================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K/A
AMENDMENT NO. 1
------------------
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2000
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ___________ to
___________
Commission file number: 1-5721
LEUCADIA NATIONAL CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
NEW YORK 13-2615557
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
315 PARK AVENUE SOUTH
NEW YORK, NEW YORK 10010
(212) 460-1900
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(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
--------------------------------------------------------------------------------
COMMON SHARES, PAR VALUE $1 PER SHARE NEW YORK STOCK EXCHANGE
PACIFIC STOCK EXCHANGE
7-3/4% SENIOR NOTES DUE AUGUST 15, 2013 NEW YORK STOCK EXCHANGE
8-1/4% SENIOR SUBORDINATED NOTES DUE NEW YORK STOCK EXCHANGE
JUNE 15, 2005
7-7/8% SENIOR SUBORDINATED NOTES DUE NEW YORK STOCK EXCHANGE
OCTOBER 15, 2006
Securities registered pursuant to Section 12(g) of the Act:
NONE.
--------------------------------------------------------------------------------
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].
Aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant at March 19, 2001 (computed by reference to the
last reported closing sale price of the Common Stock on the New York Stock
Exchange on such date): $1,141,411,973.
On March 19, 2001, the registrant had outstanding 55,296,728 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2001 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
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NY2:\1123718\01\_32#01!.DOC\76830.0001
EXPLANATORY NOTE
----------------
This Report on Form 10-K/A amends and restates in their entirety the following
Items of the Annual Report on Form 10-K of Leucadia National Corporation (the
"Company") for the fiscal year ended December 31, 2000. Prior to the filing of
this Report on Form 10-K/A, the Company filed Quarterly Reports on Form 10-Q for
the fiscal quarters ended March 31, 2001, June 30, 2001 and September 30, 2001,
as well as Current Reports on Form 8-K filed January 24, 2001, February 27,
2001, March 1, 2001, August 30, 2001, November 5, 2001 and February 8, 2002. All
of these reports should be considered in connection with this Form 10-K/A.
PART I
Item 1. Business.
------ --------
THE COMPANY
The Company is a diversified financial services holding company engaged
through its subsidiaries in a variety of businesses, including commercial and
personal lines of property and casualty insurance, banking and lending,
manufacturing, winery operations, real estate activities and precious metals
mining. The Company concentrates on return on investment and cash flow to build
long-term shareholder value, rather than emphasizing volume or market share.
Additionally, the Company continuously evaluates the retention and disposition
of its existing operations and investigates possible acquisitions of new
businesses in order to maximize shareholder value.
Shareholders' equity has grown from a deficit of $7,700,000 at December
31, 1978 (prior to the acquisition of a controlling interest in the Company by
the Company's Chairman and President), to a positive shareholders' equity of
$1,204,200,000 at December 31, 2000, equal to a book value per common share of
the Company (a "Common Share") of negative $.11 at December 31, 1978 and $21.78
at December 31, 2000. The December 31, 2000 shareholders' equity and book value
per share amounts have been reduced by the $811,900,000 cash dividend (the
"Dividend") paid in 1999.
In February 2001, the Company, Berkshire Hathaway Inc., and Berkadia LLC,
an entity jointly owned by the Company and Berkshire Hathaway, announced a
commitment to lend $6,000,000,000 on a senior secured basis to FINOVA Capital
Corporation, the principal operating subsidiary of The FINOVA Group Inc.
("FINOVA"), to facilitate a chapter 11 restructuring of the outstanding debt of
FINOVA and its principal subsidiaries. FINOVA will pay certain fees to Berkadia
in connection with this commitment, including a $60,000,000 commitment fee that
was paid at the time of execution. The commitment is subject to, among other
things, Berkadia's satisfaction with the restructuring plan for the FINOVA
companies, and bankruptcy court and necessary creditor approvals. In connection
with the commitment, the Company entered into a ten-year management agreement
with FINOVA. For additional information concerning this possible transaction and
the management agreement, see Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" of this Report.
In October 2000, the Company agreed to invest $75,000,000 in a new issue
of convertible preference shares of White Mountains Insurance Group, Ltd.
("WMIG"), that is expected to represent approximately 4% of WMIG on an as
converted basis. This investment is subject to the closing of an acquisition by
WMIG of CGU Corporation, the U.S. property and casualty operations of CGNU plc,
which, although subject to certain contingencies, currently is expected to occur
during 2001. WMIG is a Bermuda-domiciled financial services holding company,
principally engaged through its subsidiaries and affiliates in property and
casualty insurance and reinsurance.
Primarily during 2000, the Company invested an aggregate of $89,000,000
in the common stock of Fidelity National Financial, Inc. ("FNF"), a publicly
traded title insurance holding company. The Company sold its investment in FNF
common stock for $179,900,000, resulting in a pre-tax gain of $90,900,000
primarily in the fourth quarter of 2000.
In January 2000, the Company sold its 10% equity interest in Jordan
Telecommunication Products, Inc. ("JTP") for $27,300,000. The Company recorded a
pre-tax gain of $24,800,000 in the year ended December 31, 2000. Further
consideration of approximately $7,500,000 may be received in the future upon the
favorable resolution of certain contingencies.
2
During 2000, the Company invested $100,000,000 in the equity of a limited
liability company, Jefferies Partners Opportunity Fund II, LLC ("JPOF II"), that
is a registered broker-dealer. JPOF II is managed and controlled by Jefferies &
Company, Inc., a full service investment bank to middle market companies. JPOF
II invests in high yield securities, special situation investments and
distressed securities and provides trading services to its customers and
clients. For the year ended December 31, 2000, the Company recorded $17,300,000
of pre-tax income from this investment under the equity method of accounting.
At December 31, 1999, the Company had outstanding promissory notes from
Conseco, Inc. in the principal amount of $250,000,000. During the third quarter
of 2000, the entire principal amount and accrued interest then outstanding on
these notes was repaid. In addition, the Company received $7,500,000 directly
from Conseco, which constituted a prepayment penalty due under the terms of
these notes.
In June 2000, the Company replaced its $100,000,000 unsecured bank credit
facility with a new unsecured bank credit facility of $152,500,000, which bears
interest based on the Eurocurrency Rate or the prime rate and matures in June
2003. At December 31, 2000, no amounts were outstanding under this bank credit
facility.
The Company's insurance operations consist of commercial and personal
property and casualty insurance primarily conducted through Empire Insurance
Company ("Empire"), Allcity Insurance Company ("Allcity") and Centurion
Insurance Company ("Centurion"). The Company's insurance operations have a
diversified investment portfolio of securities, of which 71% are issued or
guaranteed by the U.S. Treasury or by U.S. governmental agencies or are rated
"investment grade" by Moody's Investors Service Inc. ("Moody's") and/or Standard
& Poor's Corporation ("S&P").
The Company's banking and lending operations principally consist of
making instalment loans to niche markets primarily funded by customer banking
deposits insured by the Federal Deposit Insurance Corporation (the "FDIC"). The
Company's principal lending activities consist of providing collateralized
personal automobile loans to individuals with poor credit histories.
The Company's manufacturing operations manufacture and market lightweight
plastic netting used for a variety of purposes including, among other things,
construction, agriculture, packaging, carpet padding, filtration and consumer
products.
The Company's foreign real estate operations are conducted through
Compagnie Fonciere FIDEI ("Fidei"), a French company whose bonds are listed on
the Paris Stock Exchange. The Company's domestic real estate operations consist
of office buildings, residential land development projects and other unimproved
land, all in various stages of development and available for sale.
The Company's winery operations consist of its 90% interest in Pine Ridge
Winery in Napa Valley, California and Archery Summit in the Willamette Valley of
Oregon. These wineries produce and sell super-ultra-premium wines.
The Company's precious metals mining operations consist of its 72.9%
interest in MK Gold Company ("MK Gold").
As used herein, the term "Company" refers to Leucadia National
Corporation, a New York corporation organized in 1968, and its subsidiaries,
except as the context otherwise may require.
3
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company's reportable segments consist of its operating units, which
offer different products and services and are managed separately. These
reportable segments are: property and casualty insurance, banking and lending,
foreign real estate, manufacturing and other operations. Property and casualty
insurance operations have historically provided commercial and personal lines of
insurance in the New York metropolitan area. Banking and lending operations
principally make collateralized personal automobile instalment loans to
individuals who have difficulty obtaining credit, at interest rates above those
charged to individuals with good credit histories. Such loans are primarily
funded by deposits insured by the FDIC. Foreign real estate consists of the
operations of Fidei in France. Manufacturing operations manufacture and market
proprietary plastic netting used for a variety of purposes. Other operations
primarily consist of domestic real estate activities, winery operations and
precious metals mining operations. Associated companies primarily include equity
interests in entities that the Company does not control and that are accounted
for on the equity method of accounting. The information in the following table
for Corporate assets primarily consists of investments, notes receivable from
the sale of certain businesses and cash and cash equivalents. Corporate revenues
listed below primarily consist of investment income and securities gains and
losses on Corporate assets. Corporate assets, revenues, overhead expenses and
interest expense are not allocated to the operating units. In addition to the
Company's foreign real estate operations, the Company has an interest, through
MK Gold, in exploration and mining rights in Spain. The Company does not have
any other material foreign operations and investments.
Certain information concerning the Company's segments for 2000, 1999 and
1998 is presented in the following table.
