliance on any major customer.
The Company evaluates segment profitability based on pre-tax operating
profit. Net investment income, interest expense and operating expenses are
allocated based on certain assumptions and estimates; stated segment operating
results would change if different methods were applied. The accounting
policies of the operating segments are the same as those described in Note A.
54
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note N--Segment Information (continued)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
1999 1998 1997
-------- ---------- ----------
<S> <C> <C> <C>
Revenues
Reinsurance Operations
Net premiums earned......................... $ 96,029 $ 194,261 $ 335,360
Net investment income and realized
gain/(loss)................................. 10,659 9,136 17,976
-------- ---------- ----------
Total reinsurance........................... 106,688 203,397 353,336
Personal insurance operations
Net premiums earned.......................... 248,077 247,064 139,425
Net investment income and realized
gain/(loss)................................. 24,204 22,998 17,267
Other........................................ 9,327 5,473 2,094
-------- ---------- ----------
Total personal.............................. 281,608 275,535 158,786
Commercial insurance operations (discontinued)
Net premiums earned.......................... 52,230 68,368 42,873
Net investment income and realized
gain/(loss)................................. 5,198 6,196 4,000
Other........................................ -- -- --
-------- ---------- ----------
Total commercial (discontinued)............. 57,428 74,564 46,873
-------- ---------- ----------
Total revenues.............................. $445,724 $ 553,496 $ 558,995
======== ========== ==========
Total pretax income from operations
Reinsurance Operations
Underwriting gain (loss)..................... $ 5,493 $ (70,028) $ 38,788
Net investment income and realized
gain/(loss)................................. 10,659 9,136 17,976
Interest expense............................. 3,700 6,184 7,711
-------- ---------- ----------
Gain on sale of renewal rights............... 15,000 -- --
-------- ---------- ----------
Total reinsurance........................... 27,452 (67,076) 49,053
Personal Operations
Underwriting gain (loss)..................... (4,388) (51,005) (2,484)
Net investment income and realized
gain/(loss)................................. 24,204 22,998 17,267
Other income................................. 9,327 5,473 2,094
Interest expense............................. 9,515 7,870 3,149
Loss on asset impairment..................... -- 65,496 --
Goodwill..................................... 2,118 5,177 3,065
-------- ---------- ----------
Total personal.............................. 17,510 (101,077) 10,663
Commercial Operations(discontinued)
Underwriting gain (loss)..................... (8,646) (20,590) 2,252
Net investment income and realized
gain/(loss)................................. 5,198 6,196 4,000
Other income................................. -- -- --
Loss on asset impairment..................... -- 9,000 --
Interest expense............................. -- -- --
Goodwill..................................... -- 1,432 942
-------- ---------- ----------
Total commercial (discontinued)............. (3,448) (24,826) 5,310
-------- ---------- ----------
Total pretax income (loss) from operations.. $ 41,514 $ (192,979) $ 65,026
======== ========== ==========
Total identifiable assets
Reinsurance operations
Investments and other assets................. $ 84,741 $ 240,022 $ 681,273
Deferred acquisition costs................... 7,453 47,662 52,742
Personal operations
Investments and other assets................. 636,505 803,283 580,809
Deferred acquisition costs................... 31,362 35,465 38,772
Commercial operations (discontinued)
Investments and other assets................. 154,205 213,542 272,653
Deferred acquisition costs................... 1,542 7,728 10,610
-------- ---------- ----------
Total assets................................ $915,809 $1,347,702 $1,636,859
======== ========== ==========
</TABLE>
55
<PAGE>
The Company has reclassed prior year's segment data to reflect the
discontinuance of Commercial Lines. The reclasses reflect changes to the
Company's allocation of investment income and operating expenses to present the
Personal and Reinsurance segments on a continuing operations basis.
55--1
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note O--Debt
Long-term debt and deferrable capital securities at December 31, 1999 and
1998 consists of the following (in thousands):
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
8.75% Senior Debentures, due July 15, 2025............ $100,000 $100,000
12.5% Senior Notes, due December 30, 2006............. 44,082 --
Less: debt issue cost................................ (2,206) (1,698)
-------- --------
Long-term debt...................................... $141,876 $ 98,302
======== ========
8.525% Deferrable Capital Securities, issued by
Vesta Capital Trust I................................ $ 41,225 $100,000
======== ========
</TABLE>
The 12.5% senior notes have one million warrants attached that become
exercisable in the event that the notes are still outstanding on December 31,
2004. Based on the probability of exercise, Vesta's stock price at the date of
issuance and other factors, the value of the warrants is immaterial to the
financial statements.
The Company's short-term debt outstanding at December 31, 1999 and 1998 as
follows (in thousands):
<TABLE>
<CAPTION>
Outstanding Available
----------- ---------
<S> <C> <C>
1999................................................. $ 5,000 $10,000
1998................................................. $70,000 $ 0
</TABLE>
The credit agreement related to the 1998 line of credit contains certain
covenants that require, among other things, the Company to maintain a certain
consolidated net worth, maintain a certain amount of earnings before interest
and taxes available for the payment of interest and dividend expense, cause
each insurance subsidiary to maintain a certain total adjusted statutory
capital, and that limits the amount of indebtedness of the companies. As of
December 31, 1998, the Company was not in compliance with all of its financial
covenants.
The Company's former banks agreed to amend the covenants and waive any
event of default arising from non-compliance with the covenants as of December
31, 1998. The interest rate on the Amended Facility was the prime rate plus
1%, provided that from and after September 30, 1999 the rate increased to the
prime rate plus 3% if the Company has not made permanent principal prepayments
on the Amended Facility aggregating at least $25 million.
The Amended Facility required the Company to make a closing principal
prepayment of $15 million less transaction expenses the net amount of which
reduces the obligation to make permanent principal payments aggregating
$25 million. The Amended Facility also provides for warrants equal to
approximately 6.6% of the Company's outstanding shares being issued to the
banks participating on the Amended Facility, which become exerciseable in the
event the Company does not make $25 million of permanent principal prepayments
on the facility by March 15, 2000. Based on its ability and intent to make the
required principal payments, the Company assigned no value to the warrants. On
September 30, 1999, the Company repaid the Amended Credit Facility and
cancelled the warrants.
56
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note O--Debt (continued)
As of December 31, 1999, the Company's credit facilities consisted of a
$5 million unsecured line of credit and an additional $10 million line of
credit, secured by a pledge of the management contract between our wholly
owned management company, J. Gordon Gaines, Inc., and our operating insurance
subsidiaries and carried an interest rate of the bank's prime rate.
In 1997, our single purpose finance subsidiary, Vesta Capital Trust I,
issued $100 million principal amount of its 8.525% Deferrable Interest Capital
Securities. We have unconditionally guaranteed Vesta Capital Trust's
obligation to make semi-annual distributions on these capital securities, and
we have issued a debenture in a like amount to Vesta Capital Trust which
requires us to make interest payments in the same amounts and at the same
times as the distributions which are payable on these capital securities. The
terms of the capital securities and the underlying debenture permit us to
defer interest payments on the debentures, and, therefore, distributions on
the capital securities, for up to ten years. We exercised this right of
deferral with respect to the semi-annual payment originally due July 15, 1999.
While we have elected to resume payment on these capital securities effective
January 15, 2000, including all accrued amounts due since July 15, 1999, we
may elect to defer payments again in the future. In the event we elect to
defer such payments again in the future, we will not be permitted to pay any
dividends on our common stock or other equity securities, including the
preferred stock held by the Birmingham Investment Group, LLC. On December
30, 1999, the Company exchanged $44.1 million of 12.5% senior notes, due 2006
for $58.8 million of the Deferrable Capital Securities. The resulting after-
tax gain of $9.5 million was recorded directly to retained earnings in
accordance with EITF 86-32 "Early Extinguishment of a Subsidiary's Mandatorily
Redeemable Preferred Stock". As of December 31, 1999, approximately
$41 million of these capital securities remained outstanding and carried a
semi-annual distribution obligation of approximately $1.8 million.
