10-K405 1 d95389e10-k405.txt FORM 10-K FOR FISCAL YEAR END DECEMBER 31, 2001 [THE GAINSCO COMPANIES LOGO] UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15 (d) of The Securities Exchange Act of 1934 For the fiscal year ended Commission file number 1-9828 December 31, 2001 GAINSCO, INC. (Exact name of registrant as specified in its charter) TEXAS 75-1617013 (State of Incorporation) (IRS Employer Identification No.) 500 Commerce Street Fort Worth, Texas 76102 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (817) 336-2500 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock ($.10 par value) The New York Stock Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes No ---- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ x ] The aggregate market value of registrant's Common Stock ($.10) par value), registrant's only class of voting or non-voting common equity stock, held by non-affiliates of the registrant (19,171,193 shares) as of the close of the business on February 28, 2002 was $5,751,358 (based on the closing sale price of $0.30 per share on that date on the New York Stock Exchange). As of February 28, 2002, there were 21,169,736 shares of the registrant's Common Stock ($.10 par value) outstanding. PART I ITEM 1. BUSINESS GENERAL DESCRIPTION GAINSCO, INC. ("GNA") is a holding company that provides administrative and financial services for its wholly owned subsidiaries. The term "Company" as used in this document includes GNA and its subsidiaries unless the context otherwise requires. GNA was incorporated in Texas on October 11, 1978. It completed its initial public offering on November 14, 1986. The Company is a property and casualty insurance company concentrating its efforts on the nonstandard personal automobile market in Florida. The Company's insurance operations are conducted through four insurance companies: General Agents Insurance Company of America, Inc. ("General Agents"), an Oklahoma corporation; MGA Insurance Company, Inc. ("MGAI"), a Texas corporation; GAINSCO County Mutual Insurance Company ("GCM"), a Texas chartered company; and Midwest Casualty Insurance Company ("MCIC"), a North Dakota insurance corporation acquired January 7, 2000. During 2001 the Company was approved to write insurance in 48 states and the District of Columbia on a non-admitted basis and in 44 states and the District of Columbia on an admitted basis. The Company previously marketed its commercial lines of insurance through 200 non-affiliated general agency offices and currently markets its personal lines of insurance through approximately 565 non-affiliated retail agencies. Approximately 75% of the Company's gross premiums written during 2001 resulted from risks located in California, Florida, Pennsylvania, and Texas. The Company's lines of insurance are written on certain classes and types of risks which are not generally insured by many of the standard companies, although such companies have been competing in this market more frequently in recent years. The strategy of the Company is to identify various types of risks where it can price its coverages profitably and competitively. For a description of the product lines presently written by the Company, see "Recent Developments" and "Product Lines." The Company sets its policy premiums by applying its own judgment after consideration of the risks involved and the competition. Part of its analysis includes the review of historical premium rate and loss cost information as compiled and reported by independent rating bureaus. The Company has fronting agreements with three non-affiliated insurance companies. The business written under these agreements is ceded 100% to reinsurers rated "A (Excellent)" or better by A.M. Best Company ("Best's"), and 100% of the liabilities are collateralized with pledged investment grade securities or letters of credit or the reinsurer has fully indemnified the Company against business, credit and insurance risk. RECENT DEVELOPMENTS Discontinuance of Commercial Lines and Redeployment of Capital. On February 7, 2002, the Company announced its decision to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. The Company's commercial lines business segment produced approximately $70 million in gross premiums written in 2001. The Company plans to reduce its cost structure commensurate with the business reduction. Since February 7, 2002, the Company has reduced its employee count by 35 and notified all of its commercial lines agents of its intent to cancel their agency contracts. The Company has notified all states, where required by statute, of its intent to cease writing commercial lines of insurance in their state. The Company has ceased writing new commercial business and has taken certain steps allowed under the statutes to not renew commercial business. The discontinuance of writing commercial lines will likely result in the Company ceasing to be approved to write insurance in a number of states. The Company continues to operate a personal lines insurance operation in Florida that produced approximately $40 million in gross premiums written in 2001. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company will be in a period of transition as it exits from its commercial lines insurance business. During the transition process, the Company may consider the sale of subsidiaries associated with that business. The Company also intends to continue to review current trends and profitability prospects for its nonstandard personal automobile business, and may endeavor to increase, decrease or dispose of all or part of it. The Company intends to redeploy the capital now required by the commercial lines business, once it becomes available, to pursue other opportunities in the future that offer a better prospect for profitability. The Company believes that suitable capital redeployment opportunities should be available after commercial lines capital becomes available, but cannot predict the amount of capital that will ultimately be available for redeployment, the timing or the nature of the opportunities that may be available at the time capital becomes available. The opportunities may be outside of the insurance business and could be in the financial services business. 2 Noncompliance with NYSE Continued Listing Criteria. GNA has received notice from the New York Stock Exchange (the "NYSE") that GNA is not in compliance with certain of the NYSE's quantitative criteria for continued listing. The NYSE noted that the Company's average market capitalization of its common stock for the 30 trading days ended February 27, 2002 was $22.0 million and stockholders' equity at December 31, 2001 was estimated at $27.5 million, as disclosed in the Company's earnings release on February 27, 2002. This is below NYSE continued listing criteria requiring total market capitalization of not less than $50 million over a 30 trading day period and stockholders' equity of not less than $50 million. In addition, the average closing price of GNA's common stock has fallen below the NYSE $1.00 minimum standard for a consecutive 30 trading day period and the total market capitalization of GNA's common stock has fallen below the NYSE $15 million minimum standard for a consecutive 30 trading day period. NYSE procedures indicate that listed companies that fall below continued listing standards generally have a period of time to respond to the NYSE with a plan to regain compliance. GNA has acknowledged receipt of the notification and is involved in discussions with the NYSE regarding its business plan. If GNA's shares cease to be listed on the NYSE, the Company believes that an alternative trading venue will be available. A.M. Best Rating Downgrade. A.M. Best Company, the insurance industry's primary rating agency, has downgraded the financial strength rating of General Agents Group to "B-" (Fair) from "B++" (Very Good), and assigned it a negative outlook. General Agents Group consists of the Company's four insurance subsidiaries: General Agents, MGAI, GCM and MCIC. Tri-State Acquisition and Sale. On January 7, 2000, the Company expanded its personal lines business conducted through Lalande Financial Group, Inc. ("Lalande"), National Specialty Lines, Inc. ("NSL") and DLT Insurance Adjusters, Inc. ("DLT") (Lalande, NSL and DLT collectively, the "Lalande Group") through the acquisition of Tri-State, Ltd. ("Tri-State"), an insurance operation specializing in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. Tri-State owned and operated a managing general agency, a motor vehicle driving records service company and an insurance subsidiary, MCIC that had policyholders' surplus of approximately $3,034,000. The purchase price consideration consisted of $6,000,000 in cash at closing, plus additional cash payments of $1,200,000 and $1,600,000 paid in July 2000 and January 2001, respectively. On August 31, 2001, the Company sold all of the stock of Tri-State to Herbert A. Hill for a cash price of $935,000. Mr. Hill is the President and a former owner of Tri-State. The Company retained MCIC which had policyholders' surplus of approximately $3,078,000 at December 31, 2001. Transactions with Goff Moore Strategic Partners, L.P. ("GMSP"). 1999 GMSP Transaction. On October 4, 1999, GNA sold to GMSP, for an aggregate purchase price of $31,620,000, (i) 31,620 shares of Series A Preferred Stock, which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share (subject to adjustment for certain events), (ii) the Series A Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share. At closing GNA and its insurance company subsidiaries entered into Investment Management Agreements with GMSP, pursuant to which GMSP manages their respective investment portfolios. Completion of these transactions (the "1999 GMSP Transaction") concluded the strategic alternatives review process that the Company initiated in 1998. Proceeds from the 1999 GMSP Transaction were available for acquisitions, investments and other corporate 3 purposes. See "Investment Strategy" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Operations." 2001 GMSP Transaction. On March 23, 2001, the Company consummated a transaction with GMSP (the "2001 GMSP Transaction") pursuant to which, among other things, the Company issued shares of its newly created Series C Preferred Stock to GMSP in exchange for an aggregate purchase price of $3,000,000 in cash. The annual dividend rate on the Series C Preferred Stock is 10% during the first three years and 20% thereafter. Unpaid dividends are cumulative and compounded. The Series C Preferred Stock is redeemable at the Company's option after five years and at the option of the majority holders after six years at a price of $1,000 per share plus accrued and unpaid dividends. The Series C Preferred Stock is not convertible into Common Stock. The agreement with GMSP was conditioned upon the following changes in the securities currently held by GMSP. The exercise prices of the Series A Warrant and the Series B Warrant held by GMSP were amended to $2.25 per share and $2.5875 per share, respectively. Each of these warrants provides for the purchase of 1,550,000 million shares of Common Stock, subject to adjustment. Further, the Company is required to redeem the outstanding shares of its Series A Preferred Stock on January 1, 2006, subject to certain conditions at a price of $1,000 per share plus accrued and unpaid dividends. Any Series A Preferred Stock unredeemed for any reason after that date would accrue interest, payable quarterly at a rate equal to eight percent per year with any unpaid interest compounded annually. The Series A Preferred Stock is convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share. The agreement with GMSP provided an opportunity to convert the Company's illiquid investments with a cost of $4,200,000 to cash as of November 2002, as follows: the Company could at its option require GMSP to purchase the illiquid investments for $2,100,000, less any future cash received prior to November 2002 from the investments. GMSP could at its option require the Company to sell the illiquid investments to GMSP for $4,200,000, less any future cash received prior to November 2002 from the investments. During the second quarter of 2001, the Company recognized a permanent impairment of these investments and wrote down the carrying value to the amount recoverable from GMSP under the put option. In February 2002, GMSP consented to an early exercise of the Company's option, and the Company exercised its option to require GMSP purchase the illiquid investments for approximately $2,100,000. Transactions with Robert W. Stallings On March 23, 2001, the Company consummated a transaction with Robert W. Stallings (the "Stallings Transaction") pursuant to which, among other things, the Company issued shares of its newly created Series B Preferred Stock and a warrant to purchase an aggregate of 1,050,000 shares of Common Stock at $2.25 per share in exchange for an aggregate purchase price of $3,000,000 in cash. The annual dividend provisions and the redemption provisions of the Series B Preferred Stock are the same as those for the Series C Preferred Stock. The Series B Preferred Stock is convertible into Common Stock at $2.25 per share. Subject to adjustment for certain events, the Series B Preferred Stock is convertible into a maximum of 1,333,333 shares of Common Stock. The term of the warrant is five years. Mr. Stallings was elected non-executive Vice Chairman of the Board and a director of the Company. On September 6, 2001, Mr. Stallings was elected non-executive Chairman of the Board of Directors of the Company. 4 PRODUCT LINES The Company's principal products previously served certain nonstandard markets within the commercial lines and personal lines. As previously mentioned, the Company decided to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. The Company continues to serve the nonstandard personal auto market. The following table sets forth, for each product line, gross premiums written (before ceding any amounts to reinsurers), percentage of gross premiums written for the periods indicated and the number of policies in force at the end of each period.
As of and for the years ended December 31 ----------------------------------------------------- 2001 2000 1999 ------------ -------------- ---------------- (Dollar amounts in thousands) Gross Premiums Written: Commercial Lines $ 68,499 58% $ 113,354 67% $ 97,139 73% Personal Lines 48,684 42 54,932 33 36,759 27 ------ -- ------- --- ------ -- $ 117,183 100% $ 168,286 100% $ 133,898 100% ======= === ======= === ======= === Policies in Force (End of Period) 64,797 87,048 68,943
Commercial Lines As previously mentioned, the Company decided to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. The commercial lines of insurance previously written by the Company include: Commercial Auto The commercial auto coverage underwritten by the Company included risks associated with local haulers of specialized freight, tradespersons' vehicles and trucking companies. Garage The Company's garage product line included garage liability, garage keepers' legal liability and dealers' open lot coverages. The Company targeted its coverage to used car dealers, recreational vehicle dealers, automobile repair shops and wrecker/towing risks. General Liability The Company underwrote general liability insurance for businesses such as car washes, janitorial services, small contractors, apartment buildings, rental dwellings and retail stores. Property The Company underwrote commercial property coverages that included fire, extended coverage and vandalism on commercial establishments packaged with its liability product or on a monoline basis. Specialty Lines The Company underwrote and managed programs in professional liability for lawyers, real estate agents, educators and other general professions, as well as directors and officers liability. Personal Lines The personal lines of insurance currently written by the Company include personal auto only. The personal lines of insurance previously written by the Company include:: Personal Auto The Company's personal auto product line is in the nonstandard personal auto market and is primarily written with minimum liability limits in Florida. Umbrella The Company wrote personal umbrella risks which did not have access to the preferred markets. Property The Company wrote nonstandard dwelling fire risks. 5 REINSURANCE The Company purchases reinsurance in order to reduce its liability on individual risks and to protect against catastrophe claims. A reinsurance transaction takes place when an insurance company transfers, or "cedes", to another insurer a portion or all of its exposure. The reinsurer assumes the exposure in return for a portion or the entire premium. The ceding of insurance does not legally discharge the insurer from its primary liability for the full amount of the policies, and the ceding company is required to pay the claim if the reinsurer fails to meet its obligations under the reinsurance agreement. Commercial Lines Prior to 1999 and beginning in 2001, the Company wrote commercial casualty policy limits of $1,000,000. For policies with an effective date occurring from 1995 through 1998 and policies with an effective date occurring during 2001 or 2002, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 limits, resulting in a maximum net claim retention per risk of $500,000 for such policies. During 1999 and 2000, the Company wrote commercial casualty policy limits of $5,000,000. For policies with an effective date occurring in 1999 or 2000, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to $1,000,000 and second excess casualty reinsurance for 100% of casualty claims exceeding $1,000,000 up to the $5,000,000 limits, resulting in a maximum net claim retention per risk of $500,000. The Company uses facultative reinsurance for policy limits written in excess of the limits reinsured under the excess casualty agreements. Effective December 31, 2000 the Company entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 through December 31, 2001, the Company has quota share reinsurance whereby the Company ceded 21.03% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $57,150,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2000. Also in connection with this agreement, the Company is required to maintain assets in a trust fund with a fair value at least equal to the funds held liability. The trust fund was established during the third quarter of 2001 and at December 31, 2001 the assets in the trust had a fair value of $49,553,698. Because the Company's statutory policyholders' surplus fell below certain levels specified in the agreement, the reinsurer has the option to direct the trustee to transfer the assets of the trust to the reinsurer. If the reinsurer were to exercise its option, based upon December 31, 2001 balances, investments and funds held under reinsurance agreements would each be reduced by approximately $47,800,000. The reinsurer would continue to be responsible for reimbursing the Company for claim payments covered under this agreement. Prior to 2001, the Company had property excess per risk reinsurance that covered property claims exceeding $100,000 up to $5,000,000 net loss each risk. The Company used facultative reinsurance for limits written on individual risks in excess of $5,000,000. Beginning in 2001, the Company has property excess per risk reinsurance that covers property claims exceeding $150,000 up to $1,500,000 net loss each risk. The Company uses facultative reinsurance for limits written on individual risks in excess of $1,500,000. For 1998 through 2001, the Company also has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident. For 2002, the Company has excess casualty clash reinsurance for 35% of $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident. 6 The Company is operating under excess casualty reinsurance agreements with two reinsurance companies for its commercial lines business, each of which reinsures a given percentage of ceded risks. The Company's excess reinsurance is provided in varying amounts by these reinsurers who are rated "A+ (Superior)" or better by Best's. See "Rating." The following table identifies each such reinsurer and sets forth the percentage of the coverage assumed by each of them:
Percentage of Risk Reinsured ------------------------------------------------ 2002 2001 2000 ---------- ---------- ----------------------- 1st Excess 1st Excess 1st Excess 2nd Excess ---------- ---------- ---------- ---------- American Re-insurance Company --% --% 35% 40% First Excess and Reinsurance Corporation -- -- -- 40 Folksamerica Reinsurance Company -- -- 15 -- GE Reinsurance Corporation 65 65 20 -- GMAC Re/Motors Insurance Corporation 35 15 -- -- Liberty Mutual Insurance Company -- 20 20 20 Republic Western Insurance Company -- -- 10 -- --- --- --- --- 100% 100% 100% 100% === === === ===
Specialty Lines For its lawyers professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $500,000. For its real estate agents professional liability coverages with policy effective dates prior to August 1, 2001, the Company has quota share reinsurance for 25% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $750,000. For policies with an effective date occurring on August 1, 2001 through April 15, 2002, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. For its educators professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 60% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $400,000. For its directors and officers liability coverages with policy effective dates occurring prior to 2001, the Company has quota share reinsurance for 90% of the first $5,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. For policies with an effective date occurring during 2001, the Company has quota share reinsurance for 85% of the first $5,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $750,000. For its miscellaneous professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. 7 Personal Lines The Company's personal auto business is produced by NSL and, prior to August 1, 2001, Tri-State or written on a direct basis through MCIC. For business produced by NSL with an effective date of April 1, 2000 through December 31, 2000, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 20% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $20,000. For business produced by NSL with an effective date of January 1, 2001 through December 31, 2001, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500. Effective December 31, 2001, the Company's personal lines excess of loss and quota share reinsurance treaties expired and were not replaced. Under the terms of these treaties, the reinsurer remains liable for claims with regard to policies in force at the date of expiration. Beginning in 2002 the Company no longer writes nonstandard personal auto limits in excess of $25,000. For business produced by Tri-State or written on a direct basis with MCIC with an effective date prior to August 1, 2001, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500 and therefore has no need for excess of loss reinsurance. For its umbrella coverages for 1999 through 2001, the Company has excess casualty reinsurance for 100% of umbrella claims exceeding $1,000,000 up to $10,000,000 policy limits. For policies with an effective date occurring prior to February 1, 2001, the Company also has quota share reinsurance for 75% of the first $1,000,000 of umbrella claims resulting in a maximum net claim retention per risk of $250,000. For policies with an effective date occurring on February 1, 2001 through December 31, 2001, the Company has quota share reinsurance for 77.5% of the first $1,000,000 of umbrella claims resulting in a maximum net claim retention per risk of $225,000. For its personal auto coverages for 1998 through 2001, the Company has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident. Beginning in 2002, the Company has excess casualty clash reinsurance for 35% of $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident. Commercial and Personal Lines Certain reinsurance carried by the Company includes "extra-contractual obligations" coverage. This coverage protects the Company against claims arising out of certain legal liability theories not directly based on the terms and conditions of the Company's policies of insurance. Extra-contractual obligation claims are covered 90% under the quota share, excess casualty and excess casualty clash reinsurance treaties up to their respective limits. Prior to 2001, the Company carried catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims that exceed $500,000 but do not exceed $17,500,000 for a single catastrophe. In 2001, the Company carried catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims that exceed $1,500,000 but do not exceed $13,000,000 for a single catastrophe as well as second event catastrophe property reinsurance for 100% of $1,000,000 excess of $500,000 on a second catastrophic event. Beginning in 2002, the Company carries catastrophe property reinsurance to protect it against catastrophe occurrences for property claims that exceed $500,000 but do not exceed $7,000,000. Since 1995, the Company has had reinsurance fronting arrangements with non-affiliated insurance companies. The Company retains no portion of the business written under these agreements as it is 100% ceded to non-affiliated reinsurers. Although these cessions are made to authorized reinsurers rated "A (Excellent)" or better by Best's, the agreements require that collateral (in the form of trust agreements and/or letters of credit) be maintained to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to the risks insured under these fronting arrangements. See Note (5) of Notes to Consolidated Financial Statements. 8 The Company has signed contracts in force for its reinsurance agreements for all years through 2001. The Company has written confirmations from reinsurers for 2002 regarding the basic terms and provisions under which they will assume the Company's risks, but, as of the date hereof, formal reinsurance contracts with these reinsurers have not been executed. It is customary in the industry for insurance companies and reinsurers to operate under such commitments pending the execution of formal reinsurance agreements. No assurance can be given that such reinsurance agreements will be executed or, if executed, that the terms and provisions thereof will not be modified. MARKETING AND DISTRIBUTION Certain coverages, such as auto liability, may only be written in some states by companies with the authority to write insurance on an admitted basis in such states. The Company currently is approved to write insurance on an admitted basis in 44 states and the District of Columbia. The Company has errors and omissions insurance coverage to protect against negligence on the part of its employees. Commercial Lines The Company previously marketed its commercial lines insurance products through 200 non-affiliated general agency offices that were compensated on a commission basis that varied by line of business. These general agents each represented several insurance companies, some of which may have been competitors of the Company. The general agents solicited business from independent local agents or brokers, commonly referred to as retail agents, who are in direct contact with insurance buyers. The Company elected to utilize general agents to market its insurance products in order to avoid the fixed costs of a branch office system. The Company required that its general agents have a specified level of errors and omissions insurance coverage, which indirectly protected the Company against certain negligence on the part of general agents. The Company reviewed its appointed agencies for financial solvency and liquidity levels. The Company had developed underwriting manuals to be used by its general agents. The general agents were authorized to bind the Company to provide insurance if the risks and terms involved in the particular coverage are within the underwriting guidelines set forth in the Company's underwriting manuals. The manuals stipulated minimum rates to be charged for the various classes of coverage offered. Personal Lines The Company markets its nonstandard personal auto insurance through approximately 565 non-affiliated retail agencies that are compensated on a commission basis. The retail agents may represent several insurance companies, some of which may compete with the Company. The Company utilizes the retail agency market because they are in direct contact with the insurance buyers. The Company requires that its retail agents have a specified level of errors and omissions insurance coverage. The Company has developed underwriting manuals to be used by its retail agents. The retail agents are authorized to bind the Company to provide insurance if the risks and terms involved in the particular coverage are within the underwriting guidelines set forth in the Company's underwriting manuals. UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES The Company maintains reserves for the payment of claims and claim adjustment expenses for both reported and unreported claims. Claim reserves are estimates, at a given point in time, of amounts that the Company expects to pay 9 on incurred claims based on facts and circumstances then known. The amount of claim reserves for reported claims is primarily based upon a case-by-case evaluation of the type of claim involved, the circumstances surrounding the claim, and the policy provisions relating to the type of claim. The amount of claim reserves for unreported claims and case reserve development is determined on the basis of historical information and anticipated future conditions by lines of insurance and actuarial review. Reserves for claim adjustment expenses are intended to cover the ultimate costs of settling claims, including investigation and defense of lawsuits resulting from such claims. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. The process of establishing claim reserves is an imprecise science and reflects significant judgmental factors. In many liability cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured claim and the settlement of the claim. Some judicial decisions and legislative actions, even after coverage is written and reserves are initially set, broaden liability and policy definitions and increase the severity of claim payments. As a result of this and other societal and economic developments, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience have increased significantly, further complicating the already difficult claim reserving process. Ultimate liability may be greater or lower than current reserves. Reserves are monitored by the Company using new information on reported claims and a variety of statistical techniques. The reserves are reviewed annually by an independent actuarial firm. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. The following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company's consolidated financial statements for the periods indicated:
As of and for the years ended December 31 ----------------------------------------- 2001 2000 1999 ------- ------ ------ (Amounts in thousands) Unpaid claims and claim adjustment expenses, beginning of period $ 164,160 132,814 136,798 Less: Ceded unpaid claims and claim adjustment expenses, beginning of period 37,703 37,299 35,030 ------- ------- ------- Net unpaid claims and claim adjustment expenses, beginning of period 126,457 95,515 101,768 ------- ------- ------- Net claims and claim adjustment expense incurred related to: Current period 56,920 124,077 75,976 Prior periods 30,506 19,362 373 ------- ------- ------- Total net claim and claim adjustment expenses incurred 87,426 143,439 76,349 ------- ------- ------- Net claims and claim adjustment expenses paid related to: Current period 26,776 58,898 32,651 Prior periods 71,619 54,683 49,951 ------- ------- ------- Total net claim and claim adjustment expenses paid 98,395 113,581 82,602 ------- ------- ------- Net reserves acquired through purchase of subsidiary - 1,084 - ------- ------- ------- Net unpaid claims and claim adjustment expenses, end of period 115,488 126,457 95,515 Plus: Ceded unpaid claims and claim adjustment expenses, end of period 65,571 37,703 37,299 ------- ------- ------- Unpaid claims and claim adjustment expenses, end of period $ 181,059 164,160 132,814 ======= ======= =======
For 2001 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development of commercial auto and commercial general liability claims for the 2000, 1999 and 1998 accident years. For 2000 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development of commercial auto claims for the 1999, 1997 and 1996 accident years. At December 31, 2001 the Company believes that the carried reserves and the reinsurance agreements currently in force are sufficient to support the future emergence of prior year claim and claim adjustment expenses. 10 The following table sets forth, as of December 31, 2001, 2000 and 1999, differences between the amount of net unpaid claims and claim adjustment expenses reported in the Company's statements, prepared in accordance with statutory accounting principles ("SAP"), and filed with the various state insurance departments, and those reported in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"):
As of December 31 --------------------------------- 2001 2000 1999 -------- -------- -------- (Amounts in thousands) Net unpaid claims and claim adjustment expenses reported on a SAP basis $ 112,488 126,457 96,472 Adjustments: Reserves recorded subsequent to issuance of SAP financial statements 3,000 - - Estimated recovery for salvage and subrogation - - (957) ------- ------- ----- Net unpaid claims and claim adjustment expenses reported on a GAAP basis and on an adjusted SAP basis $ 115,488 126,457 95,515 ======= ======= ======
In January 2000, the Company elected to take estimated salvage and subrogation into account when determining ultimate incurred losses and unpaid losses for financial statements prepared in accordance with SAP. The effect on prior periods was reflected in the Company's statutory financial statements as an adjustment to policyholders' surplus. The following table represents the development of GAAP balance sheet reserves for the years ended December 31, 1991 through 2001. The top line of the table shows the reserves for unpaid claims and claim adjustment expenses for the current and all prior years as recorded at the balance sheet date for each of the indicated years. The reserves represent the estimated amount of claims and claim adjustment expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including claims that have been incurred but not yet reported to the Company. The second portion of the following table shows the net cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The third portion of the table shows the reestimated amount of the previously recorded net unpaid claims and claim adjustment expenses based on experience as of the end of each succeeding year, including net cumulative payments made since the end of the respective year. For example, the 1994 liability for net claims and claim adjustment expenses reestimated seven years later (as of December 31, 2001) was $69,030,000 of which $68,673,000 has been paid, leaving a net reserve of $357,000 for claims and claim adjustment expenses in 1994 and prior years remaining unpaid as of December 31, 2001. "Net cumulative deficiency" represents the change in the estimate from the original balance sheet date to the date of the current estimate. For example, the 1994 net unpaid claims and claim adjustment expenses indicates a $8,273,000 net deficiency from December 31, 1994 to December 31, 2001 (seven years later). Conditions and trends that have affected development of liability in the past may or may not necessarily occur in the future. Accordingly, it may or may not be appropriate to extrapolate future redundancies or deficiencies based on this table. 11
As of and for the years ended December 31 ------------------------------------------------------------------------------------------------ 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ (Amounts in thousands) Unpaid claims & claim adjustment expenses: Gross 53,148 66,517 72,656 80,729 95,011 105,691 113,227 136,798 132,814 164,160 181,059 Ceded 15,105 16,594 16,701 19,972 24,650 26,713 29,524 35,030 37,299 37,703 65,571 ------ ------ ------ ------ ------ ------- ------- ------- ------- ------- ------- Net 38,043 49,923 55,955 60,757 70,361 78,978 83,703 101,768 95,515 126,457 115,488 Net cumulative paid as of: One year later 15,037 22,470 24,090 24,730 32,584 39,654 48,595 49,951 54,683 71,619 Two years later 26,819 37,032 39,182 41,874 56,605 70,185 82,950 80,158 90,403 Three years later 33,879 45,884 46,688 55,338 73,349 90,417 103,025 99,446 Four years later 37,292 51,082 54,428 62,389 82,667 101,273 114,196 Five years later 39,999 54,092 57,628 66,573 87,432 107,584 Six years later 41,143 55,828 58,191 68,438 90,114 Seven years later 42,020 56,754 59,733 68,673 Eight years later 42,464 56,941 59,744 Nine years later 42,540 56,920 Ten years later 42,514 Net unpaid claims and claim adjustment expenses reestimated as of: One year later 38,528 54,150 59,573 61,157 75,703 87,095 110,421 102,141 114,877 156,963 Two years later 42,235 57,223 59,922 62,296 80,356 104,588 111,981 111,861 130,952 Three years later 43,217 57,459 59,247 63,871 88,867 105,386 121,024 119,524 Four years later 42,493 56,832 58,414 67,442 89,030 111,314 125,418 Five years later 42,191 56,337 59,735 67,607 91,641 114,483 Six years later 41,984 56,721 59,695 68,660 94,177 Seven years later 42,356 56,938 60,008 69,030 Eight years later 42,527 57,354 60,265 Nine years later 42,955 57,445 Ten years later 43,042 Net cumulative deficiency (4,999) (7,522) (4,310) (8,273) (23,816) (35,505) (41,715) (17,756) (35,437) (30,506)
The deficiencies in the 1995 through 2001 years are primarily related to unanticipated development of commercial auto and commercial general liability claims in those years as previously discussed. Net unpaid claims and claim adjustment expenses at December 31, 2001 were approximately $115,488,000, which the Company believes is adequate. INSURANCE RATIOS CLAIMS, EXPENSE AND COMBINED RATIOS: Claims and expense ratios are traditionally used to interpret the underwriting experience of property and casualty insurance companies. Statutory Accounting Principles (SAP) Basis - Claims and claim adjustment expenses are stated as a percentage of premiums earned because claims may occur over the life of a particular insurance policy. Underwriting expenses on a SAP basis are stated as a percentage of net premiums written rather than premiums earned because most underwriting expenses are incurred when policies are written and are not spread over the policy period. Underwriting profit margin is achieved when the combined ratio is less than 100%. The Company's claims, expense and combined ratios and the property and casualty industry's claims, expense and combined ratios, both on a SAP basis, are shown in the following table: 12
Years ended December 31 --------------------------------------- 2001 2000 1999 1998 1997 ----- ----- ----- ----- ------ COMPANY RATIOS(1) -------------- Claims Ratio 129.1% 95.6% 67.9 95.9% 60.0% Expense Ratio 38.4 28.6 30.7 37.9 34.4 ----- ----- ----- ----- ---- Combined Ratio 167.5% 124.2% 98.6% 133.8% 94.4% ===== ===== ===== ===== ==== INDUSTRY RATIOS (2) ------------------- Claims Ratio 90.1% 81.5% 78.6% 76.2% 72.8% Expense Ratio 26.2 27.5 28.0 27.3 27.1 ----- ----- ----- ----- ---- Combined Ratio 116.3% 109.0% 106.6% 103.5% 99.9% ===== ===== ===== ===== ==== --------------------- (1) The Company ratios have been adjusted to reflect the $3,000,000 in reserves recorded subsequent to the issuance of the SAP financial statements. (2) The property and casualty industry as a whole, not companies with comparable lines of coverage, was used in the calculation of these ratios by A.M. Best. Ratios for 2001 are A.M. Best estimates.
