The Company's financial statements include increases in earthquake reserves in 1996 of $40 million and in 1995 of $60 million offset partially by a $32 million reduction in the Prop. 103 liability, and in 1994, earthquake-related losses and expenses of $844.1 million. On an after-tax basis, these additional charges reduced primary earnings (loss) per share by $0.44, $0.32 and $(10.68) for 1996, 1995 and 1994, respectively.
PRIVATE PASSENGER AUTOMOBILE. In 1996, with its financial condition restored substantially to pre-earthquake levels, the Company was once again able to focus on the growth of its core automobile business. The Company, in connection with an aggressive marketing campaign and declining trends in loss costs and frequency, lowered overall rate levels approximately 11.5% in 1996 (3.2% effective March 15, 1996 in connection with a new auto rating plan; 2.3% effective June 1, 1996 to implement a new persistency discount; and 6% effective September 1, 1996 in response to continuing favorable loss trends). These actions helped to achieve increases in new business production and the rate of renewals and led to a resumption of growth in the number of vehicles in force during the fourth quarter of 1996. Vehicles in force grew by 4,940 in the fourth quarter of 1996, and were up 16,224 in the first two months of 1997, compared to declines in the comparable year-ago periods of 20,039 and 13,144, respectively.
PELP. The penetration of this coverage has averaged about 1% of the vehicles in force during the three years ended December 31, 1996, which is not expected to change significantly in 1997.
As of December 31, 1996, the Company had a net unrealized gain on fixed maturity investments of $3,665,000 compared to $50,527,000 in 1995 and an unrealized loss of $(61,425,000) in 1994. The primary reasons for the shifts in unrealized gains and losses are twofold. Interest rates rose sharply in 1994 but fell in 1995 reducing the fair value of the bond portfolio in 1994 and increasing it in 1995. The decrease in unrealized gains between 1995 and 1996 resulted largely from a declining bond market coupled with an overall decline in invested assets. In 1994, the Company sold practically all appreciated fixed maturity investments to cover earthquake loss payments.
In 1996, the Company's insurance subsidiaries entered into a 100% quota share reinsurance agreement with F&G Re and Risk Capital Re covering the homeowner and condominium lines of business. This agreement covers, for a one-year policy term, all business in force as of July 1, 1996 plus renewal business attaching between July 1, 1996 and July 23, 1996, effectively terminating with the expiration of the underlying, one-year policies. Under this contract, 100% of each subsidiary's homeowner and condominium unearned premium reserves as of June 30, 1996 were ceded 50/50 to F&G Re and Risk Capital Re, a total of $33.3 million. Additionally, 100% of written premiums and incurred losses and allocated loss adjustment expenses subsequent to June 30, 1996, on covered policies, are ceded under this contract. The Company's insurance subsidiaries earn a commission on ceded premiums based on a sliding scale dependent on the incurred loss ratio. In 1996, the Company earned commissions at a rate of 15.8%. Homeowner policies renewed February 15, 1997 and subsequent, which are not covered under this contract, are expected to be covered by a new reinsurance program currently under negotiation.
Minimum rental commitments under the Company's lease obligations are as follows:
For disclosure purposes, the fair value of stock options was estimated at each date of grant using a Black-Scholes option pricing model using the following assumptions: Risk-free interest rates of 6.5% and 6.6% for 1996 and 1995, respectively; dividend yields ranging from 1.0% to 1.3% in 1996 and from 1.5% to 1.6% in 1995; volatility factors of the expected market price of the Company's common stock of .39 and .43 for 1996 and 1995, respectively; and a weighted average expected life of the options of 10 years. Using the Black-Scholes valuation model, the estimated weighted average fair value of options granted during 1996 and 1995, respectively, were $10.04 and $6.62. Had the accounting for stock-options been based on those values, the pro forma net income would have been $70.5 million in 1996 and $69.2 million in 1995; pro forma primary earnings per share would have been $.86 in 1996 and $.87 in 1995, while fully diluted earnings per share would have been antidilutive in 1996 and equal to the primary figure in 1995.
*Fully diluted earnings per common share are not shown as the results are antidilutive.
AUTO. The $22.7 million decline in underwriting profit for the auto lines in 1996 compared to 1995 was caused principally by a $30 million reduction in 1995 of amounts previously set aside for Proposition 103 rebates (see Note 14), and 1996 weather-related claims of approximately $8 million. In 1994 and 1995, excluding earthquake-related claims and expenses, earthquake reinsurance reinstatements and Proposition 103 rebate adjustments, the underwriting profit for the auto lines would have been $10.1 million and $73.8 million, respectively, with the increase in 1995 principally attributable to the 6% rate increase implemented in the fourth quarter of 1994 and the 3.7% rate increase implemented in the second quarter 1995.