Covenants
The Credit Agreements and indentures related to the Company's commercial
credit facilities and long term debt described above contain various covenants
which restrict the Company's ability to incur additional indebtedness, issue
additional preferred stock, dispose of certain assets and pay dividends on its
common stock in excess of $.15 per share on an annual basis. In addition,
these agreements require Vesta to maintain certain minimum levels of
consolidated net income, statutory consolidated net income and statutory
surplus, which levels vary from quarter to quarter over the term of the credit
agreement, and also require Vesta Fire's "total adjusted capital" to be at
least 150% of the applicable "company action level" for Vesta Fire's risk
based capital at any time. The Company's liability to comply with these
covenants and financial tests may be affected by events beyond the Company's
control, including economic, financial and industry conditions. Failure to
comply with covenants may result in a default under the Company's credit
agreements and/or indentures, and if any such default were not remedied within
the applicable grace period, if any, the lenders under such agreements would
be entitled to declare the amounts outstanding thereunder due and payable.
The estimated fair value and carrying amounts of the Company's long term
debt are as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
-----------------
1999 1998
-------- --------
<S> <C> <C>
Fair Value.............................................. $ 58,227 $ 84,151
Carrying amount......................................... 183,101 198,302
</TABLE>
57
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note P--Stock Options
During 1995, the Financial Accounting Standards Board issued Financial
Accounting Statement No. 123, Accounting for Stock-Based Compensation
("SFAS 123"). The Statement defines a fair value based method of accounting
for an employee stock option. It also allows an entity to continue using the
intrinsic value based accounting method prescribed by Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees. The Company
has continued to use this method to account for its stock options. However,
SFAS 123 requires entities electing to remain with the intrinsic method of
accounting to provide pro forma disclosures of net income and earnings per
share as if the fair value based method of accounting had been applied as well
as other disclosures about the Company's stock-based employee compensation
plans. Information about the Company's stock option plans and the related
required disclosures follow.
Prior to completion of the Company's initial public offering, the Company's
stockholders approved the Vesta Insurance Group, Inc. Long Term Incentive Plan
("Plan"), which provided for grants to the Company's executive officers of
restricted stock, stock options, stock appreciation rights, and deferred stock
awards, and in certain instances grants of options to directors. The Company's
stockholders approved certain amendments to the Plan effective August 27, 1999
and May 16, 1995, including an amendment to increase the shares of the
Company's common stock available for awards under the Plan to 2,221,998 shares
and an amendment to delete the provision for the grant of options to non-
employee directors. The Company's stockholders also approved the Vesta
Insurance Group, Inc. Non-Employee Director Stock Plan ("Director Plan")
effective May 16, 1995, which provides for grants to the Company's non-
employee directors of stock options and restricted stock.
Pro forma information regarding net income and earnings per share is
required by FAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of that Statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions for 1999, 1998 and 1997, respectively; risk-free interest rates of
6.22%, 5.16% and 5.75%; dividend yields of 1.67%, 0.44% and 0.27%; volatility
factor of the expected market price of the Company's common stock of 67.02,
44.7, and 38.75; and a weighted-average expected life of the options of ten
years for all years.
The Company's actual and pro forma information follows (in thousands except
for earnings per share information):
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1999 1998 1997
------- --------- -------
<S> <C> <C> <C>
Net income:
As reported................................... $22,892 $(141,184) $36,860
Pro forma..................................... 22,261 (144,684) 33,576
Basic net income per common share:
As reported................................... $ 1.22 $ (7.61) $ 1.98
Pro forma..................................... 1.19 (7.80) 1.81
Diluted net income per common share:
As reported................................... $ 1.16 $ (7.61) $ 1.93
Pro forma..................................... 1.10 $ (7.80) $ 1.76
</TABLE>
58
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note P--Stock Options (continued)
The following summary sets forth activity under the Plan for the years
ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
----------------- ----------------- -------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- --------- ------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding--beginning
of the year............ 564,048 $24.40 937,451 $25.65 1,022,872 $20.38
Granted................. 431,500 4.58 101,500 21.30 135,085 51.64
Exercised............... -- -- 237,000 17.16 220,506 17.15
Forfeited............... 134,912 16.91 237,903 35.14 -- --
------- ------ ------- ------ --------- ------
Outstanding--end of the
year................... 860,636 $15.64 564,048 $24.43 937,451 $25.65
======= ====== ======= ====== ========= ======
Weighted-average fair
value of options
granted during the
year................... $ 2.92 $ 12.56 $ 36.89
</TABLE>
Of the 860,636 outstanding options at December 31, 1999, 585,636 were
exercisable. Of the remaining 275,000 shares, 50% will vest in 2003 and 50% in
2004. Exercise prices for options outstanding as of December 31, 1999 ranged
from $4.44 to $59.19.
The following table shows expiration dates and the weighted average
exercise price for all outstanding options at December 31, 1999.
<TABLE>
<CAPTION>
Weighted Average
Expiration Date Number of Shares Exercise Price
--------------- ---------------- ----------------
<S> <C> <C>
2003.................................. 90,917 16.14
2004.................................. 22,500 15.25
2005.................................. 80,418 20.98
2006.................................. 55,700 31.17
2007.................................. 69,798 37.15
2008.................................. 109,803 33.28
2009.................................. 431,500 4.58
</TABLE>
At December 31, 1999, the Company had issued 249,307 shares of restricted
stock. 74,307 shares have been issued to officers of the Company in exchange
for promissory notes. The common stock is being held by the Company for
security for the repayment of the notes. The balance of the notes at December
31, 1999 and 1998, respectively, was $1.8 million and $2.1 million. The
promissory notes are shown as deductions from stockholders' equity.
The restrictions on the remaining 175,000 shares expire in 2003 and 2004.
59
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note Q--Quarterly Financial Information (Unaudited)
The following is a summary of quarterly financial data, in thousands except
per share data:
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------
March 31, June 30, September 30, December 31,
1999 1999 1999 1999
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
Gross premiums written........... $ 59,609 $84,462 $64,875 $53,260
Net premiums written............. 43,641 81,011 72,425 45,785
Premiums earned.................. 105,604 83,745 87,782 66,975
Net investment income............ 6,564 6,159 6,338 7,846
Operating costs and expenses..... 113,224 88,134 88,185 68,790
Net income (loss) from continuing
operations...................... 9,123 5,376 7,977 3,221
Preferred stock dividend......... -- -- -- 563
Net income (loss) from
discontinued operations......... (330) (873) (2,947) 1,908
Net income available to
stockholders.................... $ 8,793 $ 4,503 $ 5,030 $ 4,566
Diluted per share data:
Net income from continuing
operations...................... .49 .29 .43 .06
Net income from discontinued
operations...................... (.02) (.05) (.16) .12
Net income from available
stockholders.................... .47 .24 .27 .18
Stockholder's equity per share... 8.81 8.60 10.13 10.63
Cash dividends per share......... .04 -- -- --
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------
March 31, June 30, September 30, December 31,
1998 1998 1998 1998
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
Gross premiums written.......... $196,359 $220,529 $ 82,123 $ 135,600
Net premiums written............ 115,294 153,381 34,694 119,200
Premiums earned................. 120,875 147,812 47,802 124,836
Net investment income........... 7,631 7,461 6,784 10,258
Operating costs and expenses.... 129,995 174,854 83,473 193,267
Loss on asset impairment........ -- -- -- (65,496)
Net income (loss) from
continuing operations.......... (1,577) (12,461) (21,465) (89,544)
Net income (loss) from
discontinued operations........ 3,648 (4,726) (3,306) (11,753)
Net income available to
shareholders................... $2,071 $(17,185) $(24,773) $(101,297)
Diluted per share data:
Net income from continuing
operations..................... (.09) (.68) (1.16) (4.82)
Net income from discontinued
operations..................... .20 (.25) (.18) (.63)
Net income available to
stockholders................... .11 (.93) (1.34) (5.45)
Stockholder's equity per share.. 16.73 15.72 14.63 8.47
Cash dividends per share........ 0.04 0.04 0.04 0.04
</TABLE>
As discussed in Note S, the Company discontinued its commercial operations
effective in the fourth quarter of 1999. Quarters prior to such effective rates
have been reclassified in accordance with Accounting Principal Board Opinion
No. 30 (APB 30) for presentation of discontinued operations.