2000 1999 1998
---- ---- ----
(In millions)
REVENUES:
Property and Casualty Insurance $144.5 $185.3 $299.8
Banking and Lending 108.8 59.0 46.0
Foreign Real Estate 49.2 65.0 11.0
Manufacturing 65.1 64.0 56.6
Other Operations (a) 127.1 238.4 58.9
------ ------ ------
Total revenue for reportable segments 494.7 611.7 472.3
Equity in Associated Companies 29.3 (2.9) 23.3
Corporate (b) 191.5 97.8 34.9
------ ------ ------
Total consolidated revenues $715.5 $706.6 $530.5
====== ====== ======
(continued)
4
2000 1999 1998
---- ---- ----
(In millions)
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES, MINORITY EXPENSE OF TRUST
PREFERRED SECURITIES AND EXTRAORDINARY GAIN (LOSS):
Property and Casualty Insurance $ (59.4) $ (22.4) $ (7.9)
Banking and Lending 11.0 12.7 13.9
Foreign Real Estate 22.9 31.8 1.2
Manufacturing 11.3 11.9 10.1
Other Operations (a) 63.4 198.9 21.6
-------- -------- --------
Total income (loss) from continuing
operations before income taxes, minority
expense of trust preferred securities
and extraordinary gain (loss) for reportable segments 49.2 232.9 38.9
Equity in Associated Companies 29.3 (2.9) 23.3
Corporate (b) 114.8 13.5 (32.8)
-------- -------- ---------
Total consolidated income (loss) from continuing
operations before income taxes, minority expense of
trust preferred securities and extraordinary gain (loss) $ 193.3 $ 243.5 $ 29.4
======== ======== ========
IDENTIFIABLE ASSETS EMPLOYED:
Property and Casualty Insurance $ 643.4 $ 803.9 $ 990.1
Banking and Lending 664.1 467.1 269.3
Foreign Real Estate 254.7 276.7 365.1
Manufacturing 63.4 42.9 41.8
Other Operations 380.1 416.5 308.5
-------- -------- --------
Total assets of reportable segments 2,005.7 2,007.1 1,974.8
Investments in Associated Companies 192.5 74.0 172.4
Net Assets of Discontinued Operations - - 45.0
Corporate 945.4 989.1 1,766.8
-------- -------- --------
Total consolidated assets $3,143.6 $3,070.2 $3,959.0
======== ======== ========
----------
(a) For 1999, includes pre-tax gains on sale of Caja de Ahorro y Seguro S.A.
("Caja"), The Sperry & Hutchinson Company, Inc. and its Russian joint
venture with PepsiCo, Inc. ("PIB"), as described in Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
of this Report.
(b) For 2000, includes pre-tax securities gains on sale of FNF and JTP, and for
1998, includes pre-tax securities losses relating to the writedown of
investments in Russian and Polish securities, as described in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" of this Report.
At December 31, 2000, the Company and its consolidated subsidiaries had
1,383 full-time employees.
5
PROPERTY AND CASUALTY INSURANCE
General
The Company's principal property and casualty insurance operations are
conducted through the Empire Group, which consists of Empire, Allcity and
Centurion. During the past several years, the Empire Group has experienced poor
underwriting results and adverse reserve development in all of its lines of
business. The Empire Group has responded to these developments by raising
premium rates and reducing the volume of unprofitable business, while at the
same time attempting to reduce its overhead.
Effective January 1, 2000, all assigned risk policy renewal obligations
were assigned to another insurance company. In 1999, a determination was made
not to accept any applications for new private passenger automobile business
from certain agents with the highest loss ratios. During the fourth quarter of
2000, this determination was extended to include the entire agency force.
Existing policies of private passenger automobile insurance will be either sold,
non-renewed or cancelled in accordance with New York insurance law. If this book
of business is not sold, it is expected that the Empire Group will continue to
issue renewal policies over the next several years as required by applicable
insurance law. The Empire Group also announced that all statutory automobile
policies (public livery vehicles) would be non-renewed effective March 1, 2001
due to poor underwriting results.
On March 1, 2001, the Empire Group announced that, effective immediately,
it would no longer issue any new (as compared to renewal) insurance policies in
any lines of business and that it filed plans of orderly withdrawal with the New
York Insurance Department as required. Existing commercial lines policies will
be non-renewed or canceled in accordance with New York insurance law or replaced
by Tower Insurance Company of New York or Tower Risk Management (collectively,
"Tower") under an agreement for the sale of the Empire Group's renewal rights
(the "Tower Agreement"). Under the Tower Agreement, Tower will buy the renewal
rights for substantially all of the Empire Group's remaining lines of business,
excluding private passenger automobile and commercial automobile/garage, for a
fee based on the direct written premium actually renewed by Tower. The amount of
the fee is not expected to be material. The Empire Group will continue to be
responsible for the remaining term of its existing policies and all claims
incurred prior to the expiration of these policies. For commercial lines, the
Empire Group will thereafter have no renewal obligations for those policies.
Under New York insurance law, the Empire Group is obligated to offer renewals of
homeowners, dwelling fire, personal insurance coverage and personal umbrella for
a three-year policy period; however, the Tower Agreement provides that Tower
must offer replacements for these policies. The closing of the transaction is
subject to the approval of the New York Insurance Department.
Certain of the lines of business included in the agreement with Tower
historically had acceptable loss ratios. However, despite repeated attempts, the
Empire Group has not been able to reduce its expenses sufficiently to be
profitable with its reduced volume of business. This has been due in part to
information systems and a personnel infrastructure built to service multiple
lines of property and casualty business, where the costs are more fixed than
variable in nature, and a high cost agency distribution channel. An additional
investment of both capital and management would have been required to attempt to
reduce the Empire Group's cost structure to a level commensurate with its book
of business. In weighing the potential returns against the risks inherent in
that strategy, the Empire Group determined not to make the investment.
The Empire Group is currently exploring its options for the future.
Assuming the Tower Agreement is consummated, the Empire Group will only have
renewal obligations for remaining personal lines insurance (primarily
automobile) not replaced by Tower, the remaining policy term of all existing
policies and a claim run-off operation. The Empire Group may commence new
property and casualty insurance operations if a new business model with an
acceptable expense structure can be developed, enter into a joint venture with
another property and casualty insurance operation, explore entering the claim
services business or commence a liquidation. There may be other options that the
Company will explore, but no assurance can be given at this time as to what the
ultimate plan will be.
6
As of March 3, 2001, the Empire Group was rated "B+" (very good) by A.M.
Best Company ("Best") and rated "BB-" (marginal) by S&P. Should the Empire Group
decide to commence new property and casualty insurance operations or enter into
an insurance joint venture, its existing ratings may affect its ability to
pursue its plans. As with all ratings, Best and S&P ratings are subject to
change at any time.
For the years ended December 31, 2000, 1999 and 1998, net earned premiums
for the Empire Group were $108,500,000, $145,200,000 and $228,600,000,
respectively. During the year ended December 31, 2000, 4% of net earned premiums
of the Empire Group were derived from assigned risk business, 22% from
commercial automobile lines, 39% from other commercial lines and 35% from
personal lines. Substantially all of the Empire Group's policies are written in
New York for a one-year period. The Empire Group is licensed in New York to
write most lines of insurance that may be written by a property and casualty
insurer. The Empire Group is also licensed to write insurance in Connecticut,
Massachusetts, Missouri, New Hampshire and New Jersey.
On a quarterly basis, the Empire Group reviews and adjusts its estimated
loss reserves for any changes in trends and actual loss experience. Included in
the Empire Group's results for 2000 was $53,000,000 related to losses and loss
adjustment expenses ("LAE") from prior accident years. The Empire Group will
continue to evaluate the adequacy of its loss reserves and record future
adjustments to its loss reserves as appropriate.
Set forth below is certain statistical information for the Empire Group
prepared in accordance with generally accepted accounting principles ("GAAP")
and statutory accounting principles ("SAP"). The Loss Ratio is the ratio of net
incurred losses and loss adjustment expenses to net premiums earned. The Expense
Ratio is the ratio of underwriting expenses (policy acquisition costs,
commissions, and a portion of administrative, general and other expenses
attributable to underwriting operations) to net premiums written, if determined
in accordance with SAP, or to net premiums earned, if determined in accordance
with GAAP. A Combined Ratio below 100% indicates an underwriting profit and a
Combined Ratio above 100% indicates an underwriting loss. The Combined Ratio
does not include the effect of investment income.
Year Ended December 31,
----------------------------------------
2000 1999 1998
---- ---- ----
Loss Ratio:
GAAP 138.8% 98.5% 102.6%
SAP 138.8% 98.5% 102.6%
Industry (SAP) (a) N/A 78.8% 76.5%
Expense Ratio:
GAAP 48.4% 39.9% 26.7%
SAP 50.6% 44.8% 31.4%
Industry (SAP) (a) N/A 29.3% 29.5%
Combined Ratio (b):
GAAP 187.2% 138.4% 129.3%
SAP 189.4% 143.3% 134.0%
Industry (SAP) (a) N/A 108.1% 106.0%
----------
(a) Source: Best's Aggregates & Averages, Property/Casualty, 2000 Edition.
Industry Combined Ratios may not be fully comparable as a result of, among
other things, differences in geographical concentration and in the mix of
property and casualty insurance products.
(b) For 1998, the difference in the accounting treatment for curtailment gains
relating to defined benefit pension plans was the principal reason for the
difference between the GAAP Combined Ratio and the SAP Combined Ratio.
Additionally for all three years, the difference relates to the accounting
7
for certain costs which are treated differently under SAP and GAAP. For
further information about the Empire Group's Combined Ratios, see Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" of this Report.
Losses and Loss Adjustment Expenses
Liabilities for unpaid losses, which are not discounted (except for
certain workers' compensation liabilities), and LAE are determined using
case-basis evaluations, statistical analyses and estimates for salvage and
subrogation recoverable and represent estimates of the ultimate claim costs of
all unpaid losses and LAE. Liabilities include a provision for losses that have
occurred but have not yet been reported. These estimates are subject to the
effect of trends in future claim severity and frequency experience. Adjustments
to such estimates are made from time to time due to changes in such trends as
well as changes in actual loss experience. These adjustments are reflected in
current earnings.
The Empire Group relies upon standard actuarial ultimate loss projection
techniques to obtain estimates of liabilities for losses and LAE. These
projections include the extrapolation of both losses paid and incurred by
business line and accident year and implicitly consider the impact of inflation
and claims settlement patterns upon ultimate claim costs based upon historical
patterns. In addition, methods based upon average loss costs, reported claim
counts and pure premiums are reviewed in order to obtain a range of estimates
for setting the reserve levels. For further input, changes in operations in
pertinent areas including underwriting standards, product mix, claims management
and legal climate are periodically reviewed.
In the following table, the liability for losses and LAE of the Empire
Group is reconciled for each of the three years ended December 31, 2000.
Included therein are current year data and prior year development.
