EX-13 15 gex13-27854.txt ANNUAL REPORT TO SHAREHOLDERS SYMONS INTERNATIONAL GROUP, INC. ANNUAL REPORT TO SHAREHOLDERS DECEMBER 31, 2001 CORPORATE PROFILE Symons International Group, Inc. owns insurance companies principally engaged in the sale of nonstandard automobile insurance. Superior Insurance Company of Tampa, Florida and Pafco General Insurance Company of Indianapolis, Indiana underwrite nonstandard automobile insurance in the United States. Nonstandard automobile insurance is marketed and sold through independent agents to drivers who are unable to obtain coverage from insurers at standard or preferred rates. Prior to 2001, the Company was also engaged in the crop insurance business through its subsidiary IGF Insurance Company. On June 6, 2001, the Company exited the crop insurance business when it sold the crop insurance operations of IGF to a third party. Accordingly, the financial statements included in this report reflect the results of the crop insurance segment as "discontinued operations". The common stock of Symons International Group, Inc. trades on the OTC Bulletin Board under the symbol "SIGC.OB".
TABLE OF CONTENTS PAGE ----------------- ---- Financial Highlights 2 Vice Chairman's Report to Shareholders 3 Selected Financial Data 4 Management's Discussion and Analysis of Financial Condition and Results of Operations 5 Consolidated Financial Statements 15 Notes to Consolidated Financial Statements 19 Reports of Independent Accountants 41 Shareholder Information 42 Roster of Directors and Executive Officers 43 Subsidiary and Branch Office Locations 44
1 FINANCIAL HIGHLIGHTS For the years ended December 31, (In thousands, except per share data)
2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Gross premiums written $161,092 $174,461 $236,401 $310,164 $334,199 Net operating earnings (loss) from continuing operations (1) (14,574) (18,997) (48,374) (335) 7,739 Net earnings (loss) from discontinued operations (2,156) (17,041) (15,373) (6,484) 13,560 Net earnings (loss) (32,892) (88,425) (80,816) (14,417) 16,305 Basic operating earnings (loss) per share from continuing operations (1) (1.40) (1.83) (4.66) (0.03) 0.74 Basic earnings (loss) per share from discontinued operations (0.21) (1.64) (1.48) (0.62) 1.30 Basic earnings (loss) per share (3.17) (8.51) (7.78) (1.39) 1.56 Shareholders' equity (deficit) (144,012) (112,445) (24,980) 61,995 78,363 Return on average equity (2) N/A N/A N/A (20.5%) 21.9% Book value (deficit) per share (13.87) (10.83) (2.41) 5.97 7.50 Market value per share 0.07 0.36 1.44 7.25 19.22
(1) Operating earnings and per share amounts exclude amortization, interest, taxes, deferred income, realized capital gains and losses, minority interest, and any extraordinary items. (2) Return on average equity cannot be calculated due to the accumulated deficit in shareholders' equity in 2001, 2000 and 1999.
SYMONS INTERNATIONAL GROUP, INC. CORPORATE STRUCTURE Symons International Group, Inc. -------------------------------------------------------- Superior Insurance Group Management, Inc. IGF Holdings, Inc. Superior Insurance Group, Inc. IGF Insurance Company ----------------------------- Pafco General Superior Insurance Insurance Company Company ----------------------- Superior American Superior Guaranty Insurance Company Insurance Company
2 Vice Chairman's Report to Shareholders -------------------------------------------------------------------------------- Dear Fellow Shareholder: Hopefully, this year will be the last that I will have to report poor results on behalf of management. The year was a very tough one due to a poor market coupled with the closing of IGF and the sale of the crop assets. We exited the crop operations after three years of very difficult times. This exit from the industry resulted from poor crop/hail results, as well as from a product called AgPI, which was the result of a third party insurance company and several brokers causing irreparable harm to us. The government-sponsored MPCI product continually reducing government subsidies and, at the same time, increasing the overhead cost of companies through reporting and government mandated risk management also hurt the business. We set out to sell the operations in December of 2000 and on June 6, 2001 successfully sold IGF's crop assets to Acceptance Insurance Companies, Inc. In return for a fee, we also agreed that Symons International Group and all of its subsidiaries would stay out of the crop business for a certain period of time. We kept the IGF company and certain assets and liabilities. We are running off the remaining risks as well as taking legal action against the third party insurance company and the agents who sponsored and sold improperly the AgPI product in an endeavor to recover an approximate $30 million in cash, plus damages. On a more positive note, the nonstandard auto operations, which are written in PAFCO General Insurance Company and the Superior Insurance Group of companies, have seen substantial changes to management, the building of a new operating system, the withdrawal from certain states and substantial increases in rates over the last 2 years. The renewal business is performing at acceptable loss ratios. New business continues to be at unacceptable loss ratios. We've continued to take steps to rectify this imbalance and are hopeful that 2002 will see a return to profitability. While we've reduced our overall employment from approximately 1,000 people to approximately 336, we are hopeful that once we get things right, we can start growing the company again. The market for insurance, and specifically nonstandard auto, could not be better. There has been a withdrawal of many companies from nonstandard auto, as well as a shutdown of small independents due to the pullback of reinsurance support. Rate increases by all auto writers have allowed pricing to return to reasonable levels. We now have offices in California, Virginia, Florida, Georgia, Indiana, and Colorado. It is management's feeling that regional centers improve the ultimate marketing of products and the settlement of losses. We wish to thank our many employees and our Board of Directors for helping us work towards returning Symons International to profitability. Yours sincerely, /s/ Alan G. Symons -------------------------- Alan G. Symons Vice Chairman of the Board 3 SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA SYMONS INTERNATIONAL GROUP, INC. The selected consolidated financial data presented below is derived from the consolidated financial statements of the Company and its subsidiaries for the years ended December 31. This information should be read in conjunction with the consolidated financial statements of the Company and the notes thereto, included elsewhere in this report. All information in thousands, except share, per share, and ratio data.
2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Gross Premiums Written $161,092 $174,461 $236,401 $310,164 $334,199 Net Premiums Earned 76,947 137,706 249,094 264,022 251,020 Fee Income 12,295 14,140 15,185 16,431 15,545 Net Investment Income 6,286 10,074 12,242 12,098 11,256 Income (Loss) from Continuing Operations $(30,736) $(71,384) $(65,443) $(7,933) $2,745 Income (Loss) from Discontinued Operations (2,156) (17,041) (15,373) (6,484) 13,560 ------- -------- -------- ------- ------ Net Income (Loss) $(32,892) $(88,425) $(80,816) $(14,417) $16,305 ========= ========= ========= ========= ======= PER COMMON SHARE DATA: Basic Income (Loss) from Continuing Operations $(2.96) $(6.87) $(6.30) $(.76) $.26 Basic Income (Loss) from Discontinued Operations (0.21) (1.64) (1.48) (.62) 1.30 ------ ------ ------ ----- ---- Basic Net Income (Loss) $(3.17) $(8.51) $(7.78) $(1.38) $1.56 ======= ======= ======= ======= ===== Basic Weighted Average Shares Outstanding 10,385 10,385 10,385 10,402 10,450 ====== ====== ====== ====== ====== RATIOS: Loss and LAE Ratio (1) 91.5% 82.3% 92.7% 82.5% 78.0% Expense Ratio (2) 36.7% 38.8% 31.6% 22.2% 23.4% ----- ----- ----- ----- ----- Combined Ratio (3) 128.2% 121.1% 124.3% 104.7% 101.4% ====== ====== ====== ====== ====== CONSOLIDATED BALANCE SHEET DATA: Total Investments $107,027 $134,140 $201,887 $220,366 $213,829 Total Assets 243,536 287,957 373,812 448,885 469,872 Loss and Loss Adjustment Expense Reserves 81,142 108,117 152,455 134,024 118,988 Trust Preferred Securities 135,000 135,000 135,000 135,000 135,000 Total Shareholders' Equity (Deficit) (144,012) (112,445) (24,980) 61,995 78,363 Book Value (Deficit) Per Share (13.87) (10.83) (2.41) 5.97 7.50
(1) Loss and LAE Ratio: The ratio of loss and loss adjustment expenses ("LAE") incurred during the period, as a percentage of premiums earned. (2) Expense Ratio: The ratio of policy acquisition, general and administrative expenses less billing fees, as a percentage of premiums earned. (3) Combined Ratio: The sum of the Loss and LAE Ratio and the Expense Ratio. 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS All statements, trend analyses, and other information herein contained relative to markets for the Company's products and/or trends in the Company's operations or financial results, as well as other statements including words such as "anticipate," "could," "feel(s)," "believes," "plan," "estimate," "expect," "should," "intend," "will," and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things: (i) the effect on customers, agents, employees and others due to the Company's receipt of a going concern opinion from its accountants; (ii) general economic conditions, including prevailing interest rate levels and stock market performance; (iii) factors affecting the Company's nonstandard automobile operations such as rate increase approval, policy renewals, new business written, and premium volume; and (iv) the factors described in this section and elsewhere in this report. OVERVIEW Symons International Group, Inc. (the "Company") owns insurance companies that underwrite and market nonstandard private passenger automobile insurance. The Company's principal insurance company subsidiaries are Pafco General Insurance Company ("Pafco"), Superior Insurance Company ("Superior") and IGF Insurance Company ("IGF"). The Company is a 73.1% owned subsidiary of Goran Capital Inc. ("Goran"). THE COMPANY'S ACCOUNTANTS HAVE ISSUED A GOING CONCERN OPINION The Company's accountants have issued a report on their audit of the Consolidated Financial Statements of the Company as of December 31, 2001 which raises doubt as to the Company's ability to continue as a going concern given the recurring operating losses experienced by the Company over the past few years and the Company's net capital deficiency. None of the Company's insurance subsidiaries have going concern opinions. See - Liquidity and Capital Resources for a discussion of management's plans to address these matters. STRATEGIC ALIGNMENT As previously announced, in the fourth quarter of 2000, management initiated a strategic review of the Company's operations. This review resulted in a plan to divest the Company's crop insurance segment, allowing management to focus on nonstandard automobile insurance. In June 2001, the Company sold its crop segment and adopted a plan to wind-down the remaining crop segment obligations. Accordingly, financial results of the crop insurance segment are presented as discontinued operations in the Company's financial statements. Continuing operations of the Company consist of the single nonstandard automobile insurance segment. NONSTANDARD AUTOMOBILE INSURANCE OPERATIONS Pafco, Superior, Superior Guaranty Insurance Company ("Superior Guaranty"), Superior American Insurance Company ("Superior American") and IGF, are engaged in the writing of insurance coverage for automobile physical damage and liability policies for nonstandard risks. Nonstandard risk insureds are those individuals who are unable to obtain insurance coverage through standard market carriers due to factors such as poor premium payment history, driving experience or violations, particular occupation or type of vehicle. The Company offers several different policies that are directed towards different classes of risk within the nonstandard market. Premium rates for nonstandard risks are higher than for standard risks. Since it can be viewed as a residual market, the size of the nonstandard private passenger automobile insurance market changes with the insurance environment and grows when the standard coverage becomes more restrictive. Nonstandard policies have relatively short policy periods and low limits of liability. Also, since the nonstandard automobile insurance business typically experiences lower rates of retention than standard automobile insurance, the number of new policyholders underwritten by nonstandard automobile insurance carriers each year is substantially greater than the number of new policyholders underwritten by standard carriers. 5 RESULTS OF OPERATIONS OVERVIEW 2001 COMPARED TO 2000 For the year 2001, the Company reported a loss on continuing operations of $(30,736,000) or $(2.96) per share (basic and diluted). Loss on continuing operations for the year 2000 was $(71,384,000) or $(6.87) per share (basic and diluted), which included a one-time write down of goodwill in the amount of $33,464,000. Loss before income taxes and distributions on minority interest was $(15,930,000) and $(59,946,000) for 2001 and 2000, respectively. Operating earnings (loss) from continuing operations, measured as income/(loss) before amortization, interest, taxes, realized capital gains and losses and minority interest was $(14,574,000) or $(1.40) per share (basic and diluted) in 2001 and $(18,997,000) or $(1.83) per share in 2000 (basic and diluted). The loss from discontinued operations was $(2,156,000) and $(17,041,000) for 2001 and 2000, respectively. Underwriting losses and operating costs in excess of original estimates contributed to the losses in 2001. The Company is continuing to seek and implement rate increases and other underwriting actions to achieve profitability. A number of systems have been automated and service problems have been eliminated or significantly reduced. Although the Company has taken a number of actions to address factors contributing to these past losses, there can be no assurance that operating losses will not continue. See "Liquidity and Capital Resources" for further discussion of recent trends and uncertainties that are reasonably likely to have a material effect on the Company's financial condition and results of operations. 