10-Q 1 w62917e10vq.txt FORM 10-Q PHILADELPHIA CONSOLIDATED HOLDING CORP. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended June 30, 2002 COMMISSION FILE NUMBER 0-22280 PHILADELPHIA CONSOLIDATED HOLDING CORP. --------------------------------------- (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2202671 ------------ ---------- (State of Incorporation) (IRS Employer Identification No.) ONE BALA PLAZA, SUITE 100 BALA CYNWYD, PENNSYLVANIA 19004 (610) 617-7900 ----------------------------------------- (Address, including zip code and telephone number, including area code, of registrant's principal executive offices) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES: [X] NO [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock as of August 8, 2002. Preferred Stock, $.01 par value, no shares outstanding Common Stock, no par value, 21,626,402 shares outstanding PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES INDEX FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002 Part I - Financial Information Item 1. Financial Statements: Consolidated Balance Sheets - June 30, 2002 and December 31, 2001 3 Consolidated Statements of Operations and Comprehensive Income - For the three and six months ended June 30, 2002 and 2001 4 Consolidated Statements of Changes in Shareholders' Equity - For the six months ended June 30, 2002 and year ended December 31, 2001 5 Consolidated Statements of Cash Flows - For the six months ended June 30, 2002 and 2001 6 Notes to Consolidated Financial Statements 7-11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12-17 Item 3. Quantitative and Qualitative Disclosures About Market Risk 18 Part II - Other Information 19-21 Signatures 22
2 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
As of -------------------------------------------- June 30, December 31, 2002 2001 (Unaudited) ----------------- ------------------ ASSETS INVESTMENTS: FIXED MATURITIES AVAILABLE FOR SALE AT MARKET (AMORTIZED COST $708,101 AND $626,326)..................... $ 721,681 $ 632,416 EQUITY SECURITIES AT MARKET (COST $42,653 AND $34,065)............................................... 47,185 40,992 ------------ ------------ TOTAL INVESTMENTS........................................ 768,866 673,408 CASH AND CASH EQUIVALENTS.................................... 45,711 49,910 ACCRUED INVESTMENT INCOME.................................... 7,722 6,582 PREMIUMS RECEIVABLE.......................................... 109,609 96,025 PREPAID REINSURANCE PREMIUMS AND REINSURANCE RECEIVABLES...................................... 98,031 99,601 DEFERRED INCOME TAXES........................................ 7,480 6,196 DEFERRED ACQUISITION COSTS................................... 48,836 41,526 PROPERTY AND EQUIPMENT, NET.................................. 10,609 10,082 GOODWILL..................................................... 25,724 25,724 OTHER ASSETS................................................. 6,882 8,668 ------------ ------------ TOTAL ASSETS............................................ $ 1,129,470 $ 1,017,722 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY POLICY LIABILITIES AND ACCRUALS: UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES..................... $ 331,889 $ 302,733 UNEARNED PREMIUMS............................................ 244,905 197,839 ------------ ------------ TOTAL POLICY LIABILITIES AND ACCRUALS.................... 576,794 500,572 LOANS PAYABLE................................................ 31,341 31,341 PREMIUMS PAYABLE............................................. 32,451 25,659 OTHER LIABILITIES............................................ 34,282 31,458 ------------ ------------ TOTAL LIABILITIES........................................ 674,868 589,030 ------------ ------------ COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: PREFERRED STOCK, $.01 PAR VALUE, 10,000,000 SHARES AUTHORIZED, - - NONE ISSUED AND OUTSTANDING................................ COMMON STOCK, NO PAR VALUE, 100,000,000 SHARES AUTHORIZED, 21,626,519 AND 21,509,723 SHARES ISSUED AND OUTSTANDING................... 270,977 268,509 NOTES RECEIVABLE FROM SHAREHOLDERS........................... (2,873) (3,373) ACCUMULATED OTHER COMPREHENSIVE INCOME....................... 11,773 8,461 RETAINED EARNINGS............................................ 174,725 155,095 ------------ ------------ TOTAL SHAREHOLDERS' EQUITY............................... 454,602 428,692 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............... $ 1,129,470 $ 1,017,722 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 3 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (Unaudited)
For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------------------- ------------------------------- 2002 2001 2002 2001 ------------- -------------- ------------- -------------- REVENUE: NET EARNED PREMIUMS............................... $ 100,273 $ 71,703 $ 189,517 $ 138,226 NET INVESTMENT INCOME............................. 9,375 8,091 18,230 16,133 NET REALIZED INVESTMENT GAIN (LOSS)............... (3,181) 318 (3,134) 2,617 OTHER INCOME...................................... 15 63 16 116 ----------- ----------- ----------- ----------- TOTAL REVENUE................................... 106,482 80,175 204,629 157,092 ----------- ----------- ----------- ----------- LOSSES AND EXPENSES: LOSS AND LOSS ADJUSTMENT EXPENSES................. 72,067 54,686 137,678 100,224 NET REINSURANCE RECOVERIES........................ (11,235) (11,820) (23,797) (18,206) ------------ ------------ ------------ ------------ NET LOSS AND LOSS ADJUSTMENT EXPENSES............. 60,832 42,866 113,881 82,018 ACQUISITION COSTS AND OTHER UNDERWRITING EXPENSES........................ 31,057 22,695 58,878 45,163 OTHER OPERATING EXPENSES.......................... 1,454 2,130 2,938 4,162 ----------- ----------- ----------- ----------- TOTAL LOSSES AND EXPENSES....................... 93,343 67,691 175,697 131,343 ----------- ----------- ----------- ----------- MINORITY INTEREST: DISTRIBUTIONS ON COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST.................................. - 938 - 2,749 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES........................... 13,139 11,546 28,932 23,000 ----------- ----------- ----------- ----------- INCOME TAX EXPENSE (BENEFIT): CURRENT........................................... 5,798 5,921 12,369 10,698 DEFERRED.......................................... (1,612) (2,111) (3,067) (3,148) ------------ ------------ ------------ ------------ TOTAL INCOME TAX EXPENSE........................ 4,186 3,810 9,302 7,550 ----------- ----------- ----------- ----------- NET INCOME...................................... $ 8,953 $ 7,736 $ 19,630 $ 15,450 =========== =========== =========== =========== OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX: HOLDING GAIN (LOSS) ARISING DURING PERIOD............. 5,334 (921) 1,275 (1,512) RECLASSIFICATION ADJUSTMENT........................... 2,068 (207) 2,037 (1,701) ----------- ------------ ----------- ------------ OTHER COMPREHENSIVE INCOME (LOSS)..................... 7,402 (1,128) 3,312 (3,213) ----------- ------------ ----------- ------------ COMPREHENSIVE INCOME..................................... $ 16,355 $ 6,608 $ 22,942 $ 12,237 =========== =========== =========== =========== PER AVERAGE SHARE DATA: BASIC EARNINGS PER SHARE.......................... $ 0.41 $ 0.50 $ 0.91 $ 1.06 =========== =========== =========== =========== DILUTED EARNINGS PER SHARE........................ $ 0.40 $ 0.48 $ 0.88 $ 1.01 =========== =========== =========== =========== WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING....................................... 21,578,045 15,587,962 21,553,206 14,538,780 WEIGHTED-AVERAGE SHARE EQUIVALENTS OUTSTANDING....................................... 753,575 692,256 741,742 712,939 ----------- ----------- ----------- ----------- WEIGHTED-AVERAGE SHARES AND SHARE EQUIVALENTS OUTSTANDING........................... 22,331,620 16,280,218 22,294,948 15,251,719 =========== =========== =========== ===========