RECONCILIATION OF LIABILITY FOR LOSSES AND
LOSS ADJUSTMENT EXPENSES
2000 1999 1998
---- ---- ----
(In thousands)
Net SAP liability for losses and LAE at
beginning of year $381,550 $469,318 $487,116
-------- -------- --------
Provision for losses and LAE for claims
occurring in the current year 97,089 124,172 191,482
Increase in estimated losses and LAE for
claims occurring in prior years 52,977 18,255 42,290
-------- -------- --------
Total incurred losses and LAE 150,066 142,427 233,772
-------- -------- --------
Losses and LAE payments for claims occurring during:
Current year 31,023 41,955 64,739
Prior years 177,607 188,240 186,831
-------- -------- --------
208,630 230,195 251,570
-------- -------- --------
Net SAP liability for losses and LAE
at end of year 322,986 381,550 469,318
Reinsurance recoverable 42,972 61,492 72,956
-------- -------- --------
Liability for losses and LAE at end of year as reported in
financial statements (GAAP) $365,958 $443,042 $542,274
======== ======== ========
8
The following table presents the development of balance sheet liabilities
from 1990 through 2000 for the Empire Group. The liability line at the top of
the table indicates the estimated liability for unpaid losses and LAE recorded
as of the dates indicated. The middle section of the table shows the
re-estimated amount of the previously recorded liability based on experience as
of the end of each succeeding year. As more information becomes available and
claims are settled, the estimated liabilities are adjusted upward or downward
with the effect of decreasing or increasing net income at the time of
adjustment. The lower section of the table shows the cumulative amount paid with
respect to the previously recorded liability as of the end of each succeeding
year.
The "cumulative deficiency" represents the aggregate change in the
estimates over all prior years. For example, the initial 1990 liability estimate
indicated on the table of $251,401,000 has been re-estimated during the course
of the succeeding ten years, resulting in a re-estimated liability at December
31, 2000 of $282,476,000 or a deficiency of $31,075,000. If the re-estimated
liability were less than the liability initially established, a cumulative
redundancy would be indicated.
In evaluating this information, it should be noted that each amount shown
for "cumulative deficiency" includes the effects of all changes in amounts for
prior periods. For example, the amount of the deficiency related to losses
settled in 1994, but incurred in 1990, will be included in the cumulative
deficiency amount for 1990, 1991, 1992 and 1993. This table is not intended to
and does not present accident or policy year loss and LAE development data.
Conditions and trends that have affected development of the liability in the
past may not necessarily occur in the future. Accordingly, it would not be
appropriate to extrapolate future redundancies or deficiencies based on this
table.
9
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
Year Ended December 31,
------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996
---- ---- ---- ---- ---- ---- ----
(In thousands)
Liability for
Unpaid
Losses and Loss
Adjustment
Expenses $ 251,401 $ 280,679 $ 322,516 $ 353,917 $ 406,695 $ 476,692 $ 481,138
Liability
Re-estimated
as of:
One Year Later $ 249,492 $ 280,020 $ 321,954 $ 344,156 $ 441,165 $ 504,875 $ 508,165
Two Years Later 245,141 277,866 324,262 374,158 467,659 537,372 546,724
Three Years Later 243,849 284,052 345,576 394,418 500,286 577,266 599,015
Four Years Later 247,314 296,484 361,903 415,251 534,014 609,425 617,755
Five Years Later 255,045 306,094 377,097 442,696 556,072 613,371
Six Years Later 260,031 316,887 395,291 459,573 555,215
Seven Years Later 265,525 330,866 406,188 458,872
Eight Years Later 277,626 337,660 405,068
Nine Years Later 281,995 336,883
Ten Years Later 282,476
Cumulative
Deficiency $ (31,075) $(56,204) $(82,552) $(104,955) $(148,520) $(136,679) $(136,617)
========= ======== ======= ========= ========= ========= =========
Cumulative Amount
of Liability
Paid Through:
One Year Later $ 78,954 $ 89,559 $ 113,226 $ 116,986 $ 152,904 $ 202,334 $ 189,308
Two Years Later 126,908 150,043 182,250 199,214 270,020 318,693 314,755
Three Years Later 167,330 197,848 239,092 272,513 353,649 407,833 410,631
Four Years Later 196,099 233,244 285,880 326,637 415,919 472,384 490,591
Five Years Later 216,749 259,946 320,044 363,873 456,410 521,689
Six Years Later 231,892 279,682 341,636 390,027 488,197
Seven Years Later 242,275 293,860 357,735 410,323
Eight Years Later 253,104 304,610 370,559
Nine Years Later 260,340 312,924
Ten Years Later 266,193
Net Liability -
End of Year $ 353,917 $ 406,695 $ 476,692 $ 481,138
Reinsurance 37,912 44,747 40,730 51,181
--------- --------- ---------- ---------
Gross Liability -
End of Year $ 391,829 $ 451,442 $ 517,422 $ 532,319
========= ========= ========= =========
Net Re-estimated
Liability - Latest $ 458,872 $ 555,215 $ 613,371 $ 617,755
Re-estimated
Reinsurance - Latest 71,030 72,657 71,479 77,151
--------- --------- --------- ---------
Gross Re-estimated
Liability - Latest $ 529,902 $ 627,872 $ 684,850 $ 694,906
========= ========= ========= =========
Gross Cumulative
Deficiency $(138,073) $(176,430) $(167,428) $(162,587)
========= ========= ========= =========
Table continued....
Year Ended December 31,
---------------------------------------------------------
1997 1998 1999 2000
---- ---- ---- ----
(In thousands)
Liability for
Unpaid
Losses and Loss
Adjustment
Expenses $ 487,116 $ 469,318 $ 381,550 $ 322,986
Liability
Re-estimated
as of:
One Year Later $ 529,406 $ 487,573 $ 434,527 $ -
Two Years Later 546,643 544,219
Three Years Later 591,078
Four Years Later
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
Cumulative
Deficiency $(103,962) $ (74,901) $ (52,977) $ -
========= ========= ========= =========
Cumulative Amount
of Liability
Paid Through:
One Year Later $ 186,831 $ 188,240 $ 177,607 $ -
Two Years Later 313,040 327,322
Three Years Later 422,053
Four Years Later
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
Net Liability -
End of Year $ 487,116 $ 469,318 $ 381,550 $ 322,986
Reinsurance 58,592 72,956 61,492 42,972
--------- --------- --------- ---------
Gross Liability -
End of Year $ 545,708 $ 542,274 $ 443,042 $ 365,958
========= ========= ========= =========
Net Re-estimated
Liability - Latest $ 591,078 $ 544,219 $ 434,527
Re-estimated
Reinsurance - Latest 63,269 78,954 58,916
--------- --------- ---------
Gross Re-estimated
Liability - Latest $ 654,347 $ 623,173 $ 493,443
========= ========= =========
Gross Cumulative
Deficiency $(108,639) $ (80,899) $ (50,401)
========= ========= =========
10
As reflected in the above table, the Empire Group's reported loss and
loss adjustment expense reserves as of the end of each calendar year were
subsequently determined to be deficient. This adverse development first became
apparent to the Empire Group during the 1995 calendar year, when an increase to
prior years' reserves was recorded for the first time. In each subsequent
calendar year, the Empire Group's recalculation of the reserve balances for
prior periods continued to result in higher reserve estimates. These higher
reserve estimates were reflected in the Empire Group's annual financial
statements upon determination.
During the period from 1991 through 2000, the Empire Group recorded in
its Statements of Operations total net adverse reserve development of
$190,311,000, as disclosed in the Reconciliation of Liability for Losses and LAE
table for such years. This adverse development was experienced in substantially
all of the Empire Group's lines of insurance; however, the amount of reserve
increases and the periods in which the reserves were recorded were not the same
for all lines of insurance. On a calendar year basis, the aggregate $190,311,000
adverse reserve development was recorded, as set forth in the table below:
Redundancy/
(Deficiency)
Calendar year recorded (in thousands)
----------------
1991 $ 1,909
1992 659
1993 562
1994 9,761
1995 (34,470)
1996 (28,183)
1997 (27,027)
1998 (42,290)
1999 (18,255)
2000 (52,977)
--------
Prior year reserve development recorded 1991 to 2000 $(190,311)
This reserve development is reflected in the ten-year Analysis of Loss
and Loss Adjustment Expense Development table above; however, because the
deficiency line in the table is calculated on a cumulative basis, the
$190,311,000 of actual adverse reserve development experienced by the Company is
reported as deficiencies in multiple years in the table. An examination of the
adverse loss reserve development recorded during 2000 will illustrate this
point. During 2000 the Empire Group recorded $52,977,000 of adverse loss reserve
development related to claims incurred in years prior to 2000. This amount is
reflected in the 1999 column of the table as a cumulative deficiency. However,
since this adverse loss reserve development related to claims incurred and whose
settlement cost was originally estimated in various periods prior to 2000, the
cumulative deficiency line in years prior to 2000 includes this adverse loss
reserve development as follows: 1999: $52,977,000; 1998: $56,646,000; 1997:
$44,435,000; 1996: $18,740,000; and 1995: $3,946,000 (amounts prior to 1995 were
insignificant). Because the cumulative deficiencies reflected in the ten-year
Analysis of Loss and Loss Adjustment Expense Development table above add up to a
much greater number than the actual adverse development recorded by the Empire
Group, an understanding of the Empire Group's reserve deficiencies during
1990-1999 can only be obtained from an analysis of the adverse reserve
development actually recorded by the Empire Group in its financial statements in
each year in the period, beginning in 1995 (the first year in which adverse
reserve development was recorded).
11
The information below identifies certain of the more significant trends
and events that the Empire Group has experienced in recent years, resulting in
the Empire Group's recognition of the adverse loss reserve development in 1995
and each subsequent calendar year. As described below, the reserve development
recorded by the Empire Group was caused by many factors, including initial loss
ratio estimates used by the Empire Group that were subsequently found to be too
low as a result of actual loss experience, as well as factors external to the
Empire Group that weren't known at the time business was written. In addition,
the long period of time it takes to settle third-party liability claims in the
New York City marketplace further complicates the reserve estimation process.
Frequently, these claims are not received immediately after the accident occurs,
and in fact, a claimant can wait until just before the expiration of the statute
of limitations (three years from the date of the accident) to make a claim. Once
received, a claim may take several years until the claim reaches final
resolution in the New York City courts.
1995
----
In 1995, of the $34,470,000 of adverse loss reserve development recorded
by the Empire Group, $23,000,000 was in the private passenger automobile line of
insurance. In 1994, the Empire Group acquired a large block of assigned risk
private passenger automobile business that nearly doubled the volume previously
written by the Empire Group. In 1995, losses began to develop in this line of
insurance that indicated a higher ultimate loss ratio than the Empire Group had
experienced on similar blocks of assigned risk business from earlier periods,
which experience formed the basis of the Empire Group's original loss estimate.
As a result, the Empire Group increased its estimate for loss reserves for the
assigned risk business acquired in 1994 and earlier years.
