The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD & A") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results could differ materially from those projected in these forward-looking statements as a result of certain risks and uncertainties, including those factors set forth in this MD & A section and elsewhere in this Form 10-K including, but not limited to "Item 1. Business."
Fremont General Corporation is an insurance and financial services holding company operating select businesses nationally in niche markets. The reported assets of Fremont General Corporation and its subsidiaries ("Fremont" or "the Company") as of December 31, 1998 were $7.4 billion, with 1998 pre-tax earnings of $196.7 million. Fremont's business strategy includes achieving income balance and geographic diversity among its business units in order to limit its exposure to industry, market and regional concentrations. The Company's business strategy also includes growing its business through new business development and acquisitions. The Company's stock is traded on the New York Stock Exchange under the symbol "FMT."
The Company's businesses are managed within two reportable segments: property and casualty insurance and financial services. These segments offer two basic financial products; policies of insurance (property and casualty insurance), and loans (financial services). They are managed separately and use different pricing, distribution, and operating methods. Fremont evaluates the performance of its reportable segments based on income before taxes using accounting policies which are the same as those described in the summary of significant accounting policies. (See Note A of Notes to Consolidated Financial Statements.) Additionally, there are certain corporate revenues and expenses, comprised primarily of investment income, interest expense and certain general and administrative expenses, that Fremont does not allocate to its segments.
The real estate lending operations of Fremont currently consists of more than 4,000 residential real estate accounts and 500 commercial real estate accounts. The real estate lending activities are primarily conducted through a California thrift and loan ("the thrift") and are financed mainly through deposit accounts (53,000 accounts at December 31, 1998), which are insured by the Federal Deposit Insurance Corporation ("FDIC"). (See "Item 1. Business -- Regulation -- Thrift and Loan Regulation.") The thrift's deposits are serviced through 14 branch offices in California. (Fremont's insurance premium finance loans and certain of its syndicated loans are also financed by the thrift.) Fremont originates real estate loans nationwide through independent loan brokers and through its own marketing representatives. For commercial real estate loans, principal amounts primarily range between $1 million to $15 million and for residential real estate loans, principal amounts are generally below $350,000. The residential real estate loans are originated using underwriting standards that are less stringent than the Federal National Mortgage Association's guidelines and are commonly known as "sub-prime" loans. To mitigate the higher potential for credit losses that accompanies these types of borrowers, Fremont focuses on its loan origination on the higher grades of loans in this category and attempts to maintain underwriting standards that require conservative loan to collateral valuations. The Company's operating strategy is to grow its loan portfolio through origination of new loans and acquisition of loan portfolios that meet its underwriting guidelines applied to origination of new loans. The loan portfolio of the real estate lending operation grew from $807.5 million at the end of 1994 to $2.1 billion at the end of 1998, due primarily to increased loan originations and, to a lesser extent, the purchase of loan portfolios from other financial institutions. (See "Item 1. Business -- Financial Services Operation -- Commercial and Residential Real Estate Lending.")
Fremont provides commercial finance loans, primarily secured by accounts receivable, inventory, and machinery and equipment, to small and middle market companies on a nationwide basis. The total commercial finance loan portfolio was $485.5 million at December 31, 1998. Loan originations are developed primarily by referrals from various financial intermediaries and financial institutions. (See "Item 1. Business -- Financial Services Operation -- Commercial Finance.") The lending market continues to be competitive for small to middle market commercial borrowers. As a result, Fremont's commercial finance loans have experienced decreasing yields.
By engaging in several selected businesses nationwide which are geographically diverse, Fremont believes it has achieved stability and provided opportunities for growth in its operating results. Since the year ended
Between 1986 and 1991, Fremont discontinued its domestic treaty reinsurance business, its other primary and excess property and casualty insurance operations and the underwriting of all remaining assumed reinsurance. In 1990, a single management group was put in charge of all discontinued operations, and it is the intention of the Company to complete the liquidation of these operations by the commutation of liabilities and as claims are paid. (See "Item 1. Business -- Discontinued Operations" and Note N of Notes to Consolidated Financial Statements.)
