10-Q 1 w65688e10vq.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 September 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES: |X| NO | | Indicate the number of shares outstanding of each of the issuer's classes of common stock as of November 12, 2002. Preferred Stock, $.01 par value, no shares outstanding Common Stock, no par value, 21,560,335 shares outstanding PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES INDEX FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002 Part I - Financial Information Item 1. Financial Statements: Consolidated Balance Sheets - September 30, 2002 and December 31, 2001 3 Consolidated Statements of Operations and Comprehensive Income - For the three and nine months ended September 30, 2002 and 2001 4 Consolidated Statements of Changes in Shareholders' Equity - For the nine months ended September 30, 2002 and year ended December 31, 2001 5 Consolidated Statements of Cash Flows - For the nine months ended September 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 Item 4 Controls and Procedures 19 Part II - Other Information 20 Signatures 21 Certification of the Company's Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 22 Certification of the Company's Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 23
2 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
As of ---------------------------- September 30, December 31, 2002 2001 (Unaudited) ------------ ------------ ASSETS INVESTMENTS: FIXED MATURITIES AVAILABLE FOR SALE AT MARKET (AMORTIZED COST $787,746 AND $626,326) ............. $ 815,257 $ 632,416 EQUITY SECURITIES AT MARKET (COST $44,164 AND $34,065) ....................................... 44,357 40,992 ------------ ------------ TOTAL INVESTMENTS ................................ 859,614 673,408 CASH AND CASH EQUIVALENTS ............................ 48,941 49,910 ACCRUED INVESTMENT INCOME ............................ 7,595 6,582 PREMIUMS RECEIVABLE .................................. 132,745 96,025 PREPAID REINSURANCE PREMIUMS AND REINSURANCE RECEIVABLES ........................................ 135,360 99,601 DEFERRED INCOME TAXES ................................ 5,121 6,196 DEFERRED ACQUISITION COSTS ........................... 60,212 41,526 PROPERTY AND EQUIPMENT, NET .......................... 10,744 10,082 GOODWILL ............................................. 25,724 25,724 OTHER ASSETS ......................................... 10,184 8,668 ------------ ------------ TOTAL ASSETS ..................................... $ 1,296,240 $ 1,017,722 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY POLICY LIABILITIES AND ACCRUALS: UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES ............. $ 399,502 $ 302,733 UNEARNED PREMIUMS .................................... 306,282 197,839 ------------ ------------ TOTAL POLICY LIABILITIES AND ACCRUALS ............ 705,784 500,572 LOANS PAYABLE ........................................ 30,881 31,341 PREMIUMS PAYABLE ..................................... 40,711 25,659 OTHER LIABILITIES .................................... 54,962 31,458 ------------ ------------ TOTAL LIABILITIES ................................ 832,338 589,030 ------------ ------------ 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, 21,625,335 AND 21,509,723 SHARES ISSUED AND OUTSTANDING ........... 270,949 268,509 NOTES RECEIVABLE FROM SHAREHOLDERS ................... (2,672) (3,373) ACCUMULATED OTHER COMPREHENSIVE INCOME ............... 18,008 8,461 RETAINED EARNINGS .................................... 177,617 155,095 ------------ ------------ TOTAL SHAREHOLDERS' EQUITY ....................... 463,902 428,692 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ....... $ 1,296,240 $ 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 Nine Months Ended September 30, Ended September 30, ---------------------------- ---------------------------- 2002 2001 2002 2001 ------------ ------------ ------------ ------------ REVENUE: NET EARNED PREMIUMS .................................. $ 106,146 $ 77,755 $ 295,663 $ 215,981 NET INVESTMENT INCOME ................................ 9,497 8,238 27,727 24,371 NET REALIZED INVESTMENT GAIN (LOSS) .................. 199 488 (2,935) 3,105 OTHER INCOME ......................................... 419 105 435 221 ------------ ------------ ------------ ------------ TOTAL REVENUE ...................................... 116,261 86,586 320,890 243,678 ------------ ------------ ------------ ------------ LOSSES AND EXPENSES: LOSS AND LOSS ADJUSTMENT EXPENSES .................... 114,325 59,109 252,003 159,333 NET REINSURANCE RECOVERIES ........................... (35,976) (8,469) (59,773) (26,675) ------------ ------------ ------------ ------------ NET LOSS AND LOSS ADJUSTMENT EXPENSES ................ 78,349 50,640 192,230 132,658 ACQUISITION COSTS AND OTHER UNDERWRITING EXPENSES ........................... 32,343 25,880 91,221 71,043 OTHER OPERATING EXPENSES ............................. 1,632 974 4,570 5,136 ------------ ------------ ------------ ------------ TOTAL LOSSES AND EXPENSES .......................... 112,324 77,494 288,021 208,837 ------------ ------------ ------------ ------------ MINORITY INTEREST: DISTRIBUTIONS ON COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST .................................... -- -- -- 2,749 ------------ ------------ ------------ ------------ INCOME BEFORE INCOME TAXES .............................. 3,937 9,092 32,869 32,092 ------------ ------------ ------------ ------------ INCOME TAX EXPENSE (BENEFIT): CURRENT .............................................. 2,044 3,571 14,413 14,269 DEFERRED ............................................. (999) (451) (4,066) (3,599) ------------ ------------ ------------ ------------ TOTAL INCOME TAX EXPENSE ........................... 1,045 3,120 10,347 10,670 ------------ ------------ ------------ ------------ NET INCOME ......................................... $ 2,892 $ 5,972 $ 22,522 $ 21,422 ============ ============ ============ ============ OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX: HOLDING GAIN ARISING DURING PERIOD ................... 