ITEM 1. BUSINESS
GENERAL
SCPIE Holdings Inc. (SCPIE
Holdings) is a holding company owning subsidiaries licensed to provide insurance and reinsurance products. The Company is primarily a provider of medical malpractice insurance and related liability insurance products to physicians, oral surgeons,
healthcare facilities and others engaged in the healthcare industry in California and Delaware. Previously, the Company had also been actively engaged in hospital and dental liability insurance, medical malpractice insurance and related products in
other states and the global assumed reinsurance business. Since 2002, the assumed reinsurance business, hospital and dental business and medical malpractice insurance business outside its core states of California and Delaware have been in run-off.
The Company conducts its insurance business through three insurance company
subsidiaries. The largest, a wholly owned subsidiary, SCPIE Indemnity Company (SCPIE Indemnity) is licensed to conduct direct insurance business only in California, its state of domicile. American Healthcare Indemnity Company (AHI), domiciled in
Delaware, is licensed to transact insurance in 47 states and the District of Columbia. American Healthcare Specialty Insurance Company (AHSIC), domiciled in Arkansas, is eligible to write policies as an excess and surplus lines insurer in 20 states
and the District of Columbia. AHI and AHSIC are wholly owned subsidiaries of SCPIE Indemnity. The Company also has an insurance agency subsidiary, SCPIE Insurance Services, Inc., two subsidiary corporations providing management services, and a
corporate member of Lloyds of London (Lloyds), SCPIE Underwriting Limited, which is owned by SCPIE Indemnity.
The Company was founded in 1976 as the Southern California Physicians Insurance Exchange (the Exchange), a California reciprocal insurance company, and for the next 20 years
conducted its operations as a policyholder-owned California medical malpractice insurance company. SCPIE Holdings was organized in Delaware in 1996 and acquired the business of the Exchange and the three insurance company subsidiaries in a
reorganization that was consummated on January 29, 1997. The policyholders of the Exchange became the stockholders of SCPIE Holdings in the reorganization, and SCPIE Holdings concurrently sold additional shares of common stock in a public
offering. The common stock of SCPIE Holdings is listed on the New York Stock Exchange under the trading symbol SKP.
For purposes of this annual report on Form 10-K, the Company refers to SCPIE Holdings and its subsidiaries. The term Insurance Subsidiaries refers to SCPIE
Indemnity, AHI and AHSIC.
The Companys website address is
www.scpie.com
.
The Company makes available free of charge through its website the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material has
been electronically filed with or furnished to the Securities and Exchange Commission. The Company also makes available on its website its corporate charter documents and corporate governance documents. Information contained on the Companys
website is not incorporated into and does not constitute a part of this annual report on Form 10-K. The Companys website address referenced above is intended to be an inactive textual reference only and not an active hyperlink to the
Companys website.
Proposed Merger with The Doctors Company
On October 15, 2007, the Company agreed to be acquired by The Doctors
Company for $28.00 in cash for each outstanding share of Company common stock in a merger transaction valued at approximately $281.1 million. The merger is subject to customary closing conditions, including, among others, (i) the approval of
the merger by the holders of a majority in voting power of the outstanding common stock of the Company; (ii) the approval of the merger by the Departments of Insurance of California, Delaware and Arkansas; (iii) the receipt of antitrust
approvals, or the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; and (iv) the absence of any order or injunction prohibiting the consummation of the merger. The
Company currently expects the merger to close during the first half of 2008. However, it is possible that factors outside of the Companys control could require the parties to complete the proposed merger at a later time or not to complete it
at all.
INFORMATION ABOUT OPERATIONS
The Companys insurance operations have historically been
reported in two business segments: direct healthcare liability insurance and assumed reinsurance. Since 2002, the Company has focused its business operations on writing direct insurance in
3
its core direct healthcare liability insurance markets of California and Delaware. In direct insurance activities, the insurer assumes the risk of liability or loss
from persons or organizations that are directly subject to the risks. In assumed reinsurance, the reinsurer assumes all or a portion of the risk directly covered by another insurer. Such risks may relate to liability (or casualty), property, life,
accident, health, financial and other perils that may arise from an insurable event. Since 2002, the Company has been actively disengaging from the assumed reinsurance business.
The direct healthcare liability insurance operations are comprised of core and non-core business components. The Companys core business
principally represents its direct healthcare liability insurance business in California and Delaware, excluding a dental program managed by a national independent insurance agency Brown & Brown, Inc. (Brown & Brown), and hospital
business. The Companys non-core business represents its direct healthcare liability business outside of California and Delaware and the above mentioned dental program and all hospital business. The non-core business is in run-off and no new or
renewal policies have been issued since March 6, 2003. See Managements Discussion and Analysis of Financial Conditions and Results of Operations.
The Insurance Subsidiaries are rated B+ (Good) by A.M. Best Company (A.M. Best), the leading rating organization for the insurance industry.
DIRECT HEALTHCARE LIABILITY CORE INSURANCE OPERATIONS
Overview and Developments During 2007Core Business
The Company has been a leading provider of medical malpractice insurance to
physicians, oral surgeons and healthcare providers and facilities in California for many years. In 2001, the Company undertook the insurance of physicians in Delaware through a single Delaware broker. During 2007, the Company had net premiums earned
under policies issued to California insureds representing 96.9% of the total net premiums earned in its core business component of the direct healthcare liability insurance operations.
The Company has also developed and markets ancillary liability insurance products for the healthcare industry, including directors and officers
liability insurance for healthcare entities, errors and omissions coverage for managed care organizations and billing errors and omissions coverage for the medical profession. These represent a small part of the Companys business.
The 2007 operations improved over 2006 due primarily to re-estimations of previous years loss
and LAE reserves that had a favorable impact on the calendar year loss ratio in 2007. The 2006 operations were relatively stable compared to 2005. No rate increases were taken and a further decline in claims frequency offset severity increases. The
following table displays the core business results for the years ended December 31, 2007, 2006 and 2005:
Core Direct Healthcare Liability Insurance Operations
Underwriting Results
(In Thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
YEAR ENDED DECEMBER 31,
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Net Premiums Written
|
|
$
|
121,169
|
|
|
$
|
123,280
|
|
|
$
|
126,872
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Premiums Earned
|
|
$
|
121,872
|
|
|
$
|
123,170
|
|
|
$
|
127,556
|
|
Losses and LAE Incurred
|
|
|
75,609
|
|
|
|
86,928
|
|
|
|
90,463
|
|
Underwriting Expenses
|
|
|
26,159
|
|
|
|
25,479
|
|
|
|
25,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
101,768
|
|
|
|
112,407
|
|
|
|
116,363
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting Gain
|
|
$
|
20,104
|
|
|
$
|
10,763
|
|
|
$
|
11,193
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss Ratio
|
|
|
62.0
|
%
|
|
|
70.6
|
%
|
|
|
70.9
|
%
|
Expense Ratio
|
|
|
21.5
|
%
|
|
|
20.7
|
%
|
|
|
20.3
|
%
|
Combined Ratio
|
|
|
83.5
|
%
|
|
|
91.3
|
%
|
|
|
91.2
|
%
|
4
Products
In its core direct healthcare liability operations, the Company underwrites professional and related liability policy coverages for physicians (including oral and maxillofacial
surgeons), physician medical groups and clinics, managed care organizations and other providers in the healthcare industry. The following table summarizes the premiums earned by product in the Companys core business for the periods indicated:
Premiums Earned in Core Business
(In Thousands)
|
|
|
|
|
|
|
|
|
|
YEAR ENDED DECEMBER 31,
|
|
2007
|
|
2006
|
|
2005
|
Physician and medical group professional liability
|
|
$
|
112,712
|
|
$
|
113,477
|
|
$
|
116,834
|
Healthcare provider and facility liability
|
|
|
7,108
|
|
|
7,324
|
|
|
8,400
|
Ancillary liability products
|
|
|
1,561
|
|
|
1,860
|
|
|
1,785
|
Other
|
|
|
491
|
|
|
509
|
|
|
537
|
|
|
|
|
|
|
|
|
|
|
Total core premiums earned
|
|
$
|
121,872
|
|
$
|
123,170
|
|
$
|
127,556
|
|
|
|
|
|
|
|
|
|
|
Physician and Medical Group Professional
Liability
Professional liability insurance for sole practitioners and for medical groups provides protection against the legal liability of the insureds for such things as injury caused by, or as a result of, the performance of patient
treatment, failure to treat a patient and failure to diagnose an illness or injury. The Company offers separate policy forms for physicians who are sole practitioners and for those who practice as part of a medical group or clinic. The policy issued
to sole practitioners includes coverage for professional liability that arises in the medical practice and may also include coverages for certain other premises liabilities that may arise in the non-professional operations of the medical
practice, such as slip-and-fall accidents, and a limited defense reimbursement benefit for proceedings instituted by state licensing boards and other governmental entities.
The policy issued to medical groups and their physician members includes not only professional liability coverage and defense reimbursement benefits,
but also substantially more comprehensive coverages for commercial general liability and employee benefit program liability and also provides a small medical payment benefit to injured persons. The business liability coverage included in the medical
group policy includes coverage for certain employment-related liabilities and for pollution, which are normally excluded under a standard commercial general liability form. The Company also offers, as part of its standard policy forms for both sole
and group practitioners, optional excess personal liability coverage for the insured physicians. Excess personal liability insurance provides coverage to the physician for personal liabilities in excess of amounts covered under the physicians
homeowners and automobile policies. The Company has developed a nonstandard program that may exclude business liability coverages.
The professional liability coverages are issued primarily on a claims-made and reported basis. Coverage is provided for claims reported to the Company during the policy
period arising from incidents that occurred at any time the insured was covered by the policy. The Company also offers tail coverage for claims reported after the expiration of the policy for occurrences during the coverage period. The
price of the tail coverage is based on the length of time the insured has been covered under the Companys claims-made and reported policy. The Company provides free tail coverage for insured physicians who die or become disabled during the
coverage period of the policy and those who have been insured by the Company for at least five consecutive years and retire completely from the practice of medicine. Free tail coverage is automatically provided to physicians with at least five
consecutive years of coverage with the Company and who are also at least 65 years old.
Business liability coverage for medical groups and clinics and the excess personal liability insurance are underwritten on an occurrence basis. Under occurrence coverage, the coverage is provided for incidents that occur at any time the
policy is in effect, regardless of when the claim is reported. With occurrence coverage, there is no need to purchase tail coverage.
The Company offers standard limits of insurance up to $5.0 million per claim or occurrence, with up to a $10.0 million aggregate policy limit for all claims reported or occurrences
for each calendar year or other 12-month policy period. The most common limit is $1.0 million per claim or occurrence, subject to a $3.0 million aggregate policy limit. The Companys limit of liability under the excess personal liability
insurance coverage is $1.0 million per occurrence with no aggregate limit. The defense reimbursement benefit for governmental proceedings is $25,000, and the medical payments benefit for persons injured in non-professional activities is $10,000.
5
Healthcare Provider Liability/Healthcare Facility Liability
The Company offers its professional liability coverage
to a variety of specialty provider organizations, including outpatient surgery centers, medical urgent care facilities, hemodialysis, clinical and pathology laboratories and, on a limited basis, hospital emergency departments. The Company also
offers its professional liability coverage to healthcare providers such as chiropractors, podiatrists and nurse practitioners. These policies include the standard professional liability coverage provided to physicians and medical groups, with
certain modifications to meet the special needs of these healthcare providers. The policies are generally issued on a claims-made and reported basis with the limits of liability up to those offered to larger medical groups. The limits of coverage
under the current healthcare provider policies issued by the Company are between $1.0 million and $5.0 million per incident, subject to $3.0 million to $5.0 million aggregate policy limits.
Ancillary Liability Products
The Company offers a policy for managed care organizations
that provides coverage for liability arising from covered managed care incidents or vicarious liability for medical services rendered by non-employed physicians. Covered services include peer review, healthcare expense review, utilization
management, utilization review and claims and benefit handling in the operation of the managed care organizations. These policies are generally issued on a claims-made and reported basis. The annual aggregate limit of coverage under the current
managed care organization policies issued by the Company is $1.0 million. The Company offers directors and officers liability policies to medical providers. The directors and officers liability policies are generally issued on a
claims-made and reported basis. The limit of coverage on directors and officers liability policies written by the Company is $1.0 million. The Company also offers a policy that provides physicians and medical groups with protection for defense
expenses and certain liabilities related to governmental investigations into billing errors and omissions to Medicare and other government-subsidized healthcare programs.
