Edgar Filing: 21ST CENTURY INSURANCE GROUP

21st Century Insurace 10K 12-31-2004

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

Commission File Number 0-6964

21ST CENTURY INSURANCE GROUP

(Exact name of registrant as specified in its charter)

Delaware	95-1935264
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

6301 Owensmouth Avenue
Woodland Hills, California	91367
(Address of principal executive offices)	(Zip Code)

(818) 704-3700	www.21st.com
(Registrant's telephone number, including area code)	(Registrant's Web site)

Securities registered pursuant to Section 12 (b) of the Act:

	Name of each exchange on
Title of each class	which registered
Common Stock, Par Value $0.001	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. Yes x No o

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. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No o

The aggregate market value of the voting stock held by non-affiliates of 21st Century Insurance Group, based on the average high and low prices for shares of the registrant's Common Stock on June 30, 2004, as reported by the New York Stock Exchange, was approximately $401,000,000.

There were 85,489,061 shares of common stock outstanding on January 31, 2005.

Document Incorporated By Reference:

Part III of this Form 10-K incorporates by reference certain information from the registrant's definitive proxy statement for the Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, 2004.

TABLE OF CONTENTS

Description		Page Number
Part I
Item 1.	Business	4
Item 2.	Properties	19
Item 3.	Legal Proceedings	19
Item 4.	Submission of Matters to a Vote of Security Holders	20
Part II		20
Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	20
Item 6.	Selected Financial Data	21
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	22
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	38
Item 8.	Financial Statements and Supplementary Data	40
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	76
Item 9A.	Controls and Procedures	76
Item 9B.	Other Information	77
Part III		77
Item 10.	Directors and Executive Officers of the Registrant	77
Item 11.	Executive Compensation	77
Item 12.	Security Ownership of Certain Beneficial Owners and Management	77
Item 13.	Certain Relationships and Related Transactions	77
Item 14.	Principal Accountant Fees and Services	77
Part IV		78
Item 15.	Exhibits and Financial Statement Schedules	78
Schedule II - Condensed Financial Information of Registrant		81
Signatures of Officers and Board of Directors		85

Exhibits		86
10(i)	Short Term Incentive Plan.
10(r)	Summary of Director Compensation.
10(v)	Amendments to Lease Agreements for Registrant's Principal Offices.
10(w)	Registrant's Supplemental Pension Plan.
10(x)	Registrant's Supplemental 401(k) Plan.
10(y)	Settlement and Release Agreement between Registrant and G. Edward Combs.
10(z)	Registrant's Executive Medical Reimbursement Plan.
14	Code of Ethics.
21	Subsidiaries of Registrant.
23	Consent of Independent Registered Public Accounting Firm.
31.1	Certification of President and Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a).
31.2	Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a).
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

PART I

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.

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
Homeowner³and 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 rate changes	None	+3.9% April	+5.7% May	+4.0% July	+6.4% 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.

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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.

_____________________

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).

_________________________

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.

ITEM 2.

PROPERTIES

We lease approximately 406,000 square feet of office space for our headquarters facilities, which are located in Woodland Hills, California. The lease term expires in February 2015, and the lease may be renewed for two consecutive five-year periods.

We also lease office space in 15 other locations, of which 12 locations are in California primarily for claims-related employees. We anticipate no difficulty in extending these leases or obtaining comparable office facilities in suitable locations.

Our newest location is a customer service, sales and claims center in Lewisville, Texas. The facility opened in mid-2004 and represents a strategic expansion of our service and sales resources.

On December 31, 2002, the Company entered into a sale-leaseback transaction for $15.8 million of equipment and leasehold improvements and $44.2 million of software. The leaseback transaction has been accounted for as a capital lease. For a summary of the Company's lease obligations, see discussion under Item 7 of this report and Notes 9 and 12 of the Notes to Consolidated Financial Statements.

ITEM 3.

LEGAL PROCEEDINGS

In the normal course of business, the Company is named as a defendant in lawsuits related to claims and insurance policy issues, both on individual policy files and by class actions seeking to attack the Company's business practices. A description of the legal proceedings to which the Company and its subsidiaries are a party is contained in Note 12 of the Notes to Consolidated Financial Statements.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters submitted during the fourth quarter of 2004.

PART II

ITEM 5.

MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Price Range of Common Stock

The Company's common stock is listed on the New York Stock Exchange ("NYSE") under the ticker symbol "TW". The following table sets forth the high and low bid prices on the NYSE for the common stock for the indicated periods.

	2004				2003
	*High*		*Low*		High		Low
Fourth Quarter	$	13.82	$	12.39	$	14.50	$	13.00
Third Quarter		14.15		12.50		16.05		13.03
Second Quarter		15.35		12.50		17.25		12.00
First Quarter		14.90		13.19		13.50		11.20

(b)

Holders of Common Stock

The approximate number of holders of our common stock on December 31, 2004 was 600.

(c)

Dividends

Quarterly dividends of $0.02 per share were declared from the first quarter of 2003 through the fourth quarter of 2004. The Company's Board of Directors considers a variety of factors in determining the timing and amount of dividends. Accordingly, the Company's past history of dividend payments does not assure that future dividends will be paid. In addition, there are limits on the insurance subsidiaries' dividend paying capacity. In 2005, the Company estimates that one of its insurance subsidiaries has capacity to pay approximately $109.8 million in dividends to its parent, before the effect of California state income taxes, without prior approval of the CDI.

(d)

Securities Authorized for Issuance under Equity Compensation Plans

Securities authorized for issuance under equity compensation plans at December 31, 2004 are as follows:

	COLUMN A	COLUMN B	COLUMN C

Plan Category	Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (in thousands)	Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights	Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (A)) (in thousands)
Equity compensation plans approved by stockholders	8,109	$16.49	5,367
Equity compensation plans not approved by stockholders	None	N/A	N/A
Total	8,109	$16.49	5,367

See Note 14 of the Notes to Consolidated Financial Statements for additional information.