6,364 3,221 7,639 1,709 RECLASSIFICATION ADJUSTMENT .......................... (129) (317) 1,908 (2,018) ------------ ------------ ------------ ------------ OTHER COMPREHENSIVE INCOME (LOSS) .................... 6,235 2,904 9,547 (309) ------------ ------------ ------------ ------------ COMPREHENSIVE INCOME .................................... $ 9,127 $ 8,876 $ 32,069 $ 21,113 ============ ============ ============ ============ PER AVERAGE SHARE DATA: BASIC EARNINGS PER SHARE ............................. $ 0.13 $ 0.34 $ 1.04 $ 1.37 ============ ============ ============ ============ DILUTED EARNINGS PER SHARE ........................... $ 0.13 $ 0.32 $ 1.01 $ 1.31 ============ ============ ============ ============ WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING .......................................... 21,625,799 17,808,317 21,577,670 15,645,956 WEIGHTED-AVERAGE SHARE EQUIVALENTS OUTSTANDING .......................................... 636,828 704,534 716,017 766,746 ------------ ------------ ------------ ------------ WEIGHTED-AVERAGE SHARES AND SHARE EQUIVALENTS OUTSTANDING .............................. 22,262,627 18,512,851 22,293,687 16,412,702 ============ ============ ============ ============
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 Nine Months Ended For the Year Ended September 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 .............................. 325 2,067 ------------ ------------ BALANCE AT END OF PERIOD .................. 270,949 268,509 ------------ ------------ NOTES RECEIVABLE FROM SHAREHOLDERS: BALANCE AT BEGINNING OF YEAR .................. (3,373) (2,287) NOTES RECEIVABLE FORFEITED (ISSUED) PURSUANT TO STOCK PURCHASE PLAN ...................... 84 (2,158) COLLECTION OF NOTES RECEIVABLE ................ 617 1,072 ------------ ------------ BALANCE AT END OF PERIOD .................. (2,672) (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 9,547 (5,033) ------------ ------------ BALANCE AT END OF PERIOD .................. 18,008 8,461 ------------ ------------ RETAINED EARNINGS: BALANCE AT BEGINNING OF YEAR .................. 155,095 124,536 NET INCOME .................................... 22,522 30,559 ------------ ------------ BALANCE AT END OF PERIOD .................. 177,617 155,095 ------------ ------------ TOTAL SHAREHOLDERS' EQUITY ................ $ 463,902 $ 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 Nine Months Ended September 30, ----------------------------- 2002 2001 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: NET INCOME ......................................... $ 22,522 $ 21,422 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: NET REALIZED INVESTMENT (GAIN) LOSS .............. 2,935 (3,105) DEPRECIATION AND AMORTIZATION EXPENSE ............ 1,345 1,967 DEFERRED INCOME TAX BENEFIT ...................... (4,066) (3,599) CHANGE IN PREMIUMS RECEIVABLE .................... (36,720) (28,930) CHANGE IN OTHER RECEIVABLES ...................... (36,772) (24,482) CHANGE IN INCOME TAXES PAYABLE ................... (5,520) (9,219) CHANGE IN DEFERRED ACQUISITION COSTS ............. (18,686) (8,631) CHANGE IN OTHER ASSETS ........................... (458) 1,054 CHANGE IN UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES ....................................... 96,769 49,293 CHANGE IN UNEARNED PREMIUMS ...................... 108,443 54,705 CHANGE IN OTHER LIABILITIES ...................... 32,490 12,935 TAX BENEFIT FROM EXERCISE OF EMPLOYEE STOCK OPTIONS .................................. 1,251 25,607 ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES .... 163,533 89,017 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: PROCEEDS FROM SALES OF INVESTMENTS IN FIXED MATURITIES ..................................... 188,746 27,063 PROCEEDS FROM MATURITY OF INVESTMENTS IN FIXED MATURITIES ..................................... 82,793 47,099 PROCEEDS FROM SALES OF INVESTMENTS IN EQUITY SECURITIES ..................................... 13,898 12,603 COST OF FIXED MATURITIES ACQUIRED .................. (422,182) (178,611) COST OF EQUITY SECURITIES ACQUIRED ................. (26,703) (11,691) PURCHASE OF PROPERTY AND EQUIPMENT ................. (2,484) (1,385) ----------- ----------- NET CASH USED BY INVESTING ACTIVITIES .......... (165,932) (104,922) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: REPAYMENTS ON LOANS PAYABLE ........................ (461) (22,000) PROCEEDS FROM LOANS PAYABLE ........................ -- 29,841 PROCEEDS FROM EXERCISE OF EMPLOYEE STOCK OPTIONS ... 864 2,911 PROCEEDS FROM COLLECTION OF NOTES RECEIVABLE ....... 617 708 PROCEEDS FROM SHARES ISSUED PURSUANT TO STOCK PURCHASE PLANS ............................. 410 33 ----------- ----------- NET CASH PROVIDED BY FINANCING ACTIVITIES .... 1,430 11,493 ----------- ----------- NET DECREASE IN CASH AND CASH EQUIVALENTS ............. (969) (4,412) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ...... 49,910 49,742 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD ............ $ 48,941 $ 45,330 =========== =========== CASH PAID DURING THE PERIOD FOR: INCOME TAXES ....................................... $ 18,412 $ 5,435 INTEREST ........................................... $ 466 $ 130 NON-CASH TRANSACTIONS: ISSUANCE OF SHARES (FORFEITURES) PURSUANT TO EMPLOYEE STOCK PURCHASE PLAN IN EXCHANGE FOR ...... $ (84) $ 1,243 NOTES RECEIVABLE 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 nine months ended September 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 nine months ended September 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. The Company measures the fair value of investments based upon quoted market prices or by obtaining quotes from dealers. At September 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 for securities meeting predetermined thresholds 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 September 30, 2002 and 2001 were $0.3 million and $0 million, respectively, and for the nine months ended September 30, 2002 and 2001 were $1.5 million and $4.3 million, respectively, as a result of the other than temporary impairment evaluations. 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 nine months ended September 30, 2001 amounted to $1.1 million. 7 The following table provides a reconciliation of the prior year's three and nine month periods ended September 30 reported net income to adjusted net income had SFAS No. 142 been applied at the beginning of fiscal 2001 (in thousands, except per share amounts):
