Independent Agents underwriting results improved by $34 million in 1997 over 1996. The principal components of the improvement include reduced catastrophe premium costs of $8 million, reduced catastrophe loss costs of $4 million, favorable loss experience excluding catastrophes of $10 million and favorable adjustments of premium related and operating expenses of $12 million resulting from procedures performed in connection with the 100% reinsurance of Independent Agents business.
Effective January 1, 1998, TIG Insurance elected to retain all catastrophe exposure without the benefit of catastrophe reinsurance. TIG Insurance's single largest PML is approximately $27 million as of January 1, 1999. TIG Insurance monitors geographical exposure accumulations and will purchase property catastrophe coverage when certain trigger points are reached. As long as TIG Insurance continues to write Independent Agents policies on a direct basis ceding 100% to Nationwide (see Item 7.1 - Consolidated Results), TIG Insurance will retain contingent exposure for catastrophes impacting Independent Agents business.
Primary operations and corporate cash flow declined slightly in 1998. This decline is due to offsetting factors. Significantly increased expenditures on general operating expenses, including debt interest and tax payments, and increased loss payments were partially offset by increased premium receipts. The increase in primary and corporate cash flow in 1997 is due to increased premium receipts and lower paid losses, and improvements in the timing of premium receivable and reinsurance recoverable collections. These increases were partially offset by increased payments for taxes and an increase in general operating expenses, including debt interest. In addition, the cession of Independent Agents unearned premium reserves (see Item 7.1 - Consolidated Results) reduced primary operations cash flow by $29 million.
Shareholders' Equity. Shareholders' equity decreased by $36 million during 1998, primarily as a result of dividends paid to shareholders, treasury share repurchases, and a decrease in net unrealized investment gains, partially offset by net income and issuance of common stock (see Consolidated Statements of Changes in Shareholders' Equity at Item 8). Unrealized investment gains as of December 31, 1998 were $87 million (net of tax) compared to $98 million as of December 31, 1997. Book value per share decreased from $22.82 at December 31, 1997 to $22.10 at December 31, 1998. Approximately 500,000 unallocated Employee Stock Ownership shares have been excluded from outstanding common shares for purposes of computing book value per common share at December 31, 1998 and 1997, respectively.
TIG Holdings would like to caution readers regarding certain forward-looking statements in the Management's Discussion and Analysis and elsewhere in this Form 10-K. Statements which are based on management's projections, estimates and assumptions are forward-looking statements. The words "believe", "expect", "anticipate" and similar expressions generally identify forward-looking statements. While TIG Holdings believes in the veracity of all statements made herein, forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by TIG Holdings, are inherently subject to significant business, economic and competitive uncertainties and contingencies, including without limitation:
* changes in general market or economic conditions which could impact the demand for the Company's products and loss frequency and severity for certain lines of business
Net premium written: Direct premium written plus assumed reinsurance less premium on ceded business for a given period.
PML (probable maximum loss): The largest loss the underwriter considers possible based upon the underwriter's experience and judgment.
Policyholder dividends ratio: The ratio of dividends paid to policyholders to earned premium, determined in accordance with statutory accounting practices.
Stock Compensation. TIG adopted Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("Statement 123") effective January 1, 1996. Statement 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. TIG elected to continue to account for employee stock-based compensation as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" and to provide pro forma disclosures in the Notes to Consolidated Financial Statements of the effects of Statement 123 on net income and earnings per share (see Note K - Incentive Compensation Plans). There was no effect on net income or earnings per share as a result of adopting Statement 123.
In April 1993, in connection with it's IPO, TIG Holdings issued 250,000 shares of non-voting mandatory redeemable preferred stock with a cumulative annual cash dividend rate of $7.75 per share and an aggregate liquidation preference/redemption value of $25 million plus accrued and unpaid dividends. The preferred stock must be redeemed on April 27, 2000. With each regular quarterly dividend declared on the preferred shares, each holder also receives one non-transferable right (a "Right"). Each Right will constitute the right to receive an additional amount to the extent that the regular cash dividend to which the related Right was, in whole or in part, not made out of TIG Holdings' current or accumulated earnings and profits, as calculated for federal income tax purposes. In such event, the holder of a Right will be entitled to receive an amount which, when taken together with the regular cash dividend to which the Right was related, would cause the net after-tax return to such holder to equal what the net after-tax return on the mandatory redeemable preferred stock would have been had the regular cash dividend been paid entirely out of the current or accumulated earnings and profits of TIG Holdings. During 1998, TIG paid an additional $1 million in respect to these Rights in connection with dividends declared on the mandatory redeemable preferred stock during 1997. No additional payments were required during 1997 and 1996.
If the fair value of the stock compensation granted had been accounted for under SFAS 123, the proforma net loss for 1998 would have been $7.2 million or $0.14 per basic share; net income for 1997 would have been $41.1 million or $0.76 per basic share or $0.74 per diluted share; and net income for 1996 would have been $74.5 million or $1.29 per basic share or $1.26 per diluted share. For purposes of proforma disclosures, the estimated fair value of the stock compensation is amortized to expense over the stock compensation's vesting period. The effect on net income of the stock compensation amortization for the years presented above is not likely to be representative of the effects on reported net income for future years.
On July 17, 1998, TIG Premier Insurance Company ("TIG Premier"), a subsidiary of TIC, filed a complaint and jury demand against MBNA America Bank, N.A. d.b.a. MBNA Insurance Services ("MBNA") in federal court in the Northern District of Texas that was based on an agency agreement between TIG Premier and MBNA (the "Agency Agreement") pursuant to which TIG Premier offered an insurance program that was marketed by MBNA to its customers. In its complaint, TIG Premier sought a declaratory relief judgment declaring that TIG could reduce the commission payable to MBNA and lengthen the 5-year term of the Agency Agreement in order to, at a minimum, reduce TIG Premier's underwriting losses and improve the possibility of TIG Premier's achieving the agreed upon 15% minimum rate of return. On August 19, 1998, TIG filed an amended complaint seeking monetary damages for MBA's repudiation and breach of the Agency Agreement, including, without limitation, the underwriting losses that TIG Premier incurred and the minimum 15% rate of return over the entire five-year initial term of the Agency Agreement, in an amount to be determined at trial. In its amended answer, dated August 31, 1998, MBNA instituted a counterclaim against TIG Premier based on TIG Premier's alleged breach and repudiation of the Agency Agreement, seeking damages in an amount not less than $100 million. Management believes that the liability arising from this case, if any, will not materially impact the Company's consolidated results of operations or financial condition.
In addition to the costs incurred for Year 2000 system modifications, TIG will incur expenses in ascertaining whether key third parties with which it has a material relationship are Year 2000 compliant. TIG estimates that such expenses will not exceed $1.5 million. This amount includes both IT and non IT portions of this project.
All estimates of future costs related to assessing and achieving Year 2000 compliance are based on management's best estimates and there can be no guarantee that actual amounts expended will not differ from such estimates.