The unfavorable variance to the industry for 2001 with regard to the claims ratio is primarily the result of unanticipated development of commercial auto and commercial general liability claims for the 2000, 1999 and 1998 accident years. For 2001 the unfavorable expense ratio in relation to the industry expense ratio is primarily the result of decreases in premiums written due to the commercial quota share reinsurance agreements and the decision to cease writing commercial trucking business. The unfavorable variance to the industry for 2000 with regard to the claims ratio is primarily the result of unanticipated development of commercial auto claims for the 1999, 1997 and 1996 accident years. The favorable variance to the industry for 1999 with regard to the claims ratio is primarily the result of writing shorter duration business than the industry as a whole. The unfavorable variance to the industry with regard to the claims ratio in 1998 is largely related to unanticipated unfavorable claim development recorded in 1998 on the 1997, 1996 and 1995 accident years for the commercial auto liability line. For 1998, the increase in the unfavorable variance to the industry with regard to the expense ratio is largely because of downward adjustments in reinsurance commission income as a result of the unanticipated unfavorable claim development in 1998. For 1999 and prior years, the unfavorable variance to the industry with regard to the expense ratios is a function of the specific lines that the Company writes. The Company ratios in the table above relate only to insurance operations. GNA as a holding company provides administrative and financial services for its wholly owned subsidiaries. The allocation of GNA's expenses solely to its insurance companies would have an impact on their results of operations and would also affect the ratios presented. As such, expenses related to GNA's strategic alternatives review process conducted in 1999 and 1998 are not included in these ratios. Accounting Principles Generally Accepted in the United States of America (GAAP) Basis - Claims and claim adjustment expenses are stated as a percentage of premiums earned as they are on a SAP basis. However, earned premiums include policy fees earned net of the related commission expense whereas on a SAP basis policy fees earned are recorded gross of the related commission expense. The GAAP expense ratio is based on premiums earned and includes the change in policy acquisition costs and underwriting expenses. Other differences include the treatment of the allowance for doubtful accounts. 13 The following table presents the Company's claims, expense and combined ratios on a GAAP basis:
Years ended December 31 ---------------------------------------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Claims Ratio 127.2% 94.7% 67.4% 93.7% 60.7% Expense Ratio 45.4 31.6 32.0 39.0 33.7 ----- ----- ---- ----- ---- Combined Ratio 172.6% 126.3% 99.4% 132.7% 94.4% ===== ===== ==== ===== ====
The Company ratios in the table above relate only to insurance operations. The holding company provides administrative and financial services for its wholly owned subsidiaries. The allocation of the holding company's expenses solely to its insurance companies would have an impact on their results of operations and would also affect the ratios presented. PREMIUM TO SURPLUS RATIO: The following table shows, for the periods indicated, the Company's statutory ratios of statutory net premiums written to statutory policyholders' surplus. While there is no statutory requirement which establishes a permissible net premiums written to surplus ratio, guidelines established by the National Association of Insurance Commissioners ("NAIC") provide that this ratio should not be greater than 3 to 1.
As of and for the years ended December 31 -------------------------------------------------------------- 2001 2000 1999 1998 1997 ------- ------- ------- ------- ------- (Dollar amounts in thousands) Net premiums written $ 67,313 117,497 130,105 87,040 98,858 Policyholders' surplus(1) $ 49,898 77,532 69,155 71,826 78,496 Ratio 1.35 to 1 1.52 to 1 1.88 to 1 1.21 to 1 1.26 to 1
---------- (1) Policyholders' surplus for 2001 has been adjusted to reflect the reserves recorded subsequent to the issuance of the SAP financial statements. INVESTMENT PORTFOLIO HISTORICAL RESULTS AND COMPOSITION The following table sets forth, for the periods indicated, the Company's investment results before income tax effects:
As of and for the years ending December 31 ------------------------------------------------------------- 2001 2000 1999 1998 1997 --------- -------- -------- -------- -------- (Dollar amounts in thousands) Average investments (1) $207,765 246,091 228,945 212,215 209,121 Investment income $ 8,091 14,093 9,722 9,803 9,731 Return on average investments (2) 3.9% 5.7% 4.2% 4.6% 4.7% Taxable equivalent return on average investments 4.3% 6.5% 5.7% 6.2% 6.5% Net realized gains (losses) $ 4,275 (1,907) 606 693 327 Net unrealized gains (losses) (3) $ 5,425 5,906 (3,456) 2,922 2,422
---------------------------- (1) Average investments is the average of beginning and ending investments at amortized cost, computed on an annual basis. (2) Includes taxable and tax-exempt securities. (3) Includes net unrealized gains (losses) for total investments. 14 The following table sets forth the composition of the investment portfolio of the Company.
As of December 31 ------------------------------------------------------------------------ 2001 2000 1999 -------------------- ---------------------- ---------------------- (Dollar amounts in thousands) Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- ------- --------- ------- --------- ------- Type of Investment Fixed Maturities: Bonds available for sale: U.S. Government securities $ 16,730 17,167 21,138 21,317 24,365 24,029 Tax-exempt state and municipal bonds 8,912 9,139 45,284 45,472 148,983 146,204 Corporate bonds 101,727 106,488 121,564 125,553 27,067 26,844 Certificates of deposit 645 645 845 845 455 455 Common stock - - 6,027 7,716 - - Other investments 2,110 2,112 4,581 4,442 1,288 1,170 --------- ------- --------- ------- --------- ------- 130,124 135,551 199,439 205,345 202,158 198,702 --------- ------- --------- ------- --------- ------- Short-term investments 45,127 45,127 40,840(1) 40,840(1) 46,478(1) 46,478(1) --------- ------- --------- ------- --------- ------- Total investments $175,251 180,678 240,279 246,185 248,636 245,180 ========= ======= ========= ======= ========= =======
---------------------------- (1) Includes proceeds from 1999 GMSP Transaction and funds accumulated pending assumption of investment management of portfolio by GMSP. The maturity distribution of the Company's investments in fixed maturities is as follows:
As of December 31 ---------------------------------------------------- 2001 2000 ----------------------- ------------------------ (Dollar amounts in thousands) Amortized Amortized Cost Percent Cost Percent --------- ------- --------- -------- Within 1 year $ 15,463 12.1% $ 22,203 11.8% Beyond 1 year but within 5 years 68,984 53.9 102,822 54.4 Beyond 5 years but within 10 years 42,135 32.9 59,531 31.5 Beyond 10 years but within 20 years 1,432 1.1 4,275 2.3 Beyond 20 years - - - - -------- ----- -------- ----- $ 128,014 100.0% $188,831 100.0% ======= ===== ======== ===== Average duration 3.3 yrs 2.9 yrs
As of December 31, 2000, the Company did not have any non-performing fixed maturity securities. In 2001 the Company recognized an other than temporary impairment on a non-rated security by recording a charge to earnings of $489,554, net of deferred income taxes of $252,195 (see Note (1c) of Notes to Consolidated Financial Statements). In March 2002, the Company reduced the carrying value of this non-rated security to $0 resulting in a write down of approximately $2,010,000 as a result of a significant increase in the default rate in January and February of 2002 in the underlying collateral, which has disrupted the cash flow stream sufficiently to virtually eliminate future cash flows. (see Note (12) of Notes to Consolidated Financial Statements) 15 INVESTMENT STRATEGY Commencing with the closing of the 1999 GMSP Transaction on October 4, 1999, the investment portfolios of GNA and its insurance company subsidiaries are managed by GMSP pursuant to its Investment Management Agreements with the respective companies. The investment policies are subject to the oversight and direction of the Investment Committees of the Boards of Directors of the respective companies. The respective Investment Committees consist entirely of directors not affiliated with GMSP. The investment policies of the insurance subsidiaries, which are also subject to the respective insurance company legal investment laws of the states in which they are organized, are to maximize after-tax yield while maintaining safety of capital together with adequate liquidity for insurance operations. See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk." The insurance company portfolios may also be invested in equity securities within limits prescribed by applicable legal investment laws. RATING A. M. Best Co. has currently assigned to the Company a pooled rating of "B-" (Fair), with a negative outlook. Best's ratings are based on an analysis of the financial condition and operation of an insurance company as they relate to the industry in general. See "Recent Developments." GOVERNMENT REGULATION The Company's insurance companies are subject to varied governmental regulation in the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the Company's business and is concerned primarily with the protection of policyholders rather than shareholders. The Company is also subject to statutes governing insurance holding company systems in the states of Oklahoma, Texas and North Dakota. These statutes require the Company to file periodic information with the state regulatory authorities, including information concerning its capital structure, ownership, financial condition and general business operation. These statutes also limit certain transactions between the Company and its insurance companies, including the amount of dividends that may be declared and paid by the insurance companies (see Note (7) of Notes to Consolidated Financial Statements). Additionally, the Oklahoma, Texas and North Dakota statutes restrict the ability of any one person to acquire 10% or more of the Company's voting securities without prior regulatory approval. COMPETITION The property and casualty insurance industry is highly competitive. The Company underwrites lines of insurance on risks not generally insured by many of the large standard property and casualty insurers. However, few barriers exist to prevent property and casualty insurance companies from entering into the Company's segments of the industry. To the extent this occurs, the Company can be at a competitive disadvantage because many of these companies have substantially greater financial and other resources and can offer a broader variety of specialty risk coverages. 16 EMPLOYEES As of December 31, 2001, the Company employed 220 persons, of whom 16 were officers, 197 were staff and administrative personnel, and 7 were part-time employees. The Company is not a party to any collective bargaining agreement. EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning the executive officers of the Company as of March 29, 2002 is set forth below:
Name Age Position with the Company ---- --- ------------------------- Glenn W. Anderson 49 President, Chief Executive Officer and Director Richard M. Buxton 53 Senior Vice President Daniel J. Coots 50 Senior Vice President and Chief Financial Officer McRae B. Johnston 51 President, National Specialty Lines, Inc. Richard A. Laabs 46 Senior Vice President Joseph W. Pitts 38 Senior Vice President Carolyn E. Ray 49 Senior Vice President Sam Rosen 66 Secretary and Director
Glenn W. Anderson has served as President, Chief Executive Officer and Director of the Company since April 1998. From 1996 to April 1998, Mr. Anderson served as Executive Vice President of USF&G. From 1993 to 1996, Mr. Anderson held the position of Senior Vice President with USF&G. Mr. Anderson has been engaged in the property and casualty insurance business since 1975. Richard M. Buxton has served as Vice President of the Company since December of 1996. In 1999, Mr. Buxton was promoted to Senior Vice President. Daniel J. Coots has served as Vice President and Chief Financial Officer of the Company since 1987. In 1991 Mr. Coots was promoted to Senior Vice President. Mr. Coots has been engaged in the property and casualty insurance business since 1983. McRae B. Johnston joined the Company in October 1998 when the Company acquired Lalande Group and since that time has served as President of National Specialty Lines, Inc., a subsidiary of the Company. Mr. Johnston is co-founder of National Specialty Lines, Inc. and has served as President since 1989. Mr. Johnston has been engaged in the property and casualty insurance business since 1976. Richard A. Laabs has served as Vice President of the Company since June of 1996. Mr. Laabs was promoted to Senior Vice President in 1999. From August of 1995 to May of 1996, Mr. Laabs served as Assistant Vice President of the Company. Mr. Laabs has been engaged in the property and casualty insurance business since 1978. Joseph W. Pitts has served as Vice President of the Company since August of 1997. Mr. Pitts was promoted to Senior Vice President in 1999. From 1992 to 1997, Mr. Pitts was with USAA in the position of Actuary and Manager. Mr. Pitts has been engaged in the property and casualty insurance business since 1988. 17 Carolyn E. Ray has served as Senior Vice President of the Company since 1998. From 1986 to 1998, Ms. Ray served as Vice President of the Company. From 1984 to 1985, Ms. Ray served as Assistant Vice President of the Company. Ms. Ray has been engaged in the property and casualty insurance business since 1976. Sam Rosen has served as the Secretary and a Director of the Company since 1983. Mr. Rosen is a partner with the law firm of Shannon, Gracey, Ratliff & Miller, L.L.P. He has been a partner in that firm or its predecessors since 1966. That firm, or its predecessors, has provided significant legal services for the Company since 1979. ITEM 2. PROPERTIES The Company owns its corporate offices in Fort Worth, Texas that provide approximately 35,000 square feet of office space and additional parking. The Company has entered into a contract to sell this office building. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company owns a 3.28 acre tract of land in Fort Worth, Texas and all improvements located thereon, including a 10,000 square foot office building. The Company currently has this property under lease to an unaffiliated third party. ITEM 3. LEGAL PROCEEDINGS In the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. In the opinion of the Company's management the ultimate liability, if any, resulting from the disposition of these claims will not have a material adverse effect on the Company's consolidated financial position or results of operations. The Company's management believes that unpaid claims and claim adjustment expenses are adequate to cover liabilities from claims that arise in the normal course of its insurance business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 18 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. GNA's Common Stock is listed on the NYSE (Symbol: GNA). The following table sets forth for the fiscal periods indicated the high and low closing sales prices per share of the Common Stock as reported by the NYSE. The prices reported reflect actual sales transactions.
High Low 1999 First Quarter 6 7/16 4 13/16 1999 Second Quarter 5 7/8 3 15/16 1999 Third Quarter 6 13/16 5 3/16 1999 Fourth Quarter 6 5/16 5 3/8 2000 First Quarter 6 5/16 5 1/2 2000 Second Quarter 6 4 9/16 2000 Third Quarter 4 15/16 3 11/16 2000 Fourth Quarter 4 1/4 2 3/8 2001 First Quarter 4.00 1.70 2001 Second Quarter 1.75 1.20 2001 Third Quarter 1.50 1.13 2001 Fourth Quarter 1.76 1.30
Cash dividends of $.0175 per share were paid to shareholders of record on March 31, June 30, September 30 and December 31, 1999 and March 31, June 30, September 30 and December 31, 2000. In February 2001, the Company discontinued quarterly dividends on the common stock. As of February 28, 2002, there were 245 shareholders of record of GNA's Common Stock. GNA has received notice from the NYSE that GNA is not in compliance with certain of the NYSE's quantitative criteria for continued listing. The NYSE noted that the Company's average market capitalization of its common stock for the 30 trading days ended February 27, 2002 was $22.0 million and stockholders' equity at December 31, 2001 was estimated at $27.5 million, as disclosed in the Company's earnings release on February 27, 2002. This is below NYSE continued listing criteria requiring total market capitalization of not less than $50 million over a 30 trading day period and stockholders' equity of not less than $50 million. In addition, the average closing price of GNA's common stock has fallen below the NYSE $1.00 minimum standard for a consecutive 30 trading day period and the total market capitalization of GNA's common stock has fallen below the NYSE $15 million minimum standard for a consecutive 30 trading day period. NYSE procedures indicate that listed companies that fall below continued listing standards generally have a period of time to respond to the NYSE with a plan to regain compliance. GNA has acknowledged receipt of the notification and is involved in discussions with the NYSE regarding its business plan. If GNA's shares cease to be listed on the NYSE, the Company believes that an alternative trading venue will be available. 19 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data presented below for, and as of the end of each of the years ended December 31, have been derived from the consolidated financial statements of the Company which have been audited by KPMG LLP, independent certified public accountants. The consolidated balance sheets as of December 31, 2001 and 2000, and the consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2001, and the independent auditors report thereon are included elsewhere in this document. The information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations", consolidated financial statements and the notes thereto, and the other financial information included herein.
