The Company and its subsidiaries own or lease office buildings or office space suitable to conduct their operations. Owned property is as follows:
The Company has executed an agreement for the acquisition of a building to be used as the Company's headquarters, which is expected to close by June 1, 1996.
(2) Total assets and reserves for losses and loss expenses reflect the adoption of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short Duration and Long-Duration Contracts," as of December 31, 1992.
The demand for insurance can be characterized as fairly stable and is influenced primarily by general economic conditions, while the supply of insurance is directly related to available capacity, i.e., the level of policyholders' surplus employed in the industry and the willingness of insurance management to risk that capital. In general, it is believed that the amount of available capacity changes as the perceived rate of return on capital employed fluctuates based on the adequacy of premium rates and available investment returns. The adequacy of premium rates is affected mainly by the severity and frequency of claims which are influenced by many factors including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage and the effects of economic inflation on the amount of compensation due for injuries or losses. In addition, investment rates of return may impact policy rates. These factors can have a significant impact on the ultimate adequacy of premium rates because a property casualty insurance policy is priced before its costs are known, as premiums usually are determined long before claims are reported. Over the past several years a trend of increasing price competition, combined with an increase in the number and size of catastrophic losses, has produced a significant reduction in underwriting profitability for the Company and the industry.
Net premiums written in 1995 grew by 20% to $860 million from $718 million written during 1994 due to increases recorded by all four segments of our operations. Premiums written by the regional segment grew by 24% in 1995 to $478 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.
Net investment income increased, on a pre-tax basis, to $137 million from $110 million earned in 1994. The higher level of investment earnings is due primarily to growth in investable assets generated by an increase in cash flow from operations and increased portfolio yields. The pretax yield of the portfolio increased as a result of a change in the mix of fixed maturity investments, an increase in the duration of the portfolio and an increase in trading account profits (see "Liquidity and Capital Resources").
Minority interest for 1995 was an expense of $4 million as compared to income of $3 million reported in 1994. The change in minority interest was due to earnings generated by Signet Star in 1995 versus a loss in 1994.
Net income for 1994 was $25 million, or $1.44 per share, compared with 1993 earnings of $52 million, or $2.87 per share. The 1994 results include after-tax realized investment losses of $86,000, or $.01 per share, compared with after-tax realized investment gains of $15 million, or $.82 per share, realized in 1993. In addition, the 1994 results were adversely impacted by a higher level of catastrophes losses including the Company's share of losses incurred by Signet Star due to the Northridge earthquake in California. Furthermore, in January 1994 the Company issued $150 million of 7.375% Series A Cumulative Redeemable Preferred Stock which resulted in preferred dividends of $10 million and had a negative impact on the comparative results.
Management fees and commissions increased by 20% to $65 million from $54 million recorded in 1993 due primarily to a full year's earnings of Signet Star's alternative markets division and the acquisition of Key Risk in April 1994. The pre-tax earnings of this segment decreased to $7 million from $8 million earned in 1993 due to the affects of the restructuring referred to above.
In October 1995, the Company issued 3,450,000 shares of common stock, and received net proceeds of approximately $145 million which was used to finance the acquisition of Midwest.
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. 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.
The investment portfolio, valued on a cost basis, grew in 1995 by $553.0 million to approximately $2,508 million primarily due to the combined effects of the acquisition of Midwest and net cash flow from operations.
During 1995, the Company invested approximately $66 million of its available cash inflow in equity securities and $127 million in corporate bonds (principally mortgage-backed securities). At December 31, 1995, the portion of the portfolio invested in tax-exempt securities was 32% (36% in 1994) and U.S. Government securities and cash equivalents comprised 30% (33% in 1994) of invested assets. Investments in corporate fixed maturity securities (including mortgage-backed securities) were 28% (24% in 1994) of the portfolio at December 31, 1995, and equity securities represented the balance.