ITEM 6.

SELECTED FINANCIAL DATA

The following selected financial data for each of the years in the five-year period ended December 31, 2004 should be read in conjunction with the Company's consolidated financial statements and the accompanying notes included in Item 8 of this report. All amounts set forth in the following tables are in thousands, except for ratios and per share data.

Years Ended December 31,	2004			2003			2002			2001			2000
Personal Auto Lines Data
Direct premiums written	$	1,337,190		$	1,223,377		$	995,794		$	898,862		$	881,212
Ceded premiums written¹		(4,815	)		(4,858	)		(18,902	)		(56,205	)		(72,675	)
Net premiums written		1,332,375			1,218,519			976,892			842,657			808,537
Net premiums earned		1,313,551			1,172,679			924,559			838,489			803,770

Loss and LAE ratio²		75.4	%		78.6	%		82.9	%		88.1	%		90.8	%
Underwriting expense ratio³		19.7			17.9			15.6			14.9			14.2
Combined ratio⁴		95.1	%		96.5	%		98.5	%		103.0	%		105.0	%

All Lines Data
Direct premiums written	$	1,337,198		$	1,223,484		$	998,248		$	929,315		$	910,720
Ceded premiums written⁵		(4,814	)		(4,854	)		(32,949	)		(60,359	)		(78,592	)
Net premiums written		1,332,384			1,218,630			965,299			868,956			832,128
Net premiums earned		1,313,670			1,172,677			924,559			864,145			825,486
Total revenues		1,383,332			1,246,464			981,295			914,078			869,762

Loss and LAE ratio		75.6	%		82.0	%		89.4	%		96.7	%		90.8	%
Expense ratio³		19.7			17.9			15.5			15.0			14.4
Combined ratio⁶		95.3	%		99.9	%		104.9	%		111.7	%		105.2	%

Net Income (Loss)	$	88,225		$	53,575		$	(12,256	)	$	(27,568	)	$	12,945

Earnings (Loss) per Share
Basic	$	1.03		$	0.63		$	(0.14	)	$	(0.32	)	$	0.15
Diluted		1.03			0.63			(0.14	)		(0.32	)		0.15
Dividends declared per Share		0.08			0.08			0.26			0.32			0.48

__________________________

¹	The decrease in premiums ceded from 2000 through 2004 was caused primarily by scheduled decreases in the AIG subsidiaries quota share program, which was terminated effective September 1, 2002.

²	The loss and LAE ratios have decreased since 2000 primarily due to increases in net premiums earned and the favorable impact on claim frequency of drought conditions that have largely prevailed in southern California.

The increase in the 2002 to 2004 expense ratios is primarily due to increased advertising expenditures, increased costs for improving customer service and opening a call center in Texas. The increase in the expense ratio from 2000 to 2001 reflects higher depreciation charges due to investments in new technology.

⁴

The combined ratio for the personal auto lines was impacted by the following items: $13.6 million of costs associated with workforce reductions and the settlement of litigation matters in 2001; Year 2000 remediation costs of $2.4 million in 1999; and (favorable) unfavorable prior accident year loss and LAE development of $(2.9) million, $11.2 million, $16.2 million, $45.7 million, and $42.2 million in 2004, 2003, 2002, 2001, and 2000, respectively.

⁵	In addition to the AIG subsidiaries cession discussed in footnote 1 above, our homeowners line was 100% reinsured in 2002.

⁶

In addition to the effect of the items described in footnote 4 above, the combined ratio for all lines was impacted by adverse development on remaining loss reserves from the homeowner and earthquake lines, which are in runoff, of $2.8 million in 2004, $40.2 million in 2003, $58.8 million in 2002, $77.6 million in 2001, and $2.7 million in 2000.

December 31,	2004		2003		2002		2001		2000
Balance Sheet Data:
Total investments and cash	$	1,418,912	$	1,284,686	$	1,030,478	$	884,633	$	920,328
Total assets		1,864,314		1,738,132		1,470,037		1,354,398		1,340,916
Unpaid losses and loss adjustment expenses		495,542		438,323		384,009		349,290		298,436
Unearned premiums		331,036		312,254		266,477		236,473		236,519
Debt¹		138,290		149,686		60,000		—		—
Total liabilities		1,089,913		1,037,442		814,429		695,092		620,355
Stockholders' equity		774,401		700,690		655,608		659,306		720,561
Book value per common share		9.06		8.20		7.67		7.72		8.46
Statutory surplus²		614,893		535,026		397,381		393,119		475,640
Net premiums written to surplus ratio³		2.2:1		2.3:1		2.4:1		2.2:1		1.7:1

ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a direct-to-consumer provider of personal auto insurance in California and eight other Western, Southwestern and Midwestern states. We also provide motorcycle and personal umbrella insurance in California. We believe that we deliver superior policy features and customer service at a competitive price. We began offering personal auto insurance in Illinois, Indiana and Ohio on January 28, 2004, and in Texas on January 3, 2005.⁴

Our primary goals include achieving and sustaining 15% annual growth in premiums written and a 96% (or better) combined ratio in our personal auto lines. For 2004, our net premiums earned for personal auto grew 12% ($140.9 million) to $1,313.6 million from $1,172.7 million in 2003. The combined ratio for personal auto improved 1.4% to 95.1% in 2004 compared to 96.5% in 2003.

Net income for 2004 was $88.2 million, compared to net income of $53.6 million in 2003 and a net loss in 2002 of $12.3 million. The 2003 full year results include a first quarter after-tax charge of $24.1 million to strengthen earthquake reserves and certain nonrecurring, nonoperational items that increased second quarter net income by $9.6 million after-tax.