2000 COMPARED TO 1999 For the year 2000, the Company reported a loss on continuing operations of $(71,384,000) or $(6.87) per share (basic and diluted) which included a one-time write down of goodwill in the amount of $33,464,000. Loss on continuing operations for the year 1999 was $(65,443,000) or $(6.30) per share. Loss before income taxes and distributions on minority interest was $(59,946,000) and $(50,892,000) for 2000 and 1999, respectively. Operating earnings (loss) from continuing operations, measured as income/(loss) before amortization, interest, taxes, realized capital gains and losses and minority interests was $(18,997,000) or $(1.83) per share (basic and diluted) in 2000 and $(48,374,000) or $(4.66) per share in 1999 (basic and diluted). Premium rate increases and reductions in loss ratios are the primary factors contributing to the reduction in operating losses for 2000. Discontinued operations reported losses of $(17,041,000) and $(15,373,000) for 2000 and 1999, respectively. YEARS ENDED DECEMBER 31, 2001 AND 2000 GROSS PREMIUMS WRITTEN Gross premiums written have decreased 7.7% or $13,369,000 in 2001 from 2000 levels. Premium rate increases of approximately 24.8% were implemented throughout 2001 that were offset by a reduction in policies in force of 23.3%. In addition, the decline in gross premiums resulted from the Company exiting certain highly competitive markets and instituting other underwriting initiatives intended to increase profitability, which had the effect of reducing premium. Regulatory action in certain states also limited premiums written. NET PREMIUMS WRITTEN Net premiums written represent the portion of premiums retained by the Company after consideration for risk sharing through reinsurance contracts. As a result of losses in the Company's insurance subsidiaries and to manage overall risk retention, the Company entered into a reinsurance agreement to cede a portion of its gross written premiums to a third party. During 2001, the Company ceded approximately 54% of its gross written premiums on new and renewal business, under a quota share reinsurance contract that was effective January 1, 2000, to the reinsurers. In addition, the Company ceded a portion of its unearned premium reserve bringing the total cession to 79% in 2001. NET PREMIUMS EARNED Net premiums earned decreased 44.1% or $60,759,000 for the year ended December 31, 2001 as compared to the same period in 2000. Premiums are earned ratably over the term of the underlying insurance contracts. The 6 reduction in net premiums earned is reflective of the overall reduction in gross premiums written and the increase in ceded premiums. FEE INCOME Fee income is derived from installment billings and other services provided to policyholders. For the year ended December 31, 2001, fee income decreased 13.0% or $1,845,000. The reduction in fee income is attributed to the reduction of insurance policies in force of 23.3% and the overall decline in written premium. NET INVESTMENT INCOME Net investment income decreased 37.6% or $3,788,000 in 2001 as compared to 2000. This decrease is reflective of the decline in invested assets during a period of declining premiums and the liquidation of investments to pay prior year losses settled in 2001. Furthermore, return on investments deteriorated due to a highly volatile market dominated by unfavorable economic conditions due to the worldwide recession and fallout from the September 2001 terrorist attacks. NET REALIZED CAPITAL LOSSES Net realized capital losses were $(1,185,000) in 2001 as compared to net realized capital losses of $(5,972,000) in 2000. Capital losses resulted from the liquidation of longer duration fixed income securities in 2001 in order to rebalance the investment activities in the portfolio. These transactions resulted in higher cash proceeds that were reinvested in shorter duration investment instruments. Capital losses were also realized due to the continued liquidation of investments to fund operations and claim payments under unfavorable market conditions. LOSSES AND LAE The loss and LAE ratio for the Company for the year ended December 31, 2001, was 91.5% of net premiums earned as compared to 82.3% of net premiums earned for 2000. A portion of LAE, unallocated loss adjustment expense ("ULAE") is not ceded as part of the quota share reinsurance contract mentioned above and accounts for approximately 4 points of the increased loss ratio in 2001with the reminder of the increase due to adverse current loss expense. POLICY ACQUISITION AND GENERAL AND ADMINISTRATIVE EXPENSE The Company reduced policy acquisition and general and administrative expenses for the year 2001 to $40,535,000 from the 2000 level of $67,538,000, a reduction of approximately 40%. This reduction is reflective of the decline in gross written premiums, an increase in ceding commissions associated with the quota share reinsurance contract, and overall operating expense reduction initiatives. As a percentage of gross premiums earned, the Company experienced a decrease in its operating expense ratio, net of fee income, from 38.8% in 2000 to 36.7% in 2001. This decrease in the expense ratio is the result of reduced operating expense initiatives and an increase in ceding commissions earned under the quota share reinsurance contract. AMORTIZATION OF INTANGIBLES Amortization expense decreased nearly 100%, or $34,806,000, in 2001 as compared to 2000 as the goodwill on the books in 2000 was written to zero at December 31, 2000. INCOME TAXES At December 31, 2001 the Company's net deferred tax assets are fully offset by a 100% valuation allowance that resulted in no tax benefit in 2001. YEARS ENDED DECEMBER 31, 2000 AND 1999 GROSS PREMIUMS WRITTEN Gross premiums written decreased 26.2% or $61,940,000 in 2000 from 1999 levels. Premium rate increases of approximately 14% were implemented throughout 2000 that were offset by a reduction in policies in force of 7 29%. The reduction in written premiums was further affected by a shift during the second quarter of 2000 to writing a higher mix of six-month policies while management evaluated rate adequacy. NET PREMIUMS WRITTEN Net premiums written represent the portion of premiums retained by the Company after consideration for risk sharing through reinsurance contracts. As a result of losses in the Company's insurance subsidiaries and to manage overall risk retention, a reinsurance agreement was negotiated to cede a portion of the gross written premiums to a third party. The Company ceded approximately 45% of its gross written premiums in 2000 under a quota share reinsurance contract that was effective January 1, 2000. NET PREMIUMS EARNED Premiums are earned ratably over the term of the underlying insurance contracts. The reduction in net premiums earned is reflective of the overall reduction in gross premiums written and the increase in ceded premiums. FEE INCOME Fee income is derived from installment billings and other services provided to policyholders. The reduction in fee income of 6.9% in the year 2000 is attributed to the reduction of insurance policies in force of 29%, offset by earned fee rate increases from 1999. NET INVESTMENT INCOME Net investment income decreased 17.7% in 2000 as compared to 1999. This is reflective of the decline in invested assets during a period of declining premiums and the payout of prior year losses when settled in 2000. NET REALIZED CAPITAL LOSSES Net realized capital losses were $(5,972,000) in 2000 as compared to $(324,000) in 1999. Capital losses were realized in 2000 due to the liquidation and reinvestment of a portion of the equity portfolio during the year as well as continued liquidation of investments to fund operations during a period of declining premiums. LOSSES AND LAE The loss and LAE ratio was 82.3% for 2000 as compared to 92.7% for 1999. The Company estimates accident year 2000 gross loss and LAE ratio to be 85.6% as compared to its current estimate of 84.8% for accident year 1999. Accident year 1999 reserves developed favorably during 2000, as a result, the current estimate for accident year 1999 is 4.5 percentage points lower than projected as of year-end 1999. The Company also experienced favorable development on accident years 1998 and prior. POLICY ACQUISITION AND GENERAL AND ADMINISTRATIVE EXPENSE The Company reduced policy acquisition and general and administrative expenses for the year 2000 to $67,538,000 or 28.1% from 1999 amounts of $93,922,000. This reduction is reflective of a 26.2% decline in gross written premiums, an increase in ceding commissions associated with the quota share reinsurance contract, and overall operating expense reductions. As a percentage of net premiums earned, the Company experienced an increase in its operating expense ratio net of billing fees from 31.6% to 38.8%. This increase was the result of the Company ceding 45% of its gross written premium under a quota share reinsurance contract and the 44.8% decline in earned premiums. AMORTIZATION OF INTANGIBLES Amortization expense increased in 2000 due to an impairment charge on the carrying value of goodwill resulting from the Superior Insurance Group Management, Inc. ("Superior Group Management") acquisition in 1997. The impairment charge and amortization expense recognized in 2000 was $34,806,000. Amortization of debt acquisition costs of $171,000 comprises the balance of the year 2000 expense. 8 INCOME TAXES The variance in the rate from the federal statutory rate of 35%, before the effect of a valuation allowance on deferred tax assets, is primarily due to nondeductible goodwill amortization and alternative minimum taxes. At December 31, 2000, the Company's net deferred tax assets were fully offset by a valuation allowance. Therefore, the Company has not recognized the benefit of tax losses carried forward. Earnings in future periods will result in no income tax expense until the current operating loss carryforwards are utilized. LIQUIDITY AND CAPITAL RESOURCES The primary source of funds available to the management and holding companies are fees from policyholders, management fees and dividends from its primary subsidiaries. Superior Insurance Group, Inc. ("Superior Group") collects billing fees charged to policyholders who elect to make their premium payments in installments. Superior Group also receives management fees under its management agreement with its insurance subsidiaries. When the Florida Department of Insurance ("FDOI") approved the acquisition of Superior by Superior Group, it prohibited Superior from paying any dividends (whether extraordinary or not) for four years from the date of acquisition (May 1, 1996) without the prior written approval of the FDOI, which restriction expired in April 2000. As a result of regulatory actions taken by the Indiana Department of Insurance ("IDOI") with respect to Pafco and IGF, those subsidiaries may not pay dividends without prior approval by the IDOI. Pafco cannot pay extraordinary dividends, within the meaning of the Indiana Insurance Code, without the prior approval of the Indiana Insurance Commissioner. The management fees charged to Pafco, Superior and IGF are subject to review by the IDOI and FDOI. The nonstandard automobile insurance subsidiaries' primary source of funds is premiums, investment income and proceeds from the maturity or sale of invested assets. Such funds are used principally for the payment of claims, payment of claims settlement costs, operating expenses (primarily management fees), commissions to independent agents, premium taxes, dividends and the purchase of investments. There is variability in cash outflows because of uncertainties regarding settlement dates for liabilities for unpaid losses. Accordingly, the Company maintains investment programs intended to provide adequate funds to pay claims. During 2001 and 2000, due to reduced premium volume, the Company has liquidated investments to pay claims. The Company historically has tried to maintain duration averages of 3.5 years. However, the reduction in new funds due to lower premium volume has and will continue to cause the Company to shorten the duration of its investments. The Company may incur additional costs in selling longer bonds to pay claims, as claim payments tend to lag premium receipts. Due to the decline in premium volume, the Company has experienced a reduction in its investment portfolio, but to date has not experienced any problems meeting its obligations for claims payments. The Company has $1.2 million available at December 31, 2001 under its $2.5 million revolving credit facility ("Facility") with Granite Reinsurance Company, Ltd., a related party. The terms of the Facility call for monthly interest payments at the prime rate (as printed in the Wall Street Journal on the first business day of each month) plus 5.25% (the total rate was 10.0% at March 1, 2002) computed on an annual basis and not to exceed 18% per annum calculated on the average principal outstanding each month. All principal borrowed under the Facility is due on December 20, 2004. On August 12, 1997, the Company issued through a wholly owned trust subsidiary $135 million aggregate principal amount in trust originated preferred securities (the "Preferred Securities"). The Preferred Securities have a term of 30 years with semi-annual interest payments of $6.4 million that commenced February 15, 1998. The Company may redeem the Preferred Securities in whole or in part after 10 years. The Company elected to defer the semi-annual interest payments due in February and August 2000. The Company may continue to defer interest payments in accordance with the terms of the trust indenture for a period of up to five years. The unpaid interest installment amounts accrue interest at 9.5%. The Company continued the same deferral practice for the February and August payments due in 2001 and may continue this deferral practice for all payments due in 2002, 2003, and 2004. The payment due in February 2002 has been deferred. 9 The following table sets forth the minimum required obligations of the Company under the Preferred Securities for interest and principal payments for each of the next four years and thereafter assuming all semi-annual interest payments due in 2002, 2003, and 2004 are deferred (in thousands):
2002 2003 2004 2005 THEREAFTER TOTAL ---- ---- ---- ---- ---------- ----- Interest payments $ - $ - $ - $96,779 $282,150 $378,929 Principal payments - - - - 135,000 135,000 ---- ---- ---- ------- -------- -------- Total due $ - $ - $ - $96,779 $417,150 $513,929 ==== ==== ==== ======= ======== ========
The trust indenture contains certain restrictive covenants based upon the Company's consolidated coverage ratio of earnings before interest, taxes, depreciation and amortization (EBITDA). If the Company's EBITDA falls below 2.5 times consolidated interest expense (including Preferred Securities distributions) for the most recent four quarters, the following restrictions become effective: o The Company may not incur additional indebtedness or guarantee additional indebtedness. o The Company may not make certain restricted payments including making loans or advances to affiliates, repurchasing common stock or paying dividends in excess of a stated limitation. o The Company may not increase its level of non-investment grade securities defined as equities, mortgage loans, real estate, real estate loans and non-investment grade fixed income securities. These restrictions currently apply, as the Company's consolidated coverage ratio was (0.90) in 2001, and will continue to apply until the Company's consolidated coverage ratio complies with the terms of the trust indenture. The Company complied with these additional restrictions as of December 31, 2001 and is in compliance as of March 29, 2002. The Company discovered it was not in compliance with the covenant dealing with the percentage of investment in other than "Permitted Investments" as defined by the indenture. The indenture allows for no more than 15% of total invested assets to be in non-investment grade securities as defined above. At December 31, 2001, approximately 21% of the Company's investment portfolio was invested in equity securities and non-investment grade bonds. The Company rectified the situation as of March 29, 2002 through the sale of approximately $8 million of the non-investment grade securities, the proceeds of which were invested in Permitted Investments. Net cash used by operating activities in 2001 aggregated $(21,966,000) compared to $(48,153,000) in 2000 due to reduced cash provided by operations as a result of lower premium volumes and the reduced number of policies in force. The Company believes cash flows in the nonstandard automobile operations from premiums, investment income and billing fees are sufficient to meet obligations to policyholders and operating expenses for the foreseeable future. This is due primarily to the lag time between receipt of premiums and the payment of claims. Accordingly, while there can be no assurance as to the sufficiency of the Company's cash flow in future periods, the Company believes that its cash flow will be sufficient to meet all of the Company's operating expenses and operating debt service (not including the Preferred Securities) for the foreseeable future. The preceding paragraph notwithstanding, the Company has experienced, beginning in the fourth quarter of 2001 and continuing in January and February 2002, sustained adverse loss experience on a substantial portion of its new business written in certain markets. In late February and early March 2002, the Company commenced further analysis of loss ratios by individual agency and a review of claim settlement procedures. Based on this and other analysis, the Company has as of the filing of this document, taken the following actions to improve the financial position and operating results of the Company: o Eliminated reinstatements in all markets, i.e., upon policy cancellation, the insured must obtain a new policy at prevailing rates and underwriting guidelines; o Terminated or placed on new business moratorium several hundred agents whose loss ratios were abnormally high when compared to the average for the remaining agents (these agents accounted for approximately 16% of the total gross written premium in 2001); o Increased underwriting requirements in certain markets including: higher down payments, new policy fees, and shorter policy terms; o Hired a consultant with significant auto claims experience to review processes and suggest modifications to the claims function. 