Marketing and Policyholder Services
Initially, the Company marketed its physician professional liability policies directly to physicians and medical groups in California. Infrequently, larger medical groups were
written through insurance brokers. During the past several years, brokered business has become a more important source of business in California. In Delaware, the Company markets its policies through a single broker.
The following tables set forth core healthcare liability policies sold
directly to the insured and through brokers:
Core Healthcare Liability
(In Thousands)
|
|
|
|
|
|
|
|
|
|
YEAR ENDED DECEMBER 31,
|
|
2007
|
|
2006
|
|
2005
|
Gross Premiums Written
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
81,783
|
|
$
|
86,720
|
|
$
|
89,751
|
Brokerage
|
|
|
50,918
|
|
|
49,375
|
|
|
51,721
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
132,701
|
|
$
|
136,095
|
|
$
|
141,472
|
|
|
|
|
|
|
|
|
|
|
New business written
(annualized) during the year
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
2,279
|
|
$
|
1,925
|
|
$
|
2,705
|
Brokerage
|
|
|
4,851
|
|
|
3,889
|
|
|
5,480
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
7,130
|
|
$
|
5,814
|
|
$
|
8,185
|
|
|
|
|
|
|
|
|
|
|
The Companys Marketing Department consists
of a Senior Vice President in charge of both marketing and underwriting, and approximately 15 employees who directly solicit prospective policyholders, maintain relationships with existing insureds and provide marketing support to brokers. The
Companys marketing efforts include sponsorship by local medical associations, educational seminars, advertisements in medical journals and direct mail solicitation to licensed physicians and members of physician medical specialty group
organizations.
The Company attracts new physicians through special rates for medical residents and discounts for physicians just entering medical practice. In addition, the Company sponsors and participates in various medical group and healthcare
administrator programs, medical association and specialty society conventions and similar programs that provide visibility in the healthcare community.
6
The Companys current marketing emphasis is directed almost entirely toward California physicians and medical groups. The
Company conducts its marketing efforts from its principal office in Los Angeles.
Underwriting
The Underwriting Department consists of the Senior
Vice President, two divisional underwriting managers, 10 underwriters and six technical and administrative assistants. The Companys Underwriting Department is responsible for the evaluation of applicants for professional liability and other
coverages, the issuance of policies and the establishment and implementation of underwriting standards for all of the coverages underwritten by the Company. Certain of these underwriters specialize in underwriting managed care organizations and
directors and officers liability products.
The Company performs a continuous
process of reunderwriting its insured physicians, medical groups and healthcare facilities. Information concerning insureds with large losses, a high frequency of claims or unusual practice characteristics is developed through claims and risk
management reports or correspondence.
Rates
The Company establishes, through its own actuarial staff and independent actuaries, rates and rating
classifications for its physician and medical group insureds based on the Companys loss and loss adjustment expense (LAE) experience developed over the past 10 years and upon rates charged by its competitors. The Company has various rating
classifications based on practice, location, medical specialty, limits and other factors. The Company utilizes various discounts, including discounts for part-time practice, physicians just entering medical practice and large medical groups. The
Company has developed nonstandard programs for physicians who have unfavorable loss history or practice characteristics, but whom the Company considers insurable. Policies issued in this program have significant surcharges. The Company has
established its premium rates and rating classifications for managed care organizations utilizing data publicly filed by other insurers, and based in part on its own experience. The data for managed care organization errors and omissions liability
is extremely limited, as tort exposures for these organizations are only recently beginning to develop. The rates for directors and officers liability are developed using historical data publicly filed by other insurers, financial analysis and
loss history. All rates for liability insurance in California are subject to the prior approval of the Insurance Commissioner.
The Company has instituted annual overall rate increases in California during the past 10 years ranging from approximately 3.5% to 10.6%. Rate increases of 9.9% and 6.5% were
approved and implemented in California effective October 1, 2003, and January 1, 2005, respectively. The Company did not request any rate change in California for 2006, 2007 or 2008. Rate increases of 13.3% and 19.2% were approved in
Delaware effective July 15, 2004 and 2005, respectively. Approximately 23% of the Companys in force premium as of December 31, 2007 is evaluated using experience rating formulas and therefore is not necessarily subject to base rate
changes. Experience rating formulas are sensitive to the individual loss experience of groups of physicians and may produce increases or decreases different than the change in the general base rate. In general, in force premiums for experience rated
policies has been declining in the last three years as frequency of claims has declined. See Risk FactorsRate Increases in California.
Claims
The Companys Claims Department is responsible for claims investigation, establishment of appropriate case reserves for losses and LAE, defense planning and coordination, control of attorneys engaged by the Company to defend a claim
and negotiation of the settlement or other disposition of a claim. Under most of the Companys policies, except managed care organization errors and omissions policies, and directors and officers liability policies, the Company is
obligated to defend its insureds, which is in addition to the limit of liability under the policy. Medical malpractice claims often involve the evaluation of highly technical medical issues, severe injuries and conflicting expert opinions. In almost
all cases, the person bringing the claim against the physician is already represented by legal counsel when the Company is notified of the potential claim.
The Claims Department staff includes a Senior Vice President in charge of Claims, an assistant claims manager, unit managers, litigation supervisors, investigators and other
experienced professionals trained in the evaluation and resolution of medical professional liability and general liability claims. The Claims Department staff consists of approximately 20 employees. The Company has unit managers and branch managers
responsible for specific geographic areas, and additional units for specialty areas such as healthcare facilities, birth injuries and policy coverage issues. The Company also occasionally uses independent claims adjusters, primarily to investigate
claims in remote locations. The Company selects legal counsel from among a group of law firms in the geographic area in which the action is filed.
7
The Company vigorously defends its insureds against claims, but seeks to expediently resolve cases with high-exposure
potential. The defense of a healthcare professional liability claim requires significant cooperation between the litigation supervisor or claims manager responsible for the claim and the insured physician. In California and other states, the law
requires that a healthcare professional liability claim cannot generally be settled without the consent of the insured. California law requires that the insurer report such settlements of more than $30,000 to a medical disciplinary board, and
federal law requires that any claim payment, regardless of amount, be reported to a national data bank, which can be accessed by various state licensing and disciplinary boards and medical peer evaluation committees. Thus, the physician or other
healthcare professional is often placed in a difficult position of knowing that a settlement may result in the initiation of a disciplinary proceeding or some other impediment to his or her ability to practice. The Claims Department supervisor must
be able to fully evaluate considerations of settlement or trial and to communicate effectively the Companys recommendation to its insured. If the insured will not consent to a settlement offer, the Company may be exposed to its policy limit if
the case proceeds to trial.
The Company also maintains a risk management staff,
including a department manager and two members. The Risk Management Department works directly with medical groups and individual insureds to improve their procedures in order to minimize the incidence of claims.
BUSINESS OPERATIONS IN RUN-OFF
Direct Healthcare Liability Insurance Operations in Run-Off
The Company formerly offered a number of direct healthcare liability insurance programs outside its
core business. These programs were all discontinued and no policies were issued or renewed after March 2003. However, there are outstanding policy claims to be resolved under these programs. The principal programs involved hospitals, some
nonstandard physician programs and physician and dentist programs administered by Brown & Brown.
Hospital Programs
In 1996, the Company undertook an expansion plan which included products that offered comprehensive hospital and related liability coverages for individual hospitals and large healthcare systems.
These policies were written through national and regional brokers and covered facilities in four states, in addition to California. The Company encountered intense price competition and incurred material adverse loss experience under many of its
large hospital and other healthcare facility policies. As a result, the Company began to non-renew a number of its hospital policies or offered renewal only at substantially increased premium rates. The last hospital policy expired in December 2002.
Physician Programs Outside of California and Delaware
The Company undertook
a major geographic expansion in the physician and small medical group market through an arrangement with Brown & Brown. This arrangement commenced January 1, 1998, and eventually encompassed nine states, the largest in terms of premium
volume being Connecticut, Florida and Georgia. During 2000, the Company entered into a separate arrangement with Brown & Brown covering the California and Texas portion of a dental liability program developed by Brown & Brown. The
Company also reinsured the entire risk of policies issued nationally by another insurer to oral and maxillofacial surgeons marketed by Brown & Brown.
The Company and Brown & Brown agreed in March 2002 to terminate both the physician and dental programs no later than March 2003, and as of March 2004, all policies had
expired.
8
Current Status
The Company continues to settle and close the claims associated with the direct healthcare liability business in run-off. As of December 31, 2007, non-core healthcare
liability reserves accounted for 6.9% of the Companys total net reserves. The following table shows the progress the Company has achieved in the disposition of these claims over the last three years.
Direct Healthcare Liability Claims in Run-Off:
(Dollars in Thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
YEAR ENDED DECEMBER 31,
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Net Loss Reserves Outstanding Beginning of Period
|
|
$
|
37,654
|
|
|
$
|
60,616
|
|
|
$
|
97,331
|
|
Loss Payments
|
|
|
13,741
|
|
|
|
22,962
|
|
|
|
34,418
|
|
Decrease in Estimated Ultimate Losses
|
|
|
|
|
|
|
|
|
|
|
(2,297
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Loss Reserves End of Period
|
|
$
|
23,913
|
|
|
$
|
37,654
|
|
|
$
|
60,616
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Claims Outstanding Beginning of Period
|
|
|
136
|
|
|
|
229
|
|
|
|
431
|
|
Claims Closed During Period
|
|
|
67
|
|
|
|
104
|
|
|
|
218
|
|
Claims Opened During Period
|
|
|
6
|
|
|
|
11
|
|
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Claims Outstanding End of Period
|
|
|
75
|
|
|
|
136
|
|
|
|
229
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Claims Closed with Indemnity Payments
|
|
|
41.8
|
%
|
|
|
39.4
|
%
|
|
|
42.2
|
%
|
Average Reserve (including IBNR on outstanding claims)
|
|
$
|
318.8
|
|
|
$
|
276.9
|
|
|
$
|
264.7
|
|
New claims currently arise principally from tail
policies which were required by regulation to be offered upon cancellation and expiration of the underlying policy. The Company continues to settle claims at amounts it considers reasonable and defends against claims it considers non-meritorious.
The Companys average reserves held on open claims have increased as smaller claims tend to settle earlier in the claims settlement process.
Assumed Reinsurance Operations In Run-Off
In August 1999, the Company established a separate Assumed Reinsurance Division under the direction of two senior officers. The principal reinsurance programs included casualty,
property, accident and health and workers compensation and marine programs.
Reinsurance is an arrangement in which an insurance company, the reinsurer or the assuming company, agrees to indemnify another insurance company, the reinsured or the ceding company, against all or a portion of the insurance risks
underwritten by the ceding company under one or more insurance contracts. The Company concentrated the majority of its assumed reinsurance portfolio on treaty reinsurance. Treaty reinsurers, including the Company, do not separately evaluate each of
the individual risks assumed under their treaties and, consequently, after a review of the ceding companys underwriting practices, are largely dependent on the original risk underwriting decisions made by the ceding company. The Company also
focused on pro rata, or quota share, arrangements, in which the ceding company bears a proportional share of the risk and therefore the incentive to underwrite and price the business appropriately.
Exit From Most Reinsurance Operations
The Company suffered significant losses in 2001 in its non-California healthcare operations and in its
assumed reinsurance operations from the World Trade Center terrorist attack. These losses impacted the capital adequacy ratios under the A.M. Best and NAIC capital adequacy models and resulted in the reduction in the A.M. Best rating assigned to the
Insurance Subsidiaries.
In order to reduce its capital requirements related to assumed
reinsurance operations, the Company entered into a 100% quota share reinsurance agreement with Rosemont Re, under which the Company ceded almost all of its assumed earned reinsurance premiums after June 30, 2002, for the 2001 and 2002
underwriting years. This treaty relieved the Company of significant premium leverage and significantly improved the Companys risk-based capital adequacy ratios under both the A.M. Best and NAIC models.