The accompanying notes are an integral part of the consolidated financial statements. 4 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS)
For the Six Months Ended For the Year Ended June 30, 2002 December 31, (Unaudited) 2001 --------------------- --------------------- COMMON STOCK: BALANCE AT BEGINNING OF YEAR.................................. $ 268,509 $ 46,582 ISSUANCE OF SHARES PURSUANT TO PUBLIC OFFERING................ - 114,518 ISSUANCE OF SHARES PURSUANT TO STOCK PURCHASE CONTRACTS.......................................... - 98,905 EXERCISE OF EMPLOYEE STOCK OPTIONS............................ 2,115 6,437 ISSUANCE OF SHARES PURSUANT TO STOCK PURCHASE PLANS.............................................. 353 2,067 ----------------- ----------------- BALANCE AT END OF PERIOD.................................. 270,977 268,509 ----------------- ----------------- NOTES RECEIVABLE FROM SHAREHOLDERS: BALANCE AT BEGINNING OF YEAR.................................. (3,373) (2,287) NOTES RECEIVABLE FORFEITED (ISSUED) PURSUANT TO STOCK PURCHASE PLAN...................................... 46 (2,158) COLLECTION OF NOTES RECEIVABLE................................ 454 1,072 ----------------- ----------------- BALANCE AT END OF PERIOD.................................. (2,873) (3,373) ------------------ ------------------ ACCUMULATED OTHER COMPREHENSIVE INCOME, NET OF DEFERRED INCOME TAXES: BALANCE AT BEGINNING OF YEAR.................................. 8,461 13,494 OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAXES............... 3,312 (5,033) ----------------- ------------------ BALANCE AT END OF PERIOD.................................. 11,773 8,461 ----------------- ----------------- RETAINED EARNINGS: BALANCE AT BEGINNING OF YEAR.................................. 155,095 124,536 NET INCOME.................................................... 19,630 30,559 ----------------- ----------------- BALANCE AT END OF PERIOD.................................. 174,725 155,095 ----------------- ----------------- TOTAL SHAREHOLDERS' EQUITY................................ $ 454,602 $ 428,692 ================= =================
The accompanying notes are an integral part of the consolidated financial statements. 5 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (Unaudited)
For the Six Months Ended June 30, ----------------------------------------- 2002 2001 ---------------- ------------------ CASH FLOWS FROM OPERATING ACTIVITIES: NET INCOME $ 19,630 $ 15,450 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: NET REALIZED INVESTMENT (GAIN) LOSS........................ 3,134 (2,617) DEPRECIATION AND AMORTIZATION EXPENSE...................... 738 1,225 DEFERRED INCOME TAX BENEFIT................................ (3,067) (3,148) CHANGE IN PREMIUMS RECEIVABLE................................ (13,584) (1,281) CHANGE IN OTHER RECEIVABLES................................ 430 (15,356) CHANGE IN INCOME TAXES PAYABLE............................... (3,078) (8,015) CHANGE IN DEFERRED ACQUISITION COSTS....................... (7,310) (5,596) CHANGE IN OTHER ASSETS..................................... 5 784 CHANGE IN UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES................................................... 29,156 31,094 CHANGE IN UNEARNED PREMIUMS................................ 47,066 31,188 CHANGE IN OTHER LIABILITIES................................ 10,134 (137) TAX BENEFIT FROM EXERCISE OF EMPLOYEE STOCK OPTIONS............................................. 1,251 24,474 ---------------- ------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES.............. 84,505 68,065 ---------------- ------------------ CASH FLOWS FROM INVESTING ACTIVITIES: PROCEEDS FROM SALES OF INVESTMENTS IN FIXED MATURITIES............................................... 137,290 23,311 PROCEEDS FROM MATURITY OF INVESTMENTS IN FIXED MATURITIES............................................... 49,730 25,482 PROCEEDS FROM SALES OF INVESTMENTS IN EQUITY SECURITIES............................................... 12,891 11,988 COST OF FIXED MATURITIES ACQUIRED............................ (264,746) (131,266) COST OF EQUITY SECURITIES ACQUIRED........................... (23,850) (7,695) PURCHASE OF PROPERTY AND EQUIPMENT, NET...................... (1,736) (1,083) ---------------- ------------------ NET CASH USED BY INVESTING ACTIVITIES.................... (90,421) (79,263) ---------------- ------------------ CASH FLOWS FROM FINANCING ACTIVITIES: REPAYMENTS ON LOANS PAYABLE.................................. - (22,000) PROCEEDS FROM LOANS PAYABLE.................................. - 20,841 PROCEEDS FROM EXERCISE OF EMPLOYEE STOCK OPTIONS............. 864 1,860 PROCEEDS FROM COLLECTION OF NOTES RECEIVABLE................. 454 435 PROCEEDS FROM SHARES ISSUED PURSUANT TO STOCK PURCHASE PLANS....................................... 399 24 ---------------- ------------------ NET CASH PROVIDED BY FINANCING ACTIVITIES.............. 1,717 1,160 ---------------- ------------------ NET DECREASE IN CASH AND CASH EQUIVALENTS....................... (4,199) (10,038) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD................ 49,910 49,742 ---------------- ------------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD...................... $ 45,711 $ 39,704 ================ ================== CASH PAID DURING THE PERIOD FOR: INCOME TAXES................................................. $ 13,936 $ - INTEREST..................................................... $ 288 $ 130 NON-CASH TRANSACTIONS: ISSUANCE OF SHARES (FORFEITURES) PURSUANT TO EMPLOYEE STOCK PURCHASE PLAN IN EXCHANGE FOR NOTES RECEIVABLE............................................ $ (46) $ (84) ISSUANCE OF COMMON SHARES IN SATISFACTION OF STOCK PURCHASE CONTRACTS.................................... $ - $ 98,905
The accompanying notes are an integral part of the consolidated financial statements. 6 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The consolidated financial statements as of and for the six months ended June 30, 2002 and 2001 are unaudited, but in the opinion of management, have been prepared on the same basis as the annual audited consolidated financial statements and reflect all adjustments, consisting of only normal recurring accruals, necessary for a fair statement of the information set forth therein. The results of operations for the six months ended June 30, 2002 are not necessarily indicative of the operating results to be expected for the full year or any other period. These financial statements should be read in conjunction with the financial statements and notes included in the Company's Annual Report on Form 10-K as of and for the year ended December 31, 2001. 2. Investments The carrying amounts for the Company's investments approximates their estimated fair value, except for investments in limited partnerships, which are valued at cost. The Company measures the fair value of investments based upon quoted market prices or by obtaining quotes from dealers. At June 30, 2002, the Company held no derivative financial instruments or embedded financial derivatives. The Company performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed to determine whether a decline in fair value below a security's cost basis is other than temporary. If the Company determines a decline in value to be other than temporary, the cost basis of the security is written down to its fair value with the amount of the write down included in earnings as a realized loss in the period the impairment arose. The Company's impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. Under this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent (prior) estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. Realized losses recorded for the three months ended June 30, 2002 and 2001 were $1.2 million and $4.3 million, respectively, and for the six months ended June 30, 2002 and 2001 were $1.2 million and $4.3 million, respectively, as a result of this impairment evaluation. 3. Goodwill The Company adopted the provisions of Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets" on January 1, 2002. SFAS No. 142 eliminates the practice of amortizing goodwill through periodic charges to earnings and establishes a new methodology for recognizing and measuring goodwill and other intangible assets. Under this new accounting standard, the Company ceased goodwill amortization on January 1, 2002. Goodwill amortization for the six months ended June 30, 2001 amounted to $0.8 million. 7 The following table provides a reconciliation of the prior year's three and six month periods ended June 30 reported net income to adjusted net income had SFAS No. 142 been applied at the beginning of fiscal 2001 (in millions, except per share amounts):
