The Company leases its principal offices, located at 395 Oyster Point Boulevard, South San Francisco, California 94080, pursuant to a lease agreement entered into in November 1992. The lease is for approximately 45,600 rentable square feet at lease payments ranging from approximately $49,400 per month in the first year to $66,500 per month in the seventh year. The Company leases approximately 22,000 square feet in Concord, California at approximately $25,500 per month. The Company relocated its loan tracking operations (excluding its computer operations) from Bellevue, Washington, to South San Francisco, California, during 1994. In order to accommodate the Company's computer-related operations remaining in Bellevue, Washington, the Company entered into a new 3-year lease commencing approximately May 1, 1995, for approximately 5,060 square feet at a rental of approximately $7,600 per month. In connection with the final move of the Bellevue, Washington, operations to South San Francisco, California, the Company anticipates an early termination of such lease. The Company also entered into a new lease for approximately 11,860 square feet of office facilities in Springfield, Ohio, at lease payments of approximately $9,920 per month for the period August 1, 1995, through April 30, 1999, which lease may be terminated by the Company on July 31, 1998, upon three months prior notice and payment of a $3,000 termination fee. Some of the leases require the Company to pay certain operating expenses in addition to the lease payment.
The following table sets forth certain historical selected consolidated financial data of the Company which has been derived from the audited consolidated statements of the Company for and as of the end of each of the years ended December 31, 1992, 1993, 1994, 1995 and 1996.
The Company's primary sources of revenues are premiums and commissions earned from its specialized insurance products, fees billed to customers who use Flood Zone Determination or Tracking Services and investment income. Net premiums written represent direct and assumed premiums generated by the Insurance Subsidiary, less premiums canceled or ceded to other insurers, and adjusted for changes in the reserve for return premiums. Net premiums earned represent net premiums written adjusted for changes in unearned premium reserves. Flood inquiry fees are generated by Flood Zone Determination Services and are based on the number of flood inquiries rendered. The Company provides either one-time flood determinations
or higher fee, life-of-loan services where the Company updates the flood determinations over the periods in which the loans are outstanding or over the term of the agreement with the particular customer. Revenues from flood zone determinations are generally related to the volume of mortgage loan originations, both new and refinanced. Tracking fees are generated by Tracking Services and are usually based on the number of loans and leases tracked. Net commission income represents commissions received from nonaffiliated insurance companies for force-place insurance produced by the Agency and from the Federal Emergency Management Agency ("FEMA") for flood insurance written by the Insurance Subsidiary.
The Company's insurance products include force-place insurance policies which have stated terms of either up to ninety (90) days ("short-term policies") or six (6) months to one (1) year ("longer-term policies"), most of which are longer-term policies. Premiums for longer-term policies are recorded as revenues when earned. The Company's policies are canceled at a relatively high rate because they generally remain in effect only until financial institutions receive proof that borrowers have obtained their own insurance. At the time the policies are issued, a reserve is established to provide for return of premiums for anticipated cancellations, which has the effect of decreasing net premiums written. Since 1993, the reserve has been established at approximately 64% to 68% of premiums. Premiums are written directly by the Insurance Subsidiary or by third party insurance companies in certain states where the Insurance Subsidiary is not licensed or where its products are not approved. The following table summarizes premiums written net of cancellations during the periods indicated (in thousands):
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128. SFAS No. 128 is designed to improve the earnings per share (EPS) information provided in the financial statements by simplifying the existing computational guidelines, revising the disclosure requirements, and increasing the comparability of EPS data on an international basis. SFAS No. 128 is effective for financial statements issued for periods ending after December 31, 1997, including interim periods. The Company will implement SFAS No. 128 in 1997. Management has not determined the impact that SFAS No. 128 may have on the financial statements.
The following table sets forth certain items as a percentage of total revenues for the periods indicated.
Net premiums earned decreased from $17.0 million in 1995 to $13.6 million in 1996, a decrease of $3.4 million or 20.0%. The decrease was partially due to the increase in reserve for return premiums and also partially due to a decline in written premiums.
Tracking fees increased from $4.8 million in 1995 to $5.5 million in 1996, an increase of $700,000 or 14.6%. The increase was primarily due to new business from two new customers.
Loss and LAE was $6.0 million in 1995 (35.5% of net premiums earned) and $4.0 million in 1996 (29.5% of net premiums earned), a decrease of $2.0 million or 33.3%. The decline in losses and LAE was a direct result of fewer losses and loss adjustment expenses incurred during 1996. The loss ratio for the fourth quarter of 1996 was very favorable and contributed approximately one-half of the decrease when compared to 1995. The average loss per new claim reported decreased from $6,316 in 1995 to $5,513 in 1996. The number of new claims decreased from 957 reported in 1995 to 726 reported in 1996.
Commissions paid to nonaffiliates decreased from $4.1 million (24.1% of premiums earned) in 1995 to $2.0 million (14.4% of premiums earned) in 1996, a decrease of $2.1 million, or 51.2%, due primarily to the fact that a larger percentage of the insurance business has transferred to customers with lower commission rates.
All other expenses increased from $12.2 million in 1995 to $14.2 million in 1996, an increase of $2 million or 16.4%. In June 1996, the Company accrued $1.4 million of expense as a result of retention agreements entered into with certain executives. The purpose of the agreements was to ensure the availability and employment of those executives through the transition following the change of control of the Company which occurred in July 1996.