1996, 1997 and 1998
-------------------
For the years ended December 31, 1996, 1997, and 1998, the Empire Group
recorded adverse loss reserve development of $28,183,000, $27,027,000 and
$42,290,000, respectively. For 1996, 1997 and 1998, these amounts included
$20,000,000, $7,000,000 and $14,000,000, respectively, in the commercial
automobile liability line, and $8,000,000, $11,000,000 and $14,000,000,
respectively, in the commercial package liability line. Beginning in 1992, the
Empire Group entered into new market segments of the voluntary commercial
business for automobile and general liability lines, including specialty
programs for sanitation trucks, gas stations, fuel oil deliveries and
limousines. Initially, the Empire Group's loss ratio estimate for these new
market segments was based upon its experience with similar lines of business and
standard actuarial ultimate loss projection techniques, which consider expected
loss ratios.
During 1996, claims began to develop unfavorably and the Empire Group
used such claim development to revise the assumptions that had formed the basis
of its actuarial studies; as a consequence reserves were increased. The increase
in ultimate loss estimates did not become apparent prior to 1996, primarily due
to the long period of time it takes to settle claims in these new sub-lines of
business. The Empire Group further increased its loss estimates and increased
reserves for these market segments in 1997 and 1998 as well. Except for the
three-year period from 1996 to 1998, there has been no other material
development for these market segments first entered into in 1992.
In addition, during 1998 the Empire Group's claim examiners began
recording increases in the expected settlement costs for 1997 accident year
claims in other sub-lines of the commercial automobile line of insurance in
larger amounts than previously expected. As a result, the 1997 accident year
loss ratio for the commercial automobile line is now currently estimated to be
130%, which is 30 points higher than the current estimate for the 1996 accident
year and 50 points higher than the current estimate for the 1995 accident year.
Such a large change in the loss experience for this book of business from prior
experience was not expected.
1999 and 2000
-------------
In 1999 and 2000, the Empire Group recorded adverse loss reserve
development of $18,255,000 and $52,977,000, respectively, of which $17,000,000
and $20,200,000, respectively, related to Personal Injury Protection ("PIP")
coverage in all of its automobile lines of insurance. The majority of the 1999
development resulted from increased claim cost estimates for the 1998 accident
year. It was during 1999 that the Empire Group first began to experience greater
severity (the amount paid to a claimant) in automobile liability claims, which
12
were subsequently determined to be PIP related. Also during 1999, the Empire
Group started to see the lengthening of the time from the date of loss to the
date a claim was first reported. This change in loss development patterns
resulted in more claims being reported at later dates, which further increased
the Empire Group's loss estimates. In 1999, the Empire Group incorporated this
developing trend into its ultimate loss estimate for PIP related claims and
increased its loss reserves accordingly.
During the latter half of 2000, and in particular, the fourth quarter,
the Empire Group experienced further unfavorable development in PIP claims. This
development occurred in all accident years from 1996 through 1999, with further
deterioration in the 1998 accident year being the most significant component.
The Empire Group observed this unfavorable development with respect to both the
frequency and severity of claims. The Empire Group incorporated the results of
this activity with that of developing industry trends into its actuarial
valuation for its PIP coverage and increased its loss reserve estimate.
In the past, the Empire Group has written various commercial package and
homeowner policies that offer liability protection to the insured, and has
exposure to third party liability claims in these lines of insurance. During
2000, the Empire Group experienced newly reported and reopened liability claims
with increased severity for accident years 1998 and prior. As a result, the
Empire Group recognized $15,000,000 of loss reserve development for those
accident years. One of the primary reasons for the reopened claims was that the
increase in severity made certain types of liability claims that previously had
lower settlement values more attractive litigation candidates for plaintiff's
attorneys.
Throughout 2000, the Empire Group outsourced a significant portion of its
claim handling responsibilities to outside third party claim administrators.
While the Empire Group anticipates that these administrators will be able to
settle these claims for smaller amounts than the Empire Group was achieving, the
loss adjustment expense reserve needed to be increased to recognize the fees due
to the administrators. Such fees are higher on a per claim basis than the Empire
Group's cost to handle claims in-house. Accordingly, in 2000 the adverse loss
reserve development recorded by the Empire Group included an increase to the
loss adjustment expense reserve of $11,000,000. The Empire Group has not
recognized any reserve reduction for the potentially lower settlement amounts
that may be achieved by the third party administrators.
For additional information, see Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," included elsewhere
herein.
Investments
Investment activities represent a significant part of the Company's
insurance related revenues and profitability. Investments are managed by the
Company's investment advisors under the direction of, and upon consultation
with, the Company's investment committees.
The Company's insurance subsidiaries have a diversified investment
portfolio of securities, a substantial portion of which is rated "investment
grade" by Moody's and/or S&P or issued or guaranteed by the U.S. Treasury or by
governmental agencies. The Company's insurance subsidiaries do not generally
invest in less than "investment grade" or "non-rated" securities, real estate or
mortgages, although from time to time they may make such investments.
13
The composition of the Company's insurance subsidiaries' investment
portfolio as of December 31, 2000 and 1999 was as follows:
2000 1999
---- ----
(Dollars in thousands)
Bonds and notes:
U.S. Government and agencies 44% 60%
Rated investment grade 27 15
Non rated - other - 2
Rated less than investment grade 5 3
Equity securities, primarily preferred 15 15
Other 9 5
----- -----
Total 100% 100%
===== =====
Estimated average yield to maturity
of bonds and notes (a) 6.6% 6.8%
Estimated average remaining life
of bonds and notes (a) 2.4 yrs. 2.7 yrs.
Carrying value of investment portfolio $421,114 $584,906
Market value of investment portfolio $421,252 $584,788
----------
(a) Excludes trading securities, which are not significant.
Reinsurance
The Empire Group's maximum retained limit for all lines of business was
$300,000 for 2000 and 1999. The Empire Group's maximum retained limit for 1998
was $500,000 for workers' compensation and $300,000 for other property and
casualty lines. Additionally, the Empire Group has entered into a property
catastrophe excess of loss treaty to protect against certain losses. The Empire
Group's retention of lower level losses in this treaty is $7,500,000 for 2001
and was $7,500,000 for 2000, 1999 and 1998.
Although reinsurance does not legally discharge an insurer from its
primary liability for the full amount of the policy liability, it does make the
assuming reinsurer liable to the insurer to the extent of the reinsurance ceded.
The Company's reinsurance generally has been placed with certain of the largest
reinsurance companies, including (with their respective Best ratings) General
Reinsurance Corporation (A++) and Zurich Reinsurance (NA), Inc. (A+). The
Company believes its reinsurers to be financially capable of meeting their
respective obligations. However, to the extent that any reinsuring company is
unable to meet its obligations, the Company's insurance subsidiaries would be
liable for the reinsured risks. The Company has established reserves, which the
Company believes are adequate, for any nonrecoverable reinsurance.
Competition
The insurance industry is a highly competitive industry, in which many of
the Company's competitors have substantially greater financial resources, larger
sales forces, more widespread agency and broker relationships, endorsements from
affinity groups and more diversified lines of insurance coverage. Additionally,
federal administrative, legislative and judicial activity has resulted in
changes to federal banking laws that increase the ability of national banks to
offer insurance products.
14
The Company believes that property and casualty insurers generally
compete on the basis of price, customer service, consumer recognition, product
design, product mix and financial stability. The industry has historically been
cyclical in nature, with periods of less intense price competition generating
significant profits, followed by periods of increased price competition
resulting in reduced profitability or loss. The current cycle of intense price
competition has continued for a longer period than in the past, suggesting that
the significant infusion of capital into the industry in recent years, coupled
with larger investment returns has been, and may continue to be, a depressing
influence on policy rates. The profitability of the property and casualty
insurance industry is affected by many factors, including rate competition,
severity and frequency of claims (including catastrophe losses), interest rates,
state regulation, court decisions and judicial climate, all of which are outside
the Company's control.
Government Regulation
Insurance companies are subject to detailed regulation and supervision in
the states in which they transact business. Such regulation pertains to matters
such as approving policy forms and various premium rates, minimum reserves and
loss ratio requirements, the type and amount of investments, minimum capital and
surplus requirements, granting and revoking licenses to transact business,
levels of operations and regulating trade practices. Insurance companies are
required to file detailed annual reports with the supervisory agencies in each
of the states in which they do business, and are subject to examination by such
agencies at any time. Increased regulation of insurance companies at the state
level and new regulation at the federal level is possible, although the Company
cannot predict the nature or extent of any such regulation or what impact it
would have on the Company's operations.
The National Association of Insurance Commissioners ("NAIC") has adopted
model laws incorporating the concept of a "risk based capital" ("RBC")
requirement for insurance companies. Generally, the RBC formula is designed to
measure the adequacy of an insurer's statutory capital in relation to the risks
inherent in its business. The RBC formula is used by the states as an early
warning tool to identify weakly capitalized companies for the purpose of
initiating regulatory action. Although New York State has not adopted the RBC
requirements for property and casualty insurance companies, New York does
require that property and casualty insurers file the RBC information with the
New York Department of Insurance. The NAIC also has adopted various ratios for
insurance companies which, in addition to the RBC ratio, are designed to serve
as a tool to assist state regulators in screening and analyzing the financial
condition of insurance companies operating in their respective states. The
Company's insurance operations had certain NAIC ratios outside of the acceptable
range of results for the year ended December 31, 2000. Although no assurance can
be given, the Company believes that it is unlikely that material adverse
regulatory action will be taken.
The Company's insurance subsidiaries are members of state insurance funds
which provide certain protection to policyholders of insolvent insurers doing
business in those states. Due to insolvencies of certain insurers, the Company's
insurance subsidiaries have been assessed certain amounts which have not been
material and are likely to be assessed additional amounts by state insurance
funds. The Company believes that it has provided for all anticipated assessments
and that any additional assessments will not have a material adverse effect on
the Company's financial condition or results of operations.
BANKING AND LENDING
The Company's banking and lending operations principally are conducted
through American Investment Bank, N.A. ("AIB"), a national bank subsidiary, and
American Investment Financial ("AIF"), an industrial loan corporation. AIB and
AIF take money market and other non-demand deposits that are eligible for
insurance provided by the FDIC. AIB and AIF had deposits of $526,200,000 and
$329,300,000 at December 31, 2000 and 1999, respectively. AIB and AIF currently
have several deposit-taking and lending facilities in the Salt Lake City area,
which have generated approximately one-half of their deposit balances. The
15
remainder of the Company's deposits were generated by various brokers. Deposits
are primarily used to fund consumer instalment loans.