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------ ------------------------------ 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Reported net income ................ $ 2,892 $ 5,972 $ 22,522 $ 21,422 Adjustment for goodwill amortization -- 376 -- 1,128 ------------ ------------ ------------ ------------ Adjusted net income ................ $ 2,892 $ 6,348 $ 22,522 $ 22,550 ============ ============ ============ ============ Reported basic earnings per share .. $ 0.13 $ 0.34 $ 1.04 $ 1.37 Adjustment for goodwill amortization -- 0.02 -- 0.07 ------------ ------------ ------------ ------------ Adjusted basic earnings per share .. $ 0.13 $ 0.36 $ 1.04 $ 1.44 ============ ============ ============ ============ Reported diluted earnings per share $ 0.13 $ 0.32 $ 1.01 $ 1.31 Adjustment for goodwill amortization -- 0.02 -- 0.07 ------------ ------------ ------------ ------------ Adjusted diluted earnings per share $ 0.13 $ 0.34 $ 1.01 $ 1.38 ============ ============ ============ ============
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 September 30, 2002, the related adjustments could have a material adverse impact on the Company's financial condition, and results of operations. Due to adverse changes in the estimates of insured events in prior years for the Company's outstanding residual value policies, as previously reported in the Company's Form 10-Q for the period ending June 30, 2002, the Company, as part of its monitoring and evaluation procedures, engaged two consulting firms to aid in evaluating the ultimate potential loss exposure under these policies. As a result of the indications of these evaluations, the Company increased its unpaid loss and loss adjustment expenses by $27.0 million ($15.0 million net of reinsurance recoverables). The adverse development results from changes in various factors primarily related to the used car market which have occurred subsequent to the inception date of the policies. Additionally, the increase in unpaid loss and loss adjustment expense ceded to the Company's reinsurer for the residual value policies utilized the remaining reinsurance limit available to the Company under a combined coverage reinsurance contract. Accordingly, the ceded unearned premium reserve of $5.1 million for the Company's combined coverage reinsurance was fully amortized during the three months ended September 30, 2002. The combined coverage reinsurance contract provided a 2002 accident year aggregate stop loss cover which had not been utilized by the Company, reinsurance coverage for the residual value line of business, and $10.0 million excess $5.0 million catastrophe property reinsurance coverage. The Company continues to maintain $306.5 million excess $15.0 million catastrophe property reinsurance on its Florida business. 5. Loans Payable As of September 30, 2002, the Company had aggregate borrowings of $30.9 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 are 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 nine months ended September 30, 2002 and 2001, respectively (in thousands, except per share data):
As of and For the Three As of and For the Nine Months Ended Months Ended September 30, September 30 ----------------------- ---------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Weighted-Average Common Shares Outstanding ... 21,626 17,808 21,578 15,646 Weighted-Average Share Equivalents Outstanding 637 705 716 767 -------- -------- -------- -------- Weighted-Average Shares and Share Equivalents Outstanding ..................... 22,263 18,513 22,294 16,413 ======== ======== ======== ======== Net Income ................................... $ 2,892 $ 5,972 $ 22,522 $ 21,422 ======== ======== ======== ======== Basic Earnings per Share ..................... $ 0.13 $ 0.34 $ 1.04 $ 1.37 ======== ======== ======== ======== Diluted Earnings per Share ................... $ 0.13 $ 0.32 $ 1.01 $ 1.31 ======== ======== ======== ========
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. 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 arising during the three and nine months ended September 30, 2002 and 2001 was $3.4 million and $1.7 million, respectively, and $4.1 million and $0.9 million, respectively. The related tax effect of Reclassification Adjustments for the three and nine months ended September 30, 2002 and 2001 was ($0.1) million and ($0.2) million, respectively, and $1.0 million and ($1.1) million respectively. 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 9 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 nine months ended September 30, 2002 and 2001. Corporate information is included to reconcile segment data to the consolidated financial statements (in thousands):
Nine Months Ended, ------------------------------------------------------------------------ Commercial Specialty Personal Lines Lines Lines Corporate Total ------------ ------------ ------------ ------------ ------------ September 30, 2002: Gross Written Premiums .................... $ 360,169 $ 82,427 $ 65,125 $ -- $ 507,721 ------------ ------------ ------------ ------------ ------------ Net Written Premiums ...................... $ 287,797 $ 76,625 $ 31,670 $ -- $ 396,092 ------------ ------------ ------------ ------------ ------------ Revenue: Net Earned Premiums ..................... $ 208,396 $ 61,157 $ 26,110 $ -- $ 295,663 Net Investment Income ................... -- -- -- 27,727 27,727 Net Realized Investment Loss ............ -- -- -- (2,935) (2,935) Other Income ............................ -- -- 1,294 (859) 435 ------------ ------------ ------------ ------------ ------------ Total Revenue ........................... 