Under the terms of the treaty with Rosemont Re, there are no limitations on the amount of losses
recoverable by the Company, and the treaty includes a profit-sharing provision should the combined ratio calculated on the base premium ceded be below 100%. The treaty requires Rosemont Re to reimburse the Company for its acquisition and
administrative expenses. In addition, the Company was required to pay Rosemont Re additional premium in excess of the base premium ceded of 14.3%.
9
There are certain losses not included in the treaty with Rosemont Re, including any World Trade Center losses. Further, the
treaty does not involve the assumption of any earned premium or losses attributable to periods prior to June 30, 2002, which remain the responsibility of the Company. See Managements Discussion and Analysis of Financial Condition
and Results of Operations.
After consummation of the Rosemont Re reinsurance
treaty, the Company continued to participate during 2003 in one Lloyds syndicate that specialized in underwriting professional liability excess insurance. The Companys decision to continue to support this syndicate was primarily due to
the attractive increases in reinsurance rates in this segment of the market, as well as the significant capital costs involved in running off the business if the syndicate were terminated. This syndicate was commuted as of December 31, 2005 and
the Company is no longer exposed to losses related to insureds of this syndicate.
Remaining Assumed Reinsurance Operations
The Company continues
to administer claims and other matters relating to reinsurance treaties and contracts entered into by the Company, including those subject to the 100% quota share reinsurance treaty with Rosemont Re. At year-end 2007, 2006 and 2005, the principal
net loss reserves retained by the Company under these treaties involved (i) occupational accident coverage and excess workers compensation benefits, which typically provides lifetime medical and related benefits at high coverage levels,
(ii) excess of loss directors and officers liability reinsurance, (iii) bail and immigration bonds, and (iv) London-based business including Lloyds syndicates.
The following table presents the net assumed reinsurance reserves (including retrospective reserves ceded under the Rosemont Re Treaty of $5.7
million, $6.4 million, and $7.1 million, respectively) by major component as of December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
|
2005
|
|
|
|
(In Thousands)
|
|
Occupational accident business
|
|
$
|
21,657
|
|
$
|
19,134
|
|
|
$
|
21,780
|
|
Excess D&O liability
|
|
|
3,839
|
|
|
5,414
|
|
|
|
6,375
|
|
Bail and immigration bonds
|
|
|
3,606
|
|
|
136
|
(1)
|
|
|
573
|
(1)
|
London-based business
|
|
|
2,247
|
|
|
19,494
|
|
|
|
24,427
|
|
Other
|
|
|
3,841
|
|
|
4,849
|
|
|
|
6,039
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
35,190
|
|
$
|
49,027
|
|
|
$
|
59,194
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Additional net liabilities of $3.6 million representing payment requests made to the Company are included in other liabilities on the Companys balance sheet. These net liabilities are
being contested in pending arbitrations. (See Legal ProceedingsBail and Immigration Bond Proceedings.)
|
The assumed reinsurance net reserves continue to decline as payments are made and reserves are settled or contracts are commuted. The Company, from time to time, commutes
individual contracts to speed up the settlement process. Commutation requires an agreement between the insured and reinsurer whereby one payment by the reinsurer will settle all its remaining obligations. Such settlements normally include actuarial
estimates of potential losses on an individual contract basis, fees, as well as the effect of the time value of money.
LOSS AND LOSS ADJUSTMENT EXPENSE (LAE) RESERVES
The determination of loss reserves is a projection of ultimate losses through an actuarial analysis of the claims history of the Company and other
professional liability insurers, subject to adjustments deemed appropriate by the Company due to changing circumstances. Included in its claims history are losses and LAE paid by the Company in prior periods and case reserves for anticipated losses
and LAE developed by the Companys Claims Department as claims are reported and investigated. Actuaries rely primarily on such historical loss experience in determining reserve levels on the assumption that historical loss experience provides a
good indication of future loss experience despite the uncertainties in loss cost trends and the delays in reporting and settling claims. As additional information becomes available, the estimates reflected in earlier loss reserves may be revised.
Any increase in the amount of reserves, including reserves for insured events of prior years, could have an adverse effect on the Companys results for the period in which the adjustments are made. See Risk FactorsLoss and LAE
Reserves.
The loss and LAE reserves included in the Companys financial
statements represent the Companys best estimate of the amounts that the Company will ultimately pay on claims, and the related costs of adjusting those claims, as of the date of the
10
financial statements. The uncertainties inherent in estimating ultimate losses on the basis of past experience have increased in recent years principally as a result
of judicial expansion of liability standards and expansive interpretations of insurance contracts. These uncertainties may be further affected by, among other factors, changes in the rate of inflation and changes in the propensities of individuals
to file claims. The inherent uncertainty of establishing reserves is relatively greater for companies writing liability insurance, including medical malpractice insurance, due primarily to the longer-term nature of the resolution of claims. There
can be no assurance that the ultimate liability of the Company will not exceed the amounts reserved.
The Company relies on its internal actuarial staff in establishing its reserves. The Companys internal actuarial staff reviews reserve adequacy on a quarterly basis. The Company continually refines reserve estimates as
experience develops and further claims are reported and resolved. The Company reflects adjustments to reserves in the results of the periods in which such adjustments are made. The Companys medical malpractice and assumed reinsurance insurance
written are lines of business for which the initial loss and LAE estimates may be impacted by events occurring long after the claim is incurred. Such events include sudden severe inflation or adverse judicial or legislative decisions in medical
malpractice insurance and the inherent long reporting delays in assumed reinsurance.
The
Companys actuaries use a variety of actuarial methodologies in evaluating the adequacy of healthcare liability loss and LAE reserves. Loss development methods use historical loss development patterns by the year a claim is reported (the report
year) and the valuation points of reported losses during ensuing periods. Paid loss and reported incurred loss development projections are base methods and are used to support other techniques. Report year claim count and severity (average claim
size) projections are developed to provide alternative projections using reported claim frequency and trended severity. Alternative reported projections are developed by adjusting the claims settlement rates so that these patterns are consistent
from year to year. Trended pure premium projections are developed by trending average losses per exposure from mature periods and are considered the most consistent methods. The Company also uses the Bornhuetter-Ferguson method, a standard method
which combines reported or paid losses, loss development or payment patterns and expected loss ratios.
The indications derived under the various methodologies are analyzed by limit, resulting average loss trends, the year in which the medical incident occurred or was reported and known policy limit claims outstanding. An
individual reserve level is selected by report year or accident year in the case of occurrence coverages.
Loss development methods based on historical patterns as well as the Bornhuetter-Ferguson method, are sensitive to changes in the pattern of loss payments or reported losses. Methods which determine trends from mature periods
are less sensitive to changes in loss payment or reporting patterns. In general, trended pure premium loss methodologies have been given more weight in selecting the levels for the most recent report years. As more data emerges in payments and
settled claims, the various methodologies begin to converge.
In the assumed reinsurance
area, the Companys actuaries rely heavily on losses, including IBNR, reported by the ceding companies. The Company obtains analysis from the actuary of the ceding companies, when available. These analyses are reviewed by the Companys
actuaries as well as general industry patterns to determine the Companys reserve position. The volatility is greatest in those areas in which claims take a long time, often many years, to be reported through the worldwide reinsurance market.
In connection with the reserve certification required under state statutory regulations,
independent actuaries review the Companys reserves for losses and LAE at the end of each fiscal year. The independent actuaries report includes a single point estimate of required reserve levels. The Company considers the independent actuaries
work when determining reserve levels, but primarily as a validation that the Companys reserve analysis is reasonable and has considered the relevant factors inherent in such a determination, such as, anticipated or estimated changes in the
frequency and severity of claims, loss retention levels and premium rates.
11
The Companys loss reserve experience is shown in the following table, which sets forth a reconciliation of beginning and
ending reserves for unpaid losses and LAE for the years indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
DECEMBER 31,
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In Thousands)
|
|
Reserves for losses and LAEat beginning of year
|
|
$
|
405,448
|
|
|
$
|
429,315
|
|
|
$
|
638,747
|
|
Less reinsurance recoverablesat beginning of year
|
|
|
38,224
|
|
|
|
45,535
|
|
|
|
183,623
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for losses and LAE, net of related reinsurance recoverableat beginning of year
|
|
|
367,224
|
|
|
|
383,780
|
|
|
|
455,124
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for losses and LAE for claims incurred in the current year, net of reinsurance
|
|
|
103,023
|
|
|
|
109,343
|
|
|
|
113,128
|
|
Decrease in estimated losses and LAE for claims incurred in prior years, net of reinsurance
|
|
|
(20,984
|
)
|
|
|
(11,255
|
)
|
|
|
(1,972
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incurred losses during the year, net of reinsurance
|
|
|
82,039
|
|
|
|
98,088
|
|
|
|
111,156
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deduct losses and LAE payments for claims, net of reinsurance, occurring during:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
4,057
|
|
|
|
12,201
|
|
|
|
24,466
|
|
Prior years
|
|
|
97,109
|
|
|
|
102,443
|
|
|
|
158,034
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total payments during the year, net of reinsurance
|
|
|
101,166
|
|
|
|
114,644
|
|
|
|
182,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for losses and LAE, net of related reinsurance recoverableat end of year
|
|
|
348,097
|
|
|
|
367,224
|
|
|
|
383,780
|
|
Reinsurance recoverable for losses and LAEat end of year
|
|
|
30,334
|
|
|
|
38,224
|
|
|
|
45,535
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for losses and LAE, gross of reinsurance recoverableat end of year
|
|
$
|
378,431
|
|
|
$
|
405,448
|
|
|
$
|
429,315
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decreases during 2007, 2006 and 2005 in
estimated losses and LAE occurring in prior years were primarily attributable to favorable loss experience in direct healthcare liability insurance due to the declining frequency in claims in those years and non-core direct healthcare liability
insurance in 2005, partially offset by adverse experience in the assumed reinsurance business. See Managements Discussion and Analysis of Financial Condition and Results of OperationsOverview.
The following table reflects the development of loss and LAE reserves for the periods indicated at the
end of that year and each subsequent year. The line entitled Loss and LAE reserves reflects the reserves, net of reinsurance recoverables, as originally reported at the end of the stated year. Each calendar year-end reserve includes the
estimated unpaid liabilities for that report or accident year and for all prior report or accident years. The section under the caption Cumulative net paid as of shows the cumulative amounts paid related to the reserve as of the end of
each subsequent year. The section under the caption Liability reestimated as of shows the original recorded reserve as adjusted as of the end of each subsequent year to reflect the cumulative amounts paid and all other facts and
circumstances discovered during each year. The line Net cumulative redundancy (deficiency) reflects the difference between the latest reestimated reserve amount and the reserve amount as originally established.
The gross liability for losses before reinsurance, as shown on the balance sheet, and the
reconciliation of that gross liability to amounts net of reinsurance are reflected below the table.