60
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note R--Reinsurance assumed
On March 24, 1999 the Company sold its reinsurance assumed business with
the exception of the homeowner's reinsurance business that is currently being
converted to primary operations. The Company received $15 million in exchange
for its commitment to (a) enter into a 100% quota share treaty, effective
January 1, 1999 for all business written on or after that date; b) use its
best efforts to novate to the purchaser or renew on the purchaser's paper, all
assumed treaties except those currently being converted to primary business
and; (c) facilitate the hiring by the purchaser of several of the Company's
reinsurance employees. The Company is exiting the reinsurance assumed business
with this transaction and continued conversion or commutation and termination
of the other assumed reinsurance business.
The Company acquired a block of personal lines of business from CIGNA on
December 31, 1997 via a 100% quota share reinsurance contract and entered into
an agreement whereby CIGNA would use its best efforts to renew the business on
Company paper as expeditiously as possible. The Company continues to convert
this business to its paper as state rate approvals are obtained and renewal
dates are reached. The results of this business are reported in the
Reinsurance Segment until renewals are made onto Company paper, at which time
such policies become reported in the Personal Lines Segment.
In connection with the above acquisition, the Company agreed to compensate
the Seller with an initial ceding commission of $18 million, $9 million of
which represented value of business acquired and quarterly commissions through
conversion. A portion of these quarterly commissions represents additional
payments for the renewal rights to the business. Such amounts, representing
initial and additional purchase price, have been capitalized as value of
business acquired, included in goodwill and other intangibles, herein and are
amortized over the estimated retention of such business. The Company changed
its estimate of such retention in the third quarter of 1999, resulting in a
$3.4 million net income improvement for the year ended December 31, 1999 as
compared to results which would have been reported under previous estimates.
Note S--Discontinued operations
In 1999, the Company elected to exit all commercial lines programs by not
accepting new commercial policy applications and non renewing existing in-
force policies at their renewal dates. In November of 1999 the Company
received final regulatory approval to non renew its commercial lines policies
from all of the states in which the Company wrote commercial lines. Such
approval represented the measurement date for treatment of the commercial
segment as a discontinued operation under APB 30. Therefore, the commercial
operations have been segregated from continuing operations herein for all
periods presented. The Company will continue to earn premium and incur losses
on policies which were in-force through November 1999. Operating results of
commercial lines were as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------- -------- -------
<S> <C> <C> <C>
Net premium earned............................... $52,230 $ 68,368 $42,873
======= ======== =======
Income (loss) from discontinued operations before
tax............................................. (3,450) (24,826) 5,310
Income tax expense (benefit)..................... (1,208) (8,689) 1,859
------- -------- -------
Income (loss) from discontinued operations....... $(2,242) $(16,137) $ 3,451
======= ======== =======
Basic net income (loss) from discontinued
operations
per common share............................... (.12) (.87) .19
Diluted net income (loss) from discontinued
operations
per common share............................... (.11) (.87) .18
</TABLE>
61
<PAGE>
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note S--Discontinued operations (continued)
Assets and liabilities of the commercial lines are primarily comprised of
the following at December 31, 1999:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Investments and other assets.............................. $154,205 $213,542
Deferred acquisition costs................................ 1,542 7,728
Reserves for loss, LAE and unearned premium............... 155,747 221,270
</TABLE>
Note T--Subsequent Events
Subsequent to December 31, 1999, the Company repaid the outstanding $5
million on the revolving line of credit and cancelled the related credit
agreement effective February 29, 2000.
On March 3, 2000, the Company established a revolving credit facility which
consists of a $7.5 million unsecured line which bears interest at prime plus
.23% and an additional $7.5 million line, secured by a pledge of the
management contract between our wholly owned management company, J. Gordon
Gaines, Inc. and our operating subsidiaries.
Note U--Sale of Convertible Preferred Stock
On September 30, 1999, the Company raised $25.1 million from placement of
its Series A Convertible Preferred Stock. 2,950,000 shares of the Company's
preferred stock were issued at $8.50 per share. Each share of the preferred
stock is convertible into two shares of the Company's common stock. Dividends
are cumulative at a 9% rate compounded semi-annually. The preferred stock will
automatically be converted into shares of common stock of the Company at the
date the common stock achieves an average closing price of $8.00 per share for
twenty consecutive trading days. The preferred stock can also be converted at
any time at the election of the preferred stockholders and must be converted
at the end of fifteen years. The preferred stockholders have a liquidation
preference senior to common stock, have voting rights of 5.9 million shares of
common stock, and have the right to elect 3 members of the Board of Directors.
62
<PAGE>
PART III
Item 10. Directors and Executive Officers of Registrant
Information required by this item is incorporated by reference from the
sections entitled "Election of Directors," "Profiles of Directors and
Nominees," "Profiles of Executive Officers who are not directors" and
"Compensation and Other Transactions with Executive Officers and Directors" in
the Proxy Statement for the Annual Meeting of Stockholders to be held May ,
2000 (the "Proxy Statement"), which is to be filed with the Securities and
Exchange Commission prior to May 1, 1999.
Item 11. Executive Compensation
Information required by this item is incorporated by reference from the
section entitled "Compensation and Other Transactions with Executive Officers
and Directors" in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Security ownership of certain beneficial owners:
Information required by this item is incorporated by reference from the
section entitled "Principal Stockholders" in the Proxy Statement.
(b) Security ownership of management:
Information required by this item is incorporated by reference from the
section entitled "Stock Ownership" in the Proxy Statement.
(c) Changes in control:
The Company knows of no arrangements, including any pledges by any
person of its securities, the operation of which may at a subsequent
date result in a change of control.
Item 13. Certain Relationships and Related Transactions
Information required by this item is incorporated by reference from the
section entitled "Compensation Committee Interlocks and Insider Participation;
Other Transactions" in the Proxy Statement.
63
<PAGE>
PART IV
Item 14. Exhibits, Financial Statements Schedules, and Reports on Form 8-K
(a) Index of documents filed as a part of this report:
<TABLE>
<CAPTION>
Page of
this
Report
-------
<S> <C>
(1) Financial Statements:
Vesta Insurance Group, Inc.
Report of Independent Accountants.................................... 42
Independent Auditors' Report......................................... 30
Consolidated Balance Sheets at December 31, 1999 and 1998............ 31
Consolidated Statements of Operations for each of the years in the
three-year period
ended December 31, 1999............................................. 32
Consolidated Statements of Stockholders' Equity for each of the years
in the three-year
period ended December 31, 1999...................................... 33
Consolidated Statements of Cash Flow for each of the years in the
three-year period
ended December 31, 1999............................................. 34
Notes to Consolidated Financial Statements........................... 35
(2) Schedules Supporting Financial Statements for the three years
ended December 31,
1999:
II.Condensed Financial Information of Registrant (Parent Company)..... 78
III.Supplemental Insurance Information (Consolidated)................. 81
IV.Reinsurance (Consolidated)......................................... 83
V.Valuation and Qualifying Accounts (Consolidated).................... 84
Schedules not referred to have been omitted as inapplicable or not required by
Regulation S-X.