Years ended December 31 ------------------------------------------------------------ 2001 2000 1999 1998 1997 -------- -------- -------- -------- -------- (Dollar amounts in thousands, except per share data) Income Data: ----------- Gross premiums written (1) $ 117,183 168,286 133,898 91,162 99,776 Ceded premiums written 48,888 49,463 2,761 2,603 1,637 ------- ------- ------- ------- ------- Net premiums written 68,295 118,823 131,137 88,559 98,139 Decrease (increase) in unearned premiums 432 32,633 (17,857) 3,644 4,117 ------- ------- ------- ------- ------- Net premiums earned 68,727 151,456 113,280 92,203 102,256 Net investment income 8,091 14,093 9,722 9,803 9,731 Net realized gains (losses) 4,275 (1,907) 606 693 327 Insurance services 327 1,054 1,849 2,927 2,631 ------- ------- ------- ------- ------- Total revenues 81,420 164,696 125,457 105,626 114,945 ------- ------- ------- ------- ------- Claims and claim adjustment expenses 87,426 143,439 76,349 86,353 62,086 Policy acquisition costs 14,419 33,326 24,288 23,619 22,552 Underwriting and operating expense 20,210 18,880 16,479 16,934 15,545 Goodwill impairment 18,447 - - - - ------- ------- ------- ------- ------- Total expenses 140,502 195,645 117,116 126,906 100,183 ------- ------- ------- ------- ------- Income (loss) before taxes and cumulative effect of change in accounting principle (59,082) (30,949) 8,341 (21,280) 14,762 Income tax expense (benefit) 16,035 (11,398) 1,214 (9,617) 2,838 ------- ------- ------- ------- ------- Income (loss) before cumulative effect of change in accounting principle (75,117) (19,551) 7,127 (11,663) 11,924 Cumulative effect of change in accounting principle, net of tax (490) - - - - ------- ------- ------- -------- ------- Net Income (loss) (2) $ (75,607) (19,551) 7,127 (11,663) 11,924 ======= ======= ======= ======= ======= Earnings (loss) per common share, basic: --------------------------------------- Income (loss) before cumulative effect of change in accounting principle $ (3.66) (.97) .34 (.56) .57 Cumulative effect of change in accounting principle (.02) - - - - ----- ----- ---- ----- ---- Net earnings (loss) per common share, basic $ (3.68) (.97) .34 (.56) .57 ===== ===== ==== ===== ===
20
Years ended December 31 (continued) ------------------------------------------------------------ 2001 2000 1999 1998 1997 -------- -------- -------- -------- -------- (Dollar amounts in thousands, except per share data) Earnings (loss) per common share, diluted: ----------------------------------------- Income (loss) before cumulative effect of change in accounting principle $ (3.66) (.97) .32 (.56) .56 Cumulative effect of change in accounting principle (.02) - - - - ----- ----- ----- ----- --- Net earnings (loss) per common share, diluted $ (3.68) (.97) .32 (.56) .56 ===== ===== ===== ===== ==== GAAP insurance ratios: --------------------- Claims ratio 127.2% 94.7% 67.4% 93.7% 60.7% Expense ratio 45.4 31.6 32.0 39.0 33.7 ----- ----- ----- ----- ----- Combined ratio 172.6% 126.3% 99.4% 132.7% 94.4% ===== ===== ==== ===== ====
As of December 31 ----------------------------------------------------- 2001 2000 1999 1998 1997 --------- -------- ------- ------- ------- (Dollar amounts in thousands, except per share data) Balance Sheet Data: ------------------ Investments $ 180,678 246,185 245,180 210,989 216,802 Premiums receivable $ 21,242 25,471 25,432 14,885 14,250 Reinsurance balances receivable $ 62,303 54,495 3,254 2,393 2,605 Ceded unpaid claims and claim adjustment expense $ 65,571 37,703 37,299 35,030 29,524 Ceded unearned premiums $ 21,822 45,995 23,149 22,388 19,146 Deferred policy acquisition costs $ 3,188 2,302 14,928 11,320 11,618 Goodwill $ 3,469 22,797 18,351 17,058 - Total assets $ 379,218 475,043 395,648 345,590 313,685 Unpaid claims and claim adjustment expenses $ 181,059 164,160 132,814 136,798 113,227 Unearned premiums $ 47,974 72,578 82,220 63,602 64,005 Note payable $ 10,800 16,000 18,000 18,000 - Funds held under reinsurance agreements $ 47,784 47,850 - - - Total liabilities $ 326,671 351,938 257,949 240,106 195,123 Shareholders' equity $ 27,516 123,104 137,699 105,484 118,562 Shareholders' equity per share (3) $ 1.01 4.50 5.08 5.05 5.68
-------------------------------------- (1) Excludes premiums of $16,627,000 in 2001, $26,973,000 in 2000, $58,137,000 in 1999, $47,588,000 in 1998 and $40,136,000 in 1997 from the Company's fronting arrangements, the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania under which the Company was a servicing carrier and the reinsurance arrangement in Florida whereby MGAI premiums are ceded to a non-affiliated reinsurer and assumed by General Agents. (2) Includes after tax net realized gains (losses) from securities transactions of $2,822,000, $(1,258,000), $400,000, $457,000 and $212,000 for 2001, 2000, 1999, 1998 and 1997, respectively. (3) Based on shares of Common Stock outstanding of 27,369,736, 27,369,736, 27,119,833, 20,896,563, and 20,874,224 at the end of 2001, 2000, 1999, 1998, and 1997, respectively. Common Stock outstanding at December 31, 2001, 2000 and 1999 assumes conversion of the Series A Convertible Preferred stock that was issued in the 1999 GMSP transaction. 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRITICAL ACCOUNTING POLICIES The discussion and analysis of the Company's financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgements and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company's critical accounting policies are described below. For a detailed discussion on the application of these and other accounting policies, see Note (1) of the Notes to Consolidated Financial Statements. Investments Bonds available for sale, common stock and other investments are stated at fair value with changes in fair value recorded as a component of comprehensive income. Short-term investments are stated at cost. The "specific identification" method is used to determine costs of investments sold. Provisions for possible losses are recorded only when the values have experienced impairment considered "other than temporary" by a charge to realized losses resulting in a new cost basis of the investment. The Company's policy is to review investments on a regular basis to evaluate whether or not each investment has experienced an "other than temporary" impairment. Deferred Policy Acquisition Costs and Deferred Ceding Commission Income Policy acquisition costs, principally commissions, premium taxes and certain marketing and underwriting expenses, are deferred and charged to operations over periods in which the related premiums are earned. Ceding commission income, which is realized on a written basis, is deferred and recognized over periods in which the related premiums are earned. Deferred ceding commission income is netted against deferred policy acquisition costs. The change in the resulting deferred asset is charged (credited) to operations. The Company utilizes investment income when assessing recoverability of deferred policy acquisition costs. Estimates of recoverability are based upon assumptions as to loss ratios, investment income and maintenance expenses. Goodwill Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is amortized on a straight-line basis over 25 years, which is the expected period to be benefited. The Company periodically reviews the recoverability of goodwill based on an assessment of undiscounted cash flows of future operations to ensure it is appropriately valued. The recoverability of goodwill is evaluated on a separate basis for each acquisition. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" (Statement 141) and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (Statement 142). Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. Statement 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual 22 values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Company adopted the provisions of Statement 141 effective July 1, 2001 and Statement 142 effective January 1, 2002. The adoption of Statement 141 had no impact on the consolidated financial statements. The adoption of Statement 142 will result in the Company no longer amortizing the remaining goodwill. The remaining $3,468,507 of goodwill is associated with the 1998 acquisition of the Lalande Group and reflects the estimated fair valuation levels of agencies in the personal automobile marketplace. Claims and Claim Adjustment Expenses Claims and claim adjustment expenses, less related reinsurance, are provided for as claims are incurred. The provision for unpaid claims and claim adjustment expenses includes: (1) the accumulation of individual case estimates for claims and claim adjustment expenses reported prior to the close of the accounting period; (2) estimates for unreported claims based on past experience modified for current trends; and (3) estimates of expenses for investigating and adjusting claims based on past experience. Liabilities for unpaid claims and claim adjustment expenses are based on estimates of the ultimate cost of settlement. Changes in claim estimates resulting from the review process and differences between estimates and ultimate payments are reflected in expense for the year in which the revision of these estimates first become known. The process of establishing claim reserves is an imprecise science and reflects significant judgmental factors. In many liability cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured claim and the settlement of the claim. Some judicial decisions and legislative actions, even after coverage is written and reserves are initially set, broaden liability and policy definitions and increase the severity of claim payments. As a result of this and other societal and economic developments, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience have increased significantly, further complicating the already difficult claim reserving process. Ultimate liability may be greater or lower than current reserves. Reserves are monitored by the Company using new information on reported claims and a variety of statistical techniques. The reserves are reviewed annually by an independent actuarial firm. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. Income Taxes The Company and its subsidiaries file a consolidated Federal income tax return. Deferred income tax items are accounted for under the "asset and liability" method which provides for temporary differences between the reporting of earnings for financial statement purposes and for tax purposes, primarily deferred policy acquisition costs, the discount on unpaid claims and claim adjustment expenses, net operating loss carry forwards and the nondeductible portion of the change in unearned premiums. In assessing the realization of its deferred tax assets, management considers whether it is more likely than not that a portion or all of the deferred tax assets will be realized. The Company recorded a valuation allowance in an amount equal to its net deferred tax asset at December 31, 2001. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. 23 ACCOUNTING PRONOUNCEMENTS In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" (Statement 144), establishing financial accounting and reporting for the impairment or disposal of long-lived assets. Statement 144 is effective for fiscal years beginning after December 15, 2001. Pursuant to Statement 144 the discontinuance of commercial lines will not be reported as discontinued operations. The Company believes that the adoption of Statement 144 will have no other effect on the Company's financial position or results of operation. BUSINESS OPERATIONS In 2001 the Company recorded a net loss of $75,607,047, or $3.68 per share (basic), primarily as a result of unfavorable claims experience, goodwill impairment and a valuation allowance for deferred Federal income taxes. On February 7, 2002, the Company announced its plans to discontinue writing commercial lines insurance due to continued adverse claims development and unprofitable results. In 2000 the Company recorded a net loss of $19,551,365, or $.97 per share (basic), primarily as a result of significant unfavorable claims experience in the commercial auto liability line of business. The Company materially increased the ultimate estimated liabilities for the line and entered into a reinsurance agreement, effective December 31, 2000, that provides significant additional protection in the event of further adverse reserve development. Additionally, the Company has reinsured the run-off of this business in 2001. In 1999, net income was $7,127,137, or $.32 per share (diluted). The Company recorded GAAP combined ratios of 172.6% in 2001, 126.3% in 2000, and 99.4% in 1999. Discontinuance of Commercial Lines and Redeployment of Capital. On February 7, 2002, the Company announced its decision to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. The Company's commercial lines business segment produced approximately $70 million in gross premiums written in 2001. The Company plans to reduce its cost structure commensurate with the business reduction. Since February 7, 2002, the Company has reduced its employee count by 35 and notified all of its commercial lines agents of its intent to cancel their agency contracts. The Company has notified all states, where required by statute, of its intent to cease writing commercial lines of insurance in their state. The Company has ceased writing new commercial business and has taken certain steps allowed under the statutes to not renew commercial business. The discontinuance of writing commercial lines will likely result in the Company ceasing to be approved to write insurance in a number of states. The Company continues to operate a personal lines insurance operation in Florida that produced approximately $40 million in gross premiums written in 2001. See "Results of Operations." The Company will be in a period of transition as it exits from its commercial lines insurance business. During the transition process, the Company may consider the sale of subsidiaries associated with that business. The Company also intends to continue to review current trends and profitability prospects for its nonstandard personal automobile business, and may endeavor to increase, decrease or dispose of all or part of it. The Company intends to redeploy the capital now required by the commercial lines business, once it becomes available, to pursue other opportunities in the future that offer a better prospect for profitability. The Company believes that suitable capital redeployment opportunities should be available after commercial lines capital becomes available, but cannot predict the amount of capital that will ultimately be available for redeployment, the timing or the nature of the opportunities that may be available at the time capital becomes available. See "Liquidity and Capital Resources". The opportunities may be outside of the insurance business and could be in the financial services business. Tri-State Acquisition and Sale On January 7, 2000, the Company expanded its personal lines business conducted through the Lalande Group through the acquisition of Tri-State, an insurance operation specializing in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. Tri-State owned and operated a managing general agency, a motor vehicle driving records service company and an insurance subsidiary, MCIC that had policyholders' surplus of approximately $3,034,000. The purchase price consideration consisted of $6,000,000 in cash at closing plus additional cash payments of $1,200,000 and $1,600,000 paid in July 2000 and January 2001, respectively. On August 31, 2001, the Company sold all of the stock of Tri-State to Herbert A. Hill for a cash price of $935,000. Mr. Hill is the President and a former owner of Tri-State. The Company retained MCIC which had policyholders' surplus of approximately $3,078,000 at December 31, 2001. Transactions with Goff Moore Strategic Partners, L.P. ("GMSP") 1999 GMSP Transaction. On October 4, 1999, GNA sold to GMSP, for an aggregate purchase price of $31,620,000, (i) 31,620 shares of Series A Preferred Stock, which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share (subject to adjustment for certain events), (ii) the Series A Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share. At closing GNA and its insurance company subsidiaries entered into Investment Management Agreements with GMSP, pursuant to which GMSP manages their respective investment portfolios. Completion of these transactions (the "1999 GMSP Transaction") concluded the strategic alternatives review process that the Company initiated in 1998. Proceeds from the 1999 GMSP Transaction were available for acquisitions, investments and other corporate purposes. See "Item 1. Business -- Investment Strategy". 2001 GMSP Transaction. On March 23, 2001, the Company consummated a transaction with GMSP (the "2001 GMSP Transaction") pursuant to which, among other things, the Company issued shares of its newly created Series C Preferred Stock to GMSP in exchange for an aggregate purchase price of $3.0 million in cash. 24 The annual dividend rate on the Series C Preferred Stock is 10% during the first three years and 20% thereafter. Unpaid dividends are cumulative and compounded. The Series C Preferred Stock is redeemable at the Company's option after five years and at the option of the majority holders after six years at a price of $1,000 per share plus accrued and unpaid dividends. The Series C Preferred Stock is not convertible into Common Stock. The agreement with GMSP was conditioned upon the following changes in the securities currently held by GMSP. The exercise prices of the Series A Warrant and the Series B Warrant held by GMSP were amended to $2.25 per share and $2.5875 per share, respectively. Each of these warrants provides for the purchase of 1,550,000 million shares of Common Stock, subject to adjustment. Further, the Company is required to redeem the outstanding shares of its Series A Preferred Stock on January 1, 2006, subject to certain conditions at a price of $1,000 per share plus accrued and unpaid dividends. Any Series A Preferred Stock unredeemed for any reason after that date would accrue interest, payable quarterly at a rate equal to eight percent per year with any unpaid interest compounded annually. The Series A Preferred Stock is convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share. The agreement with GMSP provided an opportunity to convert the Company's illiquid investments with a cost of $4.2 million to cash as of November 2002, as follows: the Company could at its option require GMSP to purchase the illiquid investments for $2.1 million, less any future cash received prior to November 2002 from the investments. GMSP could at its option require the Company to sell the illiquid investments to GMSP for $4.2 million, less any future cash received prior to November 2002 from the investments. During the second quarter of 2001, the Company recognized a permanent impairment of these investments and wrote down the carrying value to the amount recoverable from GMSP under the put option. In February 2002, GMSP consented to the early exercise of the Company's option, and the Company exercised its option to require GMSP purchase the illiquid investments for approximately $2.1 million. Transactions with Robert W. Stallings On March 23, 2001, the Company consummated a transaction with Robert W. Stallings (the "Stallings Transaction") pursuant to which, among other things, the Company issued shares of its newly created Series B Preferred Stock and a warrant to purchase an aggregate of 1,050,000 shares of Common Stock at $2.25 per share in exchange for an aggregate purchase price of $3.0 million in cash. The annual dividend provisions and the redemption provisions of the Series B Preferred Stock are the same as those for the Series C Preferred Stock. The Series B Preferred Stock is convertible into Common Stock at $2.25 per share. Subject to adjustment for certain events, the Series B Preferred Stock is convertible into a maximum of 1,333,333 shares of Common Stock. The term of the warrant is five years. Mr. Stallings was elected non-executive Vice Chairman of the Board and a director of the Company. On September 6, 2001, Mr. Stallings was elected non-executive Chairman of the Board of Directors of the Company. Reinsurance Transactions Effective December 31, 2000, the Company entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 through December 31, 2001, the Company entered into a quota share reinsurance agreement whereby the Company will cede 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $89,650,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2000 and December 31, 2001. Also in connection with this agreement, the Company is required to maintain assets in a trust fund with a fair value at least equal to the funds held liability. The trust fund was established during the third quarter of 2001 and at December 31, 2001 the assets in the trust had a fair value of $49,553,698. Because the Company's statutory policyholders' surplus fell below certain levels specified in the agreement, the reinsurer has the option to direct the trustee to transfer the assets of the trust to the reinsurer. If the reinsurer were to exercise its option, based upon December 31, 2001 balances, investments and funds held under reinsurance agreements would each be reduced by approximately $47,800,000. The reinsurer would continue to be responsible for reimbursing the Company for claim payments covered under this agreement. 25 The discussion below primarily relates to the Company's insurance operations, although the selected consolidated financial data appearing elsewhere is on a consolidated basis. The expense item "Underwriting and operating expenses" includes the operating expenses of the computer software, plan servicing and premium finance operations. RESULTS OF OPERATIONS Gross premiums written in 2001 of $117,183,182 are 30% below the $168,285,832 recorded in 2000 primarily due to the Company's decision in the fourth quarter of 2000 to cease writing certain identified non-profitable commercial trucking business. Gross premiums written in 2000 of $168,285,832 were 26% above the $133,898,001 recorded in 1999 primarily because of increases in commercial specialty lines, personal auto business written in Florida and personal umbrella business written in 2000. The following table compares the major product lines between the years for gross premiums written:
Years ended December 31 ------------------------------------------------ 2001 2000 1999 -------------- -------------- -------------- (Dollar amounts in thousands) Gross Premiums Written: Commercial Lines $ 68,499 58% $113,354 67% $ 97,139 73% Personal Lines 48,684 42 54,932 33 36,759 27 ------- --- ------- --- ------- --- $117,183 100% $168,286 100% $133,898 100% ======= === ======= === ======= === Policies in Force (End of Period) 64,797 87,048 68,943
COMMERCIAL LINES decreased 40% in 2001 and increased 17% in 2000. Commercial auto contributed 30 points to the decrease in 2001 for the reason mentioned previously and 2 points to the increase in 2000. The general liability line contributed 6 points to the decrease in 2001 and 14 points to the increase in 2000. The large increase in 2000 is primarily attributable to specialty lines of business in professional liability and directors and officers liability. Commercial lines writings should decline very rapidly in 2002 since the Company announced its decision to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. PERSONAL LINES decreased 11% in 2001 primarily as a result of the Florida nonstandard auto business. Personal lines increased 49% in 2000 primarily as a result of nonstandard auto and umbrella business. The Company began a transition during 2001 to write a majority of the nonstandard auto business on six month policies instead of twelve month policies as had been done in the past. This accounts for a significant portion of the decrease in writings in 2001. This decision gives the Company greater flexibility in managing the business. For 2001 gross premiums written percentages by significant product line are as follows: personal auto (37%), general liability (22%), commercial auto (20%) and garage (14%), with no other product line comprising 5% or more. Net premiums earned decreased 55% in 2001 primarily as a result of the commercial quota share reinsurance agreements and exiting certain commercial trucking business. They increased 34% in 2000 primarily as a result of the level of premiums written. Net investment income decreased 43% in 2001 from 2000 after an increase of 45% in 2000 from 1999. Effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement required the Company to maintain a funds held liability and to increase this liability at an annual interest rate of 7.5%. This resulted in a charge to investment income of $3,650,417 during 2001. During 2000, approximately $80.5 million in bond securities were sold for a pre-tax loss of $1,906,911 and a large portion of the proceeds were reinvested in bond securities with an average taxable equivalent yield of more than 150 basis points over the bond securities that were sold. The increase in investments and the increase in yield on the proceeds reinvested from the sales of bonds account for the increase in investment income in 2000. 26 The Company recorded net realized capital gains of $4,275,192 and $605,606 in 2001 and 1999, respectively, versus net realized capital losses of $1,906,911 in 2000. The losses recorded in 2000 were the result of restructuring the portfolio into higher taxable equivalent yields. Insurance service revenues decreased $727,443 in 2001 from 2000 and $794,453 in 2000 from 1999. The decreases were primarily a result of the decrease in claim adjusting service revenues. Claims and claim adjustment expenses ("C & CAE") decreased $56,013,096 in 2001 from 2000 and increased $67,090,034 in 2000 from 1999. The C & CAE ratio was 127.2% in 2001, 94.7% in 2000 and 67.4% in 1999. The C & CAE ratio in 2001 is above the 2000 level primarily because of continued adverse development in commercial lines. The ratio in 2000 is above the 1999 level primarily because of significant unfavorable claims experience in the commercial auto liability line of business for the current and prior accident years. The Company began to cease writing new policies in the trucking portion of this line of business in the fourth quarter of 2000. Reinsurance agreements were in place effective December 31, 2000 that are expected to minimize future adverse results from this line of business. Under the reserve reinsurance cover agreement approximately $7,937,000 of C & CAE for 2002 will ultimately be amortized as a deferred gain on reinsurance arrangements in future periods. In accordance with accounting principles generally accepted in the United States of America, the reinsurance recoveries from these reserve increases are recorded as deferred revenue and not immediately recognized as reductions to C & CAE. Recognition of this deferred revenue item occurs through other income in the future based upon claims recovered from the reinsurer in relation to the total amount of the reinsured layer under the reserve reinsurance cover agreement. With regard to environmental and product liability claims, the Company has an immaterial amount of exposure. The Company does not provide environmental impairment coverage and excludes pollution and asbestos related coverages in its policies. The Company's premium writings for product liability coverages are immaterial. Inflation impacts the Company by causing higher claim settlements than may have originally been estimated. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. The ratio of commissions and the change in deferred policy acquisition costs and deferred ceding commission income to net premiums earned is 21% in 2001, 22% in 2000 and 21% in 1999. Interest expense from the note payable decreased in 2001 as a result of principal payments on the note and lower interest rates. The increase in 2000 was a result of higher interest rates. Amortization of goodwill decreased in 2001 as a result of the sale of Tri-State and the second quarter 2001 write-off of its goodwill. Amortization of goodwill increased in 2000 as a result of the goodwill related to the Tri-State acquisition in January 2000. Underwriting and operating expenses were up 12% in 2001 from 2000 and 14% in 2000 from 1999. The increase for 2001 was the result of the Company recording a provision for potentially uncollectible reinsurance balances receivable of $2,653,597. Without this provision underwriting and operating expenses were down 4% primarily as a result of a decrease in personnel costs. The increase for 2000 was primarily due to salary increases, personnel additions and bad debt reserve increases on premiums receivable. Goodwill impairment is a result of the Company's decision to no longer pursue a long-term geographic expansion strategy in personal automobile beyond that of its core operation in Florida and to sell its Tri-State agency subsidiary (See "Business Operations - Tri-State Acquisition and Sale"). As a result the remaining goodwill associated with the Tri-State acquisition was written off in the second quarter of 2001. In December 2001 the Company recorded an impairment of $13,360,603 on the goodwill associated with the 1998 acquisition of the Lalande Group. This action was taken to reflect estimated fair valuation levels of agencies in the personal automobile marketplace. The remaining $3,468,507 of goodwill is associated with Lalande. 27 The Federal income tax expense for 2001 is a result of the Company recording a valuation allowance of $31,534,712 against its deferred Federal income tax asset offset by the income tax benefit generated by the net loss from operations. Establishing the valuation allowance was necessary because of the uncertainty of future profitability levels. The Company does not lose the right to utilization of its net operating loss carry forwards for Federal income tax purposes in the future. For 2000 the Company generated a current tax benefit, with an effective tax benefit rate of 37%, as a result of a net loss from operations. The effective tax rate of 15% for 1999 was primarily the result of tax-exempt income comprising a major portion of income before taxes. A reconciliation between income taxes computed at the Federal statutory rates and the provision for income taxes is included in Note (6) of Notes to Consolidated Financial Statements. The cumulative effect of change in accounting principle was recorded as a result of EITF 99-20, which became effective April 1, 2001. This amount represents the write down of an investment that was considered temporarily impaired and was written down in the first quarter of 2001 through accumulated other comprehensive income. EITF 99-20 changed the definition of impairment which resulted in this asset being reclassified as an impairment other than temporary which requires recognition through the statement of operations. LIQUIDITY AND CAPITAL RESOURCES Parent Company GAINSCO, INC. ("GNA") is a holding company that provides administrative and financial services for its wholly owned subsidiaries. GNA needs cash for: (1) principal and interest on its bank note payable, (2) administrative expenses, and (3) investments. The primary sources of cash to meet these obligations are statutory permitted payments from its insurance subsidiaries, including (1) dividend payments, (2) surplus debenture interest payments, and (3) tax sharing payments. Statutes in Oklahoma and North Dakota restrict the payment of dividends by the insurance company subsidiaries to the available surplus funds derived from their realized net profits. The maximum amount of cash dividends that each subsidiary may declare without regulatory approval in any 12-month period is the greater of net income for the 12-month period ended the previous December 31 or ten percent (10%) of policyholders' surplus as of the previous December 31. On February 28, 2002, General Agents (the Oklahoma subsidiary) paid dividends to GNA of $7,238,000. Based on its surplus amounts at December 31, 2001 and generally without prior regulatory approval, in early 2003 General Agents may declare dividends to GNA of up to approximately $4,700,000 and in 2002 MCIC (the North Dakota subsidiary) may declare dividends to GNA of up to approximately $300,000. GNA believes the cash dividends from its insurance subsidiaries should be sufficient to meet its expected obligations for 2002. The Company had Federal income tax loss carry forwards at December 31, 2001 of approximately $19,864,000 that could be applied against any future earnings of the Company, subject to certain limitations. Thus, the Company does not currently require funds to satisfy Federal income tax obligations. GNA entered into an amendment dated as of February 27, 2002 to its bank credit agreement which cured GNA's covenant breaches and provided for principal prepayments. Pursuant to the amendment, GNA prepaid $6,100,000 of the indebtedness outstanding under the credit agreement. Several covenants in the existing credit agreement were eliminated or modified by the amendment and the interest rate was changed to a base rate (which approximates prime) plus 175 basis points. The remaining $4,200,000 principal balance under the Credit Agreement is payable in 2003. The credit agreement precludes payment of dividends on common or preferred stock and restricts the kinds of investments that GNA may make. Subject to bank credit agreement restrictions, GNA may also obtain cash through the sale of subsidiaries or assets and through the issuance of common or preferred stock. The bank credit agreement generally requires a note prepayment in the event of the sale of GNA of any subsidiary or assets (except certain ordinary course of business sales), or any issuance of stock, equal to 50% of the proceeds received. 