21ST CENTURY INSURANCE GROUP - TW Annual Report (10-K) ITEM 1. BUSINESS

The following is an excerpt from a 10-K SEC Filing, filed by 21ST CENTURY INSURANCE GROUP on 2/17/2005.

Jump to :

ITEM 1. BUSINESS

General
21st Century Insurance Group (together with its subsidiaries, referred to hereinafter as the "Company", "we", "us" or "our") is an insurance holding company registered on the New York Stock Exchange (NYSE: TW).

We are a direct-to-consumer provider of personal auto insurance covering over 1.5 million vehicles in California and eight other Western, Southwestern and Midwestern states.1 We also provide motorcycle and personal umbrella insurance in California. Twenty-four hours per day, 365 days a year, customers have the option to purchase insurance, service their policy or report a claim over the phone directly through our licensed insurance professionals at 1-800-211-SAVE (English) or 1-888-920-2121 (Spanish) or through our full service bilingual Web site at www.21st.com. We believe that we deliver superior policy features and customer service at a competitive price.

21st Century Insurance Group was founded in 1958 and, effective December 4, 2003, was incorporated under the laws of the State of Delaware. Previously, the Company was incorporated in California. Several subsidiaries of American International Group, Inc. (hereinafter referred to as "AIG") together own approximately 63% of our outstanding common stock.

Copies of our filings with the Securities and Exchange Commission on Form 10-K, Form 10-Q, Form 8-K and proxy statements are available along with copies of earnings releases on the Company's Web site at www.21st.com. Copies may also be obtained free of charge directly from the Company's Investor Relations Department (6301 Owensmouth Avenue, Woodland Hills, California 91367, phone 818-673-3996).

Geographic Concentration of Business
We write private passenger automobile insurance primarily in California (96% of policyholders). We also currently write auto insurance in Arizona, Nevada, Oregon, Washington, Illinois, Indiana, Ohio, and Texas1.

1We began offering insurance in Texas on January 3, 2005. Results from Texas are not expected to be material in 2005.
4

The following table presents a geographical summary of our direct premiums written for the past five years (in millions):

Direct Premiums Written Years Ended December 31, 2004 2003 2002 2001 2000 Personal auto lines1
California $ 1,285.6 $ 1,189.5 $ 967.3 $ 879.4 $ 861.6 Arizona2 33.0 21.2 13.0 Nevada 6.3 6.7 8.1 8.9 7.7 Oregon 1.2 1.4 1.6 2.0 2.2 Washington 3.7 4.6 5.8 8.5 9.7 Ohio 1.6
Indiana 1.3
Illinois 4.4
Total personal auto lines 1,337.1 1,223.4 995.8 898.8 881.2 Lines in runoff
Homeowner3 and Earthquake4 0.1 0.1 2.4 30.5 29.5 Total $ 1,337.2 $ 1,223.5 $ 998.2 $ 929.3 $ 910.7

The table below summarizes the concentrations of our California vehicles in force for the personal auto lines excluding the Assigned Risk program and personal umbrella and motorcycle coverages as of the end of each of the past five years. Our California market share reflects a weighted distribution that tracks the concentration of households and population. At the end of 2004, 30.3% of the vehicles insured by us were registered in Los Angeles County. In comparison, December 31, 2003 data from the California Department of Motor Vehicles (the most recent available) indicates that 24% of its registrations were for vehicles in Los Angeles County.

Voluntary Personal Auto Lines Concentration of California Vehicles in Force December 31, 2004 2003 2002 2001 2000 Los Angeles County 30.3 % 32.3 % 37.2 % 42.0 % 43.6 % San Diego County 13.6 13.5 13.4 13.4 12.6 Southern California excluding Los
Angeles and San Diego Counties5 20.3 21.4 23.5 25.9 26.5 Central and Northern California6 35.8 32.8 25.9 18.7 17.3 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %

Types and Limits of Insurance Coverage
Our private passenger auto insurance contract generally covers: bodily injury liability; property damage; medical payments; uninsured and underinsured motorist; rental reimbursement; uninsured motorist property damage and collision deductible waiver; towing; comprehensive; and collision. All of these policies are written for a six-month term except for policies sold under the Assigned Risk Program, which are for twelve months. 1 Includes motorcycle and personal umbrella coverages, which are immaterial for all periods presented.

2 Excludes amounts not consolidated prior to our acquisition of a majority of the voting interests in 21st Century Insurance Company of the Southwest (previously named 21st Century Insurance Company of Arizona): $12.8 million in 2001 and $14.7 million in 2000.

3 We no longer have any California homeowner policies in force. See further discussion in Item 7 under the caption Underwriting Results - Homeowner and Earthquake Lines in Runoff.

4 We ceased writing earthquake coverage in 1994, but we have remaining loss reserves from the 1994 Northridge Earthquake that are subject to possible adverse development. See further discussion in Item 7 under the captions Underwriting Results - Homeowner and Earthquake Lines in Runoff, Critical Accounting Estimates, and in Note 16 to the Notes to Consolidated Financial Statements.

5 Includes the following counties: Imperial, Kern, Orange, Riverside, Santa Barbara, San Bernardino and Ventura.

6 Includes all California counties other than Los Angeles County, San Diego County, and those specified in Footnote 5.

Minimum levels of bodily injury and property damage are required by state law and typically cover the other party's claims when our policyholder causes an accident. Uninsured and underinsured motorist are optional coverages and cover our policyholder when the other party is at fault and has no or insufficient liability insurance to cover the insured's injuries and loss of income. Comprehensive and collision coverages are also optional and cover damage to the policyholder's automobile whether or not the insured is at fault. In some states, we are required to offer personal injury protection coverage in lieu of the medical payments coverage required in California.