Cash flow from operations for the fourth quarter of 2004 was $34.1 million compared to $43.2 million from the fourth quarter of 2003. For the year ended December 31, 2004, cash flow from operations was $203.4 million compared to $188.5 million for 2003. Total assets also increased to $1.86 billion at December 31, 2004, from $1.74 billion at December 31, 2003. In December 2003, the Company completed a $100 million senior debt offering and used $85 million of the proceeds to increase the statutory surplus of its principal insurance subsidiary.

See "Results of Operations" for more details as to our overall and personal auto lines results.

___________________________

¹	Amount shown for 2002 is a capital lease obligation (see Note 9 of the Notes to Consolidated Financial Statements).

²	Amount shown for 2002 would be $343,661 were it not for the sale-leaseback transaction described in Note 9 of the Notes to Consolidated Financial Statements.

³	Amount shown for 2002 would be 2.8:1 were it not for the sale-leaseback transaction referred to above.

⁴	Results from the Texas market are not expected to be material in 2005.

The remainder of our Management's Discussion and Analysis provides a narrative on the Company's financial condition and performance that should be read in conjunction with the accompanying financial statements. It includes the following sections:

·	Financial Condition

·	Liquidity and Capital Resources

·	Contractual Obligations and Commitments

·	Off Balance Sheet Arrangements

·	Results of Operations

·	Underwriting Results

·	Losses and LAE Incurred

·	Investment Income

·	Other Income

·	Critical Accounting Estimates

·	Recent Accounting Standards

·	Forward-Looking Statements

Financial Condition

Investments and cash increased $134.2 million (10.4%) since the prior year primarily due to the $203.4 million of operating cash flow offset by cash outflows of $40.4 million for fixed assets, $20.0 million for debt servicing, $8.5 million in shareholder dividends, and $0.3 million net change in various accounts.

The Company's investment portfolio of $1,384.2 million contained $42.0 million of equity securities, which are a new investment vehicle for the Company.

At December 31, 2004, investment-grade bonds comprised substantially all of the fair value of the fixed maturity portfolio. As of December 31, 2004, eleven fixed maturity securities were rated below BBB. These securities represent less than 1% of our total investments. Of our total investments at December 31, 2004, approximately 22.3% were invested in tax-exempt, fixed-income securities, compared to 61.7% at December 31, 2003.

Increased advertising, compensation and other operating costs through December 31, 2004, associated with increased customer volume, contributed to an increase in deferred policy acquisitions costs ("DPAC") of $5.7 million to $58.8 million, compared to $53.1 million at December 31, 2003. The Company's DPAC is estimated to be fully recoverable (see Critical Accounting Estimates - Deferred Policy Acquisition Costs).

Our loss and LAE reserves, gross and net of reinsurance, are summarized in the following table:

AMOUNTS IN THOUSANDS	2004				2003
December 31,	Gross		Net		Gross		Net
Unpaid Losses and LAE:
Personal auto lines	$	489,411	$	485,759	$	419,913	$	413,348
Homeowner and earthquake lines in runoff		6,131		5,138		18,410		16,011
Total	$	495,542	$	490,897	$	438,323	$	429,359

Gross unpaid losses and LAE increased by $57.2 million in 2004 primarily due to a reserve increase of $69.5 million in the personal auto lines as a result of growth in our customer base. The increase in the personal auto lines was offset by the $12.3 million net decrease in the homeowner and earthquake lines, which are in runoff (see Results of Operations - Loss and LAE Incurred for a description of the Company's reserving process).

Unearned premiums increased 6.0% to $331.0 million at the end of 2004 compared to $312.3 million at the end of 2003 due to higher volume in our personal auto lines.

Debt consists of a $38.4 million capital lease obligation with GE Capital Corporation and the $99.9 million senior note offering issued in December 2003, aggregating $138.3 million (see Note 9 of the Notes to Consolidated Financial Statements). The primary purpose of both borrowings was to increase the statutory surplus of 21st Century Insurance Company, our wholly-owned subsidiary, which had significant adverse earthquake and auto reserve development in 2000, 2001, and 2002. The decrease in debt of $11.4 million from the prior year is attributable to principal payments on the capital lease.

Stockholders' equity and book value per share increased to $774.4 million and $9.06, respectively, at December 31, 2004, compared to $700.7 million and $8.20 at December 31, 2003. The increase for the year ended December 31, 2004, was primarily due to net income of $88.2 million, offset by a decrease in accumulated other comprehensive income of $8.9 million and dividends to stockholders of $6.8 million.

Effective December 4, 2003, we changed our state of incorporation from California to Delaware. In connection with the change, our common stock was assigned a par value of $0.001 per share, resulting in a reclassification of $419.2 million from common stock to additional paid-in capital. There was no change in the location of company operations, location of employees, or the way we do business as a result of the reincorporation.

Liquidity and Capital Resources

21st Century Insurance Group. Our holding company's main sources of liquidity historically have been dividends received from our insurance subsidiaries and proceeds from issuance of debt or equity securities. Apart from the exercise of stock options and restricted stock grants to employees, the effects of which have not been significant, we have not issued any equity securities since 1998 when AIG exercised its warrants to purchase common stock for cash of $145.6 million. 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).

In December 2003, we completed a private offering of $100 million principal amount of 5.9 percent Senior Notes due in December 2013. 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 net proceeds from the offering, $85.0 million was used to increase the statutory surplus of our wholly-owned insurance subsidiary, 21st Century Insurance Company, and the balance was retained by our holding company. 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.

Effective December 31, 2003, the California Department of Insurance approved an intercompany lease whereby 21st Century Insurance Company leases certain computer software from our holding company. The monthly lease payment, currently $0.6 million, started in January 2004 and is subject to upward adjustment based on the cost incurred by the holding company to complete certain enhancements to the software.