28 As the Company exits from the commercial lines business, GNA may consider the sale of subsidiaries associated with that business. The Company also intends to reevaluate its personal lines business and may endeavor to increase, decrease or dispose of all or part thereof. See "Business Operations - Discontinuance of Commercial Lines and Redeployment of Capital." Subsidiaries, Principally Insurance Operations The primary sources of the insurance subsidiaries' liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At December 31, 2001, the insurance subsidiaries held short-term investments and cash that the insurance subsidiaries believe are adequate liquidity for the payment of claims and other short-term commitments. With regard to long term liquidity, the average duration of the investment portfolio is approximately 3.3 years. The fair value of the fixed maturity portfolio at December 31, 2001 was $5,425,067 above amortized cost, before taxes. With regard to the availability of funds to the holding company, see Note (7) of Notes to Consolidated Financial Statements for restrictions on the payment of dividends by the insurance companies. Various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 2001 and 2000, the balance on deposit for the benefit of such policyholders totaled $15,398,298 and $16,507,427, respectively. Effective December 31, 2000, the insurance subsidiaries entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 through December 31, 2001, the Company entered into a quota share reinsurance agreement whereby the Company ceded approximately 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $57,150,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2000. Also in connection with this agreement, the Company is required to maintain assets in a trust fund with a fair value at least equal to the funds held liability. The trust fund was established during the third quarter of 2001 and at December 31, 2001 the assets in the trust had a fair value of $49,553,698. Because the Company's statutory policyholders' surplus fell below certain levels specified in the agreement, the reinsurer has the option to direct the trustee to transfer the assets of the trust to the reinsurer. If the reinsurer were to exercise its option, based upon December 31, 2001 balances, investments and funds held under reinsurance agreements would each be reduced by approximately $47,800,000. The reinsurer would continue to be responsible for reimbursing the Company for claim payments covered under this agreement. Net cash used for operating activities was $61,384,654 for 2001 versus $4,649,539 and $13,775,750 in net cash provided by operating activities in 2000 and 1999, respectively. The large change in 2001 was primarily related to the decrease in premium writings, mentioned previously. Investments decreased primarily for the reasons mentioned regarding net cash used for operating activities. At December 31, 2001, 98% of the Company's investments were investment grade with an average duration of approximately 3.3 years, including approximately 25% that were held in short-term investments. On a taxable equivalent basis the return on average investments was 4.3% in 2001, 6.5% in 2000, and 5.7% in 1999. The Company classifies its bond securities as available for sale. In February 2002 GMSP purchased the equity investments and the note receivable, classified as "Other investments", for approximately $2,087,000 which was their carrying value at December 31, 2001. In March 2002, the Company reduced the carrying value of a non-rated security to $0 resulting in a write down of approximately $2,010,000 as a result of a significant increase in the default rate in January and February of 2002 in the underlying collateral, which has disrupted the cash flow stream sufficiently to virtually eliminate future cash flows. This write down is not reflected in the Statement of Operations for 2001, but will be included in the first quarter 2002 Statement of Operations. The unrealized gain associated with the investment portfolio was $3,580,690 (net of tax effects) at December 31, 2001. The duration of the bonds available for sale approximates the average expected payout of claims. Certain investments are held in trust under the terms of the reserve reinsurance cover agreement. Because the Company's statutory policyholders' surplus fell below certain levels specified in the agreement, the reinsurer has the option to direct the trustee to transfer the investments of the trust to the reinsurer. If the reinsurer were to exercise its option, based upon December 31, 2001 balances, investments would be reduced by approximately $47,800,000. Premiums receivable decreased as a result of the decrease in writings caused primarily by the exiting of commercial auto during 2001. This balance is comprised of premiums due from general agents for commercial lines and premiums due from insureds for personal lines. The commercial lines premiums are generally received within forty-five days of 29 the month end in which coverage was bound, whereas the personal lines premiums are written with a down payment and monthly payment terms of up to nine months. At December 31, 2001, approximately 42% of the balance was due under the deferred payment terms. The Company has recorded an allowance for doubtful accounts of $200,000 which it considers adequate at the present time. Reinsurance balances receivable increased primarily as a result of C & CAE claims paid under the reserve reinsurance cover agreement and the quota share reinsurance agreements for both commercial and personal lines of business written in 2001. This balance is primarily comprised of claims and claim adjustment expenses paid by the Company and due from reinsurers under the Company's various reinsurance agreements. During the fourth quarter of 2001, the Company recorded an allowance for doubtful accounts of $2,653,597 as a result of concern regarding the collectibility of amounts due from specific reinsurers. Balances written off in previous years have been immaterial. The Company considers the allowance adequate at the present time. Ceded unpaid claims and claim adjustment expenses increased as a result of the increase in unpaid claims and claim adjustment expenses and the increase in cessions under the quota share reinsurance agreements for 2001. This balance represents unpaid claims and claim adjustment expense reserves which have been ceded to reinsurers under the Company's various reinsurance agreements. These amounts are not currently due from the reinsurers but are expected to become due in the future when the Company pays the claim and requests reimbursement from the reinsurers. If the Company experiences collectibility problems on paid claims (Reinsurance balances receivable) from a specific reinsurer it would record a corresponding allowance for doubtful accounts against the ceded unpaid claims and claim adjustment expenses from this reinsurer. Ceded unearned premiums decreased primarily as a result of the decrease in ceded unearned premiums from the 2000 commercial quota share reinsurance agreement. This balance represents the portion of premiums ceded to reinsurers which are applicable to the unexpired terms of policies in force under the applicable reinsurance agreement. In the event the Company cancels policies, the reinsurer is required to return the premium to the Company. This type of action, on a material scale, is not expected to occur. Deferred policy acquisition costs increased primarily as a result of a decrease in deferred ceding commission income primarily generated from the 2000 commercial quota share reinsurance agreements. This balance represents commissions, premium taxes and certain marketing and underwriting expenses which are deferred and charged to operations over periods in which the related premiums are earned. Ceding commission income, which is realized on a written basis, is deferred and recognized over periods in which the related premiums are earned. Deferred ceding commission income is netted against deferred policy acquisition costs. The change in the resulting deferred asset is charged (credited) to operations. The Company recorded impairments on its deferred policy acquisition costs at December 31, 2001 of $2,487,009 related to the property and commercial auto lines of business and at December 31, 2000 of $501,930 related to the property and nonstandard personal auto lines of business. With the Company's exit from commercial lines, deferred policy acquisition costs are expected to decrease rapidly during 2002 as the commercial lines writings decrease. Property and equipment decreased primarily as a result of information technology software write-offs in the second quarter of 2001 and equipment disposed of in conjunction with the sale of Tri-State. Approximately $4,400,000 of this balance consists of the office building located in Fort Worth, Texas housing the Company's principal offices. The Company has entered into a contract to sell the building at a purchase price equal to $5,000,000. The sale is subject to certain conditions, including the buyer's satisfaction with its due diligence. The sale of the building, if consummated at all, could be consummated in August 2002. The Company plans to lease space in the Dallas/Fort Worth area and will move in August subject to the closing of the sale. The remaining portion of property and equipment is computer hardware, computer software, furniture and an office building the Company previously occupied which is under lease until May, 2003. As the Company exits commercial lines, future write-offs of software and equipment will likely occur. 30 Current Federal income taxes are expected to be received no later than July 2002. Deferred Federal income taxes have a valuation allowance for its full amount recorded against the asset. This asset is primarily a tax benefit from net operating loss carry forwards which can be used to offset tax expense on future operating earnings or capital gains. A change in ownership of the Company's stock greater than 50% (as specified under Internal Revenue Code Section 382) could severely limit the Company's ability to recover this asset in future periods. Management contract is the unamortized purchase price of GAINSCO County Mutual Insurance Company's management contract which expires in 2042 and is being amortized over a forty year period ending 2032. The Company believes that the fair value of this asset is significantly above its amortized cost. Other assets are comprised of funds held by reinsurers where the Company has assumed business from the reinsurers and the funds are collateral for the reinsurer. Also contained in this balance are prepaid commissions on personal lines business and prepaid insurance premiums on policies the Company has purchased for its protection. Goodwill decreased primarily as a result of the $5,086,283 impairment recorded in the second quarter of 2001 related to the January 2000 Tri-State acquisition and the $13,360,603 impairment recorded during the fourth quarter of 2001 related to the October 1998 Lalande acquisition. Tri-State was sold in the third quarter of 2001. The remaining goodwill of $3,468,507 reflects estimated fair valuation of agencies in the personal automobile marketplace. Effective in 2002, goodwill will no longer be amortized but will be subject to an impairment test based on its estimated fair value. Therefore, additional impairment losses could be recorded in future periods. Unpaid claims and claim adjustment expenses increased primarily as a result of higher levels of case reserves on known claims and higher levels of bulk reserves to cover future development. The Company considers the reserves to be adequate and has the confidence of an independent actuarial valuation of the unpaid claims and claim adjustment expense reserves which supports the Company's conclusion. Unearned premiums decreased because of the decrease in writings. This balance represents the portion of premiums written which are applicable to the unexpired terms of policies in force. Because of the Company's decision to exit commercial lines, this balance is expected to decrease rapidly in future periods. Commissions payable increased primarily due to a decrease in estimated commission income from the 2000 commercial quota share reinsurance agreements. This balance is primarily commissions payable to reinsurers based on claim experience. Accounts payable decreased primarily because of a payment made in January 2001 to Tri-State for meeting certain targets specified in the acquisition agreement. This balance is comprised primarily of premiums due to a nonaffiliated insurance company that was fronting for the Company in 2001 on personal lines in Florida. Reinsurance balance payable decreased primarily due to the funding of the 2000 commercial quota share reinsurance agreement during the first six months of 2001. This balance is comprised primarily of premiums due reinsurers on business ceded to them under the Company's various reinsurance agreements. Deferred revenues increased due to reserve development under the reserve reinsurance cover agreement. This balance is primarily comprised of C & CAE recoveries under this agreement which will be recognized as other income in future periods based upon the ratio of actual C & CAE paid to the total of potential C & CAE payable under this reinsurance agreement. Drafts payable decreased primarily as a result of a decrease in claims paid for the fourth quarter of 2001 versus the fourth quarter of 2000. This balance is comprised of outstanding drafts which have been issued to pay for claims and claim adjustment expenses, but which have not cleared the bank account of the Company. 31 Note payable decreased due to scheduled principal repayments made during 2001 and unscheduled principal prepayments of $2,500,000 and $200,000 made during the first and fourth quarter of 2001, respectively, in conjunction an amendments to the credit agreement (see Note (4) of Notes to Consolidated Financial Statements). In the first quarter of 2002, the Company made a scheduled repayment of $500,000 and an unscheduled prepayment of $6,100,000. The unscheduled prepayment was made in conjunction with an amendment to the credit agreement which cured covenant breaches. The remaining $4,200,000 principal balance under the credit agreement is payable in 2003. (see Note (4) of Notes to Consolidated Financial Statements). Funds held under reinsurance agreements is primarily the funds for payment of C & CAE on claims under the reinsurance reserve cover agreement. The Company is required to increase the fund balance at a 7.5% annual rate based upon the fund balance and the fund balance is decreased for C & CAE payments made on claims under the reinsurance reserve cover agreement. The Company is required to maintain assets in a trust fund with a fair value at least equal to the funds held liability. Because the Company's statutory policyholders' surplus fell below certain levels specified in the agreement, the reinsurer has the option to direct the trustee to transfer the assets of the trust to the reinsurer. If the reinsurer were to exercise its option, based upon December 31, 2001 balances, funds held under reinsurance agreements would be reduced by approximately $47,800,000. As a result of the 2001 GMSP Transaction and the Stallings Transaction, the Company has three series of redeemable preferred stock, which are classified as mezzanine financing. The Series A Convertible Redeemable Preferred Stock was previously classified in shareholders' equity because it was not subject to mandatory redemption. The Series B and the Series C preferred stock each include accrued dividends in the amount of $230,672 as of December 31, 2001. With the reclassification of the Series A Convertible Redeemable Preferred Stock during the first quarter of 2001, preferred stock capital was reduced to $0 and additional paid-in capital was reduced by the discount on the convertible redeemable preferred stock. Common stock warrants decreased for the discount in value of the previously issued Series A and Series B Warrants offset by an increase for the issuance of the warrant in the Stallings Transaction. At December 31, 2001 $13,051,000 has yet to be charged to Retained Deficit related to the accretion of the discount on the preferred stock. Accumulated other comprehensive income of $3,580,690 was recorded at December 31, 2001 as a result of the unrealized gains on bonds available for sale and common stocks. The decrease in retained earnings to a retained deficit of $71,977,743 is attributable to the net loss of $75,607,047 for the 2001 year. The Company is not aware of any current recommendations by regulatory authorities, which if implemented, would have a material effect on the Company's liquidity, capital resources or results of operations. The Company's statutory capital exceeds the benchmark capital level under the Risk Based Capital formula for its insurance companies that are subject to Risk Based Capital Requirements. Risk Based Capital is a method for establishing the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The tragic events of September 11, 2001 did not impact the Company's financial results for 2001. LIQUIDATION VALUE At December 31, 2001, total assets less total liabilities (excluding redeemable preferred stock) of the Company was $52,546,273, and there were outstanding three series of preferred stock with an aggregate liquidation value of $38,081,344 ($37,620,000 stated value plus accrued dividends of $461,344). In the event of a liquidation of the Company (which is not contemplated) based upon consolidated shareholders' equity at December 31, 2001, there would be $14,464,929 available for distribution to the holders of the common stock ($0.68 per common share) after the payment of creditors and the liquidation value of the preferred stock. The amount ultimately available to the shareholders would vary with changes in the assets and liabilities of the Company. 32 FORWARD LOOKING STATEMENTS Statements made in this report that are not strictly historical may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that important factors, representing certain risks and uncertainties, could cause actual results to differ materially from those contained in the forward-looking statements. These factors include, but are not limited to, (a) the Company's ability to effect the successful exit from unprofitable lines and businesses that the Company believes cannot be counted on to produce future profit, (b) heightened competition from existing competitors and new competitor entrants into the Company's markets, (c) the extent to which market conditions firm up, the acceptance of higher prices in the market place and the Company's ability to realize and sustain higher rates, (d) contraction of the markets for the Company's business, (e) the Company's ability to secure an A.M. Best rating acceptable to its end markets and meet its obligations under its capital and debt agreements, (f) the ongoing level of claims and claims-related expenses and the adequacy of claim reserves, (g) the effectiveness of investment strategies implemented by the Company's investment manager, (h) continued justification of recoverability of goodwill in the future, (i) the availability of reinsurance and the ability to collect reinsurance recoverables, (j) the Company's ability to invest in new endeavors that are successful, (k) the limitation on the Company's ability to use net operating loss carry forwards as a result of constraints caused by ownership changes within the meaning of Internal Revenue Code Section 382, (l) continued listing of the Company's common stock on the NYSE or, if such listing is not continued, the qualification of the Company's common stock for trading on a different market which would allow acceptable liquidity and trading for the Company's common stock, and (m) general economic conditions including fluctuations in interest rates. A forward-looking statement is relevant as of the date the statement is made. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which the statements are made. 33 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as the result of changes in equity prices, interest rates, foreign exchange rates and commodity prices. The Company's consolidated balance sheets include assets whose estimated fair values are subject to market risk. The primary market risk to the Company is interest rate risk associated with investments in fixed maturities. The Company has no foreign exchange, commodity or equity risk. INTEREST RATE RISK The Company's fixed maturity investments are subject to interest rate risk. Increases and decreases in interest rates typically result in decreases and increases in the fair value of these investments. Most of the Company's investable assets are in the portfolios of the insurance company subsidiaries and come from premiums paid by policyholders. These funds are invested predominately in high quality bonds with relatively short durations. The fixed maturity portfolio had an average duration of 3.3 years at December 31, 2001. The fixed maturity portfolio is exposed to interest rate fluctuations; as interest rates rise, fair values decline and as interest rates fall, fair values rise. The changes in the fair value of the fixed maturity portfolio are presented as a component of shareholders' equity in accumulated other comprehensive income, net of taxes. The effective duration of the fixed maturity portfolio is managed with consideration given to the estimated duration of the Company's liabilities. The Company has investment policies that limit the maximum duration and maturity of the fixed maturity portfolio. The Company utilizes the modified duration method to estimate the effect of interest rate risk on the fair values of its fixed maturity portfolio. The usefulness of this method is to a degree limited, as it is unable to accurately incorporate the full complexity of market interactions. 34 The table below summarizes the Company's interest rate risk and shows the effect of a hypothetical change in interest rates as of December 31, 2001. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios (dollars in thousands):
Estimated Estimated Hypothetical Estimated Fair Change in Fair Value After Percentage Increase Value at Interest Rates Hypothetical Change (Decrease) in December 31, 2001 (BP=basis points) in Interest Rates Shareholders' Equity ----------------- ----------------- -------------------- --------------------- U.S. Treasury securities $ 62,294 200 BP Decrease $ 62,782 1.77 (including short-term 100 BP Decrease $ 62,538 .89 Investments) 100 BP Increase $ 62,050 (.89) 200 BP Increase $ 61,806 (1.78) Obligation of states, $ 9,139 200 BP Decrease $ 9,613 1.72 municipalities and 100 BP Decrease $ 9,376 .86 Political subdivisions 100 BP Increase $ 8,902 (.86) 200 BP Increase $ 8,665 (1.72) Corporate bonds and $ 107,134 200 BP Decrease $115,078 28.87 Certificates of Deposit 100 BP Decrease $111,106 14.43 100 BP Increase $103,162 (14.43) 200 BP Increase $ 99,190 (28.87) Total fixed maturity investments $ 178,567 200 BP Decrease $187,473 32.37 (including short-term 100 BP Decrease $183,020 16.18 Investments) 100 BP Increase $174,114 (16.18) 200 BP Increase $169,661 (32.37)
35 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated Financial Statements are on pages 43 through 81
Page ---- Report of Management 43 Independent Auditors' Report 44 Consolidated Balance Sheets as of December 31, 2001 and 2000 45-46 Consolidated Statements of Operations for the Years Ended December 31, 2001, 2000, and 1999 47-48 Consolidated Statements of Shareholders' Equity and Comprehensive Income for the Years Ended December 31, 2001, 2000, and 1999 49-50 Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2000, and 1999 51-52 Notes to Consolidated Financial Statements December 31, 2001, 2000, and 1999 53-81
The following Consolidated Financial Statements Schedules are on pages 82 through 93:
Schedule Page -------- ---- Independent Auditors' Report on Supplementary Information 82 I Summary of Investments 83 II Condensed Financial Information of the Registrant 84-90 III Supplementary Insurance Information 91 IV Reinsurance 92 VI Supplemental Information 93
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. 36 PART III The information required by this Part III will be supplied by a Schedule 14A filing or an amendment to this Report. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORMS 8-K (a) Documents filed as part of the report: 1. The following financial statements filed under Part II, Item 8: Independent Auditors' Report Consolidated Balance Sheets as of December 31, 2001 and 2000 Consolidated Statements of Operations for the Years Ended December 31, 2001, 2000 and 1999 Consolidated Statements of Shareholders' Equity and Comprehensive Income for the Years Ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements, December 31, 2001, 2000 and 1999 2. The following Consolidated Financial Statement Schedules are filed under Part II, Item 8:
Schedule Description -------- ----------- I Summary of Investments II Condensed Financial Information of the Registrant III Supplementary Insurance Information IV Reinsurance VI Supplemental Information
37 3. The following Exhibits:
Exhibit No. ----------- *3.1 Restated Articles of Incorporation of Registrant as filed with the Secretary of State of Texas on July 24, 1986 [Exhibit 3.1, filed in Registration Statement No. 33-7846 on Form S-1, effective November 6, 1986]. *3.2 Articles of Amendment to the Articles of Incorporation as filed with the Secretary of State of Texas on June 10, 1988 [Exhibit 3.2, filed in Registration Statement No. 33-25226 on Form S-1, effective November 14, 1988]. *3.3 Articles of Amendment to Articles of Incorporation as filed with the Secretary of State of Texas on August 13, 1993 [Exhibit 3.6, Form 10-K dated March 25, 1994]. *3.4 Statement of Resolution Establishing and Designating Series A Convertible Preferred Stock of Registrant as filed with the Secretary of State of the State of Texas on October 1, 1999 [Exhibit 99.18, Form 8-K dated June 29, 1999]. *3.5 Bylaws of Registrant as amended through September 6, 2001. [Exhibit 3.5, Form 8-K dated August 31, 2001] *3.6 Statement of Resolution Establishing and Designating Series B Convertible Redeemable Preferred Stock of Registrant as filed with the Secretary of State of the State of Texas on March 22, 2001. [Exhibit 99.19, Form 8-K/A dated March 30, 2001] *3.7 Statement of Resolution Establishing and Designating Series C Redeemable Preferred Stock of Registrant as filed with the Secretary of State of the State of Texas on March 22, 2001. [Exhibit 99.20, Form 8-K/A dated March 30, 2001] *4.1 Rights Agreement, dated as of March 3, 1988, between the Registrant and Team Bank/Fort Worth, N.A. [Exhibit 1, Form 8-K dated March 14, 1988]. *4.2 Amendment No. 1 dated as of March 5, 1990 to Rights Agreement dated as of March 3, 1988 between Registrant and Team Bank as Rights Agent [Exhibit 4.2, Form 10-K dated March 27, 1992]. *4.3 Amendment No. 2 dated as of May 25, 1993 to Rights Agreement between Registrant and Society National Bank (successor to Team Bank (formerly Texas American Bank/Fort Worth, N.A.)), as Rights Agent [Exhibit 4.4, Form 10-K dated March 25, 1994]. *4.4 Amendment No. 3 to Rights Agreement and appointment of Continental Stock Transfer & Trust Company as Successor Rights Agent, dated September 30, 1994 [Exhibit 10.29, Form 10-K dated March 30, 1995]. *4.5 Amendment No. 4 dated June 29, 1999 to Rights Agreement between Registrant and Continental Stock Transfer & Trust Company [Exhibit 99.21, Form 8-K dated June 29, 1999]. *4.6 Form of Common Stock Certificate [Exhibit 4.6, Form 10-K dated March 28, 1997]. *4.7 Agreement dated August 26, 1994 appointing Continental Stock Transfer & Trust Company transfer agent and registrar [Exhibit 10.28, Form 10-K dated March 30, 1995].
38 *10.1 1990 Stock Option Plan of the Registrant [Exhibit 10.16, Form 10-K dated March 22, 1991]. *10.2 1995 Stock Option Plan of the Registrant [Exhibit 10.31, Form 10-K dated March 28, 1996]. *10.3 1998 Long Term Incentive Plan of the Registrant [Exhibit 99.8, Form 10-Q Report dated August 10, 1998]. [dag]10.4 Form of Change of Control Agreements *10.5 Employment Agreement dated April 25, 1998 between Glenn W. Anderson and the Registrant [Exhibit 99.5, Form 10-Q/A dated June 16, 1998]. *10.6 Change of Control Agreement for Glenn W. Anderson [Exhibit 99.7, Form 10-Q/A dated June 16, 1998]. *10.7 Replacement Non-Qualified Stock Option Agreement dated July 24, 1998 between Glenn W. Anderson and the Registrant [Exhibit 99.6, Form 10-Q Report dated August 10, 1998]. *10.8 Management Contract between GAINSCO County Mutual Insurance Company and GAINSCO Service Corp. and related Surplus Debenture, Amendment to Surplus Debenture, Certificate of Authority and accompanying Commissioner's Order granting Certificate Authority, allowing for charter amendments and extension of charter [Exhibits 10.23, 10.24 and 10.25, Form 10-K dated March 29, 1993; Exhibit 10.27, Form 10-K dated March 25, 1994]. *10.9 Revolving Credit Agreement dated November 13, 1998 among Registrant, GAINSCO Service Corp. and Bank One, Texas, N.A., First Amendment thereto dated October 4, 1999 and related Promissory Note, Security Agreement and Pledge Agreement, Amendment No. 2 thereto dated March 23, 2001, Amendment No. 3 thereto dated November 13, 2001, and Amendment No. 4 thereto dated February 27, 2002. [Exhibits 10.50 to 10.53, Form 10-K/A dated March 30, 1999; Exhibit 99.22, Form 8-K dated October 4, 1999; Exhibit 99.24, Form 8-K/A dated March 30, 2001, Exhibit 10.23, Form 10-Q dated November 13, 2001, Exhibit 10.9, Form 8-K dated February 27, 2002]. *10.10 Securities Purchase Agreement dated as of June 29, 1999 between Registrant and Goff Moore Strategic Partners, L.P. ("GMSP") and related Series A Common Stock Purchase Warrant and Series B Common Stock Purchase Warrant [Exhibit 2.1, Form 8-K dated June 29, 1999; Exhibits 99.19 and 99.20, Form 8-K dated October 4, 1999]. *10.11 Investment Management Agreements dated October 4, 1999 between GMSP and each of Registrant, General Agents Insurance Company of America, Inc., MGA Insurance Company, Inc. and GAINSCO County Mutual Insurance Company; and Investment Management Agreement dated January 6, 2000 between GMSP and Midwest Casualty Insurance Company. [Exhibit 10.11, Form 10-K dated March 30, 2000] *10.12 Stock Purchase Agreements dated August 17, 1998 with Carlos de la Torre, McRae B. Johnston, Michael S. Johnston and Ralph Mayoral relating to acquisition by Registrant of Lalande Group and related employment agreements with them [Exhibits 99.6 to 99.13, Form 8-K dated August 26, 1998].