12
In evaluating the information in the table below, it should be noted that each amount includes the effects of all changes in
amounts of prior periods. For example, if a loss determined in 2005 to be $100,000 was first reserved in 1995 at $150,000, the $50,000 redundancy (original estimate minus actual loss) would be included in the cumulative redundancy in each of the
years 1995 through 2005 shown below. This table presents development data by calendar year and does not relate the data to the year in which the claim was reported or the incident actually occurred. Conditions and trends that have affected the
development of these reserves in the past will not necessarily recur in the future.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
YEARS ENDED
DECEMBER
31,
|
|
1997
|
|
1998
|
|
1999
|
|
2000
|
|
|
2001
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
2005
|
|
2006
|
|
2007
|
|
|
(In thousands)
|
Loss and LAE Reserves, net.
|
|
$
|
433,441
|
|
$
|
451,072
|
|
$
|
404,857
|
|
$
|
389,549
|
|
|
$
|
502,390
|
|
|
$
|
564,741
|
|
|
$
|
534,155
|
|
|
$
|
455,124
|
|
$
|
383,780
|
|
$
|
367,224
|
|
$
|
348,097
|
Cumulative net paid, as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
107,748
|
|
|
156,913
|
|
|
148,891
|
|
|
155,626
|
|
|
|
210,907
|
|
|
|
173,528
|
|
|
|
206,867
|
|
|
|
158,035
|
|
|
102,443
|
|
|
97,109
|
|
|
|
Two years later
|
|
|
179,016
|
|
|
246,835
|
|
|
238,718
|
|
|
273,680
|
|
|
|
319,076
|
|
|
|
336,913
|
|
|
|
331,158
|
|
|
|
235,877
|
|
|
177,545
|
|
|
|
|
|
|
Three years later
|
|
|
204,773
|
|
|
279,629
|
|
|
281,048
|
|
|
319,636
|
|
|
|
390,400
|
|
|
|
403,098
|
|
|
|
388,775
|
|
|
|
284,317
|
|
|
|
|
|
|
|
|
|
Four years later
|
|
|
216,448
|
|
|
299,106
|
|
|
304,588
|
|
|
344,700
|
|
|
|
423,621
|
|
|
|
445,175
|
|
|
|
430,074
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later
|
|
|
223,540
|
|
|
309,809
|
|
|
312,633
|
|
|
360,419
|
|
|
|
449,232
|
|
|
|
478,810
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later
|
|
|
228,007
|
|
|
311,677
|
|
|
319,349
|
|
|
372,133
|
|
|
|
467,887
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later
|
|
|
229,213
|
|
|
315,923
|
|
|
327,732
|
|
|
382,962
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later
|
|
|
229,256
|
|
|
321,863
|
|
|
333,094
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later
|
|
|
230,663
|
|
|
325,078
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten years later
|
|
|
233,191
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liability reestimated, as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
339,673
|
|
|
389,893
|
|
|
359,954
|
|
|
403,373
|
|
|
|
519,610
|
|
|
|
556,633
|
|
|
|
550,054
|
|
|
|
453,152
|
|
|
372,525
|
|
|
346,240
|
|
|
|
Two years later
|
|
|
283,276
|
|
|
351,238
|
|
|
356,298
|
|
|
402,559
|
|
|
|
510,274
|
|
|
|
573,603
|
|
|
|
539,144
|
|
|
|
449,670
|
|
|
354,591
|
|
|
|
|
|
|
Three years later
|
|
|
250,962
|
|
|
341,763
|
|
|
338,196
|
|
|
397,129
|
|
|
|
516,663
|
|
|
|
562,185
|
|
|
|
551,028
|
|
|
|
436,660
|
|
|
|
|
|
|
|
|
|
Four years later
|
|
|
243,561
|
|
|
329,588
|
|
|
342,176
|
|
|
402,009
|
|
|
|
518,952
|
|
|
|
564,458
|
|
|
|
545,039
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later
|
|
|
237,487
|
|
|
329,172
|
|
|
343,780
|
|
|
402,107
|
|
|
|
519,115
|
|
|
|
558,818
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later
|
|
|
239,389
|
|
|
330,264
|
|
|
343,901
|
|
|
404,795
|
|
|
|
517,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later
|
|
|
238,918
|
|
|
330,148
|
|
|
346,883
|
|
|
405,584
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later
|
|
|
234,758
|
|
|
332,823
|
|
|
346,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later
|
|
|
238,608
|
|
|
333,255
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten years later
|
|
|
239,655
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cumulative redundancy / (deficiency)
|
|
$
|
193,786
|
|
$
|
117,817
|
|
$
|
58,338
|
|
$
|
(16,035
|
)
|
|
$
|
(14,627
|
)
|
|
$
|
5,923
|
|
|
$
|
(10,884
|
)
|
|
$
|
18,464
|
|
$
|
29,189
|
|
$
|
20,984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Original gross liabilityend of year
|
|
$
|
454,970
|
|
$
|
475,970
|
|
$
|
449,864
|
|
$
|
429,700
|
|
|
$
|
576,636
|
|
|
$
|
650,671
|
|
|
$
|
643,046
|
|
|
$
|
638,747
|
|
$
|
429,315
|
|
$
|
405,448
|
|
$
|
378,431
|
Less: Reinsurance recoverables
|
|
|
21,529
|
|
|
24,898
|
|
|
45,007
|
|
|
40,151
|
|
|
|
74,246
|
|
|
|
85,930
|
|
|
|
108,891
|
|
|
|
183,623
|
|
|
45,535
|
|
|
38,224
|
|
$
|
30,334
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Original net liabilityend of year
|
|
$
|
433,441
|
|
$
|
451,072
|
|
$
|
404,857
|
|
$
|
389,549
|
|
|
$
|
502,390
|
|
|
$
|
564,741
|
|
|
$
|
534,155
|
|
|
$
|
455,124
|
|
$
|
383,780
|
|
$
|
367,224
|
|
$
|
348,097
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross re-estimated liabilitylatest period
|
|
$
|
252,612
|
|
$
|
358,950
|
|
$
|
378,896
|
|
$
|
464,943
|
|
|
$
|
583,580
|
|
|
$
|
663,608
|
|
|
$
|
675,245
|
|
|
$
|
587,000
|
|
$
|
392,816
|
|
$
|
382,368
|
|
|
|
Less: Estimated reinsurance recoverables
|
|
|
12,957
|
|
|
25,695
|
|
|
32,377
|
|
|
59,359
|
|
|
|
66,563
|
|
|
|
104,790
|
|
|
|
130,206
|
|
|
|
150,340
|
|
|
38,225
|
|
|
36,128
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net estimated liabilitieslatest period
|
|
$
|
239,655
|
|
$
|
333,255
|
|
$
|
346,519
|
|
$
|
405,584
|
|
|
$
|
517,017
|
|
|
$
|
558,818
|
|
|
$
|
545,039
|
|
|
$
|
436,660
|
|
$
|
354,591
|
|
$
|
346,240
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cumulative redundancy / (deficiency)
|
|
$
|
202,358
|
|
$
|
117,020
|
|
$
|
70,968
|
|
$
|
(35,243
|
)
|
|
$
|
(6,944
|
)
|
|
$
|
(12,937
|
)
|
|
$
|
(32,199
|
)
|
|
$
|
51,747
|
|
$
|
36,499
|
|
$
|
23,080
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prior to the Companys expansion outside of its California healthcare liability markets beginning in 1997, the Company had historically experienced favorable development in
loss and LAE reserves established for prior years on both a gross and net basis. The Company believes that the favorable loss and LAE reserve development resulted from four factors: (i) the Companys conservative approach of establishing
reserves for medical malpractice insurance losses and LAE, (ii) the continuing benefits from the Medical Injury Compensation Reform Act (MICRA), the California tort reform legislation that was declared constitutional in a series of decisions by
the California Supreme Court in the mid-1980s, (iii) benefits from California legislation requiring matters in litigation to proceed more expeditiously to trial, and (iv) improved results from a restructuring of the Companys internal
claims process. The Company believes, based on its analysis of annual statements filed with state regulatory authorities, that its principal California competitors experienced similar favorable loss and LAE reserve development in those years.
13
Core Healthcare Business
The Companys reserve analysis (and its independent consulting actuaries analysis) began to exhibit less variability related to the core
California healthcare liability business from 1999 forward as the effects of the items mentioned in the preceding paragraph were reflected in the historical loss and LAE data which is the foundation of actuarial estimates. As this variability
decreased, the Companys core business reserve estimates, although still considered conservative, were inherently less variable than before.
The ultimate results of the number of policy-limit losses which may occur in any single year or the ultimate effect litigation results may have on the average severity of losses,
will not be known for several years. The majority of severe cases will not be settled in the twenty-four month period following reporting of the claim. The Company has continued its historical policy of estimating the current years incurred
losses in a manner designed to protect against unfavorable trends in large losses or severity.
This policy, along with a significant decrease in the frequency of claims (a cumulative 35.1% over the last four years) has allowed favorable development in the core healthcare reserves of between 5.9% and 10.0% of the preceding year-end
net reserve balances. Frequency has stabilized in 2007. This may represent the low point of the recent downward trend.
The primary trend affecting the adequacy of reserve estimates in the core area is the trend in pure loss costs (the combination of frequency and average severity changes) related
to malpractice coverage. The inherent pure loss cost trend included in the setting of the 2004, 2005, 2006 and 2007 reserves has been 3.3%, 2.2%, 1.2% and 0.0 % respectively. A change in the pure loss cost trend not only affects the reserving for
the current years incurred losses, but also previously established reserves, especially IBNR. At 2007 reserve levels, a 1% change in the pure loss costs trend produces a change in prior reserves of approximately $4.0 million. Such changes in
estimates are reflected in the period of change. Reserves related to medical malpractice coverage account for 95% of core reserves.
Non-Core Business
The cumulative deficiencies which have emerged for reserves held over the past four years relate entirely to the Companys non-core healthcare liability and assumed reinsurance reserves which are now in run-off.
Beginning with the Companys expansion into hospital (1997) and healthcare
liability outside of California (1998) and assumed reinsurance (mid 1999), the reserve estimation process became significantly more volatile. The healthcare liability business outside of California did not have the benefits of MICRA-type reform
and assumed reinsurance business is, by its nature, extremely volatile.
The Company
attempted to apply the same conservative reserving process as had been applied in the core business reserves. Because the Companys expansion into the hospital and the healthcare liability outside of California represented new areas for which
the Company had limited historical experience. As the actual extent and size of the increases in the frequency and severity of claims related to the non-core healthcare liability areas emerged in the actuarial data used to project reserve levels,
upward reserve adjustments were necessary. Although the Company took significant rate action and underwriting restrictions were implemented, ultimately the Company withdrew from these markets (hospitals in 2001 and non-core healthcare physician
business in 2002.) Development in the non-core healthcare reserves of between 6.6% unfavorable and 2.3% favorable has occurred over the last four years.
Since very few new claims are reported in this area, the primary factor in determining the need for additional reserves is whether current settlement patterns are conforming to the
reserving models. In 2007, current patterns indicated no reserve change was required. Since several of the legal jurisdictions outside of California where the Company used to write policies require many years for claims to settle through the system,
future events could affect the adequacy of carried reserves. If claims ultimately close for an average of $15,000 more than currently reserved on average, additional reserves of $1.1 million would be required.
The Assumed Reinsurance operations encompassed various risks in the worldwide reinsurance market. The
Company has relied heavily on ceding company information in establishing loss reserves, including IBNR. The assumed reinsurance reserves have a very long development pattern and are subject to frequent delays in reporting through the worldwide
reinsurance system.
14
CEDED REINSURANCE PROGRAMS
The Company follows customary industry practice by reinsuring a portion of its healthcare liability
insurance risks. The Company cedes to reinsurers a portion of its risks and pays a fee based upon premiums received on all policies subject to such reinsurance. Insurance is ceded principally to reduce net liability on individual risks and to
provide protection against large losses. Although reinsurance does not legally discharge the ceding insurer from its primary liability for the full amount of the policies reinsured, it does make the reinsurer liable to the insurer to the extent of
the reinsurance ceded. The Company determines how much reinsurance to purchase based upon its evaluation of the risks it has insured, consultations with its reinsurance brokers and market conditions, including the availability and pricing of
reinsurance. In 2007, the Company ceded $11.2 million of its healthcare liability earned premiums to reinsurers.
From 2002 through 2007 the Company has reinsured losses above a retention of approximately $2.0 million to $20.0 million subject to an aggregate deductible of $3.0 million in each
respective year for losses in excess of the Companys retention. For 2003 and 2002 the Company also reinsured losses in excess of $20.0 million up to $50.0 million subject to 16% and 8% Company participation in these reinsurance layers,
respectively. For 2001 and 2000 the Company reinsured losses above a $1.25 million and $2.0 million retention, respectively, up to $70.0 million subject to a $3.0 million aggregate deductible for each year. Prior to 2000 the Company generally
reinsured losses up to $20.0 million above a $1 million retention subject to a $1 million aggregate deductible.
The Company may have more than one insured named as a defendant in a lawsuit or claim arising from the same incident, and, therefore, multiple policies and limits of liability may
be involved. The Companys reinsurance program is purchased in several layers, the limits of which may be reinstated under certain circumstances, at the Companys option, subject to the payment of additional premiums.
In addition, in December 2002, the Company entered into the Rosemont Re retrocessional reinsurance
agreement more fully described in Note 4 to Consolidated Financial Statements and Business Operations in Run-OffDivestitures of Most Reinsurance OperationsThe Rosemont Re Treaty.