Various limits of liability are underwritten with maximum limits of $500,000 per person and $500,000 per accident. Our most popular bodily injury liability limits in force are $100,000 per person and $300,000 per accident.

Our personal umbrella policy ("PUP") provides a choice of liability coverage limits of $1.0 million, $2.0 million or $3.0 million in excess of underlying automobile liability coverage that we write. Since May 2002, we have required minimum underlying automobile limits, written by us, of $250,000 per person and $500,000 per accident for PUP policies sold. We reinsure 90% of any PUP loss with unrelated reinsurers.

Personal Auto Product Innovations
Starting in May 2002, we began offering motorcycle coverage primarily to our auto policyholders in California. In August 2002, we introduced a new private passenger auto policy in California that does not have certain standard features found in our primary policy. This limited-feature product is similar in most respects to the product offered by many of our competitors, and is positioned as a lower-cost alternative for customers who believe they need less coverage than provided by our standard product. In October 2002, we enhanced our underwriting guidelines allowing us to provide quotes to more customers who do not meet California's statutory "good driver" definition, but who are considered to be insurable risks within our class plan.

The foregoing product innovations account for approximately 14% of new auto policies written in California in 2004. Each innovation was designed to earn an underwriting profit equivalent to the rest of the California auto product (with the exception of the Assigned Risk program). Initial results for each product innovation are in line with expected profit levels.

Marketing
While we offer personal auto policies in nine states, most of our marketing efforts are focused on the larger urban markets in California. Beginning in late 2001, we resumed active marketing in Arizona. We began offering personal auto insurance in Illinois, Indiana and Ohio on January 28, 2004, and in Texas on January 3, 2005.

Our marketing and underwriting strategy is to appeal to careful and responsible drivers who desire a feature-rich product at a competitive price. We use direct mail, broadcast and print media, outdoor, community events and the Internet to generate inbound telephone calls, which are served by centralized licensed insurance agents. Because our sales agents are centralized, we can deliver a highly efficient and professional experience for our customers 24 hours per day, 365 days per year through a convenient, toll-free 800-211-SAVE telephone number. Customers may also obtain an auto rate quotation and purchase a policy on our Web site at www.21st.com.

Approximately 60% of all Spanish speaking residents in the United States live in the states of California, Arizona, Illinois, and Texas. We are the only significant auto insurer to provide full service in Spanish via our Web site and bilingual professionals 24 hours per day, 365 days per year through a dedicated toll-free telephone number at 888-920-2121. Additionally we utilize Spanish speaking advertising and materials to attract the Spanish speaking community.

The following table summarizes advertising expenditures (in millions) and total new auto policies written for the past five years:

Years Ended December 31, 2004 2003 2002 2001 2000 Total advertising expenditures $ 66.7 $ 53.9 $ 43.3 $ 16.9 $ 9.8 New auto policies written 1 225,349 265,589 189,652 63,264 89,429

Consumer Advocacy
We have introduced several publications and community events designed to assist customers and potential customers in making choices about their auto insurance and automobile safety. Crash Course in Auto Insurance, available in both English and Spanish, compares coverage and service features of products offered by the Company and its major competitors for California, Arizona, Illinois, Indiana and Ohio. The comparisons are explained in understandable language to help "demystify" the choices consumers must make in selecting their personal auto insurance carrier.

We also publish the Child Safety Seat Guide, Crash Test Ratings Guide, and The Golden Road - Today's Senior Drivers, which we distribute through county fairs, direct mail promotions and other venues.

For the past three years, 21st Century Insurance and the California Highway Patrol ("CHP") have conducted safety fairs in communities throughout California. In the last three years, the CHP has conducted nearly 3,900 inspections, removed and destroyed over 1,900 hazardous child safety seats, and we donated over 2,900 new seats to California families. Based on the success of this program in California, we entered into a partnership in 2004 with the state of Illinois to conduct safety fairs in communities throughout Illinois. In 2004, the state conducted nearly 500 inspections, removed and destroyed over 160 hazardous seats, and we donated 800 new seats to Illinois families. In January 2005, the Company also formed a partnership with the governor of Texas and the Texas Department of Public Safety to conduct safety fairs throughout the state.

21st Century Insurance has also partnered with the CHP and the Arizona Department of Public Safety to post billboards around the states encouraging drivers to be safe. Ads in English and Spanish feature lighthearted messages discussing a serious topic - Sober Driving. All of the materials are co-branded by the Company, the CHP and the Arizona Department of Public Safety, as applicable.

