Underwriting ratios (statutory basis): Loss and loss adjustment expense ratio 78.0% 69.2% 69.8% 69.4% 70.8% Expense ratio 30.0 31.0 32.0 32.4 32.3 Combined ratio 108.0% 100.2% 101.8% 101.8% 103.1%
(1) The 1996, 1995 and 1994 investments reflect the Company's adoption of SFAS No. 115 (See Note 2 of the Notes to the Consolidated Financial Statements).
The high level of catastrophe and other weather-related losses in 1996 is principally to blame for breaking the Company's several year trend of improved operating results. Extensive property damage claims arising primarily from hailstorms, tornadoes and high winds resulted in the worst year for catastrophic claims in our Company's history. Gross catastrophe losses were approximately six times those of an average year. In spite of the significant increase in the magnitude of such claims, our claims service quality remained high.
The Company's general operating and amortization expenses of $50.2 million for the year ended December 31, 1996 were 11.6 percent higher than the $45.0 million reported for the same 1995 period. Relative to earned premium volume, the Company's expense ratio for 1996 improved to 30.0 percent from 31.3 percent for the prior year. Factors leading to the reduced expense ratio include certain economies of scale and decreases in employee incentive compensation, agent profit-sharing and assessments from certain boards and bureaus. As a result of the Citizens Security Group acquisition, the Company incurred approximately $252,000 of additional expense in 1996 for goodwill amortization and incurred interest expense of approximately $308,000 on the related bank loan.
For the most recent year, the Company recorded income tax expense of $150,000. The low effective tax rate results primarily from the amount of tax-exempt investment income in relation to pre-tax income.
Net investment income for 1995 increased 4.1 percent to $14.6 million from $14.0 million in 1994 resulting primarily from a larger invested asset base. A reduction in the Company's pre-tax net investment yield to 6.1 percent in 1995 from 6.4 percent in 1994 primarily was a result of a greater proportion of common stocks and tax-exempt bonds in the investment portfolio and increased investment expenses. During 1995 the Company realized gains on the disposition of invested assets of $1.5 million compared to $0.3 million of realized gains for the prior year. Such gains were realized primarily on the sale of common stocks and have an insignificant effect on future investment yields.
The Company's effective tax rate in 1995 increased to 26.1 percent compared to the prior year's 20.9 percent. This increase was attributed to an overall growth in taxable income causing the Company to be subject to less relative impact of tax-exempt income and the dividends received deduction.
On July 31, 1996, the Company completed the acquisition of Citizens Security Group Inc. of Red Wing, Minnesota. The Company purchased all of the outstanding shares of Citizens Security Group and its wholly- owned property and casualty insurance subsidiaries, Citizens Fund Insurance Company and Insurance Company of Ohio, for approximately $30.3 million in cash, including capitalized acquisition costs, and became affiliated with Citizens Security Mutual Insurance Company. Approximately 60 percent of the purchase price was generated from the sale of a portion of the Company's investment portfolio. The remaining $12 million was financed through bank debt and is being amortized over seven years with a variable interest rate of LIBOR plus 50 basis points. The acquisition was accounted for as a purchase with the assets acquired and liabilities assumed being recorded at their estimated fair value at the date of acquisition. The excess cost over the fair value of the net assets of approximately $15.1 million was recorded as goodwill, which is being amortized on a straight-line basis over a 25 year period.
The Company considers inflation when estimating liabilities for losses and loss adjustment expenses, particularly for claims having a long period between occurrence and settlement. The liabilities for losses and loss adjustment expenses are management's estimates of the ultimate net cost of underlying claims and expenses and are not discounted for the time value of money. In times of inflation, the normally higher investment yields may partially offset potentially higher claims and expenses.
Financial Statements: Consolidated Statement of Income 26 Consolidated Balance Sheet 27 Consolidated Statement of Shareholders' Equity 28 Consolidated Statement of Cash Flows 29 Notes to Consolidated Financial Statements 30
As discussed in Note 2, the Company changed its method of accounting for certain investments in debt and equity securities in 1994.