The Company generated revenues of $1.04 billion for 1998, as compared to revenues of $974 million and $796 million for 1997 and 1996, respectively. Higher revenues in 1998 as compared to 1997 resulted from higher financial services revenues, offset partially by lower revenues in the property and casualty segment. The lower property and casualty revenues were due primarily to the net effects of higher workers' compensation insurance premiums and investment income resulting from the acquisitions of Unicare on September 1, 1998 and Industrial on August 1, 1997, more than offset by additional ceded reinsurance premiums which have the result of lowering premium revenues. These additional ceded reinsurance premiums were due mainly to additional excess of loss reinsurance purchased for Fremont's workers' compensation insurance business which became effective January 1, 1998. The acquisition of Industrial resulted in higher revenues in the property and casualty insurance segment in 1997 as compared to 1996. (See "Property and Casualty Insurance Opera-
tion.") Higher revenues in the financial services segment in 1998 and 1997 as compared to the respective prior year were achieved primarily from increased loan interest revenues which resulted from significant growth in the average financial services loan portfolio. Additionally, higher financial services revenues in 1998 resulted from gains on sales of residential real estate loans. (See "Financial Services Operation.") Realized investment losses were $0.6 million, $2.0 million, and $1.7 million for 1998, 1997 and 1996, respectively.
Fremont posted net income of $133.0 million or $1.90 diluted earnings per share for 1998, as compared to $108.3 million or $1.62 diluted earnings per share and $87.3 million or $1.37 diluted earnings per share for 1997 and 1996, respectively. Income before taxes for 1998 was $196.7 million as compared to $158.9 million and $128.3 million for 1997 and 1996, respectively, representing an increase of 24% in 1998 and 1997.
Up until January 1, 1998 the Company maintained a small medical malpractice insurance operation within the property and casualty insurance segment. On January 1, 1998, the Company entered into reinsurance and assumption agreements with a reinsurer whereby substantially all of the assets and liabilities related to the medical malpractice policies were ceded to the reinsurer. These reinsurance agreements are part of several other agreements which collectively result in the sale of the Company's medical malpractice operations effective January 1, 1998. The effect on the Company's results of operations from these agreements was not material. Revenues from medical malpractice operations were $32.6 million and $31.6 million for 1997 and 1996, respectively.
Unallocated corporate revenues consisted primarily of investment income, while unallocated corporate expenses consisted primarily of interest expense and general and administrative expense. The unallocated corporate loss before income taxes was $28.0 million, $28.1 million and $25.9 million for 1998, 1997 and 1996, respectively. The unallocated corporate loss before tax was flat in 1998 as compared to 1997 due primarily to the net effects of lower interest expense, offset by higher general and administrative expenses. The increase in unallocated corporate loss in 1997 as compared to 1996 was due primarily to lower investment income and higher general and administrative expense.
Income tax expense of $63.7 million, $50.6 million and $41.0 million for 1998, 1997 and 1996, respectively, represents an effective tax rate of 32% each year on pretax income of $196.7 million, $158.9 million and $128.3 million for the corresponding periods. The Company's effective tax rates for all years presented are lower than the enacted federal income tax rate of 35%, due primarily to tax exempt investment income which reduces the Company's taxable income.
Premiums. Premiums earned from the Company's property and casualty insurance operation were $552.1 million for 1998, as compared to $601.2 million and $486.9 million for 1997 and 1996, respectively. The lower insurance premiums in 1998 were due mainly to the offsetting effects of higher workers' compensation insurance premiums resulting from the acquisitions of Unicare and Industrial, more than offset by additional ceded reinsurance premiums. These additional ceded reinsurance premiums were due primarily to additional excess of loss reinsurance purchased for the Company's workers' compensation insurance business, which became effective January 1, 1998. Fremont purchased the additional reinsurance in an effort to further reduce the volatility of operating results which occurs through fluctuations in loss costs. This additional reinsurance reduced the point at which reinsurers assume liability ("attachment point") from $1 million per loss occurrence to $50,000 per loss occurrence. The higher premiums in 1997 were due primarily to the acquisition of Industrial. With this acquisition, Fremont further broadened the geographic diversity of its premium writings to include a significant presence in certain western states that the Company previously had little or no premium writings in prior to the Industrial acquisition. (See "Item 1. Business -- Property and Casualty Insurance Operation" and "Variability of Operating Results" and "Workers' Compensation Regulation.")