In general, reinsurance is placed under reinsurance treaties and agreements with a number of individual
companies and syndicates at Lloyds to avoid concentrations of credit risk. The following table identifies the Companys most significant reinsurers based upon recoverable balances as of December 31, 2007 by company and their current
A.M. Best ratings. No other single reinsurers percentage participation in 2007 exceeded 7.0% of total reinsurance premiums ceded.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RECOVERABLE
BALANCES AT
YEAR END
DECEMBER 31,
2007
|
|
PREMIUMS CEDED
FOR YEAR ENDED
DECEMBER 31,
2007
|
|
RATING(1)
|
|
PERCENTAGE OF
PREMIUMS CEDED
|
|
|
|
(In Thousands)
|
|
Rosemont Re (Bermuda)
|
|
$
|
25,208
|
|
$
|
1,357
|
|
n/a
|
|
10.5
|
%
|
Lloyds of London Syndicates
|
|
$
|
4,538
|
|
$
|
5,629
|
|
A
|
|
43.7
|
%
|
Hannover Ruckversicherungs
|
|
$
|
3,712
|
|
$
|
4,723
|
|
A
|
|
36.6
|
%
|
|
(1)
|
|
All ratings are assigned by A.M. Best.
|
In December 2002, when the Company entered into its 100% quota share arrangement with Rosemont Re, Rosemont Re had an A- rating from A.M. Best. As a result of significant losses
related to hurricanes Katrina, Rita and Wilma, Rosemont Re has been placed in run-off.
Assets approximately equal to Rosemont Res estimated liabilities under the reinsurance agreement with the Company are currently held in trust to satisfy the liabilities under the agreement. The provisions of the trust are intended to
comply with the requirements of the California Department of Insurance. If the estimated recoveries were to increase in the future, the Company would have to rely on Rosemont Res continuing ability to fund these amounts. As of June 30,
2007, Rosemont Re reported $66.2 million of shareholders equity.
The Company
analyzes the credit quality of its reinsurers and relies on its brokers and intermediaries to assist in such analysis. To date, the Company has not experienced any material difficulties in collecting reinsurance recoverables. No assurance can be
15
given, however, regarding the future ability of any of the Companys reinsurers to meet their obligations. Should future events cause the Company to determine
adjustments in the amounts recoverable from reinsurance are necessary, such adjustments would be reflected in the results of current operations.
INVESTMENT PORTFOLIO
An important component of the Companys operating results has been the return on its invested assets. The Companys investments are made by investment managers under
policies established and supervised by management, the Boards of Directors for the Company and the Insurance Subsidiaries. The Companys investment policy has placed primary emphasis on investment grade, fixed-maturity securities and
maximization of after-tax yields.
All of the fixed-maturity securities are classified as
available-for-sale and carried at estimated fair value. For these securities, temporary unrealized gains and losses, net of tax, are reported directly through stockholders equity, and have no effect on net income. The following table sets
forth the composition of the Companys investments in available-for-sale securities at the dates indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DECEMBER 31, 2007
|
|
DECEMBER 31, 2006
|
|
|
COST OR
AMORTIZED
COST
|
|
FAIR
VALUE
|
|
COST OR
AMORTIZED
COST
|
|
FAIR
VALUE
|
|
|
(In Thousands)
|
Fixed-maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government and agencies
|
|
$
|
152,265
|
|
$
|
155,927
|
|
$
|
176,032
|
|
$
|
173,320
|
Mortgage-backed and asset-backed
|
|
|
63,821
|
|
|
64,071
|
|
|
69,963
|
|
|
68,975
|
Corporate
|
|
|
119,727
|
|
|
117,786
|
|
|
151,558
|
|
|
147,659
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed-maturity securities
|
|
|
335,813
|
|
|
337,784
|
|
|
397,553
|
|
|
389,954
|
Common stocks
|
|
|
1,428
|
|
|
1,665
|
|
|
1,723
|
|
|
2,034
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
337,241
|
|
$
|
339,449
|
|
$
|
399,276
|
|
$
|
391,988
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Companys current policy is to limit
its investment in equity securities and real estate to no more than 8.0% of the total market value of its investments. The Companys investment portfolio of fixed-maturity securities consists primarily of intermediate-term, investment-grade
securities. The Companys investment policy provides that fixed-maturity investments are limited to purchases of investment-grade securities or unrated securities which, in the opinion of a national investment advisor, should qualify for such
rating.
As of December 31, 2007, the Company held mortgage and asset-backed
securities with a fair value of $64.1 million. Of these securities, 60.3% were backed by U.S. Government or U.S. Government-sponsored enterprise guarantees, 39.4% were asset-backed securities with a remaining .3% in securities collateralized by
mortgages that have characteristics of sub-prime lending.
The exposure to sub-prime
residential mortgage lending is through a single issue within the Companys fixed income investment portfolio that contains securities collateralized by mortgages that have characteristics of sub-prime lending. This investment is in the form of
a collateral mortgage obligation supported by sub-prime mortgage loans. The collective carrying value of this investment is approximately $.2 million, representing less than 1/10 of 1 percent of the Companys total fixed income investments, and
had a Standard & Poors credit rating of AAA. This security was not considered as other than temporarily impaired as of December 31, 2007. While the Companys exposure to sub-prime securities is not significant to the total
investment portfolio, if the residential mortgage market continues to decline and / or the decline expands beyond the U.S. sub-prime, such circumstances could ultimately have an impact on other securities held within the investment portfolio.
16
The table below contains additional information concerning the investment ratings of the Companys fixed-maturity
investments at December 31, 2007:
|
|
|
|
|
|
|
|
|
|
TYPE/RATING OF INVESTMENT(1)
|
|
AMORTIZED
COST
|
|
FAIR
VALUE
|
|
PERCENTAGE
OF FAIR
VALUE
|
|
|
|
(In Thousands)
|
|
AAA (including U.S. government and agencies)
|
|
$
|
212,180
|
|
$
|
216,114
|
|
64.0
|
%
|
AA
|
|
|
39,436
|
|
|
38,920
|
|
11.5
|
%
|
A
|
|
|
70,404
|
|
|
69,038
|
|
20.4
|
%
|
BBB
|
|
|
13,793
|
|
|
13,712
|
|
4.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
335,813
|
|
$
|
337,784
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
The ratings set forth above are based on the ratings, if any, assigned by Standard & Poors Corporation (S&P). If S&Ps ratings were unavailable, the equivalent
ratings supplied by Moodys Investors Services, Inc. were used.
|
The
following table sets forth certain information concerning the maturities of fixed-maturity securities in the Companys investment portfolio as of December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
AMORTIZED
COST
|
|
FAIR
VALUE
|
|
PERCENTAGE
OF FAIR
VALUE
|
|
|
|
(In Thousands)
|
|
Years to maturity:
|
|
|
|
|
|
|
|
|
|
One or less
|
|
$
|
41,643
|
|
$
|
41,618
|
|
12.3
|
%
|
After one through five
|
|
|
154,399
|
|
|
154,951
|
|
45.9
|
%
|
After five through ten
|
|
|
71,747
|
|
|
72,859
|
|
21.6
|
%
|
After ten
|
|
|
4,203
|
|
|
4,285
|
|
1.2
|
%
|
Mortgage-backed and asset-backed securities
|
|
|
63,821
|
|
|
64,071
|
|
19.0
|
%
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
335,813
|
|
$
|
337,784
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
The average weighted maturity of the securities
in the Companys fixed-maturity portfolio as of December 31, 2007, was 4.1 years. The average duration of the Companys fixed-maturity portfolio as of December 31, 2007, was 2.8 years.
The Company maintains cash and highly liquid short-term investments, which at December 31, 2007,
totaled $217.3 million. As investments matured or were called in recent periods, the Company grew its short-term investment position as it represented an attractive sector. As market conditions change the Company will look for strategic
opportunities to reinvest these short-term investments in fixed-maturity securities in accordance with its guidelines.
The following table summarizes the Companys investment results for the three years ended December 31, 2007, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
FOR THE YEARS ENDED DECEMBER 31,
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In Thousands)
|
|
Average invested assets (includes short-term investments)(1)
|
|
$
|
544,353
|
|
|
$
|
531,187
|
|
|
$
|
548,829
|
|
Net investment income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Before income taxes
|
|
$
|
21,908
|
|
|
$
|
20,410
|
|
|
$
|
17,818
|
|
After income taxes
|
|
$
|
14,240
|
|
|
$
|
13,267
|
|
|
$
|
11,582
|
|
Average annual yield on investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
Before income taxes
|
|
|
4.0
|
%
|
|
|
3.8
|
%
|
|
|
3.2
|
%
|
After income taxes
|
|
|
2.6
|
%
|
|
|
2.5
|
%
|
|
|
2.1
|
%
|
Net realized investment (losses) gains
|
|
|
|
|
|
|
|
|
|
|
|
|
Before income taxes
|
|
$
|
(114
|
)
|
|
$
|
(493
|
)
|
|
$
|
4,018
|
|
After income taxes
|
|
$
|
(74
|
)
|
|
$
|
(320
|
)
|
|
$
|
2,612
|
|
Increase (decrease) in net unrealized losses on all investments after income taxes
|
|
$
|
6,172
|
|
|
$
|
274
|
|
|
$
|
(8,009
|
)
|
|
(1)
|
|
Includes fixed-maturity securities and equities at market and cash equivalents.
|
17
In 2001 and 2002 the Company recognized significant capital gains primarily to generate statutory surplus to improve its
capital adequacy ratios. In addition, the Company moved its portfolio entirely into taxable securities over the 2002-2003 time frame to maximize its cash income based on its current tax position. As a result, the majority of securities in the
Companys portfolio were purchased after 2002. The Companys average yield may be less than other comparable insurance companies who have a portfolio of securities which include securities purchased prior to 2002 when interest rates were,
in general, higher.
COMPETITION
The California physician professional liability insurance market is highly
competitive. The Company competes principally with three physician-owned mutual or reciprocal insurance companies and a physician-owned mutual protection trust for physician and medical group insureds. Two of the companies and the trust solicit
insureds in Southern California, the Companys primary area of operations, and each has offered competitive rates during the past few years. In addition, two of these companies have announced that they will provide some level of dividends to
their policyholders during 2007. The Company believes that the principal competitive factors, in addition to pricing, include financial stability, breadth and flexibility of coverage and the quality and level of services provided. In addition, large
commercial insurance companies actively compete in this market, particularly for larger medical groups, hospitals and other healthcare facilities. The Company has considered its A.M. Best rating to be extremely important to its ability to compete.
The Company currently has a B+ (Good) rating from A.M. Best, while its principal competitors in California have ratings of A- or better. See A.M. Best Rating for a description of potential impact of these reductions. See also Risk
FactorsImportance of A.M. Best Rating.
In Delaware, the Company competes
principally through its relationship with a Delaware broker, who has considerable and long-standing relationships with Delaware physician insureds.
REGULATION
General
Insurance companies are regulated by government agencies in each state in which they transact insurance. The extent of regulation varies by state, but the regulation usually includes: (i) regulating premium rates and policy forms;
(ii) setting minimum capital and surplus requirements; (iii) regulating guaranty fund assessments; (iv) licensing companies and agents; (v) approving accounting methods and methods of establishing statutory loss and expense
reserves; (vi) establishing requirements for and limiting the types and amounts of investments; (vii) establishing requirements for the filing of annual statements and other financial reports; (viii) conducting periodic statutory
examinations of the affairs of insurance companies; (ix) approving proposed changes of control; and (x) limiting the amounts of dividends that may be paid without prior regulatory approval. Such regulation and supervision are primarily for
the benefit and protection of policyholders and not for the benefit of investors.
Licenses
SCPIE Indemnity, AHI and AHSIC are licensed in their
respective states of domicileCalifornia, Delaware and Arkansas. AHI is also licensed to transact insurance and reinsurance in 47 states and the District of Columbia. This permits ceding company clients to take credit on their regulatory
financial statements for reinsurance ceded to AHI in jurisdictions in which it is authorized as a reinsurer. AHSIC is licensed to write policies as an excess and surplus lines insurer in 20 states. SCPIE Indemnity is not licensed in any jurisdiction
outside of California.
SCPIE Underwriting Limited is authorized under the laws of the
United Kingdom to participate as a corporate member of Lloyds underwriting syndicates.