Customer Retention and Vehicles in Force Customer retention in California, measured based on the number of vehicles in force, were as follows as of the end of each of the past five years:

December 31, 2004 2003 2002 2001 2000 Average customer
retention -
California personal
auto2 93% 92% 93% 92% 96% California vehicles
in force3 1,477,625 1,383,175 1,178,459 1,051,982 1,150,643 All other states
vehicles in force 62,922 33,332 27,174 23,489 31,337 Total vehicles in
force 1,540,547 1,416,507 1,205,633 1,075,471 1,181,980

California auto base +3.9% +5.7% +4.0% +6.4% rate changes None April May July November

From March 1996 to February 1999, we implemented six rate decreases which resulted in a cumulative reduction in rates of nearly 23% in our California Personal Auto Program. As a result of this series of rate decreases, retention rates rose to record levels for us through 2000. Growth in vehicles in force during this period was modest as our major competitors also lowered their rates. In the year 2000 we recognized that loss costs had stopped declining and were again rising. While our competitors took no action or, in some cases, continued to take rate decreases, we took decisive action to improve our results and resume profitable growth when the marketplace ultimately did react to these adverse trends. In 2000 we curtailed our advertising, adopted stricter underwriting measures, modified our class plan rating system, and increased our California auto program base rate by 6.4%, followed by a further rate increase of 4% in 2001. These actions contributed to a decline in retention and vehicles in force in 2001. Beginning in the latter half of 2001, our major California competitors began implementing rate increases and we restarted active marketing and advertising, both of which contributed to the increases in our retention and vehicles in force in 2002. In January 2003, the Company received approval for a 3.9% rate increase, which we implemented for new and renewal policies effective March 31, 2003. This increase did not significantly impact retention. We took no California rate increases or decreases in 2004.

1 Includes new PUP and motorcycle policies, which are insignificant for all periods presented.

2 Represents an overall measure of customer retention, including new customers as well as long-time customers. Retention rates for new customers typically are lower than for long-time customers.

3 Includes PUP and motorcycle.

Underwriting and Pricing
The regulatory system in California requires the prior approval of insurance rates. Within the regulatory framework, we establish our premium rates based primarily on actuarial analyses of our own historical loss and expense data. This data is compiled and analyzed to establish overall rate levels as well as classification differentials.

Our rates are established at levels intended to generate underwriting profits and vary for individual policies based on a number of rating characteristics. These rates are a blend of base rates and class plan filings made with the California Department of Insurance ("CDI"). Base rates are the primary amount projected to generate an adequate underwriting profit. Class plan changes are filings that serve to modify the factors that impact the base rates so that each individual receives a rate that reflects their respective losses and expenses. Class plan changes are generally meant to be revenue neutral to us, but ultimately are done in conjunction with a base rate filing.

California law requires that the primary rating characteristics that must be used for automobile policies are driving record (e.g., history of accidents and moving violations), annual mileage and number of years the driver has been licensed. A number of other "optional" rating factors are also permitted and used in California, which include characteristics such as automobile garaging location, make and model of car, policy limits and deductibles, and gender and marital status.

The following table summarizes increases in our premium rates for each of the past five years:

Increases in Our Premium Rates Years Ended December 31, 2004 2003 2002 2001 2000 Personal auto lines excluding PUP
California % 3.9 % 5.7 % 4.0 % 6.4 % Arizona 4.8 3.0 3.7 16.5 20.0 Nevada 6.4 22.0 12.6 Oregon 3.1 14.0 21.0 Washington 7.4 10.7 44.9 Lines in runoff
Homeowner N/A N/A 13.2 4.0 Earthquake N/A N/A N/A N/A N/A

We are required to offer insurance to any California applicant who meets the statutory definition of a "good driver." This definition includes, but is not limited to, all drivers licensed the previous three years with no more than one violation point count under criteria contained in the California Vehicle Code. These criteria include a variety of moving violations and certain at-fault accidents.

We review many of our policies prior to the time of renewal and as changes occur during the policy period. Some mid-term changes may result in premium adjustments, cancellations or non-renewals because of a substantial increase in risk.

Competition
The personal automobile insurance market is highly competitive and is comprised of a large number of well-capitalized companies, many of which operate in more states and offer a wider variety of products than we do. Several of these competitors are larger and have greater financial resources than we do on a stand-alone basis. According to A.M. Best, we were the seventh largest writer of private passenger automobile insurance in California based on direct premiums written for 2003 (latest year for which information is available). Our main competition comes from other major writers who concentrate on the "good driver" market.

Market shares in California of the top ten writers of personal automobile insurance, based on direct premiums written, according to A.M. Best, for the past five years were as follows:

Market Share in California Based on Direct Premiums Written Years Ended December 31, 2003 2002 2001 2000 1999 21st Century Insurance Group 6 % 6 % 6 % 6 % 6 % State Farm Group 14 14 13 13 14 Zurich/Farmers Group 10 11 12 13 14 Mercury General Group 9 9 8 8 8 Automobile Club of Southern California Group 9 9 9 9 9 California State Auto Group 9 9 10 10 10 Allstate Insurance Group 8 9 11 10 9 USAA Group 3 3 3 3 3 Progressive Insurance Group 3 2 2 2 3 Government Employees Group (GEICO) 3 3 3 3 2

Servicing of Business
Computerized systems provide the information resources, telecommunications and data processing capabilities necessary to manage our business. These systems support the activities of our marketing, sales, service and claims people who are dedicated to serving the needs of customers. New technology investments have been focused on making it faster and easier for customers to transact business while ultimately lowering our per-transaction costs.

Using our bilingual Web site, most customers are now able to receive and accept quotations, bind policies, pay their bills, inquire about the status of their policies and billing information, make most common policy changes, submit first notice of loss on a claim and access a wealth of consumer information. New technology provides our sales and service agents with integrated knowledge about customer contacts and enables speedier and even more convenient customer service.