Net Investment Income. Net investment income within the property and casualty insurance operation was $178.3 million, $138.9 million and $111.6 million in 1998, 1997 and 1996, respectively. Significantly higher invested assets, due primarily to the acquisitions of Unicare and Industrial, resulted in increased investment income in 1998 as compared to 1997. The acquisition of Industrial also was the main contributor to higher net investment income in 1997 as compared to 1996. (See "Item 1. Business -- Investment Portfolio.")
The Company regularly reviews its reserving techniques, overall reserve position and reinsurance. In light of present facts and current legal interpretations, management believes that adequate provisions have been made for loss reserves. In making this determination, management has considered its claims experience to date, loss development history for prior accident years and estimates of future trends of claims frequency and severity. However, establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. Subsequent actual experience has resulted, and could result, in loss reserves being too high or too low. Future loss development could require reserves for prior periods to be increased, which would adversely impact earnings in future periods.
Policy Acquisition Costs and Other Operating Costs and Expenses. The ratio of policy acquisition costs and other operating costs and expenses to premiums earned is referred to as the expense ratio, which was 34.5%, 27.5% and 25.9% in 1998, 1997 and 1996, respectively. The increase in this ratio in 1998 as compared to 1997 is due mainly to a lower premium base in 1998 resulting from the additional reinsurance purchased by Fremont that became effective January 1, 1998. (See "Premiums.") The increase in this ratio in 1997 is due primarily to higher agents' commission costs and higher operating costs and expenses.
Variability of Operating Results. The Company's profitability can be affected significantly by many factors including competition, the severity and frequency of claims, interest rates, legislation and regulations, court decisions, the judicial climate, and general economic conditions and trends, all of which are outside of Fremont's control. In addition, Fremont's results of operations may be affected by the Company's ability to assess and integrate successfully the operations of acquired companies. These factors have contributed, and in the future could contribute, to significant variation of results of operations in different aspects of the Company's business from quarter to quarter and year to year. With respect to the workers' compensation insurance business, changes in economic conditions can lead to reduced premium levels due to lower payrolls as well as increased claims due to the tendency of workers who are laid off to submit workers' compensation claims. Legislative and regulatory changes can also contribute to variable operating results for workers' compensation insurance businesses. For example, in 1995, the Company experienced the negative impact of lower premiums and lower profitability on Fremont's California workers' compensation business due to increased price competition resulting from legislation enacted in California in July 1993 which, among other things, repealed the minimum rate law effective January 1, 1995. Additionally, price competition in Illinois, where the Company has a significant presence, continues to adversely impact the Company's profitability, where overall average decreases of 0.2%, 7.9%, and 10.0% in advisory premium rates, which workers' compensation insurance companies in Illinois tend to follow, became effective January 1, 1999, 1998 and 1997, respectively. (See "Workers' Compensation Regulation.") The acquisition of Industrial has mitigated the adverse effects of this price competition in Illinois by providing Fremont with a broader geographic diversity of its premium writings. Industrial has a significant presence in the western United States, in addition to California. The Company anticipates that its results of operations and financial condition will continue to be adversely affected by the continued price competition in Illinois and California. Also, the establishment of appropriate reserves necessarily involves estimates, and reserve adjustments have caused significant fluctuations in operating results from year to year.
The financial services operation of FGCC is principally engaged in commercial and residential real estate lending, commercial finance, syndicated loans and insurance premium financing. Revenues consist principally of interest income and, to a lesser extent, fees and other income.
The following table identifies the interest income, interest expense, average interest-bearing assets and liabilities, and interest margins for Fremont's financial services operation:
During 1997, the Company began originating both commercial and residential real estate loans outside of California. The Company intends to seek portfolio growth outside of California in order to achieve greater geographic diversity in its loan portfolio and thereby lessen Fremont's exposure to regional economic conditions. The total amount of commercial and residential real estate loans outstanding on properties located outside of California at December 31, 1998 was $328 million and $179 million, respectively.
During periods when economic conditions are unfavorable, Fremont's financial services businesses may not be able to originate new loan products or maintain credit quality at previously attained levels. This may negatively affect the Company's net finance income and levels of non-performing assets and net charge-offs. Changes in market interest rates, or in the relationships between various interest rates, could cause the Company's interest margins to vary and may result in significant changes in the prepayment patterns of Fremont's finance receivables, which could adversely affect the Company's results of operations and financial condition.