208,396 61,157 27,404 23,933 320,890 ------------ ------------ ------------ ------------ ------------ Losses and Expenses: Net Loss and Loss Adjustment Expenses .. 147,723 30,551 13,956 -- 192,230 Acquisition Costs and Other Underwriting Expenses ............................. -- -- -- 91,221 91,221 Other Operating Expenses ............... -- -- 140 4,430 4,570 ------------ ------------ ------------ ------------ ------------ Total Losses and Expenses .............. 147,723 30,551 14,096 95,651 288,021 ------------ ------------ ------------ ------------ ------------ Income Before Income Taxes ................ 60,673 30,606 13,308 (71,718) 32,869 Total Income Tax Expense .................. -- -- -- 10,347 10,347 ------------ ------------ ------------ ------------ ------------ Net Income ................................ $ 60,673 $ 30,606 $ 13,308 $ (82,065) $ 22,522 ============ ============ ============ ============ ============ Total Assets .............................. $ -- $ -- $ 215,058 $ 1,081,182 $ 1,296,240 ============ ============ ============ ============ ============ September 30, 2001: Gross Written Premiums .................... $ 236,795 $ 60,699 $ 64,406 $ -- $ 361,900 ------------ ------------ ------------ ------------ ------------ Net Written Premiums ...................... $ 167,088 $ 53,465 $ 35,268 $ -- $ 255,821 ------------ ------------ ------------ ------------ ------------ Revenue: Net Earned Premiums ..................... $ 137,106 $ 50,060 $ 28,815 $ -- $ 215,981 Net Investment Income ................... -- -- -- 24,371 24,371 Net Realized Investment Gain ............ -- -- -- 3,105 3,105 Other Income ............................ -- -- 2,189 (1,968) 221 ------------ ------------ ------------ ------------ ------------ Total Revenue ........................... 137,106 50,060 31,004 25,508 243,678 ------------ ------------ ------------ ------------ ------------ Losses and Expenses: Net Loss and Loss Adjustment Expenses .. 86,551 31,458 14,649 -- 132,658 Acquisition Costs and Other Underwriting Expenses ............................. -- -- -- 71,043 71,043 Other Operating Expenses ............... -- -- 1,162 3,974 5,136 ------------ ------------ ------------ ------------ ------------ Total Losses and Expenses .............. 86,551 31,458 15,811 75,017 208,837 ------------ ------------ ------------ ------------ ------------ Minority Interest: Distributions on Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust ................................... -- -- -- 2,749 2,749 ------------ ------------ ------------ ------------ ------------ Income Before Income Taxes ................ 50,555 18,602 15,193 (52,258) 32,092 Total Income Tax Expense .................. -- -- -- 10,670 10,670 ------------ ------------ ------------ ------------ ------------ Net Income ................................ $ 50,555 $ 18,602 $ 15,193 $ (62,928) $ 21,422 ============ ============ ============ ============ ============ Total Assets .............................. $ -- $ -- $ 174,652 $ 704,916 $ 879,568 ============ ============ ============ ============ ============
10
Three Months Ended, ------------------------------------------------------------------------- Commercial Specialty Personal Lines Lines Lines Corporate Total ------------ ------------ ------------ ------------ ------------ September 30, 2002: Gross Written Premiums .................... $ 161,139 $ 30,103 $ 19,232 $ -- $ 210,474 ------------ ------------ ------------ ------------ ------------ Net Written Premiums ...................... $ 126,595 $ 28,137 $ 6,501 $ -- $ 161,233 ------------ ------------ ------------ ------------ ------------ Revenue: Net Earned Premiums ..................... $ 77,051 $ 21,748 $ 7,347 $ -- $ 106,146 Net Investment Income ................... -- -- -- 9,497 9,497 Net Realized Investment Gain ............ -- -- -- 199 199 Other Income ............................ -- -- 372 47 419 ------------ ------------ ------------ ------------ ------------ Total Revenue ........................... 77,051 21,748 7,719 9,743 116,261 ------------ ------------ ------------ ------------ ------------ Losses and Expenses: Net Loss and Loss Adjustment Expenses .. 66,457 7,398 4,494 -- 78,349 Acquisition Costs and Other Underwriting Expenses ............................. -- -- -- 32,343 32,343 Other Operating Expenses ............... -- -- 78 1,554 1,632 ------------ ------------ ------------ ------------ ------------ Total Losses and Expenses .............. 66,457 7,398 4,572 33,897 112,324 ------------ ------------ ------------ ------------ ------------ Income Before Income Taxes ................ 10,594 14,350 3,147 (24,154) 3,937 Total Income Tax Expense .................. -- -- -- 1,045 1,045 ------------ ------------ ------------ ------------ ------------ Net Income ................................ $ 10,594 $ 14,350 $ 3,147 $ (25,199) $ 2,892 ============ ============ ============ ============ ============ Total Assets .............................. $ -- $ -- $ 215,058 $ 1,081,182 $ 1,296,240 ============ ============ ============ ============ ============ September 30, 2001: Gross Written Premiums .................... $ 101,206 $ 19,101 $ 16,886 -- $ 137,193 ------------ ------------ ------------ ------------ ------------ Net Written Premiums ...................... $ 72,782 $ 16,733 $ 6,683 -- $ 96,198 ------------ ------------ ------------ ------------ ------------ Revenue: Net Earned Premiums ..................... $ 51,028 $ 17,350 $ 9,377 -- $ 77,755 Net Investment Income ................... -- -- -- 8,238 8,238 Net Realized Investment Gain ............ -- -- -- 488 488 Other Income ............................ -- -- 591 (486) 105 ------------ ------------ ------------ ------------ ------------ Total Revenue ........................... 51,028 17,350 9,968 8,240 86,586 ------------ ------------ ------------ ------------ ------------ Losses and Expenses: Net Loss and Loss Adjustment Expenses .. 35,040 10,854 4,746 -- 50,640 Acquisition Costs and Other Underwriting Expenses ............................. -- -- -- 25,880 25,880 Other Operating Expenses ............... -- -- 384 590 974 ------------ ------------ ------------ ------------ ------------ Total Losses and Expenses .............. 35,040 10,854 5,130 26,470 77,494 ------------ ------------ ------------ ------------ ------------ Income Before Income Taxes ................ 15,988 6,496 4,838 (18,230) 9,092 Total Income Tax Expense .................. -- -- -- 3,120 3,120 ------------ ------------ ------------ ------------ ------------ Net Income ................................ $ 15,988 $ 6,496 $ 4,838 $ (21,350) $ 5,972 ============ ============ ============ ============ ============ Total Assets .............................. -- -- $ 174,652 $ 704,916 $ 879,568 ============ ============ ============ ============ ============
