The Company leases office space at 222 N. LaSalle Street, Chicago, Illinois, for its executive offices and insurance operations. The 39,000 square feet facility has a monthly rental of approximately $63,000. The current lease expires in May 2002.
The following discussion and analysis should be read in conjunction with the 1998 Consolidated Financial Statements and notes thereto.
American Country is the successor to an insurance company that was organized in 1978 under the name Calumet Insurance Company. In 1997, American Country entered into a transaction with The Western Systems Corp. ("Western Systems") in which a subsidiary of Western Systems acquired substantially all the assets and assumed substantially all the liabilities of American Country and its wholly owned subsidiary, Financial Services, for a purchase price of $40.3 million (the "Acquisition"), and contemporaneously Western Systems sold 24 million shares of its common stock to three investors, two of whom were shareholders of the parent company of American Country. Following the Acquisition, Western Systems changed its name to American Country Holdings Inc. to better reflect its property and casualty and premium finance business.
American Country's hospitality lines experienced the largest percentage growth in premium revenues over other lines, increasing nearly 52% to $5.1 million in 1998 as compared to $3.4 million in 1997. The hospitality program accomplished its significant growth outside of Illinois by expanding into the states of Minnesota and New Jersey.
Premium revenues generated from American Country's other commercial lines decreased slightly in 1998 to $19.7 million from $19.8 million for 1997, a 0.6% decrease. This decrease is attributable to American Country's re-underwriting program as well as the continuing pricing competition industry-wide for commercial lines. American Country also realized additional savings by renegotiating reinsurance costs for its commercial lines.
Other income, which consists of interest and fees earned on premium financing activities decreased from $331,000 in 1997 to $315,000 in 1998, a 4.8% decrease. The decrease is the result of the lower volume of premiums finance contracts entered into in 1998.
The ratio of losses and LAE for other commercial lines decreased to 82.1% in 1998 as compared to 99.0% in 1997. Much of this improvement is the result of the re-underwriting program initiated for these lines in 1997 and to a lower severity in claims during the year. Workers' compensation and multi-peril liability and property coverages were the lines most responsible for effecting this improvement.
Administrative and general expenses increased 16% in 1998 as a result of higher corporate expenses incurred in connection with acquisition and financing activities of the Company. Expenses of the operating companies decreased to $6.6 million as compared to $6.7 million in 1997. The decrease is attributable to cost saving initiatives begun during the fourth quarter of 1997, primarily staff reductions. Interest expense for 1998 increased by $330,000 to $491,000, due to increased borrowings and to a full period of interest expense.
Total premium revenues generated by this line increased nearly 10% over the prior years to $28.1 million in 1997 from $25.5 million in 1996. This increase is attributable to coverage written for Chicago suburban taxis and limousines and American Country's expansion into the states of Michigan and Wisconsin.
Other income, principally income generated by the premium financing activity of Financial Services, increased from $219,000 in 1996 to $331,000 for 1997, an increase of 51%.
The ratio of losses and LAE for other commercial lines increased from 76.7% during 1996 to 101.2% in 1997. The increase reflects the continuing industry-wide decline in net premiums written for this type of insurance primarily due to price competition. As with the personal lines, management is closely evaluating this line, with special emphasis being placed on re-underwriting individual risks and programs to improve returns.
The ratio of losses and LAE for personal lines during 1997 increased to 94.5% compared to 91.6% for 1996, due to a general increase in claims, and the occurrence of two catastrophic losses during the period. As a result of the poor results derived from this line of business, management decided to significantly reduce its business in this line, and effective January 1, 1998, entered into an agreement with Ohio Casualty pursuant to which nearly all of this line was reinsured by Ohio Casualty without further exposure to American Country.
Commission and acquisition costs were slightly higher for 1997, which is attributable to the fact that American Country's business written by independent producers increased in 1997. General and administrative expenses increased due in part to nonrecurring expenses of approximately $1 million associated with the Acquisition and related activities and with interest expense on the bank loan incurred in connection with the Acquisition.