Three Months Ended June 30, Six Months Ended June 30, -------------------------------- ------------------------------ 2002 2001 2002 2001 -------------- -------------- ------------ -------------- Reported net income $ 8,953 $ 7,736 $ 19,630 $ 15,450 Adjustment for goodwill amortization - 376 - 752 -------------- -------------- ------------ -------------- Adjusted net income $ 8,953 $ 8,112 $ 19,630 $ 16,202 ============== ============== ============ ============== Reported basic earnings per share $ 0.41 $ 0.50 $ 0.91 $ 1.06 Adjustment for goodwill amortization - 0.02 - 0.05 -------------- -------------- ------------ -------------- Adjusted basic earnings per share $ 0.41 $ 0.52 $ 0.91 $ 1.11 ============== ============== ============ ============== Reported diluted earnings per share $ 0.40 $ 0.48 $ 0.88 $ 1.01 Adjustment for goodwill amortization - 0.02 - 0.05 -------------- -------------- ------------ -------------- Adjusted diluted earnings per share $ 0.40 $ 0.50 $ 0.88 $ 1.06 ============== ============== ============ ==============
4. Liability for Unpaid Loss and Loss Adjustment Expenses The liability for unpaid loss and loss adjustment expenses reflects the Company's best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events. Estimating the ultimate claims liability is necessarily a complex and judgmental process, inasmuch as the amounts are based on management's informed estimates and judgments using data currently available. In some cases significant periods of time, up to several years or more, may elapse between the occurrence of an insured loss and the reporting of such to the Company. The method for determining the Company's liability for unpaid loss and loss adjustment expenses includes, but is not limited to, reviewing past loss experience and considering other factors such as legal, social, and economic developments. As additional experience and data become available the Company's estimate for the liability for unpaid loss and loss adjustment expenses is revised accordingly. If the Company's ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at June 30, 2002, the related adjustments could have a material adverse impact on the Company's financial condition, and results of operations. As a result of changes in estimates of insured events in prior years, the Company increased loss and loss adjustment expenses incurred by $5.0 million during the second quarter ended June 30, 2002. Such adverse loss development is due to losses emerging at a higher rate on automobile leases currently expiring on residual value policies underwritten during the years 1996 through 1998 than had been originally anticipated when the reserves were estimated as a result of changes in the automobile after market. The Company continues to evaluate and monitor the remaining leases outstanding on its residual value policies underwritten during the period 1996 through 2002. As part of this evaluation the Company has recently engaged an outside consulting firm, which is a leading provider of residual values, portfolio risk analysis and analytical data products to the automotive industry, to further evaluate the current conditions and determine the impact, if any, on the Company's outstanding residual value policies as a result of changes in the benchmark for residual values and the automotive after market which have occurred subsequent to the inception date of the Company's policies. It is expected that the outside consulting firm will complete their analysis during the third quarter of 2002. 5. Loans Payable As of June 30, 2002, the Company had aggregate borrowings of $31.3 million from the Federal Home Loan Bank. These borrowings bear interest at adjusted LIBOR and mature twelve months from inception. The proceeds from these borrowings were invested in collateralized mortgage obligation and asset backed securities to achieve a positive spread between the rate of interest on these securities and the borrowing rates. 8 6. Earnings Per Share Earnings per common share has been calculated by dividing net income for the period by the weighted average number of common shares and common share equivalents outstanding during the period. Following is the computation of earnings per share for the three and six months ended June 30, 2002 and 2001, respectively (in thousands):
As of and For the Three As of and For the Six Months Ended June 30, Months Ended June 30 -------------------------- --------------------------- 2002 2001 2002 2001 ----------- ----------- ---------- ----------- Weighted-Average Common Shares Outstanding 21,578 15,588 21,553 14,539 Weighted-Average Share Equivalents Outstanding 754 692 742 713 -------- -------- -------- -------- Weighted-Average Shares and Share Equivalents Outstanding 22,332 16,280 22,295 15,252 ======== ======== ======== ======== Net Income $ 8,953 $ 7,736 $ 19,630 $ 15,450 ======== ======== ======== ======== Basic Earnings per Share $ 0.41 $ 0.50 $ 0.91 $ 1.06 ======== ======== ======== ======== Diluted Earnings per Share $ 0.40 $ 0.48 $ 0.88 $ 1.01 ======== ======== ======== ========
7. Income Taxes The effective tax rate differs from the 35% marginal tax rate principally as a result of tax-exempt interest income, the dividend received deduction and other differences in the recognition of revenues and expenses for tax and financial reporting purposes. 8. Commitments and Contingencies On April 30, 2002, U.S. Bank, N.A. d/b/a Firstar Bank ("Firstar"), a bank to which one of the Company's insurance subsidiaries, Philadelphia Indemnity Insurance Company ("PIIC"), issued insurance coverages, filed a complaint against PIIC in the United States District Court for the Southern District of Ohio (Western Division). The complaint asks for damages and a declaratory judgment against PIIC. The complaint arises principally out of a loss adjustment change and also relates to other coverage interpretations made by PIIC under the terms of residual value protection insurance policies issued to Firstar relating to vehicles financed by Firstar. The complaint alleges that as a result of the loss adjustment change Firstar may suffer damages of as much as $75,000,000. On June 27, 2002, PIIC filed an answer to the complaint denying liability with respect to the matters set forth above. PIIC believes that this claim is without merit and intends to vigorously defend this action. As previously reported in the Company's Form 10-Q for the period ending March 31, 2001 and Form 10-K for the period ending December 31, 2001, two of the Company's subsidiaries, Liberty American Insurance Group Inc. and Mobile Homeowners Insurance Agency Inc., had filed an action in the U.S. District Court in the Middle District of Florida against WestPoint Underwriters LLC, a managing general agent, two former employees of Liberty American and a third individual, and a federal magistrate judge issued a report and recommendations to the Federal District court. With respect to Liberty American's request for preliminary relief, the findings and recommendations stated that one of the former employees had misappropriated Liberty American's trade secrets by using its software to write WestPoint's software. The magistrate judge recommended against injunctive relief, finding that damages may be available as a remedy. Liberty American objected, in part, to the findings. The District Court judge has now issued orders denying Liberty American's objections to the findings, adopting substantially all the magistrate judge's recommendations and dismissing the Company's subsidiaries' claim against the third individual referred to above. The claims against WestPoint and the two former employees referred to above are still pending. The accompanying financial statements contain no benefit, if any, from damages related to this action. 