Signet Star's retrocessional program provides coverage for property losses in three layers as follows: (i) 100% of $6.5 million in excess of $7 million per occurrence; (ii) 95% of $9 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 1995, Signet Star had retrocessional coverage for its casualty facultative business which provides coverage for 40% (20% in 1996) of $5 million per certificate on a pro-rata basis; this coverage applies to Signet Star's individual certificate business only. During 1995, Signet Star had retrocessional coverage for its fidelity and surety business for approximately 60% (80% in 1996) of each loss up to $2,250,000 in excess of $750,000 per occurrence.
Admiral's retention in 1995 was $170,000 ($175,000 in 1996) per risk for most classes of business and $2.1 million ($5.0 million in 1996), per insured, for business written by Monitor Liability Managers. In addition, in 1996 Admiral's Directors and Officer coverage will also include additional protection on an aggregate basis. Nautilus generally retained $97,500 per risk in 1995 ($140,000 in 1996) and Carolina maintained its retention at $300,000 on liability exposures.
In our opinion, the information set forth in the selected financial data for each of the years in the five-year period ended December 31, 1995, appearing on page 23, is fairly presented, in all material respects, in relation to the consolidated financial statements from which it has been derived.
Consolidated Balance Sheets December 31, 1995 and 1994 (Dollars in thousands, except share data)
Consolidated Statements of Stockholders' Equity Years ended December 31, 1995, 1994 and 1993 (Dollars in thousands, except per share data)
The Company has classified its investments into three categories. Securities that the Company has the positive intent and ability to hold to maturity are classified as "held to maturity" and reported at amortized cost. Securities which the Company purchased with the intent to sell in the near term are classified as "trading" and are reported at estimated fair value, with unrealized gains and losses reflected in the statement of operations. The remaining securities are classified as "available for sale" and carried at estimated fair value, with unrealized gains and losses, net of applicable income taxes, excluded from earnings and reported as a separate component of stockholders' equity.
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 this potential uncollectability.
In October 1995, the Financial Accounting Standards Board ("FASB") issued statements of financial accounting standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. This statement addressed the accounting for the cost of stock-based compensation, such as stock options. SFAS No. 123 permits either expensing the cost of stock-based compensation over the vesting period or disclosing in the financial statement footnotes what this expense would have been. This cost would be measured at the grant date based upon estimated fair values, using option pricing models. The Company expects to adopt the disclosure alternative of this statement in 1996.
The net assets acquired in 1995 were as follows (dollars in thousands):
On July 1, 1993, the Company exchanged all the stock of Signet Reinsurance Company ("Signet") for 60% of the stock of Signet Star, a newly formed holding company. Signet Star simultaneously acquired all the stock of North Star Reinsurance Company ("North Star Reinsurance") from General Re in exchange for 40% of the stock of Signet Star and senior and convertible notes. In connection with the formation of Signet Star, North Star Reinsurance entered into a Retrocessional Agreement (the "Retrocessional Agreement") with General Reinsurance Corporation ("GRC"), pursuant to which North Star Reinsurance reinsured its respective liabilities and assigned its respective rights and obligations arising from any insurance or reinsurance contracts written prior to January 1, 1993 with and to GRC.
In connection with the 1995 acquisition of the remaining 40% interest in Signet Star, North Star Reinsurance was sold to General Re and all business written subsequent to July 1, 1993 was novated to Signet Star. As a result, business written by North Star Reinsurance prior to January 1, 1993, which had been retroceded to General Re, is no longer reflected in the Company's financial statements. The only effect on the Company's financial statements resulting from this aspect of the transaction is that the Company's reserves for losses and loss expenses is reduced by $735,144,000 and "due from reinsurers" is reduced by the same amount. This aspect of the transaction does not effect the Company's cash flow, equity or statements of operations.
The Company's consolidated Proforma results of operations assuming the acquisitions of MECC, Inc. and the remaining 40% interest in Signet Star occurred as of January 1, 1995 and 1994, respectively, are as follows (dollars in thousands):
The Proforma consolidated financial data do not purport to represent what the Company's results of operations actually would have been had the acquisitions and related financings occurred on the dates indicated, or to project the Company's results of operations for any future period. The above amounts primarily reflect adjustments for the effects of the revaluation of assets and liabilities of the purchased companies and the financing of such acquisitions on the results of operations.