Our holding company's significant cash obligations over the next several years consist of interest payments on the Senior Notes ($5.9 million annually) and the estimated cost of $22.0 million to implement our California policy servicing system in 2005, exclusive of any dividends to stockholders that the holding company may declare, and the repayment of the $100 million principal on the Senior Notes due in 2013. The holding company expects to be able to meet those obligations from sources of cash currently available (i.e., payments received from the intercompany lease and cash and investments at the holding company. Total cash and investments at the holding company were $16.2 million at December 31, 2004.), additional funds obtainable from the capital markets or from dividends received from its insurance subsidiaries. California currently levies state income taxes of approximately 1.8% on the amount of any such dividends received.

Our insurance subsidiaries could pay $109.8 million in 2005 as dividends to the holding company without prior written approval from insurance regulatory authorities.

Insurance Subsidiaries. We have achieved underwriting profits in our core auto insurance operations for the last twelve quarters and have thereby enhanced our liquidity. Our cash flow from operations and short-term cash position generally are more than sufficient to meet obligations for claim payments, which by the nature of the personal automobile insurance business tend to have an average duration of less than a year. In California, where approximately 96.5% of our premium is written, underwriting profit improved in 2004 without additional rate increases. We implemented a 3.9% auto premium rate increase effective March 31, 2003 and a 5.7% rate increase in May of 2002, both of which continued a series of actions we began taking in 2000 to restore underwriting profitability.

Although in the past years we have been successful in gaining regulatory approval for rate increase, there can be no assurance that insurance regulators will grant future rate increases that may be necessary to offset possible future increases in claims cost trends. Also, we remain exposed to possible upward development in previously recorded reserves for claims pursuant to SB 1899. As a result of such uncertainties, underwriting losses could occur in the future. Further, we could be required to liquidate investments to pay claims, possibly during unfavorable market conditions, which could lead to the realization of losses on sales of investments. Adverse outcomes to any of the foregoing uncertainties would create some degree of downward pressure on the insurance subsidiaries' earnings or cash flows, which in turn could negatively impact our liquidity.

As of December 31, 2004, our insurance subsidiaries had a combined statutory surplus of $614.9 million compared to $535.0 million at December 31, 2003. The change in statutory surplus was primarily due to statutory net income of $110.3 million. This was partially offset by a decrease in net deferred tax assets of $20.9 million and an increase in nonadmitted assets of $10.0 million. Our ratio of net premiums written to statutory surplus improved to 2.2 at December 31, 2004, compared to 2.3 at December 31, 2003.

On June 15, 2004, the CDI finalized its examination reports on the statutory financial statements for the Company's California-domiciled insurance subsidiaries for the three-year period ended December 31, 2002. The reports did not contain any findings or adjustments.

Transactions with Related Parties. Since 1995, we have entered into several transactions with AIG subsidiaries, including various reinsurance agreements, which are discussed under Item 1. Business. At December 31, 2004, reinsurance recoverables, net of payables, from AIG subsidiaries were $1.4 million, compared to $5.8 million at December 31, 2003. Other transactions with AIG subsidiaries, which are immaterial, have resulted from competitive bidding processes for certain corporate insurance coverages and certain software and data processing services. In October 2003, as a result of a competitive bidding process, we entered into an agreement with an AIG subsidiary to provide investment management services to us; the agreement was approved by the California Department of Insurance.

Contractual Obligations and Commitments

We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. Certain contractual obligations, such as operating lease obligations, are not recognized as liabilities in our consolidated financial statements, but are required to be disclosed.

The following table summarizes our significant contractual obligations and commitments at December 31, 2004 and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal payments on outstanding senior notes.

			Payments Due by Period
AMOUNTS IN MILLIONS	Total		2005		2006 through 2007		2008 through 2009		Remaining years after 2009
Senior notes	$	153.1	$	5.9	$	11.8	$	11.8	$	123.6
Capital lease obligation		41.9		14.0		27.9		–		–
Debt		195.0		19.9		39.7		11.8		123.6
Operating Leases¹		194.3		27.2		42.8		34.1		90.2
Total	$	389.3	$	41.1	$	82.5	$	45.9	$	213.8

The table above excludes periodic contributions to pension plans and payments to settle claims, which are discussed below. The capital lease obligation above resulted from the sale-leaseback transaction discussed earlier (see further discussion of these items in Notes 9 and 12 of the Notes to Consolidated Financial Statements). We have no material purchase obligations or other on or off balance sheet long-term liabilities or obligations at December 31, 2004 (see discussion about variable interest entities in Note 2 of the Notes to Consolidated Financial Statements).

Our largest insurance subsidiary is responsible for making payments on both the capital lease obligation and most of the operating lease obligations. The holding company is the obligor on the home office subsidiary leases in Woodland Hills, California.

We sponsor defined benefit pension plans that may obligate us to make contributions to the plans from time to time. Total contributions to the plans were $2.7 million in 2004, $7.0 million in 2003 and $21.5 million in 2002. For the past several years we have followed the practice of contributing sufficient amounts to the qualified defined benefit pension plan to meet or exceed statutory funding requirements, without exceeding the maximum amount that would be deductible for corporate income tax purposes, and while maintaining plan assets at a level at least equal to the actuarial present value of accumulated plan benefits. The amount and timing of future contributions to our qualified defined benefit pension plan depends on a number of unpredictable factors including statutory funding requirements, the market performance of the plan's assets, cash requirements for benefit payments to retirees, and future changes in interest rates that affect the actuarial measurement of the plan's obligations. Contributions to our non-qualified defined benefit pension plan generally are limited to amounts needed to make benefit payments to retirees, which are expected to total approximately $1.1 million in 2005.