9. Comprehensive Income Components of comprehensive income, as detailed in the Consolidated Statements of Operations and Comprehensive Income, are net of tax. The related tax effect of Holding Gains (Losses) arising during the three and six months ended June 30, 2002 and 2001 was $2.9 million and ($0.5) million, respectively, and $0.7 million and ($0.8) million, respectively. The related tax effect of Reclassification Adjustments for the three and six months ended June 30, 2002 and 2001 was $1.1 million and ($0.1) million, respectively, and $1.1 million and ($0.9) million respectively. 9 10. Segment Information The Company's operations are classified into three reportable business segments: The Commercial Lines Underwriting Group ("Commercial Lines"), which has underwriting responsibility for the Commercial Automobile and Commercial Property and Commercial multi-peril package insurance products; the Specialty Lines Underwriting Group ("Specialty Lines"), which has underwriting responsibility for the professional liability insurance products; and the Personal Lines Group ("Personal Lines"), which designs, markets and underwrites personal property and casualty insurance products for the Manufactured Housing and Homeowners markets. The reportable segments operate solely within the United States. The segments follow the same accounting policies used for the Company's consolidated financial statements. Management evaluates a segment's performance based upon underwriting results. Following is a tabulation of business segment information for the three and six months ended June 30, 2002 and 2001. Corporate information is included to reconcile segment data to the consolidated financial statements (in thousands):
Six Months Ended, ----------------------------------------------------------------- Commercial Specialty Personal Lines Lines Lines Corporate Total ----------------------------------------------------------------- June 30, 2002: Gross Written Premiums $ 199,029 $ 52,324 $ 45,894 - $ 297,247 ----------------------------------------------------------------- Net Written Premiums $ 161,202 $ 48,488 $ 25,169 - $ 234,859 ----------------------------------------------------------------- Revenue: Net Earned Premiums $ 131,346 $ 39,408 $ 18,763 - $ 189,517 Net Investment Income - - - 18,230 18,230 Net Realized Investment Loss - - - (3,134) (3,134) Other Income - - 922 (906) 16 ----------------------------------------------------------------- Total Revenue 131,346 39,408 19,685 14,190 204,629 ----------------------------------------------------------------- Losses and Expenses: Net Loss and Loss Adjustment Expenses 37,81,266 23,153 9,462 - 113,881 Acquisition Costs and Other Underwriting Expenses - - - 58,878 58,878 Other Operating Expenses - - 62 2,876 2,938 ----------------------------------------------------------------- Total Losses and Expenses 81,266 23,153 9,524 61,754 175,697 ----------------------------------------------------------------- Income Before Income Taxes 50,080 16,255 10,161 (47,564) 28,932 Total Income Tax Expense - - - 9,302 9,302 ----------------------------------------------------------------- Net Income $ 50,080 $ 16,255 $ 10,161 $ (56,866) $ 19,630 ================================================================= Total Assets - - $ 193,830 $ 935,640 $ 1,129,470 ================================================================= June 30, 2001: Gross Written Premiums $ 135,590 $ 41,598 $ 47,519 - $ 224,707 ----------------------------------------------------------------- Net Written Premiums $ 94,306 $ 36,732 $ 28,585 - $ 159,623 ----------------------------------------------------------------- Revenue: Net Earned Premiums $ 86,077 $ 32,711 $ 19,438 - $ 138,226 Net Investment Income - - - 16,133 16,133 Net Realized Investment Gain - - - 2,617 2,617 Other Income - - 1,598 (1,482) 116 ----------------------------------------------------------------- Total Revenue 86,077 32,711 21,036 17,268 157,092 ----------------------------------------------------------------- Losses and Expenses: Net Loss and Loss Adjustment Expenses 51,510 20,604 9,904 - 82,018 Acquisition Costs and Other Underwriting Expenses - - - 45,163 45,163 Other Operating Expenses - - 778 3,384 4,162 ----------------------------------------------------------------- Total Losses and Expenses 51,510 20,604 10,682 48,547 131,343 ----------------------------------------------------------------- Minority Interest: Distributions on Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust - - - 2,749 2,749 ----------------------------------------------------------------- Income Before Income Taxes 34,567 12,107 10,354 (34,028) 23,000 Total Income Tax Expense - - - 7,550 7,550 ----------------------------------------------------------------- Net Income $ 34,567 $ 12,107 $ 10,354 $ (41,578) $ 15,450 ================================================================= Total Assets - - $ 169,520 $ 636,124 $ 805,644 =================================================================
10
Three Months Ended, ------------------------------------------------------------------ Commercial Specialty Personal Lines Lines Lines Corporate Total ------------------------------------------------------------------ June 30, 2002: Gross Written Premiums $ 108,471 $ 27,895 $ 24,414 $ - $ 160,780 ------------------------------------------------------------------ Net Written Premiums $ 86,340 $ 25,715 $ 13,305 $ - $ 125,360 ------------------------------------------------------------------ Revenue: Net Earned Premiums $ 70,275 $ 20,474 $ 9,524 - $ 100,273 Net Investment Income - - - 9,375 9,375 Net Realized Investment Loss - - - (3,181) (3,181) Other Income - - 352 (337) 15 ------------------------------------------------------------------ Total Revenue 70,275 20,474 9,876 5,857 106,482 ------------------------------------------------------------------ Losses and Expenses: Net Loss and Loss Adjustment Expenses 44,609 11,487 4,736 - 60,832 Acquisition Costs and Other Underwriting Expenses - - - 31,057 31,057 Other Operating Expenses - - 43 1,411 1,454 ------------------------------------------------------------------ Total Losses and Expenses 44,609 11,487 4,779 32,468 93,343 ------------------------------------------------------------------ Income Before Income Taxes 25,666 8,987 5,097 (26,611) 13,139 Total Income Tax Expense - - - 4,186 4,186 ------------------------------------------------------------------ Net Income $ 25,666 $ 8,987 $ 5,097 $ (30,797) $ 8,953 ================================================================== Total Assets - - $ 193,830 $ 935,640 $ 1,129,470 ================================================================== June 30, 2001: Gross Written Premiums $ 75,200 $ 21,015 $ 24,459 - $ 120,674 ------------------------------------------------------------------ Net Written Premiums $ 52,495 $ 18,847 $ 11,194 - $ 82,536 ------------------------------------------------------------------ Revenue: Net Earned Premiums $ 44,659 $ 16,855 $ 10,189 - $ 71,703 Net Investment Income - - - 8,091 8,091 Net Realized Investment Gain - - - 318 318 Other Income - - 693 (630) 63 ------------------------------------------------------------------ Total Revenue 44,659 16,855 10,882 7,779 80,175 ------------------------------------------------------------------ Losses and Expenses: Net Loss and Loss Adjustment Expenses 27,097 10,586 5,183 - 42,866 Acquisition Costs and Other Underwriting Expenses - - - 22,695 22,695 Other Operating Expenses - - 389 1,741 2,130 ------------------------------------------------------------------ Total Losses and Expenses 27,097 10,586 5,572 24,436 67,691 ------------------------------------------------------------------ Minority Interest: Distributions on Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust - - - 938 938 ------------------------------------------------------------------ Income Before Income Taxes 17,562 6,269 5,310 (17,595) 11,546 Total Income Tax Expense - - - 3,810 3,810 ------------------------------------------------------------------ Net Income $ 17,562 $ 6,269 $ 5,310 $ (21,405) $ 7,736 ================================================================== Total Assets - - $ 169,520 $ 636,124 $ 805,644 ==================================================================