MERIDIAN INSURANCE GROUP, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME for the Years Ended December 31, 1996, 1995 and 1994
Losses and loss adjustment expenses 130,101,192 99,123,849 93,970,529 General operating expenses 13,766,868 14,155,631 14,527,021 Interest expense 307,887 --- --- Amortization expenses 36,442,635 30,820,058 29,304,576 Total expenses 180,618,582 144,099,538 137,802,126
Income before taxes 5,950,093 15,722,039 11,536,063 Income taxes (benefit) Current 702,141 3,554,000 2,574,000 Deferred (552,000) 551,000 (159,000) Total income taxes 150,141 4,105,000 2,415,000
Per share data: Net income $ 0.86 $ 1.72 $ 1.35
December 31, 1996 1995 ASSETS Investments: Fixed maturities--available for sale, at market value (cost $234,356,000 and $213,816,000) $238,343,040 $220,036,772 Equity securities, at market (cost $33,779,000 and $26,961,000) 40,629,633 31,119,875 Short-term investments, at cost, which approximates market 1,326,634 2,483,338 Other invested assets 1,390,176 1,053,905 Total investments 281,689,483 254,693,890 Cash 3,128,154 935,098 Premium receivable, net of allowance for bad debts 4,674,984 2,642,425 Accrued investment income 3,241,125 2,942,194 Deferred policy acquisition costs 16,690,275 13,354,600 Goodwill 16,848,829 2,152,339 Reinsurance receivables 45,850,830 32,469,285 Prepaid reinsurance premiums 5,020,605 2,617,138 Due from Meridian Mutual Insurance Company 8,973,672 9,358,803 Other assets 11,679,744 1,422,444 Total assets $397,797,701 $322,588,216
LIABILITIES AND SHAREHOLDERS' EQUITY Losses and loss adjustment expenses $161,309,239 $123,577,240 Unearned premiums 84,065,751 64,558,695 Other post-employment benefits 1,417,814 1,298,378 Bank loan payable 11,875,000 --- Reinsurance payables 8,664,358 6,863,626 Other liabilities 8,291,558 8,047,610 Total liabilities 275,623,720 204,345,549
Unrealized Appreciation Common Contributed (Depreciation) Retained Shares Capital of Investments Earnings
December 31, 1996 1995 1994 Cash flows from operating activities: Net income $ 5,799,952 $ 11,617,039 $ 9,121,063 Reconciliation of net income to net cash provided by operating activities: Realized investment gains (3,793,778) (1,538,281) (285,701) Amortization 36,442,635 31,257,989 30,202,060 Deferred policy acquisition costs (39,321,446) (32,068,780) (29,181,486) Increase in unearned premiums 2,034,199 4,895,409 982,535 Increase (decrease) in loss and loss adjustment expense 11,054,147 (177,410) 3,990,725 Decrease (increase) in amount due from Meridian Mutual 385,131 (2,548,320) (1,337,003) Decrease (increase) in reinsurance receivables (7,352,448) 234,172 (2,303,137) Decrease (increase) in prepaid reinsurance premiums (349,547) 2,654 205,510 Decrease (increase) in other assets 2,064,651 66,763 (638,901) Increase in other post-employment benefits 119,436 197,223 102,060 Increase (decrease) in reinsurance payables 1,800,732 972,951 (248,655) Increase (decrease) in other liabilities (1,866,664) 116,619 831,814 Other, net (61,732) 755,919 (247,430) Net cash provided by operating activities 6,955,268 13,783,947 11,193,454
Cash flows from investing activities: Purchase of fixed maturities (47,518,736) (39,897,557) (37,157,445) Proceeds from sale of fixed maturities 38,131,207 17,111,272 18,528,560 Proceeds from calls, prepayments and maturity of fixed maturities 24,843,739 14,404,070 16,403,055 Purchase of equity securities (19,794,358) (15,735,622) (16,369,601) Proceeds from sale of equity securities 18,633,656 9,556,180 10,267,616 Net (increase) decrease in short-term investments 3,300,088 1,641,491 (2,075,005) Decrease (increase) in other invested assets (336,271) 31,366 (347,414) Acquisition of subsidiary (30,262,442) --- --- Increase (decrease) in securities payable (1,533,830) 1,117,355 430,569 Net cash used in investing activities (14,536,947) (11,771,445) (10,319,665)
Cash flows from financing activities: Repurchase and retirement of common stock (22,080) (77,033) --- Exercise of stock options 23,241 222,996 39,819 Proceeds from bank loan 12,000,000 --- --- Repayment of bank loan (125,000) --- --- Dividends paid (2,101,426) (1,826,933) (1,617,696) Net cash provided by (used in) financing activities 9,774,735 (1,680,970) (1,577,877) Increase (decrease) in cash 2,193,056 331,532 (704,088) Cash at beginning of year 935,098 603,566 1,307,654 Cash at end of year $ 3,128,154 $ 935,098 $ 603,566
Premiums are recognized as revenue on a monthly pro rata basis over the coverage terms of the respective policies. Any premiums applicable to the future terms of the policies are included in liabilities as unearned premiums.