At December 31, 1998 and 1997, the Company's fixed asset maturity securities included mortgage-backed bonds of $25.7 million and $15.5 million, respectively, which are subject to risks associated with variable prepayments of the underlying mortgage loans. Prepayments can cause those securities to have different actual maturities than that expected at the time of purchase. Securities that have an amortized cost greater than par that are backed by mortgages that prepay faster than expected will incur a reduction in yield or loss, while securities that have an amortized cost less than par that are backed by mortgages that prepay faster than expected will generate an increase in gain or yield. The degree to which a security is susceptible to either gains or losses is influenced by the difference between its amortized cost and par, the relative sensitivity of the underlying mortgages backing the assets to prepayments in a changing interest rate environment and the repayment priority of the securities in the overall securitization structure.
The Company does not own or utilize derivative financial instruments for the purpose of hedging, enhancing the overall return of its investment portfolio, or reducing the cost of its debt obligations. The Company employs traditional investment management tools and techniques to address the yield and valuation exposures of its invested assets. The long term fixed maturity investment portfolio is managed so as to limit various risks inherent in the bond market. Credit risk is addressed through adequate diversification and the purchase of investment grade securities. Reinvestment rate risk is controlled by concentrating on non-callable issues, and through asset-liability matching practices. Purchases of mortgage and asset backed securities, which have variable principal prepayment options, are generally avoided. Market value risk is limited through the purchase of bonds of intermediate maturity. The combination of these investment management tenets generally provides a more stable long term fixed maturity investment portfolio that is not subject to extreme interest rate sensitivity and principal deterioration. The market value of the Company's long term fixed maturity investment portfolio is sensitive, however, to fluctuations in the level of interest rates, but not materially affected by changes in anticipated cash flows caused by any prepayments. The impact of interest rates movements on the long term fixed maturity investment portfolio generally affects net realized gains or losses when securities are sold. With a market value of approximately $125.1 million, the long term fixed maturity investment portfolio has an average maturity of 5.82 years and an indicated duration of 4.12. This implies that a 100 basis point parallel increase in interest rates from current levels would result in a possible decline in the market value of the long term fixed maturity investment portfolio of approximately 7.4%, or $9.3 million. These possible declines in values for bond and stock portfolios would affect negatively the common stockholders' equity at any point in time, but would not necessarily result in the recognition of realized investment losses as long as operating cash flow and the ongoing emergence of bond maturities continued to provide sufficient funds to meet obligations to policyholders and claimants, as well as debt service and cash dividend requirements at the holding company level.
Cash flow generated from operations for the year ended December 31, 1998 and 1997 was $390,000 and $4.0 million respectively, which amounts were adequate to meet all obligations during the periods. The decrease in cash flow for the year ended December 31, 1998 compared to the year ended December 31, 1997 is primarily related to the decrease in personal lines premiums and to a decrease in loss reserves.
The line of credit agreement contains various debt covenants including conditions for prepayment and certain financial covenants. The Company is in compliance with all covenants of the agreement as of December 31, 1998. The most restrictive covenant being the ratio of debt to equity. In addition, there is a commitment fee of .25 per annum charged for the unused portion of the total credit facility.
The NAIC recently completed its process of recodifying statutory accounting practices ("codification"), the result of which is the only source of "prescribed" statutory accounting practices after adoption by the state of domicile. It is expected that codification will be adopted by the State of Illinois and be implemented in 2001, which will likely change, to some extent, prescribed, statutory accounting practices, and may result in changes in the Company's insurance subsidiary's statutory surplus.
The Company cautions readers regarding certain forward-looking statements contained in the foregoing and elsewhere and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical facts. In particular, statements using verbs such as "expect," "intend," "plan," "anticipate," "believe" or similar words generally involve forward-looking statements. Forward-looking statements also include but may not be limited to, statements relating to future plans, targets and objectives, financial results, cyclical industry conditions, government and regulatory policies, the uncertainties of the reserving process and the competitive environment in which the Company operates.
The following is a summary of unaudited quarterly results of operations for 1998 and 1997 (in thousands, except per share data):