Claims
Claims operations include the receipt and analysis of initial loss reports, assignment of legal counsel when necessary, and management of the settlement process. Whenever possible, physical damage claims are handled by our drive-in claims facilities, vehicle inspection centers and Direct Repair Program ("DRP") providers. The claims management staff administers the claims settlement process and oversees the work of the legal and adjuster personnel involved in that process. Each claim is carefully analyzed to provide for fair loss payments, compliance with our contractual and regulatory obligations and management of loss adjustment expenses. Liability and property damage claims are handled by specialists in each area.

We make extensive use of our DRP to expedite the repair process. Our program involves agreements with more than 200 independent repair facilities. We agree to accept the repair facility's damage estimate without requiring each vehicle to be reinspected by our adjusters. All DRP facilities undergo a screening process before being accepted, and we maintain an aggressive inspection audit program to assure quality results. Our inspection teams visit all repair facilities each month and perform a quality control inspection on approximately 45% of all repairable vehicles in this program. The customer benefits by getting the repair process started faster and by having the repairs guaranteed for as long as the customer owns the vehicle. We benefit by not incurring the overhead expense of a larger staff of adjusters and by negotiating repair prices we believe are beneficial. Currently, more than 30% of all damage repairs are handled using the DRP method.

Our policy is to use original equipment manufacturer ("OEM") parts for body repairs. As a result, we believe we do not have exposure to the types of class action suits some competitors have drawn over their use of after-market parts.

We have established 12 claims division service offices in areas of major customer concentrations. Our four vehicle inspection centers, located in Southern and Northern California, as well as Arizona, handle total losses, thefts and vehicles that are not drivable.

The claims services division is responsible for subrogation and medical payment claims. We also maintain a Special Investigations Unit as required by the California State Insurance Code, which investigates suspected fraudulent claims. We believe our efforts in this area have been responsible for saving several million dollars annually.

We utilize internal legal staff to handle most aspects of claims litigation. These attorneys handle approximately 80% of all lawsuits against our policyholders. Suits directly against the Company, and those which may involve a conflict of interest, are assigned to outside counsel.

Growth and Profitability Objectives
We have stated that our long-term goal is to build an organization that consistently produces a 96% combined ratio or better, using accounting principles generally accepted in the United States of America ("GAAP"), and at least 15% annual growth in direct written premiums. To achieve these goals, we have undertaken many steps since 1999 including:

· Continued our multi-state expansion with the addition of Illinois, Indiana and Ohio in 2004, and Texas in 2005;

· Restored pricing and underwriting discipline;

· Successfully restarted active advertising for new customers;

· Introduced product innovations to spur growth and profitability; and

· Launched numerous initiatives to lower per-transaction costs.

Underwriting Expense Ratio - Personal Auto Lines Under GAAP, the underwriting expense ratio is defined as underwriting expenses divided by net premiums earned as underwriting expenses are recognized over the period that net premiums are earned. The statutory underwriting expense ratio is stated as a percentage of premiums written rather then premiums earned because most underwriting expenses are recognized when policies are written. Information extracted from statutory filings by A.M. Best for the top ten California personal automobile insurance companies for 2003, the most recent year available, indicates that our direct statutory underwriting expense ratio for private passenger auto (defined as direct underwriting expenses on a statutory basis divided by direct premiums written) was lower then seven of our nine largest competitors in the markets in which we served for 2003. Our GAAP underwriting results and ratios are discussed in Item 6. Selected Financial Data and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations.

Losses and Loss Adjustment Expense Reserves The cost to settle a customer's claim is comprised of two major components:
losses and loss adjustment expenses ("LAE").

Losses in connection with third party coverages represent damages as a result of an insured's acts that result in property damage or bodily injury. First party losses involve damage or injury to the insured's property or person. In either case, the ultimate cost of the loss is not always immediately known and, over time, may be higher or lower than initially estimated. When establishing initial and subsequent estimates, the amount of loss is reduced for salvage (e.g., proceeds from the disposal of the wrecked automobile) and subrogation (e.g., proceeds from another party who is fully or partially liable, such as the insurer of the driver who caused the accident involving one of our customers).

Loss adjustment expenses represent the costs of adjusting, investigating and settling claims, and are primarily comprised of the cost of our claims department, external inspection services, and internal and external legal counsel. Corporate support areas such as human resources, finance, and information technology provide services to our overall operations, and, accordingly, a portion of their operational costs are also allocated to LAE. The LAE allocable portion of such corporate support costs is reviewed periodically as changes occur in our organization, and we modify the allocation percentages as appropriate. During 2004, such changes effectively decreased our ratio of overhead LAE to earned premium by 2.7 percentage points from 4.4% in 2003 to 1.7% in 2004.

Accounting for losses and LAE is highly subjective because these costs must be estimated, often weeks, months or even years in advance of when the payments are actually made to claimants, attorneys, claims personnel and others involved in the claims settlement process.

Accounting principles require insurers to record estimates for losses and LAE in the periods in which the insured events, such as automobile accidents, occur. This estimation process requires us to estimate both the number of accidents that have occurred (called "frequency") and the ultimate amount of loss and LAE (called "severity") related to each accident. We employ actuaries who are professionally trained and certified in the process of establishing estimates for frequency and severity. Historically, our actuaries have not projected a range around the carried loss reserves. Rather, they have used several methods and different underlying assumptions to produce a number of point estimates for the required reserves. Management reviews the assumptions underlying the loss ratios and selects the carried reserves after carefully reviewing the appropriateness of the underlying assumptions.