11 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL Although the Company's financial performance is dependent upon its own specific business characteristics, certain risk factors can affect the profitability of the Company. These include, but are not limited to: o Industry factors - Historically the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical patterns of soft markets followed by hard markets. The Company's strategy is to focus on underwriting profits, and accordingly the Company's marketing organization is being directed into those niche businesses that exhibit the greatest potential for underwriting profits. o Competition - The Company competes in the property and casualty business with other domestic and international insurers having greater financial and other resources than the Company. o Regulation - The Company's insurance subsidiaries are subject to a substantial degree of regulatory oversight, which generally is designed to protect the interests of policyholders, as opposed to shareholders. o Inflation - Property and casualty insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such amounts is known. o Investment Risk - Substantial future increases in interest rates could result in a decline in the market value of the Company's investment portfolio and resulting losses and/or reduction in shareholders' equity. o Catastrophe Exposure - The Company's insurance subsidiaries issue insurance policies which provide coverage for commercial and personal property and casualty risks. It is possible that a catastrophic event could greatly increase claims under the insurance policies the insurance subsidiaries issue. Catastrophes may result from a variety of events or conditions, including hurricanes, windstorms, earthquakes, hail and other severe weather conditions and may include terrorist events. It is possible that a catastrophic event could adversely impact profitability. The above risk factors should be read in conjunction with the Certain Critical Accounting Estimates and Judgments included in the Company's Annual Report on Form 10-K For the Fiscal Year Ended December 31, 2001. RESULTS OF OPERATIONS (SIX MONTHS ENDED JUNE 30, 2002 VS. JUNE 30, 2001) Premiums: Gross written premiums grew $72.5 million (32.3%) to $297.2 million for the six months ended June 30, 2002 from $224.7 million for the same period of 2001; gross earned premiums grew $58.1 million (30.2%) to $250.5 million for the six months ended June 30, 2002 from $192.4 million for the same period of 2001; net written premiums increased $75.3 million (47.2%) to $234.9 million for the six months ended June 30, 2002 from $159.6 million for the same period of 2001; and net earned premiums grew $51.3 million (37.1%) to $189.5 million in 2002 from $138.2 million in 2001. The respective gross written premium increases (decreases) for commercial lines, specialty lines and personal lines segments for the six months ended June 30, 2002 vs. June 30, 2001 amount to $63.4 million (46.8%), $10.7 million (25.8%) and ($1.6) million (3.4%) respectively. The overall growth in gross written premiums is primarily attributable to the following: o Rating downgrades of certain major competitor property and casualty insurance companies have led to their diminished presence in the Company's commercial and specialty lines business segments and continue to result in additional prospects and increased premium writings, most notably for the Company's various commercial package and non-profit D&O product lines. 12 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) o The consolidation of certain competitor property and casualty insurance companies has led to the displacement of certain of their independent agency relationships. This consolidation continues to result in new agency relationship opportunities for the Company. These relationships have resulted in additional prospects and premium writings for the Company's commercial and specialty lines segments. o Continued expansion of marketing efforts relating to commercial lines and specialty lines products through the Company's field organization and preferred agents. o Rate increases. Overall premium growth in the specialty lines segment has been offset in part by the Company's decision not to renew certain policies in the professional liability product lines due to inadequate pricing levels being experienced as a result of market conditions and/or loss experience emerging at higher than expected levels. The overall premium decrease for the personal lines segment was due principally to the Company's decision not to write new business or renew certain policies in designated areas of Florida in the Company's manufactured housing product line, based on an evaluation of property exposures. This decrease has been partially offset by an increase in premiums for the Company's homeowners product line for which new and renewal policies are being added in select areas. Pursuant to a routine underwriting review which focused on pricing adequacy, loss experience, as well as other underwriting criteria, the Company cancelled a Commercial Automobile Excess Liability Insurance customer (Commercial Lines Underwriting Group) effective October 22, 2002 as a result of an unacceptable underwriting risk profile. Such customer's gross written premium and net written premium amounted to $45.8 million and $11.8 million, respectively, for the year ended December 31, 2001 and $20.1 million and $5.8 million, respectively, for the six months ended June 30, 2002. The respective net written premium increases (decreases) for commercial lines, specialty lines and personal lines segments for the six months ended June 30, 2002 vs. June 30, 2001 amount to $66.9 million (70.9%), $11.8 million (32.0%) and ($3.4) million (12.0%) respectively. The differing percentage increases (decreases) in net written premiums versus gross written premiums for the period is primarily due to the Company commuting a 2001 accident year aggregate stop loss reinsurance program whereby net written and net earned premiums increased by $3.6 million ($2.4 million Commercial Lines, $0.8 million Specialty Lines, 0.4 million Personal Lines), and in part to other various changes in the Company's reinsurance program. Net Investment Income: Net investment income approximated $18.2 million for the six months ended June 30, 2002 and $16.1 million for the same period of 2001. Total investments grew to $768.9 million at June 30, 2002 from $511.0 million at June 30, 2001. The growth in investment income is due to investing net cash flows provided from operating activities and the proceeds of the Company's equity offering received during the fourth quarter of 2001. The capital market environment during 2001 and most of 2002 (low U.S. Treasury yields) had the effect of increasing the level of prepayments in certain of the Company's interest rate sensitive investments. The Company's average duration in its fixed income portfolio approximated 3.5 years at June 30, 2002, compared to 3.2 years at June 30, 2001, and the Company's tax equivalent book yield on its fixed income holdings was 6.2% at June 30, 2002, compared to 7.2% at June 30, 2001. Net Realized Investment Gain (Loss): Net realized investment gains (losses) were ($3.1) million for the six months ended June 30, 2002 and $2.6 million for the same period in 2001. The Company realized net investment losses of $1.9 million principally from the sales of common stock equity securities during the six months ended June 30, 2002. Additionally, $1.2 million in non-cash realized investment losses were recorded on