(3) Exhibits
Exhibits are listed in the index of Exhibits at page 47.
(b) Reports on Form 8-K: No reports on Form 8-K were filed during the
last quarter of the
period covered by this report.
</TABLE>
64
<PAGE>
EXHIBITS INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S> <C>
3.1 Restated Certificate of Incorporation of the Company, dated
September 1, 1993 (filed as an exhibit to the Company's Form
10-Q for the quarter ended June 30, 1998, filed on June 16,
1998 and incorporated herein by reference (File No. 1-
12338))
3.2 By-Laws of the Company (Amended and Restated as of October
1, 1993) (filed as an exhibit to Amendment No. 1 to the
Registration Statement on Form S-1 (Registration No. 33-
68114) of Vesta Insurance Group, Inc., filed on October 18,
1993 and incorporated herein by reference (File No. 1-
12338))
3.3 Certificate of Designation, filed with the Secretary of
State of the State of Delaware, establishing rights and
preferences of the Company's Series A Convertible Preferred
Stock.
4.1 Indenture between the Company and Southtrust Bank of
Alabama, National Association, dated as of July 19, 1995
(filed as an exhibit to the Company's Form 10-K for the year
ended December 31, 1995, filed on March 28, 1996 and
incorporated herein by reference (File No. 1-12338))
4.2 Supplemental Indenture between the Company and Southtrust
Bank of Alabama, National Association, dated July 19, 1995
(filed as an exhibit to the Company's Form 10-K for the year
ended December 31, 1995, filed on March 28, 1996 and
incorporated herein by reference (File No. 1-12338))
4.3 Indenture dated as of January 31, 1997, between the Company
and First Union National Bank of North Carolina, as trustee
(filed as an exhibit to the Company's Form 10-Q for the
quarter ended March 31, 1997, filed on May 13, 1997 and
incorporated herein by reference (File No. 1-12338))
4.4 Amended and Restated Declaration of Trust, dated as of
January 31, 1997, of Vesta Capital Trust I (filed as an
exhibit to the Company's Form 10-Q for the quarter ended
March 31, 1997, filed on May 13, 1997 and incorporated
herein by reference (File No. 1-12338))
4.5 Capital Securities Guarantee Agreement, dated as of January
31, 1997, between the Company and First Union National Bank
of North Carolina, as trustee (filed as an exhibit to the
Company's Form 10-Q for the quarter ended March 31, 1997,
filed on May 13, 1997 and incorporated by reference (File
No. 1-12338))
10.1 Separation and Public Offering Agreement between Torchmark
Corporation and the Company dated September 13, 1993 (filed
as an exhibit to the Company's Form 10-K for the year ended
December 31, 1993, filed on March 28, 1994 and incorporated
herein by reference (File No. 1-2338))
10.2 Marketing and Administrative Services Agreement between
Liberty National Fire Insurance Company, Liberty National
Insurance Corporation and Liberty National Life Insurance
Company dated September 13, 1993 (filed as an exhibit to the
Company's Form 10-K for the year ended December 31, 1993,
filed on March 28, 1994 and incorporated herein by reference
(File No. 1-2338))
10.3 Investment Services Agreement between Waddell & Reed Asset
Management Company and the Company (filed as an exhibit to
Amendment No. 1 to the Registration Statement on Form S-1
(Registration No. 33-68114) of Vesta Insurance Group, Inc.,
filed on October 18, 1993 and incorporated herein by
reference (File No. 1-12338)) dated September 13, 1993.
</TABLE>
65
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S> <C>
10.5 Management Agreement between J. Gordon Gaines, Inc., Liberty
National Fire Insurance Company, Sheffield Insurance
Corporation, Liberty National Insurance Corporation and Vesta
Insurance Corporation dated November 15, 1994 (filed as an
exhibit to the Company's Form 10-K for the year ended December
31, 1993, filed on March 28, 1994 and incorporated herein by
reference (File No. 1-2338))
10.6 Form of Restricted Stock Agreement (filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 33-68114)
of Vesta Insurance Group, Inc., filed on August 31, 1993 and
incorporated herein by reference (File No. 1-12338))
10.7* The Company's Long Term Incentive Plan as amended effective as
of May 16, 1995 (filed as an exhibit to the Company's Form 10Q
for the quarter ended June 30, 1995, filed on August 14, 1995
and incorporated herein by reference (File No. 1-12338))
10.8* Form of Non-Qualified Stock Option Agreement entered into by and
between the Company and certain of its executive officers and
directors (filed as an exhibit to the Company's Form 10-K for
the year ended December 31, 1995, filed on March 28, 1996 and
incorporated herein by reference (File No. 1-12338))
10.9* Cash Bonus Plan of the Company (filed as an exhibit to the
Company's Form 10-K for the year ended December 31, 1993, filed
on March 28, 1994 and incorporated herein by reference (File No.
1-2338))
10.10* J. Gordon Gaines, Inc. Post Retirement Benefits Plan (filed as
an exhibit to the Company's Form 10-K for the year ended
December 31, 1994, filed on March 29, 1995 and incorporated
herein by reference (File No. 1-12338))
10.11* J. Gordon Gaines, Inc. Retirement Savings Plan (filed as an
exhibit to the Company's Form 10-K for the year ended December
31, 1994, filed on March 29, 1995 and incorporated herein by
reference (File No. 1-12338))
10.12* The Company's Non-Employee Director Stock Plan (filed as an
exhibit to the Company's 10-Q for the quarter ended June 30,
1995, filed on August 14, 1995 and incorporated herein by
reference (File No. 1-12338))
10.13 Employment Agreement between the registrant and Norman W. Gayle,
III, dated as of September 30, 1999. (filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-90473)
of Vesta Insurance Group, Inc., filed on November 5, 1999 and
incorporated herein by reference.)
10.14 Employment Agreement between the registrant and James E. Tait,
dated as of September 30, 1999. (filed as an exhibit to the
Registration Statement on Form S-1 (registration No. 333-90473)
of Vesta Insurance Group, Inc., filed on November 5, 1999 and
incorporated herein by reference.)
10.15 Employment Agreement between the registrant and Donald W.
Thornton, dated as of September 30, 1999. (filed as an exhibit
to the Registration Statement on Form S-1 (Registration
No. 333-90473) of Vesta Insurance Group, Inc., filed on
November 5, 1999 and incorporated herein by reference.)
10.16 Vesta Insurance Group, Inc. Executive Officer Incentive
Compensation Plan. (filed as an exhibit to the Registration
Statement on Form S-1 (Registration No. 333-90473) of Vesta
Insurance Group, Inc., filed on November 5, 1999 and
incorporated herein by reference.)
10.17 Office Lease between the Company and Torchmark Development
Corporation, dated as of April 20, 1992 (filed as an exhibit to
the Company's Form 10-K for the year ended December 31, 1993,
filed on March 28, 1994 and incorporated herein by reference
(File No. 1-12338))
</TABLE>
66
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S> <C>
10.18 Agency Agreement between Liberty National Fire Insurance
Company, Vesta Insurance Corporation, Sheffield Insurance
Corporation, and Overby-Seawell Company (filed as an exhibit
to Amendment No. 1 to the Registration Statement on Form S-1
(Registration No. 33-68114) of Vesta Insurance Group, Inc.,
filed on October 18, 1993 and incorporated herein by
reference (File No. 1-12338))
10.19 Commercial/Personal Property Risk Excess Reinsurance
Contracts, dated July 1, 1993, constituting the Company's
Direct Per Risk Treaty Program, between Vesta Fire Insurance
Corporation and its subsidiary and affiliated companies and
various reinsurers (filed as an exhibit to Amendment No. 1
to the Registration Statement on Form S-1 (Registration No.