Estimating the Frequency of Auto Accidents. By studying the historical lag between the actual date of loss and the date the accident is reported by the customer to the claims department, our actuaries can make a reasonable, yet never perfect, estimate for the number of claims that ultimately will be reported for a given period. This measurement is referred to as frequency. The difference between the estimated ultimate number of claims that will be made and the number that have actually been reported in any given period is referred to as incurred but not reported ("IBNR") claims.

Estimating the Severity of Auto Claims. For both property damage and injury claims our adjusters determine what exposures exist in open reserves. All property damage reserves and any injury reserves estimated to be less than $15,000 are set at "average amounts" determined by our actuaries. For both bodily injury and uninsured motorist claims estimated to have value in excess of $15,000, adjusters in our claims department establish loss estimates based upon various factors such as the extent of the injuries, property damage sustained, and the age of the claim. Our actuaries review these estimates, giving consideration to the adjusters' historical ability to accurately estimate the ultimate claim and length of time it will take to settle the claim, and provide for development in the adjusters' estimates as applicable. Generally, the longer it takes to settle a claim, the higher the ultimate claim cost. The ultimate amount of the loss is considered the "severity" of the claim. In addition, the actuaries estimate the severity of the IBNR claims.

The severities are estimated by our actuaries each month based on historical studies of average claim payments and the patterns of how the claims were paid. Again, the fundamental assumption used in making these estimates is that past events are reliable indicators of future outcomes.

Estimating Losses and LAE for Lines in Runoff. While the personal auto lines represent our core business, we also have losses and LAE relating to development on remaining loss reserves for homeowners and earthquake lines. These lines are said to be "in runoff" because we no longer have policies in force. As discussed in the Notes to Consolidated Financial Statements, we have not written any earthquake policies since 1994 and we exited the homeowners insurance business at the beginning of 2002. Developing reserve estimates for the earthquake line is particularly subjective because most of the remaining earthquake claims are in litigation. Our actuaries evaluate the homeowners reserve requirement on a quarterly basis, while personnel in our legal and claims areas prepare monthly evaluations of the earthquake reserves.

Loss and LAE Reserve Development
Management believes that our reserves are adequate and represent our best estimate based on the information currently available. However, because reserve estimates are necessarily subject to the outcome of future events, changes in estimates are unavoidable in the property and casualty insurance business. These changes sometimes are referred to as "loss development" or "reserve development."

For the personal auto lines, our actuaries prepare a monthly evaluation of loss and LAE indications by accident year, and we assess whether there is a need to adjust reserve estimates. As claims are reported and settled and as other new information becomes available, changes in estimates are made and are included in earnings of the period of the change.

The changes in prior accident year estimates of losses and LAE incurred recorded in each of the past five calendar years, net of reinsurance, are summarized below (in thousands):

Changes in the Calendar Year of Prior Accident Year Estimates, Net of Reinsurance Years ended December 31, 2004 2003 2002 2001 2000 Personal auto $ (2,936 ) $ 11,159 $ 16,200 $ 45,742 $ 42,178 Homeowner and Earthquake1 2,831 40,048 56,158 72,265 2,845 Total $ (105 ) $ 51,207 $ 72,358 $ 118,007 $ 45,023

Positive amounts represent deficiencies in loss and LAE reserves, while negative amounts represent redundancies.

To understand these changes, it is useful to put them in the context of the cumulative reserve development experienced by the Company over a longer time frame. The tables on the following pages present the development of loss and LAE reserves for the personal auto lines (Table 1) and for the homeowner and earthquake lines in runoff (Table 2), for the years 1994 through 2004. The figures in both tables are shown gross of reinsurance.

1 We no longer have any California homeowner policies in force. We ceased writing earthquake coverage in 1994, but we have remaining loss reserves from the 1994 Northridge Earthquake that are subject to possible adverse development. See further discussion in Item 7 under the captions Underwriting Results - Homeowner and Earthquake Lines in Runoff, Critical Accounting Estimates, and the Notes to Consolidated Financial Statements.

In Tables 1 and 2 on the following pages, a redundancy (deficiency) exists when the original reserve estimate is greater (less) than the re-estimated reserves. Each amount in the tables includes the effects of all changes in amounts for prior periods. The tables do not present accident year or policy year development data. Conditions and trends that have affected the development of liabilities in the past may not necessarily occur in the future. Therefore, it would not be appropriate to extrapolate future deficiencies or redundancies based on the table. A detailed discussion of loss and LAE reserve development follows the tables.

The top line of each table shows the reserves at the balance sheet date for each of the years indicated. The upper portion of the table indicates the cumulative amounts paid as of subsequent year ends with respect to that reserve liability. The lower portion of the table indicates the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year, including cumulative payments made since the end of the respective year. The estimates change as more information becomes known about the frequency and severity of claims for individual years.