The Company's consolidated banking and lending operations had outstanding
loans (net of unearned finance charges) of $515,800,000 and $339,800,000 at
December 31, 2000 and 1999, respectively. At December 31, 2000, 80% were loans
to individuals generally collateralized by automobiles; 16% were loans to
consumers, substantially all of which were collateralized by real or personal
property; 1% were unsecured loans to executives and professionals, generally
with good credit histories; and 3% were loans to small businesses.
Collateralized personal automobile instalment loans are primarily made
through automobile dealerships to individuals who have difficulty obtaining
credit, at interest rates above those charged to individuals with good credit
histories. These loans are made to consumers principally to purchase used,
moderately priced automobiles. In 2000, the average initial loan balance was
$12,150 and provided the Company with a yield of 21.4%. The contractual maturity
for automobile loans originated in 2000 was 58 months, with an anticipated
average life of 26 months. The Company currently generates automobile loans in
31 states through non-exclusive relationships with dealers, with no individual
state or dealership representing a significant portion of the Company's loan
volume. In determining which individuals qualify for these loans, the Company
takes into account a number of highly selective criteria with respect to the
individual, as well as the collateral, to attempt to minimize the number of
defaults. The Company closely monitors these loans and takes prompt possession
of the collateral in the event of a default. For the three year period ended
December 31, 2000, the Company generated $489,300,000 of these loans
($271,900,000 during 2000). Such amounts exclude purchased portfolios of
$1,000,000 in 2000, $67,900,000 in 1999 and $36,900,000 in 1998. The Company
intends to continue to acquire additional portfolios of loans that meet the
Company's underwriting standards if they can be purchased on attractive terms.
Such purchases would enable the Company to spread its existing infrastructure
and overhead costs over a larger asset base.
It is the Company's policy to charge to income an allowance for losses
which, based upon management's analysis of numerous factors, including current
economic trends, aging of the loan portfolio and historical loss experience, is
deemed adequate to cover reasonably expected losses on outstanding loans. At
December 31, 2000, the allowance for loan losses for the Company's entire loan
portfolio was $27,400,000 or 5.3% of the net outstanding loans, compared to
$17,000,000 or 5.0% of net outstanding loans at December 31, 1999.
The Company's policy is to charge-off an account when the automobile
securing the delinquent loan is repossessed, which generally occurs when the
loan is 60 days delinquent. Otherwise, the Company charges off the account due
to the customer's bankruptcy and in no event later than the month in which it
becomes 120 days delinquent. The charge-off represents the difference between
the net realizable value of the automobile and the amount of the delinquent
loan, including accrued interest. During 2000, and particularly in the latter
half of the year, the Company experienced an increase in loan losses. This
increase primarily is attributable to the subprime automobile portfolio
purchased in 1999 from Tranex Credit Corp. ("Tranex"), for which the actual
collection experience was less than expected, a larger amount of loans
outstanding, including the Tranex purchased portfolio, that are reaching the age
of peak losses, generally twelve to eighteen months after origination, and an
increase in loan originations. In addition, the Company believes that a weaker
economy has contributed to its loan losses. In an effort to reduce losses, the
Company plans to exit certain states and dealer relationships with historically
higher losses. Because these actions will reduce the volume of new loans
generated, the Company has closed its underwriting activities in Indianapolis
and consolidated underwriting in Salt Lake City.
Certain information with respect to the Company's banking and lending
segment is as follows for the years ended December 31, 2000, 1999 and 1998
(dollars in thousands):
16
2000 1999 1998
---- ---- ----
Average loans outstanding $ 423,030 $ 238,561 $ 148,713
Interest income earned on loans $ 87,865 $ 49,891 $ 29,717
Average loan yield 20.8% 20.9% 20.0%
Average deposits outstanding $ 422,607 $ 239,786 $ 195,601
Interest expense on non-demand deposits $ 26,421 $ 12,688 $ 11,202
Average rate on non-demand deposits 6.3% 5.3% 5.7%
Net yield on interest-bearing assets 13.1% 13.4% 9.7%
Investments held by the banking and lending segment are primarily
comprised of short-term bonds and notes of the United States Government and its
agencies.
The Company's banking and lending operations compete with banks, savings
and loan associations, credit unions, credit card issuers and consumer finance
companies, many of which are able to offer financial services on very
competitive terms. Additionally, substantial national financial services
networks have been formed by major brokerage firms, insurance companies,
retailers and bank holding companies. Some competitors have substantial local
market positions; others are part of large, diversified organizations.
The Company's principal banking and lending operations are subject to
detailed supervision by state authorities, as well as federal regulation
pursuant to the Federal Consumer Credit Protection Act, the Truth in Lending
Act, the Equal Credit Opportunity Act, the Right to Financial Privacy Act, the
Community Reinvestment Act, the Fair Credit Reporting Act and regulations
promulgated by the Federal Trade Commission. The Company's banking operations
are subject to federal and state regulation and supervision by, among others,
the Office of the Comptroller of the Currency (the "OCC"), the FDIC and the
State of Utah. AIB's primary federal regulator is the OCC, while the primary
federal regulator for AIF is the FDIC.
The Competitive Equality Banking Act of 1987 ("CEBA") places certain
restrictions on the operations of AIB and restricts further acquisitions of
banks and savings institutions by the Company. CEBA does not restrict AIF as
currently operated.
FOREIGN REAL ESTATE
Through its French subsidiary, Fidei, the Company owns foreign commercial
real estate properties with a book value of $43,600,000 at December 31, 2000.
After considering Fidei's other assets and non-recourse liabilities, the
Company's net investment in this segment was $46,000,000 at December 31, 2000.
During 2000, Fidei sold 38 properties resulting in pre-tax gains of $27,100,000;
at December 31, 2000, a total of 53 properties aggregating approximately
1,300,000 square feet remain. The Company expects to complete the sale of
Fidei's real estate holdings by the end of 2001. The Company currently is
seeking new investments for Fidei or, in the alternative, may sell Fidei.
17
MANUFACTURING
Through its plastics division, the Company manufactures and markets
proprietary lightweight plastic netting used for a variety of purposes
including, among other things, construction, agriculture, packaging, carpet
padding, filtration and consumer products. The plastics division is a market
leader in netting products used in carpet cushion, turf reinforcement, erosion
control, nonwoven reinforcement and crop protection. The plastics division
markets its products both domestically and internationally, with approximately
15% of its 2000 sales exported to Europe, Latin America, Japan and Australia.
New product development focuses on niches where the division's proprietary
technology and expertise can lead to sustainable competitive economic
advantages. For the years ended December 31, 2000, 1999 and 1998, the plastics
division's revenues were $65,000,000, $64,000,000 and $56,600,000, respectively.
In order to meet existing and projected product demand, the plastics
division is constructing a manufacturing facility in Belgium, which is expected
to be operational in the third quarter of 2001. The Belgium facility will
service customers in the European and Asian markets, which are currently being
supplied by the Company's domestic manufacturing facilities. The Company expects
that the Belgium facility and equipment will require a capital investment of
approximately $18,500,000. When fully operational, the facility is expected to
increase the division's capacity by approximately 20%.
During 1999, when the Company decided to construct the Belgium facility,
and through the first half of 2000, the plastics division operated near
capacity. During the second half of 2000, the plastics division began to
experience a slowdown in business and currently has excess capacity. The Belgium
facility will allow the plastics division to service new customers as well as
provide improved service to existing customers in Europe and Asia. In addition,
the available manufacturing capacity will provide adequate machine time for
product development as well as servicing seasonal peaks. However, the ability to
fully utilize the Belgium facility will depend upon developing new products as
well as expanding sales geographically.
The plastics division is subject to domestic and international
competition, generally on the basis of price, service and quality. Additionally,
certain products are dependent on cyclical industries, including the
construction industry. The Company holds patents on certain improvements to the
basic manufacturing processes and on applications thereof. The Company believes
that the expiration of these patents, individually or in the aggregate, is
unlikely to have a material effect on the plastics division.
OTHER OPERATIONS
The Company has a 90% interest in two wineries, Pine Ridge Winery in Napa
Valley, California and Archery Summit in the Willamette Valley of Oregon. Pine
Ridge, which was acquired in 1991, has been conducting operations since 1981,
while Archery Summit was started by the Company in 1993. These wineries produce
and sell super-ultra-premium wines. During 2000, the wineries sold approximately
79,300 9-liter equivalent cases of wine generating revenues of $15,300,000.
Since acquisition, the Company's investment in winery operations has grown,
principally to fund the Company's acquisition of land for vineyard development
and to increase production capacity and storage facilities at both of the
wineries. It can take up to five years for a new vineyard property to reach full
production and, depending upon the varietal produced, up to an additional two
years before the wine can be sold. The Company expects all of its vineyards will
be in substantially full production for the 2001 harvest, and with normal
farming yields should result in total production of approximately 100,000
9-liter equivalent cases of wine. At December 31, 2000, the Company's combined
investment in these wineries was $54,300,000. During 2000, in response to
certain inquiries, the Company engaged an investment banker to consider possible
offers for the purchase of the wineries. While the Company received many
expressions of interest and some offers to purchase the wineries, the Company
has determined that the prices offered were not adequate and it does not intend
to sell the wineries at this time.
18
At December 31, 2000, the Company's domestic real estate investments had
a book value of $166,500,000. Such real estate consists of office buildings,
residential land development projects and other unimproved land, all in various
stages of development and available for sale. The Company's largest domestic
real estate investment is a project located in San Diego County, California that
will be a master-planned community of approximately 3,400 homes and apartments
as well as commercial properties expected to be completed over the next nine
years. The Company expects to earn a preferred return of 15% on its investment
in this project (approximately $59,000,000 remains to be paid as of December 31,
2000); any amounts generated above this preferred return will primarily benefit
the project's development manager, HomeFed Corporation, a Delaware corporation
("HomeFed") that was distributed to the Company's shareholders in 1999. Also
included in the Company's domestic real estate is an investment in three
shopping centers on Long Island, New York, one shopping center in upstate New
York, and one shopping center in Louisiana. During 2000, the Company foreclosed
on all of the New York properties and recognized a pre-tax gain of $10,700,000;
the Company is in the process of foreclosing on the property in Louisiana.
During 2000, the Company received proceeds of $94,300,000 from an office complex
located on Capital Hill in Washington, D.C. Such amount was funded by a
non-recourse loan from a third-party lender and, when combined with amounts
previously received from the property, fully repaid the Company's investment
plus a 17-1/2% preferred return.