33-68114) of Vesta Insurance Group, Inc., filed on October
18, 1993 and incorporated herein by reference (File No. 1-
12338)) Renewed July 1, 1997.
10.20 Specific Regional Catastrophe Excess Contracts, dated
January 1, 1996, constituting the Company's Regional
Property Catastrophe Program, between Vesta Fire Insurance
Corporation and various reinsurers (filed as an exhibit to
the Company's Form 10-K for the year ended December 31,
1995, filed on March 28, 1996 and incorporated herein by
reference (File No. 1-12338)). Renewed January 1, 1998.
10.21 Casualty Excess of Loss Reinsurance Agreements, dated
January 1, 1998, constituting the Company's Casualty Excess
of Loss Reinsurance Program, between Vesta Fire Insurance
Corporation, Vesta Insurance Corporation, Sheffield
Insurance Corporation, Vesta Lloyds Insurance Company and
Employers Reinsurance Corporation, (filed as an exhibit to
the Company's Form 10-Q for the quarter ended March 31,
1998, filed on May 13, 1998 and incorporated herein by
reference (File No. 1-12338)).
10.22 Amendment to Catastrophe Reinsurance Contracts, dated July
1, 1995, constituting the Company's Direct Property
Catastrophe Program, between Vesta Fire Insurance
Corporation, Vesta Insurance Corporation, Sheffield
Insurance Corporation, Vesta Lloyds Insurance Company,
Hawaiian Insurance & Guaranty Company, Limited and various
reinsurers. (Filed as an exhibit to the Company's Form 10-Q
for the quarter ended September 30, 1995, filed on November
14, 1995 and incorporated herein by reference (File No. 1-
12338)). Renewed July 1, 1997
10.23 Amendment to Catastrophe Reinsurance Contracts, dated
January 1, 1996, constituting the Company's Direct Property
Catastrophe Program, between Vesta Fire Insurance
Corporation, Vesta Insurance Corporation, Sheffield
Insurance Corporation, Vesta Lloyds Insurance Company,
Hawaiian Insurance & Guaranty Company, Limited and various
reinsurers (filed as an exhibit to the Company's Form 10-K
for the year ended December 31, 1995, filed on March 28,
1996 and incorporated herein by reference (File No. 1-
12338)). Renewed January 1, 1997
10.24 Credit Agreement dated September 30, 1999 between Vesta
Insurance Group, Inc. and The Bank establishing a
$15,000,000 revolving credit facility (filed as an exhibit
to the Registration Statement on Form S-1 (Registration
No. 333-90473) of Vesta Insurance Group, Inc., filed on
November 5, 1999 and incorporated herein by reference (File
No. 1-12338)).
10.25 Credit Agreement, dated September 30, 1999, between Vesta
Insurance Group, Inc. and The Banc Corporation establishing
a $5,000,000 revolving credit facility (filed as an exhibit
to the Registration Statement on Form S-1 (Registration
No. 333-90473) of Vesta Insurance Group, Inc., filed on
November 5, 1999 and incorporated herein by reference (File
No. 1-12338)).
</TABLE>
67
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S> <C>
10.26 Stock Purchase Agreement between Anthem Casualty Insurance
Group, Inc., and Vesta Insurance Group, Inc., dated April
23, 1997 (filed as an exhibit to the Company's Form 10-Q for
the year ended September 30, 1997, filed on November 13,
1997 and incorporated herein by reference (File No. 1-
12338))
10.27 Business Transfer and Management Agreement between Vesta
Fire Insurance Corporation and its affiliated companies and
CIGNA Property and Casualty Insurance Company and its
affiliated companies, dated January 28, 1998 (filed as an
exhibit to the Company's Form 10-K for the year ended
December 31, 1997, filed on March 27, 1998 and incorporated
herein by reference (File No. 1-12338))
10.28 Agreement for Data Processing Services between Shelby
Insurance Company and Policy Management Systems Corporation,
dated January 1, 1998 (filed as an exhibit to the Company's
Form 10-Q for the period from June 30, 1998, filed on August
20, 1998 and incorporated herein by reference (File No. 1-
12338))
10.29 Agreement by and among Hartford Fire Insurance Company, J.
Gordon Gaines, Inc. and Vesta Fire Insurance Corporation
(filed as Exhibit 2.1 to the Company's Form 8-K filed April
12, 1999)
10.30 Convertible Preferred Stock Purchase Agreement by and
between Vesta Insurance Group, Inc. and Birmingham
Investment Group, LLC (filed as Exhibit 10.1 to the
Company's Form 8-K filed on July 2, 1999)
10.31 Acquisition Agreement between Vesta Insurance Group, Inc.,
Vesta Management Corporation of Texas, Inc. and Employers'
Reinsurance Corporation (filed as Exhibit 10.2 to the
Company's Form 8-K filed on July 2, 1999)
11 Statement regarding computation of earnings
21 List of subsidiaries
23.1+ Consent of KPMG LLP
23.2+ Consent of PricewaterhouseCoopers LLP
99.1+ Risk Factors
</TABLE>
- - --------
*These are the Company's compensatory plans.
+Filed herewith.
68
<PAGE>
Exhibit 11. Statement re computation of per share earnings
VESTA INSURANCE GROUP, INC.
COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1999 1998 1997
------- --------- -------
(In thousands except per
share data)
<S> <C> <C> <C>
BASIC EARNINGS PER SHARE:
Weighted average common shares outstanding......... 18,699 18,549 18,600
Income available to common shareholders............ $22,892 $(141,184) $36,860
Basic earnings per share........................... $ 1.22 $ (7.61) $ 1.98
DILUTED EARNINGS PER SHARE:
Weighted average common shares outstanding......... 18,699 18,549 18,600
Conversion of preferred stock...................... 1,503
Net effect of the assumed exercise of stock options
and nonvested restricted stock--based on the
treasury stock method using average market price
for the year...................................... -- -- 453
------- --------- -------
Total weighted average common shares and common
stock equivalents outstanding..................... 20,202 18,549 19,053
Net income......................................... $23,455 $(141,184) $36,860
Diluted earnings per share......................... $ 1.16 $ (7.61) $ 1.93
======= ========= =======
</TABLE>
Exhibit 21. Subsidiaries of the Registrant
The following table lists subsidiaries of the registrant which meet the
definition of "significant subsidiary" according to Regulation S-X:
<TABLE>
<CAPTION>
Name Under Which
Company State of Incorporation Company Does Business
------- ---------------------- ---------------------
<S> <C> <C>
Vesta Fire Illinois Vesta Fire
Insurance Corporation Insurance Corporation
</TABLE>
All other exhibits required by Regulation S-K are listed as to location in
the Exhibits Index on pages 64 through 67 of this report. Exhibits not
referred to have been omitted as inapplicable or not required.
69
<PAGE>
VESTA INSURANCE GROUP, INC.