Most of the Companys healthcare liability insurance policies are written in California where SCPIE Indemnity is domiciled. California laws and regulations, including the tort liability laws, and laws relating to professional liability
exposures and reports, have the most significant impact on the Company and its operations.
Insurance Guaranty Associations
Most states, including
California, require admitted property and casualty insurers to become members of insolvency funds or associations that generally protect policyholders against the insolvency of such insurers. Members of the fund or association
18
must contribute to the payment of certain claims made against insolvent insurers. Maximum contributions required by law in any one year vary by state, and California
permits a maximum assessment of 2% of annual premiums written by a member in that state during the preceding year. However, such payments are recoverable by law through policy surcharges.
Holding Company Regulation
SCPIE Holdings is subject to the California Insurance Holding Company System Regulatory Act (the Holding Company Act). The Holding Company Act requires the Company to periodically
file information with the California Department of Insurance and other state regulatory authorities, including information relating to its capital structure, ownership, financial condition and general business operations. Certain transactions
between an insurance company and its affiliates of an extraordinary type may not be effected if the California Commissioner disapproves the transaction within 30 days after notice. Such transactions include, but are not limited to,
certain reinsurance transactions and sales, purchases, exchanges, loans and extensions of credit and investments, in the net aggregate, involving more than the lesser of 3% of the insurers admitted assets or 25% of surplus as to policyholders,
as of the preceding December 31.
The Holding Company Act also provides that the
acquisition or change of control of a California insurance company or of any person or entity that controls such an insurance company cannot be consummated without the prior approval of the California Insurance Commissioner. In general,
a presumption of control arises from the ownership of voting securities and securities that are convertible into voting securities, which in the aggregate constitute more than 10% of the voting securities of a California insurance
company or of a person or entity that controls a California insurance company, such as SCPIE Holdings Inc. A person or entity seeking to acquire control, directly or indirectly, of the Company is generally required to file with the
California Commissioner an application for change of control containing certain information required by statute and published regulations and provide a copy of the application to the Company. The Holding Company Act also effectively restricts the
Company from consummating certain reorganizations or mergers without prior regulatory approval.
The Company is also subject to insurance holding company laws in other states that contain similar provisions and restrictions.
Regulation of Dividends from Insurance Subsidiaries
The Holding Company Act also limits the ability of SCPIE Indemnity to pay dividends to the Company. Without prior notice to and approval of the Insurance Commissioner, SCPIE
Indemnity may not declare or pay an extraordinary dividend, which is defined as any dividend or distribution of cash or other property whose fair market value together with other dividends or distributions made within the preceding 12 months exceeds
the greater of such subsidiarys statutory net income of the preceding calendar year or 10% of statutory surplus as of the preceding December 31. Applicable regulations further require that an insurers statutory surplus following a
dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs, and permit the payment of dividends only out of statutory earned (unassigned) surplus unless the payment out of other
funds is approved by the Insurance Commissioner. In addition, an insurance company is required to give the California Department of Insurance notice of any dividend after declaration, but prior to payment.
The other insurance subsidiaries are subject to similar provisions and restrictions under the insurance
holding company laws of the other states in which they are organized.
Risk-Based
Capital
The NAIC has developed a methodology for assessing the adequacy of
statutory surplus of property and casualty insurers which includes a risk-based capital (RBC) formula that attempts to measure statutory capital and surplus needs based on the risks in a companys mix of products and investment portfolio. The
formula is designed to allow state insurance regulators to identify potentially under-capitalized companies. Under the formula, a company determines its authorized control level RBC by taking into account certain risks related to the insurers
assets (including risks related to its investment portfolio and ceded reinsurance) and the insurers liabilities (including underwriting risks related to the nature and experience of its insurance business). The RBC rules provide for four
different levels of regulatory attention depending on the ratio of a companys total adjusted capital to its authorized control level RBC. The threshold requiring the least regulatory attention is a company action level when total adjusted
capital is less than or equal to 200% of the authorized control level RBC and the level requiring the most regulatory involvement is a mandatory control level RBC when total adjusted capital is less than 70% of authorized control level RBC. At the
mandatory control level the state Insurance Commissioner is required to restrict the writing of business or place the insurer under regulatory supervision or control.
19
At December 31, 2007, the adjusted surplus level of each Insurance Subsidiary exceeded the threshold requiring the least
regulatory attention. At December 31, 2007, SCPIE Indemnitys adjusted surplus level of $195.8 million was 466% of this threshold.
Regulation of Investments
The Insurance Subsidiaries are subject to state laws and regulations that require diversification of their investment portfolios and limit the amount of investments in certain investment categories such as below investment
grade fixed-income securities, real estate and equity investments. Failure to comply with these laws and regulations would cause investments exceeding regulatory limitations to be treated as nonadmitted assets for purposes of measuring statutory
surplus and, in some instances, would require divestiture of these non-qualifying investments over specified time periods unless otherwise permitted by the state insurance authority under certain conditions.
Prior Approval of Rates and Policies
Pursuant to the California Insurance Code, the Insurance Subsidiaries must submit rating plans, rates,
and certain policies and endorsements to the Commissioner for prior approval. The possibility exists that the Company may be unable to implement desired rates, policies, endorsements, forms or manuals if the Insurance Commissioner does not approve
these items. AHI is similarly required to make policy form and rate filings in most of the other states to permit the Company to write medical malpractice insurance in these states. AHSIC is required in many states to obtain approval to issue
policies as a non-admitted excess and surplus lines insurer, but it is typically not required to obtain rate approvals.
The Company has encountered challenges to its rate applications in recent years. See Risk FactorsRate Increases in California. The Commissioner approved in its
entirety the Companys most recent application, which was implemented on January 1, 2005. As a result of the performance of its core business during the past two years the Company did not have a rate increase in 2007, and will not have a
rate increase in 2008.
Medical Malpractice Tort Reform
The California Medical Injury Compensation Reform Act (MICRA), enacted in 1975, has been one of the
most comprehensive medical malpractice tort reform measures in the United States. MICRA currently provides for limitations on damages for pain and suffering of $250,000, limitations on fees for plaintiffs attorneys according to a specified
formula, periodic payment of medical malpractice judgments and the introduction of evidence of collateral source benefits payable to the injured plaintiff. The Company believes that this legislation has brought stability to the medical malpractice
insurance marketplace in California by making it more feasible for insurers to assess the risks involved in underwriting this line of business. Bills have been introduced in the California Legislature from time to time to modify or limit certain of
the tort reform benefits provided to physicians and other healthcare providers by MICRA. Neither the proponents nor opponents have been able to enact significant changes. The Company cannot predict what changes, if any, to MICRA may be enacted
during the next few years or what effect such changes might have on the Companys medical malpractice insurance operations.
Medical Malpractice Reports
The Company has been required to report detailed information with regard to settlements or judgments against its California physician insureds in excess of $30,000 to the Medical
Board of California, which has responsibility for investigations and initiation of proceedings relating to professional medical conduct in California. Since January 1, 1998, all judgments, regardless of amount, must be reported to the Medical
Board, which now publishes on the Internet all judgments reported and in the future will publicize certain settlements above $30,000. In addition, all payments must also be reported to the federal National Practitioner Data Bank and such reports are
accessible by state licensing and disciplinary authorities, hospital and other peer review committees and other providers of medical care. A California statute also requires that defendant physicians must consent to all medical professional
liability settlements in excess of $30,000, unless the physician waives this requirement. The Companys policy provides the physician with the right to consent to any such settlement, regardless of the amount, but that either party may submit
the matter of consent to a medical review board. In virtually all instances, the Company must obtain the consent of the insured physician prior to any settlement.
Health Insurance Portability and Accountability Act
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) was enacted by Congress to ultimately simplify the healthcare
administrative process. HIPAA contains a variety of provisions, including privacy and security rules designed to
20
maintain the confidentiality, integrity and availability of protected health information. Protected health information includes, among other things,
medical and billing records relating to medical care provided by the Companys insureds and loss descriptions and other information relating to medical liability claims asserted by patients against such insureds. The Company has developed
various documents and procedures for use with its insureds and vendors to safeguard this information from disclosure and use not permitted under HIPAA.
A.M. BEST RATING
A.M. Best rates insurance companies based on factors of concern to policyholders. A.M. Best currently assigns to each insurance company a rating that ranges from A++
(Superior) to F (In Liquidation). A.M. Best reviews a companys profitability, leverage and liquidity, as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of
its assets, the adequacy of its loss reserves, the adequacy of its surplus, its capital structure, the experience and competence of its management and its market presence. A.M. Bests ratings reflect its opinion of an insurance companys
financial strength, operating performance and ability to meet its obligations to policyholders and are not evaluations directed to purchasers of an insurance companys securities.
For a number of years, the Insurance Subsidiaries received an A.M. Best rating of A (Excellent), the third highest rating classification. As a result
of losses in the non-core businesses, the Companys rating was reduced in 2002 and 2003 to B (Fair). The Company took actions to improve its capital adequacy position through the orderly withdrawal from the non-core healthcare and assumed
reinsurance businesses. In November, 2006, A.M. Best increased its rating for the Insurance Subsidiaries to B+ (Good). With the recent announcement that SCPIE Holdings Inc. has entered into a definitive agreement to be acquired by The Doctors
Company, A. M. Best has placed the Company under review with developing implications. A.M. Best assigns a B+ rating to companies that have, in its opinion, a good ability to meet their ongoing obligations to policyholders.
An A.M. Best rating of at least an A- classification is important to some consumers in the
property/casualty insurance industry. At the present time, the Company has not been significantly affected by the lower A.M. Best ratings. The Company believes that its major competitors in California may use the Insurance Subsidiaries lower
A.M. Best rating in an attempt to solicit some of the Companys customers.
The
Insurance Subsidiaries participate in a pooling arrangement and each of the Insurance Subsidiaries has been assigned the same pooled B+ (Good) A.M. Best rating based on their consolidated performance.
EMPLOYEES
As of December 31, 2007, the Company employed 107 persons. None of the employees are covered by a
collective bargaining agreement. The Company believes that its employee relations are good.
EXECUTIVE OFFICERS
The Executive Officers of the Company and their ages as of March 6, 2008, are as follows:
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NAME
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AGE
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POSITION
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Donald J. Zuk
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71
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President, Chief Executive Officer and Director
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Ronald L. Goldberg
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56
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Senior Vice President, Underwriting and Marketing
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Joseph P. Henkes
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58
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Secretary and Senior Vice President, Operations and Actuarial Services
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Robert B. Tschudy
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59
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Senior Vice President, Chief Financial Officer and Treasurer
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Edward G. Marley
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47
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Vice President and Chief Accounting Officer
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Margaret A. McComb
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63
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Senior Vice President, Claims
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Donald J. Zuk became Chief Executive Officer of
the Companys predecessor in 1989. Prior to joining the Company, he served 22 years with Johnson & Higgins, insurance brokers. His last position there was Senior Vice President in charge of its Los Angeles Health Care operations, which
included the operations of the Companys predecessor. Mr. Zuk is a director of BCSI Holdings Inc., a privately held insurance company.
21
Ronald L. Goldberg joined the Company in May 2001. From June 2000 to April 2001, Mr. Goldberg was a Senior Consultant to
ChannelPoint, Inc., a privately held firm providing technology services to the insurance industry. Prior to that time, Mr. Goldberg served as Senior Vice President of the PHICO Group, a privately held professional liability insurer, from June
1998 to May 2000, and as President of its Independence Indemnity Insurance Company subsidiary. From April 1993 to May 1998, he was Vice President of USF&G Insurance Co., a large diversified insurance company that is now part of The St. Paul
Travelers Companies, Inc.
Joseph P. Henkes has been with the Company since 1990, serving
initially as Vice President, Operations and Actuarial Services. He was named Senior Vice President, Operations and Actuarial Services in 1992. Prior to joining the Company, he served three years with Johnson & Higgins, insurance brokers,
where his services were devoted primarily to the Company. He has been an Associate of the Casualty Actuarial Society since 1975 and a member of the American Academy of Actuaries since 1980.
Robert B. Tschudy joined the Company in May 2002. From July 1995 to March 2001, Mr. Tschudy was
Senior Vice President and Chief Financial Officer with 21st Century Insurance Group, a publicly held property casualty insurance company writing primarily personal automobile insurance in California. Prior to that time, Mr. Tschudy was a
partner, specializing in insurance, in the Los Angeles Office of Ernst & Young LLP for over 10 years.