11 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES ITEM 2. 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: - 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. - 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. - 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. - 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. - 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. - Claims development and the process of estimating loss reserves - Estimating the Company's ultimate liability for unpaid loss and loss adjustment expenses is necessarily a complex and judgemental process, inasmuch as the amounts of any ultimate liability of the Company with respect to such claims are based on management's informed estimates and judgments using data currently available. - 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 (NINE MONTHS ENDED SEPTEMBER 30, 2002 VS. SEPTEMBER 30, 2001) Premiums: Gross written premiums grew $145.8 million (40.3%) to $507.7 million for the nine months ended September 30, 2002 from $361.9 million for the same period of 2001; gross earned premiums grew $92.7 million (30.2%) to $399.7 million for the nine months ended September 30, 2002 from $307.0 million for the same period of 2001; net written premiums increased $140.3 million (54.9%) to $396.1 million for the nine months ended September 30, 2002 from $255.8 million for the same period of 2001; and net earned premiums grew $79.7 million (36.9%) to $295.7 million in 2002 from $216.0 million in 2001. The respective gross written premium increases for commercial lines, specialty lines and personal lines segments for the nine months ended September 30, 2002 vs. September 30, 2001 amount to $123.4 million (52.1%), $21.7 million (35.8%) and $0.7 million (1.1%), respectively. The overall growth in gross written premiums is primarily attributable to the following: - 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 12 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES ITEM 2. 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. - 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. - Continued expansion of marketing efforts relating to commercial lines and specialty lines products through the Company's field organization and preferred agents. - Rate increases realized on renewal business for the commercial lines segment, the specialty lines segment and the personal lines segment and increases in the number of policies written. Overall premium growth has been offset in part by the following factors: - Specialty Lines Segment - 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. - Personal Lines Segment - The Company's decision not to write new business or renew certain policies in designated areas of Florida in the Company's manufactured housing and homeowners product lines, based on an evaluation of property exposures and related catastrophe loss considerations. Pursuant to a routine underwriting review which focused on pricing adequacy and 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 $30.9 million and $9.5 million, respectively, for the nine months ended September 30, 2002. Additionally, the respective net written premium increases (decreases) for commercial lines, specialty lines and personal lines segments for the nine months ended September 30, 2002 vs. September 30, 2001 amount to $120.7 million (72.2%), $23.2 million (43.3%) and ($3.6) million (10.2%) 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 during the three months ended June 30, 2002 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, or pricing of, the Company's reinsurance program. Additionally, during the three months ended September 30, 2002, as a result of utilizing the remaining reinsurance limit available to the Company under a combined coverage reinsurance contract for its residual value line of business, the ceded unearned premium reserve of $5.1 million related to this reinsurance was fully amortized. Net Investment Income: Net investment income approximated $27.7 million for the nine months ended September 30, 2002 and $24.4 million for the same period of 2001. Total investments grew to $859.6 million at September 30, 2002 from $543.6 million at September 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 fourth quarter 2001 equity offering. 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. Additionally, due to the capital market environment, the Company has invested approximately $100 million in floating rate and shorter amortizing securities to minimize interest rate risk with the expectation of reinvesting these funds into longer duration investments at higher future fixed income rates. The Company's average duration of its fixed income portfolio approximated 3.3 years at September 30, 2002, compared to 3.1 years at September 30, 2001, and the Company's tax equivalent book yield on its fixed income holdings was 5.7% at September 30, 2002, compared to 7.0% at September 30, 2001. 