We had estimated liabilities for losses and LAE of $495.5 million at December 31, 2004, the majority of which will be required to be paid in 2005 as the related claims are settled. We expect operating cash flow to be sufficient to meet our obligations to pay claims and we have readily marketable investments available for sale should operating cash flows prove to be inadequate.

Off Balance Sheet Arrangements

We currently have no letters of credit, have issued no guarantees on behalf of others (other than the guarantee by 21st Century Insurance Group of the capital lease obligation described above), have no trading activities involving non-exchange-traded contracts accounted for at fair value, and have no obligations under any derivative financial instruments. In addition, the Company has no material retained interests in assets transferred to any unconsolidated entity (see further discussion in Note 2 of the Notes to Consolidated Financial Statements).

_________________________

¹	Includes amounts due under long-term software license agreements of approximately $15.1 million.

Results of Operations

Overall Results. We reported an increase of 64.7% in net income to $88.2 million, or $1.03 earnings per share, on direct premiums written of $1,337.2 million for the year ended December 31, 2004, compared to a net income of $53.6 million, or $0.63 earnings per share, on direct premiums written of $1,223.5 million for the year ended December 31, 2003. For the year ended December 31, 2002, we reported a net loss of $12.3 million, or $0.14 loss per share, on direct premiums written of $998.2 million. The results for 2003 and 2002 include: (i) after-tax charges of $24.1 million in the first quarter of 2003 and $34.2 million in the third quarter of 2002 to strengthen earthquake reserves; (ii) after-tax net income of $9.6 million for the year ended December 31, 2003, resulting from nonrecurring, nonoperational items and a favorable tax settlement with the IRS; and (iii) an after-tax charge of $24.2 million, for the year ended December 31, 2002, relating to a write-off of software.

Personal Auto Lines Results. The following table presents the components of our personal auto lines underwriting profit or loss and the components of the combined ratio for the past three years:

AMOUNTS IN THOUSANDS	Personal Auto Lines
Years Ended December 31,	2004			2003			2002
Direct premiums written	$	1,337,190		$	1,223,377		$	995,794
Net premiums written		1,332,375			1,218,519			976,892
Net premiums earned		1,313,551			1,172,679			924,559
Net losses and loss adjustment expenses		991,008			922,122			768,277
Underwriting expenses incurred		258,571			209,551			142,899
Personal auto lines underwriting profit	$	63,972		$	41,006		$	13,383
Ratios:
Loss and LAE ratio		75.4	%		78.6	%		82.9	%
Underwriting expense ratio		19.7	%		17.9	%		15.6	%
Combined ratio		95.1	%		96.5	%		98.5	%

The following table reconciles our personal auto lines underwriting profit to our consolidated net income (loss):

AMOUNTS IN THOUSANDS
Years Ended December 31,	2004			2003			2002
Personal auto lines underwriting profit	$	63,972		$	41,006		$	13,383
Homeowner and earthquake lines in runoff, underwriting loss		(2,714	)		(40,175	)		(58,768	)
Net investment income		58,831			45,833			46,345
Realized investment gains		10,831			13,177			10,391
Write-off of software		–			–			(37,177	)
Other income		–			14,777			–
Interest and fees expense		(8,627	)		(3,471	)		–
Federal income tax (expense) benefit		(34,068	)		(17,572	)		13,570
Net income (loss)	$	88,225		$	53,575		$	(12,256	)

Comments relating to the underwriting results of the personal auto and the homeowner and earthquake lines in runoff are presented below.

Underwriting Results

The tables presented in the Notes to Consolidated Financial Statements summarize the Company's unaudited quarterly results of operations for each of the two years in the period ended December 31, 2004. The following discussion of underwriting results by line of business should be read in conjunction with the information presented in those tables and elsewhere herein.

Personal Auto. Personal automobile insurance is our primary line of business. Vehicles insured outside of California accounted for less than 4% of our direct premiums written in 2004, 2003 and 2002.

Our management remains focused on achieving sustainable 15% direct premium written growth and a combined ratio of 96%. In 2004, we met our profitability goals, posting our best combined ratio since 1999, and our direct premiums written grew 9.3% despite an increasingly competitive California marketing climate.

Direct premiums written grew 9.3% in 2004, 22.8% in 2003 and 10.8% in 2002, for a three-year compound average growth rate of 14.1%, or slightly less than our long-term goal of 15%. Market conditions in California were somewhat less favorable for growth in 2004 than in the preceding two years; for example, some major competitors sought rate decreases in 2004 in contrast with the market-wide rate increases, which helped to spur consumers' shopping activity in 2003 and 2002. As we proceed with our multi-state expansion, we believe that achieving our long-term growth goal will steadily depend less on the California marketplace.

California auto retention was 93% for the year ended December 31, 2004, compared to 92% and 93% for the years ended December 31, 2003 and 2002, respectively. The increase in 2004 is primarily due to a decline in the growth rate of new customers who typically have a lower retention rate than long-time customers.

Net premiums earned increased $140.9 million (12.0%) to $1,313.6 million in 2004, compared to $1,172.7 million in 2003 and $924.6 million in 2002. The combined ratio was 95.1% for the year ended December 31, 2004, compared to 96.5% and 98.5% for 2003 and 2002, respectively.

Net losses and LAE incurred increased $68.9 million (7.5%) to $991.0 million in 2004 compared to $922.1 million and $768.3 million in 2003 and 2002, respectively. The loss and LAE ratios were 75.4%, 78.6% and 82.9% for the years ended December 31, 2004, 2003 and 2002, respectively. The effects on the loss and LAE ratios of changes in estimates relating to insured events of prior years were as follows: 0.2% favorable in 2004; 1.0% unfavorable in 2003; and 1.8% unfavorable in 2002. For additional discussion of the factors that led to these changes in estimates, please see Item 1 of this report under the heading Loss and Loss Adjustment Expense Reserves. In general, changes in estimates are recorded in the period in which new information becomes available indicating that a change is warranted, usually in conjunction with our monthly actuarial review.