certain structured securities as a result of the Company's impairment evaluation. The proceeds from the common stock sales were reinvested principally in common stock securities. The Company realized net investment gains of $5.9 million from the sales of common stock equity securities and $1.0 million from the sales of fixed maturity securities during the six months ended June 30, 2001. These realized net investment gains were offset in part by $4.3 million in non-cash realized investment losses experienced on certain structured securities as a result of an impairment evaluation. The proceeds from the sales were reinvested in fixed maturity securities to increase current investment income, lessen 13 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) the Company's holdings in certain common stock positions, and decrease the overall percentage of investments in common stock securities. Other Income: Other income approximated $16,000 for the six months ended June 30, 2002 and $116,000 for the same period of 2001. Other income primarily consisted of commissions earned on brokered personal lines business. Such commissions earned decreased as brokering activities were discontinued in favor of writing business directly. However, the Company is seeking to increase brokering activities in the future, as it is not writing new business or renewing certain policies in designated areas of Florida for the Company's manufactured housing product as a result of its property exposures in these areas and related catastrophe loss considerations. Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased $31.9 million (38.9%) to $113.9 million for the six months ended June 30, 2002 from $82.0 million for the same period of 2001 and the loss ratio increased to 60.1% in 2002 from 59.3% in 2001. This increase in net loss and loss adjustment expenses was due principally to the 37.1% growth in net earned premiums, and in part to the Company increasing loss and loss adjustment expenses incurred by $5.0 million as a result of changes in estimates of insured events in prior years. Such adverse loss development is due to losses emerging at a higher rate on automobile leases currently expiring on residual value policies underwritten during the years 1996 through 1998 than had been originally anticipated when the reserves were estimated, as a result of changes in the automobile after market. The Company also commuted a 2001 accident year aggregate stop loss reinsurance program, resulting in net written and net earned premium increasing by $3.6 million. The Company had not ceded any losses to the 2001 accident year aggregate stop loss reinsurance program. Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $13.7 million (30.3%) to $58.9 million for the six months ended June 30, 2002 from $45.2 million for the same period of 2001. This increase was due primarily to the 37.1% growth in net earned premiums, offset by relative changes in the Company's product mix and associated distribution channel expense. Other Operating Expenses: Other operating expenses decreased $1.3 million to $2.9 million for the six months ended June 30, 2002 from $4.2 million for the same period of 2001. The decrease in other operating expenses was primarily due to the discontinuance of goodwill amortization effective January 1, 2002. Income Tax Expense: The Company's effective tax rate for the six months ended June 30, 2002 and 2001 was 32.2% and 32.8%, respectively. The effective rates differed from the 35% statutory rate principally due to investments in tax-exempt securities and in part due to the discontinuance of goodwill amortization. The decrease in the effective tax rate is principally due to a greater investment of cash flows in tax-exempt securities relative to taxable securities. RESULTS OF OPERATIONS (THREE MONTHS ENDED JUNE 30, 2002 VS. JUNE 30, 2001) Premiums: Gross written premiums grew $40.1 million (33.2%) to $160.8 million for the three months ended June 30, 2002 from $120.7 million for the same period of 2001; gross earned premiums grew $30.1 million (29.7%) to $131.3 million for the three months ended June 30, 2002 from $101.2 million for the same period of 2001; net written premiums increased $42.9 million (52.0%) to $125.4 million for the three months ended June 30, 2002 from $82.5 million for the same period of 2001; and net earned premiums grew $28.6 million (39.9%) to $100.3 million in 2002 from $71.7 million in 2001. The respective gross written premium increases (decreases) for commercial lines, specialty lines and personal lines segments for the three months ended June 30, 2002 vs. June 30, 2001 amount to $33.3 million (44.2%), $6.9 million (32.7%) and ($45,000), (0.2%) respectively. The overall growth in gross written premiums is primarily attributable to the following: o Rating downgrades of certain major competitor property and casualty insurance companies have led to their diminished presence in the Company's commercial and specialty lines business segments and continue to result 14 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) in additional prospects and increased premium writings, most notably for the Company's various commercial package and non-profit D&O product lines. o The consolidation of certain competitor property and casualty insurance companies has led to the displacement of certain of their independent agency relationships. This consolidation continues to result in new agency relationship opportunities for the Company. These relationships have resulted in additional prospects and premium writings for the Company's commercial and specialty lines segments. o Continued expansion of marketing efforts relating to commercial lines and specialty lines products through the Company's field organization and preferred agents. o Rate increases. Overall premium growth in the specialty lines segment has been offset in part by the Company's decision not to renew certain policies in the professional liability product lines due to inadequate pricing levels being experienced as a result of market conditions and/or loss experience emerging at higher than expected levels. The overall premium decrease for the personal lines segment was due principally to the Company's decision not to write new business or renew certain policies in designated areas of Florida in the Company's manufactured housing product line based on an evaluation of property exposures. This decrease has been partially offset by an increase in premiums for the Company's homeowners product line for which new and renewal policies are being added in select areas. Pursuant to a recent underwriting review which focused on pricing adequacy, loss experience, as well as other underwriting criteria, the Company cancelled a Commercial Automobile Excess Liability Insurance customer (Commercial Lines Underwriting Group) effective October 27, 2002 as a result of an unacceptable underwriting risk profile. Such customer's gross written premium and net written premium amounted to $45.8 million and $11.8 million, respectively, for the year ended December 31, 2001 and $20.1 million and $5.8 million, respectively, for the six months ended June 30, 2002. The respective net written premium increases for commercial lines, specialty lines and personal lines segments for the three months ended June 30, 2002 vs. June 30, 2001 amount to $33.8 million (64.5%), $6.9 million (36.4%) and $2.1 million (18.9%) respectively. The differing percentage increases (decreases) in net written premiums versus gross written premiums for the period is primarily due to the Company commuting a 2001 accident year aggregate stop loss reinsurance program whereby net written and net earned premiums increased by $3.6 million ($2.4 million Commercial Lines, $0.8 million Specialty Lines, $0.4 million Personal Lines), and in part to other various changes in the Company's reinsurance program. Net Investment Income: Net investment income approximated $9.4 million for the three months ended June 30, 2002 and $8.1 million for the same period of 2001. Total investments grew to $768.9 million at June 30, 