(PARENT COMPANY)
SCHEDULE II--CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
At December 31,
------------------
1997 1998
-------- --------
<S> <C> <C>
Assets
Assets Investment in affiliates.......................... $425,387 $430,910
Short-term investments................................... 3,584 4,791
-------- --------
Total investments...................................... 428,971 435,701
Cash..................................................... -- 10,523
Other assets............................................. 4,045 11,179
-------- --------
Total assets........................................... $433,016 $457,403
======== ========
Liabilities Other liabilities
Other liabilities........................................ $ 41,202 $ 27,981
Long term debt........................................... 191,749 271,395
-------- --------
Total liabilities...................................... 232,951 299,376
Stockholders' equity
Preferred stock $.01 par value, 5,000,000 shares
authorized, issued: 1999--2,950,000; 1998--0............ 30 --
Common stock, $.01 par value, 32,000,000 shares
authorized, issued: 1999--18,964,322 shares; 1998--
18,964,322 shares....................................... 190 190
Additional paid-in capital............................... 179,046 156,465
Other comprehensive income, net of applicable taxes...... (6,213) 8,889
Retained earnings........................................ 41,862 10,120
Receivable from issuance of restricted stock............. (1,802) (2,045)
Treasury stock........................................... (13,048) (15,592)
-------- --------
Total stockholders' equity............................. 200,065 158,027
-------- --------
Total liabilities and stockholders' equity............. $433,016 $457,403
======== ========
</TABLE>
70
<PAGE>
VESTA INSURANCE GROUP, INC.
(PARENT COMPANY)
SCHEDULE II--CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Year Ended December 31,
----------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Net other income (loss).................... $ (4,109) $ 8,457 $ (5,224)
---------- ---------- ---------
Expenses:
Interest expenses.......................... 18,080 22,579 10,901
Operating expenses......................... 2,724 2,384 (10,327)
---------- ---------- ---------
Total expenses........................... 20,804 24,963 574
---------- ---------- ---------
Net loss before income tax and equity
in earnings of affiliates.................. (24,913) (16,506) (5,798)
Income tax benefit.......................... 8,720 5,698 1,932
---------- ---------- ---------
Income before equity in earnings of
affiliates................................. (16,193) (10,808) (3,866)
Equity in earnings of affiliates............ 39,648 (130,376) 40,726
---------- ---------- ---------
Net income (loss)........................... $ 23,455 $ (141,184) $ 36,860
========== ========== =========
</TABLE>
71
<PAGE>
VESTA INSURANCE GROUP, INC.
(PARENT COMPANY)
SCHEDULE II--CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year Ended December 31,
-----------------------------------
1999 1998 1997
---------- ---------- -----------
<S> <C> <C> <C>
Cash provided from operations............. $ 29,002 $ 6,526 $ 48,163
Cash used in investing activities:
Contribution to investments in
affiliates.............................. -- (25,000) (154,616)
Net (increase) decrease in short-term
investments............................. 1,207 2,224 (35)
---------- ---------- -----------
Cash provided by (used) in investing
activities............................... 1,207 (22,776) (154,651)
Cash (used in) provided from financing
activities:
Dividends paid........................... (698) (2,770) (2,797)
Acquisition of treasury stock............ -- -- (21,164)
Issuance of treasury stock............... -- -- 6,302
Preferred Stock issuance................. 25,075 -- --
Capital Contributions from exercising
stock options........................... 324 4,836 828
Issuance(retirement) of debt and
deferrable capital securities........... (65,507) 24,700 123,321
---------- ---------- -----------
Cash (used in) provided from financing
activities............................... (40,806) 26,766 106,490
Net increase (decrease) in cash........... (10,597) 10,516 2
Cash balance at beginning of period....... 10,523 7 5
---------- ---------- -----------
Cash balance at end of period............. $ (74) $ 10,523 $ 7
========== ========== ===========
</TABLE>
72
<PAGE>
VESTA INSURANCE GROUP, INC.
SCHEDULE III--SUPPLEMENTAL INSURANCE INFORMATION (CONSOLIDATED)
As of December 31, 1999 and 1998
<TABLE>
<CAPTION>
Reserves for
Deferred Unpaid Claims
Policy and Claim
Acquisition Adjustment Unearned
Costs Expenses Premiums
----------- ------------- --------
<S> <C> <C> <C>
As of December 31, 1999:
Reinsurance................................. $ 7,453 $ 62,188 $ 30,007
Commercial.................................. 1,542 150,018 5,729
Personal.................................... 31,362 142,503 97,293
------- -------- --------
$40,357 $354,709 $133,029
======= ======== ========
As of December 31, 1998
Reinsurance................................. $47,662 $148,021 $139,663
Commercial.................................. 7,728 178,511 42,759
Personal.................................... 35,465 178,379 127,093
------- -------- --------
$90,855 $504,911 $309,515
======= ======== ========
</TABLE>
For the Years Ended December 31, 1999, 1998 and 1997
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Claim and
Claim
Net Net Adjustment Amortization Other Net
Earned Investment Expenses of Operating Premium
Premium Income Incurred DAC Expenses Written
-------- ---------- ---------- ------------ --------- --------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999:
Reinsurance............ $ 96,029 $ 8,272 $ 46,687 $ 41,348 $ 2,500 $ 15,055
Commercial............. 52,230 5,198 35,062 10,497 15,317 23,392
Personal............... 248,076 18,635 165,014 47,392 40,059 227,807
-------- ------- -------- -------- ------- --------
$396,335 $32,105 $246,763 $ 99,237 $57,876 $266,254
======== ======= ======== ======== ======= ========
As of December 31, 1998:
Reinsurance............ $194,261 $12,846 $175,633 $ 77,706 $20,838 $157,728
Commercial............. 68,368 7,827 54,712 24,717 6,461 69,022
Personal............... 247,064 14,385 164,977 62,177 51,595 264,840
-------- ------- -------- -------- ------- --------
$509,693 $35,058 $395,322 $164,600 $78,894 $491,590
======== ======= ======== ======== ======= ========
As of December 31, 1997:
Reinsurance............ $335,360 $17,023 $193,473 $ 65,725 $51,377 $351,811
Commercial............. 42,873 6,565 16,812 12,088 4,545 33,499
Personal............... 139,425 12,372 88,353 27,396 19,333 141,165
-------- ------- -------- -------- ------- --------
$517,658 $35,960 $298,638 $105,209 $75,255 $526,475
======== ======= ======== ======== ======= ========
</TABLE>
73
<PAGE>
VESTA INSURANCE GROUP, INC.
SCHEDULE IV--REINSURANCE (CONSOLIDATED)
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
Assumed
Gross Ceded to from Percentage of
Direct Other Other Net Amount Assumed
Premiums Earned Amount Companies Companies Amount to Net
- - --------------- ------- --------- --------- ------- --------------
<S> <C> <C> <C> <C> <C>
1999......................... 371,416 91,759 116,678 396,335 29.5%
1998......................... 478,389 310,652 341,956 509,693 67.1%
1997......................... 323,394 300,799 495,063 517,658 95.6%
</TABLE>
VESTA INSURANCE GROUP, INC.
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS (CONSOLIDATED)
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
Balance Additions Balance
at Charged at End
Beginning to Costs and of
Description of Period Expenses Deductions Period
- - ----------- --------- ------------ ---------- -------
<S> <C> <C> <C> <C>
Allowance for premiums in course of
collection:
1999............................... 14,212 1,550 13,350 2,412
1998............................... 654 13,688 130 14,212
1997............................... 70 797 213 654
</TABLE>
74
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report to be signed on its behalf by the has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Birmingham, State of Alabama, on March 23, 2000.
VESTA INSURANCE GROUP, INC.