10 The Company expects the above actions to result in a decline of approximately 10 to 15% in gross written premiums from 2001 levels with a corresponding decrease in management fees payable to Superior Group, offset by reductions in operating expenses due to process changes and efficiencies. Shareholders' equity reflected a deficit of $(144) million at December 31, 2001, which does not reflect the statutory surplus upon which the Company conducts its various insurance operations. The Company's insurance subsidiaries, not including IGF, after the effects of codification, had statutory surplus of approximately $21.9 million at December 31, 2001. (See Note 12 of the Consolidated Financial Statements for discussion regarding the effect of codification on statutory surplus.) Given the financial position and loss experience of the Company over the past several years as described above, the Company's accountants have issued an opinion based on their audit of the December 31, 2001 Consolidated Financial Statements which includes an emphasis paragraph that raises the question of whether or not the Company can continue as a going concern. The Company's plans to improve financial results are described above. Additionally, IGF, as further described in Note 13 to the consolidated financial statements, has been held responsible for payment of the premium attributable to a $15 million appeal bond in an action in Missouri. IGF is unable to post the premium for this bond and, if ultimately required to by the courts, such outcome could have a material adverse impact on the financial position of IGF and the Company. EFFECTS OF INFLATION Due to the short time that claims are outstanding in the product lines the Company underwrites, inflation does not pose a significant risk to the Company. SIGNIFICANT ACCOUNTING POLICIES Our financial statements reflect the selection and application of accounting policies that require management to make significant estimates and assumptions. We believe that the following is the more critical judgment area in the application of our accounting policies that currently affect our financial condition and results of operations. The reserve for losses and loss adjustment expenses includes estimates for reported unpaid losses and loss adjustment expenses, including a portion attributable to losses incurred but not reported. These reserves are not discounted. Reserves are established using individual case-basis evaluations and statistical analysis as claims are reported. Those estimates are subject to the effects of trends in loss severity and frequency. While management believes the reserves make reasonable provisions for unpaid loss and loss adjustment expense obligations, those provisions are necessarily based on estimates and are subject to variability. Changes in the estimated reserves are charged or credited to operations, as additional information on the estimated amount of a claim becomes known during the course of its settlement. The gross reserve for losses and loss adjustment expenses is reported net of anticipated receipts for salvage and subrogation. See Note 7 to the Consolidated Financial Statements for additional disclosure regarding the reserve for losses and loss adjustment expenses. The variation between the estimated loss and loss adjustment expenses and actual experience can be material. PRIMARY DIFFERENCES BETWEEN GAAP AND SAP The financial statements contained herein have been prepared in conformity with Generally Accepted Accounting Principles ("GAAP") which differ from Statutory Accounting Practices ("SAP") prescribed or permitted for insurance companies by regulatory authorities in the following respects: (i) certain assets are excluded as "Nonadmitted Assets" under statutory accounting; (ii) costs incurred by the Company relating to the acquisition of new business are expensed for statutory purposes; (iii) the investment in wholly-owned subsidiaries is consolidated for GAAP rather than valued on the statutory equity method in which the net income or loss and changes in unassigned surplus of the subsidiaries is reflected in net income for the period rather than recorded directly to unassigned surplus; (iv) fixed maturity investments are reported at amortized cost or market value based on their National Association of Insurance Commissioners ("NAIC") rating; (v) the liability for losses and loss adjustment expenses and unearned premium reserves are recorded net of their reinsured amounts for statutory accounting purposes; (vi) deferred income taxes are recognized as specified by statutory guidance; and (vii) credits for reinsurance are recorded only to the extent considered realizable. 11 NEW ACCOUNTING STANDARDS The NAIC adopted the Codification of Statutory Accounting Principles guidance (the "Codification"), which replaces the Accounting Practices and Procedures manual, as the NAIC's primary guidance on statutory accounting effective January 1, 2001. The IDOI and the FDOI have adopted the Codification. The changes in statutory accounting principles resulting from codification that impact the Company's insurance subsidiaries, among other things, limit the statutory carrying value of electronic data processing equipment and deferred tax assets in determining statutory surplus. The consolidated statutory surplus of insurance subsidiaries as of December 31, 2001 is $21.9 million, exclusive of IGF. In June 2001, the Financial Accounting Standards Board (the "Board") finalized FASB Statements No. 141, BUSINESS COMBINATIONS, No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, and No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS. In August 2001, the Board issued FASB Statement No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. These new standards are effective in 2002 and are not expected to have a material impact on the Company's financial position or results of operations. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Insurance company investments must comply with applicable laws and regulations that prescribe the kind, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common securities, real estate mortgages and real estate. The investment portfolios of the Company at December 31, 2001, consisted of the following (in thousands):
2001 ---- Cost or TYPE OF INVESTMENT Amortized Market Cost Value ---- ----- Fixed maturities: U. S. Treasury securities and other obligations of the United States Government or agencies $29,912 $30,210 Obligations of states and political subdivisions 17,500 19,381 Corporate securities 29,528 28,305 ------ ------ Total fixed maturities 76,940 77,896 Common stocks 17,964 14,396 Short-term investments 13,266 13,266 Other invested assets 1,469 1,469 ----- ----- $109,639 $107,027 ======== ======== The following table sets forth the composition of the fixed maturity securities portfolio of the Company by time to maturity as of December 31 (in thousands): 2001 2000 ---- ---- Percent Total Percent Total Time to Maturity Market Value Market Value Market Value Market Value ---------------- ------------ ------------ ------------ ------------ 1 year or less $7,998 10.2 $7,956 8.0% More than 1 year through 5 years 25,950 33.3 40,391 40.6 More than 5 years through 10 years 20,477 26.3 14,825 14.9 More than 10 years 4,091 5.3 22,724 22.8 ----- --- ------ ---- 58,516 75.1 85,896 86.3 Mortgage-backed securities 19,380 24.9 13,610 13.7 ------ ---- ------ ---- Total $77,896 100.0% $99,506 100.0% ======= ====== ======= ======
12 The following table sets forth the ratings assigned to the fixed maturity securities of the Company as of December 31 (in thousands):
2001 2000 ---- ---- Percent Total Percent Total ------------- ------------- Rating (1) Market Value Market Value Market Value Market Value ---------- ------------ ------------ ------------ ------------ Aaa or AAA $51,754 66.4% $65,421 65.8% Aa or AA 3,300 4.2% 1,732 1.7% A 9,242 11.9% 11,530 11.6% Baa or BBB 7,617 9.8% 14,861 14.9% Ba or BB 4,883 6.3% 5,148 5.2% Other below investment grade 1,100 1.4% 814 .8% ----- ---- --- --- Total $77,896 100% $99,506 100% ======= ==== ======= ====
(1) Ratings are assigned by Standard & Poor's Corporation, and when not available, are based on ratings assigned by Moody's Investors Service, Inc. The investment results of the Company's continuing operations for the periods indicated are set forth below (in thousands):
Years Ended December 31, 2001 2000 1999 ---- ---- ---- Net Investment income (1) $6,286 $10,074 $12,242 Average investment portfolio (2) $123,859 $173,231 $214,690 Pre-tax return on average investment portfolio 5.1% 5.8% 5.7% Net realized gains (losses) $(1,185) $(5,972) $(324)
(1) Includes dividend income received in respect of holdings of common stock. (2) Average investment portfolio represents the average (based on amortized cost) of the beginning and ending investment portfolio. If interest rates were to increase 10% from the December 31, 2001 levels, the decline in fair value of the fixed maturity securities would not significantly affect the Company's ability to meet its obligations to policyholders and creditors. MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT The Company's investment strategy is to invest available funds in a manner that will maximize the after-tax yield of the portfolio while emphasizing the stability and preservation of the capital base. The Company seeks to maximize the total return on investments through active investment management utilizing third-party professional administrators, in accordance with pre-established investment policy guidelines established and reviewed regularly by the board of directors of the Company. Accordingly, the entire portfolio of fixed maturity securities is available to be sold in response to changes in market interest rates; changes in relative values of individual securities and asset sectors; changes in prepayment risks; changes in credit quality; and liquidity needs, as well as other factors. The portfolio is invested in types of securities and in an aggregate duration, which reflect the nature of the Company's liabilities and expected liquidity needs diversified among industries, issuers and geographic locations. The Company's fixed maturity and common equity investments are substantially in public companies. 13 The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates. For investment securities and debt obligations, the table presents principal cash flows and related weighted-average interest rates by expected maturity date. Additionally, the Company has assumed its available for sale securities are similar enough to aggregate those securities for presentation purposes.
Interest Rate Sensitivity Principal Amount by Expected Maturity Average Interest Rate (Dollars in thousands) Cost or Amortized Cost ------------------------------------------------------------------------------ Market Value 2002 2003 2004 2005 2006 Thereafter Total 12/31/01 ---- ---- ---- ---- ---- ---------- ----- -------- ASSETS Available for sale $7,586 $7,709 $7,163 $8,440 $6,901 $39,139 $76,940 $77,896 Average interest rate 7.3% 5.6% 6.6% 4.3% 6.3% 6.5% 6.1% 6.1% LIABILITIES Preferred securities - - - - - $135,000 $135,000 $9,000 Average interest rate - - - - - 9.5% 9.5% 9.5%
14
CONSOLIDATED BALANCE SHEETS As of December 31, 2001 and 2000 (In thousands, except share data) 2001 2000 ---- ---- ASSETS Investments available for sale: Fixed maturities, at market $77,896 $99,506 Equity securities, at market 14,396 16,561 Short-term investments, at amortized cost, which approximates market 13,266 14,872 Mortgage loans, at cost - 1,870 Other invested assets 1,469 1,331 ----- ----- Total investments 107,027 134,140 Cash and cash equivalents 3,385 1,363 Receivables, net of allowance of $1,526 and $1,940, respectively 44,688 50,364 Reinsurance recoverable on paid and unpaid losses, net 31,546 48,315 Prepaid reinsurance premiums 40,039 24,773 Deferred policy acquisition costs 763 6,454 Advances to/(from) related parties (596) 680 Property and equipment, net of accumulated depreciation 9,890 12,392 Intangible assets 4,376 4,547 Other assets 2,418 3,545 Net assets of discontinued operations - 1,384 -------- -------- Total assets $243,536 $287,957 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Liabilities: Loss and loss adjustment expense reserves $81,142 $108,117 Unearned premiums 59,216 62,386 Reinsurance payables 58,226 62,059 Distributions payable on preferred securities 33,203 18,397 Deferred income 3,625 - Other liabilities 17,136 14,443 ------- ------- Total liabilities 252,548 265,402 ------- ------- Minority interest: Company-obligated mandatorily redeemable preferred stock of trust subsidiary holding solely parent debentures 135,000 135,000 ------- ------- Shareholders' deficit: Common stock, no par value, 100,000,000 shares authorized, and 10,385,399 shares issued and outstanding in both 2001 and 2000 38,136 38,136 Additional paid-in capital 5,851 5,851 Unrealized loss on investments available for sale (2,613) (3,938) Retained (deficit) (185,386) (152,494) --------- --------- Total shareholders' (deficit) (144,012) (112,445) --------- --------- Total liabilities and shareholders' (deficit) $243,536 $287,957 ======== ======== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
15
CONSOLIDATED STATEMENTS OF OPERATIONS For the years ended December 31, 2001, 2000 and 1999 (In thousands, except per share data) 2001 2000 1999 ---- ---- ---- Gross premiums written $161,092 $174,461 $236,401 Less ceded premiums (105,158) (78,621) 8,425 --------- -------- ----- Net premiums written $55,934 $95,840 $244,826 ======= ======= ======== Net premiums earned $76,947 $137,706 $249,094 Fee income 12,295 14,140 15,185 Net investment income 6,286 10,074 12,242 Other income 874 - - Net realized capital loss (1,185) (5,972) (324) ------- ------- ----- Total revenues 95,217 155,948 276,197 ------ ------- ------- Expenses: Losses and loss adjustment expenses 70,441 113,379 230,973 Policy acquisition and general and administrative expenses 40,535 67,538 93,922 Amortization of intangibles and impairment 171 34,977 2,194 --- ------ ----- Total expenses 111,147 215,894 327,089 ------- ------- ------- Loss from continuing operations before income taxes and minority interest (15,930) (59,946) (50,892) -------- -------- -------- Income taxes: Current income tax expense (benefit) - 487 (968) Deferred income tax expense (benefit) - (2,636) 7,183 ----------- ------- ----- Total income taxes - (2,149) 6,215 ----------- ------- ----- Loss from continuing operations before minority interest (15,930) (57,797) (57,107) Minority interest: Distributions on preferred securities, net of tax of nil in 2001and 2000, and $4,489 in 1999 (14,806) (13,587) (8,336) -------- -------- ------- Loss from continuing operations (30,736) (71,384) (65,443) Discontinued operations: Loss from operations of discontinued segment, less applicable income taxes of nil in 2001 and 2000 and $(5,170) in 1999. - (16,141) (15,373) Loss on disposal of discontinued segment, less applicable taxes of nil (2,156) (900) - ------- ----- -------- Loss from discontinued operations (2,156) (17,041) (15,373) ------- -------- -------- Net loss $(32,892) $(88,425) $(80,816) ========= ========= ========= Weighted average shares outstanding - basic and fully diluted 10,385 10,385 10,385 ====== ====== ====== Net loss from continuing operations per share - basic and fully diluted $(2.96) $(6.87) $(6.30) ======= ======= ======= Net loss of discontinued operations per share - basic and fully diluted $(0.21) $(1.64) $(1.48) ======= ======= ======= Net loss per share - basic and fully diluted $(3.17) $(8.51) $(7.78) ======= ======= ======= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
16
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT) For the years ended December 31, 2001, 2000 and 1999 (In thousands, except number of shares) Common Stock Unrealized ------------ Additional Gain/(Loss) Retained Total Paid-In On Earnings Shareholders' Shares Amount Capital Investments (Deficit) Equity ------ ------ ------- ----------- --------- ------ Balance at January 1, 1999 10,385,399 $38,136 $5,851 $1,261 $16,747 $61,995 ---------- ------- ------ ------ ------- ------- Comprehensive income: Net loss - - - - (80,816) (80,816) Change in unrealized gains (losses) on securities - - - (6,159) - (6,159) ---------- ------ ----- ------- --------- ----- Comprehensive income (loss) - - - (6,159) (80,816) (86,975) ---------- ------ ------ ----- -------- ------ Balance at December 31, 1999 10,385,399 38,136 5,851 (4,898) (64,069) (24,980) ---------- ------ ----- ------- -------- -------- Comprehensive income: Net loss - - - - (88,425) (88,425) Change in unrealized gains (losses) on securities - - - 960 - 960 ---------- ------ ----- ------- --------- ----- Comprehensive income (loss) - - - 960 (88,425) (87,465) ---------- ------ ----- ------- --------- ----- Balance at December 31, 2000 10,385,399 38,136 5,851 (3,938) (152,494) (112,445) ---------- ------ ----- ------- --------- --------- Comprehensive income: Net loss - - - - (32,892) (32,892) Change in unrealized gains (losses) on securities - - - 1,325 - 1,325 ---------- ------ ----- ------- --------- ----- Comprehensive income (loss) - - - 1,325 (32,892) (31,567) ---------- ------ ----- ------- --------- -------- Balance at December 31, 2001 10,385,399 $38,136 $5,851 $(2,613) $(185,386) $(144,012) ========== ======= ====== ======== ========== ========== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
17
CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 2001, 2000 and 1999 (In thousands) 2001 2000 1999 ---- ---- ---- Cash flows from operating activities Net loss $(32,892) $(88,425) $(80,816) Adjustments to reconcile net loss to net cash provided by (used in) operations: Depreciation, amortization, impairment and other 2,710 39,305 7,398 Deferred income tax expense (benefit) - (2,636) 4,175 Net realized capital loss 1,185 5,972 324 Net changes in operating assets and liabilities: Receivables 5,676 12,163 (3,248) Reinsurance recoverable on losses, net 16,769 (33,560) 14,712 Prepaid reinsurance premiums (15,266) (23,691) 18,924 Federal income taxes recoverable - - 11,340 Deferred policy acquisition costs 5,691 7,454 2,424 Other assets and liabilities 7,445 (6,868) 7,238 Losses and loss adjustment expenses (26,975) (44,338) 18,431 Unearned premiums (3,170) (18,176) (17,367) Reinsurance payables (3,833) 56,198 2,859 Distributions payable on preferred securities 14,806 13,587 - Net assets from discontinued operations 5,888 34,862 (310) ----- ------ ----- Net cash (used in) operations (21,966) (48,153) (13,916) -------- -------- -------- Cash flows from investing activities, net of assets acquired: Net sales (purchases) of short-term investments 1,606 6,947 (6,266) Purchases of fixed maturities (34,204) (9,937) (181,197) Proceeds from sales, calls and maturities of fixed maturities 60,262 76,947 195,784 Purchase of equity securities (11,668) (25,195) (9,786) Proceeds from sales of equity securities 10,820 17,491 9,617 Proceeds from repayment of mortgage loans 1,870 120 110 Purchase of property and equipment (1,378) (1,685) (8,437) Purchase of other investments (92) (414) (45) Net investing activities from discontinued operations (4,456) (150) (1,385) ------- ----- ------- Net cash provided by / (used in) investing activities 22,760 64,124 (1,605) ------ ------ ------- Cash flow from financing activities, net of assets acquired: Loans from and (repayments to) related parties 1,276 (274) 2,438 Net financing activities from discontinued operations (48) (16,473) 4,954 ---- -------- ----- Net cash provided by / (used in) financing activities: 1,228 (16,747) 7,392 ----- -------- ----- Increase (decrease) in cash and cash equivalents 2,022 (776) (8,129) Cash and cash equivalents, beginning of year 1,363 2,139 10,268 ----- ----- ------ Cash and cash equivalents, end of year $3,385 $1,363 $2,139 ====== ====== ====== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
18 SYMONS INTERNATIONAL GROUP, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- 1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES Symons International Group, Inc. (the "Company") is a 73.1% owned subsidiary of Goran Capital Inc. ("Goran"). The Company operates in one segment, the sale of nonstandard automobile insurance. The Company's products are marketed through independent agents and brokers. The Company's active insurance subsidiaries are licensed in 24 states. The following is a description of the significant accounting policies and practices employed: A. BASIS OF PRESENTATION: The consolidated financial statements include the accounts, after intercompany eliminations, of the Company and its wholly-owned subsidiaries as follows: Superior Insurance Group Management, Inc ("Superior Group Management") a holding company for the nonstandard automobile operations which includes: Superior Insurance Group, Inc. ("Superior Group") a management company for the nonstandard automobile operations; Superior Insurance Company ("Superior") an insurance company domiciled in Florida; Superior American Insurance Company ("Superior American") an insurance company domiciled in Florida; Superior Guaranty Insurance Company ("Superior Guaranty") an insurance company domiciled in Florida; Pafco General Insurance Company ("Pafco") an insurance company domiciled in Indiana; IGF Holdings, Inc. ("IGFH") a holding company; and, IGF Insurance Company ("IGF") an insurance company domiciled in Indiana (See Note 19). B. USE OF ESTIMATES: The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. C. SIGNIFICANT ESTIMATES: The most significant estimates in the Company's balance sheet are the determination of prepaid policy acquisition costs and the reserve for insurance losses and loss adjustment expenses. Management's estimate of prepaid policy acquisition costs is based on historical studies and assumptions made regarding costs incurred. Management's estimate of insurance losses and loss adjustment expenses is based on past loss experience and consideration of current claim trends, as well as prevailing social, economic, and legal conditions. Actual results could differ from these estimates. D. PREMIUMS: Premiums are recognized as income ratably over the life of the policies and are stated net of ceded premiums. Unearned premiums are computed on the daily pro rata basis. E. INVESTMENTS: Investments are presented on the following basis: Fixed maturities and equity securities are classified as available for sale and are carried at market value with the unrealized gain or loss considered a component of Shareholders' equity. Accordingly, any change in the unrealized gain or loss has no effect on net income. Real estate is carried at cost, less an allowance for depreciation. Mortgage loans are carried at outstanding principal balance. 19 Realized gains and losses on the sale of investments are recorded on the trade date and are recognized in net income on the specific identification basis. Interest and dividend income are recognized as earned. F. CASH AND CASH EQUIVALENTS: For presentation in the statement of cash flows, the Company includes in cash and cash equivalents all cash on hand and demand deposits with original maturities of three months or less. G. DEFERRED POLICY ACQUISITION COSTS: Deferred policy acquisition costs are comprised of agents' commissions, premium taxes, certain other costs and investment income that are related directly to the acquisition of new and renewal business, net of expense allowances received in connection with reinsurance ceded, which have been accounted for as a reduction of the related policy acquisition costs. These costs are deferred and amortized over the term of the policies to which they relate. Acquisition costs that exceed estimated losses and loss adjustment expenses and maintenance costs are charged to expense in the period in which the excess costs are determined. H. PROPERTY AND EQUIPMENT: Property and equipment are recorded at cost. Depreciation for buildings is based on the straight-line method over 31 1/2 years. Other property and equipment is depreciated on the straight-line basis over their estimated useful lives ranging from three to seven years. Asset and accumulated depreciation accounts are relieved for disposals, with resulting gains or losses included in net income. I. INTANGIBLE ASSETS: Intangible assets consist primarily of debt acquisition costs and goodwill, in years 2000 and prior. Deferred debt acquisition costs are amortized over the term of the debt. Prior to 2000, goodwill was amortized over a 25-year period on a straight-line basis based upon management's estimate of the expected benefit period. See Note 5 regarding the goodwill impairment charge recorded in 2000. J. ASSET IMPAIRMENT POLICY: The Company reviews the carrying values of its long-lived and identifiable intangible assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. See Note 5 regarding the goodwill impairment charge recorded in 2000. Any long-lived assets held for disposal are reported at the lower of carrying amount or fair value, less expected costs to sell. K. LOSSES AND LOSS ADJUSTMENT EXPENSES: Reserves for losses and loss adjustment expenses include estimates for reported unpaid losses and loss adjustment expenses, including a portion attributable to losses incurred but not reported. These reserves have not been discounted. Reserves are established using individual case-basis evaluations and statistical analysis as claims are reported. Those estimates are subject to the effects of trends in loss severity and frequency. While management believes the reserves make reasonable provisions for unpaid loss and loss adjustment expense obligations, those provisions are necessarily based on estimates and are subject to variability. Changes in the estimated reserves are charged or credited to operations as additional information on the estimated amount of a claim becomes known during the course of its settlement. The gross reserve for losses and loss adjustment expenses is reported net of anticipated receipts for salvage and subrogation of approximately $5,822,000 and $6,983,000 at December 31, 2001 and 2000, respectively. L. PREFERRED SECURITIES: Preferred securities represent Company-obligated mandatorily redeemable securities of a trust subsidiary holding solely parent debentures and are reported at their liquidation value under minority interest. Distributions on these securities are charged against consolidated earnings. M. INCOME TAXES: The Company utilizes the liability method of accounting for deferred income taxes. Under the liability method, companies will establish a deferred tax liability or asset for the future tax effects of temporary differences between book and taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. N. REINSURANCE: Reinsurance premiums, commissions, and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies and the terms 20 of the reinsurance contracts. Premiums ceded to other companies have been reported as a reduction of premium income. O. EARNINGS PER SHARE: The Company's basic earnings per share calculations are based on the weighted average number of shares of common stock outstanding during each period. As the Company has reported losses in 2001, 2000, and 1999, common stock equivalents are anti-dilutive; therefore, fully diluted earnings per share is the same as basic earnings per share. P. NEW ACCOUNTING PRONOUNCEMENTS: In June 2001, the Financial Accounting Standards Board (the "Board") finalized FASB Statements No. 141, BUSINESS COMBINATIONS, No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, and No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS. In August 2001, the Board issued FASB Statement No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. These new standards are effective in 2002 and will not have a material impact on the Company's financial position or results of operations. Q. RECLASSIFICATIONS: Certain amounts from prior periods have been reclassified to allow for comparability to the 2001 presentation. 2. INVESTMENTS Investments are summarized as follows (in thousands):
Cost or Estimated December 31, 2001 Amortized Unrealized Unrealized Market Cost Gain Loss Value ---- ---- ---- ----- Fixed Maturities: U.S. Treasury securities and obligations of U.S. government corporations and agencies $29,912 $609 $(311) $30,210 Mortgage backed securities 17,500 1,928 (47) 19,381 ------ ----- ---- ------ Total U.S. treasury and other government Obligations 47,412 2,537 (358) 49,591 Corporate securities 29,528 430 (1,653) 28,305 ------ --- ------- ------ Total fixed maturities 76,940 2,967 (2,011) 77,896 Equity securities 17,965 27 (3,596) 14,396 Short-term investments 13,266 - - 13,266 Other invested assets (including real estate) 1,469 - - 1,469 ----- ------ ------- ----- Total investments $109,640 $2,994 $(5,607) $107,027 ======== ====== ======== ======== Cost or Estimated December 31, 2000 Amortized Unrealized Unrealized Market Cost Gain Loss Value ---- ----- ---- ----- Fixed Maturities: U.S. Treasury securities and obligations of U.S. government corporations and agencies $42,934 $265 $(161) $43,038 Mortgage backed securities 13,480 156 (26) 13,610 ------ --- ---- ------ Total U.S. treasury and other government obligations 56,414 421 (187) 56,648 Corporate securities 45,151 148 (2,441) 42,858 ------ --- ------- ------ Total fixed maturities 101,565 569 (2,628) 99,506 Equity securities 18,326 1,567 (3,332) 16,561 Short-term investments 14,986 - (114) 14,872 Mortgage loans 1,870 - - 1,870 Other invested assets (including real estate) 1,331 - - 1,331 ----- ------ -------- ----- Total investments $138,078 $2,136 $(6,074) $134,140 ======== ====== ======== ========
21 At December 31, 2001, The Standard & Poors Corporation or Moody's Investor Services, Inc. considered 92.3% of the Company's fixed maturities investment grade. Securities with quality ratings, Baa and above are considered investment grade securities. In addition, the Company's investments in fixed maturities did not contain any significant geographic or industry concentration of credit risk. The amortized cost and estimated market value of fixed maturities at December 31, 2001, by contractual maturity, are shown in the table that follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty (in thousands): Estimated Amortized Cost Market Value -------------- ------------ Due in one year or less $7,894 $7,998 Due after one year through five years 26,057 25,950 Due after five years through ten years 20,713 20,477 Due after ten years 4,776 4,091 Mortgage-backed securities 17,500 19,380 ------ ------ $76,940 $77,896 ======= ======= Gains and losses realized on sales of investments are as follows (in thousands): 2001 2000 1999 ---- ---- ---- Proceeds from sales $71,082 $94,558 $205,511 Gross gains realized 481 1,359 2,983 Gross losses realized (1,666) (7,331) (3,307) Net investment income for the years ended December 31 are as follows (in thousands): 2001 2000 1999 ---- ---- ---- Fixed maturities $5,666 $8,795 $11,372 Equity securities 213 304 376 Cash and short-term investments 469 1,077 1,139 Mortgage loans 65 - 152 Other 769 - (174) --- - ----- Total investment income 7,182 10,176 12,865 Investment expenses (896) (102) (623) ----- ----- ----- Net investment income 6,286 $10,074 $12,242 ===== ======= ======= Investments with a market value of $13,663,118 and $7,495,000 (amortized cost of $13,348,887 and $7,545,000 as of December 31, 2001 and 2000, respectively, were on deposit in the United States. The deposits are required by various insurance departments and others to support licensing requirements and certain reinsurance contracts. 3. DEFERRED POLICY ACQUISITION COSTS Policy acquisition costs are capitalized and amortized over the life of the policies. Policy acquisition costs are those costs directly related to the issuance of insurance policies including commissions, premium taxes, and underwriting expenses net of reinsurance commission income on such policies. Policy acquisition costs both acquired and deferred, and the related amortization charged to income were as follows (in thousands): 22 2001 2000 1999 ---- ---- ---- Balance, beginning of year $6,454 $13,908 $16,332 Costs deferred during year 28,056 29,999 40,241 Amortization during year (33,747) (37,453) (42,665) -------- -------- -------- Balance, end of year $763 $6,454 $13,908 ==== ====== ======= 4. PROPERTY AND EQUIPMENT Property and equipment at December 31 are summarized as follows (in thousands):
Accumulated 2001 Cost Depreciation 2001 Net 2000 Net --------- ------------ -------- -------- Land 100 - 100 $100 Buildings 4,273 1,618 2,655 2,964 Office furniture and equipment 2,162 1,354 808 939 Automobiles 76 34 42 57 Computer equipment 14,071 7,786 6,285 8,332 ------ ----- ----- ----- Total $20,682 $10,792 $9,890 $12,392 ======= ======= ====== =======
Accumulated depreciation at December 31, 2000 was $9,852,000. Depreciation expense related to property and equipment for the years ended December 31, 2001, 2000 and 1999 were $3,738,000, $3,498,000 and $2,909,000, respectively. 5. INTANGIBLE ASSETS: In accordance with SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS, the Company determined in 2000 that the carrying value of goodwill that resulted from the acquisition of Superior Group Management exceeded its fair value. This determination was made considering the series of continued losses which the company had experienced, the reduction in the volume of premiums written, as well as an evaluation of future cash flows. Based on this assessment, a charge of $33,464,000 was recorded in the fourth quarter of 2000 to write-off the remaining carrying value of the goodwill. Such charge is included as amortization expense in the accompanying financial statements for 2000. Intangible assets at December 31 are as follows (in thousands):
Accumulated 2001 Cost Amortization 2001 Net 2000 Net --------- ------------ -------- -------- Deferred securities issuance costs $5,132 $755 $4,376 $4,547