TABLE 1 - Auto Lines as
of December 31,
(Amounts in thousands,
except claims) 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Reserves for losses and LAE, direct
$ 552,872 $ 506,747 $ 468,257 $ 403,263 $ 329,021 $ 261,990 $ 286,057 $ 301,985 $ 333,113 $ 419,913 $ 489,411 Paid (cumulative) as of:
One year later 329,305 318,273 260,287 253,528 247,317 242,579 268,515 239,099 249,815 280,534 Two years later 403,462 392,420 336,538 319,064 307,797 311,659 332,979 312,909 328,951 Three years later 429,595 416,541 354,854 333,349 324,778 324,740 352,592 333,955 Four years later 435,795 422,393 357,913 340,907 326,932 327,745 358,806 Five years later 437,041 423,429 363,068 341,446 327,418 328,557 Six years later 437,052 427,723 362,824 341,374 327,162 Seven years later 437,015 427,355 362,508 341,076 Eight years later 436,737 427,059 362,216 Nine years later 436,518 426,844 Ten years later 436,307
Reserves re-estimated as
of:
One year later 465,934 440,158 365,566 359,262 313,192 309,953 352,709 323,791 348,865 417,225 Two years later 438,672 424,091 366,858 337,258 321,711 340,914 354,720 338,338 354,784 Three years later 439,125 425,404 359,925 335,246 341,695 328,190 361,264 339,965 Four years later 438,895 424,643 357,607 355,605 326,506 329,182 361,068 Five years later 436,397 422,389 377,414 340,537 326,565 329,318 Six years later 435,878 442,024 361,980 340,552 327,626 Seven years later 451,478 426,719 361,865 341,396 Eight years later 448,972 426,636 362,541 Nine years later 436,237 427,093 Ten years later 436,540
Redundancy (Deficiency) $ 116,332 $ 79,654 $ 105,716 $ 61,867 $ 1,395 $ (67,328 ) $ (75,011 ) $ (37,980 ) $ (21,671 ) $ 2,688

Supplemental Auto Claims
Data:
Claims reported during
the year for CA only 352,182 324,143 294,615 279,211 295,905 307,403 323,395 298,417 293,955 331,734 354,156 Claims pending at year
end for CA only 70,717 63,142 58,172 55,738 56,739 57,134 54,760 50,365 51,488 58,577 59,676

See Note 8 of the Notes to Consolidated Financial Statements.

TABLE 2 - Homeowner and
Earthquake Lines in
Runoff as of December 31,
(Amounts in thousands) 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Reserves for losses and LAE, direct
$ 203,371 $ 78,087 $ 75,272 $ 34,624 $ 52,982 $ 14,258 $ 12,379 $ 47,305 $ 50,896 $ 18,410 $ 6,131 Paid (cumulative) as of:
One year later 193,887 55,738 75,100 30,232 48,848 13,103 30,706 58,274 71,147 16,277 Two years later 236,406 119,211 100,296 74,127 58,281 37,404 78,647 125,447 87,343 Three years later 295,768 139,792 142,850 82,974 81,887 83,985 143,564 140,742 Four years later 314,225 180,799 151,342 106,274 128,266 147,856 157,792 Five years later 354,324 188,987 174,513 152,592 192,121 161,560 Six years later 362,379 211,771 220,805 216,383 205,591 Seven years later 385,161 257,839 284,455 229,808 Eight years later 431,154 321,169 297,754 Nine years later 494,260 334,053 Ten years later 507,110
Reserves re-estimated as
of:
One year later 253,775 116,741 101,903 77,445 58,582 18,024 68,245 103,470 89,281 22,406 Two years later 290,526 142,071 145,635 82,716 61,393 72,546 121,176 142,211 93,388 Three years later 316,256 182,616 150,434 85,519 116,429 125,089 159,331 146,152 Four years later 355,690 186,631 153,521 140,532 169,157 163,045 162,998 Five years later 359,084 190,334 208,533 193,375 207,064 166,548 Six years later 363,260 245,267 261,389 231,217 210,486 Seven years later 418,407 298,161 299,109 234,661 Eight years later 471,330 335,657 302,550 Nine years later 508,639 338,735 Ten years later 511,724
Redundancy (Deficiency) $ (308,353 ) $ (260,648 ) $ (227,278 ) $ (200,037 ) $ (157,504 ) $ (152,290 ) $ (150,619 ) $ (98,847 ) $ (42,492 ) $ (3,996 )

NOTE: Costs associated with claims that were re-opened as a result of SB 1899 are displayed in the table as a 1994 event (since they all related to the Northridge Earthquake) even though the legislation allowing the re-opening of these claims was not passed until almost seven years later.

See Notes 8 and 16 of the Notes to Consolidated Financial Statements.

Auto Lines Reserve Development. As shown in the ten-year development table, our auto lines historically developed redundancies prior to 1999 and have exhibited adverse development for 1999 through 2002. For 2003, there was favorable development of $2.7 million. The period from 1993 to 1999 was quite unusual in that, during that time, we experienced declining frequencies and declining severities in our auto line. As Table 1 shows, we did not immediately have confidence in these declining trends and did not immediately lower our reserve estimates.

Much of the decline in trend occurred between 1996 and 1998 because of moderation in health care costs due to greater use of HMO's and laws that were enacted in California that limited the ability of uninsured motorists and drunk drivers to collect non-economic damages. During 1999, we assumed that the past trend of declining frequencies and severities would continue. However, in retrospect, it can now be seen that the favorable decline in trends ended and loss costs began to increase. In 2000, we continued to assume lower loss severity primarily because of what then seemed to be an acceleration in the pattern of claims payments and the uncertainty inherent in identifying a change in multi-year patterns. In 2001, we experienced significant, unexpected development in our uninsured motorist coverage while the actuarial indications for most prior accident years were adjusted upward as more data became available. The changes in injury trends affected the entire California market and occurred, to a greater or lesser degree, in virtually every state in the country.

Starting in 2001, we improved the quality and timeliness of the data available to make initial estimates and periodic changes in estimates. We have dedicated more resources to better understand the underlying drivers of the changes in frequency and severity trends as they begin emerging. For example, in the second quarter of 2003 we began making accident month actuarial analyses of our reserves for the auto lines. Our improved methodology is reflected in the small favorable development of $2.7 million recorded in 2004 with respect to 2003 and prior accident years.