Fremont's financial services businesses compete in markets that are highly competitive and are characterized by factors that vary based upon product and geographic region. The markets in which the Company competes are typically characterized by a large number of competitors who compete based primarily upon price, terms and loan structure. Fremont primarily competes with banks, mortgage, insurance, and finance companies, many of which are larger and have greater financial resources than Fremont. The competitive forces of these markets could adversely affect the Company's net finance income, loan origination volume or net credit losses.
The following table describes the asset classifications, loss experience and reserve reconciliation of the financial services operation as of or for the periods ended as shown below:
The lower provision for loan losses over the three years ended December 31, 1998 is due primarily to improved loan loss experience. Additionally, a lower loan loss provision occurred in 1997 as the Company was adversely impacted in 1996 by a specific loan loss provision associated with one commercial finance loan.
Substantially all of the charge-offs on commercial finance loans in 1996 were related to this loan. The Company's overall improved loan loss experience is evidenced by the decreases in the ratio of net charge-offs to average total loans receivable over the three years ended December 31, 1998, as well as the decrease of the ratio of non-performing assets to total loans receivable from 1997 to 1998 in the preceding table. Additionally, the reductions in the charge-off ratio occurred during a period in which loans receivable increased.
The following table provides information about the assets and liabilities of the Company's financial services operation that are sensitive to changes in interest rates. For loans, investments, thrift deposits and other liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturity, adjusted for estimated loan prepayments based upon historical behaviors of its financial services loan portfolio. Thrift deposits that have no contractual maturity are presented as maturing in 1999.
Fremont General Corporation is also subject to interest rate exposure related to LIBOR and United States prime interest rates because of its long-term debt and other obligations with both fixed and variable interest rates. For fixed rate obligations, Fremont General Corporation runs the risk that if market rates decline, the related required payments will exceed those based on the current market rates. For obligations with variable interest rates, fluctuations in the market rates will directly affect interest expense.
The following table provides information about interest rate sensitive assets and liabilities of Fremont General Corporation. For short-term investments with variable interest rates, the table presents principal cash flows by expected maturity dates. The weighted-average interest rates are based on implied forward rates as derived from appropriate annual spot rate observations as of the reporting date.
Fremont's commercial finance loans are funded primarily through its asset securitization program, an unsecured revolving line of credit with a syndicated bank group and its capital. The asset securitization program was established in 1993 to provide a stable and cost effective source of funds to facilitate the expansion of this business. As of December 31, 1998, an aggregate of $235 million in senior series of certificates and an aggregate of $39 million in subordinated series of certificates were outstanding. The interest rate on the certificates, set monthly, ranged from LIBOR plus 0.23% to LIBOR plus 0.95% at December 31, 1998. The securities issued in this program have a scheduled maturity of two to four years, but could mature earlier depending on fluctuations in the outstanding balances of loans in the portfolio and other factors. As of December 31, 1998, up to $265 million in additional publicly offered term asset-backed certificates may be issued pursuant to a shelf registration statement to fund future growth in the commercial finance loan portfolio. In February 1996, $135 million of the senior series certificates ("Series C") were issued. The proceeds were used, in conjunction with existing cash, to retire $200 million in Series A certificates, which were outstanding as of December 31, 1995. In April 1997, $109 million in certificates ("Series D") were issued, comprised of $100 million in senior certificates and $9 million in subordinated certificates. The Series D certificates were issued to retire $100 million in maturing Series B certificates. In December 1995, a commercial paper facility was established as part of the asset securitization program. This facility, which expires in December 2000, provides for the issuance of up to $150 million in commercial paper, dependent upon the level of assets within the asset securitization program. As of December 31, 1998, $25 million in commercial paper was outstanding under this facility. Commercial finance loans are also financed under an unsecured revolving line of credit with a syndicated bank group that presently permits borrowings of up to $438 million, which includes a revolving credit facility of $350 million and a term loan of $88 million. The revolving credit facility converts to a term loan in August 2000, with ultimate maturity in June 2002. The term loan matures July 2001. This facility is also used to finance certain syndicated loans. The balance outstanding at December 31, 1998 of the revolving credit facility and the term loan was $264 million and $88 million, respectively, with a weighted average interest rate of 5.74%. This credit line is primarily used to finance assets which are not included in the Company's asset securitization program. (See "Item 1. Business -- Financial Services Operation -- Commercial Finance.")