39
*10.13 Asset Purchase Agreement dated March 9, 1999 between the Registrant, Agents Processing Systems, Inc. and Insurance Business Solutions Incorporated [Exhibit 10.49, Form 10-K dated March 30, 1999]. *10.14 Stock Purchase Agreement dated as of November 17, 1999 among Registrant, Tri-State, Ltd., Herbert A. Hill and Alan E. Heidt and related Pledge Agreement dated as of January 7, 2000 executed by the Registrant in favor of Bank One, NA and Unlimited Guaranty dated as of January 7, 2000 executed by Tri-State, Ltd. in favor of Bank One, NA.[Exhibit 10.14, Form 10-K dated March 30, 2000] *10.15 Agreement of Limited Partnership of GNA Investments I, L.P. dated as of November 30, 1999 between Registrant and Goff Moore Strategic Partners, L.P. [Exhibit 10.15, Form 10-K dated March 30, 2000] *10.16 Professional Service Agreement dated as of October 22, 1999 between Registrant and ClientSoft, Inc. [Exhibit 10.16, Form 10-K dated March 30, 2000] *10.17 First Amendment to Stock Purchase Agreement dated May 16, 2000 among Registrant, Tri-State, Ltd., Herbert A. Hill and Alan E. Heidt [Exhibit 10.14, Form 10-Q Report dated August 11, 2000] *10.18 GAINSCO, INC. 401(k) Plan and related Adoption Agreement [Exhibit 99.1 to Registration Statement on Form S-8, effective April 12, 2000] *10.19 Securities Purchase Agreement dated as of February 26, 2001 between Registrant and GMSP (including exhibits) and related First Amendment to Securities Purchase Agreement, letter regarding redemption of Registrant's outstanding Series A Convertible Preferred Stock, First Amendment to Series A Common Stock Purchase Warrant, and First Amendment to Series B Common Stock Purchase Warrant. [Exhibit 2.1, Form 8-K dated March 2, 2001; Exhibits 2.2, 2.8, 99.21 and 99.22, Form 8-K/A dated March 30, 2001] *10.20 Securities Purchase Agreement dated as of February 26, 2001 between Registrant and Robert W. Stallings ("Stallings") (including exhibits) and related First Amendment to Securities Purchase Agreement, Assignment and Assumption Agreement between Stallings and ING Pilgrim Capital Corporation, LLC, Amendment to Assignment and Assumption Agreement, letter dated March 23, 2001 from Stallings to Registrant, and Common Stock Purchase Warrant. [Exhibit 2.2, Form 8-K dated March 2, 2001; Exhibits 2.4 to 2.7 and 99.23, Form 8-K/A dated March 30, 2001] *10.21 Consulting Agreement dated as of February 26, 2001 between Registrant and Stallings. [Exhibit 99.15, Form 8-K dated March 2, 2001] *10.22 Agreement dated March 23, 2001 among Registrant, GAINSCO Service Corp., GMSP, Stallings and Bank One, N.A. [Exhibit 99.25, Form 8-K/A dated March 30, 2001] *10.23 Letter agreement dated February 27, 2002 between the Registrant and GMSP pursuant to which the Registrant exercised its right to put certain illiquid investments to GMSP for $2,087,354.27 pursuant to Section 6.9 of the Securities Purchase Agreement dated February 26, 2001 between the Registrant and GMSP, as amended. [Exhibit 10.24, Form 8-K dated February 27, 2002] [dag]10.24 Agreement of Sale and Purchase dated March 7, 2002 between General Agents Insurance Company of America, Inc. and Turonian Corp. 11 Statement regarding Computation of Per Share Earnings (the required information is included in Note 1(m) of Notes to Consolidated Financial Statements included in this Report and no separate statement is, or is required to be, filed as an exhibit).
40 [dag]21 Subsidiaries of Registrant. [dag]23 Consent of KPMG LLP to incorporation by reference. [dag]24 Form of Power of Attorney.
---------------------------- * Exhibit has previously been filed with the Commission as an exhibit in the filing designated in brackets and is incorporated herein by this reference. Registrant's file number for reports filed under the Securities Exchange Act of 1934 is 1-9828. [dag] Filed herewith (see Exhibit Index). ---------------------------- (b) Reports on Form 8-K No current reports on Form 8-K were filed by the Registrant during the quarter ended December 31, 2001. (c) Exhibits required by Item 601 of Regulation S-K. The exhibits listed in Item 14(a) 3 of this Report, and not incorporated by reference to a separate file, are filed herewith. 41 SIGNATURES 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. GAINSCO, INC. (Registrant) /s/ Glenn W. Anderson -------------------------------- By: Glenn W. Anderson, President Date: 03/29/02 ------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Name Title Date ---- ----- ---- Robert W. Stallings* Chairman of the Board 3/29/02 ----------------------- ---------- Robert W. Stallings Joel C. Puckett* Vice Chairman of the Board 3/29/02 ----------------------- ---------- Joel C. Puckett /s/ Glenn W. Anderson President, Chief Executive 3/29/02 ----------------------- Officer and Director ---------- Glenn W. Anderson /s/ Daniel J. Coots Senior Vice President and 3/29/02 ----------------------- Chief Financial Officer ---------- Daniel J. Coots Sam Rosen* Secretary and Director 3/29/02 ----------------------- ---------- Sam Rosen J. Randall Chappel* Director 3/29/02 ----------------------- ---------- J. Randall Chappel John C. Goff* Director 3/29/02 ----------------------- ---------- John C. Goff Harden H. Wiedemann* Director 3/29/02 ----------------------- ---------- Harden H. Wiedemann John H. Williams* Director 3/29/02 ----------------------- ---------- John H. Williams
*By: /s/ Glenn W. Anderson ------------------------------- Glenn W. Anderson, Attorney in-fact under Power of Attorney 42 REPORT OF MANAGEMENT The accompanying consolidated financial statements were prepared by the Company, which is responsible for their integrity and objectivity. The statements have been prepared in conformity with accounting principles generally accepted in the United States of America and include some amounts that are based upon the Company's best estimates and judgement. Financial information presented elsewhere in this report is consistent with the accompanying consolidated financial statements. The accounting systems and controls of the Company are designed to provide reasonable assurance that transactions are executed in accordance with management's criteria, that the financial records are reliable for preparing financial statements and maintaining accountability for assets, and that assets are safeguarded against claims from unauthorized use or disposition. The Company's consolidated financial statements have been audited by KPMG LLP, independent auditors. The auditors have full access to each member of management in conducting their audits. The Audit Committee of the Board of Directors, comprised solely of directors from outside of the Company, meets regularly with management and the independent auditors to review the work and procedures of each. The auditors have free access to the Audit Committee, without management being present, to discuss the results of their work as well as the adequacy of the Company's accounting controls and the quality of the Company's financial reporting. The Board of Directors, upon recommendation of the Audit Committee, appoints the independent auditors, subject to shareholder approval. /s/ Glenn W.Anderson ------------------------------------------- Glenn W. Anderson President and Chief Executive Officer /s/ Daniel J. Coots ------------------------------------------- Daniel J. Coots Senior Vice President and Chief Financial Officer 43 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders GAINSCO, INC.: We have audited the accompanying consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of GAINSCO, INC. and subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. We have also previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1999, 1998, and 1997, and the related consolidated statement of operations, shareholders' equity and cash flow for the years ended December 31, 1998 and 1997, and we expressed unqualified opinions on those consolidated financial statements. In our opinion, the information set forth in the selected consolidated financial data for each of the years in the five-year period ended December 31, 2001, appearing on pages 20 and 21, is fairly presented, in all material respects, in relation to the consolidated financial statements from which it has been derived. As discussed in note 1(c) to the consolidated financial statements, GAINSCO, INC. and subsidiaries changed its method of accounting for residual interests in securitizations in 2001 as a result of the adoption of EITF 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. KPMG LLP Dallas, Texas March 18, 2002 44 GAINSCO, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2001 and 2000
Assets 2001 2000 ------ -------------- ----------- Investments (note 2): Fixed maturities: Bonds available for sale, at fair value (amortized cost: $127,369,239 - 2001, $187,985,651 - 2000) $ 132,794,306 192,342,374 Certificates of deposit, at cost (which approximates fair value) 645,000 845,000 Common stock, at fair value (cost: $6,027,392 - 2000) - 7,716,250 Other investments, at fair value (cost: $2,110,467 - 2001, $4,580,690 - 2000) 2,111,712 4,441,240 Short-term investments, at cost (which approximates fair value) 45,126,581 40,839,852 ------------ ----------- Total investments 180,677,599 246,184,716 Cash 3,567,717 3,111,311 Accrued investment income 2,078,582 3,539,804 Premiums receivable (net of allowance for doubtful accounts: $200,000 - 2001 and 2000) 21,241,819 25,471,377 Reinsurance balances receivable (net of allowance for doubtful accounts: $2,653,597 - 2001, $0 - 2000) (note 5) 62,303,215 54,494,967 Ceded unpaid claims and claim adjustment expenses (notes 1 and 5) 65,570,973 37,703,034 Ceded unearned premiums (note 5) 21,822,265 45,994,658 Deferred policy acquisition costs (note 1) 3,188,226 2,301,944 Property and equipment (net of accumulated depreciation and amortization: $9,851,888 - 2001, $9,745,505 - 2000) (note 1) 6,224,872 7,944,404 Current Federal income taxes (note 1) 1,043,814 1,242,801 Deferred Federal income taxes (net of valuation allowance: $31,534,712 - 2001, $0 - 2000) (notes 1 and 6) - 15,671,326 Management contract 1,537,571 1,587,571 Other assets 6,492,486 6,997,501 Goodwill (note 1) 3,468,507 22,797,358 ------------ ----------- Total assets $ 379,217,646 475,042,772 ============ ===========
See accompanying notes to consolidated financial statements. 45 GAINSCO, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2001 and 2000
Liabilities and Shareholders' Equity 2001 2000 ------------------------------------ ----------- ----------- Liabilities: Unpaid claims and claim adjustment expenses $ 181,058,706 164,159,519 Unearned premiums (notes 1 and 5) 47,973,720 72,578,157 Commissions payable 6,498,442 2,077,771 Accounts payable 8,573,166 10,899,280 Reinsurance balances payable (note 5) 7,774,187 27,154,389 Deferred revenue 9,066,824 1,632,174 Drafts payable 7,017,595 8,862,849 Note payable (note 4) 10,800,000 16,000,000 Funds held under reinsurance agreements (note 5) 47,783,905 47,850,000 Other liabilities 124,828 724,354 ----------- ----------- Total liabilities 326,671,373 351,938,493 ----------- ----------- Convertible redeemable preferred stock - Series A ($1,000 stated value, 31,620 shares authorized, 31,620 issued at December 31, 2001 and none issued at December 31, 2000) (note 7) 18,722,000 - Convertible redeemable preferred stock - Series B ($1,000 stated value, 3,000 shares authorized, 3,000 issued at December 31, 2001 and none issued at December 31, 2000) (note 7) 3,077,672 - Redeemable preferred stock - Series C ($1,000 stated value, 3,000 shares authorized, 3,000 issued at December 31, 2001 and none issued at December 31, 2000) (note 7) 3,230,672 - ----------- ----------- 25,030,344 - ----------- ----------- Shareholders' Equity (notes 7 and 8): Preferred stock ($100 par value, 10,000,000 shares authorized, none issued at December 31, 2001 and 31,620 issued at December 31, 2000) - 3,162,000 Common stock ($.10 par value, 250,000,000 shares authorized, 22,013,830 issued at December 31, 2001 and December 31, 2000) 2,201,383 2,201,383 Common stock warrants 540,000 2,040,000 Additional paid-in capital 100,866,124 113,540,252 Accumulated other comprehensive income (notes 2 and 3) 3,580,690 3,897,371 Retained earnings (deficit) (71,977,743) 5,957,798 Treasury stock, at cost (844,094 shares at December 31, 2001 and December 31, 2000) (note 1) (7,694,525) (7,694,525) ------------ ----------- Total shareholders' equity 27,515,929 123,104,279 ------------ ----------- Commitments and contingencies (notes 5, 8, 9, 11 and 12) Total liabilities and shareholders' equity $ 379,217,646 475,042,772 ============ ===========
See accompanying notes to consolidated financial statements. 46 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------ ------------- ------------ Revenues: Net premiums earned (note 5) $ 68,727,021 151,455,505 113,280,292 Net investment income (note 2) 8,090,798 14,092,914 9,722,213 Net realized gains (losses) (note 1) 4,275,192 (1,906,911) 605,606 Insurance services 326,694 1,054,137 1,848,590 ------------ ------------- ------------ Total revenues 81,419,705 164,695,645 125,456,701 ------------ ------------- ------------ Expenses: Claims and claims adjustment expenses (notes 1 and 5) 87,425,982 143,439,078 76,349,044 Commissions 15,305,110 20,687,486 27,895,646 Change in deferred policy acquisition costs and deferred ceding commission income (note 1) (886,282) 12,638,482 (3,607,531) Interest expense 842,368 1,409,378 1,265,529 Amortization of goodwill 881,965 963,700 688,645 Underwriting and operating expenses 18,485,524 16,506,906 14,524,068 Goodwill impairment 18,446,886 - - ------------ ------------- ------------ Total expenses 140,501,553 195,645,030 117,115,401 ------------ ------------- ------------ Income (loss) before Federal income taxes and cumulative effect of change in accounting principle (59,081,848) (30,949,385) 8,341,300 Federal income taxes (note 6): Current expense (benefit) (51,014) (1,110,714) 1,113,399 Deferred expense (benefit) 16,086,659 (10,287,306) 100,764 ------------- ------------- ------------ Total taxes 16,035,645 (11,398,020) 1,214,163 ------------- ------------- ------------ Income (loss) before cumulative effect of change in accounting principle (75,117,493) (19,551,365) 7,127,137 ============= ============= ============ Cumulative effect of change in accounting principle, net of tax (note 1) (489,554) - - ------------- ------------- ------------ Net income (loss) $ (75,607,047) (19,551,365) 7,127,137 ------------- ------------- ------------ Earnings (loss) per common share, basic (notes 1 and 7): Earnings (loss) before cumulative effect of change in accounting principle, per common share $ (3.66) (.97) .34 Cumulative effect of change in accounting principle, net of tax, per common share (.02) - - --- --- --- Net income (loss) per common share, basic $ (3.68) (.97) .34 ==== === ===
(continued) 47 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------- ------------- ------------ Earnings (loss) per common share, diluted (notes 1 and 7): Earnings (loss) before cumulative effect of change in accounting principle, per common share $ (3.66) (.97) .32 ---- Cumulative effect of change in accounting principle, net of tax, per common share (.02) - - --- --- ---- Net income (loss) per common share, diluted $ (3.68) (.97) .32 ==== === ====
See accompanying notes to consolidated financial statement 48 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity and Comprehensive Income Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------ ------------ ----------- Preferred stock: Balance at beginning of year $ 3,162,000 3,162,000 - Issuance of shares (31,620 - 1999) - - 3,162,000 Conversion of shares to redeemable preferred stock (31,620 - 2001) (3,162,000) - - ------------ ------------ ----------- Balance at end of year - 3,162,000 3,162,000 ------------ ------------ ----------- Common stock: Balance at beginning of year 2,201,383 2,176,393 2,174,066 Exercise of options to purchase shares (249,903 - 2000, 23,270 - 1999) - 24,990 2,327 ------------ ------------ ----------- Balance at end of year 2,201,383 2,201,383 2,176,393 ------------ ------------ ----------- Common stock warrants: Balance at beginning of year 2,040,000 2,040,000 - Repricing of Series A and Series B warrants (1,680,000) - - Issuance of warrants in connection with preferred stock 180,000 - 2,040,000 ------------ ------------ ----------- Balance at end of year 540,000 2,040,000 2,040,000 ------------ ------------ ----------- Additional paid-in capital: Balance at beginning of year 113,540,252 112,674,842 87,778,548 Exercise of options to purchase shares (249,903 - 2000, 23,270 - 1999) - 519,246 47,551 Issuance of preferred shares (31,620 - 1999) - - 24,762,929 Conversion of shares to redeemable preferred stock (31,620 - 2001) (12,761,278) - - Accretion of discount on preferred shares 87,150 346,164 85,814 ------------ ------------ ----------- Balance at end of year $ 100,866,124 113,540,252 112,674,842 ------------ ------------ -----------
(continued) 49 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity and Comprehensive Income Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------------------- -------------------------- ------------------------ Retained earnings (deficit): Balance at beginning of year $ 5,957,798 27,586,440 22,086,868 Net income (loss) for year (75,607,047) (75,607,047) (19,551,365) (19,551,365) 7,127,137 7,127,137 Cash dividend - common (note 7) - (1,474,206) (1,463,227) Cash dividend - preferred (note 7) - (434,000) (108,500) Accrued dividends - redeemable preferred stock (note 7) (461,344) - - Accretion of discount on preferred shares (87,150) (346,164) (85,814) Accretion of discount on redeemable preferred shares (1,780,000) - - Tax benefit on non-qualified stock options exercised - 177,093 29,976 ----------- ----------- ---------- Balance at end of year (71,977,743) 5,957,798 27,586,440 ----------- ----------- ---------- Accumulated other comprehensive income (loss): Balance at beginning of year 3,897,371 (2,246,575) 1,138,941 Unrealized gains (losses) on securities, net of reclassification adjustment, net of tax (note 3) (316,681) (316,681) 6,143,946 6,143,946 (3,385,516) (3,385,516) ----------- ---------- ----------- --------- ----------- --------- Comprehensive income (loss) (75,923,728) (13,407,419) 3,741,621 ========== ==========- ========= Balance at end of year 3,580,690 3,897,371 (2,246,575) ----------- ----------- ---------- Treasury stock: Balance at beginning and at end of year (7,694,525) (7,694,525) (7,694,525) ----------- ----------- ---------- Total shareholders' equity at end of year $ 27,515,929 123,104,279 137,698,575 =========== ============ ===========
See accompanying notes to consolidated financial statements. 50 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------ -------------- ------------- Cash flows from operating activities: Net income (loss) $ (75,607,047) (19,551,365) 7,127,137 Adjustments to reconcile net income (loss) to cash provided by (used for) operating activities: Depreciation and amortization 1,848,981 2,734,855 4,312,400 Goodwill impairment 18,446,886 - - Impairment of other investments 2,176,231 - - Cumulative effect of change in accounting principle 489,554 - - Change in deferred Federal income taxes 16,086,659 (10,287,306) 100,764 Change in accrued investment income 1,372,346 307,007 426,944 Change in premiums receivable 3,518,337 558,442 (10,546,651) Change in reinsurance balances receivable (7,808,248) (50,365,554) (862,354) Change in ceded unpaid claims and claim adjustment expenses (27,867,939) 21,819 (2,269,326) Change in ceded unearned premiums 24,172,393 (22,846,077) (760,982) Change in deferred policy acquisition costs and deferred ceding commission income (886,282) 12,638,482 (3,607,531) Change in other assets 432,256 (734,871) (2,795,813) Change in unpaid claims and claim adjustment expenses 16,899,187 29,836,469 (3,984,566) Change in unearned premiums (24,604,437) (9,786,141) 18,618,108 Change in commissions payable 4,436,611 355,072 (2,649,644) Change in accounts payable (664,171) 1,158,081 1,886,907 Change in reinsurance balances payable (19,380,202) 19,254,839 6,571,553 Change in deferred revenue 7,434,650 404,311 (707,427) Change in drafts payable (1,845,254) 4,656,535 (1,628,532) Change in funds held under reinsurance agreements (66,095) 47,850,000 - Change in other liabilities (120,555) (33,446) (372,535) Change in current Federal income taxes 151,485 (1,521,613) 4,917,298 ------------- ------------ ------------ Net cash provided by (used for) operating activities $ (61,384,654) 4,649,539 13,775,750 ------------- ------------ ------------
(continued) 51 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------ -------------- ------------- Cash flows from investing activities: Bonds held to maturity: Matured $ - - 17,833,400 Bonds available for sale: Sold 61,152,815 80,469,659 32,934,481 Matured 19,294,852 32,030,354 11,177,942 Purchased (20,531,623) (98,744,876) (61,910,875) Common stock purchased - (6,027,392) - Common stock sold 6,027,392 - - Other investments purchased - (3,959,136) (973,169) Other investments sold 382,868 690,016 3,148 Certificates of deposit matured 660,000 740,000 510,000 Certificates of deposit purchased (460,000) (545,000) (370,000) Net change in short-term investments (4,795,577) 5,792,476 (41,728,589) Property and equipment disposed (purchased) 622,347 (1,341,872) (568,270) Net assets acquired through purchase of subsidiary (net of cash acquired of $662,422 - 2000) - (8,488,225) (2,012,500) Net assets disposed of through sale of subsidiary (net of cash acquired of $847,617 - 2001) (198,765) - - ---------- ---------- ---------- Net cash provided by (used for) investing activities 62,154,309 616,004 (45,104,432) ---------- ---------- ---------- Cash flows from financing activities: Payments on note payable (5,200,000) (2,000,000) - Cash dividends paid (478,971) (1,903,832) (1,462,820) Preferred stock and warrants issued (net of transaction fees) - - 29,964,929 Redeemable preferred stock and warrants issued (net of transaction fees) 5,365,722 - - Proceeds from exercise of common stock options - 544,236 49,878 ---------- ---------- ---------- Net cash provided by (used for) financing activities (313,249) (3,359,596) 28,551,987 ---------- ---------- ---------- Net increase (decrease) in cash 456,406 1,905,947 (2,776,695) Cash at beginning of year 3,111,311 1,205,364 3,982,059 ---------- ---------- ---------- Cash at end of year $ 3,567,717 3,111,311 1,205,364 ========== ========== ==========
See accompanying notes to consolidated financial statements. 52 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (1) SUMMARY OF ACCOUNTING POLICIES (a) Basis of Consolidation The accompanying consolidated financial statements include the accounts of GAINSCO, INC. ("GNA") and its wholly-owned subsidiaries (collectively, the "Company"), General Agents Insurance Company of America, Inc. ("General Agents"), General Agents Premium Finance Company, Agents Processing Systems, Inc., Risk Retention Administrators, Inc., GAINSCO Service Corp. ("GSC"), Lalande Financial Group, Inc. ("Lalande"), National Specialty Lines, Inc. ("NSL"), DLT Insurance Adjusters, Inc. ("DLT") (Lalande, NSL and DLT collectively, the "Lalande Group") and Midwest Casualty Insurance Company ("MCIC"). General Agents has one wholly owned subsidiary, MGA Insurance Company, Inc. ("MGAI") which, in turn, owns 100% of MGA Agency, Inc. GSC has one wholly owned subsidiary, MGA Premium Finance Company. GSC controls the management contract and charter of GAINSCO County Mutual Insurance Company ("GCM") and its accounts have been included in the accompanying consolidated financial statements. All significant intercompany accounts have been eliminated in consolidation. The accompanying consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (b) Nature of Operations On February 7, 2002, the Company announced its decision to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. During 2001 the Company was predominately a property and casualty insurance company concentrating its efforts on nonstandard markets within the commercial, personal and specialty insurance lines. Beginning in 2002 the Company is predominantly a property and casualty insurance company concentrating its efforts on nonstandard personal automobile markets. During 2001 the Company was approved to write insurance in 48 states and the District of Columbia on a non-admitted basis and in 44 states and the District of Columbia on an admitted basis. The Company previously marketed its commercial lines of insurance through 200 non-affiliated general agency offices and currently markets its nonstandard personal auto line through approximately 565 non-affiliated retail agencies. Approximately 75% of the Company's gross premiums written during 2001 resulted from risks located in California, Florida, Pennsylvania and Texas. (c) Investments Bonds available for sale, common stock and other investments are stated at fair value with changes in fair value recorded as a component of comprehensive income. Short-term investments are stated at cost. 53 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 The following schedule summarizes the components of other investments:
As of December 31 ------------------------------------------------------- 2001 2000 ------------------------ --------------------------- Fair value Cost Fair Value Cost ------------ --------- --------- --------- Equity investments $ 1,058,613 1,058,613 2,117,226 2,117,226 Marketable securities 24,358 23,113 266,530 405,980 Note receivable 1,028,741 1,028,741 2,057,484 2,057,484 ------------ --------- --------- --------- Total other investments $ 2,111,712 2,110,467 4,441,240 4,580,690 ============ ========== ========= =========
The equity investments were predominately private equity investments that are not traded in public markets and cost was considered to approximate fair value. Cost was considered to approximate fair value for the equity investments and the note receivable because they were carried at the amount recoverable from GMSP under the put. The Company holds an embedded derivative financial instrument in common stock warrants attached to the note receivable. As of December 31, 2001 and 2000, the exercise price of the warrants was not determinable and, therefore, the warrants were not recorded in these financial statements. The agreement with GMSP, disclosed in note (8), provided an opportunity to convert the equity investments and the note receivable with a cost of $4.2 million to cash as of November 2002, as follows: the Company could at its option require GMSP to purchase these investments for $2.1 million, less any future cash received prior to November 2002 from the investments. GMSP could at its option require the Company to sell the equity investments and the note receivable to GMSP for $4.2 million, less any future cash received prior to November 2002 from the investments. During the second quarter of 2001, the Company recognized a permanent impairment of these investments and wrote down the carrying value to the amount recoverable from GMSP under the put. This write down amounted to $2,176,231 and was recorded as a realized capital loss in the Statement of Operations. In February 2002, GMSP consented to the early exercise of the Company's option, and the Company exercised its option to require GMSP purchase the illiquid investments for approximately $2.1 million. The "specific identification" method is used to determine costs of investments sold. Provisions for possible losses are recorded only when the values have experienced impairment considered "other than temporary" by a charge to realized losses resulting in a new cost basis of the investment. In November 2000, the Emerging Issues Task Force of the Financial Accounting Standards Board ("EITF") issued EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets", which reached a consensus on impairment accounting for retained beneficial interests. Under EITF 99-20, impairment on certain beneficial interests in securitized assets must be recognized when the asset's fair value is below its carrying value and it is probable that there has been an adverse change in estimated cash flows. Previously, impairment on such assets was recognized when the asset's carrying value exceeded estimated cash flows discounted at a risk free rate of return. At March 31, 2001, prior to adoption of EITF 99-20, the Company had recognized a temporary impairment on a fixed maturity by recording a net unrealized loss of $489,554, net of deferred income taxes of $252,195, in accumulated other comprehensive income. The Company adopted 54 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 EITF 99-20 effective April 1, 2001, which resulted in reclassifying this impairment as other than temporary and recording a charge to earnings reported as a cumulative effect of change in accounting principle in its Consolidated Statement of Operations. Realized gains and losses on investments for the years ended December 31, 2001, 2000 and 1999 are presented in the following table:
Years ended December 31 ----------------------------------- 2001 2000 1999 ------- --------- --------- Realized gains: Bonds $ 3,576,530 17,554 684,029 Common stock 2,730,923 - - Sale of subsidiary 281,667 - - Other investments 20,265 33,602 - --------- -------- ------- Total realized gains 6,609,385 51,156 684,029 --------- -------- ------- Realized losses: Bonds 17,456 1,958,067 78,423 Other investments 140,506 - - Impairment of other investments 2,176,231 - - --------- -------- ------- Total realized losses 2,334,193 1,958,067 78,423 --------- -------- ------- Net realized gains (losses) $ 4,275,192 (1,906,911) 605,606 ========= ========= =======