Homeowner and Earthquake Lines in Runoff. In Table 2, substantially all of the development relates to the earthquake line. A major earthquake occurred on January 17, 1994, centered in the San Fernando Valley community of Northridge (the "Northridge Earthquake"). Through December 31, 2004, we have settled over 46,000 Northridge Earthquake claims (including auto claims) at a total cost (i.e., loss plus LAE) of over $1.2 billion.

In September 2000, the State of California enacted Senate Bill 1899 ("SB 1899"), which allowed Northridge Earthquake claims barred by contract and the statute of limitations to be reopened during calendar year 2001. Please see Note 16 of the Notes to Consolidated Financial Statements for additional background on the Northridge Earthquake and SB 1899, including a discussion of factors that have contributed to the difficulty of obtaining accurate loss and LAE estimates in the wake of that legislation.

The loss development in Table 2 is easiest to understand by dividing it into "pre-SB 1899" and "post-SB 1899" segments. This is because the costs relating to the reopened claims are displayed in the table as a 1994 event (since they all related to the Northridge Earthquake), even though the legislation allowing the re-opening of certain claims was not passed until almost seven years later. Before SB 1899 was passed in late 2000, we had only approximately 50 earthquake claims remaining to be resolved out of an initial 35,000 homeowner earthquake claims. Although we settled 98% of the claims within a year of the quake, many upward changes in estimates were required in 1994 and beyond as new information emerged on the severity of the damages and as settlements of litigated claims occurred. As a result, we recorded the following upward changes in loss estimates after 1994, but before SB 1899 came into play: 1995 - $57 million; 1996 - $40 million; 1997 - $24.8 million; 1998 - $40 million; 1999 - $2.5 million; and 2000 - $3.5 million.

Calendar year 2001 was the one-year window SB 1899 permitted for claimants to bring additional insurance claims and legal actions allegedly arising out of the Northridge Earthquake. Prior to the enactment of this law, such claims were considered by previously applicable law to be fully barred, or settled and closed. Any additional legal actions with respect to such claims were barred under the policy contracts, settlement agreements, and/or applicable statutes of limitation. As a result of the enactment of this unprecedented legislation, claimants asserted additional claims against the Company allegedly related to damages that occurred in the 1994 earthquake but which were now being reported seven years later in 2001. Plaintiff attorneys and public adjusters conducted extensive advertising campaigns to solicit claimants. Hundreds of claims were filed in the final days and hours before the December 31, 2001 deadline.

During 2001, the Company recorded an additional $70.0 million of pre-tax losses related to the 1994 earthquake, including $50 million in the fourth quarter to cover the indemnity and inspection portion of the claims. In the first two quarters of 2002, we expensed an additional $11.9 million of legal defense costs as they were paid. The Company lacked sufficient information to record a reasonable estimate of the related legal defense costs until the third quarter of 2002, at which time an additional provision of $46.9 million was recorded. Based on subsequent developments, we recorded an additional provision of $37.0 million in the first quarter of 2003 and $2.2 million in 2004 (see additional discussion in Note 16 of the Notes to Consolidated Financial Statements).

At the end of each month, legal and claims personnel within the Company review the adequacy of the remaining SB 1899 reserves based on the most current information available. Based on that review, we believe our remaining earthquake reserves are adequate as of December 31, 2004. More than ninety-eight percent of the claims submitted and litigation brought against the Company as a result of SB 1899 have been resolved. Substantially all of the Company's remaining 1994 Earthquake claims are in litigation. No class actions have been certified and the trial court has denied class action status for the two remaining cases seeking class action status. While the reserves established are the Company's current best estimate of the cost of resolving its 1994 Earthquake claims, including claims arising as a result of SB 1899, these reserves continue to be highly uncertain because of the difficulty in predicting how the remaining litigated cases will be resolved.

Reinsurance
A reinsurance transaction occurs when an insurer transfers or cedes a portion of its exposure to a reinsurer for a premium. The reinsurance cession does not legally discharge the insurer from its liability for a covered loss, but provides for reimbursement from the reinsurer for the ceded portion of the risk. We periodically monitor the continuing appropriateness of our reinsurance arrangements to determine that our retention levels are reasonable and that our reinsurers are financially sound, able to meet their obligations under the agreements and that the contracts are competitively priced.

The majority of our cessions are with AIG subsidiaries, which have earned A.M. Best's highest financial rating of A++. The A.M. Best financial ratings of our other reinsurers range from A- to A+. Our reinsurance arrangements are discussed in more detail in Note 10 of the Notes to Consolidated Financial Statements.

Our net retention of insurance risk after reinsurance for 2005 and the preceding five years is summarized below:

Contracts Incepting During Net Retention 2005 2004 2003 2002 2001 2000 Auto and motorcycle lines 100 % 100 % 100 % 97 % 1 94 % 92 % Personal umbrella policies2 10 10 10 10 16 37 Homeowner line in runoff 94 92

We also have catastrophe reinsurance agreements relating to the auto line with Endurance Specialty Insurance Company, National Union Insurance Company of Pittsburg, PA and Transatlantic Reinsurance Company, which reinsure any covered events up to $45.0 million in excess of $20.0 million ($30.0 million in excess of $15.0 million prior to January 1, 2004).