Accumulated amortization with impairment at December 31, 2000 was $40,140,000. Amortization expense related to intangible assets for the years ended December 31, 2001, 2000 and 1999 was $171,000, $34,977,000, and $2,194,000 respectively. 6. PREFERRED SECURITIES On August 12, 1997, the Company's trust subsidiary issued $135 million in preferred securities ("Preferred Securities") bearing interest at an annual rate of 9.5%. The principal assets of the trust subsidiary are senior subordinated notes of the Company in the principal amount of $135 million with an interest rate and maturity date substantially identical to those of the Preferred Securities. Expenses of the issue aggregated $5.1 million and are amortized over the term of the Preferred Securities. The Preferred Securities represent Company-obligated mandatorily redeemable securities of a trust subsidiary holding solely parent debentures and have a term of 30 years with semi-annual interest payments commencing February 15, 1998. The Company may redeem the Preferred Securities in whole or in part after 10 years. The annual Preferred Security obligations of approximately $13 million per year are funded 23 from the Company's nonstandard automobile management company. The nonstandard auto funds are the result of management and billing fees in excess of operating costs. Under the terms of the indenture, the Company is permitted to defer semi-annual interest payments for up to five years. The Company elected to defer the interest payments due in February and August 2000 and 2001 and may continue this practice through 2004 (the payment due in February 2002 was deferred). The trust indenture for the Preferred Securities contains certain restrictive covenants. These covenants are based upon the Company's consolidated coverage ratio of earnings before interest, taxes, depreciation and amortization ("EBITDA"). If the Company's EBITDA falls below 2.5 times consolidated interest expense (including Preferred Security distributions) for the most recent four quarters the following restrictions become effective: o The Company may not incur additional indebtedness or guarantee additional indebtedness. o The Company may not make certain restricted payments including making loans or advances to affiliates, repurchasing common stock or paying dividends in excess of a stated limitation. o The Company may not increase its level of non-investment grade securities defined as equities, mortgage loans, real estate, real estate loans and non-investment grade fixed income securities. These restrictions currently apply, as the Company's consolidated coverage ratio was (0.90) in 2001, and will continue to apply until the Company's consolidated coverage ratio complies with the terms of the trust indenture. The Company complied with these additional restrictions as of December 31, 2001 and is in compliance as of March 29, 2002. The Company discovered it did not comply with the covenant dealing with the percentage of investment in other than "Permitted Investments" as defined by the indenture. The indenture allows for no more than 15% of total invested assets to be in non-investment grade securities as defined above. At December 31, 2001, approximately 21% of the Company's investment portfolio was invested in equity securities and non-investment grade bonds. The Company rectified the situation as of March 29, 2002 through the sale of approximately $8 million of the non-investment grade securities, the proceeds of which were invested in Permitted Investments. 7. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows (in thousands): 2001 2000 1999 ---- ---- ---- Balance at January 1 $108,117 $152,455 $134,024 Less reinsurance recoverables 23,252 13,527 17,844 ------ ------ ------ Net balance at January 1 84,865 138,928 116,180 ------ ------- ------- Incurred related to: Current year 69,667 127,497 214,606 Prior years 774 (14,118) 16,367 ------ -------- ------ Total incurred 70,441 113,379 230,973 ------ ------- ------- Paid related to: Current year 46,973 85,334 122,380 Prior years 57,791 82,108 85,845 ------ ------ ------ Total paid 104,764 167,442 208,225 ------- ------- ------- Net balance at December 31 50,542 84,865 138,928 Plus reinsurance recoverables 30,600 23,252 13,527 ------ ------ ------ Balance at December 31 $81,142 $108,117 $152,455 ======= ======== ======== Reserve estimates are regularly adjusted in subsequent reporting periods as new facts and circumstances emerge to indicate that a modification of the prior estimate is necessary. The adjustment, referred to as "Reserve development," is inevitable given the complexities of the reserving process and is recorded in the statements of operations in the period when the need for the adjustment becomes apparent. The foregoing reconciliation indicates unfavorable development of $774,000 on the December 31, 2000 reserves. The 2000 deficient reserve development resulted primarily from a higher than expected frequency and severity 24 on nonstandard automobile claims. The favorable reserve development of $14,118,000 during 2000 resulted from a major restructuring and strengthening of the nonstandard automobile claims function effective at the beginning of 2000. At that time, the Company replaced its existing claims management team with new claims management that improved performance of the claims staff. The anticipated effect of inflation is implicitly considered when estimating losses and loss adjustment expenses liabilities. While anticipated price increases due to inflation are considered in estimating the ultimate claims costs, increases in average claim severities is caused by a number of factors. Future severities are projected based on historical trends adjusted for implemented changes in underwriting standards, policy provisions, claims management practices and procedures, and general economic trends. Anticipated severity trends are monitored relative to actual development and are modified if necessary. Liabilities for loss and loss adjustment expenses have been established when sufficient information has been developed to indicated the involvement of a specific insurance policy. In addition, reserves have been established to cover additional exposure on both known and unasserted claims. 8. INCOME TAXES The Company files a consolidated federal income tax return with its wholly-owned subsidiaries. Intercompany tax sharing agreements between the Company and its wholly-owned subsidiaries provide that income taxes will be allocated based upon separate return calculations in accordance with the Internal Revenue Code of 1986, as amended. A reconciliation of the differences between federal tax computed by applying the federal statutory rate of 35% to income before income taxes and the income tax provision is as follows (in thousands):
2001 2000 1999 ---- ---- ---- Computed income taxes (benefit) at statutory rate $(5,576) $(20,981) $(17,812) Goodwill - 12,176 779 Other 32 (4,042) 2,121 -- ------- ----- Total (5,544) (12,847) (14,912) Valuation allowance 5,544 10,698 21,127 ----- ------ ------ Income tax expense $ - $(2,149) $6,215 ==== ======== ======
The net deferred tax asset at December 31, 2001 and 2000 is comprised of the following (in thousands):
2001 2000 ---- ---- Deferred tax assets: Unpaid losses and loss adjustment expenses $1,300 $2,787 Unearned premiums 1,159 2,633 Allowance for doubtful accounts 629 1,302 Unrealized losses on investments 914 1,378 Net operating loss carryforwards 18,279 18,118 Other 15,180 8,758 ------ ----- Deferred tax assets 37,461 34,976 ------ ------ Deferred tax liabilities: Deferred policy acquisition costs (168) (2,259) Other (924) (892) ----- ----- Valuation allowance (36,369) (31,825) -------- -------- Net deferred tax assets $ - $ - ==== ====
At December 31, 2001, the Company's net deferred tax assets are fully offset by a valuation allowance. The Company will continue to assess the valuation allowance and to the extent it is determined that such 25 allowance is no longer required, the tax benefit of the corresponding portion of remaining net deferred tax assets will be then be recognized. As of December 31, 2001, the Company has unused net operating loss carryovers available as follows (in thousands): Year of expiration: Amount ------ 2002 $126 2019 35,005 2020 17,096 ------ Total $52,227 ======= Approximately $12 million of the total unused net operating loss carryover was generated by the discontinued operations. The loss generated by the discontinued operations is available for use by the continuing operations. Federal income tax filings of the Company for years prior to 2000 have been examined by the Internal Revenue Service. 9. LEASES The Company leases buildings, furniture, cars and equipment under operating leases. Operating leases generally include renewal options for periods ranging from two to seven years and require the Company to pay utilities, taxes, insurance and maintenance expenses. The following is a schedule of future minimum lease payments under cancelable and non-cancelable operating leases for each of the five years succeeding December 31, 2001 and thereafter, excluding renewal options (in thousands): Years Ending December 31: 2002 $1,343 2003 499 2004 202 2005 131 2006 and Thereafter 166 Rental expense charged to operations in 2001, 2000 and 1999 amounted to $1,688,000, $1,848,000, and $2,370,000 respectively, including amounts paid under short-term cancelable leases. 10. REINSURANCE The Company limits the maximum net loss that can arise from a large risk, or risks in concentrated areas of exposure, by reinsuring (ceding) certain levels of risks with other insurers or reinsurers, either on an automatic basis under general reinsurance contracts known as "treaties" or by negotiation on substantial individual risks. Such reinsurance includes quota share, excess of loss, stop-loss and other forms of reinsurance on essentially all property and casualty lines of insurance. The Company remains contingently liable with respect to reinsurance ceded, which would become an ultimate liability of the Company in the event that such reinsuring companies might be unable, at some later date, to meet their obligations under the reinsurance agreements. In addition, the Company assumes reinsurance on certain risk. Approximately 89.7% of uncollateralized amounts recoverable are with companies which maintain an A.M. Best rating of at least A+. Another 5.6% of recoverable amounts are with Granite Reinsurance Company Ltd. ("Granite Re"), an affiliated foreign corporation which has not applied for an A.M. Best rating, related primarily to commercial business which is ceded 100% to Granite Re, which are fully collateralized. Company management believes amounts recoverable from reinsurers are collectible. The Company commuted the accident year 2000 portion of the reinsurance treaty with National Union Fire Insurance Company. The Company recognized the amounts received from National as a reduction of losses and loss adjustments expenses paid (thereby increasing losses and loss adjustment expenses incurred) to 26 recognize the effect of releasing National from its obligations under the treaty, there was no effect on premiums earned, losses incurred, loss adjustment expense incurred or commission in the current year income statement due to this commutation. The Company sold 100% of its 2001 crop year business to Acceptance Insurance Companies Inc. ("Acceptance"), effective June 6, 2001. The agreements are without recourse as they relate to the net profit or loss on the 2001 crop year book of business. The sale was approved by the Indiana Department of Insurance. Reinsurance activity for 2001, 2000 and 1999, which includes reinsurance with related parties, is summarized as follows (in thousands):
2001 Direct Assumed Ceded Net ---- ------ ------- ----- --- Premiums written 159,821 1,271 (105,158) 55,934 Premiums earned 163,828 2,484 (89,365) 76,947 Incurred losses and loss adjustment expenses 132,589 2,616 (64,764) 70,441 Commission expenses (income) 18,979 151 (25,716) (6,586) 2000 Direct Assumed Ceded Net ---- ------ ------- ----- --- Premiums written $168,626 $5,835 $(78,621) $95,840 Premiums earned 187,720 4,918 (54,932) 137,706 Incurred losses and loss adjustment expenses 144,987 4,828 (36,436) 113,379 Commission expenses (income) 21,234 1,041 (14,043) 8,232 1999 Direct Assumed Ceded Net ---- ------ ------- ----- --- Premiums written $233,514 $2,887 $8,425 $244,826 Premiums earned 252,357 88 (3,351) 249,094 Incurred losses and loss adjustment expenses 231,197 7,838 (8,062) 230,973 Commission expenses (income) 27,352 633 435 28,420
Amounts recoverable from reinsurers relating to unpaid losses and loss adjustment expenses were $30,181,000 and $23,252,000 as of December 31, 2001 and 2000, respectively. These amounts are reported as assets and are not netted against the liability for loss and loss adjustment expenses in the accompanying Consolidated Balance Sheets. 11. RELATED PARTIES The Company and its subsidiaries have entered into transactions with various related parties including transactions with Goran and its affiliates, Granite Insurance Company ("Granite") and Granite Re. 27 The following balances were outstanding at December 31 (in thousands):
2001 2000 ---- ---- Due from directors and officers $42 $291 Other receivables from and (payables to) related parties (638) 389 ----- --- Total receivables (payables) $ (596) $ 680 ======= ===== Reinsurance payable to affiliates $ 617 $ - ===== ===
The following transactions occurred with related parties in the years ended December 31 (in thousands):
2001 2000 1999 ---- ---- ---- Reinsurance under various treaties, net: Ceded premiums earned $3 $186 $2,850 Ceded losses and loss adjustment expenses incurred (419) (4,858) 2,932 Ceded commissions 1 (1) 114 Consulting fees charged by various related parties 16 1,895 3,652
The amounts due from officers and directors are non-interest-bearing loans. The Company paid $1,846,000 and $3,112,000 in 2000 and 1999, respectively, for consulting and other services to a vendor owned in part by the brother of the Company's president. The consulting and other services were for the conversion of the Company's nonstandard automobile operating system. The Company has capitalized these costs as part of its nonstandard automobile operating system. Approximately 90% of these payments are for services provided by consultants and vendors unrelated to the Company. In December 2001, Superior Group obtained a line of credit from Granite Re in the total amount of $2.5 million. At December 31, 2001, $1.3 million was outstanding under the line. This note bears interest at the rate of prime plus 5.25% for a total of 10.0% at December 31, 2001. Interest only payments are due monthly until the principal is due on December 20, 2004. 12. REGULATORY MATTERS Two of the Company's insurance company subsidiaries, Pafco General Insurance Company ("Pafco") and IGF are domiciled in Indiana and prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the Indiana Department of Insurance ("IDOI"). While neither Pafco nor IGF has surplus from which to pay dividends, statutory requirements place limitations on the amount of funds that can be remitted to the Company from Pafco and IGF. The Indiana statute allows 10% of surplus in regard to policyholders or 100% of net income, whichever is greater, to be paid as dividends only from earned surplus; however, the Consent Orders with the IDOI, described below, prohibit the payment of any dividends by Pafco and IGF. Another insurance company subsidiary, Superior and Superior's insurance company subsidiaries, Superior American and Superior Guaranty, are domiciled in Florida and prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the Florida Department of Insurance ("FDOI"). The Florida statute also contains limitations with regard to the payment of dividends. Superior may pay dividends of up to 10% of surplus or 100% of net income, whichever is greater, from earned surplus. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. On June 6, 2001 IGF sold substantially all of its crop insurance assets to Acceptance. On June 24, 2001, following the sale of IGF's crop insurance assets and as a result of losses experienced by IGF in its crop insurance operations, the IDOI and IGF entered into a Consent Order (the "Consent Order") relating to IGF. IGF has discontinued writing new business and its operations are presently in run off. 28 The IDOI has continued to monitor the status of IGF. The Consent Order prohibits IGF from taking any of the following actions without prior written consent of the IDOI: o Sell or encumber any of its assets, property, or business in force; o Disburse funds, except to pay direct unaffiliated policyholder claims and normal operating expenses in the ordinary course of business (which does not include payment to affiliates except for the reimbursement of costs for running IGF by the Company, and does not include payments in excess of $10,000); o Lend its funds or make investments, except in specified types of investments; o Incur debts or obligations, except in the ordinary course of business to unaffiliated parties; o Merge or consolidate with another company; o Enter into new, or amend existing, reinsurance agreements; o Complete, enter into or amend any transaction or arrangement with an affiliate, and o Disburse funds or assets to any affiliate. The Consent Order requires IGF to provide the IDOI with monthly written updates and immediate notices of any material change regarding the status of litigation with Mutual Service Casualty Insurance Company and with Continental Casualty Company, statutory reserves, number of non-standard automobile insurance policies in-force by state, and reports of all non-claims related disbursements. IGF's failure to comply with the Consent Order could cause the IDOI to begin proceedings to have a rehabilitator or liquidator appointed for IGF to extend the provisions of the Consent Order. While IGF is prohibited from writing any new business pursuant to the Consent Order, the departments of insurance of Florida, Illinois, Minnesota, Missouri, Nebraska, Virginia and South Carolina have required IGF to cease writing business in those states. IGF has also agreed with the departments of insurance of Texas and Washington to not write business in those states, and IGF presently intends to surrender its certificates of authority in most states in which it operated prior to the sale to Acceptance. As a result of the Consent Order, IGF was prohibited from writing new non-standard automobile insurance in Pennsylvania after July 30, 2001. Prior to July 31, 2001, the non-standard automobile insurance policies written in Pennsylvania by IGF accounted for approximately 10% of the total gross written premiums of the Company. During the third quarter of 2001, the Pennsylvania Department of Insurance determined that it would not permit new business to be written in that state by Superior or the Company's other insurance company subsidiaries. Therefore, total written premiums for 2001 were less than anticipated. Pafco has been subject to an agreed to order of the IDOI since February 17, 2000 that requires Pafco, among other matters, to: o Refrain from doing any of the following without the IDOI's prior written consent: (i) selling assets or business in force or transferring property, except in the ordinary course of business; (ii) disbursing funds, other than for specified purposes or for normal operating expenses and in the ordinary course of business (which does not include payments to affiliates, other than under written contracts previously approved by the IDOI, and does not include payments in excess of $10,000); (iii) lending funds; (iv) making investments, except in specified types of investments; (v) incurring debt, except in the ordinary course of business and to unaffiliated parties; (vi) merging or consolidating with another company; or (vii) entering into new, or modifying existing, reinsurance contracts. o Reduce its monthly auto premium writings, or obtain additional statutory capital or surplus, such that the ratio of gross written premium to surplus and net written premium to surplus does not exceed 4.0 and 2.4, respectively; and provide the IDOI with regular reports demonstrating compliance with these monthly writings limitations. o Continue to comply with prior IDOI agreements and orders to correct business practices under which Pafco must provide monthly financial statements to the IDOI, obtain prior IDOI approval of reinsurance arrangements and affiliated party transactions, submit business plans to the IDOI that address levels of surplus and net premiums written, and consult with the IDOI on a monthly basis. Pafco's inability or failure to comply with any of the above could result in the IDOI requiring further reductions in Pafco's permitted premium writings or in the IDOI instituting future proceedings against Pafco. Restrictions on premium writings result in lower premium volume. Management fees payable to 29 Superior Group are based on gross written premium; therefore lower premium volume results in reduced management fees paid by Pafco. Pafco has agreed with the Iowa Department of Insurance ("IADOI") that it will not write any new non-standard business in Iowa, until such time as Pafco has reduced its overall non-standard automobile policy counts in the state or has: o Increased surplus, or o Has achieved a net written premium to surplus ratio of less than three to one, or o Has surplus reasonable to its risk. Pafco has continued to service existing policyholders and renew policies in Iowa and provide policy count information on a monthly basis in conformance with IADOI requirements. Superior and Pafco also provide monthly financial information to the departments of insurance in certain states in which they write business, and Pafco has agreed to obtain IDOI prior approval of any new affiliated party transactions. The financial review of Superior for the year ended December 31, 1999 by the FDOI has been completed and the FDOI issued its final report during the fourth quarter of 2001. The FDOI's final report recommended additional examination of compliance issues and financial records' accuracy for years subsequent to 1999 and the FDOI took no additional action. On July 7, 2000, the FDOI issued a notice of its intent to issue an order (the "Notice") which principally addressed certain policy and finance fee payments by Superior to Superior Group. A formal administrative hearing to review the Notice and a determination that the order contemplated by the Notice not be issued was held in February 2001. The administrative law judge entered a recommended order on June 1, 2001 that was acceptable to the Company. On August 30, 2001, the FDOI rejected the recommended order and issued its final order which the Company believes improperly characterized billing and policy fees paid by Superior to Superior Group. Superior filed an appeal of the final order to Florida District Court. On March 4, 2002, the FDOI filed a petition in the Circuit Court of the Second Judicial Circuit in and for Leon County, Florida which seeks court enforcement of the FDOI's final order. Superior filed a motion with the FDOI for stay of the FDOI's final order. Superior also filed a motion with the District Court of Appeals, which was denied pending a ruling from the FDOI on Superior's motion for stay. In 1999, Superior ceased writing business in Illinois and agreed to obtain the approval of the Illinois Department of Insurance prior to writing any new business in Illinois. In July 2001, Superior agreed with the Department of Insurance in Texas to obtain its prior approval before writing any new business in that state. On October 9, 2001, the State Corporation Commission of Virginia issued an order to take notice regarding an order suspending Superior's license to write business in that state, which Superior believes is unwarranted. An administrative hearing for a determination that the suspension order not be issued was held March 5, 2002. The nonstandard automobile insurance policies written in Virginia by Superior accounted for approximately 13.1% of the total gross written premiums of the Company in 2001. A decision has not yet been rendered, and although Superior does not expect an adverse decision, Superior would appeal any decision that prohibits it from writing business in Virginia. The Company's operating subsidiaries, their business operations, and their transactions with affiliates, including the Company, are subject to regulation and oversight by the IDOI, the FDOI, and the insurance regulators of other states in which the subsidiaries write business. The Company is a holding company and all of its operations are conducted by its subsidiaries. Regulation and oversight of insurance companies and their transactions with affiliates is conducted by state insurance regulators primarily for the protection of policyholders and not for the protection of other creditors or of shareholders. Failure to resolve issues with the IDOI and the FDOI or other state insurance regulators in a mutually satisfactory manner could result in future regulatory actions or proceedings that materially and adversely affect the Company. The NAIC adopted the Codification of Statutory Accounting Principles guidance ("Codification"), which replaces the Accounting Practices and Procedures manual, as the NAIC's primary guidance on statutory accounting effective January 1, 2001. The IDOI and FDOI have adopted Codification. 30 The changes in statutory accounting principles resulting from Codification which impact the Company's insurance subsidiaries, among other things, limit the statutory carrying value of electronic data processing equipment and deferred tax assets in determining statutory surplus. The consolidated statutory surplus of the Company's insurance subsidiaries as of December 31, 2001 was $21.9 million, excluding IGF. 13. COMMITMENTS AND CONTINGENCIES As previously reported, IGF, which is a wholly owned subsidiary of the Company, had been a party to a number of pending legal proceedings and claims relating to agricultural production interruption insurance policies (the "AgPI Program") which were sold during 1998. All of the policies of insurance which were issued in the AgPI Program were issued by and under the name of Mutual Service Casualty Insurance Company ("MSI"), a Minnesota corporation with its principal place of business located in Arden Hills, Minnesota. Sales of this product resulted in large underwriting losses by IGF. Approximately $29 million was paid through December 31, 2001 in settlement of legal proceedings and claims related to the AgPI Program, with payments totaling approximately $359,000 during 2001. The Company reduced reserves related to AgPI by approximately $7 million during 2001. The Company has retained a reserve of approximately $3 million as a provision for expenses and settlement of ongoing litigation. All AgPI policyholder claims had been settled during 2000. However, on January 12, 2001 a case was filed in the Superior Court of California, County of Fresno, entitled S&W Seed Company, Dudley Silveira, Ric Blanchard and Darrell Silveira v. Mutual Service Casualty Insurance Company, IGF Insurance Company, and Dibuduo & Defendis Insurance Agency, Inc.; Case No. OICE CG 00137. The case was brought by four AgPI policyholders who had previously settled their AgPI claims pursuant to binding settlement agreements who now seek additional compensation by asserting through litigation that IGF and the third party carrier paid less than the policy limits they were promised when they purchased the policy and that each settling policyholder was forced to accept the lesser amount due to their economic duress - a legal theory recognized in California if certain elements of economic duress can be established. Discovery is proceeding. On January 16, 2002, the court entered an order granting IGF's motion for judgment on the pleadings and required plaintiffs to show an insurable interest. Plaintiffs amended their complaint attempting to allege an insurable interest and on March 19, 2002, the court granted IGF's demurrer to the amended complaint. In granting the demurrer the court held that any recovery payable to plaintiff would be limited to their actual economic losses regardless of how much plaintiffs thought they had been promised (i.e. plaintiffs cannot be paid policy limits without regard to actual losses incurred). The plaintiffs have ten (10) days in which to again amend their complaint. IGF remains a defendant/cross-complainant in eight lawsuits pending in Fresno County, California, which relate to the cross-claims between the selling brokers, MSI and IGF. These lawsuits have been consolidated for all purposes and discovery is proceeding. IGF and MSI are engaged in arbitration with respect to responsibility for the AgPI program settlements. The arbitration commenced in December 2000 and the parties had their first meeting with the panel on May 22, 2001. At that meeting, MSI moved for an order requiring IGF to post pre-hearing security through the issuance of a letter of credit in the amount of $39 million. Over IGF's objection, in a two to one vote, the panel ordered IGF to post the $39 million security by June 19, 2001. IGF sought relief from the order in the United States District Court for the District of New Jersey, but was unsuccessful. On November 7, 2001, the arbitration panel considered a petition for default judgment against IGF based on IGF's failure to post the pre-hearing security. On November 23, 2001, the arbitration panel issued an order denying MSI's motion for default judgment and requiring IGF to place $600,000 in an escrow account to cover MSI's prospective legal expenses. The panel also continued its original order that required IGF to post the $39 million security. IGF has deposited $600,000 into an escrow account as required by the arbitration panel but has not posted the $39 million letter of credit and is financially unable to do so. On June 25, 2001, MSI filed a complaint for preliminary and permanent injunctive relief and damages (the "MSI Complaint") against the Company, IGF Holdings, Inc., ("IGFH"), Granite Reinsurance Company Ltd. ("Granite Re"), Goran and certain affiliates of those companies, as well as certain members of the Symons family, and Acceptance in the United States District Court for the Southern District of Indiana, 31 Indianapolis Division. The MSI Complaint alleges that the June 6, 2001 transfer of IGF's assets to Acceptance and the payments by Acceptance to the Company, Goran and Granite Re violated Indiana law and are voidable. In addition, the MSI Complaint alleges that Acceptance, the Company, Goran, IGFH and the Symons Family are liable to MSI for the entire $39 million claim which MSI is asserting against IGF in the arbitration proceeding on theories of successor liability and "piercing the corporate veil." The MSI Complaint seeks preliminary and permanent injunctive relief against the defendants, an order voiding the various transactions between and among the defendants and an order determining that the defendants are directly responsible to MSI for MSI's $39 million claim against IGF. The defendants filed answers to the MSI Complaint denying the material allegations and asserting affirmative defenses to the MSI Complaint. A hearing on MSI's Motion for Preliminary Injunctive Relief was held Thursday, August 2, 2001. On August 3, 2001, the court denied MSI preliminary injunctive relief. On January 7, 2002, MSI filed an amended complaint which added Superior Insurance Group Management, Inc., Superior Group, Superior and Pafco as defendants (the "MSI Amended Complaint"). The MSI Amended Complaint asserts claims substantively identical to the claims in the MSI Complaint. On February 21, 2002, the defendants filed answers to the MSI Amended Complaint and denied the material allegations contained in the MSI Amended Complaint and asserted affirmative defenses. Should MSI be successful in obtaining permanent injunctive relief against the Company and its affiliates, any such relief would have an adverse impact upon the Company and its affiliates and their respective assets and operations. Further, in the event MSI is successful in voiding the various transactions between the defendants or in the event the defendants are determined to be responsible to MSI for MSI's $39 million claim against IGF, those orders and determinations could have an adverse effect upon the Company and its affiliates and their respective assets and operations. As previously reported in the Company's Form 8-K filed on August 2, 2001, the Company and two of its subsidiaries, IGFH and IGF, are parties to a "Strategic Alliance Agreement" dated February 28, 1998 (the "SAA") with Continental Casualty Company ("CNA"), pursuant to which IGF acquired certain crop insurance operations of CNA. Through reinsurance agreements, CNA was to share in IGF's profits or losses on IGF's total crop insurance business. By letter dated January 3, 2001, CNA gave notice pursuant to the SAA of its exercise of the "Put Mechanism" under the SAA effective February 19, 2001. According to the SAA, upon exercise of the Put Mechanism, IGFH is obligated to pay CNA an amount equal to 5.85 times "Average Pre-Tax Income", an amount based in part upon payments made to CNA under the SAA. The SAA further provided that 30 days after exercise of the Put, IGF will execute a promissory note payable six months after the exercise of the Put in the principal amount equal to the amount owed, as specified by the SAA. In a letter dated March 20, 2001, CNA also asserted a claim for amounts allegedly due under reinsurance agreements for the 2000 crop year. Also, as previously reported in the Company's Form 8-K filed on August 2, 2001, the Company believes it has claims against CNA and defenses to CNA's claim that may ultimately offset or reduce amounts owed to CNA. The Company and CNA engaged in discussions regarding possible alternatives for the resolution of their respective claims against each other; however, those discussions ultimately proved to be unsuccessful. Following the failure of settlement discussions, on June 4, 2001, IGF, IGFH and the Company filed a complaint against CNA (the "IGF Complaint") in the United States District Court for the Southern District of Indiana, Indianapolis Division. The IGF Complaint asserts claims against CNA for fraud and constructive fraud in connection with the SAA and breach of contract and seeks relief against CNA for compensatory and punitive damages. On June 27, 2001, CNA filed its "Answer, Separate Defenses and Counterclaim", in which CNA generally denied the material allegations of the IGF Complaint and asserted various defenses to those claims. On June 6, 2001, CNA filed a complaint against IGF, IGFH and the Company in the United States District Court for the Southern District of Indiana, Indianapolis Division (the "CNA Complaint"), asserting claims based on the SAA and related agreements for approximately $25 million allegedly owed CNA by virtue of its exercise of the Put Mechanism, $3 million for amounts