SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 1996
Net income attributable to common stockholders ("Net Income") for 1996 was $76 million, or $3.84 per share, compared with 1995 earnings of $50 million, or $2.86 per share. The 1996 results include after-tax realized investment gains of $5 million, or $.24 per share, compared with $6 million, or $.36 per share for 1995.
Net premiums written in 1996 grew 22% to $1,053 million from $860 million written during 1995 due to increases recorded by all segments of our operations. Premiums written by the regional segment grew by 13% to $531 million from $471 million written during 1995. Regional net premiums written grew by 16% excluding business assumed from national workers' compensation pools. The majority of this growth was due to new operations which the Company has established during the past five years. Premiums written by the reinsurance segment grew by 11% to $218 million from $196 million written during 1995. The growth in reinsurance premiums written was substantially due to the start-up of a Latin American and Caribbean division and increases in business written by the Fidelity and Surety division. Premiums written by the specialty segment grew by 26% to $202 million from $161 million. The growth in specialty premiums written is due to an increase in business written by Admiral and Monitor as well as increases in the amount of business retained by Admiral, Monitor and Nautilus. These increases more than offset a decline in premiums written by Carolina Casualty. Premiums written by the alternative markets segment grew by $50 million to $76 million. This increase is due to the inclusion of results of Midwest Employers Casualty Company ("MECC"), which was acquired in November 1995. Premiums written by the international segment grew by $19 million to $25 million. The increase in premiums written is due to the inclusion of our primary insurance operations in Argentina, which were acquired in 1995, for a full year and the start up of an Argentine operation in 1996. As a result of this start up operation, the Company expects the international operation to sustain a loss in 1997. Such loss is not expected to have a material adverse impact on the Company's results of operations.
Management fees and commissions consist primarily of fees earned by the alternative markets segment. Management fees and commissions were basically unchanged for 1996 as market conditions, particularly in workers' compensation insurance, inhibited growth.
Other operating costs and expenses, which consists of the expenses of the Company's insurance and alternative markets segments as well as the Company's corporate and investment expenses, increased by 20% to $409 million from $340 million recorded in 1995. The increase in other operating costs is primarily due to substantial growth in premium volume in all segments of the Company's business, which in turn results in an increase in underwriting expenses. The consolidated expense ratio of the Company's insurance operations (underwriting expenses expressed as a percentage of premiums written) increased to 33.1% for the 1996 period from 31.3% for the comparable 1995 period. The underwriting expense ratio increased primarily due to increased commissions expense in certain specialty and reinsurance segments.
investment gains of $6 million or $.36 per share, compared with after-tax realized investment losses of $86,000 or $.01 per share recorded in 1994.
Net premiums written in 1995 grew by 20% to $860 million from $718 million written during 1994 due to increases recorded by all five segments of our operations. Premiums written by the regional segment grew by 22% in 1995 to $471 million compared to $387 million written during 1994. Approximately 60% of the growth was from three operations which the Company established in 1992 and 1993. The balance of this increase primarily results from the expansion by the regional operations into new markets. Premiums written by the reinsurance segment grew by 11% to $196 million from $177 million written during 1994. The growth in reinsurance premiums written was mainly due to growth in facultative and fidelity and surety premiums written. Premiums written by the specialty segment grew by 19% in 1995 to $161 million from $135 million in 1994. The growth in the specialty premiums written is due mainly to decreases in the amounts of business ceded to unaffiliated reinsurers. Premiums written by the alternative markets segment grew by 30% in 1995, to $26 million from $20 million in 1994. The growth in this segment's premiums written is due to the inclusion of Midwest, which was acquired in November 1995, and modest premium growth recorded by Signet Star's alternative markets division.
Management fees and commissions consists primarily of fees and commissions earned by the alternative markets operating units. These fees and commissions grew by 6% to $68 million in 1995 from $65 million earned in 1994. This increase was due mainly to the inclusion of a full year's results for Key Risk Services, Inc. which was acquired in May 1994, as well as fees earned by Berkley Care Network which the Company established in June 1995. These increases were partially offset by a restructuring of one alternative markets operating unit.
Other operating costs and expenses, which consists of the expenses of the Company's insurance and alternative markets segments as well as the Company's corporate and investment expenses, increased by 19% to $340 million from $286 million recorded in 1994. This increase was due primarily to the substantial growth in premium volume which in turn results in an increase in variable underwriting expenses. The consolidated expense ratio (underwriting expenses expressed as a percentage of premiums written) of the Company's insurance operations increased to 31.3% from 30.8% in 1994. The expense ratio increased due to the effects of start-up operations which generally incur a higher expense ratio in the early stages of their development.