/s/ Norman W. Gayle, III
By___________________________________
Norman W. Gayle, III
Its President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Norman W. Gayle, III
- - ------------------------------------
Norman W. Gayle, III Director, President and March 23, 2000
Chief Executive Officer
(Principal Executive Officer)
/s/ James E. Tait
- - ------------------------------------
James E. Tait Director, Executive Vice President March 23, 2000
and Chief Financial Officer
(Principal Financial Officer)
/s/ William P. Cronin
- - ------------------------------------
William P. Cronin Senior Vice President, Controller March 23, 2000
(Principal Accounting Officer)
/s/ Robert B. D. Batlivala, PhD.
- - ------------------------------------
Robert B. D. Batlivala, PhD. Director March 23, 2000
/s/ Walter M. Beale, Jr.
- - ------------------------------------
Walter M. Beale, Jr. Director March 23, 2000
/s/ Ehney A. Camp, III
- - ------------------------------------
Ehney A. Camp, III Director March 23, 2000
/s/ Clifford F. Palmer
- - ------------------------------------
Clifford F. Palmer Director March 23, 2000
/s/ Stephen R. Windom
- - ------------------------------------
Stephen R. Windom Director March 23, 2000
/s/ Larry D. Striplin
- - ------------------------------------
Larry D. Striplin Director March 23, 2000
/s/ James A. Taylor
- - ------------------------------------
James A. Taylor Director March 23, 2000
</TABLE>
75
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Vesta Insurance Group, Inc.:
We consent to incorporation by reference in the registration statement (No.
33-74160) on Form S-8 for the Vesta Insurance Group, Inc. Long-Term Incentive
Plan of our report dated March 27, 1998, except as to the statement of
comprehensive income which is as of April 19, 1999 and the statement of
operations, Note N and Note S which are as of March 30, 2000, relating to the
consolidated balance sheet of Vesta Insurance Group, Inc. and subsidiaries as of
December 31, 1997, and the related consolidated statements of operations,
comprehensive income, stockholders' equity, cash flow, and related schedules for
the year ended December 31, 1997, which report appears in the December 31, 1999
annual report on Form 10-K of Vesta Insurance Group, Inc.
KPMG LLP
Birmingham, Alabama
March 30, 2000
<PAGE>
EXHIBIT 23.2
Consent of Independent Certified Public Accountants
To the Board of Directors and Stockholders
Vesta Insurance Group, Inc.
We consent to incorporation by reference in the Registration Statements on Forms
S-8 (Nos. 33-74160, 33-81114, 33-81126, 33-80385, 33-80387, and 33-80395) of our
report dated March 12, 2000, on our audit of the consolidated financial
statements and financial statement schedules of Vesta Insurance Group, Inc. and
subsidiaries as of December 31, 1999 and 1998 and for the years then ended,
which report appears in this Annual Report on Form 10-K of Vesta Insurance
Group, Inc., dated March 12, 2000.
PricewaterhouseCoopers LLP
Birmingham, Alabama
March 30, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from 1999 10-K
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> DEC-31-1999 DEC-31-1998
<DEBT-HELD-FOR-SALE> 339,429 457,219
<DEBT-CARRYING-VALUE> 0 0
<DEBT-MARKET-VALUE> 0 0
<EQUITIES> 1,865 21,099
<MORTGAGE> 0 0
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 466,320 609,347
<CASH> 17,677 25,321
<RECOVER-REINSURE> 77,925 111,577
<DEFERRED-ACQUISITION> 40,357 90,855
<TOTAL-ASSETS> 915,809 1,347,702
<POLICY-LOSSES> 354,709 504,911
<UNEARNED-PREMIUMS> 133,029 309,515
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 0 0
<NOTES-PAYABLE> 146,876 168,302
0 0
30 0
<COMMON> 190 190
<OTHER-SE> 199,845 157,837
<TOTAL-LIABILITY-AND-EQUITY> 915,809 915,809
344,106 441,325
<INVESTMENT-INCOME> 26,907 28,862
<INVESTMENT-GAINS> 7,956 3,272
<OTHER-INCOME> 24,327 5,473
<BENEFITS> 211,701 337,131
<UNDERWRITING-AMORTIZATION> 88,638 149,905
<UNDERWRITING-OTHER> 42,662 75,322
<INCOME-PRETAX> 44,962 (168,153)
<INCOME-TAX> 13,633 (48,555)
<INCOME-CONTINUING> 25,697 (125,047)
<DISCONTINUED> (2,242) (16,137)
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 22,892 (141,184)
<EPS-BASIC> 1.22 (7.61)
<EPS-DILUTED> 1.16 (7.61)
<RESERVE-OPEN> 504,911 596,797
<PROVISION-CURRENT> 268,931 396,091
<PROVISION-PRIOR> (22,167) (769)
<PAYMENTS-CURRENT> (218,083) (267,566)
<PAYMENTS-PRIOR> (178,883) (219,642)
<RESERVE-CLOSE> 354,709 504,911
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
<PAGE>
Exhibit 99.1
------------
Risk Factors that May Affect Future Operating Results
From time to time, we may make "forward-looking" statements and comments in
our public filings (including this report on Form 10-K), press releases and in
other forums, such as other publications and analysts conference calls. These
"forward looking" statements and comments (which may be oral or written),
generally identified with words such as "believe," "expect," "anticipate" and
similar expressions, are based on our current plans and objectives for future
operations, including strategies and initiatives to grow our personal lines
segment, increase our renewal retention rates, control operating expenses and
reduce our debt-to-capital ratio. These statements and comments may also relate
to issues involving third parties, such as insurance coverage for pending
securities class actions and the status of pending reinsurance arbitrations,
which underlie our anticipated future economic performance. These comments are
inherently "forward-looking" in nature and are subject to a number of risks and
uncertainties, including those discussed below. You should recognize that our
actual results of operations could differ materially if our beliefs inherent in
these statements and comments prove to be inaccurate.
When we make forward-looking statements, they are based upon information
available to us on the date such statement is made, and we undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
Investors should also be aware that while we do, from time to time,
communicate with securities analysts, it is against our policy to disclose to
them any material non-public information or other confidential commercial
information. Accordingly, investors should not assume that Vesta agrees with any
statement or report issued by any analyst irrespective of the content of the
statement or report. Furthermore, Vesta has a policy against issuing or
confirming financial forecasts or projections issued by others. Thus, to the
extent that reports issued by securities analysts contain any projections,
forecasts or opinions, such reports are not Vesta's responsibility
The following discussion identifies the material facts and circumstances
that we believe present a potential risk to Vesta's ability to achieve its
anticipated performance described or implied in any forward-looking statements,
together with a brief statement of the general nature in which our performance
is most likely to be adversely affected (if at all) as a result of those facts
and circumstances. Obviously, the determination and presentation of a "risk
factor" in this manner is an inherently uncertain process, as we can not predict
with certainty which facts and circumstances will ultimately result in adverse
business consequences, or the extent of such consequences (if any). Moreover,
new "risk factors" emerge from time to time, and it is not possible for us to
predict all such risk factors. Accordingly, the discussion which follows
should not be read as an exhaustive presentation of all potentialities which may
cause Vesta's actual results of operations to differ materially from those
described or implied in any forward-looking statements, or which may otherwise
erode the value of an investment in Vesta.
<PAGE>
BUSINESS RISKS
We have recently restated our financial statements and the impact of the
restatements has, and may continue to, dissuade agents from selling, and
customers from buying, our insurance policies.
As more fully discussed in our public filings, our historical financial
statements have been criticized and restated since we first announced our
intention to correct certain errors in June of 1998. Such criticism has
resulted in class action litigation and significant negative publicity.
Although we believe that our current reported results of operations and
financial condition (on both a GAAP and statutory basis) are reliable, lingering
customer and agent uncertainty about our financial condition may continue to
have an adverse effect on our ability to sell Personal Lines insurance products.