The Company has a 72.9% interest in MK Gold, a company that is traded on
the NASD OTC Bulletin Board. MK Gold owns Cobre Las Cruces, S.A., a Spanish
company that holds the exploration and mining rights to the Las Cruces copper
deposit in the Pyrite Belt of Spain. A feasibility study indicates the existence
of proven and probable reserves of 15.8 million metric tonnes grading 5.94%
copper that are overlain by a gold-bearing gossan (which has not been evaluated)
and by 150 meters of unconsolidated overburden. This reserve calculation was
based upon the analysis of 280 drill holes totaling over 82,000 meters. This
feasibility study estimates the capital cost will be approximately $290,000,000
to bring the mine into production. Mining will be subject to permitting
(currently underway), obtaining both debt and equity financing for the project,
engineering and construction. A mining concession application, accompanied by
the feasibility study and environmental impact studies, was submitted to the
applicable Spanish and Andalusian governmental agencies during the first quarter
of 2001.
OTHER INVESTMENTS
The Company owns equity interests representing more than 5% of the
outstanding capital stock of each of the following domestic public companies at
March 19, 2001: GFSI Holdings, Inc. ("GFSI") (6.4%), Jordan Industries, Inc.
("JII") (10.1%) and PhoneTel Technologies, Inc. (7.1%).
A subsidiary of the Company is an owner in The Jordan Company LLC and
Jordan/Zalaznick Capital Company. These entities each specialize in structuring
leveraged buyouts in which the owners are given the opportunity to become equity
participants. Since 1982, the Company has invested an aggregate of $91,100,000
in these entities and related companies and, through December 31, 2000, has
received $149,000,000 relating to the disposition of investments and management
and other fees. At December 31, 2000, through these entities, the Company had
interests in JII, GFSI, JZ Equity Partners PLC (a British company traded on the
London Stock Exchange in which the Company holds a 6.5% equity interest) and a
total of 41 other companies. These investments are carried in the Company's
consolidated financial statements at $59,200,000, of which $52,400,000 relates
to public companies carried at market value. In January 2000, the Company sold
its 10% equity interest in one of these entities, JTP, for proceeds of
$27,300,000.
For further information about the Company's business, including the
Company's investment in JPOF II, reference is made to Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" of
this Report and Notes to Consolidated Financial Statements.
19
Item 7. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations.
----------------------
The purpose of this section is to discuss and analyze the Company's
consolidated financial condition, liquidity and capital resources and results of
operations. This analysis should be read in conjunction with the consolidated
financial statements and related notes which appear elsewhere in this Report.
LIQUIDITY AND CAPITAL RESOURCES
Parent Company Liquidity
Leucadia National Corporation (the "Parent") is a holding company whose
assets principally consist of the stock of its several direct subsidiaries, cash
and other liquid investments. The Parent continuously evaluates the retention
and disposition of its existing operations and investigates possible
acquisitions of new businesses in order to maximize shareholder value.
Accordingly, while the Parent does not have any material arrangement, commitment
or understanding with respect thereto (except as disclosed in this Report),
further acquisitions, divestitures, investments and changes in capital structure
are possible. Its principal sources of funds are its available cash resources,
bank borrowings, public and private capital market transactions, repayment of
subsidiary advances, funds distributed from its subsidiaries as tax sharing
payments, management and other fees, and borrowings and dividends from its
regulated and non-regulated subsidiaries. It has no substantial recurring cash
requirements other than payment of interest and principal on its debt, tax
payments and corporate overhead expenses. As of December 31, 2000, the Company's
readily available cash, cash equivalents and marketable securities, excluding
those amounts held by its regulated subsidiaries, totaled $643,400,000.
Additional sources of liquidity as of December 31, 2000 include $156,800,000 of
marketable securities collateralizing letters of credit and $183,100,000 of
cash, cash equivalents and marketable securities held by Fidei.
Primarily during 2000, the Company invested an aggregate of $89,000,000
in the common stock of FNF, a publicly traded title insurance holding company.
The Company sold its investment in FNF common stock for $179,900,000, resulting
in a pre-tax gain of $90,900,000 in 2000.
In January 2000, the Company sold its 10% equity interest in JTP for
$27,300,000, and recorded a pre-tax gain of $24,800,000. Further consideration
of approximately $7,500,000 may be received in the future upon the favorable
resolution of certain contingencies.
At December 31, 1999, the Company had outstanding promissory notes of
Conseco, Inc. in the principal amount of $250,000,000. During the third quarter
of 2000, the entire principal amount and accrued interest then outstanding on
these notes was repaid. In addition, the Company received $7,500,000 directly
from Conseco which constituted a prepayment penalty due under the terms of these
notes.
Except for the Euro denominated debt of Fidei, which is non-recourse to
the Company, the Parent maintains the principal borrowings for the Company and
its non-banking subsidiaries and has provided working capital to certain of its
subsidiaries. These borrowings have primarily been made from banks through the
Company's credit agreement facility and through public financings.
In June 2000, the Company replaced its $100,000,000 unsecured bank credit
facility with a new unsecured bank credit facility of $152,500,000, which bears
interest based on the Eurocurrency Rate or the prime rate and matures in June
2003. As of December 31, 2000, no amounts were outstanding under this bank
credit facility.
During 2000, the Company invested $100,000,000 in the equity of JPOF II,
a limited liability company that is a registered broker-dealer. JPOF II is
managed and controlled by Jefferies & Company, Inc. JPOF II invests in high
yield securities, special situation investments and distressed securities and
provides trading services to its customers and clients. Generally, the Company
20
may not redeem its interest in JPOF II during 2001. For the year ended December
31, 2000, the Company recorded $17,300,000 of pre-tax income from this
investment under the equity method of accounting.
In October 2000, the Company agreed to invest $75,000,000 in a new issue
of convertible preference shares of WMIG, which is expected to represent
approximately 4% of WMIG on an as converted basis. This investment is subject to
the closing of an acquisition by WMIG of CGU Corporation, the U.S. property and
casualty operations of CGNU plc, which, although subject to certain
contingencies, currently is expected to occur during 2001.
During 2000, the Company repurchased 1,505,000 Common Shares for an
aggregate cost of $32,100,000. As of March 19, 2001, the Company is authorized
to repurchase an additional 4,495,000 Common Shares. Such purchases may be made
from time to time in the open market, through block trades or otherwise.
Depending on market conditions and other factors, such purchases may be
commenced or suspended at any time without prior notice.
At December 31, 2000, a maximum of $20,900,000 was available to the
Parent as dividends from its regulated subsidiaries without regulatory approval.
Additional amounts may be available to the Parent in the form of loans or cash
advances from regulated subsidiaries, although no amounts were outstanding at
December 31, 2000 or borrowed to date in 2001. There are no restrictions on
distributions from non-regulated subsidiaries. The Parent also receives tax
sharing payments from subsidiaries included in its consolidated income tax
return, including certain regulated subsidiaries. Because of the tax loss
carryforwards available to the Parent and certain subsidiaries, together with
current interest deductions and corporate expenses, the amount paid by the
Parent for income taxes has been substantially less than tax sharing payments
received from its subsidiaries. Payments from regulated subsidiaries for
dividends, tax sharing payments and other services totaled $8,300,000 for the
year ended December 31, 2000.
In February 2001, the Company, Berkshire Hathaway Inc., and Berkadia LLC,
an entity jointly owned by the Company and Berkshire Hathaway, announced a
commitment to lend $6,000,000,000 on a senior secured basis to FINOVA Capital
Corporation, the principal operating subsidiary of FINOVA, to facilitate a
chapter 11 restructuring of the outstanding debt of FINOVA and its principal
subsidiaries. Under the commitment, Berkadia's funding obligations to FINOVA
Capital have been guaranteed, 90% by Berkshire Hathaway and 10% by the Company
(with the Company's guarantee being secondarily guaranteed by Berkshire
Hathaway). The parties intend to finance this commitment; such financing is
expected to be similarly guaranteed. The commitment, which expires on August 31,
2001, or earlier if certain events occur or conditions are not satisfied,
provides that Berkadia will receive $6,000,000,000 principal amount of newly
issued five year senior notes of FINOVA Capital, secured by substantially all of
the assets of FINOVA and its subsidiaries (the "Secured Note"). The notes will
also be guaranteed on a secured basis by FINOVA and substantially all of the
subsidiaries of FINOVA and FINOVA Capital. Berkadia's obligation to make the
loan is subject to a number of conditions, including Berkadia's satisfaction
with the chapter 11 reorganization plan of the FINOVA companies, including
bankruptcy court and necessary creditor approvals, the issuance to the Company
and Berkshire Hathaway of newly issued common stock of FINOVA totaling 51% of
the stock of FINOVA to be outstanding on a fully diluted basis, and Berkadia
being able to designate a majority of the Board of Directors of FINOVA.
Upon execution of the commitment, FINOVA Capital paid Berkadia a
non-refundable commitment fee of $60,000,000 and has agreed to pay a funding fee
of $60,000,000 upon funding (or a termination fee of $60,000,000 if the
commitment is not funded except in certain limited circumstances). In addition,
FINOVA Capital has agreed to reimburse Berkadia, Berkshire Hathaway and the
Company for all fees and expenses incurred in connection with Berkadia's
financing of its funding obligation under the commitment.
In connection with the commitment, the Company entered into a ten-year
management agreement with FINOVA pursuant to which the Company agreed to provide
general management services, including services with respect to the formulation
21
of a restructuring plan. For these services, the Company will receive an annual
fee of $8,000,000, the first of which was paid when the agreement was signed.
Under the agreement governing Berkadia, the Company and Berkshire
Hathaway have agreed to equally share the commitment fee, funding or termination
fee and all management fees. An annual facility fee to be paid by FINOVA
Capital, equal to .25% of the outstanding amount of the loan, will be shared 70%
to Berkshire Hathaway and 30% to the Company, and all income related to the
Secured Note will be shared 90% to Berkshire Hathaway and 10% to the Company.
All decisions with respect to the management of Berkadia will require the mutual
consent of the Company and Berkshire Hathaway, except for decisions related to
the commitment, the financing of the commitment or the Secured Note, which are
in the sole control of Berkshire Hathaway.
As indicated above, the completion of the loan is subject to a number of
conditions and there can be no assurance that it ultimately will be consummated.
Based on discussions with commercial and investment bankers, the Company
believes that it has the ability to raise additional funds under acceptable
conditions for use in its existing businesses or for appropriate investment
opportunities. Since 1993, the Company's senior debt obligations have been rated
as investment grade by S&P and Duff & Phelps Inc. Ratings issued by bond rating
agencies are subject to change at any time.