1996 1995 1994 Interest on fixed maturities: Tax-exempt securities $ 3,875,822 $ 3,578,156 $ 3,050,947 Taxable securities 8,686,144 8,727,315 8,251,261 Dividends on redeemable preferred stock 2,489,104 2,402,974 2,673,605 Dividends on equity securities 773,238 560,390 339,559 Interest on short-term investments 243,837 247,272 162,067 Other investment income 93,861 84,873 146,698 Total investment income 16,162,006 15,600,980 14,624,137 Investment expenses 1,253,721 1,037,160 628,153 Net investment income $ 14,908,285 $ 14,563,820 $ 13,995,984
Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Under this statement the Company classified all investment securities into three categories: held-to-maturity securities carried at amortized cost; available-for-sale securities carried at fair value, with the unrealized gains and losses recorded, net of deferred tax, to shareholders' equity; and trading securities carried at fair value, with the unrealized gains and losses reflected in the consolidated statement of income. Initially, the Company classified approximately 98 percent of its fixed maturities as "available for sale" and 2 percent as "held to maturity", with no fixed maturities being assigned to the "trading" category. The cumulative effect of adopting SFAS No. 115 resulted in a $4,417,201 increase, net of deferred taxes, to the Company's shareholders' equity. On November 30, 1995, the Company, as permitted in Q61 of the Financial Accounting Standards Board ("FASB") Special Report on SFAS No. 115, transferred all holdings classified as "held to maturity" to the "available for sale" category. This transaction did not have a material effect on the Company's financial statements.
The amortized cost and estimated market values of investments in fixed maturity securities at December 31, 1996 and 1995, are as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value December 31, 1996 Available for sale: Government and agency domestic bonds $ 11,441,004 $ 317,830 $ 50,708 $ 11,708,126 Municipal bonds 73,550,278 1,954,019 302,450 75,201,847 Corporate bonds 61,810,087 1,141,551 152,224 62,799,414 Mortgage-backed securities 54,090,640 714,993 155,481 54,650,152 Sinking fund preferred stocks 33,464,362 1,080,656 561,517 33,983,501 Total fixed maturity securities $234,356,371 $5,209,049 $1,222,380 $238,343,040
December 31, 1995 Available for sale: Government and agency domestic bonds $ 8,127,012 $ 600,241 $ 3,790 $ 8,723,463 Municipal bonds 72,356,941 2,649,867 371,703 74,635,105 Corporate bonds 40,484,745 1,633,386 5,580 42,112,551 Mortgage-backed securities 57,037,770 1,425,970 158,915 58,304,825 Sinking fund preferred stocks 35,809,142 803,950 352,264 36,260,828 Total fixed maturity securities $213,815,610 $7,113,414 $ 892,252 $220,036,772
Unrealized appreciation resulting from changes in the valuation of equity securities at December 31, 1996 totaled approximately $6,851,000 representing $7,614,000 of gains on certain securities and $763,000 of losses on other securities.
On July 31, 1996, the Company acquired Citizens Security Group Inc. and its property and casualty insurance subsidiaries, Citizens Fund Insurance Company and Insurance Company of Ohio, for a cash purchase price of approximately $30,262,000, including capitalized acquisition costs. Approximately 60 percent of the purchase price was generated from the sale of a portion of the Company's investment portfolio and the remainder was financed through bank debt. (See Note 4). The acquisition was accounted for as a purchase with the assets acquired and liabilities assumed being recorded at their estimated fair value at the date of acquisition. The excess cost over the fair value of the net assets resulted in goodwill of approximately $15,140,000, which is being amortized over 25 years on the straight-line basis.
1996 1995 Premiums earned $185,808,000 $174,501,000 Total revenues $206,201,000 $192,416,000 Net income $ 4,138,000 $ 11,310,000 Net income per share $ 0.61 $ 1.67
The Citizens Security Group acquisition was funded in part through a $12,000,000 bank loan. The debt has a variable interest rate of LIBOR plus 50 basis points and will mature on August 1, 2003. The Company is required to make principal payments in accordance with the following schedule:
Meridian Security, Citizens Fund, ICO, Meridian Mutual and Citizens Security Mutual are parties to a reinsurance pooling agreement ("pooling agreement") under which all premiums, losses and loss adjustment expenses as well as other underwriting expenses are shared by the companies on the basis of their percentage participation defined in the pooling agreement. Other expenses are allocated on the basis of specific identification or estimated costs. Amounts either due to or due from Meridian Mutual and Citizens Security Mutual result from these transactions, and are normally reimbursed on a monthly basis. Management believes that such expenses would not be materially different if incurred directly by each company.
Beginning August 1, 1996, the reinsurance pool participation percentages of the Company's insurance subsidiaries total 74 percent. Prior to August 1, Meridian Security and Meridian Mutual were the only participants in the aforementioned pooling arrangement, of which Meridian Security assumed 74 percent of the combined underwriting income and expenses of the two companies.
The Company's non-insurance subsidiaries are provided office space and various services by Meridian Mutual and Meridian Security. Expenses are allocated to such subsidiaries on the basis of specifically identified or estimated costs.