As a holding company, Fremont General Corporation ("the holding company") pays its operating expenses, meets its other obligations and pays stockholders' dividends from its cash on hand, management fees paid by its subsidiaries and dividends paid by its subsidiaries. Stockholders' dividends declared aggregated $20.9 million, $18.9 million and $15.8 million during 1998, 1997 and 1996, respectively. Several of Fremont's subsidiaries are subject to certain statutory and regulatory restrictions and various agreements, principally loan agreements, that restrict their ability to distribute dividends to the holding company. The holding company expects that during the next few years dividends from its subsidiaries will consist of dividends from its property and casualty insurance subsidiaries and dividends on preferred stock of its financial services subsidiaries. The
On August 1, 1997, the Company completed the acquisition of Industrial which resulted in the ultimate disbursement of funds totaling $434 million, comprised of $355 million in purchase price, as adjusted pursuant to certain audit and settlement provisions in the purchase agreement, $79 million in the pay-off of an outstanding debt obligation that Industrial owed to Talegen, and $9.5 million in costs incurred in connection with the acquisition. The disbursement of cash used to fund the acquisition included $219 million in borrowings under the Company's existing line of credit and the remainder from internally generated funds. (See "General.")
During 1998, an aggregate $21.0 million principal amount at maturity of Liquid Yield Option(TM) Notes due October 12, 2013 (Zero Coupon-Subordinated) ("LYONs") were converted into 809,000 shares of Fremont General Corporation's Common Stock. The effect of these conversions was an increase in stockholders' equity and a decrease in long-term debt of $10 million. During 1997, an aggregate $266.7 million principal amount at maturity of LYONs were converted into 10.3 million shares of Fremont General Corporation's Common Stock. The effect of the conversions was an increase in stockholders' equity and a decrease in long-term debt of $117 million. During 1996, an aggregate $72.5 million principal amount at maturity of LYONs were converted into 2.8 million shares of Fremont General Corporation's Common Stock. The effect of the 1996 conversions was an increase in stockholders' equity and a decrease in long-term debt of $31 million.
On March 1, 1996, Fremont General Financing I, a statutory business trust (the "Trust") and consolidated wholly-owned subsidiary of the holding company, sold $100 million of 9% Trust Originated Preferred Securities(SM) ("the Preferred Securities") in a public offering. The Preferred Securities represent preferred undivided beneficial interests in the assets of the Trust. The proceeds from the sale of the Preferred Securities were invested in 9% Junior Subordinated Debentures of the holding company ("the Junior Subordinated Debentures"). The proceeds from the sale of the Junior Subordinated Debentures were used to repay approximately $50 million in revolving bank line of credit indebtedness, with the remainder used for general corporate purposes. The $100 million Junior Subordinated Debentures are the sole asset of the Trust. The Preferred Securities will be redeemed upon maturity of the Junior Subordinated Debentures in 2026, subject to the election available to Fremont General Corporation to extend the maturity up to 2045, and they may be redeemed, in whole or in part, at any time on or after March 31, 2001 and under certain specified circumstances. The Junior Subordinated Debentures are subordinate and junior to all senior indebtedness of the holding company. Payment of distributions out of cash held by the Trust, and payments on liquidation of the Trust or the redemption of the Preferred Securities are guaranteed by Fremont General Corporation.