13 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) Net Realized Investment Gain (Loss): Net realized investment gains (losses) were ($2.9) million for the nine months ended September 30, 2002 and $3.1 million for the same period in 2001. The Company realized net investment losses of $2.6 million from the sales of common stock equity securities and $1.2 million in net investment gains from the sale of fixed maturity securities during the nine months ended September 30, 2002. Additionally, $1.5 million in non-cash realized investment losses were recorded on certain securities as a result of the Company's impairment evaluation. The Company realized net investment gains of $5.9 million from the sales of common stock equity securities and $1.5 million from the sales of fixed maturity securities during the nine months ended September 30, 2001. These realized net investment gains were offset in part by $4.3 million in non-cash realized investment losses experienced on certain securities as a result of the Company's 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 $435,000 for the nine months ended September 30, 2002 and $221,000 for the same period of 2001. Other income primarily consists of commissions earned on brokered personal lines business, and to a lesser extent brokered commercial lines business. The Company is seeking to increase brokering activities in its personal lines segment 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 $59.5 million (44.8%) to $192.2 million for the nine months ended September 30, 2002 from $132.7 million for the same period of 2001 and the loss ratio increased to 65.0% in 2002 from 61.4% in 2001. This increase in net loss and loss adjustment expenses was due principally to the 36.9% growth in net earned premiums, and in part to the Company increasing loss and loss adjustment expenses incurred by $32.0 million ($20.0 million net of reinsurance recover- ables) 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 than had been originally anticipated when the reserves were estimated, primarily as a result of a deterioration in the value of used cars. The Company also commuted a 2001 accident year aggregate stop loss reinsurance program in the second quarter of 2002, 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. The nine months ended September 30, 2001 included a $4.0 million increase to unpaid loss and loss adjustment expenses arising from business interruption, business personal property, business property and workers' compensation exposures relating to the September 11, 2001 terrorist attacks. Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $20.2 million (28.5%) to $91.2 million for the nine months ended September 30, 2002 from $71.0 million for the same period of 2001. This increase was due primarily to the 36.9% growth in net earned premiums, offset in part by: - A lower weighted average effective commission rate incurred on the commercial and specialty lines segment products of 12.8% for the nine months ended September 30, 2002 compared to a weighted average effective commission rate of 13.4% for the nine months ended September 30, 2001. The Company has been able to incur a relatively lower commission rate on business produced by independent agents in the current market environment. - Incremental written premium growth without a corresponding incremental increase in operating leverage. Other Operating Expenses: Other operating expenses decreased $0.5 million to $4.6 million for the nine months ended September 30, 2002 from $5.1 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. This decrease has been partially offset by an increase in expenses attributable to increased operating activities. 14 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) Income Tax Expense: The Company's effective tax rate for the nine months ended September 30, 2002 and 2001 was 31.5% and 33.3%, 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 SEPTEMBER 30, 2002 VS. SEPTEMBER 30, 2001) Premiums: Gross written premiums grew $73.3 million (53.4%) to $210.5 million for the three months ended September 30, 2002 from $137.2 million for the same period of 2001; gross earned premiums grew $34.7 million (30.3%) to $149.3 million for the three months ended September 30, 2002 from $114.6 million for the same period of 2001; net written premiums increased $65.0 million (67.6%) to $161.2 million for the three months ended September 30, 2002 from $96.2 million for the same period of 2001; and net earned premiums grew $28.3 million (36.4%) to $106.1 million in 2002 from $77.8 million in 2001. The respective gross written premium increases for commercial lines, specialty lines and personal lines segments for the three months ended September 30, 2002 vs. September 30, 2001 amount to $59.9 million (59.2%), $11.0 million (57.6%) and $2.3 million, (13.9%) respectively. The overall growth in gross written premiums is primarily attributable to the following: - 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. - 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. - Continued expansion of marketing efforts relating to commercial lines and specialty lines products through the Company's field organization and preferred agents. - Rate increases realized on renewal business for the commercial lines segment, the specialty lines segment and the personal lines segment and increases in the number of policies written. The respective net written premium increases (decreases) for commercial lines, specialty lines and personal lines segments for the three months ended September 30, 2002 vs. September 30, 2001 amount to $53.8 million (73.9%), $11.4 million (68.2%) and ($0.2) million (2.7%) respectively. The differing percentage increases (decreases) in net written premiums versus gross written premiums for the period is primarily due to various changes in the Company's reinsurance program. Additionally, during the three months ended September 30, 2002, as a result of utilizing the remaining reinsurance limit available to the Company under a combined coverage reinsurance contract for its residual value line of business, the ceded unearned premium reserve of $5.1 million related to this reinsurance was fully amortized. Net Investment Income: Net investment income approximated $9.5 million for the three months ended September 30, 2002 and $8.2 million for the same period of 2001. Total investments grew to $859.6 million at September 30, 2002 from $543.6 million at September 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 fourth quarter 2001 equity offering. The capital market environment of 2001 and the third 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. Additionally, due to this capital market environment, the Company has invested approximately $100 million in floating rate and shorter amortizing securities to minimize interest rate risk with the expectation of reinvesting these funds in longer duration investments at higher future fixed income rates. 