Total revenue increased from $34.8 million in 1994 to $35.9 million in 1995, an increase of $1.1 million or 3.2%. Net premiums written decreased from $20.0 million in 1994 to $15.0 million in 1995, a decrease of $5.0 million or 25.0%. The decrease in net premiums was principally due to two factors: (1) approximately $4.3 million less business in 1995 from one customer which ceased writing premiums with the Company in early 1995, and; (2) 1994 premiums written included $1.4 million from a significant customer whose loan
Commissions paid to nonaffiliates decreased from $4.7 million (22.7% of premiums earned) in 1994 to $4.1 million (24.1% of premiums earned) in 1995, a decrease of $600,000, or 12.8%, due primarily to lower commission rates and the loss of premiums from customers who did not renew with the Company.
All other expenses increased from $9.1 million in 1994 to $12.3 million in 1995, an increase of $3.2 million or 35.2%. The Company incurred charges of $1.6 million in connection with the employment termination of Mark Speizer who was the Company's Chief Executive Officer and Howard L. Herman who was the Company's President. The Company also recorded $600,000 for the write-off of software used to provide its information services products.
As a result of the above factors, loss before provision for income taxes increased from $1.6 million in 1994 to $7.4 million in 1995, an increase of $5.8 million.
interest or investment income. The principal assets of National are the stock of its Subsidiaries. National is, and for the foreseeable future will continue to be, dependent on the dividends from its Subsidiaries to meet its liquidity requirements, including debt service obligations. Dividends payable to National by the Insurance Subsidiary are subject to certain regulatory restrictions which are described below.
The Insurance Subsidiary collects and invests premiums written in advance of the payments for associated claims. In the absence of a catastrophic loss, this timing difference between premium collection and claims payment, combined with investment income, normally provides short-term funds in excess of normal operating demands for cash. As of December 31, 1996, the Company had cash and short-term investments aggregating $13.2 million.
A second repurchase of 100,000 shares was made on October 22, 1996. The shares were acquired through a private transaction at a price of $6.95 per share. The total purchase price of that stock was approximately $700,000.
Industry and regulatory guidelines suggest that a property and casualty insurers' annual statutory net written premium should not exceed approximately three times its policyholders' surplus. The Company's surplus ratio is significantly lower than such guidelines. For the year ended December 31, 1996, the Company's net written premium to policyholder surplus ratio was .50 to 1. See "Business -- Insurance Operations -- Insurance Operating Ratios".
The Company is not aware of any trends, requirements, commitments, or events that will or are reasonably likely to have a negative impact on the Company's liquidity during 1997. This paragraph contains forward-looking statements reflecting the Company's current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Investors should review the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - -- Factors Affecting Future Operating Results" for a discussion of factors that could affect future performance.
The Company derives a substantial portion of its total revenues from fees for Flood Zone Determination Services. These services are primarily provided to assist lenders in complying with federal laws which in many instances require lenders to determine whether property being financed is located in a federally-designated Special Flood Hazard Area ("SFHA") and require borrowers to obtain flood insurance. Any significant change in federal legislation or secondary market requirements limiting these requirements on lenders or borrowers, or the development by competitors of significantly enhanced service or delivery systems or an increase in interest rates or a reduction in real estate loan fundings could have a material adverse effect on the Company's business or operating results.
The Company derives a significant amount of its revenues from insurance premiums and investment income. In the event that, for whatever reason, the Insurance Subsidiary experiences abnormally high losses, purchases reinsurance from reinsurers who will not or cannot pay losses submitted, or other adverse developments occur, then any such event or combination of events could have a material adverse impact on the Company. In addition, insurance companies and others have often been sued under certain legal theories, such as bad faith handling or settlement of claims, which could subject the Insurance Subsidiary to liability in excess of policy limits. An adverse outcome of any such lawsuit could have a material negative impact on the Company.
in the Insurance Subsidiary's estimate of ultimate losses on reported claims may materially adversely affect the results of the Insurance Subsidiary's operations in the period reported. The Insurance Subsidiary has in the past experienced adverse developments in its loss reserves. The Insurance Subsidiary's loss and loss adjustment expense reserves are reviewed on an annual basis by unaffiliated actuaries. The Insurance Subsidiary's most recent actuarial review of such reserves as of December 31, 1996 concluded that the reserves (i) met the requirements of the insurance laws of California; (ii) were computed in accordance with accepted loss reserving standards and principles and (iii) make a reasonable provision for all unpaid loss and loss expense obligations of the Insurance Subsidiary under the terms of its policies and agreements.
The Insurance Subsidiary's business is partially dependent upon its ability to cede to reinsurers risks insured by the Insurance Subsidiary. The amount, availability and cost of reinsurance are subject to prevailing market conditions, beyond the control of the Insurance Subsidiary, which can affect the Insurance Subsidiary's level of business and profitability. The Insurance Subsidiary is ultimately liable for the reinsured risk if for any reason the reinsurers do not cover or will not pay the Insurance Subsidiary for the losses of the insureds. As a result of the anticipated increased cost and more limited availability of reinsurance, in the future, the Insurance Subsidiary may elect to retain a higher portion of the risk historically ceded to reinsurers. If the Insurance Subsidiary were to retain a higher proportion of insured risks, it would increase its exposure to significant losses relating to properties insured by the Insurance Subsidiary. This increased exposure could have a material adverse effect on the Company's results of operation. See "Regulation - Reinsurance".
Pinnacle and/or the Company also indemnifies its customers for certain losses resulting from erroneous flood inquiry determinations, where a borrower was not properly advised whether the collateral was located in or out of an SFHA. While to date Pinnacle has experienced no significant losses in this regard and maintains reserves equal to its estimate of incurred but unreported indemnification losses, there can be no assurance such reserves will prove adequate in the future. The Company does not maintain errors and omissions insurance coverage against losses.
services. No assurance can be given that the introduction of new technologies will enable the Company to gain market share, realize cost savings or increase revenues.