2002 from $511.0 million at June 30, 2001. The growth in investment income is due to investing net cash flows provided from operating activities and the proceeds of the Company's equity offering received during the fourth quarter of 2001. The capital market environment of 2001 and the latter part of the second quarter 2002 (low U.S. Treasury yields) had the effect of increasing the level of prepayments in certain of the Company's interest rate sensitive investments. Net Realized Investment Gain (Loss): Net realized investment gains (losses) were ($3.2) million for the three months ended June 30, 2002 and $0.3 million for the same period in 2001. The Company realized net investment losses of $2.0 million principally from the sales of common stock equity securities during the three months ended June 30, 2002. Additionally, $1.2 million in non-cash realized investment losses were recorded on certain structured securities as a result of the Company's impairment evaluation. The proceeds from the common stock sales were reinvested principally in common stock securities. The Company realized net investment gains of $3.6 million from the sales of common stock equity securities and $1.0 million from the sales of fixed maturity securities during the three months ended June 30, 2001. These realized net investment gains were offset in part by $4.3 million in non-cash realized investment losses experienced on certain structured securities as a result of an 15 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) impairment evaluation. The proceeds from the sales were reinvested in fixed maturity securities to increase current investment income, lessen the Company's holdings in certain common stock positions, and decrease the overall percentage of investments in common stock securities. Other Income: Other income approximated $15,000 for the three months ended June 30, 2002 and $63,000 for the same period of 2001. Other income primarily consisted of commissions earned on brokered personal lines business. Such commissions earned decreased as brokering activities were discontinued in favor of writing business directly. However, the Company is seeking to increase brokering activities in the future as it is not writing new business or renewing certain policies in designated areas of Florida for the Company's manufactured housing product as a result of its property exposures in these areas and related catastrophe loss considerations. Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased $17.9 million (41.7%) to $60.8 million for the three months ended June 30, 2002 from $42.9 million for the same period of 2001 and the loss ratio increased to 60.7% in 2002 from 59.8% in 2001. This increase in net loss and loss adjustment expenses was due principally to the 39.9% growth in net earned premiums, and in part to the Company increasing loss and loss adjustment expenses incurred by $5.0 million as a result of changes in estimates of insured events in prior years. Such adverse loss development is due to losses emerging at a higher rate on automobile leases currently expiring on residual value policies underwritten during the years 1996 through 1998 than had been originally anticipated when the reserves were estimated, as a result of changes in the automobile after market. The Company also commuted a 2001 accident year aggregate stop loss reinsurance program resulting in net written and net earned premium increasing by $3.6 million. The Company had not ceded any losses to the 2001 accident year aggregate stop loss reinsurance program. Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $8.4 million (37.0%) to $31.1 million for the three months ended June 30, 2002 from $22.7 million for the same period of 2001. This increase was due primarily to the 39.9% growth in net earned premiums offset by relative changes in the Company's product mix and associated distribution channel expense. Other Operating Expenses: Other operating expenses decreased $0.6 million to $1.5 million for the three months ended June 30, 2002 from $2.1 million for the same period of 2001. The decrease in other operating expenses was primarily due to the discontinuance of goodwill amortization effective January 1, 2002. Income Tax Expense: The Company's effective tax rate for the three months ended June 30, 2002 and 2001 was 31.9% and 33.0%, respectively. The effective rates differed from the 35% statutory rate principally due to investments in tax-exempt securities and in part to the discontinuance of goodwill amortization. The decrease in the effective tax rate is principally due to a greater investment of cash flows in tax-exempt securities relative to taxable securities. LIQUIDITY AND CAPITAL RESOURCES For the six months ended June 30, 2002, the Company's investments experienced unrealized investment appreciation of $3.3 million, net of the related deferred tax expense of $1.8 million. At June 30, 2002, the Company had total investments with a carrying value of $768.9 million, of which 93.9% consisted of investments in fixed maturity securities, including U.S. treasury securities and obligations of U.S. government corporations and agencies, obligations of states and political subdivisions, corporate debt securities, collateralized mortgage securities and asset backed securities. The collateralized mortgage securities and asset backed securities consist of short tranche securities possessing favorable pre-payment risk profiles. The remaining 6.1% of the Company's total investments consisted primarily of publicly traded common stock securities. The Company produced net cash from operations of $84.5 million and $68.1 million, respectively, for the six months ended June 30, 2002 and 2001. Management believes that the Company has adequate ability to pay all claims and meet all other cash needs. 16 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) Risk-based capital is designed to measure the acceptable amount of capital an insurer should have based on the inherent specific risks of each insurer. Insurers failing to meet this benchmark capital level may be subject to scrutiny by the insurer's domiciliary insurance department and ultimately rehabilitation or liquidation. Based on the standards currently adopted, the Company's insurance subsidiaries' capital and surplus is in excess of the prescribed risk-based capital requirements. FORWARD-LOOKING INFORMATION Certain information included in this report and other statements or materials published or to be published by the Company are not historical facts but are forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new and existing products, expectations for market segment and growth, and similar matters. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary remarks regarding important factors which, among others, could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, results of the Company's business, and the other matters referred to above include, but are not limited to: (i) changes in the business environment in which the Company operates, including inflation and interest rates; (ii) changes in taxes, governmental laws, and regulations; (iii) competitive product and pricing activity; (iv) difficulties of managing growth profitably; and (v) catastrophe losses. 17 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's financial instruments are subject to the market risk of potential losses from adverse changes in market rates and prices. The primary market risks to the Company are equity price risk associated with investments in equity securities and interest rate risk associated with investments in fixed maturities. The Company has established, among other criteria, duration, asset quality and asset allocation guidelines for managing its investment portfolio market risk exposure. The Company's investments are held for purposes other than trading and consist of diversified issuers and issues. The table below provides information about the Company's financial instruments that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. The information is presented in U.S. dollar equivalents.