Balance at beginning of period $123,577,240 $123,754,650 $119,763,925 Less reinsurance recoverables 31,204,462 31,815,440 30,133,606 Net balance at beginning of period 92,372,778 91,939,210 89,630,319
Incurred related to: Current year 137,817,367 104,584,909 99,444,243 Prior years (7,716,175) (5,461,060) (5,473,714) Total incurred 130,101,192 99,123,849 93,970,529 Paid related to: Current year 93,199,000 61,791,602 55,216,000 Prior years 30,470,408 36,898,679 36,445,638 Total paid 123,669,408 98,690,281 91,661,638
The reinsurance agreements maintained by Citizens Security Mutual, Citizens Fund and ICO in 1996 were of two general types, consisting of excess of loss reinsurance and pro rata reinsurance. Effective January 1, 1996, the companies entered into a pro rata reinsurance contract covering 40 percent of each homeowner policy. Under other reinsurance contracts, the companies retained the first $300,000 of loss on any one risk on property coverage. The companies have pro rata reinsurance contracts for property risks covering losses between $300,000 and $4,600,000 per risk. For property risks in excess of $4,600,000, the companies negotiate reinsurance arrangements for each risk on an individual basis. The casualty reinsurance written by the companies is reinsured for losses in excess of $250,000 up to a maximum of $5,000,000 per occurrence. Effective January 1, 1996, the companies entered into an aggregate excess of loss contract which reinsures losses and allocated loss adjustment expenses in excess of 62 percent in any accident year. The reinsurer's obligation is limited to 5 percent of accident year subject net earned premium. Losses and allocated adjustment expenses in excess of 67 percent are retained.
Approximately 89 percent of the Company's ceded reserves for losses and loss adjustment expenses are with Michigan Catastrophic Claims Association, Employers Reinsurance Corporation and Swiss Reinsurance America Corporation. Reinsurance recoveries recognized for the years ended December 31, 1996, 1995 and 1994 were $24,136,000, $1,547,000 and $2,758,000, respectively. The effect of reinsurance on premiums written and earned for the years ended December 31, 1996, 1995 and 1994 are as follows:
Premiums earned: Direct $176,718,644 $149,748,331 $141,275,894 Assumed 6,425,316 5,222,170 5,744,277 Ceded (15,839,546) (11,104,680) (12,018,290) Net $167,304,414 $143,865,821 $135,001,881
On December 29, 1995, Meridian Mutual entered into an indemnity reinsurance agreement with Celina Mutual Insurance Company regarding commercial line business in the state of Pennsylvania. This transaction was recorded as assumed written premium, which was earned over the succeeding twelve months. Renewals of these policies will be recorded as direct business of Meridian Mutual. Through the pooling agreement, Meridian Security assumed premiums written of approximately $2,100,000 and ceding commissions of approximately $409,000.
Current tax expense for the following periods differed from the tax expected solely on pre-tax income by applying the applicable statutory corporate tax rate to the various differences identified as follows:
Tax at statutory rate $ 2,023,000 $ 5,403,000 $ 3,813,000 Tax-exempt interest (1,134,000) (1,005,000) (897,000) Dividends received deduction (619,000) (598,000) (593,000) Loss, LAE and Salvage and subrogation fresh start (17,000) (7,000) (20,000) Nondeductible expenses 168,000 109,000 74,000 Other (270,859) 203,000 38,000 Total income taxes $ 150,141 $ 4,105,000 $ 2,415,000
The Revenue Reconciliation Act of 1990 required insurance companies to accrue future recoveries of salvage and subrogation on a discounted basis. A fresh start of 87 percent of the beginning 1990 discounted balance was provided for by that act. The impact of this provision has been calculated at $923,000, of which no amortization was recognized in 1996. Approximately $7,000 was recognized in 1995, and $20,000 in 1994. Prior to 1994, $876,000 was recognized.
Under SFAS No. 109, "Accounting For Income Taxes", the Company recorded a net deferred tax asset in 1996 and 1995, which is included among other assets. The net deferred tax asset at December 31, 1996, 1995 and 1994, is comprised of the following:
The Company has paid income taxes during the last three preceding years that exceed the recorded deferred income tax asset generated by operations ($1,678,000 in 1996, $3,248,000 in 1995 and $2,950,000 in 1994).
The Company has an Incentive Stock Plan ("Plan") for the purpose of attracting and retaining key employees. The maximum number of common shares authorized for issuance under the Plan is 750,000 shares. Awards under the Plan may include non-qualified and incentive stock options, stock appreciation rights, and restricted stock. Options to purchase common shares granted under the Plan are to have an exercise price of not less than the fair market value of the Company's common shares on the date of grant. Options are to be exercisable beginning one year from the date of grant and are to expire over various periods not to exceed ten years from the date of grant. Restricted stock awards may be granted subject to terms and conditions as prescribed by the committee which administers the Plan.
12. Unaudited Selected Quarterly Financial Data: (Amounts in thousands except per-share data)