The ratios of underwriting expenses to net premiums earned were 19.7%, 17.9% and 15.6% for the years ended December 31, 2004, 2003 and 2002, respectively. The increase from 2002 to 2003 was primarily due to growth in advertising expenditures and costs associated with increasing the number of new sales agents to handle record volume of new business during the latter half of 2002 and all of 2003. The increase from 2003 to 2004 consists primarily of increased advertising costs, additional sales workforce costs, and facility and support costs to improve service and support the Texas call center. Several productivity enhancement initiatives are underway aimed at reducing per unit process costs and lowering fixed costs in corporate support areas.

Homeowner and Earthquake Lines in Runoff. We have not written any earthquake policies since 1994 and we exited the homeowners insurance business at the beginning of 2002. The homeowner and earthquake lines, which are in runoff, experienced adverse development on the remaining loss reserves of $2.8 million, compared to adverse development of $40.1 million in 2003 and $56.2 million in 2002. Of these amounts, $2.2 million, $36.9 million, and $52.6 million, respectively, related to SB 1899 earthquake claims. We caution that the recorded loss and LAE estimates for our earthquake lines are subject to a greater than normal degree of uncertainty for a variety of reasons (see Note 16 of the Notes to Consolidated Financial Statements).

We have executed various transactions to exit from our homeowner line. Under a January 1, 2002 agreement with Balboa Insurance Company ("Balboa"), a subsidiary of Countrywide Financial Corporation ("Countrywide"), 100% of homeowner unearned premium reserves and losses on or after that date were ceded to Balboa. Under the terms of this agreement, we retain certain loss adjustment expenses. We began non-renewing homeowner policies expiring on February 21, 2002, and thereafter. Substantially all of these customers were offered homeowner coverage through an affiliate of Countrywide. We have completed this process and no longer have any homeowner policies in force.

Losses and LAE Incurred

The following table summarizes losses and LAE incurred, net of reinsurance, for the periods indicated:

AMOUNTS IN THOUSANDS
Years Ended December 31,	2004			2003		2002
Net Losses and LAE incurred related to insured events of:
Current year:
Personal auto lines	$	993,944		$	910,963	$	752,077
Homeowner and earthquake lines in runoff		2			141		2,222
Total current year	$	993,946			911,104		754,299

Prior years:
Personal auto lines		(2,936	)		11,159		16,200
Homeowner and earthquake lines in runoff		2,831			40,048		56,158
Total prior years' reserve (redundancy) deficiency recorded in current year		(105	)		51,207		72,358
Total	$	993,841		$	962,311	$	826,657

Net favorable reported loss development for the prior accident years was $0.1 million, which resulted from favorable development on the personal auto lines that was offset by adverse development on the homeowner and earthquake lines in runoff. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments resulting therefrom are reflected in current operating income. It is management's belief that the unpaid losses and LAE are adequate to cover unpaid losses and LAE as of December 31, 2004. While we perform quarterly reviews of the adequacy of established unpaid losses and LAE, there can be no assurance that our ultimate unpaid losses and LAE will not develop redundancies or deficiencies and possibly differ materially from our unpaid losses and LAE as of December 31, 2004. In the future, if the unpaid losses and LAE develop redundancies or deficiencies, such redundancy or deficiency would have a positive or adverse impact, respectively, on future results of operations.

The process of making changes to unpaid losses and LAE begins with the preparation of several point estimates of unpaid losses and LAE, a review of the actual claims experience in the quarter, actual rate changes achieved, actual changes in coverage, mix of business, and changes in certain other factors such as weather and recent tort activity that may affect the loss ratio. Our actuaries prepare several point estimates of unpaid losses and LAE for each of the coverages, and they use their experience and judgment to arrive at an overall actuarial point estimate of the unpaid losses and LAE for that coverage. Meetings are held with appropriate departments to discuss significant issues as a result of the review. This process culminates in a reserve meeting to review the unpaid losses and LAE. Other relevant internal and external factors considered include a qualitative assessment of inflation and other economic conditions, changes in the legal, regulatory, judicial and social environments, underlying policy pricing, exposure and policy forms, claims handling, and geographic distribution shifts. As a result of the meeting, unpaid losses and LAE are finalized and we record quarterly changes in unpaid losses and LAE for each of our coverages. The change in unpaid losses and LAE for the quarter for each coverage is the difference between net ultimate losses and LAE and the net paid losses and LAE recorded through the end of the quarter. The overall change in our unpaid losses and LAE is based on the sum of these coverage level changes.

The point estimate methods include the use of paid loss triangles, incurred loss triangles, claim count triangles, and severity triangles, as well as expected loss ratio methods. Quantitative techniques frequently have to be supplemented by subjective consideration, including managerial judgment, to assure that the overall unpaid losses and LAE are adequate to meet projected losses. For example, in property damage coverages, repair cost trends by geographic region vary significantly. These factors are periodically reviewed and subsequently adjusted, as appropriate, to reflect emerging trends which are based upon past loss experience. Thus, many factors are implicitly considered in estimating the loss costs recognized.

Judgment is required in analyzing the appropriateness of the various methods and factors to avoid overreacting to data anomalies that may distort such prior trends. For example, changes in limits distributions or development in the most recent accident quarters would require more actuarial judgment. We do not believe disclosure of specific point estimates calculated by the actuaries would be meaningful. Any one actuarial point estimate is based on a particular series of judgments and assumptions of the actuary. Another actuary may make different assumptions, and therefore reach a different point estimate.