Edward G. Marley joined the Company in December 2001 as Vice President and Controller. He was named Chief Accounting Officer in 2003. Prior to that time, he spent 14 years with CAMICO Mutual Insurance Company where he served as
Chief Financial Officer, Secretary and Treasurer.
Margaret A. McComb has been with the
Company since 1990. Prior to joining the Company, she served 14 years with Johnson & Higgins, insurance brokers. She assumed management responsibility for the Claims Department in 1985. Ms. McComb was named Senior Vice President in May
2002.
ITEM 1A. RISK FACTORS
The
Companys business involves various risks and uncertainties, some of which are discussed in this section. The information discussed below should be considered carefully with the other information contained in this Annual Report on Form 10-K and
the other documents and materials filed by the Company with the SEC, as well as news releases and other information publicly disseminated by the Company from time to time.
The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties not presently known to the Company, or that
it currently believes to be immaterial, may also adversely affect the Companys business. Any of the following risks or uncertainties that develop into actual events could have a materially adverse effect on the Companys business,
financial conditions or results of operations.
Proposed Merger with The Doctors
Company
On October 15, 2007, the Company agreed to be acquired by The
Doctors Company for $28.00 in cash for each outstanding share of Company common stock in a merger transaction valued at approximately $281.1 million. The merger is subject to customary closing conditions, including, among others, (i) the
approval of the merger by the holders of a majority in voting power of the outstanding common stock of the Company; (ii) the approval of the merger by the Departments of Insurance of California, Delaware and Arkansas; (iii) the receipt of
antitrust approvals, or the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; and (iv) the absence of any order or injunction prohibiting the consummation of the merger.
The Company currently expects the merger to close during the first half of 2008. However, it is possible that factors outside of the Companys control could require the parties to complete the proposed merger at a later time or not to complete
it at all.
In addition, the announcement of the proposed merger may have a negative
impact on the Company due to:
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risks that the proposed merger disrupts current plans and operations and potential difficulties in employee retention as a result of the merger;
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the effect of the announcement of the merger on the Companys agent, broker and customer relationships, operating results and business generally; and
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the amount of the costs, fees, expenses and charges related to the merger.
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22
In the event that the proposed merger is not completed:
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under specified circumstances, the Company may be required to pay a termination fee of up to 3% of the aggregate merger consideration; and
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the market price of the Companys common stock may decline to the extent that the current market price reflects a market assumption that the proposed merger will be
completed.
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Any of these events could have a negative impact on the
Companys results of operations and financial condition and could adversely affect the price of its common stock.
Concentration of Business
Substantially all of the Companys direct premiums written are generated from healthcare liability insurance policies issued to physicians and medical groups, healthcare facilities and other providers in the healthcare
industry. As a result, negative developments in the economic, competitive or regulatory conditions affecting the healthcare liability insurance industry, particularly as such developments might affect medical malpractice insurance for physicians and
medical groups, could have a material adverse effect on the Companys results of operations.
Almost all of the Companys 2008 premiums written will be generated in California. The revenues and profitability of the Company are therefore subject to prevailing regulatory, economic and other conditions in California, particularly
Southern California. In addition, approximately 23.3% of premiums written were generated by groups of nine physicians or more. The largest group of physicians accounted for 2.5% of total premiums written in 2007 and one program of affiliated groups,
accounted for 6.8% of premiums written in 2007.
Importance of Brokers
In the past few years, brokers have become increasingly important to the Companys
growth. During 2007, the Company wrote approximately 32% of its core healthcare liability business through independent brokers. The Company competes with other insurers for this brokerage business. To maintain its relationship with independent
brokers, the Company must pay competitive commissions, be able to respond to their needs quickly and adequately, and create a consistently high level of policyholder service and satisfaction. In addition, an insurers A.M. Best rating is an
important factor. If a broker finds it preferable to do business with a competitor with a higher A.M. Best rating, it could be difficult to renew existing business written through such broker or attract new business.
Uncertainties of Future Expansion
From 1996 to 2001, the Company significantly expanded its healthcare liability insurance products into
markets outside California. This expansion was not successful, and the Company is now running off this non-core healthcare liability business. At the present time, the Company has one continuing non-California program for physicians and
medical groups in Delaware and may consider adding programs on a selective basis in the future. The Company cannot predict whether this remaining program will be ultimately successful or whether the Company will have the opportunity to add such
programs in other jurisdictions, and, if so, whether any additional program will be successful. Success will depend upon, among other things, the A.M. Best rating of the insurance subsidiaries and the Companys access to sufficient capital for
any future expansion and its ability to accurately underwrite the healthcare risks and adequately price its policies in these other jurisdictions in which the Company does not have current experience.
Industry Factors
Many factors influence the financial results of the healthcare liability insurance industry, several of which are beyond the control of the Company.
These factors include, among other things, changes in severity and frequency of claims; changes in applicable law and regulatory reform; changes in judicial attitudes toward liability claims; and changes in inflation, interest rates and general
economic conditions.
The availability of healthcare liability insurance, or the
industrys underwriting capacity, is determined principally by the industrys level of capitalization, historical underwriting results, returns on investment and perceived premium rate adequacy. Historically, the financial performance of
the healthcare liability insurance industry has tended to fluctuate between a soft insurance market and a hard insurance market. In a soft insurance market, competitive conditions could result in premium rates
23
and underwriting terms and conditions that may be below profitable levels. For a number of years, the healthcare liability insurance industry in California and
nationally has faced a soft insurance market. Although the Company believes that the California insurance market is profitable, there can be no assurance that this profitability will continue or as to its effect on the Companys financial
condition and results of operations.
Competition
The Company competes with numerous insurance companies in the California market. The Companys
principal competitors for physicians and medical groups in California consist of three physician-owned mutual or reciprocal insurance companies, several commercial companies and a physicians mutual protection trust, which levies assessments
primarily on a claims paid basis. In addition, commercial insurance companies compete for the medical malpractice insurance business of larger medical groups and other healthcare providers. Several of these competitors have greater
financial resources than the Company. Between 1993 and 2002, the Company instituted overall rate increases in order to improve its underwriting results. These rate increases were higher than those implemented by most of its competitors. As a result,
the Company lost some of its policyholders, in part due to its rate increases. In 2003, the Companys rates became more competitive, as its requested rate increase for that year was delayed until the fourth quarter. In October 2003, the Company
instituted an average 9.9% rate increase for California physicians and medical groups and in January 2005, implemented an additional 6.5% rate increase. The Company believes its rates remain generally competitive with those of other companies, after
giving effect to these rate increases. The effect of any future rate increases on the Companys ability to retain and expand its healthcare liability insurance business in California is uncertain.
In addition to pricing, competitive factors may include policyholder dividends, financial stability,
breadth and flexibility of coverage and the quality and level of services provided. Three of the Companys physician-owned competitors have announced their intention to pay some level of policyholder dividends in California in 2008.
The Company considers its A.M. Best rating to be extremely important to its ability to compete in
its core markets. The Companys current rating of B+ (Good) could adversely affect the Companys ability to attract and retain policyholders in California and Delaware. See Importance of A.M. Best Rating.
Loss and LAE Reserves
The reserves for losses and LAE established by the Company are estimates of amounts needed to pay reported and unreported claims and related LAE. The
estimates are based on assumptions related to the ultimate cost of settling such claims based on facts and interpretation of circumstances then known, predictions of future events, estimates of future trends in claims frequency and severity,
judicial theories of liability, legislative activity, reports from ceding reinsurers and other factors. However, establishment of appropriate reserves is an inherently uncertain process involving estimates of future losses, and there can be no
assurance that currently established reserves will prove adequate in light of subsequent actual experience.
The inherent uncertainty is greater for healthcare liability reserves where a longer period may elapse before a definite determination of ultimate claim liability is made, and where the judicial, political and regulatory
climates are changing. Healthcare liability claims and expenses may be paid over a period of 10 or more years, which is longer than most property and casualty claims. Trends in losses on long-tail lines of business such as healthcare liability may
be slow to appear, and accordingly, the Companys reaction in terms of modifying underwriting practices and changing premium rates may lag underlying loss trends. The core healthcare liability net reserves account for $283.3 million or 81.4% of
total net reserves as of December 31, 2007. This portion of the reserves has the most historical experience available for actuarial analysis, and therefore should be the most predictable. A change of 1% in estimated loss cost trends based on
more recent experience would have an effect of approximately $7.4 million on estimated reserve levels.
The reserves related to the non-core healthcare liability business present additional problems in determining adequate reserves. As the size of these reserves decline and the number of underlying cases decrease, the ultimate
losses become more related to specific case results. Therefore, unexpected legal results in healthcare liability cases can produce unexpected reserve development. This was evident in 2004 as one adverse verdict in a Florida hospital case and an
unexpected rise in severe dental claims caused a material upward development of prior years reserves. Since some of the remaining cases in the non-core
24
healthcare liability business will ultimately go to trial many years after the event of loss, adverse verdicts or settlements at trial may affect the accuracy of
future reserving. As of December 31, 2007, non-core healthcare liability reserves accounted for $23.9 million or 6.9% of total net reserves. Outstanding claims are 75 at December 31, 2007.
The following table presents the net assumed reinsurance reserves (including retrospective reserves
ceded under the Rosemont Re Treaty of $5.7 million, $6.4 million, and $7.1 million, respectively) by major component as of December 31:
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2007
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2006
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2005
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(In Thousands)
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Occupational accident business
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$
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21,657
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$
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19,134
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$
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21,780
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Excess D&O liability
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3,839
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5,414
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6,375
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Bail and immigration bonds
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3,606
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|
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136
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(1)
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573
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(1)
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London-based business
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2,247
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19,494
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24,427
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Other
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3,841
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|
|
4,849
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|
|
|
6,039
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$
|
35,190
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$
|
49,027
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$
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59,194
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(1)
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Additional net liabilities of $3.6 million representing payment requests made to the Company are included in other liabilities on the Companys balance sheet. These net liabilities are
being contested in pending arbitrations. (See Legal ProceedingsBail and Immigration Bond Proceedings.)
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Approximately 60% of the net assumed reinsurance reserves outstanding as of December 31, 2007 are supported by actuarial work performed by or for the ceding insurers. Since
the time required for the ultimate losses to be reported through the worldwide reinsurance system may cover several years, unexpected events are more difficult to predict.
Establishing reserves in the assumed reinsurance area is complicated by the delay in reporting that naturally occurs as information passes through the
worldwide reinsurance network. In addition, sudden and catastrophic events do occur and further complicate the reserving process. Such events have caused the Company to revise upward its assumed reinsurance reserves over time. Examples of these
types of events include the World Trade Center terrorist attack in 2001, the sudden collapse of GoshawK Syndicate 102 in 2003 and the collapse of a large bonding company in 2004. (See Legal ProceedingsBail and Immigration Bond Proceedings). In
2005 and 2007 a number of London-based insureds including various Lloyds syndicates increased reserve estimates from 2000 and 2001 policy years. The Company believes that its current assumed reinsurance reserve levels are adequate, but they
may vary as the Company receives new information from the ceding insurers.
While the
Company believes that its reserves for losses and LAE are adequate, there can be no assurance that the Companys ultimate losses and LAE will not deviate, perhaps substantially, from the estimates reflected in the Companys financial
statements. If the Companys reserves should prove inadequate, the Company will be required to increase reserves, which could have a material adverse effect on the Companys financial condition or results of operations.
Rate Changes in California
California law requires that the Insurance Subsidiaries must submit proposed rate changes in California to the California Commissioner for approval
prior to implementation. Interested parties have the right to object to such proposed changes, and to request hearings that can be time consuming, if granted, and can result in rulings adverse to the applicant. A consumer group has challenged
proposed rate increases by the Company in recent years, with some success. The Commissioner approved in its entirety the Companys most recent application, which was implemented on January 1, 2005.
The Company plans to file applications for future rate changes in California that it considers
justified by reason of its loss experience. The Company may encounter objections and delays in obtaining approval of any requested changes. If future rate requests are denied or significantly reduced, or if there are substantial delays in
implementing a favorable decision, the Companys operations could be adversely affected.