During 2001, approximately $61.2 million in bond securities were sold for a pre-tax gain of $3,576,530 in order to generate realized capital gains and offset the Company's realized capital loss carryforward for Federal income tax purposes. During 2000, approximately $80.5 million in bond securities were sold for a pre-tax loss of $1,906,911 and a large portion of the proceeds were reinvested in bond securities with an average taxable equivalent yield of more than 150 basis points over the bond securities that were sold. Proceeds from the sale of bond securities totaled $61,152,815, $80,469,659 and $32,934,481 in 2001, 2000 and 1999, respectively. Proceeds from the sale of common stocks totaled $6,027,392 in 2001. There were no sales of common stocks in 2000 or 1999. Proceeds from the sale of other investments totaled $382,868, $690,016 and $3,148 in 2001, 2000 and 1999, respectively. (d) Financial Instruments For premiums receivable, which include premium finance notes receivable, and all other accounts (except investments) defined as financial instruments in Statement of Financial Accounting Standards No.107, "Disclosures About Fair Values of Financial Instruments," the carrying amount approximates fair value due to the short-term nature of these instruments. The carrying amount of notes payable approximates fair value due to the variable interest rate on the note. These balances are disclosed on the face of the balance sheets. Fair values for investments, disclosed in note 2, were obtained from independent brokers and published valuation guides. 55 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (e) Deferred Policy Acquisition Costs and Deferred Ceding Commission Income Policy acquisition costs, principally commissions, premium taxes and certain marketing and underwriting expenses, are deferred and charged to operations over periods in which the related premiums are earned. Ceding commission income, which is realized on a written basis, is deferred and recognized over periods in which the related premiums are earned. Deferred ceding commission income is netted against deferred policy acquisition costs. The change in the resulting deferred asset is charged (credited) to operations. The Company recorded impairments on its deferred policy acquisition costs at December 31, 2001 of $2,487,009 related to the property and commercial auto lines of business and at December 31, 2000 of $501,930 related to the property and nonstandard personal auto lines of business. The marketing expenses are predominately salaries, salary related expenses and travel expenses of the Company's marketing representatives who actively solicit business from the independent general agents. The Company utilizes investment income when assessing recoverability of deferred policy acquisition costs. Information relating to these net deferred amounts, as of and for the years ended December 31, 2001, 2000 and 1999 is summarized as follows:
2001 2000 1999 --------- ----------- ----------- Asset balance, beginning of period $ 2,301,944 14,927,673 11,320,142 --------- ----------- ----------- Asset balance acquired through purchase of subsidiary - 12,753 - Deferred commissions 22,961,339 34,050,455 27,149,110 Deferred premium taxes, boards & bureaus and fees 2,410,409 2,792,869 3,129,942 Deferred marketing and underwriting expenses 2,346,330 2,968,031 3,078,115 Deferred ceding commission income (4,274,975) (12,623,698) (212,127) Amortization (20,069,812) (39,324,209) (29,537,509) Impairment (2,487,009) (501,930) - --------- ----------- ----------- Net change 886,282 (12,625,729) 3,607,531 --------- ----------- ----------- Asset balance, end of period $ 3,188,226 2,301,944 14,927,673 ========= =========== ===========
The decrease in deferred commissions in 2001 is primarily attributable to the decrease in premium writings in 2001. The decrease in deferred ceding commission income in 2001 is primarily related to the decrease in the quota share cession percentages and the decrease in writings in 2001. The increase in the deferred ceding commission income in 2000 is a result of the quota share reinsurance agreement effective December 31, 2000, whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums. 56 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (f) Property and Equipment Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets (30 years for buildings and primarily 5 years for furniture and software and 3 years for equipment). The following schedule summarizes the components of property and equipment:
As of December 31 ---------------------------- 2001 2000 ---------- ---------- Land $ 865,383 865,383 Buildings 6,391,739 6,332,850 Furniture and equipment 5,219,400 5,709,400 Software 3,600,238 4,782,276 Accumulated depreciation and amortization (9,851,888) (9,745,505) ---------- ---------- $ 6,224,872 7,944,404 ========== ==========
(g) Software Costs Computer software costs relating to programs for internal use are recorded in property and equipment and are amortized using the straight-line method over five years or the estimated useful life, whichever is shorter. As the Company exits commercial lines, future write-offs of software and equipment will likely occur. (h) Goodwill Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is amortized on a straight-line basis over 25 years, which is the expected period to be benefited. The Company periodically reviews the recoverability of goodwill based on an assessment of undiscounted cash flows of future operations to ensure it is appropriately valued. The recoverability of goodwill is evaluated on a separate basis for each acquisition. On January 7, 2000, the Company completed the acquisition of Tri-State, an insurance operation specializing primarily in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. The purchase price was approximately $6,000,000 with an additional payment of $1,148,454 made in July, 2000 and additional payments up to approximately $4,350,000 in cash possible over the next several years based on a conversion goal and specific profitability targets. The Company paid $1,566,081 in January of 2001 for the conversion goal. The Company decided to no longer pursue a long-term geographic expansion strategy in personal automobile beyond that of its core operation in Florida, and sold Tri-State to Tri-State's president for $935,000 in cash on August 31, 2001. The remaining goodwill associated with the Tri-State acquisition of $5,086,283 was recorded as goodwill impairment during the second quarter of 2001. The Company recognized a capital loss for tax purposes of $5,066,423 from this sale during the second quarter of 2001. In December 2001 the Company recorded an impairment of $13,360,603 on the goodwill associated with the 1998 acquisition of the Lalande Group. The remaining goodwill of $3,468,507 reflects 57 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 estimated fair valuation levels of agencies in the personal automobile marketplace. Effective in 2002, goodwill will no longer be amortized but will be subject to an impairment test based on its estimated fair value. Therefore, additional impairment losses could be recorded in future periods. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" (Statement 141) and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (Statement 142). Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. Statement 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Company adopted the provisions of Statement 141 effective July 1, 2001 and Statement 142 effective January 1, 2002. The adoption of Statement 141 had no impact on the consolidated financial statements. The adoption of Statement 142 will result in the Company no longer amortizing the remaining goodwill. Statement 141 required, upon adoption of Statement 142, that the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Upon adoption of Statement 142, the Company is required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company is required to test the intangible asset for impairment in accordance with the provisions of Statement 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. Prior to adoption of Statement 142, the Company recorded an impairment of $13,360,603 on the goodwill associated with the 1998 acquisition of the Lalande Group. This action was taken to reflect estimated fair valuation levels of agencies in the personal automobile marketplace. As of the date of adoption, the Company had unamortized goodwill in the amount of $3,468,507 that will be subject to the transition provisions of Statements 141 and 142. Amortization expense related to goodwill was $881,965, $963,700 and $688,645 for the years ended December 31, 2001, 2000 and 1999, respectively. 58 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (i) Treasury Stock The Company records treasury stock in accordance with the "cost method" described in Accounting Principles Board Opinion (APB) 6. The Company held 844,094 shares as treasury stock at December 31, 2001 and 2000 with a cost basis of $9.12 per share. (j) Revenue Recognition Premiums are recognized as earned on a pro rata basis over the period the Company is at risk under the related policy. Unearned premiums represent the portion of premiums written which are applicable to the unexpired terms of policies in force. NSL charges policy fees to recoup the cost of processing and issuing policies. These fees are non-refundable and are recognized as earned when the policy is written. NSL's net commission revenues are recognized as earned on a pro rata basis over the policy period. (k) Claims and Claim Adjustment Expenses Claims and claim adjustment expenses, less related reinsurance, are provided for as claims are incurred. The provision for unpaid claims and claim adjustment expenses includes: (1) the accumulation of individual case estimates for claims and claim adjustment expenses reported prior to the close of the accounting period; (2) estimates for unreported claims based on past experience modified for current trends; and (3) estimates of expenses for investigating and adjusting claims based on past experience. Liabilities for unpaid claims and claim adjustment expenses are based on estimates of the ultimate cost of settlement. Changes in claim estimates resulting from the review process and differences between estimates and ultimate payments are reflected in expense for the year in which the revision of these estimates first become known. The process of establishing claim reserves is an imprecise science and reflects significant judgmental factors. In many liability cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured claim and the settlement of the claim. Some judicial decisions and legislative actions, even after coverage is written and reserves are initially set, broaden liability and policy definitions and increase the severity of claim payments. As a result of this and other societal and economic developments, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience have increased significantly, further complicating the already difficult claim reserving process. Ultimate liability may be greater or lower than current reserves. Reserves are monitored by the Company using new information on reported claims and a variety of statistical techniques. The reserves are reviewed annually by an independent actuarial firm. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. The following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company's consolidated financial statements for the periods indicated: 59 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999
As of and for the years ended December 31 ------------------------------ 2001 2000 1999 -------- ------- ------- (Amounts in thousands) Unpaid claims and claim adjustment expenses, beginning of period $ 164,160 132,814 136,798 Less: Ceded unpaid claims and claim adjustment expenses, beginning of period 37,703 37,299 35,030 -------- ------- ------- Net unpaid claims and claim adjustment expenses, beginning of period 126,457 95,515 101,768 -------- ------- ------- Net claims and claim adjustment expense incurred related to: Current period 56,920 124,077 75,976 Prior periods 30,506 19,362 373 -------- ------- ------- Total net claim and claim adjustment expenses incurred 87,426 143,439 76,349 -------- ------- ------- Net claims and claim adjustment expenses paid related to: Current period 26,776 58,898 32,651 Prior periods 71,619 54,683 49,951 -------- ------- ------- Total net claim and claim adjustment expenses paid 98,395 113,581 82,602 -------- ------- ------- Net reserves acquired through purchase of subsidiary - 1,084 - -------- ------- ------- Net unpaid claims and claim adjustment expenses, end of period 115,488 126,457 95,515 Plus: Ceded unpaid claims and claim adjustment expenses, end of period 65,571 37,703 37,299 -------- ------- ------- Unpaid claims and claim adjustment expenses, end of period $ 181,059 164,160 132,814 ======== ======= =======
For 2001 the development in claims and claim adjustment expense incurred was primarily the result of unanticipated development of commercial auto and commercial general liability claims for the 2000, 1999 and 1998 accident years. For 2000 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development of commercial auto claims for the 1999, 1997 and 1996 accident years. At December 31, 2001 the Company believes that the carried reserves and the reinsurance agreements currently in force are sufficient to support the future emergence of prior year claim and claim adjustment expenses. (l) Income Taxes The Company and its subsidiaries file a consolidated Federal income tax return. Deferred income tax items are accounted for under the "asset and liability" method which provides for temporary differences between the reporting of earnings for financial statement purposes and for tax purposes, primarily deferred policy acquisition costs, the discount on unpaid claims and claim adjustment expenses, net operating loss carry forwards and the nondeductible portion of the change in unearned premiums. The Company paid income taxes of $0, $280,000 and $1,340,161 during 2001, 2000 and 1999, respectively. The Company received Federal income tax refunds totaling $250,000, $251,644 and $5,144,060 during 2001, 2000 and 1999, respectively. 60 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (m) Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share:
Years ended December 31 -------------------------------------------- 2001 2000 1999 ------------- ------------- ----------- Basic earnings (loss) per share: ------------------------------- Numerator: Net income (loss) $ (75,607,047) (19,551,365) 7,127,137 Less: Preferred stock dividends 461,344 434,000 108,500 Less: Accretion of discount on preferred stock 1,867,150 346,164 - ------------- ------------- ----------- Net income (loss) available to common shareholders $ (77,935,541) (20,331,529) 7,018,637 ------------- ------------- ----------- Denominator: Weighted average shares outstanding 21,169,736 21,027,699 20,903,723 ------------- ------------- ----------- Basic earnings (loss) per share $ (3.68) (.97) .34 ==== === === Diluted earnings (loss) per share: --------------------------------- Numerator: Net income (loss) $ (75,607,047) (19,551,365) 7,127,137 ------------- ------------- ----------- Denominator: Weighted average shares outstanding 21,169,736 21,027,699 20,903,723 Effect of dilutive securities: Employee stock options - - 157,536 Convertible preferred stock 1,430,769 6,200,000 1,430,769 ------------- ------------- ----------- Weighted average shares and assumed conversions 22,600,505 27,227,699 22,492,028 ------------- ------------- ----------- Diluted earnings (loss) per share (1) $ (3.68) (.97) .32 ==== ==== ===
(1) The effects of common stock equivalents and convertible preferred stock are antidilutive for the 2001 and 2000 periods; therefore, diluted earnings (loss) per share is reported the same as basic earnings (loss) per share. (n) Stock-Based Compensation In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"). Statement 123 defines a fair value based method of accounting for an employee stock option or similar equity instrument. Under Statement 123, the Company elects to measure compensation costs using the intrinsic value based method of accounting prescribed by APB 25 "Accounting for Stock Issued to Employees". (o) Accounting Pronouncements Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities"("Statement 133"), as amended. Statement 133 establishes accounting and reporting standards for derivative instruments and requires that an entity recognize all derivatives as either assets or liabilities in the financial statements and measure those instruments at fair value with changes in fair value recorded through the income statement. The adoption of Statement 133 had no impact on the consolidated financial statements. In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" (Statement 144), establishing financial accounting and reporting for the impairment or disposal of long-lived assets. Statement 144 is effective for fiscal years beginning after December 15, 2001. Pursuant to Statement 144 the discontinuance of commercial lines will not be reported as discontinued operations. The Company believes that the adoption of Statement 144 will have no other effect on the Company's financial position or results of operation. 61 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (2) INVESTMENTS The following schedule summarizes the components of net investment income:
Years ended December 31 -------------------------------------------- 2001 2000 1999 ----------- ------------ ------------- Investment income on: Fixed maturities $ 11,022,596 12,137,120 9,086,506 Common stocks 378,980 602,300 - Other investments 1,418 109,307 - Short-term investments 1,288,027 2,266,657 1,019,238 ----------- ------------ ------------- 12,691,021 15,115,384 10,105,744 Investment expenses (4,600,223) (1,022,470) (383,531) ----------- ------------ ------------- Net investment income $ 8,090,798 14,092,914 9,722,213 =========== ============ =============
The increase in investment expenses was primarily due to the interest charge required under the reserve reinsurance cover agreement the Company entered into effective December 31, 2000. The Company is required to maintain a funds held liability and to increase this liability at an annual interest rate of 7.5%. 62 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 The following schedule summarizes the amortized cost and estimated fair values of investments in debt securities:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- --------- --------- --------- (Amounts in thousands) Fixed maturities: Bonds available for sale: U.S. Government securities - 2001 $ 16,730 470 (33) 17,167 U.S. Government securities - 2000 21,138 205 (26) 21,317 Tax-exempt state & municipal bonds - 2001 8,912 227 - 9,139 Tax-exempt state & municipal bonds - 2000 45,284 330 (142) 45,472 Corporate bonds - 2001 101,727 5,632 (871) 106,488 Corporate bonds - 2000 121,564 4,857 (868) 125,553 Certificates of deposit - 2001 645 - - 645 Certificates of deposit - 2000 845 - - 845 Total Fixed maturities - 2001 128,014 6,329 (904) 133,439 Total Fixed maturities - 2000 $188,831 5,392 (1,036) 193,187
The amortized cost and estimated fair value of debt securities at December 31, 2001 and 2000, by maturity, are shown below.
2001 2000 ------------------------- ------------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value ----------- --------- ----------- ---------- (Amounts in thousands) Due in one year or less $ 15,463 15,045 22,203 22,274 Due after one year but within five years 68,984 72,670 102,822 103,944 Due after five years but within ten years 42,135 44,156 59,531 62,601 Due after ten years but within twenty years 1,432 1,568 4,275 4,368 Due beyond twenty years - - - - ------- ------- ------- ------- $ 128,014 133,439 188,831 193,187 ======= ======= ======= =======
Investments of $15,398,298 and $16,507,427, at December 31, 2001 and 2000, respectively, were on deposit with various regulatory bodies as required by law. 63 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (3) ACCUMULATED OTHER COMPREHENSIVE INCOME The following schedule presents the components of other comprehensive income:
Years ended December 31 ------------------------------------------- 2001 2000 1999 --------- --------- --------- Unrealized gains (losses) on securities: Unrealized holding gains (losses) during period $ 5,689,937 7,455,491 (4,613,296) Less: Reclassification adjustment for amounts included in net income for realized gains (losses) 6,169,756 (1,906,911) 605,606 --------- --------- ---------- Other comprehensive income (loss) before Federal income taxes (479,819) 9,362,402 (5,218,902) Federal income tax expense (benefit) (163,138) 3,218,456 (1,833,386) --------- --------- ---------- Other comprehensive income (loss) $ (316,681) 6,143,946 (3,385,516) --------- --------- ----------
The 2001 reclassification adjustment for amounts included in net income for realized gains (losses) excludes the realized gain on the sale of subsidiary and the realized loss due to the impairment of other investments because these amounts were not a component of accumulated other comprehensive income as of December 31, 2000. (4) NOTE PAYABLE In November 1998, the Company entered into a credit agreement with a commercial bank pursuant to which it borrowed $18,000,000. Interest was due monthly at an interest rate that approximated the 30-day London Interbank Offered Rate (LIBOR) plus 175 basis points. Principal payments of $500,000 were due each quarter with the balance of $10,500,000 due at maturity of the note on October 1, 2003. In March 2001, the credit agreement was amended, specific breaches of covenants were waived, $2,500,000 in principal was prepaid and certain terms were amended. Interest was due monthly at an interest rate that approximates the 30-day LIBOR plus 250 basis points with an increase of 25 basis points each quarter beginning October 1, 2001 (4.89375% at December 31, 2001). Principal payments of $500,000 were due each quarter and were scheduled to increase to $750,000 beginning April 1, 2002, with the balance of $6,500,000 due at maturity of the note on November 1, 2003. On November 13, 2001, the credit agreement was further amended to change certain covenants and to provide the following revised principal amortization schedule: $200,000 upon effectiveness of the amendment on November 13, 2001, $500,000 on January 2, 2002; and $1,000,000 on the first day of each calendar quarter thereafter. The loan is scheduled to mature on November 1, 2003. A $50,000 fee was paid to the bank for this amendment. On February 27, 2002 the Company entered into an amendment to the credit agreement which cured covenant breaches and provided for principal prepayments. The Company prepaid $6,100,000 of the indebtedness outstanding under the credit agreement on March 4, 2002. Several covenants in the 64 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 existing credit agreement were eliminated or modified by the amendment and the interest rate was changed to a base rate (which approximates prime) plus 175 basis points. The remaining $4,200,000 principal balance under the credit agreement is payable in 2003. The Company recorded interest expense of $842,368, $1,409,378 and $1,265,529 during 2001, 2000 and 1999, respectively. The Company paid interest of $920,227, $1,286,438 and $1,367,292 during 2001, 2000 and 1999, respectively. The Company made unscheduled principal prepayments of $2,500,000, $500,000 and $200,000 in the first, third and fourth quarters of 2001, respectively, and scheduled principal payments of $500,000 in January, April, July and October of 2001 and in January 2002. (5) REINSURANCE On February 7, 2002, the Company announced its decision to cease writing commercial lines insurance due to continued adverse claims development and unprofitable underwriting results. Commercial lines insurance also includes specialty lines. CEDED Commercial Lines Prior to 1999 and beginning in 2001, the Company wrote commercial casualty policy limits of $1,000,000. For policies with an effective date occurring from 1995 through 1998, and policies with an effective date occurring during 2001 or 2002, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 limits, resulting in a maximum net claim retention per risk of $500,000 for such policies. During 1999 and 2000, the Company wrote commercial casualty policy limits of $5,000,000. For policies with an effective date occurring in 1999 or 2000, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to $1,000,000 and second excess casualty reinsurance for 100% of casualty claims exceeding $1,000,000 up to the $5,000,000 limits, resulting in a maximum net claim retention per risk of $500,000. The Company uses facultative reinsurance for policy limits written in excess of the limits reinsured under the excess casualty reinsurance agreements. Effective December 31, 2000 the Company entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 through December 31, 2001, the Company entered into a quota share reinsurance agreement whereby the Company ceded 21.03% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $57,150,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. At December 31, 2001 a deferred reinsurance gain of $7,937,531 has been recorded in deferred revenues and $1,112,469 has been recorded in other income which represents the reserve development under the reserve reinsurance cover agreement since its inception at December 31, 2000. The deferred gain item will be recognized in income in future periods based upon the ratio of claims paid in the $57,150,000 layer to the total of the layer. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2001 and December 31, 2000. Also in connection 65 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 with this agreement, the Company is required to maintain assets in a trust fund with a fair value at least equal to the funds held liability. The trust fund was established during the third quarter of 2001 and at December 31, 2001 the assets in the trust had a fair value of $49,553,698. Because the Company's statutory policyholders' surplus fell below certain levels specified in the agreement, the reinsurer has the option to direct the trustee to transfer the assets of the trust to the reinsurer. If the reinsurer were to exercise its option, based upon December 31, 2001 balances, investments and funds held under reinsurance agreements would each be reduced by approximately $47,800,000. The reinsurer would continue to be responsible for reimbursing the Company for claim payments covered under this agreement. Prior to 2002, the Company also had excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of each accident. Beginning in 2002, the Company has excess casualty clash reinsurance for 35% of $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of each accident. Specialty Lines For its lawyers professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $500,000. For its real estate agents professional liability coverages with policy effective dates prior to August 1, 2001, the Company has quota share reinsurance for 25% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $750,000. For policies with an effective date occurring on August 1, 2001 through April 15, 2002, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. For its educators professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 60% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $400,000. For its directors and officers liability coverages with policy effective dates occurring prior to 2001, the Company has quota share reinsurance for 90% of the first $5,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. For policies with an effective date occurring during 2001, the Company has quota share reinsurance for 85% of the first $5,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $750,000. For its miscellaneous professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. Personal Lines For its umbrella coverages with policy effective dates occurring during 2001 or prior, the Company has excess casualty reinsurance for 100% of umbrella claims exceeding $1,000,000 up to $10,000,000 policy limits. For policies with an effective date occurring prior to February 1, 2001, the Company has quota share reinsurance for 75% of the first $1,000,000 of umbrella claims resulting in a maximum net claim retention per risk of $250,000. For policies with an effective date occurring February 1, 2001 through December 31, 2001, the Company has quota share reinsurance for 77.5% of the first $1,000,000 of umbrella claims resulting in a maximum net claim retention per risk of $225,000. 66 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 Prior to 2002, for its personal auto coverages, the Company has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of each accident. Beginning in 2002, the Company has excess casualty clash reinsurance for 35% of $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of each accident. The Company's personal auto business is produced by NSL and, prior to August 1, 2001, by Tri-State or written on a direct basis through MCIC. For business produced by NSL with an effective date of April 1, 2000 through December 31, 2000, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 20% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $20,000. For business produced by NSL with an effective date of January 1, 2001 through December 31, 2001, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500. Effective December 31, 2001, the Company's personal lines excess of loss and quota share reinsurance treaties expired and were not replaced. Under the terms of these treaties, the reinsurer remains liable for claims with regard to policies in force at the date of expiration. Beginning in 2002 the Company no longer writes nonstandard personal auto limits in excess of $25,000. For business produced by Tri-State or written on a direct basis with MCIC with an effective date prior to August 1, 2001, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500 and therefore has no need for excess of loss reinsurance. For 2001, the Company carried catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims that exceed $1,500,000 but do not exceed $13,000,000 for a single catastrophe as well as second event catastrophe property reinsurance for 100% of $1,000,000 excess of $500,000 on a second catastrophic event. Beginning in 2002, the Company carries catastrophe property reinsurance to protect it against catastrophe occurrences for property claims that exceed $500,000 but do not exceed $7,000,000. Effective August 1, 2001, MGAI and MCIC entered into a fronting arrangement with Tri-State. All business written under this fronting arrangement is ceded to a non-affiliated reinsurer rated "A+ (Superior)" by Best's. The reinsurer has fully indemnified the Company against business, credit and insurance risk. MGAI utilized a reinsurance arrangement in Florida whereby premiums were ceded to a non-affiliated authorized reinsurer and the reinsurer ceded the premiums to General Agents. This was necessary because General Agents was not an authorized reinsurer in Florida until the fourth quarter of 2000. This program is currently in run off. 67 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 GCM has entered into fronting arrangements with non-affiliated insurance companies. GCM retains no portion as the business written under these agreements is 100% ceded. Although these cessions are made to authorized reinsurers rated "A- (Excellent)" or better by Best's, the agreements require that collateral (in the form of trust agreements and/or letters of credit) be maintained to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to the risks insured under these fronting arrangements. The balances in such accounts as of December 31, 2001 and 2000 total $11,548,559 and $24,148,000, respectively. The amounts deducted in the consolidated financial statements for reinsurance ceded as of and for the years ended December 31, 2001, 2000 and 1999 respectively, are set forth in the following table.