There is a potential for significant variation in developing unpaid losses and LAE. Most automobile claims are reported within two to three months whereas the estimate of ultimate severities exhibits greater variability at the same maturity. Generally, actual historical loss development factors are used to project future loss development, and there can be no assurance that future loss development patterns will be the same as in the past. However, we believe that our reserving methodologies are in line with other personal lines insurers and would normally expect ultimate unpaid losses and LAE development to vary by as much as 5% of the carried unpaid losses and LAE.

As a result of the significant growth in the non-Los Angeles County regions, the Company has experienced changes in the mix of business relative to geography and policy limits. We believe that the assumption with the highest likelihood of change that could materially affect carried unpaid losses and LAE is property damage and collision severity in the San Francisco and Bay Area regions, which have significantly different repair costs and have exhibited significant policy growth. A 5% change in the severity assumption for these regions would result in an increase or decrease in total unpaid losses and LAE of 0.14%, or $1.8 million.

While we have settled over 98% of Northridge Earthquake claims and related litigation, estimates of both the litigation costs and ultimate settlement or judgment amounts related to these claims are subject to a high degree of uncertainty. Please see Note 16 of the Notes to Consolidated Financial Statements for additional background on the Northridge Earthquake and SB 1899.

Investment Income

We utilize a conservative investment philosophy. No derivatives or nontraditional securities are held in our investment portfolio and only 3% of the portfolio consists of equity securities. Substantially all of the fixed maturity portfolio is investment grade. Net investment income was $58.8 million in 2004, compared to $45.8 million in 2003 and $46.3 million in 2002. Average invested assets increased 23.2% in 2004, 17.9% in 2003 and 1.3% in 2002. The average annual pre-tax yields on invested assets were 4.4% in 2004, 4.2% in 2003, and 5.1% in 2002. The average annual after-tax yields on invested assets were 3.3% in 2004, 3.6% in 2003, and 4.3% in 2002.

Net realized gains on the sale of investments¹were $10.8 million in 2004 (gross realized gains were $14.1 million and gross realized losses were $3.3 million), compared to net realized gains of $13.2 million in 2003 (gross realized gains were $13.7 million and gross realized losses were $0.5 million), and net realized gains of $10.4 million in 2002 (gross realized gains were $13.1 million and gross realized losses were $2.7 million). At December 31, 2004, $308.0 million (22.3%) of our total fixed maturity investments at fair value were invested in tax-exempt bonds, compared to 64.9% at December 31, 2003 and 60.7% at December 31, 2002, with the remainder, representing 77.7% of the portfolio, invested in taxable securities, compared to 35.1% at December 31, 2003 and 39.3% at December 31, 2002. The shift to taxable securities in 2004 was made to reduce the average duration of the portfolio and to accelerate the realization of the Company's NOL carryforward.

_______________________________

¹	Includes loss on disposal of fixed assets of $849, $156 and $479 in 2004, 2003, and 2002, respectively.

We recognized no other-than-temporary impairments in 2004, 2003, or 2002 (see discussion under Critical Accounting Estimates).

Other Income

Other income of $14.8 million in the year ended December 31, 2003, included $9.3 million resulting from a nonrecurring, nonoperational item from the settlement of litigation, interest income of $4.8 million relating to a favorable settlement with the Internal Revenue Service ("IRS"), and miscellaneous items of $0.7 million. No other income was reported in 2004 and 2002.

Critical Accounting Estimates

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within those statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Our significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements and are essential to understanding Management's Discussion and Analysis of Financial Condition and Results of Operations. Some of our accounting policies require significant judgment to estimate values of either assets or liabilities. In addition, significant judgment may be needed to apply what often are complex accounting principles to individual transactions to determine the most appropriate treatment. We have established procedures and processes to facilitate making the judgments necessary to prepare the financial statements.

The following is a summary of the more judgmental and complex accounting estimates and principles. In each area, we have discussed the assumptions most important in the estimation process. We have used the best information available to estimate the related items involved. Actual performance that differs from our estimates and future changes in the key assumptions could change future valuations and materially impact our financial condition and results of operations.

Management has discussed our critical accounting policies and estimates, together with any changes therein, with the Audit Committee of our Board of Directors.

Losses and Loss Adjustment Expenses. The estimated liabilities for losses and loss adjustment expenses ("LAE") include the accumulation of estimates of losses for claims reported on or prior to the balance sheet dates, estimates (based upon actuarial analysis of historical data) of losses for claims incurred but not reported, the development of case reserves to ultimate values and estimates of expenses for investigating, adjusting and settling all incurred claims. Amounts reported are estimates of the ultimate costs of settlement, net of estimated salvage and subrogation. The estimated liabilities are necessarily subject to the outcome of future events, such as changes in medical and repair costs, as well as economic and social conditions that impact the settlement of claims. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than relatively longer-tail liability claims. For our current mix of auto exposures, which include both property and liability exposures, an average of approximately 80% of the ultimate losses are settled within twelve months of the date of loss. Given the inherent variability in the estimates, management believes the aggregate reserves are adequate, although we continue to caution that the reserve estimates relating to SB 1899 are subject to a greater than normal degree of variability and possible future material adjustment as new facts become known. The methods of making such estimates and establishing the resulting reserves are reviewed and updated monthly and any resulting adjustments are reflected in current operations. Changes in these recorded liabilities flow directly to the income statement on a dollar-for-dollar basis. For example, an upward revision of $1 million in the estimated recorded liability for unpaid losses and LAE would decrease underwriting profit, and pre-tax income, by the same $1 million amount. Conversely, a downward revision of $1 million would increase pre-tax income by the same $1 million amount.