Consolidated Liquidity
In 2000 and 1999, net cash was used for operations principally as a
result of a decrease in premiums written and the payment of claims at the Empire
Group. As discussed above, it is currently anticipated that the premiums of the
Empire Group will continue to decline while the Empire Group runs off its claims
liabilities. The Empire Group will continue to sell its investment portfolio and
collect its reinsurance receivables to generate the cash that will be required
to settle its loss and loss adjustment expense reserves. At December 31, 2000,
these assets totaled $479,400,000 as compared to the Empire Group's loss and
loss adjustment expense reserves of $366,000,000. The Empire Group expects to
settle approximately 80% of these liabilities within the next 3 years.
Additionally, the Empire Group has not experienced any material default in the
payment of reinsurance claims due from its reinsurance providers.
The investment portfolio of the Company's insurance subsidiaries
principally consists of fixed maturity investments; the balance of their
portfolio consists largely of preferred securities. Of the fixed maturity
securities, the majority consists of those rated "investment grade" or U.S.
governmental agency issued or guaranteed obligations, although limited
investments in "non-rated" or rated less than investment grade securities have
been made from time to time.
The Company provides collateralized automobile loans to individuals with
poor credit histories. The Company's investment in automobile loans was
$410,300,000 and $277,100,000 at December 31, 2000 and 1999, respectively. These
loans are primarily funded by deposits generated by the Company's deposit-taking
facilities and by brokers. Deposits raised in 2000 totaled $228,000,000 and had
an average maturity of 12 months and a weighted average interest rate of 6.6%.
In the past, the Company has at times funded the construction and/or
expansion of its manufacturing facilities with industrial revenue bonds. At
December 31, 2000, the Company has $9,800,000 principal amount outstanding for
such financing. The Company expects to finance the construction of the plastics
division's Belgium facility, estimated to aggregate $18,500,000, with available
cash resources.
As of December 31, 2000, the principal amount of Fidei's Euro denominated
outstanding debt, all of which is non-recourse to the Company, was $184,000,000
(195,200,000 Euros). Inasmuch as Fidei's Euro denominated cash, cash equivalents
22
and marketable securities approximate its Euro denominated debt, there is
currently no need to acquire a currency hedge for Fidei's debt.
The Company and certain of its subsidiaries have or have had tax loss
carryforwards and other tax attributes, the amount and availability of which are
subject to certain qualifications, limitations and uncertainties. In order to
reduce the possibility that certain changes in ownership could impose
limitations on the use of the tax loss carryforwards, the Company's certificate
of incorporation contains provisions which generally restrict the ability of a
person or entity from accumulating at least five percent of the Common Shares
and the ability of persons or entities now owning at least five percent of the
Common Shares from acquiring additional Common Shares.
RESULTS OF OPERATIONS
Property and Casualty Insurance
For the year ended December 31, 2000, the Company's insurance segment
contributed 20% of total revenues from continuing operations and, at December
31, 2000, constituted 20% of total assets Historically, the Company's property
and casualty insurance operations have provided commercial and personal lines of
insurance in the New York metropolitan area.
The Company's insurance segment pre-tax losses were $59,400,000,
$22,400,000 and $7,900,000 for the years ended December 31, 2000, 1999 and 1998,
respectively. These amounts were negatively impacted by adverse reserve
development of prior years' reserves of $52,977,000, $18,255,000 and $42,290,000
for 2000, 1999 and 1998, respectively. The more significant trends and events
that the Company has experienced in recent years, which resulted in the
recognition of the adverse loss reserve development, are identified below
following the Company's combined ratios.
Net earned premium revenues of the Empire Group were $108,500,000,
$145,200,000 and $228,600,000 for the years ended December 31, 2000, 1999 and
1998, respectively. While earned premiums declined in almost all lines of
business during 2000 and 1999, the most significant reductions during 2000 were
in assigned risk automobile ($14,700,000) and voluntary private passenger
automobile ($14,700,000), and during 1999 were in assigned risk automobile
($24,100,000), voluntary private passenger automobile ($26,900,000) and
commercial package policies ($11,600,000). Effective January 1, 2000, all policy
renewal obligations for assigned risk contracts were assigned to another
insurance company. However, the Empire Group remains liable for the claim
settlement costs for assigned risk claims that occurred during the policy term.
The decline in voluntary private passenger automobile resulted from tighter
underwriting standards, increased competition and the Empire Group's decision in
1999 to no longer accept new policies from those agents who historically have
had poor underwriting results. The Empire Group's termination of certain
unprofitable agents also adversely affected premium volume in other lines of
business.
During the fourth quarter of 2000, the Empire Group announced that it
would no longer accept any new private passenger automobile policies from any
agents. Existing policies of private passenger automobile insurance will be
either sold, non-renewed or cancelled in accordance with New York insurance law.
If this book of business is not sold, it is expected that the Empire Group will
continue to issue renewal policies over the next several years as required by
applicable insurance law. The Empire Group also announced that all statutory
automobile policies (public livery vehicles) would be non-renewed effective
March 1, 2001, due to poor underwriting results.
On March 1, 2001, the Empire Group announced that, effective immediately,
it would no longer issue any new (as compared to renewal) insurance policies and
that it has filed plans of orderly withdrawal with the New York Insurance
Department as required. Existing commercial lines policies will be non-renewed
or canceled in accordance with New York insurance law or replaced by Tower. The
Empire Group will continue to be responsible for the remaining term of its
existing policies and all claims incurred prior to the expiration of these
23
policies. For commercial lines, the Empire Group will thereafter have no renewal
obligations for those policies. Under New York insurance law, the Empire Group
is obligated to offer renewals of homeowners, dwelling fire, personal insurance
coverage and personal umbrella for a three-year policy period; however, the
Tower Agreement provides that Tower must offer replacements for these policies.
The closing of the transaction is subject to the approval of the New York
Insurance Department.
During the remaining term of the Empire Group's policies that will be
sold or non-renewed at the expiration of the policy term, and for other policies
which may have to be renewed under New York insurance law, the Empire Group's
estimate of losses for those policies will be based on its accumulated loss
experience in those lines of insurance as well as industry trends. The Empire
Group's accident year loss ratios for certain of these policies, in particular
private passenger automobile, will be high reflecting the poor loss experience
and adverse reserve development that the Empire Group has experienced in the
past.
The Empire Group is currently exploring its options for the future.
Assuming the Tower Agreement is consummated, the Empire Group will only have
renewal obligations for remaining personal lines insurance (primarily
automobile) not replaced by Tower, the remaining policy term of all existing
policies and a claim run-off operation. The Empire Group may commence new
property and casualty insurance operations if a new business model with an
acceptable expense structure can be developed, enter into a joint venture with
another property and casualty insurance operation, explore entering the claim
services business or commence a liquidation. There may be other options that the
Company will explore, but no assurance can be given at this time as to what the
ultimate plan will be.
The Empire Group's combined ratios as determined under GAAP and SAP were
as follows:
Year Ended December 31,
-----------------------
2000 1999 1998
---- ---- ----
GAAP 187.2% 138.4% 129.3%
SAP 189.4% 143.3% 134.0%
The Empire Group's combined ratios increased in 2000 primarily due to
unfavorable loss reserve development from prior accident years, increased loss
adjustment expenses for newly outsourced claims and adverse development in loss
adjustment expenses. In addition, these ratios increased due to reduced service
fees, higher 2000 accident year loss ratios, higher severance costs and overhead
costs which, although lower, have not declined commensurate with the reduced
premium volume. The Empire Group's combined ratios increased in 1999 primarily
due to the reduction in premium volume at a rate greater than the reduction in
net underwriting and other costs. In addition, in 1999, the expense ratios were
adversely affected by the reduction in service fees, increased expenditures
related to the installation of new information systems, providing Internet
access to agents and severance costs.
During 2000, the Empire Group recorded adverse loss reserve development
of $52,977,000, principally in the 1996 through 1999 accident years. This
development was attributable to an increase in the severity of personal injury
protection claims ("PIP") and an increase in the frequency of liability claims
in the private passenger automobile line ($9,200,000), an increase in the
frequency of liability claims in the commercial automobile line ($6,200,000), an
increase in the frequency and severity of PIP claims in the assigned risk
automobile line ($4,800,000) and an increase in the severity of certain
liability claims in the commercial package policies lines of business
($15,000,000). The increases in severity and frequency of claims in automobile
lines of business, particularly with respect to PIP claims, are consistent with
emerging industry trends in the New York City marketplace. In addition, the
Empire Group increased its estimate for loss adjustment expenses by $11,000,000
as a result of the decision to outsource a significant amount of claim handling
functions in 2000. Claim files for workers' compensation, automobile no-fault
24
and automobile and other liability claims were outsourced at a cost greater than
the reserves previously recorded to handle the claims internally. The Empire
Group has outsourced almost two-thirds of its claims. Currently, the Empire
Group is primarily handling complex claims, first party claims and certain
automobile liability and general liability claims internally. Complex claims
generally consist of those that have potentially large settlement exposure and
are not expected to settle quickly. The Empire Group has also increased its
reserve estimate for claims handled internally.
During 1999, the Empire Group recorded adverse loss reserve development
of $18,255,000, principally due to an increase in severity of 1998 accident year
losses in the assigned risk automobile and voluntary private passenger
automobile lines, and 1996 accident year losses in certain classes of the
commercial automobile line. As a result, the Empire Group increased its reserves
by $7,500,000 for assigned risk automobile, $5,000,000 for voluntary private
passenger automobile and $4,500,000 for commercial automobile lines.
During 1998, the Empire Group recorded adverse loss reserve development
of $42,290,000. In 1998, the Empire Group reviewed the adequacy of the reserves
carried for its open claims' files, focusing on workers' compensation,
commercial auto and other commercial liability lines of business. As part of the
review, substantially all open workers' compensation claim files were reviewed
for every accident year up to and including 1998. Additionally, during 1998, the
Empire Group reorganized the commercial auto claims department. As part of this
realignment, more complex claims files were reviewed by the most experienced
claims examiners and assumptions regarding average claims severity and probable
ultimate losses were revised. Accordingly, prior years reserves were increased
by $13,000,000 for workers' compensation, $14,000,000 for commercial automobile
and $14,000,000 for other commercial liability lines of business.