As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. The Company is obligated to service its debt, pay consolidated Federal income taxes and pay its expenses. Tax payments and management fees from the insurance subsidiaries are made under agreements which generally are subject to approval by state insurance departments. Maximum amounts of dividends that can be taken without regulatory approval are prescribed by statute; to date, cash dividends have not required regulatory approval (See Note 14 of "Notes to Consolidated Financial Statements").
In October 1995, the Company issued 3,450,000 shares of common stock, par value $.20 per share and received net proceeds of approximately $145 million which was used to finance the acquisition of MECC.
On December 31, 1995, in connection with the acquisition of the remaining 40% of Signet Star, the Company issued to General Reinsurance Corporation (General Re), 458,667 shares of Series B Cumulative Redeemable Preferred Stock having an aggregate liquidation preference of $68,800,000. The Series B Preferred Stock had a dividend rate increasing up to 6% during the first twelve months. In addition, the Company guaranteed a senior subordinated promissory note of Signet Star in the principal amount of $35,793,085, which matures July 1, 2003 and bears interest at the rate of 6.5%. This note was issued to General Re in exchange for the convertible note previously held by General Re. In November 1993, Signet Star borrowed the maximum amount available under its revolving credit facility and used the proceeds to redeem senior notes issued in connection with the July 1, 1993 acquisition. The revolving credit facility was repaid on January 19, 1996 as discussed below.
On January 19, 1996, the Company issued $100 million of 6.25%, ten-year notes which are not redeemable until maturity and utilized a portion of the proceeds to retire $28.4 million of Signet Star's bank debt. In addition, a portion of the proceeds were used to retire $28 million of Series B Preferred Stock. The balance of the proceeds from all of the above-mentioned offerings of securities is available for acquisitions, working capital and other general corporate purposes.
In March 1995, the Company purchased 117,000 shares of Common Stock for approximately $4.1 million. During 1996, the Company purchased 575,000 shares of its Common Stock for approximately $24.2 million. On April 19, 1996, the Board of Directors authorized the Company to purchase an additional 1,000,000 shares of Common Stock. As a result of the above, approximately 759,000 shares remain under the current authorization.
The investment portfolio, valued on a cost basis, grew in 1996 by $374.9 million to approximately $2,882.9 million primarily due to the combined effects of net cash flow from operations and the financing activities discussed above.
During 1996, the Company invested approximately $90.8 million of its available cash inflow in equity securities, $56.6 million in state and municipal bonds and $52.7 million in mortgage-backed securities. At December 31, 1996, the portion of the portfolio invested in tax-exempt securities was 29% (31% in 1995); U.S. Government securities and cash equivalents comprised 27% (24% in 1995); mortgage-backed securities were 19% (19% in 1995); corporate fixed maturity securities were 14% (15% in 1995), and equity securities represented the balance.
The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for current operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset. In establishing the amount of the deferred tax asset, management has included a valuation allowance for the future uncertainty associated with the extended time period required for the complete reversal of the effects of loss reserve discounting.
In 1996, Continental Western and Clermont Specialty Managers, Ltd., formerly Habitational Division of Firemen's generally retained $475,000 on individual risks while the Company's other regional subsidiaries generally retained $400,000 on individual risks. In 1997, all regional subsidiaries will generally retain $300,000 on individual risks. The regional group also maintained catastrophe reinsurance protection for approximately 95% of weather-related losses above $3 million per occurrence ($6 million in 1997) up to a maximum of $34 million. In addition the Company carried additional aggregate catastrophe protection of $17.5 million in excess of $8 million for storms exceeding $500,000. In 1997, the aggregate catastrophe protection is: $13.5 million in excess of $4 million for storms exceeding $500,000; $5 million in excess of $6.5 million for storms exceeding $1.0 million; and $4.5 million in excess of $7 million for storms exceeding $1.5 million.
Signet Star's catastrophe retrocession program provides coverage for property losses in three layers as follows: (i) 100% of $7.0 million in excess of $6.5 million per occurrence; (ii) 95% of $9.0 million in excess of $13.5 million per occurrence; and (iii) 90% of $7.5 million in excess of $22.5 million per occurrence. In 1996, Signet Star had retrocession coverage for its casualty facultative business for up to 20% of $5.0 million per certificate. In 1997, Signet Star has a variable quota share program on its casualty facultative business with retentions varying from a low of $425,000 up to $2.5 million depending on the certificate limit. These coverages apply to Signet Star's individual certificate business only. During 1996, Signet Star had retrocession coverage for its fidelity and surety business for approximately 86.5% (100% in 1997) of each loss up to $2.5 million in excess of $750,000 per occurrence. In 1997, Signet Star purchased an additional layer of 79.5% of each loss up to $2.5 million in excess of $3.25 million per occurrence for its fidelity and surety business.
