The information in the following discussion is presented on the basis of generally accepted accounting principles ("GAAP") and should be read in conjunction with the Company's consolidated financial statements and notes thereto included elsewhere in this Report. All amounts and percentages are approximations.
American Safety is a specialty insurance holding company which, through its subsidiaries, develops, underwrites, manages and markets primary casualty insurance and reinsurance programs in the alternative insurance market for (i) environmental remediation risks; (ii) employee leasing and staffing industry risks; and (iii) other specialty risks.
The Company's specialty insurance programs include coverages for general liability, pollution liability, professional liability, workers' compensation and surety, as well as custom designed risk management programs (including captive and rent-a-captive programs), for contractors, consultants and other businesses and property owners who are involved with environmental remediation, employee leasing and staffing, and other specialty risks. Through its U.S. brokerage and management services subsidiaries, the Company also provides specialized insurance program development, underwriting, risk placement, reinsurance, program management, brokerage, loss control, claims administration and marketing services.
The Company's development and structuring of programs are focused primarily on the generation of revenues and earnings, whether attributable to underwriting profits, fees, commissions, or a combination of these items. For example, a profitable program may be structured to result in break-even underwriting results in the Company's insurance subsidiaries, while at the same time creating revenues and earnings in the Company's program management or insurance brokerage subsidiaries.
This Report contains certain forward-looking statements within the meaning of United States' securities laws which are intended to be covered by the safe harbors created thereby. Investors are cautioned that all forward-looking statements necessarily involve risks and uncertainties that are subject to change based on various factors, including, without limitation, the competitive conditions in the insurance industry, the unpredictable developments in loss trends, the adequacy and changes in loss reserves, the market acceptance of new coverages and enhancements, and the changes in levels of general business activity and economic conditions. All statements, other than statements of historical facts, included or incorporated by reference in this Report that address activities, events or developments that the Company expects or anticipates will or may occur in the future constitute forward-looking statements. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could over time prove to be inaccurate and therefore, there can be no assurance that the forward-looking statements included in this Report will themselves prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved.
Interest from Notes Receivable. Interest from notes receivable increased 201.9% from $798,000 in 1997 to $2,409,000 in 1998 as a result of an increase of $10.9 million in outstanding secured notes receivable. These notes bear interest rates ranging from 9% to 25% and are payable on various dates.
Acquisition Expenses. Policy acquisition expenses decreased 56.8% from $2.3 million in 1997 to $1 million in 1998 as a result of increased premiums written by the Company's U.S. insurance subsidiary and produced by the Company's U.S. brokerage subsidiary where acquisition expenses and brokerage income are eliminated due to consolidation.
Year Ended December 31, 1997 compared to Year Ended December 31, 1996.
Net Premiums Earned. Net premiums earned increased 95.4% from $4.3 million in 1996 to $8.3 million in 1997. The principal factor accounting for the increase was the Company's assumption in 1997 of workers' compensation reinsurance business from an unaffiliated insurance carrier, which increased net premiums earned from workers' compensation reinsurance by 96.3% from $2.6 million in the 1996 to $5.1 million in 1997. The magnitude of this increase was also affected by workers' compensation premium refunds of $782,000 in 1996 on business that had been recorded in the prior year. In workers' compensation insurance, annual premium payments are generally determined on the basis of the insured company's payroll. At the start of a policy year, the level of payroll is unknown and must be estimated. The insured then pays workers' compensation premiums based on this estimate of future payroll. At policy expiration, an audit is performed to determine the insured's actual payroll for the policy period. Then, the actual payroll is compared to the original estimate, and either an additional workers' compensation premium is billed or a return premium is refunded. The workers' compensation premium refunds of $782,000, which reduced the Company's 1996 revenues, were a result of changes in the Company's estimate of the ultimate premium, based upon audits of the insured's 1994 and 1995 payroll estimates.
General liability reinsurance premiums remained substantially the same from $1.5 million in 1996 to $1.5 million in 1997. In the Company's primary insurance business, net premiums earned from the Company's U.S. insurance subsidiary's surety program increased from $130,000 in 1996 to $1.7 million in 1997, primarily due to the initiation of a bail bond program in 1997 which produced $1.4 million in net premiums earned in such year. The Company has discontinued its participation in the prior bail bond program due to inadequate premium production.
Interest from Notes Receivable. Interest from notes receivable decreased 9.8% from $885,000 in 1996 to $798,000 in 1997. This decrease resulted primarily from a decrease in the outstanding notes receivable.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses increased 99.1% from $2.1 million in 1996 to $4.1 million in 1997 due to the 95.4% increase in net premiums earned and a corresponding increase in reserves primarily due to the increase in the workers' compensation line of business.
Acquisition Expenses. Policy acquisition expenses increased from $646,000 in 1996 to $2.3 million in 1997. This increase resulted from the initiation of the bail bond program which was structured to have an expense ratio of approximately 96%.
Other Expenses. Other expenses increased 12.4% from $3.1 million in 1996 to $3.5 million in 1997 due to salary and employee benefit increases resulting from additional staffing for new and existing programs.
Income Taxes. Federal and state income taxes increased from $177,000 in 1996 to $356,000 in 1997 due to increased taxable income in the Company's U.S. insurance subsidiary.
The Company historically has met its cash requirements and financed its growth principally through cash flows generated from operations. The Company's primary sources of cash flow are proceeds from the sale or maturity of invested assets, premiums earned, investment income, commission income and management fees. The Company's short-term cash requirements are primarily for claims payments, reinsurance premiums, commissions, salaries, employee benefits and other operating expenses, and the purchase of investment securities, which have historically been satisfied from operating cash flows. Due to the uncertainty regarding settlement of unpaid claims, the long-term liquidity requirements of the Company may vary, and the Company has attempted to structure its investment portfolio to take into account the historical payout patterns. Management believes that the Company's current cash flows are sufficient for its short-term needs and the Company's invested assets are sufficient for its long-term needs. The Company also purchases reinsurance to mitigate the effect of large claims and to help stabilize demands on its liquidity.
American Safety is an insurance holding company whose principal assets are its investment portfolio and its investment in the capital stock of its subsidiaries. As an insurance holding company, American Safety's ability to pay dividends to its shareholders will depend, to a significant degree, on the ability of the Company's subsidiaries to pay dividends to American Safety. The jurisdictions in which American Safety and its insurance and reinsurance subsidiaries are domiciled place limitations on the amount of dividends or other distributions payable by insurance companies in order to protect the solvency of insurers.
Property and casualty insurance premiums are established before the amounts of losses and loss adjustment expenses are known and therefore before the extent by which inflation may affect such expenses is known. Consequently, the Company attempts, in establishing its premiums, to anticipate the potential impact of inflation. However, for competitive and regulatory reasons, the Company may be limited in raising its premiums consistent with anticipated inflation, in which event the Company, rather than its insureds, would absorb inflation costs. Inflation also affects the rate of investment return on the Company's investment portfolio with a corresponding effect on the Company's investment income.