allegedly due under reinsurance agreements for the 2000 crop year, $1 million for certain "fronting costs," and $1 million pursuant to a note executed by IGFH to CNA's affiliate in connection with the acquisition by IGFH of North American Crop Underwriters, Inc. in 1998. CNA also asserted claims to the effect that the June 6, 2001 sale of IGF assets to Acceptance resulted in payments of funds to Goran, the Company and Granite Re, which funds allegedly 32 should have been paid to IGF instead. On June 6, 2001, CNA asked the district court to enter a temporary restraining order preventing IGF, IGFH and the Company from disposing of the proceeds received by them in connection with the sale of IGF assets to Acceptance. In an emergency hearing, the court denied CNA the relief it requested, without prejudice to reconsideration of those issues at a future time. CNA has since amended the CNA Complaint to add Goran and Granite Re as defendants. CNA's counterclaim in response to the IGF Complaint asserts essentially the same claims against the same parties as the amended CNA Complaint. On September 20, 2001 the court ordered a consolidation of the two cases. On December 4, 2001, CNA filed an Amended Answer and Counterclaim that added Pafco, Superior and certain members of the Symons family as counterdefendants. CNA's Amended Answer and Counterclaim also alleges that IGF, IGFH, The Company, and the other counterdefendants are alter egos of each other and are directly liable to CNA for its claims. Discovery in the case is proceeding. Although the Company continues to believe that it has claims against CNA and defenses to CNA's claims which may offset or reduce amounts owing by the Company or its affiliates to CNA, there can be no assurance that the ultimate resolution of the claims asserted by CNA against the Company and its affiliates will not have a material adverse effect upon the Company's and its affiliates' financial condition or results of operations. The California Department of Insurance ("CDOI") filed a Notice of Noncompliance against Superior on June 29, 2001, which alleged that broker fees were charged by independent brokers in violation of California law. The Company and the CDOI agreed to a resolution of the matters raised in the Notice of Noncompliance by a Stipulation and Consent Order entered on December 26, 2001, wherein Superior agreed to pay the CDOI a penalty in the amount of $200,000 in settlement of the action. The Company is a defendant in a case filed on February 23, 2000, in the United States District Court for the Southern District of Indiana entitled Robert Winn, et al. v. Symons International Group, Inc., et al., Cause No. IP 00-0310-C-B/S. Other parties named as defendants are Goran, three individuals who were or are officers or directors of the Company or of Goran, PricewaterhouseCoopers, LLP and Schwartz Levitsky Feldman, LLP. The case purports to be brought on behalf of a class consisting of purchasers of the Company's stock or Goran's stock during the period February 27, 1998, through and including November 18, 1999. Plaintiffs allege, among other things, that defendants misrepresented the reliability of the Company's reported financial statements, data processing and financial reporting systems, internal controls and loss reserves in violation of Section 10(b) of the Securities Exchange Act of 1934 ("1934 Act") and SEC Rule 10b-5 promulgated thereunder. The individual defendants are also alleged to be liable as "controlling persons" under ss.20(a) of the 1934 Act. The Company and the individual defendants filed a motion to dismiss the amended consolidated complaint for failure to state a claim and for failure to plead with particularity as required by Fed. R. Civ. P.9 (b) and the Private Securities Litigation Reform Act of 1995. The accounting firms also filed motions to dismiss. On February 19, 2002 the court granted in part and denied in part defendants' motion to dismiss. On March 15, 2002 the Company and the individual defendants filed a motion for reconsideration of the court's ruling on the motion to dismiss, or alternatively to certify an order for appeal. Superior is a defendant in a case filed on May 8, 2001 in the United States District Court for the Southern District of Florida entitled The Chiropractic Centre, Inc. v. Superior Insurance Company which purports to be brought on behalf of a class consisting of healthcare providers improperly paid discounted rates on services to patients based upon a preferred provider contract with a third party. The plaintiff alleges that Superior breached a third party beneficiary contract, committed fraud and engaged in racketeering activity in violation of federal and Florida law by obtaining discounted rates offered by a third party with whom the plaintiff contracted directly. On September 28, 2001 the case was consolidated with fifteen or more similar actions. On October 29, 2001 Superior filed a motion to dismiss the action for lack of jurisdiction, which is pending. Superior intends to vigorously defend the claims brought against it. IGF is a defendant in a declaratory action entitled Kevin L. Stevens, Bank of America, Conservator of the Estate of Samuel Jay Ramsey and Gael Ramsey v. IGF Insurance Company originally filed on February 21, 2001 in the Circuit Court of Green County, Missouri. The action was subsequently removed to the Federal District Court for the Western District of Missouri. On October 11, 2001, the Federal District Court granted declaratory judgment in favor of the Company's insured, Stevens, and held that IGF was responsible for payment of the premium attributable to a $15 million appeal bond for Steven's appeal from a judgment against him in a related personal injury action. IGF believes that the District Court erred in granting declaratory judgment for Stevens and in holding that IGF is responsible for payment of the 33 premium on the bond. IGF has appealed to the United States Court of Appeals for the Eighth Circuit for relief from the declaratory judgment. In the event IGF is ultimately required to pay the premium on the appeal bond, it would have a material adverse impact on IGF's financial position. Superior is a defendant in a case filed September 15, 2000 in the Circuit Court for Lee County, Florida entitled Charles L. Fulton, D.C. v. Superior Insurance Company. The case is purported to be brought on behalf of a class consisting of healthcare providers that rendered treatment to and obtained a valid assignment of benefits from persons insured by Superior. The court granted Superior's motions to dismiss the original and amended complaints but denied Superior's motion to dismiss the second amended complaint. The court is permitting plaintiff to go forward with class discovery. The plaintiff alleges that Superior reduced or denied claims for medical expenses payable to the plaintiff without firsT obtaining a written report in violation of Florida law. The plaintiff also alleges that Superior inappropriately reduced the amount of benefits payable to the plaintiff in breach of Superior's contractual obligations to the plaintiff. Superior believes the allegations of wrongdoing in violation of law are without merit and intends to vigorously defend the claims brought against it. Superior is a defendant in a case now entitled Oviedo Family Chiropractic Center, P.A. v. Superior Insurance Company originally filed February 4, 2000 in the Circuit Court for Dade County, Florida and entitled Medical Re-Hab Center v. Superior Insurance Company. The court granted Superior's motions to dismiss the original and first amended complaints. The plaintiff has filed a motion for leave to file a second amended complaint which is pending. The case purports to be brought on behalf of a class consisting of (i) healthcare providers that rendered treatment to Superior insureds and claimants of Superior insureds and (ii) such insureds and claimants. The plaintiff alleges that Superior reduced medical benefits payable and improperly calculated interest in violation of Florida law. The Company believes the claim is without merit and intends to vigorously defend the charges brought against it. Superior Guaranty is a defendant in a case filed October 8, 1999, in the Circuit Court for Manatee County, Florida entitled Patricia Simmons v. Superior Guaranty Insurance Company. The case purports to be brought on behalf of a class consisting of purchasers of insurance from Superior Guaranty. The plaintiff alleges that the defendant charged interest in violation of Florida law. Superior Guaranty believes that the allegations of wrongdoing as alleged in the complaint are without merit and intends to vigorously defend the claims brought against it. Superior Guaranty is a defendant in a case filed on November 26, 1996, in the Circuit Court for Lee County, Florida entitled Raed Awad v. Superior Guaranty Insurance Company, et al. The case purports to be brought on behalf of a class consisting of purchasers of insurance from Superior Guaranty. The plaintiffs allege that the defendant charged premium finance service charges in violation of Florida law. Superior Guaranty believes that the allegations of wrongdoing as alleged in the complaint are without merit and intends to vigorously defend the claims brought against it. On July 7, 2000, the FDOI issued a notice of its intent to issue an order (the "Notice") which principally addressed certain policy and finance fee payments by Superior to Superior Group. A formal administrative hearing to review the Notice and a determination that the order contemplated by the Notice not be issued was held in February 2001. The administrative law judge entered a recommended order on June 1, 2001 that was acceptable to the Company. On August 30, 2001, the FDOI rejected the recommended order and issued its final order which the Company believes improperly characterized billing and policy fees paid by Superior to Superior Group. Superior filed an appeal of the final order to Florida District Court. On March 4, 2002, the FDOI filed a petition in the Circuit Court of the Second Judicial Circuit in and for Leon County, Florida which seeks court enforcement of the FDOI's final order. Superior filed a motion with the FDOI for stay of the FDOI's final order. Superior also filed a motion with the District Court of Appeals, which was denied pending a ruling from the FDOI on Superior's motion for stay. See Business-Regulation-"REGULATORY DEVELOPMENTS", in Part I of this report, for additional legal matters involving insurance regulatory matters. The Company's insurance subsidiaries are parties to other litigation arising in the ordinary course of business. The Company believes that the ultimate resolution of these lawsuits will not have a material adverse effect on its financial condition or results of operations. The Company, through its claims reserves, reserves for both the amount of estimated damages attributable to these lawsuits and the estimate costs of litigation. 34 The Company is a 50% owner in a limited liability corporation ("LLC") established to provide business services to the Company and an unrelated third party. The fair market value of the LLC's operating assets approximated its outstanding debt at December 31, 2001. The Company and its subsidiaries are named as defendants in various other lawsuits relating to their business. Legal actions arise from claims made under insurance policies issued by the Company's subsidiaries. The Company in establishing its loss reserves has considered these actions. The Company believes that the ultimate disposition of these lawsuits will not materially affect the Company's operations or financial position. 14. SUPPLEMENTAL CASH FLOW INFORMATION Cash paid/(received) for income taxes and interest is summarized as follows (in thousands):
2001 2000 1999 ---- ---- ---- Cash paid/(received) for federal income taxes, net of refunds $ - $(6,134) $(17,952) ========== ======== ========= Cash paid for interest on preferred securities $ - $ - $12,825 ========== ======== =======
15. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS The following discussion outlines the methodologies and assumptions used to determine the estimated fair value of the Company's financial instruments. Considerable judgment is required to develop these fair values and, accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of the Company's financial instruments. A) FIXED MATURITY, EQUITY SECURITIES, AND OTHER INVESTMENTS: Fair values for fixed maturity and equity securities are based on quote market prices. B) SHORT-TERM INVESTMENTS, AND CASH AND CASH EQUIVALENTS: The carrying value for assets classified as short-term investments, and cash and cash equivalents in the accompanying Consolidated Balance Sheets approximates their fair value. C) SHORT-TERM DEBT: The carrying value for short-term debt approximates fair value. D) PREFERRED SECURITIES: There is not an active market for the Preferred Securities; however, the estimated market value as of December 31, 2001 was approximately $9,000,000. 16. STOCK OPTION PLANS On November 1, 1996, the Company adopted the Symons International Group, Inc. ("SIG"). 1996 Stock Option Plan (the "SIG Stock Option Plan"). The SIG Stock Option Plan provides the Company authority to grant nonqualified stock options and incentive stock options to officers and key employees of the Company and its subsidiaries and nonqualified stock options to non-employee directors of the Company and Goran. Options have been granted at an exercise price equal to the fair market value of the Company's stock at date of grant. All of the outstanding stock options vest and become exercisable in three equal installments on the first, second and third anniversaries of the date of grant. On October 14, 1998, all SIG options were repriced to $6.3125 per share. In November 1999, certain officers and non-employee directors of the Company surrendered a total of 1,153,600 stock options. 35 Information regarding the SIG Stock Option Plan is summarized below:
2001 2000 1999 Weighted Weighted Weighted Average Average Average 2001 Exercise 2000 Exercise 1999 Exercise Shares Price Shares Price Shares Price ------ ----- ------ ----- ------- ----- Outstanding at the beginning of the year 1,344,833 $0.9400 213,033 $6.3125 1,457,833 $6.3125 Granted - - 1,287,000 0.5436 - - Exercised - - - - (1,667) 6.3125 Forfeited/Surrendered (73,500) 2.8474 (155,200) 5.0391 (1,243,133) 6.3125 -------- --------- ----------- Outstanding at the end of the year 1,271,333 0.8283 1,344,833 0.9400 213,033 6.3125 ========= ========= ======= Options exercisable at year end 465,333 1.3180 73,500 6.3125 120,366 6.3125 Available for future grant 228,667 - 155,167 - 1,286,967 - Options Options Outstanding Exercisable Weighted Weighted Weighted Average Average Average Number Remaining Exercise Number Exercise Range of Exercise Prices Outstanding Life (In Years) Price Exercisable Price ------------------------ ----------- --------------- ----- ----------- ----- $0.50 - $0.8750 1,209,000 8.2 $0.5448 403,000 $0.5455 $6.3125 62,333 5.5 6.3125 62,333 6.3125 --------- ------ 1,271,333 8.0 465,333 ========= === =======
The Board of Directors of Superior Group Management adopted the GGS Management Holdings, Inc. Stock Option Plan (the "Superior Group Management Stock Option Plan"), effective April 30, 1996. The Superior Group Management Stock Option Plan authorizes the granting of nonqualified and incentive stock options to such officers and other key employees as may be designated by the Board of Directors of Superior Group Management. Options granted under the Superior Group Management Stock Option Plan have a term of ten years and vest at a rate of 20% per year for the five years after the date of the grant. The exercise price of any options granted under the Superior Group Management Stock Option Plan is subject to the following formula: 50% of each grant of options having an exercise price determined by the Board of Directors of Superior Group Management at its discretion, with the remaining 50% of each grant of options subject to a compound annual increase in the exercise price of 10%, with a limitation on the exercise price escalation as such options vest. Information regarding the Superior Group Management Stock Option Plan is summarized below:
2001 2000 1999 Weighted Weighted Weighted Average Average Average 2001 Exercise 2000 Exercise 1999 Exercise Shares Price Shares Price Shares Price ------ ----- ------ ----- ------ ----- Outstanding at the beginning of the year 83,432 $54.42 92,232 $51.75 94,732 $51.75 Granted - - - - - - Forfeited (100) 57.65 (8,800) 51.48 (2,500) 51.75 ----- ------- ------- Outstanding at the end of the year 83,332 57.65 83,432 54.42 92,232 51.75 ====== ====== ====== Options exercisable at year end 83,332 - 66,726 - 42,448 - Available for future grant 27,779 - 27,679 - 18,879 -
36