Midwest's retention is generally $1 million per occurrence above the self insured's underlying retention.
For the year ended December 31, 1996, the purchase of common and preferred stock discussed above under "Financing Activity", and the decline in unrealized investment gains more than offset the increase in retained earnings. This resulted in a decrease in stockholders' equity of approximately $50 million. In addition, as a result of the issuance of the Capital Trust Securities the total amount of capital employed in the business grew to $1,478 million. Accordingly, the percentage of the Company's capital attributable to long-term debt was 26% at December 31, 1996 and December 31, 1995.
Consolidated statements of operations, years ended December 31, 1996, 1995, and 1994 33
Consolidated statements of stockholders' equity, years ended December 31, 1996, 1995, and 1994 34
Consolidated statements of cash flows, years ended December 31, 1996, 1995, and 1994 35
We have audited the consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of W. R. Berkley Corporation and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles.
We have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 1994, 1993 and 1992, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1993 and 1992 (none of which are presented herein); and we expressed unqualified opinions on those consolidated financial statements. W. R. Berkley Corporation adopted the provisions of the Financial Accounting Standards Board's statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes" in 1992 and the provisions of SFAS No. 115 "Accounting For Certain Investments in Debt and Equity Securities" on December 31, 1993.
Consolidated Balance Sheets December 31, 1996 and 1995 (Dollars in thousands, except share data)
Consolidated Statements of Operations Years ended December 31, 1996, 1995 and 1994 (Dollars in thousands, except per share data)
Consolidated Statements of Stockholders' Equity Years ended December 31, 1996, 1995 and 1994 (Dollars in thousands, except per share data)
W. R. Berkley Corporation and Subsidiaries Consolidated Statements of Cash Flows Years Ended December 31, 1996, 1995 and 1994 (Dollars in thousands)
Ceded unearned premiums are reported as prepaid reinsurance premiums and estimated amounts of reinsurance recoverable on unpaid losses are included in due from reinsurers. To the extent any reinsurer does not meet its obligations under reinsurance agreements, the liability must be discharged by the Company. The Company has provided reserves for uncollectible reinsurance.
The Company's method of accounting for income taxes is the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are measured annually using tax rates currently in effect or expected to apply in the years in which those temporary differences are expected to reverse.
In October 1995, FASB Statement No. 123 "Accounting for Stock-Based Compensation" (FAS 123) was issued by the FASB which is effective for fiscal year December 31, 1996. FAS 123 provides an alternative to continue the Company's current method of accounting for stock based compensation, or to adopt the fair value method of accounting which would require the Company to expense, over the service or vesting period, the fair value of employees stock based compensation at the date of the grant. The Company will continue its present method of accounting for its stock option plan under APB No. 25.
Net assets of the acquired companies for 1996 were as follows: Investments in fixed maturity and equity securities of $6,434,000; cash and invested cash of $4,216,000; excess of cost over net assets acquired of $7,138,000; and other liabilities, net of other assets of $1,833,000.
During 1995, the Company purchased majority interests in two property and casualty companies in Argentina for consideration of approximately $9.2 million, which constituted a portion of the Company's initial contribution to Berkley International, LLC. The proforma effect of these transactions on the Company's results of operations is not significant.
On November 8, 1995, the Company acquired 100% of the stock of MECC, Inc., the Parent of Midwest Employers Casualty Company, for $141,908,000. In connection with this acquisition, the Company also retired approximately $19,590,000 of MECC, Inc.'s debt. The purchase was funded by the issuance of 3,450,000 shares of Common Stock issued at $43.75 per share. On December 31, 1995, the Company acquired General Re Corporation's ("General Re")
40% interest in Signet Star Holdings, Inc. ("Signet Star") by issuing to General Re 458,667 shares of Series B Cumulative Redeemable Preferred Stock of the Company having an aggregate liquidation preference of $68,800,000. The only significant effect on the Company's financial statements from this acquisition is an increase in preferred stock outstanding and the elimination of the related minority interest because Signet Star's results of operations were previously consolidated.
A reconciliation of the Federal income tax expense (benefit) and the amounts computed by applying the Federal income tax rate of 35% to pre-tax income is as follows (dollars in thousands):
The difference between the face value of long-term debt and the carrying value is unamortized discount. All outstanding long-term debt is not redeemable until maturity and ranks on a parity with all other outstanding indebtedness of the Company. In 1995 long-term debt included a note payable to banks pursuant to a revolving credit facility entered into by Signet Star. The face value of the debt at December 31, 1995 was $28,400,000 and the carrying value was $28,306,000. The interest rate was based on the London Interbank offered rate plus .75% to 1.50% and was 5.75% at December 31, 1995. The debt was retired in January 1996.