Necessary Capital and Surplus
Measures of capital and surplus
are used in the casualty insurance industry to evaluate the safety and financial strength of an insurer. Recognized guidelines in the Companys segment are that (i) an insurer should not operate at a ratio of net premiums written to
statutory capital and surplus (policyholder surplus) greater than 1 to 1, and (ii) an insurer should not have a ratio of
25
net loss and LAE reserves to policyholder surplus greater than 3 to 1. In recent years the Company had unfavorably exceeded both these measures because of the losses
incurred in the non-core healthcare liability insurance and assumed reinsurance business. During 2005, 2006 and 2007, the Company has improved its capital and surplus position. At December 31, 2007, the Company had a ratio of net premiums
written to policyholder surplus of .61 to 1 and a ratio of net loss and LAE reserves to policyholder surplus of 1.78 to 1. The Company cannot predict whether this improvement in policyholder surplus will be sufficient to result in continued improved
ratings from A.M. Best.
The Company may need to raise additional statutory capital
through financings to improve its financial rating. Any equity or debt financing, if available at all, may not be available on terms that are favorable to the Company. In the case of equity financings, dilution to the Companys stockholders
could result, and in any case securities may have rights preferences and privileges that are senior to those of the Companys current stockholders. Debt financing would impact future earnings because of interest charges.
Liquidity
The Companys investment portfolio primarily consists of readily marketable fixed-income securities. In addition, the Company holds a significant cash and
short-term investment position as of December 31, 2007. Should cash needs of the Company, primarily loss reserve payments, require the unplanned sale of a portion of the fixed income portfolio when the portfolios carrying value is in excess of
current market rates, losses on security sales could impact the Companys earnings in the period of sale.
Changes in Healthcare
Significant attention has
recently been focused on reforming the healthcare system at both the federal and state levels. A broad range of healthcare reform and patients rights measures have been suggested, and public discussion of such measures will likely continue in
the future. Proposals have included, among others, spending limits, price controls, limits on increases in insurance premiums, limits on the liability of doctors and hospitals for tort claims, increased tort liabilities for managed care
organizations and changes in the healthcare insurance system. The Company cannot predict which, if any, reform proposals will be adopted, when they may be adopted or what impact they may have on the Company. While some of these proposals could be
beneficial to the Company, the adoption of others could have a material adverse effect on the Companys financial condition or results of operations.
In addition to regulatory and legislative efforts, there have been significant market-driven changes in the healthcare environment. In recent years, a number of factors related to
the emergence of managed care have negatively impacted or threatened to impact the medical practice and economic independence of physicians. Physicians have found it more difficult to conduct a traditional fee for service practice and
many have been driven to join or contractually affiliate with managed care organizations, healthcare delivery systems or practice management organizations. This consolidation could result in the elimination or significant decrease in the role of the
physician and the medical group from the medical professional liability purchasing decision. In addition, the consolidation could reduce primary medical malpractice insurance premiums paid by healthcare systems, as larger healthcare systems
generally retain more risk by accepting higher deductibles and self-insured retentions or form their own captive insurance companies.
Importance of A.M. Best Rating
A.M. Best ratings are an increasingly important factor in establishing the competitive position of insurance companies. The rating reflects A.M. Bests opinion of an insurance
companys financial strength, operating performance and ability to meet its obligations to policyholders. The Companys principal competitors in the healthcare liability insurance market in California all have an A- or better rating from
A.M. Best.
In October 2007, following the Companys announcement to be acquired by
The Doctors Company, A.M. Best Co. placed the financial strength rating (FSR) of B+ (Good) under review with developing implications. In the year prior to the announcement, A.M. Bests outlook for the Company was stable. The Insurance
Subsidiaries ratings are at a competitive disadvantage with its principal California competitors. The Insurance Subsidiaries rely heavily on their longstanding policyholder relations and reputation in California, and compete principally on this
basis in the California market. The Insurance Subsidiaries have not currently experienced a significant loss of business because of this A.M. Best rating; however, competitors could use their rating advantage to attract some of the Insurance
Subsidiaries policyholders. If the Insurance Subsidiaries A.M. Best rating were to be reduced, this could have a material adverse effect on the Insurance Subsidiaries ability to continue to write policies in some segments of the
market.
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Ceded Reinsurance
The amount and cost of reinsurance available to companies specializing in medical professional liability insurance are subject, in large part, to prevailing market conditions
beyond the control of the Company. The Companys ability to provide professional liability insurance at competitive premium rates and coverage limits on a continuing basis will depend in part upon its ability to secure adequate reinsurance in
amounts and at rates that are commercially reasonable. In general, the Companys reinsurance agreements are for a one-year term. Although the Company anticipates that it will continue to be able to obtain such reinsurance on reasonable terms,
there can be no assurance that this will be the case. In some years, the Company experiences large paid losses under its healthcare liability insurance policies that are in excess of the limits of insurance retained by the Company and thus are borne
by the reinsurers.
The Company is subject to a credit risk with respect to its
reinsurers because reinsurance does not relieve the Company of liability to its insureds for the risks ceded to reinsurers. Although the Company places its reinsurance with reinsurers it believes to be financially stable, a significant
reinsurers inability to make payment under the terms of a reinsurance treaty could have a material adverse effect on the Company. Rosemont Re, with which the Company had the largest receivable balance at December 31, 2007, incurred
substantial unexpected losses during 2005 as a result of hurricanes Katrina, Rita and Wilma. Rosemont Re has ceased writing any new business and is in run-off. Under the Companys reinsurance arrangement with Rosemont Re, Rosemont Re assets
approximately equal to the estimated liabilities are currently held in trust to satisfy the liabilities. If the liabilities increased materially in the future, the Company would have to look to Rosemonts Res general assets to satisfy any
liabilities not covered by the trust assets. As of June 30, 2007, Rosemont Re reported shareholder equity of $66.2 million. See BusinessCeded Reinsurance Programs.
Highlands Insurance Group Contingent Liability
The Company is obligated to assume certain policy obligations of Highlands Insurance Company (Highlands) in the event Highlands is declared insolvent by a court of competent
jurisdiction and is unable to pay these obligations. The coverages principally involve workers compensation, commercial automobile and general liability. Highlands currently is under the jurisdiction of the Texas District Court which appointed
the Texas Insurance Commissioner as a permanent Receiver of Highlands in November 2003. The Receiver, through a Special Deputy Receiver (SDR) continues to resolve Highlands claim liabilities and otherwise conduct its business as part of
his efforts to rehabilitate Highlands. At December 31, 2007, Highlands had established case loss reserves of $2.8 million, net of reinsurance, for the subject policies. Based on a limited review of the exposures remaining, the Company estimates
that incurred but not reported (IBNR) losses are $2.4 million, for a total loss and loss adjustment expenses (LAE) reserve of $5.2 million. This estimate is not based on a full reserve analysis of the exposures and is not
recorded in the Companys reserves. If Highlands is declared insolvent and liquidated by court order, the Company would likely be required to assume Highlands remaining obligations under the subject policies.
The receiver has filed a rehabilitation plan with the Texas Court. A hearing on that plan is scheduled
for May 12, 2008. In the interim, Highlands continues to pay and settle claims as the Receivership remains in place. If a Rehabilitation Plan ultimately is not approved, Highlands could be placed in liquidation.
Bail and Immigration Bond Proceedings
The Companys Insurance Subsidiary, AHI, was a reinsurer during 2001 and 2002 under separate
reinsurance agreements with Highlands and two other primary insurers covering bail and immigration bond programs administered by a single bonding company. During 2004, the bonding company failed and the primary insurers have made claims against AHI
that are now part of active arbitration proceedings. The Company believes that its liability could amount to a potential loss of approximately $6.0 million. The Companys best estimate of $3.6 million is recorded in the financial statements as
part of loss and LAE reserves. See Legal ProceedingsBail and Immigration Bond Proceedings.
Holding Company StructureLimitation on Dividends
SCPIE Holdings is an insurance holding company whose assets consist of all of the outstanding capital stock of SCPIE Indemnity, which in turn owns all of the outstanding capital stock of AHI and AHSIC. As an insurance holding company, SCPIE
Holdings ability to meet its obligations and to pay dividends, if any, may depend upon the receipt of sufficient funds from SCPIE Indemnity. The payment of dividends to SCPIE Holdings by SCPIE Indemnity is subject to general limitations
imposed by California insurance laws. See BusinessRegulationRegulation of Dividends from Insurance Subsidiaries and Note 6 to Consolidated Financial Statements.
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Anti-Takeover Provisions
SCPIE Holdings amended and restated certificate of incorporation and amended and restated bylaws include provisions that may delay, defer or
prevent a takeover attempt that stockholders may consider to be in their best interests. These provisions include:
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a classified Board of Directors;
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authorization to issue up to 5,000,000 shares of preferred stock, par value $1.00 per share, in one or more series with such rights, obligations, powers and preferences as
the Board of Directors may provide;
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a limitation which permits only the Board of Directors, the Chairman of the Board or the President of SCPIE Holdings to call a special meeting of stockholders;
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a prohibition against stockholders acting by written consent;
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provisions prohibiting directors from being removed without cause and only by the affirmative vote of holders of two-thirds of the outstanding shares of voting securities;
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provisions allowing the Board of Directors to increase the size of the Board and to fill vacancies and newly created directorships;
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provisions that do not permit cumulative voting in the election of directors; and
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advance notice procedures for nominating candidates for election to the Board of Directors and for proposing business before a meeting of stockholders.
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The Company is subject to Section 203 of the Delaware general
corporation law which, in general, prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder for a period of three years following the date the person became an interested
stockholder, unless the business combination or the transaction in which the person became an interested stockholder is approved in a prescribed manner. An interested stockholder is defined generally as a person who, together with
affiliates and associates, owns or within three years prior to the determination of interested stockholder status, did own, 15% or more of a corporations voting stock. The existence of this provision may have an anti-takeover effect with
respect to transactions not approved in advance by the Board of Directors.
In addition,
state insurance holding company laws applicable to the Company in general provide that no person may acquire control of SCPIE Holdings without the prior approval of appropriate insurance regulatory authorities. See
BusinessRegulationHolding Company Regulation.
Fluctuations
in Stock Price
The market price of the Companys common stock price could
be subject to significant fluctuations and/or may decline. Among the factors that could affect the Companys stock price are:
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variations in the Companys operating results;
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actions or announcements by our competitors;
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actions by institutional and other stockholders
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general market conditions; and
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domestic and international economic factors unrelated to our performance.
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The stock markets in general have recently experienced volatility that has sometimes been unrelated to the operating performance of particular
companies. These broad market fluctuations may cause the trading price of the Companys common stock to decline.
Regulatory and Related Matters
Insurance companies are subject to supervision and regulation by the state insurance authority in each state in which they transact business. Such supervision and regulation relate
to numerous aspects of an insurance companys business and financial condition, including limitations on lines of business, underwriting limitations, the setting of premium rates, the establishment of
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standards of solvency, statutory surplus requirements, the licensing of insurers and agents, concentration of investments, levels of reserves, the payment of
dividends, transactions with affiliates, changes of control, the approval of policy forms, and periodic examinations of the insurance companys financial statements and records. Such regulation is concerned primarily with the protection of
policyholders interests rather than stockholders interests. See BusinessRegulation.
The Risk-Based Capital rules provide for different levels of regulatory attention depending on the amount of a companys total adjusted capital compared to its various RBC
levels. At December 31, 2007 each of the Insurance Subsidiaries RBC exceeded the threshold requiring the least regulatory attention. At December 31, 2007, SCPIE Indemnitys adjusted surplus level of $195.8 million was 466% of
this threshold.
State regulatory oversight and various proposals at the federal level
may in the future adversely affect the Companys results of operations. In recent years, the state insurance regulatory framework has come under increased federal scrutiny, and certain state legislatures have considered or enacted laws that
alter and, in many cases, increase state authority to regulate insurance companies and insurance holding company systems. Further, the NAIC and state insurance regulators are reexamining existing laws and regulations, which in many states has
resulted in the adoption of certain laws that specifically focus on insurance company investments, issues relating to the solvency of insurance companies, RBC guidelines, interpretations of existing laws, the development of new laws and the
definition of extraordinary dividends. See BusinessRegulation.