15 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) Net Realized Investment Gain: Net realized investment gains were $0.2 million for the three months ended September 30, 2002 and $0.5 million for the same period in 2001. The Company realized net investment losses of $0.3 million from the sales of common stock equity securities and $0.8 million in net investment gains from the sales of fixed maturity securities during the three months ended September 30, 2002. Additionally, $0.3 million in non-cash realized investment losses were recorded on certain securities as a result of the Company's impairment evaluation. The Company realized net investment gains of $0.5 million from the sales of fixed maturity securities during the three months ended September 30, 2001. Other Income: Other income approximated $400,000 for the three months ended September 30, 2002 and $105,000 for the same period of 2001. Other income primarily consisted of commissions earned on brokered personal lines business and to a lesser extent brokered commercial lines business. The Company is seeking to increase brokering activities in its personal lines segment 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 $27.7 million (54.7%) to $78.3 million for the three months ended September 30, 2002 from $50.6 million for the same period of 2001 and the loss ratio increased to 73.8% in 2002 from 65.1% in 2001. This increase in net loss and loss adjustment expenses was due principally to the 36.4% growth in net earned premiums, and in part to the Company increasing loss and loss adjustment expenses incurred by $27.0 million ($15.0 million net of reinsurance recover- ables) 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 than had been originally anticipated when the reserves were estimated, primarily as a result of the deterioration in the value of used cars. The three months ended September 30, 2001 included a $4.0 million increase to unpaid loss and loss adjustment expenses arising from business interruption, business personal property, business property and workers' compensation exposures relating to the September 11, 2001 terrorist attacks. Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $6.4 million (24.7%) to $32.3 million for the three months ended September 30, 2002 from $25.9 million for the same period of 2001. This increase was due primarily to the 36.4% growth in net earned premiums, offset in part by: - A lower weighted average effective commission rate incurred on the commercial and specialty lines segment products of 12.3% for the three months ended September 30, 2002 compared to a weighted average effective commission rate of 13.1% for the three months ended September 30, 2001. The Company has been able to incur a relatively lower commission rate on business produced by independent agents in the current market environment. - Incremental written premium growth without a corresponding incremental increase in operating leverage. Other Operating Expenses: Other operating expenses increased $0.6 million to $1.6 million for the three months ended September 30, 2002 from $1.0 million for the same period of 2001. The increase in other operating expenses is principally due to increased expenses attributable to operating activities, partially offset by the discontinuance of goodwill amortization effective January 1, 2002. Income Tax Expense: The Company's effective tax rate for the three months ended September 30, 2002 and 2001 was 26.5% and 34.3%, 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. 16 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Continued) LIQUIDITY AND CAPITAL RESOURCES For the nine months ended September 30, 2002, the Company's investments experienced unrealized investment appreciation of $9.5 million, net of the related deferred tax expense of $5.1 million. At September 30, 2002, the Company had total investments with a carrying value of $859.6 million, of which 94.9% 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 5.1% of the Company's total investments consisted primarily of publicly traded common stock securities. The Company produced net cash from operations of $163.5 million and $89.0 million, respectively, for the nine months ended September 30, 2002 and 2001. Management believes that the Company has adequate ability to pay all claims and meet all other cash needs. Two of the Company's insurance subsidiaries are members of the Federal Home Loan Bank of Pittsburgh ("FHLB"). A primary advantage of FHLB membership is the ability of members to access credit products from a reliable capital markets provider. The availability of any one member's access to credit is based upon its FHLB eligible collateral. At September 30, 2002 the insurance subsidiaries' borrowing capacity was $92.9 million. The insurance subsidiaries have utilized a portion of their borrowing capacity to purchase a diversified portfolio in investment grade floating rate securities. These purchases were funded by floating rate FHLB borrowings to achieve a positive spread between the rate of interest on these securities and borrowing rates. The remaining borrowing capacity will provide an immediately available line of credit. Borrowings aggregated $30.9 million at September 30, 2002 and bear interest at adjusted LIBOR and mature twelve months from inception and are collateralized by $35.6 million of the Company's fixed maturity securities. The weighted-average interest rate on borrowings outstanding as of September 30, 2002 was 1.94%. 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, (v) claims development and the process of estimating loss reserves; and (vi) 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.