The Federal income tax expense (benefit) applicable to realized investment gains (losses) was $3,664,000, ($61,000) and $8,233,000 in 1995, 1994 and 1993, respectively. The Company had a current income tax receivable of $210,000 and $1,073,000 at December 31, 1995 and 1994, respectively.
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. At December 31, 1994, the Company recorded an additional valuation allowance of $4.2 million, which represented the tax benefit the Company would have had on its share of Signet Star's unrealized investment losses. This additional valuation allowance was established because Signet Star filed a separate consolidated return, and no capital loss carryback benefit was available. At December 31, 1995, Signet Star had an unrealized investment gain; therefore, the valuation allowance was not required. The change in the valuation allowance did not affect the Company's results of operations.
At present, neither the Company nor any of its subsidiaries are engaged in any litigation known to the Company which management believes will have a material adverse effect upon the Company's business. As is common with other insurance companies, the Company's subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. In the aggregate, the Company's commitments for future buildings, land and equipment is approximately $50 million as of December 31, 1995.
Per share data have been computed based on the weighted average number of common shares outstanding. The assumed dilutive effect of employee stock options was not material. Treasury shares have been excluded from average outstanding shares from the date of acquisition. The number of shares used in the computations was 17,414,000, 17,182,000, and 17,946,000 for 1995, 1994 and 1993, respectively.
Changes in shares of common stock outstanding, net of treasury shares, are as follows (in thousands):
The following table summarizes option information, including options granted under both the 1992 and prior Plans:
(a) Adjusted as necessary for amortization of premium or discount. (b) Includes United States government agencies and authorities. (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, 1995, 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):
Realized gains (losses) and the change in difference between fair value and cost of investments, before applicable income taxes, are as follows (dollars in thousands):
Due to the nature of Excess Workers Compensation ("EWC") business and the long period of time over which losses are paid in this line of business, the Company discounts the liability for losses and loss expenses established for the excess workers' compensation line of business. Discounting liabilities for losses and loss expenses gives recognition to the time value of money set aside to pay claims in the future and is intended to appropriately match losses and loss expense to income earned
on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from Midwest's loss payout experience and is supplemented with data compiled from insurance companies writing workers' compensation on an excess-of-loss basis. The expected payout pattern has a very long duration because it reflects the nature of losses which generally penetrate self-insured retention limits contained in excess workers' compensation policies. The Company has limited the payout duration to 30 years in order to introduce an additional level of conservatism into the discounting process. The liabilities for losses and loss expenses have been discounted using "risk-free" discount rates determined by reference to the U.S. Treasury yield curve weighted for the EWC premium volume to reflect the seasonality of the anticipated duration of losses associated with such coverages. The average discount rate for accident years 1995 and prior is 5.80%. The aggregate net discount, after reflecting the effects of ceded reinsurance, is $152,235,000 at December 31, 1995. For Statutory purposes, Midwest uses a discount rate of 3.0% as permitted by the Department of Insurance of the State of Ohio.
To date, known pollution and environmental claims at the insurance company subsidiaries have not had a material impact on the Company's operations. Environmental claims have not materially impacted the Company because our subsidiaries generally did not insure the larger industrial companies which are subject to significant environmental exposures.
The Company follows the customary industry practice of reinsuring a portion of its exposures principally to reduce net liability on individual risks and to protect against catastrophic losses. The following amounts arising under reinsurance ceded contracts have been deducted in arriving at the amounts reflected in the statement of operations (dollars in thousands):
Combined net income and policyholders' surplus of the Company's consolidated insurance subsidiaries, as determined in accordance with statutory accounting practices, are as follows (dollars in thousands):
W. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
The following table presents the carrying amounts and estimated fair values of the Company's financial instruments as of December 31, 1995 and 1994 (dollars in thousands):