Net cash used in operating activities of continuing operations was $199.7 million, $18.0 million and $96.0 million for 1998, 1997 and 1996, respectively. Net cash used in continuing operations increased in 1998 as compared to 1997, due primarily to a higher reduction in claims and policy liabilities and an increase in premiums receivable and agents' balances, offset partially by an increase in net income and an increase in the provision for deferred income taxes. The higher reduction in claims and policy liabilities is due mainly to an increase in 1998 in reinsurance recoverables on unpaid losses resulting from the additional excess of loss reinsurance purchased by Fremont and which became effective January 1, 1998. (See "Results of Operations -- Property and Casualty Insurance Operation -- Premiums.") Additionally, the higher provision for
Net cash provided by (used in) investing activities was $(721.4) million, $(393.2) million and $229.8 million for 1998, 1997 and 1996, respectively. The decrease in net cash provided by (used in) investing activities is due primarily to increases in loan originations and bulk purchases funded, net of repayments and a smaller decrease in short-term investments. This was partially offset by increases in investment sales, maturities and calls, net of purchases and a decrease in the purchase of subsidiaries. The increase in loan originations and bulk purchases funded is consistent with the general growth in Fremont's financial services loan portfolio. The decrease in the purchase of subsidiaries occurs as the 1998 acquisition of Unicare at $110 million in purchase price was smaller than the 1997 acquisition of Industrial. The decrease in net cash provided by (used in) investing activities in 1997 as compared to 1996 was due mainly to the August 1, 1997 acquisition of Industrial; an increase in investment purchases, net of sales, maturities and short-term investment activity; and an increase in loan originations, net of repayments. The increase in loan originations is consistent with the general growth in the Company's financial services' loan portfolio. The decrease in short-term investments was due primarily to the investing of the acquired short-term investment portfolio of Industrial into long-term investments.
Problems may arise from computer software programs and operating systems that use only two digits to designate the calendar year in a date code field. For example, where the date December 21, 2000, is encoded as "12/21/00" instead of "12/21/2000." Based on this two-digit format for date coding, computers with date-sensitive programs could recognize the year 2000 as "00" and incorrectly assume that the year is 1900. Similar problems can arise for systems dependent upon embedded chips that are encoded to only use or recognize two digits when referring to a calendar year. Additionally, problems may arise from the computer's inability to process (including calculating, comparing, sequencing, displaying, or storing), transmit, or receive date data from, into, and between the 20th and 21st centuries, and during the years 1999 and 2000, and leap year calculations. Fremont refers to these problems as the "Year 2000 Problem." The Company considers the Year 2000 Problem a critical business continuity issue and has categorized the Year 2000 Problem into the following four areas:
Key business partners, vendors, other suppliers -- Will Fremont's key business partners, major vendors, and other suppliers face significant disruption to the goods and services provided to the Company due to Year 2000 Problems?
Customers -- Will Fremont's revenues be significantly adversely affected by customers' inability to remediate successfully their own Year 2000 Problems?
Regarding the Company's leased facilities, we have inquired from facility owners the extent of any Year 2000 Problems (if any) as they relate to the elevator, air conditioning/heating, and other utility systems in these facilities. Fremont has evaluated representations rendered by these facility owners for most of the Company's leased facilities. Based on the representations received through January 31, 1999, Fremont anticipates no significant disruption from these various facility-related systems due to the Year 2000 Problem. Further, with respect to Fremont's owned facilities, an evaluation of the extent of any Year 2000 Problems relating to these facilities' utility and elevator systems has been made and no significant disruptions (if any) to the Company's operations from these systems are anticipated.
anticipates this process to be completed by June 30, 1999. Many surveys have already been received and evaluated in the areas of employee benefits and reinsurance. Based on the evaluations received to date, most of these business partners have stated that they anticipate their Year 2000 compliance and testing to be completed in early 1999.
Within the financial services segment, substantially all operations utilize application Systems that are vendor supported. For commercial and residential real estate lending, all current application Systems are substantially Year 2000 compliant. Additionally, these application Systems have been tested internally to validate their Year 2000 compliance, with no significant errors identified or left unresolved. Similarly, the
application Systems for commercial finance lending and syndicated loans, while substantially compliant in their present form, will be fully compliant after upgrading to the current version of the software, which is already available and installed at several of the vendor's clients. Fremont intends to install the software upgrades and test these Systems to verify the vendors' representations. The Company expects to complete these procedures by June 30, 1999.
With regard to the property and casualty insurance operation, the Company developed an action plan in 1996 to render its workers' compensation Systems Year 2000 compliant. Based on an evaluation of the progress made as of January 31, 1999, Fremont believes that its Systems that support its California operations are Year 2000 compliant (including testing), and the Company estimates that the Systems that support its non-California operations, excluding those Systems supporting recently acquired Industrial, will be Year 2000 compliant and tested by March 31, 1999. Industrial's Systems are expected to be converted to Year 2000 compliant Systems by September 30, 1999. The property and casualty insurance operation will be moving onto new Systems that will, after full implementation, be the workers' compensation operation's new nationwide claims and policy handling platform. The costs to be incurred by Fremont in completing these Year 2000 initiatives are not expected to have a material impact on the Company's results of operations (1998 costs of approximately $4.5 million).