1 Effective September 1, 2002, we entered into an agreement to cancel future cessions under our quota share with AIG subsidiaries. The treaty would have ceded 4% of premiums for the auto and motorcycle lines to AIG subsidiaries in the remainder of 2002 and would have declined to 2% in 2003. After September 1, 2002, 100% of auto and motorcycle premiums are retained by us.

2 Personal umbrella coverage is only available to our auto customers.
Approximately 1% of auto customers have umbrella coverage.

State Regulation of Insurance Companies
Insurance companies are subject to regulation and supervision by the insurance departments of the various states. The insurance departments have broad regulatory, supervisory and administrative powers, such as:

· Licensing of insurance companies, agents and customer service employees;

· Prior approval, in California and some other jurisdictions, of premium rates;

· Establishment of capital and surplus requirements and standards of solvency;

· Nature of, and limitations on, investments insurers are allowed to hold;

· Periodic examinations of the affairs of insurers;

· Annual and other periodic reports of the financial condition and results of operations of insurers;

· Establishment of statutory accounting rules;

· Issuance of securities by insurers;

· Restrictions on payment of dividends; and

· Restrictions on transactions with affiliates.

Currently, the California Department of Insurance ("CDI") has primary regulatory jurisdiction over our subsidiaries, 21st Century Insurance Company and 21st Century Casualty Company, including prior approval of premium rates. The CDI typically conducts a financial examination of our affairs every three years. The most recently completed triennial examination, for the three years ended December 31, 2002, contained no findings or adjustments. In general, the current regulatory requirements in the other states in which our subsidiaries are licensed insurers are less restrictive than in California. 21st Century Insurance Company of the Southwest (formerly 21st Century Insurance Company of Arizona) changed its state of domicile from Arizona to Texas effective December 31, 2004.

In addition to regulation by the CDI, the Company and the personal lines insurance business in general are also subject to legislative, judicial and political action in addition to the normal business forces of competition between companies and the choices consumers make based on their preferences.

To our knowledge, no new laws were enacted in 2004 by any state in which we do business that are expected to have a material impact on the auto insurance industry. However, during 2004, hearings were conducted by the CDI, which could ultimately result in regulations that would restrict the use of territory in automobile insurance rating. Such regulations, if implemented, could negatively affect our book of business.

Holding Company Regulation
Our subsidiaries are also subject to regulation by the CDI pursuant to the provisions of the California Insurance Holding Company System Regulatory Act (the "Holding Company Act"). Many transactions defined to be of an "extraordinary" nature may not be effected without the prior approval of the
CDI. In addition, the Holding Company Act limits the amount of dividends our insurance subsidiaries may pay. An extraordinary transaction includes a dividend which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurance company's policyholders' surplus as of the preceding December 31 or (ii) the insurance company's statutory net income for the preceding calendar year.

The insurance subsidiaries currently have $199.6 million of statutory unassigned surplus. Up to $109.8 million of this amount could be paid as dividends to the parent company without prior written approval from insurance regulatory authorities in 2005. Our insurance subsidiaries have not paid any dividends to our holding company since 2001 due to the previous uncertainty surrounding the taxability of dividends received by holding companies from their insurance subsidiaries (see further discussion in Note 5 of the Notes to Consolidated Financial Statements).

Non-Voluntary Business
Automobile liability insurers in California are required to participate in the California Automobile Assigned Risk Plan ("CAARP"). Drivers whose driving records or other relevant characteristics make them difficult to insure in the voluntary market may be eligible to apply to CAARP for placement as "assigned risks." The number of assignments for each insurer is based on the total applications received by the plan and the insurer's market share. As of December 31, 2004, the number of assigned risk insured vehicles was 2,254 compared to 3,678 at the end of 2003. The CAARP assignments have historically produced underwriting losses. As of December 31, 2004, this business represented less than 1% of our total direct premiums written, and the underwriting losses were $0.9 million in 2004, $0.5 million in 2003 and $0.5 million in 2002.

Insurers offering homeowner insurance in California are required to participate in the California FAIR Plan ("FAIR Plan"). FAIR Plan is a state administered pool of difficult-to-insure homeowners. Each participating insurer is allocated a percentage of the total premiums written and losses incurred by the pool according to its share of total homeowner direct premiums written in the state. Participation in the current year FAIR Plan operations is based on the pool from two years prior. Since we ceased writing direct homeowners business in 2002, the Company will continue to receive assignments in the 2005 calendar year. Our FAIR Plan underwriting results for 2003, 2002 and 2001 were immaterial.

Employees
We had approximately 2,800 full and part-time employees at December 31, 2004. We provide medical, pension and 401(k) savings plan benefits to eligible employees, according to the provisions of each plan.

Debt Offering
In December 2003, the Company completed a private offering of $100 million principal amount of 5.9 percent Senior Notes due in December 2013 at a discount of $0.8 million. The effective interest rate on the Senior Notes, when all offering costs are taken into account and amortized over the term of the Senior Notes, is approximately 6 percent per annum. Of the $99.2 million in net proceeds from the offering, $85.0 million was used to increase the statutory surplus of 21st Century Insurance Company, a wholly-owned subsidiary of the Company, and the balance was retained by the holding company.

On April 6, 2004, pursuant to a registration rights agreement executed in connection with the offering, the Company filed a registration statement with the SEC enabling holders to exchange the private offering notes for publicly registered notes. On July 8, 2004, the Company completed an exchange offer in which all of the private offering notes were exchanged for publicly registered notes having the same terms.