Property and Equipment. Accounting standards require a write-off to be recognized when an asset is abandoned or an asset group's carrying value exceeds its fair value. For purposes of recognition and measurement of an impairment loss, a long-lived asset or assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Accounting standards require asset groups to be tested for possible impairment under certain conditions. In the third quarter of 2002, we recorded a pre-tax charge to write off $37.2 million of previously capitalized software costs for abandoned portions of an advanced personal lines processing system. As such, in 2002, we assessed the asset group that included the advanced personal lines processing system for impairment. However, an impairment was not triggered by the abandonment as we determined that the impairment recognition criterion had not been met. Future cash flows expected to be generated by the asset group exceeded its carrying amount. There have been no events or circumstances in 2004 that would require a reassessment of the asset group for impairment.

Income Taxes. Determining the consolidated provision for income tax expense, deferred tax assets and liabilities and any related valuation allowance involves judgment. Generally accepted accounting principles require deferred tax assets and liabilities ("DTAs" and "DTLs," respectively) to be recognized for the estimated future tax effects attributed to temporary differences and carryforwards based on provisions of the enacted tax law. The effects of future changes in tax laws or rates are not anticipated. Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the financial statements. For example, we have a DTA because the tax bases of our loss and LAE reserves are smaller than their book bases. Similarly, we have a DTL because the book basis of our capitalized software exceeds its tax basis. Carryforwards include such items as alternative minimum tax credits, which may be carried forward indefinitely, and net operating losses ("NOLs"), which can be carried forward 15 years for losses incurred before 1998 and 20 years thereafter. A summary of the significant DTAs and DTLs relating to the Company's temporary differences and carryforwards is included in Note 5 of the Notes to Consolidated Financial Statements.

At December 31, 2004, our DTAs total $136.7 million, and our DTLs total $80.6 million. The net of those amounts, $56.1 million, represents the net deferred tax asset reported in the consolidated balance sheet.

We are required to reduce DTAs (but not DTLs) by a valuation allowance to the extent that, based on the weight of available evidence, it is "more likely than not" (i.e., a likelihood of more than 50%) that any DTAs will not be realized. Recognition of a valuation allowance would decrease reported earnings on a dollar-for- dollar basis in the year in which any such recognition were to occur. The determination of whether a valuation allowance is appropriate requires the exercise of management judgment. In making this judgment, management is required to weigh the positive and negative evidence as to the likelihood that the DTAs will be realized.

Portions of our NOL carryforward are scheduled to expire beginning in 2017, as shown in the table below (amounts in millions):

Year of Expiration	NOL Excluding 21st of Southwest		SRLY¹ NOL of 21st of Southwest		Consolidated NOL
2017	$	–	$	1,794	$	1,794
2018		–		1,068		1,068
2019		–		1,466		1,466
2020		35,061		3,172		38,233
2021		134,647		2,180		136,827
2022		37,316		–		37,316
Totals	$	207,024	$	9,680	$	216,704

Our core business has generated an underwriting profit for the past three years. Management believes it is reasonable to expect future underwriting profits and to conclude it is at least more likely than not that we will be able to realize the benefits of our DTAs. If necessary, we believe we could implement tax-planning strategies, such as investing a higher proportion of our investment portfolio in taxable securities, in order to generate sufficient future taxable income to utilize the NOL carryforwards prior to their expiration. Accordingly, no valuation allowance has been recognized as of December 31, 2004 and 2003. However, generating future taxable income is dependent on a number of factors, including regulatory and competitive influences that may be beyond our ability to control. Future underwriting losses could possibly jeopardize our ability to utilize our NOLs. In the event adverse development or underwriting losses due to either SB 1899 matters or other causes were to occur, management might be required to reach a different conclusion about the realization of the DTAs and, if so, recognize a valuation allowance at that time.

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¹	“SRLY” stands for Separate Return Limitation Year. Under the Federal tax code, only future income generated by 21st of Southwest (formerly 21st of Arizona) may be utilized against this portion of our NOL.

Deferred Policy Acquisition Costs. Deferred policy acquisition costs ("DPAC") include premium taxes and other variable costs incurred with writing business. These costs are deferred and amortized over the 6-month policy period in which the related premiums are earned.

Management assesses the recoverability of deferred policy acquisition costs on a quarterly basis. The assessment calculates the relationship of actuarially estimated costs incurred to premiums from contracts issued or renewed for the period. We do not consider anticipated investment income in determining the recoverability of these costs. Based on current indications, no reduction in DPAC is required.

The loss and LAE ratio used in the recoverability estimate is based primarily on expected ultimate ratios provided by our actuaries. While management believes that is a reasonable assumption, actual results could differ materially from such estimates.

Investments. Temporary unrealized investment gains and losses, net of applicable tax effects, are included as an element of accumulated other comprehensive income (loss), which is classified as a separate component of stockholders' equity. For investments with unrealized losses due to market conditions or industry-related events, where the Company has the positive intent and ability to hold the investment for a period of time sufficient to allow a market recovery or to maturity, declines in value below cost are not assumed to be other-than-temporary.

Where declines in values of securities below cost or amortized cost are considered to be other-than-temporary, a charge is required to be reflected in income for the difference between cost or amortized cost and the fair value. The determination of whether a decline in market value is "other-than-temporary" is necessarily a matter of subjective judgment. No such charges were recorded in 2004, 2003 or 2002. The timing and amount of realized losses and gains reported in income could vary if conclusions other than those made by management were to determine whether an other-than-temporary impairment exists. However, there would be no impact on equity because any unrealized losses are already included in accumulated other comprehensive income.

The following is a summary by issuer of non-investment grade securities and unrated securities held (at fair value):

AMOUNTS IN THOUSANDS
December 31,	2004		2003
Non-investment grade securities (i.e., rated below BBB):
Cox Communications, Inc.	$	2,240	$	—
Ford Motor Credit Company		4,615		—
General Motors Acceptance Corp		5,643		—
Unrated securities:
Impact Community Capital LLC¹		2,023		2,023
Impact C.I.L. Parent		5,111		2,444