In addition to its various application Systems, Fremont maintains several PC-based client/server network infrastructures. The majority of these installations were established within the past five years. Substantially all of these networks use the most current versions of network operating and data transmission software, all of which are believed to be Year 2000 compliant. The Company is in the process of testing vendors' representations as to Year 2000 compliance of installed network software. These processes are anticipated to be completed by March 31, 1999 with no significant Year 2000 Problems expected. Additionally, the Company has inventoried all of its PC hardware. Substantially all of the PC hardware is believed to be Year 2000 compliant and the Company anticipates that any non-compliant PC hardware will be rendered Year 2000 compliant by June 30, 1999.
Management of the Company continues to monitor the progress of its Year 2000 compliance initiatives and will continue to allocate resources necessary to resolve significant Year 2000 Problems as they are identified. Based on the progress of the work performed through January 31, 1999, Fremont anticipates that its office facilities and equipment; key business partners, vendors and other suppliers; major customers; and internal computer systems will be substantially Year 2000 compliant before December 31, 1999. For all mission critical Systems, Fremont is developing appropriate contingency plans in the event an unanticipated Year 2000 Problem occurs. These plans are expected to be completed by September 30, 1999.
Due to the dependence of Fremont's insurance services and financial services businesses on computer technology to operate its businesses, and the dependence of the insurance and financial services industries on computer technology, the nature and impact of Year 2000 processing failures on the Company's businesses could be material. Fremont believes its mission critical Systems will be substantially Year 2000 compliant by September 30, 1999. The Company cannot assure you that its Year 2000 compliance efforts will be completed in a timely manner or that the Company's Year 2000 compliance efforts will be successful even if these compliance efforts are completed in a timely manner. It is difficult to predict with certainty what will happen in connection with the Year 2000 Problem after December 31, 1999. Despite Fremont's best efforts to mitigate and remediate its Year 2000 Problem, if key business partners, vendors and other suppliers, facility owners, or customers have over-estimated their own Year 2000 readiness, or been less than truthful or forthcoming in their Year 2000 readiness disclosure, Fremont will be forced to implement certain of its contingency plans, and may be jeopardized with respect to its own Year 2000 compliance status. In this scenario, it is possible that Fremont may experience unfavorable business factors and expenditures in excess of
Worst-case scenarios (events the Company does not anticipate will occur) might involve the inability of several of the Company's workers' compensation insurance operation's major insureds, and/or agents, to resolve their respective Year 2000 Problem. If this were to occur, effects could include the loss of business that might be material to Fremont. Furthermore, negative economic conditions precipitated by the Year 2000 Problem could adversely impact the financial services operation's ability to originate loans or maintain credit quality at previously attained levels and could negatively affect Fremont's net finance income, levels of non-performing assets and net charge-offs. Fremont's operations are highly dependent on the ability of its banking business partners to process its financial transactions. If the Company's key banking business partners, as well as the banking industry in general, fail to resolve their respective Year 2000 Problems, if any, serious consequences to Fremont could result including the disruption to its normal pattern of cash flows, or increased risk for possible legal actions for breach of contract or other harm. These consequences could adversely affect the Company's results of operations and financial condition. While the Company does not anticipate any of these scenarios to occur, in making its own Year 2000 Readiness Disclosure statements, Fremont has relied upon the honesty and forthrightness of its key business partners, vendors and other suppliers, facility owners and customers in making their respective Year 2000 readiness representations to the Company.
Readers are cautioned that forward-looking statements contained in this Year 2000 Readiness Disclosure section should be read in conjunction with the Company's cautionary statements at the beginning of this section. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.")
The information set forth under the subheadings "Market Risk," "Property and Casualty Insurance Operations -- Interest Rate Risk," "Financial Services Operations -- Interest Rate Risk," and "Fremont General Corporation (Parent-only) -- Interest Rate Risk" in the Company's Management's Discussion and Analysis is incorporated herein by reference.
The Company's Consolidated Financial Statements, including supplementary data, are set forth in the "Index" on page 54 hereof.