SEPTEMBER 30, 2002 EXPECTED MATURITY DATES TOTAL (In thousands, except average interest rate) FAIR 2002 2003 2004 2005 2006 Thereafter TOTAL VALUE -------- -------- -------- -------- -------- ---------- -------- ----------- FIXED MATURITIES AVAILABLE FOR SALE: Principal Amount $ 18,650 $ 67,830 $143,810 $115,380 $ 61,680 $381,940 $789,290 $ 806,177 Book Value $ 18,670 $ 67,870 $144,750 $116,520 $ 61,520 $369,456 $778,786 -- Average Interest Rate 6.22% 5.17% 4.67% 4.81% 5.85% 5.29% 5.16% 4.16% PREFERRED: Principal Amount -- $ 3,750 $ 1,500 $ 1,000 $ 2,500 -- $ 8,750 $ 9,080 Book Value -- $ 3,860 $ 1,490 $ 1,040 $ 2,570 -- $ 8,960 -- Average Interest Rate -- 5.90% 6.06% 6.84% 6.41% -- 6.18% 6.10% SHORT-TERM INVESTMENTS: Principal Amount $ 45,050 -- -- -- -- -- $ 45,050 $ 45,040 Book Value $ 45,040 -- -- -- -- -- $ 45,040 -- Average Interest Rate 1.60% -- -- -- -- -- 1.60% 1.60% LOANS PAYABLE: Principal Amount $ 2,500 $ 28,381 -- -- -- -- $ 30,881 -- Average Interest Rate 1.94% 1.94% -- -- -- -- 1.94% --
18 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures. The Company's Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) as of a date within 90 days of the filing date of this quarterly report on Form 10-Q (the "Evaluation Date"), have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures were effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within such entities, particularly during the period in which this quarterly report on Form 10-Q was being prepared. (b) Changes in Internal Controls. There were no significant changes in the Company's internal controls or in other factors that could significantly affect those controls subsequent to the Evaluation Date, including any corrective actions with regard to deficiencies and material weaknesses in such controls. 19 PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES PART II - OTHER INFORMATION Item 1. Legal Proceedings Not applicable. 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 Not applicable. Item 5. Other information Not applicable. Item 6. Exhibits and Reports on Form 8-K a. Exhibits:
Exhibit No. Description ---------- ---------------------------------------------------------------- 10.1* (1) Employment Agreement with James J. Maguire, effective June 1, 2002 10.2* (1) Employment Agreement with Christopher J. Maguire, 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. (1) Compensatory plan or arrangement. b. The Company has not filed any reports on Form 8-K during the quarter for which this report is filed. 20 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 November 13, 2002 /s/ James J. Maguire, Jr. ------------------------ ----------------------------------------- James J. Maguire, Jr. President and Chief Executive Officer (Principal Executive Officer) Date November 13, 2002 /s/ Craig P. Keller ------------------------ ----------------------------------------- Craig P. Keller Senior Vice President, Secretary, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) 21 CERTIFICATION I, James J. Maguire, Jr., President and Chief Executive Officer of Philadelphia Consolidated Holding Corp., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Philadelphia Consolidated Holding Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 Signed: /s/ James J. Maguire, Jr. ------------------- --------------------------------------- Name: James J. Maguire, Jr. --------------------------------------- Title: President and Chief Executive Officer --------------------------------------- 22 CERTIFICATION I, Craig P. Keller, Chief Financial Officer of Philadelphia Consolidated Holding Corp., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Philadelphia Consolidated Holding Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 Signed: /s/ Craig P. Keller ------------------------ ------------------------------ Name: Craig P. Keller ------------------------------- Title: Chief Financial Officer ------------------------------- 23