The Personal Lines Insurance Business is Highly Competitive, and We May Not be
Able to Compete Effectively Against Larger, Better Capitalized Companies
We compete with dozens of property and casualty insurance companies, many
of which are better capitalized than us and have higher A.M. Best ratings than
us. We believe that the superior capitalization of many of our competitors
enables them to withstand lower profit margins and, therefore, to offer lower
rates. We believe that the superior capitalization of many of our competitors
enables them to market their products more aggressively and to take advantage
more quickly of new marketing opportunities, such as the internet. We also
believe that our competition may become increasingly better capitalized in the
future as the traditional barriers between insurance companies and banks and
other financial institutions erode and as the property and casualty industry
continues to consolidate. We believe that our ability to compete against our
larger, better capitalized competitors depends on our ability to deliver
superior service and our strong relationships with our independent agency force.
If Our Competitors Decided to Target Our Customer Base by Offering Lower Priced
Insurance, We May Not Be Able to Respond Competitively
We price our insurance based on estimated profit margins, and we do not
expect to be able to significantly reduce our current estimated profit margins
in the near future. Many of our competitors, however, are better capitalized
than we are and may be able to withstand significant reductions in their
estimated profit margins. If our competitors decided to target our customer base
by offering lower priced insurance, we may not be able to respond competitively.
We Depend On Agents Who May Discontinue Sales of Our Policies at Any Time.
As discussed above, our relationship with our independent agents is perhaps
the most important component of our current competitive profile. If these
independent agents decide, for whatever reason, to do business with our
competitors, it would be difficult to renew our existing business or attract new
business in our Personal Lines segment. Because we do business with
approximately
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3800 agencies in 42 states, we can not rely on their loyalty to our company.
Although we believe we enjoy good relationships with our independent agents and
are striving to make doing business with us as attractive as possible, we can
not be sure that these agents will continue to sell our insurance to the
individuals they represent.
If We Can Not Adequately Meet Our Independent Agents' Needs or Keep Pace with
Our Competitors' Technological Advances, We May Lose Significant Business.
Because we do business with so many agents (approximately 3800 agencies in
42 states), we must be able to offer these agents innovative solutions to their
daily problems and be able to respond to their needs as quickly as possible in
order to develop their loyalty. Although we are currently pursuing important
technological projects in our Personal Lines segment to accomplish this goal, we
can not be sure that these projects will adequately meet these agents' needs or
keep pace with our competitors' technological advances. If our agency force
decides, for whatever reason, to do business with our competitors, we may not be
able to retain their business.
If the Book of Homeowners Business We Recently Acquired From CIGNA Does Not
Convert to Personal Lines as Expected, Our Premium Volume Will Be Significantly
Reduced.
We recently acquired a large book of business from CIGNA, and we have not
had historical relationships with the agents responsible for placing this
business with CIGNA. We initially captured the premiums associated with this
business through a Reinsurance arrangement. As the policies in this book of
business expire, however, our ability to retain the associated premium revenues
depends on our ability to persuade the new individual insureds, or their agents,
to renew the insurance with us in our own Personal Lines business. Although
CIGNA has agreed to use its best efforts to assist us in these renewals, we have
no legal right to such renewals, and the lack of historical relationships with
the agents responsible for this business may make it more difficult for us to
renew them in our Personal Lines segment. If this business does not convert to
our Personal Lines segment as expected, our premium volume will suffer.
We Experienced a Decrease in New Policy Applications in 1999, and We May Not Be
Able to Achieve Our Financial Performance Goals if We Cannot Restore Our New
Policy Applications to Prior Levels.
The growth of our Personal Lines segment depends upon increasing new policy
applications. During 1999, we experienced a significant decline in new policy
applications as compared to 1998. Although we believe that this reflects a
temporary uncertainty about our financial condition and results of operations
that may dissipate as we move forward, we can not predict whether new policy
applications will return to past levels. If new policy application levels do
not rise in the near future, we may not be able to generate sufficient premium
volume to achieve our financial performance goals.
If We Cannot Maintain and Improve Our A.M. Best Ratings, We May Not Be Able to
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Maintain Premium Volume in Our Personal Lines Segment Sufficient to Attain Our
Financial Performance Goals.
Our ability to retain our existing business or to attract new business in
our Personal Lines segment depends largely on our rating by A.M. Best Company.
During 1999, downgrades in our A.M. Best ratings to "B" (in the vulnerable
category) necessitated the discontinuation of our Reinsurance and Commercial
Lines segments. Such downgrades also impacted our Personal Lines segment,
although we can not quantify such impact. Although A.M. Best Company recently
upgraded our rating to "B+" (in the secure category), we believe we must further
improve our rating in order to more effectively compete in the highly
competitive property and casualty insurance market. Although we intend to work
towards a higher rating, A.M. Best Company has ultimate discretion over its
rating assignments. If we are unable to achieve a higher A.M. Best rating, we
may not be able to grow our premium volume sufficient to attain our financial
performance goals. If A.M. Best were to downgrade our rating, we could lose
significant premium volume.
FINANCIAL RISKS
We Are Currently Defending Class Action Litigation Seeking Unspecified but
Potentially Significant Damages.
As discussed in our public filings (including our 1999 Form 10-K), we are
currently defending a class action lawsuit alleging, among other things,
violations of the federal securities laws. As of December 31, 1999, this class
action was still in its preliminary stages and there had been no discovery
conducted related to the merits of the claim. However, the damages or settlement
costs incurred by the Company in disposition of this proceeding could be
substantial. Although the Company has procured a multi-tiered package of
directors and officers liability insurance to cover such damages or settlement
costs, the issuer of the primary policy, the Cincinnati Insurance Company, has
attempted to rescind its policy, and we can not guarantee that insurance
coverage will ultimately be available for all damages or settlements costs
incurred (if any). If the damages or settlement costs incurred in connection
with this class action (if any) are ultimately determined to be not covered by
our directors' and officers' insurance policies for any reason, we may incur a
significant loss during the period in which such determination is made.
We Face a Risk of Non-Collection of Reinsurance Recoverables Involving
Substantial Amounts
Although we reinsure a significant portion of potential losses on the
policies which we issue, we initially pay all claims (as adjusted) and seek to
recover the reinsured losses from our reinsurers. Although we report as assets
the amount of claims paid which we expect to recover from reinsurers (in
accordance with generally accepted accounting principles), we can never be
certain that we will be able to collect those amounts. Sometimes the reinsurer
is unable to pay, and other times the reinsurer may dispute our calculation of
the amounts recoverable.
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Approximately $54.4 million of our reinsurance recoverables as of December 31,
1999 was attributable to one reinsurance treaty. Although we believe this amount
is properly recoverable under the terms of such treaty, the various treaty
participants have disputed our calculation. If the amount recoverable under such
treaty is ultimately determined to be materially less than $54.4 million as of
December 31, 1999, we may incur a significant loss during the period in which
such determination is made.
If Loss Reserves Prove to be Inadequate, Then We Would Incur a Charge to
Earnings
State laws require our insurance subsidiaries to maintain reserves to cover
their estimated ultimate liability for losses and loss adjustment expenses
("LAE") with respect to reported and unreported claims incurred. To the extent
that reserves prove to be inadequate in the future, we would have to increase
our reserves and incur a charge to earnings in the period such reserves are
increased, which could have a material adverse effect on our financial condition
and results of operations. The establishment of appropriate reserves is an
inherently uncertain process, and we can not be sure that ultimate losses will
not materially exceed our loss and LAE reserves. Reserves are estimates
involving actuarial and statistical projections at a given time of what we
expect to be the cost of the ultimate settlement and administration of claims
based on facts and circumstances then known, estimates of future trends in
claims severity and other variable factors such as inflation.