JUNE 30, 2002 EXPECTED MATURITY DATES (In thousands, except average interest rate) TOTAL FAIR 2002 2003 2004 2005 2006 Thereafter TOTAL VALUE -------- -------- -------- -------- -------- ---------- -------- ----------- FIXED MATURITIES AVAILABLE FOR SALE: Principal Amount $ 34,285 $ 97,076 $ 95,359 $ 91,883 $ 59,577 $330,067 $708,247 $ 710,170 Book Value $ 34,317 $ 97,331 $ 95,641 $ 92,355 $ 59,875 $317,227 $696,746 -- Average Interest Rate 6.49% 4.63% 6.04% 6.22% 5.77% 5.57% 5.65% 4.79% PREFERRED: Principal Amount $ 2,400 $ 3,750 $ 1,500 $ 1,000 $ 2,500 -- $ 11,150 $ 11,511 Book Value $ 2,402 $ 3,858 $ 1,489 $ 1,040 $ 2,566 -- $ 11,355 -- Average Interest Rate 5.27% 5.90% 6.06% 6.84% 6.41% -- 5.99% 5.90% SHORT-TERM DEBT: Principal Amount $ 34,558 -- -- -- -- -- $ 34,558 $ 34,558 Book Value $ 34,558 -- -- -- -- -- $ 34,558 -- Average Interest Rate 1.89% -- -- -- -- -- 1.89% 1.89%
18 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES PART II - OTHER INFORMATION Item 1. Legal Proceedings (a) On April 30, 2002, U.S. Bank, N.A. d/b/a Firstar Bank ("Firstar"), a bank to which one of the Company's insurance subsidiaries, Philadelphia Indemnity Insurance Company ("PIIC"), issued insurance coverages, filed a complaint against PIIC in the United States District Court for the Southern District of Ohio (Western Division). The complaint asks for damages and a declaratory judgment against PIIC. The complaint arises principally out of a loss adjustment change and also relates to other coverage interpretations made by PIIC under the terms of residual value protection insurance policies issued to Firstar relating to vehicles financed by Firstar. The complaint alleges that as a result of the loss adjustment change Firstar may suffer damages of as much as $75,000,000. On June 27, 2002, PIIC filed an answer to the complaint denying liability with respect to the matters set forth above. PIIC believes that this claim is without merit and intends to vigorously defend this action. (b) As previously reported in the Company's Form 10-Q for the period ending March 31, 2001 and Form 10-K for the period ending December 31, 2001, two of the Company's subsidiaries, Liberty American Insurance Group Inc. and Mobile Homeowners Insurance Agency Inc., had filed an action in the U.S. District Court in the Middle District of Florida against WestPoint Underwriters LLC, a managing general agent, two former employees of Liberty American and a third individual, and a federal magistrate judge issued a report and recommendations to the Federal District court. With respect to Liberty American's request for preliminary relief, the findings and recommendations stated that one of the former employees had misappropriated Liberty American's trade secrets by using its software to write WestPoint's software. The magistrate judge recommended against injunctive relief, finding that damages may be available as a remedy. Liberty American objected, in part, to the findings. The District Court judge has now issued orders denying Liberty American's objections to the findings, adopting substantially all the magistrate judge's recommendations and dismissing the Company's subsidiaries' claim against the third individual referred to above. The claims against WestPoint and the two former employees referred to above are still pending. Item 2. Changes in Securities and Use of Proceeds Not applicable. Item 3. Defaults Upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders At the Company's annual meeting of shareholders held on May 1, 2002 the following nominees were elected to the Board of Directors:
Votes For Votes Withheld -------------------------- ----------------------- Elizabeth H. Gemmill 15,846,157 257,353 William J. Henrich, Jr. 15,845,862 257,648 Paul R. Hertel, Jr. 15,846,157 257,353 James J. Maguire 14,041,074 2,062,436 James J. Maguire, Jr. 14,045,569 2,057,941 Thomas J. McHugh 15,831,707 271,803 Michael J. Morris 15,846,157 257,353 Dirk A. Stuurop 15,846,157 257,353 Sean S. Sweeney 13,926,964 2,176,546 J. Eustace Wolfington 15,845,862 257,648 James L. Zech 13,879,864 2,223,646
19 The following other matters were approved at the Annual Meeting:
Votes For Votes Against Abstentions Broker Non Votes -------------- ----------------- --------------- ------------- Approval of the Appointment of 15,993,295 109,538 677 0 PricewaterhouseCoopers LLP as Independent Auditors for the Fiscal Year Ending December 31, 2002 Approval of an amendment of the Company's Articles of Incorporation to increase its authorized shares of common stock from 50,000,000 to 100,000,000 shares 15,155,143 947,015 1,352 0 Approval and adoption of the amendment and restatement of the Company's Employee Stock Option Plan (the "Stock Option Plan") to increase the number of shares of the Company's common stock for which options may be granted under the Stock Option Plan and to make certain changes to Plan administration 14,657,939 381,490 54,962 1,009,119 Approval of the continuation of the Company's Cash Bonus Plan 14,927,516 111,270 55,605 1,009,119 Approval of the Company's Nonqualified Employee Stock Purchase Plan 14,533,417 508,174 52,800 1,009,119
Item 5. Other information Not applicable. 20 Item 6. Exhibits and Reports on Form 8-K a. Exhibits:
Exhibit No. Description ---------------- ------------------------------------------------------------------------------------ 3.1.2* Amendment to Articles of Incorporation, Philadelphia Consolidated Holding Corp. 10.1 Philadelphia Insurance Companies Non Qualified Employee Stock Purchase Plan - incorporated by reference to Exhibit 4 to Registration Statement on Form S-8 (file no. 333-91216) filed with the Securities and Exchange Commission on June 26, 2002 10.2 Philadelphia Consolidated Holding Corp. Employee's Stock Option Plan (Amended and Restated Effective March 24, 2002) - incorporated by reference to Exhibit 4 to Registration Statement on Form S-8 (file no. 333-91218) filed with the Securities and Exchange Commission on June 26, 2002 10.3 Philadelphia Insurance Companies Key Employee Deferred Compensation Plan - incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-8 (file no. 333-90534) filed with the Securities and Exchange Commission on June 14, 2002 10.4* Employment Agreement with James J. Maguire, Jr. effective June 1, 2002 10.5* Employment Agreement with Sean S. Sweeney effective June 1, 2002 10.6* Employment Agreement with Craig P. Keller effective June 1, 2002 99.1* Certification of the Company's chief executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2* Certification of the Company's chief financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Filed herewith. b. The Company has not filed any reports on Form 8-K during the quarter for which this report is filed. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHILADELPHIA CONSOLIDATED HOLDING CORP. Registrant Date August 12, 2002 /s/ James J. Maguire ------------------------ ----------------------------------------- James J. Maguire Chairman of the Board of Directors, and Chief Executive Officer (Principal Executive Officer) Date August 12, 2002 /s/ Craig P. Keller ------------------------ ----------------------------------------- Craig P. Keller Senior Vice President, Secretary, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) 22