2001 2000 1999 ---------- ---------- --------- Premiums earned $ 71,935,247 11,796,216 2,745,843 Premiums earned - Florida business $ 598,135 13,928,709 9,360,816 Premiums earned - plan servicing $ - - 977,684 Premiums earned - fronting arrangements $ 17,605,870 27,864,491 47,415,305 Claims and claim adjustment expenses $ 68,950,651 15,824,110 5,867,896 Claims and claim adjustment expenses - Florida business $ 1,075,935 13,215,687 6,998,999 Claims and claim adjustment expenses - plan servicing $ 409,339 1,094,163 3,456,779 Claims and claims adjustment expenses - fronting arrangements $ 11,645,471 20,315,134 35,075,008
Premiums and claims ceded to the commercial automobile plans of Arkansas, California, Louisiana, Mississippi and Pennsylvania are designated as "plan servicing". 68 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 The amounts included in the Consolidated Balance Sheets for reinsurance ceded under fronting arrangements and reinsurance ceded to the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania were as follows:
2001 2000 1999 ----------- --------- ---------- Unearned premiums - Florida business $ - 617,477 7,817,052 Unearned premiums - plan servicing $ - - - Unearned premiums - fronting arrangements $ 6,135,014 6,642,887 14,263,564 Unpaid claims and claim adjustment expenses - Florida business $ 1,222,401 4,253,582 2,651,273 Unpaid claims and claim adjustment expenses - plan servicing $ 1,578,861 4,700,008 8,094,763 Unpaid claims and claim adjustment expenses fronting arrangements $ 6,411,608 9,481,175 13,575,089
The Company remains directly liable to its policyholders for all policy obligations and the reinsuring companies are obligated to the Company to the extent of the reinsured portion of the risks. Assumed The Company, from time to time, utilizes reinsurance arrangements with various non-affiliated admitted insurance companies, whereby the Company underwrites the coverage and assumes the policies 100% from the companies. These arrangements require that the Company maintain escrow accounts to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to risks insured through such arrangements and assumed by the Company. As of December 31, 2001, 2000 and 1999, the balance in such escrow accounts totaled $9,578,691, $15,059,497 and $13,200,000, respectively. For 2001, 2000 and 1999 the premiums earned by assumption were $3,131,323, $18,243,710 and $5,396,727, respectively. The assumed unpaid claims and claim adjustment expenses were $1,839,889 $5,142,488 and $3,148,901, respectively. 69 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (6) FEDERAL INCOME TAXES In the accompanying consolidated statements of operations, the provisions for Federal income tax as a percent of related pretax income differ from the Federal statutory income tax rate. A reconciliation of income tax expense using the Federal statutory rates to actual income tax expense follows:
2001 2000 1999 -------------- ------------- -------- Income tax expense (benefit) at 34% - 2001 and 2000, 35% - 1999 $ (20,087,828) (10,522,791) 2,919,455 Tax-exempt interest income (240,604) (988,145) (2,137,175) Dividends received deduction (76,959) (144,767) (1,620) Amortization of goodwill 299,868 327,658 241,026 Goodwill impairment 6,271,941 - - Tax loss on sale of Tri-State (1,715,943) - - Deferred tax asset valuation allowance 31,534,712 - - Other, net 50,458 (69,975) 192,477 ------------ ------------ ---------- Income tax expense (benefit) $ 16,035,645 (11,398,020) 1,214,163 ============ ============ ==========
Under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("Statement 109"), the primary objective is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. As a consequence, the portion of the tax expense, which is a result of the change in the deferred tax asset or liability, may not always be consistent with the income reported on the statement of operations. 70 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 The following table represents the tax effect of temporary differences giving rise to the net deferred tax asset established under Statement 109.
As of December 31 ------------------------- 2001 2000 ----------- ---------- Deferred tax assets: Unpaid claims and claims adjustment expenses $ 5,596,158 5,692,474 Unearned premiums 1,778,305 1,807,709 Deferred service fee income 69,708 81,654 Deferred reinsurance gain 2,698,761 - Impairments of securities 992,113 - Allowance for doubtful accounts 1,004,752 74,663 Alternative minimum tax credit 2,619,735 3,514,715 Net operating loss 19,818,063 7,710,640 Capital loss 5,772 648,350 Stock options exercised - 177,093 Other 22,044 - ------------ ---------- Total deferred tax assets 34,605,411 19,707,298 ------------ ---------- Deferred tax liabilities: Deferred policy acquisition costs and deferred ceding commission income 321,268 782,661 Unrealized gains on investments 1,844,947 2,008,760 Depreciation and amortization 584,334 1,068,177 Accrual of discount on bonds 320,150 173,290 Other - 3,084 ------------ ----------- Total deferred tax liabilities 3,070,699 4,035,972 ------------ ----------- Net deferred tax assets before valuation allowance 31,534,712 15,671,326 Valuation allowance (31,534,712) - ------------ ----------- Net deferred tax assets $ - 15,671,326 ============ ==========
In assessing the realization of its deferred tax assets, management considers whether it is more likely than not that a portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon management's consideration of expected reversal of deferred tax liabilities and projected future taxable income, management believes it is more likely than not that the Company will not realize the benefits of these deferred tax assets in the near future. As of December 31, 2001, the Company has net operating loss carry forwards for tax purposes of approximately $1,639,332, $30,985, $23,531,349 and $33,086,756 which, if not utilized, will expire in 2018, 2019, 2020 and 2021, respectively. As of December 31, 2001 the Company has capital loss carry forwards of $16,976 for tax purposes which, if not utilized, will expire in 2005. (7) SHAREHOLDERS' EQUITY GNA has 250,000,000 shares of authorized $.10 par value common stock (the "Common Stock"). Of the authorized shares 22,013,830 were issued as of December 31, 2001 and 2000, respectively, and 21,169,736 were outstanding as of December 31, 2001 and 2000, respectively. GNA also has 10,000,000 shares of preferred stock with $100 par value authorized of which none were issued and outstanding at December 31, 2001 and 31,620 shares were issued and outstanding as of December 31, 2000 71 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 On October 4, 1999 GNA sold to GMSP, for an aggregate purchase price of $31,620,000 (i) 31,620 shares of Series A Preferred Stock, which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share, (ii) the Series A Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share. As a result of the value attributable to the Common Stock purchase warrants issued with the Series A Preferred Stock, the Series A Preferred Stock was issued at a discount which is being amortized over a five year period using the effective interest method. Proceeds were allocated based upon the relative fair values of the Series A Preferred Stock, and the Series A Warrants and the Series B Warrants. The Series A Warrants and the Series B Warrants are anti-dilutive. On March 23, 2001, GNA consummated the 2001 GMSP Transaction with GMSP pursuant to which, among other things, the Company issued shares of its newly created Series C Preferred Stock to GMSP in exchange for an aggregate purchase price of $3.0 million in cash. The annual dividend rate on the Series C Preferred Stock is 10% during the first three years and 20% thereafter. Unpaid dividends are cumulative and compounded. The Series C Preferred Stock is redeemable at GNA's option after five years and at the option of the majority holders after six years at a price of $1,000 per share plus accrued and unpaid dividends. The Series C Preferred Stock is not convertible into Common Stock. The agreement with GMSP was conditioned upon the following changes in the securities currently held by GMSP. The exercise prices of the Series A Warrant and the Series B Warrant held by GMSP were amended to equal $2.25 and $2.5875 per share, respectively. Each of these warrants provides for the purchase of 1,550,000 million shares of Common Stock, subject to adjustment. Further, GNA is required to redeem the outstanding shares of its Series A Preferred Stock on January 1, 2006, subject to certain conditions at a price of $1,000 per share plus accrued and unpaid dividends. Any Series A Preferred Stock unredeemed for any reason after that date would accrue interest, payable quarterly at a rate equal to eight percent per year with any unpaid interest compounded annually. On March 23, 2001, GNA consummated the Stallings Transaction pursuant to which, among other things, GNA issued shares of its newly created Series B Preferred Stock and a warrant to purchase an aggregate of 1,050,000 shares of Common Stock at $2.25 per share in exchange for an aggregate purchase price of $3.0 million in cash. The annual dividend provisions and the redemption provisions of the Series B Preferred Stock are the same as those for the Series C Preferred Stock. The Series B Preferred Stock is convertible into Common Stock at $2.25 per share. Subject to adjustment for certain events, the Series B Preferred Stock is convertible into a maximum of 1,333,333 shares of Common Stock. The term of the warrant is five years. The transaction dated March 23, 2001 results in all preferred stock being redeemable. The discount on the preferred stock is being amortized over the period until redemption using the effective interest method. At December 31, 2001, there was $13,051,000 in unaccreted discount on the preferred stock and $461,344 in accrued dividends on the Series B and Series C Preferred Stock. In 2000 and 1999, GNA paid quarterly cash dividends of $.0175 per share on its common stock for every quarter. The Board of Directors discontinued quarterly dividends on the common stock in February 2001. 72 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 The following table presents the statutory policyholders' surplus and statutory net income (loss) as of and for the years ended December 31, 2001, 2000, and 1999:
As of and for the years ended December 31 ---------------------------------------------------------------- 2001 2000 1999 ------------------------------ ----------- ------------ As reported As adjusted ------------ ----------- Statutory policyholders' surplus: General Agents and MGAI $ 47,749,966 44,852,966 72,383,234 67,155,036 MCIC 3,078,162 3,045,162 3,149,255 -- GCM 2,000,000 2,000,000 2,000,000 2,000,000 ------------ ----------- ----------- ----------- Consolidated statutory policyholders' surplus $ 52,828,128 49,898,128 77,532,489 69,155,036 ============ =========== =========== =========== Statutory net income (loss): General Agents and MGAI $(19,975,679) (22,872,679) (13,173,203) 5,703,199 MCIC (110,898) (143,898) 144,869 -- GCM 1,265,681 1,204,921 (331,520) (186,918) ------------ ----------- ----------- ----------- Consolidated statutory net income (loss) $(18,820,896) (21,811,656) (13,359,854) 5,516,281 ============ =========== =========== ===========
The 2001 "as adjusted" consolidated statutory policyholders' surplus and consolidated statutory net loss reflects $3,000,000 in C & CAE reserve development that was recorded subsequent to the issuance of the statutory financial statements as filed with the respective state insurance departments. In addition, in the first quarter of 2002, General Agents declared and paid a $7,238,000 cash dividend to GNA and reduced the carrying value of an investment to $0 resulting in a write-down of approximately $2,010,000. These actions reduce consolidated statutory policyholders' surplus on a pro-forma basis to approximately $40,650,000. The Company's statutory capital exceeds the benchmark capital level under the Risk Based Capital formula for its insurance companies that are subject to Risk Based Capital requirements. The Company adopted the NAIC Accounting Practices and Procedures (Codification of Statutory Accounting) effective January 1, 2001, which resulted in a decrease to consolidated statutory policyholders' surplus of $1,123,936. Statutes in Texas, Oklahoma and North Dakota restrict the payment of dividends by the insurance company subsidiaries to the available surplus funds derived from their realized net profits. The maximum amount of cash dividends that each subsidiary ordinarily may declare without regulatory approval in any 12-month period is the greater of net income for the 12-month period ended the previous December 31 or ten percent (10%) of policyholders' surplus as of the previous December 31. In 2003, General Agents (the Oklahoma subsidiary) may declare dividends to GNA of up to $4,744,997 without regulatory approval. In 2002, MGAI (the Texas subsidiary) may declare dividends to General Agents of up to $1,924,751 without regulatory approval; and MCIC (the North Dakota subsidiary) may declare dividends to GNA of up to $307,816 without regulatory approval. In 1988, the Board of Directors declared, pursuant to a Rights Plan, a dividend distribution of one common share purchase right on each outstanding share of $.10 par value Common Stock. The dividend distribution was made on March 18, 1988, payable to shareholders of record on that date. In 1993, the Board of Directors amended the Rights Plan and extended the expiration date of these rights from March 18, 1998 to May 25, 2003. Each right, as amended during 1993, has an exercise price of $70. The rights are not exercisable until the Distribution Date (as defined in the Rights Plan). The Rights Plan provides, among other things, that if any person or group (other than the Company, one of its subsidiaries or an employee benefit plan of the Company or a subsidiary) acquires 20% or more of the Company's Common Stock (except pursuant to an offer for all outstanding Common Stock which the Continuing Directors (as defined in the Rights Plan) have determined to be in the best interests of the Company and its shareholders), if a 20% holder engages in certain self-dealing transactions or if a holder of 15% or more of the Company's Common Stock is declared an Adverse Person (as defined in the Rights Plan) by the Board of Directors, each holder of a right (other than 73 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 the 20% holder or the Adverse Person, whose rights would become null and void) would have the right to receive, upon exercise of the right, Common Stock having a market value of two times the exercise price of the right. The Company is able to redeem rights under certain conditions set forth in the Rights Plan. If, following a public announcement that a person has acquired 20% or more of the common stock, the Company is acquired in a merger (other than a merger which follows an offer approved by the Continuing Directors as defined in the Rights Plan) or other business combination transaction or if 50% of the assets or earning power of the Company is sold, each right (except rights which have previously become null and void as described above), will entitle its holder to purchase, at the right's then-current exercise price, shares of the acquiring Company's common stock having a market value of two times the exercise price of the right. (8) BUSINESS TRANSACTIONS On October 4, 1999 GNA sold to GMSP, for an aggregate purchase price of $31,620,000 (i) 31,620 shares of Series A Preferred Stock, which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share, (ii) the Series A Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share (the "1999 GMSP Transaction"). At closing GNA and its insurance company subsidiaries entered into Investment Management Agreements with GMSP pursuant to which GMSP manages their respective investment portfolios. Completion of the 1999 GMSP Transaction concluded the strategic alternatives review process that the Company initiated in 1998. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Operations." On March 23, 2001, the Company consummated a transaction with GMSP pursuant to which, among other things, the Company issued shares of its newly created Series C Preferred Stock to GMSP in exchange for an aggregate purchase price of $3.0 million in cash (the "2001 GMSP Transaction"). In the 2001 GMSP Transaction, the Company and GMSP changed certain terms of certain of the securities issued to GMSP pursuant to the 1999 GMSP Transaction and the Company undertook to redeem the Series A Preferred Stock in 2006, subject to certain conditions. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Operations." On March 23, 2001, the Company consummated a transaction with Robert W. Stallings pursuant to which, among other things, the Company issued shares of its newly created Series B Preferred Stock and a warrant to purchase an aggregate of 1,050,000 shares of GNA Common Stock at $2.25 per share in exchange for an aggregate purchase price of $3.0 million in cash (the "Stallings Transaction"). See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Operations." On January 7, 2000, the Company expanded its personal lines business conducted through the Lalande Group through the acquisition of Tri-State, an insurance operation specializing in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. Tri-State owned and operated a managing general agency, a motor vehicle driving records service company and an insurance subsidiary, MCIC that had policyholders' surplus of approximately $3,034,000. The purchase price consideration consisted of $6,000,000 in cash at closing plus additional cash payments of $1,200,000 and $1,600,000 paid in July 2000 and January 2001, respectively. 74 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 The pro forma unaudited results of operations for the year ending December 31, 1999, assuming the purchase of Tri-State had consummated on January 1, 1999 are presented below:
1999 ------- (Amounts in thousands, except per share data) Revenues $ 132,998 Net income (loss) $ 8,310 Basic earnings (loss) per share $ .40 Diluted earnings (loss) per share $ .37
On August 31, 2001, the Company sold all of the stock of Tri-State to Herbert A. Hill for a cash price of $935,000. The remaining goodwill associated with the Tri-State acquisition of $5,086,283 was recorded as goodwill impairment during the second quarter of 2001. Mr. Hill is the President and a former owner of Tri-State. The Company retained MCIC which had policyholders' surplus of approximately $3,078,000 at December 31, 2001. (9) BENEFIT PLANS At December 31, 2001, the Company had two plans under which options to purchase shares of GNA's common stock could be granted: the 1995 Stock Option Plan ("95 Plan") and the 1998 Long-Term Incentive Plan ("98 Plan"). The 1990 Stock Option Plan and all unexercised options thereunder expired during 2000. The 95 Plan was approved by the shareholders on May 10, 1996 and 1,071,000 shares are reserved for issuance under this plan. Options granted under the 95 Plan have a maximum ten year term and are exercisable at the rate of 20% immediately upon grant and 20% on each of the first four anniversaries of the grant date. The 98 Plan was approved by the shareholders on July 17, 1998, and the aggregate number of shares of common stock that may be issued under the 98 Plan is limited to 1,000,000. Under the 98 Plan, stock options (including incentive stock options and non-qualified stock options), stock appreciation rights and restricted stock awards may be made. In 2000 options for 531,925 shares were granted to officers, directors and employees of the Company under the 98 Plan at an average exercise price of $5.57 per share. In 1998 options for 579,710 shares were granted to Glenn W. Anderson under an employment agreement at an exercise price of $5.75 per share. The exercise price of each outstanding option equals the market price of the GNA's common stock on the date of grant. 75 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 A summary of the status of the Company's outstanding options as of December 31, 2001 and 2000, and changes during the years ended December 31, 2001 and 2000 is presented below:
2001 2000 --------------------------------- ---------------------------------- Underlying Weighted Average Underlying Weighted Average Shares Exercise Price Shares Exercise Price ---------- ---------------- -------------- ------------------ Options outstanding, beginning of period: 1,815,630 $ 6.79 1,565,147 $ 6.49 Options granted - $ - 531,925 $ 5.57 Options exercised - $ - (249,903) $ 2.18 Options forfeited (110,295) $ 6.69 (31,539) $ 7.35 ---------- ----------- Options outstanding, end of period 1,705,335 $ 6.81 1,815,630 $ 6.79 ========== =========== Options exercisable at end of period 1,350,220 1,287,601 Weighted average fair value of options granted during period N/A 2.71
The following table summarizes information for the stock options outstanding at December 31, 2001:
Options Outstanding Options Exercisable ------------------------------------------------------- ---------------------------------- Number Weighted Average Weighted Number Weighted Range of Outstanding Remaining Average Exercisable Average Exercise Prices at 12/31/01 Contractual Life Exercise Price at 12/31/01 Exercise Price --------------- ------------ ---------------------- -------------- ------------ --------------- $ 5 to 7 1,311,496 4.58 years $ 5.73 956,381 $ 5.78 $ 7 to 9 42,000 5.36 years $ 8.31 42,000 $ 8.31 $ 9 to 11 351,839 4.36 years $ 10.63 351,839 $ 10.63 ----------- ------------ $ 5 to 11 1,705,335 4.73 years $ 6.81 1,350,220 $ 7.12 =========== ============
76 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 The Company applies APB 25 and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost been determined consistent with Statement 123 for the options granted, the Company's net income and earnings per share would have been the pro forma amounts indicated below:
Years ended December 31 ------------------------------------------------------------------------------------ 2001 2000 1999 ---------------------------- ------------------------- -------------------------- As reported Pro forma As reported Pro forma As reported Pro forma ----------- --------- ------------ --------- ------------ ---------- Net income (loss) $ (75,607,047) (76,268,498) (19,551,365) (20,098,914) 7,127,137 6,615,014 Less: Preferred stock dividends 461,344 461,344 434,000 434,000 108,500 108,500 Less: Accretion of discount on preferred 1,867,150 1,867,150 346,164 346,164 - - stock --------- --------- ---------- -------- --------- --------- Net income available to common shareholders $ (77,935,541) (78,596,992) (20,331,529) (20,879,078) 7,018,637 6,506,514 ========== ========== =========== ========== ========== ========= Basic earnings (loss) per common share $ (3.68) (3.71) (.97) (.99) .34 .31 Diluted earnings (loss) per common share $ (3.68) (3.71) (.97) (.99) .32 .29
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: expected volatility of 31.81 to 32.00% for 2000 and 25.3 to 28.4% for 1999, risk free interest rates of 6.31 to 6.66% for 2000 and 6.58% for 1999, expected dividend yields of 1.23 to 1.27 % for 2000 and 1.2% for 1999, and an expected life of 7.5 years for 2000 and 1999. There were no options granted during 2001. The Company has a 401(k) plan for the benefit of its eligible employees. The Company made quarterly contributions to the plan which totaled $232,663 and $265,836 during 2001 and 2000, respectively. The Company did not make any contributions to the plan during 1999. In 1998, the Company implemented an incentive compensation plan under which all full time employees with at least six months of service participate. Factors applicable to the incentive compensation plan are: Company's net income level, individual performance, employee's salary and position with the Company. The amount expensed for 1999 was $934,659. There were no amounts expensed under this plan during 2000 and 2001. (10) SEGMENT REPORTING On February 7, 2002, the Company announced its decision to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. During 2001 the Company made operating decisions and assessed performance for the commercial lines segment and the personal lines segment. The commercial lines segment wrote primarily commercial auto, garage, general liability and property. The personal lines segment writes primarily nonstandard personal auto coverages. 77 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 The Company considers many factors including the nature of the insurance product and distribution strategies in determining how to aggregate operating segments. The following tables represent a summary of segment data as of and for the years ended December 31, 2001, 2000 and 1999:
2001 ----------------------------------------------- Commercial Personal Lines Lines Other Total -------- ------ --------- -------- (Dollar amounts in thousands) Gross premiums written $ 68,499 48,684 - 117,183 ====== ====== ========= ======= Premiums earned $ 36,891 31,836 - 68,727 Net investment income 5,413 2,531 147 8,091 Insurance services - (1,310) 1,637 327 Expenses (83,928) (34,665) (1,738) (120,331) ------ ------ ----- ------- Operating income (loss) (41,624) (1,608) 46 (43,186) Net realized gains - - 4,275 4,275 Interest expense - (842) - (842) Amortization expense - (882) (882) Goodwill impairment - (18,447) - (18,447) --------- ------ -------- ------ Income (loss) before Federal income taxes $ (41,624) (21,779) 4,321 (59,082) ====== ====== ======== ====== Combined ratio (GAAP) basis 227.5% 108.9% 172.6% ===== ===== Total assets $ 276,275 76,332 26,611 379,218 ======= ====== ====== =======
2000 ----------------------------------------------- Commercial Personal Lines Lines Other Total -------- ------ --------- -------- (Dollar amounts in thousands) Gross premiums written $ 113,354 54,932 - 168,286 ======= ====== ====== ======= Premiums earned 107,922 43,534 - 151,456 Net investment income 8,671 4,301 1,121 14,093 Insurance services - 354 700 1,054 Expenses (141,454) (49,847) (1,971) (193,272) ------- ------ ----- ------- Operating income (loss) (24,861) (1,658) (150) (26,669) Net realized gains - - (1,907) (1,907) Interest expense - (1,409) - (1,409) Amortization expense - (964) - (964) ------- ------- ------ -------- Income (loss) before Federal income taxes $ (24,861) (4,031) (2,057) (30,949) ====== ===== ===== ======= Combined ratio (GAAP) basis 131.1% 114.5% 126.3% ===== ===== ===== Total assets $ 308,148 84,599 82,296 475,043 ======= ====== ====== =======