Options Options Outstanding Exercisable Weighted Weighted Weighted Average Average Average Number Remaining Exercise Number Exercise Range of Exercise Prices Outstanding Life (In Years) Price Exercisable Price ------------------------ ----------- --------------- ----- ----------- ----- $44.17 41,667 4.1 yrs $44.17 41,667 $44.17 $71.14 41,665 4.1 yrs $71.14 41,665 $71.14
The Company applies Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretation in accounting for its stock option plans. Accordingly, no compensation cost has been recognized for such plans. Had compensation cost been determined, based on the fair value at the grant dates for options granted under both the SIG Stock Option Plan and the Superior Group Management Stock Option Plan during 2000, 1999 and 1998 consistent with the method of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, the Company's pro forma net earnings and pro forma earnings per share for the years ended December 31, 2001, 2000 and 1999 would have been as follows:
(Dollars in thousands, except 2001 As 2001 2000 As 2000 1999 As 1999 per share amounts) Reported Pro Forma Reported Pro Forma Reported Pro Forma -------- --------- -------- --------- -------- --------- Net earnings (loss) $(32,892) $(33,096) $(88,425) $(88,709) $(80,816) $(82,513) Basic earnings (loss) per share $(3.17) $(3.19) $(8.51) $(8.54) $(7.78) $(7.95) Fully diluted earnings (loss) per Share $(3.17) $(3.19) $(8.51) $(8.54) $(7.78) $(7.95)
The fair value of each option grant used for purposes of estimating the pro forma amounts summarized above is estimated on the date of grant using the Black-Scholes option-price model with the weighted average assumptions shown in the following table:
SIG SIG SIG 2001 Grants 2000 Grants 1999 Grants ----------- ----------- ----------- Risk-free interest rates N/A 5% N/A Dividend yields N/A - N/A Volatility factors N/A 106% N/A Weighted average expected life N/A 4.0 Years N/A Weighted average fair value per share N/A $0.40 N/A
17. MANAGEMENT'S PLANS The Company reported net losses of $(32.9) million and $(88.4) million for the years 2001 and 2000, respectively, and is a party to a number of legal proceedings and claims. While shareholders' equity at December 31, 2001 is a deficit of approximately $(144) million, the Company has offsetting thirty-year mandatorily redeemable trust preferred stock outstanding of $135 million, which are not due for redemption until 2027. The insurance subsidiaries, excluding IGF, have statutory surplus of approximately $21.9 million. Management has initiated substantial changes in operational procedures in an effort to return the Company to profitable levels and to improve its financial condition. The Company has and is continuing to raise its rates in a market environment where increasing rates and withdrawal from the market by other companies show positive trends for improving profitability of nonstandard automobile insurance underwriters. Beginning in the fourth quarter of 2001 and continuing in January and February 2002, the Company sustained adverse loss experience on a substantial portion of its new business written in certain markets. In late February and early March 2002, the Company commenced further analysis of loss ratios by individual agency and a review of claim settlement procedures. Based on this and other analysis, the Company has as 37 of the filing of this document, taken the following actions to improve the financial position and operating results of the Company: o Eliminated reinstatements in all markets, i.e., upon policy cancellation, the insured must obtain a new policy at prevailing rates and underwriting guidelines; o Terminated or placed on new business moratorium several hundred agents whose loss ratios were abnormally high when compared to the average for the remaining agents (these agents accounted for approximately 16% of the total gross written premium in 2001); o Increased underwriting requirements in certain markets including: higher down payments, new policy fees, and shorter policy terms; o Hired a consultant with significant auto claims experience to review processes and suggest modifications to the claims function. The Company expects the above actions to result in a decline of approximately 10 to 15% in gross written premiums from 2001 levels with a corresponding decrease in management fees payable to Superior Group, offset by reductions in operating expenses due to process changes and efficiencies. Management believes that despite the recent losses and the deterioration in shareholders' equity and statutory surplus, it has developed a business plan that, if successfully implemented, can improve the Company's operating results and financial condition in 2002. 18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Quarterly financial information of continuing operations is as follows (in thousands):
2001 ---- First Second Third Fourth Total ----- ------ ----- ------ ----- Gross written premiums $48,222 $46,868 $27,268 $38,734 $161,092 Net premiums written 16,829 24,620 14,607 (122) 55,934 Net premiums earned 18,728 23,031 22,839 12,349 76,947 Total revenues 22,483 27,858 28,874 16,002 95,217 Net operating loss from Continuing operations (1) (5,011) (2,848) (4,029) (2,686) (14,574) Net loss from continuing operations (2) (9,432) (7,009) (6,824) (7,471) (30,736) Basic operating loss per share from continuing Operations (.48) (.27) (.39) (.26) (1.40) Net loss from continuing operations Per share - basic and diluted (.91) (.68) (.66) (.71) (2.96) 2000 ---- First Second Third Fourth Total ----- ------ ----- ------ ----- Gross written premiums $59,859 $30,032 $45,842 $38,728 $174,461 Net premiums written 30,469 19,346 28,086 17,939 95,840 Net premiums earned 43,042 37,376 30,857 26,431 137,706 Total revenues 50,254 41,822 33,997 29,875 155,948 Net operating loss From continuing operations (1) (5,511) (4,837) (5,952) (2,697) (18,997) Net loss from continuing operations (2) (9,388) (10,365) (12,528) (39,103) (71,384) Basic operating loss per share from continuing Operations (.53) (.47) (.57) (.26) (1.83) Net loss from continuing operations Per share - basic and diluted (.91) (.99) (1.21) (3.76) (6.87)
(1) Operating earnings and per share amounts exclude amortization, interest, taxes, realized capital gains and losses, minority interest, and any extraordinary items. 38 (2) In the fourth quarter of 2000, the Company recorded an impairment charge related to goodwill of $33.5 million and increased reserves on its nonstandard automobile business by $6.9 million for both current and prior accident years. 19. DISCONTINUED OPERATIONS As previously announced, the Company sold its crop insurance operations to Acceptance on June 6, 2001. This business was predominantly written through IGF. The divestiture of the crop insurance segment transferred ownership of crop insurance accounts, effective with the 2001 crop cycle. Management does not expect any remaining crop business to be material to the consolidated financial statements and accordingly has discontinued reporting crop insurance as a business segment. The results of the crop insurance segment have been reflected as "Discontinued Operations" in the accompanying consolidated financial statements. Summarized results of operations and financial position for discontinued operations were as follows: STATEMENTS OF OPERATIONS (in thousands)
Year Ended December 31, 2001 2000 1999 ---- ---- ---- Gross premiums written $256,722 $241,748 $237,286 ======== ======== ======== Net premiums written $(308) $26,466 $12,737 ====== ======= ======= Net premiums earned $(308) $26,531 $14,240 Net investment and fee income 1,657 1,229 749 Net realized capital gain 799 10 21 --- -- -- Total revenues 2,148 27,770 15,010 ----- ------ ------ Loss and loss adjustment expenses 3,559 40,690 34,225 Policy acquisition and general and administrative expenses 654 2,059 215 Interest and amortization expense 91 1,162 1,113 -- ----- ----- Total expenses 4,304 43,911 35,553 ----- ------ ------ Loss before income taxes (2,156) (16,141) (20,543) Income taxes: Current income tax (benefit) - - (5,852) Deferred income tax expense - - 682 ------- ------- --- Total income tax expense (benefit) - - (5,170) ------- ------- ------- Loss from operations of discontinued segment - (16,141) (15,373) Loss on disposal of discontinued segment (2,156) (900) - ------- ----- ------- Net loss from discontinued operations $(2,156) $(17,041) $(15,373) ======== ========= =========
39 -------------------------------------------------- MANAGEMENT'S RESPONSIBILITY -------------------------------------------------- Management recognizes its responsibility for conducting the Company's affairs in the best interests of all its shareholders. The consolidated financial statements and related information in this Annual Report are the responsibility of management. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles, which involve the use of judgement and estimates in applying the accounting principles selected. Other financial information in this Annual Report is consistent with that in the consolidated financial statements. The Company maintains a system of internal controls, which is designed to provide reasonable assurance that accounting records are reliable and to safeguard the Company's assets. The independent accounting firm of BDO Seidman, LLP has audited and reported on the Company's consolidated financial statements for 2001, 2000 and 1999. Their opinion is based upon audits conducted by them in accordance with generally accepted auditing standards to obtain assurance that the consolidated financial statements are free of material misstatements. The Audit Committee of the Board of Directors, the members of which include outside directors, meets with the independent external auditors and management representatives to review the internal accounting controls, the consolidated financial statements and other financial reporting matters. In addition to having unrestricted access to the books and records of the Company, the independent external auditors also have unrestricted access to the Audit Committee. The Audit Committee reports its findings and makes recommendations to the Board of Directors. /s/ Douglas H. Symons -------------------------- Douglas H. Symons President, Chief Executive Officer and Secretary March 25, 2002 40 BOARD OF DIRECTORS AND SHAREHOLDERS OF SYMONS INTERNATIONAL GROUP, INC. AND SUBSIDIARIES INDIANAPOLIS, INDIANA We have audited the accompanying consolidated balance sheets of Symons International Group, Inc. and subsidiaries (the "Company") as of December 31, 2001 and 2000, and the related consolidated statements of earnings (loss), changes in shareholders' equity (deficit) and cash flows for the years ended December 31, 2001, 2000 and 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Symons International Group, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for the years ended December 31, 2001, 2000 and 1999 in conformity with accounting principles generally accepted in the United States of America. The accompanying Consolidated Financial Statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 17 to the consolidated financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency, and as discussed in Note 13 is a party to a number of legal proceedings and claims, that raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 17. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ BDO Seidman, LLP ---------------------- BDO Seidman, LLP Grand Rapids, Michigan March 29, 2002 41 SHAREHOLDER INFORMATION CORPORATE OFFICES REGISTRAR AND TRANSFER AGENT Symons International Group, Inc. National City Bank 4720 Kingsway Drive 4100 West 150th Street Indianapolis, Indiana 46205 3rd Floor (317) 259-6300 Cleveland, Ohio 44135-1385 INDEPENDENT PUBLIC ACCOUNTANTS ANNUAL MEETING OF SHAREHOLDERS BDO Seidman, LLP 4720 Kingsway Drive 99 Monroe, Avenue, N.W., Suite 800 Indianapolis, Indiana 46205 Grand Rapids, Michigan 49503-2698 May 30, 2002 at 10:00 A.M. (EST) ANNUAL REPORT ON FORM 10-K: A copy of the Annual Report on Form 10-K for Symons International Group, Inc. for the year ended December 31, 2001, filed with the Securities and Exchange Commission, may be obtained, without charge, upon request to the individual and address noted under Shareholder Inquiries. MARKET AND DIVIDEND INFORMATION As of July 1, 2000 Symons International Group, Inc.'s common stock began trading on the OTC Bulletin Board under the symbol SIGC.OB. Prior to this date the Company's stock was traded on the NASDAQ Stock Market's National Market. STOCK TRADING PRICES 2001 2000 ---- ---- Quarter Ended High Low High Low ------------- ---- --- ---- --- March 31 $1.19 $.41 $2.16 $.86 June 30 $.59 $.35 $1.31 $.22 September 30 $.51 $.06 $1.25 $.53 December 31 $.17 $.04 $.81 $.16 Quotations reflect inter-dealer prices without retail markdown or commission and may not represent actual transactions. As previously reported on October 25, 2000 the NASDAQ Listing and Hearing Review Council affirmed the decision of the NASDAQ Listing Qualifications Panel to delist the Company's securities from the NASDAQ National Market. As of March 27, 2002, the Company had approximately 1,200 shareholders, based on the number of holders of record and an estimate of the number of individual participants represented by securities position listings. Symons International Group, Inc. did not declare or pay cash dividends on its common stock during the years ended December 31, 2001, 2000 and 1999, nor does the Company presently plan to pay cash dividends on its common stock. Upstream dividend payments to the Company by its insurance subsidiaries are subject to restrictions and limitations under applicable laws under which an insurance subsidiary may not pay dividends to the Company without prior notice to, or approval by, the subsidiary's domiciling insurance regulator. The indenture relating to the Preferred Securities currently prohibits the payment of dividends on the common stock. 42 SHAREHOLDER INQUIRIES INQUIRIES SHOULD BE DIRECTED TO: Mr. Douglas H. Symons President, Chief Executive Officer and Secretary Symons International Group, Inc. Tel.: (317) 259-6413 Email: dsymons@sigins.com BOARD OF DIRECTORS G. GORDON SYMONS Chairman of the Board Symons International Group, Inc. and Goran Capital Inc. ALAN G. SYMONS Vice Chairman of the Board Symons International Group, Inc. President and Chief Executive Officer Goran Capital Inc. DOUGLAS H. SYMONS President and Chief Executive Officer Symons International Group, Inc. Vice President and Chief Operating Officer Goran Capital Inc. ROBERT C. WHITING President Prime Advisors, Ltd. LARRY S. WECHTER Managing Director and Chief Executive Officer Monument Advisors, Inc. GENE S. YERANT Executive Vice President Symons International Group, Inc. President Superior Insurance Group, Inc. TERRY W. ANKER Chairman of the Board Anthology Companies 43 EXECUTIVE OFFICERS DOUGLAS H. SYMONS President, Chief Executive Officer and Secretary Symons International Group, Inc. GENE S. YERANT Executive Vice President Symons International Group, Inc. President Superior Insurance Group, Inc. GREGG F. ALBACETE Vice President and Chief Information Officer Symons International Group, Inc. DAVID N. HAFLING Vice President and Chief Actuary Symons International Group, Inc. MARK A. PAUL Vice President, Chief Financial Officer and Treasurer Symons International Group, Inc. COMPANY, SUBSIDIARY AND BRANCH OFFICES CORPORATE OFFICE Symons International Group, Inc. 4720 Kingsway Drive Indianapolis, Indiana 46205 Tel: 317-259-6300 Fax: 317-259-6395 Website: WWW.SIGINS.COM SUBSIDIARY AND BRANCH OFFICES Superior Insurance Group, Inc. 4720 Kingsway Drive Indianapolis, Indiana 46205 Tel: 317-259-6300 Fax: 317-259-6395 Website: WWW.SIGAUTO.COM Pafco General Insurance Company 4720 Kingsway Drive Indianapolis, Indiana 46205 Tel: 317-259-6300 Fax: 317-259-6395 Superior Insurance Company 280 Interstate North Circle, N.W., Suite 500 Atlanta, Georgia 30339 Tel: 770-952-4885 Fax: 770-988-8583 44 IGF Insurance Company 4720 Kingsway Drive Indianapolis, Indiana 46205 Tel: 317-259-6300 Fax: 317-259-6395 Superior Insurance Company - Claims Office 1745 West Orangewood Road, Suite 210 Orange, California 92826 Tel: 714-978-6811 Fax: 714-978-0353 Superior Insurance Company - Claims Office 6303 Little River Turnpike, Suite 220 Alexandria, Virginia 22312 Tel: 703-916-8001 Fax: 703-916-1783 Superior Insurance Company - Claims Office 700N Central Avenue, Suite 570 Glendale, California 91203 Tel: 818-956-3077 Fax: 818-956-3069 Superior Insurance Company - Claims Office 5503 W Waters Avenue, Suite 500 Tampa, Florida 33634 Tel: 813-887-4878 Fax: 813-243-0268 Superior Insurance Company - Claims Office 141 Union Boulevard, Suite 130 Lakewood, Colorado 80228 Tel: 303-984-7000 Fax: 303-985-1253 Superior Insurance Company- Claims Office 4500 PGA Boulevard, Suite 304A Palm Beach Gardens, Florida 33418 Tel: 561-622-7831 Fax: 561-622-9741 Superior Insurance Company- Claims Office 7775 Baymeadows Way, Suite 107 Jacksonville, Florida 32256 Tel: Pending Fax: Pending Superior Insurance Company- Claims Office 5700 Cleveland Street, Suite 336 Virginia Beach, Virginia 23462 Tel: 757-499-0500 Fax: 757-499-0560 45