During the period between 1984 and 1995, the Empire Group entered into
certain retrospectively rated reinsurance contracts covering substantially all
lines of business, except workers' compensation. Under these contracts, the
Empire Group paid the reinsurer provisional premiums that are subject to
adjustment based on subsequent loss development. Ceded premiums accrued under
these contracts reduce both net written and earned premiums during the period
the retrospective reinsurance premiums are accrued. If additional unfavorable
loss development emerges in future periods, the Empire Group may be required to
accrue additional retrospective reinsurance premiums.
Net earned premiums revenues of the Empire Group were reduced for
retrospective reinsurance premiums by $4,500,000, $4,600,000, and $2,000,000 for
the years ended December 31, 2000, 1999 and 1998, respectively.
For all lines of property and casualty insurance business, the Company
employs a variety of standard actuarial ultimate loss projection techniques,
statistical analyses and case-basis evaluations to estimate its liability for
unpaid losses. The actuarial projections include an extrapolation of both losses
paid and incurred by business line and accident year and implicitly consider the
impact of inflation and claims settlement patterns upon ultimate claim costs
based upon historical patterns. These estimates are performed quarterly and
consider any changes in trends and actual loss experience. Any resulting change
in the estimate of the liability for unpaid losses, including those discussed
above, is reflected in current year earnings during the quarter the change in
estimate is identified.
The reserving process relies on the basic assumption that past experience
is an appropriate basis for predicting future events. The probable effects of
current developments, trends and other relevant matters are also considered.
Since the establishment of loss reserves is affected by many factors, some of
which are outside the Company's control or are affected by future conditions,
reserving for property and casualty claims is a complex and uncertain process
requiring the use of informed estimates and judgments. As additional experience
and other data become available and are reviewed, the Company's estimates and
judgments may be revised. While the effect of any such changes in estimates
25
could be material to future results of operations, the Company does not expect
such changes to have a material effect on its liquidity or financial condition.
In management's judgment, information currently available has been
appropriately considered in estimating the Company's loss reserves. The Company
will continue to evaluate the adequacy of its loss reserves on a quarterly
basis, incorporating any future changes in trends and actual loss experience,
and record adjustments to its loss reserves as appropriate.
Banking and Lending
Finance revenues, which reflect the level and mix of consumer instalment
loans, increased in each of the last two years due to greater average loans
outstanding. Average loans outstanding were $423,200,000, $238,600,000 and
$148,700,000 for 2000, 1999 and 1998, respectively. The increase in 2000 was
primarily due to the acquisition in 1999 of Tranex and increased new loan
originations. Pre-tax results declined in 2000 as compared to 1999 primarily due
to an increase in the provision for loan losses, higher interest expense due to
increased customer banking deposits and higher interest rates thereon, and
higher salaries expense.
The higher loan losses were principally caused by the poor performance of
the subprime automobile portfolio purchased from Tranex, for which the actual
collection experience was less than expected, a larger amount of loans
outstanding, including the Tranex purchased portfolio, that are reaching the age
of peak losses, generally twelve to eighteen months after origination, and the
increased loan originations. The Company also believes that a weaker economy has
contributed to its loan losses.
For 1999, although finance revenues increased due to greater average
loans outstanding, pre-tax results declined primarily due to an increase in the
provision for loan losses for the larger volume of loans outstanding. In
addition, 1998 results reflected the pre-tax gain of $6,500,000 from the sale of
substantially all of the Company's executive and professional loan portfolio.
The increase in average loans outstanding was primarily due to the purchase of a
subprime automobile portfolio in December 1998, the Tranex acquisition in 1999
and increased new loan originations.
Manufacturing
For 2000, revenues for the plastics division modestly increased to
$65,000,000 as compared to $64,000,000 for 1999. Gross profit and pre-tax income
for the plastics division declined slightly in 2000 primarily due to higher raw
material costs. In 1999, revenues of the plastics division increased 13% over
1998. In addition, despite rising raw material prices, the gross profit
increased 16% to $24,900,000.
Other
Investment and other income declined in 2000 as compared to 1999
primarily due to gains recognized in 1999 from the sale of Caja, The Sperry and
Hutchinson Company, Inc., PIB and an equity interest in an associated company
aggregating $177,700,000. Investment and other income also decreased in 2000 due
to a reduction in investment income ($11,500,000), resulting primarily from the
payment of the Dividend and debt repurchases in 1999 and decreased rent income
(due to a smaller base of remaining real estate properties) and decreased gains
from sales of real estate properties related to Fidei ($18,500,000). This
decrease was partially offset by increased gains from sales and foreclosures of
various domestic real estate properties ($50,800,000), the prepayment penalty
related to the Conseco notes ($7,500,000) and revenues relating to MK Gold
($12,300,000), which the Company began consolidating in the fourth quarter of
1999. During 2000, Fidei sold 38 real estate properties; 53 properties remain at
December 31, 2000, all of which are currently being marketed for sale.
26
Investment and other income in 1999 included the aforementioned gains on
sale of Caja ($120,800,000), The Sperry and Hutchinson Company, Inc.
($18,700,000) and PIB ($29,500,000), and the gain on sale of an equity interest
in an associated company ($8,700,000). Investment and other income also
increased in 1999 due to increased rent income and gains from sales of real
estate properties, of which $49,800,000 related to Fidei. Such increases were
partially offset by a reduction in investment income resulting primarily from
payment of the $811,900,000 dividend in 1999 and debt repurchases in 1999, a
reduction in investments held by the Empire Group and the gain in 1998 on the
sale of the executive and professional loan portfolio.
Payment of the Dividend required the Company to make an offer to purchase
all of its 8-1/4% Notes and its 7-7/8% Notes at a purchase price of 101% of
principal, plus accrued and unpaid interest thereon. Pursuant to such offers, in
1999, the Company repurchased $80,900,000 principal amount of the 8-1/4% Notes
and $113,300,000 principal amount of the 7-7/8% Notes for $198,000,000,
including accrued interest. The Company recorded an extraordinary loss, net of
income tax benefit, of $2,600,000 on this early extinguishment of debt.
Net securities gains (losses) for 2000 include pre-tax security gains
related to the Company's investments in FNF ($90,900,000) and JTP ($24,800,000),
as described above. During 1998, due to declines in values that were deemed
other than temporary, the Company recorded a pre-tax writedown of $75,000,000
related to its investments in Russian and Polish debt and equity securities.
Such writedowns are reflected in the caption "Net securities gains (losses)." At
December 31, 2000, the remaining book value of the Company's investments in
these securities was $1,200,000.
Equity in income (losses) of associated companies increased in 2000
primarily due to income of $17,300,000 related to JPOF II, described above.
Equity in income (losses) of associated companies declined in 1999 as compared
to 1998, primarily due to income of $30,800,000 recorded in 1998 from an
investment partnership that was subsequently liquidated.
Interest expense for 2000 reflects increased customer banking deposits
and higher interest rates thereon, partially offset by a reduction in interest
expense related to debt repurchases in 1999. The increase in interest expense in
1999 as compared to 1998 primarily relates to Fidei's outstanding debt,
partially offset by the Company's debt repurchases in 1999.
Salaries expense in 2000 reflects an increase in employees, primarily at
the banking and lending segment.
The increase in selling, general and other expenses in 2000 principally
reflects higher provisions for loan losses, as described above, and expenses
related to MK Gold. The increase in selling, general and other expenses in 1999
as compared to 1998 principally relates to expenses incurred by Fidei, higher
provisions for loan losses, expenses incurred in connection with the Dividend
and the recognition in 1998 of net curtailment gains relating to the Company's
pension plan.
Income taxes for 1999 reflect a benefit of $40,100,000 from the
utilization of capital loss carryforwards, of which $33,300,000 was previously
included in the valuation allowance. Income taxes for 1999 also reflect a
benefit of $3,400,000 for the favorable resolution of certain federal income tax
contingencies. Income taxes for 1998 reflect a benefit of $39,000,000 for a
change in the Company's estimated 1997 federal tax liability and the favorable
resolution of certain contingencies.
The number of shares used to calculate basic earnings (loss) per share
was 55,529,000, 59,338,000 and 63,409,000 for 2000, 1999 and 1998, respectively.
The number of shares used to calculate diluted earnings (loss) per share was
55,598,000, 59,352,000 and 63,510,000 for 2000, 1999 and 1998, respectively.
27
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking
statements. Such forward-looking statements are made pursuant to the safe-harbor
provisions of the Private Securities Litigation Reform Act of 1995. Such
statements may relate, but are not limited, to projections of revenues, income
or loss, capital expenditures, fluctuations in insurance reserves, plans for
growth and future operations, competition and regulation as well as assumptions
relating to the foregoing. Forward-looking statements are inherently subject to
risks and uncertainties, many of which cannot be predicted or quantified. When
used in this Report, the words "estimates", "expects", "anticipates",
"believes", "plans", "intends" and variations of such words and similar
expressions are intended to identify forward-looking statements that involve
risks and uncertainties. Future events and actual results could differ
materially from those set forth in, contemplated by or underlying the
forward-looking statements. The factors that could cause actual results to
differ materially from those suggested by any such statements include, but are
not limited to, those discussed or identified from time to time in the Company's
public filings, including general economic and market conditions, changes in
foreign and domestic laws, regulations and taxes, changes in competition and
pricing environments, regional or general changes in asset valuation, the
occurrence of significant natural disasters, the inability to reinsure certain
risks economically, the adequacy of loss reserves, prevailing interest rate
levels, weather related conditions that may affect the Company's operations,
consummation of the Tower Agreement, adverse selection through renewals of the
Empire Group's policies, the Company's ability to develop an alternate business
model for the Empire Group, adverse environmental developments in Spain that
could delay or preclude the issuance of permits necessary to develop the
Company's Spanish mining rights, changes in the commercial real estate market in
France, the success of ultimate negotiations with the FINOVA companies and their
creditors, approval of a FINOVA chapter 11 plan having materially different
terms than those set forth in the commitment letter of Berkadia LLC filed as an
exhibit to the Company's Annual Report on Form 10-K for the year ended December
31, 2000, and changes in the composition of the Company's assets and liabilities
through acquisitions or divestitures. Undue reliance should not be placed on
these forward-looking statements, which are applicable only as of the date
hereof. The Company undertakes no obligation to revise or update these
forward-looking statements to reflect events or circumstances that arise after
the date of this Report or to reflect the occurrence of unanticipated events.
28
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
LEUCADIA NATIONAL CORPORATION
February 12, 2002 By: /s/ Barbara L. Lowenthal
-------------------------------
Barbara L. Lowenthal
Vice President and Comptroller
29