78 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999
1999 ----------------------------------------------- Commercial Personal Lines Lines Other Total --------- -------- ------- -------- (Dollar amounts in thousands) Gross premiums written $ 97,139 36,759 - 133,898 ====== ====== ====== ======= Premiums earned 91,928 21,352 - 113,280 Net investment income 7,607 2,115 - 9,722 Insurance services - 992 857 1,849 Expenses (91,091) (21,537) (2,533) (115,161) ------- ------- ------ ------- Operating income (loss) 8,444 2,922 (1,676) 9,690 Net realized gains - - 606 606 Interest expense - (1,266) - (1,266) Amortization expense - (689) - (689) ------- -------- ------ -------- Income (loss) before Federal income taxes $ 8,444 967 (1,070) 8,341 ======= ==== ===== ====== Combined ratio (GAAP) basis 99.1% 100.9% 99.4% ==== ===== ==== Total assets $ 253,576 73,786 68,286 395,648 ======= ====== ====== =======
(11) CONTINGENCIES In the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. The Company's management believes that unpaid claims and claim adjustment expenses are adequate to cover possible liability from lawsuits which arise in the normal course of its insurance business. In the opinion of the Company's management the ultimate liability, if any, resulting from the disposition of all claims will not have a material adverse effect on the Company's consolidated financial position or results of operations. The Company does not have any financial instruments where there is off-balance-sheet-risk of accounting loss due to credit or market risk. There is credit risk in the premiums receivable and reinsurance balances receivable of the Company. At December 31, 2001 and 2000 the Company did not have a premiums receivable balance nor a reinsurance balance receivable from any one entity that was material with regard to shareholders' equity. (12) SUBSEQUENT EVENTS Note Payable On February 27, 2002 the Company entered into an amendment to the credit agreement which cured covenant breaches and provided for principal prepayments. The Company prepaid $6,100,000 of the indebtedness outstanding under the credit agreement on March 4, 2002. Several covenants in the existing credit agreement were eliminated or modified by the amendment and the interest rate was changed to a base rate (which approximates prime) plus 175 basis points. The remaining $4,200,000 principal balance under the credit agreement is payable in 2003. 79 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 New York Stock Exchange The Company has received notice from the New York Stock Exchange (the "NYSE") that the Company is not in compliance with certain of the NYSE's quantitative criteria for continued listing. The NYSE noted that the Company's average market capitalization of its common stock for the 30 trading days ended February 27, 2002 was $22.0 million and stockholders' equity at December 31, 2001 was estimated at $27.5 million, as disclosed in the Company's earnings release on February 27, 2002. This is below NYSE continued listing criteria requiring total market capitalization of not less than $50 million over a 30 trading day period and stockholders' equity of not less than $50 million. In addition, the average closing price of the Company's common stock has fallen below the NYSE $1.00 minimum standard for a consecutive 30 trading day period and the total market capitalization of the Company's common stock has fallen below the NYSE $15 million minimum standard for a consecutive 30 trading day period. NYSE procedures indicate that listed companies that fall below continued listing standards generally have a period of time to respond to the NYSE with a plan to regain compliance. The Company has acknowledged receipt of the notification and is involved in discussions with the NYSE regarding its business plan. If the Company's shares cease to be listed on the NYSE, the Company believes that an alternative trading venue will be available. Rating. On March 18, 2002, A. M. Best Co. downgraded the Company's insurance subsidiaries' current rating of "B++" (Very Good) to "B-" (Fair), and assigned a negative outlook. Impairment of Securities In March 2002, the Company reduced the carrying value of a non-rated security to $0 resulting in a write down of approximately $2,010,000 as a result of a significant increase in the default rate in January and February of 2002 in the underlying collateral, which has disrupted the cash flow stream sufficiently to virtually eliminate future cash flows. 80 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (13) QUARTERLY FINANCIAL DATA (UNAUDITED) The following table contains selected unaudited consolidated financial data for each quarter (in thousands, except per share data):
2001 Quarter 2000 Quarter ------------------------------------ ------------------------------------- Fourth Third Second First Fourth Third Second First ------ ------- ------ ------- ------ ------- ------ ------- Gross premiums written $ 22,873 27,079 29,127 38,104 39,706 40,274 44,552 43.754 Total revenues $ 21,865 19,933 19,346 20,276 40,818 42,541 42,279 39,057 Total expenses $ 61,428 26,292 30,579 22,203 57,340 54,375 44,205 39,724 Net loss $ (62,249) (4,291) (7,879) (1,188) (10,752) (7,561) (1,104) (134) Loss per common share: Basic $ (2.98) (.24) (.41) (.06) (.52) (.37) (.06) (.02) Diluted $ (2.98) (.24) (.41) (.06) (.52) (.37) (.06) (.02) Common share prices (a) High 1.76 1.55 1.90 4.0625 4 1/4 5 1/16 6 1/8 6 3/8 Low 1.30 1.10 1.10 1.40 2 3/16 3 11/16 4 1/2 5 3/8
(a) As reported by the New York Stock Exchange The net loss of $62,249,000 recorded for the fourth quarter of 2001 is primarily a result of unfavorable claims experience, goodwill impairment, a provision for potentially uncollectible receivables and a valuation allowance for deferred Federal income taxes. The Company recorded an increase in estimated ultimate claims liabilities of approximately $20,000,000 in the fourth quarter of 2001. The Company also recorded a provision for potentially uncollectible receivables of approximately $2,654,000. In December 2001 the Company recorded an impairment of approximately $13,361,000 on the goodwill associated with the 1998 acquisition of the Lalande Group. This action was taken to reflect estimated fair valuation levels of agencies in the personal automobile marketplace. Due to the uncertainty of future profitability levels, the Company recorded a valuation allowance of approximately $31,535,000 against its deferred Federal income tax asset. 81 INDEPENDENT AUDITORS' REPORT ON SUPPLEMENTARY INFORMATION The Board of Directors and Shareholders GAINSCO, INC: Under date of March 18, 2002 we reported on the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2001. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Our report refers to a change in the method of accounting for residual interests in securitizations in 2001 as a result of the adoption of EITF 99-20. Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. KPMG LLP Dallas, Texas March 18, 2002 82 SCHEDULE I GAINSCO, INC. AND SUBSIDIARIES Summary of Investments - Other Than Investments in Related Parties (Amounts in thousands)
As of December 31 ------------------------------------------------- 2001 2000 ---------------------- -------------------- (Amounts in thousands) Amortized Fair Amortized Fair Cost Value Cost Value --------- ------- -------- ------- Type of Investment Fixed Maturities: Bonds available for sale: U.S. Government securities $ 16,730 17,167 21,138 21,317 Tax-exempt state and municipal bonds 8,912 9,139 45,284 45,472 Corporate bonds 101,727 106,488 121,564 125,553 Certificates of deposit 645 645 845 845 Common stock - - 6,027 7,716 Marketable securities 2,110 2,112 4,581 4,442 ------- -------- ------- ------- 130,124 135,551 199,439 205,345 ------- -------- ------- ------- Short-term investments 45,127 45,127 40,840 40,840 ------ ------- ------ ------ Total investments $ 175,251 180,678 240,279 246,185 ======= ======= ======= =======
See accompanying independent auditors' report on supplementary information. 83 SCHEDULE II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Balance Sheets December 31, 2001 and 2000
2001 2000 ----------- ----------- Assets ------ Investments in subsidiaries $ 56,403,052 107,044,187 Common stock, at fair value (cost: $448,097 - 2000) - 710,000 Other investments, at cost (which approximates fair value) 2,087,354 4,174,710 Short term investments 2,125,213 11,839,744 Cash 3,119 46,743 Accrued investment income - 88,876 Net receivables from subsidiaries 482,750 - Deferred Federal income taxes (net of valuation allowance: $2,016,628 - 2001, $0 - 2000) - 1,660,781 Other assets 118,290 457,147 Goodwill 3,468,507 22,797,358 ----------- ----------- Total assets $ 64,688,285 148,819,546 ----------- ------------ Liabilities and Shareholders' Equity ------------------------------------ Liabilities: Accounts payable $ 120,704 2,073,733 Net payables to subsidiaries - 6,405,987 Note payable 10,800,000 16,000,000 Dividends payable - 478,971 Current Federal income taxes 1,221,308 756,576 ----------- ----------- Total liabilities 12,142,012 25,715,267 ----------- ----------- Convertible redeemable preferred stock - Series A ($1,000 stated value, 31,620 shares authorized, 31,620 issued at December 31, 2001 and none issued at December 31, 2000) 18,722,000 - Convertible redeemable preferred stock - Series B ($1,000 stated value, 3,000 shares authorized, 3,000 issued at December 31, 2001 and none issued at December 31, 2000) 3,077,672 - Redeemable preferred stock - Series C ($1,000 stated value, 3,000 shares authorized, 3,000 issued at December 31, 2001 and none issued at December 31, 2000) 3,230,672 - ----------- ----------- 25,030,344 - ----------- ----------- Shareholders' equity: Preferred stock ($100 par value, 10,000,000 shares authorized, none issued at December 31, 2001, and 31,620 issued at December 31, 2000) - 3,162,000 Common stock ($.10 par value, 250,000,000 shares authorized, 22,013,830 issued at December 31, 2001 and December 31, 2000) 2,201,383 2,201,383 Common stock warrants 540,000 2,040,000 Additional paid-in capital 100,866,124 113,540,252 Accumulated other comprehensive income 3,580,690 3,897,371 Retained earnings (deficit) (71,977,743) 5,957,798 Treasury stock, at cost (844,094 shares at December 31, 2001 and December 31, 2000) (7,694,525) (7,694,525) ----------- ----------- Total shareholders' equity 27,515,929 123,104,279 ---------- ----------- Total liabilities and shareholders' equity $ 64,688,285 148,819,546 =========== ===========
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 84 SCHEDULE II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Operations Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ---------- -------- --------- Revenues: Dividend income $ 500,000 1,930,000 6,980,000 Investment income 146,354 1,121,049 371,928 Realized capital gains (losses) (1,643,781) 26,676 - ---------- --------- --------- Total revenues (997,427) 3,077,725 7,351,928 ---------- --------- --------- Expenses: Interest expense 842,368 1,409,378 1,265,529 Amortization of goodwill 881,965 963,700 688,645 Operating expense 1,868,240 2,118,502 1,720,440 Goodwill impairment 18,446,886 - - ---------- --------- --------- Total expenses 22,039,459 4,491,580 3,674,614 ----------- --------- --------- Operating income (loss) before Federal income taxes (23,036,886) (1,413,855) 3,677,314 Federal income taxes: Current expense (benefit) 596,386 756,576 (872,941) Deferred expense (benefit) 2,016,628 (1,572,735) 44,545 ---------- ---------- --------- 2,613,014 (816,159) (828,396) ---------- ---------- --------- Income (loss) before equity in undistributed income (loss) of subsidiaries (25,649,900) (597,696) 4,505,710 Equity in undistributed income (loss) of subsidiaries (49,957,147) (18,953,669) 2,621,427 ---------- ---------- --------- Net income (loss) $ (75,607,047) (19,551,365) 7,127,137 ========== ========== ========= Earnings (loss) per common share: Basic $ (3.68) (.97) .34 ==== === === Diluted $ (3.68) (.97) .32 ==== === ===
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 85 SCHEDULE II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Shareholders' Equity and Comprehensive Income Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 -------------- ------------- ------------ Preferred stock: Balance at beginning of year $ 3,162,000 3,162,000 - Issuance of shares (31,620 - 1999) - - 3,162,000 Conversion of shares to redeemable preferred stock (31,620 - 2001) (3,162,000) - - -------------- ------------- ------------ Balance at end of year - 3,162,000 3,162,000 -------------- ------------- ------------ Common stock: Balance at beginning of year 2,201,383 2,176,393 2,174,066 Exercise of options to purchase shares (249,903 - 2000, 23,270 - 1999) - 24,990 2,327 -------------- ------------- ------------ Balance at end of year 2,201,383 2,201,383 2,176,393 -------------- ------------- ------------ Common stock warrants: Balance at beginning of year 2,040,000 2,040,000 - Repricing of Series A and Series B warrants (1,680,000) - - Issuance of warrants in connection with preferred stock 180,000 - 2,040,000 -------------- ------------- ------------ Balance at end of year 540,000 2,040,000 2,040,000 -------------- ------------- ------------ Additional paid-in capital: Balance at beginning of year 113,540,252 112,674,842 87,778,548 Exercise of options to purchase shares (249,903 - 2000, 23,270 - 1999) - 519,246 47,551 Issuance of preferred shares (31,620 - 1999) - - 24,762,929 Conversion of shares to redeemable preferred stock (31,620 - 2001) (12,761,278) - - Accretion of discount on preferred shares 87,150 346,164 85,814 -------------- ------------- ------------ Balance at end of year $ 100,866,124 113,540,252 112,674,842 -------------- ------------- ------------
(continued) 86 SCHEDULE II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Shareholders' Equity and Comprehensive Income Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ----------------------------- ----------------------------- ----------------------- Retained earnings (deficit): Balance at beginning of year $ 5,957,798 27,586,440 22,086,868 Net income (loss) for year (75,607,047) (75,607,047) (19,551,365) (19,551,365) 7,127,137 7,127,137 Cash dividend - common - (1,474,206) (1,463,227) Cash dividend - preferred - (434,000) (108,500) Accrued dividends - redeemable preferred stock (461,344) - - Accretion of discount on preferred shares (87,150) (346,164) (85,814) Accretion of discount on redeemable preferred shares (1,780,000) - - Tax benefit on non-qualified stock options exercised - 177,093 29,976 ---------- ------------ ---------- Balance at end of year (71,977,743) 5,957,798 27,586,440 ---------- ------------ ---------- Accumulated other comprehensive income (loss): Balance at beginning of year 3,897,371 (2,246,575) 1,138,941 Unrealized gains (losses) on securities, net of reclassification adjustment, net of tax (316,681) (316,681) 6,143,946 6,143,946 (3,385,516) (3,385,516) ------- -------- ------------ --------- ---------- --------- Comprehensive income (loss) (75,923,728) (13,407,419) 3,741,621 ========== ========== --------- Balance at end of year 3,580,690 3,897,371 (2,246,575) --------- ------------ ----------- Treasury stock: Balance at beginning and at end of year (7,694,525) (7,694,525) (7,694,525) --------- ------------ ----------- Total shareholders' equity at end of year $ 27,515,929 123,104,279 137,698,575 ---------- ----------- ===========
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 87 SCHEDULE II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Cash Flows Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 -------------- ------------- ------------ Cash flows from operating activities: Net income (loss) $ (75,607,047) (19,551,365) 7,127,137 Adjustments to reconcile net income (loss) to cash provided by (used for) operating activities: Depreciation and amortization 881,966 963,700 688,645 Goodwill impairment 18,446,886 - - Impairment of other investments 2,176,231 - - Change in deferred Federal income taxes 1,641,139 (1,572,735) - Change in accrued investment income - (13,484) (75,392) Change in net receivables from/payables to subsidiaries (6,888,737) 9,852,766 (1,214,283) Change in other assets 338,857 (314,969) (16,960) Change in accounts payable (1,953,029) 45,520 1,981,005 Equity in (income) loss of subsidiaries 49,957,147 18,953,669 (2,621,427) Change in current Federal income taxes 464,732 756,576 - ------------ ------------ ------------ Net cash provided by (used for) operating activities (10,541,855) 9,119,678 5,868,725 ---------- ------------ ------------ Cash flows from investing activities: Common stock purchased - (448,097) - Common stock sold 448,097 - - Other investments purchased - (3,505,932) (916,278) Other investments sold - 247,500 - Change in short term investments 9,714,531 19,195,181 (30,991,387) Capital contributions to subsidiaries - (12,553,071) - Net assets acquired through purchase of subsidiary - (9,150,647) (2,012,500) Net assets disposed of through sale of subsidiary 648,852 - - ------------ ------------ ------------ Net cash provided by (used for) investing activities $ 10,811,480 (6,215,066) (33,920,165) ------------ ------------ ------------
(continued) 88 SCHEDULE II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Cash Flows Years ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------- ------------- ------------- Cash flows from financing activities: Payments on note payable $ (5,200,000) (2,000,000) - Cash dividends paid (478,971) (1,903,830) (1,462,820) Preferred stock and warrants issued (net of transaction fees) - - 29,964,929 Redeemable preferred stock and warrants issued (net of transaction fees) 5,365,722 - - Proceeds from exercise of common stock options - 544,236 49,878 ------------ ----------- ----------- Net cash provided by (used for) financing activities (313,249) (3,359,594) 28,551,987 ------------ ----------- ----------- Net increase (decrease) in cash (43,624) (454,982) 500,547 Cash at beginning of year 46,743 501,725 1,178 ------------ ----------- ----------- Cash at end of year $ 3,119 46,743 501,725 ============ ========== ==========
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 89 SCHEDULE II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Notes to Condensed Financial Statements December 31, 2001, 2000 and 1999 (1) GENERAL The accompanying condensed financial statements should be read in conjunction with the notes to the consolidated financial statements for the years ended December 31, 2001, 2000 and 1999 included elsewhere in this Annual Report. (2) RELATED PARTIES The Company made a cash capital contribution of $2,500,000 to General Agents in June of 2000. Also during 2000, the Company made capital contributions to GAINSCO Service Corp by forgiving intercompany debt in the amount of $2,061,066. Included in the payable to General Agents at December 31, 2000 was an accrued capital contribution of $8,000,000. The cash was paid to General Agents in February 2001. The Company acquired the net assets of Tri-State of $3,732,708 in January 2000 through the purchase of all its outstanding capital stock. The capital stock was sold in August 2001 to Herbert A. Hill, Tri-State's president and former owner. The following table presents the components of the net receivables from and payables to subsidiaries at December 31, 2001 and 2000:
2001 2000 --------- ---------- Name of subsidiary ------------------ Agents Processing Systems, Inc. $ 887,775 887,775 GAINSCO Service Corp (405,525) (902) General Agents Insurance Company of America, Inc. 500 (7,292,860) -------- --------- Net receivable from (payables to) subsidiaries $ 482,750 (6,405,987) ======= =========
See accompanying independent auditors' report on supplementary information. 90 SCHEDULE III GAINSCO, INC. AND SUBSIDIARIES Supplementary Insurance Information Years ended December, 2001, 2000 and 1999 (Amounts in thousands)
Other Deferred Reserves policy policy for claims claims and Net acquisition and claim Unearned benefits premiums Segment costs(1) expenses premiums payable earned ------- --------- --------- --------- ------- --------- Year ended December 31, 2001: Commercial lines $ 2,240 162,255 31,071 5,657 36,891 Personal lines 948 18,804 16,903 1,361 31,836 Other - - - - - ------- ------- ------ ----- ------- Total $ 3,188 181,059 47,974 7,018 68,727 ======= ======= ====== ===== ======= Year ended December 31, 2000: Commercial lines $ (375) 150,807 49,286 7,121 107,922 Personal lines 2,677 13,353 23,292 1,742 43,534 Other - - - - - ------- ------- ------ ----- ------- Total $ 2,302 164,160 72,578 8,863 151,456 ======= ======= ====== ===== ======= Year ended December 31, 1999: Commercial lines $11,019 127,460 65,350 4,206 91,928 Personal lines 3,909 5,354 16,870 - 21,352 Other - - - - - ------- ------- ------ ----- ------- Total $14,928 132,814 82,220 4,206 113,280 ======= ======= ====== ===== =======
Amortization of deferred Other Net Claims policy operating Net Investment and claim acquisition costs and premiums Segment Income expenses costs (2) expenses written ------- ---------- --------- --------- --------- --------- Year ended December 31, 2001 Commercial lines 5,413 58,453 10,678 28,090 45,001 Personal lines 2,531 28,973 9,392 24,134 23,294 Other 147 - - 1,738 - ------ ------- ------ ------ ------- Total 8,091 87,426 20,070 53,962 68,295 ====== ======= ====== ====== ======= Year ended December 31, 2000: Commercial lines 8,671 103,475 28,883 26,543 75,516 Personal lines 4,301 39,964 10,441 11,053 43,307 Other 1,121 - - 1,971 - ------ ------- ------ ------ ------- Total 14,093 143,439 39,324 39,567 118,823 ====== ======= ====== ====== ======= Year ended December 31, 1999: Commercial lines 7,607 60,083 24,399 32,161 94,607 Personal lines 2,115 16,266 5,139 7,624 36,530 Other - - - 4,589 - ------ ------- ------ ------ ------- Total 9,722 76,349 29,538 44,374 131,137 ====== ======= ====== ====== =======
(1) Net of deferred ceding commission income. (2) Net of the amortization of deferred ceding commission income. See accompanying independent auditors' report on supplementary information. 91 SCHEDULE IV GAINSCO, INC. AND SUBSIDIARIES Reinsurance Years ended December 31, 2001, 2000 and 1999 (Amounts in thousands, except percentages)
Percentage Ceded to Assumed of amount Direct other from other Net Assumed amount Companies Companies amount to net ------- --------- ---------- ------ --------- Year ended December 31, 2001: Premiums earned: Property and casualty $ 138,130 - - 138,130 Reinsurance - (72,534) 3,131 (69,403) ------- ------ ----- ------- Total $ 138,130 (72,534) 3,131 68,727 4.6% ======= ====== ===== ====== ==== Year ended December 31, 2000 Premiums earned: Property and casualty $ 158,937 - - 158,937 Reinsurance - (25,725) 18,244 (7,481) ------- ------ ------ ----- Total $ 158,937 (25,725) 18,244 151,456 12.0% ======= ====== ===== ====== ==== Year ended December 31, 1999 Premiums earned: Property and casualty $ 113,375 - - 113,375 Reinsurance - (12,107) 12,012 (95) ------- ------ ------ ------- Total $ 113,375 (12,107) 12,012 113,280 10.6% ======= ====== ====== ======= ====
See accompanying independent auditors' report on supplementary information. 92 SCHEDULE VI GAINSCO, INC. AND SUBSIDIARIES Supplemental Information Years ended December 31, 2001, 2000 and 1999 (Amounts in thousands)
Column A Column B Column C Column D Column E Column F -------- -------- -------- -------- -------- -------- Reserves for unpaid Discount Deferred claims if any, Affiliation policy and claim deducted with acquisition adjustment in Unearned Net earned Segment registrant costs (1) expenses Column C premiums premiums ------- ---------- ----------- ---------- -------- -------- ---------- Year ended December 31, 2001: Commercial lines $ - 2,240 162,255 - 31,071 36,891 Personal lines - 948 18,804 - 16,903 31,836 Other - - - - - - ------ ----- ------- ----- ------ ------ Total $ - 3,188 181,059 - 47,974 68,727 ====== ===== ======= ===== ====== ====== Year ended December 31, 2000: Commercial lines $ - (375) 150,807 - 49,286 107,922 Personal lines - 2,677 13,353 - 23,292 43,534 Other - - - - - - ------ ----- ------- ----- ------ ------ Total $ - 2,302 164,160 - 72,578 151,456 ====== ===== ======= ===== ====== ======= Year ended December 31, 1999: Commercial lines $ - 11,019 127,460 - 65,350 91,928 Personal lines - 3,909 5,354 - 16,870 21,352 Other - - - - - - ------ ----- ------- ----- ------ ------ Total $ - 14,928 132,814 - 82,220 113,280 ====== ====== ======= ===== ====== =======
Column H Column I Column J Column K Column L -------- -------- -------- -------- -------- Claims and claim adjustment expenses incurred related to Amortization Paid ----------------- of deferred claims and Net policy claim Net Investment Current Prior acquisition adjustment premiums Segment Income year year costs (2) expenses written ------- ---------- ------- ----- ------------ ---------- -------- Year ended December 31, 2001: Commercial lines 5,413 28,695 29,758 10,678 78,828 45,001 Personal lines 2,531 28,225 748 9,392 19,567 23,294 Other 147 - - - - - ----- ------ ------ ------ ------ ------ Total 8,091 56,920 30,506 20,070 98,395 68,295 ===== ====== ====== ====== ====== ====== Year ended December 31, 2000: Commercial lines 8,671 86,339 17,136 28,883 78,342 75,516 Personal lines 4,301 37,738 2,226 10,441 35,239 43,307 Other 1,121 - - - - - ----- ------ ------ ------ ------ ------ Total 14,093 124,077 19,362 39,324 113,581 118,823 ====== ======= ====== ====== ======= ======= Year ended December 31, 1999: Commercial lines 7,607 59,894 189 24,399 71,422 94,607 Personal lines 2,115 16,082 184 5,139 11,180 36,530 Other - - - - - - ----- ------ ------ ------ ------ ------ Total 9,722 75,976 373 29,538 82,602 131,137 ===== ====== ====== ====== ====== =======
(1) Net of deferred ceding commission income. (2) Net of the amortization of deferred ceding commission income. See accompanying independent auditors' report on supplementary information. 93 INDEX OF EXHIBITS
Exhibit No. Description 10.4 Forms of Change of Control Agreements 10.24 Agreement of Sale and Purchase dated March 7, 2002 between General Agents Insurance Company of America, Inc. and Turonian Corp. 21 Subsidiaries of Registrant. 23 Consent of KPMG LLP to incorporation by reference. 24 Powers of Attorney.