(5) Company obligated mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debt securities
On September 11, 1995, the Company formed Berkley International, LLC ("Berkley International"), a limited liability company. The Company is obligated to contribute $45.5 million to Berkley International over the next seven years as required.
The Company and several of its subsidiaries use office space and equipment under leases expiring at various dates through September 1, 2004. These leases are operating leases for financial reporting purposes. Some of these leases have options to extend the length of the leases and contain clauses for cost of living, operating expense and real estate tax adjustments. Rental expense was approximately; $11,098,000, $9,437,000 and $8,000,000 for 1996, 1995 and 1994 respectively. Future minimum lease payments (without provision for sublease income) are: $9,814,000 in 1997; $9,202,000 in 1998; $7,292,000 in 1999; $5,516,000 in 2000; $3,855,000 in 2001; and $11,799,000 thereafter.
Changes in shares of Common Stock outstanding, net of treasury shares, are as follows (in thousands):
As of December 31, 1996 930,807 shares of the 7 3/8% Series A Cumulative Redeemable Preferred Stock were issued and outstanding. During January 1997, the Company purchased an additional 183,080 shares for an aggregate cost of $28,506,000. In addition, $115,800,000 was placed in a trust which will be used to service the remaining outstanding Series A Preferred Stock. The Company expects that the proceeds of the trust will be utilized to redeem the Series A Preferred Stock on January 25, 1999.
In December 1995, the Company issued 458,667 shares of variable rate series B cumulative redeemable Preferred Stock at its fair value of $66,000,000. The Series B Preferred Stock was being accreted to its stated value of $68,800,000 over 18 months. During 1996, the Company purchased all outstanding shares of the Series B Preferred Stock for $66 million.
As discussed previously, FAS 123 provides an alternative to continue the Company's current method of accounting for stock based compensation, or to adopt the fair value method of accounting. The Company will continue its present method of accounting for its stock option plan under APB No. 25; accordingly, the adoption of the Statement will have no effect on the Company's financial statements.
The fair value of the options granted under FAS 123 is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 1996 and 1995 respectively: (a) dividend yield of 1%, (b) expected volatility of 20%, (c) risk free interest rate of 6.65% and 6.37%, and (d) expected life of 7.5 years. The weighted average fair value of options granted during the year were $16.15 and $15.58 for the year ended December 31, 1996 and 1995, respectively. The following table summarizes information about stock options outstanding at December 31, 1996 and 1995:
The Company and its subsidiaries have profit sharing retirement plans in which substantially all employees participate. The plans provide for minimum annual contributions of 5% of eligible compensation; contributions above the minimum are discretionary and vary with each participating subsidiary's profitability. Employees become eligible to participate in the Retirement Plans on the first day of the month following the first full three months in which they are employed. Profit sharing expense amounted to $7,370,000, $6,344,000 and $5,625,000 for 1996, 1995 and 1994, respectively.
At December 31, 1996 and 1995, there were no investments, other than investments in United States government securities, which exceeded 10% of stockholders' equity. At December 31, 1996 and 1995, investments were as follows:
(c) Short-term investments which mature within three months of the date of purchase.
The amortized cost and fair value of fixed maturity securities, at December 31, 1996, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations (dollars in thousands):
In November 1996, the Company invested $10,000,000 in a municipal security trading partnership. The primary focus of the partnership is municipal arbitrage. Municipal arbitrage is an investment strategy which attempts to capitalize on the certain anomilies which tend to occur in the municipal bond market. Such inefficiencies are arbitraged through a disciplined use of futures, options and municipal bond positions.
The arbitrage positions are generally hedged against market declines by purchasing put options, selling call options or entering into future contracts. Therefore, just as long portfolio positions may also incur losses during market declines, hedge positions may incur losses during market advances. As of December 31, 1996 the notional amount of option and future contracts outstanding are $30,242,000 and $41,100,000, respectively. As of December 31, 1996 the net short market value of option and future contracts outstanding are $948,000 and $184,000, respectively.
Investment income earned from trading account activity includes unrealized trading gains of $2,013,000, $352,000 and $1,271,000 for 1996, 1995 and 1994, respectively.
The National Association of Insurance Commissioners ("NAIC") has adopted risk based capital ("RBC") requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company's mix of products and its balance sheet. The implementation of RBC did not effect the operations of the Company's insurance subsidiaries since all of its subsidiaries have an RBC amount above the authorized control level RBC, as defined by the NAIC.
The following table presents the carrying amounts and estimated fair values of the Company's financial instruments as of December 31, 1996 and 1995 (dollars in thousands):